Investing in Commodities (Reading 67)

Exercise Problems:

1. When market participants expect the spot price of a commodity to be higher in the future, the commodity market is most likely said to be in:

A. contango.

B. full carry.

C. backwardation.

Ans: A;

A is correct because when a commodity market is in contango, futures prices are higher than the spot price because market participants believe the spot price will be higher in the future. When spot prices are above the futures price, the market is said to be in backwardation.

2. An investor might consider investments in commodities because, historically, commodity returns have had a higher positive correlation with:

A. inflation.

B. bond returns.

C. stock returns.

Ans: A;

A is correct because commodity returns have had a positive correlation with inflation, as opposed to their low to negative correlation with bond and stock returns.

3. The three main sources of return for commodities-related investments are:

A. collateral yield, roll yield, and spot price return.

B. collateral yield, convenience yield, and roll yield.

C. convenience yield, dividend yield, and spot price return.

Ans: A;

A is correct because the three main sources of return for a commodities investment are collateral yield, roll yield, and spot price return.

4. A commodity market is in contango when futures prices are:

A. lower than the spot price.

B. higher than the spot price.

C. the same as the spot price.

Ans: B;

B is correct. When a commodity market is in contango, futures prices are higher than the spot price because market participants believe the spot price will be higher in the future.

5. When investing in commodities through a collateralized commodity futures position, the return associated with rolling forward the maturity of a futures contract is referred to as the:

A. collateral yield.

B. spot price return.

C. convenience yield.

Ans: C;

C is correct because the roll or convenience yield is the return from rolling forward the maturity of the derivatives position. The roll yield can be either negative or positive.

6. When a commodity market is in contango, the roll yield is most likely :

A. zero.

B. positive.

C. negative.

Ans: C;

The roll yield when the market is in contango is negative.