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Exam Feedback FRM Part 1 (May 2014) Exam Feedback


Selected normal,.... -> normal market and contango have the same meaning. So does inverted market and backwardation.

Append - Please ignore my earlier note w.r.t,...normal / contango & inverted / backwardation meaning the same.
Normal / Inverted are terms use to describe a futures price curve which is an increasing / decreasing function of time to maturity.
Contango / backwardation are terms used to describe the futures price drift towards the spot price as you approach maturity.

Hi David, can you explain with reference to this?I've not sat for the exam but Ive always thought normal=contango

In the BT hull notes it writes (pg 23)

If the forward price is higher than the spot price (or the distant forward price is higher than the near forward price) the Futures curve is said to be normal, or in Contango.
If the forward price is less than the spot price (or the distant forward price is less than the near forward price), the Futures curve is said to be inverted, or in Backwardation



I have no issues understanding the concept. If you see what i quoted, it seems like GARP has a dif way of seeing things

Normal(GARP) Vs Contango(BT)
Inverted(GARP) Vs Backwardation(BT)


Contango(Garp) vs Normal Contango (BT)

Am i over thinking this?
Has Garp ever used Normal Contango or Normal backwardation?
I always thought than Normal=Contango
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Well-Known Member
There is difference between normal contango and contango and also bw normal backwardation and backwardation.Do not get confused with normal.the above are four different concepts i mean there is no such technical term as inverted contango or backwardation.normal contango is not same as contango. We say normal or inverted market not contango. We just say normal contango or just contango.refer https://www.bionicturtle.com/forum/threads/two-different-definitions-for-contango-market.5514/ and http://mutualfunds.about.com/od/mutualfundglossary/g/contango.htm

David Harper CFA FRM

David Harper CFA FRM
Staff member
I agree with @ShaktiRathore of course, but the practical problem is that "normal" and "normal contango" are not used the same everywhere. Before the semantics, there is a key underlying difference between:
  • Properties of an observed curve; e.g., F(T2) > F(T1) > S(0) is an upward-sloping futures curve such that the futures price is greater than the spot price
  • Unobserved properties: Is the observed F(T) less than the expected future spot price, E[S(t)]. F(T) is a traded price, but E[S(t)] is a theory
For most exam-type purposes, only the former matters: what's the shape of the observed curve. We tend to refer to this as either:
  • Contango is verifiable: F(T2) > F(T1) > S(0); e.g., in the Metallgesellschaft case, it has always been a key cause the shift from oil curve backwardation to contango ("futures price greater than spot price")
  • Backwardation; aka, inverted is also objective and verifiable F(T2) < F(T1) < S(0)
Note this is consistent with McDonald (who is assigned for commodity forwards; if you want to be strict to the syllabus here is an answer) who avoids "normal:"
"Table 6.1 illustrates two terms often used by commodity traders in talking about forward curves: contango and backwardation. If the forward curve is upward sloping—i.e., forward prices more distant in time are higher—then we say the market is in contango. We observe this pattern with near-term corn and soybeans, and with gold. If the forward curve is downward sloping, we say the market is in backwardation. We observe this with medium-term corn and soybeans, with gasoline (after 2 months), and with crude oil." McDonald, Robert L. (2012-11-05). Derivatives Markets (3rd Edition) (Pearson Series in Finance) (Page 166). Prentice Hall. Kindle Edition.

I happen to agree with @ShaktiRathore, if I understand him correctly: when you add "normal," you change these to definitions about unobserved relationship between F(T) and unobserved E[S(t)], where "normal backwardation" refers to F(T) < E[S(t)] under a "Theory of N.B." which says the speculator is long and the hedger is short such that the speculator expects a gain and hedger actually expects a loss on the contract. But this is where we've added normal: "normal backwardation" is not highly relevant as a semantic term so much as it is an explanation for why the futures price is a biased predictor of the expected future spot price.

And here is Hull referring (please note) to exclusively observed curve shapes:
"Futures prices can show a number of different patterns. In Table 2.2, gold, wheat, and live cattle settlement futures prices are an increasing function of the maturity of the contract. This is known as a normal market. The situation where settlement futures prices decline with maturity is referred as an inverted market ... The term contango is sometimes used to describe the situation where the futures price is an increasing function of maturity and the term backwardation is sometimes used to describe the situation where the futures price is a decreasing function of the maturity of the contract. Strictly speaking, as will be explained in Chapter 5, these terms refer to whether the price of the underlying asset is expected to increase or decrease over time." Hull, John C (2014-02-19). Options, Futures, and Other Derivatives (9th Edition) (Page 37). Prentice Hall. Kindle Edition.

What's my conclusion?
  • Observed upward-sloping = contango. Or, if you insist, "normal" by itself (but I'm not a fan of "normal" by itself: even it's dual-purpose confusion, in a near-zero interest rate environment, why would upward-sloping necessarily be normal?)
  • Observed downward-sloping = backwardation = inverted
  • Don't worry about semantics of F(T) ?< or >? E[S(t)]. At most, be familiar with "theory of normal backwardation"
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