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Financial Risk Management Question Paper

Financial Risk Management

Course:Bachelor Of Commerce

Institution: Kca University question papers

Exam Year:2009

UNIVERSITY EXAMINATIONS: 2009/2010
THIRD YEAR STAGE 2 EXAMINATION FOR THE DEGREE OF
BACHELOR OF COMMERCE
CFM 306: FINANCIAL RISK MANAGEMENT (EVENING CLASS)
DATE: DECEMBER 2009 TIME: 2 HOURS
INSTRUCTIONS: Answer Question ONE and Any other TWO Questions
QUESTION ONE
a) Discuss any 5 differences between forward and futures contracts. (10 Marks)
b) Consider a four-month forward contract to buy a zero-coupon bond that will mature one year from today. The current price of the bond is $930. Assume that the four-month risk-free rate of interest (continuously compounded) is 6% per annum. Determine the forward price.
(3 Marks)
c) An investor buys a European put option on a share for Ksh.6. The share price is Ksh.84 and the strike price is Ksh.80. Under what circumstances does the investor make a profit? When will the option be exercised? Draw a profit and the share price at maturity of the option.
(6 Marks)
d) Assume that a European call sells for C0 = $2 and a European put on the same stock (S0 = $45), with the same strike price ($44), and time to expiration (one year), sells for P0 = $1. If the one year, risk free interest rate is 10 percent, the put-call parity formula is violated, and there is an
arbitrage opportunity. Describe it. (4 Marks)
e) A trader wants an exposure similar to a long forward contract. Use algebraic notation of other positions to establish his position. (3 Marks)
f) Explain the following terms:
i) Shorting
ii) Arbitrage and Arbitrageurs. (4 Marks)
QUESTION TWO
a) Outline the assumptions of the Black and Scholes model. (10 Marks)
b) The stock price six months from the expiration of an option is sh.42. The exercise price of the option is sh.40. The risk free rate is 10% p.a and the volatility is 20% p.a. Find:
i) Call price
ii) Put price (10 Marks)
QUESTION THREE
a) Explain the Greek letters (GREEKS) in relation to risk. (10 Marks)
b) A share price is currently Sh.50. It is known that at the end of two months it will be either sh.53 or Sh.48. The risk free rate is 10 percent per annum. What is the value of a two-month call option with a strike price of Ksh.49? Use n-arbitrage arguments.
(10 Marks)
QUESTION FOUR
(a) The buyer of a commodity hedges against an increase in the price of the community by buying futures contracts on 1 June. The futures contracts are always fairly priced and expire on 21 September.
The following apply on 1 June:
1. The spot price of a commodity is Ksh.1000 per tonne
2. Short-term interest rates are 17 percent per annum
3. Other costs, such as storage and insurance of the commodity, amount to Ksh.65 per
tonne per annum.
The buyer closes out the position on 15 August and buys the commodity in the sport Market.
The following apply on the close-out date:
1. The price of the commodity has increased to Ksh.1100 per tonne
3
2. The short-term interest rate has decreased to 15 percent.
3. Other costs have remained unchanged.
Has the hedge improved the position of the buyer? Show all your calculations. Ignore
margining and transaction costs. (10 Marks)
(b) You enter into a futures contract to buy maize for Ksh.1500 per tonne. The contract is for the delivery of 1000 tonnes. The initial margin is Ksh.120,000 and the maintenance margin is Ksh.60,000.
i) What change in the futures price will lead to a margin call? (4 Marks)
ii) What happens if you do not meet the margin call?
iii) In what circumstances can you withdraw Ksh.60,000 from the margin account?
QUESTION FIVE
a) Using option algebra price that the put-call parity formula truly represents a risk-free portfolio.
(6 Marks)
b) A call option with a strike price of Ksh.50 costs sh.2. A put option with a strike price of sh.45 cost Sh.3. Explain how a strangle can be created from these two options. What is the pattern
of profits from the strangle? (8 Marks)
c) Discuss the following trading strategies involving options:
i) Straddle
ii) A strip
iii) A strap? (6 Marks)

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