Illustrate what does cost-of-carry of futures

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Reference no: EM1370923

Q. You are a gold manufacturer and you suppose to find 1,000 ounces of gold to process within couple days. A bank offers you a choice between borrowing cash at 11% per annum and borrowing gold at 2% per annum. Which deal is a cheaper way of borrowing?

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You expect to make a one year loan. Risk-free interest rate is 9.25% per annum and storage costs of gold are 0.5% per annum. Spot price of gold is equal to $550 per ounce. Assuming re is no administration fee and all interest rates are a continuous compounding rate.

1) Illustrate what is repayment amount if you make a cash loan?

2) If gold is borrowed, interest must be repaid in gold. If you decide to borrow 1,000 ounces of gold for a period of one year, explain how many ounce of gold you need to repay back to bank?

3) Illustrate what does cost-of-carry of futures or forward pricing mean? Explain how is it related to storage cost of gold? Illustrate what is formula to calculate futures gold price which is taken into account storage cost?

4) If you borrow in gold, you will repay bank loan in gold at end of year. Illustrate what is futures price of gold at end of year?

Reference no: EM1370923

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