Chapter 5

DERIVATIVE ANALYSIS
AND VALUATION

UNIT – I
FUTURE CONTRACT

LEARNING OUTCOMES

After going through the chapter student shall be able to understand

❑ Factors Forward/ Future Contract
❑ Options (Call/Put)
❑ Commodity Derivatives

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 5.2 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT

QUOTATION OF FUTURE CONTRACT

Question No. 1A
The following quotes were observed by MR KARUNA on March 10, 2017 in the Economic Times:
(i) SBI MARCH 2017 FUT 1441
(ii) NIFTY APRIL 2017 FUT 4280.
Required:
(i) Explain what these quotes indicate?
(ii) If the initial Margin is 10% and Mr. Karuna wants to buy 100 of each how much margin, he has to deposit
individually?
[CMA-MTP-June-2014-2M] [CMA-June-2012-4M]

MARGIN MONEY AND MARGIN CALL

Question No. 2A [SM-2023] [MTP-M22-8M] [D21-8M] [RTP-Nov-19] [RTP-May-15] [RTP-May-13]
Sensex futures are traded at a multiple of 50. Consider the following quotations of Sensex futures in the 10 trading
days during February, 2009:
Day High Low Closing
4-2-09 3306.4 3290.00 3296.50
5-2-09 3298.00 3262.50 3294.40
6-2-09 3256.20 3227.00 3230.40
7-2-09 3233.00 3201.50 3212.30
10-2-09 3281.50 3256.00 3267.50
11-2-09 3283.50 3260.00 3263.80
12-2-09 3315.00 3286.30 3292.00
14-2-09 3315.00 3257.10 3309.30
17-2-09 3278.00 3249.50 3257.80
18-2-09 3118.00 3091.40 3102.60
Abhishek bought one Sensex futures contract on February, 04. The average daily absolute change in the value of
contract is 10,000 and standard deviation of these changes is  2,000. The maintenance margin is 75% of initial
margin.
(i) You are required to determine the daily balances in the margin account and payment on margin calls, if any.
Additional Requirement as in Dec-2021-Exam:
(ii) Compute the Gain or Loss of Abhishek if contract squared off on 18-02-2009.
(iii) What would be the Gain or Loss if Abhishek, had taken the short position?

Question No. 2B
On August 2, Mr. Tandon buys 5 contract of Reliance futures at 840. Each contract covers 50 shares. Initial margin
was set at 2400 per contract while maintenance margin was fixed at 2000 per contract. Daily settlement prices
are as follows:
Aug 2 818
Aug 3 866
Aug. 4 830
Aug. 5 846
Mr. Tandon meet all margin calls. Whenever he is allowed to withdraw money from the margin account, he
withdraws half the maximum amount allowed.
Compute for each day

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 DERIVATIVES ANALYSIS AND VALUATION 5.3
(i) Margin call.
(ii) Profit & Loss on the contracts
(iii) The balance in the Account at the end of the day.
[CMA-June-2006-7M]
Ans: (i) 5500, Nil, 3,000, Nil (ii) (-) 5,500, 12,000, (-) 9000, 4000 (iii) 12000, 18000, 12000, 14000

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 2.1 [MTP-M23-8M] [Jan-2021-8M]
The settlement price of june Nifty Futures contract on a particular day was 4585. The minimum trading lot on Nifty
futures is 100. The initial margin is 8% and the maintenance margin is 6%. The index closed at the following levels
on the next five days:
Day Settlement Price ()
1 4690
2 4760
3 4550
4 4480
5 4570
Required:
(i) Calculate the Mark to Market Cash Flows and daily closing balances in the account of
(A) an investor who has gone long at 4585
(B) An investor who has gone short at 4585
(ii) Calculate the net profit/Loss on each of the contracts.
[CMA-June-2007-9M]
Ans: (i) (A) Cash Flows: + 10,500, + 7,000, -21000, -7000, +9000 Closing Bal: 47180, 54180, 33180, 36680
(i) (B) Cash Flows: -10,500, 7000, +21000, +7000, -9000; Closing Bal: 36680, 29680, 50680, 57680, 48680
(ii) Long: Loss of 1500, short: profit of 1500

Question No. 2.2

On Monday morning, an investor takes a short position (i.e., agrees to sell) in a pound sterling futures contract that
matures on Wednesday afternoon in the next week. The agreed upon price is $1.5200 for £62500 (one contract). At
the close of trading on Monday, the futures price rises to $1.5250. At Tuesday close, the price falls to %1.5150. At
Wednesday close, the price rises to $1.5225. On Thursday close, the price further rises to $1.5260. Show the daily
settlement process. The initial margin is $2000 while the maintenance margin is $1500.
[CMA-SM22]

PROFIT AND LOSS FROM FUTURE CONTRACT

Question No. 3A [CS-June-2009-4M]
An investor buys a NIFTY futures contract for 2,80,000 (lot size 200 futures). On the settlement date, the Nifty
closes at 1,378. Find out his profit or loss, if he pays 1,000 as brokerage. What would be the amount of profit or
loss, if he has sold the futures contract?
Ans: Loss if buy = 5,400; Gain if sale = 3,400

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 5.4 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 3B [RTP-Nov-2011]
Mr. V decides to sell short 10000 shares of ABC plc, when it was selling at yearly high of £5.60. His broker
requested him to deposit a margin requirement of 45% and commission of £1550 while Mr. V was short the share,
the ABC paid a dividend of £0.25 per share. At the end of one-year, Mr. V buys 10000 shares of ABC plc at £4.50
to close out position and was charged a commission of £1450.
You are required to calculate the return on investment of Mr. V.
Ans: ROI = 20.56%

Question No. 3C
Nifty Index is currently quoting at 1300. Each lot is 250. Mr. X purchases a March contract at 1300. He has been
asked to pay 10% initial margin. Calculate the amount of initial margin. To what level Nifty futures should rise to
get a percentage gain of 5%.
[CMA-MTP-June-2015-7M]
Ans: 32,500; 1306.50

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 3.1
Nifty Index is currently quoting at 1329.78. Each lot is 250. Z purchases a March contract at 1364. He has been
asked to pay 10% initial margin. What is the amount of initial margin? Nifty futures rise to 1370. What is the
percentage gain?
[CMA-June-2015-2M] [CMA-PTP-Dec-2014-2M]
Ans: Margin = 34100; % Gain = 4.4%

COMMODITY DERIVATIVE (DELIVERY OF UNDERLYING)

Question No. 4A [May-2023-8M] [RTP-Nov-2020]
A Rice Trader has planned to sell 22000 kg of Rice after 3 months from now. The spot price of the Rice is 60 per
kg and 3 months Future on the same is trading at 59 per kg. Size of the contract is 1000 kg. The price is expected
to fall as low as 56 per kg, 3 months hence.
Required:
(i) to interpret the position of trader in the Cash Market.
(ii) to advise the trader the trader should take in Future Market to mitigate its risk of reduced profit.
(iii) to demonstrate effective realized price for its sale if he decides to make use of future market and after 3 months,
spot price is ₹ 57 per kg and future contract price for closing the contract is ₹ 58 per kg.
[CMA-July-2023-8M] [CMA-RTP-Dec-2018] [CMA-Dec-2014-6M]
Ans: (i) Long Position in Cash or Spot Market.
(ii) by selling Rice Futures (iii) 58/kg.

Question No. 4AA [May-2019-New-8M] [RTP-May-2013]

A wheat trader has planned to sell 440000 kgs of wheat after 6 months from now. The spot price of wheat is  19
per kg and 6 months future on same is trading at  18.50 per kg (Contract Size= 2000 kg). The price is expected to
fall to as low as  17.00 per kg 6 month hence. What trader can do to mitigate its risk of reduced profit? If he
decides to make use of future market what would be effective realized price for its sale when after 6 months is spot
price is  17.50 per kg and future contract price for 6 months is 17.55.
[CMA-July-2023-8M] [CMA-RTP-Dec-2018] [CMA-Dec-2014-Old-6M]
Ans: Trader would go short on future at current future price of  18.50 per kg.
This will help the trader to realize sure  18.50 after 6 months

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 DERIVATIVES ANALYSIS AND VALUATION 5.5
Question No. 4B
Bharat Oil Corporation (BOC) imports crude oil for its requirements on a regular basis. Its requirements are
estimated at 100 tonnes per month. Of late, there has been a surge in the prices of oil. The current price (month of
June) of crude oil is 5,500 per barrel. The firm expects the price to rise in the coming months to 5,800 by August.
It wants to hedge against the rising prices for some of its requirements of the month of August.
Multi Commodity Exchange (MCX) in India offers futures contracts in crude oil. The Contract size is 100 barrels
and August contract is currently traded at 5,668 per barrel.
BOC would like to hedge half its exposure in futures and leave the other half to market conditions. While hedging,
the number of futures contracts dealt with should be rounded off to the next higher integer. Then, how many
contracts should it book?
Compare the hedged and exposed parts regarding the effective price per barrel and also compute the effective price
per barrel for the whole requirement of August,
If in August,
(i) The spot price is 5,570 and futures price is 5,788
(ii) The spot price is 5,417 and futures price is 5,455?
Ignore marking-to-market and initial margin on futures contracts.
Given that 1 tonne = 7.33 barrels.
[CMA-Dec-2021-9M] [CMA-Dec-2019-10M] [CMA-June-2018-6M]

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 4.1
A petrochemical plant needs to process 10,000 barrels of oil in 3 months time. To hedge against the rising price the
plant needs to go long on the futures contract of crude oil. The spot price of crude oil is 1,950 per barrel, while
futures contract expiring three months from now is selling for 2,200 per barrel. By going long on the futures the
petrochemical plant can lock-in the procurement at 2,200 per barrel. Assuming the size of one futures contract of
100 barrels, the firm buys 100 futures to cover its exposure of 10,000 barrels.
Find out the price that would be payable under two scenarios of rise in price to 2,400 or fall in price to 1,800
per barrel after three months.
[CMA-June-2015-4M] [CMA-PTP-June-2014-3M]
Ans: (i) 2200; (ii) 2200

Question No. 4.2

Today is 24th March. A refinery needs 1075 barrels of crude oil in the month of September. The current price of
crude oil is 3000 per barrel. September futures contract at Multi commodity exchange (MCX) is trading at 3200.
The firm expects the price to go up further and beyond 3200 in September. It has the option of buying the stock
now. Alternatively, it can hedge through futures contract. Lot size is 100 barrels.
a. If the cost of capital insurance and storage is 15% per annum, examine if it is beneficial for the firm to buy
now?
b. Instead, if the upper limit to buying price is 3200 what strategy can the firm adopt?
c. If the firm decides to hedge through future find out the effective price it would pay for crude oil if at the time
of lifting the hedge
i) The spot and futures price are 2900 and 2910 respectively,
ii) The spot and futures price are 3300 and 3315 respectively.
[CMA-DEC-2017-8M] [CMA-SM-2016] [CMA-MTP-June-2014-(2+2+4)=8M [CMA-RTP-DEC-2013] ]
Ans: (a) Effective cost = 3233.65 (Assumed Continuous Compounding);
(b) Buy Future to lock price around 3200; (c) (i) 3197; (ii) 3182

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 5.6 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT

CALCULATION OF FAIR FUTURE PRICE

Question No. 5A [RTP-June-2009]
A 3-month future contract on NIFTY is available at a time when Nifty is quoting 9000 points. Continuously
compounded risk-free rate is 10%. Continuously Compounded yield on the NIFTY Stock is 2% per annum. One
Future contract equals to 1000 Nifty. How much will you pay for NIFTY Futures? If Nifty Forward trades at 9125,
what action would follow?
Ans: Fair future price = 9181.80

Question No. 5B [SM-2023] [RTP-May-12]

On 31-7-2011, the value of stock index is 2,600. The risk-free rate of return is 9% p.a. The dividend yield on this
stock index is as follows:
Month Dividend Paid
January 2%
February 5%
March 2%
April 2%
May 5%
June 2%
July 2%
August 5%
September 2%
October 2%
November 5%
December 2%
Assuming that interest is continuously compounded daily, then what will be future price of contract deliverable on
31-12-2011. Given = e0.02417 = 1.02446.
Ans: Future Price = 2,663.60

Question No. 5C [RTP-Nov-2012]

Suppose that there is a future contract on a share presently trading at  1000. The life of future contract is 90 days
and during this time the company will pay dividends of  7.50 in 30 days,  8.50 in 60 days and  9.00 in 90 days.
Assuming that the compounded continuously Risk-free rate of interest (CCRRI) is 12% p.a. you are required to find
out:

(a) Fair value of the contract if no arbitrage opportunity exists.

