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For physical commodities like grains, energy products (e.g. oil) and metals, expenditure is incurred through storage space, insurance and finance charges etc simply to hold these items. This is known as Cost of Carry.

For non-physical underlying Futures contracts like interest rates, cost of carry refers to the differential between the yield on a cash instrument and the cost of the funds necessary to buy that instrument.

Cost of carry contributes to the Contango effect present in some Futures contracts and exists because longer-dated contracts that have further until expiration have a higher cost of carry. Where prices are in Backwardation, this may imply that the cost of carry is offset by an expectation that prices will rise faster than the cumulative effects of cost of carry.
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Contributed by: Ralph Windsor





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