GUIDE TO THE BACHE COMMODITY INDEX SM Sepember 2008 PFDS Holdings, LLC One New York Plaza, 13h Fl NY, NY 10292-2013
BCI SM Manual 2008 Ediion TABLE OF CONTENTS 1. Inroducion 1.1 Overview of he Bache Commodiy Index SM (BCI SM ) 1.2 The Advisory Commiee 1.3 Definiions 2. Index Srucure and Selecion Crieria 2.1 Iniial Eligibiliy Crieria 2.2 Guidelines for Selecion 2.3 Choice of Exchanges for Commodiies 2.4 Announcemens 2.5 Daes 2.6 Official BCI SM Values and Indicaion Values 2.7 Roll Schedule for BCI SM Fuures Markes 3. Calculaion of he BCI SM and Relaed Indexes 3.1 Compuing he Number of BSCI SM Unis 3.2.1 Compuing he BSCI SM Values 3.2.2 Compuing London Meal Exchange (LME) Conrac Values 3.3 The Trading Rule and he Targe Allocaion 3.3.1 Descripion of he Trading Rule 3.3.2 Compuing he Fuures price index 3.3.3 Compuing he Trading Rule 3.3.4 The Targe Allocaion 3.3.5 The Acual Allocaion 3.4 The Transacion Minimizing Sraegy 3.4.2 The TMS Mehodology 2
BCI SM Manual 2008 Ediion Copyrigh 2008 PFDS Holdings, LLC. All righs reserved. The daa and informaion presened in his Manual (he Informaion ) reflec he mehodology for deermining he composiion and calculaion of he Bache Commodiy Index SM (he BCI SM ). This Manual, he informaion and he BCI SM are compiled and published by, and are he exclusive propery of, PFDS Holdings, LLC. The mehodology of, and inellecual propery righs in, he Bache Commodiy Index SM are proprieary o, and owned by, PFDS Holdings, LLC and may be covered by one or more pending paen applicaions. The Rock logo, BCI sm, Bache Commodiy Index sm, Bache Single Commodiy Index sm and BSCI sm are service marks of PFDS Holdings, LLC and is affiliaes. The informaion is solely for your inernal use and may no be issued as he basis of any produc, or reproduced, redisribued or ransmied in whole or in par, in any form or by any means, elecronic or mechanical, including phoocopying, or by any informaion sorage or rerieval sysem, wihou he express or wrien consen of PFDS Holdings, LLC. Nohing conained in his Manual should be consrued as a soliciaion of any ransacion or as a represenaion regarding he poenial success of any ransacion, which is based on he BCI SM. Neiher PFDS Holdings, LLC nor any subsidiary or affiliae (ogeher, PFDS ) acs as a fiduciary or financial, invesmen or commodiy rading advisor for is counerparies, each of which is responsible is own invesmen and rading decisions. PFDS SHALL HAVE NO LIABILITY, CONTINGENT OR OTHERWISE, TO ANY PERSON OR ENTITY FOR THE QUALITY, ACCURACY, TIMELINESS AND/OR COMPLETENESS OF THE INFORMATION, THE BCI SM OR ANY DATA INCLUDED IN THIS MANUAL, OR FOR DELAYS, OMISSIONS OR INTERRUPTIONS IN THE DELIERY OF THE BCI SM OR DATA RELATED THERETO. PFDS MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE RESULTS TO BE OBTAINED BY ANY PERSON OR ENTITY IN CONNECTION WITH ANY USE OF THE BCI SM, INCLUDING BUT NOT LIMITED TO THE TRADING OR OF INVESTMENTS IN PRODUCTS BASED ON OR INDEXED OR RELATED TO THE BCI SM, ANY DATA RELATED THERETO OR ANY COMPONENTS THEREOF. PFDS MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE INFORMATION, THE BCI OR ANY DATA RELATED THERETO. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL PFDS HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INLCUDING LOST PROFITS), IN CONNECTION WITH ANY USE BY ANY PERSON OF THE BCI SM OR ANY PRODUCTS BASED ON OR INDEXED OR RELATED THERETO, EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. 3
BCI SM Manual 2008 Ediion 1. Inroducion 1.1 Overview of he Bache Commodiy Index (BCI SM ) The Bache Commodiy Index SM (BCI SM ) is currenly comprised of 19 Commodiies ha are raded on seven major fuures Exchanges locaed in he Unied Saes and he Unied Kingdom. The primary objecive of he BCI SM is o provide broad-based exposure o global Commodiy markes. There are addiional objecives of he BCI SM mehodology. The firs of hese is o provide broad, long-erm diversified exposure o individual Commodiies wihin each major Commodiy secor consisen wih heir overall imporance o ha secor as well as heir marke liquidiy. The second objecive is o ensure ha he BCI SM does no become dominaed by a single Commodiy secor or by several Commodiies wihin a Commodiy secor. This is accomplished by employing upper and lower bounds on he marke and Commodiy weighs, and by a frequen rebalancing of he BCI SM weighs. The hird objecive is o moderae he volailiy inheren in he major Commodiy marke secors. This is accomplished by considering he opimized weighs derived from he risk-reurn profiles of mean-variance efficien porfolios ha can be creaed wih he hree major Commodiy secors. Addiional risk reducion facors considered in he BCI SM mehodology include sysemaically reducing near-erm exposure o Commodiy markes ha are experiencing price declines, and reducing he pricing impac ha BCI SM -linked invesmen producs will have on he underlying Commodiy markes. This is accomplished hrough a precise roll mehodology. Lasly, given he dynamic naure of Commodiy markes, overall consrucion of he BCI SM is moniored by an Advisory Commiee. The Commiee reviews he BCI SM mehodology on an ongoing basis and may recommend changes in BCI SM componens as well as is mehodology. For 2008, exposure o he hree major Commodiy secors (energy, meals, and agriculure) is as follows: Bache Commodiy Index SM Componens: March 2008 Major Commodiy Secors Weigh (%) Energy 50.0 Meals 22.5 Agriculure 27.5 Toal 100.0 4
