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FRM Part I · FRM Exam Part I · Commodity Forwards and Futures

A cattle rancher short hedges using futures expiring after the planned sale date. Which statement about basis risk is correct?

A short hedger benefits when the basis strengthens, meaning spot rises relative to futures. The effective price received equals the initial futures price plus the final basis, so a higher basis raises proceeds. Basis risk persists even with the same commodity and affects both long and short hedgers.

  1. AIf the basis strengthens unexpectedly (spot rises relative to futures), the short hedger benefitsCorrect
  2. BIf the basis strengthens unexpectedly, the short hedger is harmed
  3. CBasis risk is eliminated whenever futures are used for the same commodity
  4. DBasis risk affects only long hedgers

Explanation

Short hedger's effective price = initial futures price + final basis (spot - futures). A stronger basis raises the price received, so the short hedger benefits. Basis risk still exists even for the same commodity because of timing, location or grade differences, and it affects both hedgers.

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