Commodity Forward pricing-Quesn #Doubt

blackjack21
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Commodity Forward pricing-Quesn #Doubt

Postby blackjack21 » Tue May 08, 2012 2:05 am

Calculate the 3 mnth fwd price for a bushel of corn if the current spot price is 3$/bushel, effective monthly intr rate is 1% and the monthly storage costs are .04$/bushel

Soln: While calculating the FV of storage costs why
0.04+ 0.04*1.01+ .04*1.01^2 is the calculation instead of 3*0.04
since 0.04 is the fixed cost per mnth why is it being taken like a cash flow study sort of thng...?

Also if yearly rates were given in the quesn then we could have calculated the same by dividing by 4 ryt? or frst converting to mnthly and then following the procedure mentioned in soln??

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suresh.wadhwani2009
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Re: Commodity Forward pricing-Quesn #Doubt

Postby suresh.wadhwani2009 » Tue May 08, 2012 7:55 pm

Dear Blackjack,

Remember, how we use to calculate FV which is nothing but,

FV=PV*(1+r)^n
Here PV is monthly storage cost. And in this qn you are calculating final value. So FV of monthly storage cost for 1st month=0.04*(1+0.01)^0=0.04

FV of 2nd month storage cost=0.04(1+0.01)^1=0.04*1.01
FV of 3rd month storage cost=0.04(1+0.01)^2=0.04*1.02

So total FV of monthly storage cost= 0.04 + 0.04*1.01 + 0.04*1.01^2

Hope it helps!
Last edited by suresh.wadhwani2009 on Tue May 08, 2012 11:23 pm, edited 1 time in total.

blackjack21
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Re: Commodity Forward pricing-Quesn #Doubt

Postby blackjack21 » Tue May 08, 2012 11:22 pm

This implies whenever I deal with fwd prices in my life I always treat the transactions, they might be constant or anything, as a "cash flow" because it would ultimately be involved in determining the prices.
:o :?

K...tq

suresh.wadhwani2009
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Re: Commodity Forward pricing-Quesn #Doubt

Postby suresh.wadhwani2009 » Tue May 08, 2012 11:31 pm

Dear Blackjack,

As you have written "whenever I deal with fwd prices in my life I always treat the transactions, they might be constant or anything as Cash Flow". First of all wehenever you are dealing with fwd/future price that can never be constant, fa sure it is going to vary. Theoretically you can say it is constant.

And whenever you are calculating future value/present value, you have to do the compounding/discounting. There is no other way out.

Dear Content pristine,

Help both of us if m wrong.

content.pristine
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Re: Commodity Forward pricing-Quesn #Doubt

Postby content.pristine » Thu May 10, 2012 3:25 pm

Hi Guys,

Monthly storage costs are paid monthly. So each month would be a separate cash flow. They are not be to be clubbed together.

Think about this like the future value of the rent you pay. Unless its in the structure, you would pay for this monthly, each month being a cash flow and compounded separately.

Look for hints about the frequency of compounding in the questions.

Hope this helps.. 8-)

suresh.wadhwani2009
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Re: Commodity Forward pricing-Quesn #Doubt

Postby suresh.wadhwani2009 » Thu May 10, 2012 4:03 pm

Dear Content Pristine,

Where I have clubbed the Cash Flows? I have compounded them separately only.

content.pristine
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Re: Commodity Forward pricing-Quesn #Doubt

Postby content.pristine » Thu May 10, 2012 5:39 pm

Suresh,
Your answer is good 8-)


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