One reason for basis risk in an interest rate swap is that changes in the index on the variable rate portion of the swap may not be perfectly correlated with changes in the index on the balance sheet portion of the liabilities.

Question

Quizplus · Accepted Answer

Basis risk arises when there is imperfect correlation between the index on the variable rate portion of the swap and the index on the balance sheet portion of the liabilities, leading to potential mismatches in cash flows.

One Reason for Basis Risk in an Interest Rate Swap