Derivative Analysis and Valuation Techniques

Chapter – 4
DERIVATIVE ANALYSIS
AND VALUATION
Learning Outcomes
After going through the chapter student shall be able to understand
❑ Forward/ Future Contract
❑ Options (Call/Put)
❑ Commodity Derivatives
// CA NAGENDRA SAH // WWW.FMGURU.ORG

Page 4.2 STRATEGIC FINANCIAL MANAGEMENT
QUOTATION OF FUTURE CONTRACT
Question No. 1A
The following quotes were observed by MR KARUNA on March 10, 2017 in the Economic Times:
(i) SBI MARCH 2017 FUT 1441
(ii) NIFTY APRIL 2017 FUT 4280.
Required:
(i) Explain what these quotes indicate?
(ii) If the initial Margin is 10% and Mr. Karuna wants to buy 100 of each how much margin he has to deposit
individually?
[CMA-June-2012-Old-4M] [CMA-MTP-June-2014-Old-2M]
MARGIN MONEY AND MARGIN CALL

Question No. 2A [SM-New] [RTP-May-2013-Old] [RTP-May-2015-Old]
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 3306.4 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
Abshishek 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.
Ans:
Question No. 2B
On Aug, 2, Mr. Tandon buys 5 contract of Reliance futures at 840. Each contract covers 50 shares. Initial margin
was set at 2400 per contract while maintenance margin was fixed at 2000 per contract. Daily settlement prices
are as follows:
Aug 2 818
Aug 3 866
Aug. 4 830
Aug. 5 846
Mr. Tandon meet all margin calls. Whenever he is allowed to withdraw money from the margin account, he
withdraws half the maximum amount allowed.
Compute for each day
(i) Margin call;
(ii) Profit & Loss on the contracts
(iii) The balance in the Account at the end of the day.
[CMA-June-2006-Old-7M]
Ans: (i) 5500, Nil, 3,000, Nil (ii) (-) 5,500, 12,000, (-) 9000, 4000 (iii) 12000, 18000, 12000, 14000

DERIVATIVE ANALYSIS AND VALUATION Page 4.3
 TEST YOUR KNOWLEDGE

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Question No. 2.1
The settlement price of june Nifty Futures contract on a particular day was 4585. The minimum trading lot on Nifty
futures is 100. The initial margin is 8% and the maintenance margin is 6%. The index closed at the following levels
on the next five days:
Day Settlement Price ()
1 4690
2 4760
3 4550
4 4480
5 4570
Required:
(i) Calculate the Mark to Market Cash Flows and daily closing balances in the account of
(A) an investor who has gone long at 4585
(B) An investor who has gone short at 4585
(ii) Calculate the net profit/Loss on each of the contracts.
[CMA-June-2007-Old-9M]
Ans: (i) (A) Cash Flows: + 10,500, + 7,000, -21000, -7000, +9000 Closing Bal: 47180, 54180, 33180, 36680
(i) (B) Cash Flows: -10,500, 7000, +21000, +7000, -9000; Closing Bal: 36680, 29680, 50680, 57680, 48680
(ii) Long: Loss of 1500, short: profit of 1500
PROFIT AND LOSS FROM FUTURE CONTRACT

Question No. 3A [CS-June-2009-Old-4M]
An investor buys a NIFTY futures contract for 2,80,000 (lot size 200 futures). On the settlement date, the Nifty
closes at 1,378. Find out his profit or loss, if he pays 1,000 as brokerage. What would be the amount of profit or
loss, if he has sold the futures contract?
Ans: Loss if buy = 5,400; Gain if sale = 3,400
Question No. 3B [RTP-Nov-2011-Old]

Mr. V decides to sell short 10000 shares of ABC plc, when it was selling at yearly high of £5.60. His broker
requested him to deposit a margin requirement of 45% and commission of £1550 while Mr. V was short the share,
the ABC paid a dividend of £0.25 per share. At the end of one year Mr. V buys 10000 shares of ABC plc at £4.50
to close out position and was charged a commission of £1450.
You are required to calculate the return on investment of Mr. V.
Ans: ROI = 20.56%
Question No. 3C
Nifty Index is currently quoting at 1300. Each lot is 250. Mr. X purchases a March contract at 1300. He has been
asked to pay 10% initial margin. Calculate the amount of initial margin. To what level Nifty futures should rise to
get a percentage gain of 5%.
[CMA –MTP-June-2015-Old-7M]
Ans: 32500; 1306.50


’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 3.1
Nifty Index is currently quoting at 1329.78.Each lot is 250. Z purchases a March contract at 1364. He has been
asked to pay 10% initial margin. What is the amount of initial margin? Nifty futures rise to 1370.What is the
percentage gain?
[CMA-June-2015-Old-2M] [CMA-PTP-Dec-2014-Old-2M]
Ans: Margin = 43100; % Gain = 4.4%
COMMODITY DERIVATIVE (DELIVERY OF UNDERLYING)
Question No. 4A [RTP-May-2013]
A wheat trader has planned to sell 440000 kgs of wheat after 6 months from now. The spot price of wheat is  19
per kg and 6 months future on same is trading at  18.50 per kg (Contract Size= 2000 kg). The price is expected to
fall to as low as  17.00 per kg 6 month hence. What trader can do to mitigate its risk of reduced profit? If he
decides to make use of future market what would be effective realized price for its sale when after 6 months is spot
price is  17.50 per kg and future contract price for 6 months is  17.55.
[CMA-RTP-Dec-2018] [CMA-Dec-2014-Old-6M]
Ans: Trader would go short on future at current future price of  18.50 per kg.
This will help the trader to realize sure  18.50 after 6 months
Question No. 4B
Bharat Oil Corporation (BOC) imports crude oil fir its requirements on a regular basis. Its requirements are
estimated at 100 tonnes per month. Of late, there has been a surge in the prices of oil. The current price (month of
June) of crude oil is 5,500 per barrel. The firm expects the price to rise in the coming months to 5,800 by August.
It wants to hedge against the rising prices for some of its requirements of the month of August.
Multi Commodity Exchange (MCX) in India offers futures contracts in crude oil. The Contract size is 100 barrels
and August contract is currently traded at 5,668 per barrel.
BOC would like to hedge half its exposure in futures and leave the other half to market conditions. While hedging,
the number of futures contracts dealt with should be rounded off to the next higher integer. Then, how many
contracts should it book?
Compare the hedged and exposed parts regarding the effective price per barrel and also compute the effective price
per barrel for the whole requirement of August,
If in August,
(i) The spot price is 5,570 and futures price is 5,788
(ii) The spot price is 5,417 and futures price is 5,455?
Ignore marking-to-market and initial margin on futures contracts.
Given that 1 tonne = 7.33 barrels.
[CMA-June-2018-New-6M]

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Question No. 4.1
A petrochemical plant needs to process 10,000 barrels of oil in 3 months time. To hedge against the rising price the
plant needs to go long on the futures contract of crude oil. The spot price of crude oil is 1,950 per barrel, while
futures contract expiring three months from now is selling for 2,200 per barrel. By going long on the futures the
petrochemical plant can lock-in the procurement at 2,200 per barrel. Assuming the size of one futures contract of
100 barrels, the firm buys 100 futures to cover its exposure of 10,000 barrels.
Find out the price that would be payable under two scenarios of rise in price to 2,400 or fall in price to 1,800
per barrel after three months.
[CMA-June-2015-Old-4M] [CMA-PTP-June-2014-Old-3M]
Ans: (i) 2200; (ii) 2200
Question No. 4.2

