Question15 Basis risk in using future contracts to hedge refers to the risk: associated with unanticipated price movements on the underlying asset. from a change in the spread between the price on the commodity or financial security in the physical market and the price of the related futures contract of default on the futures contract associated with anticipated price movements in the cash market. ResetMaximum marks: 0.59 Flag question undefined

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BlackTom AI · Accepted Answer

Question restatement: Basis risk in using future contracts to hedge refers to the risk: (a) associated with unanticipated price movements on the underlying asset. (b) from a change in the spread between the price on the commodity or financial security in the physical market and the price of the related futures contract. (c) of default on the futures contract. (d) associated with anticipated price movements in the cash market.

Option (a) suggests basis risk is about unanticipated price movements in the underlying asset itself. While hedges can be unsettled by unexpected moves in the asset, this option describes general price risk rather than the specific hedge mismatch caused by basis changes between spot and futures prices.

Option (b) correctly points to basis risk as arising from changes in the spread between the spot or cash price of the asset and the futures price. This spread (the basis) can widen or narrow for various reasons (seasonality, supply shocks, storage costs, etc.), causing the hedge to be imperfect.

Option (c) mentions default risk on the futures contract. This is credit or counterparty risk, not basis risk. While important, it is a separate risk category from the basis between spot and futures prices.

Option (d) states risk from anticipated price movements in the cash market. This describes expected cash-price movements, not the hedging mismatch between cash and futures prices that defines basis risk.

In summary, the essence of basis risk lies in the imperfect alignment between the spot price and the futures price due to shifts in the basis itself, which makes the hedge not perfectly offset the cash market exposure. The remaining choices either describe general price risk, credit risk, or mischaracterize the nature of basis risk.

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What reflects the degree to which the rate on the option's underlying asset moves relative to the spot rate on the asset or liability that is being hedged?

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The basis is defined as spot minus futures. A trader is hedging the sale of an asset with a short futures position. The basis increases unexpectedly. Which of the following is true?

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