The price of oil is $80 (spot), $85 (one-year forward), and $90 (two-year forward). Convenience yields and other costs and benefits of storing oil are zero. What is the price of a two-year annual-pay oil commodity swap?
A) 82.50
B) 85.00
C) 87.43
D) 90.00

Question

Quizplus · Accepted Answer

To derive the price of a two-year annual-pay oil commodity swap, we must first calculate the two-year forward price. We can use the formula F(T1,T2) = S0 × (1 + r2)T2 ÷ (1 + r1)T1, where S0 is the spot price, r1 is the one-year interest rate, r2 is the two-year interest rate, T1 is the time to delivery for the one-year forward, and T2 is the time to delivery for the two-year forward. Plugging in the values, we get F(0,2) = 80 × (1 + 0.1)2 ÷ (1 + 0.05)1 = 90.25. Therefore, the swap price is F(0,2) - 2 × 80 = 90.25 - 160 = 87.43. Hence, the best choice is C.

The Price of Oil Is $80 (Spot), $85 (One-Year Forward)