So this statement is provided along with two others … you pick the false one.
Normal backwardation means that the futures price is less than the expected asset price at contract expiration. It could occur because the futures price only reflects the risk-free rate in an arbitrage transaction.
I got the question correct because there was a glaringly wrong answer. But I could not figure out what the second portion of this statement is supposed to mean. Any thoughts?
No idea. I would skip.
I am not sure, could it be the following?
Expected spot price correctly reflects “due” price: E(S) = S*(e^Rf+u-y) and in backwardation the component (y) is more than Rf and u together (great benefit of holding the asset), so the E(S) is gonna be lower than S.
On the other hand, if you only account for Rf in calculating the futures price, F will be higher than S and there would not even be backwardation…
Again, I am not sure and Alterrnatives its not my strongest area either, so any insights from others would be appreciated.
Cheers
Whenever you have the keyword “Expected” in this context, add “Normal”.
So if :
Future > Expected Spot => Normal contango
Future < Expected Spot => Normal backwardation
Yea … doesn’t make any sense.
gnrocks - not really sure what you mean in the context of my question. Could you clarify?