CAIA - 22 - Key Concepts in Commodity Markets Flashcards
Effects of the business cycle vary across and within commodity sectors. For instance, responses to the business cycle are ___ for most energy commodities but quite ___ for agricultural commodities.
Effects of the business cycle vary across and within commodity sectors. For instance, responses to the business cycle are similar for most energy commodities but quite varied for agricultural commodities.
___ ___ is the main currency in which commodities are traded globally.
U.S. Dollar is the main currency in which commodities are traded globally.
The clearest relationship between commodity prices and the business cycle is with ___ and ___ ___.
The clearest relationship between commodity prices and the business cycle is with energy and industrial materials.
Factors that affect the relationship between commodity prices and the business cycle are:
- I___ ___
- C___ ___ ___
- I___
- D___.
Factors that affect the relationship between commodity prices and the business cycle are
- Interest rates
- Central bank policies
- Inflation
- Demand.
High ___ ___ ___increase the opportunity cost for investors who have commodities in storage
High real interest rates increase the opportunity cost for investors who have commodities in storage
High real interest rates ___ the incentive for extracting commodities today rather than tomorrow.
High real interest rates increase the incentive for extracting commodities today rather than tomorrow.
High real interest rates ___ the desire of companies to carry inventories.
High real interest rates decrease the desire of companies to carry inventories.
High real interest rates ___ investors to move out of commodity contracts into fixed-income instruments.
High real interest rates encourages investors to move out of commodity contracts into fixed-income instruments.
High real interest rates ___ the market price of commodities.
High real interest rates reduce the market price of commodities.
At times, commodity prices can still decline in a low interest rate environment. This was demonstrated in 20___-___ and was due to the ___of the ___in commodities.
At times, commodity prices can still decline in a low interest rate environment. This was demonstrated in 2014-16 and was due to the maturation of the supercycle in commodities.
When a central bank adopts a contractionary monetary policy to try and fight inflation, the short-term real interest rate ___, which causes commodity prices to ___.
When a central bank adopts a contractionary monetary policy to try and fight inflation, the short-term real interest rate increases, which causes commodity prices to decline.
High inflation ___ prices of commodities. This is driven by investors seeking an ___ ___and also usually during expansionary phases of the economy when demand for ___ ___is higher.
High inflation increases prices of commodities. This is driven by investors seeking an inflation hedge and also usually during expansionary phases of the economy when demand for commodity inputs is higher.
___ ___effects dominate the pricing relationship for agricultural and livestock commodities, while ___dominates the pricing relationship for energy-based commodities and industrial metals.
Interest rate effects dominate the pricing relationship for agricultural and livestock commodities, while inflation dominates the pricing relationship for energy-based commodities and industrial metals.
According to the ___ ___, prices of exhaustible commodities should increase at the prevailing interest rate.
According to the hotelling theory, prices of exhaustible commodities should increase at the prevailing interest rate.
The hotelling theory (is/is not) consistent with empirical data.
The hotelling theory is not consistent with empirical data.
The hotelling theory assumes that production costs (do/do not) change.
The hotelling theory assumes that production costs do not change.
Unpredictable changes in ___ for a commodity may cause commodity prices to change at rates that differ from the prevailing interest rate.
Unpredictable changes in demand for a commodity may cause commodity prices to change at rates that differ from the prevailing interest rate.
Commodity ___ refer to long periods of increasing commodity prices followed by long periods of decreasing prices cause by supply shocks. Evidence suggests that they last ___-___years.
Commodity supercycles refer to long periods of increasing commodity prices followed by long periods of decreasing prices cause by supply shocks. Evidence suggests that they last 30-40 years.
Non-oil supercycles follow ___.
Non-oil supercycles follow GDP.
The average of each supercycle of non-oil commodities tends to be ___ than that of the previous cycle.
The average of each supercycle of non-oil commodities tends to be lower than that of the previous cycle.
___ ___had the strongest and steepest long-term downward trend during the 20th century, followed by ___-___ ___ and ___. In contrast, real ___prices had a long-term upward trend.
Tropical agriculture had the strongest and steepest long-term downward trend during the 20th century, followed by non-tropical agriculture and metals. In contrast, real oil prices had a long-term upward trend.
Between 2003 and 2008, real prices of energy, metals and food commodities ___ significantly.
Between 2003 and 2008, real prices of energy, metals and food commodities increased significantly.
The current supercycle expansion can be attributed to ___.
The current supercycle expansion can be attributed to China.
Commodity trading firms, in pursuing trading profits, serve as ___ of ___.
