An investor goes long (purchases) two (2) cotton futures contracts on April 5 fo

Question

An investor goes long (purchases) two (2) cotton futures contracts on April 5 for delivery on July 10. The purchase price under the contract agreement is 0.54 cents (54 cents) a pound and the contract size is 50,000 pounds. The initial margin requirement level is 5.5%, with a maintenance level requirement of 3.25%.

a. Determine how much the investor must put down as an initial margin to purchase 2 cotton contracts. ($2970)

b. Below what dollar value will the investor’s margin account receive a margin call? ($1755)

c. On May 29, the price of July cotton stands at .58 (58 cents) a pound. At that point the investor decides to close out the two contracts with reverse trade positions.

1.) What is the dollar amount of the investor’s profit/loss from closing out the cotton positions? (+$4000)

2.) What is the HPY (holding period yield) for the cotton contracts at the time of their closeout? (7.41%)

3.) What is the return on investment the investor received based upon the investor’s total investment (here, the initial margin amount)? (135%)

PLEASE find show me how to find these answers without the use of excel. I have the answers in the parenthesis next to the question, but I need to know how to get these answers.

Thanks.

Explanation / Answer

Part a)

Initial margin = no. of contract x price x contract size x initial margin %

                          = 2 x 0.54 x 50,000 x 5.50%

                          = 2,970

Part b)

Value to receive margin call = maintenance margin required

                                                        = no. of contract x price x contract size x maintenance margin %

                                                          = 2 x 0.54 x 50,000 x 3.50%

                                                          = 1755

Part c)

profit = no. of contract x price change x contract size

                                     = 2 x (0.58 -0.54) x 50,000

                                     = 2 x 0.04 x 50,000

                                     = 4000

Holding period return = price change / initial price

                                                = 0.04/ 0.54

                                                = 7.41%

Return on investment = profit/ Initial margin

                                                = 4000 /2970

                                                = 134.68% or 135%

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