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Financial Derivatives
Jun 2026 Examination
Q1.
Meera is an investor interested in Solarwave Industries Ltd, currently trading
at Rs.950 per share. She is considering two option contracts: A call option
with a strike price of Rs.920 and a premium of Rs.60 per share. A put option
with a strike price of Rs.980 and a premium of Rs.70 per share. Calculate the
intrinsic value, and profit or loss for both the call and put options if the
stock price rises to Rs.940 at expiry and if the stock price remains at Rs.950
at expiry. Also calculate the initial time value of both call and put options
at the time of purchase. Further, comment on the minimum stock price at expiry
at which Meera will start making a profit on the call option and the maximum
stock price at expiry at which she will start making a profit on the put
option. (10 Marks)
Ans
1.
Introduction
Options
are derivative contracts that give the buyer the right, but not the obligation,
to buy or sell an underlying asset at a predetermined strike price before or at
expiry. A call option gives the buyer the right to buy shares, while a put
option gives the right to sell. The buyer pays a premium upfront for this
right. The profitability of an option at expiry depends on the relationship
between the market price of the underlying and the strike price, compared
against the premium paid. Understanding intrinsic value, time value, and
breakeven points is essential for evaluating
Q2
(A). Arjun, an investor, buys 40 futures contracts of XYZ Motors Ltd. at a
futures price of Rs.1,500 per share. Each contract represents 25 shares. The
exchange follows daily mark-to-market (MTM) settlement. Over the next three
days, the closing futures prices are Rs.1,480 on Day 1, Rs.1,520 on Day 2, and
Rs.1,510 on Day 3. Calculate Arjun's daily profit or loss based on the change
in futures prices each day. Also determine the total net gain or loss after
three days of MTM settlement. (5 Marks)
Ans
2(A).
Introduction
Mark-to-Market
settlement is a daily process in futures trading where gains and losses are
calculated based on the change in closing futures prices each day and credited
or debited to the investor's margin account. Unlike options, futures are
binding contracts, and the MTM mechanism ensures that profit and loss is
settled daily rather than accumulated until expiry. This prevents default risk
by adjusting each party's account every
Q2
(B). Global Auto Components Ltd., an Indian company operating in Europe, earns
revenue in Euros but has long-term debt in Indian Rupees. Due to exchange rate
fluctuations, its debt servicing costs have become uncertain. To manage this
currency risk, the company enters into a five-year, privately negotiated
agreement with an international financial institution to better match its debt
obligations with its foreign currency earnings. Identify the type of financial
contract entered into by Global Auto Components Ltd. and explain how such
contracts play a crucial role in cross-border transactions. (5 Marks)
Ans
2(B).
Introduction
Global
Auto Components Ltd. has entered into a Currency Swap, specifically a
cross-currency interest rate swap. This is a privately negotiated,
over-the-counter derivative contract where two parties agree to exchange
principal amounts and interest payments in different currencies over a
specified period. The five-year duration, the bilateral negotiation with a
financial institution, and the objective of aligning Euro earnings with Rupee
debt obligations are all defining characteristics of this
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