An investor establishes a short position in a futures contract on Day 0 when the price per contract is $100. The investor deposits $5 per contract to meet the initial margin requirement. The maintenance margin requirement per contract is $3. The Day 1 settlement price that would require the investor deposit additional funds on Day 2 equal to $4 per contract is closest to:
A. $96. B. $103. C. $104. Help please! I have no clue how to solve this. Thanks.
The answer is c).
If the additional funds must be deposited, that means 2 things:
the margin has fallen below the maintenance margin requirement; and
the account must be brought back to the initial amount.
Now, the short position loses when the price of the stock rises, because they must sell the asset at a fixed price for less than the market would otherwise demand.
So you can see that oif the price rises to $104, that will decrease the margin account by $4 from $5 to $1.
Therefore we can see that a price of $104 will mean ADDITIONAL funds of $4 to be invested to bring the account back to the initial margin requirement.
So the initial margin requirement is always a dollar amount? I thought it would be 5%.
Another question, if the question was asking at what price the margin will fall below the maintenance margin requirement, how to calculate it?
Thanks a lot.
Kelly
You can take the difference of the initial margin, and the maintanence margin, and add (for short position) or subtract (for long position) to the price of the underlying to determine the price at which a margin call will occur. (It gets slightly more complicated when talking about multi-period as exhibited below.
So, it initiation,
price at which margin call poccurs = price of underlying +/- (initial margin - maintenance margin).
But when the margin is not currently at the initialmargin (say that price from period 1 to period 2 moves such that it does not trigger a margin call), then:
price at which margin call occurs = price of underlying +/- (current margin - maintenance margin)
I would suggest using the tables provided in the CFAI curriculum when dealing with these problems.
In reality, initial margin is quoted as a percentage of the contract amount for a futures contract.