24-8 One reason for basis risk in an interest rate swap is that changes in the index on the variable rate portion of the swap may not be perfectly correlated with changes in the index on the cash balance sheet portion of the liabilities.

Question

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Basis risk can occur in an interest rate swap when there is imperfect correlation between the index on the variable rate portion of the swap and the index on the cash balance sheet portion of the liabilities. This can result in fluctuations and inconsistencies between the payments made and received by the parties involved in the swap.

24-8 One Reason for Basis Risk in an Interest Rate