PES INSTITUTE OF TECHNOLOGY BANGALORE SOUTH CAMPUS Dept.

of MBA
Lesson Plan Semester IV Subject Code: 08MBAFM427 Lectures: 56 Subject Title: RISK MANAGEMENT Faculty Name: Dr. R. Duraipandian No of Hours / Week: 04
100 03 50

Total no of IA Marks: Exam Hours: Exam Marks:

Course Delivery
Every module, one session will be devoted to intensive teaching, one session will be devoted to case analysis by the extensive participation by students themselves and the remaining sessions will be devoted to problem solving. In this respect, students are expected to be prepared to discuss the cases and to participate actively in case analysis. In addition, students will be asked to hand in exercises related to the thought material and brief case analyses before or after the case discussion takes place in class. Regular class meetings will include a variety of teaching methods from lectures to case discussions: Lectures to present the theoretical framework; Exercises or problems as an expedite tool to visualise a specific issue in a quick manner. These pedagogical materials are distributed in class at the moment it is required; Case studies for analyse and discuss more real and complex situations are distributed in advance, and must be read, and studied before each class, which will be distributed by the instructor in the previous day of the class. If the topic demands; a Video will be shown to the students about 10 to 15 minutes and the instructor would hoist questions to initiate the discussion relevant to the topic of the day

 An electronic version of lectures (slides) will also be available via email, as you usually wish so.

Aim of the Course

Risk is all pervasive. For business the various kinds of risk relate to price, interest rates, foreign exchange rates, credit etc. Of late tactical management of these risks has gained prominence especially with advent of derivative products. The course concerns with tactical management of these risk through investment in financial assets. The objective of this course is to familiarise the participants with the various instruments available for risk management. It covers rather simpler instruments such as options, futures, swaps, and credit derivatives. Besides discussing the pricing of these instruments and hedging principles the course would also aim at introduction of some complex instruments such as options on futures and swaps etc

Learning Objectives

As the subject is of practical utility and significance, the course would be conducted in an interactive manner. To stimulate the thought process the participants are requested to read any financial newspaper daily and present/seek views on the subject/article of their interest. Conceptual framework of the subject shall be covered adequately through lectures/power point presentations. Sessions plan as below would be followed with following module objectives: An overview of risk and derivatives: The objective of the session is to draw distinction between various kinds of risks that a firm is exposed to. Some of these risks are manageable with derivative instrument. The session on Introduction to derivatives is intended to provide an overview of derivatives, their characteristics and misconceptions about them. Forwards and Futures: These sessions are aimed at introducing the terminology of forwards and futures, their applications of hedging fro variety of underlying assets such as commodities, currencies, stocks and interest rates. This would also cover the pricing principles and methods of trading, settlement etc. Separate sessions for commodities, currencies and stock indices would deal extensively with the examples of hedging, speculation and arbitrage. Options: Sessions on options are aimed at developing an understanding about the complex nature of the derivative. The objective is to familiarize the participants with the various ways to value options. Hedging using

options would be discussed in details with suitable real life applications. Trading strategies with options would deliberate upon how the combination of options can be used to achieve the desired risk profiles of different classes of investors. Sessions on exotic options would concentrate on how the parameters of options can be modified to suit the individual needs of hedging and cost associated with them. Swaps and Interest Rate Derivatives: These sessions are useful for the sectors such as banking, construction and infrastructure that are sensitive to broad economic factors and interest rate structures and changes in them. The tools of managing the interest rate risk would be introduced with emphasis on swaps and interest rate futures.

Table - 1 Session Plan

Evaluation Technique LearningStudent Contents Pedagogic al Tools Presentatio n Assignment s/ additional work Cumulative Coverage Module No

Session No. I 1-2 Over view of Risk, Risk identification, Risk, Insurance and Management: Introduction to Risk and Insurance. Risk

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

# Class Discussion # Test I # Case

identification and Risk Evaluation, 3-4 Risk assessment & ManagementRisk analysis: Exposure of physical assets, financial assets, and Human assets, Exposure to legal liability. Risk Management, Risk control.

Presentatio n 07%

II

5-7

Risk Management using futures and forwards differences-valuation of futures, valuation of long and short forward contract.

