In: Finance
FUTURE PRICE OF COMODITY WITH STORAGE COST IS CALLED COST OF CARRY
What Is Cost of Carry?
Cost of carry refers to costs associated with the carrying value of an investment. These costs can include financial costs, such as the interest costs on bonds, interest expenses on margin accounts, interest on loans used to make an investment, and any storage costs involved in holding a physical asset.
Theoretically, the price of a futures contract is the sum of the
prevailing spot price and the cost of carry. (See formula) But the
actual price of futures contract also depends on the demand and
supply of the underlying stock.
Formula:
Futures price = Spot price + cost of carry
Or cost of carry = Futures price – spot price
BSE defines the cost of carry as the interest cost of a similar
position in cash market and carried to maturity of the futures
contract, less any dividend expected till the expiry of the
contract.
Example:
Suppose the spot price of scrip X is Rs 1,600 and the prevailing
interest rate is 7 per cent per annum. Futures price of one-month
contract would therefore be:
1,600 + 1,600*0.07*30/365 = Rs 1,600 + Rs 11.51 = 1,611.51
Here, Rs 11.51 is the cost of carry.