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Fnce 423: Futures And Options Question Paper
Fnce 423: Futures And Options
Course:Bachelor Of Commerce
Institution: Kabarak University question papers
Exam Year:2013
KABARAK
UNIVERSITY
UNIVERSITY EXAMINATIONS
2012/2013 ACADEMIC YEAR
FOR THE DEGREE OF BACHELOR OF COMMERCE
FNCE 423: FUTURE MARKETS AND OPTIONS
DAY: TUESDAY
DATE: 13/08/2013
TIME: 2.00 – 5.00 P.M.
STREAM: Y4S2
INSTRUCTIONS:
Answer Question one and any other two Questions. (2hours)
QUESTION ONE
a) Define the term‘derivatives’ and explain its rolein financial management ( 8Marks)
b) Write short notes on the following terms of a contract relating to futures and option market.
i.
Strike priceor exercise price
(2 marks)
ii.
Underlying asset
(2 marks)
iii.
Out of the money and In the Money (2 marks)
iv.
Long position and Short position
(2 marks)
v.
European option and American option (2 marks)
c) Today’s date is 14th April 2013 and the price of Equity Bank stock is Shs.666. The cost of a
680 call option with expiry 22nd August 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)
d) Identify and explain at least three presuppositions for well-functioning financial markets
(6 Marks)
QUESTION TWO
a) Apart from no no-arbitrage condition, identify the three assumption under ‘cost-of-carry’
futures and forward valuation model (3 Marks)
b) Suppose the current spot price of Blue Diamond is Shs3500 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 diamond? (4 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 (6 marks)
QUESTION THREE
a) Define the term ‘Enterprise Risk Management (ERM)’ (3 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 risk management process. (12 Marks)
QUESTION FOUR
a) Identify five the assumptions on which the Black-Scholes Options Pricing Model and its
derivation are based (5 Marks)
b) Samson ole Sikinan 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
investmentat its current price of Shs.7.00? (10 Marks)
QUESTION FIVE
a) Identify two factors affecting option prices (2 Mark)
b) Explain how the following parameters affect option prices
i)
Interest rate (2 Marks)
ii)
the volatility (2 Marks)
c) ‘Futures price ar a forecast of a spot price at a time of futures expiration’. In leu of the above
statement, Explain the following terms in relation to valuation of futures contracts
i)
Backwardation (1 Mark)
ii)
Contango
(1 Mark)
d) With the use of relevant example, explain the concept of Market efficiency and theoretical
fair value in relation to derivative market (3 marks)
e) Suppose an investor buys a call option on Uchumi Supermarket stock with an exercise price
ofShs. 50 at a call premium of Shs.3. If the stock price reaches Shs. 60.
i)
How much profits will be realized if the holder exercises the option? (2 Marks)
ii)
If the price of Uchumi stock is at shs.45. What should the holder do? (2 Mark)
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