“COMMODITY FORWARDS AND FUTURES” THE CANDIDATE SHOULD BE ABLE TO

36. “Commodity Forwards and Futures” The candidate should be able to: a) discuss the unique pricing factors for commodity forwards and futures, including storability, storage costs, production, and demand, and their influence on lease rates and the forward curve; b) identify and explain the arbitrage situations which arise as a result of the convenience yield of a commodity and commodity spreads; c) compare and contrast the basis risk of commodity futures with that of financial futures. 2008 Level III Guideline Answers Morning Session – Page 21 of 40 Question: 6 Topic: Portfolio Management – Alternative Investments Minutes: 11 Guideline Answer: PART A To implement the reverse cash-and-carry arbitrage, Dalk will need to short copper in the spot market and establish a long synthetic position in the copper forward market. The long synthetic commodity position consists of: • a long position in the forward contract that expires in three months, and • Zero-coupon bonds with a maturity date identical to the forward expiration date, and a face value equal to the forward price at maturity. PART B The reverse cash-and-carry arbitrage involves the following transactions: