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FRM Part I · FRM Exam Part I · Futures Markets

Which statement about basis risk in a short hedge is correct?

A strengthening basis benefits the short hedger. The short hedger's realized price equals the initial futures price plus the final basis, so if spot rises relative to futures, the effective sale price is higher. Weakening basis hurts, and mismatched assets increase basis risk.

  1. AA strengthening basis (spot rising relative to futures) benefits the short hedgerCorrect
  2. BA weakening basis benefits the short hedger
  3. CBasis risk is eliminated when the hedge asset differs from the futures asset
  4. DBasis risk exists only if the futures contract expires before the hedge ends

Explanation

With basis = spot - futures, a short hedger's effective price is initial futures price plus the final basis, so a strengthening basis raises the realized price. A weakening basis hurts. Using a different asset increases basis risk, and it also arises when expiry does not match the hedge horizon.

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