Non-dividend-paying investment asset in cost of carry model

[DTu]

Hey guys, When I read through the notes, I'm confused by one sentence:
For a non-dividend-paying investment asset (i.e., an asset which has no storage cost) the cost

of carry model says the Futures price is given by....

I guess when gold and silver are viewed as investment assets, storage costs will occur as well...
In my view, non-dividend-paying and no storage cost have not much relationship with each other..

 

[Dr. Jayanthi Sankaran]

Hi @DTu,

I am just hazarding a guess here:

(1) In the absence of storage costs and income, the forward price of a commodity that is an investment asset (gold and silver) is given by:

F(0) = S(0)*e^rT

This is the same as for a non-dividend paying stock where the cost of carry is also r because there are no storage costs and no income

(2) You are right in saying that gold and silver will incur storage costs. However, the hedging strategies of gold producers (gold mining companies) leads to a requirement on the part of investment banks to borrow gold. Gold owners such as the central banks charge interest in the form of what is known as the gold lease rate when they lend gold.

(3) For example, suppose you are Goldman Sachs and are approached by a gold mining company that wants to sell you a large amount of gold in 1 year at a fixed price. How do you set the price and then hedge your risk? The answer is that you can hedge by borrowing the gold from a central bank, selling it immediately in the spot market, and investing the proceeds at the risk-free rate. At the end of the year, you buy the gold from the gold mining company and use it to repay the central bank. The fixed forward price you set for the gold reflects the risk-free rate you can earn and the lease rate you pay the central bank for borrowing the gold.

Hope that helps, somewhat
Jayanthi

 

[Dr. Jayanthi Sankaran]

Thanks for the star Nicole - appreciate it

Jayanthi

 

[DTu]

Hi @DTu,

I am just hazarding a guess here:

(1) In the absence of storage costs and income, the forward price of a commodity that is an investment asset (gold and silver) is given by:

F(0) = S(0)*e^rT

This is the same as for a non-dividend paying stock where the cost of carry is also r because there are no storage costs and no income

(2) You are right in saying that gold and silver will incur storage costs. However, the hedging strategies of gold producers (gold mining companies) leads to a requirement on the part of investment banks to borrow gold. Gold owners such as the central banks charge interest in the form of what is known as the gold lease rate when they lend gold.

(3) For example, suppose you are Goldman Sachs and are approached by a gold mining company that wants to sell you a large amount of gold in 1 year at a fixed price. How do you set the price and then hedge your risk? The answer is that you can hedge by borrowing the gold from a central bank, selling it immediately in the spot market, and investing the proceeds at the risk-free rate. At the end of the year, you buy the gold from the gold mining company and use it to repay the central bank. The fixed forward price you set for the gold reflects the risk-free rate you can earn and the lease rate you pay the central bank for borrowing the gold.

Hope that helps, somewhat
Jayanthi

That's really helpful. Thank you very much!