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Derivatives Securities and Markets

Problem Set: Futures-Mechanics and Hedging

Question #a

A trader buys two July futures contracts on orange juice. Each contract is for the delivery of 15,000 pounds. The current futures price is 120 cents per pound, the initial margin is $6,000 per contract, and the maintenance margin is $4,500 per contract.  What price change would lead to a margin call? Under what circumstances could $2,000 be withdrawn from the margin account?

Question #b

Trader A enters into futures contracts to buy 1 million euros for 1.1 million dollars in three months. Trader B enters in a forward contract to do the same thing. The exchange (dollars per euro) declines sharply during the first two months and then increases for the third month to close at 1.1300. Ignoring daily settlement, what is the total profit of each trader? When the impact of daily settlement is taken into account, which trader does better?

Question #c

Sixty futures contracts are used to hedge an exposure to the price of silver. Each futures contract is on 5,000 ounces of silver. At the time the hedge is closed out, the basis is $0.20 per ounce. What is the effect of the basis on the hedger’s financial position if (a) the trader is hedging the purchase of silver and (b) the trader is hedging the sale of silver?

Question #d

Examples 3.3 and 3.4 in the book (pages 58-59); discussed in the video titled “3b: Basic Risk: Examples”