Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

CAIA > 3.2 Commodities > Flashcards

3.2 Commodities Flashcards

1
Q

Julian Simon’s argument on director commodity returns. And reasoning for the argument

A

That prices for commodities decrease over time if inflation adjusted. Because of technology improvement.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Futures curve is in contango when?

How does it reflect in the prices?

A

Term structure is positive => Curve is upward sloping

Current prices are lower than futures prices

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Futures curve is in backwardation when?

How does it reflect in the prices?

A

Term structure is negative. Curve of the slope structure is downward sloping

Current prices are higher than futures prices

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is a calendar spread?

A

Difference between futures/forward contracts prices on same asset but with different settlement date

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What is a long calendar spread

A

Buy longer term option +

selling shorter term option

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is a short calendar spread?

A

Sell longer term option +

Buy shorter term option

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

In futures valuation, what does:
r, c, y stand for?

A

r = risk free rate
c = storage cost
y = convenience yield

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Steps in calculating a calendar spread

A

1) find the values of the futures (the long and short part)

2) if there is a change (storage costs increase, etc) => calculate the NEW futures price (for both the short & long part)

3) subtract the NEW (both the long and short part) from the INITIAL price of futures (of the long and short part)

4) subtract from the LONG option value the SHORT option value

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

All else equal, which of the following will result in a lower futures price?

I. An economy-wide decrease in the borrowing rate.

Il.Storage technology improvements lower spoilage rates.

III. Inclement weather halts production, leading to a higher spot price.

IV. A marked increase in storage capacity, resulting in lower storage costs.

A

1,2,4

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is cost of carry?

A

Costs of owning a security/physical commodity.

Usually: risk free interest rate + storage costs.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is the S&P GSCI? What does it consist of?

A

Benchmark for commodity investments.

24 physical Commodities: energy, metals, livestock, agriculture.

70% is energy.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What is the BCOM (type)? What does it consist of (number of commodities, sectors, limits)?

A

Bloomberg Commodity Index, market-LIQUIDITY WEIGHTED long only index.

23 commodities in 6 sectors: energy, grain, metals (precious and industrial), livestock, softs.

Upper limit of individual commodity of 15% and lower limit 2%

Upper limit of 33% on weight of each commodity sector

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is a liquidity weighted index?

A

The index is weighted based on trading activity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

4 sources of futures returns:

A

1) Excess return - return from changes in futures prices. Percentage change in futures contract

2) Spot return - change in spot price

3) Collateral yield (return) - risk free rate

4) Roll return (yield) - return on a futures position resulting from a change in contract basis

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is convergence

A

The movement of futures price toward spot price as the delivery date approaches

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is the basis of a futures/forward contract?

A

Basis = Spot price - Futures price (most common)

OR

Basis = Futures price - Spot price

I.e. difference between sport and futures price

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

Formula for Return on a Fully collateralized futures position:

A

R = collateral yield + spot return + Roll Return

OR

R = collateral yield + excess return

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is perfectly elastic and inelastic supply? How does it impact convenience yields?

A

Perfectly Elastic supply = quantity demand can be immediately supplied without changes in market price. Convenience yield is low.

Inelastic supply = quantity supplied changes slowly in response to market prices. The convenience yield is high.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What is inelastic demand? Impact on the convenience yield?

A

The demand does not change significantly in relation to changes in price.

Convenience yield is low.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What is a fully collateralized position in a futures contact?

A

Unleveraged position, the cash needed to settle the contract is posted in form of short term risk free bonds (t bills)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

3 primary sources of basis risk?

A

1) carry costs are different from the costs implied by basis => basis does not reflect actual carrying costs => indicates informational inefficiency in the pricing of the futures contract

2) convenience yield from the spot position differs from its storage cost

3) basis changes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is normal backwardation?

A

Forward price is believed to be less than EXPECTED spot price at EXPIRATION

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What is Normal Contango?

A

Forward price is expected to exceed expected spot price at expiration.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What is Hotelling’s theory?

A

Prices of exhaustible commodities SHOULD INCREASE by the prevailing NOMINAL INTEREST RATE. Perhaps with a risk premium.

=

Should grow at a risk adjusted nominal rate

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

What should the expected spot price be according to Hotelling’s theory?

