NOIDA INSTITUTE OF ENGINEERING & TECHNOLOGY

GREATER NOIDA

Financial Derivatives & Risk Management

MBA 4th Sem
Unit-3
By

Dr. Mohd Iftikhar Baig

Assistant Professor
MBA
NIET, GREATER NOIDA
 Option

• An option is a contract that goes a step further and provides the buyer of the option the
right without the obligation, to buy or sell put as specified asset at an agreed price on
or up to a specific date.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Option
• For accruing this right the buyer has to pay a premium to the seller. The seller on the
other hand has the obligation to buy or sell that specific asset at the agreed price. The
premium is determined taking into account a number of factors, such as

(a) The underlying's current market price,

(b) The number of days to the expiration the strike price of the option,

(c ) The volatility of the underlying assets, and

(d) The risk less rate of return.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Types of options
Call Option:

Calls give the buyer the right but not the obligation to buy a given quantity of the
underlying asset, at a given price on or before a future given date.

Put Option:

Puts give the buyer the right, but not obligation to sell a given quantity of the
underlying asset at a given price on or before a given date.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Futures
• A Futures Contract is an agreement between the buyer and the seller for the purchase and
sale of a particular asset at a specific future date. The price at which the asset would
change hands in the future is agreed upon at the time of entering into the contract.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Futures
• The actual purchase or sale of the underlying involving payment of cash and delivery of
the instrument does not take place until the contracted date of delivery. A future contract
involves an obligation on both the parties to fulfill the terms of the contract.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Put options vs. futures contract

• Limited Risk

• Less Volatility

Losses on buying a put option are limited to the premium you paid for the option plus
commissions and any fees. With a futures contract, you have virtually unlimited loss
potential.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Put options vs. futures contract
• Put options also do not move as quickly as futures contracts unless they are deep in the
money. This allows a commodity trader to ride out many of the ups and downs in the
markets that might force a trader to close a futures contract in order to limit risk.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Put options vs. futures contract
• One of the major drawbacks to buying options is the fact that options lose time value
everyday. Options are a wasting asset – theoretically, they are worth less each day that
passes. You not only have to be correct on the direction of the market, but also on the
timing of the move.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Buying an option

Example:
Suppose you expect the price of gold futures to move higher over the next 3-6 months. It is currently January, so you would
probably buy an August gold call to give yourself enough time. Gold is currently trading at Rs. 4000/-per gram. You expect the
price to climb to Rs. 6000/- within 6 months.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Difference between futures and options
FUTURES OPTION
Futures Contract is an agreement to buy In options the buyer enjoys the right and
or sell specified quantity of the not the obligation, to buy or sell the
underlying assets at a price agreed upon underlying asset.
by the buyer and seller, on or before a
specified time. Both the buyer and seller
are obliged to buy/sell the underlying
Unlimited upside and downside for both Limited downside (to the extent of
buyer and seller premium paid) for buyer and unlimited
upside. For seller (writer) of the option,
profits are limited whereas losses can be
unlimited.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Difference between futures and options

FUTURES OPTION
Futures contracts prices are Prices of options are however,
affected mainly by the prices of affected by (a) prices of the
the underlying asset. underlying asset, b) time
remaining for expiry of the
contact and c) volatility of the
underlying asset.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Difference between call option and put option
Call Option Put Option
Option Buyer Option Buyer Buys the right Buys the right to sell the
to buy the underlying asset at underlying asset at the strike
the strike price price

Option Seller Has the obligation to sell the Has the obligation to buy the
underlying asset to the underlying asset from the
option holder at the strike options holder at the strike
price. price.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
1. Hedgers and speculators strike a balance due to their needs because:
(a) Hedger has to take risk while speculators has to give up risk.
(b) Hedger avoid risk while the speculators takes risk.

2. Foreign Exchange future markets are………. And the foreign Exchange

forward markets are…….
(a) Informal; formal. (b) Formal; formal.
(c) Informal; informal. (d) organized; unorganized.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
3. Which of the following is NOT an example of a forward contract?
(a) An agreement to buy a car in the future at a specified.
(b) An agreement to buy an airplane ticket at a future date for a certain price.
(c) An agreement to buy a refrigerator today at the posted price.

