5.27. An index is 1,200. The three-month risk-free rate is 3% per annum and the dividend yield over the next three months is 1.2% per annum. The six-month risk-free rate is 3.5% per annum and the dividend yield over the next six months is 1% per annum. Estimate the futures price of the index for three-month and six-month contracts. All interest rates and dividend yields are continuously compounded. 5.29. The spot price of oil is $80 per barrel and the cost of storing a barrel of oil for one year is $3, payable at the end of the year. The risk-free interest rate is 5% per annum continuously compounded. What is an upper bound for the one-year futures price of oil? 5.33. A trader owns a commodity that provides no income and has no storage costs as part of a long-term investment portfolio. The trader can buy the commodity for $1,250 per ounce and sell it for $1,249 per ounce. The trader can borrow funds at 6% per year and invest funds at 5.5% per year (both interest rates are expressed with annual compounding). For what range of 1-year forward prices does the trader have no arbitrage opportunities? Assume there is no bid–offer spread for forward prices.
Foreword Preface Acknowledgments 1 Synopsis 2 Introduction to finance 3 Derivative securities 4 Hamiltonians and stock options 5 Path integrals and stock options 6 Stochastic interest rates' Hamiltonians and path integrals 7 Quantum field theory of forward interest rates 8 Empirical forward interest rates and field theory models 9 Field theory of Treasury Bonds' derivatives and hedging 10 Field theory Hamiltonian of forward interest rates 11 Conclusions Brief glossary of financial terms Brief glossary of physics terms List of main symbols References Index
Japan Food Prices Set To Soar As Government Hikes Wholesale Wheat Prices By 10% Submitted by Tyler Durden on 02/28/2013 13:30 -0500 Central Banks China Japan Nikkei Reality Trade War Yen If the past three months have been any indication of what Japan has to look forward to from Abenomics, we have a feeling his tenure will be as short, if not shorter, than all of his recent (and numerous, among which he, himself) predecessors. Because while the stock market may have risen in lock step with the plunge in the Yen, what has also soared are costs. And while a very select few benefit from the transitory surge in the Nikkei, the rising costs, i.e., inflation, hit everyone equally. Presenting this visually: the USDJPY and Nikkei correlation, which is 1:1 - this is the good news (for some ) Again, " for some ": And the flip side, as shown before , soaring energy costs - this is the bad news (for all ): As all of this happens, Japanese exports - the sole purported reason for this whole reflationary experiment, as the only way the economy improves is if Japan exports soar and the country returns to a net trade surplus status, just hit a record deficit as of a few days ago: But while the "no free lunch" reality has until now mostly been felt by those who need energy, as shown in " You Wanted Inflation, You Got It: Japanese Gasoline Price Rises To Eight Month High " the inflationary impact on Chinese imports is about to hit everyone like a sledgehammer right where it hurts the most: in the stomach, as the inevitable has finally happened, and the agriculture ministry announced that wholesale wheat prices are set to rise by a near-record 9.7% in April, which will shortly thereafter send regular food prices soaring. From Japan Times : The agriculture ministry said Wednesday it will raise wholesale prices for five imported wheat varieties by an average of 9.7 percent to 54,990 yen per ton in April , the second rise since October, due to higher international market prices and the yen's depreciation . The yen's decline triggered by the policy of the government of Prime Minister Shinzo Abe formed in December has pushed up prices 2 percent, and new prices to become effective in October might get even higher if the Japanese currency remains weak, the Ministry of Agriculture, Forestry and Fisheries said. This is only the second highest increase in wheat prices in history, with the only greater one taking place during the great inflation scare of early 2011, when even China got its brush with the "spring" movement that toppled all North African dictators. The rate of increase in April is the second steepest after the 18 percent notched in April 2011 . What food will be impacted? Pretty much anything with wheat in it. And anyone hoping that the deep-pockted government would sibsidize producers (and thus force the entrance into a trade war), will be disappointed: the prices will all be passed on to the consumer. Of five main wheat varieties, two for use in udon noodles and confection will become 14.2 percent more expensive. The prices for the remaining three varieties used in bread and Chinese noodles will jump 7.5 percent, making it likely that price hikes will be passed onto consumers. Following