Commodity Forwards and Futures (FRM Part 1 2024 – Book 3 – Chapter 11)

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After completing this reading, you should be able to:
- Explain the key differences between commodities and financial assets.
- Define and apply commodity concepts such as storage costs, carry markets, lease rate, and convenience yield.
- Identify factors that impact prices on agricultural commodities, metals, energy, and weather derivatives.
- Explain the formula for pricing commodity forwards.
- Describe an arbitrage transaction in commodity forwards and compute the potential arbitrage profit.
- Define the lease rate and explain how it determines the no-arbitrage values for commodity forwards and futures.
- Describe the cost of carry model and determine the impact of storage costs and convenience yields on commodity forward prices and no-arbitrage bounds.
- Compute the forward price of a commodity with storage costs.
- Explain how to create a synthetic commodity position and use it to explain the relationship between the forward price and the expected future spot price.
- Explain the impact of systematic and nonsystematic risk on current futures prices and expected future spot prices.
- Define and interpret normal backwardation and contango.

0:00 Introduction
3:02 Commodities vs. Financial Assets
4:49 Factors that Impact Prices on Agricultural Commodities
7:53 Factors that Impact Prices on Metal
11:32 Factors that Impact Prices on Energy
13:14 Factors that Impact Prices on Weather Derivatives
17:35 Pricing Commodity Forwards
21:12 Examples of Commodity Forwards
22:09 Arbitrage in Commodity Forwards
26:07 Reverse Cash-and-Carry Arbitrage
27:02 Commodity Concepts
33:41 Arbitrage and Lease Rate
35:41 Forward Price with Storage Costs
38:12 Forward Price with Convenience Yield
39:48 Combining Storage Cost and Convenience Yield
40:31 How to Create a Synthetic Commodity Position
43:47 Systematic Risk
50:12 Normal Backwardation