Set out, work out and interpret each part of the total return on a fully collateralised commodity futures contract
The idea
A fully collateralised long futures position sets aside the whole notional value in cash or Treasury bills, so its return has three parts. Price return is the change in the price of the futures held, current price ÷ previous price − 1. Roll return arises when the expiring contract is sold and the next one bought: (near-term price − farther-term price) ÷ near-term price, times the share of the position rolled. Collateral return is the interest earned on the cash over the period, the annual rate scaled to the holding period. Total return is the sum of the three. The usual errors are forgetting the collateral return, applying an annual rate to a one-month period, and getting the sign of the roll backwards.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Introduction to Commodities and Commodity Derivatives
- Contrast the features of the different commodity sectors
- Contrast how commodity sectors move through their life cycle, from production to trading or consumption
- Explain how valuing commodities differs from valuing equities and bonds
- Set out the kinds of participant found in commodity futures markets
- Analyse how spot and futures prices relate when markets are in contango and when they are in backwardation
- Contrast theories explaining commodity futures returns
- Contrast roll return when markets are in contango with roll return when they are in backwardation
- Explain how commodity swaps can be used to gain or adjust exposure to commodities
- Explain how the way a commodity index is built influences its returns