Skip to content

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

A treasurer observes that, since the 2008 global financial crisis, the euro/dollar cross-currency basis for three-month swaps has been persistently negative. What does this most directly imply?

A persistently negative euro/dollar basis means raising dollars through an FX swap using euros costs more than borrowing dollars directly. That is a deviation from covered interest parity, reflecting a premium for dollar funding. It does not by itself say euro rates exceed dollar rates.

  1. ABorrowing dollars by swapping euros costs more than the direct dollar money market rate implies, so CIP is violatedCorrect
  2. BBorrowing dollars via an FX swap is cheaper than the direct dollar rate
  3. CCIP holds exactly because forward points adjust to the rate differential
  4. DEuro interest rates must be above dollar rates

Explanation

A negative basis means the implied dollar rate from swapping euros into dollars exceeds the direct dollar rate, so those raising dollars synthetically pay a premium. This is a CIP deviation, not compliance. The sign of the basis says nothing about whether euro rates exceed dollar rates.

Did you get it right without looking?

One question tells you little. A timed set on Covered Interest Parity Lost: Understanding the Cross-Currency Basis shows your real accuracy, how long you take and where you lose marks.

Practise Covered Interest Parity Lost: Understanding the Cross-Currency BasisFree diagnostic mock

More Covered Interest Parity Lost: Understanding the Cross-Currency Basis questions