Explanation:
A is correct. In a normal market the futures price increases as time to maturity increases, while in an inverted market futures prices decrease as the time to maturity increases.
B is incorrect. An inverted market is the opposite of a normal market, and the futures prices decrease when maturity is shorter.
C and D are incorrect. It does not matter whether the prices are below or above spot for the definition of normal or inverted market. These refer to backwardation and contango.
Learning Objective: Explain the differences between a normal and inverted futures market.
Reference: Global Association of Risk Professionals, Financial Markets and Products (New York, NY: Pearson, 2023), Chapter 7. Futures Markets
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Q-6. The futures desk at an investment bank has organized a competition for a group of summer interns in which teams of interns are asked to demonstrate their knowledge of capital markets. One topic covers the characteristics of normal and inverted futures markets. Which of the following would an intern correctly describe as a defining characteristic of an inverted futures market for a commodity?
A
In an inverted market, the price of a longer-term futures contract is lower than the price of a shorter-term futures contract.
B
In an inverted market, the price of a longer-term futures contract is higher than the price of a shorter-term futures contract.
C
In an inverted market, the price of the futures contracts is lower than the spot price of the underlying asset.
D
In an inverted market, the price of the futures contracts is higher than the spot price of the underlying asset.
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