LOS b: Discuss how “roll yield” in a commodity future position can be positive (negative).

Q1. The portfolio manager of a passively managed commodity futures index fund establishes a collateralized position in soybean futures. The manager would most likely realize:

A)   A positive roll yield in a contango market

B)   A positive roll yield in a backwardated market.

C)   A positive roll yield only in either a contango or backwardated market.

Q2. For commodity futures in a contango market, what is the most appropriate investment in futures for an investor who expects spot prices to remain constant, and how would the futures price change as the contract approaches maturity, respectively:

              Investor’s position                         Change in futures price

A)      long futures                                             appreciate

B)      short futures                                            depreciate

C)      short futures                                            appreciate

Q3. DCL Hedge Funds (“DCL”) establishes a collateralized futures position consisting of a 120-day T-bill and 30-day natural gas futures. Assuming there is no change in the natural gas spot price over time, and assuming the market is in backwardation, which of the following statements is the most accurate description of the roll yield and DCL’s cash flow:

A)   negative roll yield and positive cash flow.

B)   positive roll yield and positive cash flow.

C)   negative roll yield and negative cash flow.

Q4. Sandrine Graffe is the portfolio manager of a successful collateralized commodities futures fund in France. In a discussion with one of her newly hired associates, Graffe makes the following statements about collateralized futures:
Statement 1: A collateralized futures position refers to investing in short-term futures contracts with an equal investment in a risk-free asset, such as a Treasury bill. The futures must be continuously reinvested to match the maturity of the risk-free asset.
Statement 2: In a collateralized investment, investors realize return through the return on the risk-free investment and the gain or loss of the futures positions over time.
Statement 3: Fortunately, the increasing number of pension and hedge funds taking speculative long positions in commodity futures contribute to increasing roll yields and increasing gains on the continuously reinvested futures positions.
The least accurate statement made by Graffe is:

A)   Statement 1.

B)   Statement 2.

C)   Statement 3.

LOS b: Discuss how “roll yield” in a commodity future position can be positive (negative). fficeffice" />

Q1. The portfolio manager of a passively managed commodity futures index fund establishes a collateralized position in soybean futures. The manager would most likely realize:

A)   A positive roll yield in a contango market

B)   A positive roll yield in a backwardated market.

C)   A positive roll yield only in either a contango or backwardated market.

Correct answer is B)       

In a backwardated market, the manager would have to roll over maturing contracts at a discount to spot prices. This would result in a positive roll yield and a gain to the fund. Even though the expected roll yield in a contango market is negative, it is still possible to achieve a gain under active management. This is not possible under passive management.

Q2. For commodity futures in a contango market, what is the most appropriate investment in futures for an investor who expects spot prices to remain constant, and how would the futures price change as the contract approaches maturity, respectively:

              Investor’s position                         Change in futures price

A)      long futures                                             appreciate

B)      short futures                                            depreciate

C)      short futures                                            appreciate

Correct answer is B)         

A long position in futures contracts in a contango market would result in a negative roll yield and return to the investor as the future price approaches the spot price closer to maturity. If spot prices are assumed to remain constant, an investor taking a short (“sell”) position in futures would realize a positive roll yield and profit as the futures price depreciates in value the closer it is to maturity.

Q3. DCL Hedge Funds (“DCL”) establishes a collateralized futures position consisting of a 120-day T-bill and 30-day natural gas futures. Assuming there is no change in the natural gas spot price over time, and assuming the market is in backwardation, which of the following statements is the most accurate description of the roll yield and DCL’s cash flow:

A)   negative roll yield and positive cash flow.

B)   positive roll yield and positive cash flow.

C)   negative roll yield and negative cash flow.

Correct answer is B)         

We know that the closer a futures contract is to expiration, the more it converges to the spot price. Also, given that the market is in backwardation, long-term futures prices are lower than short-term contract prices. A backwardated price curve produces a positive roll yield since each successive futures contract is refinanced (“rolled over”) at a lower price than the maturing contract, resulting in a positive cash flow (profit) to DCL.

Q4. Sandrine Graffe is the portfolio manager of a successful collateralized commodities futures fund in ffice:smarttags" />France. In a discussion with one of her newly hired associates, Graffe makes the following statements about collateralized futures:
Statement 1: A collateralized futures position refers to investing in short-term futures contracts with an equal investment in a risk-free asset, such as a Treasury bill. The futures must be continuously reinvested to match the maturity of the risk-free asset.
Statement 2: In a collateralized investment, investors realize return through the return on the risk-free investment and the gain or loss of the futures positions over time.
Statement 3: Fortunately, the increasing number of pension and hedge funds taking speculative long positions in commodity futures contribute to increasing roll yields and increasing gains on the continuously reinvested futures positions.
The least accurate statement made by Graffe is:

A)   Statement 1.

B)   Statement 2.

C)   Statement 3.

Correct answer is C)

Statement 1 and 2 correctly describe a collateralized futures position and how investors realize return on the position, respectively.
The increasing number of speculative institutional investors increase the demand and price of commodity futures, thereby decreasing roll yields and the possible return realized by these investors. Statement 3, therefore, is incorrect.

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