Basis Risk Explained Simply | Hedging Strategies

[@RyanOConnellCFA]

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[@tsunningwah3471]

You really save my life. My professor walked through these topic too quickly and the knowledge didnt have enough time to sink in my brain.

[@RyanOConnellCFA]

Awesome, really glad to hear that this was helpful for you!

[@tw9419]

Thank you! You explained it better than my textbook. Now I can wrap my head around it

[@RyanOConnellCFA]

Awesome, thank you for the feedback!

[@pablomoure2963]

Very well explained !!

[@RyanOConnellCFA]

Thank you Pablo!

[@mphys5370]

Ryan, could you do a video of CFA vs FRM

[@RyanOConnellCFA]

Hello, you can find that video here: kzbin.info/www/bejne/d57adnibfsZrsMk

[@МаксимСидоров-ш8я]

The best 👍🏻

[@RyanOConnellCFA]

Thank you!

[@alexwire8098]

If you had to buy gold in 2 months so you went long on a future would the basis risk then be ft- st instead of st-ft as seen in your example?

[@victorsardon3521]

No the basis would still be st-ft. The gain/loss for the long hedge will increase as the basis weakens and decrease as the basis strengthens. Vice versa for a short hedge. In Ryan's example he shows a gold buyer entering into a long hedge with platinum futures. The outcome on the final day t2 is that the platinum futures price F2 > spot price S2, contrast to time t1 when F1 < S1. So the basis has shifted from positive to negative. This is a weakening of the basis and will actually help the long hedge.

[@tsunningwah3471]

there is one point i dont get. Future price= spot price x e^rt by no arbitrage principle. so usually, future price should be greater than spot price?????? isnt it??

[@sarathprasad9112]

yes

[@RyanOConnellCFA]

Yes, you're correct! Under the no-arbitrage principle, the future price is typically greater than the spot price due to the exponential factor e^rt, where r is the risk-free rate and t is the time to maturity, accounting for the time value of money

[@victorsardon3521]

At T0, it might be the case where the future is greater or lower than the spot price. Whether F0(T) is greater or lower than S0 depends on the net cost of carry which takes into account benefits and costs on the underlying. The no-arbitrage futures price is F0(T) = (S0 - Γ+ θ) * e^rT , where Γ & θ are the present values of the benefits & costs. If Γ > θ, the benefits outweight costs, we have a negative cost of carry, we won't have to pay as much for F0(T), and it may even be less than S0. You must take into account benefits & costs. As time passes, the futures price for a new contract may change, and the spot price may change, but the old futures contract stays the same. Now per the 3 requirements for a perfect hedge that Ryan discussed, we will have a perfect hedge and the futures and spot price should converge on the final day. Thus, convergence assumes all the factors of a perfect hedge so that the basis is 0 at time T expiration. Basis risk arises when one of the assumptions for a perfect hedge fails. E.g. if you’re an airline hedging out your jet fuel cost, your futures contract will use heating oil (HO) to hedge out a spot price on jet fuel. Which means they may not perfectly converge on the last day bc the underlying ≠ spot asset. This cross-hedging of jet fuel with HO results in an imperfect hedge, and the basis will most likely not be 0 on the final day.

[@NikoZisis]

Amazingggg

[@divyaalok5538]

जय श्री राम🙏🙏🙏🙏🙏🙏🙏🙏🙏🙏

[@ivaberiashvili8827]

Nice beard

[@RyanOConnellCFA]

Thank you! I've been working on it 😂