Stumped on a ques, Can anyone help?

[yankees98a]

pg 152 Exam Flashback #2
A silver futures contract requires the seller to deliver 5,000 Troy ounces of silver. An investor sells on July silver futures contract at a price of $8 per ounce, posting a $2,025 initial margin. If the required maintenance margin is $1,500, the price per ounce at which the investor would first recieve a maintenance margin call is closest to is:
$8.11

 

[financegal]

investor has short position in futures contract, so maintenance margin call will happen when losses lead to balance fall below $1500. he is at loss when spot price is higher than futures contract price. assume the price he recieve first maintenance margin call is A;

at price $8/ounce, balance equals required deposit ie initial margin 2025.
at price A, change in price is A-8, and loss is (A-8)*5000 which results in balance of 1500


2025-((A-8)*5000)=1500
which gives A =8.105



Edited 2 time(s). Last edit at Wednesday, April 12, 2006 at 04:18PM by financegal.

 

[zimzim78]

Whoaaa, I was going about it all wrong, obviously. I was trying to use the "margin call formula" trying to figure out what percentages were the numerator (initial margin) and denominator (maintenance margin)?

Financegal - thanks, but can you further explain...I'm not following your example. So then it's just basic algebra?

 

[financegal]

hi zimzim78,

margin call comes only when future short /long position is at loss. because of marking to market , daily net loss/gain change balance and hence margin requirement. so when balance falls below maintenance margin, investor gets call to pay inorder to reach initial margin.

a position for future short contract is profitable only if future contract price> spot price, so that seller can benefit from contract by getting higher price than prevailing market price.
if spot price(prevailing price) is higher than contract price, short position in future contract is at loss because he would have got higher price if he had not entered future contract. this loss reduces balance. when balance reaches maintenance margin, investor gets call asking him to pay money so that balance equals initial margin.

now consider previous example;
spot price=A
future price=8
units promised to deliver under contract=5000
initially the balance equals inital margin =2025
maintanence margin=1500
suppose spot price A , which is greater than 8, causes balance to reach maintanence margin.
Loss=A-8 per unit
Loss =(A-8)*5000 for whole contract

therefore
initial balance -losses=final balance (equal to maintanence margin)
2025-(A-8)*5000=1500
which gives A=8.105

hope this helps!

 

[zimzim78]

Yes...that helped...thanks financegal. Props!

 

[AJF]

Thanks !