the ministry's announcement, Nippon Flour Mills Co. said it will consider raising its charges . Other milling firms that produce wheat for industrial and retail use are also expected to follow suit. The government buys all imported wheat, on which Japan relies for 90 percent of its consumption, and revises the prices twice a year -- in April and October. And just like that Japan is about to learn that soaring stock prices always have a trade off, a lesson which even GETCO's SP ramping algos will not be exempt from when the latest bout of soaring food inflation results in central banks scrambling to withdraw liquidity, just as they did in early 2011. The results will naturally be the same. As for how long Abe's government will remain in power after energy and food inflation sweep through the net importing nation, that is anyone's guess. Average: 5 Your rating: None Average: 5 ( 6 votes)
Guest Post: The Fed And Goldilocks Economic Forecasting Submitted by Tyler Durden on 06/22/2012 15:57 -040 Submitted by Lance Roberts of StreetTalk Advisors The Fed And Goldilocks Economic Forecasting Beginning in 2011 the Federal Reserve begin releasing its economic forecast for the present year and two years forward covering GDP, Unemployment, and Inflation. The question is after 18 months of forecasting - just how good has the Fed at forecasting these economic variables? I have compiled the data from each of the releases for each category and compared it to the real figures and used a current trend analysis for future estimates. GDP When it comes to the economy the Fed has consistently overstated economic strength. Take a look at the chart and table. In January of 2011 the Fed was predicting GDP growth for 2011 at 3.7%. Actual real GDP (inflation adjusted) was 1.6% or a negative 56% difference. The estimate at that time for 2012 was almost 4% versus 1.8% currently. We have been stating repeatedly over the last 2 years that we are in for a low growth economy due to the debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity. The simple fact is that when an economy requires nearly $5 of debt to provide $1 of economic growth the engine of prosperity is broken. As of the latest Fed meeting the forecast for 2013 and 2014 economic growth has been revised down as the realization of a slow-growth economy has been recognized. However, the current annualized trend of GDP suggests growth rates in the next two years that will roughly be half of the Fed's current estimates of 2.85 and 3.4%. A recession in 2013 is a strong likelihood given the current annualized trend of economic growth since 2000. A recession followed by a rebound in 2014 would leave economic growth running at annual rate close to 1%-1.5% versus the current estimate of nearly 3%. What is very important is the long run outlook of 2.6% economic growth. That rate of growth is very sub-par and, over the longer term, does not sustain the level of incomes and employment that were enjoyed in previous decades. Unemployment The Fed is as overly optimistic about the level of unemployment as they are about economic growth. One of the Fed's mandates is "full employment." At the beginning of 2011 the Fed predicted the unemployment rate for the year would be 8.7% for 2011, 7.8% for 2012 and 6.95% for 2013. The unemployment rate for 2011 was 9.1% and is currently at 8.2% currently likely to rise in the coming reports ahead as the economy again weakens. The Fed sees 2014 unemployment falling to 7% and ultimately returning to a 5.6% "full employment" rate in the long run. The issue with this full employment prediction really becomes what the definition of reality is. Today, even the average American has begun to question the credibility of the BLS employment reports. Recently even Congress has launched an inquiry into the data collection and analysis methods used to determine employment reports. Since the end of the last recession employment has improved modestly but mostly centered around temporary and lower paying positions. Since mid-2011 there has been a fairly sharp decline in the unemployment rate from 9.1% to 8.2% currently. The main driver of that decline has come from a shrinkage of the labor pool versus substantial increases in employment. In our past employment reports we have discussed the increasing number of individuals that are moving into the "Not In Labor Force" category where they are no longer counted as part of the labor pool. For the Fed the reality of "full employment" and statistical "full employment" are two entirely different things. While the Fed could be very correct at achieving "full employment" of 5.6% in their longer run scenario - it certainly doesn't mean that 94.4% of working age Americans will be gainfully employed. Inflation When it comes to inflation the Fed's outlook, for the most part, have been below reality. In January of 2011 The Fed's prediction for 2011 inflation was 1.5% which was 2% lower