It is October 12th and you are the CEO of a coffee company that has just signed a major

commercial deal supplying Barstucks Coffee Company. As a result, you will be selling

7,500,000 pounds of coffee at the end of December. To protect yourself against adverse

movements in the coffee price, you have decided to hedge your price risk through coffee

futures with a contract price of $106. Each contract is written on 37,500 pounds of coffee

(approximately 250 bags of coffee). Given this information and the information provided in

the tables above, answer the following questions:

i.

How would you use these futures contracts to protect the total cost of selling

the coffee to Barstucks? In providing your answer, show that your strategy

works if the coffee price at the end of December is 104 115. (10 marks)

ii.

Given the contract specifications, and your hedging strategy in part i., what

does the balance of your margin account look like at the end of trading on

October 20th? In answering this question, provide a table that looks like the

table below: (8 marks)

iii. Given the market price of coffee is $106.17, the riskfree rate is 1% p.a. and

the cost of storage is 3% p.a., does the cost of carry model hold on October

20th? If not, show how you could exploit the arbitrage opportunity (including a

table of cash flows). In calculating the cost of carry, you should assume that

there is exactly two months until expiration of the futures contract. (7 marks)

Trading Units Tick Size Quoted Units Contract Specifications: KC, ICE Futures 37,500 pounds 0.05cwt = $18.75 (point value = $3.75) US $ per pound Initial Margin Maintenance Margin Contract Months Last Trading Day Trading Hours Delivery Daily Limit $6,300 $4,500 Mar, May, Jul, Sep, Dec One business day prior to last notice day 1.30am - 3.15pm (NY time) Physical None Closing KC Futures Prices (expiration December 2020) Price Open High Low Date Vol. Change % -2.15% Oct 12, 2020 109.15 111.00 113.35 108.55 15.91K Oct 13, 2020 110.10 109.30 111.15 108.70 14.79K 0.87% 109.60 110.05 111.70 109.20 14.05K -0.45% 109.50 109.55 111.35 106.50 22.36K -0.09% Oct 14, 2020 Oct 15, 2020 Oct 16, 2020 Oct 19, 2020 Oct 20, 2020 107.25 109.65 111.10 106.85 14.72K -2.05% 106.05 106.55 108.65 105.60 16.87K -1.12% 104.90 107.05 107.25 104.00 17.97K -1.08% Time Price Notional Gain/Loss Margin Call Opening Margin Cash Flow Closing Margin Oct 12, 2020 Oct 13, 2020 Oct 14, 2020 Oct 15, 2020 Oct 16, 2020 Oct 19, 2020 Oct 20, 2020 Trading Units Tick Size Quoted Units Contract Specifications: KC, ICE Futures 37,500 pounds 0.05cwt = $18.75 (point value = $3.75) US $ per pound Initial Margin Maintenance Margin Contract Months Last Trading Day Trading Hours Delivery Daily Limit $6,300 $4,500 Mar, May, Jul, Sep, Dec One business day prior to last notice day 1.30am - 3.15pm (NY time) Physical None Closing KC Futures Prices (expiration December 2020) Price Open High Low Date Vol. Change % -2.15% Oct 12, 2020 109.15 111.00 113.35 108.55 15.91K Oct 13, 2020 110.10 109.30 111.15 108.70 14.79K 0.87% 109.60 110.05 111.70 109.20 14.05K -0.45% 109.50 109.55 111.35 106.50 22.36K -0.09% Oct 14, 2020 Oct 15, 2020 Oct 16, 2020 Oct 19, 2020 Oct 20, 2020 107.25 109.65 111.10 106.85 14.72K -2.05% 106.05 106.55 108.65 105.60 16.87K -1.12% 104.90 107.05 107.25 104.00 17.97K -1.08% Time Price Notional Gain/Loss Margin Call Opening Margin Cash Flow Closing Margin Oct 12, 2020 Oct 13, 2020 Oct 14, 2020 Oct 15, 2020 Oct 16, 2020 Oct 19, 2020 Oct 20, 2020