Answer-first summary for fast verification
Answer: b) The hedger cannot be 100% certain that the counterparty in the forward contract will meet their obligation (even the exchange-traded futures contract has a similar but smaller risk)
Basis risk arises from factors that cause the relationship between the spot price and futures price to be imperfect. Common sources of basis risk include: - the hedged asset not exactly matching the futures contract underlying asset, - uncertainty about the timing of the transaction, - closing out the futures position before delivery month, - location, quality, or other contract mismatches. **Counterparty default risk in a forward contract is not basis risk**; it is a separate type of credit risk. Exchange-traded futures reduce this risk through the clearinghouse. **Correct answer: B**
Author: Manit Arora
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Q-152.3 EACH of the following is a source of basis risk EXCEPT:
A
a) The asset whose price is to be hedged may not be exactly the same as the asset underlying the futures contract.
B
b) The hedger cannot be 100% certain that the counterparty in the forward contract will meet their obligation (even the exchange-traded futures contract has a similar but smaller risk)
C
c) The hedger may be uncertain as to the exact date when the asset will be bought or sold.
D
d) The hedge may require the futures contract to be closed out before its delivery month.
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