What is a basis swap and what is basis risk?

• A. A basis swap exchanges fixed payments for floating payments; basis risk is that rates move together.
• B. A basis swap exchanges cash flows tied to two different floating rates or indices; basis risk is the risk that the two indices diverge, causing imperfect hedges.
• C. A basis swap exchanges currencies.
• D. A basis swap is a type of option.

Answer: (B)