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CA-12.1.4

For spot or physical trading, the directional risk arising from a change in the spot price is the most important risk. However, conventional bank licensees applying portfolio strategies involving forward and derivative contracts are exposed to a variety of additional risks, which may well be larger than the risk of a change in spot prices (directional risk). These include:

(a) 'Basis risk', i.e., the risk that the relationship between the prices of similar commodities alters through time;
(b) 'Interest rate risk', i.e., the risk of a change in the cost of carry for forward positions and options; and
(c) 'Forward gap risk', i.e., the risk that the forward price may change for reasons other than a change in interest rates.
January 2015