You are convinced that the price of gold is going to rise significantly over the next year and want to take as large a position as you can in the market but have limited fund, $3,500. You have learned that the futures market allows you to leverage your investment and can bring large gains. So you enter COMEX to trade gold futures where one contract is 100 troy ounce. The current price of the gold futures contract is $1,300 per ounce so that the value of one futures contract is $130,000. The margin requirement is $3,500 per contract. Assume that the spot price of gold is the same as the futures price.
a. With $3,500, how many contracts can you take?
b. Calculate your return if gold prices rise by $10 per ounce next year.
c. How does this compare with the return you would have made if you have simply purchased gold in the spot market?
d. Compare the risk involved in each of these strategies.