CFA Level I · CFA Level I Exam · Arbitrage, Replication, and the Cost of Carry in Pricing Derivatives
An investor compares a forward price on a commodity with its spot price. The commodity has storage costs but provides no convenience yield. All else equal, the forward price relative to the spot price is most likely:
The forward price is most likely higher than the spot price. Holding the commodity until delivery costs storage and financing, and there is no convenience yield to offset them. The forward price must include these net carrying costs to prevent arbitrage.
- Alower than the spot price
- Bequal to the spot price
- Chigher than the spot priceCorrect
Explanation
Under cost of carry, the forward price equals the spot price plus the net cost of holding the asset. Storage costs and financing add to the cost, and with no offsetting benefit the forward price exceeds spot. A forward at or below spot would need benefits that outweigh costs.
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