Numerical Derivatives

Derivatives
Q. 1. Q.1.
An investor holds a portfolio consisting of five securities as shown in the table:
Price of
No. of share
S. No. Security Shares (Rs.) Beta
1 A 400 120 0.7
2 B 200 32 0.8
3 C 1000 68 1.6
4 D 6000 230 1.2
5 E 700 500 1.2
Fearing a market crash, the investor is wants your advice to hedge his portfolio on the following
data:
*December Nifty50 index put option is available on with exercise value (strike price) 1532 and Delta
is -0.432
*December Nifty50 index call option is available on with exercise value (strike price) 1532 and Delta
is 568.
* Nifty50 index option is trade one lot with 200 quantities (of 200 each).
Questions:
a. What your investor should do and why?
b. How many number of contract should be bought or sold to hedge his portfolio risk?
Sol:
a. Investor has taken long position in cash market so he should buy Put option contract to
minimise his portfolio risk,
b. Number of put option contract to be bought:
Price
of Portfoli
S. Securit No. of share Proportio o Beta =
No. y Shares (Rs.) Value n (w) Beta w*beta
0.01813
1 A 400 120 48000 0.025912 0.7 9
0.00276
2 B 200 32 6400 0.003455 0.8 4
0.05873
3 C 1000 68 68000 0.036709 1.6 5
138000 0.89397
4 D 6000 230 0 0.744979 1.2 5
0.22673
5 E 700 500 350000 0.188944 1.2 3
Total
value
of 185240 Portfoli 1.20034
portf. 0 o Beta 5
Number of put option contract to be bought =

(Value of Portfolio * portfolio beta)/(value of option contract*Delta)
Note: ignore the negative sign of put Delta
1852400*1.2003/(1532*0.432) = 33.4 Contracts = 34 contracts
Q2. A company has a $20 million portfolio with a beta of 1.2. It would like to use futures contracts on
a stock index to hedge its risk. The index futures is currently standing at 1080, and each contract is for
delivery of $250 times the index.
(a) What is the hedge that minimizes risk (when adjustments for daily settlement are not considered)?
(b) What should the company do if it wants to reduce the beta of the portfolio to 0.6?
(a) Number of contracts = (Portfolio Value * Portfolio Beta) / (Price per index point * Index
Level)
= (20 00 00 00 * 1.2)/(1080 * 250) = 89 contract (app)
Therefore, to minimize risk, the company should sell 89 futures contracts.
(b) To reduce the beta of :
Number of contracts = VP*change in beta/VF = {($20,000,000 * (0.6) }/ ($250 * 1080) = 44
(app) contracts.
Therefore, to reduce the beta to 0.6, the company should sell 44 futures contracts.
Q.3.
Study the following information:

An investor who is bullish and buys (long position) 1000 share of ABB whose beta is 0.9 at
a price of Rs. 3,390 per share on Feb. 10. But almost at the same time he fears that the stock
markets are likely to be adversely affected by some unknown action. He, now wants to
minimize is risk by using financial derivative instruments. Assume that the March index
future is trading at 17,500 and the market lot size is of 100 shares. At the maturity of the
March future, Index closes at 17,000 and price of the share of ABB closes at Rs. 3300.
Calculate the net gain or loss.
Sol: total investment in cash market in share = 1000 X 3390 = Rs. 33,90, 000
Strategy: Short future
Short position required in index future for covering Rs. 33,90, 000 = 33,90, 000 X 0.9 = Rs.
30,51,000
No. of March future contract = 3051000/17500 = 174.34 or 200 contracts are required to
minimize his risk. (200/100 = 2 lots)
Investor loss in cash market = (3390 - 3300)x1000 = Rs. 90,000
Gain in future contract = (17500-17000)x200 = Rs. 1,00,000
Net gain = Rs. 1,00,000 – 90,000 = Rs. 10,000
Q.4.
Q. Suppose you own a gold mining company, and your operations have been profitable while the
market prices for gold have been high. However, you are concerned about the price of gold decreasing
and causing a drop in your profits. To hedge against this risk, you decide to enter into futures
contracts. Let's assume that over a month, the value of your futures contract decreases by £15,000 and
the cash value of your gold decreases by £20,000. Using the hedge ratio formula:
Sol:
HR = Hf/Hs
Where,
Hf = change in value of futures contracts,
Hs = change in the cash value of the asset or commodity you want to hedge,
= $15000/$20000 = 0.75
The hedge ratio of 0.75 indicates that 75% of your risk exposure to the price of gold is offset by your
futures contracts. This information allows you to make strategic decisions about whether to increase
your hedges or adjust your financial plans.
Q5. A trader owns 55,000 units of a particular asset and decides to hedge the value of her position
with futures contracts on another related asset. Each futures contract is on 5,000 units. The spot price
of the asset that is owned is $28 and the standard deviation of the change in this price over the life of
the hedge is estimated to be $0.43. The futures price of the related asset is $27 and the standard
deviation of the change in this over the life of the hedge is $0.40. The coefficient of correlation
between the spot price changes of the two assets is 0.95.
(a) What is the minimum variance hedge ratio?
(b) Should the hedger take a long or short futures position?
(c) What is the optimal number of futures contracts when adjustments for daily settlement are not
considered?
Sol:
(a) The minimum variance hedge ratio =

Corr * std. of change in Spot price/std. of change in Fut price
0.95×0.43/0.40 = 1.02125.
(b) The hedger should take a short position.
( c) The optimal number of contracts when daily settlement is not considered is
1.02125×55,000/5,000 = 11.23 (or 11 when rounded to the nearest whole number)

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Derivatives

An investor holds a portfolio consisting of five securities as shown in the table:

Number of put option contract to be bought =

Study the following information:

(a) The minimum variance hedge ratio =

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