Bill Turner, CFA, is short a futures contract on wheat. Turner entered into the futures position three months ago at a contract price of $50. The contract expiration is tomorrow. The settlement prices for the past four days (from oldest to most recent) were $56, $53, $49, and $52. If the settlement price on the expiration day is
$57, which of the following best describes a method Turner is most likely to use to terminate his futures contract?
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A. B. C.B
To determine the best method for terminating his futures contract, let's analyze the situation:
Bill Turner is short a futures contract on wheat, which means he has agreed to sell wheat at a specified price in the future. The contract was entered into three months ago at a contract price of $50. The contract expiration is tomorrow.
To terminate or close the futures contract, Bill has a few options:
A. Sell a futures contract for $57 and receive a mark-to-market profit of $5. B. Buy a futures contract for $57 and incur a mark-to-market loss of $5. C. Leave the contract open, deliver the wheat to the long, and receive a price of $57.
To understand these options, we need to consider the concept of mark-to-market (MTM) and the settlement price.
Mark-to-market refers to the process of adjusting the value of a futures contract to reflect the current market price. It allows investors to settle their gains or losses daily based on the difference between the original contract price and the current market price.
The settlement price is the official price at which the futures contract is valued and settled on its expiration date.
Let's evaluate each option:
A. Sell a futures contract for $57 and receive a mark-to-market profit of $5: If Bill sells the futures contract at $57, it means he is selling the wheat at a higher price than the contract price ($50). Therefore, he would make a profit of $7 per contract ([$57 - $50] x 1 contract), not $5 as mentioned in option A. Moreover, the mark-to-market profit would be the difference between the current market price ($57) and the previous day's settlement price ($52), which is $5. However, this option incorrectly mentions the mark-to-market profit as $5.
B. Buy a futures contract for $57 and incur a mark-to-market loss of $5: If Bill buys a futures contract at $57, it means he is buying back the wheat at a higher price than the contract price ($50). As a result, he would incur a loss of $7 per contract ([$57 - $50] x 1 contract), not $5 as mentioned in option B. The mark-to-market loss would still be the difference between the current market price ($57) and the previous day's settlement price ($52), which is $5. However, this option incorrectly mentions the mark-to-market loss as $5.
C. Leave the contract open, deliver the wheat to the long, and receive a price of $57: If Bill leaves the contract open and delivers the wheat to the long (the buyer) at the settlement price of $57, it means he would fulfill his obligation of selling the wheat at the contract price of $50, even though the market price is higher. This option suggests that Bill would deliver the wheat and receive the higher price of $57, allowing him to earn a profit of $7 per contract ([$57 - $50] x 1 contract).
Considering the options, the most likely method for Bill Turner to terminate his futures contract is Option C: Leave the contract open, deliver the wheat to the long, and receive a price of $57. This option aligns with the concept of fulfilling his short position by delivering the wheat at the contracted price while taking advantage of the higher market price.