D & R A1 2 -3Question 2. Contango and BackwardationExplain the relationship between contango, cost-of-carry, and convenience yield.

Answered: D & R A1 2 -3 Question 2. Contango and…

Practical Management Science

6th Edition

ISBN:9781337406659

Author:WINSTON, Wayne L.

Publisher:WINSTON, Wayne L.

Chapter2: Introduction To Spreadsheet Modeling

Section: Chapter Questions

Problem 20P: Julie James is opening a lemonade stand. She believes the fixed cost per week of running the stand...

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D & R A1 2 -3

Question 2. Contango and Backwardation

Explain the relationship between contango, cost-of-carry, and convenience yield.

Expert Solution

Contango

The forward curve structure is denoted by the terms contango and backwardation. When a market is in contango, the forward price of a futures contract is higher than the spot price. The forward price of future contracts is less than the spot price when a market is in backwardation. When there is a contango, the profit is highest since the future price is higher. Buying it afterwards would be more profitable for an investor during backwardation because the future price is going to drop much further.