Storage costs

[wrongsaidfred]

Hi David,

I was looking at exmaple 6.1 in McDonald about the forward price of corn. I know this may be a very small point, but it looks like he is calculating the FV of the storage costs as though the payments are at the end of each month. Is this the usual convention or are they just being a little sloppy? It seems like storage would be paid at the beginning of the month and therefore all of the exponents of the storage costs should be 1 greater than they are.

Thanks,
Mike

 

[David Harper CFA FRM]

Hi Mike,

I agree it's a little sloppy (imprecise), but it does matter, to your point. However, I don't think the storage costs are necessary at the beginning (in advance) or at the end (arrears) of the month. I think it can be either. But it should be specified. You might notice that Hull has some questions with lumpy storage and he is specific about whether, for example (question 5.15) "the storage cost [of silver] are payable quarterly in advance" ... you have to know that to know how many periods to compound forward or discount backward, but it could also say "payable quarterly in arrears" which would give a different answer.

So, i think it matters because it impacts the answer, but it could be either and therefore needs to be specified
(as you likely figured out, when storage costs is specified as a continuous % of the spot price, then this is moot; it's only an issue when PV or FV lumpy costs or income/dividends)

Thanks, David