8 Alternative Investments

2023年CFA二级另类投资科目|相较于2022年,2023年另类投资的考纲要求并没有实质性的改变。该部分在整个考试中占比5%~10%，即可能出1-2个case题，定性考查多于定量考查。本部分的五个章节中，前三个章节和第四个章节，即不动产投资和私募股权估值为重点。其中，私有不动产投资的三种估值方法与私募股权估值中对目标企业和对私募股权基金的估值是考试的重点和难点。考生在学习过程中，需要结合书中的经典例题，在理解的基础上能够进行相关计算。

Alternative Investments

• Overview of Types of Real Estate Investment
  • Introduction of real estate investment
    • 特点
      • Offers investors long-term stable income
      • Protection from inflation
      • Low correlations with stocks and bonds
    • Basic forms
      • Comparison: private vs public
        • Public investors can purchase common stock, partnership units, or trust units in entities that are listed on public exchanges and freely traded
        • The key benefits to investing in publicly traded securities include liquidity, access to professional management, and a portfolio of properties combined with low minimum-purchase requirements
      • Comparison: equity vs debt
        • Equity investors generally expect a higher rate of return
        • Debt investors in real estate receive their return from promised cash flows and typically do not participate in any appreciation in value of the underlying real estate
    • Characteristics
      • Unique asset and fixed location (heterogeneity)
      • High unit value
      • Management intensive
      • High transaction costs
      • Depreciation
      • Need for debt capital
      • Illiquidity
      • Price determination: Real estate prices are typically determined by appraisals and estimates rather than by market transactions readily visible in the market as each property is unique
    • Risk factors of real estate investment
      • Property demand and supply
        • Business conditions
        • Demographics
        • Excess supply
      • Valuation
        • Cost and availability of capital
        • Availability of information
        • Lack of liquidity
        • Rising interest rates
      • Property operations
        • Management
        • Lease provisions
        • Leverage
        • ESG considerations
        • Obsolescence
        • Other risk factors
    • Role of real estate in an investment portfolio
      • Current income
      • Capital appreciation
      • Inflation hedge
      • Bond-like and stock-like characteristics
      • Diversification
      • Tax benefits
  • Investment characteristics by property type
    • Categories of Real Estate
    • Introduction of some properties
      • Office
        • The demand heavily depends on employment growth
        • The typical amount of space used per employee tends to increase when the economy is strong and decline when the economy is weak
        • The average length of an office building lease varies
      • Industrial and Warehouse
        • The demand heavily depends on the overall economy; also affected by import/export activity
        • Lease type: Net leases
      • Retail
        • The demand heavily depends on trends in consumer spending
        • Retail lease terms: Vary by the quality of the property as well as the size and importance of the tenant
        • Percentage lease or percentage rent: Tenants pay additional rent once sales reach a certain level
    • Common types of leases
      • Gross lease: The owner is responsible for the operating expenses
      • Net lease: The tenant is responsible for the operating expenses
        • Triple-net leases (or NNN leases) require each tenant to pay its share of the following three operating expenses: common area maintenance (CAM) and repair expenses; property taxes; and building insurance costs
  • Economic value drivers
    • Real estate return drivers are straightforward. Cash flow is a function of rental income, operating expenses, leverage, and capital spending
    • Major factors affecting real estate demand by sector
  • Considerations in analysis and due diligence
    • Market review
    • Lease and rent review
    • Costs of re-leasing space
    • Documentation
    • Property inspections
    • Legal documentation and tax compliance
  • Indexes
    • Appraisal-based indexes
      • 影响: Time lag
      • Example: A well-known index that measures the change in values of real estate held by institutional investors in the United States is the NCREIF Property Index (NPI)
        • 计算方法: Members of NCREIF (National Council of Real Estate Investment Fiduciaries) who are investment managers and pension fund plan sponsors contribute to NCREIF every quarter information on appraised values, along with net operating income (NOI), capital expenditures, and other information, such as occupancy
      • The return for all the properties
