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CAIA Fundamentals > Commodities1 - market; inflation > Flashcards

Commodities1 - market; inflation Flashcards

1
Q

Capacity is

A

the limit on the quantity of capital that can be deployed without substantially
diminished performance.

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2
Q

Inflation

A

is the decline in the value of money relative to the value of a general bundle of goods and services, such as oil.

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3
Q

Cash market

A

is any market in which transactions involve immediate payment and delivery: The Buyer immediately pays the price, and the seller immediately delivers the product.

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4
Q

Indirect commodity investments

A

are the most common method of obtaining commodity exposure involving equity, fixed income, and derivative instruments.

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5
Q

Counterparty risk

A

is the uncertainty associated with the economic outcomes of one party to a contract due to potential failure of the other side of the contract to fulfill its obligations, presumably due to insolvency or illiquidity.

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6
Q

Storage costs of physical commodities

A

involve such expenditures as warehouse fees, insurance, transportation, and spoilage.

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7
Q

Inflation risk

A

is the dispersion in economic outcomes caused by uncertainty regarding the value of a currency.

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8
Q

Inflation beta

A

is analogous to a market beta except that an index of price changes is used in place of the market index, creating a measure of the sensitivity of an asset’s returns to changes in inflation.

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9
Q

Expansion stage,

A

also called the development capital stage, is the stage of a company, when the firm may or may not have reached profitability, but has already established the technology and market for its new product.

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10
Q

Selective hedging

A

is the attempt to add value by market-timing the degree to which risk is hedged.

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11
Q

Commodity index swap

A

is an exchange of cash flows in which one of the cash flows is based on the price of a specific commodity or commodity index, whereas the other cash flow is fixed.

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12
Q

Duration

A

is a measure of the sensitivity of a fixed-income security to a change in the general level of interest rates.

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13
Q

Portable alpha

A

is the ability of a particular investment product or strategy to be used in the separation of alpha and beta.

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14
Q

Master limited partnerships, or MLPs,

A

are publicly traded investment pools that are structured as limited partnerships and that offer their owners pro rata claims. MLPs are frequently used to hold infrastructure assets, especially for energy distribution.

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15
Q

Prepaid forward contracts

A

are fully collateralized forward contracts for delivery.

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16
Q

Principal-guaranteed notes

A

are structured products that offer investors the upside opportunity to profit if commodity prices rise, combined with a downside guarantee that some, or potentially all (depending on the note’s terms), of the principal amount will be returned at the maturity of the structure.

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17
Q

Backwardation When the slope of the term structure of forward prices

A

is negative, the market is in backwardation, or is backwardated.

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18
Q

Contango

A

When the term structure of forward prices is upward sloping (i.e., when more distant forward contracts have higher prices than contracts that are nearby), the market is said to be in contango.

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19
Q

Normal backwardation

A

is when the forward price is believed to be below the expected spot price.

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20
Q

Normal contango

A

is when the forward price is believed to be above the expected spot price.

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21
Q

Roll yield or roll return

A

is the portion of the return of a futures position that results from the change in the contract’s basis through time.

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22
Q

Spot return

A

is the return on the underlying asset in the spot market.

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23
Q

Basis in a forward contract

A

is the difference between the spot (or cash) price of the referenced asset, S, and the price (F) of a forward contract with delivery T.

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24
Q

Market impact

A

is the degree of the short-term effect of trades on the sizes and levels of bid prices and offer prices.

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25
Q

Index products

A

take little or no active risk, extract no added value, and are not expected to generate active return.

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26
Q

The main benefits of commodities as an asset class

A

1) equity-like returns with comparable risk,
2) inflation protection
3) low correlation to traditional investments.

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27
Q

assets that show a positive correlation to inflation / have a positive inflation risk exposure

A

real assets and commodity futures including

timberland, farmland, real estate, inflation bonds, and commodity futures.

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28
Q

reason commodities serve as a good inflation hedging tool

A

commodities comprise a significant portion of the goods and services that are factored into the calculation of inflation indices. As can be seen in the composition of the U.S. Consumer Price Index, commodities directly contribute 22% to the index value, while other goods and services contribute 33%, housing: 33%, and medical and education: 10%. It is important to keep in mind that commodities that serve as production inputs also indirectly factor into the value of the other three categories of goods and services comprising the U.S. Consumer Price Index.

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29
Q

why the behavior of commodity prices is distinct from that of financial assets.

A

due to the 4 commodity specific characteristics :

1) valuation (commodity prices are not directly determined by the discounted value of future cash flows)
2) relationship with inflation (positive correlation)
3) behavior during the business cycle The value of stocks and bonds is derived from expectations regarding long-term earnings or coupon payments, whereas commodities tend to be priced on the state of current economic conditions. Early expansion stage commodities-low, stocks -high, and reverse at late expansion stage )
4) relationship with production.

30
Q

types of indirect commodity ownership

A

equity and fixed-income investments.

