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Answer: If the storage cost of a consumption commodity exceeds the riskfree rate, the forward curve must exhibit contango
The **EXCEPT** choice is **A**. Why A is false: - A high storage cost does **not** by itself guarantee contango. - The convenience yield can offset carrying costs and may produce **backwardation** even when storage costs are high. - Therefore, it is not correct to say the forward curve **must** exhibit contango. Why B, C, and D are true: - **B:** Backwardation implies the convenience yield is strong relative to the cost of carry. - **C:** The convenience yield acts economically like a benefit from holding the physical commodity, similar to a dividend or negative carrying cost. - **D:** For a non-dividend-paying stock, the cost of carry is the riskfree rate. So the incorrect statement is **A**.
Author: Manit Arora
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Question 165.5. Each of the following is TRUE about the cost of carry approach (model) to pricing commodity forwards EXCEPT:
A. If the storage cost of a consumption commodity exceeds the riskfree rate, the forward curve must exhibit contango
B. Forward curve backwardation implies a convenience yield that is greater than the cost of carry (y > c)
C. The convenience yield is economically like a dividend and therefore like a negative storage cost
D. A non-dividend-paying stock has a cost of carry equal to the riskfree rate
A
If the storage cost of a consumption commodity exceeds the riskfree rate, the forward curve must exhibit contango
B
Forward curve backwardation implies a convenience yield that is greater than the cost of carry (y > c)
C
The convenience yield is economically like a dividend and therefore like a negative storage cost
D
A non-dividend-paying stock has a cost of carry equal to the riskfree rate
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