PES INSTITUTE OF TECHNOLOGY – BANGALORE SOUTH CAMPUS

Dept. of MBA

Lesson Plan
Semester – IV

Subject Code: 14MBAFM411 Total no of

Lectures: 56
Subject Title: FINANCIAL DERIVATIVES IA Marks:
50
Type: Elective Credits: 4
Faculty Name: Dr. R. Duraipandian Exam Hours:
03
No of Hours / Week: 04 + 1 Lab Hrs Exam Marks:
100
Practical Component Hour : 01 Ratio of theory to problems:
50 :50
Aim of the Course
Risk is all pervasive. For business the various kinds of risk relate to price, interest rates, foreign exchange rates,
credit etc. Of late tactical management of these risks has gained prominence especially with advent of derivative
products. The course concerns with tactical management of these risk through investment in financial assets. The
objective of this course is to familiarise the participants with the various derivatives instruments available for
managing the risk. It covers rather simpler instruments such as options, futures, swaps, and credit derivatives.
Besides discussing the pricing of these instruments and hedging principles the course would also aim at introduction
of some complex instruments such as options on futures and swaps etc

Course Objectives:
As the subject is of practical utility and significance, the course would be conducted in an interactive manner. To
stimulate the thought process the participants are requested to read any financial newspaper daily and present/seek
views on the subject/article of their interest. Conceptual framework of the subject shall be covered adequately
through lectures/power point presentations. Sessions plan as below would be followed with following module
objectives:

An overview of risk and derivatives: The objective of the session is to draw distinction between various kinds of
risks that a firm is exposed to. Some of these risks are manageable with derivative instrument. The session on
Introduction to derivatives is intended to provide an overview of derivatives, their characteristics and
misconceptions about them.

Forwards and Futures: These sessions are aimed at introducing the terminology of forwards and futures, their
applications of hedging fro variety of underlying assets such as commodities, currencies, stocks and interest rates.
This would also cover the pricing principles and methods of trading, settlement etc. Separate sessions for
commodities, currencies and stock indices would deal extensively with the examples of hedging, speculation and
arbitrage.

Options: Sessions on options are aimed at developing an understanding about the complex nature of the
derivative. The objective is to familiarize the participants with the various ways to value options. Hedging using
options would be discussed in details with suitable real life applications. Trading strategies with options would
deliberate upon how the combination of options can be used to achieve the desired risk profiles of different classes
of investors. Sessions on exotic options would concentrate on how the parameters of options can be modified to suit
the individual needs of hedging and cost associated with them.

Swaps and Interest Rate Derivatives: These sessions are useful for the sectors such as banking, construction
and infrastructure that are sensitive to broad economic factors and interest rate structures and changes in them.
The tools of managing the interest rate risk would be introduced with emphasis on swaps and interest rate futures.

Course Outcomes:
At the end of the course, the students are able to:
1. Know the features of financial derivatives.
2. Understand the risk management process using derivatives.
3. Realize use of options and futures contracts
4. Understand the pricing of financial derivatives.
5. Be aware of fundamentals of credit risk management and Value at Risk

Table - 1
Session Plan

Cumulative Coverage
Module No

Contents Pedagogical Presentation Assignments

Evaluation Technique LearningStudent

Tools / additional
work
Session No.
I 1-2 Financial Derivatives: Introduction, DLP # Class Discussion
economic benefits of derivatives, & Refer the Refer the # Test I
Types of financial derivatives, Chalk Board Table 2 Table 3 # Case Presentation
features of derivatives market,
factors contributing to the growth of
derivatives
3-4 Functions of derivative markets, 07%
Exchange traded versus OTC
derivatives, traders in derivatives ” ” ” ”
markets, Derivative market in India

II 5-7 Futures and forwards, differences, DLP Refer the Refer the # Class Discussion
valuation of futures, valuation of & Table 2 Table 3 # Test I
long and short forward contract. Chalk Board # Case Presentation

8-9 Mechanics of buying &selling

futures, Margins, Hedging using ” ” ” ” 18%
futures -specification of futures

10-11 Commodity futures, Index futures

interest rate futures, arbitrage ” ” ” ”
opportunities
 Session No.
Module No

Cumulative Coverage
Contents Pedagogical Presentation Assignments

Evaluation Technique LearningStudent

Tools / additional
work

III 12-14 Financial Swaps, features, DLP & Refer the Refer the # Class Discussion
mechanics of interest rate swaps, Chalk Board Table 2 Table 3 # Test I
valuation of interest rate swaps # Case Presentation

32%
15-19 Currency swaps, valuation of ” ” ” ”
currency swaps.