A

Expected spot price = FV of current spot compounded at a nominal risk-less rate + risk premium

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

4 ways of getting exposure (invest in) to commodities (apart from futures)

A

1) physical ownership
2) equity related commodity investments
3) ETFs
4) Commodity linked notes (CLNs)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

What are CLNs?

A

Commodity linked notes. They are intermediate debt instruments.

Values of which at MATURITY are linked to performance of underlying commodity/basked of commodities.

AKA Commodity Backed Notes

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

Pros / cons of CLNs?

A

Pros:
1) investors dont need to rollover the futures contracts.
2) provide exposure through a debt instrument, which benefits funds that cant invest in futures

Cons:
1) CLNs contain issuing firm’s default risk
2) commodity producing CLN issuers can better match their assets and liabilities

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

2 types of CLNs

A

1) principally protected - CLN holders will get the guaranteed face value of the note at maturity + coupon.

2) non principally protected - no guarantee of face value of note. The face value and/or coupon payments are linked to the underlying security’s value => the investor shares in the upside or down side.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

CLNs vs Bond (plain vanilla) coupon/face value payments.

A

CLN coupon payments are usually lower because of ability to potentially earn more because of price fluctuations.

Face value can also change in CLN. As it is tied to the commodity’s value.

31
Q

Which option does a CLN have imbedded and why?

A

Call option. Because is the price increases the holders of principal protected CLNs also get more. If the price decreases they get the face value + coupon.

32
Q

When does the CLN payout the increase in the commodity’s value?

A

If the value of commodity increase past a certain level

=

higher than strike price.

33
Q

What is included in the principal repayment?

A

Principal + appreciation (if there is an increase above strike)

34
Q

What is the difference between normal backwardation and backwardation?

A

Normal = difference in futures price and expected future spot price

Regular = difference in futures price and current spot price

35
Q

Drawbacks of commodity related equity investments

A

1) companies usually hedge their commodity exposure

2) commodity equities are exposed to 2 betas: commodity & equity market (which is not good for equity market diversification)

3) companies are exposed to several idiosyncratic risks

36
Q

What is an ETN? How does it work? What are the risk?

A

Exchange traded note.

A bank issues a bond like debt instrument that pays out returns on a portfolio it is linked to (i.e. which portfolio the note tracks). There a no coupons, only payment based on return of a tracked portfolio at maturity.

Credit risk of issuing bank.

37
Q

When is CLNs coupon rate the lowest?

A

When it is the closest to being in the money

38
Q

Slope and shape of forward curve is driven by?

A

Carrying costs

39
Q

In a perfect market, slope of forward curve for financial forward contract is driven by?

A

Interest rates & Dividends

40
Q

In a perfect and informationally efficient market, contango and backwardation occur to prevent what?

A

Arbitrage opportunities if forward curve is flat, when r≠q (risk free rate ≠ dividend yield)

41
Q

When is market upward sloping (in contango)?

A

When risk free rate > dividend yield

42
Q

When is the market downward sloping (in backwardation)?

A

When the risk free rate < dividend yield

43
Q

3 issues that hinder arbitrage activity that insures relationship between carrying costs and shape of forward curve?

A

1) different storage costs
2) different convenience yields
3) difficulty in short selling commodities

44
Q

What happens to basis at maturity? Why?

A

Basis = 0, because at maturity the forward price always converges to spot price

45
Q

In informationally efficient market, if you are short forward and long the spot, what it your expected return?

A

Cost of carry

46
Q

Description of Thomson Reuters Core Commodity CRB Index

A

Designed to reflect importance of each commodity to world development

19 physical commodities

Tier weighted

Tier 1 commodities = 33%, Tier 2 = 42%, Tier 3 = 20%, Tier 4 = 5%

47
Q

4 reasons for a negative relationship between commodity and stock/bond prices (financial assets)

A

1) price determined by different factors:
Commodity: supply/demand, FA: PV of future cashflows

2) Different correlation between prices & inflation: Commodity increases with inflation, FA: decreases

3) Different performance at different parts of the business cycle

4) Effect of prices on earnings (FA)

48
Q

In a CAPM based perfect market, what is the optimal weight to allocate to a specific commodity?

A

The % of the total value of an asset relative to the total value of all assets globally.

If gold = 1% of total value of global assets => investors should hold 1% of their portfolio in gold

49
Q

What is Empirical evidence on long run commodity price changes?

