To insure a stock portfolio against price decreases, owners of stock portfolios should a on the stock index?

A call option with a strike price of Rs55 can be bought for Rs4. What will be your net profit if you sell the call and the stock price is Rs52 when the call expires?

Using futures contracts to transfer price risk is called?

How much money is required to buy a futures contract? 

You buy a put option on a share for Rs3.  The current stock price is Rs42 and the strike price is Rs40. Under what conditions will you make a profit?  Under what conditions will the option be exercised? 

What would motivate a hedger to open a long futures position?

What would motivate an arbitrageur to open a long futures position?

What kind of swap should a financial institution enter into if it will be adversely affected by increasing interest rates over the next 2 years?

 

Question 2

A 5-year 10% coupon bond is offered for sale on 1/1/2023. Coupon is payable at the end of each year. The redemption value of the bond is at par of Rs100.

You are willing to subscribe to the bond but require a 8% p.a. yield.  What is the price at which you will be willing to buy the bond?

What is the price of this bond on 1/1/2024 assuming the yield to maturity is unchanged at 8%?

On 1/1/2024, the Reserve Bank of India increases interest rates to fight inflation.  Investors now require a 9% p.a. yield to maturity.  What will be the price of the bond after the RBI announcement?

Due to market volatility and bad news about the company, price of the bond has declined to Rs97.55 on 1/1/2025.  What is the yield to maturity that investors are now requiring for investing in the bond?

Your friend runs a distressed debt fund and buys bonds in troubled companies if he can get a 24% p.a. return.  At what price would he be willing to buy the bond on 1/1/2026?

Question 3

Futures of ABC Limited expiring on 29/3/2023 are trading at Rs102 on 1/1/2023 when the stock price is Rs100.  Government of India Treasury bills of corresponding maturity is trading to yield 4.8% p.a?

Is the Future fairly priced?

What should you do?

What will be the result of your action?

A stock is trading at Rs40.  It is known that the price of the stock will be either Rs42 or Rs38 after 1 month.  The risk free interest rate is 8% p.a. with continuous compounding.  What is the value of a 30 day European call option with a strike price of Rs39?

Question 4

No Growth Limited is a stable business with no growth plans.  It generates an EPS of Rs15.  Since there is no growth plan, it gives out all of this as dividend.

You expect that this dividend will continue for ever.  You expect a return of 18% from a stable company such as this. What is the price that you will be willing to pay for the stock?

With change of management, the company decides that it will only pay 50% of the EPS as dividend and reinvest the remaining amount in a new business that will lead to a 12% p.a. growth in earnings for the foreseeable future. What will be the price of the stock now?

However, the new business was not performing as expected.  In light of the higher risk, investors now wanted a higher return of 24%.  How will the price react to this news?

 

Question 5

You have been provided the following summary of the performance of stocks A and B; of the market index; and the risk free rate.

	A	B	Market Index	Risk Free Asset
Average annual return	22%	14%	9%	5%
Standard deviation of annual returns	18%	8%	4%
Correlation coefficient A and B	0.75
Correlation coefficient A and Market	0.35
Correlation coefficient B and Market		0.25

Which stock is riskier - A or B?

Which stock provides a higher reward to risk?

What is the lowest risk possible in a portfolio consisting only of A and B? What is the composition of such a portfolio?

Can you have a portfolio of only the Market Index and Risk Free Asset such that it has the same risk as the portfolio of A and B above? What would be the expected return of this portfolio?

Apply Capital Asset Pricing Model (CAPM) to estimate the expected returns of A and B.  Compare it to the actual expected returns to decide if A and B are over or under priced by the stock market?

Answer rating: 100% (QA)

Here are the answers 1 To insure a stock portfolio against price decreases owners of stock portfolios should buy put options on the stock index 2 Net ... View the full answer