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FRM Part I · FRM Exam Part I · Using Futures for Hedging

A company must hedge a 10-year commodity purchase programme using a stack of one-month futures that it rolls every month. Which risk is most specifically introduced by this rolling strategy, in addition to ordinary basis risk?

Rolling a short-dated futures hedge exposes the firm to changes in the spread between successive contract months, known as roll risk. Margin outflows can arise even if spot prices are steady, creating liquidity strain. Basis risk is not removed and roll yields can be negative.

  1. AExposure to changes in the futures spread between successive contract months, which can generate large margin outflows even if the spot price is stableCorrect
  2. BComplete elimination of basis risk because the hedge is always in the nearest contract
  3. CCertainty that the roll yield will be positive in every period
  4. DExposure only to the credit risk of the clearing house, with no price risk

Explanation

Rolling means closing the near contract and opening the next, so the hedger bears the risk that the spread between them moves unfavourably, i.e. roll risk. A long-dated hedge can also face liquidity strain from interim margin calls. Basis risk is not eliminated and roll yield can be negative.

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