31
Q

types of indirect commodity ownership

A

Commodity-based equity and fixed-income investments

32
Q

commodity direct ownership (dis)advantage

A 
disadvantage
1.storage cost 
2.spoilage
3.transportation 
4. weak correlation with inflation 
advantage 
1. convenience yield
33
Q

indirect commodity ownership via publicly traded equities

dis/advantages

A

dis-

  1. depending on the commodity type low correlation with the underlying commodity
  2. companies tend to hedge commodity exposure
  3. systematic and idiosyncratic risks

advantage;

  1. straightforward exposure
  2. already embedded into portfolio
34
Q

commodity firm bonds

A

dis-
1. high-grade bond- low correlation with commodity
2. high-yield bond - high exposure to commodity
ad-
1. straightforward exposure
2. already embedded into portfolio

35
Q

high-yield bonds

A
  • pay higher interest rates
  • lower credit ratings vs investment-grade bonds.;
  • higher default risk
36
Q

high-grade bonds/investment-grade bond

A
  • lower risk of default
  • higher credit ratings from credit rating agencies (ex: Baa by Moody’s, BBB by S&P and Fitch)
  • issued at lower yields than less creditworthy bonds
37
Q

commodity index swaps

A

Ad

  1. competitive mkt making
  2. control over the cash

dis-

  1. accessible by highly creditworthy investors only
  2. secondary mkt illiquid
  3. counterparts risk
38
Q

Commodity-based Mutual funds and ETFs

A

they use one of 4 types of exposure

  1. commodity index funds or swaps
  2. equities of commodity-based companies
  3. physical commodities
  4. commodity futures
39
Q

commodity-based mutual funds vs ETFs

A 
MF
1. passive /active structure 
2. fees and costs structures
ETFs
1. trade on organized exchanges 
2. lower fees
3. higher liquidity , easily arbitraged 
4. faster growth
5. equity vs futures-based ETF
40
Q

features partnerships

A
  1. Public & Private Partnerships
    - pass-through securities (taxes advantages) at corp. level
    - underlying exposure
  2. MLP(master-limited-partnership)
    - avoid corp. taxation
    - 90% energy related
    - midstream vs upstream assets
    - fast asset growth
41
Q

commodity debt

A

ETN (exchange-traded-notes)

  • zero-coupon debt instrument
  • credit risk exposure
  • tax treatment
  • contractually set relationship with the underlying index
  • accessible by investors prohibited to invest in futures
42
Q

commodity-based hedge funds

A
  1. active managers
    - futures-based
    - manager compensation tied to benchmark
    - short lockups
    - high transparency and liquidity
  2. HF involved in physical markets
    - engaged in purchase, storage, transportation
    - specialize in specific commodity
    - long lockups
    - illiquid
    - long notice periods
43
Q

Fundamental directional strategies

A

implement allocations based on an analysis of the

underlying supply-and-demand factors for commodities or commodity sectors.

44
Q

Quantitative directional strategies

A

use technical or quantitative models to identify overpriced and underpriced commodities based on spot price forecasts or mispriced futures term structures.

45
Q

Price momentum

A

is trending in prices such that an upward price movement indicates a higher expected price and a downward price movement indicates a lower expected price.

46
Q

Mean-reverting

A

refers to the situation in which returns show negative autocorrelation—the opposite tendency of momentum or trending.

47
Q

Commodity spreads

A

Commodity spreads are strategies that seek to take advantage of trading opportunities based on relative commodity prices that can be executed entirely in derivatives markets.

48
Q

Calendar spreads

A

Calendar spreads can be viewed as the difference between futures or forward prices on the same underlying asset but with different settlement dates.

49
Q

Synthetic weather derivative

A

is a derivative position with returns that are substantially driven by weather conditions.

50
Q

Bull spread

A

is an option combination in which the long option position is at the lower of two strike prices, which offers bullish exposure to the underlying asset that begins at the lower strike price and ends at the higher strike price.

51
Q

Bear spread

A

is an option combination in which the long option position is at the higher of two strike prices, which offers bearish exposure to the underlying asset that begins at the higher strike price and ends at the lower strike price

52
Q

Forward curve

A

is the relationship between time-to-delivery and commodity futures contract prices.

53
Q

Processing spreads

A

seek to take advantage of the relative price difference between a commodity and the products the commodity produces.

54
Q

Substitution spreads

A

are trades between commodities that can be substituted for one another in terms of either production or consumption.

55
Q

Quality spreads

A

are similar to substitution spreads, except that the spread is across different grades of the same commodity.

56
Q

Location spreads

A

are trades that involve the same commodity but different delivery and storage locations.

57
Q

Scale differences

A

are when investments have unequal sizes and/or timing of their cash flows.

58
Q

Correlation trade

A

is a trade with an outcome that is driven by the statistical correlation between
two values, such as when the values of two commodities differ by location.

59
Q

Headline risk

A

is dispersion in economic value from events so important, unexpected, or
controversial that they are the center of major news stories.

60
Q

Commodity rights

A

reflect the current value of untapped commodity assets, such as oil reserves

61
Q

Enterprise value

A

is the residual value of corporate assets, equal to common equity plus preferred stock plus debt less cash and other non-operating assets.

62
Q

S&P GSCI

A

is a long-only index of physical commodity futures.

63
Q

Quantity-based index

A

Quantity-based index holds a fixed quantity of contracts for each commodity, so that the index
weights change each day in terms of percentage of value as futures prices change.

64
Q

Total-return index

A

is a fully collateralized investment strategy, with the collateralization generally taking the form of Treasury bills.

65
Q

Sovereign debt

A

is debt issued by national governments.

66
Q

Cost of carry, or carrying cost

A

in the context of futures and forward contracts, is any financial difference between maintaining a position in the cash market and maintaining a position in the forward market.

67
Q

Convenience yield

A

is the economic benefit that the holder of an inventory in the commodity receives from directly holding the inventory rather than having a long position in a forward contract on the commodity.

68
Q

Gearing

A

is the use of leverage.

69
Q

First-generation commodity indices

A

First-generation commodity indices tend to be heavily weighted in energy and hold long-only positions in front month contracts, rolling to the second month contracts regardless of the shape of the current term structure.

70
Q

Open interest

A

is the outstanding quantity of unclosed contracts.

71
Q

Tenor of an option or other contract

A

Tenor of an option or other contract is the length of time until the contract terminates.

CAIA Fundamentals (10 decks)

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