BCI SM Manual 2008 Ediion The allocaions o individual Commodiies wihin each major Commodiy secor are as follows: Bache Commodiy Index SM Componens: March 2008 Commodiy Marke Exchange Secor Sub-Secor Allocaion (%) Crude Oil WTI NYMEX Energy Peroleum 20.0 Naural Gas NYMEX Energy Naural Gas 7.5 Heaing Oil NYMEX Energy Pero Produc 5.0 Gas Oil ICE Energy Pero Produc 7.5 RBOB Gasoline NYMEX Energy Pero Produc 5.0 Crude Oil Bren ICE Energy Peroleum 5.0 Copper LME Meals Indusrial 5.0 Aluminum LME Meals Indusrial 5.0 Gold COMEX Meals Precious 7.5 Silver COMEX Meals Precious 2.5 Zinc LME Meals Indusrial 2.5 Corn CBT Agriculure Grains 7.5 Soybeans CBT Agriculure Grains 5.0 Whea CBT Agriculure Grains 2.5 Live Cale CME Agriculure Livesock 2.5 Lean Hogs CME Agriculure Livesock 2.5 Coffee NYBOT Agriculure Sof 2.5 Coon NYBOT Agriculure Sof 2.5 Sugar NYBOT Agriculure Sof 2.5 Toal 100.0 Allocaions o Commodiy secors may change. However, secor allocaions will remain wihin a pre-specified range. These ranges are deermined every five years and will remain fixed for five years barring major srucural changes in Commodiy markes. Secion 2 discusses he facors ha are aken ino accoun in deermining he allocaion range. The following secor allocaion boundaries are effecive from January 2006 o December 2010. Minimum and Maximum Secor Weighs: January 2006 o December 2010 Secor Minimum Allocaion (%) Maximum Allocaion (%) Energy 40.0 65.0 Meals 15.0 45.0 Agriculure 15.0 45.0 1.2 The Advisory Commiee PFDS Holdings has esablished an Advisory Commiee o assis i in connecion wih he operaions of he BCI SM. The Advisory Commiee mees on an annual basis and a oher imes a he reques of PFDS. The principal purpose of he Advisory Commiee is o advise PFDS wih respec o, among oher hings, he calculaion of he BCI SM, and he effeciveness of he BCI SM as a represenaive baske of commodiy fuure conracs and 5
BCI SM Manual 2008 Ediion he need for changes in he composiion or mehodology of he BCI SM. The Advisory Commiee acs solely in an advisory and consulaive capaciy; all decisions wih respec o he composiion, calculaion and operaion of he BCI SM are made by PFDS. The Advisory Commiee mees on a regular basis during each calendar year. Prior o he meeing PFDS oulines he commodiies and conracs o be included in he BCI SM in accordance wih he selecion crieria se below. The proposed composiion of he BCI SM is hen circulaed o he Advisory Commiee members in advance of he meeing and is presened and discussed a he meeing. The Advisory Commiee is also consuled on any oher significan maers wih respec o he calculaion or operaion of he BCI SM and may, if necessary or pracicable, mee a oher imes during he year as issues arise ha warran Advisory Commiee consideraion. 1.3 Definiions Acual Allocaion: The number of Fuures Conracs in a given marke ha are acually held by an invesor uilizing he Transacions Minimizing Sraegy. Advisory Commiee: An esablished group of individuals who mee o advise on he se of Commodiies and he se of allocaions o hose Commodiies ha comprise he BCI SM. These allocaion decisions are based on pre-deermined crieria and guidelines. The Advisory Commiee is comprised of seasoned global markes execuives and leading academics seleced by senior managemen of PFDS Holdings. BCI SM : Bache Commodiy Index SM. I is comprised of he Bache Single Commodiy Indices SM. BCI SM may also be used as an acronym for he Bache Commodiy Index SM. BSCI SM : Bache Single Commodiy Index SM. Business Day: a day, on which commercial banks sele paymens and are open for general business, including dealings in foreign exchange and foreign currency deposis. Commodiy: In respec of a Transacion, he Commodiy specified in he relevan Commodiy Reference Price. Commodiy Business Day: A day in which a Transacion for which he Commodiy Reference Price is announced or published by an Exchange, a day ha is (or, bu for he occurrence of a Marke Disrupion Even, would have been) a day on which ha Exchange is open for rading during is regular rading session, nowihsanding any such Exchange closing prior o scheduled closing ime. 6
