RMontgomery

I find that the easiest way to get your head around hedging is to draw yourself a little diagram. It is soooo easy to get mixed up with long and short calls or puts on rates or on bonds that a diagramm is the safest and easiest option.

If you are long a swap, you receive fixed and pay floating. You are therefore exposed to the risk of rates going up, which would mean that you are paying more than you are getting. If you were to enter into an offsetting swap, then you would effectively terminate your swap - you are left with no exposure at all. You could, however, hedge your risk by buying an interst rate call or a cap - both of which pay off when rates rise. Alternatively, you could also buy a put on a bond, which will fall in value when rates go up (as you buy the put, you profit).

Again, I can only encourage diagramms....by tests are littered with them and I end up making a lot less mistakes :-)