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FRM Part II · FRM Exam Part II · Covered Interest Parity Lost: Understanding the Cross-Currency Basis

A treasurer at a non-US bank wants to reduce vulnerability to a sudden widening of the cross-currency basis in a stress period. Which action most directly addresses this exposure?

The treasurer should lengthen the tenor of USD swap funding and diversify counterparties and maturities. Basis spikes hurt through rollover of short-dated swaps, so spreading and extending maturities reduces refinancing pressure, whereas overnight reliance or single-dealer dependence increases vulnerability.

  1. ALengthen the maturity of USD funding obtained through FX swaps and diversify counterparties and tenorsCorrect
  2. BShift more USD funding to overnight FX swaps because they reprice quickly
  3. CIncrease USD assets funded in local currency to take advantage of a wider basis
  4. DRely on a single large dealer to ensure pricing consistency

Explanation

Basis widening hurts mainly through rollover of short-term swaps, so extending tenors and diversifying counterparties reduces refinancing concentration. Overnight swaps (B) maximize rollover risk. Option C increases the currency mismatch, and D raises concentration risk.

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