CFA Level II ExamAlternative InvestmentsMedium
A pension fund is considering an investment in a global commodity index. The fund's investment committee is concerned about the 'roll yield' component of commodity futures returns. Which of the following conditions would lead to a negative roll yield for a long position in a commodity futures contract?
- AThe futures market is in contango.
- BThe spot price is increasing.
- CThe futures price is decreasing.
- DThe futures market is in backwardation.
Show answer & explanationAnswer & explanation
Correct answer: A. The futures market is in contango.
A negative roll yield occurs when the investor must sell a lower-priced expiring futures contract and buy a higher-priced longer-dated futures contract to maintain their exposure. This happens when the futures market is in contango, meaning longer-dated futures prices are higher than shorter-dated futures prices.
Why the other options are wrong
- B. An increasing spot price does not directly determine roll yield; roll yield is based on the relationship between futures prices of different maturities.
- C. A decreasing futures price might impact total return but doesn't specifically define roll yield, which is about the relative prices of different maturities.
- D. Backwardation (futures price < spot price) leads to a positive roll yield for a long position.
Roll Yield
The return generated by rolling over a futures contract from one maturity to the next. It arises from the difference between the expiring futures price and the price of the new, longer-dated futures contract.
- Positive in backwardation (expiring > new).
- Negative in contango (expiring < new).
- Component of total commodity futures return.
Memory trick: Rolling out of futures can either cost or pay.