CME GSCI Excess Return Futures Launches

Launch Date: March 12, 2006 (Effective Trade Date: March 13, 2006)

Goldman Sachs Commodity Indexes(GSCI) have become the most widely used benchmarks for commodity investing. Similarly, CME® GSCI® futures have become the most successfully traded commodity index futures contracts, offering investors the benefits of portfolio diversification and exposure to real assets.

Keeping with its reputation for innovation, CME is taking the next step by listing futures on the GSCI Excess Return Index. CME GSCI Excess Return futures will offer commodity investors an opportunity to hedge their commodity investments. CME GSCI Excess Return futures will also serve as the creation unit for the GSCI Exchange Traded Fund, an ETF based on the GSCI Total Return Index.

Understanding the GSCI Indexes
What does the "Excess Return" stand for? To understand excess returns, you must understand the relationship between the GSCI Spot Index and GSCI Excess Return Index.

The GSCI Spot Index tracks the price levels of principal physical commodities that are available in active, liquid futures markets. The commodities selected for this hypothetical portfolio are intended to be broadly representative of the entire spectrum of commodities available.

By design, the GSCI reflects a passive portfolio of long positions in the selected commodity futures. But unlike a passive equity portfolio, a passive futures portfolio requires regular transactions, for the simple reason that futures contracts expire. Thus, the expiring futures contract for a commodity must be "rolled forward"- exchanged for the nearby futures contract (i.e., the contract next nearest to expiration) - for that commodity.

When making this exchange, the GSCI Spot Index does not take into account any premium or discount at which the nearby futures contract may be trading. That's where the GSCI Excess Return Index comes in.

The GSCI Excess Return Index reflects the GSCI Spot Index returns plus any excess return resulting from the discount or premium an investor would receive by "rolling" the hypothetical positions in the contracts forward to the nearby futures contract as they approach delivery.

For comparison, the GSCI Total Return index represents the returns of the GSCI Excess Return index, plus the interest earned on the hypothetical, fully collateralized contract positions on the commodities included in the GSCI.

The Roll Period
The rolling forward of the portfolio's underlying futures contracts that are approaching expiration occurs once a month, on the 5th through 9th business days (the "roll period").

The simplest way to think of the process is as rolling from one basket of nearby futures (the first nearby basket) to a basket of futures contracts next furthest from expiration (the second nearby basket), incrementally over a five-day period. The GSCI portfolio is calculated as though these rolls occur at the end of each day during the roll period, at the daily settlement prices.

The portfolio is shifted from the first to the second nearby baskets at a rate of 20% per day for the five days of the roll period. So, during the first four business days of the month and just before the end of the 5th business day, the entire GSCI portfolio consists of the first nearby basket of commodity futures.

At the end of the 5th business day, the portfolio is adjusted so that 20% of the contracts held are in the second nearby basket (i.e., a basket of futures contracts that are next farthest from maturity), with 80% remaining in the first nearby basket.

The roll process continues on the 6th, 7th, and 8th business days, with relative weights of first to second nearby baskets gradually shifting from 60%/40% weighting, to a 40%/60% weighting, to a 20%/80% weighting. At the end of the 9th business day, the last of the old first nearby basket is exchanged, completing the roll and leaving the entire portfolio in what we have been calling the second nearby basket.

At this time, this former second nearby basket becomes the new first nearby basket, and a new second nearby basket is formed for use in the next month's roll.