DERIVATIVES

CHAPTER – 03

DERIVATIVES
PART – 01: OPTION

(I) BASICS

Question – 01
The equity share of VCC Ltd. is quoted at ₹ 210. A 3-month call option is
available at a premium of ₹ 6 per share and a 3-month put option is available
at a premium of ₹ 5 per share. Ascertain the net payoffs to the option holder of
a call option and a put option separately.

(i) The strike price in both cases in ₹ 220; and

(ii) The share price on the exercise day is ₹ 200,210,220,230,240.

Also indicate the price range at which the call and the put options may be
gainfully exercised.

(SM TYK – 20)

Solution:

Net payout for the holder of the call option

Share Price Action Gross Payoff Premium Net Payoff

200 Lapsed 0 6 (6)
210 Lapsed 0 6 (6)
220 Lapsed 0 6 (6)
230 Exercised 10 6 4
240 Exercised 20 6 14

Net payoff for the holder of the put option

Share Price Action Gross Payoff Premium Net Payoff

200 Exercised 20 5 15
210 Exercised 10 5 5
220 Lapsed 0 5 (5)

Whats App Pavan Sir 3.1

Only for study related doubts
99772-13599
 DERIVATIVES

230 Lapsed 0 5 (5)

240 Lapsed 0 5 (5)

The call option can be exercised gainfully for any price above ₹ 226 (₹ 220 + ₹
6) and put option for any price below ₹ 215 (₹ 220 − ₹ 5).

Question – 02
Hari is holding 100 equity shares of VCC Ltd. which is being quoted at ₹ 210
per share. He is interested in hedging downside risk of his holding as he is
going to sell them after 2 month. A 2-month Call option is available at a
premium of ₹ 6 per share and a 2- month put option is available at a premium
of ₹ 5 per share. The strike price in both cases is ₹ 220.You are required to:

(i) Suggest the position Hari should take in the option market to hedge his
holding in the VCC Ltd.

(ii) Calculate his final position after 2 months if after 2 months i.e. on the
day of exercise the actual market price of per share of VCC Ltd. happens
to be ₹ 200, ₹ 210, ₹ 220, ₹ 230 and ₹ 240.

(MTP October – 2023)

Solution:

(i) Since Hari holds 100 equity shares, he should buy equal no. of Put
option i.e. 100 put options in the same stock to hedge his position.

Total Premium amount to be paid = 5 × 100 Put = ₹ 500

(ii) Net Position after 2-months

Share Action Gross Pre- Net Sell Net Total

Price Payoff mium Payoff Share Position Position
200 Exercised 20 5 15 200 215 21,500
210 Exercised 10 5 5 210 215 21,500
220 Lapsed 0 5 (5) 220 215 21,500
230 Lapsed 0 5 (5) 230 225 22,500
240 Lapsed 0 5 (5) 240 235 23,500

Thus, from above table it can be observed in any case the value of
holding of Hari in VCC Ltd. shall not go below ₹ 215 per share.

Whats App Pavan Sir 3.2

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 03
Mr. A is holding 1,000 shares of face value of ₹ 100 each of M/s. ABC Ltd. He
wants to hold these shares for long term and have no intention to sell.

On 1st January 2020, M/s. XYZ Ltd. has made short sales of M/s. ABC Ltd.‟s
shares and approached Mr. A to lend his shares under Stock Lending Scheme
with following terms:

(i) Shares to be borrowed for 3 months from 1st January 2020 to 31st March
2020.

(ii) Lending Charges/Fees of 1% to be paid every month on the closing price

of the stock quoted in Stock Exchange and

(iii) Bank Guarantee will be provided as collateral for the value as on 1st
January 2020.

Other Information :

(a) Cost of Bank Guarantee is 8% per annum.

(b) On 29th February 2020 M/s. ABC Ltd. declared dividend of 25%.

(c) Closing price of M/s. ABC Ltd.‟s shares quoted in Stock Exchange on
various dates are as follows :

Date Share Price in Share Price in

Scenario – 1 Bullish Scenario – 2 Bearish
1st January 2020 1,000 1,000
31st January 2020 1,020 980
29th February 2020 1,040 960
31st March 2020 1,050 940

You are required to find out :

(i) Earnings of Mr. A through Stock Lending Scheme in both the scenarios,

(ii) Total earnings of Mr. A during 1st January 2020 to 31st March 2020 in
both the scenarios,

(iii) What is the profit or loss to M/s. XYZ by shorting the shares using
through Stock Lending Scheme in both the scenarios ?

(Exam January – 2021)

Whats App Pavan Sir 3.3

Only for study related doubts
99772-13599
 DERIVATIVES

Solution:

1. Earnings of Mr. A

I II
Lending Charges
31/01/2020 10.20 9.80
29/02/2020 10.40 9.60
31/03/2020 10.50 9.40
Lending Charges 31.10 28.80
(×) No. of Shares 1,000 1,000
Earnings 31,100 28,800

2. Total Earnings of Mr. A

I II
Lending Charges 31.10 28.80
(+) Dividend [100 × 25%] 25.00 25.00
56.10 53.80
(×) No. of Shares 1,000 1,000
Total 56,100 53,800

3. Profit/Loss to M/s XYZ

I II
Lending Charges (31.10) (28.80)
Bank Guarantee [1,000 × 8% × 3/12] (20.00) (20.00)
Gain/Loss on Short Selling (50.00) 60.00
(101.10) 11.20
(×) No. of Shares 1,000 1,000
Gain/Loss (1,01,100) 11,200

(II) OPTION STRATEGIES

Question – 04
Mr. X established the following strategy on the Delta Corporation‟s stock :

(1) Purchased one 3-month call option with a premium of ₹ 30 and an

exercise price of ₹ 550.

Whats App Pavan Sir 3.4

Only for study related doubts
99772-13599
 DERIVATIVES

(2) Purchased one 3-month put option with a premium of ₹ 5 and an

exercise price of ₹ 450.

Delta Corporation‟s stock is currently selling at ₹ 500.

CALCULATE profit or loss, if the price of Delta Corporation‟s stock:

(i) remains at ₹ 500 after 3 months.

(ii) falls at ₹ 350 after 3 months.

(iii) rises to ₹ 600.

Assume the option size is 100 shares of Delta Corporation.

(MTP April – 2022, SM TYK – 19)

Solution:

Calculation of Profit & Loss

(i) Price of share on maturity ₹ 500: In this situation, Mr. X will not
exercise call option & put option, hence

Gross Payoff =0

(-) Cost of Strategy = ₹ 35

Loss = ₹ 35

Loss on 100 shares (₹ 35 × 100) = ₹ 3,500

(ii) Price of share ₹ 350: In this situation, Mr. X will exercise his put option
& call option will lapse

Gross Payoff (450 – 350) = ₹ 100

(-) Cost of Strategy = ₹ 35

Profit = ₹ 65

Profit on 100 shares (₹ 65 × 100) = ₹ 6,500

(iii) Price of share ₹ 600: In this situation, Mr. X will exercise his call option
& put option will lapse

Whats App Pavan Sir 3.5

Only for study related doubts
99772-13599
 DERIVATIVES

Gross Payoff (600 – 550) = ₹ 50

(-) Cost of Strategy = ₹ 35

Profit = ₹ 15

Profit on 100 shares (₹ 15 × 100) = ₹ 1,500

Question – 05
The market received rumour about ABC corporation‟s tie-up with a
multinational company. This has induced the market price to move up. If the
rumour is false, the ABC corporation stock price will probably fall dramatically.
To protect from this an investor has bought the call and put options.

He purchased one 3 months call with a striking price of ₹ 42 for ₹ 2 premium,

and paid Re.1 per share premium for a 3 months put with a striking price of `
40.

(i) Determine the Investor‟s position if the tie up offer bids the price of ABC
Corporation‟s stock up to ₹ 43 in 3 months.

(ii) Determine the Investor‟s ending position, if the tie up program me fails
and the price of the stocks falls to ₹ 36 in 3 months.

(SM TYK – 16)

Solution:

Cost of Strategy Assume = 100 shares

Cost = (₹ 2 + ₹ 1) × 100 shares

= ₹ 300

Price of Shares ₹ 43

In this situation call option will exercise & put option will lapse

Gross payoff (43 – 42) =₹1

(−) Cost of Strategy =₹3

Loss =₹2

(×) No. of shares = 100

Whats App Pavan Sir 3.6

Only for study related doubts
99772-13599
 DERIVATIVES

Loss = ₹ 200

Price of Shares ₹ 36

In this situation call option will Lapse & put option will Exercise

Gross payoff (40 – 36) =₹4

(−) Cost of Strategy =₹3

Gain =₹1

(×) No. of shares = 100

Gain = ₹ 100

(III) OPTION PRICING & VALUATION

EXPECTED VALUE OF OPTION

Question – 06
Equity share of PQR Ltd. is presently quoted at ₹ 320. The Market Price of the
share after 6 months has the following probability distribution:

Market Price ₹ 180 260 280 320 400

Probability 0.1 0.2 0.5 0.1 0.1

A put option with a strike price of ₹ 300 can be written.

You are required to find out expected value of option at maturity (i.e. 6 months)

(SM TYK – 17)

Solution:

Expected Value of Option

Share Price Action Gross Pay Off Probability Gross Pay Off
× Probability
180 Exercised 120 0.1 12
260 Exercised 40 0.2 8
280 Exercised 20 0.5 10
320 Lapsed 0 0.1 0
400 Lapsed 0 0.1 0
Expected Value of Option ₹ 30

Whats App Pavan Sir 3.7

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 07
You had purchased a 3 month call option on the Equity shares of Satya Ltd for
a premium of ₹ 30 each, the current market price of the share is ₹ 560 and the
exercise price is ₹ 590. You expect the price range between ₹ 540 to ₹ 640.

The expected share price of Satya Ltd and related probability is given below:

Expected price (₹) 540 560 580 600 620 640

Probability 0.10 0.15 0.05 0.35 0.20 0.15

Compute the followings:

(i) Expected share price at the end of 3 months,

(ii) Value of call option at the end of 3 months, if the exercise price prevails,

(iii) In case the option is held to its maturity, what will be the expected value
of the call option?

