Which of the following statements is true?
A)Basis risk arises because loan rates and deposit rates are not perfectly correlated 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 always move in the same direction over time
D)FIs are not subject to the basis risk

Question

Quizplus · Accepted Answer

Basis risk arises because loan rates and deposit rates are not perfectly correlated in their movements over time. This means that even if an FI may take deposits from customers and make loans to others, the interest rates on these two transactions may not move in tandem, resulting in basis risk. This risk can lead to a mismatch in interest rate risk, affecting the profitability of the FI.

Which of the Following Statements Is True