Chapter 3 - Futures Prices

Question 0

_______ is the benefit or premium associated with holding the ACTUAL physical asset instead of the futures/forward/derivative asset. Usually because of high demand and scarcity at the same time. (it is when cost-of-carry model fails to apply when an asset has such)

Answer 0

Convenience Yield (p. 97 and investopedia)

also known as “backwardation” or backwarded market

Question 1

Contango - refers to high storage costs and no dividends. (from lecture video)

Answer 1

Wikipedia says:
it is a situation where futures price of a commodity is higher than expected spot price; buyers willing to pay more ‘premium’ to avoid storage and other carrying costs.

Question 2

the difference between the cash price (spot price) and the futures price of a commodity is called _____?

Answer 2

Basis

Question 3

Example of what ____ yield? buy physical bales of wheat instead of futures contracts. a drought occurs and scarcity/demand rises, the difference of 1st purchase wheat price vs. after-shock price of the wheat.

Answer 3

Convenience Yield

Question 4

price discrepancy for 2 futures contract expiration on SAME commodity

Answer 4

intrAcommodity spread

Question 5

True or false:
Connection btw futures prices & expected future SPOT prices is so strong that some market observers believe that they must be or should be at least equal?

Answer 5

True

Question 6

is when CURRENT spot price is more than future price; or when nearby futures price is more than the distant futures price.

(basically price appears to be falling the farther out)

Answer 6

Backwarded Market; Backwardation; (video lecture)

‘future is less than spot”

Question 7

_____ is the total cost to carry (holding) an asset forward in time

Answer 7

Cost of Carry

Question 8

Cost of Carry or Carrying Charge - consists 4 costs

Answer 8

1. Storage
2. Insurance
3. Transportation
4. Financing the item
   * also, interest lost of funds tied up**

Question 9

Arbitrage exists if:

Answer 9

it does NOT follow F = S + C of carry [ F = S(1 + C)]

Question 10

Spot & Futures Parity (equal) Theory also referred to ____

Answer 10

Cost of Carry

Question 11

What is the ONLY variable in a futures contract, which is “discovered” on the trading floor?
*not all commodity futures are quoted the same way (ie. cents, dollars, points, etc.)

Answer 11

Price

Question 12

What is the starting value of forwards and futures?

Answer 12

Zero

Question 13

the difference btw current cash price and the futures price for the SAME commodity is called what?

Answer 13

Basis

Question 14

state the Basis formula

Answer 14

Basis = S - F

S = current spot or cash price
F = current futures price

Question 15

_____ in futures market (basis) here price for more distant futures are higher than nearby futures. In other words, prices rise the farther futures are away from spot

Answer 15

Normal Market (goes higher and higher)

Question 16

____ is when distant futures prices are LOWER than nearby contract expiration. in other words, keeps on declining the further out in futures timeline.

Answer 16

Inverted Market (goes lower & lower)

Question 17

what’s it called when futures prices approaches the spot price as delivery time approaches. basis narrows and must equal 0 (with exception to transportation/transaction costs) at maturity.

Answer 17

Convergence

Question 18

______ is the difference in price btw 2 futures contracts with 2 different maturity dates on SAME commodity or asset.

Answer 18

Spread

Question 19

says that the 2 strategies - purchase now/store it OR take long position in futures market - should have same market-determined costs. in other words, MUST EQUAL, no arbitrage possible.

Answer 19

Spot-Futures Parity Theorem (F = S + C)

Question 20

‘ask price’

Answer 20

seller’s selling price

Question 21

‘bid price’

Answer 21

buyer’s selling price

Question 22

What 4 factors cause Cost-of-Carry Model to be imperfect markets?

Answer 22

1. Direct transaction costs
2. Unequal borrowing/lending rates
3. Margin & restrictions on short selling
4. Limitations to storage (rotting qualities)

Question 23

_____ is what market participants expect the price of a commodity will be.

Answer 23

Expected Future Spot Price

Question 24

what is ‘quasi-arbitrage’?

Answer 24

where all traders face different transaction cost (given his/her position as a dealer, broker, unknown, individual, etc) that may impact varying overall profit or loss.

Question 25

_____ where futures contract price is lower than EXPECTED spot price at contract maturity. (but is when futures prices are increasing - good for long position speculators - investopedia)

Answer 25

Normal Backwardation