Convenience Yield

FINANCIAL DERIVATIVES

CONVENIENCE YIELD ON FUTURE CONTRACTS OF ENERGY PRODUCTS

Submitted by

Arpit Agrawal (11PGDM017)

Dhairya Kinariwala

(11PGDM025)

INTRODUCTION

The project undertakes the study of the convenience yield of the chosen commodities. Convenience yield in simple language is explained as the amount of benefit that is associated with physically owning a particular good, rather than owning a futures contract for that good. When a good is easy to come by, an investor doesn't have need to own the actual good at that time, and can buy or sell as he pleases. When there is a shortage of a particular good, however, it is better to already own the good than to have to purchase it during the shortage because it is likely to be at a higher price due to the demand. The convenience yield is the benefit derived in the second scenario. Thus the person holding cannot hold the futures contract to sell for the shortages which they can do holding the physical quantity.

PRODUCT CONSIDERED

Brent Crude Oil: - Oil accounts for 40 per cent of the world's total energy demand. The world consumes about 76 million bbl/day of oil. United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan (5.4 million bbl/d) are the top oil consuming countries. Balance recoverable reserve was estimated at about 142.7 billion tones (in 2002), of which OPEC was 112 billion tones. India is the 10th largest oil-consuming country. India faces a large supply deficit, as domestic oil production is unlikely to keep pace with demand. India's rough production was only 0.8 million barrels per day. India had a total of 2.1 million barrels per day in refining capacity. Indian government in 2002 officially ended the Administered Pricing Mechanism (APM). Now crude price is having a high correlation with the international market price. As on date, even the prices of crude bi-products are allowed to vary +/- 10% keeping in line with international crude price, subject to certain...