4. Which of the following derivatives product can be classified as American and

European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.
5. In futures contract, tick size refers to :
(a) The daily price limit.
(b) Minimum price fluctuation that is allowed between two contracts.
(c) Change in the price from the previous closing price.
. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
6. What is put option?

7. Tell about call option.

8. Define closing price.

9. Discuss speculator.

10. What is option?

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Hedge
• A hedge is an investment that protects the finances from a risky situation.
• Hedging is done to minimize or offset the chance that assets will lose value.

• When a currency trader enters into a trade with the intent of protecting an existing or
anticipated position from an unwanted movement in foreign currency exchange rates,
they can be said to have entered into a forex hedge.
• By utilizing a forex hedge properly, a trader that is long a foreign currency pair it can
protect themselves from downside risk; while the trader that is the short foreign currency
pair, can protect against upside risk.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Methods of Hedging Currency Trades for the Retail
Forex Trade
1. Spot Contracts

• Spot contracts are essentially the regular type of trade that is made by a retail forex trader.

• Because spot contracts have a very short-term delivery date, they are not the most
efficient currency hedging vehicle.

• Regular spot contracts are the reason that a hedge is needed, rather than used as the hedge
itself.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Methods of Hedging Currency Trades for the
Retail Forex Trade

2. Foreign Currency Options

• The foreign currency option gives the purchaser right, but not the obligation, to
buy or sell the currency pair at the appropriate exchange rate at some time in the
future.

• Regular options strategies can be employed, such as long strangles and bull or bear
spreads, to limit loss potential of a trade.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Forex Hedging Strategy

• A forex hedging strategy is developed in four parts, including an analysis of the forex
trader's risk tolerance, risk exposure and preference of strategy.
• These components make up the forex hedge.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Forex Hedging Strategy
1. Analyze Risk

• The trader must identify what types of risk (s)he is taking in the current or proposed
position.

• From there, the trader must identify what the implications could be of taking on the risk
un-hedged, and determine the risk is high or low in the forex currency market.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Forex Hedging Strategy

2. Determine Risk Tolerance

• The trader uses their risk tolerance levels, to determine how much of the position's risk needs
to be hedged.

• No trade will ever have zero risks; it is up to the trader to determine the level of risk they are
willing to take, and how they are willing to pay to remove excess risks.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Forex Hedging Strategy
3. Determine the Forex Hedging Strategy

If using foreign currency options to hedge the risk of a currency trade, the trader must
determine which strategy is the most cost-effective.

4. Monitor the Strategy

By making assured that the strategy works the way it should, the risk will stay minimized.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Forex Hedging Strategy
• The forex currency trading market is a risky one, and hedging is the only way that a trader
help to minimize the amount of risk they take on.
• So much of being a trader is money and risk management which have another tool like
hedging in the arsenal is incredibly useful.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

1. A trader is short in the spot and long in the future. If the basis is positive and
decrease, it leads to:
(a) Loss. (b)Gain.
(c) Wealth remaining the same. (d)None of the above.

2. Foreign Exchange future markets are………. And the foreign Exchange

forward markets are…….
(a) Informal; formal. (b) Formal; formal.
(c) Informal; informal. (d) organized; unorganized.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
3. Which of the following is NOT an example of a forward contract?
(a) An agreement to buy a car in the future at a specified.
(b) An agreement to buy an airplane ticket at a future date for a certain price.
(c) An agreement to buy a refrigerator today at the posted price.
4. Which of the following derivatives product can be classified as American and
European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.
5. Which of the following is / are true?
(a) Volume traded in a particular session is equal to the number of contracts bought and
number of contracts sold.
(b) The settlement price is the price of the last trade on that day.
(c) Open interest denotes the number of contracts outstanding.
.
(d) All of the above
Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

