Explanation:
A futures market is described as being in backwardation with a downward-sloping forward curve. In other words, near-term futures prices are higher than longer-dated futures prices. A backwardation commodity market occurs when the lease rate (the amount of interest the lender of a commodity requires) is greater than the risk-free interest rate. The presence of storage costs will have a positive impact on futures prices, but we cannot determine whether a market is in contango or backwardation without knowledge of the relationship between the risk-free rate and any benefits (lease rates or convenience yield) from holding the commodity.
(Book 3, Module 37.2, LO 37.f)
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Question 3
The futures market for corn is currently in backwardation. Knowing this fact, which of the following statements is most likely correct?
A
Lenders require a rate of interest for lending out corn that is higher than the risk-free rate.
B
The risk-free interest rate is higher than the rate of interest lenders require for buying and lending out corn.
C
Annualized storage costs for corn are higher than the interest rate lenders require for buying and lending out corn.
D
The rate of interest lenders require for buying and lending out corn is higher than the annualized storage costs for corn.
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