What does it mean by this phrase in the answers below" For backwardation to occur, there must be a significant benefit to holding the asset, either monetary or non-monetary"
Thank you so much for your time.
Backwardation refers to a situation where:
A) the futures price is above the spot price. B) long hedgers outnumber short hedgers. C) the futures price is below the spot price.
Your answer: C was correct!
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.
Consider the cost-of-carry model where futures price = [spot price X (1+risk free rate)] - future value of net costs.
In a situation where your net costs (ie, costs minus benefits) are negative, your benefits will outweigh your costs. This negative value in your cost-of-carry will cause your futures price to be lower than your spot price. As you are aware, FP < SP is the very definition of backwardation.
Consider the cost-of-carry model where futures price = [spot price X (1+risk free rate)] - future value of net costs.
In a situation where your net costs (ie, costs minus benefits) are negative, your benefits will outweigh your costs. This negative value in your cost-of-carry will cause your futures price to be lower than your spot price. As you are aware, FP < SP is the very definition of backwardation.
I would draw this out on a graph or if you have schweser videos I know they do it there…if not then let me know and I will email/call you and explain it