Question #6
Reading: Reading 32 Introduction to Commodities and Commodity Derivatives
PDF File: Reading 32 Introduction to Commodities and Commodity Derivatives.pdf
Page: 2
Status: Incorrect
Correct Answer: B
Your Answer: B
Question
Don Chancery is working on a forecast of commodity price movements for the economic research department at his investment firm. He is basing his predictions on the theory that pricing is driven solely by producers who hold (or expect to hold) commodities, and hedge their position with a short futures contract, leading to normal backwardation. Which of the following theories is Chancery most likely using?
Answer Choices:
A. The Hedging Pressure Hypothesis
B. The Insurance Theory
C. The Theory of Storage
Explanation
Under the Insurance Theory, the shape of the futures price curve can be explained by
producers of a commodity (i.e. market participants that are long the physical good) selling
the commodity for future delivery in order to hedge their exposure to price risk. The
Hedging Pressure Hypothesis extends the insurance perspective to include consumers
who hedge long positions, not solely producers with short positions. The Theory of
Storage links convenience yields to inventory levels.