What are Lease Rates?
As we pay interest rates for financial instruments, we pay lease rates for commodities similarly. We define lease rate as the amount of interest a lender of a commodity requires. The lease rate is defined as the investor’s amount of return to buy and then lend a commodity. In other words, the lease rate represents the cost of borrowing the commodity. The lease and risk-free rates are important inputs to determine the commodity forward price.
Examples of Lease Rates:
The commodity forward price for time T with an active lease market is expressed as:
F0,T = S0 × [(1 + r) / (1 + δ)]T
S0 = current spot price
r = risk-free rate
δ = lease rate
The lease rate, δ, is income earned only if the commodity is loaned out.
Let’s take an example of a commodity forward. If we have one year forward for corns with a spot price of $5 and a lease rate of 7%, with a risk-free rate of 9%. The forward price would be:
F0,T = 5 × [(1 + 0.09) / (1 + 07)]1= 5.093