When it comes to derivative I know that one speaks of backwardation if the spot rate is greater the the futures rate (i.e., S_0>f_0). In this situation the long earns a positive roll yield.
However, when it comes to currency (I refer in the following to the base currency and the price to base nomenclature) we speak of backwardation if the spot exchange rate is below the forwards exchange rate (i.e., S_0
I do not get this. It seems to me odd: S_0>f_0 vs. S_0
Could anyone tries to explain the logic behind these?
Thanks a lot!
Well basically roll yield = forward premium/discount.
If a currency trade at forward prmium, roll yield is positive -> reduce hedging cost
If a currency trade at forward discount, roll yield is negative -> increase hedging cost
if you bought a US dollar and it is expected to be traded at premium (forward rate) then you will roll your position at higher rate and you will have negative roll yield. in other words. If your contract needs you to buy US for 1 year and you have only 3 month contractS and the trending is upward, then you have to buy US every three months (rolling your contracts) comparing to today (spot) you will buy US at higher rate (forward three month). So negative roll yield. Got it?
I think I get your example.
For me it always was (for commodities): Backwardation --> f_0 < S_0 --> buy low (at the future price) in the future and sell high at the future spot price (for a long position) --> pos. roll yield.
And for currencies: Backwardation --> F_0 > S_0 --> buy high (at the forward price) in the future and sell low at the future spot price (for a long position) --> neg. roll yield.
I understand the thing with the roll yield, but with commodities pos. roll yield = backwardation and with currencies neg. roll yield is backwardation?
I miss something…
Both are same concept backwardation when future price is lower than current spot price. Don’t buy today buy in the future . If future price will be higher than today then contingo and don’t sell today sell in the future. This apply for commodies and currency.
I read this: https://books.google.de/books?id=3ralb7z0HmYC&pg=SA3-PA11&lpg=SA3-PA11&dq=backwardation+forward+premium+currencies&source=bl&ots=xE2o5-NfbX&sig=-Ccz9tquCd7v0WNX5n8vt3FaLpk&hl=de&sa=X&ei=NXJQVeHsOYqR7Abp14HwBA&ved=0CEkQ6AEwBDgK#v=onepage&q&f=false
Their is an example: if interest rate of a foreign currency is above that of the domestic currency, the forward price of the foreign currency is less than the spot price, i.e., the foreign currency is traded at a forward discount — that should be a case of backwardation.
Hm. I have to think about it a little bit more
Isn’t it: ?
Backwardation: When future price is lower than expected (future) spot? ie, Future will converge with time until it reaches the spot at maturity?
This happens with passing of time.
What you’re referring to, i think, is taking a snapshot of future prices over time: Spot vs 1 month future vs 3 months future. etc. This was L2 material. Now we talk about moving in time, and the future contract gradually converges to become the spot price at its maturity (of course).
If am wrong please blame it on my 4th cup of coffee today; am hyper