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

Which statement about hedging with currency futures is correct?

Basis risk makes a futures hedge imperfect. The difference between futures price and spot rate converges to zero only at expiry, so if the position is closed earlier the two prices may move by different amounts. Futures are standardised and exchange-traded, so they cannot be tailored exactly.

  1. ABasis risk arises because the futures price and the spot rate need not move by the same amount before expiry, so the hedge is usually imperfectCorrect
  2. BFutures can be tailored to the exact amount and date of the exposure, so basis risk does not arise
  3. CFutures remove all risk because margin is refunded at the fixed price
  4. DFutures are over-the-counter contracts so the counterparty risk is high

Explanation

Basis (futures price minus spot) converges to zero at expiry but may change unpredictably before then, so closing out before expiry leaves residual risk. Futures are standardised in size and dates, so exact tailoring is not possible. They are exchange-traded with a clearing house, so counterparty risk is low.

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