A company is considering using futures contracts to hedge an identified interest rate exposure on its debt facilities.However, it is concerned about the impact of basis risk.All of the following statements regarding basis risk are correct, except:
A)basis risk is the difference between prices in the physical market and the price of the relevant futures market contract.
B)the existence of basis risk removes the opportunity for a perfect borrowing hedge.
C)initial basis will be evident while the market is of the view that physical market prices will remain stable.
D)final basis will exist where a futures contract is used to hedge a risk associated with a different physical market product.

Question

Quizplus · Accepted Answer

Basis risk indeed involves the risk that the price of a futures contract will not move in perfect correlation with the price of the underlying asset, but the statement about initial basis being evident when the market views physical market prices as stable is incorrect. Basis risk primarily arises from differences in location, quality, or timing between the futures contract and the underlying asset, not necessarily from market views on price stability.

A Company Is Considering Using Futures Contracts to Hedge an Identified