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Sir can you please explain why examiner has used basis risk in answer if he states in the question company faces no basis risk
ThanksThe question does not say that they face no basis risk.
The question says “it can also be assumed that basis diminishes to zero at contract maturity at a constant rate”, which is what we normally assume when dealing with the basis.
Have you watched my free lectures on interest rate risk management where this is explained?
Yes sir you are right but in the requirement b part it says
BASED ON THE CHOICE OF OPTIONS ON FUTURES OR COLLARS WHICH MASSIE IS CONSIDERING AND ASSUMING THE COMPANY DOES NOT FACE ANY BASIS RISK recommend a hedging startegy for the €2t million receiptI find the both statements contradicting
And in the examiners answer it took me very long to understand the answer as i was assuming no basisThe examiner interprets ‘basis risk’ as being the risk that the basis does not fall linearly. We always assume that it falls linearly in calculations, but in real life there is no reason that it should be linear.
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