Income Approach Methods of Private Com ...
We can use the following modes of valuation to compare commodities and equities.
Commodities are mostly physical or tangible assets, e.g., a lump of gold, a pile of corn, etc., except for some energy commodities, e.g., electricity. Equities and bonds are intangible.
Commodities are intrinsic with variable economic value. They also don’t generate future cash flows since they trade in derivative contracts with finite lifetimes, e.g., future contracts. Equities and bonds have a claim on the economic output of a firm,i.e., profits. They also generate future cash flow.
For commodities, the forward price and future contracts are affected by demand and supply, ongoing expenditures, e.g., transportation and storage costs. Equities and bonds receive periodic income hence they are not affected by ongoing expenditures, e.g., storage and transportation costs.
Some commodity contracts require actual delivery of the physical commodity. Equity and bonds are settled through cash payments.
It is difficult to arbitrage commodity prices since some participants cannot make or take delivery of the physical commodity. It is easy to arbitrage equity and bond prices.
Which of the following is most likely a key difference between the valuation of commodities and valuation of stocks and bonds?
- Valuation of stocks and bonds focuses on future supply and demand, whereas commodity valuation focuses on future profit margins and cash flow.
- The valuation of commodities focuses on supply and demand, whereas the valuation of stocks and bonds focuses on discounted cash flows.
- Valuation of commodities cannot be conducted using technical analysis.
The correct answer is B.
Valuation of commodities is based on a forecast of future prices based on supply and demand factors and expected price volatility. In contrast, valuation of stocks and bonds is based on estimating future profitability and cash flow.
A is incorrect. Choice B provides a stuck contrast to this position.
C is incorrect. Technical analysis is sometimes applied to valuing commodities.
Reading 39: Introduction to Commodities and Commodity Derivatives
LOS 39 (c) Contrast the valuation of commodities with the valuation of equities and bonds.
The swap spread is obtained by taking the difference between a swap’s fixed... Read More