BCI SM Manual 2008 Ediion Commodiy Reference Price: A price announced or published by an Exchange. Daily Roll: The porion of he BCI SM ha is sold each day as i approaches expiraion, wih an accompanying purchase of new Fuures Conracs for delivery furher in he fuure. Daily Roll Quaniy: The inverse of he number of Business Days beween expiraions. If his quaniy is rolled each rading day, hen he enire posiion will be rolled in equal insallmens by he Las Roll Dae. For example, if here are 62 Business Days Beween Expiraions for a given copper Fuures Conrac, hen if 1/62 (1.613%) of he posiion is rolled each rading day he posiion will be fully rolled on he Las Roll Dae for he nearby copper conrac. Days Beween Expiraions: The number of rading weekdays beween he Las Roll Dae of he prior Nearby Conrac (he conrac ha has mos recenly passed is las roll dae) and he las roll dae of he curren Nearby Conrac. Essenially Similar Commodiies: Commodiies ha demonsrae comparable rais in rading behavior and expeced reurn. Essenially Similar Commodiy pairs include gold/plainum and soybeans/soybean meal. Exchange: The Exchange or principal rading marke specified in he relevan confirmaion or Commodiy Reference Price. Fuures Conrac: In respec of a Commodiy Reference Price, he conrac for fuure delivery of a conrac size in respec of he relevan delivery dae relaing o he Commodiy referred o in ha Commodiy Reference Price. Index Value: The value of he BCI SM, which is he sum of he number of BSCI Unis held in each marke muliplied by he BSCI values. Index Holiday: If all he U.S. producs in he BCI SM do no sele (he exchange is no producing a selemen price) hen he day is declared an Index Holiday. On an Index Holiday we do no publish BCI SM value and do no rade any producs in he BCI SM. Curren index holidays include: New Years Day, Marin Luher King Day, Presiden s Day, Good Friday, Memorial Day, July 4 h, Labor Day, Thanksgiving and Chrismas. Indicaion Value: The value of he BCI SM if one or more of he Fuures Conracs represened in he index did no rade due o marke closure or could no be ransaced due o rading limis a he close of rading. 7
BCI SM Manual 2008 Ediion Las Roll Dae: The las dae ha an invesor will hold a posiion in he Nearby Conrac. Afer his dae any posiion in he Nearby Conrac mus be eiher rolled or closed ou. This value is deermined by he PFDS Holdings and will generally be se in a manner ha ensures adequae liquidiy remaining in he Nearby Conrac so ha posiions can be easily liquidaed. Marke Disrupion Even: An even ha would give rise o an alernaive basis for deermining he relevan price in respec of a specified Commodiy Reference Price or he erminaion of he Transacion were he even o occur or exis on a day ha is a pricing dae for ha Transacion. Maximum Nearby Allocaion: The larges posiion ha can be held in he Nearby Conrac. This quaniy canno be more han 100% of he oal allocaion, and mus be zero afer he Las Roll Dae for he Nearby Conrac. Maximum Roll Quaniy: The larges percenage of a Fuures Conrac ha will be rolled on a given day. Minimum Allocaion: For a new Commodiy, Minimum Allocaion is 2.5% of he Index Value. Nearby Conrac: A Fuures Conrac ha is close o is expiraion dae. In a Rollover sraegy, he Nearby Conrac is he posiion ha mus be closed ou. Nexou Conrac: A Fuures Conrac wih an expiraion dae furher in he fuure han he Nearby Conrac. In a Rollover sraegy, he Nexou Conrac is he one ha will be used o iniiae a new posiion. Official Index Value: The value of he BCI SM if here was an official closing price for all Commodiy Fuures Conracs represened in he index for ha day, and if none of he Commodiy Fuures Conracs represened in he BCI SM were subjec o rading limis a he close of rading. Rollover: A Fuures Conrac calls for delivery of a Commodiy a a paricular ime in he fuure. An invesor in Fuures Conracs does no generally ake delivery of he Commodiy, bu raher sells he Fuures Conrac as i approaches expiraion and buys a new Fuures Conrac for delivery furher in he fuure. This Transacion is called a Rollover or someimes simply a roll. An invesor can roll an enire fuures posiion or roll a porion of an open posiion. Rollover Sraegy: A mehod ha describes how a paricular porfolio of Fuures Conracs will be rolled. 8
BCI SM Manual 2008 Ediion Targe Allocaion: The Targe Allocaion is he number of Fuures Conracs in a given marke ha some fuures rading sraegy indicaes should be held. Transacion: Any Transacion ha is a Commodiy swap Transacion, Commodiy basis swap Transacion, Commodiy cap Transacion, Commodiy floor Transacion, Commodiy collar Transacion, Commodiy opion Transacion, Commodiy index Transacion, Commodiy forward Transacion, or Commodiy spo Transacion. Uni: Each uni of he BSCI SM. Value Weigh: The percenage of each BSCI SM allocaed o he Nearby and Nexou Conracs, and o cash. 9
BCI SM Manual 2008 Ediion 2. Index Srucure and Selecion Crieria 2.1 Iniial Eligibiliy Crieria PFDS Holdings will consider for inclusion Commodiy markes ha saisfy he following iniial selecion crieria: Physical Commodiies. Financial markes (e.g., ineres rae, currency, and equiy) will no be considered. Financially seled derivaives ha are based on physical Commodiies will be considered for inclusion in he BCI SM. Acive Derivaive Markes. Commodiies included in he BCI SM mus have acively raded fuures or oher derivaive conracs lised on an approved exchange. All exposure o Commodiy markes mus ake place hrough derivaive conracs. Represenaive. Allocaions o global Commodiy secors and o Commodiies wihin hose secors will ake ino accoun heir imporance o he global economy, which will include heir size based on producion. Liquidiy. Derivaive markes on approved Commodiies mus have sufficien liquidiy across muliple delivery monhs o suppor a significan invesmen wihou resuling in undue marke impac. Consider liquidiy measures such as open ineres when deermining allocaions across and wihin Commodiy secors. 