(iv) Find out the price of the shares quoted at the stock exchange to get the
value of the call option as computed in (iii) above.
(Exam May – 2022)

Solution:

(i) Expected Share Price

Expected Price = (540 × 0.10) + (560 × 0.15) + (580 × 0.05) + (600 ×

0.35) + (620 × 0.20) + (640 × 0.15)

= ₹ 597

(ii) Value of Call Option, If Exercise Price Prevails

[अगर Maturity को Exercise Price ी Market Price ोग]

Value of Call = 590 – 590 = 0

(iii) Expected Value of Option

Share Action Gross Pay Off Probability Gross Pay Off

Price × Probability
540 Lapsed 0 0.10 0
560 Lapsed 0 0.15 0
580 Lapsed 0 0.05 0

Whats App Pavan Sir 3.8

Only for study related doubts
99772-13599
 DERIVATIVES

600 Exercised 10 0.35 3.50

620 Exercised 30 0.20 6.00
640 Exercised 50 0.15 7.50
₹ 17

(iv) Price of Share so that Value of Call be ₹ 17

Price of Share = 590 + 17

= ₹ 607

BINOMIAL MODEL

Question – 08
The current market price of an equity share of Penchant Ltd is ₹ 420. Within a
period of 3 months, the maximum and minimum price of it is expected to be ₹
500 and ₹ 400 respectively. If the risk free rate of interest be 8% p.a., what
should be the value of a 3 months Call option under the “Risk Neutral” method
at the strike rate of ₹ 450?
Given e0.02 = 1.0202

(SM TYK – 24)

Solution:

Step 1: Given

S = ₹ 420

₹ 500
us = = ₹ 1.1905
₹ 420

₹ 400
ds = = ₹ 0.9524
₹ 420

E = ₹ 450

3
R =8× = 2%
12

E0.02 = 1.0202

Whats App Pavan Sir 3.9

Only for study related doubts
99772-13599
 DERIVATIVES

Step 2: Risk Neutral Probability

ert − d 1.0202 – 0.9524

P = = = 0.2844
u–d 1.1905 – 0.9524

Step 3: Binomial Tree

Step 4: Value of Call Option

Cup + Cd (1 – p)
C0 =
e rt

(50 × 0.2844) + (0 × 0.7156)

=
1.0202

= ₹ 13.94

Question – 09
Sumana wanted to buy shares of ElL which has a range of ₹ 411 to ₹ 592 a
month later. The present price per share is ₹ 421. Her broker informs her that
the price of this share can sore up to ₹ 522 within a month or so, so that she
should buy a one-month CALL of ElL. In order to be prudent in buying the call,
the share price should be more than or at least ₹ 522 the assurance of which
could not be given by her broker.

Though she understands the uncertainty of the market, she wants to know the
probability of attaining the share price ₹ 592 so that buying of a one-month
CALL of EIL at the execution price of ₹ 522 is justified. Advice her. Take the
risk-free interest to be 3.60% and e0.036 = 1.037.

(SM TYK – 21)

Solution:

Whats App Pavan Sir 3.10

Only for study related doubts
99772-13599
 DERIVATIVES

Risk Neutral Probability

ert – d
P =
u–d

ert = e0.036 = 1.037

592
u = = 1.4062
421

411
d = = 0.9762
421

1.037 – 0.9762
P = = 0.1414
1.4062 – 0.9762

TWO PERIOD BINOMIAL MODELS

Question – 10
A two year tree for a share of stock in ABC Ltd., is as follows:

Consider a two years American call option on the stock of ABC Ltd., with a
strike price of ₹ 98. The current price of the stock is ₹ 100. Risk free return is 5
per cent per annum with a continuous compounding and e0·05 = 1.05127.
Assume two time periods of one year each.

Using the Binomial Model, calculate:

(i) The probability of price moving up and down;

(ii) Expected pay offs at each nodes i.e. N1, N2 and N3 (round off upto 2
decimal points).
(Exam Nov – 2020)

Whats App Pavan Sir 3.11

Only for study related doubts
99772-13599
 DERIVATIVES

Solution:

Step 1: Binomial Tree E = 98

116.64
0.78
14.79
18.64
₹ 108
0.78
N2 0.22
₹ 100 102.60
0.78
N1 3.41
4.60
0.22
₹ 95

N3
0.22 90.25

Step 2: Risk Neutral Probability 0

ert – d
P =
u–d

1.05127 – 0.95
P =
1.08 – 0.95

= 0.78

Step 3: Value of Option

N2

(18.64 × 0.78) + (4.60 × 0.22)

C0 =
1.0512

= 14.79

Intrinsic Value = 108 – 98

= ₹ 10

Hence, value of option at node 2 is ₹ 14.79

Whats App Pavan Sir 3.12

Only for study related doubts
99772-13599
 DERIVATIVES

N3

(4.60 × 0.78) + (0 × 0.22)

C0 =
1.0512

= 3.41

Intrinsic Value =0

Hence, value of option at node 3 is ₹ 3.41

N1

(14.79 × 0.78) + (3.41 × 0.22)

C0 =
1.0512

= 11.69

Intrinsic Value =2

Hence, value of call today is ₹ 11.69

Question – 11
Consider a two-year call option with a strike price of ₹ 50 on a stock the
current price of which is also ₹ 50. Assume that there are two-time periods of
one year and in each year the stock price can move up or down by equal
percentage of 20%. The risk-free interest rate is 6%. Using binominal option
model, calculate the probability of price moving up and down. Also draw a two-
step binomial tree showing prices and payoffs at each node.

(SM TYK – 23)

Whats App Pavan Sir 3.13

Only for study related doubts
99772-13599
 DERIVATIVES

Solution:

(i) Binomial Tree

Year 2

Year 1 72
0.65
₹ 13.49 D 22
₹ 60
₹ 8.272 0.65
B ₹ 10 0.35
₹ 50 48
0.65
A 0
E 4.60
0.35
₹ 40

C
0.35 32

F 0
(ii) Risk Neutral Probability

R = 6%, u = 1.20, d = 0.80

R−d 1.06 – 0.80

P = = = 0.65
u−d 1.20− 0.80

(iii) Value of Option

(22 × 0.65) + (0 × 0.35)

Node B = = ₹ 13.49
1.06

P.V. of Expected Payoff = ₹ 13.49

Intrinsic Value = ₹ 10

Value of option at Node B (Higher) = ₹ 13.49

Node C Value of Option =0

(₹ 13.49 × 0.65) + (0 × 0.35)

Node A = = ₹ 8.272
1.06

Whats App Pavan Sir 3.14

Only for study related doubts
99772-13599
 DERIVATIVES

Intrinsic Value = 50 – 50 = 0

Hence Value of Call Option today is ₹ 8.272

DELTA HEDGING BINOMIAL MODEL

Question – 12
Mr. Dayal is interested in purchasing equity shares of ABC Ltd. which are
currently selling at ₹ 600 each. He expects that price of share may go upto ₹
780 or may go down to ₹ 480 in three months. The chances of occurring such
variations are 60% and 40% respectively. A call option on the shares of ABC
Ltd. can be exercised at the end of three months with a strike price of ₹ 630.

(i) What combination of share and option should Mr. Dayal select if he
wants a perfect hedge?

(ii) What should be the value of option today (the risk free rate is 10% p.a.)?

(iii) What is the expected rate of return on the option?

(SM TYK – 22)

Solution:

Given: S = ₹ 600

us = ₹ 780

ds = ₹ 480

Period = 3 Months

E = ₹ 630

Option = Call

Delta Hedging

₹ 780 Cu = 150

₹ 600

₹ 480 Cd = 0

Whats App Pavan Sir 3.15

Only for study related doubts
99772-13599
 DERIVATIVES

(i) Combination of Shares & Options

Cu – Cd
Delta of Call =
us − ds

150 – 0
= = 0.5
₹ 780 − ₹ 480

Write a Call Option & buy 0.5 share today for perfect hedge.

(ii) Cash Flow

(1) Price = ₹ 780

Call Option Exercised = (150)

Sell Shares (₹ 780 × 0.5) = 390

Cash Inflows = 240

(2) Price = ₹ 480

Call Option Lapsed =0

Sell Shares (₹ 480 × 0.5)= 240

Cash Inflows = 240

240
Present Value Cash Inflow =
1.025

= 234.15

Value of Call = 0.5 × 600 – 234.15

= ₹ 65.85

(3) Cost of option = 65.85

Expected Profit = (150 × 0.6) + (0 × 0.5)

= ₹ 90

90 – 65.85
Expected Rate of Return = × 100
65.85

= 36.67%

Whats App Pavan Sir 3.16

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 13
Following is the information available pertaining to shares of Omni Ltd.:

Current Market Price (₹) ₹ 420.00

Strike Price (₹) ₹ 450.00
Maximum Price (₹) expected in next 3 months‟ time ₹ 525.00
Minimum Price (₹) expected in next 3 months‟ time ₹ 378.00
Continuously Compounded Rate of Interest (p.a.) (%) 8.00%
ert 1.0202

From the above:

(i) Calculate the 3 months call option by using Binomial Method and Risk
Neutral Method. Are the calculated values under both the models are
same?

(ii) State also clearly the basis of Valuation of options under these models.

(Exam Nov – 2023)

Solution:

(i) (1) Call Option value using Binomial Model

₹ 75 − 0
∆= = 0.51
₹ 525 − ₹ 378

Delta of Call = 0.51 means write 1 call & buy 0.51 share.

Initial Cash Outflows = 420 × 0.51= 214.20

Cash Flows on Maturity

If price 525

Whats App Pavan Sir 3.17

Only for study related doubts
99772-13599
 DERIVATIVES

Sell share (525 × 0.51) = 267.75

Call Exercise = (75)

Cash Inflows = 192.75

If price 378

Sell Share (378 × 0.51) = 192.78

Call Lapse =0

Cash Inflows = 192.78

192.78
P.V. off payoff = = 188.96
1.0202

C0 = 214.20 – 188.96 = ₹ 25.24

(2) Value of Call Option using Risk Neutral Method

Let „‟P‟ be the probability of Price increase, then

p × 525 + (1 − p) × 378 = 420(1.0202)

147p = 50.48

p = 0.34

Probability of Price increase = 0.34

Probability of Price decrease = 0.66

0.34 × 75 + 0.66 × 0
= ₹ 25.24
1.0202

Yes, the value of option under both Models is same.

(ii) Basis of valuation of options :

 Binomial model uses an approach called “Risk less Hedge

Approach” to find the price of the option, by creating a portfolio
which will have same value at expiration irrespective of any price.

Whats App Pavan Sir 3.18

Only for study related doubts
99772-13599
 DERIVATIVES

Hedge means to create an equal and opposite position for

protecting the value of portfolio.

 In Risk Neutral Model, valuation of options is based on arbitrage

and is therefore independent of risk preferences; one should be
able to value options assuming any set of risk preferences and get
the same answer.

