One of the unique features of futures contracts is that they have only one source of return—the capital gains that can accrue when price movements have an upward bias. Remember that there are no current cash flows associated with this financial asset. These instruments are known for their volatility due to swings in prices and the use of leverage upon purchase. With futures trading done on margin, small amounts of capital are needed to control relatively large investment positions.
Assume that you are interested in investing in commodity futures—specifically, oats futures contracts. Refer to the contract terms of oats: “OATS (CBOT) 5000 bu.; cents per bushel.” Suppose you had purchased 5 December oats contracts at the settlement price of 186.75. The required amount of investor capital to be deposited with a broker at the time of the initial transaction is 5.35% of a contract’s value. Create a spreadsheet to model and answer the following questions concerning the investment in futures contracts.
a.What is the total amount of your initial margin for the five contracts?
b.What is the total amount of bushels of oats that you control?
c.What is the purchase price of the oats commodity contracts you control according to the December settlement date?
d.Assume that the December oats actually settled at 186.75, and you decide to sell and take your profit. What is the selling price of the oats commodity contracts?
e.Calculate the return on invested capital earned on this transaction. (Remember that the return is based on the amount of funds actually invested in the contract rather than on the value of the contract itself.)