Derivatives (Futures) 8A.

# Student’s Space

DERIVATIVES
(FUTURES)
Quick INDEX Ques Number
• (Optional) Warm up examples
• Basic of futures 1–5
• Margin, Open Interest 6-8
• Beta management using futures 9 - 15
• Arbitrage using futures 16a & b
• Hedge ratio 17a & b
• Discrete or special ques 18 – 22
Finance Acharya Jatin Nagpal (CA, FRM) 8A.2 Derivatives (Futures) .
# Futures - warm up examples (Optional) iv) Storage cost of ₹6 will be incurred at the end of 3-months.
(Only required when practising futures after a long time.) Rf = 7% p.a. cc.
v) Storage cost of ₹2 will be incurred at the end of every month.
Ex 1: Calculate futures price in the following cases: Rf = 4% p.a. cc
i) SR = ₹250, rf = 4% p.a., period = 3-month. A Futures price = (SR + PV of storage cost) x (1+r)n
A: Futures price = SR (1+r)n = 250 x (1 + 0.04 x 3/12) = ₹252.5 or = (SR + PV of storage cost) ert
or = SR e(r+s)t
ii) SR = ₹250, rf = 4% continuously compounded, period = 3-months.
A: Futures price = SR x ert = 250 x e0.04x3/12 i) Future price = (600 + 5) x (1 + 0.07x3/12) = 615.5875 per gram
= 250 x 1.010050167 = 252.5125
ii) Future price = (600 + 5) x e0.07 x 3/12
iii) SR = 850, rf = 5% p.a. compounded annually, period = 1 month. = 605 x 1.0177
A: Futures price = SR (1+r)n = 850 x (1+0.05)1/12 = 615.7085 per gram
= 850 x 1.004074 = 853.463
iii) Future price = 600 x e(r+s)t = 600 x e(0.07 + 0.01) x 3/12
Note: In first two examples, the words compounded annually = 600 x 1.0202 = 612.12
was missing. Hence, we assumed that the interest rate has a
compounded frequency equal to the period of futures contract. iv) Calculating PV of storage cost = 6 e-0.07 x 3/12 = 5.896
Futures price = (600 + 5.896) e0.07 x 3/12
Ex 2: 3-m silver futures are traded in lots of 500 grams. SR/gram = 600. = 605.896 x 1.0177
Find Future price in the following cases: = 616.62
i) Storage cost of ₹5 will be incurred at the time of storing the
silver i.e., today only. Rf = 7% p.a. or alternatively, we could have done:
ii) Storage cost of ₹5 will be incurred today. Rf = 7% p.a.c.c. Futures price = 600 x e0.07 x 3/12 + 6
iii) Storage cost of 1% p.a.c.c. will be incurred. Rf = 7% p.a. cc. = 610.62 + 6 = 616.62
Derivatives (Futures) 8A.3

iii. PV of dividends = 2e-0.05 x 1/12 + 4e-0.05 x 2/12

v) PV of storage cost = = 1.99168 + 3.9668 = 5.9585
2e-0.07 x 1/12 + 2e-0.07 x 2/12 + 2e-0.07 x 3/12 = 5.93
Futures price = (600 + 5.93) x e0.07 x 3/12 Futures price = (150 - 5.9585) x e0.05x3/12
= 605.93 x 1.0177 = 144.0415 x 1.01258
= 616.65 = 145.853

