chapter5 - Chapter 5 1 CHAPTER 5 Agricultural, Energy and...

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Unformatted text preview: Chapter 5 1 CHAPTER 5 Agricultural, Energy and Metallurgical Futures Contracts This chapter explores futures contracts on physical commodities, those written on agricultural, energy and metallurgical commodities. This chapter is organized into the following sections: 1. Commodity characteristics that interfere with the Cost- of-Carry Model. A. Commodity Supply and Storability B. Commodity Seasonal Production C. Commodity Seasonal Consumption D. Commodity Poor Storability 2. Spread A. Intra-commodity Spreads B. Inter-commodities Spreads 3. Hedging Chapter 5 2 Commodity Characteristics Recall: the Cost-of-Carry Model implies a range of permissible prices. These prices are defined by the cash- and-carry and reverse cash-and-carry arbitrage strategies. Applying the cash-and-carry arbitrage strategy assumes that the physical good or commodity can be stored from one day to the next. Applying the reserve cash-and-carry arbitrage depends upon short selling. Some goods have a convenience yield, which stems from the usefulness of having them in inventory. Chapter 5 3 Commodity Characteristics Recall: the relationships between cash and futures prices depend upon: Storage characteristics of the commodity Supplies of the commodity Production and consumption cycle for the commodity Ease of short selling the commodity Transaction costs In the following section, we begin by discussing how the supply and storability move the market to or away from full carry. Then, we provide examples of commodities that are at full carry and commodities that are not at full carry. Chapter 5 4 Commodity Characteristics Supply and Storability Insert Figure 5.1 here Chapter 5 5 Commodity Characteristics Supply and Storability Table 5.1 presents the various features of the commodities and the expected price behavior. Table 5.1 Storage and Stock Char acteristics and Price Beha vior Storability Relative Stocks Example Commodities H igh H igh Precious metals C expect general conformance to full carry. Good Production cycle causes fluctuations in stocks Grains and oilseeds C expect de- partures from full carry. Good Consumption cycle causes fluctuations in stocks Energy products C expect depar- tures from full carry. Poor Low , largely due to poor storability Livestock C expect frequent depar- tures from full carry. Chapter 5 6 Commodity Characteristics SUMMARY If a good has excellent storage characteristics and a large supply relative to consumption, we expect markets for the good to approximate full carry (e.g., gold). Commodities with good storability may at some point, depart from full carry, due to fluctuation in production (grains during harvesting time) or fluctuations in consumption (gasoline during summer time)....
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This note was uploaded on 02/28/2010 for the course MBA 87 taught by Professor Dpg during the Spring '10 term at Indian Institute Of Management, Kolkata.

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chapter5 - Chapter 5 1 CHAPTER 5 Agricultural, Energy and...

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