Chartered Financial Analyst (CFA) Practice Exam Level 2

When are roll returns generally negative in commodity futures?

1. When markets are in backwardation

2. When markets are in contango

3. When demand exceeds supply

4. When interest rates increase

The correct answer is: When markets are in contango

Roll returns are generally negative in commodity futures markets during periods of contango. This occurs when the future price of a commodity is higher than its spot price. In such a scenario, when an investor rolls over a futures contract by selling the expiring contract and buying a new one with a later expiration date, they end up selling low (the expiring contract) and buying high (the new contract). This creates a loss in the roll return, leading to negative roll returns. In contrast, backwardation occurs when future prices are lower than spot prices, which can lead to positive roll returns as investors would be selling high and buying low. Additionally, conditions related to demand exceeding supply can influence spot and futures prices, but they do not directly imply that roll returns are negative. Changes in interest rates can affect overall market dynamics and pricing but are not the primary driver of negative roll returns associated specifically with contango conditions.