On August 15, a trader attempts to hedge the risk of a future decline in the price of silver by

taking a short position in two December silver futures contracts. The spot price of silver on

August 15 is $11.5 per ounce. The futures price on August 15 is $11 per ounce. Each futures

contract is for the delivery of 5,000 ounces of silver. On November 20, the trader closes the

futures position with an offsetting transaction in futures. On November 20, the spot price of

silver is $9.5 per ounce and the price of a December silver futures is $8.5 per ounce.

a) What is the gain or loss on the futures position after the close out on November 20?

[9 marks]

b) Suppose the initial margin for opening the futures account is $7,000 per contract and

the maintenance margin is $3,000 per contract. On August 16, the price of December

silver futures increases to $12 per ounce. There is a margin call on August 16. How

much should the trader deposit on August 16 to satisfy the margin call?

[9 marks]

c) Explain carefully the difference between hedging, speculation, and arbitrage.

[12 marks