Explain how commodity swaps can be used to gain or adjust exposure to commodities
The idea
Commodity swaps let investors and hedgers take or change exposure without trading and rolling futures themselves. In a total return swap the receiver gets the return on a commodity index and pays a floating rate such as the Treasury bill rate plus a spread, which suits a pension fund wanting passive exposure. An excess return swap pays the index's change above a fixed level for a fixed fee. A basis swap exchanges a price on one commodity for a price on a related, more liquid one, letting an airline hedge jet fuel against a liquid reference. Variance and volatility swaps pay the gap between realised and agreed variance or volatility. The trap is choosing a swap by name rather than by the risk to be moved.
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
- Set out, work out and interpret each part of the total return on a fully collateralised commodity futures contract
- Contrast roll return when markets are in contango with roll return when they are in backwardation
- Explain how the way a commodity index is built influences its returns