Backwardation can be explained by:

Backwardation can be explained by:
A . expectations of oversupply in the future
B . convenience yields being greater than the total carrying cost
C . short term shortages in the spot markets
D . all of the above

View Answer

Answer: D

Explanation:

When forward prices are greater than the spot prices, the market is said to be in contango. When forward prices are lower than spot prices, the market is said to be backwarded. A short squeeze may contribute to backwardation as shorts try to buy in the spot market to cover their short positions. Similarly, expectations of oversupply in the future, for example due to a bumper harvest may create situations where the forward prices fall below spot prices. Convenience yield is the benefit from having access to the commodity – and if the convenience yield is very high, for example in a market where manufacturers must never run out of a particular raw material, then these can switch the costs of carry (which include interest and storage costs, less convenience yields) to being negative.

Since all these factors can contribute to backwardation in the market, Choice ‘d’ is the correct answer.