University Name Course Name Semester

Gujarat University MBA-Financial Services 4

FINANCIAL DERIVATIVES

Block Number Block Name

1 Future and o tion

Unit.1
1. An investor enters into a short forward contract to sell100,000 British

pounds for U.S. dollars at an exchange rate of 1.9000 U.S. dollars per pound. How much does the investor gain or lose if the exchanges rate at the end of the contract is A) 1.!900 and "# 1.9$00%
A! &he investor gain or lose if the exchange rate at the end of the

contract
B! '1000 loss C! '990 gain

is 1.!900

"! $1000 gain #! '9!0 gain

Answer(
$a% &he investor is o"ligated to sell pounds for 1.9000 when the) are worth

1.!900. &he gain is 1.9000 * 1.!900# x 100,000 + '1,000. B. &he investor gain or lose if the exchange rate at the end of the contract is 1.9$00%
A! $ 2000 loss B! ' 1,00 gain C! ' 1$00 gain "! ' $000 gain

Answer( "# &he investor is o"ligated to sell pounds for 1.9000 when the) are worth 1.9$00. &he loss is 1.9$00 * 1.9000# - 100,000 + '$,000.
2. In our 3- ont! "#ro-$ou%on &on' $ontra$t #(a %l#) *# '#t#r in#' t!at t!# no ar&itrag# For*ar' %ri$# *as $+0,.3-. Su%%os# t!at a.t#r t*o ont!s t!# s%ot %ri$# on t!# "#ro-$ou%on &on' is $ + 1 +) an' t!# ris/-.r## rat# is still 0o1o. Cal$ulat# t!# 2alu# o. t!# long an' s!ort %ositions in t!# .or*ar' $ontra$t.

&!

what is present value of long position of forward contract% A! '10.1$ B! $10.1, C! '10.10 "! '9.99 #! .one of these

&&!

what is value of short position of forward contract after two month% A! -$10.12 B! *'10.1/ C! '10.11 "! *'10.$0 #! .one of these

&&&!

what is value of long position of forward contract after two month% A! B! C! "! #! $10.1, '10.1$ '10.,0 '10.0, .one of these

Answer:
+

1$ of long position after two months#

$ 515

$ 507.34 1.061 /12

+',1,*',02.!! +'10.1$ 1$ of short position after two months#+ *'10.1$ Another wa) to see this is to note that "ecause the spot price has increased to ',1,, the current no*ar"itrage forward price is( 34 + ',1, - 1.05161$ + ',1/.,1

&he long position has made mone) and the short position has lost mone)# "ecause the forward price has in$r#as#' ") ' 10.1/ from ',0/.02 to ',1/.,1 since the contract was initiated. &he value of the long position toda) is the present value of '10.1/ for one month at 57( 1$ long position after two months#

$ 10.17 + 1.06 1/12 +'10.1$

&&! what is present value of dividend% A! '0.59,! B! $0.,7-0 C! '0./0,2 "! '0./9,2 #! .one of these &&&! what is present value of dividend after 50 da)s% A! $0.374, B! '0.20,0 C! '0.0!2, "! '0.0/,5 #! .one of these &'! what are of following value of the e8uit) forward contract on the stoc9 to the long position% A! ',.15 B! '5.15 C! '5.,0 "! ',.99 #! .one of these

If you plan to grow 500 bushels of wheat next year, you could sell your wheat for whate er the pr!ce !s when you har est !t, or you could loc" !n a pr!ce now by sell!ng a forward contract that obl!gates you to sell 500 bushels of wheat to, say, #ellogg after the har est for a f!xed pr!ce. $y loc"!ng !n the pr!ce now, you el!%!nate the r!s" of fall!ng wheat pr!ces. &n the other hand, !f pr!ces r!se later, you w!ll get only what your contract ent!tles you to. If you are #ellogg, you %!ght want to purchase a forward contract to loc" !n pr!ces and control your costs. 'owe er, you %!ght end
4.

