Derivatives

ASSIGNMENT-1 (15 MARKS)

INTRODUCTION TO DERIVATIVES

1. In class we discussed the case of a finance manager of Bharat Petroleum who will be paying $1 million to a foreign client in Dubai. He had a long position in a 6 month forward contract. Now suppose an Indian exporter is to receive $1 million dollars in 6 months for the goods it has sold. The present spot rate is Rs.50/1 USD. If nothing changes, then after 6 months the exporter receives $1 million. He converts the money into Indian rupee and gets Rs.50 million. But suppose that exchange rate falls to Rs.49/ 1 USD after 6 months. In this case, the exporter will get only Rs.49 million after converting $1 million dollars. What should the exporter do in such a case to hedge against a fall in exchange rate? USE THE BID-ASK DATA GIVEN IN CLASS NOTES THAT I HAVE MAILED YOU. Also draw the payoff diagram. (10 Marks)

2. An investor enters into a short forward contract to sell 100,000 pounds for US dollars at an exchange rate of 1.90 USD per Pound. How much does the investor gain or lose if the spot exchange rate at the end of the contract is

a) 1.89 USD/Pound

b) 1.92 USD/Pound (2.5 Marks)

3. A trader enters into a short cotton futures contract when futures price is 50 paise per kg. The contract is for delivery of 50,000 kg. How much does the trader gain or lose if the cotton price at the end of the contract is

a) 48 paise per kg

b) 51 paise per kg (2.5 Marks)

DUE ON 29th AUGUST BY 4.30 PM

Go through the notes that I mailed you. The assignment is based on the notes.