The Basis and the Risk Involved 1. Define what the basis is. Does the basis have to be constant? 2. When do we have to worry about basis risk? What is the basis at the maturity of any futures contract? Suppose a farmer will have corn to sell but he currently sells 1 year corn futures at $20 to hedge his price risk. The current price is $22 per standard unit of corn. He sells enough futures to cover how much corn he will sell. After 6 months, his corn is ready to sell, the price of corn is $19, and the 6 month futures price is $18. 3. What is the basis at the start of his position? 4. Suppose the farmer sells his crops now and closes out his hedge. How much does he get in revenue per standard unit of corn? Did he win or lose? Could this work the other way? The Basis and the Risk Involved 1. Define what the basis is. Does the basis have to be constant? 2. When do we have to worry about basis risk? What is the basis at the maturity of any futures contract? Suppose a farmer will have corn to sell but he currently sells 1 year corn futures at $20 to hedge his price risk. The current price is $22 per standard unit of corn. He sells enough futures to cover how much corn he will sell. After 6 months, his corn is ready to sell, the price of corn is $19, and the 6 month futures price is $18. 3. What is the basis at the start of his position? 4. Suppose the farmer sells his crops now and closes out his hedge. How much does he get in revenue per standard unit of corn? Did he win or lose? Could this work the other way