1.

Consider the following settlement prices of Nifty Bank futures on NSE from 1st August –
9th August 2019 for August expiry. Contract size of Nifty Bank on futures segment is 20.
Symbol Date Expiry Settle Price

BANKNIFTY 01-Aug-19 29-Aug-19 28499.30

BANKNIFTY 02-Aug-19 29-Aug-19 28327.30

27795.75
BANKNIFTY 05-Aug-19 29-Aug-19

BANKNIFTY 06-Aug-19 29-Aug-19 28109.75

BANKNIFTY 07-Aug-19 29-Aug-19 27748.45

BANKNIFTY 08-Aug-19 29-Aug-19 28239.90

28474.10
BANKNIFTY 09-Aug-19 29-Aug-19

With a bullish view point, Mr. Syed has taken long position in Nifty Bank futures on 1st August
and closed on 9th August. Show the marking to market mechanism, opening and closing balances
in the margin account and margin call if any, in his account. Also show overall gain/loss on their
respective positions. Assume initial margin is Rs 30,000 and maintenance margin is Rs 20,000.
(10 Marks)
Ans.
Balance
after
Value Marking Marking
Settle of the Opening to to Margin Closing
Date Price Position Balance Market Market Call Balance
01-Aug-
19 28499.3 569986 30000
02-Aug-
19 28327.3 566546 30000 -3440 26560 0 26560
05-Aug-
19 27795.8 555915 26560 -10631 15929 14071 30000
06-Aug-
19 28109.8 562195 30000 6280 36280 0 36280
07-Aug-
19 27748.5 554969 36280 -7226 29054 0 29054
08-Aug-
19 28239.9 564798 29054 9829 38883 0 38883
09-Aug-
19 28474.1 569482 38883 4684 43567 0 43567
Overall gain/loss = (28474.1 - 28499.3)×20 = -504.
2. An Indian exporting company had exported product at a price of AUD$2,52,000 on June 01,
2019. On that day the currency market was trading at Rs 48.00 to 1 AUD. The company had
expected payment after 3 months. In order to hedge the exposure, the company decided to take
a position in the currency futures market immediately (1 contract size in the futures market is
for AUD42,000). On June 01, 2019 the futures was trading at 48.5 Rs to 1 AUD. After 3 months
(September 2019) when the company decided to pay for the imports the spot market was
trading at Rs 47.00 to 1AUD. The company squared off the position in the futures market when
the futures were trading at Rs 48.00 to 1AUD.
a. What was the gain/loss in the spot market
b. What was the gain/loss in the derivatives market
c. What was the net gain/loss due to combined position
d. What would be the net gain/loss due to combined position if the company hedges with a
hedge ratio of 1.5

(2+2+2+4 = 10 marks)

Answer)

Date Spot Futures

June 2,52,000 x 48 = 12, 096,000 42,000 x 6 x 48.5 = 12,22,2000
(SELL)
September 2,52,000 x 47 = 11,84,4000 42,000 x 6 x 48 = 12,09,6000
(BUY)
Gain/Loss 2,52,000 -125,000

Combined position = -1,26,000 gain

Hedge Ratio = 1.5

Date Spot Futures

June 2,52,000 x 48 = 12, 096,000 42,000 x 9 x 48.5 = 18,333,000
(SELL)
September 2,52,000 x 47 = 11,84,4000 42,000 x 9 x 48 = 18,144,000
(BUY)
Gain/Loss 2,52,000 -189,000
Combined position = 63,000 gain

3. Mr. Rahul bought the shares of Reliance Industries Ltd. (RIL) at the price of Rs.1180
each with a view to benefitting from the rise in the stock price. However, he also wants to
protect his position from the possible fall in the stock price. Suggest him suitable
strategy, given the following information available on NSE regarding options trading on
RIL stock.
 Option Type Strike Price Expiry Premium
Put Option 1180 29-Aug-2019 40
And also show payoff table and payoff diagram clearly indicating maximum profit,
maximum loss and break even points of the strategy suggested, assuming that Infosys
stock price may move between any of the following prices between 1160 and 1260 may
prevail on expiry. You may consider in multiples of Rs.10 price range.

10 Marks)

Ans.

