Weekly Assignment 8.2: Futures Pricing Exercise

Assume the corn spot and 1-year futures prices per bushel today are 348 and 356 cents, respectively. The initial margin requirement to buy the futures contract is 5%. The standard contract size for corn futures is 5,000 bushels. The carrying costs for the corn bought from the spot market will be 1% to cover shipping, insurance, storage/warehousing, etc. You decide to speculate on the corn futures and buy 10 contracts today and pay cash into the margin account to meet the initial margin requirement. One month later, the corn price in the spot market drops by 1.65% as compared to todays price.

Note: The spot-futures parity relationship for a stock is F0 = S0(1 + rf d)T

For futures on corns, which pays no dividend yield, we can set d = 0%. While dividend yield is a cash inflow from holding a stock, carrying cost or cost of carry is a cash outflow from holding a commodity. Thus, the spot-futures parity for corn futures can be adjusted to reflect the cost of carry, q:

F0 = S0(1 + rf + q)T

1. What will be your profits/losses?

2. What will be your return on your initial cash outlay?