kmf229

The theoretical question of whether futures prices are unbiased predictors of future spot rates focuses on:

A) whether futures markets are efficient.

B) the correlation between interest rate changes and asset price changes.

C) whether futures buyers are taking on asset owners’ price risk.

---

The theoretical analysis of whether futures prices are unbiased predictors of spot rates at futures expiration dates depends on whether futures buyers are being compensated for taking on the asset price risk that futures sellers are avoiding. Under the assumption that futures transactions are driven by those with natural short price risk transacting with those who have natural long positions, expected future spot prices are equal to futures prices.

kmf229

What is the situation called when a futures price continuously increases over its life because most hedging strategies are short hedges?

A) Contango.

B) Normal backwardation.

C) A normal market.

---

Normal backwardation means that expected futures spot prices are greater than futures prices. It suggests that when hedgers are net short futures contracts, they must sell them at a discount to the expected future spot prices to get investors to buy them. The futures price rises as the contract matures to converge with spot prices.

kmf229

Under the view that futures transfer risk from asset holders to futures buyers, the:

A) expected asset price in the future will be less than the futures price.

B) futures price will be less than the expected future spot price.

C) convenience yield is positive.

---

Under the view that futures transfer risk from asset holders to futures buyers, the futures price will be less than the expected future spot price. The longs (speculators) must be compensated for bearing asset price risk by receiving a lower future purchase price for the asset.

kmf229

Which of the following statements regarding normal backwardation is CORRECT? Futures prices tend to:

A) rise over the life of the contract because speculators are net long and have to receive compensation for bearing risk.

B) rise over the life of the contract because hedgers are net long and have to receive compensation for bearing risk.

C) fall over the life of the contract because hedgers are net short and have to receive compensation for bearing risk.

---

Normal backwardation means that expected futures spot prices are greater than futures prices. It suggests that when hedgers are net short futures contracts, they must sell them at a discount to the expected future spot prices to get speculators to assume the risk of holding a net long position. The futures price rises over the life of the contract, which compensates speculators for the exposure of their long positions.

kmf229

Which of the following best defines normal contango? Normal contango is when the futures price lies:

A) above the expected future spot price and the futures price falls over the life of the contract.

B) above the expected future spot price and the futures price rises over the life of the contract.

C) below the expected future spot price and the futures price falls over the life of the contract.

---

A pattern of falling futures prices is known as normal contango. This situation occurs if hedgers are net long.

kmf229

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

A) positive carry.

B) contango.

C) normal backwardation.

---

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

kmf229

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.

---

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.

kmf229

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

A) backwardation.

B) contango.

C) negative carry.

---

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

kmf229

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

A) the cash price exceeds the futures price.

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

C) the futures price exceeds the cash price.

---

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.

kmf229

Backwardation refers to a situation where:

A) the futures price is below the spot price.

B) the futures price is above the spot price.

C) long hedgers outnumber short hedgers.

---

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.