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CFA Level I · CFA Level I Exam · Pricing and Valuation of Futures Contracts

An analyst observes that a commodity futures price is below the spot price, and the market is in backwardation. Storage costs are positive and interest rates are positive. This situation is most likely explained by:

Backwardation here is most likely explained by a convenience yield exceeding storage plus financing costs. That makes net cost of carry negative, so the futures price falls below spot. Positive interest rates and storage costs alone would push futures above spot, and daily settlement is not a material cause.

  1. Aa convenience yield large enough to exceed storage costs plus financing costs.Correct
  2. Ba negative risk-free rate that reduces the cost of carry.
  3. Ca futures contract that is marked to market more frequently than a forward.

Explanation

With carry costs of storage and interest positive, futures exceed spot unless a benefit of holding the physical commodity offsets them. A convenience yield larger than storage plus financing costs makes the net cost of carry negative, producing backwardation. The stated positive rates rule out B, and daily settlement alone does not produce a sizeable discount.

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