Today is 24th March. A refinery needs 1075 barrels of crude oil in the month of September. The current price of
crude oil is 3000 per barrel. September futures contract at Multi commodity exchange (MCX) is trading at
3200. The firm expects the price to go up further and beyond 3200 in September. It has the option of buying
the stock now. Alternatively it can hedge through futures contract. Lot size is 100 barrels.
a. If the cost of capital insurance and storage is 15% per annum, examine if it is beneficial for the firm to
buy now?
b. Instead if the upper limit to buying price is 3200 what strategy can the firm adopt?
c. If the firm decides to hedge through future find out the effective price it would pay for crude oil if at the
time of lifting the hedge
i) The spot and futures price are 2900 and 2910 respectively,
ii) The spot and futures price are 3300 and 3315 respectively.
[CMA-DEC-2017-NEW-8M] [CMA-RTP-DEC-2013] [CMA-MTP-June-2014-(2+2+4)=8M] [CMA-SM-
2016]
Ans: (a) Effective cost = 3233.65 (Assumed Continuous Compounding);
(b) Buy Future to lock price around 3200; (c) (i) 3197; (ii) 3182
CALCULATION OF FAIR FUTURE PRICE

Question No. 5A [RTP-June-2009-old]
A 3 month future contract on NIFTY is available at a time when Nifty is quoting 9000 points. Continuously
compounded risk free rate is 10%. Continuously Compounded yield on the NIFTY Stock is 2% per annum. One
Future contract equals to 1000 Nifty. How much will you pay for NIFTY Futures? If Nifty Forward trades at 9125,
what action would follow?
Ans: Fair future price = 9181.80
Question No. 5B [RTP-May-12-Old]
On 31-7-2011, the value of stock index is  2,600. The risk free rate of return is 9% p.a. The dividend yield on this
stock index is as follows:
Month Dividend Paid
January 2%
February 5%
March 2%
April 2%
May 5%
June 2%
July 2%
August 5%
September 2%
October 2%
November 5%
December 2%
Assuming that interest is continuously compounded daily, then what will be future price of contract deliverable on
31-12-2011. Given = e0.02417 = 1.02446.
Ans: Future Price = 2663.60
Question No. 5C [RTP-Nov-2012-Old]
Suppose that there is a future contract on a share presently trading at  1000. The life of future contract is 90 days
and during this time the company will pay dividends of  7.50 in 30 days,  8.50 in 60 days and  9.00 in 90 days.
Assuming that the compounded continuously Risk free rate of interest (CCRRI) is 12% p.a. you are required to find
out:
(a) Fair value of the contract if no arbitrage opportunity exists.
(b) Value of cost to carry.
[Given 𝑒 −0.01 = 0.9905, 𝑒 −0.02 = 0.9802, 𝑒 −0.03 and 𝑒 0.03 = 1.03045]
Ans: (a) Fair Value = 1005.21; (b) 5.21

Question No. 5D
The stock of Aptech Ltd (FV 10) quotes 920 today on NSE and the 3 month futures price quotes at 950. The
one month borrowing rate is given as 8% and the expected annual dividend yield is 15% p.a. payable before
expiry.
You are required to calculate the price of 3 month APTECH FUTURES.
[CMA-Dec-2008-Old-3M] [CMA-MTP-June-2014-Old-2M] [CMA-PTP-Dec-2014-Old-2M]
Ans: 903.90

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Question No. 5.1
The 3-month futures contract on NIFTY maturing in April 2009 is currently trading at 2610. The current value of
NIFTY is 2590. The one-year risk free rate is 8% and the year -end dividend yield on the market index is 4%. Find
the theoretical futures price and comment on arbitrage opportunity.
[CMA-RTP-Dec-2014-Old]
Ans: 2616.03
Question No. 5.2 [May-2012-Old-5M] [RTP-Nov-2014-Old]

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:
January 3%
February 4%
March 3%
April 3%
May 4%
June 3%
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
[CMA-MTP-June-2015-Old-5M]
Ans: Future Price = 2235.05
Question No. 5.3 [SM-New]

Consider a 4 month future contract on 500 shares with each share priced at  75. Dividend @  2.50 per share is
expected to accrue to the shares in a period of 3 months. The CCRRI (Continuous compounded Require Rate of
Interest) is 10% p.a. find the value of the future contract.
Ans: 74.996

HEDGING WITH THE HELP OF INDEX FUTURE

Question No. 6A
Identify the hedging strategies that would be required using the index future under the following circumstances:
Stock Position Beta No. of shares Price () Hedge needed
SBI Long 1.30 1000 1900 Full
RIL Long 1.20 1000 800 Full
BHEL Short 1.10 1000 300 90%
TSL Short 0.80 1000 400 80%
Infosys Long 1.00 1000 1800 120%
[CMA-June-2013-5 M]
Question No. 6B [Nov-2004-old-6 Marks]
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.
[CMA-MTP-June-2015-5M] [CMA Compendium]
Ans: (i) sell index for  62.50 lakh, (ii) buy index for  22.5 lakh, (iii) buy index for  15 lakh
Question No. 6C [Nov-2007-8M] [RTP-Nov-2013] [RTP-Nov-2015] [MTP-Nov-2014]

Consider the data given below:
BSE Index 5000
In CA examination it was wrongly
Value of Portfolio 10,10,000 printed as 500.
Risk free interest rate 9% p.a.
Dividend yield on Index 6% p.a.
Beta of portfolio 1.5
We assume that a futures contract on the BSE index with four months maturity is used to hedge the value of
portfolio over next three months. One future contract is for delivery of 50 times the index.
Based on the above information calculate:
(i) Price of future contract
(ii) The gain on short futures position if the index turns out to be 4500 in three months.
[CMA-RTP-Dec-2018] [CMA-June-2015-4M] [CMA-June-2009-7M] [CMA Compendium] [CMA-PTP-
June-2014-(3+6)=9M] [CMA-SM-2016]
Ans (i) 5050.25; 252512.5 (ii) 1,61,700
Question No. 6D [Nov-2013-6 Marks]]

Ram buys 10000 shares of X Ltd. at a price of 22 per share beta value is 1.5 and sells 5000 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 1000 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?
Ans:  11,450

Question No. 6E [May-2012-5 M] [RTP-Nov-2014]
A company is long on 10 MT of copper @  474 per kg (spot) and intends to remain so for the ensuing quarter.
The standard deviation of change of its spot and future prices are 4% and 6% respectively, having correlation
coefficient of 0.75.
What is its hedge ratio? What is the amount of the copper future it should short to achieve a perfect hedge?
Ans: Hedge ratio (Beta) = 0.5; Amount of copper future = 2370,000

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Question No. 6.1 [May-2005]
Tam buys 10000 shares of X Ltd. at 22 and obtains a hedge of shorting 400 Nifties at 1100 each. He closes out
his position at the closing price of the next day at which point the share of X Ltd. has dropped 2% and the nifty
future has dropped 1.5%. What is the overall profit/loss of this set of transaction?
Ans: Net Gain =  2,200
Question No. 6.2 [RTP-May-2015]

Mr. Careless was employed with ABC Portfolio Consultants. The work profile of Mr. Careless involves advising
the clients about taking position in Future Market to obtain hedge in the position they are holding. Mr. ZZZ, their
regular client purchased 100,000 shares of X Inc. at a price of $22 and sold 50,000 shares of A plc for $40 each
having beta 2. Mr. Careless advised Mr. ZZZ to take short position in Index Future trading at $1,000 each contract.
Though Mr. Careless noted the name of A plc along with its beta value during discussion with Mr. ZZZ but forgot
to record the beta value of X Inc.
On next day Mr. ZZZ closed out his position when:
• Share price of X Inc. dropped by 2%
• Share price of A plc appreciated by 3%
• Index Future dropped by 1.5%
Mr. ZZZ, informed Mr. Careless that he has made a loss of $114,500 due to the position taken. Since record of Mr.
Careless was incomplete he approached you to help him to find the number of contract of Future contract he advised
Mr. ZZZ to be short to obtain a complete hedge and beta value of X Inc.
You are required to find these values.
Ans: Thus number of future contract short is 700; Beta = 1.5
Mr. X, is a Senior Portfolio Manager at ABC Asset Management Company. He expects to purchase a portfolio of
shares in 90 days. However he is worried about the expected price increase in shares in coming day and to hedge
against this potential price increase he decides to take a position on a 90-day forward contract on the Index. The
index is currently trading at 2290. Assuming that the continuously compounded dividend yield is 1.75% and risk
free rate of interest is 4.16%, you are required to determine:
(a) Calculate the justified forward price on this contract.
(b) Suppose after 28 days of the purchase of the contract the index value stands at 2450 then determine gain/ loss
on the above long position.
(c) If at expiration of 90 days the Index Value is 2470 then what will be gain on long position.
Note: Take 365 days in a year and value of e0.005942 = 1.005960, e0.001849 = 1.001851.
Ans: (a) Forward Price = 2303.65; (b) 156.4; (c) 166.35

