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FRM Part I · FRM Exam Part I · Commodity Forwards and Futures

A commodity futures curve for crude oil shows the 3-month futures price at USD 78, the 6-month price at USD 81 and the 12-month price at USD 85, with the spot price at USD 76. Which description of the market is most accurate?

The market is in contango because futures prices rise steadily as maturity lengthens, from a spot of USD 76 up to USD 85 at twelve months. Backwardation would require futures prices below spot or a downward-sloping curve, which is not the case here.

  1. AThe market is in contango, with futures prices rising with maturityCorrect
  2. BThe market is in backwardation, with futures prices above spot
  3. CThe market is in backwardation, with a negative convenience yield
  4. DThe market is flat, since the curve is positively sloped only at long maturities

Explanation

Futures prices increase with maturity (76 < 78 < 81 < 85), which defines contango. Backwardation means futures prices are below spot or decline with maturity. A futures price above spot is not backwardation.

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