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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 a commodity with no storage costs, the forward price of an otherwise identical commodity with positive storage costs and a positive convenience yield is most likely:

Storage costs raise the forward price because they add to the cost of carrying the asset, while convenience yield lowers it because holding the physical commodity provides a benefit. The forward price therefore reflects higher storage costs and lower convenience yield, and the two do not automatically offset.

  1. Ahigher by the storage costs and lower by the convenience yieldCorrect
  2. Bunaffected, because storage costs and convenience yield cancel exactly
  3. Clower by the storage costs and higher by the convenience yield

Explanation

Storage costs are a cost of carry and raise the forward price. Convenience yield is a benefit of holding the physical asset and lowers the forward price. The two do not cancel in general.

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