(b) Value of cost to carry.
[Given 𝑒 −0.01= 0.9905, 𝑒 −0.02= 0.9802, 𝑒 −0.03 and 𝑒 0.03 = 1.03045]
Ans: (a) Fair Value = 1005.21; (b) 5.21

Question No. 5D [SM-2023]

The stock of Aptech Ltd (FV 10) quotes 920 today on NSE and the 3-month futures price quotes at 950. The
one month borrowing rate is given as 8% Per annum. and the expected annual dividend yield is 15% p.a. payable
before expiry.
You are required to calculate the price of 3-month APTECH FUTURES.
[CMA-SM22] [CMA-MTP-June-2014-2M] [CMA-PTP-Dec-2014-2M] [CMA-Dec-2008-3M]
Ans: 936.90

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 DERIVATIVES ANALYSIS AND VALUATION 5.7
Question No. 5E [MTP-May-2021-4M] [MTP-May-2021-5M] [Nov-2019-6M]
A future contract is available on R Ltd. that pays an annual dividend 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 marking to market. The
corporate treasury bill rate is 8%.
Required:
(i) Given the above information, what should the price of one future contract be?
(ii) If the company stock price decreases by 6%, what will be the price of one futures contract?
(iii) As a result of the company stock price decreases, will an investor that has a long position in one futures
contract of R Ltd. realizes a gain or loss? What will be the amount of his gain or loss? (Ignore margin and
taxation, if any)
Ans: (i) Ans: 1,31,000 (ii) Rs. 1,22,900 (iii) Rs. 8,100
Question No. 5F [RTP-Nov-2020]
Mr. SG sold five 4-Month Nifty Futures on 1st February 2020 for  9,00,000. At the time of closing of trading on
the last Thursday of May 2020 (expiry), Index turned out to be 2100. The contract multiplier is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1st February 2020.
(ii) Approximate Nifty Sensex on 1st February 2020 if the Price of Future Contract on same date was
theoretically correct. On the same day Risk Free Rate of Interest and Dividend Yield on Index was 9% and
6% p.a. respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.
Ans: (i) 1,80,000; (ii) 2376 (iii) Basis is negative hence Contango is 2400 – 2376=24 (iv)  1,12,500

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 5.1
The 3-month futures contract on NIFTY maturing in April 2009 is currently trading at 2610. The current value of
NIFTY is 2590. The one-year risk free rate is 8% and the year -end dividend yield on the market index is 4%. Find
the theoretical futures price and comment on arbitrage opportunity.
[CMA-SM22] [CMA-RTP-Dec-2014]
Ans: 2616.03
Question No. 5.2 [RTP-Nov-2014] [May-2012-5M]
On 31 – 8 – 2011, the value of stock index was 2,200. The risk-free rate of return has been 8% per annum. The
dividend yield on this Stock Index is as under:
January 3%
February 4%
March 3%
April 3%
May 4%
June 3%
July 3%
August 4%
September 3%
October 3%
November 4%
December 3%
Assuming that interest is continuously compounded daily, find out the future price of contract deliverable on 31 -
12 – 2011. Given: e0.01583 = 1.01593

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 5.8 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
[CMA-MTP-June-2015-5M]
Ans: Future Price = 2235.05

Question No. 5.3 [SM-2016]

Consider a 4 month future contract on 500 shares with each share priced at  75. Dividend @  2.50 per share is
expected to accrue to the shares in a period of 3 months. The CCRRI (Continuous compounded Require Rate of
Interest) is 10% p.a. find the value of the future contract.
Ans: 74.996

HEDGING WITH THE HELP OF INDEX FUTURE

Question No. 6A
Identify the hedging strategies that would be required using the index future under the following circumstances:
Stock Position Beta No. of shares Price () Hedge needed
SBI Long 1.30 1000 1900 Full
RIL Long 1.20 1000 800 Full
BHEL Short 1.10 1000 300 90%
TSL Short 0.80 1000 400 80%
Infosys Long 1.00 1000 1800 120%
[CMA-June-2013-5M]

Question No. 6B [SM-2023] [Nov-2004-6 Marks]

Which position on the index future gives a speculator, a complete hedge against the following transactions?
(i) The share of Right Limited is going to rise. He has a long position on the cash market of  50 lakhs on
the Right Limited. The beta of the Right Limited is 1.25.
(ii) The share of Wrong Limited is going to depreciate. He has a short position on the cash market of  25
lakhs on the Wrong Limited. The beta of the Wrong Limited is 0.90.
(iii) The share of Fair Limited is going to stagnant. He has a short position on the cash market of  20 lakhs
of the Fair Limited. The beta of the Fair Limited is 0.75.
[CMA-SM22] [CMA-MTP-June-2015-5M] [CMA Compendium]
Ans: (i) sell index for  62.50 lakh, (ii) buy index for  22.5 lakh, (iii) buy index for  15 lakhs.

Question No. 6C [SM-2023] [RTP-May-2022] [July-2021-8M] [Nov-2020-8M] [RTP-Nov-15] [MTP-Nov-

14] [RTP-Nov-2013] [Nov-2007-8M]
Following information is available for consideration:

BSE Index 25,000

Value of portfolio  50,50,000
Risk free interest rate 9% p.a.
Dividend yield on Index 6% p.a.
Beta of portfolio 1.5
We assume that a future contract on the BSE index with 4 months maturity is used to hedge the value of portfolio
over next 3 months. One future contract is for delivery of 50 times the index.
Based on the above information calculate:
(i) Price of future contract.
(ii) Gain on short futures position if index turns out to be 22,500 in 3 months.
Note: Daily compounding (exponential) formula is not required to be used.

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 DERIVATIVES ANALYSIS AND VALUATION 5.9
[CMA-MTP-D23-7M] [CMA-SM22/16] [CMA-MTP-Dec-2021] [CMA-RTP-Dec-2018] [CMA-June-2015-
4M] [CMA-PTP-June-2014-(3+6)=9M] [CMA-June-2009-7M] [CMA Compendium]
Ans: (i)  12,62,500 (ii)  8,08,125

Question No. 6D [Dec-2021-6M]

A future contract on BSE Index with 4 months maturity is used to hedge the value of the portfolio over the next 3
months. One future contract for delivery is 50 times of the index.
The following information is available:

Value of the portfolio  1,16,00,000

BSE Sensex on 1st January 2022 58580
(Anticipated on 1st September 2021)

BSE Sensex on 1st January 2022 56641.25

(Anticipated on 1st December 2021)

Dividend Yield of Index 6% p.a.

181 days’ treasury bills offers a rate of interest 9% p.a.
Beta of the portfolio 1.5
You are required to calculate:
(i) The present value of the Sensex as on 1st September 2021
(ii) Turned out value of the Sensex as on 1st December 2021
(iii) The number of contracts to hedge the portfolio.
Ans: (i) 58,000 (ii) 56,500 (iii) 6

Question No. 6E [SM-2023] [RTP-N22] [MTP-Nov-2020-8M] [Nov-2013-6 Marks]

Ram buys 10,000 shares of X Ltd. at a price of 22 per share whose beta value is 1.5 and sells 5000 shares of A
Ltd. at a price of 40 per share having a beta value of 2. He obtains a complete hedge by Nifty futures at 1000
each. He closes out his position at the closing price of the next day when the share of X ltd. dropped by 2% share
of A Ltd. appreciated by 3% and nifty futures dropped by 1.5%.
What is the overall profit/loss to Ram?
Ans:  11,450 loss

Question No. 6F [RTP-N23] [RTP-Nov-2021] [As MTP-Nov-2020-8M] [RTP-Nov-2014] [May-2012-5M]

A company is long on 10 MT of copper @  534 per kg (spot) and intends to remain so for the ensuing quarter.
The variance of change in its spot and future prices are 16% and 36% respectively, having correlation coefficient
of 0.75. The contract size of one contract is 1,000 kgs.
Required:
(i) Calculate the Optimal Hedge Ratio for perfect hedging in Future Market.
(ii) Advice the position to be taken in Future Market for perfect hedging.
(iii) Determine the number and the amount of the copper futures to achieve a perfect hedge.
Ans: (i) Hedge ratio = 0.5; (ii) take short position in Future Market; (iii) Amount of copper future =26,70,000

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 5.10 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 6G
A portfolio manager controls ₹50 Crores in equity stock. In anticipation of a stock market decline, the decision is
made to hedge the portfolio using the index futures contract with each contract of 250 units. The portfolio’s beta is
1.20, and the current value of the index futures contract selected is 238.50.
(i) Calculate the number of futures contracts that should be bought or sold.
(ii) Suppose that when the contracts are closed out, the portfolio has fallen in value to ₹42 Crores and that the
index has fallen to 215.00. Calculate the gain or loss on the combined positions (stock portfolio and futures
contracts).
(iii) Why does the net gain or loss not exactly equal zero?
[CMA-MTP-June-2020-8M]
Ans: (i) 10,063 (ii)Loss overall= 3 lakhs approx. (iii) The gain or loss does not set off exactly because:
(a). Round off error (we sell standard number of contracts)
(b). The movement of underlying and movement of index future are not exact.
(c). Beta is only an approximate measure of hedge.

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 6.1 [RTP-M23] [Jan-2021-4M] [May-2005]
Shyam buys 10,000 shares of X Ltd., @ 25 per share and obtains a complete hedge of shorting 400 Nifty at 1,100
each. He closes out his position at the closing price of the next day when the share of X Ltd., has fallen by 4% and
Nifty Future has dropped by 2.5%.
What is the overall profit or loss from this set of transaction?
Ans: Net gain 1,000

Question No. 6.2 [RTP-May-2015]

Mr. Careless was employed with ABC Portfolio Consultants. The work profile of Mr. Careless involves advising
the clients about taking position in Future Market to obtain hedge in the position they are holding. Mr. ZZZ, their
regular client purchased 100,000 shares of X Inc. at a price of $22 and sold 50,000 shares of A plc for $40 each
having beta 2. Mr. Careless advised Mr. ZZZ to take short position in Index Future trading at $1,000 each contract.
Though Mr. Careless noted the name of A plc along with its beta value during discussion with Mr. ZZZ but forgot
to record the beta value of X Inc.
On next day Mr. ZZZ closed out his position when:
• Share price of X Inc. dropped by 2%
• Share price of A plc appreciated by 3%
• Index Future dropped by 1.5%
Mr. ZZZ, informed Mr. Careless that he has made a loss of $114,500 due to the position taken. Since record of Mr.
Careless was incomplete he approached you to help him to find the number of contract of Future contract he advised
Mr. ZZZ to be short to obtain a complete hedge and beta value of X Inc.
You are required to find these values.
Ans: Number of future contract short is 700; Beta = 1.5