BLACK SCHOLES MODEL

Question – 14
From the following data for certain stock, find the value of a call option:

Price of stock now = ₹ 80

Exercise price = ₹ 75

Standard deviation of continuously compounded

annual return = 0.40

Maturity period = 6 months

Annual interest rate = 12%

Given

Number of S.D. from Mean, (z) Area of the left or right (one tail)

0.25 0.4013

0.30 0.3821

0.55 0.2912

0.60 0.2743

e0.12×0.5 = 1.062

In 1.0667 = 0.0646

(SM TYK – 25)

Solution:

Working Note 1: d1 & d2

Whats App Pavan Sir 3.19

Only for study related doubts
99772-13599
 DERIVATIVES

S (σ) 2
Ln 0 + r + t
E 2
d1 =
σ t

80 (0.40)2
Ln + 0.12 + 0.5
75 2
d1 =
0.400.5

Ln 1.0667 + 0.10
d1 =
0.2828

0.0646 + 0.10
d1 = = 0.5820
0.2828

d2 = d1 − σt

= 0.5820 – 0.2828 = 0.2992

Working Note 2: n (d1) & (d2)

[BSM म मश Cumulative Area  खन ै । But d1 & d2 negative दय ै तो दिर म
Tail Aera  खेग]

d1 = 0.5820

n(d1) =

0.55 0.2912

0.60 0.2743

0.05 0.0169

0.0169
n(d1) = 0.2912 −  × 0.032
0.05

n(d1) = 0.2804

n(d1) = 1 – 0.2804 = 0.7196

d2 = 0.2992

n(d2) =

Whats App Pavan Sir 3.20

Only for study related doubts
99772-13599
 DERIVATIVES

0.25 0.4013

0.30 0.3821

0.05 0.0192

0.0192
n(d2) = 0.4013 −  × 0.0492
0.05

n(d2) = 0.3824

n(d2) = 1 – 0.3824 = 0.6176

E
C0 = S0 × n(d1) − × n(d2)
ert

75
= 80 × 0.7196 – × 0.6176
e0.12 × 0.5

75
= 80 × 0.7196 – × 0.6176
1.062

= ₹ 13.952

Question – 15
The shares of TIC Ltd. are currently priced at ₹ 415 and call option exercisable
in three months‟ time has an exercise rate of ₹ 400. Risk free interest rate is
5% p.a. and standard deviation (volatility) of the share price is 22%. The TIC
Ltd. is not going to declare any dividend over the next three months.

(i) DECIDE whether the option worth buying for ₹ 25.

(ii) CALCULATE the value of aforesaid call option if the current price of
share is considered as ₹ 380.

(iii) CALCULATE the value of aforesaid call option if present price of share is
taken as ₹ 408 and a dividend of ₹ 10 is expected to be paid in the two
months‟ time.

Given

In(1.0375) = 0.03681, In(0.95) = -0.05129 and In(0.9952) = -0.00481

e0.0125 = 1.0126 and e0.00833 = 1.0084

Cumulative Area of Number of S.D. from Mean (z)

Whats App Pavan Sir 3.21

Only for study related doubts
99772-13599
 DERIVATIVES

Z 0.0150 0.1250 0.3933 0.5033 -0.2976 -0.4076

Area 0.5060 0.5497 0.6530 0.6926 0.3830 0.3418

(MTP Oct – 2022)

Solution:

(1) Current Price of share of TIC Ltd. = ₹ 415

Exercise rate = ₹ 400

Risk free interest rate is = 5% p.a.

SD (Volatility) = 22%

Based on the above bit is calculated value of an option based on Black

Scholes Model:

415 1
In
400
 +0.05 +20.222 0.25
d1 =
0.220.25

0.03681+ 0.01855
= = 0.5033
0.11

415 1
In
400
 +0.05 - 20.222 0.25
d2 =
0.220.25

0.03681+ 0.00645
= = 0.3933
0.11

E
Vo = Vs N(d1) − N(d2)
ert

N(d1) = N (0.5033) = 0.6926

N(d2) = N (0.3933) = 0.6530

400
Value of Option = 415(0.6926) − (0.6530)
e(0.05)(0.25)

400
= 287.43 − (0.6530)
1.0126

Whats App Pavan Sir 3.22

Only for study related doubts
99772-13599
 DERIVATIVES

= 287.43 – 257.95 = ₹ 29.48

Since market price of ₹ 25 is less than ₹ 29.48 (Black Scholes Valuation

Model) indicate that option is underpriced, hence worth buying.

Extra Work

Value of Put Option: अगर Value of Call दय हआ ै तो Value of Put, Put
Call Parity स Calculate दकय ज सकत ै ।

Put Call Parity:

S0 + P0 = C0 + P.V. of EP

400
415 + P0 = 29.48 +
1.0126

P0 = 9.50

Black Scholes Model:

E
× N(-d2) – S0 N(-d1)
ert
400
× 0.347 – 415 × 0.3074
1.0126

P0 = 9.50

(2) If the current price is taken as ₹ 380 the computations are as follows:

380 1
In
400
 +0.05 + 20.222 0.25
d1 =
0.220.25

-0.05129 + 0.01855
= = - 0.2976
0.11

380 1
In
400
 +0.05 − 20.222 0.25
d2 =
0.220.25

-0.05129 + 0.00645
= = - 0.4076
0.11

N(d1) = N (- 0.2976) = 0.3830

Whats App Pavan Sir 3.23

Only for study related doubts
99772-13599
 DERIVATIVES

N(d2) = N (- 0.4076) = 0.3418

400
Value of Option = 380(0.3830) − (0.3418)
e(0.05)(0.25)

400
= 145.54 − (0.3418)
1.0126

= 145.54 – 135.02 = ₹ 10.52

(3) Since dividend is expected to be paid in two months time was we have to
adjust the share price and then use Black Scholes model to value the
option:

Present Value of Dividend (using continuous discounting)

= Dividend ÷ ert

= ₹ 10/1.0084 = ₹ 9.92

Adjusted price of shares is ₹ 408.00 − ₹ 9.92 = ₹ 398.08

This can be used in Black Scholes model

398.08 1
In
400
 +0.05 +20.222 0.25
d1 =
0.220.25

-0.00481 + 0.01855
= = 0.1250
0.11

398.08 1
In
400
 +0.05 − 20.222 0.25
d2 =
0.220.25

-0.00481 + 0.00645
= = 0.0150
0.11

N(d1) = N (0.1250) = 0.5497

N(d2) = N (0.0150) = 0.5060

400
Value of Option = 398.08(0.5497) − (0.5060)
e(0.05)(0.25)

Whats App Pavan Sir 3.24

Only for study related doubts
99772-13599
 DERIVATIVES

400
= 218.82 − (0.5060)
1.0126

= 218.82 – 199.88 = ₹ 18.94

PART – 02: FUTURE

(V) MARGIN A/C

Question – 16
On 31/08/2021 Mr. R has taken a Long position of Two lots of Nifty Futures at
17300.

One lot of Nifty future is 50 units.

Initial Margin required is 10% of Contract Value.

Maintenance Margin required is 80% of Initial Margin.

The closing price of 5 days are given below –

Date Closing Price of Nifty Future

01/09/2021 17340
02/09/2021 17180
03/09/2021 16990
06/09/2021 16900
07/09/2021 17120

You are required to-

(i) Prepare a statement showing the daily balances in the margin account &
payment on margin calls, if any.

(ii) Compute the Gain or Loss of Mr. R, if contract squared off on

07/09/2021.

(iii) What would be the Gain or Loss if Mr. R, had taken the short position?

(Exam December – 2021)

Solution:

Initial Margin = [17,300 × 50 × 2] × 10%

= ₹ 1,73,000

Whats App Pavan Sir 3.25

Only for study related doubts
99772-13599
 DERIVATIVES

Maintenance Margin = ₹ 1,73,000 × 80%

= ₹ 1,38,400

(i) Margin Account

Date Closing Profit/Loss Balance Margin

Price Call
31/08/2021 17,300 − 1,73,000 −
01/09/2021 17,340 40 × 100 = +4,000 1,77,000 −
02/09/2021 17,180 -160 × 100 = -16,000 1,61,000 −
03/09/2021 16,990 -190 × 100 = -19,000 1,42,000 −
06/09/2021 16,900 -90 × 100 = -9,000 1,73,000 40,000
07/09/2021 17,120 +220 × 100 = 22,000 1,95,000 −

(ii) Gain or Loss

Closing Balance = ₹ 1,95,000

(-) Initial Margin = ₹ 1,73,000

(-) Variation Margin = ₹ 40,000

Loss = ₹ 18,000

OR

(17,300 – 17,120) × 100 = 18,000 (Loss)

(iii) Gain or Loss (Short Position)

Margin Account

Date Closing Profit/Loss Balance Margin

Price Call
31/08/2021 17,300 − 1,73,000 −
01/09/2021 17,340 -40 × 100 = -4,000 1,69,000 −
02/09/2021 17,180 160 × 100 = 16,000 1,85,000 −
03/09/2021 16,990 190 × 100 = 19,000 2,04,000 −
06/09/2021 16,900 90 × 100 = 9,000 2,13,000 −
07/09/2021 17,120 -220 × 100 = -22,000 1,91,000 −

Gain or Loss

Closing Balance = ₹ 1,91,000

Whats App Pavan Sir 3.26

Only for study related doubts
99772-13599
 DERIVATIVES

(-) Initial Margin = ₹ 1,73,000

Gain = ₹ 18,000

Question – 17
Sensex futures are traded at a multiple of 50. Consider the following quotations
of Sensex futures in the 10 trading days during February, 2009:

Day High Low Closing

4-2-09 3306.40 3290.00 3296.50

5-2-09 3298.00 3262.50 3294.40

6-2-09 3256.20 3227.00 3230.40

7-2-09 3233.00 3201.50 3212.30

10-2-09 3281.50 3256.00 3267.50

11-2-09 3283.50 3260.00 3263.80

12-2-09 3315.00 3286.30 3292.00

14-2-09 3315.00 3257.10 3309.30

17-2-09 3278.00 3249.50 3257.80

18-2-09 3118.00 3091.40 3102.60

Abhishek bought one sensex futures contract on February, 04. The average
daily absolute change in the value of contract is ₹ 10,000 and standard
deviation of these changes is ₹ 2,000. The maintenance margin is 75% of initial
margin.

You are required to determine the daily balances in the margin account and
payment on margin calls, if any.

(SM TYK – 14)

Solution:

Initial Margin =μ+3σ

= 10,000 + (3 × 2000)

= ₹ 16,000

Whats App Pavan Sir 3.27

Only for study related doubts
99772-13599
 DERIVATIVES

Maintenance Margin = 16,000 × 75%

= ₹ 12,000

Margin A/c (Long)

Day Closing Profit Loss Margin Balance

Price A/c (₹)
04/02/09 3296.50 - - 16,000

05/02/09 3294.40 (3294.40 – 3296.50) × 50 = -105 - 15,895

06/02/09 3230.40 (3230.40 – 3294.40) × 50 = - 3200 - 12,695

07/02/09 3212.30 (3212.30 – 3230.40) × 50 = - 905 4210 16,000

10/02/09 3267.50 (3267.50 – 3212.30) × 50 = - 2760 - 18,760

11/02/09 3263.80 (3263.80 – 3267.50) × 50 = -185 - 18,575

12/02/09 3292.00 (3292.00 – 3263.8) × 50 = 1410 - 19,985

14/02/09 3309.30 (3309.30 – 3292.00) × 50 = 865 - 20,850

17/02/09 3257.80 (3257.80 – 3309.30) × 50 = -2575 - 18,275

18/02/09 3102.60 (3102.60 – 3257.80) × 50 = -7760 5485 16,000

(VI) VALUATION OF FUTURE

Question – 18
The following data relate to Anand Ltd.'s share price:

Current price per share ₹ 1,800

6 months future's price/share ₹ 1,950

Assuming it is possible to borrow money in the market for transactions in

securities at 12% per annum, you are required:

(i) to calculate the theoretical minimum price of a 6-months forward

purchase; and

(ii) to explain arbitrate opportunity.

