Birla Institute of Technology & Science, Pilani

Hyderabad Campus,
II Semester 2015-16, Comprehensive Examination
Course No. FIN F311 & ECON 351 Course Title: Derivatives & Risk
Management
Date: 06-05-2016 Time: 9:00 AM-12:00 PM Total Marks: 40

Note:
a) Answer to questions must be in sequence.
b) Answer Part A and B in separate answer sheet]
PART-A

Q: 1/ Assume that you own a security currently worth $500. You plan to sell it in two months.
To hedge against a possible decline in price during the next two months, you enter into a
forward contract to sell the security in two months. The risk-free rate is 3.5 percent.
A. Calculate the forward price on this contract.

B. Suppose the dealer offers to enter into forward contract at $498. Indicate how you
could earn an arbitrage profit.

C. After one month, the security sells for $490. Calculate the gain or loss to your
position. [3.00 marks]

Q: 2/ Price of an American call on a non-dividend paying stock is $4. The stock price is $31,
strike price is $30, and expiration date is in three months. The risk free interest rate is
8%. Derive upper and lower bounds for the price of an American put on the same stock
with the same strike price and expiration date.
[3.00 marks]
Q: 3/ Price of a European call that expires in six months and has a strike price of $30 is $2. The
underlying stock price is $29, and a dividend of $0.50 is expected in two months and
again in five months. The term structure is flat, with all risk free interest rates being 10%.
What is the price of a European put option that expires in six months and has a strike
price of $30? [3.00 marks]
Q: 4/ Present stock price is $100. Over each of the next two six-month periods, it is expected
to go up by 10% or down by 10%. The riskfree interest rate is 8% per annum with
continuous compounding. Calculate the value of a one-year European call option with a
strike price of $100? [3.00 marks]

Q: 5/ Consider a 3-year plain vanilla fixed-floating interest rate swap. The notional principal is $
20 million. The swap fixed rate is 6%. The floating rate is 6-month LIBOR. The payment
dates are every six months, beginning six months hence. On the origination date, 6-
month LIBOR is 5.5%. The day count basis for both the fixed rate and the floating rate is
30/360.On subsequent dates 6-month LIBOR is

SI No Time 6-month
LIBOR
1 0.5 5.25%
2 1.0 5.50%
3 1.5 6.00%
 4 2.0 6.20%
5 2.5 5.44%
[4.00 marks]
Compute the cash flows and net cash flows that are exchanged between the counter parties
(Fixed & Floating)
Q: 6/ Firm wants to enter into a 2-year fixed Yen-Deutschemark (DM) currency swap. The spot
exchange rate is 77/DM. The principal amount is 20 million DM. The swap dealer is
quoting fixed rates on this type of swap of 2% in Yen and 5% in DM. Payments are
quarterly , on a 30/360 day count basis. The firm wants to pay fixed DM and receive fixed
Yen. What are the cash flows that will be exchanged if the firm agrees to the swap?
[4.00 marks]
Q: 7/ Firm wants to pay quarterly yen LIBOR and receive quarterly US dollar LIBOR and have
both payments in US dollars. The notional principal is $60 million. The diff swap tenor is
two years, and payments are quarterly. Current spot interest rates on zero coupon debt
instruments are as follows:

Years to Maturity US Japan

0.25 4.5 % 1.0 %
0.50 5.0 % 1.2 %
0.75 5.4 % 1.6 %
1.00 5.8 % 1.8 %
1.25 5.9 % 2.0 %
1.50 6.0 % 2.3 %
1.75 6.1 % 2.5 %
2.00 6.2 % 2.7 %
[5.00 marks]

Determine the price of the swap.

PART B (Answer in separate answer sheet)

Q: 1/ Derivatives provide ample opportunities to manage risk and bring in liquidity into the
system. The effectiveness of derivatives depends on regulatory framework and practices
(self-regulations) followed by the end users in the financial markets. However, empirical
studies show that usages of derivatives have led to the collapse of institutions and
markets. Explain the causes and consequences of the Barings Banks failure (risk of
using derivatives) in the following manner.
A. Incident [0.50 marks]
B. Result [0.50 marks]
C. How the unauthorized positions arose [1.00 marks]
D. How the unauthorized positions failed to be detected [3.00
marks]
E. How the unauthorized positions were eventually detected [1.00 marks]
F. Lessons to be learned [2.00 marks]

Q:2/ Write tile of your assignment (name of the topic).

Why did you choose the topic (rationale behind choosing the topic)? [2.00
marks]
What did you do? Explain the summary of the work and learning for you. [5.00
marks]