Futures on Commodities: CONSUMPTION Assets

Futures on Commodities: CONSUMPTION Assets

1. Those who HOLD consumption assets do so because of their consumption value

2. Consumption assets usually provide no incoe but MAY REQUIRE SIGNIFICANT STORAAGE COSTS (e.g grains, oil)

3. Holders are reluctant to sell the commodity and buy forward, because forwards cannot be consumed until the DELIVERY DATE. As a result......

4. ...arbitrage activity is muted where...

5. Therefore, we can only show an upper bound for a consumption asset's price:

6. Cost of Carry

7. The Convenience Yield (y)

   • If a commodity is in short supply this may produce an abnormally high spot price
   • The benefit from holding a physical asset (as distinct from a futures contract) is that the asset can be used in production as required
   • This "benefit" is known as the CONVENIENCE YIELD - The premium earned by those who hold inventory of a commodity in short supply

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