ALTERNATIVE INVESTMENTS
TOPIC AREA QUESTIONS
ITEM SET - 1
Wabash Case Scenario
Wabash Trading Advisors is a commodities trading and advisory firm with particular emphasis in the grains
and livestock markets. Their clients include major food companies, financial institutions, and trading
companies.
Tomas Gorski recently joined Wabash as a commodity analyst after several years with another firm as an
equity analyst. He meets with a senior commodity analyst at Wabash, Pilar Moreno. She asks Gorski, “What
differences are there between valuing commodities and valuing equities? In response, Gorski makes the
following statements:
Statement 1 Commodity valuation focuses on supply and demand, while equity valuation focuses on
discounted cash flows.
Statement 2 Commodities do not generate future cash flows beyond what can be realized through their
purchase and sale.
Statement 3 Equities and commodities are both considered financial assets.
Moreno explains to Gorski that Wabash does not participate in all of the commodity sectors. We have
intentionally chosen to avoid base metals, precious metals, and energy.
Gorski responds, “It makes sense to concentrate on commodities that have similar characteristics. Even
though metals and energy may require storage, they are non-perishable and are not affected by weather.
Livestock is perishable and can only be stored for a very short period while grain can be stored longer.”
Moreno describes how some of Wabash’s clients hedge positions for critical commodities used in
manufacturing. To illustrate, she shows Gorski data for a position taken on behalf of Platte River Foods. The
position is now close to expiration.
Moreno continues, “One of Wabash’s oldest clients, Fond du Lac, has been in business for over 100 years
and has developed sophisticated pricing models. Currently their models predict that the price of corn is
poised to more than double in the next six months. Fond du Lac has purchased a large amount of corn in the
spot market and has taken delivery at its storage facilities. When the price increase occurs, they intend to
sell the corn in the spot market.”
Moreno asks Gorski to help her prepare a market overview to include in all client presentations. Gorski
collects the spot and futures prices of three commodities.
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QUESTION 1
Which of Gorski’s statements about the differences in the valuation of equities and commodities is least
likely correct?
A. Statement 2
B. Statement 1
C. Statement 3
QUESTION 2
Gorski’s response to Moreno regarding metals, energy, livestock, and grains is least likely correct with
respect to:
A. perishability.
B. weather.
C. storage.
QUESTION 3
The total return for the Platte River Foods hedge position is closest to:
A. 5.5%
B. 5.7%
C. 5.3%
QUESTION 4
In order to roll forward Platte River Foods’s current exposure and maintain its dollar value, Moreno would:
A. buy 2,000 near-term contracts and sell 3,000 of the longer-term contracts.
B. sell 2,000 near-term contracts and buy 2,000 of the longer-term contracts.
C. sell 2,000 near-term contracts and buy 3,000 of the longer-term contracts.
QUESTION 5
Fond du Lac would most likely be acting as a(n):
A. speculator.
B. arbitrageur.
C. informed investor.
QUESTION 6
Based on the information presented in Exhibit 2, the commodity most likely in contango is:
A. lean hogs.
B. live cattle.
C. corn.
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SOLUTIONS
TOPIC AREA QUESTIONS
ITEM SET - 1
QUESTION 1
C is correct. Equities represent financial assets, whereas commodities are almost always physical assets (the
exception being newer classes of commodities, such as electricity or weather).
QUESTION 2
B is correct. Because energy production is often located in coastal zones, it can be susceptible to severe
weather conditions, such as hurricanes. In addition, energy demand is seasonal, with gasoline consumption
rising in summer months, and fuel oil consumption increasing in cold weather. All of the commodities
mentioned (energy, metals, grains, and livestock) can be stored, although in the case of livestock, only for a
short period. Livestock is highly perishable.
QUESTION 3
B is correct, because total return is the sum of the price return, the roll return, and the collateral return.
Total return = 4.0% +1.5% + 0.2% = 5.7%.
QUESTION 4
C is correct. In order to maintain the $1,500,000 exposure to the commodity, Moreno would need to sell the
current contracts and purchase enough contracts to maintain the $1,500,000 exposure. The $1.5 million
exposure represents 2,000 near-term contracts ($1,500,000 ÷ $750 = 2,000 contracts). In turn, Moreno
would need to purchase 3,000 contracts at $500 ($1,500,000 ÷ $500 = 3,000 contracts).
QUESTION 5
B is correct. Arbitrageurs have the ability to inventory physical commodities and can capitalize on mispricing
between the commodity (along with storage and financing cost) versus the futures price by purchasing the
commodity in the spot market and holding it in storage until a future date.
QUESTION 6
C is correct. Spot prices for corn are lower than its futures prices. When the spot price of a commodity is
lower than its futures prices, the situation is called contango.
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