Reference no: EM133072176

Let us pretend that today was in Oct. 2019. The crude oil futures contract would mature one year later, Oct. 2020;

Each contract consists of 1,000 barrels, with "Multiplier" = 1000.00;

Each contract requires $4,180.00 as the initial margin for traders to long (i.e., "buy on margin") or short, with "Margin" = 4180.00;

No matter you long or short this commodity today, assume that the price can be settled at $50.68 per barrel, with "Last Price" = 50.68;
Your specific brokerage firm will decide the interest rate for cash. Currently, the borrowing interest rate (for buy-on-margin clients who borrow cash) is assumed to be APR = 2.5% per year, while the cash deposit interest rate is negligible (APR = 0%);

And crude oil, of course, pays no interest or dividend at all.

Question (A) Your friend Jimmy predicts crude oil price will drop within the year, and thus invests $4,180 today as margin to short one contract of 1000 barrels @$50.68 per barrel. In other words, Jimmy invests $4,180 of his own money today and borrows 1,000 barrels of crude oil from the brokerage to sell for $50.68 per barrel.

One year later, if the crude oil price rises to $60.00 per barrel (but the borrowed oil will have no interest or dividend to be due), what shall be the % rate of return on Jimmy's oil investment?

Question (B)

The brokerage firm requires all buyers and sellers must keep the maintenance margin to be at least 2% of the traded commodity value.
In other words, traders' equity amount must be no less than 2% of the market value of 1,000 barrels of oil, otherwise they will receive margin call (to urge for more money or to foreclose account).

What price amount of oil will begin to trigger a margin call to you? And what price amount of oil will begin to trigger a margin call to Jimmy?

(Please note that a magin call could happen any time soon, even long before the interest on borrowed cash becomes due.)