Question

Problem 2.2. A company has a short position in futures contract to sell 5,000 bushels of wheat. The company had entered into the contract when the futures price was 225 cents per bushel. The initial margin is $3,000 and the maintenance margin is $2,000. The current futures price is 250 cents per bushel and the margin account balance is $3,250. (a) Determine the net margin deposits to or margin withdrawals from the margin account so far. (6) What price change would lead to a margin call? (c) Under what circumstances can $1,000 be withdrawn from the margin account?

Answer 1

a) The current price is 250 cents and thus the company will have to deposit money because it is holding a short position in the contract.

Value at beginning = 225 cents * 5,000 = $11,250

Value at end = 250 cents * 5000 = $12,500

Here Initial margin percentage = $3,000/$11,250 = 26.67%

Maintenance margin percentage = $2,000/$11,250 = 17.78%

Now at the end of the contract the maintenance margin required will be based on the current value

Thus, maintainenance margin = 17.78% * 12,500 = $2222.5 and thus will need a net deposit of $222.5 in the margin account

b) Here the contract value = 225 cents * 5000 bushels = $ 11,250

Initial margin = $3,000 = $3,000/$11,250 = 26.67%

Maintenance margin = $2,000 = $2,000 / $11,250 = 17.78%

Margin call = Selling price * ((1 + initial margin) / (1 + maintenance margin))

= 225 cents * ((1 + 26.67%) / (1 + 17.78%)) = 225 * (1.2667/1.1778)

= 225 * 1.0755 = 241.98 cents ~ 242 cents

So 242 cents will lead to margin call.

c) $1,000 can be withdrawn when you don't require that $1,000 to be kept as maintenance margin.

Since maintenance margin is 17.78% of the market value, the current will need to be such that the 17. 78% of the same will free up the $1,000 that you want to withdraw.

Thus, current value = $1,000/17.78% = $5,624.30

This can happen thus when the price per bushel =$5, 624.3/5000 = $1.12= 112 cents