than what inflation turned out to be. As of the latest meeting the Fed's 2012 inflation prediction is 1.6%. With current deflationary pressures pulling headline inflation down from 3% at the beginning of this year to 1.7% currently the Fed's prediction appears to be fairly accurate. The question, however, is how long can inflation remain suppressed at or below 2% which is the long run prediction of the Fed? The Fed has much more control over inflationary pressures in the economy than they do at stimulating economic growth or increasing employment. By increasing or decreasing interest rates, using monetary policy tools and coordinated actions the Fed has historically been able to influence inflation. Unfortunately, their actions in this regard can also be directly linked to economic and market booms and busts. What the Fed has much less control over are deflationary pressures. We have discussed that the threat of deflation in the U.S. economy is currently a much greater than inflation. It is also the primary concern of the Fed. However, there are two things that are likely occur that could drive headline inflation higher than the Fed's current long run estimate of 2%. The first is further stimulative action which expands the Fed's balance sheet known as "quantitative easing." The direct impact of these programs, as liquidity is injected into the financial system, has been higher commodity prices which translates to an increase in headline inflation. The second, and more importantly, is that an organic economic recovery will eventually take hold. During real economic expansions where demand is increasing, wages are rising and the velocity of money is accelerating - real levels of higher inflation take hold. However, an organic economic expansion is likely some years away as the balance sheet deleveraging cycle continues globally. Why The Fed Forecasts Like Goldilocks Is the Federal Reserve really as bad at predicting future economic conditions as it appears? The answer is no. The Federal Reserve faces a severe challenge, when communicating to the financial markets and the media, which is the creation of a self-fulfilling prophecy. Imagine that following an FOMC meeting Bernanke stated: "The policies and actions that we have implemented to date have done little to curb economic weakness. The economy is in much worse shape that we have previously communicated as the transmission system of Fed policy through the economy, and the financial markets, is obviously broken." The immediate reaction to such a statement would be a complete collapse of the financial markets. Such a collapse in the financial markets would negatively impact consumer confidence which would subsequently throw the economy into a recession. Conversely, an overly optimistic outlook would lead to an increase of inflationary pressures and asset bubbles. Neither situation is healthy for the economy in the longer term. Therefore, communication from the Federal Reserve must be very guided in its approach - not too hot or cold. This "goldilocks" appoach works to create a "glide path" to the Fed's destination while giving the financial markets and economy time to adjust to the incremental adjustments to forecasts. Let me be clear. I am not making a case for the relevance of the Federal Reserve or its policies. That is another article entirely. What I am stating is that the communications from the Federal Reserve should NEVER be taken at face value. Since the Fed can not communicate its real position at any given time, due to the immediately excessive postive or negative effect on the economy and financial markets, as investors we must read between the lines. The problem for the financial markets, and the mainstream media, is that they tend to extrapolate current estimates indefinitely and generally in an upwardly biased manner. This is not the Fed's objective nor have they been able to repeal the economic and business cycles. The Fed has been slowly guiding economic forecasts lower since 2011. The reality is that 2.6% economic growth is not a boon of economic prosperity, corporate profitability, increasing incomes or a secular bull market. It is also not the "death of America" or the return to the stone age. What is important to understand, as investors, is the impact on investment portfolios, expectated real rates of returns and the realization that higher levels of market volatility with more frequent "booms and busts" are here to stay. Average: 4 Your rating: None Average: 4 ( 7 votes) Tweet Login or register to post comments 7066 reads Printer-friendly version Send to friend Similar Articles You Might Enjoy: Guest Post: Change In Corporate Profits Leads To Market Movements Guest Post: The Return Of Economic Weakness Jan Hatzius On Centrally-Planned Goldilocks New Forecast From NABE 'Professional' Economists Guest Post: 10 More Years Of Low Returns
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