Assignment

Multiple Choice

Identify the choice that best completes the statement or answers the question.

1. Soybean is harvested once a year and thus its expected cash market price follows a typical seasonal pattern, which can be described as .
a. the lowest price occurs in Nov-Dec                   c. market is inverted for the new crop
b. prices steadily increase until next harvest         d. all of the above

2. Which one of the following factors is the main driver of the prices of futures contracts with different maturities?
a. the systematic risk      c. the spread
b. the cost of carry         d. none of the above

3. Assume that (i) current soybean cash market price is $10.00/bushel, (ii) annual interest rate is 10%, (iii) the delivery date is the 15th for all maturity months, (iv) storage cost is $0.02 per bushel per month, and (v) insurance cost is $0.001 per bushel per month. What is the cost of carry per bushel from March to July 2016?
a. $0.11       c. $0.62
b. $0.42       d. need more information

4. (Continued from Q3) The futures prices for March and July contracts are $10.00 and $10.42 per bushel respectively. We know that .
a. the soybean market is currently at full carry
b. the soybean market has an arbitrage opportunity
c. You can make $0.11/bu by selling a March contract and buying a July contract
d. You can make $0.11/bu by buying a March contract and selling a July contract

5. Each of the follwing statement about convenience yield is true except .
a. The convenience yield is like a negative storage cost
b. The convenience yield decreases in aggregate inventory and approaches zero for high inventory levels
c. Convenience yield relfects the benefits that ownership of physical commodity provides, but are not obtained by holders of futures contracts
d. High convenience yield associated with low inventory levels will lead to a positive price change in the next period

Short Answer

6. The current market prices for the May, July, and September corn futures are listed below.

(1) Explain the concepts of normal and inverted markets and point out which pair of contracts represents the normal market? Which pair represents the inverted market?

(2) Assume that (i) annual interest rate is 5%, (ii) the delivery date is the 15th for all maturity months, (iii) storage cost is $0.02 per bushel per month, and (iv) insurance cost is $0.001 per bushel per month. What is the cost of carry per bushel from May to July? Is the market at full carry? Why?

(3) Is there any arbitrage opportunity? If yes, how to profit from it?

(4) Based on the theory of the price of storage, explain why inverted market is possible? Hint: (i) there are three major components of the net cost of carry; (ii) P_t+1 - P_t = net cost of carry.

7. Cattle prices are currenlty $0.70/pound and hog prices are $0.60/pound. Expecing the price difference between cattle and hogs to continue to grow wider, a spread trader puts on a long June CME live Cattle/short June CME Lean Hog spread trade (one contract each). Three months later when the change in the spread differential reaches $0.15 per pound, she liquidates the position.

(1) When she initiated the spread trade, which contract did she believe would rise more? Which contract was over-priced?

(2) What is the initial cattle-hog spread?

(3) What profit does the spread trader make on the trade ($/pound)?

8. Suppose that you are the risk manager for a ethanol plant. For your plant, corn is the raw product, and ethanol and DDGs (distiller's dry grain) are the products of the corn crushing process. Assume the normal yield of crushing from 1 bushel of corn is 2.8 gallons of ethanol and 17 pounds of DDGs. The current futures prices for corn, ethanol and DDGs are PC ($/bushel), PE ($/gallon) and PDDG ($/short ton), respectively, and cost of crushing is C ($/bushel).

(1) Write down the equation for the locked-in profit in terms of product prices and cost.

(2) Given the current futures prices: Corn: $7/bushel, Ethanol: $2.6/gallon and DDGs: $120/ton, calculate the corn crush spread.

(3) Describe spread trading strategies that take advantage of abnormal corn crush spread levels.

9. Soybeans can be processed into two products: soybean meal and soybean oil. Typically 60 pounds of soybean will yield about 11 pounds of oil, 48 pounds of meal, and 1 pound of waste. This is referred to as the soybean crush yield.

(1) Given the following current futures prices, calculate the soybean crush spread.

(2) Based on the historical normal soybean crush spread of $0.30, indicate which contract(s) is over-priced or under-priced and describe the corresponding spread trading strategy.

Over-priced: ______      Under-priced: __________
Buy: ______                 Sell: _______

(3) Suppose that the normal soybean crush spread is $0.20. Which contract(s) is over-priced or under-priced? What should the corresponding spread trading strategy be?

Over-priced: ______      Under-priced: __________
Buy: ______                 Sell: _______