(SM TYK – 02)

Whats App Pavan Sir 3.28

Only for study related doubts
99772-13599
 DERIVATIVES

Solution:

(1) Theoretical Future Price

F = S (1 + r) – D

= 1,800 (1.06) – 6 = ₹1,908

= ₹435

(2) Arbitrage

(i) Action: Since future is overpriced, hence sell future & buy spot

(ii) Process

Today

- - Borrow ₹ 1,800 & buy stock

- Contract to sell such stock at future price ₹ 1,950

After 6 Months

Cash Inflows

Sell share at future price = ₹ 1,950

Cash outflows

Repayment of Borrowing ₹ 1,800 (1.06) = ₹ 1,908

Arbitrage Gain = ₹ 42

Question – 19
Calculate the price of 3 months PQR futures, if PQR (FV ₹ 10) quotes ₹ 220 on
NSE and the three months future price quotes at ₹ 230 and the one month
borrowing rate is given as 15 percent per annum and the expected annual
dividend is 25 percent, payable before expiry. Also examine arbitrage
opportunities.

(SM TYK – 04)

Solution:

(1) Theoretical Future Price

Whats App Pavan Sir 3.29

Only for study related doubts
99772-13599
 DERIVATIVES

F = S (1 + r) – D

= ₹ 220 (1.0375) – 2.5

= ₹ 225.75

(2) Arbitrage

(i) Action: Since future is overpriced. Hence, buy spot & sell future.

(ii) Process:

Today:

 Borrow ₹ 220 @ 15% p.a. for 3 months & buy spot

 Sell future @ 230

After 3 Months

Cash Flows = Sell Stock = +230

Dividend = +2.50

Repay 220(1.0375) = −228.25

Arbitrage Gain = 4.25

Question – 20
The share of X Ltd. is currently selling for ₹ 300. Risk free interest rate is 0.8%
per month. A three month futures contract is selling for ₹ 312. Develop an
arbitrage strategy and show what your riskless profit will be 3 months hence
assuming that X Ltd. will not pay any dividend in the next three months.

(SM TYK – 06)

Solution:

(I) Theoretical Future Price

F = S (1 + r)

= 300 × (1.008)3

= ₹ 307.26

Whats App Pavan Sir 3.30

Only for study related doubts
99772-13599
 DERIVATIVES

(II) Arbitrage

(i) Action: Since future is overpriced, hence buy spot & sell future.

(ii) Process

Today

 Borrow ₹ 300 @ 0.8% p.m. & buy share

 Sell future at ₹ 312

After 3 Months

Sell Stock = + 312

Repay 300(1.08)3 = 307.27

Arbitrage Gain = 4.74

Note: यदि rate per month दिया है तो monthly compounding लेना है।

Question – 21
The 6-months forward price of a security is ₹ 208.18. The borrowing rate is 8%
per annum payable with monthly rests. What should be the spot price?

(SM TYK – 01)

Solution:

Forward Price = S (1 + r)n

208.18 = S (1.0067)6

S = ₹ 200

Question – 22
On 31-8-2011, the value of stock index was ₹ 2,200. The risk free rate of return
has been 8% per annum. The dividend yield on this Stock Index is as under:

Month Dividend Paid p.a.

January 3%
February 4%
March 3%
April 3%
May 4%
June 3%

Whats App Pavan Sir 3.31

Only for study related doubts
99772-13599
 DERIVATIVES

July 3%
August 4%
September 3%
October 3%
November 4%
December 3%

Assuming that interest is continuously compounded daily, find out the future
price of contract deliverable on 31-12-2011. Given: e0.01583 = 1.01593

(SM TYK – 03)

Solution:

Average Dividend Yield

3+3+4+3
=
4

= 3.25% p.a.

F = S × e(r – d)t

= 2,200 × e(0.08 – 0.0325)4/12

= 2,200 × e0.01583

= 2,200 × 1.01593

= 2,235.046

Question – 23
The NSE-50 Index futures are traded with rupee value being ₹100 per index
point. On 15th September, the index closed at 1195, and December futures
(last trading day December 15) were trading at 1225. The historical dividend
yield on the index has been 3% per annum and the borrowing rate was 9.5%
per annum.

(i) Determine whether on September 15, the December futures were under-
priced or overpriced?

(ii) What arbitrage transaction is possible to gain out this mispricing?

(iii) Calculate the gains and losses if the index on 15thDecember closes at (a)
1260 (b) 1175.

Whats App Pavan Sir 3.32

Only for study related doubts
99772-13599
 DERIVATIVES

Assume 365 days in a year for your calculations

(Exam November – 2019)

Solution:

(I) Theoretical Future Price

Future Price = S × [1 + (r – d)t]

91
= 195 1 + (0.095 − 0.03) × 
365

= 1,214.37

Future Price = 1,214.37 × 100 = 1,21,437

Actual Future Price = 1,225 × 100 = 1,22,500

(i) Since actual future price is more than Theoretical Future Price
hence future is overpriced.

(ii) Since future is overpriced, hence buy spot & sell future [short
position]

(iii) - Borrow ₹ (1,195 × 100) @ 9.5% p.a. for 91 days & buy index

- Sell future (short position) at 1,225 × 100

After 91 Days

1260 1175
(1,260 × 100) (1,175 × 100)
Sell Index + 1,26,000 + 1,17,500
Dividend Received
91 + 893.79 + 893.79
1,195 × 3% ×  × 100
365

Repayment
91
1,195 1 + (0.095 × ) × 100 - 1,22,330.35 - 1,22,330.35
365

Gain/Loss on short position (-35 × 100) (+50 × 100)

= -3,500 = +5,000
Arbitrage 1,063.44 1,063.44

Whats App Pavan Sir 3.33

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 24
Suppose current price of an index is ₹ 13,800 and yield on index is 4.8% (p.a.).
A 6 months future contract on index is trading at ₹ 14,340.

Assuming that risk free rate of interest is 12%. Show Mr. X (an arbitrageur) can
earn an abnormal rate of return irrespective of outcome after 6 months . You
can assume that after 6 months index closes at ₹ 10,200 and ₹ 15,600 and
50% of stock included in index shall pay dividend in next 6 months. Also
Calculate implied risk free rate.

Solution:

Theoretical Future Price

F = 13,800(1.06)

= 13,800 × 50% × 4.8%

= 14,628 – 331.20

= 14,296.80

Since future is overpriced hence buy spot & sell future (short position)

After 6 Months 14340

10,200 15,600
Sell Index + 10,200 + 15,600
Dividend + 331.20 + 331.20
Buy Index (Spot) - 13,800 - 13,800
Gain/Loss on Short Position + 4,140 - 1,260
Arbitrage Gain 871.20 871.20

871.20 12
Implied Risk Free Rate = × 100 ×
13,800 6

= 12.63% p.a.

Note: जब भी Implied Risk Free Rate मा गग Borrowing नी ा न ै ।

Question – 25
A future contract is available on R Ltd. that pays an annual dividend of ₹4 and
whose stock is currently priced at ₹125. Each future contract calls for delivery

Whats App Pavan Sir 3.34

Only for study related doubts
99772-13599
 DERIVATIVES

of 1,000 shares to stock in one year, daily marking to market. The corporate
treasury bill rate is 8%.

Required:

(i) Given the above information, what should the price of one future
contract be?
(ii) If the company stock price decreases by 6%, what will be the price of
one futures contract?
(iii) As a result of the company stock price decrease, will an investor that
has a long position in one futures contract of R Ltd. realizes a gain or
loss ? What will be the amount of his gain or loss?

(Ignore margin and taxation, if any)

(Exam Nov – 2019)

Solution:

(i) Price of one future contract

F = S (1 + r) – D

= ₹ 125 (1.08) – 4

= ₹ 131

= 131 × 1,000 shares

= ₹ 1,31,000

(ii) If stock price decrease by 6%

S = 125 × 0.94 = 117.50

F = 117.50 (1.08) – 4

= ₹ 122.90

= ₹ 122.90 × 1,000 shares

= ₹ 1,22,900

(iii) Gain or Loss on Long Position

If stock price decrease then loss on long position

Whats App Pavan Sir 3.35

Only for study related doubts
99772-13599
 DERIVATIVES

(1,31,000 – 1,22,900) = 8,100 (Loss)

Question – 26
The price of ACC stock on 31 December 2010 was ₹ 220 and the futures price
on the same stock on the same date, i.e., 31 December 2010 for March 2011
was ₹ 230. Other features of the contract and related information are as
follows:
Time to expiration - 3 months (0.25 year)

Borrowing rate - 15% p.a.

Annual dividend on the stock - 25% payable before 31.03.2011

Face Value of the Stock - ₹ 10

i. Based on the above information, what should be the futures price?

ii. Show the process of arbitrage

Solution:

i. Futures price = 220 + (220 × 0.15 × 0.25) – (0.25 × 10) = 225.75

ii. He will buy the ACC stock at ₹ 220 by borrowing the amount @ 15 % for
a period of 3 months and at the same time sell the March 2011 futures
on ACC stock. By 31st March 2011, he will receive the dividend of ₹ 2.50
per share. On the expiry date of 31st March, he will deliver the ACC stock
against the March futures contract sales.

The arbitrager‟s inflows/outflows are as follows:

Sale proceeds of March 2011 futures ₹ 230.00

Dividend ₹ 2.50
Total (A) ₹ 232.50
Pays back the Bank ₹ 220.00
Cost of borrowing ₹ 8.25
Total (B) ₹ 228.25
Balance (A) – (B) ₹ 4.25

Thus, the arbitrage earns ₹ 4.25 per share without involving any risk.

Whats App Pavan Sir 3.36

Only for study related doubts
99772-13599
 DERIVATIVES

(VII) BETA MANAGEMENT

Question – 27
On April 1, 2015, an investor has a portfolio consisting of eight securities as
shown below:

Security Market Price No. of Shares Value

A 29.40 400 0.59
B 318.70 800 1.32
C 660.20 150 0.87
D 5.20 300 0.35
E 281.90 400 1.16
F 275.40 750 1.24
G 514.60 300 1.05
H 170.50 900 0.76

The cost of capital for the investor is 20% p.a. continuously compounded. The
investor fears a fall in the prices of the shares in the near future. Accordingly,
he approaches you for the advice to protect the interest of his portfolio.

