Chartered Alternative Investment Analyst Association (CAIA) Practice Exam

What is referred to as the basis in commodity contracts?

1. The price spread between two futures contracts.

2. The difference between spot price and forward price of a commodity.

3. The average price of a commodity over a specific period.

4. The cost of storing a commodity before it is sold.

The correct answer is: The difference between spot price and forward price of a commodity.

In commodity contracts, the term "basis" specifically refers to the difference between the spot price of a commodity and the futures price. The spot price is the current market price at which the commodity can be bought or sold for immediate delivery, while the futures price reflects the agreed-upon price for delivery at a future date. Understanding this concept is crucial for various trading strategies and risk management practices in commodities. For instance, an investor might analyze the basis to determine whether to buy or sell futures contracts versus physical commodities. A narrowing basis can indicate that the spot price is catching up to the futures price, suggesting potential price convergence as the contract expiration approaches. While other terms mentioned might relate to commodity trading, such as price spreads, average price calculations, or storage costs, none accurately define the basis in the same way. These concepts play important roles in trading strategies and understanding market dynamics but do not represent the fundamental definition of the basis itself.