INCREASING/DECREASING BETA WITH THE HELP OF INDEX FUTURE

Question No. 7A [RTP-June-2009]
The portfolio composition of Mr. X is given below:
Equity 8,00,000
Cash & Cash Equivalent 2,00,000
Beta of equity portfolio = 0.69
The current NSE index future value is 930 with multiple of 200. If Mr. X wants to achieve an overall portfolio
beta of 1.10, then how many number of futures contract he should go short?
[CMA-SM-2016]
Ans: 2.946 contract [i.e. 3 contract appx]
Question No. 7B [Nov-2013-5 M]

A trader is having in its portfolio shares worth Rs. 85 lakhs at current price and cash  15 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 the trader on current date goes for long position on Rs. 100 lakhs Nifty futures.
[CMA-PTP-June-2015-6M]
Ans: (i) 1.36; (ii) 2.36.
Question No. 7C [May-2011-5 M] [MTP-May-2015] [RTP-Nov-2013] [RTP-Nov-2014]
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 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 so that the portfolio
beta is reduced to 1.00? One index future consists of 50 units.
Substantiate your answer assuming the fund manager’s apprehension will materialize.
Ans: Number of contract to be sold = 4605 (Apprx)
Question No. 7D [May-2013-8M] [MTP-May-2015-8M]

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: Ln (1.105)=0.0998; 𝑒 (0.015858) = 1.01598
Ans: (i) .849; (ii) 5994.28; (iii) 13.36 (Either 13 or 14); (iv) 3.92 (i.e. 4)


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Question No. 7.1
A Portfolio manager owns 3 stocks:
Stock Shares Owned Stock Price Beta
1 1 Lakh 400 1.1
2 2 Lakh 300 1.2
3 3 Lakh 100 1.3
The spot Nifty Index is at 1350 and futures price is 1352 to use stock index futures to:
(a) decrease the portfolio beta to 0.8 and
(b) increase the portfolio beta to 1.5.
Assume the index factor is 100. Find out the number of contracts to be bought or sold of stock index futures.
[CMA-RTP-Dec-2018] [CMA-June-2014-5M]
Ans: (a) sell 376.92 contract (b) buy 296.15 contract
Question No. 7.2 [Nov-2015-8M]

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:
(i) The current NIFTY value is 8500.
(ii) NIFTY futures can be traded in units of 25 only.
(iii) 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
Ans: (i) 1.102; (ii) 8788, 8935.8; (iii) (a) 4.953 (or, 5); (b) 2.47 (or, 3) ; (c) 5.94 (or 6)

ARBITRAGE IN FUTURE
Question No. 8A [Nov-2002-4M]
In International Monetary Market an international forward bid for December, 15 on pound sterling is $ 1.2816 at the same time
that the price of IMM sterling future for delivery on December, 15 is $ 1.2806. The contract size of pound sterling is £ 62,500.
How could the dealer use arbitrage in profit from this situation and how much profit is earned?
[CMA Compendium]
Ans: $ 62.5
Question No. 8B [SM-New]
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) Calculate futures price for ACC stock on 31 December 2010
(ii) How much arbitrager can earns without involving any risk. Show calculation.
[CMA-SM-2016]
Ans: 225.75
Question No. 8C [SM-New] [Nov-2008-5M]
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 per cent and the expected annual dividend
yield is 25 per cent per annum payable before expiry. Also examine arbitrage opportunities.
[CMA Compendium]
Ans: Future Price =  214.5; For arbitrage opportunities advised to sell future and buy stock in cash market,
profit earned by arbitrageur =  15.5

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Question No. 8.1 [June-2009-4M]
The share of X Ltd. is currently selling for  300. Risk free interest rate is 0.8% per month. A three months futures
contract is selling for  312. Develop an arbitrage strategy and show what your riskless profit will be 3 month hence
assuming that X Ltd. will not pay any dividend in the next three months.
Ans: Risk less profit =  4.74. [hint: interest rate is compounded monthly]
Question No. 8.2 [RTP-Nov-2009] [Use concept of cover interest arbitrage of Forex Chapter]
If the interest rate for the next 6 months for the US$ is 1.5%. The interest rate for the € is 2%(6 month rate). The
spot price of the € is US $ 1.665. The forward price is expected to be US$ 1.664. Please determine correct
forward price and recommend an arbitrage strategy.
Ans: Correct Forward Price = US $ 1.6568; Arbitrage gain = .44%. Amount = $ 0.0073
Question No. 8.3 [Nov-2009-old-6M] [May-2004-old-6 M] [MTP-Nov-2014-5M] [MTP-May-2015-5M]
[CMA-RTP-Dec-2018]
The following data relates to ABC Ltd.’s share prices:
Current price per share : 180
Price per share in the futures market-6 months : 195
It is possible to borrow money in the market for securities transactions at the rate of 12% per annum.
Required:
(i) Calculate the theoretical minimum price of a 6 month-forward contract.
(ii) Explain if any arbitraging opportunities exist.
[CMA –MTP-June-2015-7M] [CMA –RTP-June-2014/2015] [CMA-SM-2016]
Ans: (i) Price 190.80; (ii) Sell future & buy a share by taking loan. Gain = 4.20

Question No. 8.4
The following information pertaining to two securities is given:
Securities
A Ltd. B Ltd.
Spot Price () 4,550 360
Dividend Expected () 50 20
Dividend Receivable (in Months) 2 3
Recommended Action Sell Spot, Buy Future Buy Spot, Sell Future
Risk free interest rate may be taken as 9% p.a.
(i) Determine the 6 months' theoretical forward prices of securities of A Ltd. and B Ltd. For what values of
futures contract rates will the above recommended action be appropriate?
(ii) What would your answer to (i) above be if there is no dividend expected for A and B?
[CMA-June-2017-8M] [CMA-SM-2016]
Ans: (i) A: 4,707.91; Less than 4707 B: 356.126; More than 356
(ii) A: 4759.4; Less than 4759 B: 376.57; More than 376
Important Notes:

UNIT-II
OPTION
(DERIVATIVE ANALYSIS AND VALUATION)
Learning Outcomes
❑ What is Options (Call/Put)
❑ Calculation of Loss/Gain from option
❑ Valuation of Option
❑ Strategies of Option

OPTION QUOTATION
Question No. 10A
The ITC stock is selling at 4,000. Mr. X has a negative view about the stock. He decides to go through the option
route to take advantage of the situation. He buys an option from Mr. A which will entitle him to sell 100 shares on
or before 30th December at 3,500 per share for which he has to pay 200 per share today.
You are required to identify:
(i) Type of option; (ii) Exercise price; (iii) Expiry date; (iv) Option premium; (v) Buyer of the option;
(vi) Writer of the option; (vii) Underlying asset; (viii) Current market price
Ans: [CMA-Dec-2010-8M]
Question No. 10B

The following quotes were observed by Mr. Saxena on September 10, 2010 in the Economic Times.
Contracts Open High Low Close Open Traded No of Underlying
Interest Quantity Contracts
CE-2145-Sept. 2010 210.15 222.5 210.15 225.39 45100 1600 8 NIFTY
PE-2310-Sept. 2010 21.45 28.6 20.51 21.89 2911700 1369000 6845 NIFTY
Explain, what these quotes indicate.
[CMA-Dec-2010-5M]
LOSS/GAIN FROM OPTION IF HOLD TILL EXPIRY

