suppose the future of a commodity covers one year and risk free rate is 10% per year. The spot price of the commodity is $100. The futures price of the commodity in one year is $105. After one year, the spot price of the commodity becomes $115. What is the return of investing on this future? According to Schweser, total return = spot return + collateral return + roll return 1. spot return: 115/100 - 1 = 15%. 2. collateral return: 10% as pointed out by Schweser to be the risk free rate. 3. roll return: here we have a contango so the roll return would be -5% answer: total return would be 15+10-5=20%. But my question would be: 1. Have we double counted the risk free rate? Ignore storage cost, the expected future price would be $110 according to non-arbitrage condition, right? Am I wrong or Schweser is wrong here? 2. Schweser defines contango as: “the term structure is positive”. Since expected futures price is spot price times (1+risk free rate). Does it mean we have contango all the time? Something must be wrong here. Any comment would be great.
you con tango with me any time (as long as you’re female and we’re in paris…)
CFAMonster Wrote: ------------------------------------------------------- > suppose the future of a commodity covers one year > and risk free rate is 10% per year. The spot price > of the commodity is $100. The futures price of the > commodity in one year is $105. After one year, the > spot price of the commodity becomes $115. What is > the return of investing on this future? > > According to Schweser, total return = spot return > + collateral return + roll return > > 1. spot return: 115/100 - 1 = 15%. > 2. collateral return: 10% as pointed out by > Schweser to be the risk free rate. > 3. roll return: here we have a contango so the > roll return would be -5% > > answer: total return would be 15+10-5=20%. > > But my question would be: > > 1. Have we double counted the risk free rate? > Ignore storage cost, the expected future price > would be $110 according to non-arbitrage > condition, right? Am I wrong or Schweser is wrong > here? > > 2. Schweser defines contango as: “the term > structure is positive”. Since expected futures > price is spot price times (1+risk free rate). Does > it mean we have contango all the time? No (if I understand you correctly). Forward term structure is positive, not interest rate term structure. They mean that the further you go out in time the higher the forward prices. As opposed to backwardation where the further you go out in time the lower the forward price. > > Something must be wrong here. Any comment would be > great.
contango is where the benefits, convenience yield, dividends, etc total more than the costs (like storage, RFR, transport, etc). Here the RFR is 10%, and the benefits, net of costs, are only say 5%, so the Futures price is above the current spot. Eg if RFR = 10%, but expected dividend on the stock (for example) is 20%, then Futures price will be (1+10%*(1-20%) = below spot = backwardation. Hope this is what you were asking…
geez, I thought I knew this stuff… How is the roll yield -5?
Market has to be in backwardation for the futures price to converge UPWARD to the spot at expiration of the contract giving you a positive roll return. In this case the market is in contango, so the future price will converge DOWNWARD to the spot at expiration.
show me the math? Question is worded funny or I’m deep fried
I think this question was made up by the OP. I wouldn’t go off of it. I can’t tell what the future was priced at when purchased or “where we are” in time in the question.
I saw a similar problem in CFAI EOC (it’s among the last few problem). For the question in this topic, what do you think about the followinf approach? Spot return = 115-100 = 15 Colateral return = 105 * 10% = 10.5 Total futures return = 115-105 = 10. This is because the 1-year futures will approach spot after one year. So the contribution of roll return = 10-15-10.5 = -15.5
can anybody help me understand why colateral return is RFR. I understand that if it is fully collaterized, it is essentially invested in T-Bills therefore it should be RFR. However, why investor don’t invest X / (1+RFR)^T instead of investing X amount during the initial purchase?
Hmm. It doesn’t say anywhere that they actually roll the future - so I wouldn’t have included a roll return. More fool me I suppose.
monki Wrote: ------------------------------------------------------- > can anybody help me understand why colateral > return is RFR. I understand that if it is fully > collaterized, it is essentially invested in > T-Bills therefore it should be RFR. However, why > investor don’t invest X / (1+RFR)^T instead of > investing X amount during the initial purchase? Good question, but i supect the clearing house may decide that you have to post 100% ,margin. Also, understand there is a credit component, i guess it depends of what they know this counterparty. It is credit worthy enough to not require a 100% margin? In addition, when ppl do these types of transaction, bear in mind that they only want to take a position for which they usually can go ahead and buy directly, intead, they elect to go to the futures markets. I suspect, it everything were that way, leverage would be less and may and just maybe our Wall Street would have not come to kill us. I hope someone who is doing that type of tracsactions shed more light.
chrismaths Wrote: ------------------------------------------------------- > Hmm. It doesn’t say anywhere that they actually > roll the future - so I wouldn’t have included a > roll return. More fool me I suppose. You don’t have to roll to a new contract to get the roll return.