Exam 2 Flashcards
theory of storage
futures prices go below full-carry because of convenience yields (Working)
convenience yield
benefits for holding stocks/inventory today due to uncertainties
hedging
risk management strategy to reduce the loss from adverse price changes
short hedge
(output) you plan to sell your commodity in the future
long hedge
(input) you plan to buy the commodity in the future
net price of hedging
= cash price + gain from futures
why does hedging work?
because cash and futures prices move in the same direction; futures price = cash price + transportation cost
basis
difference between prices in the local cash market & the futures market
basis =
cash price - futures contract price
3 dimensions of commodity represented in prices
time - storage/insurance/financing
space - transportation
form - quality premiums/discounts
basis is theoretically __ in delivery month at delivery location because
storage is no longer a factor
cash prices vary because of
commodity quality & geographic location
net hedging price = (can be used for forecasting)
futures price you locked in + basis at time of offsetting
why is basis important for hedging to be effective?
basis is relatively stable
theory of normal backwardation
futures prices go below full-carry because hedgers are willing to sell them so that speculators will assume their price risk (Keynes)
