AI Intro to Commodity Futures Markets

Question 1

What are commodities?

Answer 1

Energy, Agriculture, Metals, Meats/Livestock

Question 2

How many % of global GDP are made up of commodities?

Answer 2

7%

Question 3

Are commodities volatile?

Answer 3

Yes, increasingly volatile

Question 4

Which problems does the volatility bring about?

Answer 4

• more volatile income of commodity producers
• more problems with planning production
• fiscal planning becomes more difficult

Question 5

What is a solution to the volatility problem?

Answer 5

Futures contracts: specify a price now for future selling of e.g. crops irrespective of the market price

Question 6

What is a futures contract?

Answer 6

• obligation to make or take delivery of the underlying asset at a predetermined time and price

Question 7

Long

Answer 7

• commitment to purchase the commodity on the delivery date

profit/loss Ft-Fo

Question 8

Short

Answer 8

• commitment to sell the commodity on the delivery date

profit/loss Fo-Ft

Question 9

spot market

Answer 9

The spot market or cash market is a public financial market in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market, in which delivery is due at a later date.

Question 10

Open interest

Answer 10

• the number of contracts outstanding
• most future contracts are closed out before delivery (>97%)
• spot market require storage capabilities

Question 11

What does it mean that futures are traded on margin?

Answer 11

• at the time the contract is entered into, no money changes thanks (zero-cost security)
• post margin, 5-15%

Question 12

Marking to market

Answer 12

Marking to market refers to the daily settling of gains and losses due to changes in the market value of the security.
Each day the profits or losses from the new futures price are paid or subtracted from the account

Question 13

Margin of futures contracts

Answer 13

Futures margin is a good-faith deposit or an amount of capital one needs to post or deposit to control a futures contract. The margin is a down payment on the full contract value of a futures contract.

Question 14

Good faith deposit

Answer 14

Good faith money is a deposit of money into an account by a buyer to show that he or she has the intention of completing a deal. Good faith money is often later applied to the purchase, but may be nonrefundable if the deal does not go through.

Question 15

Three ways to acquire commodity

Answer 15

1. Purchase it now and store it (Po)
2. Take a long position in future (Fo)
3. Wait and purchase in the future (Pt)

Question 16

Cost of Carry

Answer 16

Fo=Po(1+rf+c)

c= carrying costs in % (storage - convenience yield)

Question 17

Expectation hypothesis

Answer 17

• futures price versus expected future spot price

Fo = E(Pt) + risk premium

Question 18

How does the farmer hedge:

• she will have 20 bushels of wheat in 2021 and faces faces uncertainly about the price of the west at harvest time

Answer 18

• she should enter a short position in wheat futures

- this locks today’s price of wheat at which she can sell her harvest in July 2020

Question 19

What is the commodities future market regulated by?

Answer 19

By the Commodity Futures Trading Commission (CFTC)

Question 20

What does the CFTC do?

Answer 20

• sets capital requirements, position limits, requires information disclosure (commercial vs. non-commercial use of commodity)

Question 21

Who are hedgers?

Answer 21

Commercial

• exposed to underlying commodity
  e. g. commercial producers or consumers like oil companies, airline industry, farmers, jewelers

Question 22

Who are speculators?

Answer 22

Non-commercial

- no exposure to underlying commodity, never take the delivery

Question 23

Do contracts expire

Answer 23

yes.

–> create roll-over strategies that are every month in the shortest contract

Question 24

Are returns similar to those of U.S. equities?

Answer 24

Yes. Fully collateralized commodity futures historically offered similar returns and Sharpe ratios

Question 25

How are commodity futures correlated with stocks and bonds?

Answer 25

• negatively correlated

Question 26

How is the relation to inflation?

Answer 26

positive relation to inflation. This leads to the negative correlation to stocks and bonds

Question 27

Are commodity market prices more correlated with each other and the oil price now?

Answer 27

Yes. Concurrent (zugleich) with inflow of index investment in commodity markets prices of non-energy commodities became more correlated with oil prices.

Question 28

Result of financialization?

Answer 28

• prices of individual commodities are no longer determined solely by its supply and demand
• > prices reflect risk appetite for financial assets of commodity index investors
• -> increase in correlation between commodity markets and stock markets