What is basis risk in the context of a swap?
Understand the Problem
The question is asking about the concept of basis risk specifically in relation to swap contracts and provides multiple-choice options to clarify the definition of this risk.
Answer
Basis risk in swaps is the risk of mismatch between the floating interest rates on the bonds and from the swap counterparty.
Basis risk in the context of a swap is the risk that arises from a difference in movements between the floating interest rate on the underlying bonds and the floating rate received from the swap counterparty.
Answer for screen readers
Basis risk in the context of a swap is the risk that arises from a difference in movements between the floating interest rate on the underlying bonds and the floating rate received from the swap counterparty.
More Information
Basis risk occurs when there is not a perfect correlation between the expected movement of rates. This can lead to unanticipated cash flows or financial outcomes for the party using the swap for hedging.
Tips
A common mistake is assuming that the floating rates are perfectly correlated, which can lead to unexpected financial outcomes.
Sources
- Debt Portfolio Interest Rate Swap Policy - policies.dartmouth.edu
- What Is a Basis Rate Swap? Definition, Example & Basis Risk - traditiondata.com
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