QUESTION 3

(a) [What is a commodity?

(b) Explain how commodities may act as a hedge against inflation.

(c) (i) Explain how a hedger may trade in futures contracts.

(c) (ii) [ Explain how a speculator may trade in futures contracts.

(d) In lectures, we discussed the formula for pricing a futures contract as follows:

= (1 + ) +

(d) (i) Explain what it means for a futures market to be in backwardation or

contango. Explain how the formula above can explain how a futures market could be in

backwardation or contango.

(d) (ii) Suppose that the current spot price of corn is $720 per bushel. The one

year risk-free rate is 6% per annum. The futures price for delivery of one bushel of corn

in one years time is $792 per bushel. Assume that net costs (storage costs minus

convenience yield) are $15 per bushel (over the next one year).

Is the futures contract correctly priced? If not, what is the theoretically correct price for the

futures contract and how could you take advantage of any mispricing?

(d) (iii) Suppose that a Managed Futures Fund takes a fully collateralized long

futures position in nearby soybean futures contracts at a quoted futures price of 870.0 (US

cents/bushel). The spot price at this time is 876.0 US cents/bushel. Three months later,

the entire futures position is rolled forward when the near-term futures price is 890.0 and

the farther-term futures price is 887.0. During the three-month period between the time

that the initial long position was taken and the rolling of the contract, the collateral earned

an annualized rate of 1.00%.

What is the rate of return to the fund over this 3-month period?