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

8-9

# Class Discussion # Test I # Case Presentatio n 18%

Mechanics of buying &selling futures, Margins, Hedging using futures -specification of futures

10-11

Commodity futures, Index futures interest rate futures-arbitrage opportunities.

Session No.

III

12-14

Risk Management using Swaps: Mechanics of interest rate swaps, volatility of interest rate swaps

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

# Class Discussion # Test I # Case Presentatio n

Evaluation Technique LearningStudent

Contents

Pedagogic al Tools

Presentatio n

Assignment s/ additional work

32%

15-19

Currency swaps, currency swaps.

Valuation

of

IV

20-21

Risk Management using Options: Types of options, option pricing, factors affecting option pricing,

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

# Class Discussion # Test II # Case Presentatio n

Cumulative Coverage

Module No

22-23

call and put options on dividend and non-dividend paying stocks put-call parity, mechanics of options- stock optionsoptions on stock index- options on futures,

24-25

50%

26-27

Interest rate options. Concept of exoctic option. Hedging & Trading strategies involving options,

Session No.

28-29

Valuation of option: basic model, one step binomial model, Black and Scholes analysis, option Greeks.

Evaluation Technique LearningStudent

Contents

Pedagogic al Tools

Presentatio n

Assignment s/ additional work

Cumulative Coverage

Module No

Arbitrage profits in options. V 30-31 Commodity derivatives : commodity futures market-exchanges for commodity futures in India, DLP & Chalk Board Refer the Table 2 Refer the Table 3 # Class Discussion # Test II # Case Presentatio 64% n

32-33

Forward markets, commissions and regulation-commodities traded Trading and settlements physical delivery of commodities. Interest rate markets, Type of rates, Zero rates, Bond pricing,

34-36 VI 37-38

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

# Class Discussion # Test III # Case Presentatio n 75%

39-40

Determining Zero rates, Farward rules, Farward rate agreements (FRA),

41-43

Treasury bond & Treasury note futures, Interest rate derivatives (Black model).

Session No.

VII5

44-45

Credit risk-Bond prices and the probability of default, Historical default experience,

DLP & Chalk Board

Refer the Table 2

Refer the Table 3

# Class Discussion # Test III # Case Presentatio n

46-48

Reducing exposure to Credit risk, Credit default swaps, Total return swaps, Credit spread options, Collateralized debt obligation. Value at Risk (VAR)-Measure, Historical simulation, Model building approach, linear approach, Quadratic model, Monte Carlo

VIII8

49-51

Evaluation Technique LearningStudent

Contents

Pedagogic al Tools

Presentatio n

Assignment s/ additional work

100%

52-53

Cumulative Coverage

Module No

54-56

simulation, stress testing and back testing Syllabus review

A complete revision through the presentation by the students based on the presentation topics

Table 2 Presentation Topics

S.No. 1-30 Mod. No. I to VIII Presentation Topics Case study and assignment topics will be considered as presentation topics, Presentation only after T3 during review period.

Table 3 Assignments & Additional Work

S.No. 1 to 30 Mod. No. I to VIII Assignment Topic Each students will be given one question each from Question Bank from the following manner ( 1 - 3 marks question, 1- 7 marks question and 1- 10 marks question) Question Bank contents will be divided as an assignment topics to the students

Table 4 Case Study Topics

S.No. 1 30 1 2 3 4 5 6 7 8 9 10 11 12 13

Mod. No. I VIII

Particulars Case study will be given to the students for presentation based on previous year question papers problems and case let from text books Question Paper, VTU, June-July 2010 Question Paper, VTU, June-July 2009 Question Paper, VTU, December 2008 Question Paper, VTU, July 2008 Question Paper, VTU, December 2006 / January 2007 Question Paper, VTU, July 2006 Question Paper, VTU, December 2005 / January 2006 Question Paper, VTU, January / February 2005 Question Paper, VTU, June / July 2004 Question Paper, VTU, January / February 2004 Question Paper, VTU, June / July 2003 Question Paper, VTU, January / February 2003 Question Paper, VTU, July / August 2002

