Reference no: EM132978201

Question - Volatile Investor Ltd has a diversified portfolio of shares. On 1 July 2021, the shares are worth $2,950,000. On this day, the company enters into 80 futures contracts on the All Ordinaries Index futures in which it takes a sell position. The All Ordinaries Index on 1 July 2021 is 3000 and the total price of futures contract is calculated as 3000 x 80 x $12 contracts = $2,880,000. A total deposit of $150,000 is paid to the broker on the futures contract and the broker requires a minimum deposit of $150,000 and this deposit must be maintained at the same level.

On 5th August 2021, Cluey Investor Ltd decided to sell its portfolio of shares and to close out its futures contract and recover its deposit from the broker. On this date, the market value of the share portfolio is $2,850,000 and the All Ordinaries Index is 2900 points.

Required -

a. Briefly explain the difference between futures contracts for hedging and futures contract for speculation.

b. Provide the journal entries to record the above transactions, assuming that the above transaction is a fair value hedge.

c. Describe three essential characteristics of a derivative financial instrument.