Answer: Basis strengthens by +$0.20

**Correct Answer: C: Basis strengthens by +$0.20** **Step-by-step explanation:** In the FRM Part I curriculum (Foundations of Risk Management and Financial Markets and Products), the **basis** for a commodity is defined as: **Basis = Spot price (S) − Futures price (F)** This is the standard convention used in GARP materials. 1. **Initial basis (May 2011):** S₁ = $7.00 F₁ = $9.00 (December 2011 futures) Basis₁ = 7.00 − 9.00 = **−$2.00** 2. **Basis three months later (August 2011):** S₂ = $7.30 F₂ = $9.10 Basis₂ = 7.30 − 9.10 = **−$1.80** 3. **Change in basis:** Change = Basis₂ − Basis₁ = (−1.80) − (−2.00) = **+$0.20** 4. **Interpretation of the change:** - The basis moved from −$2.00 to −$1.80 (i.e., it became **less negative**). - In futures terminology, when the basis **increases algebraically** (moves toward zero or becomes more positive), the basis is said to **strengthen**. - Here the basis strengthened by exactly **+$0.20**. **Why the other choices are incorrect:** - **A & B:** Both use +$0.10, which is the actual change in the futures price only. They ignore the larger spot-price increase ($0.30). - **D:** This option would be correct only if the basis were incorrectly defined as Futures − Spot (which is **not** the FRM convention). Even then, the sign wording would not match standard strengthening/weakening language. **Key takeaway for the exam:** Always calculate Basis = S − F. A positive change in basis (Basis₂ > Basis₁) = **basis strengthens**. A negative change in basis (Basis₂ < Basis₁) = **basis weakens**. This concept appears frequently in hedging-risk questions (e.g., basis risk for a short or long hedge).

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