Explanation

Correct Answer: C - Commodity index returns differ from the changes in the prices of their underlying commodities.

Why Option C is Correct:

1. Commodity Index Returns vs. Spot Price Changes: Commodity index returns are not simply the changes in spot prices of the underlying commodities. They incorporate several additional factors:

   • Roll yield: The return from rolling futures contracts forward
   • Collateral yield: Return from investing collateral (usually Treasury bills)
   • Rebalancing effects: Returns from periodic rebalancing of the index

2. Components of Commodity Index Returns:

   • Spot return: Change in spot prices of commodities
   • Roll return: Gain or loss from rolling futures contracts
   • Collateral return: Interest earned on collateral
   • Total return = Spot return + Roll return + Collateral return

Why Other Options are Incorrect:

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

• Incorrect: Commodity indexes typically use production-weighted or consumption-weighted methodologies, not equal-weighting. Equal-weighting is more common in equity indexes.

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

• Incorrect: Different commodity indexes can have significantly different risk and return profiles even within the same market due to:
  • Different weighting methodologies
  • Different commodity selection
  • Different rebalancing frequencies
  • Different roll strategies
  • Examples: S&P GSCI vs. Bloomberg Commodity Index vs. DJ-UBS Commodity Index

Key Takeaways:

1. Commodity index returns are more complex than simple spot price changes
2. Understanding the components of commodity returns (spot, roll, collateral) is essential
3. Different commodity indexes can have substantially different characteristics even when tracking similar markets
4. Commodity indexes typically use production or consumption-based weighting, not equal weighting