Question No. 11A [Nov-2018-Old-8M] [SM-New] [June-2009-10M]
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 holder of put option.
(i) the strike price in both cases is  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.
[CMA-RTP-Dec-2018-4M] [CMA-June-2017-8M] [Dec-2009-10M] [PTP-June-2015-10M] [TP-Dec-
2013/2014-10M]
Ans: (i) Net payoff for call option is  -6, -6, -6, 4, 14 for exercise price  200, 210, 220, 230, 240 respectively,
(i) Net payoff for put option is  15, 5, -5, -5, -5 for exercise price  200, 210, 220, 230, 240 respectively,
Question No. 11B

Dravid Investments Ltd deals in equity derivatives. Their Current Portfolio comprises of the following
instruments:
Infosys 5600 Call Expiry June 2004, 2,000 Units bought at  197 each (cost)
Infosys  5700 Call Expiry June 2004, 3,600 Units bought at 131 each (cost)
Infosys  5400 Put Expiry June 2004, 4,000 Units bought at 181 each (cost)
What will the profit or loss to Dravid Investments Ltd in the following situations?
(i) Infosys closes on the expiry day at 6,041
(ii) Infosys closes on the expiry day at  5,812
(iii) Infosys closes on the expiry day at  5,085.
[CMA-June-2004-8M] [CMA-June-2013-7M]
Ans: (i)  5,20,000; (ii) (-) 7,62,400 (iii) (-) 3,29,600


’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 11.1
Calculate Profits and losses from the following transactions:
(i) Mr. X writes a call option to purchase (it must be sale) share at an exercise price of 60 for a premium of 12 per
share. The share price rises to 62 by the time the option expires.
(ii) Mr. Y buys a put option at an exercise price of 80 for a premium of 8.50 per share. The share price falls
to 60 by the time the option expires.
(iii) Mr Z writes a put option at an exercise price of 80 for a premium of 11 per share. The price of the share
rises to 96 by the time the option expires.
(iv) Mr. XY writes a put option with an exercise price of 70 for a premium of 8 per share. The price falls to
48 by the time the option expires.
[CMA-Dec-2004-6M]
Ans: (i)  10; (ii) 11.50 (iii) 11; (iv) (-) 14.00
Question No. 11.2

The shares of Bengaluru Corporation Limited are selling at 105 each. Chandra Shekhar wants to chip in with
buying a three months call option at a premium of 10 per option. The exercise price is 110. Five possible prices
per share on the expiration date ranging from 100 to 140, with intervals of 10 are taken into consideration by
him. What is Chandra Shekhar’s pay-off as call option holder on expiration?
[CMA-June-2006-3M]
Ans: 0, 0, 10, 20, 30
Question No. 11.3
Consider a trader who buys an European call option on British Pound with a strike price of $ 1.6500 and a premium
of 2 cents ($0.020). The current spot rate is $ 1.6329. Calculate his gain/loss when the option expires if the spot
rates are as follows. 1.6300, 1.6270, 1.6400, 1.6500, 1.6549, 1.6320, 1.6500, 1.6900, 1.7000.
[CMA-RTP-Dec-2014]
Question No. 11.4 [RTP-Nov-2012] [CA-Final-May-2010]

A call and put exist on the same stock each of which is exercisable at  60. They now trade for:
Market price of Stock or stock index 55
Market price of call 9
Market price of put 1
Calculate the expiration date cash flow, investment value, and net profit from:
(i) Buy 1.0 call; (ii) Write 1.0 call; (iii) Buy 1.0 put; (iv) Write 1.0 put
for expiration date stock prices of  50,  55,  60,  65,  70.
LOSS/GAIN FROM OPTION/FUTURE IF EXIT BEFORE EXPIRY

Question No. 12A
An investor purchased. Reliance November Future (600 shares Tick size) at  542 and write a  580 November
call option at a premium of  6 (600 shares Tick size). As on November 20, spot price rises and so the future price
rises to  575 and call premium rises to  12. Find out profit/loss of the investor, if he/she settles the transaction
on that date and at stated prices. Brokerage is 0.05% for the transaction value of futures and strike price net of call
premium for option.
[CMA-Dec-2004-8M]
Ans: Overall Gain = 15,522.5 [Hint: Profit from Future= 19464.90]


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Question No. 12.1
An investor purchased Reliance November Futures (600 shares Tick Size) at  1,150 and write a  1,190 November
Call option at a premium of 10 (600 shares Tick Size). As on November 25, spot price rises and so the futures
Price and the call Premium also rise. Futures Price rises to  1,180 and call premium rises to 16. Brokerage is
0.045% for the transaction value of futures and strike price net of call premium for option.
Find out the Profit/loss of the investor, if he/she settles the transaction on that date and at stated prices.
(Assuming no transaction taxes and service taxes exist.)
[CMA-Dec-2006-7M]
Ans: Profit of the investor = 13135.52
OPTION STRATEGIES
Question No. 13A [May-2018-New-8M] [SM-NEW] [Nov-2011-8M] [RTP-Nov-2009]
Mr. X established the following spread on the Delta Corporation’s stock :
(i) Purchased one 3-month call option with a premium of 30 and an exercise price of 550.
(ii) 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. Determine profit or loss, if the price of Delta
Corporation’s:
(i) remains at 500 after 3 months.
(ii) falls at 350 after 3 months.
(iii) rises to 600.
Assume the size option is 100 shares of Delta Corporation.
[CMA-RTP-Dec-13] [CMA-June-2013-7M] [CMA-MTP-June-2014-(3+4+4)=11M]
Ans: (i) Net loss = 3,500; (ii) net Gain = 6,500, (iii) Net Gain = 1,500
Question No. 13B [June-2009-New-8M]

On 19th April following are the spot rates
Spot EUR/USD 1.20000 USD/INR 44.8000
Following are the quotes of European Options:
Currency pair Call/Put Strike Price Premium Expiry date
EUR/USD Call 1.2000 $ 0.035 July 19
EUR/USD Put 1.2000 $ 0.04 July 19
USD/INR Call 44.8000  0.12 Sep. 19
USD/INR Put 44.8000  0.04 Sep. 19
(i) A trader sells an at-the-money spot straddle expiring at three months (July 19). Calculate gain or loss if
three months later the spot rate is EUR/USD 1.2900.
(ii) Which strategy gives a profit to the dealer if five months later (Sep. 19) expected spot rate is USD/INR
45.00. Also calculate profit for a transaction USD 1.5 million.
[CMA-RTP-June-2014/2015]
Ans: (i) Net loss = $ 0.015 per Euro (ii) Buying strategy of call option give profit to dealer; Net gain = 120,000

Question No. 13C [RTP-Nov-2009]

The current ¥ / $ spot rate is 123.00. 6 month European calls with strike 0.0087 and 0.0083 ($/￥) are trading at
premia of ¢ 0.015/￥ and ¢ 0.02/￥ (cents per yen) respectively. A speculator is expecting a fairly strong
appreciation of the yen over the next six months.
(i) What option strategy should he adopt to profit from this forecast?
(ii) What is the breakeven rate?
(iii) How much is the maximum possible profit? (Ignore brokerage fees and interest costs/gains).
Ans: bullish Call Spread; break even rate = .8350 cent per yen; Max. Profit = .035 cent per yen.

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Question No. 13.1 [May-2006-Old-7M] [MTP-Nov-2014-6M]
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 fails and the price of the stocks falls to 36 in 3
months.
[CMA-June-2007-8M] [CMA-Dec-2012-7M] [CMA-RTP-June-2014/2015]
Ans: (i) Net loss = 200; (ii) Gain = 100

The current spot price of share of ABC Ltd. is121.00 with strike price 125.00 and  130.00 are trading at a
premium of 3.30 and1.80 respectively. Mr. X, a speculator is bullish about the share price over next six months.
However, he is also of belief that share price could also go down. He approaches to you for advice, you are required
to:
a. Suggest a strategy that Mr. X can adopt which puts limit on his gain and loss.
b. How much is maximum possible profit.
c. What will be break-even price of the share?
[Assume – No brokerage fees and interest cost/gains].
Ans: (a) Bull call spread; Max possible profit =  3.5; BEP = 126.50.

