DEFINITION of cost of carry (CoC)
The cost of carry appertains to costs incurred as a result of an investment position.
WHAT IT IS IN ESSENCE
These costs can cover financial costs, such as the interest costs on bonds, interest expenses on margin accounts. And interest on loans used to purchase security.
They can also include economic costs, such as the opportunity costs associated with taking the initial position.
The CoC or carrying charge is also a cost of storing a physical commodity, such as grain or metals, over a period of time.
The carrying charge includes insurance, storage, and interest on the invested funds as well as other incidental costs.
In interest rate futures markets, it refers to the differential between the yield on a cash instrument and the cost of the funds necessary to buy the instrument. If long, the cost of carry is the cost of interest paid on a margin account.
Conversely, if short, the cost of carry is the cost of paying dividends.
Or rather the opportunity cost; the cost of purchasing a particular security rather than an alternative. For most investments, the cost of carry generally refers to the risk-free interest rate. Traders can affect CoC by investing currency in a theoretically safe investment vehicle. Like a money market account minus any future cash flows from holding an equivalent instrument with the same risk.
Generally, it is expressed in percentage terms and called the convenience yield.
The risk-free interest rate is part of this cost. Dividend payouts from the underlying are not part of the CoC.
Storage costs generally represent a percentage of the spot price. And they have to be part of the cost of carry for physical commodities such as corn, wheat, or gold.
HOW TO USE
Traders often refer to CoC to gauge market sentiment. Analysts interpret a significant fall in the cost of carry as an indicator of an impending fall in the underlying. When the CoC for a stock future rises, it means that traders are willing to incur higher costs for holding the position.
And, thus expect a rise in the underlying.
CoC is expressed as an annualized figure in percentage.