Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 95

of this book. However, I would like to mention that one of the criteria used in determining such prices is the concept of "cost of carry."Cost of carry refers to the total cost required to carry a commodity into the future. It includes factors such as storage, insurance, transportation, and financing, all of which vary depending on the commodity. In the end however, the futures prices are always determined by competitive bidding, which is based on traders' judgments on what the supply and demand for a particular commodity will be at the future maturity dates of the contracts. If it is believed that supplies will be short and demand will be high for a particular commodity at a particular time, the futures prices of that commodity for that delivery time rise. Otherwise they fall.

So again, the price difference between the spot and the future price is the premium you pay for the privilege of having a guaranteed price for the delivery at the particular time specified by the contract. If the price of the futures contracts happens to be below the spot price of a given commodity, then there is a negative premium or a discount. The discount value may also depend on factors such as seasonal or cyclical conditions. As another example, currency futures may have a discount to cash due to a situation known as Interest Rate Parity, where a certain currency will have a lower future cost against the dollar due to lower interest rates supporting that currency. Don't worry if this doesn't make a whole lot of sense. Just remember that some commodities are known to cost less in the future than they do now, while others will cost more, and this factor is worked into their future prices as well.

More On Buying And Selling Contracts

Suppose you sell gold contracts that are three months out at $305/oz. This means that you eventually would have to either offset your position by buying an equal number of contracts or deliver the gold at contract maturity in three months. In most cases you don't have to

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Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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