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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.

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

Practical Management Science
Practical Management Science
6th Edition
ISBN:9781337406659
Author:WINSTON, Wayne L.
Publisher:WINSTON, Wayne L.
Chapter2: Introduction To Spreadsheet Modeling
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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

  1. 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.

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