        • The beginning and ending market values are based on the appraisals of the properties because an actual transaction price is not possible for real estate
        • MSCI publishes a wide range of property indexes that cover markets worldwide, including emerging markets
      • Disadvantages and adjustments
        • Disadvantages: Appraisal lag (tend to have a lower correlation with other asset classes, and may underestimate the volatility of real estate returns)
        • Adjusted: “unsmooth” the appraisal-based index (may have more volatility and more correlation with other asset classes) or use a transaction-based index
    • Transaction-based indexes
      • 类型
        • Repeat sales index: relies on repeat sales of the same property
        • Hedonic index: does not require repeat sales of the same property. It requires only one sale. It include variables in the regression that control for differences in the characteristics of the property
      • Disadvantages and adjustments
        • Disadvantages: Can be noisy (that is, they include random elements in the observations) because of the need to use statistical techniques to estimate the index
        • Adjusted: Through the use of appropriate statistical techniques and collecting as much data as possible
• Investments in Real Estate through Private Vehicles
  • Highest and best use
    • 定义: The highest and best use of a vacant site is the use that would result in the highest value for the land
    • 公式: Implied land value = Value after completion − Construction cost
  • Valuation approaches to estimate real estate value
    • Income approach
      • Introduction
        • The direct capitalization method and the discounted cash flow method are income approaches used to appraise or estimate the value of a commercial (income-producing) property
        • The direct capitalization method estimates the value of an income-producing property based on the level and quality of its net operating income
        • The DCF method discounts future projected cash flows to arrive at a present value of the property
      • 计算过程
        • Calculation of NOI
          • 公式:Net operating income (NOI) = Rental income if fully occupied(1) + Other income (such as parking)(2)− Vacancy and collection loss(3)− Operating expense(4)
            • (1)+(2)=Potential gross income
            • (1)+(2)+(3)=Effective gross income
          • 说明
            • NOI is a before-tax unleveraged measure of income, it calculated before subtracting financing costs and income taxes
        • Direct capitalization method
          • Step 1: Calculate the net operating income for the first year (NOI1)
          • Step 2: Cap rate can be derived from recent comparable transaction
            • When income are growing at a constant compound growth rate
          • Step 3
          • 特殊情况
            • All risks yield (ARY): When tenants are required to pay all expenses, the cap rate can be applied to rent instead of NOI
            • Stabilized NOI: If the first year NOI is not representative of the typical first year NOI, use the stabilized NOI to estimate the value
        • DCF method
          • Step 1: Forecast the terminal value at the end of the holding period (using direct capitalization method if NOI growth is constant). R0=r-g is known as the terminal cap rate or residual cap rate
          • Step 2: Discount the NOI over the holding period and the terminal value to present
    • Cost approach
      • Introduction
        • The cost approach considers what it would cost to reproduce or replicate the asset and deducts depreciation and other factors that reduce the value of the property
        • Replacement cost includes the expense of buying the land and constructing a new property on the site that has the same utility or functionality as the property being appraised (referred to as the subject property)
        • The development cost should include the developer’s expected profit that would compensate the developer for development risk, including time and complexity, and the cost of financing development
      • Calculation
        • Step 1: Estimate the market value of the land
        • Step 2: Estimate the building's replacement cost, assuming it was built today using current construction costs and standard
        • Step 3: Deduct depreciation including
          • Physical deterioration: Related to the building’s age and occurs as a result of normal wear and tear over time
          • Functional obsolescence: Is the loss in value resulting from defects in design that impairs a building's utility.
