Suppose the soybean market is in backwardation with a cash price of $6.50/bushel and a futures price of $6.00/bushel. Also assume that a trader owns 5,000 bushels of soybeans and does not need the soybeans until after futures expiration. Which of the following is the best strategy for the trader? A) Do nothing since the convenience yield is so high. B) Sell the soybeans in the spot market, buy an appropriate futures, and profit $1,250. C) Sell the soybeans in the spot market, buy an appropriate futures, and profit $2,500. Your answer: A was incorrect. The correct answer was C) Sell the soybeans in the spot market, buy an appropriate futures, and profit $2,500. Since the trader does not need the soybeans now he should monetize the convenience yield by selling in the spot market and simultaneously buy soybean futures for his later needs. The total profit is computed as follows: Total profit = (Cash Price − Futures Price) × Amount = ($6.50 − $6.00) × 5,000 = $2,500. simple problem but why is A wrong? since F < S it is attributed to a net benefit, which is likely due to a convenience yield. i am thinking perhaps the convenience yield IS high, but that does not mean we should do nothing when we can still (regardless of ahigh conveience yield) benefit by selling at the higher price and buying the cheaper–does anyone agree?
Yea it’s because of the high CY that the market is in backwardation and FP is less than SP. But it’s given the the problem that ‘he does not need the soybeans’. So basically he is not realizing that CY, as those bushels of soyabean are getting wasted in a warehouse. Might as well sell (short) that soya in spot market, get the $6.50 and repurchase the soya back by entering into a futures contract at $6.00 and MONETIZE the deal.
thanks swaption! youre right–the key was the phrase “he does not need the soybeans.” CY is kind of a rare thing so i think in the problem they would really emphasize it if it were a factor–say something like “he enjoys have the bushels in stock because it is easy to ship them out to customers at short notice.” so basically, in t his problem, there is no CY.