Chartered Financial Analyst (CFA) Practice Exam Level 2

What condition indicates a contango market in commodity futures?

1. Convenience yield equals storage costs

2. Storage costs exceed convenience yield

3. Futures prices are lower than spot prices

4. Spot prices equal future prices

The correct answer is: Storage costs exceed convenience yield

A contango market in commodity futures occurs when futures prices are higher than spot prices. This situation arises primarily due to the costs associated with holding the physical commodity, such as storage and insurance. In the context of the choices: When storage costs exceed convenience yield, it indicates that the costs of maintaining the physical commodity outweigh the benefits derived from holding it. Convenience yield refers to the non-monetary benefits of holding a physical commodity, such as the ability to meet unexpected demand or avoid supply disruptions. Thus, when storage costs are higher, market participants will prefer to sell the commodity now rather than incur the costs of storage. This drives futures prices up relative to the spot prices, resulting in a contango condition. Therefore, the relationship defined by storage costs exceeding convenience yield correctly represents a scenario that leads to a contango market. This understanding is vital for traders and investors in predicting pricing dynamics within commodity markets.