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Question - You are a large customer of a major Wall Street investment bank. They believe the price of oil will be going up over the next year and they are willing to enter an unlimited number of long positions on forward contracts based on the price of Light Sweet Crude Oil for delivery in December 2020. Each contract will be for 1,000 barrels of oil with a price based on the futures price for the same maturity. No margin or settling up is required for the contracts.
(a) You are considering entering short forward contracts on oil. How many contracts can you enter if you have $200,000 in your trading account to use as collateral?
(b) If you enter 100 short forward contracts at today's futures price for December 2020 (assume this is a 10 month contract) and the price goes to $80 in June 2020, what is the value of your position as of June 2020 (assume there are 6 months remaining) if the risk-free rate is 1.5%?
(c) Based on your answer to part (b), is there any counterparty risk in June 2020 on this contract? Explain.
(d) Using the normal distribution, what is the 10 month 95% VAR on 100 forward contracts if the daily expected return on oil is 0 and the daily standard deviation is 1.5%? (Use 1 year = 252 trading days to find the 10 month VAR).
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