Question

38. Suppose the current price of gold is $250 per ounce and that the future spot price one year from now is projected to be $350. (7 pts.)

a. If storage costs are 3%, what rate of return do you earn on your gold if you sell it after one year?

b. How could you take your $250 and instead invest in a synthetic form of gold (from an investment perspective)? (What actions would you need to take, including in terms of buying/selling?)

c. Using the storage costs from section (a) above, what would be the forward price of the gold in this case?

Answer 1

a. The 3% storage costs mean a total cost of 1.03 x 250 = 257.5. Hence, if we sell it after one year, the return will be = (350-257.5)/257.5 = 35.9223%.

b. We could buy the spot gold and short the futures. This would ensure that the gold we have bought today, we will be able to sell it after an year at the high price we are currently seeing i.e. $350. Hence, we have to buy it at spot, wait for one year and sell it after one year.

c. If there was no arbitrage in place, the forward price would be adjusted according to the present price i.e. spot price and the storage costs. Hence, the forward price would be 1.03 x 250 = $257.5