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FRM Part I · FRM Exam Part I · Futures Markets

A company hedges a commodity purchase with futures but will close the hedge before the futures contract expires. Which statement best describes the basis risk it faces?

Basis risk is the uncertainty about the difference between the spot and futures prices when the hedge is closed. Because that future basis is unknown, the effective hedged price is not fixed, even though the initial futures price is known.

  1. AThe uncertainty about the spot minus futures difference at the time the hedge is closedCorrect
  2. BThe risk that the futures exchange defaults on the contract
  3. CThe risk that the spot price is not equal to the futures price at inception
  4. DThe risk that margin calls are never made

Explanation

Basis is spot minus futures. When a hedge is lifted before expiry, the basis then is uncertain, so the effective hedged price is uncertain. Basis risk is not clearing-house default, and a nonzero basis at inception is known, not a risk.

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