Ex 3: A stock is currently trading at ₹150. Find the 3-months futures price iv. Futures price = 150 e(0.05 – 0.03) x 3/12
on the stock in the following cases: = 150 e0.02 x 3/12 = 150 x 1.005
i. A dividend of ₹4 will be received today. Rf = 5% p.a.c.c = 150.75
ii. A dividend of ₹5 will be received after 1 month. Rf = 5% p.a.c.c.
iii. Dividend of ₹2 will be received after 1-month, another ₹4 will be Ex 4: Gold Spot is trading at ₹52,000. Storage cost of ₹1500 will be incurred
received after 2 months. Rf = 5% p.a.c.c. at the time of storage. If Gold futures are trading at ₹53,631, find
iv. Dividend yield on stock = 3% p.a.c.c. Rf = 5% p.a.c.c. convenience yield. Rf = 4% p.a
A: Futures price = (SR – PV of dividends) ert A: Futures price =
or = SR e(r-y)t (SR + PV of storage cost – PV of convenience yield) (1 + r)n
53631 = (52000 + 1500 – CY) (1 + 0.04 x 3/12)
i. Futures price = (150 -4) x e0.05x3/12 53100 = 53500 – CY
= 146 x 1.01258 CY = ₹400
= 147.836
Ex 5: Cotton spot = ₹17,500. Find 2-months futures price if Rf = 7% p.a.c.c.
ii. Futures price = (150 – 5e-0.05 x 1/12) x e0.05x3/12 and CY = 3% p.a.c.c.
= 145.0208 x 1.01258 A: Futures price = SR x e(r-cy)t
= 146.845 Futures price = 17500 x e(0.07 – 0.03) x 2/12
= 17500 x 1.006689 = 17617.056
Finance Acharya Jatin Nagpal (CA, FRM) 8A.4 Derivatives (Futures) .
# Basics of futures of ₹4 and whose stock is currently priced at ₹125. Each future
contract calls for delivery of 1,000 shares to stock in one year daily
Q 1: An investor buys a NIFTY futures contract of ₹2,80,000 (lot size marking to market. The corporate treasury bill rate is 8%.
200 futures). On the settlement date, the NIFTY closes at 1378. Find Required:
out his profit or loss, if he pays ₹1000 as brokerage. What would be (i) Given the above information, what should the price of one future
position, if he had sold the future contracts? contract be?
A 1: Note: Nifty Futures price on settlement date = Nifty spot price (ii) If the company stock price decreases by 6%, what will be the price
(as per principle of convergence) of one futures contract?
 Futures price on settlement date = 1378. (iii) As a result of the company stock price decrease, will an investor
that has a long position in one future contract of R Ltd. realizes a
i) If Investor is long futures gain or loss? What will be the amount of his gain or loss?
Buy price: 2,80,000 (Ignore margin and taxation, if any)
Selling price: 1378 x 200 2,75,600 A 2: Futures price = Spot + Cost of carry – Dividend
Loss: (4,400) = 125 + (125 x 0.08) – 4 = ₹131
(-) Brokerage (1000) Price of one futures contract = 131 x 1000 = ₹131,000
Net Loss: (5,400)
ii) Futures price if stock falls by 6% (i.e. stock price = 125x0.94 = ₹117.5)
ii) If Investor is short futures Futures price = 117.5 + (117.5 x 0.08) – 4 = 122.90
Selling price: 2,80,000 Price of one futures contract = 122.90 x 1000 = ₹122,900
Buy price: 1378 x 200 2,75,600
Profit: 4,400 iii) Calculation of profit / (loss) ₹
Less: Brokerage (1000) Long (bought) futures at: (131,000)
Net profit: 3,400 Short (sold) futures at: 122,900
Loss: 8,100
Q 2: A future contract is available on R Ltd. that pays an annual dividend
Derivatives (Futures) 8A.5

Q 3: A rice trader has planned to sell 22000 kg of Rice after 3 months Calculate the profit / loss of Mr. Pyaralal in following situation:
from now. The spot price of the Rice is ₹60 per kg. and 3 months a) Nifty future rise by 10%
future on the same is trading at ₹59 per Kg. Size of the contract is b) PL ltd. falls by 5%.
1000 Kg. The price is expected to fall as low as ₹56 per Kg., 3 months A 4: There is ambiguity where the two cases given as (a) and (b) are to
hence. What the trader can do to mitigate its risk of reduced profit? be considered together or are separate (individual cases).
If he decides to make use of future market, what would be the ICAI has considered these 2 parts separately in its suggested answer.
effective realized price for its sale when after 3 months, spot price
is ₹57 per Kg. and future contract price for 3 months is ₹58 per Kg.? Case A – Nifty future rise by 10% ₹
A 3: The trader can short futures contract today at ₹59/kg. PL ltd: 1000 x 700 x (10% x 1.25) 87,500
No. of contracts to be sold = 22000 = 22 contracts Nifty future: -1 x 875,000 x 10% (87,500)
1000 Gain / (loss): Nil

(b) After 3 months Case B – PL ltd. falls by 5%. ₹

• Gain on futures: (59 – 58) x 1000 x 22 = 22000 PL ltd: 1000 x 700 x -5% (35,000)
• Sell 22000 kg rice at spot price: 22000 x57 = 1254000 Nifty future: -1 x 875,000 x -4% 35,000
Net amount realised = 1276000 Gain / (loss): Nil

• Net realisation per kg = 1276000 = ₹58/kg Note: If PL ltd. falls by 5%, then Nifty should fall by = 5%/1.25 = 4%.
22000
Q 5: On 31-07-2011, the value of stock index is ₹2,600. The risk-free rate
Q 4: Mr. Pyaralal bought 1000 equity shares of PL ltd. at ₹700/share. of return is 9% p.a. The dividend yield on this stock index is as
Beta of PL ltd. = 1.25 Month Dividend Yield (%)
Slip!! He hedged his position by going short on 1 Nifty futures contract January 2%
Ques which is currently quoted at 17,500 and has a lot size of 50. i.e. February 5%
Value of 1 nifty future contract = 17500 x 50 = 875,000. March 2%
Finance Acharya Jatin Nagpal (CA, FRM) 8A.6 Derivatives (Futures) .
April 2% # Margin , Open interest
May 5%
June 2% Q 6a: Sensex futures are traded at a multiple of 50. Consider the following
July 2% quotation of Sensex futures in the 10 trading days during February,
August 5% 2009:
September 2% Day High Low Closing
October 2% 4-2-09 3306.4 3290.00 3296.50
November 5% 5-2-09 3298.00 3262.50 3294.40
December 2% 6-2-09 3256.20 3227.00 3230.40
Assuming that interest is continuously compounded, then what will 7-2-09 3233.00 3201.50 3212.30
be future price of contract on 31-12-2011. Given = e002417 = 1.02446 say 10-2-09 3281.50 3256.00 3267.50
1.0245 11-2-09 3283.50 3260.00 3263.80
A 5: Period of future contract = 31-7-2011 to 31-12-2011 12-2-09 3315.00 3286.30 3292.00
i.e., contract period = 5 months 14-2-09 3315.00 3257.10 3309.30
Average dividend yield during this period 17-2-09 3278.00 3249.50 3257.80
= 5% + 2% + 2% + 5% + 2% = 3.2% 18-2-09 3118.00 3091.40 3102.60
5 Abhishek bought /purchased one Sensex futures contract on
February 04 at closing rate. The average daily absolute change in the
Futures price = 2600 x e(0.09 – 0.032) x 5/12 = 2600 e0.02417 = 2663.60 value of contract is ₹10,000 and standard deviation of these changes
is ₹2,000.
The maintenance margin is 75% of initial margin. You are required to
determine the daily balances in the margin account and payment on
margin calls, if any taking closing Balance figure. Initial Margin should
by calculated by using Daily Absolute Changes + 3 x SD
A 6a: Initial margin = μ + 3.sd = 10,000 + 3 x 2000 = 16,000
Derivatives (Futures) 8A.7

