In a Text book the following is giving as an example. Can someone plz explain the process? enter image description here

  • $\begingroup$ This might not be a proper question well suited in this forum since it is obvious that it is a "school homework question". If that's the case, I apologize $\endgroup$ – Peter Sullivan Oct 18 '16 at 22:54
  • 1
    $\begingroup$ So what exactly is your question/where do you get stuck trying to follow the calculations? $\endgroup$ – LocalVolatility Oct 18 '16 at 23:10

This is a simple numerical example to illustrate the power and the danger of the leverage implicit in futures contracts. Each row in the table represents one day.

On the first day the futures price is USD 55/unit. On the second day the price rises to 60/unit. Since you are long futures on 10,000 units you have made (60-55)*10000 = USD 50,000. This amount is paid to you in cash at the end of the day so your account balance goes from 55,000 to 55,000+50,000= 105,000. (In 1 day your balance more than doubled! While the price only increased approx 10%). And so on and so forth on every successive day; your A/C balance fluctuates based on changes in the price. Unfortunately it goes negative, at that point you owe the money (both legally and ethically); so it's possible to lose more than your initial investment. The price went from 55 to 47 so you lost (47-55)*10,000 = USD 80,000 made up as follows: 55,000 initial investment plus 3,250 additional investment plus 21,750 owed at the end (the 21,050 in the last row is a typo!).

The exchange requires you to deposit a minimum of 55,000 at the beginning, and to keep the balance to a minimum of 41,250 (which is why you put up 3250 addn'l between the 5th and 6th day), however you can put in more than this if you want; if you put up a full 55*10000 = 550,000 at the beginning (full collateral) you will never have to put up more money. In the example the maximum possible degree of leverage is illustrated.

| improve this answer | |

Not the answer you're looking for? Browse other questions tagged or ask your own question.