up o erpay!ng or (hopefully) underpay!ng for the wheat depend!ng on the %ar"et pr!ce when you ta"e del! ery of the wheat. 1* + forward contract !s descr!bed by* +. +gree!ng today to buy a product at a later date at a pr!ce to be set !n the future. $. +gree!ng today to buy a product today at !ts current pr!ce. ,. Agreeing today to buy a product at a later date at a price set today. -. +gree!ng today to buy a product !f and only !f !ts pr!ce r!ses abo e the exerc!se pr!ce today at !ts current pr!ce. 2* .h!ch of the follow!ng are not character!st!cs of an !nterest/rate forward contract0 A! Specification of the place of the transaction. B! 1pec!f!cat!on of the actual debt !nstru%ent. C! 1pec!f!cat!on of the a%ount of the debt !nstru%ent "! 1pec!f!cat!on of the pr!ce (!nterest rate) on the debt !nstru%ent

5. Mr. shreyas has entered into 1 year forward contract to purchase an asset

(non- income generating) when the spot price was Rs. 115 and the interest rate at 12% p.a. After months the interest rate rise to 1!% and spot price fa""s to Rs. 1#5.
1! $hat is the va"ue of the forward contract in present% A! -25.!# B! -30.51 C! !#.51 "! -2&.5

Answer As we 'now ( ) *# on the date of contract+ we find ( with the formu"a of *# *# ) ,# - er. *# ) 115 - e#.12 - 1 ) 12/. After si0 months+ the forward prices of the same asset wi"" 1e2

*# ) 1#5 - e#.1! - #. ) &1.&3 4a"ue of the contract wi"" 1e2 f"ong ) (*# 5 () e-r. f"ong ) (&1.&3 5 12/. ) - e.-#.1! - #. ) -!#.51

.he present va"ue of the contract is -!#.51 or a "oss of Rs.!#+51 for Mr. shreyas

Unit .2
1!

Assu # t!at an in2#stor %ur$!as#' +00 s!ar#s o. N#*$o8s sto$/. T!# s!ar#s *#r# tra'ing at $+0 *!#n t!# transa$tion *as #(#$ut#'. Assu # t!# in2#stor *as a&l# to s#ll t!# s!ar#s .or $100. To '#t#r in# t!# #..#$t o. t!# l#2#rag# *it! %ur$!asing t!# s!ar#s on argin) Assu # no transa$tion $osts. Co %ut# t!# r#turn on t!# transa$tion ,05 initial r#6uir# #nt *as us#'. A. 120.17 B. 10,.,7 :. 12$.97 ;. 1,0.!7 argin

Answer( /07 initial margin re8uirement <iven the initial margin re8uirement of /07, the investor would need an initial cash outla) of '1/,,00 '$,,000 x /07#. &he investor "orrowed '/,,00 '$,,000 x $,7# from the "ro9erage firm to complete the transaction. &he investor was then a"le to sell the shares for ',0,000 ,00 shares at '100#. &he investor then repa)s the amount "orrowed of '/,,00 and the remaining position would "e e8ual to '2$,,00 ',0,000 * '/,,00#. &he return on the trade was thus '2$,,006'1/,,00# * 1 + 12$.97. As shown in the examples a"ove, the investor was a"le to magnif) his returns ") "u)ing stoc9 on margin.

2. Assu # t!at an in2#stor !a' %ur$!as#' +00 s!ar#s o. N#*$o8s sto$/. T!# s!ar#s *#r# tra'ing at $+0 *!#n t!# transa$tion *as #(#$ut#'. T!# initial argin r#6uir# #nt on t!# a$$ount *as ,05 an' t!# aint#nan$# argin is 305. Assu # no transa$tion $osts.

