help S2000magician and others: two questions about CFAI alternative investments in CFAI book

CFA Level II
#1

Here are the two questions regarding alternative investments:

  1. page 187: In the case of cash and carry arbitrage, the resale price of today’s leveraged spot position is simultaneously set by selling the commodity futures. This short futures position implies an unconditional commitment to purchase the underlying at maturity. At maturity of the futures, the specified commodites are tendered against the maturing short futures. If the profit from the spot trade of the physical commodity exceeds the value of the futures plus the cost of debt financing, the arbitrageur will realize a profit from what is known as a basis trade.

PLEASE EXPLAIN…I don’t understand this paragraph

  1. page 206 explains that commodities and stocks/bonds have a low or negative correlation (understood) and cites three reasons why. The third reason: “Finally, a trade-off between capital return and commodity return exists in industrial production.”

Question: What capital do they mean? The equity of the firm? The capital equipment used in production? and do you want to take a stab at just explaining this in better terms please? I don’t get it.

Thanks!

#2
  1. The arbitrageur borrows some cash, buys a commodity – pork bellies, say – and enters into the short position in a forward contract to deliver the commodity in the future. When the forward expires, he delivers the commodity, receives the forward price, and pays off his loan plus interest. If there’s money left over, he’s made a profit. The whole transaction is known as a basis trade.

Note that they’ve omitted the storage costs. If you buy pork bellies, you’d better pay to store them. They’ll be worth less if you don’t. Probably a lot less.

  1. I’m not altogether certain about this one, but I suspect that they mean that when industrial producers buy copper, they don’t buy it to hold and sell later for its commodity return; they buy it to make jewelry that turns your fingers green, making a capital profit.
#3

Thank you S2000!!!