Maintenance margin = 16,000 x 75% = 12,000 A 6b: Lot value = 1310 x 100 = 1,31,000
Initial margin = 1,31,000 x 8% = 10480
# Margin calculation of Abhishek (long at 3296.50) Maintenance margin = 131000 x 6% = 7860
Opening Mark to market Call amt. Closing
Day Bal. (i.e. change in value) Bal. i) Long investor
5-2 16000 (3294.40 – 3296.50) x 50 = -105 - 15895 Day Opening Bal. Mark to market Margin call Closing Bal.
6-2 15895 (3230.40 - 3294.40) x 50 = -3200 - 12695 1 10480 3000 - 13480
7-2 12695 (3212.30 – 3230.40) x 50 = -905 4210 16000 2 13480 2000 - 15480
10-2 16000 (3267.50 – 3212.30) x 50 = 2760 - 18760 3 15480 -6000 - 9480
11-2 18760 (3263.80 – 3267.50) x 50 = -185 - 18575 4 9480 -2000 3000 10480
12-2 18575 (3292.00 – 3263.80) x 50 = 1410 - 19985 5 10480 2500 - 12980
14-2 19985 (3309.30 – 3292.00) x 50 = 865 - 20850
17-2 20850 (3257.80 – 3309.30) x 50 = -2575 - 18275 ii. Short investor
18-2 18275 (3102.60 – 3257.80) x 50 = -7760 5485 16000 Day Opening Bal. Mark to market Margin call Closing Bal.
1 10480 -3000 3000 10480
Q 6b: The contract price of December Nifty futures contract on a 2 10480 -2000 - 8480
particular-day was ₹1310. The minimum trading lot on Nifty futures 3 8480 6000 - 14480
is 100. The initial margin is 8% and the maintenance margin is 6%. 4 14480 2000 - 16480
The index closed at the following levels on the next five days. 5 16480 -2500 - 13980
Day 1 2 3 4 5
Closing Price 1340 1360 1300 1280 1305 2. Calculation of Profit / (loss)
1. Calculate the mark to market cash flows and daily closing balances Long
in the a/c of (i) an investor who has gone long at 1310 and (ii) an Buy futures: 1310 x 100 = (1,31,000)
investor who has gone short at 1310. Sold futures: 1305 x 100 = 1,30,500
2. Calculate the met profit or loss on each of the contracts. Loss: = (500)
Finance Acharya Jatin Nagpal (CA, FRM) 8A.8 Derivatives (Futures) .
Short (-) Commission: 34 x 30 (1020)
Sold futures: 1310 x 100 = 1,31,000 Net Profit / (loss): (130)
Buy futures: 1305 x 100 = (1,30,500)
Profit: = 500 Q 8: Calculate the Closing Open interest for Choja ltd. futures using
following information:
Q 7: M/s Shizune took following trades in Metal B Inc futures. Opening value of Open interest = 500 contracts.
Date Futures price Action During the day Mr. X bought 60 contracts. Counterparty for
4-May 1680 Long 15 Contracts this was Mr. Y. Later, Mr. X sold 10 contracts and the counterparty
12-May 1740 Short 10 contracts for this trade was again Mr. Y. Before the day end, Mr X sold his
14 May 1760 Short 7 contracts remaining 50 contracts. Of this, 15 contracts were bought by Mr. Y
19 May 1815 Long 2 contracts and the balance were bought by Mr. Z. Mr. Z did not have any open
You are required to show the open interest (OI) of M/s Shizune for position in Choja ltd. futures earlier.
each of the above dates. Also calculate the net profit / loss from ii) Also determine the closing open interest if Mr. Z had earlier long
all the above trades. A commission of ₹30 is charged whenever a Choja ltd.’s futures.
contract is bought or sold. iii) What if Mr. Z had a previous short position of 80 lots.
A 7: Date Action Open Interest iv) What if Mr. Z had a previous short position of 20 lots.
4-May Long 15 Contracts 15 lots – Long futures A 8: Parties Lots Nature of trade Open interest
12-May Short 10 contracts 5 lots – Long futures X–Y 60 New contract 500 + 60 = 560
14 May Short 7 contracts 2 lots – Short futures X–Y 10 Squared off 560 – 10 = 550
19 May Long 2 contracts 0 lots – No open interest X-Y 15 Squared off 550 – 15 = 535
X-Z 35 Transfer 535 + 0 = 535
Calculating Profit / loss
Short futures: (10 x 1740) + (7 x 1760) 29,720 ii) Even if Mr. Z had long position, then also the answer would remain
(-) Long futures: (15 x 1680) + (2 x 1815) (28,830) same. i.e. Closing OI would be remain 535 in that case.
Profit: 890
Derivatives (Futures) 8A.9

