Market Risk Management
Initial Margin is the initial deposit you make to your broker when you open a new futures position whether long or short. Collateral required to protect a party to a contract in the event of default by a counterparty. The amount of initial margin reflects the magnitude of the potential future exposure.
Question
You enter into a futures contract to buy white maize for R1,845 per ton The contract is for delivery of 1 000 tonnes The initial margin is R 200 000, and the maintenance margin is R60 000 You receive a margin call as R140 000 was lost from the margin account. What change In the futures price led to this margin call and what will happen when you do not meet the margin call?
Suggested Solution
This will occur when the price of white maize decreases
140 000/ 1000 = R140per ton
=R1 705 per ton.
NB: You are in the long position, the futures will be beneficial to you, when the price goes up, A price decrease in maize will translate into a loss as per marked to market.
Spot price < Future price.
It is relatively cheap to buy in the market than to buy as per contract terms.
ST= R1 705
FT= R1845
Value of the contract:= R 1705- R1 845
= -R140
If you do not top up you margin account, the broker will have to close out your position.
This system is used to avoid default risk.
References
- Chance, D.M., 2003. Analysis of derivatives for the CFA Program. Assoc. for Investment Management and Research, Charlottesville, Va.
- Hull, J., 2012. Options, futures, and other derivatives – solutions manual, 8. ed., global ed. ed. Pearson Education, Harlow.