Problem:
The current spot price of 1 barrel of crude oil is $120, the 1.75 year spot rate is 5% (c.c.), the (continuous flow of) storage costs of crude oil is 1% per year.
(a) In absence of arbitrage, what should be the forward price to trade crude oil in 1.75 years if crude oil was an investment asset?
(b) Assume crude oil is a consumption asset. Is there an arbitrage if the forward price to trade 1 barrel of crude oil in 1.75 years is $140? If so, describe an arbitrage strategy.
(c) What is the convenience yield if the true forward price to trade 1 barrel of crude oil in 1.75 years is $110?
Additional Information:
This question is from Finance as well as it is calculation of spot price. The question deals with calculation of spot price of forwards for crude oil. Forward calculation in the presence of arbitrage, in the absence of arbitrage have been calculated.