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 DERIVATIVES ANALYSIS AND VALUATION 5.11
Question No. 6.3 [RTP-May-2015]
Mr. X, is a Senior Portfolio Manager at ABC Asset Management Company. He expects to purchase a portfolio of
shares in 90 days. However he is worried about the expected price increase in shares in coming day and to hedge
against this potential price increase he decides to take a position on a 90-day forward contract on the Index. The
index is currently trading at 2290. Assuming that the continuously compounded dividend yield is 1.75% and risk
free rate of interest is 4.16%, you are required to determine:
(a) Calculate the justified forward price on this contract.
(b) Suppose after 28 days of the purchase of the contract the index value stands at 2450 then determine gain/ loss
on the above long position.
(c) If at expiration of 90 days the Index Value is 2470 then what will be gain on long position.
Note: Take 365 days in a year and value of e0.005942 = 1.005960, e0.001849 = 1.001851.
Ans: (a) Forward Price = 2303.65; (b) 156.4; (c) 166.35

Question No. 6.4 [RTP-CMA-Dec-2018]

An investment management company wants to hedge its portfolios of shares worth 15 crore using NSE-NIFTY
index futures. The contract size is 100. The index is currently quoted at 9120. The beta of the portfolio is 0.8. The
beta of the index may be taken as 1. How many contracts to be traded by the investor?
[CMA-SM22]
Ans: 132 contracts

Question No. 6.5 [Dec-2021-8M]

On 1st July 2021 Mr. P has made the following investment:
Company No. of Equity Share Beta Value Purchase Price per
Equity Share
ML Ltd 1,000 1.25  700
He wants to hold the investment till end of September 2021 with an expectation of huge dividends to be announced
in the AGM.
On the date of investment, September Nifty Futures are quoting at 175,000 and tradeable with lot size of 50 for
each contract.
You are the Investment advisor to Mr. P,
(i) Please advise Mr. P how to hedge his market exposure using the available data.
(ii) Calculate the profit or loss of Mr. P during the expiry of September 2021 futures in following situation:
(a) Nifty Future rise by 10%; (b) ML Ltd. falls by 5%
(iii) Is it possible stock as well as nifty to raise or fall at the same percentage? Please state the reason.
Ans: (i) take short position in the 1 lot of Nifty Futures (ii) (a) Nil (b) Nil
(iii) Generally not, because Beta may not be the same as of market

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 5.12 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 6.6
Bharat Investments Ltd is long on 25,000 shares of Trinayan Earth Moving Equipment Ltd (TEEL). Its shares are
currently quoted at 180 per share. Bharat fears fall in prices of TEEL. It therefore wants to hedge its risk under
the Futures Contract route. However, future rate is not available for TEEL. Therefore, Bharat is looking for cross
hedge and the following particulars are made available –
Related index NIFTY Infrastructure Iron and Steel Bank Index
Index Index
Beta of TEEL Related Index 0.8 1.1 1.3 1.0
Correlation of TEEL with 0.6 0.8 0.6 0.3
Related Index
No. of Units of TEEL 1000 500 1000 1250
underlying every Futures
Contract of Index
Bharat contemplating taking a cross hedge in either Iron and Steel Index, because it has the highest Beta value.
Consequently, requiring less no. of Futures Contract, or Bank Index as it has the perfect Beta Value.
Advice Bharat.
[CMA-SM22]

Question No. 6.7

Fill up the blanks in the following matrix-
Case Portfolio Existing Outlook Activity Desired No. of
Value Beta Beta Future
Contracts
M 6,00,00,000 1.20 Bullish ? 1.8 90
N 3,60,00,000 ? ? Buy Index Futures 2.3 45

O 2,00,00,000 1.60 ? ? 1.2 ?

P 6,40,00,000 1.10 Bullish ? ? 48
Q 2,50,00,000 1.40 Bearish ? 1 ?
R 5,00,00,000 ? Bearish Sell Index Futures 1.25 45
S&P index is quoted at 4000 and the lot size is 100.
[CMA-SM22]

INCREASING/DECREASING BETA WITH THE HELP OF INDEX FUTURE

Question No. 7A [RTP-June-2009]
The portfolio composition of Mr. X is given below:
Equity 8,00,000
Cash & Cash Equivalent 2,00,000
Beta of equity portfolio = 0.69
The current NSE index future value is 930 with multiple of 200. If Mr. X wants to achieve an overall portfolio
beta of 1.10, then how many numbers of futures contract he should go short?
[CMA-SM-2016]
Ans: 2.946 contract [i.e., 3 contract appx]

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 DERIVATIVES ANALYSIS AND VALUATION 5.13
Question No. 7B [SM-2023] [July-2021-8M] [RTP-May-2020] RTP-Nov-2017] [Nov-2013-5M]
Mr. X is having a portfolio of shares worth 170 lakhs at current price and cash 30 lakhs. The beta of share
portfolio is 1.6. After 3 months the price of shares dropped by 3.2%.
Determine:
(i) Current portfolio beta.
(ii) Portfolio beta after 3 months if Mr. X on current date goes for long position on 200 lakhs Nifty futures.
[CMA-PTP-June-2015-6M]
Ans: (i) Current Beta 1.36; (ii) Revised Beta 2.36.

Question No. 7C
[SM-2023] [MTP-M19-7M] [MTP-May-2015] [RTP-Nov-2014] [RTP-Nov-2013] [May-2011-5M]
A Mutual Fund is holding the following assets in  Crores:
Investments in diversified equity shares 90.00
Cash and Bank Balances 10.00
100.00
The Beta of Portfolio is 1.1. The index future is selling at 4300 level. The Fund manager apprehends that the index
will fall at the most by 10%. How many index futures he should short for perfect hedging so that the portfolio
beta is reduced to 1.00? One index future consists of 50 units.
Substantiate your answer assuming the fund manager’s apprehension will materialize.
Ans: Number of contracts to be sold = 4605 (Approx.)

Question No. 7D
A high net worth individual (Mr. Z) is holding the following portfolio in  Crores:

Investment in diversified equity shares 80.00

Cash and Bank Balances 20.00
Total 100.00
The Beta of the portfolio is 1.2. The index future is selling at 5500 level. Mr. Z wants to reduce the beta of the
portfolio, for he believes that the market would go down from the current level. How many index futures he should
buy/sell so that the beta is decreased to 0.80? One index future consists of 100 units.
[CMA-SM22] [CMA-MTP-June-2020-8M]
Ans: 727 contracts

Question No. 7E [SM-2023] [MTP-N23-8M] [RTP-M20] [MTP-M19-8M] [MTP-M15-8M] [M13-8M]

On January 1, 2013 an investor has a portfolio of 5 shares as given below:
Security Price No. of Shares Beta
A 349.30 5,000 1.15
B 480.50 7,000 0.40
C 593.52 8,000 0.90
D 734.70 10,000 0.95
E 824.85 2,000 0.85
The cost of capital to the investor is 10.5% per annum.
You are required to calculate:
(i) The beta of his portfolio.
(ii) The theoretical value of the NIFTY futures for February 2013.

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 5.14 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
(iii) The number of contracts of NIFTY the investor needs to sell to get a full hedge until February for his portfolio
if the current value of NIFTY is 5900 and NIFTY futures have a minimum trade lot requirement of 200 units.
Assume that the futures are trading at their fair value.
(iv) The number of future contracts the investor should trade if he desires to reduce the beta of his portfolios to 0.6.
No. of days in a year be treated as 365.
Given: Ln (1.105) = 0.0998; 𝑒 (0.015858) = 1.01598
Ans: (i) 0.849; (ii) 5,994.28; (iii) 13.36 (Either 13 or 14); (iv) 3.92 (i.e., 4)

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 7.1
A Portfolio manager owns 3 stocks:
Stock Shares Owned Stock Price Beta
1 1 Lakh 400 1.1
2 2 Lakh 300 1.2
3 3 Lakh 100 1.3
The spot Nifty Index is at 1350 and futures price is 1352 to use stock index futures to:
(a) decrease the portfolio beta to 0.8 and
(b) increase the portfolio beta to 1.5.
Assume the index factor is 100. Find out the number of contracts to be bought or sold of stock index futures.
[CMA-SM22] [CMA-RTP-Dec-2018] [CMA-June-2014-5M]
Ans: (a) sell 376.92 contract (b) buy 296.15 contract.

Question No. 7.2 [SM-2023] [Nov-2023-8M] [May-2019-5M] [Nov-2015-8M]

On April 1, 2015, an investor has a portfolio consisting of eight securities as shown below:
Security Market Price No. of Shares Value
A 29.40 400 0.59
B 318.70 800 1.32
C 660.20 150 0.87
D 5.20 300 0.35
E 281.90 400 1.16
F 275.40 750 1.24
G 514.60 300 1.05
H 170.50 900 0.76
The cost of capital for the investor is 20% p.a. continuously compounded. The investor fears a fall in the prices of
the shares in the near future. Accordingly, he approaches you for the advice to protect the interest of his portfolio.
You can make use of the following information:
(i) The current NIFTY value is 8500.
(ii) NIFTY futures can be traded in units of 25 only.
(iii) Futures for May are currently quoted at 8700 and Futures for June are being quoted at 8850.
You are required to calculate:
(i) the beta of his portfolio.
(ii) the theoretical value of the futures contract for contracts expiring in May and June.
Given (e0.03 =1.03045, e0.04 = 1.04081, e0.05 =1.05127)

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 DERIVATIVES ANALYSIS AND VALUATION 5.15
(iii) the number of NIFTY contracts that he would have to sell if he desires to hedge until June in each of the
following cases:
(A) His total portfolio; (B) 50% of his portfolio; (C) 120% of his portfolio
Ans: (i) 1.102; (ii) 8788, 8935.8; (iii) (a) 4.953 (or, 5); (b) 2.47 (or, 3) ; (c) 5.94 (or 6)

Question No. 7.3 [Nov-2023-8M] [Same As Q-7.2]

On August 1, 2023, an investor has a portfolio consisting of 5 securities as shown below:
Security Market Price No. of Shares Value
A 60.00 450 0.87
B 320.00 850 1.31
C 640.00 200 0.94
D 130.00 500 0.66
E 480.00 600 1.50
The cost of capital for the investor is 20% p.a. compounded. The current NIFTY value is 19,500. NIFTY futures
are available with expiry for 3 months (Oct-23) and 4 months (Nov-23) and are currently quoted at 19,700 and
19,900 respectively. Each NIFTY futures can be traded in units of 50 only.
You are required to calculate:
(i) The beta of his portfolio;
(ii) Theoretical value of Futures contract for contracts expiring in Oct. and Nov. (Given e0.05 = 1.05127, e0.06
= 1.06184, e0.07 = 1.07251)
(iii) The number of contracts of NIFTY the investor needs to sell to get a full hedge until November for his
portfolio.
(iv) The number of future contracts the investor should trade if he desires to reduce the beta of his portfolio
to 0.25

ARBITRAGE IN FUTURE
Question No. 8A [SM-2023] [Nov-2002-4M]
In International Monetary Market an international forward bid for December, 15 on pound sterling is $ 1.2816 at
the same time that the price of IMM sterling future for delivery on December, 15 is $ 1.2806. The contract size of
pound sterling is £ 62,500. How could the dealer use arbitrage in profit from this situation and how much profit is
earned?
[CMA Compendium]
Ans: $ 62.5

Question No. 8B [SM-2016] [MTP-N23-8M] [SM-2016] [Nov-2008-5M]

The price of Random stock of face value Rs. 10 on 31st December 2019 was Rs.200 and the futures price on the
same stock on the same date for March 2020 was Rs.220.
Other features of the contract and related information are as follows:
Time to expiration= 0.25 year or 3 months.
Annual dividend on the stock of 20% payable before 31st March 2020.
Borrowing rate is @ 15% per annum.
Based on the above information:
(i) Calculate the futures price for the Random stock on 31st December 2019.
(ii) Also explain whether any arbitrage opportunity exists.
[CMA-MTP-Dec-2021-8M] [As CMA-Dec-2019-8M] [CMA-SM-2016] CMA Compendium]
Ans: 205.60