You can make use of the following information:

(1) The current NIFTY value is 8500.

(2) NIFTY futures can be traded in units of 25 only.

(3) Futures for May are currently quoted at 8700 and Futures for June are
being quoted at 8850.

You are required to calculate:

(i) The beta of his portfolio.

(ii) The theoretical value of the futures contract for contracts expiring in May
and June. Given (e0.03 =1.03045, e0.04 = 1.04081, e0.05 =1.05127)

(iii) The number of NIFTY contracts that he would have to sell if he desires to
hedge until June in each of the following cases:

(A) His total portfolio

(B) 50% of his portfolio

(C) 120% of his portfolio

(SM TYK – 13)

Whats App Pavan Sir 3.37

Only for study related doubts
99772-13599
 DERIVATIVES

Solution:

(i) Calculation of Beta of Portfolio

Stocks Market No. of Value Weight Beta W×B

Price Shares
A 29.40 400 11,760 0.01182 0.59 0.0070
B 318.70 800 2,54,960 0.2564 1.32 0.3384
C 660.20 150 99,030 0.0996 0.87 0.0866
D 5.20 300 1,560 0.00157 0.35 0.0005
E 281.90 400 1,12,760 0.1134 1.16 0.1315
F 275.40 750 2,06,550 0.2077 1.24 0.2575
G 514.60 300 1,54,380 0.15524 1.05 0.1630
H 170.50 900 1,53,450 0.1543 0.76 0.1173
9,94,450 B.P = 1.102

(ii) Calculation of theoretical future price

May future (2 months)

F = Sert
= 8,500 × e0.20 × 2/12
= 8,500 × e0.0333

= 8,500 × 1.03387

= 8,787.89

Interpolation

e0.03------------------------ 1.03045

e0.0333

e0.04------------------------ 1.04081

e0.01 0.01036

0.01036
1.03045 + × 0.0033
0.01

= 1.03387

Whats App Pavan Sir 3.38

Only for study related doubts
99772-13599
 DERIVATIVES

June Future

F = 8,500 × e(0.20 × 3/12)

= 8,500 × 1.05127

= ₹ 8,935.79

(iii) Calculation of no. of contacts

VP × BT − BP 
No. of Contract =
F×M

(A) Total portfolio

9,94,450 × (0 − 1.102)
No of contracts =
8,850 × 25

= 4.95 Contracts

5 contracts sold

(B) 50% of Portfolio

9,94,450 × 50% × (0 − 1.102)
No of contracts =
8850 × 25

= 2.48 Contracts

2 contracts sold

(C) 120% of Portfolio

(9,94,450 × 120%) × (0 – 1.102)

No of contracts =
8850 × 25

= 5.94 Contracts

6 contracts sold.

Question – 28
Details about portfolio of shares of an investor is as below:

Shares No. of shares (Iakh) Price per share Beta

A Ltd. 3.00 ₹ 500 1.40

B Ltd. 4.00 ₹ 750 1.20

Whats App Pavan Sir 3.39

Only for study related doubts
99772-13599
 DERIVATIVES

C Ltd. 2.00 ₹ 250 1.60

The investor thinks that the risk of portfolio is very high and wants to reduce
the portfolio beta to 0.91. He is considering two below mentioned alternative
strategies:

(i) Dispose off a part of his existing portfolio to acquire risk free securities,
or

(ii) Take appropriate position on Nifty Futures which are currently traded at
8125 and each Nifty points is worth ₹ 200.

You are required to determine:

(1) Portfolio beta,

(2) The value of risk free securities to be acquired,

(3) The number of shares of each company to be disposed off,

(4) The number of Nifty contracts to be bought/sold; and

(5) The value of portfolio beta for 2% rise in Nifty.

(SM TYK – 12)

Solution:

1. Beta of Portfolio

Shares MPS No. Amount Weights Beta β×W

A 3.00 500 1,500 0.3 1.40 0.42
B 4.00 750 3,000 0.6 1.20 0.72
C 2.00 250 500 0.1 1.60 0.16
Vp = 5,000 Bp = 1.30

2. Value of Risk Free Securities

5,000 × 1.30− x ×1.30+ (x × 0)

0.91 =
5,000

x = 1,500

Whats App Pavan Sir 3.40

Only for study related doubts
99772-13599
 DERIVATIVES

ICAI

BT 0.91
Wp = = = 0.70
BP 1.30

Rf = 5,000 × 0.3 = 1,500

Investment in Rf = ₹ 1,500

3. No. of Shares

Shares Weights Amount MPS No. of Shares

(Lakh) in (Lakh)
A 0.3 450 500 0.9
B 0.6 900 750 1.20
C 0.1 150 250 0.6
1,500

4. No. of Nifty Contracts

VP × (BT − BP )
No. =
F×M

5,000 × (0.91 – 1.30)

=
8,125 × 200

= 120 Contracts Short

5. Value of Portfolio Beta

Portfolio (Bp = 1.30) Nifty 5,000(0.91 – 1.30)

₹ 5,000 Lakhs 1,950 Lakhs Short Position

Portfolio will rise by (2 × 1.30) Nifty rise by 2%

= 2.6%

Loss on Short Position of Nifty

Gain on Long Position 1,950 × 2% = -39
(5,000 × 2.6%) = +130

Whats App Pavan Sir 3.41

Only for study related doubts
99772-13599
 DERIVATIVES

Overall Gain OR Loss = +91 Lakhs

91
% of Gain/Loss = × 100 = 1.82%
5,000

∆ In Portfolio Return 1.82

Beta = = = 0.91
∆ In Market Rate 2

Question – 29
On January 1, 2013 an investor has a portfolio of 5 shares as given below:

Security Price No. of Shares Beta

A 349.30 5,000 1.15
B 480.50 7,000 0.40
C 593.52 8,000 0.90
D 734.70 10,000 0.95
E 824.85 2,000 0.85

The cost of capital to the investor is 10.5% per annum.

You are required to calculate:

(i) The beta of his portfolio.

(ii) The theoretical value of the NIFTY futures for February 2013.

(iii) The number of contracts of NIFTY the investor needs to sell to get a full
hedge until February for his portfolio if the current value of NIFTY is
5900 and NIFTY futures have a minimum trade lot requirement of 200
units. Assume that the futures are trading at their fair value.

(iv) The number of future contracts the investor should trade if he desires to
reduce the beta of his portfolios to 0.6.

No. of days in a year be treated as 365.

Given: In (1.105) = 0.0998 and e(0.015858) = 1.01598

(SM TYK – 11)

Solution:

Whats App Pavan Sir 3.42

Only for study related doubts
99772-13599
 DERIVATIVES

1. Beta of Portfolio

Shares MPS No. Amount Weights Beta β×W

A 349.30 5,000 17,46,500 0.093 1.15 0.107
B 480.50 7,000 33,63,500 0.178 0.40 0.071
C 593.52 8,000 47,48,160 0.252 0.90 0.227
D 734.70 10,000 73,47,000 0.380 0.95 0.370
0.074
E 824.85 2,000 16,49,700 0.087 0.85
Vp = 1,88,54,860 Bp = 0.849

2. Theoretical Future

F = S × ert

= 5,900 × e0.105 × 58/365

= 5,900 × e0.01668

= 5,900 × 1.01682

= 5,999.24

3. No. of Contracts (BT = 0)

VP × BT −BP 
No. =
F ×M

1,88,54,860 × 0 − 0.849
=
5,999.24 × 200

= 13.35 OR 13 Contracts Short

4. BT = 0.6

1,88,54,860 × 0.6 − 0.849

No. =
5,999.24 × 200

= 3.91 OR 4 Contracts Short

Question – 30
Following information is available for consideration:

BSE Index 25,000

Whats App Pavan Sir 3.43

Only for study related doubts
99772-13599
 DERIVATIVES

Value of portfolio ₹ 50,50,000

Risk free interest rate 9% p.a.

Dividend yield on Index 6% p.a.

Beta of portfolio 1.5

We assume that a future contract on the BSE index with 4 months maturity is
used to hedge the value of portfolio over next 3 months. One future contract is
for delivery of 50 times the index.

Based on the above information calculate:

(i) Price of future contract.

(ii) Gain on short futures position if index turns out to be 22,500 in 3

months.

Note: Daily compounding (exponential) formula is not required to be used.

(RTP May – 2022, Exam July – 2021)

Solution:

(i) Price of Future Contracts

F = S [1 + (r – d)t]

= 25,000 [1 + (0.09 – 0.06)4/12]

= ₹ 25,250

Price of 1 Future Contract = ₹ 25,250 × 50

= ₹ 12,62,500

Vp (BT − Bp )
No. of Contracts =
F ×M

50,50,000 × (0 – 1.5)
=
25,250 × 50

= 6 Contracts Short

Whats App Pavan Sir 3.44

Only for study related doubts
99772-13599
 DERIVATIVES

(ii) Gain or Loss on Short Position

3 months spot = 22,500

[मन Contract 4 month future पर दकय ै तो, 3 month क End पर कटन ै

Spot पर नी ा कट ग, य Contract 1 month future पर सौ कट ग]

1
F = 22,500 1 + (0.09 − 0.06) 
12

= 22,556.25

Gain on Short Position = (25,250 – 22,556.25) × 50 × 6

= ₹ 8,08,125

Question – 31
A Future contract on BSE Index with 4 months maturity is used to hedge the
value of the portfolio over the next 3 months. One future contract for delivery is
50 times of the index.

The following information is available :

Value of the portfolio ₹ 1,16,00,000

BSE Sensex on 1st January 2022 58,580

(Anticipated on 1st September 2021)

BSE Sensex on 1st January 2022 56641.25

(Anticipated on 1st December 2021)

Dividend Yield of Index 6% p.a

181 day‟s treasury bills offers a rate of interest 9% p.a.

Beta of the portfolio 1.5

You are required to calculate

(i) The present value of the Sensex as on 1st September 2021

(ii) Turned out value of the Sensex on 1st December 2021

(iii) The number of contracts to hedge the portfolio.

Whats App Pavan Sir 3.45

Only for study related doubts
99772-13599
 DERIVATIVES

(Exam December – 2021)

Solution:

(I) Spot (01/09/2021)

F = S [1 + (r – d)t]

₹ 58,580 = S [1 + (0.09 – 0.06)4/12]

S = ₹ 58,000

(II) Spot Rate (01/12/2021)

56641.25 = S [1 + (0.09 – 0.06) × 1/12]

S = ₹ 56,500

(III) No. of Contracts

VP BT −BP 
No. of Contracts =
F ×M

1,16,00,000 0 – 1.50
=
58,580 × 50

= 6 Contracts Short

Question – 32
Mr. X is having a portfolio of shares worth ₹ 170 lakhs at current price and
cash ₹ 30 lakhs. The beta of share portfolio is 1.6. After 3 months the price of
shares dropped by 3.2%.

