Question
Suppose its currently December 1st 2022 and youre in the initial phases of drilling an Oil Well. Your forecasts have led you to believe that
Suppose its currently December 1st 2022 and youre in the initial phases of drilling an Oil Well. Your forecasts have led you to believe that youll be able to extract 8.6 Million barrels of Crude Oil in the coming months and have them ready to be sold and delivered in June 2023 (i.e. 6-months from today). Given that youre concerned Oil prices might fluctuate between now and June, you would like to hedge yourself using the June 2023 Crude Oil Futures Contracts (1 Contract = 1,000 barrels) to limit the effects of price fluctuations. Currently the spot price of Crude Oil is $91.41 and the annual cost of carry (including interest) is 8%. Assuming that the clearing house requires an initial margin of $5,000 per contract and a maintenance margin of $3,000 per contract, answer the following questions:
A) Assuming the no-arbitrage principle, what would be the price of the June 2023 Crude Oil Futures? (2 Marks)
B) What trade (i.e. how many contracts should be bought or sold) could be implemented to fully hedge your risk exposure? (2 Marks)
C) How much initial margin is required to begin your hedge and how much total margin must you maintain in your account to avoid a margin call? (2 Marks)
D) Assuming you entered into the hedge at the price calculated in Part A, calculate the mark-to-market profit/loss if the June 2023 Crude Oil Futures Contract decreased by $1/Barrel on December 2nd (i.e. the price has decreased by exactly $1.00 since you first entered into the hedge strategy). What is the value of the margin account after the mark-to-market profit/loss is applied to the account on December 2nd? Would you receive a margin? If so, explain how to answer the margin call. (6 Marks)
E) Assuming your account has been marked-to-market in Part D, calculate the mark- to-market profit/loss if the June 2023 Crude Oil Futures Contract increased by $5/Barrel on December 3rd (i.e. the price has increased by exactly $5.00 from December 2nd). What is the value of the margin account after the mark-to-market profit/loss is applied to the account on December 3rd? Would you receive a margin? If so, explain how to answer the margin call. (8 Marks)
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