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 5.16 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 8C
The following information pertaining to two securities is given:
Securities
A Ltd. B Ltd.
Spot Price () 4,550 360
Dividend Expected () 50 20
Dividend Receivable (in Months) 2 3
Recommended Action Sell Spot, Buy Future Buy Spot, Sell Future
Risk free interest rate may be taken as 9% p.a.
(i) Determine the 6 months' theoretical forward prices of securities of A Ltd. and B Ltd. For what values of futures
contract rates will the above recommended action be appropriate?
(ii) What would your answer to (i) above be if there is no dividend expected for A and B?
[CMA-MTP-J23-8M] [CMA-June-2017-8M] [CMA-SM-2016]
Ans: (i) A: 4,707.91; Less than 4707 B: 356.126; More than 356
(ii) A: 4759.4; Less than 4759 B: 376.57; More than 376

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 8.1 [SM-2023] [MTP-N22-4M] [RTP-Nov-2017] [June-2009-4M]
The share of X Ltd. is currently selling for  300. Risk free interest rate is 0.8% per month. A three months futures
contract is selling for  312. Develop an arbitrage strategy and show what your riskless profit will be 3 month hence
assuming that X Ltd. will not pay any dividend in the next three months.
Ans: Risk less profit =  4.74. [hint: interest rate is compounded monthly]

Question No. 8.2 [RTP-Nov-2009] [Use concept of cover interest arbitrage of Forex Chapter]
If the interest rate for the next 6 months for the US$ is 1.5%. The interest rate for the € is 2% (6 month rate). The
spot price of the € is US $ 1.665. The forward price is expected to be US$ 1.664. Please determine correct forward
price and recommend an arbitrage strategy.
Ans: Correct Forward Price = US $ 1.6568; Arbitrage gain = .44%. Amount = $ 0.0073

Question No. 8.3 [SM-2023] [MTP-N22-4M] [RTP-May-21] [RTP-May-2021] [MTP-May-2015-5M]

[MTP-Nov-2014-5M] [Nov-2009-6M] [May-2004-6M]
The following data relate to R Ltd.'s share price:
Current price per share  1,900
6 months future's price/share  2,050
Assuming it is possible to borrow money in the market for transactions in securities at 10% per annum,
(i) advise the justified theoretical price of a 6-months forward purchase; and
(ii) evaluate any arbitrage opportunity, if available.
[CMA-SM22/16] [CMA-MTP-J23-8M] [CMA-MTP-Dec-21-4M] [CMA-RTP-Dec-18] [CMA-MTP-June-15-7M] [CMA–
RTP-June-2014/15]
Ans: (i) Price 1,995 (ii) Sell future & buy a share by taking loan. Gain =  55

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 DERIVATIVES ANALYSIS AND VALUATION 5.17
Question No. 8.4
Super Polycarbons Ltd. has the following information about LDPE and HDPE granules (raw material used for
Manufacturing Plastic films, Polyfilms and Plastic Sheets) –
Stock Item LDPE Granules HDPE Granules
Current Market Price i.e., spot price [S0] 75 per Kg 85 per Kg
Carrying Cost 4% p.a. 100 per Quintal per quarter
[continuous compounding] (Payable after 2 months)
3-Month’s Futures Contract Rate (500 Kgs) 38,500 44,600
Risk free interest rate is at 12% p.a. Advise Super Polycarbons on the course of action to be taken?
[CMA-SM22]
Ans: (i) 39,030 (Buy Future. Sell Spot) (ii) 44,299.15 (Buy Spot. Sell Future)

Question No. 8.5 [Nov-2019-8M]

The NSE-50 Index futures are traded with rupee value being ₹ 100 per index point. On 15th September, the index
closed at 1195 and December futures (last trading day December 15) were trading at 1225. The historical dividend
yield on the index has been 3% per annum and the borrowing rate was 9.5% per annum.
(i) Determine whether on September 15, the December futures were underpriced or overpriced?
(ii) What arbitrage transaction is possible to gain out this mispricing?
(iii) Calculate the gains and losses if the index on 15th December closes at (a) 1260; (b) 1175
Assume 365 days in a year for your calculations.
Ans:

Question No. 9 series

[No question in this series]

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 5.18 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT

UNIT II

OPTION
(DERIVATIVE ANALYSIS AND VALUATION)

Learning Outcomes

After going through the chapter student shall be able to understand

❑ What is Options (Call/Put)
❑ Calculation of Loss/Gain from option
❑ Valuation of Option
❑ Strategies of Option

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 DERIVATIVES ANALYSIS AND VALUATION 5.19
OPTION QUOTATION
Question No. 10A
The ITC stock is selling at 4,000. Mr. X has a negative view about the stock. He decides to go through the option
route to take advantage of the situation. He buys an option from Mr. A which will entitle him to sell 100 shares on
or before 30th December at 3,500 per share for which he has to pay 200 per share today.
You are required to identify:
(i) Type of option; (ii) Exercise price; (iii) Expiry date; (iv) Option premium; (v) Buyer of the option;
(vi) Writer of the option; (vii) Underlying asset; (viii) Current market price
[CMA-Dec-2010-8M]

Question No. 10B

The following quotes were observed by Mr. Saxena on September 10, 2010 in the Economic Times.
Contracts Open High Low Close Open Traded No of Underlying
Interest Quantity Contracts
CE-2145-Sept. 2010 210.15 222.5 210.15 225.39 45100 1600 8 NIFTY
PE-2310-Sept. 2010 21.45 28.6 20.51 21.89 2911700 1369000 6845 NIFTY
Explain, what these quotes indicate.
[CMA-Dec-2010-5M]

LOSS/GAIN FROM OPTION IF HOLD TILL EXPIRY

Question No. 11A [SM-2023] [MTP-Nov-2019-7M] [Nov-2018-8M] [June-2009-10M]
The equity share of VCC Ltd. is quoted at  210. A 3-month call option is available at a premium of 6 per share
and a 3-month put option is available at a premium of  5 per share. Ascertain the net payoffs to the option holder
of a call option and a holder of put option.
(i) the strike price in both cases is  220; and
(ii) the share price on the exercise day is  200, 210, 220, 230, 240.
Also indicate the price range at which the call and the put options may be gainfully exercised.
[CMA-MTP-J23-8M] [CMA-RTP-D18-4M] [CMA-J17-8M] [PTP-J15-10M] [RTP-Dec-13/14-10M] [Dec-2009-10M]
Ans: (i) Net payoff for call option is  -6, -6, -6, 4, 14 for exercise price  200, 210, 220, 230, 240 respectively,
(ii) Net payoff for put option is  15, 5, -5, -5, -5 for exercise price  200, 210, 220, 230, 240 respectively.

Question No. 11B

Dravid Investments Ltd deals in equity derivatives. Their Current Portfolio comprises of the following
instruments:
Infosys 5600 Call Expiry June 2004, 2,000 Units bought at  197 each (cost)
Infosys  5700 Call Expiry June 2004, 3,600 Units bought at 131 each (cost)
Infosys  5400 Put Expiry June 2004, 4,000 Units bought at 181 each (cost)
What will the profit or loss to Dravid Investments Ltd in the following situations?
(i) Infosys closes on the expiry day at  6,041
(ii) Infosys closes on the expiry day at  5,812
(iii) Infosys closes on the expiry day at  5,085
[CMA-June-2013-7M] [CMA-June-2004-8M]
Ans: (i)  5,20,000; (ii) (-) 7,62,400 (iii) (-) 3,29,600

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 5.20 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 11.1
Calculate Profits and losses from the following transactions:
(i) Mr. X writes a call option to purchase (it must be sale) share at an exercise price of 60 for a premium of 12 per
share. The share price rises to 62 by the time the option expires.
(ii) Mr. Y buys a put option at an exercise price of 80 for a premium of 8.50 per share. The share price falls
to 60 by the time the option expires.
(iii) Mr Z writes a put option at an exercise price of 80 for a premium of 11 per share. The price of the share
rises to 96 by the time the option expires.
(iv) Mr. XY writes a put option with an exercise price of 70 for a premium of 8 per share. The price falls to
48 by the time the option expires.
[CMA-Dec-2004-6M]
Ans: (i)  10; (ii) 11.50 (iii) 11; (iv) (-) 14.00

Question No. 11.2

The shares of Bengaluru Corporation Limited are selling at 105 each. Chandra Shekhar wants to chip in with
buying a three months call option at a premium of 10 per option. The exercise price is 110. Five possible prices
per share on the expiration date ranging from 100 to 140, with intervals of 10 are taken into consideration by
him. What is Chandra Shekhar’s pay-off as call option holder on expiration?
[CMA-June-2006-3M]
Ans: 0, 0, 10, 20, 30

Question No. 11.3

Consider a trader who buys an European call option on British Pound with a strike price of $ 1.6500 and a premium
of 2 cents ($0.020). The current spot rate is $ 1.6329. Calculate his gain/loss when the option expires if the spot
rates are as follows. 1.6300, 1.6270, 1.6400, 1.6500, 1.6549, 1.6320, 1.6500, 1.6900, 1.7000.
[CMA-SM22] [CMA-RTP-Dec-2014]

Question No. 11.4 [RTP-Nov-2012] [CA-Final-May-2010]

A call and put exist on the same stock each of which is exercisable at  60. They now trade for:

Market price of Stock or stock index 55

Market price of call 9
Market price of put 1
Calculate the expiration date cash flow, investment value, and net profit from:
(i) Buy 1.0 call; (ii) Write 1.0 call; (iii) Buy 1.0 put; (iv) Write 1.0 put
for expiration date stock prices of  50,  55,  60,  65,  70.

Question No. 11.5

CMC Ltd. shares are presently quoted at 100. 3-Month’s call option carries a premium of 15 for a strike price of
120, and 3-Month’s put option carries a premium of 20 for a strike price of 120.
If the spot price on the expiry date is in the range of 90 to 160, with intervals of 5, prepare Net Pay-Off Graph
for both Call Option and Put Option, from both the buyer’s perspective and the option writer’s perspective.
[CMA-SM22] [CMA-MTP-J23-8M]

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 DERIVATIVES ANALYSIS AND VALUATION 5.21
Question No. 11.6
Fill up the blanks in the following “Break Even Price” table –
Case Option Party Exercise Price () Premium () Market Price ()
1 Call Buyer ? 20 160
2 ? Seller 2000 300 1700
3 ? Buyer 50 10 40
4 ? Seller 80 10 90
5 Put Buyer ? 50 250
6 ? Seller 320 50 370
7 Call Buyer 680 100 ?
8 Call Seller ? 80 580
9 Put Buyer 1200 ? 1020
10 Put Seller ? 330 1870
[CMA-SM22]

Question No. 11.7

Fill up the blanks in the following table ---
Case Option Exercise Premium Holder’s Holder’s Writer’s Writer’s Break
Price () Maximum Maximum Maximum Maximum Even
() Loss () Gain () Loss () Gain () Price ()
1 Call 520 75 ? ? ? ? ?
2 Put 700 140 ? ? ? ? ?
3 Put ? ? 4 16 16 4 ?
4 Call ? ? 200 ? Unlimited ? 1725
5 ? 350 70 70 280 280 70 280
6 ? 80 ? 12 Unlimited ? 12 ?
7 ? ? ? ? ? Unlimited 18 138
8 ? ? ? ? ? 592 148 592
9 Call 240 40 40 Unlimited Unlimited 40 280
10 Put 900 ? 180 ? ? ? ?
[CMA-SM22]

