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FRM Part I · FRM Exam Part I · How Do Firms Manage Financial Risk?

A firm hedges a long exposure with a short futures position. Over a period, the hedged position's change in value is the change in spot price minus the change in futures price. Initially spot is 100 and futures is 103. At the hedge close spot is 95 and futures is 96. Per unit, what is the net effective price outcome relative to the initial spot, and what does it indicate about basis?

The net result is a gain of 2 per unit. Spot falls 5 but the short futures gain 7 (103 to 96). Basis, spot minus futures, moved from -3 to -1, so it strengthened, which benefits a short hedger and explains the net gain.

  1. ALoss of 5 on spot, gain of 7 on futures, net gain of 2; basis widened from -3 to -1
  2. BLoss of 5 on spot, gain of 7 on futures, net gain of 2; basis strengthened from -3 to -1Correct
  3. CLoss of 5 on spot, gain of 3 on futures, net loss of 2; basis weakened
  4. DLoss of 5 on spot, gain of 7 on futures, net gain of 12; basis unchanged

Explanation

Short futures gain 103 - 96 = 7; spot loses 5; net +2. Basis = spot - futures: initially 100 - 103 = -3, finally 95 - 96 = -1. Basis increased (strengthened), which benefits a short hedger, matching the +2 gain. Option A uses wrong wording 'widened' for a narrowing in magnitude, and the other options miscompute.

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