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

Before 2008, deviations from CIP in major currencies were small and short-lived. Which statement best describes the change after the crisis?

After the crisis, CIP deviations in major currencies became larger and more persistent, with a premium for obtaining dollars through FX swaps against currencies like the euro and yen. Before 2008 they were small and quickly arbitraged away, so the change reflects limits to arbitrage.

  1. ADeviations became larger and more persistent, with the dollar commanding a funding premium against several currenciesCorrect
  2. BDeviations disappeared entirely as swap markets deepened
  3. CDeviations became persistent only for emerging-market currencies
  4. DDeviations turned permanently positive for all currencies against the dollar

Explanation

After 2008, and especially during the euro-area stress and later episodes, bases against the dollar for the euro and yen became large and persistent, reflecting dollar demand and limits to arbitrage. They did not vanish, were not limited to emerging markets, and were not positive for all currencies.

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