LOSS/GAIN FROM OPTION/FUTURE IF EXIT BEFORE EXPIRY

Question No. 12A
An investor purchased. Reliance November Future (600 shares Tick size) at  542 and write a  580 November
call option at a premium of  6 (600 shares Tick size). As on November 20, spot price rises and so the future price
rises to  575 and call premium rises to  12. Find out profit/loss of the investor, if he/she settles the transaction
on that date and at stated prices. Brokerage is 0.05% for the transaction value of futures and strike price net of call
premium for option.
[CMA-Dec-2004-8M]
Ans: Overall Gain = 15,522.5 [Hint: Profit from Future= 19464.90]

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 5.22 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 12.1
An investor purchased Reliance November Futures (600 shares Tick Size) at  1,150 and write a  1,190 November
Call option at a premium of 10 (600 shares Tick Size). As on November 25, spot price rises and so the futures
Price and the call Premium also rise. Futures Price rises to  1,180 and call premium rises to 16. Brokerage is
0.045% for the transaction value of futures and strike price net of call premium for option.
Find out the Profit/loss of the investor, if he/she settles the transaction on that date and at stated prices.
(Assuming no transaction taxes and service taxes exist.)
[CMA-Dec-2006-7M]
Ans: Profit of the investor = 13135.52

OPTION STRATEGIES
Question No. 13A [SM-2023] [RTP-May-2022] [MTP-II-May-2022-8M] [Nov-2020-8M] [May-2018-8M]
[Nov-2011-8M] [RTP-Nov-2009]
Mr. P established the following spread on the Coastal Corporation’s stock:
(i) Purchased one 3-month call option with a premium of 6.5 and an Exercise price of 110.
(ii) Purchased one 3-month put option with a premium of 10 and an Exercise price of 90.
Coastal Corporation’s stock is currently selling at 100. Determine profit or loss, if the price of Coastal
Corporation’s stock:
(i) Remains at  100 after 3 months.
(ii) Falls at  70 after 3 months.
(iii) Rises to  138 after 3 months.
Assume the size of option is 1,000 shares of Coastal Corporation.
[CMA-MTP-June-2014-(3+4+4)=11M] [CMA-RTP-Dec-13] [CMA-June-2013-7M] [ICAN-J15-5M]
Ans: (i) Net loss = 16,500; (ii) net Gain = 3,500, (iii) Net Gain = 11,500

Question No. 13B [June-2009-8M]

On 19th April following are the spot rates
Spot EUR/USD 1.20000 USD/INR 44.8000
Following are the quotes of European Options:
Currency pair Call/Put Strike Price Premium Expiry date
EUR/USD Call 1.2000 $ 0.035 July 19
EUR/USD Put 1.2000 $ 0.04 July 19
USD/INR Call 44.8000  0.12 Sep. 19
USD/INR Put 44.8000  0.04 Sep. 19
(i) A trader sells an at-the-money spot straddle expiring at three months (July 19). Calculate gain or loss if three
months later the spot rate is EUR/USD 1.2900.
(ii) Which strategy gives a profit to the dealer if five months later (Sep. 19) expected spot rate is USD/INR
45.00. Also calculate profit for a transaction USD 1.5 million.
[CMA-SM22] [CMA-RTP-June-2014/2015]
Ans: (i) Net loss = $ 0.015 per Euro (ii) Buying strategy of call option give profit to dealer; Net gain = 120,000

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 DERIVATIVES ANALYSIS AND VALUATION 5.23
Question No. 13C [MTP-M23-6M] [MTP-II-Nov-2021-6M] [RTP-Nov-2018]
Ram holding shares of Reliance Industries Ltd. Which is currently selling at ₹1000. He is expecting that this price
will further fall due to lower-than-expected level of profits to be announced after one month. As on following option
contract are available in Reliance Share.
Strike Price () Option Premium ()
1030 Call 40
1010 Call 35
1000 Call 30
990 Put 35
970 Put 20
950 Put 8
930 Put 5
Ram is interested in selling his stock holding as he cannot afford to lose more than 5% of its value.
Recommend a hedging strategy with option and show how his position will be protected.

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 13.1 [RTP-May-2019] [MTP-Nov-2014-6M] [May-2006-7M]
The market received rumour about ABC corporation’s tie-up with a multinational company. This has induced
the market price to move up. If the rumour is false, the ABC corporation stock price will probably fall
dramatically. To protect from this an investor has bought the call and put options.
He purchased one 3 months call with a striking price of 42 for 2 premium, and paid Re.1 per share premium for
a 3 months put with a striking price of 40.
(i) Determine the Investor’s position if the tie up offer bids the price of ABC Corporation’s stock up to 43
in 3 months.
(ii) Determine the Investor’s ending position, if the tie up program fails and the price of the stocks falls to
36 in 3 months.
[CMA-SM22] [CMA-RTP-J14/15] [CMA-D12-7M] [CMA-J07-8M] [ICAN-D22-5M] [ICAN-J11-5M]
Ans: (i) Net loss = 200; (ii) Gain = 100

Question No. 13.2

An investor wrote a naked call option. The premium was  2.50 per share and the market price and exercise price
of the share are 37 and  41 respectively. The contract being for 100 shares, calculate the amount of margin
under First Method, which is required to be deposited with the clearing house.
[CMA-June-2015-8 Marks]
Margin = (Option premium × 100) + {100 × 0.20 (market value of the share)} – {100 × (Exercise price – market price)}
= (2.50 × 100) + {100 × (0.20 × 37)} – 100 × (41 – 37) =  590

Question No. 13.3

Name the most appropriate combined trading strategy on the stock of PQ Ltd. in the following independent cases.
(You may present column I and II in you answer book)
S. No. Strategy Action Expiry date Strike Price
Buy Sell
I II III IV V VI
(i) One Call 30th June 215
One Put 30th June 215

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 5.24 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
(ii) Two Calls 20th June 220
One put 20th June 220
(iii) One Call 20th June 230
Two Puts 20th June 230
(iv) One Call 20th June 215
One Put 20th June 215
[CMA-June-2019-4M]
Question No. 13.4 [SM-2023]
A purchased a 3 month call option for 100 shares in XYZ Ltd. at a premium of  30 per share, with an exercise
price of  550. He also purchased a 3 month put option for 100 shares of the same company at a premium of  5
per share with an exercise price of  450. The market price of the share on the date of Mr. A’s purchase of options,
is  500.
Calculate the profit or loss that Mr. A would make assuming that the market price falls to  350 at the end of 3
months.
Ans: 6500

Question No. 13.7 [Nov-2023-8M]

A Japanese company imports hi-tech printer cartridges from US worth $ 1million. The chief financial officer of the
company wishes to know the best strategy for protection against uncertainty, for the payment that has to be made
at the end of 3 months. Financial team of the company has collected the following options for evaluation:
Table-1: Exchange rates quoted in FOREX Market:
¥/$ Quotations Bid Price Offer/Ask Price
Spot rates 146.03 146.63
3M-Forward Rates 144.03 145.00
6M-Forward Rates 146.35 146.70
Table-2: Options Market rates for European options with 3 months expiry:
Premium (%) for Call &
Type of Option Strike Price (X) (¥/$)
Put Options
Call & Put 145.20 1.6766 % (Call) &1:7414% (Put)

Call & Put 146.00 1.3505 % (Call) & 2.1006 % (Put)

The expected spot price at expiry is ¥ / $ : 144.90/145.05

Suggest the best strategy for CFO of the Japanese Company to protect against uncertainty, with respect to the
following alternatives:
(i) Forward Hedge
(ii) Buy 3 months call, X=145.20
(iii) Sell 3 months put, X=145.20
(iv) Buy Call & Sell put both having X = 146.00

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 DERIVATIVES ANALYSIS AND VALUATION 5.25
OPTION VALUATION (GENERAL METHOD)
Question No. 14A
[SM-2023] [MTP-M22-8M] [May-2022-8M] [Nov-2018-8M] [MTP-May-2014/2015] [Nov-2012-8M]
You had purchased a 3 month call option on the Equity shares of Satya Ltd for a premium of 30 each, the current
market price of the share is 560 and the exercise price is 590. You expect the price range between 540 to 640.
The expected share price of Satya Ltd and related probability is given below:
Expected Price () 540 560 580 600 620 640
Probability 0.10 0.15 0.05 0.35 0.20 0.15
Compute the followings:
(i) Expected share price at the end of 3 months,
(ii) Value of call option at the end of 3 months, if the exercise price prevails,
(iii) In case the option is held to its maturity, what will be the expected value of the call option?
(iv) Find out the price of the shares quoted at the stock exchange to get the value of the call option as computed
in (iii) above.
[CMA-MTP-Dec-2018]
Ans: (i)597; (ii) Nil; (iii) 17 (iv) 607
Modified information in CMA-June-2019:
(ii) value of call option at the end of 3 months, if the expected price prevails.

Question No. 14B

By using the following data calculate theoretical value of 6 months call option.
Strike price = 100
Current price of one share = 110
Rate of interest = 10% p.a.
Dividend receivable after 4 month = 5
Ans: 9.92

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 14.1
A Call Option at a strike price of 280 is selling at a premium of 23. At what share price on maturity will it break
even for the buyer of the option?
Will the writer of the option also break-even at the same price?
[CMA-June-2014-2M]

Question No. 14.2 [SM-2023]

ABC Ltd common stock has a present market price per share of  28. A 6-month call option has been written on
the stock with an exercise price of  30. Presently the option has a market value of  3. At the end of 6 months,
you estimate the market price of the stock to be  24 per share with a probability of 0.1,  28 with a probability of
0.2,  32 with a probability of 0.4,  37 with a probability of 0.2, and  43 with a probability of 0.1
a. What is the expected value of share price 6 months hence? What is the expiration value of the option if that
expected value of share price should prevail?
b. What is the expected value of option price at expiration, assuming that the option is held to this time? Why
does it differ from the option value determined in part a?
[ICAN-Dec-2008-10M]
Ans: (a) Expected share price = 32.5, expiration value of option =  2.5;
(b) Expected Value of option =  3.5; It differ from part (a) as the negative value of option are ignored.

// CA NAGENDRA SAH // WWW.NAGENDRASAH.COM

 5.26 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 14.3
Ram has Rs.300,000 to invest in the capital market. He considers stock of Shivam cement limited currently traded
at Rs. 200. Industry analysts opine that Shivam will either remain at Rs. 200 or go upto Rs. 250 in 6 months’ time,
considering the performance of the industry. Ram views this as an opportunity and has decided to invest Rs.
3,00,000 to buy shares of Shivam and earn a maximum of upto 25% which is more than the risk-free rate. His friend,
Hari, also has Rs.3,00,000 to invest. However, he considers Ram's proposition to be bit risky. Having some
knowledge, Hari intends to buy calls and invest at risk free rate of 12%. 6 months option carries an exercise price
of Rs. 220.
What should be the price of the call, for Hari's proposition to yield the same result 6 months later (i.e, a minimum
net worth of Rs. 3,00,000)? How many calls should Hari buy?
Who would be better off at the end of 6 months, if the actual spot price is Rs. 180, Rs. 250 and Rs. 300? (e0.06 =
1.0618).
[ICAN-July-2023-10M]

OPTION VALUATION (PUT CALL PARITY METHOD)

Question No. 15A [RTP-Nov-2009]
The following information is available for a call option:
Time to expiration (months) 3
Risk free rate 8% (Compounded continuously)
Exercise price €60
Stock price €70
Call price €14
What is the value of a put option?
[CMA-SM22] [CMA-PTP-June-2015-6M] [CMA-PTP-Dec-2014-4M] [CMA-June-2012-8M]
Ans: Put value = € 2.812
Question No. 15B
A put and a call option each have an expiration date 6 months hence and an exercise price 9.
The interest rate for the 6-month period is 3 percent.
(a) If the put has a market price of 2 and share is worth 10 per share, what is the value of the call?
(b) If the put has a market price of 2 and the call 4. what is the value of the share per share?
(c) If the call has a market value of 5 and market price of the share is 12 per share what is the value of the put?
[CMA-SM22]
Ans: (a) 3.14 (b) 10.86 (c) 1.86

