FMP 11. Commodity Forwards and Futures

Learning Objectives

1) Explain the key differences between commodities and financial assets.

2) Define and apply commodity concepts such as storage costs, carry markets, lease rate, and convenience yield.

3) Identify factors that impact prices on agricultural commodities, metals, energy, and weather derivatives.

4) Explain the formula for pricing commodity forwards.

5) Describe an arbitrage transaction in commodity forwards and compute the potential arbitrage profit.

6) Define the lease rate and explain how it determines the no-arbitrage values for commodity forwards and futures.

7) Describe the cost of carry model and determine the impact of storage costs and convenience yields on commodity forward prices and no-arbitrage bounds.

8) Compute the forward price of a commodity with storage costs.

9) Explain how to create a synthetic commodity position and use it to explain the relationship between the forward price and the expected future spot price.

10) Explain the impact of systematic and nonsystematic risk on current futures prices and expected future spot prices.

11) Define and interpret normal backwardation and contango.