CAIA - 24 - Assessing Commodity Investment Products

Question 1

Prices of physical commodities (have/have not) kept up with inflation while returns on commodity futures (have/have not) kept up.

Answer 1

Prices of physical commodities have not kept up with inflation while returns on commodity futures have kept up.

Question 2

Most direct commodity investments are achieved through ___.

Answer 2

Most direct commodity investments are achieved through derivatives.

Question 3

The one exception where investors would like to own the physical commodity rather than a derivative is ___ ___.

Answer 3

The one exception where investors would like to own the physical commodity rather than a derivative is precious metals.

Question 4

___ ___ ___ are the primary vehicle used by institutional investors for exposure to commodity indices.

Answer 4

Commodity index swaps are the primary vehicle used by institutional investors for exposure to commodity indices.

Question 5

A commodity swaps initial market value is ___.

Answer 5

A commodity swaps initial market value is zero.

Question 6

Investors may choose to use swaps instead of futures because:

1. Futures aren’t ___
2. ___-___swaps are available and liquid
3. Investors maintain control of ___and can use it to earn a ___ ___

Answer 6

Investors may choose to use swaps instead of futures because:

1. Futures aren’t available
2. Long-term swaps are available and liquid
3. Investors maintain control of cash and can use it to earn a higher return

Question 7

Swaps are preferred by some institutional investors because they are ___ ___ and ___ ___ risk.

Answer 7

Swaps are preferred by some institutional investors because they are competitively priced and spread counterparty risk.

Question 8

There are a number of drawbacks to swaps:

1. Direct access is limited to ___ ___
2. Secondary market is ___
3. Swaps have more ___risk

Answer 8

There are a number of drawbacks to swaps:

1. Direct access is limited to institutional investors
2. Secondary market is illiquid
3. Swaps have more counterparty risk

Question 9

Studies have found that commodity company stock have ___ returns and ___volatility than commodity futures. Additionally, commodity companies behave more like ___and (are/are not) good proxies for commodity futures.

Answer 9

Studies have found that commodity company stock have similar returns and higher volatility than commodity futures. Additionally, commodity companies behave more like equities and are not good proxies for commodity futures.

Question 10

Equity returns of a commodity company are most correlating to the commodity when returns are ___.

Answer 10

Equity returns of a commodity company are most correlating to the commodity when returns are increasing.

Question 11

High yield bonds of commodity companies have a ___ correlation to the commodities than investment grade bonds.

Answer 11

High yield bonds of commodity companies have a higher correlation to the commodities than investment grade bonds.

Question 12

Index mutual funds can outperform their benchmarks by actively managing the investment’s ___.

Answer 12

Index mutual funds can outperform their benchmarks by actively managing the investment’s collateral.

Question 13

Commodity based mutual funds usually have ___ fees ___ other mutual funds.

Answer 13

Commodity based mutual funds usually have similar fees to other mutual funds.

Question 14

Commodity ETFs tend to charge ___ fees than mutual funds

Answer 14

Commodity ETFs tend to charge lower fees than mutual funds

Question 15

Tracking errors are smallest for commodity ETFs that use ___ ___, followed by ___, then ___.

Answer 15

Tracking errors are smallest for commodity ETFs that use full replication, followed by futures, then swaps.

Question 16

Commodity partnerships in the U.S. are often structured as ___ ___ ___.

Answer 16

Commodity partnerships in the U.S. are often structured as master limited partnerships.

Question 17

MLPs (do/do not) have required distribution minimums.

Answer 17

MLPs do not have required distribution minimums.

Question 18

MLPs are required to generate at least ___% of their income from activities from qualified sources.

Answer 18

MLPs are required to generate at least 90% of their income from activities from qualified sources.

Question 19

MLPs finance their growth using the ___ ___, which can ___stakes for existing LPs

Answer 19

MLPs finance their growth using the capital markets, which can dilute stakes for existing LPs

Question 20

___ ___-___notes are debt instruments that, at maturity, pay principal and a return based on the performance of a commodity or basket of commodities over a certain time period. They may be ___-___bonds.

