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

An analyst observes that the term structure of futures prices for a commodity has become steeply inverted (backwardated) after a supply disruption, with spot well above distant futures. Holding interest and storage costs constant, what does this most likely indicate about the convenience yield?

The convenience yield has risen above interest plus storage costs. Backwardation means futures are below spot, which in the cost-of-carry model requires convenience yield to exceed the net financing and storage cost, as happens when physical supply is scarce.

  1. AIt has risen, exceeding interest and storage costsCorrect
  2. BIt has fallen below zero
  3. CIt is unchanged, since only spot rates changed
  4. DIt is equal to the risk-free rate

Explanation

Backwardation means F<S, which requires y > r+u under the cost-of-carry model. After a disruption, the benefit of holding the physical rises sharply, so the convenience yield increases beyond carrying costs.

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