Determine:

(i) Current portfolio beta.

(ii) Portfolio beta after 3 months if Mr. X on current date goes for long
position on ₹ 200 lakhs Nifty futures.

(Exam July – 2021)

Solution:

(I) Beta of Portfolio

Whats App Pavan Sir 3.46

Only for study related doubts
99772-13599
 DERIVATIVES

170 ×1.60 + (30 × 0)

BP =
200

= 1.36

(II) Beta After 3 Months

Price of shares dropped by 3.2%, It means Nifty dropped by

∆ Stock 3.2
β = = 1.6 = = 2%
∆ Market ∆ Market

Gain OR Loss

Portfolio (Long) Nifty

Share = 170 Lakhs 200 Lakhs (Long Position)
Cash = 30 Lakhs
Nifty down by 2%
Share price down 3.2%

200 × 2% = 4
Loss = (170 × 3.2%) = 5.44

Overall Gain OR Loss = 5.44 + 4 = 9.44

9.44
Loss in (%) = × 100 = 4.72%
200

4.72%
Beta = = 2.36
2%

Question – 33
Mr. SG sold five 4-Month Nifty Futures on 1st February 2020 for ₹ 9,00,000. At
the time of closing of trading on the last Thursday of May 2020 (expiry), Index
turned out to be 2100. The contract multiplier is 75.
Based on the above information calculate:

(i) The price of one Future Contract on 1st February 2020.

Whats App Pavan Sir 3.47

Only for study related doubts
99772-13599
 DERIVATIVES

(ii) Approximate Nifty Sensex on 1st February 2020 if the Price of Future
Contract on same date was theoretically correct. On the same day Risk
Free Rate of Interest and Dividend Yield on Index was 9% and 6% p.a.
respectively.

(iii) The maximum Contango/Backwardation.

(iv) The pay-off of the transaction.

Note: Carry out calculation on month basis.

(RTP November – 2020)

Solution:

(i) Price of One Future Contract

₹ 9,00,000
Price = = ₹ 1,80,000
5

₹ 1,80,000
F = = 2,400
75

(ii) Spot Price

F = S [1 + (r – d)t]

2,400 = S [1 + (0.09 – 0.06)4/12]

S = 2,376

(iii) Contango/Backwardation

Generally, Future is more than Spot, if Future is more than Spot it is

called “सीध ब” [Contango]. If S > F, उल ब [Backwardation]

Basis =S–F Negative Contango

Positive Backwardation

Maximum Contango = (2,376 – 2,400)

= ₹ 24

Whats App Pavan Sir 3.48

Only for study related doubts
99772-13599
 DERIVATIVES

(iv) Gain or Loss

Gain on Short Position = (2,400 – 2,100) × 75 × 5

= ₹ 1,12,500

Question – 34
A Mutual Fund is holding the following assets in ₹ Crores :

Investments in diversified equity shares 90.00

Cash and Bank Balances 10.00

100.00

The Beta of the equity shares portfolio is 1.1. The index future is selling at
4300 level. The Fund Manager apprehends that the index will fall at the most
by 10%. How many index futures he should short for perfect hedging? One
index future consists of 50 units.

Substantiate your answer assuming the Fund Manager's apprehension will

materialize.

(SM TYK – 07)

Solution:

No. of Contracts

Vp (BT −BP )
=
F × M × BF

₹ 90 Cr. (0 – 1.10)
= = 4,605 Contracts Short
4,300 × 50 × 1

Substantiate

If Nifty by 10%

Loss on Equity (90 × 10% × 1.1) 9.90 Cr.

Gain on Nifty (4,300 × 50 × 4,605) × 10% 9.90 Cr.

Whats App Pavan Sir 3.49

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 35
Shyam buys 10,000 shares of X Ltd., @ ₹ 25 per share and obtains a complete
hedge of shorting 400 Nifty at ₹ 1,100 each. He closes out his position at the
closing price of the next day when the share of X Ltd., has fallen by 4% and
Nifty Future has dropped by 2.5%.

What is the overall profit or loss from this set of transaction?

(Exam January – 2021)

Solution:

Today Investment

Long Position in X Ltd. (10,000 × 25) = 2,50,000

Short Position in Nifty (400 × 1,100) = 4,40,000

Calculation of Profit/Loss

Loss on Long Position of X Ltd (2,50,000 × 4%) = 10,000

Gain on Short Position of Nifty (4,40,000 × 2.5%) = 11,000

Overall Gain = 1,000

Alternative

Cash Flow Today (Initial Cashflows)

Buy X Ltd share (2,50,000)

Sell Nifty + 4,40,000

Net Cash Inflow 1,90,000

Cash Flow Next Day (Cashflow @ Closes Out)

Sell X Ltd. (10,000 × 25 × 96%) + 2,40,000

Buy Nifty (4,40,000 × 97.5%) (4,29,000)

Net Cash Outflow 1,89,000

Gain or Loss = 1,90,000 – 1,89,000 = 1,000 Profit.

Whats App Pavan Sir 3.50

Only for study related doubts
99772-13599
 DERIVATIVES

Question – 36
Which position on the index future gives a speculator, a complete hedge
against the following transactions:

(i) The share of Right Limited is going to rise. He has a long position on the
cash market of ₹ 50 lakhs on the Right Limited. The beta of the Right
Limited is 1.25.

(ii) The share of Wrong Limited is going to depreciate. He has a short

position on the cash market of ₹ 25 lakhs on the Wrong Limited. The
beta of the Wrong Limited is 0.90.

(iii) The share of Fair Limited is going to stagnant. He has a short position on
the cash market of ₹ 20 lakhs of the Fair Limited. The beta of the Fair
Limited is 0.75.

(SM TYK – 09)

Solution:

Statement Showing Position in Nifty

Company Position in Amount Beta Position in

Cash Market Future
Right Ltd. Long 50,00,000 1.25 62,50,000 Short
Wrong Ltd. Short 25,00,000 0.9 22,50,000 Long
Fair Ltd. Short 20,00,000 0.75 15,00,000 Long
Net Position in Future 25,00,000 Short

Question – 37
Ram buys 10,000 shares of X Ltd. at a price of ₹ 22 per share whose beta value
is 1.5 and sells 5,000 shares of A Ltd. at a price of ₹ 40 per share having a beta
value of 2. He obtains a complete hedge by Nifty futures at ₹ 1,000 each. He
closes out his position at the closing price of the next day when the share of X
Ltd. dropped by 2%, share of A Ltd. appreciated by 3% and Nifty futures
dropped by 1.5%.

What is the overall profit/loss to Ram?

(SM TYK – 10)

Solution:

Whats App Pavan Sir 3.51

Only for study related doubts
99772-13599
 DERIVATIVES

Statement Showing Net Position in Nifty

Company Position in Amount Beta Position in

Cash Market Future
X Ltd. Long 2,20,000 1.5 3,30,000 Short
A Ltd. Short 2,00,000 2 4,00,000 Long
Net Position in Nifty 70,000 Long

70,000
No. of Contract = = 70 Contracts Long
1,000

Overall Profit/Loss

Loss in Long Position of X Ltd. (2,20,000 × 2%) = 4,400

Loss on Short Position of A Ltd. (2,00,000 × 3%) = 6,000

Loss on Long Position of Nifty (70,000 × 1.5%) = 1,050

Overall Loss = 11,450

Question – 38
On 1 April 2015, Sunidhi was holding a portfolio of 10 securities whose value
was ₹ 9,94,450, the weighted average of beta of 9 securities was 1.10.

Since she was expecting a fall in the prices of the shares in near future to
hedge her portfolio she sold 5 contract of NIFTY Futures (Multiplier of 25)
expiring in May 2015, which was trading at 8767.07 on 1 April.

(a) Calculate the beta of the 10th security.

(b) Reconcile the reasons in spite of 2% fall in the market as per Sunidhi‟s
apprehension if she would have earned some profit on her cash position.

(MTP March – 2018)

Solution:

(i) To compute the beta of 10th security first we shall compute overall
weighted beta as follows:

Let weighted β be w, then

Whats App Pavan Sir 3.52

Only for study related doubts
99772-13599
 DERIVATIVES

9,94,450
5= ×w
8,767.07 × 25

w = 1.102 approximately

Let beta of 10th security is β then,

1.102 = 0.90 × 1.10 + 0.10 × β

β = 1.12

(ii) The main reason for the profit in cash position might due to reason that
contrary to her expectation fall in the value of cash position there may be
increase in value of cash position.

(VIII) COMODITY FUTURE

Question – 39
The following information is available about standard gold.

Spot Price (SP) ₹ 15,600 per 10 gms.

Future Price (FP) ₹ 17,100 for one year future contract

Risk free interest Rate (R)f 8.5%

Present Value of Storage Cost ₹ 900 per year

From the above information you are requested to calculate the Present Value of
Convenience yield (PVC) of the standard gold.

Solution:

Future Price = (Spot Price + Present Value of Storage Cost – Present Value
of Convenience Yield) (1 + r)

17,100 = (15,600 + 900 − x) (1.085)

PVCY = 740

Question – 40
A company is long on 10 MT of copper @ ₹ 534 per kg (spot) and intends to
remain so for the ensuing quarter. The variance of change in its spot and
future prices are 16% and 36% respectively, having correlation coefficient of
0.75. The contract size of one contract is 1,000 kgs.
Required:

Whats App Pavan Sir 3.53

Only for study related doubts
99772-13599
 DERIVATIVES

(i) Calculate the Optimal Hedge Ratio for perfect hedging in Future Market.

(ii) Advice the position to be taken in Future Market for perfect hedging.

(iii) Determine the number and the amount of the copper futures to achieve a
perfect hedge.

(RTP November – 2021)

Solution:

(i) The optional hedge ratio to minimize the variance of Hedger‟s position is
given by:

σS
H =ρ
σF
Where,

σS = Standard deviation of ∆S (Change in Spot Prices)

σF = Standard deviation of ∆F (Change in Future Prices)

ρ = Coefficient of correlation between ∆S and ∆F

H = Hedge Ratio

∆S = Change in spot price.

∆F = Change in Future price.

Accordingly

Standard deviation of ∆S = 16% = 4% and

Standard deviation of ∆F = 36% = 6% and

0.04
H = 0.75 × = 0.5
0.06

(ii) Since the company is long position in Spot (Cash) Market it shall take
Short Position in Future Market.

(iii) Since contact size of one contract is 1,000 Kg,

10,000 Kgs
No. of contract to be short = × 0.50 = 5 Contracts
1,000 Kgs

Whats App Pavan Sir 3.54

Only for study related doubts
99772-13599
 DERIVATIVES

Amount = ₹ 5,000 × 534 = ₹ 26,70,000

Question – 41
A Rice Trader has planned to sell 22,000 kg of Rice after 3 months from now.
The spot price of the Rice is ₹ 60 per kg and 3 months Future on the same is
trading at ₹ 59 per kg. Size of the contract is 1000 kg. The price is expected to
fall as low as ₹ 56 per kg, 3 months hence.
Required:

(i) To interpret the position of trader in the Cash Market.