You are given three call options on a stock at exercise price of  30,  35 and  40 with expiration date in three
months and the premium of  4,  2, and  1 respectively. Show how the option can be used to create a butterfly
spread. Construct a table with different market prices and show how profit changes with stock prices arranging from
 20 to  50 for the butterfly spread.
Question No. 13.4

An investor wrote a naked call option. The premium was  2.50 per share and the market price and exercise price
of the share are 37 and  41 respectively. The contract being for 100 shares, calculate the amount of margin
under First Method, which is required to be deposited with the clearing house.
[CMA-June-2015-8 Marks]
Margin = (Option premium × 100) + {100 × 0.20 (market value of the share)} – {100 × (Exercise price – market price)}
= (2.50 × 100) + {100 × (0.20 × 37)} – 100 × (41 – 37) =  590

OPTION VALUATION (GENERAL METHOD)
Question No. 14A [Nov-2018-Old-8M] [Nov-2012-8M] [MTP-May-2014/2015]
You as an investor had purchased a 4 month call option on the equity shares of X Ltd. of  10 of which the current
market Price is  132 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 .05 .20 .50 .10 .15
Compute the following:

(1) Expected Share Price at the end of 4 months.
(2) Value of Call option at the end of 4 months. If the exercise Price Prevails.
(3) In case the Option is held to its maturity, what will be the expected value of the call option?
[CMA-MTP-Dec-2018]
Ans: (1)160.50; (2) Nil; (3) 14
Question No. 14B

By using the following data calculate theoretical value of 6 months call option.
Strike price = 100
Current price of one share = 110
Rate of interest = 10% p.a.
Dividend receivable after 4 month = 5
Ans: 9.92

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 14.1
A Call Option at a strike price of 280 is selling at a premium of 23. At what share price on maturity will it
break even for the buyer of the option?
Will the writer of the option also break-even at the same price?
[CMA-June-2014-2M]
Question No. 14.2

ABC Ltd common stock has a present market price per share of  28. A 6-month call option has been written on
the stock with an exercise price of  30. Presently the option has a market value of  3. At the end of 6 months,
you estimate the market price of the stock to be  24 per share with a probability of 0.1,  28 with a probability of
0.2,  32 with a probability of 0.4,  37 with a probability of 0.2, and  43 with a probability of 0.1
a. What is the expected value of share price 6 months hence? What is the expiration value of the option if that
expected value of share price should prevail?
b. What is the expected value of option price at expiration, assuming that the option is held to this time? Why
does it differ from the option value determined in part a?
Ans: (a) Expected share price = 32.5, expiration value of option =  2.5;
(b) Expected Value of option =  3.5; It differ from part (a) as the negative value of option are ignored.

OPTION VALUATION (PUT CALL PARITY METHOD)

Question No. 15A [RTP-Nov-2009]
The following information is available for a call option:
Time to expiration (months) 3
Risk free rate 8% (Compounded continuously)
Exercise price €60
Stock price €70
Call price €14
What is the value of a put option if the time to expiration is 3 months, risk free rate is 8%, exercise price is €60
and the stock price is €70?
[CMA-June-2012-8M] [CMA-PTP-June-2015-6M] [CMA-PTP-Dec-2014-4M]
Ans: Put value = € 2.812
Question No. 15B
Aptex Ltd. has both European call and put options traded on NSE. Both options have an expiration date 6 months
and exercise price of  30. The call and put are currently selling for  4 respectively. If the risk free rate of interest
is 6% p.e., what would be the stock price of Aptex Ltd.? [Given PVIF (6%, 0.5 yrs) = 0.9709].
[CMA-PTP-Dec-2014-2M]
Ans: Price = 29.127

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Question No. 15.1
The common share of a company is selling at 90. A 21 week call is selling at 8. The call’s exercise price is
100. The risk free rate is 10% p.a. What should be the price of a 21 week put of 100.
Ans: Value of put option =  14.12
Question No. 15.2

In September 30, 2013, a six-month Put on VINTEX LTD.'s stock with an exercise price of 75 sold for 6.82.
The stock price was 70.00. The risk-free rate was 6% per annum. How much would you be willing to pay for a
CALL on Vintex Ltd.'s stock with same maturity and exercise price?
[Given. PVIF (6%, 1⁄2 year) = 0.9709] and PVIF (6%, 1 year) = 0.9434]
Ans: Price of Six month call = 4.00
Question No. 15.3
A six month Call option on Nagarjuna Fertilizer with a strike price of 43 sells for 8. A put option on the same
stock and same strike price sells for 2. Option on this stock is available with a strike price of 40 and an expiration
date in six months. If the risk-free rate equals 10% at what price shares of Nagaijuna Fertilizer should trade to
prevent arbitrage?
[CMA-RTP-Dec-2014]
Ans: 46.95

OPTION VALUATION (BINOMIAL MODEL)
Question No. 16A [May-2011-New-5M] [RTP-May-2013]
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
𝑒 0.02 = 1.0202
[CMA-June-2018-New-6M] [CMA Compendium]
Ans: Value of 3 month call option = 13.968
Question No. 16B [Nov-2017-Old-5M]
A call Option on gold with exercise price of 26000 per ten gram and three months to expire is being traded at a
premium of 1010 per ten gram. It is expected that in three month 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 interest with simple compounding is
12% per annum. Is the current premium for the option justified? Evaluate the option and comments.
Ans: Fair Prem 1010, Yes Justified
Question No. 16C [SM-New] [May-2012-8M]

Sumana wanded to buy share of EIL 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 EIL. 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.
Ans: The probability in rise of Price = .1413
Question No. 16D [SFM-Nov-2015-5M]

The Equity Shares of ENDALCO LTD. are currently selling at a price of 500 each. An investor is interested in
purchasing the shares of Endalco Ltd. The investor expects that there is a 80% chance that the price will go up to
650 or a 20% chance that it will to down to 450, three months from now. There is a call option on the shares of
Endalco Ltd. that can be exercised only at the end of three months at an exercise price of 550.
The risk-free rate is 12% per annum.
(i) If the investor wants a perfect hedge, what combination of the share and option should he select?
(ii) Explain how the investor will be able to maintain identical position regardless of the share price.
(iii) How much the investor should pay for buying this call option today?
(iv) What is the expected return on the option?
[CMA-Dec-2007-8M]
Ans: (i) 1 share for 2 Call options (iii) 31.55 (iv) 153.56%.


’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 16.1
Quickset company’s equity shares are currently selling at a price of 400 each. An investor is interested in
purchasing Quickset’s shares. The investor expects that there is a 70% chance that the price will go up to 550 or
a 30% chance that it will go down to 350, three months from now. There is a call option on the shares of Quickset
that can be exercised only at the end of three months at an exercise price of 450
If the investor wants a perfect hedge, what combination of the share and option should be select?
Explain how the investor will be able to maintain identical position regardless of the share price
If the risk-free rate of return is 5% for the 3 month period, what is the value of option at the beginning of the period?
What is the expected return on the option?
[CMA-Dec-2005-11M]
Ans: (i) 1 share for every 2 calls option (iii) 33.33, (iv) 110%
OPTION VALUATION (TWO PERIOD BINOMIAL MODEL)

Question No. 17A [SM-New] [RTP-Nov-2009]
Following is a two-period tree for a share of stock in CAB Ltd.:
Now S1 One Period
36.30
33.00
30 29.70
27.00
24.30
Using the Binomial model, calculate the current fair value of a regular call option on CAB Stock with the
following characteristics: X =  28, Risk Free Rate = 5 percent (per sub period). You should also indicate the
composition of the implied riskless hedge portfolio at the valuation date.
Ans: value of call = 4.81; Hedge portfolio: 0.85 share for every 1 Call option.
Question No. 17B [June-2009-New-8 M]

Consider a two year American 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.
Ans: Prob: moving Up = 0.65; moving down = 0.35; value of call an on today =  8.272

