Assignment Task: Mrs. Smith is an orange juice distributor who, in January signed a contract to deliver 60,000 pounds of frozen orange juice to Churchill Downs on Kentucky Derby Day (first Saturday of May). Mrs. Smith plans to buy the orange juice from a local distributor in May. With the small profit margins, Mrs. Smith is afraid she might incur a loss if orange juice prices increase.
1. Explain how Mrs. Smith could lock in her orange juice costs with a May frozen orange juice futures contract trading in January at F0 = $.90/lb. The contract size is 15,000lbs.
2. Show the net costs at the futures expiration date, from closing the futures position and buying 60,000lbs of frozen orange juice on the spot market at possible prices of $.90/lb, and $1.0/lb.
3. How much cash or risk-free securities would Mrs. Smith have to deposit to satisfy the initial margin requirement of 5%?