          • locational obsolescence: Occurs when the location is no longer optimal
          • Economic obsolescence: Occurs when new construction is not feasible under current economic conditions
    • Sale comparison approach(market approach)
      • Introduction
        • The sales comparison approach considers what similar or comparable properties (comparable) transacted for in the current market
        • Adjustments are made to reflect comparable differences from the subject property
      • Calculation
        • Step 1: Adjust the prices of similar (comparable) properties for size, age, location, property condition, and market conditions at the time of sale, etc
        • Step 2: Calculate the per-square-price according to each adjusted price
        • Step 3: Calculate the average of all the per-square-prices
        • Step 4: Multiply the average per-square-price by the size of the subject property to obtain the estimated value
  • Private market real estate debt
    • The maximum loan amount
      • Debt service includes both interest and principal payments on the mortgage
    • Equity dividend rate and IRR
• Investments in Real Estate Through Publicly Traded Securities
  • Types of publicly traded real estate securities
    • Real estate investment trusts (REITs)
      • 类型
        • Equity REITs: REITs that own real estate
        • Mortgage REITs: REITs that make or invest in loans secured by real estate
      • Requirements
        • Distribute 90%–100% of their otherwise taxable earnings
        • Invest at least 75% of their assets in real estate
        • Derive at least 75% of income from real estate rental income or interest on mortgages
      • Advantages and disadvantages
        • Advantages
          • Liquidity
          • Transparency
          • Diversification
          • High-quality portfolios
          • Active professional management
          • Potentially stable income
          • Tax efficiency
        • Disadvantages
          • Lack of retained earnings
          • Regulatory costs
          • Reduced portfolio diversification benefits
          • Limited in types of assets owned
    • Real estate operating companies (REOCs)
      • Definition: ordinary taxable real estate ownership companies
      • 投资原因
        • They are located in countries that do not have a tax advantaged REIT regime in place
        • They engage to a large extent in the development of for-sale real estate properties
        • They offer other non-qualifying services
    • Mortgage-backed securities (MBS)
      • Commercial mortgage-backed securities (CMBS): Mortgage loans on commercial properties
      • Residential mortgage-backed securities (RMBS): Mortgage loans on residential properties
  • Valuation approach
    • Net asset value approach
      • Accounting for investment properties
        • Under IFRS, companies are allowed to value investment properties using either a cost model or a fair value model
        • Under US GAAP, most US real estate owners use the historical cost accounting model
      • Introduction
        • Definition: The (per-share) amount by which assets exceed liabilities, using current market values rather than accounting book values, divided by the number of shares outstanding (NAVPS)
        • Generally considered the most appropriate measure of the fundamental value of REITs (and REOCs)
      • 步骤
        • Step 1: Values of properties held by REITs and REOCs are estimated by capitalizing the rental streams (NOI) using cap rate
        • Step 2: The book values of other tangible assets including cash, account receivable, land, for future development, prepaid expenses are added to obtain estimated gross asset value
          • Goodwill and deferred tax assets are excluded
        • Step 3: Debt and other liabilities are subtracted to obtain net asset value
          • Deferred tax liabilities are excluded
        • Step 4: Division by the number of shares outstanding produces NAVPS (net asset value per share)
      • Considerations
        • Private property investors may or may not value individual assets the same way public equity investors value listed real estate companies
        • NAV reflects the value of a REIT's assets to a private market buyer
        • NAV implicitly treats the REIT as a static pool of assets
        • NAV estimates can become quite subjective when property market become illiquid and when REITs own hundreds of properties
        • If REIT management is performing well in the sense of creating value, REITs and REOCs should trade at premiums to underlying NAVPS
          • Investors in the stocks have liquidity on a day-to-day basis, thus warranting a lower required return rate (higher value)
          • The competitive nature of the public markets and the size of the organizations should attract above-average management teams
    • Relative value (price multiple) approach
      • P/FFO: FFO =net income (computed in accordance with GAAP) + losses (minus gains) from sales of properties + plus depreciation and amortization related to real estate
      • P/AFFO: Adjusted Funds from Operations (AFFO)= FFO- any non-cash rent - maintenance-type capital expenditures and leasing costs
      • Advantages and disadvantages
        • Advantages
          • Multiples of earnings measures of this kind are widely accepted in evaluating shares across global stock markets and industries
          • FFO estimates are readily available through market data providers
