Question

A financial analyst expects that basis (S – F) is more likely to decrease in the future and       suggests that all the Short hedgers should hedge right away. Do you agree? Please show         your proof.

Answer 1

Yes I do agree that short hedgers must also hedge themselves, becauseof the basis risk which is there into the futures market, as futures can fall lesser in comparison to spot market and the loss of cash market would not be completely offset by the gain in the future market, so short hedgers must be also hedging in such scenario if the analyst is advocating that.

when the basis is going to get narrower, that means that fall in spot would be higher and the fall in future should be lower or vice versa so in that short hedgers are not perfectly hedged as,they will lose more in cash market and that would not be offseted by gains in the future market.