QUESTION 1 Provide a brief definition of the following Cost of carry Opcrating o

Question

QUESTION 1 Provide a brief definition of the following Cost of carry Opcrating options Net demand Net marginal convenience yield Strong backwardation Weak backwardation . o 12 Marks] With the aid of diagrams, discuss the effect of the following on both the cash and the storage markets for commodities Permanent increase in demand for the commodity (ii) Temporary increase in demand for the commodity (iii) Increase in speculation in the futures market for the commodity (iv) Increase in speculation in the physical market for the commodity 13 Marks]

Explanation / Answer

1. Cost of Carry: The cost of carry refers to costs incurred as a result of an investment position. These costs can include financial costs, such as the interest costs on bonds, interest expenses on margin accounts, and interest on loans used to purchase a security. They can also include economic costs, such as the opportunity costs associated with taking the initial position.

2. Convenience yield: A convenience yield is the benefit or premium associated with holding an underlying product or physical good, rather than the contract or derivative product.

Sometimes, due to irregular market movements such as an inverted market, the holding of an underlying good or security may become more profitable than owning the contract or derivative instrument due to its relative scarcity versus high demand.

3. Strong backwardation: When futures prices are below current spot prices

4. Weak Backwardation: When discounted futures prices are below spot prices.

Answered first 4 parts.

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