(ii) To advise the trader the trader should take in Future Market to mitigate
its risk of reduced profit.

(iii) To demonstrate effective realized price for its sale if he decides to make
use of future market and after 3 months, spot price is ₹ 57 per kg and
future contract price for closing the contract is ₹ 58 per kg.

(RTP Nov – 2020 & MTP May – 2019)

Solution:

(1) Rice Trader hold the stock for 3 months & expects that price rise. Hence,
he has Long Position in cash market.

(2) He should take Short Position in future market to hedge risk of price fall.

(3) Effective Realized Price per kg.

Sell (22,000 kg × ₹ 57) = ₹ 12,54,000

(+) Gain on short position (59 – 58) × 22,000 = ₹ 22,000

Total = ₹ 12,76,000

(÷) Quantity = ₹ 22,000

Effective Price = ₹ 58/kg

Question – 42
A call option on gold with exercise price ₹ 26,000 per ten gram and three
months to expire is being traded at a premium of ₹ 1,010 per ten gram. It is
expected that in three months time the spot price might change to ₹ 27,300 or
24,700 per ten gram. At present this option is at-the-money and the rate of

Whats App Pavan Sir 3.55

Only for study related doubts
99772-13599
 DERIVATIVES

interest with simple compounding is 12% per annum. Is the current premium
for the option justified?

Evaluate the option and comments.

Solution:

Risk Neutral

Step 1: Risk Neutral Probability

R = 1.03

27,300
u = = 1.05
26,000

24,700
d = = 0.95
26,000

R–d
P =
u–d

1.03 – 0.95
= = 0.8
1.05 – 0.95

Step 2: Value of Call

(1,300 × 0.8) + (0 × 0.2)

C0 =
1.03

= 1,010

REAL OPTION

Question – 43
IPL already in production of Fertilizer is considering a proposal of building a
new plant to produce pesticides. Suppose the PV of proposal is ₹ 100 crore
without the abandonment option. However, if market conditions for pesticide
turns out to be favorable the PV of proposal shall increase by 30%. On the
other hand, market conditions remain sluggish the PV of the proposal shall be
reduced by 40%. In case company is not interested in continuation of the
project it can be disposed of for ₹ 80 crore.

Whats App Pavan Sir 3.56

Only for study related doubts
99772-13599
 DERIVATIVES

If the risk-free rate of interest is 8% then what will be value of abandonment

option.

Solution:

(i) Binomial Tree

130 0

₹ 100

60 80 – 60 = 20

(ii) Risk Neutral Probability

30 P + (-40) (1 – P) =8

30 P – 40 + 40 P =8

48
70 P = 48 P= = 0.686
70

(iii) Value of Abandonment Option

0 × 0.686 + (20 × 0.314)

Value =
1.08

= ₹ 5.81 Cr. (Put option)

Question – 44
Suppose MIS Ltd. is considering installation of solar electricity generating plant
for light the staff quarters. The plant shall cost ₹ 2.50 crore and shall lead to
saving in electricity expenses at the current tariff by ₹ 21 lakh per year forever.

However, with change in Government in state, the rate of electricity is subject

to change. Accordingly, the saving in electricity can be of ₹ 12 lakh or ₹ 35
lakh per year and forever.

Assuming WACC of MIS Ltd. is 10% and risk-free rate of rate of return is 8%.

Decide whether MIS Ltd. should accept the project or wait and see.

Solution:

If Project Install New

Whats App Pavan Sir 3.57

Only for study related doubts
99772-13599
 DERIVATIVES

NPV = PVCI – PVCO

21
= – 250 lacs
10%

= - 40 lacs (0.4 Crore)

Wait for 1 year

(i) Binomial Tree 35

350
10%
0.652

₹ 250 NPV = 350 – 250 = 100

0.348 12
120
10%
NPV = 120 – 250 = -130

(ii) Risk Neutral Probability

- Return if PVCI = 350

350 – 250
= × 100 = 40%
250

- Return if PVCI = 120

120 – 250
= × 100 = -52%
250

40 P + (-52) (1-P) =8

40 P – 52 + 52 P =8

92 P = 60

60
P =
92

= 0.652

Whats App Pavan Sir 3.58

Only for study related doubts
99772-13599
 DERIVATIVES

(iii) Value of Abandonment Option

100 × 0.652 + (-130 × 0.348)

Value =
1.08

= ₹ 18.48 lacs

It is better to wait for 1 year due to higher NPV.

Question – 45
ABC Ltd. is a pharmaceutical company possessing a patent of a drug called
„Aidrex‟, a medicine for aids patient. Being an approach drug ABC Ltd. holds
the right of production of drugs and its marketing. The period of patent is 15
years after which any other pharmaceutical company produce the drug with
same formula. It is estimated that company shall require to incur $ 12.5
million for development and market of the drug. As per a survey conducted the
expected present value of cash flows from the sale of drug during the period of
15 years shall be $ 16.7 million. Cash flow from the previous similar type of
drug have exhibited a variance of 26.8% of the present value of cash flows. The
current yield on Treasury Bonds of similar duration (15 years) is 7.8%.
Determine the value of the patent.

Given ln(1.336) =0.2897

e-1.0005 = 0.3677 and e-1.17 = 0.3104

Solution:

Given

E = $ 12.5

So = $ 16.7

t = 15 years

Variance = 0.268

σ = 0.268 = 0.5177

r = 0.078

y = 1/15 = 0.0667

Whats App Pavan Sir 3.59

Only for study related doubts
99772-13599
 DERIVATIVES

Step 1 d1 & d2

S σ 2
Ln 0 + r − y +  t
E 2
d1 =
σ t

16.7 0.268
Ln + 0.78−0.0667 +  15
12.50 2
=
0.268 × 15

Ln 1.336 + 2.1795
=
2.005

0.2897 + 2.1795
= = 1.2315
2.005

d2 = d1 − σ  t

= 1.2315 – 2.005

= -0.7735

N (d1)

N (1.2315)

1.20 0.1151

1.25 0.1056

0.05 0.0095

0.0095
0.1151 –  × 0.0315 = 0.1091
0.05

N (d1) = 1 − 0.1091 = 0.8909

N (d2)

N (-0.7735)

N (d2) = 0.2196

Value of Patent

Value of patent = So e- yt × N d1  – E e- rt × N d2 

Whats App Pavan Sir 3.60

Only for study related doubts
99772-13599
 DERIVATIVES

= 16.7 × e-0.0667×15 × 0.8909 – 12.5 × e-0.078 ×15 × 0.2196

= 16.7 × e-1.0005 × 0.8909 – 12.5 × e-1.17 × 0.2196

= 16.7 × 0.3677 × 0.8909 – 12.5 × 0.3104 × 0.2196

= $ 5.4707 – $ 0.8520

= $ 4.619 Millions.

DERIVATIVES THEORY

(1) Exotic Option

(2) CDS & CDO‟S

(3) Weather Derivatives

(4) Electricity Derivatives

(5) Derivatives Mishaps & Lesson

(6) Option Greeks

(1) EXOTIC OPTION

- Different From Plain Vanilla Option

- Hybrid of American & European Option

- Vary In Term of Payoff

- More Complex

- Traded at OTC

1. Barriers Option: Become activated only if price reaches a certain price.

2. Chooser Option: Right to the buyer after a specified period whether

option is call or put.

3. Compound option:

- Split fee option or Option on option.

- Underlying asset is an option.

Whats App Pavan Sir 3.61

Only for study related doubts
99772-13599
 DERIVATIVES

4. Look Back Option: Choose a most favorable strike price depending on

the minimum & maximum price.

5. Asian Option: Payoff are determined by average of the price.

6. Bermuda Option: Exercise is restricted to certain date.

7. Binary Option:

- Payoff shall be pre decided amount.

- Happening of a specific event.

8. Basket Option: Instead of one asset, depends on value of portfolio

9. Spread Option: Depends on difference between price of two assets.

(2) CDS & CDO'S

Whats App Pavan Sir 3.62

Only for study related doubts
99772-13599
 DERIVATIVES

(I) CREDIT DEFAULT SWAP (CDS)

(II) COLLATERALIZED DEBT OBLIGATION (CDOS)

Types of CDOS

1. Cash flow CDOS: Transfer of asset to SPV.

2. Synthetic CDOS: Credit Risk is transferred by originator without actual

transfer of assets.

3. Arbitrage CDOS

Risk Involved in CDOS

(i) Default risk: Prime sufferers of risk “Junior tranche”

(ii) Interest Rate Risk: Floating Asset v/s fixed Liabilities

(iii) Liquidity Risk

(iv) Prepayment Risk

(v) Reinvestment Risk

(vi) Foreign exchange Risk

Whats App Pavan Sir 3.63

Only for study related doubts
99772-13599
 DERIVATIVES

(3) WEATHER DERIVATIVES

- Risk faced by company whose performance is liable to be affected by the

weather i.e. airline companies, juice manufacturing.

- To manage volumetric risk from unfavorable weather, weather derivative

is introduced [Rainfall, temperature, humidity, wind speed etc.]

- To hedge value Risk [change volume due to change weather]

- Insurance v/s weather derivatives

- Parties in weather derivatives

- Problems in pricing of weather derivatives

* Data → Differs country to country

* Forecasting of Weather → Difficult to predict

* Temperature modeling → No perfection

(4) ELECTRICITY DERIVATIVES

- Risk faced by company having requirement of electricity for long form

basis.

- Electricity spot price in India are volatile hence there is a need for
hedging instrument to reduce price risk.

- This will help the buyer to pay fixed price irrespective of variation in spot
electricity prices

- Electricity derivatives are

(i) Forward

(ii) Future

(iii) Swap

(5) DERIVATIVE MISHAPS & LESSONS

1. Orange country‟s

2. Barings Bank‟s Case

Whats App Pavan Sir 3.64

Only for study related doubts
99772-13599
 DERIVATIVES

3. Protector & Gamble & Gibson Greetings Case

(1) ORANGE COUNTRY [1994]

Municipality

Treasurer Robert Citron [No background in trading]

Use derivative is yield curve [Bonds]

Over leveraged

In 1994, Interest rate rise then bond price fall

Loss $ 1.5 billion orange country doubted bankrupt.

(2) BARINGS BANK’S CASE [1995]

Nick Leeson

Arbitrage [Singapore S.E & Osaka market-Nikkei 225 future]

Huge losses, to cover-up loss, started taking speculation]

Influence the staff of Bank office to hide losses

In 1995, Leeson take short position in Japanese Govt. Bond

Earthquake in Japan in 95 & interest rate fall

Barings Bank became bankrupt, Dutch Bank purchase this Bank for £ 1

(3) PROTECTOR & GAMBLE & GIBSON GREETING CASE [1994]

Banker Trust [BT]

Complicated derivative “Leverage Swap”

Floating v/s fixed

LIBOR Rise

In 1994, Huge losser

Whats App Pavan Sir 3.65

Only for study related doubts
99772-13599
 DERIVATIVES

LESSONS

(i) Don‟t buy any derivative product that your don‟t understand.

