Assume the date is Sep 10, 2020. You currently work for Universal Sugar Limited (USL), which is responsible for marketing Australian raw sugar exports on 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 USL to manage its transaction exposures to price risk up until the due delivery date of a sugar tranche on Nov 9, 2020. 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 = 2,240 pounds).
The proposal you present includes a strategy of taking some positions (long or short) in ICE#16 futures contracts (International Continental Exchange (ICE) contact 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. You can consider the Australian dollar futures contract traded on CME (the product name is AD – AUSTRALIAN DOLLAR FUTURES) to hedge the currency risk.
Your analysis should first identify the risks faced by the firm. Then for each type of risk, 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 implications for perfect hedge. Ideally, your analysis will show balances relating to an outstanding margin account in 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 USL. For more information on International Business check on this: https://en.wikipedia.org/wiki/International_business
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