CAIA Level II: Advanced Core Topics in Alternative Investments, 2nd Edition

28.1 MARKING THE NET ASSET VALUE

Commodity traders can execute trades in the futures market, the physical market, or the over-the-counter (OTC) market. Commodity futures contracts are easy to value, as prices are available in real time and each exchange publishes daily settlement prices. In contrast, valuation of OTC contracts, which are traded through a network of brokers and dealers, can be notoriously opaque. Consequently, since OTC data are not available through exchanges, it is difficult if not impossible to accurately mark the book and know precisely at any given time what the market is trading at. Even if OTC contracts are cleared through an exchange, derivatives are typically valued using forward curves that often are not traded on exchanges. As such, the value of these derivatives depends on the OTC forward prices of the contracts. In order to independently value positions, it is imperative for a risk manager or investor to have access to accurate and independent forward curves. This is because if exchange-traded contracts or New York Mercantile Exchange (NYMEX)-cleared prices are used as a proxy to the OTC market, investors and risk managers may be lulled into a false sense of security, believing that they have the market data to price OTC derivatives and to obtain an accurate net asset value.

To illustrate the danger of not incorporating appropriate market data into risk-management practices, note the differences in Exhibit 28.1 between exchange data and an independent ...