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FRM Part II · FRM Exam Part II · The US Dollar Shortage in Global Banking and the International Policy Response

Which feature of the cross-currency basis is most consistent with the view that post-crisis regulation has left a persistent dollar funding vulnerability, particularly around reporting dates?

A more negative cross-currency basis, widening around reporting dates, reflects dealers' constrained balance sheets limiting arbitrage of covered interest parity deviations. Post-crisis leverage and capital rules raise the cost of this arbitrage, so dollar funding premiums persist rather than being competed away.

  1. AA more negative basis arises as constrained dealer balance sheets limit arbitrage of covered interest parity deviationsCorrect
  2. BA basis of zero is guaranteed by regulation requiring parity
  3. CA positive basis arises because dollar funding becomes cheaper in stress
  4. DThe basis is determined solely by expected exchange rate movements

Explanation

Leverage ratio and other balance sheet constraints make dealers less willing to arbitrage, so covered interest parity deviations persist and the basis widens (more negative) at quarter-ends. Expected exchange rate changes do not enter covered parity, and dollar funding becomes dearer, not cheaper, in stress.

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