The cost of carry consists of all the following EXCEPT
Select one:
a. the convenience yield
b. none of the answer choices
c. the cost of storage and insurance
d. the risk-free rate to finance the purchase
e. the risk premium
The correct answer and explanation is:
The correct answer is e. the risk premium.
The cost of carry refers to the costs associated with holding a financial asset, such as a commodity or security, over time. It typically includes several components that collectively determine the total cost of holding the asset until it is sold or settled.
- The convenience yield: This refers to the non-monetary benefits of holding a physical commodity, such as the ability to use it directly in production or consumption. In futures markets, the convenience yield can offset some of the carrying costs because it adds value to holding the physical commodity, even when the financial cost is incurred.
- The cost of storage and insurance: These are typical components of the cost of carry, especially for physical commodities. Storing a commodity incurs costs related to physical storage facilities, as well as the insurance required to protect the asset from damage, theft, or loss.
- The risk-free rate to finance the purchase: This is the opportunity cost of tying up capital in the asset. If funds are borrowed to finance the purchase of the commodity or asset, the cost of borrowing at the risk-free rate represents the cost of carry. Alternatively, if the asset is financed using own funds, the opportunity cost of not using that capital elsewhere is considered part of the carry cost.
- The risk premium: This is not typically considered part of the cost of carry. The risk premium refers to the additional return that investors demand for taking on risk, and it is more relevant to pricing of risky assets rather than to the cost of carrying an asset.
In summary, while the cost of carry includes expenses like storage, insurance, and the risk-free rate, the risk premium is not part of the carry cost.