Explanation:
A is correct. Post GFC, structural changes in how market participants price market, credit, counterparty, and liquidity risks have tightened limits to arbitrage and arbitrage now incurs a balance sheet cost which is persistent. The cost for all arbitrage participants to finance offsetting positions, are now being reflected in the FX swap basis.
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A portfolio manager at a US hedge fund is exploring investment opportunities in the context of declining global interest rates since the 2007-2009 global financial crisis. During this period, the manager has noticed that there is a consistent positive cross-currency basis between a certain pair of currencies. What is the most appropriate explanation for this continued occurrence?
A
The costs for arbitrageurs to finance their positions are increasingly reflected in the basis.
B
The costs of credit value adjustments have increased, as arbitrage positions typically eliminate counterparty risks.
C
Regulatory changes have permitted an increase in US banks' speculative proprietary trading activities.
D
The addition of a liquidity risk cost to swap pricing is no longer required given the decline in the overall level of interest rates in the global economy.