Your research team has recently estimated that the risk premium in the WTI Oil market is 50
Question:
Your research team has recently estimated that the risk premium in the WTI Oil market is 50 cents per barrel per month with discrete compounding. The team has also assessed that the storage fee per barrel for WTI Crude Oil is 1.005% of the spot price with discrete compounding and 1% per year with continuous compounding. Assume you can trade at the last recorded price.
Note: For all calculations, round to 4 decimal digits at each step.
a) Focusing on the April futures, what annualized continuously compounded convenience yield, if any, is the market attributing to WTI Crude Oil? Assume the April contract expires exactly in two months and the risk-free rate of interest is 1% per year with discrete compounding and 0.9950% per year with continuous compounding.
b) Is WTI Crude Oil in Normal Contango or in Normal Backwardation?
c) Is the WTI Crude Oil futures curve upward sloping or downward sloping?
d) What is the spot price of WTI Crude Oil expected today for April (i.e., two months from today)?
e) If you are considering WTI Crude Oil futures for hedging purposes, do you expect to earn the 50 cents per barrel risk premium? Why or why not?
f) How would you interpret the current (i.e, for March-delivery) futures price if there was no risk premium in the WTI Crude Oil market?
g) You have learnt that one can earn a positive roll yield by investing in futures contracts. Details how you might do so in the WTI Crude Oil market characterized by the above quotes. Also, detail what needs to occur in the ETI oil market for you to actually earn the positive roll yield.