6. What is hedge?

7. Define SWAP.

8. Tell interest rates SWAP.

9. Define hedging strategy.

10. Discuss risk tolerance.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices
Current price of the underlying assets:
• Factor influence the option price is the current price of the asset/ stock.
• Option price will change as the stock price changes.
• Example for a call option: option price increase as the stock price increase and vice
versa. Opposite in case of put option.
Strike price of the option:
• Strike or exercise price of the option is fixed for the life of the option.
• In case of call option, the lower the strike price , the higher will be the option price and
vice versa, reverse in case of put option

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices

Time to expiration of the option:

• Option is a wasting asset, option has a fixed maturity, there is no value of option.
• Longer the time to expiration of the option, higher will be the option price.
• Time to maturity decreases, lesser time remains an option for stock price to rise or fall , and the probability
(possibility) of a favorable price movement decreases

Expected stock price volatility:

• Fluctuations in stock prices in future is a major factor to influence the option price.

• Greater the expected volatility of the price of the stock.

• Investor would be (wishing to be) willing to pay more for the option, more premium an option writer would
demand for it due to increase risk in the option contract.
.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices
Expected stock price volatility:

• Fluctuations in stock prices in future is a major factor to influence the option price.

• Greater the expected volatility of the price of the stock.

• Investor would be (wishing to be) willing to pay more for the option, more premium an
option writer would demand for it due to increase risk in the option contract.
Anticipated cash payment on the stock:
• Anticipated (estimated, expected) cash payment on the stock tend (be likely) to decrease
the price of a call option, because cash payment make it more attractive to hold stock than
to hold the option.
. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices
Log normal assumption:
• Stock option pricing model must make certain assumptions about how stock prices
behave over time.
• Example:
• If the price of SBI share is Rs. 300 today in the market, what is the probability
distribution for the price in one week or one month or one year?
• Basic assumption in B-S option pricing model is termed as a random walks.
Proportional changes in the stock price in the short period are normally distributed.
• Implies that the stock price at any future time has a log normal distribution.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices

Parameters of log normal distribution

• Two basic parameters, for the behavior of a stock price under log normal distribution are as under – (1) The expected
return from the stock (2) The volatility of the stock price

Expected return from the stock:

• Annual average return earned by investor in a short period of time.
• Expected return desired by the investor from stock depends on riskiness of the stock.
• Higher the risk, higher will be the expected return. Depends on the market rate of interest in the economy.
• Expected return can be considered with the period of time, and in time limit. Usually two estimates:

(1) expected return in a very short period

(2) expected return over longer period

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Determinants of option prices
Volatility of the stock:
• Volatility (instability) of stock , S.D is a measure of uncertainty about the return
provided by the stock.
• Volatilities are expressed in percentages per annum.
• Estimating the volatility on a particular stock is to analyze the stock past price
movement over period of time.
• Stock price is usually observed at fixed intervals of time ( e.g. day, week, month,
etc)

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
1. A trader is along in the spot and short in the futures. If the basis is positive and
increase, the trader stands to:
(a) Gain. (b) Lose.
(c) Cannot be determined. (d)None of the above.

2. At the point of entering into the future contracts:

(a) Both the buyer and seller pay initial margin to the exchange.
(b) The buyer alone pays initial margin to the exchange.
(c) The seller alone pays initial margin to the exchange.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
3. Standardized of the futures contracts in case of commodities is/are in terms of:
(a) Quality. (b)Expiration month.
(c) Quantity. (d) All of the above.

4. Which of the following derivatives product can be classified as American and

European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.
5. The valuation model for futures differs from that of an option as:
(a) Futures the right without an obligation.
(b) Option is the right without an obligation.
(c) Futures are traded in organized markets.
(d) Futures can be enforced the maturity
. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Black – Scholes option pricing model

