FRM Part II · FRM Exam Part II · The US Dollar Shortage in Global Banking and the International Policy Response
Which statement best describes why the cross-currency basis becomes more negative during dollar shortages, based on the reading's analysis of covered interest parity deviations?
The basis turns more negative because demand for dollars through FX swaps surges while arbitrageurs face balance sheet and regulatory constraints that limit their ability to supply dollars and close the gap, so the premium for borrowing dollars persists.
- ABanks' balance sheet constraints limit arbitrageurs' ability to exploit CIP deviations while demand for dollars via swaps rises, so the dollar premium persistsCorrect
- BCentral banks forbid arbitrage between currencies in crisis periods
- CInterest rate differentials become zero, which forces the basis down
- DForward contracts cease to exist during crises
Explanation
Strong hedging demand for dollars via FX swaps meets limited arbitrage capacity because of balance sheet and regulatory constraints. The dollar premium therefore persists, producing a more negative basis. The other options are not mechanisms in the reading.
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