Basis risk

Basis risk is what is left after a hedge has done its job. It arises whenever the hedging instrument and the underlying exposure are not the same thing, which for a standardised contract is almost always. The mismatch can be in grade, in location, in timing or in currency, and each of them leaves a residual.

Grade and location are the commodity version. An exchange contract references a benchmark quality delivered to a benchmark point, while the exposure is a specific input consumed at a specific plant. The two prices are correlated and they are not identical, and the gap between them widens exactly when regional markets dislocate, which is when the hedge was supposed to be most useful.

Timing is the version that shows up in currency and rates. A hedge maturing in March against an exposure that settles in June leaves the company exposed across those three months, and rolling the hedge forward means accepting whatever the market is on the roll date.

The practical consequence is that a hedge described as covering the exposure in full rarely does. It is worth being explicit about this in an interview, because the candidate who says the hedge offsets the exposure completely is describing a textbook, while the one who names the residual and where it comes from is describing a business.