Question

Please explain how to obtain the above answer (step by step explanation). Thank you.

40. Pigeon Ltd holds a well-diversified portfolio of shares with a current market value on 1 May 2014 of $900 000. On this date Pigeon Ltd decides to hedge the portfolio by taking a sell position in ten SPI futures units. The All Ordinaries SPI is 2980 on 1 May 2014. A unit contract in SPI futures is priced based on All Ordinaries SPI and a price of S25. The futures broker requires a deposit of S1500. On 30 June the All Ordinaries SPI has fallen to 2570 and the value of the company's share portfolio has fallen to $790 000. What is the gain or loss on the futures contract and the net gain or loss after hedging? A. loss on futures contract $102 500; net gain after hedging S6000 B. gain on futures contract $10 250;net loss after hedging $99 750 C. gain on futures contract $102 500; net loss after hedging $7500 D. gain on futures contract $164; net loss after hedging $109 836

Answer 1

Gain on future contracts :-

Sale at SPI of = $2980

Sale price = $2980 × 25 × 10 = $745000

Purchase back price = $2570 × 25 × 10 = $642500

Profit on future contacts = $745000 - $642500 = $102500

Loss on porfoport = €110000

Net loss = $7500