Table 5 References & Additional Readings

S.No. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

Mod. No. I, II, III, IV, V, VI, VII, VIII VI, VII, VIII I, II, III, IV I, II I, II, III, IV, V, VI, VII, VIII I, II I, II, III, IV, V, VI, VII, VIII I, II I, II II, III, IV, V, VI, VII, VIII II, III, IV, V, VI, VII, VIII I, II, III, IV, V, VI, VII, VIII I, II, III, IV, V, VI, VII, VIII I, II, III, IV, V, VI, VII, VIII I, II, III, IV, V, VI, VII, VIII I, II, III, IV, V, VI, VII, VIII

Particulars Options Futures & Other Derivatives- John C.Hull - (Pearson Education), 6/e Options & Futures- Vohra & Bagri - (TMH), 2/e Derivatives- Valuation & Risk Management-Dubofsky & Miller (Oxford University Press), 2004/05 Risk Management & Insurance Harrington & Niehaus TMH, 2/e Risk Management & Derivative Shulz Thomson / Cengage Learning. Principles of Risk Mgmt. & Insurance Rejda Pearson Education/PHI, 8/e, 2003 Introduction to Derivatives and Risk Management Chance Thomson Learning, 6/e, 2004 Introduction to Risk Management & Insurance Dorfman Pearson/PHI, 2004 International Risk & Insurance Skipper - (TMH) Options & Futures Edwards & Ma - (MacGraw Hill), 1/e Derivatives & Financial Innovations Bansal - TMH. Credit Risk Management Anderw Fight Elvis. Financial Derivatives S.S.S. Kumar PHI 2007. Futures, Options and Swaps Robert W Kolb Blackwell Publishing. Risk Management Koteshwar HPH. Derivatives and Risk Management, Rajiv Srivastava, Oxford University Press

Table 6 IA Pattern
Test Marks 60% Presentatio ns 20% Assignments 20%

For Internal Evaluation T1 marks and the best out of remaining two will be considered.

1st Test is mandatory.

10MBAFM427: RISK MANAGEMENT 3 Marks Questions:

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. Explain the Risk of Exposure to legal liability. What is meant by Exposure of Physical Assets? Write note on Risk identification & Risk Evaluation. Why are Futures & Options termed as Derivatives? What are Forward Contracts? What is their Utility? A forward contract on 200 shares, currently trading at Rs112 /share ,is due in 45 days. If the annual risk free rate is 9%, calculate the value of the contract. How would the value be changed if a dividend of Rs.4 /share is expected to be paid in 25 days before the due date? Define Basis? When do you expect the basis to be Positive or negative? Discuss the meaning of Cost to carry & Convenience Yield What are Single Stock Futures? How are they priced? How are Naked Calls different from Covered Calls? Why are American Calls likely to be more valuable than the comparable European Calls? What are the rights and obligations of the parties to a call option? Discuss the use of index options for the purposes of hedging. Who are scalpers? How are they useful? What is Rolling Settlement? Write a note on Derivatives trading in India. What is a Capped Option? What is meant by Assignment? What is meant by Arbitrage? What is Delta? What is hedge Ratio? How is it determined? Mention the principle of Put call Parity How are interest rate swaps valued? Explain with example. What do you understand by the term Interest rates? Discuss the various types of interest rates along with different yield curves.

Question Bank

25. A financial institution quotes an interest rate of 14% per year with quarterly compounding. What is the equivalent rate with i) continuous ii) annual compounding? 26. What is meant by Strap? 27. What are American options and European options? 28. What are put option and call option? 29. What are swaps? 30. What are swaptions? 31. What are LEAPS? 32. What is basket option? 33. What are warrants? 34. How do option contracts differ from both forward and future contracts? 35. What is the difference between long forward position and short forward position? 36. Explain the difference between writing a call option and buying a put option. 37. Under what circumstances are i) a short hedge ii) long hedge appropriate? 38. What is forward rate agreement? 39. What do you mean by value at risk (var)? 40. What is comparative advantage argument in swap?

