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Answer: The costs for arbitrageurs to finance their positions are increasingly reflected in the basis.
## Explanation The persistence of a positive cross-currency basis after the global financial crisis is best explained by **Option D: The costs for arbitrageurs to finance their positions are increasingly reflected in the basis.** ### Key Points: 1. **Cross-Currency Basis**: This represents the difference between the interest rate differential implied by FX forward rates and the actual interest rate differential between two currencies. 2. **Post-Crisis Environment**: After the 2007-2009 financial crisis: - Regulatory requirements increased (Basel III) - Funding costs rose significantly - Balance sheet constraints became more binding 3. **Arbitrage Costs**: - Before the crisis, arbitrageurs could easily exploit basis differences - Post-crisis, the costs of funding and balance sheet usage increased substantially - These higher costs are now embedded in the basis itself 4. **Why Other Options Are Incorrect**: - **A**: The overall level of interest rates doesn't directly explain the persistence of basis differences - **B**: While CVA costs increased, arbitrage positions don't typically eliminate counterparty risks - **C**: Regulatory changes actually restricted, not permitted, increased speculative trading ### Conclusion: The persistent positive cross-currency basis reflects the ongoing higher costs that arbitrageurs face in financing their positions, particularly due to post-crisis regulatory constraints and increased funding costs.
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A portfolio manager at a US-based hedge fund has been searching for potential return opportunities in the environment of declining global interest rates experienced after the global financial crisis of 2007-2009. The manager identifies that a positive cross-currency basis between two currencies has persisted since the global financial crisis. What is the most appropriate explanation for this persistence?
A
The overall level of interest rates in the global economy.
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 costs for arbitrageurs to finance their positions are increasingly reflected in the basis.