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Answer: A cash outflow of USD 375,000
## Explanation To calculate the cash flow from variation margin on December 31, 2024: **Step 1: Calculate the price change from previous year** - December 31, 2023 futures price: USD 2.95 - December 31, 2024 futures price: USD 3.10 - Price change: 3.10 - 2.95 = USD 0.15 increase **Step 2: Calculate total position size** - Number of contracts: 100 - Contract size: 25,000 pounds per contract - Total pounds: 100 × 25,000 = 2,500,000 pounds **Step 3: Calculate cash flow impact** - The company sold futures contracts (short position) - When futures price increases, short positions lose money - Cash flow = Price change × Total pounds - Cash flow = 0.15 × 2,500,000 = USD 375,000 **Step 4: Determine cash flow direction** - Since the company is short futures and price increased, this represents a loss - Losses on short positions require cash outflow for variation margin payments - Therefore: **Cash outflow of USD 375,000** **Verification with hedge accounting:** The company uses hedge accounting and reports cash flows from variation margin at year-end. The calculation correctly reflects the price movement from December 31, 2023 to December 31, 2024.
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An analyst at a mining company is reviewing the potential cash flow and accounting impact of a 3-year hedge on the company's copper production. The hedge was established by selling 100 three-year futures contracts at USD 3.00 per pound on December 31, 2022. Each contract represents 25,000 pounds.
The futures prices on subsequent year-ends are as follows:
The company uses hedge accounting and reports cash flows due to variation margin at the end of each calendar year. Which of the following is the best estimate of the reported cash flow on December 31, 2024?
A
A cash inflow of USD 125,000
B
A cash outflow of USD 250,000
C
A cash outflow of USD 375,000
D
A cash outflow of USD 500,000
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