CFA Level I · CFA Level I Exam · Derivative Benefits, Risks, and Issuer and Investor Uses
A corporate treasurer hedges a euro receivable with a forward contract on a related but different currency because it is cheaper. At maturity, the two exchange rates move differently and the hedge only partly offsets the loss on the receivable. This outcome is best described as:
This is basis risk. The forward was written on a related but different currency, so its value did not move in step with the euro receivable. The hedge was imperfectly correlated with the exposure and left a residual loss, with no default or failed delivery involved.
- Abasis risk, because the hedge instrument and the exposure are imperfectly correlated.Correct
- Bsettlement risk, because the counterparty failed to deliver on the contract.
- Ccredit risk, because the issuer of the receivable defaulted on payment.
Explanation
The hedge was placed on an instrument that does not move one-for-one with the exposure, so the offset is incomplete. This mismatch is basis risk. No counterparty failure or debtor default is described, so settlement and credit risk do not apply.
Did you get it right without looking?
One question tells you little. A timed set on Derivative Benefits, Risks, and Issuer and Investor Uses shows your real accuracy, how long you take and where you lose marks.
More Derivative Benefits, Risks, and Issuer and Investor Uses questions
- An investor uses a derivative to gain exposure equal to a $10 million equity position while paying only $0.6 million upfront. This feature i…
- Compared with an over-the-counter (OTC) forward contract, an exchange-traded futures contract is most likely to feature:
- An analyst observes that a derivative contract and a replicating portfolio of the underlying and a risk-free asset have different prices. Wh…
- A firm buys a forward contract to lock in the price of a commodity it will need in six months. The derivative benefit this use best illustra…
- A dealer in the OTC derivatives market most likely:
- Critics argue that derivatives are "speculative instruments that resemble gambling." Which response is most consistent with the way the CFA …