Q1. Hedging, Speculation and Arbitrage?
Hedging is a risk management strategy employed to offset losses in investments by
taking an opposite position in a related asset. The reduction in risk provided
by hedging also typically results in a reduction in potential profits. Hedging strategies
typically involve derivatives, such as options and futures contracts.
Arbitrage is the purchase and sale of an asset in order to profit from a difference in
the asset's price between markets. It is a trade that profits by exploiting the price
differences of identical or similar financial instruments in different markets or in
different forms.
Speculation refers to the act of conducting a financial transaction that has
substantial risk of losing value but also holds the expectation of a significant gain or
other major value. .
1B- Compute 3 month future price of a nifty if the index provides a yield of 2% p.a, the
current price is 10800 and risk free rate of return is 8% p.a. with continues compounding.
Ans- Futures Price = Spot Price × (1 + Risk-Free Interest Rate – Income Yield)
10800 * (1 + 8% (3/12) - 2% (3/12))
10800 * (1 + 0.02 – 0.005)
10800 * (1.015)
10962
Q2.(A) difference between a future contract and a forward contract?
Ans- . A futures contract has standardized terms and is traded on an exchange, where prices
are settled on a daily basis until the end of the contract whereas a forward contract is a
private and customizable agreement that settles at the end of the agreement and is traded over-
the-counter.
2B- the stock price of xyz. ltd. Is trading at 380. Compute the lowest price of a three
month European put option for xz.td. Stock if risk free rate of return is 9% and strike
price is 400.
Ans-: if 9% is the risk free and the current price of stock is 380,
person investing in stocks would definitely not want below the value of risk free return.
That is 380* 102.25% (which is for 3 months as a year it is 9% so, for 3 months 2.25%)
So it turns out to be 388.55. This shall be the minimum a person would want if he is investing in
stocks.
Q3- three call options on NIFTY with same expiration of 23 April 2020, with strike prices
of 8600, 8800 and 9000. Are given as 300, 175 and 90, construct a butterfly>>>
Ans-call options
Call 1 8600 300 (buy) X 1 = Rs. 300
Call 2 8800 175 (sell) X 2 = Rs. 350
Call 3 9000 90 (buy) X 1 = Rs. 90
Total expense (300+90) – 350 = -40 Rs.
So at what price range the strategy would give me a GAIN?
If goes below 8600> calls will be wasted.
If stays between 8600-8800> I will have a profit form call 1 only if the price closes above 8640.
If closes between 8800 – 9000 > call 1 gives me profit and call 2 would give me a loss.
8640 – 8800 = 160 Rs. profit. And it goes on decreasing till 8999.
If closes above and at 9000 >> it will give no profit and no loss. It will turn out to be break even.
So the only profit making region is 8640 - 8999
Q4. What is a straddle strategy?
Ans. A straddle is a trading strategy that involves options. To use a straddle, a trader
buys/sells a Call option and a Put option simultaneously for the same underlying asset at a
certain point of time provided both options have the same expiry date and same strike price.
Q4-B- bank nifty is trading at 20500 in the spot market and 3 - month bank nifty future is
trading at 20800. Compute the arbitrage opportunities if the index provides a yield of
2.5% per quarter and risk free interest rate is 7% per annum with continues
compounding.
Ans-
Futures Price = Spot Price × (1 + Risk-Free Interest Rate – Income Yield)
So here,
20500 * (1 + 7% (3/12) – 2.5%)
20500 * (1 + 0.0175 – 0.025)
20500 * (0.9925)
20346.
So, 20346 – 20800 = 454 is the opportunity in making the profit.
Q5-A Explain protective put strategy?
Ans-A protective put is a risk-management strategy using options contracts that investors
employ to guard against the loss of owning a stock or asset. The hedging strategy involves an
investor buying a put option for a fee, called a premium
Q5-B a stock currently trades at 800 face value of Rs. 5 and the risk free rate of return is
10% p.a. with continues compounding and the dividend paid by the company is 20%,
10%, 15% at the end of 2nd month, 3rd month and 4th month respectively. Compute the
future price of the mid-month contract.
Ans- the formulae for the calculation of mid-month future price is:
Spot price * [1+ risk free rate (days required/365)] – dividend paid.
So here,
800 * [1 + 10% (0.5/12)]-0 = 803.333Rs.
