. Open your sixth examination booklet QUESTION 6 [12 marks] San Miguel Brewing r
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. Open your sixth examination booklet QUESTION 6 [12 marks] San Miguel Brewing requires 1 000 tonnes of coal in nine months' time. To avoid bearing any price risk, they wish to enter into a forward contract. The current price of coal is $54.83 per tonne. San Miguel Brewing is currently able to borrow funds short-terrn at 5.0% p.a. (simple interest). The cost of storing coal (or 'carrying cost') of an amount of 1 000 tonnes of coal for nine months is $600 (payable in advance). a. [4 marks) Use the arbitrage-free pricing principle to calculate the fair forward price for coal per tonne, for delivery in 9 months' time. Give your answer rounded to the nearest cent. With reference to a cash flow diagram, write out an explanation of the steps undertaken to determine this price. San Miguel Brewing finds itself in discussions with a counterparty who is prepared to buy or sell 1000 tonnes of coal at $58.00 per tonne in nine months' time. b. [6 marks] With reference to a carefully labelled cash flow diagram list and explain all the steps that San Miguel Brewing would need to undertake in order to make an arbitrage profit on the forward contract in nine months' time. Identify the profit San Miguel Brewing could make in nine months' time. Make sure you outline all that needs to happen on all relevant future dates, as well as today For a number of reason, San Miguel Brewing chooses not to exploit the above arbitrage opportunity. They enter the forward contract to buy at $58.00 per tonne. In nine months' time the spot price of coal is $57.75 per tonne. c. [2 marks] If the contract is settled by cash, what payment will be made? Will San Miguel pay its counterparty or receive payments from its counterparty? Cease writing in your sixth bookletExplanation / Answer
(b) We have calculated that if the company was to purchase & store 1000 tonnes of coal, its cost for 9 months per tonnes is going to be $ 57.51 and since the counter party is willing to buy or sell at $ 58, the company can make a profit as below:
c. The company entered into a forward contract to purchase 1000 tonnes at $58 after 9 months. On the settlement date, the spot price is $57.75, hence the cash flow exchange will be as below:
The company will pay at the contracted rate of $58 per tonne or $58000 for 1000 tonnes but it will use $57750 (57.75 * 1000 tonnes) for purchasing 1000 tonnes of coal from spot market and pay residual $0.25 * 1000 = $ 250 to the counterparty. Hence in this way the company achieves its objective of hedging cost of 1000 tonnes at $58.
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