(ii) Due diligence before making treasury deportment as profit centre.

(iii) Specify the risk limit

(iv) Separation of front, middle & bank offices

(v) Ensure that a hedger should not become a speculator

(vi) Carryout stress test, scenario Analysis etc.

(6) OPTION GREEKS

Price of option depends upon following factors.

(1) Stock price (S0)

(2) Exercise price (E)

(3) Time (t)

(4) Volatility (σ)

(5) Rate of Interest (R)

Among these factors, exercise price is constant, remaining factors may change.
Option price will change due to change in these factors. We wish to carryout
sensitivity analysis i.e.

Rate of change in option price with respect to each factor, keeping other factors
constant. This rate of change have been assigned in Greek Letter.

(I) DELTA

(i) Delta means rate of change in option price with respect to stock price.
Since call is bullish & put is bearish hence call has positive delta & put
has negative delta.

(ii) Suppose delta of call 0.4 & Delta of put – 0.6 means.

- If means if price of stock goes by ₹ 1 then price of call option will go

up by 40 paisa & price of put option will go down by 60 paisa .

Whats App Pavan Sir 3.66

Only for study related doubts
99772-13599
 DERIVATIVES

- In Binomial

1 call is equivalent to 0.4 share long.

1 put is equivalent to 0.6 share short

Hedge Ratio

Delta call 0.4 = Write call & buy 0.4 shares.

(II) GAMMA

Delta does not move at same rate hence rate of changes in delta with respect
to rate of change in stock price is called Gamma.

(III) THETA

Rate of change in option price with respect to rate & change in time is called
theta.

Option price will go down due to passage of time.

(IV) VEGA

Rate of change in option price with respect to volatility is called vega.

Price of option will go up due to increase in volatility.

(V) RHO

Rate of change in option price with respect to increase rate is called “Rho”

MULTIPLE CHOICE QUESTIONS

Case Scenario 1
X and Y are two friends. since Y has earned a profit from trading in financial
derivative market, X is also considering speculating on Gamma corporation‟s
share which is currently trading at ₹ 700 per share through taking positions in
options on Gama corporation‟s stock:

(1) Purchasing one contract of 2-month call option with a premium of ₹ 35

and an exercise price of ₹ 750

Whats App Pavan Sir 3.67

Only for study related doubts
99772-13599
 DERIVATIVES

(2) Purchasing one contract of 2-month put option with a premium of ₹25
and an exercise price of ₹ 600

After some time, trading in Option market and understanding the nitty-
gritties of same, X being CEO in an organization advised his team to
implement the concept of financial option in the capital budgeting
decision called „Real option‟.

Based on the above information answer the following questions:

1. Assuming that the contract size of each option contract is 100 and the
price of Gama corporation‟s share after two month falls to ₹550, the net
pay-off of X will be______

Answer-1 : ₹ 1,000 loss

Answer-2 : ₹ 1,000 profit

Answer-3 : ₹ 3,000 profit

Answer-4 : ₹ 3,000 loss

2. The per share price of Gama corporation‟s stock after 2 month at which
X shall be at Break even is_____

Answer-1 : ₹ 540

Answer-2 : ₹ 600

Answer-3 : ₹ 625

Answer-4: ₹ 785

3. Which of the following position provides protection from a decrease in

prices of a share?

Answer 1 : Buying of future contracts in the share.

Answer 2 : Buying call option in the share.

Answer 3 : Selling of future contracts in the share .

Answer 4 : Selling put option in the share.

4. In a future contract the term Basis is _________

Whats App Pavan Sir 3.68

Only for study related doubts
99772-13599
 DERIVATIVES

Answer 1 : The difference between the prevailing spot price and the
future price.

Answer 2 : The difference between the current market price and the
strike price.

Answer 3 : The difference between the long position and the short
position.

Answer 4 : The difference between the initial margin and the

maintenance margin.

5. A put option on a company‟s stock has an exercise price of ₹ 200. on the

delivery date, the stock is trading at ₹ 240 per share. what should the
investors who has paid ₹ 20 for the option do ?

Answer 1 : Not exercise the option and lose ₹ 20.

Answer 2 : Not exercise the option and lose ₹ 60.

Answer 3 : Exercise the option and gain ₹ 20.

Answer 4 : Exercise the the option and gain ₹ 40.

6. The spot price of an investment asset that provides no income is ₹ 3000

and the risk-free rate for all maturities (with yearly compounding) is
10%. The three-year forward price of same investment shall be __________

Answer 1 : ₹ 3,993

Answer 2 : ₹ 4,050

Answer 3 : ₹ 4,020

Answer 4 : ₹ 4,034

7. Mr. A a speculator short 1000 shares of X Ltd. when the share price was
₹ 50 and closes out the position after 3 month when the share price was
₹ 43. The company pays a dividend of ₹ 3 per share during the 3 months.
The gain of Mr. a will be____

Answer 1 : ₹ 1,000

Answer 2 : ₹ 4,000

Whats App Pavan Sir 3.69

Only for study related doubts
99772-13599
 DERIVATIVES

Answer 3 : ₹ 7,000

Answer 4 : ₹ 3,000

8. Which amongst the following is not a Greek for options pricing

Answer 1 : Delta

Answer 2 : Gamma

Answer 3 : Alpha

Answer 4 : RHO

9. The spot price of an investment is ₹ 3,000 and the risk-free rate for all
maturities (with continuous compounding) is 10% p.a. suppose the
asset provides an income of ₹ 200 at the end of the first year and at the
second year, then three year forward prices shall be _______

(e0.10 = 1.1052, e0.20 = 1.2214 and e0.30 = 1.3499)

Answer 1 : ₹ 1,967

Answer 2 : ₹ 3,584

Answer 3 : ₹ 4,515

Answer 4 : ₹ 4,050

Case Scenario 2
You as an investor had purchased a 4-month European Call Option on the
equity shares of X Ltd. for ₹ 10, of which the current market price is ₹ 132 per
share and the exercise price ` 150. You expect the price to range between ₹ 120
to ₹ 190. The expected share price of X Ltd. and related probability is given
below:

Expected Price (₹) 120 140 160 180 190

Probability 0.05 0.20 0.50 0.10 0.15

Based on above case scenario answer the following questions:

I. Expected price of share of X Ltd. at the end of 4 months shall be…….

(a) ₹ 160.00

Whats App Pavan Sir 3.70

Only for study related doubts
99772-13599
 DERIVATIVES

(b) ₹ 160.50

(c) ₹ 158.00

(d) ₹ 140.00

II. Suppose if the exercise price prevails at the end of 4 months the Value of
Call Option shall be…………

(a) ₹0

(b) ₹ 18

(c) ₹ 10

(d) ₹ 14

III. In case the option is held to its maturity, the expected value of the call
option shall be……………

(a) ₹0

(b) ₹ 18

(c) ₹ 10

(d) ₹ 14

IV. In the given different scenarios of expected prices of share of X Ltd. at the
time of maturity the option shall be in-the-money in ……………
scenarios.

(a) two

(b) three

(c) five

(d) In none of the scenario

V. In the given different scenarios of expected prices of share of X Ltd. at the

time of maturity the option shall be at-the-money in ……………
scenarios.

Whats App Pavan Sir 3.71

Only for study related doubts
99772-13599
 DERIVATIVES

(a) two

(b) three

(c) five

(d) In none of the scenario

Case Scenario 3
Suppose you are a risk manager at a financial institution, and your company
has loaned a significant amount of ₹ 500 crore to a company X Ltd. for a period
of 3 years at 6-month at MCLR plus 200 bps. You are concerned about X Ltd.'s
ability to repay the debt due to recent market volatility. To protect your
institution from potential default, you decide to purchase a Credit Default
Swap (CDS) from ABC Bank Ltd. for same notional amount at a premium
quoted at 1% per year through cash settlement

On the respective reset dates for the same period actual MCLR interest rate
comes out as follows:

Reset MCLR
1 9.75%
2 10.00%
3 10.25%
4 10.35%
5 10.50%
6 10.60%

Based on above case scenario answer the following questions:

1. The primary purpose of a Credit Default Swap (CDS) is................... (a) to

increase the value of bonds. (b) to protect against default risk of a debt
obligation. (c) to provide guaranteed profit to the buyer. (d) to create a
new form of loan.

2. Which of the following statements is true about CDS contracts?

(a) CDS contracts cannot be used for speculation.

(b) CDS contracts are governed by government regulations.

(c) CDS contracts are private agreements between two parties.

Whats App Pavan Sir 3.72

Only for study related doubts
99772-13599
 DERIVATIVES

(d) CDS contracts eliminate all risks for the buyer.

3. Which organization publishes the guidelines and rules for conducting

Credit Default Swap transactions?

(a) Federal Reserve

(b) International Swap and Derivative Association (ISDA)

(c) Securities and Exchange Commission (SEC)

(d) World Trade Organization (WTO)

4. Assuming no default occurs the total premium your company will pay
during the designated loan period shall be........

(a) ₹ 5 crore

(b) ₹ 10 crore

(c) ₹ 15 crore

(d) ₹ 30 crore

5. Suppose if the lender defaults somewhere in the beginning of third year

of loan (after payment of interest upto 2 years) and the market value of a
reference loans falls to 75% of its par value, then ABC Bank will pay your
company ...........in a cash settlement.

(a) ₹ 15 crore

(b) ₹ 30 crore

(c) ₹ 125 crore

(d) ₹ 500 crore

Case Scenario 4
Based on the following information, choose the correct answer from the
following questions:

Situation Action Exercise Price Premium Spot Price

I Exercised 140 20 160

Whats App Pavan Sir 3.73

Only for study related doubts
99772-13599
 DERIVATIVES

II Exercised 200 15 175

III Lapsed 300 25 400

From the information given above, choose the correct answer to the Question
no. 10 to 12:

I. In situation 1, the investor's position and amount of profit or lose is:

(a) Put option and ₹ 20

(b) Call option and ₹ 0

(c) Put option and ₹ 0

(d) Call option and ₹ 20

II. In Situation III, the investor's position and the amount of profit/loss is:

(a) Put option, ₹ (25)

(b) Call option, ₹ 75

(c) Short position, ₹ 100

(d) Long position, ₹ (100)

III. In situation II, the investor's position and the amount of profit/loss is :

(a) Put option and ₹ 10

(b) Call option and ₹ 10

(c) Put option and ₹ 25

(d) Call option and ₹ 25

Whats App Pavan Sir 3.74

Only for study related doubts
99772-13599