2.2 Guidelines for Selecion PFDS Holdings will consider all Commodiy markes ha saisfy he iniial crieria. The decision o add or remove a Commodiy in he BCI SM will be based on he following guidelines: Minimum Size. The Minimum Allocaion o a new Commodiy is 2.5% of BCI SM marke value. If he Advisory Commiee deermines ha he Commodiy does no add sufficien value o he BCI SM o suppor he Minimum Allocaion, he Commodiy will no be included in he BCI SM. Essenially Similar Commodiies. Commodiies ha are essenially similar o Commodiies ha are already included in he BCI SM may be excluded. Essenially Similar Commodiy pairs such as gold/plainum and soybeans/soybean meal will only be included in he BCI SM if here is sufficien liquidiy o suppor boh Commodiies and here is sufficien diversificaion benefi from doing so. 10
BCI SM Manual 2008 Ediion Diversificaion. PFDS will base all final decisions regarding inclusion of a Commodiy marke on he primary objecive of he BCI SM, which is o provide broad-based exposure o Commodiy markes. PFDS will consider he risk impac of Commodiy invesmen allocaion and will emphasize Commodiy markes and secors ha have been deermined o provide risk reducion benefis for porfolios ha include muliple asse classes. PFDS has deermined he following minimum and maximum Commodiy weighs: Across Commodiy Secors. Currenly, Commodiy secors are defined as energy, meals, and agriculure. The minimum allowable allocaion o energy is 40% and o meals and agriculure is 15%. The maximum allowable allocaion o energy is 65% and o meals and agriculure is 45% Wihin Commodiy Secors. The BCI SM will conain a minimum of 5% of exposure o each of he following Commodiy sub-secors: peroleum-crude, peroleum-producs, naural gas, indusrial meals, precious meals, grains, livesock, and sofs and a minimum of 2.5% in any one commodiy. Addiional Characerisics. Consider he addiional roles of Commodiy invesmen hrough he BCI SM such as a poenial hedge agains inflaion, low correlaion o radiional asses and will emphasize Commodiies ha have been deermined o provide hese benefis. Secor Allocaions: January 2006 Secor Allocaion (%) Minimum* (%) Maximum* (%) Energy 55.0 40.0 65.0 Meals 17.5 15.0 45.0 Agriculure 27.5 15.0 45.0 Sub Secor Allocaions: January 2006 Peroleum-Crude 25 5.0 60.0 Peroleum-Producs 17.5 5.0 60.0 Naural Gas 12.5 5.0 60.0 Indusrial Meals 12.5 5.0 40.0 Precious Meals 5.0 5.0 40.0 Grains 15.0 5.0 35.0 Livesock 7.5 5.0 35.0 Sofs 5.0 5.0 35.0 * Based on 2006 Diversificaion Crieria 11
BCI SM Manual 2008 Ediion Candidae Markes No Included in 2008 Commodiy Exchange Secor Sub-Secor Reason(s)* Marke Plainum COMEX Meals Precious 1,2 Nickel LME Meals Indusrial 1 Lead LME Meals Indusrial 1,2 Tin LME Meals Indusrial 2 Cocoa NYBOT Agriculure Sofs 2,3 Orange Juice NYBOT Agriculure Sofs 2,3 Feeder Cale CME Agriculure Livesock 1 Soybean Meal CBT Agriculure Grains 1 Soybean Oil CBT Agriculure Grains 1 1. Essenially similar o oher marke(s) already included in he Index 2. Liquidiy no sufficien o suppor he Minimum Allocaion 3. Secor/Sub-Secor consrain limied inclusion of addiional Commodiies 2.3 Choice of Exchanges for Commodiies PFDS will deermine he appropriae Exchange(s) for a given Commodiy. Consideraions will include he liquidiy and ransparency provided by he Exchange, availabiliy of over-he-couner derivaives such as swap conracs priced using he Exchange, and he availabiliy of accurae pricing during New York rading hours. 2.4 Announcemens Decisions regarding BCI SM composiion may generally be announced 30 o 60 days prior o he dae ha he BCI SM changes are o be incorporaed ino published values, excep ha PFDS Holdings may make immediae changes in he even of a significan change in he rading environmen for a paricular Commodiy. 2.5 Daes The BCI SM is published on Reuers every Business Day excep for Index Holidays. BCI SM values will generally be available beween he hours of 8:00 pm and 10:00 pm, New York Time. 12
BCI SM Manual 2008 Ediion 2.6 Official BCI SM Values and Indicaion Values A BCI SM value will be considered an Official Index Value if here was an official closing price for all Commodiy Fuures Conracs represened in he BCI SM for ha day, and if none of he Commodiy Fuures Conracs represened in he BCI SM were subjec o rading limis a he close of rading. A BCI SM value will be considered an Indicaion Value if one or more of he Fuures Conracs represened in he BCI SM did no rade due o marke closure or could no be ransaced due o rading limis a he close of rading. Examples of evens ha would resul in Indicaion Values include: Holidays declared by Exchanges ha are no Index Holidays, marke closures resuling from unexpeced emergencies, and rading limis ha are in effec a he normally scheduled closing ime for he marke. Examples of evens ha would no resul in Indicaion Values include: emporary or emergency marke closures ha are resolved before he regularly scheduled close of rading, emporary imposiion of price limis ha are removed prior o he close of rading, and marke closures ha are differen from he usual closing ime bu are sancioned by he Exchange and are announced a leas one day prior o he even. 13