A

They do not rise at the riskless nominal rate. Some have even declined

50
Q

Why Keynes believed futures markets should be in normal backwardation?

A

1) because commodity producers have an incentive to fix their sales (enter futures now at a lower price)

2) commodity users generally buy at spot prices because of Liquidity preference theory

51
Q

Description of a humped curve in a forward market?

A

Is in contango for shorter maturities and backwardation for longer maturity contracts.

This is typical for commodities.

52
Q

Relationship of Commodities in imperfect market conditions? In practice

A

Commodities can serve as diversifiers with good returns

It is not obvious that market participants should hold any amount of commodities.

Therefore, the amounts of commodities are the amounts that provide the most risk adjusted returns

53
Q

Relationship between UNEXPECTED inflation and commodities?

A

Commodities provide protection agains unexpected inflation because they react to supply/demand

54
Q

A significant decline in supply of oil with have what effect on the returns of commodities and financial assets?

A

Commodities return will increase

Financial asset return will decrease, because commodities are often costs for financial assets

55
Q

What is roll return?

A

Return on futures position resulting in change of basis (spot - futures)

56
Q

What is excess return?

A

Return from changes in futures price (which is made up of spot return and change in basis)

57
Q

Futures price formula in a cost of carry mode with simple interest rate

A

Futures price = Spot commodity price + Carry costs

58
Q

A commodity futures index for which the face values of the underlying futures contracts are entirely collateralized by
Treasury bills is generally referred to as?

A

Unleveraged futures

59
Q

The current spot price of gold is $107, the expected future spot price of gold is $108, and the current futures price of gold is $106. Which of the following is true of the environment for gold? Why?

A

Backwardation = futures price < spot

ALSO

Normal Backwardation = futures price < expected spot price at expiration

60
Q

What is the state of the market for each of these:
A) F> St
B) F < E(S at time T)
C) F > E(S at time T)
D) F < St

A

A) contango
B) normal backwardation
C) Normal contango
D) backwardation

61
Q

Major economic events usually have what affect on commodity returns?

A

Large positive commodity returns occur more often than large negative commodity returns

62
Q

What is rolling up/down?

A

Rolling up: the price of futures rolls UP to converge with the Spot price = backwardation market

Rolling up: the price of futures rolls DOWN to converge with the Spot price. = Contango market

63
Q

In informationally efficient market what is the relationship between absolute value of basis and absolute value of carrying costs?

A

They are equal

64
Q

In informationally efficient market, roll yield of a financial futures contact is _______ to contract’s cost of carry

A

Equal

65
Q

Excess return =

A

Difference in futures prices

66
Q

3 issues regarding roll returns?

A

1) roll return is not generated when one position is closed and new is opened. (It is generated by calculating the difference between price when the forward was entered and closed)

2) roll return is positive in backwarded markets if carry costs and term structure dont change

3) position with positive roll return does not imply its total returns are superior

67
Q

Roll return is usually positive for which futures contracts?

A

Futures contracts on financial assets with dividend yields that exceed risk free rate

68
Q

What was the volatility, sharpe ratio, max drawdown, partial autocorrelation, max calendar-month loss for commodities VS global equities?

A

Volatility: moderately higher than GE

Sharpe ratio: negative vs positive for GE

Max drawdown: very large (significantly larger than GE)

Partial autocorrelation: moderately positive 1st order

Max calendar-month loss: around 30%, which is 1.5x higher than GE

69
Q

What are the 2 types of options in an option based term structure model?

A

1) option to extract commodity
2) option to store inventory

70
Q

What is asymmetry in volatility of commodity prices?

A

Prices are more volatile when there is a shortage => when prices are increasing.

This is because shortages are more of an issue that over supply

71
Q

What is the conclusion from asymmetric volatility?

A

Holding a physical commodity is more preferable than long & short term contracts

72
Q

Can

1) backwardation
2) normal backwardation
3) contango
4) normal contango

be observed?

A

1) yes
2) no
3) yes
4) no

73
Q

Working curve definition

A

Describes positive relationship between slope of forward curve & current inventory levels.

74
Q

What theory does the working curve describe?

A

Theory of storage: low inventory = downward slope, high inventory = upward sloping forward curve

CAIA (14 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions