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Fnce 423: Options And Futures Markets Question Paper
Fnce 423: Options And Futures Markets
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2014
KABARAK
UNIVERSITY
UNIVERSITY EXAMINATIONS
2013/2014 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF COMMERCE
FNCE 423: OPTIONS AND FUTURES MARKETS
DAY: THURSDAY
DATE: 10/04/2014
TIME: 8.30 – 10.30 A.M. STREAM: Y4S2
INSTRUCTIONS:
? Answer Question one and any other two Questions. (2hours)
QUESTION ONE
a) Although derivatives have been around in some form for centuries, their growth has
accelerated rapidly during the last several decades; they are now widely used by
corporations, financial institutions, professional investors, and individuals.
Identify and explain the three major roles of derivatives market in the financial
management of corporations(6 Marks)
b) Write short notes on the following terms of a contract relating to futures and option
market.
i.Time value(2 marks)
ii.At the money and In the Money(2 marks)
iii.Long position and Short position(2 marks)
iv.Strike price or exercise price(2 marks)
c) Identify and explain at least three presuppositions for well-functioning financial markets(4 Marks)
d) Today’s date is 14th January 2013 and the price of Bank of India (BOI) stock is Shs.666.
The cost of a 680 call option with expiry 22nd May 2013 is Shs.39. you expect the stock
to raise to Shs.730 between now and August. Would you rather buy the stock or sign an
option contract?(6 marks)
e) ‘Once the organizations risk has been identified, they must be assessed as to their
potential severity of loss and to their probability of occurrence’. Explain the following
terms commonly used in the process mentioned above.
i.Risk Quantification(2 marks)
ii.Risk Integration(2 marks)
iii.Risk Prioritization(2 marks)
QUESTION TWO
a) Identify and explain three risk treatment categories used in the Enterprise Risk
Management(6 marks)
b) “The modern organizations’ Risk management should be systematic and structured.
Risk is best managed where there is a formal structure for identification,
quantification and treatment of risk”. In lieu of the above statement and with the aid
of relevant examples; identify and explain the common risk identification methods.(9 Marks)
QUESTION THREE
a) Identify five the assumptions on which the Black-Scholes Options Pricing Model and its
derivation are based(5 Marks)
b) Miguna Miguna has the opportunity to purchase a six month call option for Shs.7.00 on
an Old Mutual stock which is currently selling for Shs.75. in the Nairobi Securities
Exchange (NSE), the exercise price of the call is Shs.80 and the current 91day treasury
bills rate is 10% per annum. The variance of annual returns on the Old Mutual stock is
16%.
Required
Using Black-Scholes Options Pricing Model explain whether this option represent a good
investment at its current price of Shs.7.00?(10 Marks)
QUESTION FOUR
a) Identify the four assumption under ‘cost-of-carry’ futures and forward valuation model(3 Marks)
b) Suppose the current spot price of Blue Tanzanite is Shs 3500 per gram, the risk-free
three-month rate of interest is 3% continuously compounding., and there are no costs of
holding Diamond.
i)What is the three-month future price of blue Tanzanite?(3 Marks)
ii)Suppose exercise/delivery price of the three months future contract is Shs. 3555;
is the contract overvalued or undervalued?(2 Marks)
iii)Explain the strategies to be used to take advantage of available Arbitrage
opportunity and calculate the net cash flow(5 marks)
QUESTION FIVE
a) Identify and explain three major risks faced by forward and futures market participant(6 Mark)
b) Suppose an investor buys a call option on Jack & Jill Supermarket stock with an exercise
price of Shs. 50 at a call premium of Shs.3. If the stock price reaches Shs. 60.
How much profits will be realized if the holder exercises his option?(2 Marks)
i) If the price of Jack & Jill stock is at shs.45. What should the holder do?(2 Mark)
ii) Explain how the following parameters affect option prices
(i) Strike price(1 Marks)
(ii) Interest rate(2 Marks)
(iii)the volatility(2 Marks)
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