QI. A swap bank has to entail certain risks which are inherent to the swap business and are interrelated Explain the risks involves in swap business.

Q2. Call options are said to be At the money , In the money and Out of the money depending on whether the exercise price is equal to or less than or greater than the current market price of the stock. In case of Put options, the opposite is true. Explain when a trader realizes profits in case of Call as well as Put options with the help of simple examples.

Q3. Write short notes on

(a) LBO or (b) Corporate restructuring

Q4. Futures rely on a great deal on expected spot prices. The theoreticalframework suggests that forward rates reflect the expected spot rates. How futures differ from forwards? Explain.

Q5. Arbitrage profits an investor told are risk less profits. You take simultaneous but opposite positions in two markets to reap gains from pricing disparities. Acting on this belief, his friend tried to find the arbitrage profit by trading simultaneously in futures and stock index.

He has collected to the following information:

Pricing level of stock index _- 3000

Index futures priced at 2000

Risk free rate of return - l0%p.a.

50% stocks are to pay dividcnds at 6%

The index futures has a multiple of 100

The future has six months to expiration.

Required

(a) Find arbitrage profits, if any.

(b) Discuss the risks associated with arbitrage transactions in futures.

ASSIGNMENT B

Q1. The following are the requirement of the type of funds and the borrowing rates faced by three companies X, Y, Z in different markets:

Company Requirement LIBOR Rate T-Bill rate Fixed $

X LIBOR based funds LIBOR+.75% T-Bill+.4% 5%

Y T-Bill Based Funds LIBOR+.5% T-Bill+.25% 4.5%

Z Fixed $ LIBOR+1% T-BILL+.5% 5.5%

Three companies approach a bank individually for swap deals so that they can reduce their cost of borrowing. You are required to structure swap transactions between three

parties keeping Bank as an intermediary so that after keeping a margin of 10 basis points V by the Bank for each leg of swap, the rest of the gain is distributed equally between the three parties. Also, calculate the effective cost of borrowing to the three parties.

Q2. There are a variety of option combinations which traders adopt to suit their risk return profile. Discuss the following option combinations:

(1) straddle

(2) strangle

Q3 . Option value is influenced by the option prices, which in turn depend on a number of factors What are assumptions made by Black and Scholes option Pricing model? Also discuss how does option premium depends on time to expiration, Interest rates, Spot prices and strike prices.

Case study

(a) The following options are quoted at the market:

Option Expiration Strike Price Premium

Call 1 Month Rs.48.5/$ Rs.0.30

Put 1Month Rs.48.5/$ Rs.0.05

A trader is looking at the above options and planning to adopt long strip or long strap strategy to make profit from the rupee-dollar exchange rate volatility.

You are required to:

I. Show the pay off profile and indicate break even points for strip and strap strategies in a price range of Rs 47- Rs 50 for a dollar.

II. Comment on the desirability of the above two option strategies.

(b)Consider a call option on a stock with the following parameters

Stock price: Rs210

Strike Price: Rs 220

Time to expiration: 167 days

Risk free interest rate: 10 %

Variance of annual stock returns: 20%

Compute price of the call option