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You are a gold manufacturer and you suppose to find 1,000 ounces of gold to process within couple days. A bank offers you a choice between borrowing cash at 11% per annum and borrowing gold at 2% per annum. Which deal is a cheaper way of borrowing?
Additional Information
You expect to make a one year loan. The risk-free interest rate is 9.25% per annum and storage costs of gold are 0.5% per annum. The spot price of gold is equal to $550 per ounce. Assuming there is no administration fee and all interest rates are a continuous compounding rate.
Q1.1) What is the repayment amount if you make a cash loan?
Q1.2) If gold is borrowed, interest must be repaid in gold. If you decide to borrow 1,000 ounces of gold for a period of one year, how many ounce of gold you need to repay back to the bank?
Q1.3) What does the cost-of-carry of futures or forward pricing mean? How is it related to the storage cost of gold? What is the formula to calculate futures gold price which is taken into account the storage cost?
Q1.4) If you borrow in gold, you will repay the bank loan in gold at the end of the year. What is the futures price of gold at the end of the year?.
Q1.5) Which deal is a cheaper way of borrowing and by how much? Which interest rates are too high? Explain your answer.
Q1.6) The current gold borrowing rate is 2%, what is the appropriate gold borrowing rate that will make both deals become indifferent?
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