why does the notes say that, entering a contract with a maturity equal to the desired holding period could eliminate basis risk? Basis depends upon the interest rate differential between the two economies, and at the maturity, the interest rate differential could change so that the basis is changed. How come the basis risk could be eliminated in this way? Thanks

I think the overall idea was that whenever you had a hedge that didn’t fit your underlying exactly you end up with basis risk. So if you are trying to hedge the fact that you are going to sell oil in 2 years, a 1 year oil future would have basis risk because the price of the future would not move exactly the same as the price of your underlying.

So in your opinion, a TWO year oil future has no basis risk?

Actual oil price and oil futur contract; actual stock price and stock future; acutal interest rate and interest rate future; acutal whatever and whatever future don’t move in lock steps. Therefore, if you want do a 2 year hedge, during the life of the hedge, there is basis risk if hedge is to be lifted before the 2 year period. Make sense?

guhongying Wrote: ------------------------------------------------------- > Basis depends upon the interest rate differential > between the two economies, and at the maturity, > the interest rate differential could change so > that the basis is changed. How come the basis risk > could be eliminated in this way? > > Thanks As contract moves toward to its “maturity”, the spot price will move closer and closer to its future price; if not, the arbtriager will make sure it happens.

What WS said. Under the arbitrage assumption you should have no basis risk.

Dear all, What I know is that the “basis” is the difference between the futures price and spot prce but I don’t know what does “basic risk” means. Does “basic risk” mean that the “basis” can not be kept constant ? Or the amount change in futures price does not equal to the amount change in spot price ? Or the % change in futures price does not equal to the % change in spot price ? I remember that “basic risk” is mentioned in several readings but I do not understand what it means exactly ! Anybody can help ?

in my opinion, a TWO year oil future still no basis risk. the basis risk simply getting closer to 0 when closing to the maturity if you want 2 years future to hedge 2 years oil price.