iii) If Mr. Z had a previous short position of 80 lots, then OI would be: # Beta management using futures
Parties Lots Nature of trade Open interest
X-Z 35 Square off 535 – 35 = 500 Q 9a: A Mutual fund is holding investment is diversified equity share of
₹90.00 Crore. The beta of portfolio is 1.1. The index future is selling
iv) If Mr. Z had a previous short position of 20 lots, then OI would be: at 4300 level. The fund manager apprehends that the index will fail
Parties Lots Nature of trade Open interest at the most by 10%. How many index futures he should short for
X-Z 20 Square off 535 – 20 = 515 perfect hedging? One index future consists of 50 Units. Justify your
X–Z 15 Transfer 515 + 0 = 515 answer if the index falls by 10%.
A 9a: Number of Index futures to be traded= Vh x (TB – CB)
IFP x Lot size

where, Vh = Value to be hedged TB = Target beta

CB = Current beta IFP = Index futures price

= 90 crores x (0 – 1.1) = -4604.65 or short 4605 contracts.

4300 x 50

• Justification – If market fell by 10%

Fall in equity value: 90 crores x 1.1 = -9.9 crores
Profit on futures: (4300 x 10%)x50x4605 = +9.90075 crores
Net Profit /loss: Nil (approx.)

Q 9b: The portfolio consists of Mr. X is given below:

Equity ₹8,00,000; Cash and Cash Equivalent ₹2,00,000: Beta of equity
portfolio = 0.69. Current NSE index future value is 930 with multiple
Finance Acharya Jatin Nagpal (CA, FRM) 8A.10 Derivatives (Futures) .
of 200. If Mr. X wants to achieve an overall portfolio beta of 1.10  Number of contracts = 70,000/1000 = 70 contracts.
then how many numbers of futures contract he should so long?
A 9b: Portfolio beta = 0.69x0.8 + 0x0.2 = 0.552 • Calculation of profit / (loss)
loss on X ltd: 2.2L x 2% = 4,400
• Number of Index futures to be traded = Vh x (TB – CB) Loss on A ltd: 2L x 3% = 6,000
IFP x Lot size Loss on Nifty: 70,000 x 1.5% = 1,050
Total loss: 11,450
where, Vh = Value to be hedged TB = Target beta
CB = Current beta IFP = Index futures price Q 11: Mr. Careless was employed with Baka Consultants. Mr. Ganchakkar their
regular client purchased 1,00,000 shares of X Inc. at a price of $22
= 10 Lakhs x (1.1 – 0.552) = 2.946 or Long 3 contracts and sold 50,000 shares of A plc for $4o each having beta 2.
930 x 200 Mr. Careless advised Mr. Ganchakkar to take a position* in index future
trading at $1,000 each contract. Though Mr. Careless noted the name
Q 10: Ram buys 10,000 shares of X Ltd. at a price at ₹22 per share whose & beta of A plc but forgot to record the beta value of X inc.
beta value is 1.5 and sell 5,000 shares at A Ltd, at a price of ₹40 per
share having a beta value of 2. He obtains a hedge by Nifty futures On next day Mr. Ganchakkar closed out his position when:
at ₹1,000 each. He closes out his position at the closing price of the - Share price of X Inc. dropped by 2%
next day when the share of X Ltd dropped by 2%, share of A Ltd - Share price of A plc. Appreciated by 3%
appreciated by 3% and Nifty futures dropped by 1.5%. What is the - Index Future dropped by 1.5%
overall profit / loss of Ram?
A 10: Number of Nifty futures to hedge portfolio Mr. Ganchakkar, informed Mr. Careless that he made a loss of
Shares value Beta Position Nifty hedge $1,14,500 due to the position taken.
X ltd 10,000 x 22 = 2.2L 1.5 long 3.3L short Since the records of Mr. Careless are incomplete, he has requested
A ltd 40 x 5,000 = 2L 2 short 4 L long you to calculate the:
Net position: 70,000 long i) Number of futures contract he advised Mr. Ghanchakkar to trade.
Derivatives (Futures) 8A.11

