Test Paper -1

Derivatives, IRRM, Forex and IFM

Question No. 1 is compulsory. Attempt any four out of the remaining five questions.
Wherever appropriate, suitable assumptions should be made and indicated in the
answer by the candidate.

Working notes should form part of the answer Total Marks 100
Question 1 (a)

A silver merchant requires in three months’ time, 3000 kg of silver for making silver articles
during a wedding season. He expects the price to increase. Silver sells at spot rate of ₹ 5,100 per
kg. Each silver futures contract (for 50 kg), expiring in three months sells at ₹ 5,200 per kg. The
merchant wants to hedge half his requirement through futures and leave the remaining half
uncovered. Explain his position and the gains/losses in the spot and futures market, the number
of futures to trade in, the effective price per kg for his entire requirement if after 3 months,
(i) Spot rate is ₹ 5,250/kg and futures is at ₹ 5,400 per kg.
(ii) Spot rate is ₹ 5,000/kg and futures is at ₹ 4,900 per kg. (8 marks)

Question 1 (b)

Excel Limited, an Indian company will need $ 5,00,000 in 90 days. The following information is
given: Spot Rate $ 1 = ₹ 69-50 90 days forward rate of $ 1 as of today = ₹ 71.50

Interest Rates are as follows:

Particulars US India

90 days deposit rate 1.25% 2%

90 days borrowing rate 2.00% 3%

Compare the strategies of money market hedge vs. no hedging and compute the net advantage.
Present calculations up to two decimal places. (8 marks)

Question 1 (c)

A dealer quotes 'All-in-cost' for a generic swap at 6% against six month LIBOR flat. If the
notional principal amount of swap is ₹ 12,00,000:

i. Calculate semi-annual fixed payment.

ii. Find the first floating rate payment for (i) above if the six month period from the effective
date of swap to the settlement date comprises 181 days and that the corresponding LIBOR was
5% on the effective date of swap.

iii. In (ii) above, if the settlement is on 'Net' basis, how much the fixed rate payer would pay to
the floating rate payer? Generic swap is based on 30/360 days basis
(8 marks)
Question 2 (a)

On 1st August 2019, a bank entered into a forward purchase contract with an export customer
for USD 25,000 due on 1st November at an exchange rate of INR 72.6000 and covered its
position in the market at INR 72.6500. The customer remained silent on the due rate. On 4th
November, the bank cancelled the contract without further notice as 3 days had expired after
the contract due date. The following exchange rates prevailed:

1st November Inter bank TT rates USD 1 = INR 72.7500/7600

1 month forward INR 72.9500/9600

Merchant TT rates INR 72.6700/9000

4th November Interbank TT rates INR 72.7000/7100

Merchant TT rates INR 72.6400/7800

Interest on outlay of funds is 12% p.a.

Explain the position of the bank in relation to the customer and the market on various dates,
compute the swap loss/gain, ignore margin and find out the charges payable by the customer on
cancellation. (8 marks)

Question 2 (b)

Vikrant Ltd., an Indian company, has an export exposure of ¥ 100 lakh value at September end.
Yen is not directly quoted against rupee. The current spot rates are INR/USD = 62.685 and
JPY/USD = 194.625. It is estimated that Yen will depreciate to 216 level and rupee to depreciate
against dollar to 64.50. Forward rate for September, 2013 was JPY/USD = 206.025 and INR/
USD = 64.335. If the spot rate on 30th September, 2013 was eventually INR/ USD = 64.17 and
JPY/USD = 206.775, is the decision to take forward cover justified?
(8 marks)
Question 2 (C)

Mr. A purchased a 3 month call option for 100 shares in XYZ Ltd. at a premium of Rs.30 per
share, with an exercise price of Rs.550. He also purchased a 3 month put option for 100 shares
of the same company at a premium of Rs.5 per share with an exercise price of Rs.450. The
market price of the share on the date of Mr. A’s purchase of options, is Rs.500. Calculate the
profit or loss that Mr. A would make assuming that the market price falls to Rs.350 at the end of
3 months.
(4 marks)
Question 3 (a)

Global Ltd is consumer electronics wholesaler. The business of the firm is highly
seasonal in nature. In 6 months of a year, firm has a huge cash deposits and especially
near Christmas time and other 6 months firm cash crunch, leading to borrowing of
money to cover up its exposures for running the business.
It is expected that firm shall borrow a sum of €50 million for the entire period of slack
season in about 3 months.
A Bank has given the following quotations:
Spot 5.50% - 5.75%
3 × 6 FRA 5.59% − 5.82%
3 × 9 FRA 5.62% − 5.89%
3 month €50,000 future contract maturing in a period of 3 months is quoted at 93.90
(6.10%).
You are required to determine:
(a) How a FRA, shall be useful if the actual interest rate after 3 months turnout to be:
(i) 4.5% (ii) 6.5%
(b) How 3 months Future contract shall be useful for company if interest rate turns out
as mentioned in part (a) above.
(8 marks)

Question 3 (b)

An Indian importer has to settle an import bill for $1,35,000. The exporter has given the Indian
exporter two options :

(i) Pay immediately without any interest charges.

(ii) Pay after three months with interest @ 5% per annum.

The importer’s bank charges 16% per annum on overdrafts. The exchange rates in the market
are as follows :

Spot rate (Rs./$) : 48.35/48.36

3-Month forward rate (Rs./$): 48.81/48.83

The importer seeks your advice. Give your advice

(8 marks)
Question 3 (c)

The following data relate to JB Ltd.’s share Price:

1) Current Price Per Share - Rs.1,820;
2) 6 months’ Futures price per share - Rs.2,028.