BCI SM Manual 2008 Ediion 2.7 Roll Schedule for BCI SM Fuures Markes Roll Schedule for Bache Commodiy Index SM Componens. Roll Dae: 4 h Day of: Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Energy Crude Oil WTI Nymex Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan Crude Oil Bren ICE Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan Naural Gas Nymex Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan Heaing Oil Nymex Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan Gas Oil ICE Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan RBOB Gas Nymex Feb Mar Apr May Jun Jul Aug Sep Oc Nov Dec Jan Meals Copper LME Mar May Jul Sep Dec Aluminum LME Mar May Jul Sep Dec Zinc LME Mar May Jul Sep Dec Silver Mar May Jul Sep Dec Gold Comex Feb Apr Jun Aug Oc Dec Agriculure Corn CBT Mar May Jul Sep Dec Soybeans CBT Mar May Jul Sep Nov Jan Whea CBT Mar May Jul Sep Dec Live Cale CME Feb Apr Jun Aug Oc Dec Lean Hogs CME Feb Apr Jun Aug Oc Dec Coffee Nybo Mar May Jul Sep Dec Coon Nybo Mar May Jul Oc Dec Sugar Nybo Mar May Jul Oc Dec Noes: Roll schedule applies o composie indexes, secor indexes, and single-commodiy indexes Dae is Las Roll Dae for Conrac neares o expiraion For example, January 5h is he las roll dae for he February WTI Crude Oil Conrac 3. Calculaion of he BCI SM and Relaed Indices The BCI SM is currenly comprised of 19 Bache Single Commodiy Indices SM (BSCI SM ). The BCI SM value is he sum of he number of BSCI SM Unis held in each marke muliplied by he BSCI SM values. 19 BCI = u i BSCI i (3.1) i= 1 14
BCI SM Manual 2008 Ediion Each BSCI SM is assigned a value percenage in he BCI SM. The percenages for 2008 are as follows: Bache Single Commodiy Index SM Commodiy Marke Exchange Percen of Composie Index BSCI_CL Crude Oil WTI NYMEX 20.0 BSCI_CO Crude Oil Bren ICE 5.0 BSCI_NG Naural Gas NYMEX 7.5 BSCI_HO Heaing Oil NYMEX 5.0 BSCI_QS Gas Oil ICE 7.5 BSCI_XB RBOB Gas NYMEX 5.0 BSCI_HG Copper LME 5.0 BSCI_LA Aluminum LME 5.0 BSCI_LX Zinc LME 2.5 BSCI_GC Gold COMEX 7.5 BSCI_SI Silver COMEX 2.5 BSCI_C Corn CBT 7.5 BSCI_S Soybeans CBT 5.0 BSCI_W Whea CBT 2.5 BSCI_LC Live Cale CME 2.5 BSCI_LH Lean Hogs CME 2.5 BSCI_KC Coffee NYBOT 2.5 BSCI_SB Sugar NYBOT 2.5 BSCI_CT Coon NYBOT 2.5 3.1 Compuing he Number of BSCI SM Unis To mainain he appropriae weigh for each Commodiy, he BCI SM is rebalanced each day o have he predeermined Commodiy weighs. Rebalancing generally involves increasing he allocaion o he BSCI SM unis ha declined in value by more han he BCI SM, and decreasing he unis of he BSCI SM unis ha increased in value by more han he BCI SM. In his way, he percenage of BCI SM value represened by each BSCI SM will always be equal o he pre-specified Commodiy weighs. Changes in he number of BSCI SM Unis in he BCI SM are made a he end of he nex Business Day. If one or more Exchanges are closed on a paricular day, hen no changes in hose BSCI SM Unis will be incorporaed ino he BCI SM, and ne changes will be implemened on he nex Commodiy Business Day. The equaion for calculaing he number of Unis for each BSCI SM is as follows: 15
BCI SM Manual 2008 Ediion ( BCI )( w ) i u i = (3.2) BSCIi Definiions: Composie: BSCI : i i BCI SM value Bache Single Commodiy Index SM w : Targe percenage for he BSCI SM in he composie BCI SM u i : Number of Unis of he BSCI SM o be included in he composie BCI SM on he following Index Day. The BCI SM will be rebalanced on Business Days. This includes all Commodiies raded on boh U.S. and non-u.s. Exchanges. In he calculaions of he BCI SM, Index Holidays will be couned as Commodiy Business Days, bu any rading will ake place he firs Business Day following he Index Holiday. The Transacions ha would have occurred on he U.S. Federal Bank Holiday, plus he following day s Transacions (or, he ne changes), will boh occur on he firs Business Day following he U.S. Federal Holiday. 3.2.1 Compuing he BSCI SM Values A BSCI SM is calculaed for each Commodiy marke in he BCI SM. BSCI SM values are calculaed every weekday excep for Index Holidays. Index values will generally be available beween he hours of 8:00 pm and 10:00 pm, New York Time. Each BSCI SM value is derived from he following prices: The Nearby Fuures Conrac for he BSCI Marke. The Nearby Conrac is he acive Fuures Conrac wih he closes mauriy dae, subjec o he resricion ha Fuures Conracs may no be held pas he fifh calendar dae of he monh prior o delivery. The lis of acive Fuures Conracs is deermined by PFDS Holdings. The Nexou Fuures Conrac. This is he acive Fuures Conrac ha maures jus afer he Nearby Conrac. If he nex ou Fuures Conrac for ha Commodiy has insufficien liquidiy (e.g., very limied open ineres), he nex liquid deferred Fuures Conrac will be used in he calculaion of he BSCI SM for ha Commodiy. Cash Allocaion. Each BSCI SM employs a dynamic asse allocaion mehodology, and is no always fully invesed in Fuures Conracs. The allocaion o cash is incorporaed ino he BCI SM value and he BCI SM reurn calculaions. 16
