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Explanation:
A is correct. Due to tighter management of risks and balance sheet constraints, arbitrage incurs a borrowing cost per unit of the position on the balance sheet. A positive FX swap basis may exist due to arbitrageurs having passed on these balance sheet borrowing costs by incorporating them into the forward FX swap price.
B is incorrect. A persistent positive FX swap basis may result from non-financial firms issuing foreign currency debt in offshore capital markets and hedging the proceeds back into their home currency.
C is incorrect. A positive basis may exist due to institutional investor decisions to maintain hedges on foreign currency investments. Reducing the hedges would also reduce one of the potential drivers of a persistent positive basis.
D is incorrect. A persistent positive FX swap basis may result from international banks concentrating their lending activities in offshore markets and hedging back into the home country currency while getting funding in their home country’s currency.
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A
A positive FX swap basis may exist because arbitrageurs pass on their balance sheet borrowing costs through the forward FX swap price.
B
A persistent and positive FX swap basis is likely to result from non-financial firms issuing debt denominated in their home currency in offshore capital markets rather than in their home country’s debt market.
C
A persistent and positive FX swap basis may exist because of the decision of institutional investors to reduce their hedges of foreign currency investments.
D
A persistent and positive FX swap basis is likely to result from international banks concentrating their lending activities in their home markets and reducing loan exposures in offshore markets.