Forwards and Futures

1. Currently gold price in the market is Rs 50,000 per 10 gram. One year forward price
of the gold is Rs 60,000 per 10 gram and interest rate is 10% p.a.. Under the given
scenario what do you do? What would you do if forward price of gold is Rs 52,000
instead of Rs 60,000?

2. Look at the following quotes:

Bid Offer
Spot 74.5375 74.5425
1-month forward 74.5745 74.5752
2-month forward 74.6545 74.6567
3-month forward 74.8956 74.9056
In the above case, Infosys exports $10,000 to the US today and expects to receive in
two months. How does it hedge its position using dollar forwards? What if the price
per dollar after two months is a. Rs 74 under scenario 1 and b. Rs 75 under scenario
2?
In the above case, Tata Steel imports $10,000 from the US today and expects to pay in
three months. How does it hedge its position using dollar forwards? What if the price
per dollar after three months is a. Rs 74 under scenario 1 and b. Rs 75 under scenario
2?

3. Consider the following settlement prices of Nifty futures on NSE from 4 th May 10
May 2020 for May expiry. Contract size of Nifty on futures segment is 75.

Date Expiry Settlement Price

04-May-20 28-May-20 9285.90
05-May-20 28-May-20 9208.60
06-May-20 28-May-20 9280.70
07-May-20 28-May-20 9204.25
08-May-20 28-May-20 9236.65
11-May-20 28-May-20 9225.15
12-May-20 28-May-20 9212.35

With a bullish view point, Mr Sushant has taken long position in Nifty futures on 4 th
May and closed on 12th May. Mr Agarwal has taken short position with bearish
viewpoint. Show the mark to market mechanism, opening and closing balances in the
margin account and margin call if any, for both the traders. Also show overall
gain/loss on their respective positions. Assume initial margin is Rs 20,000 and
maintenance margin is Rs 18,500.

4. An investor enters into a short position in 10 contracts of gold futures at a futures

price of Rs, 3,392 per gm. The size of one futures contract is 100 gm. The initial
margin and maintenance margin per contract are Rs 2,000 and Rs 1,500 respectively.
a. What is the initial size of the margin account?
b. Suppose the futures settlement price on the first day is Rs 3,395 per gm. What
is the new balance in the margin account? Does a margin call occur? If so,
assume that the account is topped back to its original level.

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 c. The futures settlement price on the second day is Rs 3,400 per gm. What is the
new balance in the margin account? Does a margin call occur? If so, assume
that the account is topped back to its original level.
d. On the third day, the investor closes out the short position at a futures price of
Rs. 3,380. What is the final balance in his margin account?

5. Infosys has receivables of $ 10000 to be received after a month. Treasury manager of

the company decided to use dollar futures for hedging. Contract size of each $ futures
is $ 1000. Today, spot price and one month futures prices are Rs 74.4 and Rs 74.6 per
$ respectively. Show how the treasury manager undertakes hedging and also show his
cash flows and gain/loss due to hedging, under the following scenarios.
Scenario 1: if spot price on maturity is Rs 74.1
Scenario 2: if spot price on maturity is Rs 75.1
What is your observation and is there any benefit of hedging?
What would be your answer in the above case, if it is treasury manager of IOC who
has payables of $ 10,000 for his imports?

6. On April 1, 2020 NSE 50 is traded at 9600. Three month Nifty 50 futures are traded at
9700. If dividend yield on the index is 3% p.a. and T bill yield 7% p.a. Find out
whether current Nifty 50 futures are correctly priced or not. In case of mispricing, find
out gain/loss due to arbitrage, under the following two scenarios after 3 months
Scenario 1: If Nifty 50 is traded at 9500
Scenario 2: If Nifty 50 is traded at 9800
What would be your answer in the above case if 3-month Index futures are traded at
9550 on April 1, 2020?

7. Mr. Sanjay is in-charge of a $60 million common stock portfolio for a mutual fund.
The beta of the portfolio is 1.2. He is concerned about the fall in the market over the
next three months and hence the value of the portfolio would fall. Assume that the 3
month S&P 500 index futures is currently valued at 2400. Note that the S&P mentions
that the contract size is equal to 250 times the index value. Suggest what Mr Sanjay
should do to hedge his position.

8. Infosys has receivables of $ 10000 to be received after 3 weeks. Treasury manager of

the company decided to use one month dollar futures for hedging, as there are no
contracts available for 3 weeks. Contract size of each $ futures is $ 1000. Today, spot
price and one month futures prices are Rs 74.4 and Rs 74.6 per $ respectively. Show
how the treasury manager undertakes hedging and also show his cash flows and
gain/loss due to hedging, under the following scenarios.
Scenario 1: if spot price after 3 weeks is Rs 74.1 and futures price is 74.2
Scenario 2: if spot price after 3 weeks is Rs 74.1 and futures price is 74.3
Scenario 3: if spot price after 3 weeks is Rs 74.1 and futures price is 74.4
Scenario 4: if spot price after 3 weeks is Rs 75.1 and futures price is 75.2
Scenario 5: if spot price after 3 weeks is Rs 75.1 and futures price is 75.3
Scenario 6: if spot price after 3 weeks is Rs 75.1 and futures price is 75.4
a. What is your observation?
b. What would be your answer in the above case, if it is treasury manager of IOC
who has payables of $ 10,000 for his imports?

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9. A portfolio worth Rs100 million exactly mirrors the Nifty 50. The Nifty 50 index
futures price is 9070.29 and size of each futures contract is 75. How do you hedge the
portfolio using Nifty 50 futures?

