Explanation:
The correct answer is C.
Following the Global Financial Crisis (GFC), there have been structural changes in how market participants price and manage risk. Regulatory requirements, such as Basel III, have increased the capital and funding costs for banks, making arbitrage more expensive. Therefore, the cross-currency basis increasingly incorporates the financing costs and balance sheet constraints incurred by arbitrageurs to maintain their positions. Consequently, arbitrageurs are less able to exploit mispricings, allowing a non-zero basis to persist.
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Q.5413 John Paul, the chief investment officer at Herald Advisors, is particularly concerned about the cross-currency basis since the Global Financial Crisis. Which of the following is the most suitable explanation for the continued presence of a positive cross-currency basis between two currencies?
A
Regulatory changes have allowed for an expansion in speculative proprietary trading activities conducted by US banks.
B
Given the overall decrease in global interest rates, the inclusion of a liquidity risk cost in swap pricing is no longer deemed necessary.
C
The basis increasingly incorporates the financing costs incurred by arbitrageurs to maintain their positions.
D
As arbitrage positions typically mitigate counterparty risks, the expenses associated with credit value adjustments have risen.