          • Multiples can be used in conjunction with such items as expected growth and leverage levels to deepen the relative analysis among REITs and REOCs
        • Disadvantages
          • Applying a multiple to FFO or AFFO may not capture the intrinsic value of all real estate assets held by the REIT or REOC
          • P/FFO does not adjust for the impact of recurring capital expenditures needed to keep properties operating smoothly. Assumptions are incorporated into the calculation of AFFO
          • P/FFO and P/AFFO more difficult to compute and complicating comparisons between companies
  • Private VS. Public: a comparison
    • Advantages
    • Disavantages
• Private Equity Investments
  • Introduction
    • Venture capital
    • Buyout
      • Acquisition capital: Financing in the form of debt, equity, or quasi-equity provided to a company to acquire another company
      • Leveraged buyout: Financing provided by an LBO firm to acquire a company
      • Management buyout: Financing provided to the management to acquire a company, specific product line, or division (carve-out)
    • Special situations
      • Mezzanine finance: Financing generally provided in the form of subordinated debt and an equity kicker (warrants, equity, etc.) frequently in the context of LBO transactions
      • Distressed/turnaround: Financing of companies in need of restructuring or facing financial distress
      • One-time opportunities: Financing in relation to changing industry trends and new government regulations
      • Other: Other forms of private equity financing are also possible—for example, activist investing, funds of funds, and secondaries
  • Valuation techniques in private equity transactions
    • Income approach: discounted cash flow (DCF)
      • Value is obtained by discounting expected future cash flows at an appropriate cost of capital
      • Generally applies across the broad spectrum of company stages
      • DCF provides the most relevant results when applied to companies with a sufficient operating history
        • Most applicable: expansion phase up to the maturity phase
    • Relative value: earnings multiples
      • The earnings multiple is frequently obtained from the average of a group of public companies operating in a similar business and of comparable size (include P/E, EV/EBITDA)
      • Generally applies to companies with a significant operating history and a predictable stream of cash flows
        • Apply (with caution) to: expansion stage
        • Rarely apply to: early-stage or start-up companies
    • Real option
      • Requires judgmental assumptions about key option parameters
      • Generally applies to situations in which the management or shareholders have significant flexibility in making radically different strategic decisions
        • Seed or start-up phase
    • Replacement cost
      • Estimated cost to recreate the business as it stands as of the valuation date
      • Generally applies to early-stage (seed and start-up) companies, companies operating at the development stage and generating negative cash flows, or asset-rich companies
      • Rarely applies to mature companies
    • Other considerations
      • Probabilities: In most transactions, private equity investors are faced with a set of investment decisions that are based on an assessment of prospective returns and associated probabilities
      • Monte Carlo simulation: The objective is to ensure that the simulation is as close as possible to the realities of the business and encompasses the range of possible outcomes, including base case, worst case, and best case scenarios (sometimes called a triangular approach)
      • Other key considerations when evaluating a private equity transaction include the value of control, the impact of illiquidity, and the extent of any country risk
    • How is value created in private equity
      • The survival of the private equity governance model depends on economic advantages it may have over the public equity governance model, including
        • The ability to re-engineer the private firm m to generate superior returns
        • Financial leverage and the ability to access credit markets on favorable terms
        • A better alignment of interests between private equity firm owners and the managers of the firms they control
      • The contractual clauses that private equity firms use to ensure that the management team is focused on achieving the business plan
        • Corporate board seats: A seat ensures some degree of private equity control in the case of major corporate events
        • Non-compete clause: Preventing founders from restarting the same activity during a predefined period of time
        • Preferred dividends and liquidation preference: Private equity firms generally come first when distributions take place, and they may be guaranteed a minimum multiple of their original investment
        • Reserved matters: some domains of strategic importance are subject to approval or veto by the private equity firm
        • Earnouts (mostly in venture capital): Agreements that the acquisition price paid by the private equity firm is contingent on company management achieving predefined financial performance over a specified future time period
  • Contrasting venture capital and buyout investments
  • LBO model for valuation of buyout transactions
    • Buyout: The buyer in a private equity transaction acquires from the seller a controlling stake in the equity capital of a target company, including but not limited to management buyouts (MBOs), leveraged buyouts (LBOs), and takeovers
