LOS e: Describe backwardation and contango.

Q1. Backwardation refers to a situation where:

A)   the futures price is above the spot price.

B)   long hedgers outnumber short hedgers.

C)   the futures price is below the spot price.

Q2. Which of the following best defines backwardation? The market is said to be in backwardation if:

A)   the futures price exceeds the cash price or the distant futures price exceeds the nearby futures price.

B)   the futures price exceeds the cash price.

C)   the cash price exceeds the futures price.

Q3. A situation where the futures price is below the spot price of the asset is called:

A)   contango.

B)   negative carry.

C)   backwardation.

Q4. How is market backwardation related to an asset's convenience yield? If the convenience yield is:

A)   negative, causing the futures price to be below the spot price and the market is in backwardation.

B)   positive, causing the futures price to be below the spot price and the market is in backwardation.

C)   larger than the borrowing rate, causing the futures price to be below the spot price and the market is in backwardation.

Q5. A situation where the futures price is above the spot price of the underlying asset is called:

A)   contango.

B)   positive carry.

C)   normal backwardation.

A situation where the futures price is above the spot price of the asset is called contango.

LOS e: Describe backwardation and contango. fficeffice" />

Q1. Backwardation refers to a situation where:

A)   the futures price is above the spot price.

B)   long hedgers outnumber short hedgers.

C)   the futures price is below the spot price.

Correct answer is C)

Backwardation refers to a situation where the futures price is below the spot price. For backwardation to occur, there must be a significant benefit to holding the asset, either monetary or non-monetary.

Q2. Which of the following best defines backwardation? The market is said to be in backwardation if:

A)   the futures price exceeds the cash price or the distant futures price exceeds the nearby futures price.

B)   the futures price exceeds the cash price.

C)   the cash price exceeds the futures price.

Correct answer is C)

Backwardation occurs when there is a convenience, or security, associated with holding the spot asset, usually when it is uncertain whether the asset will even be available in the future. Backwardation is rare with financial futures.

Q3. A situation where the futures price is below the spot price of the asset is called:

A)   contango.

B)   negative carry.

C)   backwardation.

Correct answer is C)

A situation where the futures price is below the spot price of the underlying asset is called backwardation.

Q4. How is market backwardation related to an asset's convenience yield? If the convenience yield is:

A)   negative, causing the futures price to be below the spot price and the market is in backwardation.

B)   positive, causing the futures price to be below the spot price and the market is in backwardation.

C)   larger than the borrowing rate, causing the futures price to be below the spot price and the market is in backwardation.

Correct answer is C)

When the convenience yield is more than the borrowing rate, the no-arbitrage cost-of-carry model will not apply. It means that the value of the convenience of holding the asset it is worth more than the cost of funds to purchase it. This usually applies to non-financial futures contracts.

Q5. A situation where the futures price is above the spot price of the underlying asset is called:

A)   contango.

B)   positive carry.

C)   normal backwardation.

Correct answer is A)

A situation where the futures price is above the spot price of the asset is called contango.

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