Basis Risk. Originates when an underlying asset and the method used to hedge that asset do not have perfectly correlated price movements. In grain markets, this is typically a result of physical ownership of grain, and a commodity derivative hedge on a futures exchange. Basis risk then often arises due to the physical grain and the hedging instrument having different characteristics i.e. quality, location, currency of value etc. CBH Grain manages basis risk using the same overarching principles by which it manages commodity price risk and foreign exchange risk. The key factor however, is to execute the physical sales strategy which involves systematically selling down the physical ownership of the Pool over time. At all times, the Pool will operate with the prescribed physical sales mandate, which is designed to reduce exposure to basis risk over time.
Basis Risk. The effectiveness of any hedging strategy is dependent upon the matching of the risks being hedged with the instruments and strategies used to mitigate such risks, creating a corresponding offsetting position. “Basis risk” is the risk of loss resulting from a hedging transaction that is imperfectly matched or correlated to the subject risk exposure. The Investment Manager will continuously monitor the Companies’ hedging transactions to ensure that they continue to be effective. Should the effectiveness of the hedge position shift significantly the Investment Manager will seek to either modify or terminate the transaction. The foregoing concept can also apply to replication transactions, where basis risk can exist between the subject derivative transaction and the asset/assets intended to be replicated.
Basis Risk. The risk of receiving insufficient receipts from the variable receipt component of a synthetic fixed-rate swap to pay the interest due on the underlying variable-rate debt issued by the State. Mitigation - The State will consider the potential savings and risk of different indices. • Termination Risk - The risk that a swap could be terminated and a market based termination payment would be required from the State due to any of several events, which may include ratings downgrade, covenant violations, swap or bond payment defaults. Mitigation - Progressive collateralization and budgeting of potential termination payments as conditions increase the possibility of a termination payment. Generally, the State needs to integrate swaps with bonds for tax purposes so that bond proceeds can be used for termination payments. Endeavor to incorporate in swap documentation nonparallel downgrade provisions benefiting the State. For example, if a termination is the result of a ratings downgrade of the counterparty, Maryland would not be required to make a termination payment. • Amortization Risk - The risk that the notional value of a swap contract could become mismatched versus the amortization of a particular series of fixed or variable rate bonds to which the swap is allocated. Mitigation - Match swap amortization with the amortization schedule of associated debt. • Operational Risk - the risk that the State or the counterparty may not have the adequate systems, policies, or practices to ensure timely and accurate cash flow exchanges and compliance with collateral provisions. Mitigation - Continue to develop and test policies and practices to ensure timely compliance by the State Treasurer’s Office with applicable swap agreement provisions. Ensure that there is sufficient staff for these responsibilities and that they have adequate experience and continuing training. Consult with Financial Advisor and/or Swap Advisor before entering any derivative contract. Invest in and update technology necessary to monitor these agreements. Implement an ongoing monitoring and reporting program for all derivative agreements.
