Please kindly provide an step by step solution, and answer all questions. 1. A c
ID: 2659250 • Letter: P
Question
Please kindly provide an step by step solution, and answer all questions.
1. A company enters into a long futures contract to buy 5,000 bushels of wheat for 480 cents per bushel. The initial margin is $1,200 and the maintenance margin is $900.
2. One orange juice futures contract is on 15,000 pounds of frozen concentrate. Suppose that in September 2009 a company sells a March 2011 orange juice futures contract for 120 cents per pound. In December 2009 the futures price is 140 cents. In December 2010 the futures price is 110 cents. In February 2011 the futures price is 125 cents. The company has a December year end.
What is the company's profit or loss on the contract?
What is the accounting treatment of the transaction if the company is classified as a) a hedger and b) a speculator?
3. Assume for simplicity that there are no storage costs in this problem. Also, assume continuous compounding.
Consider the following forward prices on an investment asset
Forward prices (cents/unit of the asset) as of February
Mar 270.25
May 275.25
Hint: There is a theoretical model for the price of a forward contract. We have data on two different forward contracts. Use the model for these two contracts to solve for the spot price and the risk-free rate.
Explanation / Answer
1) 1 $ = 100 cents
In order to make a futher call of margin we need to have the maintenance margin which is $900 as a loss in the above future contract.
So. $900/5000 bushels = $0.18 = 18 cents
so a fall of 18 cenney. or more in future price will lead to a loss of $900 or moreand hence will lead to a further call of margin money.
Future price which will lead to a further call of margin money = 480-18 = 462 cents per bushels
Future price at which the value of margin increases by $600 = $600/5000 = 12 cents upwards from the future price = 480+12= 492 cents per bushels
2) Company's overall profit or loss on the contract = Future price = 120cents/pound
on Dec 2009 - (Loss)/Profit to the company = (20 cents) per pound = Overall loss of $ 3000
on Dec 2010 - (Loss)/Profit to the company = 10 cents per pound = Overall profit of $ 1500
on Dec 2011 - (Loss)/Profit to the company = (5 cents) per pound = Overall loss of $ 750 (assuming future contract matures on feb 11)
total loss = $2250
Accounting treatment of the above transactio in the books of hedger - For he purpose of hedging, loss arising in the future contract will be booked as a loss on the financial intrument at the year end.
For the financial year ended on Dec 2009 = Treatment will be book of loss on future contract = 3000
Profit or loss A/c - dr $ 3000
to loss on future contract $ 3000
For the financial year ended on Dec 2010 =
Profit on future contract - dr $1500
To profit or loss A/c 1500
Profit or loss A/c - dr $ 750
to loss on future contract $ 750
From the view point of speculator -
The overall loss of $2250 will be booked as the year ended 31 st December 2011
3)let the spot price of the asset be'S'
accordingy,
S*e^r*1/12 = 270.25 where r = risk free rate and t= time
S*e^r*3/12 = 275.25
e^r*1/12 = 270.25/S -------------(1)
e^r*3/12 = 275.25/S--------------(2)
Taking log on both sides in (1) and (2)
r/12 = 270.25/S
3r/12 = 275.25/S