Question

Suppose silver is selling for $18 (spot price) an ounce and it costs $1 an ounce to store silver for 1 year (payable at the end of the year). If you can borrow or lend at 12% per year, what should the one-year futures price of silver be if there are no riskless profits to be made? What would you do to make riskless profits if the futures price was actually $23?

Answer 1

one-year futures price of silver = Current price × (1 + 12%) + Storage cost

= $18 × (1 + 12%) + $1

= $20.16 + $1

= $21.16

One year futrures price of silver will be $21.16.

if the futures price was actually $23 then you should do following steps to earn riskless profit.

1. Borrow $18 from bank and buy on ounce Silver.

2. After one year sale silver at $23 and pay $1 for storage cost. Net amount you have after payment of storage cost will be $22.

3. Now pay debt with interest which is $20.16.

4. total riskless profit $1.84 ($22 - $20.16) per ounce.