ii) Beta of X Inc shares. • Number of futures contracts traded = 700 i.e. Long 700 contracts
Note: The original ques of ICAI stated that Mr. Careless advised to
take a short position in futures. Which is wrong. Because here in • Putting value of ‘n’ in equation (1), we get:
this ques a long futures position is required to obtain the hedge. 1000 x 700 = 40L – 22L*a => a = 1.5
A 11: Let Beta of X Inc stock be ‘a’. Hence, Beta of X Inc stock is 1.5
Let number of futures contracts traded be ‘n’.
Q 12: On 1-04-2015, Sunidhi was holding a portfolio of 10 securities whose
Shares value Beta Position Index hedge value was ₹9,94,450. Weighted average of beta of 9 securities was
X Inc 100,000 x 22 = 22L a long 22L*a short 1.10.
A Plc 50,000 x 40 = 20L 2 short 40L long Since she was expecting a fall in the prices of the shares in near
Net position: 40L – 22L*a future to hedge her portfolio, she sold 5 contracts of NIFTY Futures
(Multiplier of 25) expiring in May 2015, which was trading at 8767.07 on
 Number of contracts = n = 40L – 22L*a 1st April.
1000 (i) Calculate the beta of the 10th security.
=> 1000 n = 40L – 22L*a … (1) (ii) Reconcile the reasons in spite of2% fall in the market as per Sunidhi’s
apprehension if she would have earned some profit on her cash
• Calculation of profit / (loss) after 1-day Gain / (loss) position.
X Inc: 100,000 x 22 x -2% = (44,000) A 12: Let overall portfolio Beta be β. then we can say that:
A Plc: -50,000 x 40 x 3% = (60,000) Number of Index futures to be traded = Vh x (TB – β)
Index futures: n x 1000 x -1.5% = (15n) IFP x Lot size
Total Gain / (loss): (1,14,500)
-5 = 994450 x (0 – β) => β = 1.102 (approx.)
=> (44000) + (60,000) + (15n) = (114,500) 8767.07 x 25
n = 700
• Portfolio Beta = weighted average Beta.
Finance Acharya Jatin Nagpal (CA, FRM) 8A.12 Derivatives (Futures) .
Let Beta of 10th security be ‘a’ (iv) The number of future contracts the investor should trade if he
1.102 = 1.10 x 0.9 + 0.10a desires to reduce the beta of his portfolio to 0.6.
a = 1.12 Given: Ln (1.105) = 0.0998 and e(0.015858) = 1.01598. Take 365 days in a year.
⸫ Beta of 10th security = 1.12 A 13: i) Stock No. of Weight Beta Weighted
Price shares Value Wi βi Beta (Wi x βi)
(ii) The main reason for the profit in cash position might be due to A 349.30 5,000 17,46,500 0.093 1.18 0.107
reason that contrary to her expectation of fall in the value of cash B 480.50 7,000 33,63,500 0.178 0.40 0.071
position there may be increase in value of cash position. C 593.52 8,000 47,48,160 0.252 0.90 0.227
D 734.70 10,000 73,47,000 0.390 0.95 0.370
Q 13: On Jan. 1, 2018 an investor has a portfolio of 5 shares as given below: E 824.85 2,000 16,49,700 0.087 0.85 0.074
Security Price No. of shares Beta Total: 1,88,54,860 0.849
A 349.30 5,000 1.15 Portfolio Beta = 0.849
B 480.50 7,000 0.40
C 593.52 8,000 0.90 (ii) Theoretical future price (F) = Sert = 5900 e0.105x58/365 = 5999.28
D 734.70 10,000 0.95
E 824.85 2,000 0.85 • Number of Index futures to be traded = Vh x (TB – CB)
IFP x Lot size
The cost of capital to the investor is 10.5% p.a. Calculate:
(i) The beta of his portfolio. (iii) Obtain complete hedge (i.e. target beta = 0)
(ii) The theoretical value of the NIFTY futures for February 2018. = 18854860 x (0 – 0.849) = -13.31 or -14 contracts
(iii) The number of contracts of NIFTY the investor needs to sell to get 5999.28 x 200 i.e. short 14 contracts
a full hedge until February for his portfolio if the current value of
NIFTY is 5900 and NIFTY futures have a minimum trade lot (iv) Obtain partial hedge with target beta = 0.6.
requirement of200 units. Assume that the futures are trading at = 18854860 x (0.6 – 0.849) = -3.91 or -4 contracts
their fair value. 5999.28 x 200 i.e. short 4 contracts.
Derivatives (Futures) 8A.13

