Question #24 - Reading 30 Pricing and Valuation of Forward Commitments

Reading: Reading 30 Pricing and Valuation of Forward Commitments

PDF File: Reading 30 Pricing and Valuation of Forward Commitments.pdf

Page: 11

Status: Unattempted

Correct Answer: B

Shared Context

- For a futures contract on an asset with no storage costs, convenience yield, or other expected cash flows over the term of the contract, there should be a: A) positive correlation between the futures price and interest rates and a negative correlation between the futures price and the spot price. B) negative correlation between the futures price and interest rates and a positive correlation between the futures price and the spot price. C) positive correlation between the futures price and both interest rates and the spot price.

Question

Oil futures prices might be higher than the spot price because:

Answer Choices:

A. of reverse contango

B. there are more costs than benefits to holding the asset

C. there are more benefits than costs to holding the asset

Explanation

In calculating the futures price, we would subtract the benefits of holding the asset, e.g., the present value of dividends and coupons, and add the costs of holding the asset. Oil does not pay a dividend, and there would be costs for holding oil. Contango describes the situation where the futures price exceeds the spot price, and there is not such thing as reverse contango.

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