Commodity trading firms, in pursuing trading profits, serve as agents of transformation.
Trading firms transform commodities in 3 ways:
- ___
- ___
- ___
Trading firms transform commodities in 3 ways:
1. Space
2. Time
3. Form
___ transformations generally involve transporting commodities from regions where they are produced to regions in which they are consumed.
Spatial transformations generally involve transporting commodities from regions where they are produced to regions in which they are consumed.
If a firm buys a commodity to store it for future delivery, they are engaging in a ___ transformation.
If a firm buys a commodity to store it for future delivery, they are engaging in a time transformation.
If a firm takes a raw material and transforms it into another product, they are engaging in a ___ transformation.
If a firm takes a raw material and transforms it into another product, they are engaging in a form transformation.
___ ___risk refers to risk associated with changes in spot commodity prices.
Flat price risk refers to risk associated with changes in spot commodity prices.
Commodity trading firms typically have (a lot/little) exposure to flat price risk.
Commodity trading firms typically have little exposure to flat price risk.
___ risk refers to a change in the difference between the price of the commodity being hedged and the price of the hedging instrument.
Basis risk refers to a change in the difference between the price of the commodity being hedged and the price of the hedging instrument.
___ risk arises from timing mismatches between a commodity and its hedging instrument.
Spread risk arises from timing mismatches between a commodity and its hedging instrument.
___ and ___traded are positively correlated and tend to increase with demand. This can be a risk if firms are dependent on profitability based on these metrics.
Margin and volumes traded are positively correlated and tend to increase with demand. This can be a risk if firms are dependent on profitability based on these metrics.
The risk that a train breaks down for a commodity transported by rail is an example of ___ risk.
The risk that a train breaks down for a commodity transported by rail is an example of operational risk.
Commodity trading firms that need to enter and exit positions quickly may be exposed to ___ risk.
Commodity trading firms that need to enter and exit positions quickly may be exposed to liquidity risk.
___ ___risk arises due to limits on access to financing.
Funding liquidity risk arises due to limits on access to financing.
Many commodity transactions have ___ leverage.
Many commodity transactions have high leverage.
European inflation is ___ correlated with energy returns while asian inflation is ___correlated with energy returns.
European inflation is positively correlated with energy returns while asian inflation is negatively correlated with energy returns.
Speculators are generally subject to ___ ___to ensure their actions do not drive commodity prices away from fundamental supply-and-demand-based levels.
Speculators are generally subject to position limits to ensure their actions do not drive commodity prices away from fundamental supply-and-demand-based levels.
___ ___in commodities refers to buying a commodity with the expectation that its price will increase.
Price speculation in commodities refers to buying a commodity with the expectation that its price will increase.
Changes in spot prices and volatility have been attributed to the ___ of ___.
Changes in spot prices and volatility have been attributed to the financialization of commodities.
Prices have ___ for commodities that have not developed futures markets or institutional fund investments.
Prices have increased for commodities that have not developed futures markets or institutional fund investments.
Markets in which index trading is greatest as a percentage of open interest have experienced ___ prices.
Markets in which index trading is greatest as a percentage of open interest have experienced decreasing prices.
Speculation in agriculture and oil markets has remained ___.
Speculation in agriculture and oil markets has remained stable.
A report by the G20 on commodity speculation indicated that increased participation in these markets has ___ market liquidity and ___correlation.
A report by the G20 on commodity speculation indicated that increased participation in these markets has increased market liquidity and increased correlation.
Most commodity investing is performed directly or indirectly using ___ and ___.
Most commodity investing is performed directly or indirectly using futures and forwards.
___ ___are the key environment for price discovery in most commodity markets.
Futures markets are the key environment for price discovery in most commodity markets.
The ___ of ___explains the relationship between spot and futures prices of commodities by examining commodity inventory levels and the benefit of holding physical commodities.
The theory of storage explains the relationship between spot and futures prices of commodities by examining commodity inventory levels and the benefit of holding physical commodities.
The economic benefit of physically owning an asset is referred to as the ___ ___.
The economic benefit of physically owning an asset is referred to as the convenience yield.
The ___ ___provides a non-monetary measure of how much a buyer would pay to avoid the inconvenience of ordering and waiting for delivery of new inventory.
The convenience yield provides a non-monetary measure of how much a buyer would pay to avoid the inconvenience of ordering and waiting for delivery of new inventory.
The convenience yield my be viewed in terms of an embedded ___ ___associated with owning a commodity, since the holder of the commodity can decide how to use it.
