Question 5 (15 marks) PART A Aubrey O's Cookies Ltd. is a major manufacturer of oatmeal cookies in the United States. The company is expecting that it will need 40,000 bushels of oats to meet a projected surge in demand during December. Audrey O's is however concerned about the possibility of price fluctuations between now and December, and therefore decides to hedge its position by purchasing futures contracts on half of its expected December needs at the final price of the day. The table below gives a partial listing of selected futures contracts for oats at the time Audrey O's enters into the futures contract. Assume that the market price turns out to 228.0 at the settlement date. Oats - 5,000 bu.: cents per bu. Open High Low Settle Previous Settle July December 227.00 228.0 227.0 228.0 232.5 229.2 231.6 226.4 230.0 236.0 Required: i. Explain the difference between a forward and a futures contract. (2 marks) ii. Calculate the gain or loss incurred by Audrey O's by hedging their position. (3 marks) iii. Identify another form of derivative contract which Audrey O's could have used to hedge the position. (2 marks) PART B Adora Company and Buena Enterprises both need to raise funds to pay for capital improvements at their manufacturing plants. Adora and Buena have entered into a five- year fixed-for-floating rate swap with semi-annual interest payments and a notional principal of $250 million. Adora will pay Buena a fixed rate of 9.75% and Buena will pay Adora a floating rate set to equal the six-month LIBOR rate. The following table provides the movement in the 6-month LIBOR rate over the first two years of the swap. Year 6-month LIBOR rate 0.00 8.5% 0.50 7.2% 1.00 10.0% 1.50 9.3% 2.00 9.8% Required: i. Calculate the net swap cash flow fixed for floating, which Adora will pay to Buena over the first two years of the interest rate swap. (8 marks)