Answer 20

Commodity index-linked notes are debt instruments that, at maturity, pay principal and a return based on the performance of a commodity or basket of commodities over a certain time period. They may be zero-coupon bonds.

Question 21

Commodity index-linked investments have ___ minimums than swaps.

Answer 21

Commodity index-linked investments have smaller minimums than swaps.

Question 22

Commodity index-linked notes have an active ___ ___.

Answer 22

Commodity index-linked notes have an active secondary market.

Question 23

Commodity index-linked notes (do/do not) require posting of collateral.

Answer 23

Commodity index-linked notes do not require posting of collateral.

Question 24

___ ___-___ notes are commodity-linked debt instruments traded on an exchange.

Answer 24

Commodity exchange-traded notes are commodity-linked debt instruments traded on an exchange.notes are debt instruments traded on an exchange.

Question 25

\_\_\_ are issued by financial institutions that promise to pay a return on an index and then repay the principal at maturity.

Answer 25

**ETNs** are issued by financial institutions that promise to pay a return on an index and then repay the principal at maturity.

Question 26

ETNs are exposed to ___ risk from the issuer.

Answer 26

ETNs are exposed to **credit** risk from the issuer.

Question 27

ETNs have ___ counterparty risk than swaps.

Answer 27

ETNs have **higher** counterparty risk than swaps.

Question 28

The key advantage of ETNs is that there is little ___ \_\_\_.

Answer 28

The key advantage of ETNs is that there is little **tracking error**.

Question 29

ETNs are often referred to as ___ \_\_\_ \_\_\_.

Answer 29

ETNs are often referred to as **prepaid forward contracts**.

Question 30

ETNs may qualify for \_\_\_-\_\_\_ tax treatment.

Answer 30

ETNs may qualify for **long**-**term** tax treatment.

Question 31

An economically equivalent alternative to ETNs are \_\_\_-\_\_\_ ___ \_\_\_ on commodity indexes.

Answer 31

An economically equivalent alternative to ETNs are **index**-**linked futures contracts** on commodity indexes.

Question 32

\_\_\_-\_\_\_funds in ___ markets buy and hold undervalued commodity futures contracts in unhedged portfolios.

Answer 32

**Long**-**biased** funds in **futures** markets buy and hold undervalued commodity futures contracts in unhedged portfolios.

Question 33

Long-biased funds in futures markets lock ups are \_\_\_, liquidity is \_\_\_and transparency is \_\_\_relative to other hedge funds.

Answer 33

Long-biased funds in futures markets lock ups are **short**, liquidity is **high** and transparency is **high** relative to other hedge funds.

Question 34

\_\_\_-\_\_\_funds in ___ markets buy, store and transport physical commodities.

Answer 34

**Long**-**biased** funds in **physical** markets buy, store and transport physical commodities.

Question 35

Equation for daily performance on a leveraged ETF

Answer 35

Question 36

Value of levered ETF after T days (equation)

Answer 36

Question 37

\_\_\_ \_\_\_are index-linked notes that also may offer leveraged exposure to a commodity index.

Answer 37

**Leveraged notes** are index-linked notes that also may offer leveraged exposure to a commodity index.

Question 38

\_\_\_-\_\_\_ \_\_\_are index-linked notes that provide a downside guarantee of payment of some or all of the principal at the note's maturity and provide an upside of profit if the commodity price increases.

Answer 38

**Principal**-**guaranteed notes** are index-linked notes that provide a downside guarantee of payment of some or all of the principal at the note's maturity and provide an upside of profit if the commodity price increases.

Question 39

Principal-guaranteed notes have two structures: 1. ___ and \_\_\_Strategy (or \_\_\_note) 2. ___ \_\_\_(or ___ \_\_\_ ___ \_\_\_[\_\_\_])

Answer 39

Principal-guaranteed notes have two structures: 1. **Cash** and **Call** Strategy (or **participation** note) 2. **Dynamic Strategy** (or **constant proportion portfolio insurance** [CPPI])

Question 40

The most commonly used structure of principal guaranteed notes is the ___ and \_\_\_strategy.