Suitable strategy to protect from the possible fall in the price is Protective Put which consists
of buying an underlying asset and buying a put option on the asset. From the given
information, since underlying stock of RIL is bought at 1180, put option can be bought at 40.

Payoff
from
Gross Net Value
Spot Payoff Long
Gross Net Value of of
Price on from Put
Payoff Payoff Combined Combined
Maturity Underlying Max(
Position Position
K-St,
0)
1160 -20 20 0 -40 1180 1140
1170 -10 10 0 -40 1180 1140
1180 0 0 0 -40 1180 1140
1190 10 0 10 -30 1190 1150
1200 20 0 20 -20 1200 1160
1210 30 0 30 -10 1210 1170
1220 40 0 40 0 1220 1180
1230 50 0 50 10 1230 1190
1240 60 0 60 20 1240 1200
1250 70 0 70 30 1250 1210
1260 80 0 80 40 1260 1220

Maximum Gain: Unlimited

Maximum Loss: Limited
BEP: Strike Price + Cost
4. Currently the stock of ICICI Bank is trading at Rs. 400. It is estimated that its price may
go up by 5% or down by 5% in each of two time steps, where each time step is of one
month. Using Binomial option pricing model, what would be the value of European call
option and put option with the strike price of Rs. 400, if 364 treasury bills yield 6.5% p.a.
(10 Marks)

Ans. Pricing Call Option:

u= 1.05; d =0.95

p = (e0.065×1/12-0.95)/(1.05-0.95) = 0.446
420
441
40.78
D 41
B
400
18.19
399
A E
0

C
380
0 F 361
0

At node B = e-0.065×1/12 ×[0.446 × 41 + 0.554 × 0) = Rs. 40.78

At node A = e-0.065×1/12 ×[0.446 × 40.78 + 0.554 × 0) = Rs. 18.19

Pricing Put Option:

u= 1.05; d =0.95

p = (e0.065×1/12-0.95)/(1.05-0.95) = 0.446
420
441
0.55
D 0
B
400
12.33
399
A E 1

C
380
21.93 F 361
39
 At node B = e-0.065×1/12 ×[0.446 × 0 + 0.554 × 1) = Rs. 0.55

At node C = e-0.065×1/12 ×[0.446 × 1 + 0.554 × 39) = Rs. 21.93

At node A = e-0.065×1/12 ×[0.446 × 0.55 + 0.554 × 21.93) = Rs. 12.33

5. Current market price of Wipro is Rs. 250. Greeks of the option contracts on the stock are
as follows: ∆ = 0.5476, ɵ = -26.57, Γ= 0.086, υ= 14, ρ = 14.23

a. If the stock moves to Rs 255, what is the predicted new option price?
(2 Marks)
b. If stock price jumps to Rs 270, what is the new option price predicted by delta
alone? What is the new option price predicted by delta and gamma?
(2 Marks)
c. What is the new option price, if volatility increases by 2%? (2 Marks)
d. What is the new option price, if time to maturity falls by 0.05? (2 Marks)
e. What is the new option price, if interest rates increase by 75 bps? (2 Marks)
(Assume current price of call option is 9.56)

Ans.

a. If S changes to 255, dS=5. Thus, the change in the option price predicted by the
delta is ∆.dS=0.5476×5=2.738
Since the original option price is 9.56, predicted new price is C=9.56+2.738 = 12.298
b. If there is a large increase in the price, we must use a curvature correction, since using the
delta alone will lead to large errors. In this problem, dS=20. If we used the delta alone, we
would predict a change in the call price of ∆.dS=0.5476 × 20 = 10.952. So the predicted new
price on this basis would be 9.56+10.952 = 20.512
Combined effect of delta and gamma = ∆.dS+1/2 Γ.dS2 = 0.5476 × 20 +1/2×0.086×20^2=
10.952+ 36.4=Rs 47.352. New price is 9.56+47.352 = 56.912
c. If dσ=0.02, vega predicts call values will change by v.dσ=14×0.02 = 0.28. Thus,
predicted new call value is 9.56+0.28 = 9.84.
d. If dt=0.05, theta predicts call values will change by ɵ.dt=-26.57×0.05 = -1.3285. Thus,
the predicted new call value is 9.56-1.3285= 8.2315
e. If dr=0.0075, rho predicts call values will change by ρ.dr=14.23×0.0075 = 0.106725.
Thus, predicted new call value is 9.56 + 0.106725 = 9.666725

6. Companies A and B have been offered the following rates per annum on a $20 million five year
loan:

Fixed Rate Floating Rate

Company A 5.0% LIBOR+0.1%
Company B 6.4% LIBOR+0.6%
Company A requires a floating-rate loan; company B requires a fixed-rate loan. Design a swap that will
net a bank, acting as intermediary, 0.1% per annum and that will appear equally attractive to both
companies.

