Armstrong Group (Sept/Dec 2015)

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August 31, 2017 at 10:26 am #404609
cys94
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Dear John,
At (b),the question state that it assume the company does not face any basis risk. What does this mean and what must we understand from this? According to the answers when calculating future prices (for option on futures), the basis risk is still calculated. So why did the question assume there is no basis risk?
August 31, 2017 at 4:27 pm #404686
John Moffat
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We assume that the basis falls linearly to zero over the life of the future. In practice there is no reason why it should be linear, and the basis risk is the risk that it isn’t linear. (So if there is no basis risk then you assume it falls linearly.)
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