IV 20-21 Options, types of options, option DLP & Refer the Refer the # Class Discussion
pricing, factors affecting option Chalk Board Table 2 Table 3 # Test II
pricing # Case Presentation

22-23 Call and put options on dividend and ” ” ” ”

non-dividend paying stocks put-call
parity
 24-25 Mechanics of options, stock options, ” ” ” ”
options on stock index- options on 50%
futures, Interest rate options

26-27 Concept of exoctic option, Hedging & ” ” ” ”

Trading strategies involving options
Session No.

Cumulative Coverage
Module No

Contents Pedagogical Presentation Assignments

Evaluation Technique LearningStudent

Tools / additional
work

28-29 Valuation of option: basic model, ” ” ” ”

one step binomial model, Black and
Scholes model, option Greeks.
Arbitrage profits in options.
V
30-31 Commodity derivatives : commodity DLP & Refer the Refer the # Class Discussion
futures market-exchanges for Chalk Board Table 2 Table 3 # Test II
commodity futures in India # Case Presentation
 32-33 Forward markets, commissions and 64%
regulation-commodities traded – ” ” ” ”

34-36 Trading and settlements – physical ” ” ” ”

delivery of commodities.
VI
37-38 Interest rate markets, Type of rates, DLP & Refer the Refer the # Class Discussion
Zero rates, Bond pricing, Chalk Board Table 2 Table 3 # Test III
# Case Presentation

39-40 Determining Zero rates, Farward

rules, Farward rate agreements ” ” ” ” 75%
(FRA)

41-43 Treasury bond & Treasury note

futures, Interest rate derivatives ” ” ” ”
(Black model).
 Session No.
Module No

Cumulative Coverage
Contents Pedagogical Presentation Assignments

Evaluation Technique LearningStudent

Tools / additional
work

VII5 44-45 Credit risk: Bond prices and the DLP & Refer the Refer the # Class Discussion
probability of default, Historical Chalk Board Table 2 Table 3 # Test III
default experience # Case Presentation
85%
46-47 Reducing exposure to Credit risk,
Credit default swaps, Total return
swaps, Credit spread options, ” ” ” ”
Collateralized debt obligation.

48-51 Value at Risk (VAR)-Measure,

Historical simulation, Model
building approach, linear ” ” ” ”
approach 100%
52-53 Quadratic model, Monte Carlo
simulation, stress testing and back
testing ” ” ” ”

54-62 Lab Sessions Every fifth hour will be handled lab sessions which will focus the practical
aspect of the syllabus content. A complete revision through the
 presentation by the students based on the presentation topics will be
covered during this slot.

Table – 2
Presentation Topics
S.No. Mod. No. Presentation Topics
1-30 I to VII Case study and assignment topics will be considered as
presentation topics, Presentation only after T3 during
review period.

Table – 3
Assignments & Additional Work
S.No. Mod. No. Assignment Topic
1 to 30 I to VII Each students will be given one question each from Question
Bank from the following manner ( 1 - 3 marks question,
1- 7 marks question and 1- 10 marks question)
Question Bank contents will be divided as an assignment topics to the students
S.No. Mod. No. Particulars
Table – 4 1 – 30 I – VII Case study will be given to the students for presentation based
Case Study on previous year question papers problems and case let Topics
from text books
1 ” Question Paper, VTU, June-July, December 2015
2 ” Question Paper, VTU, June-July, December 2013 & 14
3 ” Question Paper, VTU, June-July, December 2011 & 12
4 ” Question Paper, VTU, June-July, December 2009 & 10
5 ” Question Paper, VTU, December 2008
6 ” Question Paper, VTU, July, December 2008
7 ” Question Paper, VTU, December 2006 / January 2007
8 ” Question Paper, VTU, July 2006
9 ” Question Paper, VTU, December 2005 / January 2006
10 ” Question Paper, VTU, January / February 2005
11 ” Question Paper, VTU, June / July 2004
12 ” Question Paper, VTU, January / February 2004
13 ” Question Paper, VTU, June / July 2002, February 2003
 S.No. Mod. No. Particulars
Table – 5 1 I, II, III, IV, V, Options Futures & Other Derivatives- John C.Hull - (Pearson Education),
VI, VII 6/e
References &
2 VI, VII Options & Futures- Vohra & Bagri - (TMH), 2/e
Additional Readings
3 I, II, III, IV Derivatives- Valuation & Risk Management-Dubofsky & Miller - (Oxford
University Press), 2004/05
4 I, II, III, IV Financial Derivatives – Mishra V, Excel Books.
5 I, II Risk Management & Insurance – Harrington & Niehaus – TMH, 2/e

