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

A commodity trades at spot USD 50. The 1-year forward price is USD 48. The risk-free rate is 4% continuously compounded and storage costs are negligible. Which statement best describes the market and the implication?

The market is in backwardation, with an implied convenience yield of about 8%. The forward of 48 is below the spot of 50, so ln(48/50) is about -4.08%. Setting this equal to the risk-free rate minus convenience yield gives a yield of roughly 8.08%.

  1. AThe market is in contango; a cash-and-carry arbitrage is available
  2. BThe market is in backwardation, and the forward is consistent with a convenience yield of about 8%Correct
  3. CThe market is in backwardation, and the forward implies a convenience yield of about 0%
  4. DThe market is in contango, and the forward implies a negative convenience yield

Explanation

Forward below spot means backwardation. ln(48/50) = -4.08%. With F = S e^((r-y)T), r - y = -4.08%, so y = 4% + 4.08% = 8.08%, about 8%. Contango and zero yield are inconsistent with F < S.

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