7 Marks Questions:
1. 2. 3. 4. 5. What is pricing of insurance?Enumerate the distinguishing features of health and group insurance products. Critically examine the risk analysis and risk control process of financial assets. A Strangle is similar strategy to a straddle Discuss the statement in the light of option trading with suitable examples. Compare and contrast Futures and forward contracts with suitable examples. Sun Pharma wishes to borrow Rs20crore at a fixed rate for 5 years and has been offered either 11% fixed or six month LIBOR +1%. CIPLA Ltd wishes to borrow Rs 20 crore at a floating rate for 5 years and has been offered either LIBOR +0.5% or 10% fixed. On the basis of the above i) how may they enter in to swap arrangement in which each benefits equally? ii) what risk this arrangement may generate? 6. A stock is currently selling for Rs 400. The price of call option expiring six months are as follows: Strike price = Rs 350 ,call price Rs 15 Strike price = Rs 390 ,call price Rs 11 Strike price Rs 425 ,call option = Rs 8 Investor feels it is unlikely that stock price will move significantly in next six months. Draw a Butterfly spread with the given options. 7. From the following data calculate the values of call and put options using Black-Scholes formula: Current price of the share =Rs 486

Exercise price = Rs 500 Time to expiration =65 days SD = 0.54 Continuously compounded rate of interest =9% per year Dividend expected =Nil 8. Consider the following data : S=100,u=1.5,d=0.8, E=105,r=0.12,R =1.12 What is the value of the call option? 9. The following data is available for Thermal Plastics ltd, a company that is not expected to pay the dividend for a year: S0 =120,E=110,r=0.14,t=1.0,SD =0.4 What is the value of the call option as per the Black Scholes formula? 10. Assume that an investor buys a stock index futures contract on march 1 at 1125. The position is closed out on March 5. The stock index prices on 4 days after purchase were 1128,1127,1126,1128. Calculate the cash flow to the investor on a daily basis. Ignore the margin requirements. 11. Describe the features of Nifty futures contract 12. Describe the short hedge and long hedge 13. What are Merton H Millers views on derivatives and volatility? 14. The share of R ltd is currently selling for Rs 1000. The risk free interest is 1 % per month. Suppose the 3 months futures price is 1035 what will you do? Assume that R ltd will not pay dividend for the next 6 months. 15. Define the payoffs of a call option and a put option from the point of view of the option writer. 16. Describe the risk neutral valuation method. 17. Describe the salient features of options on individual securities at the NSE. 18. A stock is currently selling for Rs.40. The call option on the stock exercisable a year from now at a strike price of Rs.45 is currently selling for Rs.8. The risk free interest rate is 10%. The stock can either rise or fall after a year. It can fall by 20%. By what % it can rise? 19. What is the value of a European call option (No dividends) with an exercise price of Rs 50 and an expiration date 3 months from now if the stock price is Rs 40, the variance of the stock is 0.40 , and the risk free rate is 14%? What is the value of the put using the same information? 20. The following information is available for Abhishek Industries: S0 =Rs70, E = Rs 72 ,r = 0.12 ,SD = 0.30 Calculate the price for a 6 month call option as per the B-S Model. 21. Advice the investor with a portfolio valued at Rs 21,37,600 and having beta value equal to 1.28 for hedging with put options ,given further, Put exercise = 1470, lot size = 100 , put delta = -0.68 22. a. Calculate the values of call and put options on S and P CNX Nifty using the following data : Spot value of the index =1430, exercise price = 1450, risk free rate of return = 8% SD of the continuously compounded rate of return =0.28, Time to expiration = 36 days. b. recalculate the values in (a ) assuming continuous dividend rate on the index is 2%/ 23. Explain the assumptions underlying the B-S Model 24. Graphically depict the valuation of i) call and ii) Put options.

25. Differentiate Bull and Bear Spreads. How can each of these be created with put options? 26. Explain with example what you mean by stress testing of VaR? 27. Explain the features of a credit default swaps. 28. Determine the theoretical price of a call option given that Spot price S0 = 340, t = 6 months, r = 18% PA, Compounded continuously and strike price X = 360. If the actual call option price is Rs.9, is there a arbitrage possibility? If so, show the process of making arbitrage profit. 29. Determine the profits from the butterfly spread based on the following data and interpret the result. i. First purchase of call option at Rs.320 at a premium of Rs.40 ii. Second purchase of call option at Rs.400 at a premium of Rs.20 iii. Sell both the call option at Rs.360 at a premium of Rs.30 iv. The price on the due date is 270, 300, 360, 400, 450, or 500. 30. You have gone long on the stock at a price of Rs.340. A call and put option is available in the market at a premium of Rs.30 and strike price of Rs.360. If you are planning in hedging strategy would it be better if you go short on a call option or long on a put option. Imagine on the due date the spot prices could be i) Rs.270 ii) Rs.360 iii) Rs.500. 31. Describe the three approaches to determining VaR. 32. An index consists of 4 stocks: P, Q, R, S. The current value available. Co Market Price (Rs.) P 250 Q 790 R 1400 S 1770 of the index is 3070 points. The following information is Market Cap (Rs. in crore) 20 40 65 75