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Question No. 17.1 [RTP-Nov-2010]
X Ltd’s share is currently trading at  220. It is expected that in six months time it could double or halved
(equivalent to a σ = 98%). One year call option on X Ltd’s share has an exercise price of 165. Assuming risk
free rate of interest to be 20%, calculate,
(a) Value of option on X Ltd’s Share.
(b) Option delta for the second six month, in case stock price rises to 440 or falls to 110
Ans: (a) 116.36; (b) Delta when price rise to 440 = 1.0; When price fall to 110 = 0.33

OPTION VALUATION (BLACK SCHOLES MODEL)
Question No. 18A [SM-New] [SM-Old]
(i) 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 share price is
22%. Based on the assumption that TIC Ltd. is not going to declare any dividend over the next three months,
is the option worth buying for  25?
(ii) Calculate value of aforesaid call option based on Black-Scholes valuation model if the current price is
considered as 380.
(iii) What would be the worth of put option if current price is considered  380.
(iv) If TIC Ltd. share price at present is taken as  408 and a dividend of 10 is expected to be paid in the two
months time, then, calculate value of the call option.
[Part (iv)-CMA-Dec-2006-11M] [Part-(i)-CMA-Dec-2014-10M]
Ans: Value of option = 29.5, hence worth buying; (i) Value of call = 10.52 (ii) Value of put = 25.553 (iii) Value of call = 18.98
Question No. 18B [Nov-2006-8M] [RTP-May-2010]

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 = 0.40
annual return
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 0.2578 0.2743
e 0.12x0.5 = 1.06184
In 1.0667 = 0.0645
[CMA-June-2007-8M] [CMA Compendium]
Ans: 13.949
Question No. 18C [RTP-May-2010-Old]
You are trying to value a long term call option on the Standard and Poor’s 500, expiring in 2 months, with a strike
price of $900. The index is currently at $930, and the annualized standard deviation in stock prices is 20% per
annum. The average dividend yield on the index is 0.3% per month, and is expected to remain unchanged over the
next month. The Treasury bond rate is 8%.
a. Estimate the value of the long term call option.
b. Estimate the value of a put option, with the same parameters.
c. What are the implicit assumptions you are making when you use the Black-Scholes model to value this
option?
Which of these assumptions are likely to be violated? What are the consequences for your valuation?
Ans: (a) call = $50.65; (b) Put = $14.32;
(c) (1) The variance will be unchanged for the life of the option. This is likely to be violated because stock
price variances do change substantially over time.
(2) There will be no early exercise. This is reasonable and is unlikely to be violated.
(3) Any deviations from the option value will be arbitraged away.
While there are plenty of arbitrageurs eager to exploit deviations from true value, arbitraging an index is
clearly more difficult to do than arbitraging an individual stock.


’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 18.1
The share of EXECPRO Ltd. are currently priced at 408 and call option exercisable in three month’s time has a
exercise rate of 400. Risk free interest rate is 5% p.a. and standard deviation (volatility) of share price is 22%. The
company is going to declare a dividend of 10 and it is expected to be paid in two months time.
Required :
(i) Determine the value of a three-month CALL Option on the share of Execpro Ltd. based on Black Scholes Model.
(ii) What would be the worth of PUT OPTION if the current price is considered to be 390?
Note: Extracted from the tables:
1. Ln (0.99521) = -0.00489, Ln 1.004798
2. Value of e-x : e-0.01 = 0.99005, e-0.0125 = 0.987578, e-0.008333 = 0.9917
3. Cumulative standardization normal probability distribution: NCX.
When X≥0 : N (0.125) = 0.5498, N (0.015) = 0.5060
When X≤0 : N (-0.125) = 0.4502, N (-0.015) = 0.4940
[CMA-June-2012- 8M] [CMA-TP-Dec-2013-10M]
Ans: Call = 18.98; Put = 24.04
Question No. 18.2 [SM-Old]
We have been given the following information about XYZ company’s shares and call options:
Current share price =  165
Option exercise price =  150
Risk free interest rate = 6%
Time to option expiry = 2 years
Volatility of share price (Standard deviation) = 15%
Calculate value of the option.
Ans: Value of option =  34.78
Question No. 18.3 [Nov-2008-12M] [RTP-Nov-2009/Nov-2011]

Following information is available for X Company’s shares and Call option:
Current share price 185
Option exercise price 170
Risk free interest rate 7%
Time of the expiry of option 3 years
Standard deviation 0.18
Calculate the value of option using Black-Scholes formula.
Ans: Value of option =  51.767

From the following data compute value of call option using the Black-Scholes Option Pricing Model (OPM).
Stock Price =  27.00.
Strike Price =  25.00
Time to expiration = 6 Months.
Risk-Free Rate = 6.0%.
Stock Return Variance = 0.11.
Ans: Value of call option =  3.97

Question No. 18.5
Compute a call option price by applying the black-Scholes option pricing model on the following values:
Time remaining to expiration = 183 days
Current stock price = 47
Expected price volatility = standard deviation of the stock’s return = 0.25
Risk free rate = 10%
Given: N(0.6172) = 0.7315 and N(0.4404) = 0.6702.
[CMA-June-2013-5M] [CMA Compendium]
ARBITRAGE IN OPTION
Question No. 19A [RTP-May-11]
The following table provides the prices of options on equity shares of X ltd. and Y Ltd. The risk free interest is 9%
(compounded continuously). You as a financial planner are required to spot any mispricing in the quotations of
option premium and stock prices? Suppose, if you find any such mispricing then how you can take advantage of
this pricing position.
Share Time to exercise Exercise price Share price Call price Put price
X Ltd. 6 months 100 160 56 4
Y Ltd. 3 months 80 100 26 2
Ans: (i) Advantage using 6 month call and put = 12.97; (ii) Advantage using 3 month call and put = 2.29
Question No. 19B

Given the following data:
Current price of one share =  100
Risk free rate of interest = 10% p.a. (not continuously compounding)
(i) Calculate theoretical current (fair) price of a European call option (can be exercised on expiration date only) expiring after
one year
(ii) If price of the call option is  15 then how can an arbitrageur make profit.
[CMA-SM-2016]
Ans: (i) current value of call =  18.18; (ii) Arbitrageur can make profit if he purchase call option.

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 19.1
The following quotes are available for 3 months options in respect of a share currently traded at 31.
Strike price 30.00
Call option 3.00
Put option 2.00
An investor devises a strategy of buying a call and selling the share and a put option.
(i) What is his profit/loss profile if it is given that the rate of interest is 10% per annum?
(ii) What would the position if the strategy adopted is selling a call option and buying the share and a put
option? [Given PVIF (10%, 0.25Years) = 0.9756]
[CMA-June-2018-New-8M[ [CMA-June-2009-(4+3)=7M]
Ans: (i) Profit per share = 0.73 (ii) Loss per share = (-) 0.73

Question No. 19.2

The following information is given
Current Stock price 190
Strike price 210
Price of 6 months European Put Option 10
Risk Free interest rate 5%
Calculate the theoretical minimum price of the put option at the end of 6 months.
Show the arbitrage process step by step and find out the gain if
(ii) the price on the expiration day is 200
(iii) the price on the expiration day is 220
[CMA-Dec-2017-8M]
Important Notes:

UNIT-III
CURRENCY OPTION &
CURRENCY FUTURE
(DERIVATIVE ANALYSIS AND VALUATION)
Learning Outcomes
❑ What is Options (Call/Put)
❑ Calculation of Loss/Gain from option
❑ Valuation of Option
❑ Strategies of Option