Q 14: Detail about portfolio of shares of an investor is as below: (ii) Required Beta = 0.91
Shares No. of shares Price per share Beta Let the amount invested in existing portfolio be X
A Ltd. 3.0 lacs ₹500 1.40 => Amount to be invested in Risk-free securities = 5000 - X
B Ltd. 4.0 lacs ₹750 1.20 Portfolio Beta = 1.3 x X + 0 (beta of rf securities =0)
C Ltd. 2.0 lacs ₹250 1.60 5000
The investor think that the risk of portfolio is very high and he wants 0.91 = 1.3 x X => X = ₹3500 lacs
to reduce the portfolio beta to 0.91. 5000
He is considering two below mentioned alternative strategies:
(i) Dispose-off a part of his portfolio to acquire risk free securities, or » Portfolio manager should acquire risk-free securities worth ₹ 1500L
(ii) Take appropriate position on NIFTY Futures which are currently by disposing off the same amount of existing portfolio.
traded at 8125 and each NIFTY point is worth ₹200.
Calculate: (iii) Calculating Number of shares to be disposed-off:
(1) Portfolio beta New required Req. share Qty. to be
(2) The value of risk-free securities to be acquired Security Investment Qty (lacs) disposed off
(3) The number of shares of each company to be disposed-off, A 1500/5000 x 3500 = 1050 2.1L 3 - 2.1 = 0.9 lacs
(4) The number of NIFTY contracts to be bought/sold; and B 3000/5000 x 3500 = 2100 2.8L 4 - 2.8 = 1.2 lacs
(5) The value of portfolio beta for 2% rise in NIFTY. C 500/5000 x 3500 = 350 1.4L 2 - 1.4 = 0.6 lacs
A 14: i) Calculating Portfolio Beta
• Total investment in portfolio = 3 L x 500 + 4 L x 750 + 2 L x 250 (iv) No. of Index (use template)
= 1500 + 300 + 500 = ₹5000 lacs. • Number of Index futures to be traded = Vh x (TB – CB)
IFP x Lot size
• Portfolio Beta = Weighted average Beta
= 1.4 x 1500 + 1.2 x 3000 + 1.6 x 500 = 1.3 = 5000 L x (0.91 – 1.3) = -1200 or short 1200 contracts
5000 5000 5000 8125 x 200
Finance Acharya Jatin Nagpal (CA, FRM) 8A.14 Derivatives (Futures) .
where, Vh = Value to be hedged TB = Target beta
(v) If Nifty rises by 2% (₹ in lacs) CB = Current beta IFP = Index futures price
Change in share value = 5000 x (2% x 1.3) = 130
Change in Nifty futures = (8125 x 2%) x 200 x (-120) (39) = 60L x 40% x (0 - 1.25) = -2 or short 2 contracts
Net Change = 91 20,000 x 75

Net change in portfolio = i.e., 91/5000 = 1.82% ii) Calculating impact if Nifty falls by 10% Gain / (loss)
Loss on portfolio: 60L x 10% x 1.25 (750,000)
Portfolio Beta = Change in portfolio value = 1.82% = 0.91 Gain on Nifty futures: 15,00,000 x 10% x 2 300,000
Change in Nifty value 2% Net loss: 450,000

Q 15: Ginger has a portfolio of ₹60 lacs which includes ₹50 lacs of equity A total loss of ₹750,000 would have been incurred if there was no
shares with Beta = 1.5. Balance amount is held as cash. hedge. However, since 40% of the portfolio was hedged, so this loss
She is afraid of market crash and hence wants to hedge only 40% of is reduced by 40%. Net loss of only ₹450,000 is incurred.
her portfolio using Nifty futures.
Nifty futures are currently trading at ₹20,000. 1 lot = 75.
i) Determine what trade she should take to obtain her desired hedge.
ii) Show that the 40% of her portfolio is hedged if Nifty falls by 10%.
A 15: Portfolio Beta (βp) = Weighted average beta
= 1.5 x 50/60 + 0 = 1.25
• Value of 1 futures contract = 20,000 x 75 = 15,00,000

• Number of Index futures to be traded = Vh x (TB – CB)

