Which of the following increases basis risk? A. Dissimilarity between the underl

Question

Which of the following increases basis risk?

A. Dissimilarity between the underlying asset of the futures contract and the hedger's exposure

B. A large difference between the futures prices when the hedge is put in place and when it is closed out

C. A reduction in the time between the date when the futures contract is closed and its delivery month

D. None of the above

A. Dissimilarity between the underlying asset of the futures contract and the hedger's exposure

B. A large difference between the futures prices when the hedge is put in place and when it is closed out

C. A reduction in the time between the date when the futures contract is closed and its delivery month

D. None of the above

Explanation / Answer

Basis Risk

The risk that offsetting investments in a hedging strategy will not experience price changes in entirely opposite directions from each other. This imperfect correlation between the two investments creates the potential for excess gains or losses in a hedging strategy, thus adding risk to the position.

Simply put,

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