1) Commodity index prices are based on the commodity future contract prices, not the spot price of the commodity. why so?
2) Also, Commodity future contracts reflect the RF rate, changes in future prices. Not able to understand.
3) What is roll yield?
Thanks in advance
1. Commodities are generally harder to price because they are not as liquid compared to their futures. Hence, commodity indices use the commodity derivatives as the base.
2. Derivative pricing happens based on the prevention of arbitrage principle which says that the forward rate = S0 * (1+Rf)^n. Hence, if Rf changes, futures price changes. Of course if futures prices change, the commodity index price is going to change. But this change could be due to the Rf and not due to the actually underlying’s price.
3. Roll yield is a concept we learn in AI. When the futures settlement date approaches (say it was for 6 months from Jan-Jul and we are in May), we might want to enter into another future for the next settlement window, from Jul-Dec of this year. This is called rollover. But at this point, the price of the future is different from what we expected. Roll yield is the difference between new futures price and our older price that we paid, or the difference between spot price and futures price.
1. Commodities are generally harder to price because they are not as liquid compared to their futures. Hence, commodity indices use the commodity derivatives as the base.
2. Derivative pricing happens based on the prevention of arbitrage principle which says that the forward rate = S0 * (1+Rf)^n. Hence, if Rf changes, futures price changes. Of course if futures prices change, the commodity index price is going to change. But this change could be due to the Rf and not due to the actually underlying’s price.
3. Roll yield is a concept we learn in AI. When the futures settlement date approaches (say it was for 6 months from Jan-Jul and we are in May), we might want to enter into another future for the next settlement window, from Jul-Dec of this year. This is called rollover. But at this point, the price of the future is different from what we expected. Roll yield is the difference between new futures price and our older price that we paid, or the difference between spot price and futures price.