Assuming it is possible borrow money in the market for transactions in securities at 12% per
annum, you are required - to calculate the theoretical minimum price of a 6 months forward
purchase; and to explain arbitrating opportunity.
(4 marks)

Question 4 (a)

OJ Ltd. is a supplier of leather goods to retailers in the UK and other Western European
countries. The company is considering entering into a joint venture with a manufacturer in
South America. The two companies will each own 50 per cent of the limited liability company
JV(SA) and will share profits equally. £ 450,000 of the initial capital is being provided by OJ Ltd.
and the equivalent in South American dollars (SA$) is being provided by the foreign partner.
The managers of the joint venture expect the following net operating cash flows, which are in
nominal terms:
 SA$ 000 Forward Rates of exchange to the £ Sterling

Year 1 4,250 10
Year 2 6,500 15

Year 3 8,350 21
For tax reasons JV(SV) the company to be formed specifically for the joint venture, will be
registered in South America. Ignore taxation in your calculations.

Assuming you are financial adviser retained by OJ Limited to advise on the proposed joint
venture. Calculate the NPV of the project under the two assumptions explained below. Use a
discount rate of 18 per cent for both assumptions.
Assumption 1 : The South American country has exchange controls which prohibit the payment
of dividends above 50 per cent of the annual cash flows for the first three years of the project.
The accumulated balance can be repatriated at the end of the third year.
Assumption 2 : The government of the South American country is considering removing
exchange controls and restriction on repatriation of profits. If this happens all cash flows will be
distributed as dividends to the partner companies at the end of each year. Comment briefly on
whether or not the joint venture should proceed based solely on these calculations.
(8 marks)

Question 4 (b)

A trader is having in its portfolio shares worth ₹75 lakhs at current price and cash ₹25
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 ₹ 100 lakhs Nifty futures.
(8 marks)
Question 4 (c)

Right Limited has proposed to expand its operations for which it requires funds of $ 30
million, net of issue expenses which amount to 4% of the issue size. It proposed to raise
the funds though a GDR issue. It considers the following factors in pricing the issue:
(i) The expected domestic market price of the share is ₹ 300 (Face Value of ₹ 10
each share)
(ii) 4 shares underlay each GDR
(iii) Underlying shares are priced at 20% discount to the market price
(iv) Expected exchange rate is ₹ 70/$
You are required to compute the number of GDR's to be issued and cost of GDR to Right
Limited, if 20% dividend is expected to be paid with a growth rate of 20%.
(4 marks)
Question 5 (a)

Good Morning Ltd., London will have to make a payment of $3,64,897 in six month’s time. It is
currently 1st 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 month forward rate $1.5455 – 1.5609

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

(a) Forward market;

(b) Cash (Money) market;

(c) Currency options

(8 marks)
Question 5 (b)

Your Company has to make a US $ 1 Million payment in three month’s time. The dollars are
available now. You decide to invest them for three months and you are given the following
information.
(i) The US deposit rate is 8% p.a.
(ii) The sterling deposit rate is 10% p.a.

(iii) The spot exchange rate is S 1.80 / pound.

(iv) The three month forward rate is $ 1.78/ pound.

(a) Where should your company invest for better results?

(b) Assuming that the interest rates and the spot exchange rate remain as above, what
forward rate would yield an equilibrium situation?

(c) Assuming that the US interest rate and the spot and forward rates remain as in the
original question, where would you invest if the sterling deposit rate were 14% per
annum?
(d) With the originally stated spot and forward rates and the same dollar deposit rate, what
is the equilibrium sterling deposit rate?
(8 marks)
Question 5 (c)

Company X wishes to borrow U.S. dollars at a fixed rate of interest. Company Y wishes to
borrow Japanese yen at a fixed rate of interest. The amount required by the two companies are
roughly the same at the current exchange rate. The companies have been quoted the following
interest rates:

Yen Dollars

Company X 6.0% 9.6%,

Company Y 7.5% 10.0%

Design a swap that will net a bank, acting as an intermediary, 50 basis points per annum. Make
the swap appear equally attractive to the two companies.
(4 marks)
Question 6 (a)

The following quotes are available for 3-month options in respect of a share currently traded at
Rs. 31 :
Rs.

Strike price 30
Call option 3

Put option 2

A funds manager devises a strategy of buying a call and selling the share and a put option. Draw
his profit/loss profile if it is given that the rate of interest is 10% per annum. What would be the
profit/loss if the strategy adopted is selling a call and buying a put and a share ?
(8 marks)

Question 6 (b)

On 15th July pound futures for maturity August end are traded on the International
Monetary Market (IMM) at $1.2450 (lot size pound 62,500). A trader bullish on $
against pound takes a position in 14 futures contract. Initial margin is $1000 per lot &
maintenance $ 750 per lot.
Future price for subsequent days happen to be -
Days Future Price
16th 1.2420
17th 1.2490
18th 1.2520
19th 1.2430

He squares off his position on 19th. Show the margin balance each day and compute the
overall profit/loss.
(8 marks)
Question 6 (c)

Identify the profit or loss (ignoring dealing cost and interest) in each of the following
cases :
(i) A call option with an exercise price of Rs.200 is bought for a premium of Rs.89.
The price of underlying share is Rs.276 at the expiry date.

(ii) A put option with an exercise price of Rs.300 is written for a premium of Rs.57.
The price of the underlying share is Rs.314 at the expiry date.
(4marks)