1) The 6-month forward price for Brent Crude is $40.00 per barrel. The spot price for Brent Crude is $36.00 per barrel. The risk-free interest rate is 2% per annum with continuous compounding and the cost for storing one barrel of crude oil for 6 months is $1.5. Suppose that the quoted spot price is for instant delivery and the estimated convenience yield for holding crude oil is 6% per annum with continuous compounding. In addition, the following assumptions about the Brent forward and spot markets hold:

Market participants pay no transaction cost.

Market participants pay the same tax rate on all types of income.

Market participants can borrow and lend funds at the same risk-free interest rate.

Market participants can long and short crude in the spot and forward markets.

Market participants have the capability to take advantage of any arbitrage opportunity as it occurs.

Required:

i.Based on the information provided in this question, analyse whether an arbitrage opportunity exists. If so, discuss how to take advantage of this opportunity. Note that you need to provide detailed calculations to support your answer.

ii.With reference to the commodity forward pricing formula, discuss how the storage costs affect the prices of crude forward contracts.

2) Compare and contrast the Natural Gas (Henry Hub) Physical Futures and Options traded on the NYMEX.

The following figure shows the Henry Hub Natural Gas futures prices observed at the end of February 2017. Discuss the economic implications of the price pattern revealed by the figure.