Consider futures on a stock market index.Which of the following scenarios is most likely to increase the futures-spot basis?
A)Interest rates and dividend yields both decline.
B)Interest rates decline and dividend yields increase.
C)Interest rates and dividend yields both increase.
D)Interest rates increase and dividend yields decline.

Question

Quizplus · Accepted Answer

An increase in interest rates will typically lead to an increase in the futures-spot basis, as investors will demand more compensation for tying up their funds in a futures contract instead of investing in Treasury bills or other short-term debt securities. A decline in dividend yields will also increase the futures-spot basis, as investors will be less willing to hold futures contracts that are tied to stocks with lower dividend payments. Therefore, the combination of rising interest rates and falling dividend yields (which is what D describes) is likely to result in the largest increase in the futures-spot basis.

Consider Futures on a Stock Market Index