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Hello Sir,
The following question is quiet clear about the basis risk but my confusion is what is the difference between option 1 and 2 look like of the same idea .
Q
203 Which of the following are descriptions of basis risk?
1
It is the difference between the spot exchange rate and currency futures exchange rate
2
It is the possibility that the movements in the currency futures price and spot price will
be different
3
It is the difference between fixed and floating interest rates
4
It is one of the reasons for an imperfect currency futures hedge
A
1 only
B
1 and 3
C
2 and 4 only
D
2, 3 and 4Answer is C
Thanks.
The difference between the spot and the futures exchange rate is the basis.
However what causes the risk (i.e. the basis risk) is that this difference changes over time (as I explain in the lectures the difference falls to zero over the life of the future). As a result, it is not possible to get a perfect hedge.
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