;etermine the price at which the investor will receive a margin call.
a% $$.20' b% 21.-3$ c% $0.19' d% $1.02'

Ans*#r9 :alculate the price as follows( ',0 1* 0./0# + '$1.20 1 * 0.00 A margin call would "e received when the price of .ewco=s stoc9 fell "elow '$1.20 per share. At that time, the investor would either need to deposit additional funds or li8uidate shares to satisf) the initial margin re8uirement.
3. L#t8s start *it! a .utur#8s %ri$# o. $200. T!# initial

argin r#6uir# #nt is $10 an' t!# aint#nan$# argin is $0. T!# tra'#r &u3 .i2# $ontra$ts an' '#%osits $+0 :+ $onta$ts ( $10;
1! A! $, B! 30 C! $1 "! $$ (! A! $0 B! 21 C! $0 "! $$

How much profit are made for long position end of five da)s%

How much profit are made for short position end of five da)s%

Da3 0 - &he ending "alance is ',0.

Da3 1 - &he price moves to '199.,0. &he ad>ustment that needs to "e made is *'$.,0 $00*199., x , contracts#. &he ending "alance is now '2/.,0 ',0 * $.,0#. Since this is a"ove the maintained margin '00# no funds need to "e added to the account. Da3 2 - &he price moves down to '19,. &he loss, "ased on five contracts, is '$$.,0, so the account "alance is '$,. &his is "elow the maintenance margin. &he trader will receive a margin call and will need to deposit '$, into the account to "ring it "ac9 up to the initial margin re8uirement. &his continues over the course of the trade until it is closed out. 4lease follow the following charts( 3or a long position of five contracts, initial margin + ',, maintenance margin +'0 En'i ng <ala >ain1Loss n$#

<#ginning Fun's S#ttl# Da3 <alan$# D#%osit#' =ri$# 0 1 $ 0 0 $, $0 1, $, 0 0 0 ,0 29.5 2! 2!.,

Futur# #nt =ri$# C!ang#

*0.2 *1.5 0.,

*$ *! $.,

$0 1, 1/., $1.$ , 00

2 ,

1/., $1.$,

0 0

29.$, ,1

0./, 1./,

0./, !./,

3or a short position of five contracts, initial margin + ',, maintenance margin +'0 Futur# =ri$# En'ing C!ang# >ain1Loss <alan$#

Da3 0 1 $ 0 2 ,

<#ginning <alan$# 0 $, $/ 0, 0$., $!./,

Fun's S#ttl# D#%osit#' =ri$# $, 0 0 0 0 0 ,0 29.5 2! 2!., 29.$, ,1

#nt

0.2 1.5 *0., *0./, *1./,

$ ! *$., *0./, *!./,

$/ 0, 0$., $!./, $0

4. ?@m selling 1 million "arrels of crude oil. &he spot price for a "arrel is '19 per "arrel and the 0*month futures price is '1!./, per "arrel.

1! &hree month later sport price '1/.,0, how much profit or loss will it ma9e% A. $1.2+ B. '*1.$, :. '0./, ;. '1.$$ Spot price in three months proves to "e '1/.,0( ? gain '1!./,*'1/.,0+'1.$, per "arrel from the futures "ut ?@m selling the oil for '1.$, less per "arrel. ? end up getting '1!./, per "arrel.

ASpot price in three months proves to "e '19.,0( ? lose '19.,0*'1!./,+'0./, per "arrel from the futures "ut ?@m selling the oil for '0./, more per "arrel. ? end up getting '1!./, per "arrel. 5. Hedging period 0 months, 3utures contract expires in 2 months Be@re exposed to "asis ris9 Suppose 31 + '10, and S1 +100 :urrent "asis + 100 * 10, + *, Basis in 0 months is uncertain

Bhat is "asis in 2 months% A. '9, B. '!! C. $7, ;. '90 Answer( 2 2 ?f 3$ + 110 and S$ + '10$ Cong Hedge 3 3 2 <ain + 110 * 10, + ', Dffective cost + 10$ * , + '9/

Short Hedge 3 3 <ain + 10, * 110 + ' *, EealiFed effective# price + 10$ G *,# + '9/

2 2 2

3uture "asis + 10$ * 110 + *! 3ormula( EealiFed 4rice + 31 G "asis$ EealiFed 4rice + 10, G *!# + '9/