FIA Commodities Markets & Trading 2 — Questions and Answers
Question 1: What is the 'basis' in commodity futures trading?
- The initial margin requirement for opening a futures position
- The difference between the local cash (spot) price and the futures price (Correct answer)
- The minimum price fluctuation allowed by the exchange per contract
- The standardized contract size set by the commodity exchange
Correct answer: The difference between the local cash (spot) price and the futures price
The basis is the difference between the local cash (spot) price of a commodity and its futures price, reflecting factors like location, quality differences, transportation costs, and time to delivery.
Question 2: A commodity producer who sells futures contracts to lock in a future sale price is engaging in:
- Speculation on rising commodity prices
- Arbitrage between spot and futures markets
- A short hedge to protect against falling prices (Correct answer)
- A long hedge to protect against rising input costs
Correct answer: A short hedge to protect against falling prices
A short hedge involves selling futures contracts to lock in a future selling price, protecting commodity producers against the risk that prices will fall before they can sell their physical output.
Question 3: Which factor does NOT typically serve as a direct driver of commodity spot prices?
- Seasonal weather conditions and natural disasters
- Supply and demand fundamentals in the physical market
- The price-to-earnings (P/E) ratio of commodity-producing companies (Correct answer)
- Geopolitical events affecting production or transportation
Correct answer: The price-to-earnings (P/E) ratio of commodity-producing companies
Commodity spot prices are driven by physical supply/demand fundamentals, weather, geopolitical factors, and production costs; P/E ratios are equity valuation metrics that do not directly determine commodity prices.
Question 4: What does 'rolling over' a futures position mean in commodity trading?
- Converting an expiring futures position into a spot market position
- Closing the near-month contract and simultaneously opening a later-month contract (Correct answer)
- Increasing the total size of an existing futures position by adding contracts
- Transferring a futures contract obligation to another market participant
Correct answer: Closing the near-month contract and simultaneously opening a later-month contract
Rolling over means closing the expiring near-month futures contract and simultaneously opening a contract with a later expiration date, maintaining continuous market exposure without taking physical delivery.
Question 5: The cost-of-carry model for commodity futures pricing includes all of the following EXCEPT:
- Physical storage costs for holding the commodity
- Insurance costs for the stored commodity
- Dividend yield on the underlying asset (Correct answer)
- Financing (interest) costs for purchasing the commodity
Correct answer: Dividend yield on the underlying asset
The commodity cost-of-carry model includes storage, insurance, and financing costs; dividend yield is an equity concept applicable to stocks, not to physical commodities.
Question 6: What is 'convenience yield' in the context of commodity futures pricing?
- The interest rate earned on cash deposited as margin collateral
- The implicit benefit derived from holding physical commodity inventory (Correct answer)
- The profit opportunity available from arbitraging spot and futures prices
- The coupon yield on commodity-linked structured notes
Correct answer: The implicit benefit derived from holding physical commodity inventory
Convenience yield represents the non-monetary benefit of holding physical commodity inventory — such as the ability to meet unexpected demand or keep production running — which reduces futures prices relative to spot prices.
Question 7: When a commodity futures contract is 'marked to market' daily, this means:
- The contract price is fixed at inception and remains unchanged throughout its life
- Unrealized gains and losses are settled daily through the margin account (Correct answer)
- The physical commodity's quality is inspected and graded by the exchange each day
- Contract settlement prices are published in financial newspapers each trading day
Correct answer: Unrealized gains and losses are settled daily through the margin account
Mark-to-market means unrealized gains and losses on futures positions are credited or debited to margin accounts at the end of each trading day, ensuring the financial integrity of the market is maintained continuously.
FIA Commodities Markets & Trading 2
What is the 'basis' in commodity futures trading?