Answer 3 B)

a)
Manufacturer can take following positions in each of the derivative contracts:

Forwards – Can buy a forward contract over the counter with the party directly without any
governing body in between. The forward contract can hedge the risk when zinc prices go up
and is not in the favour of manufacturer.

Futures – manufacturer can buy a futures contract with a party wherein there is a governing
party in between this will also help hedge the risk of the manufacturer in the coming months.

Options – To hedge the risk Manufacturer can buy the call option and keep it with him of
next expiry to minimize the risk associated with price volatility of zinc.

b) Advantages and disadvantages of each of the contracts:

Forwards: -

Advantages –

 They are easy to understand.

 The use of forward contracts minimizes the risk

 Forwards are over the counter products

Disadvantages-

 It might be difficult to find counterparty

 It is always susceptible to default risk.

 There is no intermediate transaction before the settlement

Futures: -

Advantages –

 High liquidity to trade in market

 Provides protection against price fluctuation

 No time decay involved unlike Options

Disadvantages –

 Has an Expiration date. The futures become less attractive near the expiry date
  Daily fluctuation in price can be due to high leverage. It has leverage issues

Options: -

Advantages –

 Option contract has low capital requirements

 Unique strategies can be employed in market using options.

 Risk/Reward ratio is favorable when buying an option contract.

Disadvantages –

 Option contracts are complicated and not easy to understand

 Option contracts have less liquidity as compared to future contracts.

 Time decay – manufacturer loses the time value of money when he buys option
contract.

Answer 3 A)
a)
It will be better for Novak to take the loan from Serbia. Even though the rupee is stronger
than dinar the net overall amount he will have to pay to the bank will be less in Serbia than in
India.

b)

Spot market 0.72

3 month forward
contract price 0.78

Interest rate India 0.12

Interest rate Serbia 0.03

value after 3
months 0.782912621

Discount of Rupee 0.002912621