Convenience yield increase leads to higher roll returns?

CFA Level III
#1

According to the Alternative investments portfolio management chapter, under the backwardation, all else being equal , an increase in a commodity’s convenience yield should lead to future market conditions offering higher roll returns; the converse holds for a decline in convenience yields I am confused by the meaning above. the increase of conveninece yield should lead to decrease of future price. And, the decrease of future price should lead to the decrease of roll return. ( Roll return equals the difference between future price change minus the spot price change) Any help? thanksI

#2

.

#3

Convenience yield reduces the futures price, as the required return is reduced. that means that the future prices will be in backwardation. if you are long the next maturity contract, the price of the futures will tend to increase because at maturity it needs to be equal to the spot price. but the futures price of the next maturity increases less. so when it is time for you to roll your contract, you can do it at a lower price - increasing your roll return

#4

Floripop has explained it wonderfully. Just to add to that, due to the similar reasons, decline in storage costs and increase in lending rates will also lead to higher roll returns (in case they are varying). However, this won’t generally be the case because as per the curriculum, the futures price can have a range for no arbitrage values only in the case of convinience yiled.

#5

to expand a bit, does this mean that the higher the convienence yield, the greater the gap between the futures price and what the spot price will be at futures expiration?

#6

Backwardation = futures price less than spot price = positive roll yield. Higher Convinience yield = lower futures price = more positive roll yield.

#7

one thing they seem to surprisingly overlook is that in the real world if the spot is 200 and the futures one year out is 100, the spot tends to move to the future, not the future to the spot

#8

Hey there GSG! Haven’t seen you posting in a while.

#9

Hi Dwight, How are you doing ? How is your prep comming along ? I guess i got enough motivation for a while, that i was just plodding through the books without posting on AF. 10 more days …lets squeak past the finish line and call it a success. Cheers :slight_smile:

#10

GSG! Hope you will stick around until the end.

#11

mwvt9: Sure :slight_smile: