I was going through the alternative material and this concept of boundries to futures price when convenience yield is present just does not make any sense to me. Can somebody make it clearer?
Thanks for the help in advance.
If you recall the forward price formula from Level II, you’ll know that it’s just the spot price projected forward at the risk free rate plus the storage rate.
If everyone could earn the convenience yield, then you would simply subtract the convenience yield rate from those and there would, again, be a single forward price. Alas, not everyone can earn the convenience yield. Thus, you need a range of forward prices: between the forward price for those who earn the convenience yield and the forward price for those who don’t.
Thanks for your response magician, but that is exactly my confusion. I understand what you wrote. My Q is that how do you decide who can/cannot get convenience yield and why there is upper/lower bounds different?
producers who use the commodity earn a convenience for having it on hand. The greater this convenience, the lower the lower bound of the future price since F=Se^(r-g-c).
or something like that.
On the exam they’ll tell you who gets the convenience yield and who doesn’t. The upper and lower bounds are different because not everyone receives the convenience yield. Those who do will pay less in the forward market (because they don’t get the convenience yield on a future delivery). Those who don’t will will demand more in the future.