CA- FINAL

STRATEGIC FINANCIAL MANAGEMENT

Question 1(a): Ab Ltd.’s equity shares are presently selling at a price of `500 each. An investor in interested in
purchasing AB Ltd.’s shares. The investor expects that there is a 70% chance that the price will go up to `650 or a
30% chance that it will go down to `450, three months from now.
There is a call option on the share of the firm that can be exercised Only at the end of three months at an exercise
price of `550.
Calculating the following:
(a) If the investor wants a perfect hedge, what combination of the share and option should he select?
(b) Explain how the investor will be able to maintain identical position regardless of the share price.
(c) If the risk-free rate of return is 5% for the three months period, what is the value of the option at the
beginning of the period?
(d) What is the expected return on the option?
(8 Marks)
Question 1(b): Mr. SG sold five 4-Month Nifty Futures on 1st February 2020 for `9,00,000. At the time of closing
of trading on the last Thursday of May 2020 (expiry), Index turned out to be 2100. The contract multiplier is 75.
Based on the above information calculate:
(i) The price of one Future Contract on 1st February 2020.
(ii) Approximate Nifty Sensex on 1st February 2020 if the Price of Future Contract on same date was theoretically
correct. On the same day Risk Free Rate of Interest and Dividend Yield on Index was 9% and 6% p.a.
respectively.
(iii) The maximum Contango/ Backwardation.
(iv) The pay-off of the transaction.
Note: Carry out calculation on month basis.
(8 Marks)
Question 1(c): Ram holding shares of Reliance Industries Ltd. which is currently selling at `1,000. He is expecting
that this price will further fall due to lower than expected level of profits to be announced after one month. As on
following option contract are available in Reliance Share.
Strike Price (`) Option Premium (`)
1030 Call 40
1010 Call 35
1000 Call 30
990 Put 35
970 Put 20
950 Put 8
930 Put 5
Ram is interested in selling his stock holding as he cannot afford to lose more than 5% of its value.
RECOMMEND a hedging strategy with option and show how his position will be protected.
(4 Marks)
Question 2(a): A future contract is available of R Ltd. that pays an annual dividend of `4 and whose stock is currently
priced at `125. Each future contract calls for delivery of 1,000 shares to stock in one year, daily marketing to
market. The corporate treasury bill rate is 8%.
Required:
(i) Given the above information, what should the price of one future contract be?
(ii) If the company stock price decrease by 6%, what will be the price of one futures contract?
(iii) As a result of the company stock price decrease, will an investor that has a long position in one futures
contract of R Ltd. realises a gain or loss? What will be the amount of his gain or loss?
(Ignore margin and taxation, if any)
(6 Marks)
Question 2(b): A Rice Trader has planned to sell 22,000 kg of Rice after 3 months from now. The spot price of the
Rice is `60 per kg and 3 months Future on the same is trading at `59 per kg. Size of the contract is 1,000 kg. The
price is expected to fall as low as `56 per kg, 3 months hence.
Required:
(i) To interpret the position of trader in the Cash Market.
(ii) To advise the trader the trader should take in Future Market to mitigate its risk of reduced profit.
(iii) To demonstrate effective realised price for its sale if he decides to make use of future market and after 3
months, spot price is `57 per kg and future contract price for closing the contract is `58 per kg.
(6 Marks)
Question 2(c): The Following data relate to A Ltd.’s Portfolio:
Shares X Ltd. Y Ltd. Z Ltd.
No. of Shares (lakh) 6 8 4
Price per share (`) 1000 1500 500
Beta 1.50 1.30 1.70
The CEO is of opinion that the portfolio is carrying a very high risk as compared to the market risk and hence
interested to reduce the portfolio’s systematic risk to 0.95. Treasury Manager has suggested two below mentioned
alternative strategies:
(i) Dispose off a part of his existing portfolio to acquire risk free securities,
Or
(ii) Take appropriate position on Nifty Futures, currently trading at 8250 and each Nifty points multiplier is `210.
You are required to:
(a) Interpret the opinion of CEO, whether it is correct or not.
(b) Calculate the existing systematic risk of the portfolio,
(c) Advise the value of risk-free securities to be acquired,
(d) Advise the number of shares of each company to be disposed off,
(e) Advise the position to be taken in Nifty Futures and determine the number of Nifty contracts to be
bought/sold; and
(f) Calculate the new systematic risk of portfolio if the company has taken position in Nifty Futures and there
is 2% rise in Nifty.
Note: Make calculations in `lakh and upto 2 decimal points.
(8 Marks)
Question 3(a): Ms. Preeti, a school teacher, after retirement has built up a portfolio of `1,20,000 which is as follow:
Stock No. of shares Market price per share (`) Beta
ABC Ltd. 1,000 50 0.9
DEF Ltd. 500 20 1.0
GHI Ltd. 800 25 1.5
JKL Ltd. 200 200 1.2
Her portfolio consultant Sri Vijay has advised her to bring down the, beta to 0.8. You are required to compute:
(i) Present portfolio beta
(ii) How much risk free investment should be bought in, to reduce the beta to 0.8 ?
(6 Marks)
Question 3(b): A company is long on 10 MT of copper @ `534 per kg (spot) and intends to remain so for the ensuing
quarter. The variance of change in its spot and future prices are 16% and 36% respectively, having correlation
coefficient of 0.75. The contract size of one contract is 1,000 kgs.
Required:
(i) Calculate the Optimal Hedge Ratio for perfect hedging in Future Market.
(ii) Advice the position to be taken in Future Market for perfect hedging.
(iii) Determine the number and the amount of the copper futures to achieve a perfect hedge.
(6 Marks)
Question 3(c): A two year tree for a share of stock in ABC Ltd, is as follows:
 2 year later
Now 1 year later
(N2) 116.64

