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

A market shows a commodity futures curve where longer-dated contracts trade at lower prices than nearby contracts. Which explanation is most consistent with this backwardation within the cost-of-carry framework?

Backwardation is consistent with a convenience yield greater than the sum of the interest rate and storage costs. Then the net cost of carry is negative, so longer-dated forwards are priced below nearby ones. Large storage costs would instead produce contango.

  1. AThe convenience yield exceeds interest plus storage costsCorrect
  2. BStorage costs exceed the convenience yield and interest rate
  3. CThe risk-free rate is zero
  4. DFutures prices always converge upward to spot at maturity

Explanation

Forward price F = S e^((r+u−y)T) declines with T when y > r + u, which is backwardation. High storage costs would produce contango. A zero rate alone does not produce a falling curve.

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