Models for Financial Economics (MFE) Practice Test 2025 - Free MFE Practice Questions and Study Guide

Backwardation is a market condition typically characterized by the situation where the futures price of a commodity is lower than what the expected future spot price would be. This scenario can arise due to various market dynamics, including strong demand for the commodity in the present relative to future expectations or lower inventory levels. It reflects a market sentiment where traders are willing to pay a premium for immediate access to the underlying asset, indicating a perceived scarcity or increased demand for current supply.

In this context, the correct choice emphasizes that the futures price being lower than the expected spot price suggests a bullish outlook for the commodity, as it indicates that traders anticipate recovering higher prices in the future. This is distinct from the other options, which do not accurately describe backwardation. Choices that involve the spot price being higher than the futures price or equal to it describe different market conditions. Understanding backwardsation is crucial for traders and analysts as it influences their pricing strategies and investment decisions.