A financial analyst expects that basis (S – F) is more likely to decrease in the...

A financial analyst expects that basis (S – F) is more likely to decrease in the future and suggests that all the Short hedgers should hedge right away. Do you agree? Please show your proof.

Expert Solution

Yes I do agree that short hedgers must be hedging themselves because there is a basis risk which is always there into the futures market. Basis risk is a kind of risk that when the market will fall the futures will fall lesser than the cash market so it would not be beneficial for the short hedgers.

short hedgers basically are holding long-term portfolio and their hedge their portfolio through going short on the index futures or through put options. But because of the basis risk if there is a fall in the overall market the cash market will be falling more, and sometimes the future markets would not be falling that much.

So the gains in future market would not completely offset the loss made in the cash market so in such times the short hedgers would not be completely hedged.

so, the financial analyst suggestion is true and the short hedgers should hedge right away.

This can be evident through the discount or the premium which are available between the cash and the future market. or this could well be explained through the concept of contango.

jeff jeffy answered 1 year ago

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