Ans.

A has an apparent comparative advantage in fixed-rate markets but wants to borrow floating. B has
an apparent comparative advantage in floating-rate markets but wants to borrow fixed. This
provides the basis for the swap. There is a 1.4% per annum differential between the fixed rates
offered to the two companies and a 0.5% per annum differential between the floating rates offered
to the two companies.

The total gain to all parties from the swap is therefore1.4-0.5=0.9 % per annum. Because the bank
gets 0.1% per annum of this gain, the swap should make each of A and B 0.4% per annum better off.
This means that it should lead to A borrowing at LIBOR − o. 03 % and to B borrowing at 6.0%. The
appropriate arrangement is therefore as shown in the following figure.

5% Company A 5.3% Financial 5.4% Comp L +0.6%

Institution any B
LIBOR LIBOR

7. A $100 million interest rate swap has a remaining life of 10 months. Under the terms of the
swap, 6-month LIBOR is exchanged for 7% per annum (compounded semiannually). The average
of the bid–offer rate being exchanged for 6-month LIBOR in swaps of all maturities is currently
5% per annum with continuous compounding. The 6-month LIBOR rate was 4.6% per annum 2
months ago. What is the current value of the swap to the party paying floating? What is its value
to the party paying fixed?

Ans.

In four months $3.5 million ( = 0. 5x 0. 07 x$100 million) will be received and $2.3 million ( = 0 .5x 0.
046 $100 million) will be paid. (We ignore day count issues.) In 10 months $3.5 million will be
received, and the LIBOR rate prevailing in four months’ time will be paid.

The value of the fixed-rate bond underlying the swap is

=3.5e--0.05x4/12+103.5e--0.05x10/12=$102.718 million

The value of the floating-rate bond underlying the swap is

=(100+2.3) e--0.05x4/12= $100.609 million

The value of the swap to the party paying floating is $102. 718- $100.609= $2 .109million. The value
of the swap to the party paying fixed is − . $2 109 million
8. a) Explain carefully the difference between hedging, speculation and arbitrage. (5 Marks)

Speculation involves trying to make a profit from a security's price change, whereas
hedging attempts to reduce the amount of risk, or volatility, associated with a security's
price change. Hedging involves taking an offsetting position in a derivative in order to
balance any gains and losses to the underlying asset. Arbitrage is the practice of trading a
price difference between more than one market for the same good in an attempt to profit
from the imbalance.

b) “Options and futures are zero sum games.” what do you think is meant by this. (5 Marks)

In the financial markets, options and futures are examples of zero-sum games, excluding
transaction costs. For every person who gains on a contract, there is a counter-party who
loses.

9. Briefly explain the 5 option Greeks. (10 Marks)

The 5 Option Greeks are:

Delta (Greek Symbol δ) - a measure of an option's sensitivity to changes in the price of

the underlying asset

Gamma (Greek Symbol γ) - a measure of delta's sensitivity to changes in the price of the
underlying asset

Vega - a measure of an option's sensitivity to changes in the volatility of the underlying

asset

Theta (Greek Symbol θ) - a measure of an option's sensitivity to time decay

Rho (Greek Symbol ρ) - a measure of an option's sensitivity to changes in the risk free
interest rate
10. a) Briefly explain weather Derivatives. (5 Marks)
Weather derivatives are financial products that derive their values from weather-related
variables such as temperature, rainfall, snowfall, frost and wind. Weather derivatives are
typically used by organisations to hedge or mitigate the risks associated with adverse or
unexpected weather conditions.

b) State and explain Credit Risk. (5 Marks)

A credit risk is the risk of default on a debt that may arise from a borrower failing to
make required payments. In the first resort, the risk is that of the lender and includes lost
principal and interest, disruption to cash flows, and increased collection costs.