• It is developed in 1973 by two academicians, Fisher Black and Myron Scholes and
designed to price European option.
• Modified the model to make it applicable to American option.
• Popularity of the model is that it allows for an analytical solution. It has formula into
which values are input and from which an option price is obtained.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Black – Scholes option pricing model
• Not explaining derivation of the model, rather state the B-S model of pricing
formula.
Assumptions under B-S Model:
• There are no transaction costs or taxes.
• There are no dividend on the stock.
• Stock trading is continuous
• Call option can be exercised only on expiration.
• Investor can borrow or lend at the same risk free rate of interest.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Binomial option pricing model
• Model was advocated by Cox, Ross, Rubinstein in 1979 and takes the form of binomial
model.
• Model is like B-S model does not permit an analytical solution rather solves the
problem numerically.
Assumptions under Binomial Pricing Model:
• There are no market frictions, i.e. no transaction cost, no bid, no margin requirement, no
restriction on short sales, no taxes.

.. Subject:Subject: : AMBA
Financial FM0413
Derivatives & (FD
Risk&Management
RM) by: Dr. Mohd Iftikhar
(AMBAFM0413) By: MohdSlide no. Baig
Iftikhar 73
 Binomial option pricing model

• There is no risk of default by the other party in the contract.

• Markets are competitive. It mean market participants act as price takers and not the
makers.
• There are no arbitrage opportunities. Prices have adjusted in such a way so that there are
no arbitrage opportunities in the market.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
1. A trader is along in the spot and short in the futures. If the basis is positive and
increase, the trader stands to:
(a) Gain. (b) Lose.
(c) Cannot be determined. (d)None of the above.

2. At the point of entering into the future contracts:

(a) Both the buyer and seller pay initial margin to the exchange.
(b) The buyer alone pays initial margin to the exchange.
(c) The seller alone pays initial margin to the exchange.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
3. Standardized of the futures contracts in case of commodities is/are in terms of:
(a) Quality. (b)Expiration month.
(c) Quantity. (d) All of the above.

4. Which of the following derivatives product can be classified as American and

European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.
5. In futures, the terms and conditions are standardized with reference to:
(a) Rate and date only. (b) Quantity only.
(c) Place of delivery only. (d) All of the above.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

6. Define standardization in future contract.

7. Tell about arbitrage.

8. What is transaction cost?

9. Define strike price.

10. Who introduce Black – Scholes option pricing model ?

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• Identifying risk is an important first step. It is not sufficient though.

• Taking steps to deal with risk is an essential step. Knowing about and thinking about risk is not the
same as doing something about risk.

• Risk will occur. Some good, some bad. Some minor, some catastrophic.

• Avoidance

• If a risk presents an unwanted negative consequence, you may be able to completely avoid those
consequences. By stepping away from the business activities involved or designing out the causes of
the risk you can successfully avoid the occurrence of the undesired events.

• One way to avoid risk is to exit the business, cancel the project, close the factory, etc. This has other
consequences, yet it is an option.
. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• Another approach is to establish policies and procedures that assist the organization to
foresee and avoid high-risk situations. By not starting a project that includes a high
unwanted risk successfully avoids that risk.

• Acceptance

• Every product produced has a finite chance of failing in the hands of your customer.
When that risk is at an acceptable level, sufficiently low estimated field failure rate,
then ship the product. Accept the risk.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• When the decision to accept the risk is in part based on an estimate or prediction, there is
the risk the information incorrectly forecasts the future. Therefore, for high consequence
related field failures, closely monitoring field performance or establishing early warning
systems may be prudent.
• Reduction or control:
• FMEA(Failure Modes and Effects Analysis), hazard analysis, FTA(Fault tree analysis), and other risk
prioritization tools focus help you and your organization identify and prioritize risks. Reducing the
probability of occurrence or the severity of the consequences of an unwanted risk (say product failure) is a
natural outcome of risk prioritization tools.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• If it is not possible to reduce the occurrence or severity, then implementing controls is an
option. Controls that either detect causes of unwanted events prior to the consequence
occurring during use of the product, or the detection of root causes of unwanted failures
that the team can then avoid.

