Which of the following is NOT an example of basis risk? Purchasing a) an oil contract with delivery in a different geographical region b) a commodity with a desired distant delivery with long term contracts c) a Eurodollar contract due to lack of commodity futures d) a commodity with a desired distant delivery with near term contracts Please provide explanation with your answer
B
A
Can you explain why?
I choose A. As basis risk is basically the risk that the futures price and the underlying will not move together. Situation A doesn’t result in any such risks.
I’d go with B as well. using the futures of the commodity you want with expiration matching the wanted delivery eliminates your basis risk. so, you’ve got the right underlying commodity and have also matched the timing… all of the other answers have something that do not “match”. A, for example. having the commodity delivered to a different geographical location can mean more cost from transportation and storage an so on… C is the wrong underlying and D, the timing is off. so i’d go with B. i’m probably wrong. lol.
I’d say B for the same reasons listed above.
A In addition to reasons mentioned by Heeral, there is also no time frame mentioned in option A. Its just a simple contract with delivery at some place.
amit, what was the final answer to this? thanks.
B was the right answer…I am not sure why
because purchasing a long term futures contract is following pretty good the intention of buying actual oil with a long term delivery. for A , we know that because of transportation costs, oil markets tend not to be in sync. I.E you would not buy a futures contract in england for somebody that wants to have a long position in us oil
D!
D! I do not have books in my hand now. But I will find out the point and come back to post it. I remember the most important thing making basis risk the the time factor.
B. Basis risk being the potential divergence of futures price vs spot price as contract near expiry. Hence basis risk is almost non-existent for contract that has lng time to maturity. Pls correct if my understanding is wrong.
B because of perfect hedging