Question

A decrease in the basis will __________ a long hedger and __________ a short hedger. Group of answer choices hurt; hurt hurt; benefit benefit; have no effect upon benefit; benefit benefit; hurt

Answer 1

Answer:

hurt, benefit

Explanation:

The basis in a future contract is defined as the difference between the spot price of the asset in the cash market and the price of the same assets future contract.

A short hedge is an investment strategy that is used to protect hedge, against the risk of future decline in asset price or basically to hedge against potential losses by selling at a determined rate. This means that when one is in possession of a commodity and in order to protect against a decline, in the market, you sell (go short) the future contract , while long hedge is when you anticipate a need for the underlying commodity in the future. It means that to protect against an increase in the market price, you buy (go long) the future contract. Then when you are ready to buy the commodity, any increase in the market price is offset by your gain on the future contract.

The above means that where an asset and a contract are liquidated before due dates , there would be basis risk hence both the future and spot price need not move in lockstep before delivery date. This means that a decrease in the basis will benefit the short hedger and hurt the long hedger.