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Answer: The forward curve will be downward sloping.
## Explanation **A is correct.** The forward price is computed as: \[ F = S(1 + R)^T \] where \( R \) is the risk-free rate, \( T \) is the time to maturity of the forward (measured in years), and \( S \) is the spot price. The commodity lease rate is computed as \[ l = \left(\frac{S}{F}\right)^{\frac{1}{T}} (1 + R) - 1 \] So, the forward price can alternatively be expressed in terms of risk-free rate and lease rate as: \[ F = S\left(\frac{1 + R}{1 + l}\right)^T \] Therefore, as the risk-free rate falls below the lease rate, we can see from the forward price formula above that \( F < S \), and the forward curve will be downward sloping (in backwardation). **B, C, and D are incorrect** per the explanation for A above.
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A risk analyst at a commodity trading firm is examining the supply and demand conditions for various commodities and is concerned about the volatility of the forward prices for silver in the medium term. Currently, silver is trading at a spot price of USD 20.35 per troy ounce and the 6-month forward price is quoted at USD 20.50 per troy ounce. Assuming that after 6 months the lease rate rises above the continuously compounded risk-free interest rate, which of the following statements is correct about the shape of the silver forward curve after 6 months?
A
The forward curve will be downward sloping.
B
The forward curve will be upward sloping.
C
The forward curve will be flat.
D
The forward curve will be humped.
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