@Zee, Thanks for attaching the image here 🙂 .Yep,Answer is B.Can u pls explain ? I was going for A,thinking that since Fwd price is inversely related to the convenience yield(c),including high c is making the fwd price appear lower..Whats the flaw in my logic?
@Sophie,I did copy the image url when prompted..May be some issue with my browser..Thanks anyway.
@lakshya25 you’re right in saying forward price is inversely related to convenience yield, but the confusing part here is that they’re asking what Jill did in her model. Jill’s model is currently over-valuing forwards (i.e. her model thinks forwards are more expensive than they actually are, so prices of forward contracts appear lower than her model).
Answer A: If convenience yield is too high, Jill’s model would price its forwards too low (hence forward prices will appear high compared to the model)
Answer C: Lower storage costs would also lower the model’s pricing.
Answer B: Low convenience yield, or not included at all, will lead to the model pricing forwards higher than they actually are, hence the right answer.
It’s like this:
Remember, the Factors for the Futures Price are “+ Risk Free Rate “- Lease Rate”.
Lease Rate = “Storage – Convenience”.
If Convenience is 0, then Lease rate is OVERSTATED.
In the Formula, the Lease rate is negative, thus the overstatement makes it (the negative) larger reducing or understating the Forward Price.
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