# Cost Of Carry Essay

Great Essays
The Cost-of-Carry Model
In the commodity market the Cost of Carry model is used to price the futures and forwards contracts based on the spot price of the traded asset. The cost of carry is all the costs to carry an asset from the present until a certain future period, those are the cost to finance the asset (the interest), the storage costs, the transportation cost, and the insurance costs.
The cost of carry model looks at the price of the future or forwardcontract as a function of the spot price and the cost of carry, this is shown in equation (1) below.
F_t=S(1+C_t)
Where Ft is the future price at maturity t, S is the spot price, and Ct is the cost to carry the asset until maturity t and is expressed as a percentage of the price.
The cost
When the future prices are lower than what they should be according to the cost of carry model, the action of buying future contracts by arbitrageurs will put upward pressure on the price.
The cost of carry model can also be used to price the different future contracts, contracts on the same commodity but with different maturity dates. Equation (4) below represents such a model,
F_t=F_x (1+C_(t-x)) where Fx is the price of a future contract which will mature at x, and Ct-x is the cost of carry between the period t and x.
Just like the model looking at future prices in terms of spot prices, should the future price at maturity t not be equal to the future price at maturity x there will be arbitrage opportunities which when exploited will force the price into equilibrium.
Cost of Carry and Convenience Yield
Looking at the futures on commodities, a contrast should be made between the consumption and investment commodities. Investment commodities are assets held by a number of people only for investment purposes, while the consumption commodities are assets held by a number of people for primarily consumption
The market for consumption commodities is different; owners of asset have a different view of holding an asset through a future’s contract than holding an asset in their inventory. It is some time to the advantage of the owner to hold the asset in his inventory; this benefit is expressed in the literature of commodities as the convenience yield.
The cost of carry model takes the convenience yield into account when there is a persistent difference in the price of a future and its spot price and the cost of carry (equation (1)). In equation 5 below, y represents the convenience yield and is meant to calculate the difference between the right hand side and the left hand side in equation 1.
F_t (1+y)=S(1+C_t) Equation (5)
Backwardation and Contango
The prices of futuresare to some extent reflections of the future spot prices on an asset. In fact, the model of future prices in terms of return is built upon the expected future spot price, rather than the actual spot price, as it is on the expected spot price that the investor will forecast his future profit. The model is represented by equation (6)

## Related Documents

• Improved Essays

b) Discount rate: Basically VC required the higher target rate of return of 30% - 70% to discount the future cash flow. It is vary on nature of business and the probability of failure. The higher rate reduced the value of the new firm. Unlikely, DCF used lower discount rate such as cost of equity, cost of debt and WACC for discounting the future cash flows. That gives the higher value to firm and higher return to share holder.…

• 710 Words
• 3 Pages
Improved Essays
• Improved Essays

In other words, marginal utility is the utility gained from the next unit of a commodity consumed. This distinction allows Jevons to show how utility can correspond to prices, which is something that cannot be shown if one relies on total utility (T, 214). In the words of Jevons, “Many commodities which are most useful to us are esteemed and desired but little” (T, 214). From this analysis, Jevons arrives at the principal of diminishing marginal utility, which states that as the quantity of a commodity consumed increases, the marginal utility of that commodity decreases (T, 214). Thus Jevons and the Marginalists are able to manipulate the measure of utility in such a way to solve economic conundrums, such as the diamond-water paradox.…

• 997 Words
• 4 Pages
Improved Essays
• Improved Essays

As an economic barometer, the change in stock market prices is a manifestation of market participants' expectations of the future economy. While commodity prices are often closely linked to economic performance: In the economic prosperity, the real industry demand increases, the market liquidity is abundant, and the prices of production and investment commodities rise; in the economic downturn, the real industry demand decreases, and the price of gold and other commodities with hedging function declines. It can be seen that the stock market indirectly affects the commodity market by reflecting the macroeconomic…

• 1200 Words
• 5 Pages
Improved Essays
• Improved Essays

The Importance of the Concept of Elasticity in Microeconomics The concept of elasticity is intended to measure the degree of responsiveness of a buyer or seller to a change in a key determinant, in particular price. 1 In other words, elasticity means how sensitive are consumers for a price change. I would like to talk about elasticity from the perspective of the total revenue. As we already know from the law of demand, when the price goes up, the quantity goes down. However, thanks for this equation, we can measure whether the product is elastic or not.…

• 733 Words
• 3 Pages
Improved Essays
• Improved Essays

It is the difference between a stock price and a strike price. It helps in determining the worth of a commodity and paying less of what it is worth, considering the average future earning power. A general way of determining the intrinsic value is by estimating the…

• 1003 Words
• 5 Pages
Improved Essays
• Improved Essays

According to above equation, we can see that if we assume the desired portfolio shares unchanged, the change of net foreign holdings should match the changes of holder’s wealth. There will be a negative transaction effects from the changes in net foreign holdings to the real effective exchange rates due to the rebalancing model. This conclusion is said there is a negative relationship between the changes of net foreign holdings and the changes of the real effective exchange rates which match the results of Hau and Ray (2005). And from the second parts of equation (6), if the foreign stock markets have a higher return, the holding of foreign investors will increase the amount of home country’s portfolio. The error correction equation of the net foreign holdings…

• 1776 Words
• 8 Pages
Improved Essays
• Improved Essays

Introduction First, let’s talk about what supply and demand actually represents. Supply and demand is the theory explaining the collaboration among the supply of a resource and the demand for that resource. The theory that governs supply and demand defines the effect of availability of a particular product and the desire (or demand) for that product has on price. Normally, a low supply and a high demand increases price, and the greater the supply and the lower the demand, the lower the price tends to fall. Implications for each of the computed elasticities for the business regarding short-term and long- term pricing strategies.…

• 970 Words
• 4 Pages
Improved Essays
• Improved Essays

So we usually more focus on the value. Shows in figure 3. When the value of the price elasticity is less than one, the demand is price inelastic. When the value of the price elasticity is more than one, the demand is price elastic. And unitary elastic occurs when the value equals one There are many factors influence the price elasticity of demand: the substitute effect and disposition of income.…

• 997 Words
• 4 Pages
Improved Essays
• Improved Essays

The demand care has a low quantity consumed associated with high dollar price and increasing quantity is associated with lower dollar prices. The relationship of these two slopes of demand vs supply are characteristics of the competitive market. As there is increase supply the cost the price will rise. As there is a decrease in demand the price will also decrease. Where these two curves intersect, there is an equilibrium obtained.…

• 1093 Words
• 5 Pages
Improved Essays
• Improved Essays

Customers buy more at reduced prices while suppliers supply more at high prices. Market forces regulate the prices until a market equilibrium is reached where quantity demanded is equal to the quantity supplied. Below the equilibrium price, there is a shortage as the demand is more than the supply and suppliers have to increase their prices towards the equilibrium point. Markup pricing The article indicates that costs and profit margins should be factored in determining price of a product. The pricing tactic in question is known as a markup pricing.…

• 735 Words
• 3 Pages
Improved Essays