6 I, II, III, IV, V, Risk Management & Derivative – Shulz – Thomson / Cengage Learning.
VI, VII
7 I, II Principles of Risk Mgmt. & Insurance – Rejda – Pearson Education/PHI,
8/e, 2003
8 I, II, III, IV, V, Introduction to Derivatives and Risk Management – Chance – Thomson
VI, VII Learning, 6/e, 2004
9 I, II Introduction to Risk Management & Insurance – Dorfman – Pearson/PHI,
2004
10 I, II International Risk & Insurance –Skipper - (TMH)

11 II, III, IV, V, Options & Futures –Edwards & Ma - (MacGraw Hill), 1/e
VI, VII
12 II, III, IV, V, Derivatives & Financial Innovations – Bansal - TMH.
VI, VII
13 I, II, III, IV, V, Credit Risk Management – Anderw Fight –Elvis.
VI, VII
14 I, II, III, IV, V, Financial Derivatives – S.S.S. Kumar PHI 2007.
VI, VII
15 I, II, III, IV, V, Futures, Options and Swaps – Robert W Kolb – Blackwell Publishing.
VI, VII
16 I, II, III, IV, V, Risk Management – Koteshwar HPH.
VI, VII
17 I, II, III, IV, V, Derivatives and Risk Management, Rajiv Srivastava, Oxford University
VI, VII Press
 Table – 6
IA Pattern
Test Marks Presentations Assignments
60% 20% 20%

 For Internal Evaluation T1 marks and the best out of remaining two will be considered.

 1st Test is mandatory.

Question Bank
14MBAFM411: Financial Derivatives

3 Marks Questions:
1. Why are Futures & Options termed as Derivatives?
2. What are Forward Contracts? What is their Utility?
3. A forward contract on 200 shares, currently trading at Rs112 /share ,is due in 45 days. If the annual risk free rate is 9%,
calculate the value of the contract. How would the value be changed if a dividend of Rs.4 /share is expected to be paid in
25 days before the due date?
4. Define Basis? When do you expect the basis to be Positive or negative?
5. Discuss the meaning of “Cost to carry” & “Convenience Yield”
6. What are Single Stock Futures? How are they priced?
7. How are Naked Calls different from Covered Calls?
8. Why are American Calls likely to be more valuable than the comparable European Calls?
9. What are the rights and obligations of the parties to a call option?
10. Discuss the use of index options for the purposes of hedging.
11. Who are scalpers? How are they useful?
12. What is Rolling Settlement?
13. Write a note on Derivatives trading in India.
14. What is a Capped Option?
15. What is meant by Assignment?
16. What is meant by Arbitrage?
17. What is Delta?
18. What is hedge Ratio? How is it determined?
19. Mention the principle of “Put call Parity”
20. How are interest rate swaps valued? Explain with example.
21. What do you understand by the term Interest rates? Discuss the various types of interest rates along with different yield
curves.
22. A financial institution quotes an interest rate of 14% per year with quarterly compounding. What is the equivalent rate
with i) continuous ii) annual compounding?
23. What is meant by “Strap”?
24. What are American options and European options?
25. What are put option and call option?
26. What are swaps?
27. What are swaptions?
28. What are LEAPS?
29. What is basket option?
30. What are warrants?
31. How do option contracts differ from both forward and future contracts?
32. What is the difference between long forward position and short forward position?
33. Explain the difference between writing a call option and buying a put option.
34. Under what circumstances are i) a short hedge ii) long hedge appropriate?
35. What is forward rate agreement?
36. What do you mean by value at risk (var)?
37. What is comparative advantage argument in swap?

