CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
A commodity forward is priced using the cost-of-carry model. Compared with an otherwise identical asset with no storage costs, an asset with positive storage costs and no convenience yield will most likely have a forward price that is:
The forward price will be higher. Storage costs add to the cost of carrying the asset until delivery, so the no-arbitrage forward price must be raised by their future value relative to an asset with no such costs.
- Alower than the no-storage-cost forward price
- Bequal to the no-storage-cost forward price
- Chigher than the no-storage-cost forward priceCorrect
Explanation
Storage costs are a cost of carry that the forward seller incurs when holding the asset, so they add to the forward price. Benefits such as dividends or convenience yield would reduce it. Equal or lower prices would allow arbitrage by buying spot and selling forward.
Did you get it right without looking?
One question tells you little. A timed set on Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives shows your real accuracy, how long you take and where you lose marks.
More Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives questions
- A stock is priced at $80. It will pay a $2 dividend in three months. The annual risk-free rate is 5% with continuous compounding. The no-arb…
- A stock trades at 50.00 on Exchange X and 50.60 on Exchange Y at the same moment. Both trade in the same currency and can be settled immedia…
- Compared with a non-dividend-paying stock, a forward contract on an equity index with a high dividend yield will most likely have a forward …
- The law of one price most likely implies that two assets with identical future cash flows in all states of the world:
- An arbitrage opportunity is best described as a transaction that:
- An arbitrageur observes that a derivative trades above the cost of its replicating portfolio. The most appropriate arbitrage action is to: