Basis Risk

Question 0

Perfect Hedge

Answer 0

Basis is zero.

Overall price paid or received is equal to the price at which the investor originally took a position in the future contract (F1).

Question 1

Basis

Answer 1

Difference between spot price of the asset whose price is being hedged at the end of the hedge (S2) and the price of the futures contract that is used for hedging when the contract is closed (F2).

Question 2

Reasons for Basis Risk

Answer 2

1. Expiration of the hedge does not correspondend to the expiration of the futures contract used.
2. The asset being hedged is not the same as the asset underlying the future contract that is used.
3. Uncertainties concerning the exact date when the underlying transaction that is being hedged will take place.

Question 3

Cross Hedging

Answer 3

Technique that can be used to mitigate the impact of basis risk.

Question 4

Hedge Ratio

Answer 4

Computed using post data.

Can be used to find the optimal number of futures to buy or sell to attenuate basis risk.

Slope of a regression line

1. independent variable = change of the price of the asset that is being hedged
2. dependent variable = change in the price of the future that is used to hedge