Reverse Cash and Carry Arbitrage

Anyone comfortable enough with this material to set up and example and explain?

You usually do this for bond futures of stock index futures. You sell the underlying and buy the futures contract. Say that the implied repo rate is lower than the market repo rate, youll cash in. At expiration, you buy the underlying which will be lower than the price of the futures contract. The difference is yours.

This is of the thely Chapters that I still don’t like and don’t even bother to read. I guess I will have to do that sometime before the exam. The other one is the corporate governance. Too much confusion for no reason.I hate them

Im thinking about a commodities contract. go long forward, short the spot, lend the proceeds

This is my understanding and I know I have to factor in lease rate, but couldn’t remember how to do that… When forward is overpriced (Cash and Carry) Short forward (=sell underlying in a future date) Borrow at rf Long Spot and at forward expiry Deliver underlying to offset the forward delivery obligation Pay back Loan ============================================ When forward is under-valued (reverse cash and carry) Long forward (=buy underlying in a future date) Short Spot Invest proceed at rf at contract expiry Take delivery of forward Pay back Spot

You wanted an example… Cash and carry: Say that crude oil is selling now for $50 but the future price for October 2009 is $90. You expect that it costs $35 to store and deliver the oil in October if you buy it now. That’s what you do, you buy now and sell it in October for $90. Profit: $90-85 minus interest rates and stuff like that. You get the point. You can do the same for all types of futures if it’s cheaper to buy today and ‘carry’ it to the delivery date and deliver it for a price that’s higher than the implied price now. Reverse cash and carry: The other way around. Of course it’s difficult to sell short oil in real life but you can do this bonds and stock indexes. You make money because you do NOT carry it. Hope you get it.

If you’re an oil producer, or you use oil as part of yoru business you may gain a convenience yield by holding the physical commodity instead of a forward. In that case you would be willing to “carry the oil”, even if the futures contract is cheaper than what carrying costs alone would imply.

philly, have you done any of the past exams?

Yea cfasf1. This was in a past exam.

Why do you ask by the way? : )

Btw, you guys rock thanks.

I was asking because I thought their explanation for that question was pretty good. It’s just like how they have it laid out in the text… you know with the little chart that maps out the cashflows?

Yes it is good! You guys gave me an understanding of both arb methods depending on the forward price.

What Study Session is this? Thx.

SS 13

You suckers didn’t say spoiler!

to summarize: cash and carry- 1. sell futures 2. buy spot 3. borrow at RFR reverse cash and carry- 1. buy futures 2. sell spot 3. lend at RFR am i correct? haven’t taken 08 exam, but gotta think this kind of logic gets you through.

Correct. Doubt this will be repeated in the 09 exam. Highly doubt it.

They better not make 09 AM as tough as 08. The fact they pulled this crap last year has me in fear.

The 08 am was absolutely brutal. I soiled myself.