The convenience yield my be viewed in terms of an embedded timing option associated with owning a commodity, since the holder of the commodity can decide how to use it.
All real assets have a convenience yield, which depends in part on inventory levels. As inventories decline, the convenience yield ___.
All real assets have a convenience yield, which depends in part on inventory levels. As inventories decline, the convenience yield increases.
Market prices can be used to measure ___ ___ ___, which is the convenience yield that matches buyers and sellers.
Market prices can be used to measure marginal convenience yield, which is the convenience yield that matches buyers and sellers.
Buyers with higher convenience yields earn a ___ ___.
Buyers with higher convenience yields earn a consumer surplus.
A commodity’s convenience yield is often considered comparable to a ___ ___.
A commodity’s convenience yield is often considered comparable to a stock dividend.
The level of convenience yield depends on 3 factors:
- ___ ___
- ___ ___
- ___ ___
The level of convenience yield depends on 3 factors:
1. Inventory level
2. Commodity price
3. Futures price
Inventory levels are ___ correlated with volatility of commodity prices and with convenience yield.
Inventory levels are negatively correlated with volatility of commodity prices and with convenience yield.
Commodity prices are ___ correlated with volatility and convenience yield.
Commodity prices are positively correlated with volatility and convenience yield.
Convenience yield is ___ correlated with speculative increases in futures prices.
Convenience yield is negatively correlated with speculative increases in futures prices.
The ___ of ___represents the unrecoverable cost of buying and storing a commodity and is composed of four key components.
The cost of carry represents the unrecoverable cost of buying and storing a commodity and is composed of four key components.
The four key components of carry are:
- ___ costs
- ___costs
- ___
- ___ ___
The four key components of carry are:
- Financing costs
- Storage costs
- Spoilage
- Convenience yield
Cost of Carry = (equation)
Cost of Carry = Financing Cost + Storage Cost + Spoilage Cost - Convenience Yield
Break-even futures price = (equation)
Break-even futures price = Spot Price + Cost of Carry
The simultaneous cash purchase and futures market sale of a commodity to earn a riskless profit is referred to as ___-and-___ ___.
The simultaneous cash purchase and futures market sale of a commodity to earn a riskless profit is referred to as cash-and-carry arbitrage.
If the prevailing futures price is less than the break-even futures price, buyers will either use the futures market for delivery or buy the commodity today. In this case, a ___ ___ -and-___ ___trade can be implemented to earn a riskless profit by combining a short position in the spot market with a long position in the mispriced futures contract.
If the prevailing futures price is less than the break-even futures price, buyers will either use the futures market for delivery or buy the commodity today. In this case, a reverse cash-and-carry arbitrage trade can be implemented to earn a riskless profit by combining a short position in the spot market with a long position in the mispriced futures contract.
Futures price = (equation)
Futures price = Spot price + costs - convenience yield
The relationship between time-to-delivery and commodity futures contract prices is referred to as the ___ ___.
The relationship between time-to-delivery and commodity futures contract prices is referred to as the forward curve.
When the futures prices is higher than the spot price, the forward curve is upward sloping and the environment is described as being in ___.
When the futures prices is higher than the spot price, the forward curve is upward sloping and the environment is described as being in contango.
In a contango market, convenience yield is ___.
In a contango market, convenience yield is low.
When the futures price is below the spot price, the forward curve is downward sloping and the environment is in ___.
When the futures price is below the spot price, the forward curve is downward sloping and the environment is in backwardation.
When the market is in backwardation, convenience yield tends to be ___.
When the market is in backwardation, convenience yield tends to be high.
The ___ ___ ___maintains that the current futures price for a commodity equals the commodity’s expected future spot price.
The unbiased expectation hypothesis maintains that the current futures price for a commodity equals the commodity’s expected future spot price.
Tests of the unbiased expectation hypothesis are (positive/negative/mixed).
Tests of the unbiased expectation hypothesis are mixed.
A ___ ___ ___strategy involves speculators who identify commodity prices that deviate from their expected value and buy or sell them or enter into spread trades.
A relative value arbitrage strategy involves speculators who identify commodity prices that deviate from their expected value and buy or sell them or enter into spread trades.
___ ___compares the futures price with the expected futures spot price, whereas ___compares the futures price with the current spot price.
Normal backwardation compares the futures price with the expected futures spot price, whereas backwardation compares the futures price with the current spot price.
According to the theory of storage, futures prices are ___ volatile than spot prices.
According to the theory of storage, futures prices are less volatile than spot prices.