Co Q is likely to pay dividend in 40 days time at Rs.12 per share. A 90 days index futures contract is available with a contract multiplier of 200. Considering the risk free rate to be 12% PA compounded continuously. Determine the future price to Index futures. 33. A company enters into a short future contract to sell gold for Rs.1420 per gram on MCDEX. The size of contract is 10kg. The initial margin is Rs.10 lakh and maintenance margin is Rs.8 lakh. What change in future price will lead to a margin call? Under what circumstances Rs.2 lakh can be withdrawn from the margin account. 34. A stock is expected to pay a dividend of Re.1 per share in 2 months and again in 5 months. The stock price is currently Rs.50 and risk free rate of interest is 6% per annum. What is the stocks forward price for a 6 month contract? 35. A share is currently selling for Rs.120. There are 2 possible prices of the share after 1 year Rs.132 or Rs.105. Assume the risk free rate of return is 9% per annum. What is the value of one year call option with an exercise price of Rs.125?

36. Suppose that 1-year,2-year, 3-year,4-year and 5-year zero rates are 3%, 4%, 4.5%, 5% and 5.3% per annum respectively. Calculate the forward rates for the second, third, fourth and fifth years. 37. A portfolio manager plans to use a treasury bond futures contract to hedge a bond portfolio over next 3 months. The portfolio is worth Rs.100 million and will have duration of 4.0 years in 3 months. The future price is Rs.122 and each future contract is on Rs.100000 of bonds. The bond that is expected to be cheapest to deliver will have duration of 9 years at the maturity of the future contract. Why should the manager hedge and what position in futures contracts is required. 38. Discuss the difference between credit risk and market risk as applicable to financial markets. 39. Distinguish between pure risks and financial risks by providing examples. 40. Call holders and put writers exhibit bullish sentiments- Explain.

10 Marks Questions:
1. Discuss each of the following types of traders in a derivatives market: hedgers, speculators and arbitrageurs. 2. Let changes in spot values are represented by Y and changes in futures values by X from the given set of calculations it is found that : Mean of X =1.5425 Mean of Y = 0.2345 SD of X =0.680 SD of Y =0.825 R between X & Y =0.85 Obtain the regression equation from these data and determine the optimal hedge ratio. 3. Assume that a market capitalization weighted index consists of 5 stocks only. Currently the index stands at 970. Obtain the price of the futures contract, with expiration in 115 days , on this index having reference to the following additional information : a. Dividend of Rs 6 /share expected on share B , 20 days from now b. Dividend of Rs 3 /share expected on share E ,28days from now c. Continuously compounded risk free rate of return =8% per year d. Lot size 300 e. Other information:

Company share price market capitalization (In cr) A 22 110 B 85 170 C 124 372 D 54 216 E 25 200 4. What are the major stock indices in India ? Discuss in detail about Sensex and S&P CNX Nifty Indices. 5. How can a butterfly spread be created by using the following 3 put options (with same expiration dates)? Option 1: Exercise price Rs 70 Price = Rs 6 Option 2: Exercise price Rs 75 Price = Rs 9 Option 3: Exercise price Rs 80 Price = Rs 14 Determine the range of stock prices within which losses would be made by the buyer of the options 6. Examine the effect of each of the following changes on the call & put option values : Stock price =Rs 206, Exercise price =Rs 200, Time to expiration =47Days,SD of the continuously compounded rate of return on stock = 0.26, continuously compounded rate of return =8% a. the stock price increases by Rs8 b. SD is changed to 0.30 c. Risk free rate of return reduces by 2 %. 7. Obtain the values of call and put options on futures related to an index: Futures contract price =1522 Exercise price of option =1550 Time to expiration =40days Risk free rate of return = 9% Volatility = 0.25 8. Describe the goals of regulation of security and derivatives markets. How can the goals be achieved? 9. List the major changes that have taken place in the last decade in the capital market of India. 10. Explain the various principles of insurance contract. 11. Classify and explain the various types of risks. 12. An investor has portfolio consisting of seven securities as shown below: Security No of Shares Share price as on 18-4-02 Beta AA 4,000 1029.75 0.59 CI 5,200 208.40 1.32 IC 6,600 61.2 0.87 Inf 2,400 3958.95 0.35 TA 5600 308.8 1.16 Hi 1500 128.05 1.24 Zee 4000 168.00 1.05

