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ACCA Strategic Professional · Advanced Financial Management · The use of financial derivatives to hedge against interest rate risk

Which statement about basis in interest rate futures is correct?

Basis is the difference between the cash market price and the futures price, and it converges to zero as the contract reaches expiry. Closing out earlier leaves residual basis, which creates basis risk. Margin is an unrelated deposit requirement.

  1. ABasis is the difference between the spot price and the futures price, and it converges to zero at expiry of the contractCorrect
  2. BBasis risk arises only when options are used instead of futures
  3. CBasis is always zero if the futures contract is closed out before expiry
  4. DBasis is the margin deposit required on opening the position

Explanation

Basis equals the current market (cash) rate position minus the futures price position and reduces to zero as the contract reaches maturity. If closed out earlier, basis is generally not zero, so basis risk exists. Margin is a separate deposit and basis risk is not specific to options.

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