    • LBO target
      • Undervalued/depressed stock price
      • Willing management and shareholders
      • Inefficient companies
      • Strong and sustainable cash flow
      • Low leverage
      • Assets
    • LBO model
      • Description: The LBO model is not a separate valuation technique but, rather, a way of determining the impact of the capital structure, purchase price, and other parameters on the returns expected by the private equity firm from the deal
      • Three main input parameters
        • The cash flow forecasts of the target company
        • The return that the providers of financing (equity, senior debt, high-yield bonds, mezzanine) are expecting
        • The amount of financing available for the transaction
      • Exit value = investment cost + earnings growth + multiple expansion + reduction in debt
    • Calculating payoff multiples and IRR for equity investors
      • Step 1: Calculating the exit value
      • Step 2: Calculating the claimant' payoff
        • Debt
        • Preference shares
        • PE firms
        • Management
      • Step 3: Calculating the total investment and total payoff, using these two can get the payoff multiples for PE firms
      • Step 4: Calculating the IRRs for PE investors and management equity
  • VC method for valuation of venture capital transactions
    • Background
      • The primary difficulty of venture capital investing is the substantial uncertainty about the company's future prospects. Traditional valuation tools, such as discounted cash flow, earnings multiples, and the LBO model, are not usually practical in the VC context
      • Due to the uncertainty, VC financing is done in stages—financing rounds referred to as Series A, Series B, and so on—and it is essential to understand the effects of ownership dilution
    • Pre and Post money valuation
      • The two fundamental concepts in venture capital investments: pre-money (PRE) valuation and post-money (POST) valuation
      • The post-money valuation of the firm is: POST = PRE + INV
      • The ownership proportion of the VC investor is INV/POST
    • Required rate of return
      • Step 1: Post-money valuation
      • Step 2: Pre-money valuation
      • Step 3: VC fraction ownership
      • Step 4: Calculating the IRR
    • Option pools
      • 假设: fully diluted basis (options are all exercised)
    • Stage financing
  • Exit routes: return cash to investors
    • Initial public offering (IPO)
      • Advantages
        • Higher valuation multiples as a result of enhanced liquidity
        • Access to large amounts of capital
        • The possibility of attracting higher-caliber managers
      • Disadvantages
        • Cumbersome (complex) and less flexible
        • Entails significant costs
      • An appropriate exit route for private companies: Sufficient size with an established operating history and excellent growth prospects
      • Timing is important and heavily dependent on public equity market conditions
    • Secondary market
      • 定义: The sale of an investor's stake to other financial investors or to strategic investors
      • Advantages: The possibility of achieving the highest valuation multiples in the absence of an IPO
      • 条件: Specialized firms have the skill to bring their portfolio companies to the next level
    • Management buyout (MBO)
      • Significant amounts of leverage to finance the acquisition
      • May come at the expense of excessive leverage that significantly reduces the company's flexibility
    • Liquidation
      • It is no longer viable
      • A floor value for the company but may come at a cost of very negative publicity for the private equity firm
  • Risk and costs of investing in private equity·
    • Risk factors
      • Illiquidity of investments: Generally not traded on any securities market
      • Unquoted investments
      • Competition for attractive investment opportunities
      • Reliance on the management of investee companies (agency risk)
      • Loss of capital
      • Government regulations
      • Taxation risk
      • Valuation of investments: The valuation of private equity investments is subject to significant judgment
      • Lack of investment capital: Investee companies may require additional future financing that may not be available
      • Lack of diversification
      • Market risk: Long-term factors such as interest rates, currency exchange rates. Temporary short-term market fluctuations are generally irrelevant
    • Costs
      • Transaction fees: Due diligence, bank financing costs, the legal fees of arranging an acquisition, and the costs of arranging the sale of an investee company
      • Fund setup costs: Mainly the legal costs of setting up the investment vehicle and are amortized over the life
      • Administrative costs: Custodian, accounting, and transfer-agent costs
      • Audit costs
      • Management and performance fees: Usually 2% management fees and 20% performance fees
      • Dilution
      • Placement fees: Fundraising fees may be charged up front—2% is not uncommon in private equity—or by means of a trailer fee
  • Private equity fund structures and terms
    • Economic terms
      • Management fees
        • Represent an annual percentage of committed capital
        • Paid quarterly to the GP during the fund investment period
        • Fees of 1.5%–2.5% are common
      • Transaction fees
        • Fees paid to when they provide investment banking services for transactions (mergers and acquisitions, IPOs)