The cost of capital for the investor is 20% per year. The investor fears a fall in the prices of the shares in the near future. Accordingly , he approaches you for advice. You are required to : Calculate the beta of his portfolio The May future on BSE Sensex is quoted at 3444.60. Assuming the market lot to be 100, calculate the number of contracts, the investor should short for hedging his portfolio against the falling market. 13. Suppose that on july 25 , a firm knew that it will have to borrow $10 Million on Sept22 for 3 months. A bank agrees to provide these funds at 1% above whatever the 3 month LIBOR is on Sept 22. By chance the Sep 22 is also the last trading of the Sep 2002 Euro Dollar futures contract. Firm is concerned about that by that time the LIBOR may rise. How company can hedge its risk by using Eurodollar futures if Only juy25 Eurodollar price is 91.72 and implied 3 month Eurodollar rate is 8.28%. The 3 month LIBOR on July 25 is 8.375%. 14. How is the value of an option with time to expiration determined? What are the various factors affecting the option prices? 15. The current price of share is Rs 50 and its believed that at the end of 1 month the price will be either Rs 55 or Rs45. What will a European call option with an exercise price of Rs.53 on this share be valued at ,if the risk free rate of interest is 15% per year ? Also calculate the hedge ratio applying Binomial formulation. 16. The various measures of sensitivity obtained by differentiating the Black & Shcoles formulation for call & put options with respect to various input parameters , namely ,0, t, r , and SD include the values of various greeks. From the information given below , you are required to obtain and interpret : a.the call & put option values b.the values of various greeks. The stock price being Rs206; exercise price is Rs 200 ; time to expiration is 47 days with a continuously compounded rate of return as 8% and the SD of the continuously compounded rate of return on stock is 0.26. 17. Explain the value at Risk measures 18. What is meant by Credit Risk? Explain how to reduce exposure to credit risk? 19. Explain in detail the Interest rate markets and Interest rate derivatives. 20. Discuss the important economic functions performed by the derivatives markets. Does a derivatives market complete a market? 21. Discuss various characteristic features of futures contracts. What is the role of clearing corporations in trading of such contracts? 22. Write a detailed note on hedging i)a long position in stocks ii) a short position in stocks , using stock index futures. 23. Illustrate the following using rough sketches: i)Bull spread using call options ii) Long stock and short call 24. What do you understand by Implied Volatility? How can it be calculated? From the information given below, estimate the volatility implied: Stock price =126, exercise price = 132, Time to maturity =45days, Risk free rate of return =8%, call premium = 3.30 Recalculate the volatility is the stock price matches with the exercise price. 25. Discuss the role of SEBI in the Indian capital market.

26. Arbitrage Profits an investor told are riskless profits. You take simultaneous but opposite positions in two markets to reap from pricing disparities. Acting on this belief, his friend tried to find arbitrage profit by trading simultaneously in futures and stock index. He has collected the following information: i) Present level of stock index - 3000 ii) Index futures priced at 2000 iii) Risk free rate of return 10% iv) 50% stocks are to pay dividends at 6% v) The index futures has a multiple of 100 vi) The futures has six months to expiration. Required i) Find the arbitrage profits if any ii) Discuss the risk associated with arbitrage transactions in futures. 27. On December 09, 2002 an investor bought 10 T- bill futures contract trading on IMM at Rs.96.72. The initial margin requirement is Rs.2000 per contract with maintenance margin of Rs.1500 per contract. The settlement prices of T-bill futures contract for 9 trading days are as follows: Date Settlement Price (Rs.) Dec 9 96.75 Dec 10 96.68 Dec 11 96.63 Dec 12 96.59 Dec 13 96.54 Dec 16 96.50 Dec 17 96.55 Dec 18 96.60 Dec 19 96.64 On Dec 20, the investor closes his position when future price was Rs.96.67. Show the margin account balance and gains from the futures contract. 28. The following table gives the prices of bonds: Bond Principal Time to Maturity Annual coupon ($) Bond price ($) (years) 100 0.50 0.0 98 100 1.00 0.0 95 100 1.50 6.2 101 100 2.00 8.0 104 (Held the stated coupon is assumed to be paid every 6 months.) i) Calculate zero rates for maturities of 6 months, 18 months, and 24 months.

