FIN.14:5.4 - Basis and contractual floors leave different residuals

A manufacturer plans to buy 100 commodity units. The physical price is a traded reference plus a local basis. Initially those amounts are 50 and 5 per unit, and the initial futures price is also 50. A perfectly performing futures offset gains the increase in that reference on 100 units, with margin funding assumed available. At purchase, the reference is 60 but local basis is 9: physical cost is 6,900 and the hedge gain is 1,000, leaving net cost 5,900. The initial implied cost was 5,500. The residual 400 comes from the local basis, which the selected contract does not fix. Changing physical quantity also requires recomputing the offset amount.

For the rate example above, change the debt to pay max(reference, 0) + 2%, while the swap still receives the unfloored reference and pays fixed 4%. At a reference of 3%, total debt and swap cost is 5% + 1% = 6%. At a reference of −1%, debt costs 2% and the swap costs 5%, giving 7%. The debt floor defeats the claimed constant 6% even though notional and dates still match. A change in the loan’s credit spread can leave another residual; matching the base reference does not fix that spread.