FRM-FMP

anbu.edu
Finance Junkie
Posts: 205
Joined: Mon Feb 04, 2013 3:35 pm

FRM-FMP

Postby anbu.edu » Mon Apr 01, 2013 11:07 pm

Which of the following is TRUE in normal backwardation? Futures prices tend to:

A) fall over the life of the contract because hedgers are net short and have to receive compensation for bearing risk.
B) rise over the life of the contract because speculators are net long and have to receive compensation for bearing risk.
C) fall over the life of the contract because speculators are net short and have to receive compensation for bearing risk.
D) rise over the life of the contract because hedgers are net long and have to receive compensation for bearing risk.

Source : Scheweser
Ans: B- I dont understand how

content.pristine
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Posts: 356
Joined: Wed Apr 11, 2012 11:26 am

FRM-FMP

Postby content.pristine » Fri Apr 05, 2013 5:44 pm

Normal Backwardation is a comparison between future prices and EXPECTED spot prices. The futures prices will be lower than the expected spot rate.
You should attempt this question in a backward fashion.
Figure out, whether hedgers are long or short?
Lets take for example, the hedgers are long. For example, a popcorn producing company needs to buy corn in the futures. That means, they are hedgers and they are long corn futures to hedge the risk that prices might go up. Now, that means, the speculators take the short position in the futures. That means they would demand a premium for taking this position. That means the futures price needs to be higher than the expected spot price. Hence that is wrong.
Hence the opposite, option B is correct


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