ii) iii) iv)

What are the forward rates for the periods: 6 months to 12 months, 12 months to 18 months, 18 months to 24 months? What are the 6-month, 12-month, 18 month and 24-month par yields for bonds that provide semiannual coupon payments? Estimate the price and yield of a two-year bond providing a semiannual coupon of 7% per annum.

29. Consider a call option on a stock with following parameters Strike price : Rs.70 Risk free rate of interest : 6% Time to expiration : 90 days i.e. 0.2466 year Standard deviation of returns on a stock : 0.4 Spot price of the stock : Rs.60 Compute: i) Price of the call option ii) Its Delta iii) Gamma iv) Theta v) Vega

vi) Rho.

30. Three companies X, Y and Z have come together to reduce their interest cost. Following are the requirement of those companies and interest rates offered to them in different markets. Company Requirement Fixed $ Floating $ Fixed Euro X Fixed $ funds 5.75% LIBOR + 0.90% 6.00% Y Floating $ funds 5.25% LIBOR + 0.75% 6.50% Z Fixed Euro Funds 6.00 LIBOR + 0.60% 6.25% The amounts required by the companies are equal and are for three years on bullet payment basis. You are required to arrange a swap between three parties in such a way so that the benefit of swap is equally divided among the three companies. 31. October Soybean oil futures are selling at 19.44 cents per Ib. The standard size of the contract is 60000Ibs. Initial margin requirement is $3000 while the maintenance margin is $1500. If a trader goes long in 2 October futures contracts and the prices on the subsequent 4 days are 19, 19.4, 19.6 and 19.8 cents/Ib, explain how the margin accounts changes. Assume that the money in excess of the initial margin is withdrawn immediately. 32. Discuss the foundation for valuation of option premium under the Black and Scholes model. 33. Describe the rationale for retention of risk. What are the factors that determine risk retention? 34. On September 28th, the cash price of a quintal of pepper is Rs.10010 per quintal. Full carry cost of pepper till December 28th is Rs.10288/Q. A 3-month futures contract maturing in, December end is now trading at Rs.10355/Q. Can the merchant holding the stock of pepper exploit any arbitrage opportunity? Assume risk free rate of interest with continous compounding as 7%. Calculate the arbitrage profit. What is the arbitrage strategy adopted by him. Alternatively, if the merchant wants to hedge against falling prices, what information he needs to gather from NCDEX. 35. Company AKR wishes borrow U.S. Dollars at a fixed rate of interest. Company RAK wishes to borrow Japanese Yen at a fixed rate of interest. The amounts required by the two companies are roughly the same at current exchange rate. Yen Dollars

Company AKR 4.0% 8.6% Company RAK 5.5% 9.0% Design a swap that will net a bank, acting as intermediary, 50 basis points per annum. Make the swap equally attractive to the 2 companies and ensure that all foreign exchange risk is assumed by the bank. 36. The current stock price for ACG Ltd is Rs.85. A European call option with exercise price of Rs.85,, will expire in 160 days. The yield on a 160-day Treasury bill is 5.18%. The standard deviation of annual returns on ACGs stock is 44%. Compute premium for a call option and also a put option on this stock. 37. How can a butterfly spread be created by using the following 3 call options (with same expiry dates). Once contract involves 1100 shares. Strike price Premium Rs.170 Rs.21.10 Rs.180 Rs.14.00 Rs.190 Rs.8.00 Determine the range of stock prices within which losses would be made by the buyer of options. 38. Compute the delta of a At-the-money call and put European options with a volatility of 35% and interest rate of 7% p.a. with 90 days to maturity. Provide a brief interpretation of delta. 39. Differentiate between: i) OTC contracts and exchange traded contracts ii) MTM margin and initial margin. 40. What are the various types of risks?