ECON F354 & FIN F311: DERIVATIVES AND RISK MANAGEMENT

MID-SEM (CLOSED BOOK) – SECOND SEMESTER 2017-18

Time: 90 minutes Total Points: 100 Date: 06.03.2018

1) Answer the below (a-e) True or False question and (f-j) Fill in the blank question. Answer all the questions.
Each question carries three points. (10 X 3 = 30).
a) If S is the stock price and K is the strike price, a call option and a put option is at the money when S=K. (T/F)
b) All the types of derivative contracts are exchange traded contracts. (T/F)
c) In the case of straps the investor assumes that there will be a big stock price move. However, an increase in the stock price is
considered to be more likely than a decrease stock price. (T/F)

d) Put–Call parity relationship is possible with European as well as with American Options. (T/F)
e) Delta is the number of units of the stock we should hold for each option shorted in order to create a riskless portfolio. (T/F)
f) Let’s assume that PNB stock price is ₹100 and the exercise price of a call option is ₹97.50. If the call premium is ₹3.50, then
what is the time value of this option……………..
g) A trader who is willing to quote both bid and offer prices for an asset is known as……………
h) ……………………..is a combination of a bull call spread with strike prices K1 and K2 and a bear put spread with the same two
strike prices.
i) ………………….is one where only the present value of the variable is relevant for predicting the future.
j) ……………………………… process describes the evolution of a normally distributed variable with a drift of a per unit time and a
variance rate of b2 per unit time, where a and b are constants.

2) Using the below given information prove that when a speculator uses futures, the potential loss as well as the potential gain
is very large. When options are used, no matter how bad things get, the speculator’s loss is limited to the amount paid for
the options. Whereas there are only limited gains and losses are possible in the spot market. The speculator is assuming the
stock price will go up to ₹1300, whereas the historical volatility shows that it can also go down to ₹700 after 3 months.
Initial investment is ₹50,000; current stock price (S0) = ₹1000; Strike price (applicable for futures & options) (K) = ₹1100; Call
option price (c) = ₹10 and time period is 3 Months. Margin requirement is 10% (assume that margin is paid on the first day and
will be adjusted only on contract maturity, which means there is no daily settlement). (15 points)

Market Type Net investment when ST= 1300 Net investment when ST= 700
Spot Market
Futures Market
Options Market

3) Derive the put call parity using the below portfolios (15 points)

Portfolio A: one European call option plus a zero-coupon bond that provides a payoff of K at time T
Portfolio B: one share of the stock.
Portfolio C: one European put option plus one share.
Portfolio D: a zero-coupon bond paying off K at time T.

4) Consider a 1 year European call with a strike price of ₹310 on a stock whose current price is ₹300. Assume that there are two
time steps of 6 months each, and in each time step the stock price either moves up by 10 percent or moves down by 10
percent. The risk free rate is 10 percent per annum. Calculate the European call option price. All the numbers should be
rounded to four decimals only. Draw the binomial tree (15 points)

5) DRM stock got listed ten years back on BHPC stock exchange and it is also allowed to trade on futures and options (F&O)
markets on the same exchange and the current DRM stock price is ₹98. A trader observed that in the last six months DRM
stock price was within the range of ₹95 & ₹105. Using technical & fundamental analysis he concluded that DRM stock price

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 in the next three months will stay in the same range and most probably it will be ₹100. Using this fact and below information
on three month European call option prices with different strike prices create a better trading strategy. Assume that there
are no arbitrage opportunities. All the numbers should rounded to nearest four decimals. (15 points)

Strike Price (₹) Call Price (₹)

K1 90 10
K2 95 6.29
K3 100 3.09
K4 105 1.21
K5 110 0.75
A) Name the trading strategy and is there cash inflow or outflow (how much) and how it is created.
B) Show the well labelled profit diagram (Draw with pen only. Do not use pencil).
C) When the maximum profit is possible and what are (gross) profit ranges.

6) Draw the well labelled option profit (not the payoff) diagrams using the below information on Punjab National Bank stock
(PNB). Do not draw using pencil (10 Points)
A) Long European Call option price is ₹9 and Strike price is ₹120.
B) Short European Call option price is ₹9 and Strike price is ₹120.
C) Long European Put option price is ₹15 and Strike price is ₹130.
D) Short European Put option price is ₹15 and Strike price is ₹130.

Additional Information:
Stock Price Ranges
Bull Spread Bear Spread Box Spread Butterfly Spread. Straddle Strangle

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