Convenience yield

[Bruno]

Hi David,

On page 20, the notes state that "if a non-dividend paying stock offered a convenience yield, then the forward price calculation is: F=Se^(r-y)T OK
But then you say "except that a non dividend paying stock does not offered a convenience yield," so F=Se^(rT).

I don't have a problem with the math but I am confused with the wording. I don't see the relationship between the dividends and the convenience yield. First, a stock is not a physical asset so I don't see the benefits of holding the asset (do you mean benefits such as membership board?). In other words, can a stock "offered" a convenience yield? Is it related to dividends?

I thought that the convenience yield was only related to the benefits of owning a "physical" asset.

Thanks for your help.

 

[David Harper CFA FRM]

Hi Bruno,

It's probably a confusing way for me to make the point that, in cost of carry, the impacts are all either costs/benefits (add or subtracting to the forward price), so that convenience yield is economically equivalent to dividend (confers benefit to physical ownership); i.e., both reduce the forward price as they formalize an "opportunity cost" of not owning the asset. The "F=Se^(r-y)T" is maybe a confusing detour.

"Can a financial asset offer a convenience yield?"

At the top of same page, I extracted from Hull in first para: "The convenience yield reflects the “excess benefits” conferred by taking physical ownership of the asset (i.e., as opposed to holding a futures contract). The convenience yield is generally not relevant for financial assets. But for commodities (physical assets), ownership may confer positive benefits or may decrease perceived risk. "

I think the practical answer here is, following Hull, no. Hull uses the same cost of carry model for investment/consumption commodities and largely explains the difference between the two as: consumption commodities have storage costs without generally proving income; investment assets provide income generally without storage costs.

(That said, strictly speaking, I do in fact think financial assets can have a convenience yield. It may be low. I will admit it can open a debate. But I think it follows naturally from our [Hull's] definition where convenience yield is the plug-variable the impounds any otherwise not counted opportunity cost. For example, I'd argue you could attribute value to convenience yield in an OTC forward on a financial asset where the CY is impounding basis/counterpary/liquidity risk. But it's messy and the uses of convenience yield vary).

David

 

[Bruno]

Thank you very much, David.

 

[David Harper CFA FRM]

sure thing, sorry to belabor but i left out convenience in the statement. Here, to agree with your point on a practical level:

Consumption commodities have storage costs without generally proving income but possibly providing a convenience yield; Investment assets provide income generally without storage costs and typically without convenience yield.