Todays spot market is $100 per barrel of oil. The cost of storage of 1 barrel is
ID: 2659914 • Letter: T
Question
Todays spot market is $100 per barrel of oil. The cost of storage of 1 barrel is $10 per month and the risk-free interest rate is 1% per month, compounded monthly. (a) Assuming that the markets are rational and in equilibrium, what are the 1-,2-, and 3-month oil forward prices? (b) A client is interested in entering a swap contract with you (the bank), so that the client will pay you X dollars monthly for 3 months (i.e. in 1,2, and 3 months time). In return, you (the bank) will pay the client the spot value of 100 barrels of oil. What is the least value of X, so that you don't loose money on that contract.
Will be awarding full points to whoever answers this the clearest. If it's REALLY clear and well explained, I will be doubling points and awarding them.
Explanation / Answer
A]ONE MONTH OIL FORWARD PRICE = 100*(1.01) + 10
=111
TWO MONTH OIL FORWARD PRICE = 100*(1.01)^2 + 10*2
=102.01 + 20
=122.01
THREE MONTH OIL FORWARD PRICE = 100*(1.01)^3 + 10*3
= 103.03 + 30
=133.03
B] SPOT VALUE OF 100 BARRELS OF OIL = 100*100
=10000
THEREFOE,
X*PVIFA(1%,3) = 10000
X*2.9410 = 10000
X = 10000/2.9410
X = 3400.20
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