        • These fees may be subject to sharing agreements with LPs, typically a 50/50 split and generally come as a deduction to the management fees
      • Carried interest: Represents the general partner's share of the profits generated by a private equity fund
      • Ratchet: Is a mechanism that determines the allocation of equity between shareholders and the management team of the PE-controlled company
      • Hurdle rate: Is the IRR that a private equity fund must achieve before the GP receives any carried interest. (7%-10%)
      • Target fund size
        • Signals the GP's capacity to manage a portfolio of a predefined size and also the GP's ability to raise funds
        • A fund that closed with a significantly lower size relative to the target size is perceived as a negative signal
      • Vintage year: the year the private equity fund is launched
      • Term of the fund: Is typically 10 years and is extendable for additional shorter periods by agreement with the investors
    • Corporate governance terms
      • Key man clause: If a key named executive leaves the fund or does not spend a sufficient amount of time at the fund, the GP may be prohibited from making additional investments until another key executive is selected
      • Performance disclosure and confidentiality: This specifies the fund performance information that can be disclosed. Note that the performance information for underlying portfolio companies is typically not disclosed
      • Distribution waterfall: This provision specifies the method in which profits will flow to the LPs and when the GP receives carried interest
        • Deal-by-deal method: Carried interest can be distributed after each individual deal
        • Total return method: Carried interest is calculated on the entire portfolio
          • Only after the entire committed capital is returned to LPs
          • Exceeds some minimum amount
      • Clawback: If a fund is profitable early in its life, the GP receives compensation from the GP's contractually defined share of profits
      • Tag-along, drag-along clauses: Anytime an acquirer acquires control of the company, they must extend the acquisition offer to all shareholders, including firm management
      • No-fault divorce: This clause allows a GP to be fired if a supermajority (usually 75% or more) of the LPs agree to do so
      • Removal for cause: This provision allows for the firing of a manager or the termination of a fund given sufficient cause
      • Investment restrictions: A minimum level of diversification on the fund's investments, a geographic and/or sector focus, or limits on borrowing
      • Co-investment: LPs generally have a first right of co-investing along with the GP
  • Evaluating a private equity fund
    • Analysis of IRR since inception
      • Gross IRR: is a function of the cash flows between the portfolio companies and the PE fund and is often considered a good measure of the PE firm's track record in creating value
      • Net IRR: is a function of the cash flows between the PE fund and LPs, capturing the returns to investors
      • Net of fees: Means net of management fees, carried interest, or any other financial arrangements that accrue to the GP
      • The interpretation of IRR in private equity is subject to caution, however, because an implicit assumption behind the IRR calculation is that the fund is fully liquid, whereas a significant portion of the fund's underlying investments is illiquid
      • Drawbacks of IRR
        • Can be easily manipulated
        • It provides no information about the size of the return
    • Analysis of return multiples
      • PIC (paid-in capital)=paid-in capital / total committed capital
      • DPI (distributed to paid-in):=cumulative distributions/Paid in capital
      • RVPI (residual value to paid-in)=NAV after distribution/Paid in capital
      • TVPI (total value to paid-in)=DPI+RVPI
• Introduction to Commodities and Commodity Derivatives
  • Introduction
    • Commodity sectors
    • Life cycle of commodities
      • Energy
        • Natural gas can be consumed almost immediately after extraction from the ground
        • Crude oil has to be transformed into something else for it's useless in its innate form
        • The refined products (e.g., gasoline and heating oil) have a number of potential processing steps
      • Industrial/precious metals
        • The life cycle of both precious and industrial metals is probably the most flexible
        • Creating the economies of scale involved in the smelter and ore processing plants is critical
        • When supply exceeds demand for a given industrial metal, it is difficult for suppliers to either cut back production or halt it entirely
      • Grains
      • Softs
        • Coffee is harvested somewhere all year round in the various countries that circle the Equator
        • With most of the consumption in faraway foreign markets, ships are commonly used to transport the beans to their buyer, which may store them in a warehouse
        • Farmers and distributors can sell futures contracts to hedge the sales price of production
    • Valuation
      • Tangible items with an intrinsic economic value
        • They do not generate future cash flows
        • The valuation of commodities is based not on the estimation of future profitability and cash flows but on a discounted forecast of future possible prices
      • Transportation and storage costs
