Relationship Between Spot And Forward Prices

Question 1

Cost of carry model aka Theoretical value of futures contract

Answer 1

F0,T = S0(1+Rf - D)^T + SC
All things in the brackets must be annualised and expressed as a yield

SC must be in rands,cents or index points

Question 2

SC =

Answer 2

SC0 -> the cost of buying the commodity now
+ PC0,T -> commission paid for storing the commodity
+ i0,T -> cost of financing initial purchase
- D0,T -> cash flows received

Question 3

Contango market:

Answer 3

• F0,T > S0
  That is forward contract price is greater than spot price
• high storage costs and no dividends

Question 4

Backwardation aka inverted market

Answer 4

• F0,T < S0
• no storage costs and pays dividends

Question 5

Premium for owning the commodity

Answer 5

• convenience yield, captured by D

Question 6

Normal backwardation

Answer 6

• occurs when the futures price < expected spot price at maturity
• futures price will rise over the life of the contract until maturity
• theory arises from the presence of natural short hedgers

Question 7

Normal contango

Answer 7

• futures price will exceed the expected future spot price
• normal Contango: falling futures prices as a contract gets closer to maturity

Question 8

Contango vs Normal Contango

Answer 8

• they are different
• Contango: futures prices rise with maturity due to a “+ve” cost of carry
• normal Contango: falling futures prices as a contract gets closer to maturity

Question 9

Natural short hedgers?

Answer 9

Underprice the F0,T to induce a trader to take a long position