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Spread risk is
risk (usually
market risk or
earnings risk) due to exposure to some
spread. It often arises with a
long-short position or with
derivatives. A synonym for spread risk
is basis risk.
Suppose a bank lends at prime and
finances itself at Libor. It faces spread risk due to
the possibility that the prime-Libor spread might narrow. A
bond trader might
hedge a
long position in
corporate bonds by
shorting Treasury bonds. The hedge eliminates
exposure to changes in Treasury yields, but the trader remains exposed to
changes in the spread between corporate and Treasury yields. He too is taking
spread risk. See the article Interest Rate Risk
for more on basis risk in fixed income markets.
If futures are used to hedge a long or short position in an
underlier, residual risk will remain due to the spread between the futures price
and the underliers spot price. That spread is
called the futures'
basis.
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