        • Ongoing expenditures affect the shape of the forward price curve of the commodity derivative contracts with different expiration dates
        • The current demand for the commodity can move the spot price higher than the futures price
        • This time element of commodity storage and supply and demand can generate "roll return" and affect investment returns
      • Actual delivery of the physical commodity: The law of one price may not be entirely enforced by arbitrageurs because some participants do not have the ability to make or take delivery of the physical commodity
  • Commodity futures
    • Market participants
      • Commodities hedgers
      • Commodities traders and investors
        • Informed investors
        • Liquidity provider: A speculator may be willing to act as a liquidity provider
        • Arbitrageurs
      • Commodity exchanges
      • Commodity market analysts
      • Commodity regulators
    • Commodity spot and futures pricing
      • Commodity prices
        • Spot price: is simply the current price to deliver a physical commodity to a specific location or purchase it and transport it away from a designated location
        • Futures price: is a price agreed on to deliver or receive a defined quantity (and often quality) of a commodity at a future date
        • Basis: spot price - futures price
      • Backwardation
        • spot price > futures price
        • near-term (i.e., closer to expiration) futures contract price > the longer-term futures contract price
      • Contango
        • spot price < futures price
        • near-term (i.e., closer to expiration) futures contract price < the longer-term futures contract price
      • Cash-settled contracts
      • Physical-settled contracts
    • Theories of futures returns
      • Insurance theory (normal backwardation)
        • 主要内容
          • A commodity producer is long the physical good and thus would short futures contracts to hedge its sales price and make their revenues more predictable
          • The futures curve is in backwardation normally
          • The futures price has to be lower than the current spot price as a form of remuneration to speculators who takes on the price risk
        • 缺点: This theory does not explain contango
      • Hedging pressure hypothesis
        • Occurs for both producers and consumers
        • 不同情况
          • If the two forces of producers and consumers are equal in weight, then the futures curve is flat
          • If producers are more interested in selling futures than consumers, the market is backwardation
          • If consumers are more concerned about price risk, the market is contango
        • Producers generally have greater exposure to price risk than consumer do
      • Theory of storage
        • In contango: Storage costs lead to a higher price in the future. Supply dominates demand
        • In backwardation: Convenience yield leads to a lower price in the future. Demand dominates supply
        • Futures prices = spot price + storage costs – convenience yield
    • Components of futures returns
      • The price return (spot yield)= (Current price − Previous price)/Previous price (the front month contract)
      • The roll return (roll yield)= [(Near-term futures contract closing price − Farther-term futures contract closing price)/Near-term futures contract closing price]*Percentage of the position in the futures contract being rolled
      • The collateral return (collateral yield)
      • total return=spot price return + roll return + collateral return (risk-free rate return)
  • Commodity swaps
    • Introduction
      • 定义: A commodity swap is a legal contract involving the exchange of payments over multiple dates as determined by specified reference prices or indexes relating to commodities
      • 作用
        • Commodity swap provides both risk management and risk transfer while eliminating the need to set up and manage multiple futures contracts
        • Swaps also provide a degree of customization not possible with standardized futures contracts
    • Categories
      • Total return swap
      • Basis swap
      • Variance and volatility swaps
  • Commodity indexes
    • Primary roles
      • Can be used as a benchmark to evaluate broader moves in commodity pricing
      • As a broad indicator, an index can be used for macroeconomic or forecasting purposes by examining statistically significant relationships between movements in the commodity index and other macroeconomic variables
      • Can act as the basis for an investment vehicle or contract providing the information needed to record, monitor, and evaluate price changes that affect contract value
    • Key characteristics
      • The breadth of coverage (number of commodities and sectors) included in each index
      • The relative weightings assigned to each component/commodity and the related methodology for how these weights are determined
      • The rolling methodology for determining how those contracts that are about to expire are rolled over into future months
      • The methodology and frequency for rebalancing the weights of the individual commodities, sectors, and contracts in the index to maintain the relative weightings assigned to each investment
      • The governance of indexes is important because it is the process by which all the aforementioned rules are implemented
    • Rebalancing frequency
      • Rebalancing is more important if a market is frequently mean reverting
      • Frequent rebalancing can lead to underperformance in a trending market