Answer 40

The most commonly used structure of principal guaranteed notes is the **cash** and **call** strategy.

Question 41

The ___ and \_\_\_strategy entails issuers buying maturity and principal-matched zero-coupon bonds and holding them until maturity, and buying call options linked to a commodity index.

Answer 41

The **cash** and **call** strategy entails issuers buying maturity and principal-matched zero-coupon bonds and holding them until maturity, and buying call options linked to a commodity index.

Question 42

The ___ \_\_\_changes the size of the commodity investment depending on the cost of insuring the principal guarantee.

Answer 42

The **dynamic strategy** changes the size of the commodity investment depending on the cost of insuring the principal guarantee.

Question 43

Traditional commodity indices are ___ only, infrequently \_\_\_and ignore ___ \_\_\_ or \_\_\_schemes.

Answer 43

Traditional commodity indices are **long** only, infrequently **rebalanced** and ignore **term structure** or **weight** schemes.

Question 45

Commodity indices have 8 possible sources of return: 1. B 2. R 3. S 4. D 5. D 6. W 7. M 8. C

Answer 45

Commodity indices have 8 possible sources of return: **1. Beta** **2. Roll** **3. Spot** **4. Dynamic asset allocation** **5. Diversification** **6. Weighting** **7. Maturity** **8. Collateral**

Question 46

\_\_\_ is the return associated with holding a futures contract until its roll date and then rolling the exposure to the next active front-month futures contract.

Answer 46

**Beta** is the return associated with holding a futures contract until its roll date and then rolling the exposure to the next active front-month futures contract.

Question 47

\_\_\_ is the profit/loss associated with holding a futures contract due to a change in basis. It may be considered as being generated from moving up and down the forward curve.

Answer 47

**Roll** is the profit/loss associated with holding a futures contract due to a change in basis. It may be considered as being generated from moving up and down the forward curve.

Question 48

Commodities that are difficult to store usually are ___ and have \_\_\_roll yields.

Answer 48

Commodities that are difficult to store usually are **backwardated** and have **positive** roll yields.

Question 49

Indices (could/should not) be designed solely based on roll returns.

Answer 49

Indices **should not** be designed solely based on roll returns.

Question 50

\_\_\_ return is the difference between an index's excess return and roll return.

Answer 50

**Spot** return is the difference between an index's excess return and roll return.

Question 51

Spot returns (do/do not) contribute significantly to total returns.

Answer 51

Spot returns **do not** contribute significantly to total returns.

Question 52

Common strategies for ___ \_\_\_ ___ \_\_\_ include momentum and mean reversion.

Answer 52

Common strategies for **dynamic asset allocation models** include momentum and mean reversion.

Question 53

Commodity index weights should be selected based on ___ \_\_\_

Answer 53

Commodity index weights should be selected based on **economic rationale**

Question 54

\_\_\_ significantly affects an index's spot return.

Answer 54

**Maturity** significantly affects an index's spot return.

Question 55

Indices based on longer-term futures contracts have lower ___ and tend to \_\_\_

Answer 55

Indices based on longer-term futures contracts have lower **betas** and tend to **underperform**

Question 56

Commodity indices may lack the \_\_\_required by large institutional investors since they are more \_\_\_.

Answer 56

Commodity indices may lack the **capacity** required by large institutional investors since they are more **illiquid**.

Question 57

A ___ based index has fixed component weights.

Answer 57

A **value** based index has fixed component weights.

Question 58

A ___ based index holds a fixed number of contracts for each commodity.

Answer 58

A **quantity** based index holds a fixed number of contracts for each commodity.

Question 59

A ___ \_\_\_index tacks the performance of a fully collateralized portfolio of commodity futures.

Answer 59

A **total return** index tacks the performance of a fully collateralized portfolio of commodity futures.

