Hello Does basis risk and cross hedging risk exists in case of call/put options? Please explain with an example. What about basis risk/cross hedging risk in case of currency swaps? Basically I am just thinking on the lines that can we mention the point that basis risk and cross hedging risk exists for any derivative - futures, interest rate swaps, currency swaps, options etc? Thanks in advance Yogesh
Hi Yogesh Although basis risk and cross hedging risk are described in Chapter 12 in the context of futures, you are right that they may be present when using other derivatives to hedge, so I would consider them in the exam. For example, suppose a pension fund held a portfolio of UK equities and wanted to remove its exposure to UK equities and gain exposure to US equities. It could do this by taking out a total return swap, paying away the total returns on a UK equity index and receiving the total returns on a US equity index (say), but it would have cross hedging risk - because the total return on the fund's UK equity portfolio may not be the same as the total return on the UK equity index. I hope that helps Gresham
Yes, I think it could do. Eg there could be a situation where the payoff from an option is based on an index and that index might not give you exactly the exposure you require in order to hedge a risk and so you would have cross hedging risk
