Problem
1. Explain the terms initial margin and maintenance margin in the context of futures markets transactions. What purpose does this margin system serve for futures market participants?
2. A speculator believes that the spot price of oil will fall over the next 6 months to a level lower than its current 6-month futures price. Explain how the investor can use 6-month oil futures for speculation in this situation and why using futures is more advantageous relative to speculating in the spot market.
3. In January 2023, a trader takes a long position in ten May 2023 corn futures contracts. Each contract is for (reg x 1,000) bushels of corn and the current futures price is $6.50 per bushel, where reg is the last non-zero digit of your registration number. For instance, if the last two digits of your registration number are 57 then reg = 7; if they are 20 then reg = 2.
a. Assume that the initial margin is $3,100 per contract and the maintenance margin is $1,750 per contract. What value of the futures price in $ per bushel will result in a margin call?
b. Suppose that the trader decides to close out their position in March 2023. What will their total payoff be if the futures price at the time is $6.70 per bushel?
c. Explain why the payoff in (b) above takes this form in the case of a long futures position.