Reading 49: Investing in Commodities- LOS d～ Q1-4

positive, likely, return, average, close

LOS d: Demonstrate how the geometric return of an actively managed commodity basket can be positive while the underlying average commodity has a geometric return of close to zero.

Q1. The least likely condition for an actively managed commodity basket to yield a positive geometric return is when:

A) the prices of commodities with a negative return in the basket are perfectly correlated.

B) the average geometric return of each underlying commodity is zero.

C) the portfolio prohibits tactical deviations from its stated policy statement but requires annual rebalancing to the portfolio’s strategic asset allocation.

Q2. A portfolio with an initial value of $100,000 contains two commodities: sugar and corn with a 60/40 percent strategic allocation in the two commodities, respectively. The portfolio is rebalanced at the end of each year to its strategic asset allocation. Corn prices remain unchanged over the next two years, with a 0% return in each of the periods. Sugar experiences significant swings in its price, returning 60% the first year while dropping 37.5% the second year.
The value of sugar at the end of the second year and the portfolio’s geometric average return over the two years, respectively, are closest to:

Value of sugar Portfolio return

A) $51,000 2.7%

B) $60,000 16.6%

C) $60,000 0%

Q3. Gains from rebalancing a portfolio of commodities to its strategic asset allocation when the average return on the underlying commodities is zero may occur under:

A) passive but not active portfolio management.

B) either active or passive portfolio management.

C) active but not passive portfolio management.

Q4. CMH Fund (“CMH”) is a recently established, actively managed commodity futures portfolio. In an effort to attract potential investors, the following two statements appear on CMH’s website:

Statement 1:	Since commodities returns are positively correlated with inflation and positively correlated with equity and bond returns, the portfolio is appropriate for equity and bond investors seeking diversification opportunities.
Statement 2:	Our portfolio is actively managed and rebalanced each year, which ensures that we may be able to generate gains even when investors expect the average prices of commodities underlying our portfolio to remain flat.

Statement 1 and 2 on CMH’s website, respectively, are:

Statement 1 Statement 2

A) Correct Incorrect

B) Incorrect Correct

C) Correct Correct