Alternative Investments: CAIA Level I, 3rd Edition

CHAPTER 11 Commodity Forward Pricing

Commodity investing serves as the focal point to this chapter and Chapter 12. Because futures contracts are the primary vehicle with which investors obtain exposure to commodity returns, our analysis of commodities as an investment begins with a somewhat detailed discussion of futures and forwards.

11.1 Forward Contracts versus Futures Contracts

Forward contracts were discussed in moderate detail in Chapter 6. Chapter 6's discussion focused only on forward contracts and, more specifically, forward contracts on financial securities. This chapter includes futures contracts and focuses on both futures and forwards on underlying physical assets (i.e., commodities).

In their simplest form, both forward contracts and futures contracts are binding agreements for the purchase or sale of a commodity but with deferred exchange of the commodity and the cash. This section details the differences between forward contracts and futures contracts.

11.1.1 Trading Differences between Forward Contracts and Futures Contracts

In introductory material the terms forward contract and futures contract are often used interchangeably due to their similarities: the hallmark of both contracts is the deferred delivery, and both contracts are priced with similar principles. One major distinction between the two is that forward contracts are typically over-the-counter (OTC) contracts, whereas futures contracts are exchange traded. Since futures contracts are traded ...