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 15.1
The common share of a company is selling at 90. A 21-week call is selling at 8. The call’s exercise price is
100. The risk-free rate is 10% p.a. What should be the price of a 21-week put of 100.
[CMA-PTP-Dec-2014-3M]
Ans: Value of put option =  14.12
Question No. 15.2
In September 30, 2013, a six-month Put on VINTEX LTD.'s stock with an exercise price of 75 sold for 6.82.
The stock price was 70.00. The risk-free rate was 6% per annum. How much would you be willing to pay for a
CALL on Vintex Ltd.'s stock with same maturity and exercise price?
[Given. PVIF (6%, 1⁄2 year) = 0.9709] and PVIF (6%, 1 year) = 0.9434]
[CMA-PTP-Dec-2014-2M]
Ans: Price of Six month call = 4.00

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 DERIVATIVES ANALYSIS AND VALUATION 5.27
Question No. 15.3
A six month Call option on Nagarjuna Fertilizer with a strike price of 43 sells for 8. A put option on the same
stock and same strike price sells for 2. Option on this stock is available with a strike price of 40 and an expiration
date in six months. If the risk-free rate equals 10% at what price shares of Nagaijuna Fertilizer should trade to
prevent arbitrage?
[CMA-RTP-Dec-2014]
Ans: 46.95
Question No. 15.4
Aptex Ltd. has both European call and put options traded on NSE. Both options have an expiration date 6 months
and exercise price of  30. The call and put are currently selling for  4 respectively. If the risk free rate of interest
is 6% p.e., what would be the stock price of Aptex Ltd.? [Given PVIF (6%, 0.5 yrs) = 0.9709].
[CMA-PTP-Dec-2014-2M]
Ans: Price = 29.127
Question No. 15.5
With the data as given below, find the price of the call option:
P = US$0.039/£,
X = US$1.74/£
ST = US$1.7252/£
Risk free rate of return = 8 per cent p.a.
[CMA-SM22]
Ans: call premium is US$0.059/£.

OPTION VALUATION (BINOMIAL MODEL)

Question No. 16A [SM-2023] [MTP-N22-4M] [MTP-Nov-2018-6M] [RTP-May-2013] [May-2011-5M]
The current market price of an equity share of penchant Ltd is 420. Within a period of 3 months, the maximum
and minimum price of it is expected to be 500 and  400 respectively. If the risk-free rate of interest be 8% p.a.
what should be the value of a 3 months CALL option under the risk neutral method at the strike rate of 450?
Given 𝑒 0.02 = 1.0202
[CMA-SM22] [CMA-June-2018-6M] [CMA Compendium]
Ans: Value of 3-month call option = 13.968

Question No. 16B [Nov-2017-5M]

A call Option on gold with exercise price of 26000 per ten gram and three months to expire is being traded at a
premium of 1010 per ten gram. It is expected that in three month time the spot price might change to 27,300 or
24,700 per ten gram. At present this option is at-the-money and the rate of interest with simple compounding is
12% per annum. Is the current premium for the option justified? Evaluate the option and comments.
Ans: Fair Prem 1010, Yes Justified

Question No. 16C [SM-2023] [MTP-Nov-2018-4M] [RTP-Nov-2017] [May-2012-8M]

Sumana wanted to buy share of EIL which has a range of  411 to 592 a month later. The present price per share
is  421. Her broker informs her that the price of this share can sore up to  522 within a month or so, so that she
should buy a one month CALL of EIL. In order to be prudent in buying the call, the share price should be more
than or at least  522 the assurance of which could not be given by her broker.
Though she understands the uncertainty of the market, she wants to know the probability of attaining the share price
 592 so that buying of a one month CALL of EIL at the execution price of  522 is justified. Advice her. Take
the risk free interest to be 3.60% and e0.036 = 1.037.
Ans: The probability in rise of Price = .1413

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 5.28 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 16D
[SM-2023] [RTP-N22] [MTP-N22-8M] [MTP-M21-8M] [Nov-2019-8M] [SFM-Nov-2015-5M]
AB Ltd.'s equity shares are presently selling at a price of 500 each. An investor is interested in purchasing AB
Ltd.'s shares. The investor expects that there is a 70% chance that the price will go up to 650 or a 30% chance that
it will go down to 450, three months from now. There is a call option on the shares of the firm that can be exercised
only at the end of three months at an exercise price of 550.
Calculate the following:
(i) If the investor wants a perfect hedge, what combination of the share and option should he select?
(ii) Explain how the investor will be able to maintain identical position regardless of the share price.
(iii) If the risk-free rate of return is 5% for the three months period, what is the value of the option at the beginning
of the period?
(iv) What is the expected return on the option?
[CMA-Dec-2007-8M] [ICAN-D21-7M]
Ans: (i) 1 share for 2 Call options (ii) 225 (iii) 35.71 (iv) 96.02%.
Question No. 16E
Shares of M Lt d. are currently trading at Rs. 190. At the end of three months, the stock price is expected to be 125
or 225 with respective probabilities 1/3 and 2/3. The 3-months’ European call option on M Ltd. is available with
an exercise price of Rs.175. The risk-free rate of interest is 6% per annum continuously compounded.
(i) Find out the value of a 3-month European Call under the Binomial Model (Delta Method).
(ii) Calculate the value of the put option under Put -Call Parity.
(iii) If an investor wants to buy 100 shares, how many call options should be transacted in for a complete
hedge? Present workings to prove that the risk is covered.
(iv) What is the expected value of the option and also of the stock price at the end of three months?
[CMA-July-2023-8M] [CMA-Dec-2021] [ICAN-Dec-05-10M]

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 16.1
Quickset company’s equity shares are currently selling at a price of 400 each. An investor is interested in
purchasing Quickset’s shares. The investor expects that there is a 70% chance that the price will go up to 550 or
a 30% chance that it will go down to 350, three months from now. There is a call option on the shares of Quickset
that can be exercised only at the end of three months at an exercise price of 450
If the investor wants a perfect hedge, what combination of the share and option should be select?
Explain how the investor will be able to maintain identical position regardless of the share price
If the risk-free rate of return is 5% for the 3 month period, what is the value of option at the beginning of the period?
What is the expected return on the option?
[CMA-Dec-2005-11M]
Ans: (i) 1 share for every 2 calls option (iii) 33.33, (iv) 110%

Question No. 16.2

A stock is selling at 500. If the risk-free rate of interest is 10% p.a. continuously compounded, then calculate the
minimum and maximum value of the following option contract.
a. A European call option with strike price of 450 maturing in 1 month, 2 month and 3 month.
b. A European put option with strike price of 450 maturing in 1 month, 2 month and 3 month.
[CMA-SM22]
Ans: (a) 53.77; 8.26; 0 (b) 0; 0; 366.42

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 DERIVATIVES ANALYSIS AND VALUATION 5.29
Question No. 16.3 [Nov-2023-8M]
Following is the information available pertaining to shares of Omni Ltd.

Current Market Price 420.00

Strike Price 450.00
Maximum Price () expected in next 3 months’ time 525.00
Minimum Price () expected in next 3 months’ time 378.00
Continuous Compounded Rate of Interest (p.a.) (%) 8.00%
ert 1.0202

From the above:

(i) Calculate the 3 months call option by using Binomial Method and Risk Neutral Method.
Are the calculated values under the both the models are same?
(ii) State also clearly the basis of Valuation of options under these models.

OPTION VALUATION (TWO PERIOD BINOMIAL MODEL)

Question No. 17A [SM-2023] [RTP-Nov-2009]
Following is a two-period tree for a share of stock in CAB Ltd.:
Now S1 One Period
36.30
33.00
30 29.70
27.00
24.30
Using the Binomial model, calculate the current fair value of a regular call option on CAB Stock with the following
characteristics: X =  28, Risk Free Rate = 5 percent (per sub period). You should also indicate the composition of
the implied riskless hedge portfolio at the valuation date.
Ans: value of call = 4.81; Hedge portfolio: 0.85 share for every 1 Call option.

Question No. 17B [SM-2023] [RTP-Nov-2019] [June-2009-8M]

Consider a two-year American call option with a strike price of  50 on a stock the current price of which is also
 50. Assume that there are two time periods of one year and in each year the stock price can move up or down by
equal percentage of 20%. The risk-free interest rate is 6%.
Using binominal option model, calculate the probability of price moving up and down. Also draw a two-step
binomial tree showing prices and payoffs at each node.
Ans: Prob: moving Up = 0.65; moving down = 0.35; value of call an on today =  8.272

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 17.1 [RTP-Nov-2010]
X Ltd’s share is currently trading at  220. It is expected that in six months time it could double or halved
(equivalent to a σ = 98%). One year call option on X Ltd’s share has an exercise price of 165. Assuming risk free
rate of interest to be 20%, calculate,
(a) Value of option on X Ltd’s Share.
(b) Option delta for the second six month, in case stock price rises to 440 or falls to 110.
Ans: (a) 116.36; (b) Delta when price rise to 440 = 1.0; When price fall to 110 = 0.33

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 5.30 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 17.2 [RTP-M23] [Nov-2020-8M]
A two-year tree for a share of stock in ABC Ltd., is as follows:

Now 1 Year later 2 Years later

(N2) 116.64
108
100 102.60
(N1) 95
(N3) 90.25
Consider a two years American call option on the stock of ABC Ltd., with a strike price of 98. The current price
of the stock is 100. Risk free return is 5 per cent per annum with a continuous compounding and e0.05 = 1.05127.
Assume two time periods of one year each.
Using the Binomial Model, calculate:
(i) The probability of price moving up and down;
(ii) Expected pay offs at each node i.e., N1, N2 and N3 (round off upto 2 decimal points).

Question No. 17.3

Nirmal hydric Ltd. (NHL) is a newly listed Company. Its listing price today is 200. Though the industry offers
much potential, there are no proven past track records.
Analysts expect the price of NHL to either to rise by 40% every half (on the half yearly opening price), for the next
one year, weightage being 40% for every increase and 60% for every fall.
If an One-Year option carries a Exercise Price of 260, you required to compute the following under Binomial
Model –
(1) Risk Free Rate of Return,
(2) Value of Call (Future Value and Present Value),
(3) Value of Put (Future Value & Present Value)
[CMA-SM22]
Ans: 7.84% p.a.; PV of call option = 19.53; PV of put option = 59.93

OPTION VALUATION (BLACK SCHOLES MODEL)

Question No. 18A [SM-2023] [SM-Old] [MTP-N22-10M]
(i) The shares of TIC Ltd. are currently priced at  415 and call option exercisable in three months’ time has an
exercise rate of  400. Risk free interest rate is 5% p.a. and standard deviation (volatility) of share price is
22%. Based on the assumption that TIC Ltd. is not going to declare any dividend over the next three months,
is the option worth buying for  25?
(ii) Calculate value of aforesaid call option based on Black-Scholes valuation model if the current price is
considered as 380.
(iii) What would be the worth of put option if current price is considered  380.
(iv) If TIC Ltd. share price at present is taken as  408 and a dividend of 10 is expected to be paid in the two
months time, then, calculate value of the call option.
[Part (i) & (ii)-CMA-MTP-June-2020-8M] [Part-(i)-CMA-Dec-2014-10M] [Part (iv)-CMA-Dec-2006-11M]
Ans: Value of option = 29.5, hence worth buying; (i) Value of call = 10.52 (ii) Value of put = 25.553 (iii) Value of call = 18.98

// CA NAGENDRA SAH // WWW.NAGENDRASAH.COM

 DERIVATIVES ANALYSIS AND VALUATION 5.31
Question No. 18B [SM-2023] [RTP-May-2020] [RTP-May-2010] [Nov-2006-8M]
From the following data for certain stock, find the value of a call option:

