Determine the orginal basis

Reference no: EM131473700

Question :

Commodity futures

Suppose you are a chocolate manufacturer. It is September 26, and you need 112,000 pounds of sugar in January. Currently spot price of sugar is $0.0479 per pound.

The price of a futures contract expiring in January is $0.0550 per pound. Each contract is for 112,000 pounds.

a. Determine the orginal basis.

b. Calculate the profit from a hedge if it is held to expiration and the basis converges to zero. Show how the profit is explained by movements in the basis along.

c. Rework part b but assume the hedge is closed on December 10, when the spot price is $0.0574 and the January futures is $0.0590.

d. Rework part b but assume the hedge is closed on December 10, when the spot price is $0.0469 and the January futures is $0.0525.

Currency futures

On July 1, an American auto dealer enters into a contract to purchase 20 British sports cars with payment to be made in British pounds on Noveber 1.

Each car will cost 35,000 pounds. The dealer is concerned taht the pound will strengthen over the next few months, causing the cars to cost more in dollar.

The current exchange rate is $1.3190 per pound. December pound contract is at $1.278.

1.Describe the contract specifiation on T-bond futures regarding the size of contract.

2. Describe the transaction the portfolio manager should execute to hedge the risk of an appreciation in British pounds.

3.What is the outcome of the hedgeing strategy above if the spot rate is $1.442 and the December pound contract is at $1.4375 on Nov. 1.

Short term interest rate

On July 6, a firm learns that it will have approximately $10 million available for short-term investment on November 30. It believes that
the best use of the funds is to make a Eurodollar deposit. The foward rate on 90-day Eurodollar is 12.25 percent. The firm is concerned that Eurodollar rates will decrease over the next few months. The December Eurodollar IMM Index is 86.30.

a. Describe the contract specifiation on Eurodollar futures regarding the size of contract, price quotation.

b. Describe the transaction the firm should execute to hedge the risk of a decrease in Eurodollar rates.

c. What is the outcome of the strategy above if the December Eurodollar IMM index is going up and the three-month Eurodollar deposit rate is down on Nov. 30.

Long term interest rate

Portfolio managers constantly face decisions about when to buy and sell securities. In some cases, such decisions are automatic. Securities are sold at certain times to generate cash for meeting obligations, such as pension payments. Consider the following example.

On Februay25, a portfolio manager holds $1 millio face value of government bonds with a coupon of 11 7/8 percent and maturing in about 25 years. The bond currently is priced at 101 per $100 par value, and the yield is 11.74 percent. The bond must be sold on March 28. June T-bond futures is at 70 16/32 on Feb. 25. June T-bond futures is at 66 22/32 on March 28.

The portfolio manager is concerned that interest rates will increase, resulting in a lower bond price and the possibility that the proceeds from the bond's sale will be inadequate for meeting the pension obligation.

a. Describe the contract specifiation on T-bond futures regarding the size of contract, price quotation.

b. Describe the transaction the portfolio manager should execute to hedge the risk of an increase in T-bond rates.

c. What is the outcome of the hedgeing strategy above if June T-bond futures is at 66 22/32 on March 28 and spot price of the bond is 95 22/32 on march 28.

Reference no: EM131473700

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