7 Marks Questions:
1. ”A Strangle is similar strategy to a straddle “ Discuss the statement in the light of option trading with suitable examples.
2. Compare and contrast Futures and forward contracts with suitable examples.
3. Sun Pharma wishes to borrow Rs20crore at a fixed rate for 5 years and has been offered either 11% fixed or six month
LIBOR +1%. CIPLA Ltd wishes to borrow Rs 20 crore at a floating rate for 5 years and has been offered either LIBOR
+0.5% or 10% fixed. On the basis of the above
i) how may they enter in to swap arrangement in which each benefits equally?
ii) what risk this arrangement may generate?
4. A stock is currently selling for Rs 400. The price of call option expiring six months are as follows:
Strike price = Rs 350 ,call price Rs 15
Strike price = Rs 390 ,call price Rs 11
Strike price Rs 425 ,call option = Rs 8
Investor feels it is unlikely that stock price will move significantly in next six months. Draw a Butterfly spread with the
given options.
5. From the following data calculate the values of call and put options using Black-Scholes formula:
Current price of the share =Rs 486
Exercise price = Rs 500
Time to expiration =65 days
SD = 0.54
Continuously compounded rate of interest =9% per year
Dividend expected =Nil
6. Consider the following data : S=100,u=1.5,d=0.8, E=105,r=0.12,R =1.12
What is the value of the call option?
7. The following data is available for Thermal Plastics ltd, a company that is not expected to pay the dividend for a year:
S0 =120,E=110,r=0.14,t=1.0,SD =0.4
What is the value of the call option as per the Black –Scholes formula?
8. Assume that an investor buys a stock index futures contract on march 1 at 1125. The position is closed out on March 5.
The stock index prices on 4 days after purchase were 1128,1127,1126,1128. Calculate the cash flow to the investor on a
daily basis. Ignore the margin requirements.
9. Describe the features of Nifty futures contract
10. Describe the short hedge and long hedge
11. What are Merton H Miller’s views on derivatives and volatility?
12. The share of R ltd is currently selling for Rs 1000. The risk free interest is 1 % per month. Suppose the 3 months
futures price is 1035 what will you do? Assume that R ltd will not pay dividend for the next 6 months.
13. Define the payoffs of a call option and a put option from the point of view of the option writer.
14. Describe the salient features of options on individual securities at the NSE.
15. A stock is currently selling for Rs.40. The call option on the stock exercisable a year from now at a strike price of Rs.45
is currently selling for Rs.8. The risk free interest rate is 10%. The stock can either rise or fall after a year. It can fall by
20%. By what % it can rise?
16. What is the value of a European call option (No dividends) with an exercise price of Rs 50 and an expiration date 3
months from now if the stock price is Rs 40, the variance of the stock is 0.40 , and the risk free rate is 14%? What is the
value of the put using the same information?
17. The following information is available for Abhishek Industries:
S0 =Rs70, E = Rs 72 ,r = 0.12 ,SD = 0.30
Calculate the price for a 6 month call option as per the B-S Model.
18. Advice the investor with a portfolio valued at Rs 21,37,600 and having beta value equal to 1.28 for hedging with put
options ,given further, Put exercise = 1470, lot size = 100 , put delta = -0.68
19. a. Calculate the values of call and put options on S and P CNX Nifty using the following data :
Spot value of the index =1430, exercise price = 1450, risk free rate of return = 8%
SD of the continuously compounded rate of return =0.28, Time to expiration = 36 days.
b. recalculate the values in (a ) assuming continuous dividend rate on the index is 2%/
20. Explain the assumptions underlying the B-S Model
21. Graphically depict the valuation of i) call and ii) Put options.
22. Differentiate Bull and Bear Spreads. How can each of these be created with put options?
23. Explain with example what you mean by stress testing of VaR?
24. Explain the features of a credit default swaps.
25. Determine the theoretical price of a call option given that Spot price S0 = 340, t = 6 months, r = 18% PA, Compounded
continuously and strike price X = 360. If the actual call option price is Rs.9, is there a arbitrage possibility? If so, show
the process of making arbitrage profit.
26. Determine the profits from the butterfly spread based on the following data and interpret the result.
i. First purchase of call option at Rs.320 at a premium of Rs.40
ii. Second purchase of call option at Rs.400 at a premium of Rs.20
iii. Sell both the call option at Rs.360 at a premium of Rs.30
iv. The price on the due date is 270, 300, 360, 400, 450, or 500.
27. You have gone long on the stock at a price of Rs.340. A call and put option is available in the market at a premium of
Rs.30 and strike price of Rs.360. If you are planning in hedging strategy would it be better if you go short on a call
option or long on a put option. Imagine on the due date the spot prices could be i) Rs.270 ii) Rs.360 iii) Rs.500.
28. Describe the three approaches to determining VaR.

