How can basis risk arise in an FI's operations?
A)Basis risk arises because loan rates and deposit rates are inversely related in their movements over time.
B)Basis risk arises because loan rates and deposit rates are perfectly correlated in their movements over time.
C)Basis risk arises because loan rates and deposit rates are not correlated in their movements over time.
D)Basis risk arises because loan rates and deposit rates are not perfectly related in their movements over time.

Question

Quizplus · Accepted Answer

Basis risk arises because loan rates and deposit rates are not perfectly related in their movements over time. This means that changes in interest rates on loans and on deposits may not move in perfect tandem, leading to basis risk for the FI that is exposed to interest rate fluctuations. As a result, FIs may be exposed to basis risk if they do not have the right mix of assets and liabilities, leading to interest rate mismatches.

How Can Basis Risk Arise in an FI's Operations