CFA Level 1 - Alternative Investments Session 18 - Reading 67 (Notes, Practice Questions, Sample Questions) 1. In the futures market for a variety of wheat, suppose breakfast cereal companies are the dominant market participant. What willbe the most likely shape of the futures price curve? A)A downward sloping curve, reﬂective of contango markets. B)An upward sloping curve, reﬂective of contango markets. C)An upward sloping curve, reﬂective of backwardated markets. [Explanation: The dominant traders in the market are long hedgers (i.e., users of the commodity) since they purchase wheatfor cereal production. Thus, they will go long futures contracts tohedge price exposure. To induce speculators to take the other sideof the futures contract, they must pay a premium for the hedgingbeneﬁt received. As a result, the futures price curve will be upwardsloping, which would be classiﬁed as a contango market. ] 2. Which of the following best deﬁnes a contango commodities market? A)The futures price is below the expected future spot price.B)The futures price is below the current spot price. C)The futures price is above the current spot price. [Explanation: A contango commodities market occurs when the futures price is above the current spot price ]
3. Which of the following best deﬁnes a backwardated commodities market? A)The futures price is below the expected future spot price. B)The futures price is below the current spot price. C)The futures price is above the current spot price. [Explanation: A backwardated commodities market occurs when the futures price is below the current spot price ] 4. Which of the following market conditions most accurately describes the conditions of a particular commodity market for theroll yield to be positive? A)Contango. B)Futures prices are lower than spot prices. C)Market is dominated by long hedgers. [Explanation: A positive roll yield results from a backwardated market, whereas a negative yield is produced in a contangomarket. In backwardated (contango) markets, futures prices arelower (higher) than spot prices. Futures markets that aredominated by long (short) hedgers tend to be in contango(backwardation) ] 5. Which of the following best describes why adding a commodities index position to a portfolio of stocks and bonds maybe beneﬁcial? Commodities index positions: A)serve as a hedge against inﬂation. B)are positively correlated with stock and bond prices.C)beneﬁt from commodity markets oscillating between contangoand backwardation [Explanation: The correlation between commodity futures and inﬂation is positive, while the correlation between inﬂation and
stocks and bonds is negative. Therefore, declining stock and bondprices due to high inﬂation can be oﬀset by the rising prices ofcommodities that occur during times of high inﬂation. While it ispossible for commodity futures markets to change betweenbackwardation and contango, this alone is not a reason to add acommodities position to a traditional portfolio ] 6. Which of the following will result from the term structure of futures prices for a particular commodity being in contango? A)Negative collateral yield. B)Negative roll yield. C)Positive current yield. [Explanation: A positive roll yield results from a backwardated market, whereas a negative yield is produced in a contangomarket. In backwardated (contango) markets, futures prices arelower (higher) than spot prices ] 7. The component of the return on a futures position that results from interest earned on U.S. Treasury bills deposited to establishthe position is called the: A)collateral yield. B)roll yield.C)current yield [Explanation: Collateral yield is the return earned on the collateral posted to satisfy margin requirements. In most cases, the collateralposted will be U.S. Treasury Bills, in which case the collateral yieldis the T-bill yield ] 8. If a commodities market has a downward-sloping term structure of futures prices, this would be associated with:
A)normal backwardation and a positive roll return. B)normal backwardation and a negative roll return.C)contango and a positive roll return [Explanation: Normal backwardation, when it exists, produces a downward-sloping term structure of futures prices. Such acondition predicts a positive roll return. If the term structure ispositive, which is a result of contango, the roll return would benegative ] 9. The active management that is required to maintain a long-only commodity index strategy is least likely to aﬀect the: A)price return. B)roll yield.C)collateral yield [Explanation: To maintain long exposure to an index of commodity prices, the manager must periodically roll over expiring futurescontracts. The manager must also manage the short-term debtposted as collateral, replacing bills as they mature. The managercan enhance the strategy’s roll yield and collateral yield bycarrying out these transactions in ways that minimize costs andtake best advantage of market conditions. Price return on the indexstrategy depends on the direction of prices of the commodities inthe index ] 10. Which of the following activities by a manager using a commodity index strategy is most likely to be classiﬁed as activemanagement? A)Rolling futures contracts over two days before the benchmark’srollover date. B)By policy, always rolling expiring 180-day T-Bills posted ascollateral into new 180-day T-Bills.
C)Duplicating the component rebalancing scheduling of thebenchmark [Explanation: Rolling over futures contracts prior to the index rolling them over would be an example of active management.Managers who roll over contracts early attempt to enhance returnsby avoiding the higher rolling costs present when attempting toroll over at the same time as the benchmark. Duplicating therebalancing schedule of the benchmark and using a ﬁxed rule toroll over posted collateral do not represent value-adding activitiesby the manager ] 11. Which of the following most accurately describes a reason why a commodity index strategy should be considered an activestrategy? A)Managers choose benchmark index. B)High turnover of contracts held. C)Index rebalancing due to changing inﬂation [Explanation: Commodity index strategies require managers to frequently adjust their positions due to the need to roll overexpiring commodity contracts, reweight components due to indexrebalancing, and roll over collateral debt securities. Managers whocorrectly time these activities can add additional return ]