Hi I'm having trouble understanding what Basis risk and Structural Risk actually mean, i'm happy enough to just reel off the definitions from the core reading but it would be good to actually understand them if anyone can help explain? Thanks
Basis risk - the risk that the price of an asset does not move in the same way as the price of the asset being used to hedge it. So this is a risk that occurs when you are hedging a portfolio. For example - if you are hedging a portfolio of IT stocks using a FTSE future - there will be a difference in the way these move. Structural risk - the risk that the sum of the investment managers’ benchmarks does not equal the total strategic benchmark. So, this risk occurs when you are considering how to invest your portfolio across different fund managers and asset categories. For example, you allocate a % of your fund to manager A and a % to manger B. You may intend for these to be uncorrelated, but unknowingly they invest in correlated assets, creating structural risk.