108
102.60

100

(N1) 95

(N3) 90.25

Consider a two years American call option on the stock of ABC Ltd. With a strike price of `98. The current price of
the stock is `100. Risk free return is 5 per cent per annum with a continuous compounding and e 0.05 = 1.05127.
Assume two time periods of one year each.
(i) The probability of price moving up and down
(ii) Expected pay offs at each nodes i.e. N1, N2 and N3 (round off upto 2 decimal points.)
(8 Marks)

Question 4(a): TRC Cables Ltd. (an Indian Company) is in the business of manufacturing Electrical Cables and Data
Cables including Fiber Optics cables. While mainly it exports the manufactured cables to other countries it has also
established its production facilities at some African countries’ due availability of raw material and cheap labour
there. Some of the major raw material such as copper, aluminum and other non-ferrous metals are also imported
from foreign countries. Hence overall TRC has frequent receipts and expenditure items denominated in Non-INR
currencies.
Though TRC make use of Long-Term Debts and Equity to meet its long term fund requirements but to finance its
operations it make use of short-term financial instruments such as Commercial Papers, Bank Credit and Term Loans
from the banks etc. If any surplus cash is left with TRC it is invested in interest yielding securities. Recently due to
stiff competition from its competitors TRC has relaxed its policy for granting credit and to manage receivables it
has formed a separate credit division.
Further to hedge itself against the various risk it has entered into various OTC Derivatives Contracts settled outside
the Exchange.
Required: Evaluate the major risks to which TRC Ltd. is exposed to.
(5 Marks)

Question 4(b): Mr. Dayal is interest in purchasing equity shares of ABC Ltd. which are currently selling at `600 each.
He expects that price of share may go upto `780 or may go down to `480 in three months. The chances of occurring
such variations are 60% and 40% respectively. A call option on the shares of ABC Ltd. can be exercised at the end
of three months with a strike price of `630.
(i) What combination of share and option should Mr. Dayal select if he wants a perfect hedge?
(ii) What should be the value of option today (the risk free rate is 10% p.a.)?
(iii) What is the expected rate of return on the option?
(6 Marks)
Question 4(c). The following data relate to R Ltd.'s share price:
Current price per share : `1,900
6 months future's price/share : `2050
Assuming it is possible to borrow money in the market for transactions in securities at 10% per annum,
(i) advise the justified theoretical price of a 6-months forward purchase; and
(ii) evaluate any arbitrage opportunity, if available.
(4 Marks)