IFP x Lot size
Derivatives (Futures) 8A.15

# Arbitrage using Futures On futures expiry ->

• Future value of dividends to be paid (2.e0.12x2/12)x100 -204.04
Q 16a: Calculate the price of A Ltd. 6 months futures contract on a share • Purchase 100 shares under long futures at ₹74
that is currently priced at ₹75. The share is expected to pay ₹2 & use these square off short position -7400
dividend four months from today. The continuously compounded • Investment proceeds: 7500 x e0.12x6.12 +7963.77
risk-free rate is 12% p.a.c.c. Calculate fair Future price. Lot size = 100. Arbitrage profit: ₹359.73
Calculate Arbitrage Point:
(i) It the actual future Price is ₹7400 Case 2 – Actual futures price = ₹7800
(ii) If the Actual Future price is ₹7800 Fair futures price < Market price. Futures are over-valued.
A 16a: Futures price = 75 x e0.12 x 6/12 - 2.e0.12x2/12 Cash & carry arbitrage is possible.
= 79.6377 - 2.0404 = 77.5973
Price per contract = 77.5973 x 100 = 7759.73 » Particulars ₹ inflow / outflow
Today ->
Case 1 – Actual futures price = ₹7400 Borrow ₹7500 +7500
Since fair futures price > Market price. Futures are under-valued. Buy 100 stock from cash market -7500
Arbitrage is possible. Short futures at prevailing price of ₹7800 -
Net fund flow today : Nil
» Particulars ₹ inflow / outflow
Today -> On futures expiry ->
Long futures at prevailing price of ₹7400 - Future value of dividend received: (2.e0.12x2/12)x100 +204.04
Short 100 shares at ₹75 / share +7500 Deliver stock under futures contract +7800
Invest ₹7500 (from short sale) at 12% p.a.c.c -7500 Repay loan: 7500.e0.12x6/12 7963.77
Net fund flow today : Nil Arbitrage profit: ₹40.27
Finance Acharya Jatin Nagpal (CA, FRM) 8A.16 Derivatives (Futures) .
Q 16b: Calculate the price of 3 months Nara futures, if Nara ltd. stock is # Hedge ratio
trading at ₹220 on stock exchange. One month borrowing rate is
15% and the expected annual dividend is 25% p.a. payable before Q 17a: A company is long on 10MT of copper@ ₹474 per kg (spot) and intends
expiry. Assume face value of share to be ₹10. to remain so for the ensuring quarter. The standard deviation of
ii) Is there an arbitrage opportunity if the futures contract is currently changes of its spot and future prices are 4% and 6% respectively,
trading at ₹230. having correlation coefficient of 0.75. What is the hedge ratio? What
A 16b: Futures Price (F) = Spot + Cost of carry - Dividend is the amount of the copper future it should short to achieve a
F = 220 + (220 x 0.15 x 3/12) – 0.25 x 10 = 225.75 perfect hedge?
(Entire dividend of ₹2.50 is payable before expiry.) A 17a: Hedge ratio = σs x rs,f = 4% x 0.75 = 0.5
σf 6%
» Constructing arbitrage ₹ inflow / outflow
Today ->  Value of short futures = {(474 x 10) x 1000} x 0.5 = 23,70,000
Borrow ₹220 +220
Buy stock from cash market -220 Q 17b: Find hedge ratio and the value of oil futures to be traded if Jaggu
Short futures at prevailing price of ₹230 - airlines ltd. wants to hedge it ATF requirement of ₹40 crores.
Net fund flow today : Nil Following information is given:
SD of Aviation turbine fuel (ATF) spot = 15%
After 3-months (futures expiry) -> SD of oil futures = 16%
Receive dividend on stock: 10 x 25% +2.5 correlation between oil futures & ATF spot rate = 0.9
Deliver stock under futures contract +230 A 17b: Hedge ratio = σs x rs,f = 15% x 0.9 = 0.84375
Repay loan: 220 x (1 + 0.15 x 3/12) -228.25 σf 16%
Arbitrage profit: ₹4.25
 Value of oil futures = Value of spot x Hedge ratio
= 40 crores x 0.84375 = ₹33.75 crores
Derivatives (Futures) 8A.17

# Discrete or Special Ques

Note: Do not take value of index in the denominator. This is because no
Q 18: A trader is having in its portfolio shares worth ₹85 Lakhs at current amount is paid in case of futures contract (Unlike shares etc.).
price and cash ₹15 Lakhs. The beta of shares portfolio is 1.6. After 3
Months the price of shares dropped by 3.2%. Determine: Q 19: BSE (cash market) 5000
(i) Current portfolio beta. Imp Value of portfolio ₹10,10,000
(ii) Portfolio beta after 3 months if the trader on current date goes Risk free interest rate 9% p.a.
for long position on ₹100 Lakhs Nifty futures. Dividend yield on index 6% p.a.
A 18: i. Portfolio beta = 0.85 x 1.6 + 0.15 x 0 = 1.36 Beta of portfolio 1.5
We assume that a future construct on the BSE index with four
ii. Calculation of portfolio beta months maturity is used to hedge the value of portfolio. One future
value of shares after 3-months: = 85L x (1-0.032) = 82.28L contract is for delivery of 50 times the index.
Based on the above information calculate:
Value of long futures (i) Fair price of 4 Months future contract.
Shares having a beta of 1.6 fell by 3.2%. (ii) The gain on short futures position if cash market turns out to be
Beta = change in value of shares 4,500 in three months.
change in value of market index (iii) Value of portfolio after 3 months using CAPM
(a) without Hedging (b) with Hedging
1.6 = -3.2% / Change in market index A 19: Futures price = 500 x {1 + (0.09 – 0.06) x 4/12} = 5050
 Change in market index = 2% Value of futures contract = 5050 x 50 = ₹.2,52,500
Nifty futures value = 100 x (1-0.02) = 98L No. of futures contracts = (10,10,000 x 1.5) /252500 = 6 contracts