• If it is not possible to reduce the occurrence or severity, then implementing controls is an

option. Controls that either detect causes of unwanted events prior to the consequence
occurring during use of the product, or the detection of root causes of unwanted failures
that the team can then avoid

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• Controls may focus on management or decision-making processes. Improving the ability to find design
flaws or to improve the accuracy of field failure rate prediction both improve the ability to make the
appropriate decisions concerning risk.
• Transference:
• This strategy is to shift the burden of the risk consequence to another party. This may include giving up
some control, yet when something goes wrong your organization is not responsible.

• This approach may not work to protect your brand image if the product is associated with your organization.
Even if the power supply vendor pays for all damages due to failures in their unit, the customer only knows
that your product has failed and caused damage. Use this approach with caution

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Effective Risk Mitigation Strategies
• A conventional means to transfer risk to another organization is with the purchase of
insurance. This may require a careful analysis of the presenting risks and probabilities, yet
is a viable option in some situations.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
1. In futures trading, the initial margin is to be deposited with the broker by:
(a) Seller of the contract. (b) Buyer of the contract.
(c) Bothe the parties. (d) None of the above.

2. In an Index Futures Contract, if the tick size 0.1 of an index point and the index
multiple is at Rs. 50, a tick is valued at:
(a) Rs. 5.00 (b) Rs. 12.50
(c) Rs. 0.75 (d) Rs. 0.50

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

3. Standardized of the futures contracts in case of commodities is/are in terms of:

(a) Quality. (b)Expiration month.
(c) Quantity. (d) All of the above.
4. In futures trading, the initial margin is to be deposited with the broker by:
(a) Seller of the contract. (b) Buyer of the contract.
(c) Bothe the parties. (d) None of the above.
5. In futures, the terms and conditions are standardized with reference to:
(a) Rate and date only. (b) Quantity only.
(c) Place of delivery only. (d) All of the above.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Index Options Market in Indian Stock Market
• Futures contract based on an index i.e. the underlying asset is the index, are known
as Index Futures Contracts.

• Example, futures contract on NIFTY Index and BSE-30 Index. These contracts derive
their value from the value of the underlying index.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Index Options Market in Indian Stock Market

• Similarly, the options contracts, which are based on some index, are known as Index
options contract. However, unlike Index Futures, the buyer of Index Option Contracts
has only the right but not the obligation to buy / sell the underlying index on expiry.

• Index Option Contracts are generally European Style options i.e. they can be
exercised / assigned only on the expiry date.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Index Options Market in Indian Stock Market

• An index, in turn derives its value from the prices of securities that constitute the index
and is created to represent the sentiments of the market as a whole or of a particular
sector of the economy.

• Indices that represent the whole market are broad based indices and those that represent
a particular sector are sectoral indices. In the beginning futures and options were
permitted only on S&P Nifty and BSE Sensex.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Index Options Market in Indian Stock Market
• Sectoral indices were also permitted for derivatives trading subject to fulfilling the
eligibility criteria.

• Derivative contracts may be permitted on an index if 80% of the index constituents are
individually eligible for derivatives trading.

• However, no single ineligible stock in the index shall have a weightage of more than
5% in the index.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Index Options Market in Indian Stock Market

• The index is required to fulfill the eligibility criteria even after derivatives trading on
the index has begun.

• If the index does not fulfill the criteria for 3 consecutive months, then derivative
contracts on such index would be discontinued.

• By its very nature, index cannot be delivered on maturity of the Index futures or
Index option contracts therefore, these contracts are essentially cash settled on
Expiry.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

1. Hedgers and speculators strike a balance due to their needs because:

(a) Hedger has to take risk while speculators has to give up risk.
(b) Bothe hedger and speculators have to take risk.
(c) Both hedger and speculators have to give up risk.
(d) Hedger avoid risk while the speculators takes risk.
2. Foreign Exchange future markets are………. And the foreign Exchange forward
markets are…….
(a) Informal; formal. (b) Formal; formal.
(c) Informal; informal. (d) organized; unorganized.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz

3. Which of the following is NOT an example of a forward contract?

(a) An agreement to buy a car in the future at a specified.
(b) An agreement to buy an airplane ticket at a future date for a certain price.
(c) An agreement to buy a refrigerator today at the posted price.

