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

A refiner observes that the futures curve for crude oil has become steeply inverted (backwardated) after a supply disruption. Which interpretation is most consistent with cost-of-carry theory?

An inverted futures curve implies the convenience yield exceeds interest rates plus storage costs, making net carry negative. After a supply disruption, holding physical oil is very valuable, so the convenience yield rises and later-dated futures trade below spot.

  1. AThe convenience yield has risen above the sum of the interest rate and storage costsCorrect
  2. BThe convenience yield has fallen to zero
  3. CStorage costs have risen sharply relative to interest rates
  4. DThe risk-free rate has increased above the convenience yield

Explanation

Futures prices decline with maturity when r + u − y is negative, i.e. y > r + u. A supply disruption makes physical inventory highly valuable, raising y. Options 2 and 3 would produce contango, since lower y or higher u increases net carry.

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