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

A copper fabricator observes that the nearby copper futures price is higher than the price of the contract maturing in six months, and the spot price is higher than both. Which interpretation is most consistent with this term structure?

This is backwardation: spot above nearby futures above deferred futures. It indicates the convenience yield of holding the physical copper exceeds interest and storage costs, so no arbitrage is implied.

  1. ABackwardation, suggesting a high convenience yield relative to the cost of carryCorrect
  2. BContango, suggesting storage costs exceed convenience yield
  3. CContango, suggesting the risk-free rate is negative
  4. DAn arbitrage opportunity requiring buying spot and selling the nearby future

Explanation

Prices falling with maturity is backwardation, which arises when the convenience yield exceeds interest plus storage costs. Contango is the opposite shape. The shape alone does not imply arbitrage, since convenience yield is not capturable by holders of futures.

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