HI all, I was just reviewing commodities, and I’m not sure why adding the convenience yield creates a no arbitrage “region” rather than a specific price. Can anybody dumb this down for me? thanks!
Not everybody who owns a commodity will have a convenience yield. So in short there is a region created between the price charged - ----one having the convenience and one who does not
Wouldn’t that create an arbitrage region, rather than a non-arbitrage region? Example: A has a convenience yield from owning oil. B does not. B goes long on the futures, A goes short on the future. B sells oil spot to A. A will have the convenience of owning oil. A will also pay the convenience yield. B will in turn collect the convenience yield, which in turn will be an arbitrage profit from B’s perspective.
olivier Wrote: ------------------------------------------------------- > Wouldn’t that create an arbitrage region, rather > than a non-arbitrage region? > > Example: > > A has a convenience yield from owning oil. B does > not. > > B goes long on the futures, A goes short on the > future. > B sells oil spot to A. > > A will have the convenience of owning oil. A will > also pay the convenience yield. > B will in turn collect the convenience yield, > which in turn will be an arbitrage profit from B’s > perspective. Why is A paying convenience yield again?? He owns the asset and not leasing an asset? Correct me if i am wrong.
anishcandy Wrote: ------------------------------------------------------- > > Why is A paying convenience yield again?? He owns > the asset and not leasing an asset? > > Correct me if i am wrong. He only owns the asset until future’s expiration. At expiration, he will be under the obligation to deliver the asset. He does not cut a check for lease payment every month ; rather, the convenience yield is implied by the difference between the spot and the future’s price. The combination of spot and future’s transaction is akin to leasing the asset (from B)
hey, here’s a good place to ask. i think i saw a question on a practice exam talking about what happens to futures prices if convienence yield increase?.. i’m guessing the answer (which i haven’t looked up yet) is that the future price decreases. but i’m thinking real-world that the spot price increases (convienence yield is basically extreme shortage i think). and shortage doesn’t affect a future price 2 years out… i could be wrong though about what i think the exam answer was. also, anyone know where the names contango and backwardization come from? i find it confusing as i think backwardization makes more sense when future prices are lower (i.e. the more rare instance is “backwards”)
I agree with what Amit wrote above but i kind of do not agree with the forward between two same parties and the actual spot transaction between the same two parties as well… Makes it more confusing. =( wvhome: “…backwardization makes more sense when future prices are lower …” Isn’t that what it actually is?? Falling yield curve?? Edit: wvhome: I think the cost/benefit of Convenience yield depends on the perspective of the lessor/lessee!!
I don’t remember exactly, but I think the idea is that if you are an owner of a refinery, there is value to you to have the oil on hand to meet market needs. If you are just a trader, then there isn’t. As a result, you will tend to own the oil and will accept a higher futures price (assuming you are going long, which makes sense if oil is the input for refining) than you would if you were a pure arbitrager, because it allows you to keep the oil in inventory. (I may have the signs wrong here, but the gist of it is that the value of the real option of having oil on hand changes the price you’ll accept vs. a pure trader who never takes delivery) Convenience yield is also tied up with the idea of the lease rate, which is basically a correction to the no-arbitrage pricing (assuming no storage) to account for the costs of storing.
but what i’m saying is that the spot price is what corrects to the convienence yield, not the futures price… but listen, i want to pass the exam. i’m happy to go with what they give.