BCI SM Manual 2008 Ediion The following able shows a hypoheical BSCI SM calculaion for he NYMEX WTI Crude Oil fuures marke (BSCI_CL). In his example, BSCI_CL was based on 0.00035271 conracs for delivery in Ocober 2006, 0.00071763 conracs for delivery in November 2006, and 44.53 index poins held in cash. Based on he selemen prices of 73.65 dollars/barrel for he Nearby Conrac and 74.12 dollars/barrel for he Nexou Conrac, he BSCI value was 123.70. In his example, he Value Weighs for he Nearby Conrac, he Nexou Conrac, and cash are 21%, 43%, and 36%, respecively. EXAMPLE: Single Commodiy Index for WTI Crude Oil Fuures Expiraion Monh Marke Price Conrac Value Number Conracs in BSCI_CL Index Poins Value Weigh (%) CL_NEARBY Oc-06 73.65 73,650 0.00035271 25.98 21.0% CL_NEXTOUT Nov-06 74.12 74,120 0.00071763 53.19 43.0% CASH 1.00 1.00 44.53 44.53 36.0% BSCI_CL 123.70 100.0% The number of Fuures Conracs in he BSCI SM is deermined by he acual percenage. This quaniy is furher separaed ino he percenage held in he Nearby Conrac and he percenage in he Nexou Conrac. These quaniies are deermined using a separae algorihm designed o minimize he oal urnover in he BSCI SM. Afer execuing his algorihm, he following index weighs are known: w w w N N C : The BSCI weigh in he nearby conrac : The BSCI weigh in he nexou conrac = 1 w N w X : The BSCI weigh in cash (3.3) These weighs are hen convered ino he number of Fuures Conracs o be held in he BSCI SM by incorporaing he marke value of he Nearby and Nexou Conracs. Definiions: BSCI q q N X x N : The curren index value : The number of fuures conrac in he nearby conrac : The number of C : The number of dollars in cash v v : The marke value of fuures conrac in he nexou conrac one nearby fuures conrac : The marke value of one nexou fuures conrac (3.4) 17
BCI SM Manual 2008 Ediion Then he quaniy of Fuures Conracs and cash in he BSCI SM calculae he BSCI SM on he nex BCI SM dae are: ha will be used o BSCI wn qn = vn BSCI wx qx = vx C = BSCI w C (3.5) So ha on dae +1, he new BSCI SM value will be: BSCI + + 1 = pn, + 1qN, + px, + 1qX, C (3.6) The reurn on cash held in he BCI SM, referred o as Treasury Bill Reurn, or TBR, will be equal o: 1/ 91 1 TBR = 1 1 1 91/ 360 (3.7) TBAR x Where TBAR equals he daily 3-Monh Treasury Bill Rae. 3.2.2 Compuing London Meal Exchange (LME) Conrac Values A presen, he London Meals Exchange (LME) meals markes are he only forward markes included in he BCI SM. The res are fuures markes. The main difference beween forward and fuures markes is relaed o selemen procedures. Fuures conracs are seled each day, while forward markes are seled only once, on he expiraion dae of he conrac. For he BCI SM, his influences he iming of cash flows. If he BCI SM holds a posiion in NYMEX Crude Oil fuures, he cash flows associaed wih ha posiion are realized in full each rading day. However, if he BCI SM holds a posiion in LME Copper for delivery in four monhs, hen he cash flows (gains/losses) associaed wih ha rade will no be realized unil he expiraion dae in four monhs ime. In order o place a fair and accurae value on he BCI SM, we will apply a discoun rae o profis or losses from unexpired forward conracs. In his way, he published BCI SM index values will accuraely reflec he liquidaion value of all he posiions in he BCI SM. 18
BCI SM Manual 2008 Ediion The 3-Monh Treasury Bill yield was seleced as he discoun rae for he LME cash flows. The following equaion will be used, where T-bill Yield is he daily yield on 3- Monh T-bills, and Days o expiraion is he number of days unil expiraion of he LME conrac. Discoun Reurn = Reurn Days o Expiraion ( 1+ Tbill Yield ) 1 Making his change o LME posiions implicily reduces BCI SM exposure o hese markes. For example, if ineres raes were a 5% and a weighed average mauriy in LME markes of abou hree monhs, his change would reduce he LME conribuion o BCI SM risk and reurn by abou 1.25%. In order o mainain our arge exposure, he size of LME posiions will be increased by abou 1.25% (assuming 5% raes). The larger posiion sizes will resul in slighly larger profis and losses. Then, afer applying he discoun rae, he LME exposure and profi/loss will be he same as before. The equaion below shows he new weighs for LME conracs. w increase, = w Days o Expiraion ( 1+ TBill Yield ) 1 3.3 The Trading Rule and he Targe Allocaion The index uilizes a momenum-based rading rule o deermine he Targe Allocaion o a given Commodiy. To minimize urnover and rading coss, here is a maximum daily posiion change in each Commodiy, so ha he Acual Allocaion o a given Commodiy may be higher or lower han he Targe Allocaion if he Targe Allocaion changes by more han his daily maximum urnover. This secion describes he mehod of deermining he Targe Allocaion. Secion 3.3.5 describes he mehod of deermining he Acual Allocaion and he posiion changes each rading day. 19
