Derivatives Securities

1. Individual
assignment (Word limit: 2,500 words ± 10%)

This
assessment aims to provide students with an opportunity to analyse various
investment alternatives based on the respective risk and return so as to choose
the most appropriate investment opportunity. You are expected to read beyond the
textbook and be able to apply the knowledge gained from real life examples
either from your working environment or/and case studies read, and are able to
demonstrate your competence in the areas indicated in the questions. You are
encouraged to provide specific in-depth comments instead of general comments.

You will need to write up to 2,500 words (± 10%) to address all the questions.

Individual assignment
Imagine it is 10 July 2020. A UK
company has a US$6.65m invoice to pay on 26 August 2020. They are concerned
that exchange rate fluctuations could increase the £ cost and, hence, seek to
effectively fix the £ cost using exchange traded futures. The current spot rate
is $/£1.71110.
£/$ futures, where the contract
size is denominated in £, are available on the CME Europe exchange:
September
expiry – 1.71035 December expiry – 1.70865
The contract size is £100,000 and
the futures are quoted in US$ per £1. The contract specification for the
futures states that the tick size is 0.00001$ and that the tick value is $1.
Outcome on
26 August:
On
26 August the following was true: Spot rate – $/£ 1.65770
September
futures price – $/£1.65750

In the scenario above the CME
contract specification for the £/$ futures states that an initial margin of
$1,375 per contract is required. The maintenance margin is $1,250 per contract.
The settlement prices for this future are:
Settlement price on 11 July (Friday) 1.70925
Settlement price on 14 July (Monday) 1.70805
Settlement price on 15 July
(Tuesday) 1.71350
Required:
a)
Determine the net cash flow using the futures hedge ignoring
the requirements of the initial margin and the maintenance margin.

For
part a：

1. Long or short futures
2. Which contract month
3. Determine no. of futures contract that will be
required (Note: amount of exposure is quoted in USD while the contract size of
future contracts is in GBP)
4. Calculate the profit/loss on futures position
5. Calculate the amount required in the spot market
6. Combine the answer in 4 and 5

b) Determine
the daily balance in the margin account. .
For
part b:
1. Obtain the no. of futures contract that will be
required from part (a) sno 3
2. Calculate the total amount of initial margin
required
3. Calculate the total amount of maintenance margin
4. Calculate profit/loss of future contract by marking-to-market
5. Determine the margin balance
6. Determine any margin call and top-up required

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