29. An index consists of 4 stocks: P, Q, R, S. The current value of the index is 3070 points. The following information is
available.
Co Market Price (Rs.) Market Cap (Rs. in crore)
P 250 20
Q 790 40
R 1400 65
S 1770 75
 Co Q is likely to pay dividend in 40 days time at Rs.12 per share. A 90 days index futures contract is available with a
contract multiplier of 200. Considering the risk free rate to be 12% PA compounded continuously. Determine the future
price to Index futures.

30. A company enters into a short future contract to sell gold for Rs.1420 per gram on MCDEX. The size of contract is 10kg.
The initial margin is Rs.10 lakh and maintenance margin is Rs.8 lakh. What change in future price will lead to a margin
call? Under what circumstances Rs.2 lakh can be withdrawn from the margin account.

31. A stock is expected to pay a dividend of Re.1 per share in 2 months and again in 5 months. The stock price is currently
Rs.50 and risk free rate of interest is 6% per annum. What is the stock’s forward price for a 6 month contract?

32. A share is currently selling for Rs.120. There are 2 possible prices of the share after 1 year Rs.132 or Rs.105. Assume
the risk free rate of return is 9% per annum. What is the value of one year call option with an exercise price of Rs.125?

33. Suppose that 1-year,2-year, 3-year,4-year and 5-year zero rates are 3%, 4%, 4.5%, 5% and 5.3% per annum
respectively. Calculate the forward rates for the second, third, fourth and fifth years.

34. A portfolio manager plans to use a treasury bond futures contract to hedge a bond portfolio over next 3 months. The
portfolio is worth Rs.100 million and will have duration of 4.0 years in 3 months. The future price is Rs.122 and each
future contract is on Rs.100000 of bonds. The bond that is expected to be cheapest to deliver will have duration of 9
years at the maturity of the future contract. Why should the manager hedge and what position in futures contracts is
required.

35. Discuss the difference between credit risk and market risk as applicable to financial markets.

36. “Call holders and put writers exhibit bullish sentiments”- Explain.

10 Marks Questions:
1. Discuss each of the following types of traders in a derivatives market: hedgers, speculators and arbitrageurs.
2. Let changes in spot values are represented by Y and changes in futures values by X from the given set of calculations it
is found that :

Mean of X =1.5425
Mean of Y = 0.2345
SD of X =0.680
 SD of Y =0.825
R between X & Y =0.85
Obtain the regression equation from these data and determine the optimal hedge ratio.

3. Assume that a market capitalization weighted index consists of 5 stocks only. Currently the index stands at 970. Obtain
the price of the futures contract, with expiration in 115 days , on this index having reference to the following additional
information :
a. Dividend of Rs 6 /share expected on share B , 20 days from now
b. Dividend of Rs 3 /share expected on share E ,28days from now
c. Continuously compounded risk free rate of return =8% per year
d. Lot size 300
e. Other information:

Company share price market capitalization (In cr)

