Chartered Financial Analyst (CFA) Practice Exam Level 2

What three components make up the total return in commodity futures?

1. Price return, Dividend yield, Interest rate

2. Price return, Roll return, Collateral return

3. Interest yield, Roll yield, Storage yield

4. Price return, Storage cost, Dividend income

The correct answer is: Price return, Roll return, Collateral return

The total return in commodity futures is comprised of three key components: price return, roll return, and collateral return. Price return reflects the change in the price of the commodity itself over the period of holding the futures contract. It is a crucial element as it directly impacts the profitability of the investment based on the market price fluctuations of the underlying commodity. Roll return arises from the process of rolling over futures contracts from a near-term expiration to a longer-term expiration. This return can be positive or negative depending on the shape of the futures curve, specifically whether the market is in contango (where future prices are higher than spot prices) or in backwardation (where future prices are lower than spot prices). The roll yield thus adds an additional return component based on how futures prices change as contracts roll over. Collateral return refers to the interest income generated from the cash or securities that back the futures contracts. When a trader enters into futures contracts, they are typically required to deposit an initial margin, which is often invested in short-term interest-bearing instruments. This interest contributes to the overall return from investing in futures. Each of these components plays an integral role in determining the overall performance of a commodity futures investment, making it essential to understand their distinct contributions to total return.