Homework 1

Risk Management & Derivatives - FIN522 Homework 1 This assignment is due by class time on September 8. You may turn in a paper copy of your homework answers in class on September 8, or you can email me a scanned copy or a photo of your homework before the due date. The assignment is to be completed individually. 1. On August 31, 2022, you took a short position in December 2022 Crude Oil futures at a futures price of $88.31 per barrel. Suppose you close out your position on October 24, 2022, and suppose that the December 2022 Crude Oil futures price is $79.12 per barrel when you trade. You initially sold 5 contracts and each contract is written on 1,000 barrels. What is your profit (loss) from trading the futures? 2. On August 31, 2022, you took a long position in October 2022 Gold futures with a futures price of $ 1,716.90 per ounce. Suppose that you hold your position until expiration and that the gold spot price is $1816.80 on the October 1, 2022 delivery date. You initially bought 10 contracts and each contract is written on 100 ounces. What is your profit (loss) from trading the futures? 3. Copper futures are written on 25,000 pounds per contract and prices are quoted in dollars per pound. The maintenance margin is $5500 per contract, and your broker requires initial margin equal to 110% of the maintenance margin. You take a short position in one November 2022 Copper futures contract at the end of the day on August 31, 2022 and fund your account with cash to meet the initial margin. Fill in the table below based on the price realizations. Date Futures price Daily Gain Cumulative Gain Account Balance Margin Call Ending Margin August 31, 2022 3.519 September 1, 2022 3.495 September 2, 2022 3.526 September 5, 2022 3.562 September 6, 2022 3.571 September 7, 2022 3.499 September 8, 2022 3.487 September 9, 2022 3.502 4. Elkhorn Valley Ethanol needs to buy 2.5 million bushels of corn for December 2022 delivery. On August 31, 2022, the spot price of corn is $6.70 per bushel and the December 2022 futures price is $6.67. Each futures contract is written on 5,000 bushels. What position should Elkhorn Valley Ethanol take to hedge its exposure (long or short position, and number of contracts)? What is the outcome if the spot price in September ends up being $5.20? How about if the spot price in September ends up at $7.25?

5. U.S. Steel will have 150,000 tons of steel to deliver in December 2022. The August 31, 2022 spot price of steel is $1524 per ton. On August 31, 2022, the company enters into a forward contract with General Motors for 150,000 tons of steel for delivery on December 1, 2022 with a forward price of $1590 per ton. Suppose the steel spot price on December 1, 2022 turns out to be $1380 per ton. Answer questions about the following two scenarios. (a) Assuming that physical delivery of the steel actually occurs on the forward contract, how much revenue does U.S. Steel generate on the sale of steel to General Motors on December 1, 2022? (b) Assume that U.S. Steel and General Motors instead agree to cash settlement of the forward contract on December 1, 2022. The cash settlement amount is calculated as the quantity of steel times the difference between the forward price and the spot price. Further assume that U.S. Steel sells 150,000 tons of steel to another counterparty in the spot market at the spot price on December 1, 2022. Calculate the cash settlement amount on the forward contract, the revenue generated from the spot market transaction, and the total cash flow for U.S. Steel on December 1, 2022. 6. On August 31, 2022, you would like to hedge a long physical oil position that you plan to sell on November 23, 2022. Rather than directly hedge using May Crude Oil futures contracts that have a delivery date close to November 23, 2022, you wish to use a rolling hedge to take advantage of the market liquidity in the short-term Crude Oil futures contracts. On August 31, 2022, you short an October 2022 Crude Oil futures contract. You then roll into the November 2022 futures contract on September 28, 2022 and then roll again into the December 2022 futures contract on October 26, 2022. Your physical oil transaction takes place at the spot price of $75.15 on November 23, 2022. Calculate your gain or loss in the futures market and the ne t payoff from selling oil after considering both the physical and futures markets. October 2022 November 2022 December 2022 Date Futures Price Futures Price Futures Price August 31, 2022 85.11 84.13 83.19 September 7, 2022 82.74 81.65 80.59 September 14, 2022 83.15 82.13 81.12 September 21, 2022 86.91 85.93 84.91 September 28, 2022 87.88 86.7 85.51 October 5, 2022 87.9 86.65 October 12, 2022 84.18 82.88 October 19, 2022 81.43 80.1 October 26, 2022 76.94 75.4 November 2, 2022 76.34 November 9, 2022 77.12 November 16, 2022 74.18 November 23, 2022 75.15