CURRENCY FUTURE
Question No. 20A [Nov-2017-8M] [Nov-2016-8M] [May-2015-6M] [Nov-2006-old-10M]
[RTP-May-2014] [MTP-Nov-2014-6 M]
XYZ Ltd. is an export oriented business house based in Mumbai. The Company invoices in customers’ currency.
Its receipt of US $ 1,00,000 is due on September 1, 2005.Market information as at June 1, 2005.
Exchange Rates Currency Futures
US $ / INR US $ / INR Contract size 4,72,000
Spot 0.02140 June 0.02126
1 Month Forward 0.02136 September 0.02118
3 Months Forward 0.02127
Initial Margin Interest Rates in India
June 10,000 7.50%
September 15,000 8.00%
On September 1, 2005 the spot rate US $Re. is 0.02133 and currency future rate is 0.02134. Comment, which of
the following methods would be most advantageous for XYZ Ltd?
(a) Using forward contract
(b) Using currency futures
(c) Not hedging currency risks.
It may be assumed that variation in margin would be settled on the maturity of the futures contract.
[CMA Compendium] [RTP-May-2014]
Ans: (a) Rcpt =  47,01,457; (b) Rcpt =  47,20,639; (c) Rcpt =  46,88,233.
Question No. 20B [RTP-Nov-2015] [Nov-2011-8 Marks]

Nitrogen Ltd, a UK company is in the process of negotiating an order amounting to €4 million with a large German
retailer on 6 months credit. If successful, this will be the first time that Nitrogen Ltd has exported goods into the
highly competitive Ge rman market. The following three alternatives are being considered for managing the
transaction risk before the order finalized.
(i) Invoice the German firm in Sterling using the current exchange rate to calculate the invoice amount.
(ii) Alternative of invoicing the German firm in € and using a forward foreign exchange contract to hedge the
transaction risk.
(iii) Invoice the German first in € and use sufficient 6 months sterling future contracts (to the nearly whole
number) to hedge the transaction risk.
Following date is available:
Spot Rate €1.1750 - €1.1770/£
6 months forward premium 0.60-0.55 Euro Cents
6 months further contract is currently trading at €1.1760/£
6 months future contract size is £ 62,500
Spot rate and 6 months future rate €1.1785/£
Required:
(a) Calculate to the nearest £ the receipt for Nitrogen Ltd, under each of the three proposals.
(b) In your opinion, which alternative would you consider to be the most appropriate and the reason therefore.
Ans: (i) 33,98470; (ii) 34,14425; (iii) 34,01,304.62


’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 20.1
For imports from UK, Philadelphia Ltd. of USA owes £ 6,50,000 to London Ltd., payable on May, 2004. It is now
12 February, 2004. The spot rate on 12 February is 1.4850$/£ 1.
The following future contracts (contract size £ 62,500) are available on the Philadelphia exchange:
Expiry Current futures rate
March 1.4900 $ / £ 1
June 1.4960 $ / £ 1
(i) Illustrate how Philadelphia Ltd. can use future contracts to reduce the transaction risk of, on 20 May the spot
rate is 1.5030 $ / £ 1 and June futures are trading at 1.5120 $ / £ .
(ii) Calculate the “hedge efficiency”
[CMA-MTP-June-2015-10M] [CMA-June-2004-16 Marks]
Ans: (i) Loss $ 11,700, but buying future can reduce it by 11000; (ii) Hedge efficiency = 94.02% [assuming 11 contract]
Question No. 20.2 [RTP-May-11-New]

ABC Technologic is expecting to receive a sum of US$ 4,00,000 after 3 months. The company decided to go for
future contract to hedge against the risk. The standard size of future contract available in the market is $1000. As
on date spot and futures $ contract are quoting at  44.00 & 45.00 respectively.
Suppose after 3 months the company closes out its position futures are quoting at  44.50 and spot rate is also
quoting at 44.50. You are required to calculate effective realization for the company while selling the receivable.
Also calculate how company has been benefitted by using the future option.
Ans: Effective realization = 45 per $; benefit using future = 2,00,000
[Hint: Effective realization means the rate at which payment should be realized]

Zaz plc, a UK Company is in the process of negotiating an order amounting €2.8 million with a large German
retailer on 6 month’s credit. If successful, this will be first time for Zaz has exported goods into the highly
competitive German Market. The Zaz is considering following 3 alternatives for managing the transaction risk
before the order is finalized.
(a) Mr. Peter the Marketing head has suggested that in order to remove transaction risk completely Zaz should
invoice the German firm in Sterling using the current €/£ spot rate to calculate the invoice amount.
(b) Mr. Wilson, CE is doubtful about Mr. Peter’s proposal and suggested an alternative of invoicing the German
firm in € and using a forward exchange contract to hedge the transaction risk.
(c) Ms. Karen, CFO is agreed with the proposal of Mr. Wilson to invoice the German first in €, but she is of opinion
that Zaz should use sufficient 6 month sterling future contracts (to the nearest whole number) to hedge the
transaction risk.
Following data is available
Sport Rate € 1.1960 - €1.1970/£
6 months forward premium 0.60- 0.55 Euro Cents
6 month future contract is currently trading at € 1.1943/£
6 month future contract size is £62,500
Spot rate and 6 month future rate € 1.1873/£
You are required to
(i) Calculate (to the nearest £) the £ receipt for Zaz plc, under each of 3 above proposals.
(ii) In your opinion which alternative you consider to be most appropriate
Ans: (i) 2339181; (ii) 2349979; (iii) 2344290

CURRENCY OPTION
Question No. 21A [SM-NEW] [Nov-2015-8M] [MTP-May-2015] [May-2007-16M]
XYZ Ltd. a US firm will need £ 3,00,000 in 180 days. In this connection, the following information is available:
Spot rate 1 £ = $ 2.00
180 days forward rate of £ as of today = $1.96
Interest rates are as follows:
U.K. US
180 days deposit rate 4.5% 5%
180 days borrowing rate 5% 5.5%
A call option on £ that expires in 180 days has an exercise price of $ 1.97 and a premium of $ 0.04.
XYZ Ltd. has forecasted the spot rates 180 days hence as below:
Future rate Probability
$ 1.91 25%
$ 1.95 60%
$ 2.05 15%
Which of the following strategies would be most preferable to XYZ Ltd.?
(a) forward contract; (b) money market hedge; (c) an option contract; (d) no hedging
Show calculations in each case.
[CMA-June-2017-New-8M] [As CMA-Dec-2007-10M] [CMA Compendium]
Ans: (a) $5,88,000 (b) $ 6,05741.63 (c) $5,95,560 (d) no hedging = 5,86500
Question No. 21B [Nov-2015-5M] [May-2010-8M] [RTP-May-2010] [MTP-May-2015-10M]

Best of Luck Ltd, London will have to make a payment of $ 3,64,897 in six months’ time. It is currently 1 st
October. The company is considering the various choices it has in order to hedge its transaction exposure.
Exchange rates
Spot rate $ 1.5617 - 1.5773
Six-months forward rate $ 1.5455 - 1.5609
Money Market Borrow (%) Deposit (%)

rates:
US 6 4.5
UK 7 5.5
Foreign currency option prices (1 unit is £ 12,500):
Exercise Price Call option (March) Put option (March)
$1.70 / £ $0.037 $ 0.096
By making the appropriate calculations and ignoring time value of money (in case of premia) decide which of the
following hedging alternatives is the most attractive to best of luck ltd.
(a) Forward market
(b) Cash (money market)
(c) Currency options.
[CMA-June-2006-10 Marks]
Ans: (i) £2,36,103 (ii) £2,36511 (iii) if make 18 contract = 2,27,553.61
[Alternatively: if make 17 contract = £2,27922.63]

Question No. 21C [Nov-2013-8 Marks]
An American firm is under obligation to pay interests of Can$ 1010000 and Can$ 705000 on 31st july and 30th
September respectively. The firm is risk averse and its policy is to hedge the risks involved in all foreign currency
transactions. The finance manager of the firm is thinking og hedging the risk considering two methods i.e. fixed
forward or option contracts.
It is now June 30 following quotations regarding rates of exchange, US$ per Can$ from the firm’s bank were
obtained:
Spot 1 month forward 3 months forward
0.9284 – 0.9288 0.9301 0.9356
Price for a CAN$ / US$ option on a U.S. stock exchange (cents per CAN$, payable on purchase of the option,
contract size Can$ 50000) are as follows:
Strike price Calls Puts
(US$ / CAN$) July Sept. July Sept.
0.93 1.56 2.56 0.88 1.75
0.94 1.02 NA NA NA
0.95 0.65 1.64 1.92 2.34
According to the suggestion of finance manager if options are to be used, one month option should be bought at a
strike price of 94 cents and three month option at a strike price of 95 cents and for the remainder uncovered by the
options the firm would bear the risk itself. For this it would use forward rate as the best estimate of spot.
Transaction costs are ignored.
Recommended, which of the above two methods would be appropriate for the American firm to hedge its foreign
exchange risk on the two interest payments

