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# Risk Management Assignment Module 5

On

Black and Scholes model with real time data of TATA steel ltd

## Under the Guidance of

PROF. (Dr.) RAJKUMARI SONI

## Prepared by Jugal R patel Heta mehta

PARUL INSTITUTE OF ENGINEERING & TECHNOLOGY (MBA Dept.) LIMDA, DIST. VADODARA.

TABLE OF CONTENT

Sr. No.

Particulars

Page No.

1.

2.

## Equations of Black-Scholes Model

Calculation of call and put prices based on real time data Conclusion

3. 4

6 9

Bibliography

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## Basic introduction The Black-Scholes Option Pricing Formula

In 1973 Fisher Black and Myron Scholes brilliantly developed the BlackScholes option pricing formula. Assuming that the price of the underlying stock follows a lognormal random variable, they found a closed form solution for the price of a European call and European put. Essentially their method was to extend the arbitrage pricing approach developed in Section III by letting the length of a period in the binomial model go to zero. Using the binomial approximation found in Section V, they were able to find the following formulas for pricing European puts and calls.

## Black-Scholes Model Assumptions

the

The BlackScholes model of the market for a particular stock makes following explicit assumptions:

There is no arbitrage opportunity (i.e., there is no way to make a riskless profit). It is possible to borrow and lend cash at a known constant risk-free interest rate. It is possible to buy and sell any amount, even fractional; of stock (this includes short selling). The above transactions do not incur any fees or costs (i.e., frictionless market). The stock price follows a geometric Brownian motion with constant drift and volatility. The underlying security does not pay a dividend.

## Equations of Black-Scholes Model

Let S0 = Todays stock price. t = Duration of the option. Sx = Exercise or strike price. r = risk-free rate. This rate is assumed to be continuously compounded. = Annual volatility of stock y = percentage of stock value paid annually in dividends.

## C0 = S0 N (d1) SX N(d2) e-rt

Where,

ln( S 0 / X ) (r 2 / 2)T d1 T

ln( S0 / X ) (r 2 / 2)T d2 d1 T T

## For put option the price is computed as follows:

p X e rT N (d 2 ) S 0 N (d1 )
Where, N(d1) is the probability P(x<d1),1-N(d1) is the probability P(x>d1). Since a normal distribution is systematic, we can write:

## N (d 2 ) = P (x<-d2) = P (x>d2) = 1-N(d2)

Calculation of call and put prices based on real time data of TATA steel limited.

Call price:

## Step:1_calculation of d1 and d2.

d1

ln( S 0 / X ) (r 2 / 2)T

0.118

## = - 0.0055 + 0.0155 0.1098

= 0.0911

ln( S0 / X ) (r 2 / 2)T d2 d1 T T

= (-0.0187)

Step:2 value of N(d1) and N(d2). As per the normal distribution value of both the variable are as follows: N(d1)= N(0.0911)=0.5359 N(d2)=N(-0.0187)= 0.4920

= 13.83 INR

= Max(-1.65,0)
=0

## Gain or loss from purchasing call option:

GC = Max [(ST - SX C0), - C0] = Max [(299.8 - 301.45 13.83), - 13.83] = Max [(-15.48), - 13.83] = - 13.83

Put price:
We have value of N(d1) and N(d2) which are 0.6443 and 0.3632 respectively

N (d 1 ) =

## N (d 2 ) = P (x<-d2) = P (x>d2) = 1-N(d2)

= 1- 0.4920 =0.5080

Put price:

p X e rT N (d 2 ) S 0 N (d1 )

=12.46 INR

## Terminal value of put = Max (SX ST, 0) = Max (301.45 - 299.8, 0)

= Max (1.65, 0)
= 1.65

Time value of put = Put price + Terminal value = 12.46 + 1.65 = 14.11

## = Max (-12.46,-10.81) = -10.81

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Conclusion:

As per the assumptions Black and Scholes showed that it is possible to create a hedged position, consisting of a long position in the stock and a short position in the option, whose value will not depend on the price of the stock.

To buy a one share of TATA steel ltd investors have to pay call price of Rs 84.7 with an expiry of 30th may 2013.

To buy one put share of TATA steel ltd the investors have to pay a Put price of Rs. 83.52 with an expiry of 30th May 2013.

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Bibliography
Books:
Derivatives and risk management : By Sundaram Janakiramanan Derivatives and risk management : By Rajiv Shrivastava

Websites:

www.nseindia.com www.moneycontrol.com

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