IMPORTANT: Practice Questions- Not a question bank

I have already shared the paper pattern in another document.

Instructions: Use of calculators is allowed. Solve and elaborate in proportion to the marks for each
question.

Numericals

1. It is July 20. A company has a stock portfolio worth $250 million with a beta of 0.7. The
company plans to use index futures to adjust the portfolio beta to 1.0 until November 20. The
S&P 500 futures price is 4000, and one futures contract is on $250 times the index. Answer
the following (6 marks):
(i) How many index futures contracts should the company buy or sell to achieve the target
beta of 1.0?
(ii) Suppose instead the portfolio’s beta is 1.3 and the company wants to reduce it to 0.8.
What futures position is required in this case?
2. A wheat farmer expects to harvest 100,000 bushels of wheat in 3 months. The current spot
price of wheat is $4.50 per bushel, and the 3-month futures price is $4.60 per bushel. Each
futures contract is for 5,000 bushels. How can the farmer hedge his price risk using wheat
futures? Calculate the number of contracts and position he should take. If the spot price in 3
months turns out to be $4.00 per bushel, what effective price per bushel will the farmer
realize after accounting for the hedge? (4 marks)
3. The S&P 500 index is currently at 4500. The risk-free interest rate is 3% per annum and the
annual dividend yield on the index is 1.5% (both continuously compounded). The fair 6-
month futures price can be obtained using the cost-of-carry model.
(a) Calculate the theoretical 6-month futures price for the index.
(b) If the actual 6-month futures is trading at 4600, outline an arbitrage strategy to profit from
the mispricing and calculate the arbitrage profit per contract. (5 marks)
Assume one futures contract is on 50 times the index value.
4. In the Treasury bond futures market, the cheapest-to-deliver bond is a 8% annual coupon
bond with a conversion factor of 1.2500. Delivery is in 150 days. The bond pays semiannual
coupons; the last coupon was paid 70 days ago, the next coupon is due in 112 days (and the
following coupon in 294 days). The term structure is flat, with a continuously compounded
risk-free rate of 5%. The current clean price (quoted price) of the bond is $112. Calculate the
quoted futures price on the delivery date, taking into account accrued interest. (7 marks)
5. Company A (rated AAA) and Company B (rated BBB) both need ₹50 crore for 4 years. A
prefers to borrow at a floating rate, whereas B prefers fixed. The market quotes are:
o Company A can borrow at 7.0% fixed or MIBOR – 0.20% floating.
 o Company B can borrow at 9.0% fixed or MIBOR + 0.40% floating.
Determine the following (7 marks):
(i) The total interest saving (gain) possible from a swap arrangement between A and
B, and an equal sharing of this benefit (how much does each party save?).
(ii) The fixed interest rate that would be agreed upon in the swap (using the net
borrowing cost approach), if the benefit is shared equally between the two companies.
6. Using a one-step no-arbitrage binomial model, calculate the price of a 3-month European call
option on a stock. The current stock price is ₹500 and the strike price is ₹500. In 3 months
the stock is expected to either rise to ₹550 or fall to ₹470. Show your working. (5 marks)
7. Put-Call Parity Check: Current stock price S₀ = $50, strike price K = $50, time to maturity T
= 0.5 year, and risk-free rate r = 4% per annum. A call option is trading at C = $4 and a put
option at P = $2 (both European, same strike and maturity). Verify whether put-call parity
holds. If you find a violation, describe an arbitrage strategy to exploit it (specify which assets
to long and short) and calculate the arbitrage profit. (5 marks)
8. A European call option on a stock has the following parameters:
o Current stock price, S₀ = ₹100
o Strike price, X = ₹100
o Time to maturity, T = 0.083 year (approximately 30 days)
o Risk-free interest rate, r = 5% p.a. (continuous compounding)
o Market price of the call = ₹9.30

Using the Black-Scholes model, the implied volatility is estimated to be about 0.80 (80%).
Verify this by calculating the theoretical call price with the given volatility. Use: N(d₁) =
0.5530 and N(d₂) = 0.4613. Compute the call’s theoretical price and comment on whether the
market price appears to reflect a fair value. (5 marks)

9. An investor implements a bull call spread on a stock currently trading at ₹100 by buying a
call option with strike ₹95 for a premium of ₹10 and selling a call option with strike ₹105 for
a premium of ₹4 (both options have the same expiration date). Determine the following (4
marks):
(i) The net premium (initial cost) of entering the bull spread.
(ii) The maximum profit the investor can achieve with this strategy.
(iii) The maximum loss (if any) the investor can incur.
(iv) The break-even underlying price at expiration for the strategy.

Conceptual Questions
 11. Forwards vs Futures: Briefly explain the key differences between a forward contract and a
futures contract. (3 marks)
12. Why do Treasury bond futures use a conversion factor system for deliverable bonds? Explain
the rationale behind conversion factors in the bond futures market. (2 marks)
13. If a fund manager expects a significant market downturn, what derivatives strategy could be
adopted to protect an equity portfolio? Describe an appropriate strategy and its purpose under
a bearish market outlook. (4 marks)
14. Define basis risk in the context of futures hedging. Give an example of how basis risk can
affect the outcome of a hedge and why a perfect hedge is not always possible. (3 marks)
15. In an interest rate swap between two companies, each firm can exploit its comparative
advantage in borrowing. Explain why Company A and Company B might enter into a swap
agreement given their different borrowing rates. What is the benefit for each party? (3 marks)
16. Distinguish between American and European options. Under what circumstances might early
exercise of an American option be advantageous? Give an example for either a call or a put
where exercising before expiration could be optimal. (5 marks)
17. Define Delta and Vega in the context of option Greeks. How would an increase in the
underlying stock price affect the value of a call option (given its Delta)? How would an
increase in implied volatility affect the call’s value (given its Vega)? (5 marks)
18. An investor writes (sells) a short straddle using one call and one put on the same underlying
stock with the same strike price and expiration. Draw the payoff diagram for a short straddle
at expiration and explain the strategy’s goal. Under what market conditions will a short
straddle be profitable, and what are the risks involved? (5 marks)
19. Explain the concept of the put-call ratio as a sentiment indicator. What does it suggest about
market trend if the put-call ratio is less than 1? How might an investor use a very low put-call
ratio to inform their investment decisions? (5 marks)

AGAIN, these are practise questions indicative and not a question bank.

Exam questions will be different.