You buy a security (like a stock, a bond, a commodity, etc...whatever your flavor) at a specific price, and simultaneously sell it for the listed future price (futures contract). Then you have someone hang onto it (or “carry” it) until a future date, when it must be delivered to cover your sale. That someone, of course, charges you a nominal fee to carry and deliver your inventory, but in the end (and if the gods have smiled upon you), you have made some dinero.
If you could buy a new house at a deep discount, and simultaneously sell it for a profit (minus any upkeep costs, of course), but not have to move out until a future date, would you do it? If it took you more than two seconds to answer that question, you're thinking too hard.
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Finance: What are Carrying Charges?19 Views
Finance a la shmoop what are carrying charges? all right you're a luxury home
real estate developer you built this awesome house with the entry waterslide [Person riding a waterslide]
the underground Batcave style freeway connection and of course the chopper pad [Man stood on a chopper pad]
on top it costs you four million bucks to build okay you built it in like
Guatemala or somewhere you took out three million bucks in loans at 10%
interest to do so and if you sold the home for five million dollars well,
you'd make bank unfortunately some brainless realtor who is actually a [Realtor with green face appears]
genius at working your ego convinced you to list the home at 8.888
million he said uh it would be a lucky number really trust me yeah
it was a high number you'd been hoping to sell for more like a little more than
half that number but at eight mil in change you would be a financial genius
hugely profitable and a baller of real estate so you list the home in a huge [Man sitting while covered in cash]
bull market strong economy people come to the open house which proffer sushi
and caviar and you know XY and Z and well they laugh the price is crazy high
unfortunately by the time you fire the realtor a year later the market has gone [Realtor falls to the floor outside house]
completely into the crapper so you re-list the home at seven million
crickets and then six more crickets and then
finally three years later you sell it for five million bucks like right about
where you wanted to sell in the beginning so everything would have been
great except for your carrying charges you owed 300 grand a year to rent that
three million bucks you borrowed to build the home in the first place so
that's nine hundred thousand dollars just to rent the money for those three [Interest on 3 million bucks highlighted]
extra years on top of the four million bucks you spent to build the place then
you had real estate tax heat water maintenance gardener and like 18 other
carrying costs that go with just maintaining a house in shipshape to you
know be sold well all in those carrying costs beyond just the rent of
the money were another six hundred thousand bucks
so the home cost four million to build but then carrying costs for another
million and a half dollars leaving your all-in cost to build it at five and a
half million and you sold at five all that time and work for well nothing
other than a tax loss of five hundred thousand dollars well guess what
carrying costs worked this way albeit less dramatically in corporate land as [Man discussing carrying costs]
well and the most common carrying cost charge is inventory like when Ford has
gone ahead and built a thousand four cylinder you know cars featuring [Car with one wheel appears]
best-in-class one wheel drive which doesn't exactly
fly off the shelves or even drive off of them those thousand cars cost them some
thirty million bucks to build and they pay seven percent interest on the money
they borrowed to you know build them and that's 2.1 million dollars a year just
to rent the money to have a whole lot of inventory sitting there
well those cars are a low margin business to begin with like maybe 15
percent operating margins so on thirty million bucks of revenue Ford would hope
to make four and a half million in operating profits so if they carry the
cars for an average of a year before they sell well half of their operating
profits are chewed up just in the inventory cash carrying cost there so no [Man eating operating profits]
matter how sweet that water slide entry might sound in theory well you might
want to just save the cash for a rainy day