Fixed Income - Basis Risk

[MD2001]

The CFA text is not entirely clear what basis risk is within fixed income - can anybody shed some light on this, how it can be minimised etc?
Thanks

 

[S2000magician]

Basis risk is the risk that the basis – the difference between the spot price and the futures price – will change. It can be minimized by using a futures contract whose underlying is the same as the asset whose price is being hedged, and by choosing a futures contract that expires when (or as close as possible to the date when) the transaction you’re hedging will occur.

 

[MD2001]

S2000magician wrote:
Basis risk is the risk that the basis – the difference between the spot price and the futures price – will change. It can be minimized by using a futures contract whose underlying is the same as the asset whose price is being hedged, and by choosing a futures contract that expires when (or as close as possible to the date when) the transaction you’re hedging will occur.

Thanks for the response - so for example, basis risk would occur if you used Treasury bond contracts to hedge fixed rate corporate debt, as the underlying and the futures contract are different assets?

 

[S2000magician]

Yup.

 

[MD2001]

Cheers.