Commodities

Question 1

Commodities and inflation

Answer 1

Strong for energy commods. Somewhat strong for metals. Positively related to inflation.

Interest rates and ag commods is negatively correlated and stronger than energy and metals.

Question 2

Risks commod firms exposed to

Answer 2

Flat price
Spread
Margin and volume
Funding
Liquidity
Basis. Difference between spot and futures.
Operational 
Market liquidity

Question 3

Convenience yield determined by:

Answer 3

Inventories -
Volatility (of spot prices) +
Increase in futures price -

Decreases the cost of carry

Question 4

Cash and carry arbitrage

Answer 4

Commods purchased in spot market, sold in futures.

Reverse - short spot market, long misprinted futures.

Question 5

Commodity forward curve

Answer 5

Positive relationship between slope of forward curve and cost of carry.

Question 6

Normal backwardation

Answer 6

Futures price trades below spot price due to producers preference to lock in profit but selling futures.

Forward curve is relationship between time to delivery and commod futures contract price.

Question 7

Cost of carry

Answer 7

Positive when convenience yield is zero or low. Contango market.

Negative when convenience yield is higher than costs of carry. Backwardation.

Question 8

Unbiased expectation theory

Answer 8

Current futures prices represent markets expectations of future spot prices.

Main problem with testing it is that the future spot price cannot be observed.

Question 9

Stock out

Answer 9

Storage drops to zero. Consumption is dependant on production and transportation

Question 10

Volatility asymmetry

Answer 10

Vol tends to be higher when prices are rising

Question 11

Total futures return

Answer 11

Spot return + collateral return + roll return

Question 12

Business cycles

Answer 12

Ags less sensitive to them, perform better in market downturn. Are more sensitive to interest rates.

Energy and industrials are more sensitive to inflation, tend to move with business cycle.

Question 13

Diversification return

Answer 13

Enhanced average or expected geometric mean return from rebalancing

Question 14

Calendar spread

Answer 14

Bull spread: long nearby leg and short distant leg.

Bear spread: short nearby leg, long distant leg.

Question 15

Leveraged ETFs and ETNs

Answer 15

Can decline in value even when the underlying is increasing due to daily rebalancing procedures.

Question 16

Bonds issued by commodity firms

Answer 16

High yield bonds will be more correlated to commodities in a similar way to equities. IG bonds have little to no correlation with commods.

Question 17

Principal guaranteed notes

Answer 17

Offer upside opportunity to profit if commod prices rise, combined with downside guarantee that some or all of the principal will be returned on maturity.

Question 18

Spot return

Answer 18

Return left over after accounting for roll return. Excess return - roll return.

Question 19

First generation commod index

Answer 19

Passive. Size and concentration of rolling from short to longer maturities in a short time frame makes them suboptimal.

Drag on performance when markets in contango.

Question 20

Total return index

Answer 20

Performance of fully collateralised portfolio, so includes the risk free asset return.

Question 21

Excess return index

Answer 21

Tracks performance of a portfolio of commodity futures contracts in excess of the risk free rate of return.

Grows before any index changes, rolls or change in no of contracts.

Question 22

Second generations index

Answer 22

Enhance returns through forward curve positioning to spread the roll period across points along the forward curve or to target different segments of the curve.

Question 23

Third generation index

Answer 23

Include active commodity selection which may be predicted in objective rules or could be discretionary.

Academic research says second and third generation outperform first generation.

Question 24

4 factors influence commodity index returns

Answer 24

Variability in collateral returns
Entry points
Exit points
Weights

Question 25

Roll yield/return

Answer 25

= excess return index - spot return

Return from a futures contract that is due to the change in basis over time. Is positive if futures curve slopes downward

Question 26

Value index

Quantity index

Answer 26

Holds contracts according to a fixed percent of the total index value.

Quantity holds fixed number of contracts. Allows weights to change daily as a % if value if futures price change.

Question 27

Commodity index return sources (8)

Answer 27

Commodity beta, roll return, spot return, dynamic asset allocation, diversification, weighting’s and maturity and collateral.