BCI SM Manual 2008 Ediion The Targe Allocaion is based on he momenum-based rading rule described in Spurgin (1999) 1. Three signals are evaluaed for each Commodiy; a shor-erm signal, a mediumerm signal, and a long-erm signal. Each signal can be posiive or negaive. Based on hese signals, he Targe Allocaion akes on one of four possible values: 40%, 60%, 80%, or 100% of he maximum allocaion. Thus he posiion in each Commodiy will never be more han 100% or less han 40%. For example, corn is given a 5% maximum allocaion, so he Targe Allocaion for corn as a percenage of he oal value of he index can be 2%, 3%, 4%, or 5%. 3.3.1 Descripion of he Trading Rule The Targe Allocaions in he BCI SM are based on a lookback sraegy. An x-day lookback sraegy gives a posiive signal if he fuures price index on dae is higher han i was on dae -x. Oherwise he sraegy gives a negaive signal. The sraegy is called a lookback model because i looks back x days bu ignores changes in he Commodiy price ha occurred afer dae -x. The lookback rule was found o provide a higher correlaion wih Commodiy rading advisors han oher common rules such as a moving average (Spurgin, 1999). [TK1] The number of days used o compue he lookback indicaors in he BCI SM are 15 days for he shor-erm, 27 days for he medium-erm, and 55 days for he long-erm momenum sraegy. 3.3.2 Compuing he Fuures Price Index The fuures price index mus be compued before he lookback signals can be evaluaed. Noe ha his fuures price index is used only o evaluae rading signals and generae he Targe Allocaion. The fuures price index is no acually raded in he index. The fuures price index is based on a full long posiion in he underlying Commodiy Fuures Conrac and uses a slighly differen Rollover Sraegy han he raded porion of he BCI SM. 1 Trading rule has been previously published in A Benchmark for Commodiy Trading Advisor Performance, (R. Spurgin, The Journal of Alernaive Invesmens, Fall 1999) and is adaped for use in his index. 20
BCI SM Manual 2008 Ediion The fuures price index for each Commodiy is a weighed average of he reurn of he posiion in boh he Nearby and Nexou Conracs. The BCI SM uses a coninuous roll sraegy: I holds posiions in he wo neares acive Fuures Conracs, and each day sells some of he fron conrac and rolls he posiion ino he Nexou Conrac. The roll sraegy incorporaed in he fuures price index is linear if here are 90 weekdays beween he Las Roll Daes 2 of he Nearby and Nexou Conrac, hen 1/90 of he posiion will be rolled each weekday [TK2]. This sraegy is employed in order o provide he smoohes possible reurn series from which o generae a rend-following sysem. Le p be he proporion of he invesmen held in he Nearby Conrac on dae p # weekdaysunil las roll dae of nearby conrac = # weekdaysbeween las roll daes of prior expiraion and nearby expiraion (3.8) The proporion held in he Nexou Conrac is 1-p. A he end of each day (p -1 - p ) is rolled from he Nearby Conrac o he Nexou Conrac. The daily reurn is he percenage gain or loss based on he prior day s oal invesmen: oalpl r = s 1 (3.9) The fuures price index is compued from hese daily reurns: ( r ) FPI = FPI 1 + (3.10) 1 3.3.3 Compuing he Trading Rule The lookback rading rule for a given number of weekdays L x will ake on a posiive value if he oal reurn is posiive beween dae -x and dae : 1if FPI > FPI Lx = 0 if FPI FPI -x x (3.11) 2 The Las Roll Dae is he las dae a fuures conrac can be held before i mus be rolled o he nex conrac. The Las Roll Dae in he index varies from marke o marke, bu is generally in he monh prior o he delivery monh. 21
BCI SM Manual 2008 Ediion The BCI SM evaluaes hree lookback signals o deermine he Targe Allocaion: L 15, L 27, and L 55. The minimum Targe Allocaion is 40% long, and his is increased by 20% for each posiive signal: = 0.4 + 0.2 ( L + L L ) (3.12) TA + Changes in he BCI SM lookback rading rule are implemened wih a one-day lag, in order o insure ha here is no ambiguiy. 15 27 55 3.3.4 The Targe Allocaion If a Commodiy Fuures Conrac has a zero long-run rae of reurn, hen he average arge allocaion will be 70%, as each signal will have a 50% chance of being posiive on any given day. Given he posiive long-run rae of reurn observed in Commodiy fuures markes as a resul of inflaion and posiive roll reurns due o backwardaion, i is likely ha he long-run probabiliy of a posiive signal will be higher han 50%, and he average Targe Allocaion above 70%. Number of Posiive Signals Zero (all negaive) One (wo negaive) Two (one negaive) Three (zero negaive) Targe Allocaion as % of Maximum Allocaion 40% of maximum 60% of maximum 80% of maximum 100% of maximum 3.3.5 The Acual Allocaion The Acual Allocaion is percenage of asses invesed in Fuures Conracs. The remaining asses are assumed o be invesed in cash. The Acual Allocaion can differ from he Targe Allocaion (Secion 3.3.3, above) because changes o he Acual Allocaion are smoohed in order o reduce urnover and ransacions coss. The mehodology for deermining he Acual Allocaion is given in Secion 3.4. 22
