Define “Cross-Hedging” and Explain Its Relation to Basis Risk.
Cross-hedging is the practice of hedging an exposure to one asset using a derivative contract on a different, but highly correlated, asset. For example, hedging a specific altcoin with a Bitcoin futures contract.
This technique inherently increases basis risk because the prices of the two different assets may not move perfectly together.
Glossar
Hedge Ratio
Calculation ⎊ The Hedge Ratio quantifies the necessary size of a derivative position required to offset the price risk inherent in an underlying asset or portfolio, representing the change in the derivative's price relative to the change in the underlying.
Underlying Asset
Futures Pricing incorporates the cost of carry, which in crypto markets includes funding rates derived from perpetual swap markets and the time value associated with holding the spot asset.
Bitcoin Futures
Settlement ⎊ These standardized, exchange-traded contracts obligate the holder to buy or sell a specific quantity of Bitcoin at a future date for a predetermined price, forming a critical component of regulated crypto derivatives markets.