Let us take an example of a futures contract on a commodity and work out the price of the contract.
The spot price of silver is Rs.7000/kg. If the cost of financing is 15% annually, what should be the futures price of 100 gms of silver one month down the line ? Let us assume that we’re on 1st January 2001.
How would we compute the price of a silver futures contract expiring on 30th January? From the discussion above we know that the futures price is nothing but the spot price plus the cost-of-carry. Let us first try to work out the components of the cost-of-carry model.
1. What is the spot price of silver? The spot price of silver, S= Rs.7000/kg.
2. What is the cost of financing for a month? (1+0.15) 30/365
3. What are the holding costs? Let us assume that the storage cost = 0.
In this case the fair value of the futures price, works out to be = Rs.708.
F=s (1+r) T + C = 700(1.15) 30/365 =Rs. 708
If the contract was for 3 month period i.e. expiring 30th March the cost of financing would increase the futures price. Therefore, the futures price would be C = 700(1.15) 90/365 = Rs.724.5. On the other hand, if the one-month contract was for 10,000 kg.
Of silver instead of 100 gms, then it would involve a non-zero storage cost, and the price of the future contract would be Rs. 708 +the cost of storage.
The spot price of silver is Rs.7000/kg. If the cost of financing is 15% annually, what should be the futures price of 100 gms of silver one month down the line ? Let us assume that we’re on 1st January 2001.
How would we compute the price of a silver futures contract expiring on 30th January? From the discussion above we know that the futures price is nothing but the spot price plus the cost-of-carry. Let us first try to work out the components of the cost-of-carry model.
1. What is the spot price of silver? The spot price of silver, S= Rs.7000/kg.
2. What is the cost of financing for a month? (1+0.15) 30/365
3. What are the holding costs? Let us assume that the storage cost = 0.
In this case the fair value of the futures price, works out to be = Rs.708.
F=s (1+r) T + C = 700(1.15) 30/365 =Rs. 708
If the contract was for 3 month period i.e. expiring 30th March the cost of financing would increase the futures price. Therefore, the futures price would be C = 700(1.15) 90/365 = Rs.724.5. On the other hand, if the one-month contract was for 10,000 kg.
Of silver instead of 100 gms, then it would involve a non-zero storage cost, and the price of the future contract would be Rs. 708 +the cost of storage.