You currently work for Queensland Sugar Limited (QSL), which is responsible for marketing Australian raw sugar exportson behalf of Australian sugar millers and growers. You have been tasked with producing a risk management proposal in which you are required to develop an effective hedging strategy to assist QSL to manage its transaction exposures to price risk up until the due delivery date of a sugar tranche on 08/11/2015. Raw sugar is traded internationally on the basis of US dollar prices. The size of the tranche is 3,300,000 long tons of sugar (1 long ton = 2240 pounds).
The proposal you present includes a strategy of taking short positions in ICE#16futures contracts (International Continental Exchange (ICE) contract number 16) involving the whole consigned tranche in order to manage the firm’s exposure to spot price volatility for raw sugar. In your proposal, you also make mention that you expect the Australian dollar to appreciate against the US dollar over the next few months, which would therefore decrease the value of the consigned sugar in Australian dollar terms. Accordingly, you decide to simultaneously manage foreign currency risk over the hedging period by using foreign currency futures.
Your analysis should provide comparisons between the following results in hindsight: (i) implications for using the spot market and not hedging; (ii) the implications for using futures contracts to hedge over the time period;and (iii) the optimal hedging strategy. Ideally, your analysis will show balances relating to an outstanding margin accountin relation to changes in the prices over time. (Margin requirements are provided within the contract specifications and the maintenance margin may be assumed to be equal to the initial margin for simplicity). Furthermore, your analysis should identify any instances whereby margin calls would be executed on QSL.
A useful resource regarding ICE futures contracts is available at the following online address.
Data and supplementary materials for Task 1
A Microsoft Excel spreadsheet containing the appropriate contract specifications, in addition to date and price data to complete Task 1 is available on learn@jcu within the assessment/assignment folder. This includes data for both the ICE #16 futures price as well as AUD/USD futures contract prices for the corresponding periods.
Assume the nearest futures price to be the current spot price (i.e. 09/09/2015). This is the price at which you may acquire a position in both futures contract. Since the spot price and the futures price converge at the expiry date, this implies the hedge will remain in place until 08/11/2015.
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