Embenezer Limited has taken out a futures contract from the Chicago Mercantile Exchange $($CME$)$ to hedge against a euro payable from EuroParts Inc for the supply of raw materials used by Embenezer Limited in its production process. The size of a single Euro contract at the CME is

$125,000.$

Embenezer Limited has adopted the green buck as its functional currency owing to the sudden instability in its domestic currency the kwacha. As a result of the said instability, the Minister of Finance at a press conference held two days ago stated that "the country will adopt a no currency policy" and adopt the United Sates dollar as its "national currency". The exchange rate board on Wall Street today shows the following rates:

S $($EUR$/$USO$)=1\mathrm{.}50$

The financial analysts at Embenezer Limited carried out a desk research which revealed that the variance of daily changes in the price of futures prices is estimated to be $0\mathrm{.}000016.$ The results of the research also established that on average exhaustion occurs $10$ times in every $200$ cases.

Required:

a$)$ Advice Embenezer Limited on the size of variation margin call of this futures contract they should expect in their functional currency, if the number of days over which the determination is to be made is estimated to be $9$ days. $(10$ marks$)$

a$)$ The CFO at Embenezer Limited is confused as to the difference between the variance and maintenance margins. Assist the CFO with information on the difference between the variation and maintenance margin in the futures market? $(4$ marks$)$

b$)$ Embenezer Limited makes another order to buy raw materials worth $125,000$ from

EuroParts Inc. The payment for this order falls due on the third Wednesday of June $2021$

$4$

which is also the maturity date for the euros contract on the Chicago Mercantile Exchange $($CME$).$ In an attempt to hedge against foreign exchange risk, the Chief Financial Officer of Ebenezer takes out a futures contract from the CME on substantially the same terms as above save for the maturity date. The spot rate today is quoted as:

Spot Rate $($EUR$/$USO$)=0\mathrm{.}6$

Futures Rate $($EUR$/$USO$)=0\mathrm{.}63$

It is now the third Wednesday of June $2021$ and the foreign exchange board shows the following rates:

Bid Ask

Spot rate $($EUR$/$USO$)$: $0\mathrm{.}6430\mathrm{.}650$

Advice the CFO ofEmbenezer limited whether the Hedge is worthwhile. $(3$marks$)$ &

b c$)$ Evaluate the assertion by the Minister of Finance that "the country will adopt a no currency exchange rate regime". Is this possible? $(3$ marks$)$

Q$,$ d$)$ Using the data above, as well as assuming the three$-$month interest rates in the European

Union and Zambia is $6\%$ and $8\%$ respectively. Also assume that the interest rates in the

$\text{'}$

United States are $3$ percentage point lower than Zambia.

Determent the futures price of a euro futures contact whose days to maturity is $90,$ if the

Spot rate is pegged at S$($EURO$/$USO$)=0\mathrm{.}6.$