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

A company will sell an asset and is short futures to hedge. Which change in the basis (defined as spot minus futures) benefits the hedger, and why?

A strengthening basis benefits a short hedger. The effective price received equals the initial futures price plus the final basis, so if spot rises relative to futures, the hedger receives more than expected. A weakening basis lowers the effective price and hurts.

  1. AA weakening basis, because the short futures gain exceeds the loss on the spot
  2. BA strengthening basis, because the effective price received equals the initial futures price plus the final basisCorrect
  3. CA weakening basis, because the effective price equals the initial spot price
  4. DA strengthening basis, because the hedger then holds a long spot position that gains

Explanation

For a short hedge, effective price = F1 + b2, where b2 is the final basis (S2 - F2). A higher (strengthening) basis raises the price received. A weakening basis reduces it, so it hurts the short hedger.

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