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 21.1
An Indian exporter has sold handicrafts items to an American business house. The exporter will be receiving US$
1,00,000 in 90 days. Premium for a dollar put option with a strike price of 48 and a 90 days settlement is 1. The
exporter anticipates the spot rate after 90 days to be 46.50.
Should the exporter hedge its account receivable in the option market?
If the exporter is anticipating the spot rate to be 47.50 or 48.50 after 90 days, how would it effect the exporter’s
decision?
[CMA-MTP-June-2015-5M] [CMA-June-2005-5M]
Ans: Yes, he should hedge using a put option, (ii) In both the cases, the exporter will not be hedging
through the put option, as it results in negative benefit.
Question No. 21.2

Wilson Ltd an Indian company has a payable of US$ 1,00,000 due in 3 months. The company is considering to
cover the payable through the following alternatives:
(i) Forward contract;
(ii) Money market; and
(iii) Option.
The following information is available with the company:
Exchange rate:
Spot /$ 45.50/45.55
3M Forward 40/45

Interest rates (%): Per Annum

US 4.5/5.0 (Deposit/Borrow)
India 10.0/11.0 (Deposit/Borrow)
Call option on $ with a strike price of 46.00 is available at a premium of 0.10/$. Put option on $ with a strike
price of 46.00 is available with a premium of 0.05/$.
Treasury department of the company forecasted the future spot rate after 3 months to be:
Spot rate after 3-m Probability
45.60/$ 0.10
46.00/$ 0.60
 46.40/$ 0.30
You are required to suggest the best alternative of hedging.
[CMA-Dec-2009-10 Marks]
Ans: (i) Forward hedge: 46,00,000; (ii) MMO: 46,28,195; (iii) Option hedge:
Question No. 22.3

ZENITH LTD (ZL) places an order to buy machinery with an American company. As per the agreement zenith Ltd
will be paying $2,00,000 after 180 days. The company (ZL) considers to use:
(i) a forward hedge
(ii) a money market hedge,
(iii) an option hedge or
(iv) no hedge
The consultant of Zenith Ltd. collects and develops the following data/information as desired by the company,
which can be used to assess the alternative approaches for hedging:
(i) Spot rate of dollar as of today is 47/$
(ii) 180 day forward rate of dollar as of today is 47.50/$
(iii) Interest rats are as follows:
India US
180 days deposit rate (per annum) 7.5% 3%
180 day borrowing rate (per annum) 8.0% 4%
(Assume 360 days in a year)
(iv) Future spot rate in 180 days as estimated by the consultant is 47.75$.
(v) A call option on the dollar, which expires in 180 days has an exercise price of 47/$ and premium
0.52/$
(vi) A put option on the dollar, which expires in 180 days has an exercise price of 47.50 and premium
0.40/$.
Required:
Carry out a comparative analysis of various outcomes (rupee cost of import)/Alternatives and decide which of
the alternatives is the most attractive to zenith Ltd.
[CMA-Dec-2005-12 marks]
Ans: Price to be paid under various options: (i) 95 lakhs (ii) 96,31,511 (iii) 95,04,000;
(iv) 95,50,000; Forward hedge (Alternative-i) is best as it is cheapest.
Question No. 22.4

An Indian exporter has sold handicraft items to an American business house. The exporter will be receiving US
dollar 1 Lakh in 90 days. Premium for a dollar put option with a strike price of 58.00 and a 90 days settlement
is 1. The exporter anticipates the spot rate after days to be 56.50.
(i) Should the exporter hedge its account receivable in the option market?
(ii) If the exporter is anticipating a spot rate to be 57.50 or 58.50 after 90 days how would it effect the
exporter’s decision?
[CMA-June-2014-(2+3)=5M]
Question No. 22.5

A US co has struck a deal to sell goods to a German company for euro 1,250,000 due six months. Because the
contract is in Euros rather than dollars, the US Company is considering several hedging alternatives to reduce the
exchange rate risk arising from the sale. The following information is available.
The spot exchange rate is $ 1.40/euro
The six month forward rate is $1.38/euro
US company's cost of capital is 11%
The Euro zone 6-month borrowing rate is 9%
The Euro zone 6-month lending rate is 7%
The U.S. 6-month borrowing rate is 8%
The U.S. 6-month lending rate is 6%
December put options for Euro 6,25,000; strike price $ 1.42, premium price is 1.5% of spot
US Company's forecast for 6-month spot rates is $1.43/euro
Evaluate the following strategies:
1. No Hedge
2. Forward Hedge
3. Options Hedge
4. If the US Company locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was
recorded on the books was $1.40/euro, what will be the consequences?
[CMA-RTP-Dec-2014-New]
Question No. 22.6 [Nov-2015-8 M]

XYZ, an Indian firm, will need to pay JAPANESE YEN (JY) 5,00,000 on 30th June. In order to hedge the risk
involved in foreign currency transaction, the firm is considering two alternative methods i.e. forward market cover
and currency option contract.
On 1st April, following quotations (JY/INR) are made available:
Spot 3 months forward
1.9516/1.9711 1.9726./1.9923
The prices for forex currency option on purchase are as follows:
Strike Price JY 2.125
Call option (June) JY 0.047
Put option (June) JY 0.098
For excess or balance of JY covered, the firm would use forward rate as future spot rate. You are required to
recommend cheaper hedging alternative for XYZ.

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Chapter – 4

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MARGIN MONEY AND MARGIN CALL

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 TEST YOUR KNOWLEDGE

PROFIT AND LOSS FROM FUTURE CONTRACT

Question No. 3B [RTP-Nov-2011-Old]

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 TEST YOUR KNOWLEDGE

 TEST YOUR KNOWLEDGE

Question No. 4.2

CALCULATION OF FAIR FUTURE PRICE

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 TEST YOUR KNOWLEDGE

Question No. 5.2 [May-2012-Old-5M] [RTP-Nov-2014-Old]

Question No. 5.3 [SM-New]

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HEDGING WITH THE HELP OF INDEX FUTURE

Question No. 6C [Nov-2007-8M] [RTP-Nov-2013] [RTP-Nov-2015] [MTP-Nov-2014]

Question No. 6D [Nov-2013-6 Marks]]

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 TEST YOUR KNOWLEDGE

Question No. 6.2 [RTP-May-2015]

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INCREASING/DECREASING BETA WITH THE HELP OF INDEX FUTURE

Question No. 7B [Nov-2013-5 M]

Question No. 7D [May-2013-8M] [MTP-May-2015-8M]

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 TEST YOUR KNOWLEDGE

Question No. 7.2 [Nov-2015-8M]

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 TEST YOUR KNOWLEDGE

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Question No. 10B

LOSS/GAIN FROM OPTION IF HOLD TILL EXPIRY

Question No. 11B

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 TEST YOUR KNOWLEDGE

Question No. 11.2

Question No. 11.4 [RTP-Nov-2012] [CA-Final-May-2010]

LOSS/GAIN FROM OPTION/FUTURE IF EXIT BEFORE EXPIRY

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 TEST YOUR KNOWLEDGE

Question No. 13B [June-2009-New-8M]

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Question No. 13C [RTP-Nov-2009]

 TEST YOUR KNOWLEDGE

Question No. 13.2 [RTP-May-12]

Question No. 13.3 [RTP-May-2010]

Question No. 13.4

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Compute the following:

Question No. 14B

 TEST YOUR KNOWLEDGE

Question No. 14.2

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OPTION VALUATION (PUT CALL PARITY METHOD)

 TEST YOUR KNOWLEDGE

Question No. 15.2

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Question No. 16C [SM-New] [May-2012-8M]