Explanation

Correct Answer: C

Commodity index returns differ from the changes in the prices of their underlying commodities due to several factors:

1. Roll yield/roll return: Commodity futures contracts must be rolled forward before expiration. The return from this rolling process (contango or backwardation) affects index returns differently than spot price changes.

2. Collateral yield: Commodity indexes typically assume full collateralization of futures positions, generating interest income that contributes to total return.

3. Rebalancing effects: Indexes rebalance periodically, which can create returns different from simple price changes.

Why other options are incorrect:

A. Commodity indexes commonly use an equal-weighting method.

• This is incorrect. Commodity indexes typically use production-based weighting, liquidity-based weighting, or other methods, but not equal weighting. Equal weighting is uncommon because commodities have vastly different production volumes and market values.

B. Commodity indexes in the same markets will share similar risk and return profiles.

• This is incorrect. Different commodity indexes can have significantly different risk and return profiles even within the same market due to:
  • Different weighting methodologies
  • Different rebalancing frequencies
  • Different roll strategies
  • Different composition and diversification

For example, the S&P GSCI and Bloomberg Commodity Index (BCOM) both track commodities but have different sector allocations and weighting schemes, leading to different performance characteristics.