LM 5: Natural Resources Flashcards
What are the 3 broad categories of natural resources?
- Commodities
- Timberland
- Farmland
What is the difference between hard commodities and soft commodities?
Hard commodities: are mined or extracted
Soft commodities: grown over period of time
What is the difference between row crops and permanent crops?
row crops: planted and harvested at regular intervals, possibly multiple times per year depending on the climate and the crop’s life cycle.
permanent crops: grow on tree or vines.
What is the primary risk of investing in timber?
international competitive landscape.
Timber is a globally sold and consumed commodity subject to world trade interruptions. So the international context can be considered one of its major risk factors.
Who are the majority owners of farmland and timberland?
farmland: family owned
timberland: institutional investors
What are 5 broad categories of commodities?
- Energy (Oil, natural gas, electricity, coal)
- Base metals (Copper, aluminum, zinc, lead, tin, nickel)
- Precious metals (Gold, silver, platinum)
- Agriculture (Grains, livestock, coffee)
- Other (Carbon credits, freight, forest products)
What 4 things must a derivative contract for commodities specify?
- quantity
- quality
- maturity date
- delivery location
Describe the 3 other vehicles used to gain exposure to commodities beyond derivatives?
- Exchange-traded products (ETPs) (traded like ordinary common shares.)
- Commodity trading advisors (CTAs) (managed futures funds that take directional positions)
- Specialized commodity funds (used to gain exposure to specific commodity sectors.)
What must a commodity’s forward price reflect?
commodity’s forward price must reflect its spot market price, with adjustments for the costs and benefits of ownership.
Who bares the cost of carry and what all does the cost of carry include?
asset owner incurs the cost of carrying
cost of carry includes costs of storage, transportation, and insurance
What is convenience yield for commodities?
non-cash benefit that an asset’s owner gains from having physical possession of it
What is the formula for the price of a forward or futures contract if costs are stated in percentage form?
F0(T) = S0* e ^ ((r+c-i)*T)
F0 (T) = forward price agreed today to be paid at time T
S0 = spot price
r = risk-free rate
c = cost of carry in percentage terms
i = convenience yield in percentage terms
T = term of forward contract
What is the formula for the price of a forward or futures contract if costs are stated in currency units?
F0 (T) = [S0 * (1 +r)] + cost of carry(c) - convenience yield
F0 (T) = forward price agreed today to be paid at time T
S0 = spot price
r = risk-free rate
c = cost of carry in currency units
i = convenience yield in percentage terms
T = term of forward contract
What does contango mean and when does it occur?
occurs when futures price is higher than spot price
futures price > spot price
means that traders and investors anticipate an increase in prices in the coming months.
What does backwardation mean and when does it occur?
occurs when spot price is higher than futures price
only can occur if the total benefits of physical ownership of the commodity exceeds the total cost
futures price < spot price
mean companies are agreeing to pay less for a commodity in the future than they are today, a sign that the price might fall over time.
