Intro

An audio electronics manufacturer anticipates that it will purchase $50,000$ pounds of copper in each of the months April $2021$ and October $2021.$ Today is February $13,2021.$ The company plans to use the copper futures contract that trades on CME. These futures contracts have delivery months of March, June, September and December. The size of the contract is for $25,000$ pounds. The initial margin and maintenance margin are $$2,000$ and $$1,500$ per contract, respectively. The company's policy is to hedge $80\%$ of its exposure.

Suppose that market prices on the spot and futures contracts are as follows. Prices are in cents per pound.

Date Feb $13,2021$ Apr $2021$ Oct $2021$

Spot price $72\mathrm{.}00$

Mar $2021$ futures price $71\mathrm{.}30$

Jun $2021$ futures price $71\mathrm{.}50$

Sep $2021$ futures price $72\mathrm{.}20$

Dec $2021$ futures price $73\mathrm{.}10$

Attempt $2/5$ for $10$ pts$.$

Part $1$

The company wants to hedge its Apr $2021$ and Oct $2021$ exposures using futures contracts. What hedging strategy should the company choose? Choose one.

Long Jun $2021$ futures contracts and long Dec $2021$ futures contracts

Long Dec $2021$ futures contracts only

Long Mar $2021$ futures contracts and long Sep $2021$ futures contracts

Short Jun $2021$ futures contracts and long Sep $2021$ futures contracts

Long Jun $2021$ futures contracts and long Sep $2021$ futures contracts

Short Jun $2021$ futures contracts and short Dec $2021$ futures contracts

Correct $$

Because the company is purchasing copper in Apr $2021$ and Oct $2021,$ they should enter long futures positions. The optimal contracts are the ones that extend beyond but are closest to the exposure date. Thus, to hedge the Apr $2021$ exposure, the company should use the Jun $2021$ contract. Similarly, to hedge the Oct $2021$ exposure, the company should use the Dec $2021$ contract.

Attempt $1/5$ for $10$ pts$.$

Part $2$

How many contracts should the company enter into on February $13,2021$ to hedge its Apr $2021?$

$2$

Correct $$

Number of contracts $=$ Exposure$/($Size of one futures contract$)$

$=(50,000*80\%)/25,000$

$=2($rounded$)$

Attempt $1/5$ for $10$ pts$.$

Part $3$

How many contracts should the company enter into on February $13,2021$ to hedge its Oct $2021?$

$2$

Correct $$

Number of contracts $=$ Exposure$/($Size of one futures contract$)$

$=(50,000*80\%)/25,000$

$=2($rounded$)$

Attempt $2/5$ for $10$ pts$.$

Part $4$

Suppose now that today is Apr $15,2021$ and the company is ready to make the copper purchase for Apr $2021.$ The market prices on the spot and futures contracts are as follows. Prices are in cents per pound.

Date Feb $13,2021$ Apr $15,2021$ Oct $2021$

Spot price $72\mathrm{.}0069\mathrm{.}10$

Mar $2021$ futures price $71\mathrm{.}30$

Jun $2021$ futures price $71\mathrm{.}5069\mathrm{.}80$

Sep $2021$ futures price $72\mathrm{.}2071\mathrm{.}20$

Dec $2021$ futures price $73\mathrm{.}1070\mathrm{.}80$

What is the effective price per pound $($cents per pound$)$ that the company paid to acquire $50,000$ pounds of copper on April $15,2021?$

Hint: Calculate the profit of the hedged position $($exposure plus futures contracts$)$ on April $15,2021.$ Divide the result by the number of pounds in the exposure. The negative of this number is the effective price paid per pound in cents.

$0+$ decimals

Attempt $1/5$ for $10$ pts$.$

Part $5$

Suppose now that today is Oct $15,2021$ and the company is ready to make the copper purchase for Oct $2021.$ The market prices on the spot and futures contracts are as follows. Prices are in cents per pound.

Date Feb $13,2021$ Apr $15,2021$ Oct $15,2021$

Spot price $72\mathrm{.}0069\mathrm{.}1072\mathrm{.}50$

Mar $2021$ futures price $71\mathrm{.}30$

Jun $2021$ futures price $71\mathrm{.}5069\mathrm{.}80$

Sep $2021$ futures price $72\mathrm{.}2071\mathrm{.}20$

Dec $2021$ futures price $73\mathrm{.}1070\mathrm{.}8073\mathrm{.}80$

What is the effective price per pound $($cents per pound$)$ that the company paid to acquire $50,000$ pounds of copper on October $15,2021?$

Hint: Calculate the profit of the hedged position $($exposure plus futures contracts$)$ on October $15,2021.$ Divide the result by the number of pounds in the exposure. The negative of this number is the effective price paid per pound in cents.

$0+$ decimals

Attempt $1/5$ for $10$ pts$.$

Part $6$

Based on the market prices of Apr $15,2021($see above in Part $4),$ the company is facing a margin call on its Dec $2021$ contracts on Apr $15,2021.$ What is the variation margin that the company has to post on that date to comply with the margin call?