CONFIDENTIAL BM/JAN 2013/FIN541/651/630

UNIVERSITI TEKNOLOGI MARA

FINAL EXAMINATION

COURSE MALAYSIAN DERIVATIVES/MALAYSIAN

FUTURES AND OPTIONS
COURSE CODE FIN541/651/630
EXAMINATION JANUARY 2013
TIME 3 HOURS

INSTRUCTIONS TO CANDIDATES

1. This question paper consists of five (5) questions.

2. Answer ALL questions in the Answer Booklet. Start each answer on a new page.

3. Do not bring any material into the examination room unless permission is given by the
invigilator.

4. Please check to make sure that this examination pack consists of:

i) the Question Paper

ii) an Answer Booket - provided by the Faculty

DO NOT TURN THIS PAGE UNTIL YOU ARE TOLD TO DO SO

This examination paper consists of 4 printed pages
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CONFIDENTIAL 2 BM/JAN 2013/FIN541/651/630

QUESTION 1

a) Explain the process of novation and its importance in futures trading.

(5 marks)

b) An active speculator forms a strong opinion that the current economic policy relating to
the plantation sector will bring down the total production of CPO. If this policy pursues,
the price for this commodity is expected to be adversely affected due to undersupply.
The scenario will impose direct impact on the FCPO market. So, a speculator decides to
trade four December FCPO contracts at RM3,190. The changes in settlement prices of
FCPO turn out to be the following for the next five days.

Trading Day Changes in Settlement Prices:

(+ / -) Compared to Previous Day's Price
1 + RM10
2 -RM30
3 +RM10
4 -RM15
5 -RM15

i) Determine whether the speculator should enter the market as long or short position.

(2 marks)

ii) Calculate the contract value of the December FCPO contracts.

(2 marks)

iii) Prepare the marked-to-market position for the five-day trading assuming the initial
margin is 10% of the contract value and all traders must maintain 90% of it.

(10 marks)

iv) Compute the realized profit or loss if the speculator closes out his position on the fifth
day.
(1 mark)

QUESTION 2

a) It is now 17 January 2013 and the FBM KLCI is at 1146. The average dividend yield
of the FBM KLCI is 2.3% and the risk-free interest rate is 5% per annum. A trader
has RM10 million which he can fund at the risk-free rate. Meanwhile, June FKLI is
trading at 1192.5. The trader believes that there is an arbitrage opportunity.

i) Calculate the fair value of the June FKLI.

(Use the actual number of calendar days in determining the numbers of days
to maturity)
(5 marks)

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ii) Determine the number of contracts he can trade and outline the strategy he
can partake. At maturity, assume both the cash and futures market prices
converge at 1165.
(5 marks)

iii) Show the profit or loss of the arbitrage.

(6 marks)

b) Briefly explain the importance of speculators in the futures market and the reason
why speculation is considered risky.
(4 marks)

QUESTION 3

a) Identify the potential users of MGS futures and the primary use of this instrument.

(4 marks)

b) Explain how clearing house is able to guarantee performance in the futures and
option market.
(4 marks)

c) It is now February 2013 and ABC Bank intends to purchase RM200 million 5-year
MGS when these instruments are issued in one month's time. The current interest
rate is 8 percent. The bank is concerned about a fall in interest rate and decides to
hedge its position today to lock in the purchase price of the bond. Currently, March
FMG5 is trading at 114.0 In March, the interest rate falls to 7 percent and March
FMG5 trades at 116.0.

i) Describe the bank's strategy and indicate whether it makes a profit or loss.

(8 marks)
ii) Calculate and comment on the effective price.
(4 marks)

QUESTION 4

a) A trader is expecting a large move in a stock price in the next 3 months but does not
know in which direction the move will be. Currently the stock is valued at RM69 by
the market. The trader participates in a straddle with a strike price of RM70 and an
expiration date in 3 months. The call costs RM4 and the put costs RM3.

i) Construct a payoff table for the straddle if the stock prices are as follows:

Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Day 8

RM50 RM55 RM60 RM70 RM75 RM80 RM85 RM90

(8 marks)

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ii) Sketch an expiry profit diagram for this position showing the break-even
points and maximum profit or loss.
(2 marks)

b) Briefly explain the difference in risk taken by the buyer and the seller of an option.

(4 marks)

c) A trader buys a put option on a share for RM3. The stock price is RM42 and the
strike price is RM40.

i) Describe the circumstances of a profitable trade for the trader.

(2 marks)

ii) State the circumstances when the option is to be exercised.

(2 marks)

iii) Draw a diagram showing the variation of the trader's profit with the stock
price at the maturity of the option.
(2 marks)

QUESTION 5

Your uncle is working at the arbitrage desk of a large insurance firm. His job is to identify
and exploit arbitrage opportunities. He notices the following quotations in December 2012:

90-day KLIBOR 7.2%

180-day KLIBOR 8.5%
December 2012 FKB3 93.20
March 2013 FKB3 92.50

Assume that the firm can invest RM10 million.

a) Prove to him that arbitrage is possible.

(4 marks)

b) Outline the appropriate arbitrage strategy to be undertaken today.

(4 marks)

c) Determine the arbitrage profit or loss that the firm would make if the 90-day KLIBOR
and March 2013 FKB3 converge at 9.0% at the maturity.
(12 marks)

END OF QUESTION PAPER

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