According to the ___ of ___, futures prices are more volatile than spot prices.
According to the theory of storage, futures prices are less volatile than spot prices.
The unbiased expectation hypothesis assumes that markets are ___ and investors do not demand a ___ ___.
The unbiased expectation hypothesis assumes that markets are perfect and investors do not demand a risk premium.
The unbiased expectation hypothesis (does/does not) explain commodity forward curves well.
The unbiased expectation hypothesis does not explain commodity forward curves well.
Under normal ___, long commodity futures positions have the potential to earn a positive risk premium.
Under normal backwardation, long commodity futures positions have the potential to earn a positive risk premium.
The backwardation argument is similar to the ___ ___ ___, which states that borrowers prefer long maturities, while lenders prefer short maturities
The backwardation argument is similar to the liquidity preference hypothesis, which states that borrowers prefer long maturities, while lenders prefer short maturities
The ___ ___ uses the relationship between inventory levels and the convenience yield to relate the relationship between spot and futures prices to inventory levels and other factors.
The storage model uses the relationship between inventory levels and the convenience yield to relate the relationship between spot and futures prices to inventory levels and other factors.
According to the theory of storage, the forward curve is upward sloping when current inventory levels are ___ demand levels and downward sloping when inventories are extremely ___.
According to the theory of storage, the forward curve is upward sloping when current inventory levels are above demand levels and downward sloping when inventories are extremely low.
Forward curves for expensive or difficult-to-store commodities typically have ___ slopes.
Forward curves for expensive or difficult-to-store commodities typically have steep slopes.
Storage models also consider the risk of ___-___, which occurs when inventory levels drop to zero and consumption depends entirely on production and transportation.
Storage models also consider the risk of stock-out, which occurs when inventory levels drop to zero and consumption depends entirely on production and transportation.
Stock-outs occur in markets that are subject to ___ ___or ___. Commodity users avoid it by actively hedging at the points of the ___ ___ that are most susceptible to stock-outs.
Stock-outs occur in markets that are subject to seasonal production or demand. Commodity users avoid it by actively hedging at the points of the forward curve that are most susceptible to stock-outs.
The theory of storage’s implication of a negative relationship between convenience yield and the inventory level is exhibited in the ___ ___, which describes the relationship between inventory levels and the spread between spot and futures prices.
The theory of storage’s implication of a negative relationship between convenience yield and the inventory level is exhibited in the working curve, which describes the relationship between inventory levels and the spread between spot and futures prices.
The working curve is typically a ___, ___sloping curve. The curve is ___due to embedded real options related to ___ ___.
The working curve is typically a concave, upwardly sloping curve. The curve is nonlinear due to embedded real options related to inventory levels.
When inventory is ___, commodity users are exposed to costs related to searching for inventory, delays, transportation and rush charges. If inventories are depleted, they may face significant costs from ___-___, suggesting high ___ ___.
When inventory is low, commodity users are exposed to costs related to searching for inventory, delays, transportation and rush charges. If inventories are depleted, they may face significant costs from stock-outs, suggesting high convenience yields.
When inventory is extremely high, marginal convenience yields can be ___.
When inventory is extremely high, marginal convenience yields can be negative.
The ___ ___ ___explains that users of commodities that are directly consumed by the public rarely use the forward market to hedge future supplies.
The preferred habitat hypothesis explains that users of commodities that are directly consumed by the public rarely use the forward market to hedge future supplies.
According to the preferred habitat hypothesis, the relationship between the expected spot and forward rates varies ___-___over different delivery dates due to supply and demand pressures in ___ ___of the curve.
According to the preferred habitat hypothesis, the relationship between the expected spot and forward rates varies non-monotonically over different delivery dates due to supply and demand pressures in localized regions of the curve.
The preferred habitat hypothesis is a general version of the ___ ___hypothesis.
The preferred habitat hypothesis is a general version of the liquidity preference hypothesis.
In ___ ___, markets can be segregated across geographies or time. In these markets, the forward curve for the commodity (is/is not) useful.
In segmented markets, markets can be segregated across geographies or time. In these markets, the forward curve for the commodity is not useful.
Normal ___ describes an environment in which commodity users have a stronger incentive to hedge than producers, so users need to entice sellers into the forward market.
Normal contango describes an environment in which commodity users have a stronger incentive to hedge than producers, so users need to entice sellers into the forward market.
The crude oil futures market often has a ___ curve.
The crude oil futures market often has a humped curve.
Option based models focus on options to extract a ___ ___or ___options.
