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

A refiner plans to sell crude oil in three months and hedges by shorting a futures contract that expires in the same month as the sale. Which statement best describes the basis risk the refiner still bears?

Basis risk is the uncertainty about the spot-minus-futures difference when the hedge is closed. The refiner fixes the futures leg, but the final effective price depends on the basis at that time, which cannot be known in advance.

  1. AThe uncertainty about the difference between the spot price and the futures price at the time the hedge is liftedCorrect
  2. BThe risk that the spot price will fall below today's futures price before expiry
  3. CThe risk that the futures price converges exactly to the spot price at expiry
  4. DThe risk that the hedge ratio equals exactly one

Explanation

Basis is spot minus futures. Even with a short hedge, the hedger's outcome depends on the basis when the hedge is closed, and that basis is not known in advance. The second option describes outright price risk, which the hedge is designed to remove.

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