-> Portfolio beta = weighted average beta ii. Value of future contract after 3 months should be
= 82.28Lx1.6 + 15Lx0 + 98Lx1 = 2.36 4500 x {1 + (0.09 – 0.06) x 1/12} = 4511.2512
82.28L + 15L Gian = (5050 – 4511.2512) x 50 x 6 = ₹161624.64
Finance Acharya Jatin Nagpal (CA, FRM) 8A.18 Derivatives (Futures) .
Q 20: Mr V decides to sell short 10,000 shares of ABC Ltd, which was selling
iii. Market return during 3-months period a yearly high of £5.60. His broker requested him to deposit a margin
= capital gain yield + dividend yield requirement of 45% and commission of £1550. While Mr V. short the
= (4500 – 5000) + (6% x 3/12) share the ABC paid a dividend of £0.25 per share. At the end of one
5000 year Mr V buys 10,000 shares of ABC Ltd. at £4.50 to close out
= -10% + 1.5% = -8.5% i.e., Rm = -8.5% position and was charged a commission of £1450. You are required
to calculate the return on Investment of Mr. V taking opportunity
Notes: Dividend yield is given as 6% p.a. cost of dividend loss.
That means dividend yield for 3-months = 6% x 3/12 = 1.5% A 20: Profit / (loss) on short sale (£)
Sold shares: 5.60 x 10,000 56000
# CAPM return of portfolio = Rf + (Rm – Rf) x Beta Bought shares: 4.50 x 10,000 (45000)
Rf for 3-months = 9% x 3/12 = 2.25% 11000
(-) Dividends to be re-imbursed by short: 0.25 x 10,000 (2,500)
CAPM return = 2.25% + (-8.5% - 2.25%) x 1.50 = -13.875% (-) Brokerage: 1550 + 1450 (3,000)
Hence, expected return of portfolio for 3-months (as per CAPM) Profit on short sale: 5,500
= -13.875%
# Calculating of initial investment
a) Value of portfolio without hedging Margin money = {5.6 x 10,000} x 45% 25200
= 10,10,000 x (1-0.13875) = ₹8,69,862.5 + Brokerage at the time of entering into contract 1550
Total: 26,750
b) Value with hedging
Value of portfolio = 8,69,862.5 Return on investment = Return / Investment = 5500/26750 = 20.56%
+ Gain due to short futures = 1,61,624.64
Total portfolio value = 10,31,487.14 Q 21: Suppose current price of an index is ₹13,800 and yield on index is
4.8% (p.a.). A 6-month future contract on index is trading at ₹14,340.
Derivatives (Futures) 8A.19

Assuming that Risk Free Rate of Interest is 12%, show how Mr.X (an Dividend on portfolio: 13800 x 4.8% x 6/12 = 3312
arbitrageur) can earn an abnormal rate of return irrespective of (+) Profit on portfolio: 15600 – 13800 = 1800
outcome after 6 months. You can assume that after6 months index Total arbitrage profit: = 871.20
closes at ₹10,200 and ₹15,600. Also calculate implied risk-free rate of (Again, borrowing cost is to be ignored.)
return on investment. Do not incorporate borrow point.
A 21: Futures price = 13800 x {1 + (0.12 – 0.048) x 6/12} = 14,296.8 # Implied Rf calculation
Current futures price = 1430 Implied Rf = Return = 871.20 = 6.31% for 6-months
Arbitrage is possible. Investment 13800 ie. 12.63% p.a.

Steps for arbitrage Q 22: Mr. SG sold five 4-Month Nifty Futures on 1st February 2020 for
1. Sell index futures at ₹14340. ₹9,00,000. At the time of closing of trading on the last Thursday of
2. Buy a portfolio of shares replicating the index at a cost of ₹13800 May 2020 (expiry), Index turned out to be 2100. The contract
(i.e., spot rate) by borrowing the required amount at 12% p.a. multiplier is 75.
Based on the above information calculate:
i. If index closed at ₹10,200 (i) The price of one Future Contract on 1st February 2020.
Profit from short position: 14340 – 10200 = 4140 (ii) Approximate Nifty Sensex on 1st February 2020 if the Price of future
(+) Dividend on portfolio: 13800 x 4.8% x 6/12 = 331.2 contract on same date was theoretically correct. On the same day
(-) Loss on portfolio: 10200 – 13800 = (3600) risk-free Rate of interest and Dividend Yield on Index was 9% &
Total arbitrage profit: = 871.20 6% p.a. respectively.
(iii) The maximum Contango/Backwardation.
Note: Borrowing cost is ignored as it is explicitly mentioned in ques to (iv) The pay-off of the transaction.
ignore borrowing cost. Note: Carry out calculation on month basis.
A 22: (i) Let price of Nifty Futures on 1st February be F
ii. If index closed at ₹.15,600 Then: (F x 75) x 5 = 9,00,000
Loss on short position: 14340 – 15600 = 1260 F = 2400
Finance Acharya Jatin Nagpal (CA, FRM) 8A.20 Derivatives (Futures) .
Price of 1 Nifty Future contract = 2,400 x 75 = 1,80,000. # Student’s Space

(ii) Nifty Index on 1st February

Futures = S0 + S0 x (rf – y) x months
12

where, S0 = Spot Price, y = dividend yield

2,400 = S0 + S0 (0.09 – 0.06) x 4/12
2,400 = 1.01 S0
S0 = 2376.24

(iii) Basis = Spot price – Futures price

= 2376.24 – 2400 = -23.76
Hence, Basis is negative, market is in contango.

(iv) Payoff
Sold Futures: (2400 x 75) x 5 = 9,00,000
Bought Futures: (2100 x 75) x 5 = (7,87,500)
Payoff/gain = 1,12,500