BCI SM Manual 2008 Ediion 3.4 The Transacion Minimizing Sraegy The Transacion Minimizing Sraegy (TMS) incorporaes many of he feaures of he daily Rollover Sraegy described above, bu wih modificaions o allow for dynamic asse allocaion based on he rading rule, while sill minimizing Transacion coss. The daily Rollover Sraegy involves selling a small porion of he posiion in he Nearby Conrac each day and buying a similar quaniy of he deferred conrac. However, if he inen is o reduce he overall exposure o he Fuures Conrac, his can be accomplished by selling a small porion of he Nearby Conrac as planned, bu no buying he deferred conrac. The resul is a lower overall allocaion. Similarly, increasing he allocaion can be accomplished by slighly increasing he posiion in he deferred conrac bu no selling he fron conrac. Thus, wihin cerain boundaries, acive asse allocaion can be accomplished wihou increasing he ransacion coss. 3.4.1 The TMS Mehodology The TMS fixes he Maximum Roll Quaniy (MRQ) in a given marke equal o he Daily Roll Quaniy (DRQ): 1 MRQ = DRQ = (3.13) days beween expiraions This differs from oher published fuures sraegies. Oher published sraegies roll 100% of heir posiions on a paricular dae or in a paricular week. Because he Daily Roll Quaniy in he BCI SM does no exceed 5% for any of he Fuures Conracs currenly raded on major Exchanges, he Maximum Roll Quaniy of an invesor using he TMS will no exceed 5% in any marke and will ofen be much less. An addiional benefi of his mehod is a reducion in marke impac from Rollovers. If a sraegy calls for rolling 100% of a posiion on a paricular day, his may have an impac on a marke wih relaively low liquidiy. By limiing he urnover in any Fuures Conrac, he effec of low liquidiy will be considerably lessened. The Maximum Nearby Allocaion (MNA) is se equal o he produc of he Daily Roll Quaniy and he number of days unil he Las Roll Dae (LRD). This ensures ha he enire posiion can be rolled on or before he roll dae wihou ever exceeding he Daily Roll Quaniy on a given dae: MNA = DRQ LRD (3.14) 23
BCI SM Manual 2008 Ediion In a given marke, here are four possible oucomes each rading day: 1. The Targe Allocaion exceeds he Acual Allocaion by an amoun ha is a leas as large as he Daily Roll Quaniy. Acion: Make no change in nearby posiion. Purchase quaniy equal o Daily Roll Quaniy in he Nexou Conrac. If, afer his rade has been execued, he nearby allocaion exceeds he Maximum Nearby Allocaion, hen he amoun by which he nearby exceeds he maximum is rolled in he usual way (sell he Nearby Conrac, buy he Nexou Conrac). Resul: Acual Allocaion increases bu is sill below he Targe Allocaion. 2. The Targe Allocaion exceeds he Acual Allocaion by an amoun ha is less han he Daily Roll Quaniy or is equal o he Acual Allocaion. Acion: Make no change in nearby posiion. Purchase quaniy equal o he difference beween he Targe and he Acual Allocaions in he Nexou Conrac. If, afer his rade has been execued, he nearby allocaion exceeds he Maximum Nearby Allocaion, hen he amoun by which he nearby exceeds he maximum is rolled. Resul: Acual Allocaion increases and is equal o he Targe Allocaion. 3. The Targe Allocaion is less han he Acual Allocaion by an amoun ha is less han he Daily Roll Quaniy. Acion: Make no change in nexou posiion. Sell a quaniy equal o he difference beween he Targe and he Acual Allocaions in he Nearby Conrac. If, afer his rade has been execued, he nearby allocaion exceeds he Maximum Nearby Allocaion, hen he amoun by which he nearby exceeds he maximum is rolled. Resul: Acual Allocaion decreases and is equal o he Targe Allocaion. 4. The Targe Allocaion is below he Acual Allocaion by an amoun ha is a leas as large as he Daily Roll Quaniy. Acion: Make no change in nexou posiion. Sell a quaniy equal o Daily Roll Quaniy in he Nexou Conrac. Resul: Acual Allocaion decreases bu is sill above he Targe Allocaion. 24
BCI SM Manual 2008 Ediion If NB is defined as he change in he posiion of he Nearby Conrac and NX is he change in he Nexou Conrac, wih TA as he Targe Allocaion and AA as he Acual Allocaion, hen: Case1: Case 2 : Case 3 : Case 4 : TA AA DRQ > TA 0 > TA AA DRQ TA DRQ AA 0 > DRQ AA NB = NB = 0 NB = 0 ( TA AA ) NB = DRQ NX NX = TA NX NX = DRQ AA = 0 = 0 (3.15) And, if afer his Transacion, he nearby allocaion is greaer han he Maximum Nearby Allocaion (NB>MNA) hen an addiional Transacion is needed o bring he nearby allocaion o he Maximum Nearby Allocaion: NX NX = ( NB MNA) = NB MNA (3.16) These acions summarize he TMS sysem. By following hese rules, he oal urnover canno be larger han a sysem ha employs a differen Rollover Sraegy and will in almos every insance be lower. The urnover canno be higher han simply rolling a long posiion because: Wih he TMS, one almos never buys he Nearby Conrac. Once a Fuures Conrac becomes he Nearby Conrac, he posiion may be reduced each day or lef unchanged bu will almos never be increased. Wih he TMS, one almos never sells he deferred conrac. Once a Fuures Conrac becomes he deferred conrac, he posiion may be increased each day or lef unchanged bu will no be reduced. There are a few circumsances when hese rules do no hold. 25