A 22 110
B 85 170
C 124 372
D 54 216
E 25 200
4. What are the major stock indices in India ? Discuss in detail about Sensex and S&P CNX Nifty Indices.
5. How can a butterfly spread be created by using the following 3 put options (with same expiration dates)?
Option 1: Exercise price Rs 70 Price = Rs 6
Option 2: Exercise price Rs 75 Price = Rs 9
Option 3: Exercise price Rs 80 Price = Rs 14
Determine the range of stock prices within which losses would be made by the buyer of the options
6. Examine the effect of each of the following changes on the call & put option values :
Stock price =Rs 206, Exercise price =Rs 200, Time to expiration =47Days,SD of the continuously compounded rate of
return on stock = 0.26, continuously compounded rate of return =8%
a. the stock price increases by Rs8
b. SD is changed to 0.30
c. Risk free rate of return reduces by 2 %.
7. Obtain the values of call and put options on futures related to an index:
Futures contract price =1522
Exercise price of option =1550
Time to expiration =40days
Risk free rate of return = 9%
Volatility = 0.25
8. Describe the goals of regulation of security and derivatives markets. How can the goals be achieved?
9. List the major changes that have taken place in the last decade in the capital market of India.
10. Explain the various principles of insurance contract.
11. Classify and explain the various types of risks.
12. An investor has portfolio consisting of seven securities as shown below:
Security No of Shares Share price as on 18-4-02 Beta
AA 4,000 1029.75 0.59
CI 5,200 208.40 1.32
IC 6,600 61.2 0.87
Inf 2,400 3958.95 0.35
TA 5600 308.8 1.16
Hi 1500 128.05 1.24
Zee 4000 168.00 1.05
The cost of capital for the investor is 20% per year. The investor fears a fall in the prices of the shares in the near
future. Accordingly , he approaches you for advice. You are required to :
Calculate the beta of his portfolio
The May future on BSE Sensex is quoted at 3444.60. Assuming the market lot to be 100, calculate the number of
contracts, the investor should short for hedging his portfolio against the falling market.
13. Suppose that on july 25 , a firm knew that it will have to borrow $10 Million on Sept22 for 3 months. A bank agrees to
provide these funds at 1% above whatever the 3 month LIBOR is on Sept 22. By chance the Sep 22 is also the last
trading of the Sep 2002 Euro Dollar futures contract. Firm is concerned about that by that time the LIBOR may rise. How
company can hedge its risk by using Eurodollar futures if Only juy25 Eurodollar price is 91.72 and implied 3 month
Eurodollar rate is 8.28%. The 3 month LIBOR on July 25 is 8.375%.
14. How is the value of an option with time to expiration determined? What are the various factors affecting the option
prices?
15. The current price of share is Rs 50 and its believed that at the end of 1 month the price will be either Rs 55 or Rs45.
What will a European call option with an exercise price of Rs.53 on this share be valued at ,if the risk free rate of interest
is 15% per year ? Also calculate the hedge ratio applying Binomial formulation.
16. The various measures of sensitivity obtained by differentiating the Black & Shcoles formulation for call & put options with
respect to various input parameters , namely ,ρ0, t, r , and SD include the values of various greeks. From the
information given below , you are required to obtain and interpret :
a.the call & put option values
b.the values of various greeks.
The stock price being Rs206; exercise price is Rs 200 ; time to expiration is 47 days with a continuously compounded
rate of return as 8% and the SD of the continuously compounded rate of return on stock is 0.26.
17. Explain the value at Risk measures
18. What is meant by Credit Risk? Explain how to reduce exposure to credit risk?
19. Explain in detail the Interest rate markets and Interest rate derivatives.
20. Discuss the important economic functions performed by the derivatives markets. Does a derivatives market complete a
market?
21. Discuss various characteristic features of futures contracts. What is the role of clearing corporations in trading of such
contracts?
22. Write a detailed note on hedging i)a long position in stocks ii) a short position in stocks , using stock index futures.
23. Illustrate the following using rough sketches:
i)Bull spread using call options
ii) Long stock and short call
24. What do you understand by Implied Volatility? How can it be calculated?
From the information given below, estimate the volatility implied:
Stock price =126, exercise price = 132, Time to maturity =45days, Risk free rate of return =8%, call premium = 3.30
Recalculate the volatility is the stock price matches with the exercise price.
25. Discuss the role of SEBI in the Indian capital market.
26. “Arbitrage Profits” an investor told are riskless profits. You take simultaneous but opposite positions in two markets to
reap from pricing disparities. Acting on this belief, his friend tried to find arbitrage profit by trading simultaneously in
futures and stock index. He has collected the following information:
i) Present level of stock index - 3000
ii) Index futures priced at – 2000
iii) Risk free rate of return – 10%
iv) 50% stocks are to pay dividends at 6%
v) The index futures has a multiple of 100
vi) The futures has six months to expiration.
Required
i) Find the arbitrage profits if any
ii) Discuss the risk associated with arbitrage transactions in futures.
27. On December 09, 2002 an investor bought 10 T- bill futures contract trading on IMM at Rs.96.72. The initial margin
requirement is Rs.2000 per contract with maintenance margin of Rs.1500 per contract. The settlement prices of T-bill
futures contract for 9 trading days are as follows:
Date Settlement Price (Rs.)
Dec 9 96.75
Dec 10 96.68
Dec 11 96.63
Dec 12 96.59
Dec 13 96.54
Dec 16 96.50
Dec 17 96.55
Dec 18 96.60
Dec 19 96.64
 On Dec 20, the investor closes his position when future price was Rs.96.67. Show the margin account balance and gains
from the futures contract.