Option based models focus on options to extract a natural resource or inventory options.
Producers can reduce or stop production if a commodity price falls below its marginal cost of production. This option ___ the volatility of commodity prices for future delivery and represents the option to extract a ___ ___.
Producers can reduce or stop production if a commodity price falls below its marginal cost of production. This option reduces the volatility of commodity prices for future delivery and represents the option to extract a natural resource.
Commodities are ___ volatile when prices are increasing than when they are decreasing. This ___ ___means that owning physical inventory is preferable to holding long-term futures contracts. This also leads to ___.
Commodities are more volatile when prices are increasing than when they are decreasing. This volatility asymmetry means that owning physical inventory is preferable to holding long-term futures contracts. This also leads to backwardation.
Commodity futures returns may be decomposed into three sources:
- ___ return
- ___return
- ___Yield
Commodity futures returns may be decomposed into three sources:
- Spot return
- Collateral return
- Roll Yield
___ returns are generally driven by fundamental market factors. They generally ___-___and (are/are not) good sources of return. The ___model asserts that the spot price should be less than the prevailing interest rates
Spot returns are generally driven by fundamental market factors. They generally mean-revert and are not good sources of return. The hotelling model asserts that the spot price should be less than the prevailing interest rates
___ yield results from the return on the cash collateral invested in liquid assets.
Collateral yield results from the return on the cash collateral invested in liquid assets.
___ return is the portion of a futures contract’s return resulting from a change in basis over time. It will be positive for markets that are in ___. The main source of return is the presence of the ___ ___.
Roll return is the portion of a futures contract’s return resulting from a change in basis over time. It will be positive for markets that are in backwardation. The main source of return is the presence of the convenience yield.
Studies have shown that ___ ___and ___ ___represent the majority of a commodity investment’s total return and that ___ ___provides a diversification benefit.
Studies have shown that collateral yield and roll return represent the majority of a commodity investment’s total return and that spot return provides a diversification benefit.
If the forward curve is in backwardation, it may indicate that the commodity is ___ because a premium is being offered for immediate delivery of the commodity.
If the forward curve is in backwardation, it may indicate that the commodity is scarce because a premium is being offered for immediate delivery of the commodity.
Empirical studies find (positive/negative/no) correlation between commodity futures returns and inflation.
Empirical studies find positive correlation between commodity futures returns and inflation.
Inflation and commodity correlations fluctuate (a lot/very little) over the short run.
Inflation and commodity correlations fluctuate a lot over the short run.
Commodities that are not easily stored serve as a (better/worse) inflation hedge.
Commodities that are not easily stored serve as a better inflation hedge.
Commodities’ inflation hedging property is greater when inflation is (expected/unexpected).
Commodities’ inflation hedging property is greater when inflation is unexpected.
Correlation coefficients between a US Dollar Index and commodity prices is (positive/negative).
Correlation coefficients between a US Dollar Index and commodity prices is negative.
Some countries depend heavily on the export of commodities. The currencies of these countries, referred to as ___ ___, tend to be have high (positive/negative) correlation with commodity prices.
Some countries depend heavily on the export of commodities. The currencies of these countries, referred to as commodity currencies, tend to have high positive correlation with commodity prices.
The financialization of commodities has led to 2 notable changes:
- Commodity currencies have a (stronger/weaker) relationship with broad commodity indices than local commodities.
- Commodity currencies (are/are not) effective predictors of future commodity prices.
The financialization of commodities has led to 2 notable changes:
- Commodity currencies have a stronger relationship with broad commodity indices than local commodities.
- Commodity currencies are not effective predictors of future commodity prices.
The ___ ___can be attributed to commodity prices’ tendency to be mean-reverting while exhibiting low correlations with other commodities. The yield is higher when portfolio constituents are ___and have ___correlations.
The rebalancing yield can be attributed to commodity prices’ tendency to be mean-reverting while exhibiting low correlations with other commodities. The yield is higher when portfolio constituents are volatile and have low correlations.
A commodity portfolio is likely to have (greater/worse) rebalancing benefits than a stock-bond portfolio.
A commodity portfolio is likely to have greater rebalancing benefits than a stock-bond portfolio.
An investment’s geometric mean may be expressed as:
A number of factors raise concerns that past commodity returns will be of little value moving forward. For instance, market have become ___ and may not provide the same ___benefit moving forward.
A number of factors raise concerns that past commodity returns will be of little value moving forward. For instance, market have become financialized and may not provide the same diversification benefit moving forward.
