The basis is defined as spot minus futures. A trader is hedging the purchase of an asset with a futures position. The basis decreases unexpectedly. Which of the following is TRUE? Select one alternative The hedger’s position sometimes worsens and sometimes improves. The hedger’s position improves. The hedger’s position stays the same. The hedger’s position worsens.
Question
The basis is defined as spot minus futures. A trader is hedging the purchase of an asset with a futures position. The basis decreases unexpectedly. Which of the following is TRUE?
Select one alternative
The hedger’s position sometimes worsens and sometimes improves.
The hedger’s position improves.
The hedger’s position stays the same.
The hedger’s position worsens.
Solution
Step 1: Understand the concept of basis. The basis is the difference between the spot price (the current market price) and the futures price of an asset.
Step 2: Understand the scenario. A trader is hedging the purchase of an asset with a futures position. This means the trader is using a futures contract to protect against potential price changes in the asset.
Step 3: Analyze the impact of a decrease in basis. If the basis decreases unexpectedly, it means the futures price has increased relative to the spot price.
Step 4: Determine the impact on the hedger's position. If the trader is hedging the purchase of an asset, they would be negatively impacted by an increase in the futures price, because they have committed to buying the asset at this higher price in the future.
So, the correct answer is: The hedger’s position worsens.
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