Topic 4 - Valuation of forwards and futures Flashcards
1
Q
Explain Cost-of-carry
A
- Cost of buying in advance of when it is required
- commodity - 6months
- NOW = storage costs
- NOW = benefits e.g. dividends received
- Investors = indifferent, spot should be equal to forward/future
F = Se^c(T-t)
2
Q
Mark-to-Market
A
- Daily resettlement
- G/L realised by cashflows between margin accounts
e.g.
End of day = F2
- Increase from F1 to F2 = short loses. long gains the difference
- contracted futures price changes to F2
- value of contract = reset to zero
3
Q
Convenience yield
A
- Non-monetary return for holding asset rather than FF contract
- Commodities - benefits arise from storage
- C yield varies
F = Se^( r+u -y)(T-t)
for the marginal user of the commodity
4
Q
What are the buying strategies available for a manufacturing firm requiring steel in
6 months’ time?
A
Firm can either buy now at the current spot price or purchase later via forward/futures contract.
Describe advantages and disadvantages of each.
buying now:
- know the price and have the asset in stock
- have to bear the cost of buying now
- storage costs
Forward contract:
- no upfront payment
- price certainty
- spot could be lower than future cost
5
Q
Why is the cost-of-carry model an equilibrium relationship?
A
What is the cost of carry model?
What is the formula?
If equation wasn’t in equilibrium, one strategy would be preferred over the other, causing disequilibrium.
This would be reflected in F vs S+c
