Commodity Forward

In the cash-and carry model, do investor borrow money to buy the commodity and they have the money to buy it. In CFAI V5 P203 Q1, the investor borrows fund to buy gold, in Q2, the investor buy widget with his own cash. What’s the difference. Does it matter? Thanks.

Its not arbitrage if you use your own money, its just an investement. If you pay cash for comodity it requires capital, and you have a risk that interest rates go up. For instance lets say the arbitrage profit opportunity is \$2 per bushel and the bushel costs \$100 spot and you sell forward at \$102 1 year forward. Assume rates are 1%. If you dont borrow, you run the risk that interest rates go up. Lets say rates at year end are 5%. Now you dont have an opportunity cost of capital.

You mean buy borrowing at 1% at the beginning of the year, you free up your own capital to invest in projects that have a 5%ish return?

Assume no storage costs, no convenience yield… You can borrow & lend at Risk-Free Rate =2% Cash&Carry (Without Borrowing) Buy Asset Cash @ 100 Sell Forward @ 103 Profit = Implicit Rate of 3% = Above Risk-Free Rate If rates go up though… Forward Price will go up and you end up kind of losing because you could have done something else with your cash… Cash&Carry (With Borrowing) If there is a discrepancy between Market Forward Rate & Theoretical Forward Rate, you borrow to profit from it… If rates go up, you do not care because you’ve locked in your borrowing when rates were low…

Eastview Wrote: ------------------------------------------------------- > You mean buy borrowing at 1% at the beginning of > the year, you free up your own capital to invest > in projects that have a 5%ish return? Yeah. So your profit oportunity in your own money is \$2. You buy now at \$100, sell forward at \$102, you make \$2. Problem is you have \$100 locked up that can’t be deployed in other investments. If better investments are available you lose. In arbitrage, your profit is \$1. You make an arbitrage profit if you borrow. You commit no capital, and pocket \$1 in a year. If you commit no capital, you have to opportunity cost.

You guys are awesome. That is one of the those moments I really learn something from studying for the CFA exam.