Tree Row Bank has assets of $150 million, liabilities of $135 million, and equity of $15 million. The asset duration is six years and the duration of the liabilities is four years. Market interest rates are 6 percent. Tree Row Bank wishes to hedge the balance sheet with Eurodollar futures contracts, which currently have a price quote of $96 per $100 face value for the benchmark three-month Eurodollar CD underlying the contract. The current rate on three-month Eurodollar CDs is 4.0 percent and the duration of these contracts is 0.25 years. On-balance-sheet rates are expected to increase by 100 basis points. Further, assume there is basis risk such that rates on three-month Eurodollar CDs are expected to change by 0.10 times the rate change on assets and liabilities. That is, DR_F = 0.10 x DR.

What is basis risk? What are the sources of basis risk?