Convenience Yield

[Hank Moody]

Somehow this went by me in Level II, so I’d like clarification from the group.
I’m short a commodity future and have the physical asset, let’s say it’s corn. Inventories are tight.
So, what would be an example of a non-monetary benefit associated with possession? I don’t have to deliver that corn for another two months, therefore what can I do with the corn besides store it?

 

[dean99]

Lets say you work for Frito Lays and use large amounts of corn in your production. In this case, you would be willing to pay a convenience yield because holding it ensures that you will have supply for your production.

 

[Hank Moody]

That’s close to the example given in the text. But if I have to deliver the corn at a future date, how would possession benefit my production need?

 

[cpk123]

Caveat: I could be way off… Alt inv. was always a peevish topic for me!
you, as manufacturer of corn chips, are buying a future to make sure you have the corn supply you need.
so possessing it would make sure you are benefited.
for that benefit - you pay the convenience yield ….

 

[Hank Moody]

CP:
The L2 text used the example of a homeowner who had sold a future on their house. Until the house changed hands, the homeowner got to live there. The use of the home constituted a non economic benefit.
I don’t quite see how this relates to commodities that can only be consumed one time (corn, metals, energy). The text states that possession of a commodity which is in short supply has a certain non-economic benefit to the one who has possession (I think).
I’d like to figure out an example of that.

 

[CFAFRM]

Hank - The convenience yield is earned by manufacturers only not individual investors. The non-economic benefit comes from the fact that there is no disruption to production. An oil refiner values more the petroleum held in inventory than a futures contract to deliver crude oil. In addition, the oil refiner can profit if there is a temporary shortage of the commodity if it has excess inventory. The convenience yield can also reflect the market’s expectations concerning the future availability of the commodity. The greater the possibility of shortages, the higher the convenience yield. The greater the inventory levels, the less likely a shortage will occur and as a result, the convenience yield will be low and the futures contracts will probably be in contango. When inventories are low and there is a drought, the convenience yield of corn will go up and the futures contracts will go into backwardation.

 

[dean99]

Hank, as cfafrm posted above, my understanding is that the convenience yield is only earned by people who would benefit from holding the asset (ie companies that use corn in production, and not an individual investor). However, in your example where there is physical delivery of the commodity, I believe the convenience yield comes from the elimination of default and supplier risk.