My question: Where is the collateral return coming from? Question details: Reading #34 For commodity futures, total return = spot return + collateral return + roll return. The explanation of “collateral return” is: 1) It is the result of no-arbitrage. 2) Collateral return = risk-free rate of return Reading #36 The price formula of commodity future is: (r-delta)T F = S e t,0 0 Or: F_t,0 = S_0 e ^ (r-delta)T where r is the risk-free rate. Anyway, the price formula of commodity future already contains the risk-free rate, which means the price of future has already adjusted for risk-free rate. Then comes my question, where is the collateral return coming from?
time.
You margin is collateral, and collateral return is interest on your margin. The RFR embedded in the futures price is just the arbitrage price setting. You still have to put down collateral.
Collateral Return comes from the fact that instead of buying at the spot rate, you could simply take that cash, invest at the risk free rate and have sufficient funds to pay for the commodity at the forward rate. ie: Time.
PJStyles Wrote: ------------------------------------------------------- > Collateral Return comes from the fact that instead > of buying at the spot rate, you could simply take > that cash, invest at the risk free rate and have > sufficient funds to pay for the commodity at the > forward rate. > > ie: Time. future, not forward, you pay for a future now, so it’s the return on your margin
yes… my bad 
when you buy futures contract, you can deposit your margin in T-bills, the return on T-bills will be your collateral return
Just to be clear: When you buy futures, you will post only a margin(small amount). Seller/exchange get this money. The buyer could invest the rest of the money that will need to buy the asset at the end of the period and earn risk free rate. when you say you can deposit your margin in T bills I guess you are refering to the purchaser of the future right. ie RFR on the money that he is not paying right then.
Thanks a lot! I think it is the interest of margin. As the future price already contains the interest earning in the future (no arbitrage). The margin can not be hedged that way. Then comes the interest.
krishna1 Wrote: ------------------------------------------------------- > Just to be clear: > > When you buy futures, you will post only a > margin(small amount). Seller/exchange get this > money. The buyer could invest the rest of the > money that will need to buy the asset at the end > of the period and earn risk free rate. > > when you say you can deposit your margin in T > bills I guess you are refering to the purchaser of > the future right. ie RFR on the money that he is > not paying right then. ^ correct
Krishna - Both the buyer and seller of a futures contract has to post margin.