Price of stock now = 80

Exercise price = 75
Standard deviation of continuously compounded annual return = 0.40
Maturity period = 6 months
Annual interest rate = 12%
Given
Number of S.D. from Mean, (z) Area of the left or right (one tail)
0.25 0.4013
0.30 0.3821
0.55 0.2912
0.60 0.2578 0.2743

e 0.12x0.5 = 1.06184
In 1.0667 = 0.0645
[CMA-SM22] [CMA-June-2007-8M] [CMA Compendium] [ICAN-Jun-2006-6M]
Ans: 13.949

Question No. 18C [RTP-May-2010]

You are trying to value a long term call option on the Standard and Poor’s 500, expiring in 2 months, with a strike
price of $900. The index is currently at $930, and the annualized standard deviation in stock prices is 20% per
annum. The average dividend yield on the index is 0.3% per month, and is expected to remain unchanged over the
next month. The Treasury bond rate is 8%.
a. Estimate the value of the long-term call option.
b. Estimate the value of a put option, with the same parameters.
Ans: (a) call = $50.65; (b) Put = $14.32;

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 18.1
The share of EXECPRO Ltd. are currently priced at 408 and call option exercisable in three month’s time has a
exercise rate of 400. Risk free interest rate is 5% p.a. and standard deviation (volatility) of share price is 22%. The
company is going to declare a dividend of 10 and it is expected to be paid in two months time.
Required :
(i) Determine the value of a three-month CALL Option on the share of Execpro Ltd. based on Black Scholes Model.
(ii) What would be the worth of PUT OPTION if the current price is considered to be 390?
Note: Extracted from the tables:
1. Ln (0.99521) = -0.00489, Ln 1.004798
2. Value of e-x : e-0.01 = 0.99005, e-0.0125 = 0.987578, e-0.008333 = 0.9917
3. Cumulative standardization normal probability distribution: NCX.
When X≥0 : N (0.125) = 0.5498, N (0.015) = 0.5060
When X≤0 : N (-0.125) = 0.4502, N (-0.015) = 0.4940
[CMA-TP-Dec-2013-10M] [CMA-June-2012- 8M] [ICAN-Dec-2011-9M] [ICAN-June-2008-10M]
Ans: Call = 18.98; Put = 24.04

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 5.32 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 18.2 [SM-Old]
We have been given the following information about XYZ company’s shares and call options:
Current share price =  165
Option exercise price =  150
Risk free interest rate = 6%
Time to option expiry = 2 years
Volatility of share price (Standard deviation) = 15%
Calculate value of the option.
Ans: Value of option =  34.78

Question No. 18.3 [RTP-Nov-2009/Nov-2011] [Nov-2008-12M]

Following information is available for X Company’s shares and Call option:
Current share price 185
Option exercise price 170
Risk free interest rate 7%
Time of the expiry of option 3 years
Standard deviation 0.18
Calculate the value of option using Black-Scholes formula.
Ans: Value of option =  51.767

Question No. 18.4 [RTP-Nov-2009]

From the following data compute value of call option using the Black-Scholes Option Pricing Model (OPM).
Stock Price =  27.00.
Strike Price =  25.00
Time to expiration = 6 Months.
Risk-Free Rate = 6.0%.
Stock Return Variance = 0.11.
[ICAN-J18-5M]
Ans: Value of call option =  3.97

Question No. 18.5

Compute a call option price by applying the black-Scholes option pricing model on the following values:
Strike price = 45
Time remaining to expiration = 183 days
Current stock price = 47
Expected price volatility = standard deviation of the stock’s return = 0.25
Risk free rate = 10%
Given: N(0.6172) = 0.7315 and N(0.4404) = 0.6702.
[CMA-June-2013-5M] [CMA Compendium]

Question No. 18.6

Calculate the price of a three –month European put option on a non-dividend - paying stock with a strike price of
50 when the current stock price is 50, the risk –free interest rate is 10% per annum, and the volatility is 30% per
annum.
What difference does it make to your calculation if a dividend of 1.50 is expected in two months?
Ans: 2.37; 2.48
[CMA-MTP-D23-7M] [CMA-SM22]

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 DERIVATIVES ANALYSIS AND VALUATION 5.33
Question No. 18.7
Consider a European call option on a stock when there are ex-dividend dates in two months and five months. The
dividend on each ex-dividend date is expected at be 0.50. The current share price is 40, the exercise price is
40, the stock price volatility is 30% per annum, the risk-free rate of interest is 9% per annum, and the time to
maturity is six months. Find out the European call price.
Ans:  3.67
[CMA-SM22]

ARBITRAGE IN OPTION
Question No. 19A [RTP-May-11]
The following table provides the prices of options on equity shares of X ltd. and Y Ltd. The risk free interest is 9%
(compounded continuously). You as a financial planner are required to spot any mispricing in the quotations of
option premium and stock prices? Suppose, if you find any such mispricing then how you can take advantage of
this pricing position.
Share Time to exercise Exercise price Share price Call price Put price
X Ltd. 6 months 100 160 56 4
Y Ltd. 3 months 80 100 26 2
Ans: (i) Advantage using 6 month call and put = 12.97; (ii) Advantage using 3 month call and put = 2.29

Question No. 19B

Given the following data:
Strike price = 90
Current price of one share =  100
Risk free rate of interest = 10% p.a. (not continuously compounding)
(fair)
(i) Calculate theoretical current price of a European call option (can be exercised on expiration date only) expiring after one
year
(ii) If price of the call option is  15 then how can an arbitrageur make profit.
[CMA-SM-2016] [ICAN-D22-7M]
Ans: (i) current value of call =  18.18; (ii) Arbitrageur can make profit if he purchase call option.

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 19.1
The following quotes are available for 3 months options in respect of a share currently traded at 31.
Strike price 30.00
Call option 3.00
Put option 2.00
An investor devises a strategy of buying a call and selling the share and a put option.
(i) What is his profit/loss profile if it is given that the rate of interest is 10% per annum?
(ii) What would the position if the strategy adopted is selling a call option and buying the share and a put
option? [Given PVIF (10%, 0.25Years) = 0.9756]
[CMA-June-2018-8M] [CMA-June-2009-(4+3)=7M]
Ans: (i) Profit per share = 0.73 (ii) Loss per share = (-) 0.73

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 5.34 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 19.2
The following information is given

Current Stock price 190

Strike price 210
Price of 6 months European Put Option 10
Risk Free interest rate 5%

Calculate the theoretical minimum price of the put option at the end of 6 months.
Show the arbitrage process step by step and find out the gain if
(ii) the price on the expiration day is 200
(iii) the price on the expiration day is 220
[CMA-SM22] [CMA-MTP-June-2021-10M] [CMA-Dec-2017-8M]

Question No. 19.3

Shoaib is furnished with the following information about securities of two Companies- Manju Ltd. and Sanju Ltd.
1. Manju Ltd: Call option is traded at 85 for an exercise price of 700. Presently stock of Manju Ltd is
traded for 650. Put option is available for 110.
2. Sanju Ltd: Put option is traded at 40 at an exercise price of 200. Presently stock of Sanju are traded at
180. Call options are available for 20.
If Shoaib has sufficient money and also holds stock in both these companies, wants to make only ascertained profit
and no loss, advise him on the course of action and resultant gain/loss.
Risk Free Interest rate may be assumed at 10% and expiry date for option is 3 Months away.
[CMA-SM22]
Ans: (1). Theoretical Value of Put Option= 117.73; Net Gain = 8 (2). Theoretical Value of Call Option= 25.00; Net Gain =5

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 DERIVATIVES ANALYSIS AND VALUATION 5.35

UNIT III
CURRENCY OPTION &
CURRENCY FUTURE
(DERIVATIVE ANALYSIS AND VALUATION)

Learning Outcomes

After going through the chapter student shall be able to understand

❑ What is Currency Options and Currency Future
❑ Use of Currency option and Currency future to hedge currency risk

CURRENCY FUTURE
Question No. 20A [SM-2023] [M23-6M] [MTP-M22-6M] [RTP-M21] [MTP-M19-7M] [M19-5M] [RTP-
M19] [N17-8M] [N16-8M] [May-2015-6M] [RTP-M14] [MTP-N14-6M] [Nov-2006-10M]
XYZ Ltd. is an export-oriented business house based in Mumbai. The Company invoices in customers’ currency.
Its receipt of US $ 1,00,000 is due on September 1, 2005.Market information as at June 1, 2005.
Exchange Rates Currency Futures
US $ / INR US $ / INR Contract size 4,72,000
Spot 0.02140 June 0.02126
1 Month Forward 0.02136 September 0.02118
3 Months Forward 0.02127
Initial Margin Interest Rates in India
June 10,000 7.50%
September 15,000 8.00%
On September 1, 2005 the spot rate US $Re. is 0.02133 and currency future rate is 0.02134. Comment, which of
the following methods would be most advantageous for XYZ Ltd?
(a) Using forward contract
(b) Using currency futures
(c) Not hedging currency risks.
It may be assumed that variation in margin would be settled on the maturity of the futures contract.
[CMA Compendium] [RTP-May-2014]
Ans: (a) Rcpt =  47,01,457; (b) Rcpt =  47,20,639; (c) Rcpt =  46,88,233.

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 5.36 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 20B [SM-2023] [RTP-May-2020] [RTP-Nov-2015] [Nov-2011-8 Marks]
Nitrogen Ltd, a UK company is in the process of negotiating an order amounting to €4 million with a large German
retailer on 6 months’ credit. If successful, this will be the first time that Nitrogen Ltd has exported goods into the
highly competitive German market. The following three alternatives are being considered for managing the
transaction risk before the order finalized.
(i) Invoice the German firm in Sterling using the current exchange rate to calculate the invoice amount.
(ii) Alternative of invoicing the German firm in € and using a forward foreign exchange contract to hedge the
transaction risk.
(iii) Invoice the German first in € and use sufficient 6 months sterling future contracts (to the nearly whole
number) to hedge the transaction risk.
Following date is available:
Spot Rate €1.1750 - €1.1770/£
6 months forward premium 0.60-0.55 Euro Cents
6 months’ future contract is currently trading at €1.1760/£
6 months’ future contract size is £ 62,500
Spot rate and 6 months’ future rate €1.1785/£
Required:
(a) Calculate to the nearest £ the receipt for Nitrogen Ltd, under each of the three proposals.
(b) In your opinion, which alternative would you consider to be the most appropriate and the reason therefore.
[ICAN-June-2019-10M] [ICAN-June-2014-8M]
Ans: (i) 33,98470; (ii) 34,14425; (iii) 34,01,304.62

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 20.1
For imports from UK, Philadelphia Ltd. of USA owes £ 6,50,000 to London Ltd., payable on May, 2004. It is now
12 February, 2004. The spot rate on 12 February is 1.4850$/£ 1.
The following future contracts (contract size £ 62,500) are available on the Philadelphia exchange:
Expiry Current futures rate
March 1.4900 $ / £ 1
June 1.4960 $ / £ 1
(i) Illustrate how Philadelphia Ltd. can use future contracts to reduce the transaction risk of, on 20 May the spot
rate is 1.5030 $ / £ 1 and June futures are trading at 1.5120 $ / £
(ii) Calculate the “hedge efficiency”.
[CMA-MTP-June-2015-10M] [CMA-June-2004-16 Marks]
Ans: (i) Loss $ 11,700, but buying future can reduce it by 11000; (ii) Hedge efficiency = 94.02% [assuming 11 contracts]

Question No. 20.2 [SM-2023] [RTP-May-11]

