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What is the Impact of Financing Costs?

If goods are bought today, but paid for and delivered in three months' time, the buyer saves any financing costs which he might have had to pay had he paid for the goods straightaway.

However, for each futures contract the seller demands payment of a 'premium' on the cash price to precisely cover these financing costs.

Imagine you are at the dentist's. He suggests you have all your amalgam fillings replaced by new gold fillings in exactly three months. Because you are worried that the gold prices might rise by the time your scheduled dental appointment is due, you would really like to either:

  • buy the gold immediately, store it until the appointment and then take it with you, or
  • buy the gold for forward delivery in three months.

 

Current market terms:
Cash gold market price: EUR 400
Financing rate: 5% p.a.*
Price for buying gold immediately, including financing costs: EUR 400 + (EUR 400 x 5% x 90/360) = EUR 405
* he interest rate for financing costs used amongst banks, the so-called repo rate, is an interest rate for loans collateralised by securities. The difference between the interest rate for lending and borrowing is marginal. The assumed, high interest rate is for illustrative purposes only and can severely differentiate from the actual market interest rate.

 

One must consider financing costs, also when the buyer has sufficient liquidity. He would have been able to invest these monies with interest.

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