Pricing Techniques

e 2.72

short selling-Gain or loss with dividend payouts

An investor with a short position must pay to the broker any income,such as dividends or in
that have been shorted.The broker will transfer this income to the account of the client from

investor shorts position

Name shares Rate

Sale DLF 500 120 April 500*120

Dividend 1 May 500*1

Buy 500 100 June 500*100

Net Gain

60000-500-50000 9500

Cash Flows bearish phase

for Purchaser
April Purchase 500 shares of DLF for Rs 120
May Received Dividend
June sell 500 shares for 100 per shares

Net Profit

for seller April Borrow 500 shares and sell them for 120 Rs
May Pay Dividend
June Buy 500 shares for 100
Replace borrowed shares to close short position

Net Profit
come,such as dividends or interest,that normally be received on the securities
the account of the client from whom the securities have been borrowed.

60000

500

50000

-60000
500
50000

-9500

m for 120 Rs 60000

-500
-50000
ose short position

9500
 Forward Price for an Investment Asset

Risk Free Interestr is the rate at which money is borrowed or lent when there is n
so that the money is certain to be repaid
Arbitrage Arbitrageur
Trader
One who profits from the differences in price when the same, or extremely similar, security, currency, or commodity
The arbitrageur profits by simultaneously purchasing and selling these securities to take ad

Arbitrageurs are typically very experienced investors since arbitrage opportunities are difficult to find and require re
Arbitrageurs also play an important role in the operation of capital markets, as their efforts

what is zero coupon Bond

The difference between a zero-coupon bond and a regular bond is that a zero-coupon bond does not pay coupons
The holder of a zero-coupon bond only receives the face value of the bond at maturity.
The holder of a coupon paying bond receives the face value of the bond at maturity but is a
Zero-coupon bondholders gain on the difference between what they pay for the bond and the amount they will rece
Zero-coupon bonds are purchased at a large discount, known as deep discount, to the face value of the bond.
A coupon-paying bond will initially trade near the price of its face value. I
n other words, a zero-coupon bond gains from the difference between the purchase price and the face value, while
For example, imagine that you have the choices between a one-year zero-coupon bond with a face value of $1,00
If you bought the zero-coupon bond for $952.38, you would receive $1,000 at maturity, whi
If you bought the coupon bond, you would have received two coupon payments of $25 eac
So in this case, no matter which bond you buy, you will get the same return, even though th

Example
Long forward contract for 3 months

if forward rate is high…43 and current rate is 40

Rate Forward -3 Month Risk free rate

40 43 5%

Now Buy at 40 sell at 43

To buy 40 with rate 5 % for 3 months
40e^0.05*3/12 40 2.718281282^(0.05*3/12)

after 3 month

sell 43
 An arbitrageur can borrow 40 at the risk free inerest rate of 5% per annume,buy o
At the end of the 3 months,the arbitrageur delivers the shares and receives 43.

By above strategy ,the arbitrageur locks in a profit of 43-40.50=2.50 rs per share

now forward rate is low…39 and current is 40

Rate now forward 3 month

40 39
sell 40 long

invest at 5 % for 3 months

40e^0.05*3/12

40.5 Buy at 39 Profit 40.50-39 1.50 Rs per shares

In Both situations………..

Forward price 43

Action now
Borrow 40 at 5% for 3 months
Buy one share
Enter into forward contract to sell share in 3 month for 43

Action in 3 month
sell share for 43
use 40.5 to repay loan with interest

Profit realized 2.50

r lent when there is no credit risk,
GOI Bond 10 Year Bond rate …always used

ty, currency, or commodity is traded on two or more markets.

securities to take advantage of pricing differentials (spreads) created by market conditions

ficult to find and require relatively fast trading.

kets, as their efforts in exploiting price inefficiencies keep prices more accurate than they otherwise would be

ond does not pay coupons, or interest payments, to the bondholder while a typical bond does make these interest payments.
ond at maturity.
d at maturity but is also paid coupons over the life of the bond. 
d the amount they will receive at maturity.
ace value of the bond.

e and the face value, while the coupon bond gains from the regular distribution of interest.
with a face value of $1,000, which can be purchased for $952.38 or a one-year 5% semi-annual coupon bond trading at its face value of $1
000 at maturity, which is a gain of 5% ($47.62/$952.38).
payments of $25 each during the year for a total of $50, which also represents a 5% gain ($50/$1,000).
eturn, even though the source of the return is different. This is not always true, as each case is different.

1.01 40.5 Cost The sum of money to pay off loan

43

profit 43-40.50 2.5 Rs per shares

5% per annume,buy one share and short a forward contract to sell one share in 3 months.
es and receives 43.

50=2.50 rs per share at the end of 3 months.

1.50 Rs per shares

forward price 39

Action now
short 1 share to realize 40
Invest 40 at 5% for 3 months
Enter into forward contract to buy share in 3 months for 39

Action in 3 month
Buy share for 39
close short position
Receive 40.50 from investment

profit realized 1.50

otherwise would be

payments.

ding at its face value of $1,000.

$50/$1,000).
se is different.
 Lot CMP Bro. STT/other ser.Tax
1-Nov Ril.Fut-DEC,10 100 2000 0.05 0 12.5

100 4 12.5

Total cost

20-Nov 100 2025 0.05 0 12.5

101.25 4.05 12.66

Profit

Actual charges………. in %
security transaction Tax STT On Turnover 0

Transaction charges 0

stamp duty 0.01

Brokerage-Trading 0.05

delivery 0.5
 200000

116.5

200116.5

202500

117.96

###

2265.54