ABC Technologic is expecting to receive a sum of US$ 4,00,000 after 3 months. The company decided to go for
future contract to hedge against the risk. The standard size of future contract available in the market is $1000. As
on date spot and futures $ contract are quoting at 44.00 & 45.00 respectively.
Suppose after 3 months the company closes out its position futures are quoting at 44.50 and spot rate is also
quoting at 44.50. You are required to calculate effective realization for the company while selling the receivable.
Also calculate how company has been benefitted by using the future option.
Ans: Effective realization = 45 per $; benefit using future = 2,00,000
[Hint: Effective realization means the rate at which payment should be realized]

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 DERIVATIVES ANALYSIS AND VALUATION 5.37
Question No. 20.3 [RTP-May-2021] [RTP-May-2021] [RTP-Nov-2011]
Zaz plc, a UK Company is in the process of negotiating an order amounting €2.8 million with a large German
retailer on 6 month’s credit. If successful, this will be first time for Zaz has exported goods into the highly
competitive German Market. The Zaz is considering following 3 alternatives for managing the transaction risk
before the order is finalized.
(a) Mr. Peter the Marketing head has suggested that in order to remove transaction risk completely Zaz should
invoice the German firm in Sterling using the current €/£ spot rate to calculate the invoice amount.
(b) Mr. Wilson, CE is doubtful about Mr. Peter’s proposal and suggested an alternative of invoicing the German
firm in € and using a forward exchange contract to hedge the transaction risk.
(c) Ms. Karen, CFO is agreed with the proposal of Mr. Wilson to invoice the German first in €, but she is of opinion
that Zaz should use sufficient 6 months sterling future contracts (to the nearest whole number) to hedge the
transaction risk.
Following data is available:
Sport Rate € 1.1960 - €1.1970/£
6 months forward premium 0.60- 0.55 Euro Cents
6 months future contract is currently trading at € 1.1943/£
6 months future contract size is £ 62,500
Spot rate and 6 months future rate € 1.1873/£
You are required to:
(i) Calculate (to the nearest £) the £ receipt for Zaz plc, under each of 3 above proposals.
(ii) In your opinion which alternative you consider to be most appropriate
Ans: (i) 2339181; (ii) 2349979; (iii) 2344290
CURRENCY OPTION
Question No. 21A [SM-2023] [May-2019-8M] [Nov-2015-8M] [MTP-May-15] [May-2007-16M]
Sun Limited, an Indian company will need $ 5,00,000 in 90 days. In this connection, following information is given
below:
Spot Rate - $1 =  71
90 days forward rate of $1 as of today =  73
Interest Rates are as follows:
US India
90 days deposit rate 2.50% 4.00%
90 days borrowing rate 4.00% 6.00%
A call option on $ that expires in 90 days has an exercise price of 74 and a premium of Re. 0.10. Sun Limited has
forecasted the spot rates for 90 days as below:
Future rate Probability
72.50 25%
73.00 50%
74.50 25%
Which of the following strategies would be the most preferable to Sun Limited:
(i) A Forward Contract;
(ii) A Money Market hedge;
(iii) An Option Contract;
(iv) No Hedging.
Show your calculations in each case.
[CMA Compendium] [CMA-June-2017-8M] [As CMA-Dec-2007-10M] [ICAN-June-2011-10M]
Ans: (a) $ 5,88,000 (b) $ 6,05741.63 (c) $ 5,95,560 (d) no hedging = 5,86,500
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 5.38 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
Question No. 21B [SM-2023] [MTP-May-2019-8M] [Nov-2015-5M] [MTP-May-2015-10M]
[May-2010-8M] [RTP-May-2010]
Best of Luck Ltd, London will have to make a payment of $ 3,64,897 in six months’ time. It is currently 1st October.
The company is considering the various choices it has in order to hedge its transaction exposure.
Exchange rates
Spot rate $ 1.5617 - 1.5673
Six-months forward rate $ 1.5455 - 1.5609

Money Market rates: Borrow (%) Deposit (%)

US 6 4.5
UK 7 5.5
Foreign currency option prices (1 unit is £ 12,500):
Exercise Price Call option (March) Put option (March)
$1.70 / £ $0.037 $ 0.096
By making the appropriate calculations and ignoring time value of money (in case of premia) decide which of the
following hedging alternatives is the most attractive to best of luck ltd.
(a) Forward market
(b) Cash (money market)
(c) Currency options.
[CMA-SM22] [CMA-June-2006-10 Marks] [ICAN-D20-10M]
Ans: (i) £2,36,103 (ii) £2,36511 (iii) if make 18 contracts = 2,27,553.61
[Alternatively: if make 17 contracts = £2,27,922.63]

Question No. 21C [SM-2023] [MTP-N22-8M] [MTP-M22-10M] [MTP-II-Nov-2021-8M] [Nov-2013-8M]

An American firm is under obligation to pay interests of Can$ 1010000 and Can$ 705000 on 31 st July and 30th
September respectively. The firm is risk averse and its policy is to hedge the risks involved in all foreign currency
transactions. The finance manager of the firm is thinking of hedging the risk considering two methods i.e., fixed
forward or option contracts.
It is now June 30 following quotations regarding rates of exchange, US$ per Can$ from the firm’s bank were
obtained:
Spot 1 month forward 3 months forward
0.9284 – 0.9288 0.9301 0.9356

Price for a CAN$ / US$ option on a U.S. stock exchange (cents per CAN$, payable on purchase of the option,
contract size Can$ 50000) are as follows:
Strike price Calls Puts
(US$ / CAN$) July Sept. July Sept.
0.93 1.56 2.56 0.88 1.75
0.94 1.02 NA NA NA
0.95 0.65 1.64 1.92 2.34
According to the suggestion of finance manager if options are to be used, one month option should be bought at a
strike price of 94 cents and three-month option at a strike price of 95 cents and for the remainder uncovered by the
options the firm would bear the risk itself. For this it would use forward rate as the best estimate of spot. Transaction
costs are ignored.
Recommended, which of the above two methods would be appropriate for the American firm to hedge its foreign
exchange risk on the two interest payments.
[CMA-July-2023-8M] [ICAN-J22-7M] [ICAN-D17-7M]
Ans: (i) 1M: 939401, 959501; (ii) 3M: 681158, 659598

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 DERIVATIVES ANALYSIS AND VALUATION 5.39

 TEST YOUR KNOWLEDGE

’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’’
Question No. 21.1
An Indian exporter has sold handicrafts items to an American business house. The exporter will be receiving US$
1,00,000 in 90 days. Premium for a dollar put option with a strike price of 48 and a 90 days settlement is 1. The
exporter anticipates the spot rate after 90 days to be 46.50.
Should the exporter hedge its account receivable in the option market?
If the exporter is anticipating the spot rate to be 47.50 or 48.50 after 90 days, how would it effect the exporter’s
decision?
[CMA-MTP-June-2015-5M] [CMA-June-2005-5M]
Ans: Yes, he should hedge using a put option, (ii) In both the cases, the exporter will not be hedging
through the put option, as it results in negative benefit.
Question No. 21.2
Wilson Ltd an Indian company has a payable of US$ 1,00,000 due in 3 months. The company is considering to
cover the payable through the following alternatives:
(i) Forward contract; (ii) Money market; and (iii) Option.
The following information is available with the company:
Exchange rate:
Spot /$ 45.50/45.55
3M Forward 40/45
Interest rates (%): Per Annum
US 4.5/5.0 (Deposit/Borrow)
India 10.0/11.0 (Deposit/Borrow)
Call option on $ with a strike price of 46.00 is available at a premium of 0.10/$. Put option on $ with a strike
price of 46.00 is available with a premium of 0.05/$.
Treasury department of the company forecasted the future spot rate after 3 months to be:
Spot rate after 3-m Probability
45.60/$ 0.10
46.00/$ 0.60
 46.40/$ 0.30
You are required to suggest the best alternative of hedging.
[CMA-MTP-J23-8M] [As CMA-MTP-June-2020-8M] [CMA-Dec-2009-10 Marks]
Ans: (i) Forward hedge: 46,00,000; (ii) MMO: 46,28,195; (iii) Option hedge:
Question No. 21.3
ZENITH LTD (ZL) places an order to buy machinery with an American company. As per the agreement zenith Ltd
will be paying $2,00,000 after 180 days. The company (ZL) considers to use:
(i) a forward hedge; (ii) a money market hedge, (iii) an option hedge or (iv) no hedge
The consultant of Zenith Ltd. collects and develops the following data/information as desired by the company,
which can be used to assess the alternative approaches for hedging:
(i) Spot rate of dollar as of today is 47/$
(ii) 180 day forward rate of dollar as of today is 47.50/$
(iii) Interest rats are as follows:
India US
180 days deposit rate (per annum) 7.5% 3%
180 day borrowing rate (per annum) 8.0% 4%
(Assume 360 days in a year)
(iv) Future spot rate in 180 days as estimated by the consultant is 47.75$.
(v) A call option on the dollar, which expires in 180 days has an exercise price of 47/$ and premium 0.52/$

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 5.40 ADVANCED | STRATEGIC FINANCIAL MANAGEMENT
(vi) A put option on the dollar, which expires in 180 days has an exercise price of 47.50 and premium 0.40/$.
Required:
Carry out a comparative analysis of various outcomes (rupee cost of import)/Alternatives and decide which of the
alternatives is the most attractive to zenith Ltd.
[CMA-Dec-2005-12M] [ICAN-J15-10M]
Ans: Price to be paid under various options: (i) 95 lakhs (ii) 96,31,511 (iii) 95,04,000;
(iv) 95,50,000; Forward hedge (Alternative-i) is best as it is cheapest.
Question No. 21.4
An Indian exporter has sold handicraft items to an American business house. The exporter will be receiving US
dollar 1 Lakh in 90 days. Premium for a dollar put option with a strike price of 58.00 and a 90 days settlement
is 1. The exporter anticipates the spot rate after days to be 56.50.
(i) Should the exporter hedge its account receivable in the option market?
(ii) If the exporter is anticipating a spot rate to be 57.50 or 58.50 after 90 days, how would it effect the
exporter’s decision?
[CMA-June-2014-(2+3)=5M]

Question No. 21.5

A US co has struck a deal to sell goods to a German company for euro 1,250,000 due six months. Because the
contract is in Euros rather than dollars, the US Company is considering several hedging alternatives to reduce the
exchange rate risk arising from the sale. The following information is available.
The spot exchange rate is $ 1.40/euro
The six-month forward rate is $ 1.38/euro
US company's cost of capital is 11%
The Euro zone 6-month borrowing rate 9%
The Euro zone 6-month lending rate is 7%
The U.S. 6-month borrowing rate is 8%
The U.S. 6-month lending rate is 6%
December put options for Euro 6,25,000; strike price $ 1.42, premium price is 1.5% of spot.
US Company's forecast for 6-month spot rates is $1.43/euro.
Evaluate the following strategies:
1. No Hedge; 2. Forward Hedge; 3. Options Hedge
If the US Company locks in the forward hedge at $1.38/euro, and the spot rate when the transaction was recorded
on the books was $1.40/euro, what will be the consequences?
[CMA-RTP-Dec-2014]

Question No. 21.6 [SM-2023] [MTP-II-Nov-2021-8M] [Nov-2015-8M]

XYZ, an Indian firm, will need to pay JAPANESE YEN (JY) 5,00,000 on 30th June. In order to hedge the risk
involved in foreign currency transaction, the firm is considering two alternative methods i.e. forward market cover
and currency option contract.
On 1st April, following quotations (JY/INR) are made available:
Spot 3 months forward
1.9516/1.9711 1.9726/1.9923
The prices for forex currency option on purchase are as follows:
Strike Price JY 2.125
Call option (June) JY 0.047
Put option (June) JY 0.098
For excess or balance of JY covered, the firm would use forward rate as future spot rate. You are required to
recommend cheaper hedging alternative for XYZ.

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