Question 60

An ___ \_\_\_index is linked to the price movements of a portfolio of commodity futures contracts and provides a return over cash.

Answer 60

An **excess return** index is linked to the price movements of a portfolio of commodity futures contracts and provides a return over cash.

Question 61

Newer indices position themselves ___ on the forward curve and/or hold their positions for \_\_\_than first generation indices.

Answer 61

Newer indices position themselves **further** on the forward curve and/or hold their positions for **longer** than first generation indices.

Question 62

Passive long commodity indices perform poorly when roll return is \_\_\_.

Answer 62

Passive long commodity indices perform poorly when roll return is **negative**.

Question 63

To improve performance of passive strategies, some products have been developed using \_\_\_-\_\_\_methods.

Answer 63

To improve performance of passive strategies, some products have been developed using **curve**-**neutral** methods.

Question 64

Large futures positions in indices are typically rolled over ___ days.

Answer 64

Large futures positions in indices are typically rolled over **several** days.

Question 65

\_\_\_ generation commodity indices add active commodity selection as an additional enhancement.

Answer 65

**Third** generation commodity indices add active commodity selection as an additional enhancement.

Question 66

\_\_\_ generation commodity indices aim to enhance returns using forward curve positioning.

Answer 66

**Second** generation commodity indices aim to enhance returns using forward curve positioning.

Question 67

The ___ \_\_\_technique identifies mid- to long-term contracts and holds them until close to expiration.

Answer 67

The **enhanced roll** technique identifies mid- to long-term contracts and holds them until close to expiration.

Question 68

The ___ \_\_\_technique invests in several contracts across the futures curve and avoids the steepest part of the term structure.

Answer 68

The **constant expiration** technique invests in several contracts across the futures curve and avoids the steepest part of the term structure.

Question 69

The ___ \_\_\_ ___ technique selects the futures contract with the most attractive roll yield.

Answer 69

The **implied roll yield** technique selects the futures contract with the most attractive roll yield.

Question 70

The Merrill Lynch Commodity Index eXtra is an example of a ___ generation index.

Answer 70

The Merrill Lynch Commodity Index eXtra is an example of a **second** generation index.

Question 71

\_\_\_-based roll techniques are used by ___ generation commodity indices and establishes positions based on momentum.

Answer 71

**Momentum**-based roll techniques are used by **third** generation commodity indices and establishes positions based on momentum.

Question 72

The ___ \_\_\_ roll technique is used by ___ generation commodity indices and goes long commodities with the steepest backwardation forward curves and shorts commodities with greatest degree of contango.

Answer 72

The **term structure** roll technique is used by **third** generation commodity indices and goes long commodities with the steepest backwardation forward curves and shorts commodities with greatest degree of contango.

Question 73

The ___ \_\_\_roll technique is used by \_\_\_generation indices and balances long and short positions to maintain a net market-neutral position.

Answer 73

The **market neutral** roll technique is used by **third** generation indices and balances long and short positions to maintain a net market-neutral position.

Question 74

The ___ \_\_\_roll technique is used by \_\_\_generation indices and determines commodity weights using fundamental and technical analysis

Answer 74

The **rule based** roll technique is used by **third** generation indices and determines commodity weights using fundamental and technical analysis

Question 75

The CYD Long-Short TR Index is an example of a ___ \_\_\_, \_\_\_generation commodity index, which equally weights long positions in ___ commodities and short positions in \_\_\_commodities.

Answer 75

The CYD Long-Short TR Index is an example of a **term structure third**, generation commodity index, which equally weights long positions in **backwardated** commodities and short positions in **contangoed** commodities.

Question 76

\_\_\_ return is the percentage change in the market value of the futures contracts held in the index at the end of the trading session, but before accounting for index changes.

Answer 76

**Excess** return is the percentage change in the market value of the futures contracts held in the index at the end of the trading session, but before accounting for index changes.

Question 77

Realized roll return is ___ on most days.

Answer 77

Realized roll return is **zero** on most days.

Question 78

Realized roll return =