By Adam Zaremba
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Additional resources for The Financialization of Commodity Markets: Investing During Times of Transition
However, the futures price in the market is USD 25 in order to “encourage” the speculative investors to trade, which means that the futures are sold with a fivedollar discount to the spot price. The difference between the expected spot price and the futures price ($ 2) is a risk premium that is offered to the speculators. Let us suppose that on the contract maturity date, the investor’s expectations have come true and the spot price has reached the expected level of $ 27. For an investor who is interested in changes in spot prices, this means a loss of $3 (30–27).
According to Keynes’ theory, the current futures price is lower than the expected spot price in the future. In such a situation, the quotations of the futures contract should gradually increase and, ultimately, on the maturity date, be equal to the spot prices. The consequence is a positive rate of return to holders of long positions. According to the normal backwardation theory, an additional risk premium for holders of long positions should be seen as the cost of hedging against a decline in commodity prices, which the producers and consumers pay to the speculators in a market.
This means that the rate of return on the excess return index takes into account two components: the spot return and the roll return. After subtracting the return on the spot index from the spot return on the excess return index, the roll yield is obtained. We can assume in a simplified way that the excess return indices reflect a risk premium generated in the commodity market over a given period. Total Return Indices Total return indices are analogous to the income indices in the stock market because they represent the revenues generated in the commodity markets in a most complete manner.