International Commodity Trading – The differences between a forward contract for a commodity and a commodity futures contract

Question 1
Explain each of the following.
(a) The differences between a forward contract for a commodity and a commodity futures contract.
(b) Why commodity producers and consumers may wish to use these forms of contract rather than deal solely in the spot market for a commodity.
(c) What the relative merits and limitations of these two forms of contract are.

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Question 2

If a commodity has a “contango” pattern of futures prices:
(a) What does this mean?
(b) What are the main reasons for this sort of pattern of futures prices?
(c) Why may an element of “convenience yield” cause the basis to be below the full cost of carry?
(d) How may events that disrupt supply and cause uncertainty, such as the impact on the cocoa market of the 2002 conflict in the Ivory Coast, cause the futures market to switch from contango to backwardation?
Assuming that in the US cotton market:
- The NYBOT spot price is 60.00 cents per lb in May
- Cotton costs 0.82 cents per lb to store for a month
- Insurance for stored cotton costs 0.25 cents per lb.
- The annual interest rate is 6%.
(e) What is the monthly cost of carry per lb of cotton?
(f) If it is now May, what price per lb do you estimate September cotton futures should be?
(g) What will happen to cotton futures prices if interest rates fall?

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Question 3
If it is in May, the spot price of gold is $708.2 per troy oz, July gold futures are selling at $711.3 per oz, and September gold futures are priced at $717.6 per oz.
(a) What strategy could a speculator follow if they thought that the price of gold was going to fall?
(b) Construct examples, with appropriate figures, to show what the outcome of the straight speculative trade you set out in (a) might be:
(i) If the trader is successful;
(ii) If the trader’s prediction is wrong.
(c) Using the initial data and making appropriate assumptions about the price changes expected, set out a speculative spread trade that this speculator might have entered in May.
(d) Using the data you have constructed for (b), and constructing appropriate values for any other prices, evaluate the outcome of your spread trade under both scenarios (b) (i) and (b) (ii).
(e) Explain why spread trading is usually less risky than straight speculative trading, with reference to the outcomes of your examples constructed in (b) and (d).
(f) Explain briefly what factors are necessary for a commodities futures market speculator to be successful.

 

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International Commodity Trading – The differences between a forward contract for a commodity and a commodity futures contract