4. Which of the following derivatives product can be classified as American and

European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Daily Quiz
5. In futures contract, tick size refers to :
(a) The daily price limit.
(b) Minimum price fluctuation that is allowed between two contracts.
(c) Change in the price from the previous closing price.
(d) None of the above.

6. In future contracts, the contract maturity period is defined by:

(a) The Exchange. (b) The RBL.
(c) The parties to the contract. (d) The Government.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Weekly Assignment

• Q.1 Explain why Black-Scholes model is inappropriate if the stock can gap.
• Q.2 List and explain the basic features of hedging.
• Q.3 What are the five primary sources for the basis to be uncertain, also known as risk in
futures market?
• Q.4 List and explain the role of market players in option trading.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 MCQ s
1. Hedgers and speculators strike a balance due to their needs because:
(a) Hedger has to take risk while speculators has to give up risk.
(b) Bothe hedger and speculators have to take risk.
(c) Both hedger and speculators have to give up risk.
(d) Hedger avoid risk while the speculators takes risk.
2. Foreign Exchange future markets are………. And the foreign Exchange forward
markets are…….
(a) Informal; formal. (b) Formal; formal.
(c) Informal; informal. (d) organized; unorganized.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 MCQ s
3. Which of the following is NOT an example of a forward contract?
(a) An agreement to buy a car in the future at a specified.
(b) An agreement to buy an airplane ticket at a future date for a certain price.
(c) An agreement to buy a refrigerator today at the posted price.

4. Which of the following derivatives product can be classified as American and

European?
(a) Forwards. (b) Futures.
(c) Option. (d) Swaps.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 5. In futures contract, tick size refers to :
(a) The daily price limit.
(b) Minimum price fluctuation that is allowed between two contracts.
(c) Change in the price from the previous closing price.
(d) None of the above.

6. In future contracts, the contract maturity period is defined by:

(a) The Exchange. (b) The RBL.
(c) The parties to the contract. (d) The Government.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 7. A trader bought Jan. NIFTY Mini contract at the NSE. How will the trader
close out this position in the market?
(a) Sell Jan. NIFTY Mini contracts.
(b) Sell Feb. NIFTY contracts.
(c) Buy March SENSEX contracts.
(d) Buy March NIFTY contracts.
8. A trader is short in the spot and long in the future. If the basis is positive and
decrease, it leads to:
(a) Loss.
(b) Gain.
(c) Wealth remaining the same.
(d) None of the above.
. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 9. Which of the following is / are true?
(a) Volume traded in a particular session is equal to the number of contracts bought and
number of contracts sold.
(b) The settlement price is the price of the last trade on that day.
(c) Open interest denotes the number of contracts outstanding.
(d) All of the above.
10. At the point of entering into the future contracts:
(a) Both the buyer and seller pay initial margin to the exchange.
(b) The buyer alone pays initial margin to the exchange.
(c) The seller alone pays initial margin to the exchange.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 11. A trader is along in the spot and short in the futures. If the basis is positive and
increase, the trader stands to:
(a) Gain.
(b) Lose.
(c) Cannot be determined.
(d) None of the above.
12. Standardized of the futures contracts in case of commodities is/are in terms of:
(a) Quality.
(b) Expiration month.
(c) Quantity.
(d) All of the above.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Expected Questions for University Exam
1. Clearly discuss the functions of futures market.
2. Clearly differentiate between forward contracts and futures Contracts.
3. Clearly explain the concept of call options and put options in detail.
4. Clearly discuss the Black-Schole model.
5. What is an interest rate swap? Also discuss the features of an interest rate swap.
6. Clearly explain the concept of currently swap? What are the various types currency
swap, clearly discuss?
7. Clearly differentiate between options and futures.

8. Clearly discuss the concept of cost –of –carry approach in relation to futures pricing.

9. What do you mean by swaps? Also discuss the features of swaps.

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig
 Thank You

. Subject: Financial Derivatives & Risk Management (AMBAFM0413) By: Mohd Iftikhar Baig