Arbitrage, Replication, & Cost of Carry in Pricing Derivatives Flashcards
What is “Replication”?
A strategy in which a derivative’s cash flow stream may be recreated using a combination of long or short positions in an underlying asset and borrowing/lending cash.
What is “Cost of Carry”?
The net of the costs and benefits related to owning an underlying assets for a specific period.
What does “Carrying” mean?
Investing and holding an asset for a period of time.
What is “Convenience Yield”?
A non-cash benefit of holding a physical commodity vs. a derivative.
What is an example of “Convenience Yield”?
An example of convenience yield can be seen in the oil market. Imagine you’re an oil refinery company and you need oil to keep your operations running smoothly. Instead of purchasing oil on the spot market every time you need it, you might find it more convenient to maintain a stockpile or inventory of oil.
