Question

The current price of oil is $32.00 per barrel. Forward prices for 3, 6, 9, and 12 months are $31.37, $30.75, $30.14, and $29.54. Assuming a 2% continuously compounded annual risk-free rate, do you think these forward prices make sense? If yes why? If not why not? Explain.

Answer 1

Current Price (So) = $ 32 per Barrel

Annual Risk free Rate (r) = 2% Continously Compounded

Fair Future Price = (So * e^rt) - (C * e^-rt')

Where, 'C' is Carrying Cost

Assuming Carrying Cost is Zero, as it is not given.

	A. Forward Price	B. Fair Forward Price
3 Months	$    31.37	= $ 32 * e^0.02*(3/12) = $ 32 * 1.00501252 = $ 32.16
6 Months	$    30.75	= $ 32 * e^0.02*(6/12) = $ 32 * 1.01005017 =$ 32.32
9 Months	$    30.14	= $ 32 * e^0.02*(9/12) = $ 32 * 1.01257845 =$ 32.4
12 Months	$    29.54	= $ 32 * e^0.02*(12/12) = $ 32 * 1.02020134 =$ 32.65

By Comparing given Forward Prices of the Oil with the Fair Forward Prices, The given Forward Prices doesn't make sense, However the following situation arises due to some Macro Economic Situations like present COVID-19 Outbreak Lockdown., wher the Carrying Cost of the Oil is morethan the Price of the Oil.