Tutorial 1 DPM

2.
3 Suppose that you enter into a short futures contract to sell July
Silver for $17.20 per ounce. The size of the contract is 5,000 ounces.
The initial margin is $4,000, and the maintenance margin is $3,000.
What change in the future price will lead to a margin call? What
happens if you do not meet the margin call?
$17.20 X 5,000 = 86,000
Margin = $4,000-$3,000 = $1,000
86000+1,000 = 87,000
$87,000/ 5,000 = $17.40
If you do not meet the margin call, your brokerage firm can close out any open
positions in order to bring the account back up to the minimum value.
2.4 Suppose that in September 2012 a company takes a long position in
a contract on May 2013 Crude oil futures. It closes its position in March
2013. The future price (per barrel ) is $68,30 when it enters into the
contract, $70.50 when it closes out its position, and $69.10 at the end
of December 2012. One contract is for the delivery of 1,000 barrels.
a) What is the companys total profit?
b) When is it realized ?
c) How is it taxed if it is (a) a hedger and (b) a speculator?
Assume that the company has a December 31 year end.
a) Company total profit = $70.50 -$68.30 X 1,000 = 2,200
b) 69.10-68.30 X 1,000 = 800 realised in December 31
70.50-69.10 X 1,000 = 1,400 realised in March 31
c) For a hedger, the capital gains are taxed at the same rate as ordinary income.
2200 all taxed.
For a speculator, the short term capital gains are taxed at the same rate as
ordinary income, and long term capitalgains are subject to a maximum of 15%
2.5 What does a stop order to sell at $2 mean? When might it be used?
What does a limit order to sell at $2 mean? When might it be used?
Stop order happens when it is used to close out an unfavourable position , and
limits the loss. Sells at $2 to stop further loss, stop loss.
Limit order happens when you want the order to execute at a certain price. For
example if you want to sell at $2, the transaction will only happen when the price
is $2 or more ,usually for favourable position, lock in profit
Stop limit order assume that ABC Inc. is trading at $40 and an investor wants to
buy the stock once it begins to show some serious upward momentum.
The investor has put in a stop-limit order to buy with the stop price at
$45 and the limit price at $46. If the price of ABC Inc. moves above $45
stop price, the order is activated and turns into a limit order. As long as the
order can be filled under $46, which is the limit price, the trade will be filled. If
the stock gaps above $46, the order will not be filled.
2.13 Explain the difference between a market-if-touched order and a

stop order.
Market if touched is if you are not even in the Market.
2.15 At the end of one day a clearing house member is long 100
contracts, and the settlement price is $50,000 per contract. The original
margin is $2,000 per contract. On the following day the member
becomes responsible for clearing an additional 20 long contracts,
entered into a t a price of $51,000 per contract. The settlement price at
the end of this day is $51,200. How much does the member have to add
to its margin account with the exchange clearing house?
$50,000 X 100 contracts = $5,000,000
Margin of 40,000.
Gain = 200k X 100 = 20,000
Loss = 800 X 20 = 16,000
Total gain = 20000-16000=4,000
Additional margin = 40,000 4000 = 36000
.25 It is July 2011. A mining company has just discovered a small
deposit of gold. It will take 6 months to construct the mine. The gold
will then be extracted on a more or less continuous basis for 1y ear.
Futures contracts on gold are available with delivery months every 2
months from August 2011 to December 2012. Each contract is for the
delivery of 100 ounces. Discuss how the mining company might use
futures markets for hedging.
To hedge the gold prices from falling, the company can buy futures gold contract
to lockin the price .
They can start to hedge from july 2011, which willresult in cash settlement of the
futures, and starting from November 2011, they can have contracts from jan to
dec 2012 to hedge and result in delivery of gold.
Start hedging the October contract . If you got 3000 ounes expected to be
producd, you can enter into contract that expires 2011 October.
If you can have 1000 ounces you have to get 10 contracts.
3.3 Explain what is meant by a perfect hedge. Does a perfect hedge
always lead to ab etter outcome than an imperfect hedge? Explain your
answer.
A perfect hedgeis a position undertaken by an investor that would eliminate the
risk of an existing position, or a position that eliminates all market risk from a
portfolio. In order to be a perfect hedge, a position would need to have a 100%
inverse correlation to the initial position.
Completely neutralize, so no profit at all. but operationally, the size of contract is
different, and a 100% hedge is expensive. And if not 100%, you can make some
money if the price goes up
No, a perfect hedge does not always lead to a better outcome, an imperfect
hedge also provide the same purpose of hedging, but a perfect lead to the
desired outcome easier. Any movement in prices would be 100% reflected in the
perfect hedge, but notfully reflected in imperfect hedge. However, it may lead to
more desired outcome.
3.4 Under what circumstances does a minimum varience hedge portfolio
lead to no hedging at all?
It happens when the coefficient of correlation is 0.
3.6 Suppose that the SD of quarterly change in prices of commodity is

0.65, the SD of future prices on commodity is $0.81 , and correlation
between the two is 0.8. what is the optimal hedge ratio for a 3 month
contract? What does it mean?
0.8 X 0.65/ 0.81= 0.642.
It means that the size of the futures should be 64.2% of companys exposure due
to the commodity.
3.7 A company has a $20million portfolio wih a beta of 1.2 It would like
to use futures contracts on the S&P 500 to hedge its risks. The index
futures price is currently standing at 1080, and each contract for
delivery of $250 tmes the index. What is the hedge that minimizs risk?
What should the company do if it wants to reduce the beta of the
portfolio to 0.6?
PXS/F
N= 1.2 X 20M / 270,000 ( 1 contract) = 88.9

It means that 89 contracts should be shorted. So overhedge by 0.1
To reduce beta, to 0.6 they have to short 44 contracts / 2.
3.12 Suppose that in Example 3.2 of Section 3.3 the company decides to
use a hedge ratio of 0.8. How does the decision affect the way in which
the hedge is implemented and the result?
68.9 X 16000
70 X 4000
Effective cost = 1,382,400
1,382,400 / 20,000 (original )
Per barrel = 69.12
3.16 The SD of monthly changes in the spot price of live cattle is 1.2.
The SD of monhly changes in the futres prices of live cattle for the
cloest contract is 1.4. The correlation is 0.7. It is now October 15. A
beef producer is commited to purchasing 200,000 pounds of live cattle
on November 15. The producer wants to use the December live cattle
futures contract to hedge the risk. Each contract is for deliveyr of
40,000 pounds. What strategy should the beef producer follow?
N= 0.7 X 200,000 / 40,000 = 3.5 contracts.
He should long 3.5 contracts of live cattle.
H = 0.7 (1.2/1.4) = 0.6
0.2 X 200,000 = 120,000
120000/40000 = 3 contracts long
1question on margin
Mixture of qns
Look at TB

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2.

2.13 Explain the difference between a market-if-touched order and a

3.6 Suppose that the SD of quarterly change in prices of commodity is

N= 1.2 X 20M / 270,000 ( 1 contract) = 88.9

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