28. The following table gives the prices of bonds:

Bond Principal Time to Maturity Annual coupon ($) Bond price ($)
(years)
100 0.50 0.0 98
100 1.00 0.0 95
100 1.50 6.2 101
100 2.00 8.0 104
(Held the stated coupon is assumed to be paid every 6 months.)
i) Calculate zero rates for maturities of 6 months, 18 months, and 24 months.
ii) What are the forward rates for the periods: 6 months to 12 months, 12 months to 18 months, 18
months to 24 months?
iii) What are the 6-month, 12-month, 18 month and 24-month par yields for bonds that provide
semiannual coupon payments?
iv) Estimate the price and yield of a two-year bond providing a semiannual coupon of 7% per annum.

29. Consider a call option on a stock with following parameters

Strike price : Rs.70
Risk – free rate of interest : 6%
Time to expiration : 90 days i.e. 0.2466 year
Standard deviation of returns on a stock : 0.4
Spot price of the stock : Rs.60
Compute:
i) Price of the call option ii) Its Delta iii) Gamma iv) Theta v) Vega vi) Rho.

30. Three companies X, Y and Z have come together to reduce their interest cost. Following are the requirement of those
companies and interest rates offered to them in different markets.
Company Requirement Fixed $ Floating $ Fixed Euro
X Fixed $ funds 5.75% LIBOR + 0.90% 6.00%
Y Floating $ funds 5.25% LIBOR + 0.75% 6.50%
Z Fixed Euro Funds 6.00 LIBOR + 0.60% 6.25%
The amounts required by the companies are equal and are for three years on bullet payment basis. You are required to
arrange a swap between three parties in such a way so that the benefit of swap is equally divided among the three
companies.
31. October Soybean oil futures are selling at 19.44 cents per Ib. The standard size of the contract is 60000Ibs. Initial
margin requirement is $3000 while the maintenance margin is $1500. If a trader goes long in 2 October futures
 contracts and the prices on the subsequent 4 days are 19, 19.4, 19.6 and 19.8 cents/Ib, explain how the margin
accounts changes. Assume that the money in excess of the initial margin is withdrawn immediately.
32. Discuss the foundation for valuation of option premium under the Black and Scholes model.
33. Describe the rationale for retention of risk. What are the factors that determine risk retention?
34. On September 28th, the cash price of a quintal of pepper is Rs.10010 per quintal. Full carry cost of pepper till December
28th is Rs.10288/Q. A 3-month futures contract maturing in, December end is now trading at Rs.10355/Q. Can the
merchant holding the stock of pepper exploit any arbitrage opportunity? Assume risk free rate of interest with continous
compounding as 7%. Calculate the arbitrage profit. What is the arbitrage strategy adopted by him. Alternatively, if the
merchant wants to hedge against falling prices, what information he needs to gather from NCDEX.
35. Company AKR wishes borrow U.S. Dollars at a fixed rate of interest. Company RAK wishes to borrow Japanese Yen at a
fixed rate of interest. The amounts required by the two companies are roughly the same at current exchange rate.
Yen Dollars
Company AKR 4.0% 8.6%
Company RAK 5.5% 9.0%
Design a swap that will net a bank, acting as intermediary, 50 basis points per annum. Make the swap equally attractive
to the 2 companies and ensure that all foreign exchange risk is assumed by the bank.
36. The current stock price for ACG Ltd is Rs.85. A European call option with exercise price of Rs.85,, will expire in 160
days. The yield on a 160-day Treasury bill is 5.18%. The standard deviation of annual returns on ACG’s stock is 44%.
Compute premium for a call option and also a put option on this stock.
37. How can a butterfly spread be created by using the following 3 call options (with same expiry dates). Once contract involves
1100 shares.
Strike price Premium
Rs.170 Rs.21.10
Rs.180 Rs.14.00
Rs.190 Rs.8.00
Determine the range of stock prices within which losses would be made by the buyer of options.
38. Compute the delta of a At-the-money call and put European options with a volatility of 35% and interest rate of 7% p.a.
with 90 days to maturity. Provide a brief interpretation of delta.
39. Differentiate between:
i) OTC contracts and exchange traded contracts
ii) MTM margin and initial margin.