Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the Roll Return measure in futures contracts?

1. (Near term price - previous term price) / previous term price

2. (Near term futures contract closing price - farther term futures contract closing price) / NTFCP

3. (Farther term price - near term price) / near term price

4. (Current price - agreed price) / agreed price

The correct answer is: (Near term futures contract closing price - farther term futures contract closing price) / NTFCP

The Roll Return in futures contracts particularly measures the price difference between near-term and farther-term futures contracts. It arises from the phenomenon of "rolling" positions in futures trading, where investors roll over their expiring contracts into new contracts. When we look at the formula given in the answer choice, it reflects the price differential between the near-term futures contract's closing price and the farther-term futures contract's closing price, normalized by the near-term futures contract price. This calculation essentially captures how much value or return an investor might realize due to the changes in price as they transition between contracts. In an upward-sloping market (contango), the near-term future is typically priced lower than the far-term future contract, potentially leading to a positive roll yield or return for the investor. Conversely, in a downward-sloping market (backwardation), the near-term future may be more expensive than the far-term future, which would adversely affect the roll return. Thus, the answer accurately reflects the mechanics behind the roll yield and how futures contracts are priced and valued over time. Understanding the Roll Return is essential for futures traders as it helps them assess the profitability of their rolling strategies in different market scenarios. This insight aids in making informed decisions regarding entering or exiting positions