Birla Institute of Technology & Science, Pilani
Hyderabad Campus, Semester-II 2021-22
Maximum Marks- 40
End-semester examination
Course Name: DRM Course Code: ECON F354/ FIN F311
Date: 10/05/2022 Time: 2:00p.m.-5:00p.m.
Name _________________________ ID_________________________
All questions are compulsory.
There are total 23 questions.
Each question in Section A carries 0.5 points.
Each question in Section B carries 2 points.
Each question in Section C carries 5 points.
Writing with pencil is not allowed.
Sharing of calculator or any other material is not allowed.
Recheck request Comments
Section A – Answer very briefly - 5 marks
1. A put option is in the money put if __________________________________
(mention the condition only).
2. Upper bound of European call on a non-dividend paying stock is _____________.
3. Rho of an option gives the ______________________________________________
___________________________________________________________________.
4. Put-call parity does not hold for __________________________________________
options.
5. Theta of an option gives________________________________________________
___________________________________________________________________.
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6. If the delta of an option is -0.5 then the delta hedging strategy for a financial institution
writing European put option on non-dividend paying stock will be _______________
___________________________________________________________________.
7. Optimal hedge ratio of 0.7 implies that the manager should __________________
___________________________________________________________________.
8. Futures prices are greater than forward prices when _________________________
___________________________________________________________________
9. Option series refers to _________________________________________________
___________________________________________________________________.
10. Consider a call option to buy 1000 shares with a strike price of Rs.50.If the
company makes 5 for 1 stock split, then the new strike price will be __________ and
the number of underlying shares will be _________________.
Section B- Short answer type questions (10*2=20marks)
1. Consider a 12% semi-annual coupon paying bond with 15 years and 2 months to
maturity and par value $100. Find the conversion factor. What is the intuition behind
the conversion factor for a bond?
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2. Let the standard deviation of short term rates be 2%. Find the 3-month forward rate
after 6 years, if the 6-year Eurodollar futures is quoted as 95. ED rates are quarterly
compounded using 360 day per year. [Hint- Futures rate should be continuously
compounded using actual/365 day count]
3. Mention any two factors that are negatively related to the (a) call option premium and
(b) put option premium
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4. Derive the put-call parity for European options on dividend paying stock.
5. Suppose an investor writes 10 calls on a stock. Option price is Rs.10 and strike price
Rs.150 whereas the stock price is Rs.140. Each contract is on 100 underlying shares.
Find the margin requirement for the trader.
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6. Explain why early exercise of American put option on a non-dividend stock is optimal.
7. Ms. A writes a 3-month European call option (1 call is on 10 underlying shares), at a
premium of Rs.30 per share, with an exercise price of Rs.550. She also purchased 10
shares on the same date at a price of Rs.500 per share. Calculate the profit or loss for
Ms. A and give the profit matrix. What would be the profit/loss if market price falls to
Rs.350 at the end of 3 months?
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8. Suppose at maturity, the price of ABC stock futures is Rs. 450 and the ABC stock is
trading at Rs. 495 in the equity market. Is it possible? If not explain the arbitrage
strategy and find arbitrage profit.
9. Suppose you are the producer and wish to eliminate the uncertainity related to the
price of selling wheat in the market 3 months from now. You expect to produce 1000
kgs of wheat at the end of 3 months and would like to use the commodity futures and
set up perfect hedge. Suppose 3 month wheat futures are trading at Rs.55 per kg and
each contract is on 100 kgs. Set up the hedge and show that irrespective of market
price you will be able to sell wheat for Rs. 55 per kg. Give one reason why perfect
hedges may not be possible in real world.
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10. The dividend yield on index is 6% for months January, March and November and is
3% for rest of the months. If the risk-free rate is 8% per annum with continuous
compounding and the price of the index is 17000 in June. Find the futures prices for a
contract deliverable in 6 months.
Section –C – Long answer questions (5*3=15marks)
1. Assume that European put option on Dubar Ltd. with a strike price of Rs250 maturing in 3
months is trading at Rs. 8. Additionally, Dubar India Ltd is a non-dividend paying stock
and is currently trading at Rs.270 per share. Now, answer the following:
(i) What should be the premium of European call with a strike price of strike price of Rs.250
with 3 month maturity when the continuously compounded risk free rate is 5% per annum?
(ii) If the call is trading at Rs.35 then discuss the arbitrage strategy available to the trader and
the find the arbitrage profit. Show all the steps.
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2. Suppose there are three put options on a stock having the same expiration date and strike
price of Rs. 50, Rs, 55 and Rs. 60. The option premiums are Rs. 2, Rs,4 and Rs.9
respectively. Create a short butterfly spread and answer the following:
(i) Construct the pay-off and profit matrix and give the profit diagram.
(ii) For what range of stock price will the trader make profit?
(iii) What must be the underlying expectation of the trader?
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3. Consider a European call option on a non-dividend paying stock with a strike price of
Rs.400 and time to maturity of 6 months. Suppose that the stock price is Rs. 400 and risk-
free rate is 8% per annum and the volatility is 30% per annum.
(i) Find the value of the option using a two-step binomial tree.
(ii) Draw the two-step binomial tree.
(iii) Find the delta in each step.
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Useful formulae:
1. F0 = S0 e(r–q )T
e rT d
p
2. ud
t
3. u e ; d e t
4. ƒ = [ pƒu + (1 – p)ƒd ]e–rT
5. Forward Rate = Futures Rate−0.5 σ2T1T2
∑𝑇
𝑡=1 𝐶𝑡 𝑃𝑎𝑟 𝑣𝑎𝑙𝑢𝑒
6. 𝐵𝑜𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 = +
(1+𝑟)𝑡 (1+𝑟)𝑇
7. put + stock = call + PV of strike price
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