Which of the following is TRUE in normal backwardation? Futures prices tend to: A) rise over the life of the contract because hedgers are net long and have to receive compensation for bearing risk. B) rise over the life of the contract because speculators are net long and have to receive compensation for bearing risk. C) fall over the life of the contract because hedgers are net short and have to receive compensation for bearing risk. Considering the fact that there is a net long postion for the speculators in a backwardation, and they need to be compensated for bearing the risk, I don’t understand why they give these answers. In a normal backwardation the futures price must be below the expected spot price. So none of the answers seems to be right to me.
Ans must be B. Because FP is less than SP and speculators must be compensated for bearing the risk, thus future price increases over the life of the contract.
wouldn’t fp be lower because hedgers are long? fp lower than expected spot
remember, futures px and spot px converge at the end of the contract, so if futures px is less than spot, then it is going to have to rise to meet up with spot at expiration. so B is right here.
makes sense thanks
I believe swaption is correct. I always think of this as a timeline, in which the prices converge as time approaches maturity. The basis approaches 0 as time approaches the maturity of the contract, so in normal backwardation, futures prices are lower than future expected spot prices. Say futures price is 50, and expected futures spot price is 60, that leaves us a basis of 60 - 50 = 10. Over time, this will approach zero, and since the future expected spot price is the same over the life of the contract, that means the futures price must rise.
bought at discount so converge over life of contract makes sense
I agree to the intuition behind this.