TAKE AWAY CAT

BAC 309: FINANCIAL DERIVATIVES

QUESTION 1
Consider a put option with the following characteristic:

Exercise price is Sh.50

Premium per put option is Sh.5
The time remaining to expiry is 6 months

Assume the following market price of the underlying security at the expiry date of the option and
calculate the value of the put option and profit and loss and represent it graphically.

QUESTION 2
On 1st January 2012, A Kenyan importer bought goods from the USA worth $500,000 to pay for
in three months time later on 31st March 2012. Kenyan shillings futures are available in the
money market and could be bought in blocks of Kshs. 200,000 at a cost of Kshs. 2000 per
futures contract. The spot rate on 1st January 2012 is Kshs. 75.50/$ and the spot rate on 31st
March 2012 is anticipate to be Kshs. 79.50/$. The exchange rate at which the futures contract
closed out was Kshs. 77.50/$.

Required:
i) Assuming that the investor was to enter into a forward contract with a strike price of Kshs.
78.50/$. What would be the gain or loss?
ii) Determine the gain or loss if the investor was to hedge using a futures contract.
iii) Advise the investor on which of the two contracts to use.
iv) Discuss a case for and a case against the use of derivatives in hedging against financial risk.
v) Suggest some of the methods used by a firm to ease a cash shortage.

QUESTION 3
a) Briefly explain the various functions of derivative market and types of players.
b) In futures market, cotton contract has a standardized contract size of 5,000 bushels of
cottons. What advantages does this have over the well-known forward market practice of
negotiation case-by-case basis? What disadvantages does standardized contract size have?

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QUESTION 4
Assume that the following information has been obtained by an investor intending to invest in a
call option.

Market price per security = Kshs. 20

Exercise price (X) = Kshs. 20
Time (t) = 3 months (0.25 years)
Risk free rate (rf) = 12%
Variance (δ²) = 0.16

Required:
a) Determine the value of the value of the call option and a corresponding put option. Advice the
investor. (8 marks)
b) Discuss the assumptions made in the determination of the value of the option above.
(10 marks)
c) Suggest the factors limiting the application of black schools model. (2 marks)

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