Commodities: Applications and Evidence Flashcards Preview

CAIA Level 1 2020 march > Commodities: Applications and Evidence > Flashcards

Flashcards in Commodities: Applications and Evidence Deck (29)
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1
Q
  1. List four explanations that commodities should help diversify a portfolio of traditional assets.
A
  • Unlike financial securities, commodities have prices that are not directly determined by the discounted value of future cash flows
  • More so than traditional asset prices, nominal commodity prices should be positively correlated with inflation largely because commodity prices form part of the definition and computation of inflation
  • Commodity price changes may be negatively correlated with the returns to stocks and bonds is that they may react very differently at different parts of the business cycle
  • Low or negative correlation between commodity prices and financial assets is based on commodities being a major cost of corporate production and thus consistent with lowered corporate profits.
2
Q
  1. In an inflationary environment, would the real price of a commodity in 2015 based on 2010 prices be expected to be higher or lower than its nominal price in 2015?
A

• Lower. The 2015 real price of a commodity is adjusted for inflation and would roughly approximate its 2010 nominal price, whereas inflation would tend to cause the nominal 2015 price to be higher than the 2010 nominal price.

3
Q
  1. Consider an investor with a portfolio of risky assets in an economy in which markets are in the perfect equilibrium of the capital asset pricing model. What would determine the investor’s allocation to commodity X?
A

• The market weight. The market weight of commodities is equal to the percentage of the total global value of commodities relative to the total global value of all assets.

4
Q
  1. Would inflation risk tend to be higher in an economy with high inflation? Why?
A

• Yes, though not necessarily. Inflation risk emanates from the divergence between realized and anticipated rates of inflation, known an unanticipated inflation. When anticipated inflation rates are high, unanticipated rates of inflation would also tend to be high.

5
Q
  1. Consider an economy in which markets are in equilibrium. If commodities offer diversification benefits and protection against inflation risk, would the expected return of commodity investments tend to be high or low?
A

• If markets are perfect and in equilibrium, market participants should expect receiving lower returns in exchange for enjoying lower risk. Thus, if commodities have substantial risk benefits they should tend to offer lower expected returns.

6
Q
  1. In the context of analyzing the returns of futures contracts, what is excess return?
A

• The excess return of a futures contract is the return generated exclusively from changes in futures prices. The term “excess return” is used elsewhere in investment with a different meaning: the total return minus the riskless rate.

7
Q
  1. What is the definition of roll return that is earned through holding futures contracts?
A

• Roll return or roll yield from holding futures contracts is defined as the portion of the return of a futures position attributable only from the change in the contract’s basis through time.

8
Q
  1. What is the primary reason that causes a commodity futures market to be in contango or backwardation?
A

• The term structure takes on a positive or negative slope (contango or backwardated) based on carrying costs so that the risk-adjusted returns of spot positions and fully-collateralized futures positions will tend to be equal.

9
Q
  1. What happens to the basis of a futures contract as the contract approaches and reaches settlement?
A

The basis of a futures contact or forward contract tends towards being zero at settlement (convergence).

10
Q
  1. List three important propositions regarding the accrual of roll return through holding futures contracts through time.
A
  • Proposition 1: Roll return is not generated at the time that one position is closed and a new position is opened.
  • Proposition2: Realized roll return is not necessarily positive when markets are backwardated.
  • Proposition3: A position that generated a positive roll return does not indicate that the position’s total returns were superior (i.e., that there was alpha).
11
Q

basis risk

A

is the dispersion in economic returns associated
with changes in the relationship between spot prices and
futures prices.

12
Q

The Bloomberg Commodity Index (BCOM)

A

formerly the
Dow Jones-UBS Commodity Index, is a long-only index
composed of futures contracts on 22 physical commodities.

13
Q

collateral yield

A

is the interest earned from the riskless bonds
or other money market assets used to collateralize the futures
contract.

14
Q

commodity-linked note

A

(CLN) is an intermediate-term
debt instrument whose value at maturity is a function of the
value of an underlying commodity or basket of
commodities.

15
Q

convergence at settlement

A

is the process of the futures price
nearing the spot price as settlement approaches, and the two
prices matching each other at settlement.

16
Q

excess return of a futures contract

A

The return generated exclusively from changes in futures

prices is known as this.

17
Q

fully collateralised position

A

is a position in which the cash
necessary to settle the contract has been posted in the form of
short-term, riskless bonds.

18
Q

heterogeneous

A

value differs across one or more dimensions.

19
Q

inflation

A

is the decline in the value of money relative to the

value of a general bundle of goods and services.

20
Q

inflation risk

A

is the dispersion in economic outcomes caused

by uncertainty regarding the value of a currency.

21
Q

investable index

A

has returns that an investor can match
in practice by maintaining the same positions that constitute
the index.

22
Q

nominal price

A

refers to the stated price of an asset

measured using the contemporaneous values of a currency.

23
Q

production-weighted index

A

weights each underlying
commodity using estimates of the quantity of each
commodity produced.

24
Q

real price

A

refers to the price of an asset that is adjusted
for inflation through being expressed in the value of currency
from a different time period.

25
Q

Reuters/Jefferies Commodity Research Bureau (CRB)

Index

A

is the oldest major commodity index and is currently

made up of 19 commodities traded on various exchanges.

26
Q

roll yield or roll return

A

is properly defined as the portion of
the return of a futures position from the change in the
contract’s basis through time.

27
Q

roll yield or roll return

A

is properly defined as the portion of
the return of a futures position from the change in the
contract’s basis through time.

28
Q

spot return

A

is the return on the underlying asset in the spot

market.

29
Q

The Standard & Poor’s Goldman Sachs Commodity Index

S&P GSCI

A

is a longonly index of physical commodity

futures.