I decided to spend the day working on the problems I had previously punted, and made some solid progress but I am confused about a number of issues. I may be asking stupid questions but it’s late and im fried so I apologize in advance.
1.)When do you incorporate the borrowing cost in the cash and carry equation (e.g. borrowing at the risk free rate to finance the spot purchase)? For example problems 2.) (b) and © both do not incorporate the borrowing costs. The only thing I can think of is because they are actually purchasing a forward as a proxy for spot so there is no cash flow? I thought they had meant that the futures price was to be used as a proxy for the spot price but you are still buying spot…
2.) When calculating FV of storage costs, and borrowing costs for that matter, when do you simply multiple by (1+r)^t versus multiplying by e^(r*t) … I have seen it done both ways. For example problem 3 uses the first way whereas many of the examples use the latter
3.) While going through these problems, I realized that calculating the payoff on the cash and carry is simply as easy as subtracting the no arb price from the current futures price, so that is: [F0,T - S0*e^(rfr + storage costs - conv yield) *T] … so do we even really need to use the stupid table or can we just cut to the answer using the no arb model?
4.)When solving for the annualized return on a cash and carry, why do we have to use ln(VT/V0) = r * t/12 versus just doing a simple HPR and annualizing it… is this due to continuous versus normal compounding? Why do we even have to use continuous to calc a return?
5.) When are we suppose to use individual future value of storage costs and sum them all up versus convert it to a continuous rate by dividing the costs by the spot and simply throwing it in the exponent? The answers are slightly different both ways, and it is a massive shortcut to just convert to continous and solve the no-arb model.
I know thats alot of questions and probalby not 100% clear, but thanks in advance.