Commodity Derivatives, 2nd Edition

CHAPTER 2Derivative Valuation

The individual demand and supply dynamics for each commodity will be analysed within the respective chapter. This section considers some of the bigger picture issues that will influence prices.

2.1 ASSET CHARACTERISTICS

Greer (1997) argues that there are three different types of asset class.

• Capital assets – examples include bonds, which pay an investor a stream of fixed cash flows and equities, which would normally pay a stream of dividends. These types of assets can be valued using discounted cash flow (DCF) techniques. For example, for bonds, value is determined by present valuing the fixed cash flows. For equities, techniques such as the dividend discount model can also be used for valuation purposes.
• Consumable/transformable assets – According to Greer: ‘You can consume it. You can transform it into another asset. It has economic value. But it does not yield an ongoing stream of value’. Examples of this type of asset would include most commodities such as agriculture, metals, and energy. Greer's comment is significant: ‘the profound implication of this distinction is consumable/transformable (C/T) assets…cannot be valued using net present value (NPV) analysis. C/T assets must be valued more often based on the particular supply and demand characteristics of their specific market.’
• Store of value assets – this type of asset cannot be consumed, nor does it generate income. However, it does have value. One example given by Greer is fine art. ...