Birla Institute of Technology & Science, Pilani

Work-Integrated Learning Programmes Division

Second Semester 2018-2019
Mid-Semester Test (EC-2 Regular)

Course No. : FIN ZG514

Course Title : DERIVATIVES AND RISK MANAGEMENT
Nature of Exam : Closed Book
Weightage : 30% No. of Pages =2
Duration : 2 Hours No. of Questions = 7
Date of Exam : 10/03/2019 (FN)
Note:
1. Please follow all the Instructions to Candidates given on the cover page of the answer book.
2. All parts of a question should be answered consecutively. Each answer should start from a fresh page.
3. Assumptions made if any, should be stated clearly at the beginning of your answer.

Q.1. A trader creates a bear spread by selling a six-month put option with a $25 strike price for $2
and buying a six-month put option with a $29 strike price for $4.
A. What is the initial investment?
B. Assuming 0% interest rate, what is the profit when the stock price in six months is $20,
$23, $28, and $33 [1 + 4 = 5]

Q.2. The investor contacted his broker on Monday, April 10th, 2017 to buy two July XYZ futures
contracts on the Stock Exchange. The current XYZ futures price is ₹150 per share and the
contract size is 500 shares. The initial margin is ₹25,000 per contract, and the maintenance
margin is ₹18,000 per contract. The contract was closed out on April 18 at 146.
A. Compute the maintenance margin for this trade.
B. Complete the table in your answer booklet. (Check and ensure the margin account
balance on April 18th is correct.)
C. Identify the margin call dates.
D. Compute the gain / loss when the position is closed.
Note: Assume that positive excess balance from the margin account is not withdrawn and no
interest is paid on this amount.

XYZ Margin Account

Date Daily Gain Margin Call(₹)
Futures Price Balance

10-Apr-17 150 - 50000 -

11-Apr-17 140
12-Apr-17 135
13-Apr-17 128
17-Apr-17 109
18-Apr-17 146
[1 + 2 + 1 + 1 = 5]

Q.3. On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On
November 1 the price is $980 and the December futures price is $981. A producer of the
commodity entered into a December futures contracts on March 1 to hedge the sale of the
commodity on November 1. It closed out its position on November 1.
A. What position does the producer take in the Futures market?
B. What is the effective price received by the company for the commodity? [1 + 2 = 3]

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Q.4. On July 1, an investor holds 50,000 shares of a certain stock. The market price is $30 per
share. The investor is interested in hedging against movements in the market over the next
month and decides to use the September Mini S&P 500 futures contract. Both the index and
the Index Futures price are currently at 1,500 and one contract is for delivery of $50 times the
index. The beta of the stock is 1.3. Assume the beta of the futures index is 1.
A. What strategy should the investor follow?
B. Suppose the position in the futures was closed out when the index was at 1650.
Validate the strategy by doing the following
a. Compute the loss / gain on the futures contract.
b. Compute the value of the equity holding.
C. Explain why it will be difficult to get a perfect hedge when the portfolio consists of an
individual stock. [1 + 3 + 1 = 5]

Q.5. When compounded annually an interest rate is 10%. What is the rate when expressed with
A. Quarterly compounding
B. Continuous compounding, [1 + 1 = 2]

Q.6. An FRA entered into some time ago ensures that a company will receive 5% pa on $100
million for six months starting in 1 year and pay LIBOR. Currently, the forward LIBOR for
the period is 6% pa and the 1.5 year risk-free rate is 5% with continuous compounding
A. Compute the value of the FRA
B. At expiry of the FRA, the six-month LIBOR interest rate was 4.5% pa. What is the cash
flow at the expiry of the FRA? [2 + 2 = 4]

Q.7. In early 2012, the spot exchange rate between the Swiss Franc and U.S. dollar was 1.0404 ($
per franc). Interest rates in the U.S. and Switzerland were 0.25% and 0% per annum
respectively, with continuous compounding. The three-month forward exchange rate
was1.0500 ($ per franc). What arbitrage strategy was possible? Assume that one forward
contract is worth 1000 Swiss Franc.
A. Compute the theoretical forward exchange rate.
B. Write down the steps that an arbitrageur should take at time 0 to make a riskless profit.
C. Compute the profit from these steps three months hence. [1 + 3 + 2 = 6]

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