10. Value of Nifty 50 index is 9100. Mr Agarwal is managing a portfolio worth Rs

45,500,000. He is concerned about the performance of the market over next 2 months
and wants to use 3 month futures contract to hedge the portfolio. Currently, its 3
month futures price is 9191.92. Beta of the portfolio is 1.5. Risk free rate is 6% p.a.
and dividend yield on the index is 3% p.a. Size of each futures contract is 75.

a. What position should the fund manager take to hedge his portfolio over the
next 2 months?
b. Calculate the effect of your strategy on the fund manager’s return in 2
different scenarios given below:
Scenario 1: If Nifty 50 after 2 months is 8900 and its one month futures price
is 8930
Scenario 2: If the level of market after 2 months is 9200 and its one month
futures price is 9223

11. A fund manager has a portfolio worth Rs 50 mn with a beta of 1.1. He is concerned
about the market performance over the next one month and plans to use two months
futures contract on the index. Current level of index is 2000 and contract size is 200
times the index. Risk free return is 6% p.a. and dividend yield on the index is 3% p.a.
The current 2 month futures price is Rs 2100.
a. What position should the fund manager take to eliminate all exposure to the
market value over the next one month?
b. Calculate the effect of your strategy on the fund manager’s return if the level
of market in a month is a. 1800, b. 2100 and c. 2300. Assume that one month
futures price is 0.25% higher the index level after a month. What is your
observation?

12. Consider a 10 month forward contract on a stock when the stock price is Rs 50. Risk-
free rate is 6% p.a. for all maturities. Dividends of Re 0.75 per share are expected
after 3 months, 6 months and 9 months each. What is the price of forward contract?
(Assume continuous compounding).

13. A stock is expected to pay a dividend of Rs 2 per share in two months and in five
months each. The stock price is Rs 100 and risk free rate of interest is 6% p.a. with
continuous compounding for all maturities. An investor has just taken a long position
in a 6 month forward contract on the stock.

a. What are the forward price and the initial value of forward contract?

b. Three months later, the price of the stock is Rs 96 and risk free rate is 6% p.a.
What are the forward price and the value of long position in the forward
contract?

How would your answer change if it is short position in forward contract?

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14. A long forward contract on a non-dividend paying stock was entered into some time
ago. It currently has 6 months to maturity. The risk free rate of interest is 10% p.a.
Current market price of the stock price is Rs 25 and delivery price is Rs 24. What is
the value of forward contract? What would be your answer if you entered a short
forward contract instead of long forward contract?

15. Look at the following cases and determine open interest and volume in each of the
cases. How do you analyse the market conditions based on open interest, volume and
price?

Day 1: A buys 3 futures contracts and B buys 2 futures contracts, while C sells all of
those 5 contracts. After this transaction, there are 5 contracts in total with 5 on the
long side (3 + 2) and another 5 on the short side; hence the open interest is 5.  This is
summarized in the table below.
Day 2: C closes 4 contracts out of the 5 contracts he holds, D comes into the market
and takes on the 4 shorts contracts from him.
Day 3: D wants to take 3 more short contracts to the existing contracts, of which A
and B want to buy one each and C wants to close his position.
Day 4: E sells 10 contracts of which A buys 2 contracts, B buys 1 contract, C buys 2
contracts and D buys 5 contracts.
Day 5: E wants to square-off 8 contracts of which he buys 4 contracts from A and 4
contracts from B.
Points to remember:
Basis = Cash Price – Futures Price
If concern (hedger)/expectation (speculator)/overpricing (arbitrage) is increase in price in
future, take long position in derivatives today
If concern (hedger)/expectation (speculator)/overpricing (arbitrage) is decrease in price in
future, take short position in derivatives today
Long position in futures: overall gain/loss
(close price-open price)×contract size
or
(Balance at the time of close–Balance at the time of open) - Margin call
Short position in futures: overall gain/loss
(Open price-Close price) ×contract size
(Balance at the time of close–Balance at the time of open) - Margin call

Pay off from a long position in a forward contract = S-K where, ST =spot price on maturity
and K= delivery price
Pay off from a short position in a forward contract = K-S where, S =spot price and K=
delivery price
P
N ¿=
F
*
N = Optimal number of contracts for hedging
P = Current value of the portfolio
F = Current value of one futures contract (futures price times the contract size)

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Cross Hedging:
P
N ¿ =β
F

β = Beta of a portfolio/asset
Pricing Forwards and Futures
a. For an asset which provides no dividend or any other income
F0 = S0erT (Continuous compounding)
F0 = S0 × (1+r×T)(Discrete compounding)
b. For an asset which provides known income with present value I
F0 = (S0-I) erT (Continuous compounding)
F0 = (S0-I) × (1+r×T) (Discrete compounding)
c. For an asset which provides known yield q
F0 = S0 e(r-q)T(Continuous compounding)
F0 = S0[1+ (r-q)×T](Discrete compounding)
d. For commodities with storage cost
F0 = S0 e(r+u)T(Continuous compounding)
F0 = S0[1+ (r+u)×T](Discrete compounding)
e. For commodities with storage cost and convenience yield
F0 = S0 e(r+u-y)T(Continuous compounding)
F0 = S0[1+ (r+u-y)×T](Discrete compounding)
r= interest rate per annum, q = dividend yield per annum, T= time to maturity (in
years), u=storage cost per annum, y=convenience yield per annum
I= present value of income during the life of the forward/futures contract
Convenience yield= Benefit of holding physical asset
Value of long forward/futures contract = f=(F0 –K)e-rT
Value of short forward/futures contact = f= (K-F0)e-rT