David
I think I heard 3 types of backwardation.  Normal, when the spot price is above the forward price and when the forward curve is downward sloping.  Is that correct

Frank

Hi Frank,

Among the assigned FRM authors there is indeed a slight discrepancy in terminology, with regard to backwardation/contango and normal backwardation/contango. To settle this, for years I have followed Don Chance who is the expert author for the CFA cirriculum.

Here is an brief screencast on this and here is Q&A;that relates to the Metallgesellshaft case study (FRM assigned)

But in summary, contango/backwardation refer to the observed shape of the forward curve while “Normal” c/b refers to an instantaneously unobserved phenonemon because it relates to the expected future spot price.

* Contango = futures price > spot price.
* Backwardation (i.e., inverted curve) = futures price < spot price.
* Normal contango = futures price > expected future spot price.
* Normal backwardation = futures price < expected future spot price

For the FRM candidate, the relationship between F and E(S) is relevant; for the FRM 2008 program, I am impressed at how many AIMs invoke it indirectly. It is not an easy idea the first time:

If the asset has systematic risk (beta > 0), then “theory of normal backwardation” says

F < E(S)

Under these definitions, a typical physical commodity (i.e., with storage cost > convenience) will be in contango (i.e., upward sloping forward curve) and normal backwardation (future speculators pay less than expected future spot price)

David