Inventory Level & Convenience Yield

CFA Level II Alternative Investments
#1

Why will an increase in inventory level for storable asset bring about a reduced convenience yield, and thus lead to a reduced future prices?

I understand that negative relationship exist between Future Price and Inventory level:

An increase in Inventory level I assumed will bring about an increase in convenience yield (benefit from holding the asset), which will thus reduce the future price {FP = Spot + Storage - Conv Yield * (1+Rf)}.

However, Scweser said that increase in Inventory level will reduce convenience yield, this is confusing, please help me shed more light on this.

Thank you.

#2

You’re willing to pay a convenience yield because holding the asset ensures you won’t suffer from shortages (nb: this is what leads to backwardation, when current price > futures price).

If there is a rise in inventory levels, you are less likely to suffer from a shortage of that asset, i.e. the convenience yield is lower (this is now less interesting to be holding the asset).

#3

Still not clear enough, and I am having problem agreeing with you fr_clem

#4
#5

Thank you cpk123, you have made my day…

Thank you.

#6

You can refer to my comment in the below link if you like. Might help

http://www.analystforum.com/forums/cfa-forums/cfa-level-iii-forum/91349107

#7

Suppose you’re a baker, and you need to get up at 4:00 in the morning to make muffins and croissants and scones and cinnamon rolls and things for the breakfast crowd.

If you have 200 kg of flour in your pantry, the convenience of another kg isn’t going to be much: you’re not going to run out.

If you have 3kg of flour in your pantry, the conveniene of another kg is quite high: if you run out of flour at 4:00 in the morning (which is likely: 3kg ain’t much), you cannot just run to the local grocer to buy some more. Local grocers are closed at 4:00AM.

#8

and this is even a more better explanation…

Thank you Magician.

#9

My pleasure.

#10

Really good