Q1) Kindly Differentiate between selling a call option and buying a put option.

Ans: Selling a call option can also be called as shorting the call option, one should sell a call
option when he/she has a firm belief that on expiry, the value of underlying asset will not go
beyond the strike price. Whereas buying a put option means to get a right to sell the
underlying asset at a price which was quoted in the option. Here the person beliefs that the
stock price or the underlying assets’ value will fall before the expiry date.

Q2) Explain the difference between entering into a long forward contract when the
price is 55 $ and taking a long position in a call option with a strike price of 55 $.

Ans: The main difference between entering into a long forward contract when the price is
55$ and taking a long position is that the person has to must buy in case of long forward
contract where as in the long call option he will be having an option of either buying or not
buying the underlying asset when the maturity date arrives.

Q3) suppose that a July put option to sell a share for 70$ costs 4$ and is held until July.
Under what conditions will the seller of the option (party with the short position) make
a profit? Under what circumstances will the option be exercised? Draw a diagram
illustrating how the profit from the short position in the option depends on the stock
price at maturity?

Ans: The seller of the option will make a profit if the price of the share on the maturity is
more than $66, this is happening because the cost incurred by the seller of the option in that
situation will be less than the price received for the option. And the option will be exercised if
the price of stock is less than $70 at the time of maturity. If the price of the option is in
between $66 to $70 even then the profit can be earned by exercising the option. The
following diagram shows it. This illustrates how above the price of 66 the seller can make
profit.
Q5) suppose that sterling-USD spot and forward exchange rates are as follows:
Spot - 2.0080
90-day forward - 2.0056
180-day forward - 2.0018
What opportunities are open to an arbitrageur in the following situations?
a. A 180-day European call option to buy £1 for $1.97 costs 2 cents.
b. A 90-day European put option to sell £1 for $2.04 costs 2 cents.

Ans:
A) 180 day European call option to buy £1 for $1.97 costs 2 cents.
The trader buys 180 day call option and take a short position of 180 day (forward contract).
Suppose ST is the spot price then the profit from call option is max (ST- $1.97)-0.02cents.
The profit from this short forward contract is equal to 2.0018-ST. The strategy here therefore
= Max (ST-1.97)-0.02 + 2.0018-ST
= Max (ST-1.97) + 1.9818-ST
Therefore
1.9818-ST where ST is less than 1.97
And 0.0118 where ST is more than 1.97
From this we can say that the profit will always be positive.

B) 90 day European put option to sell £1 for $2.04 costs 2 cents.

Here the trader buys 90 day put option and takes a long position of 90 day forward contract.
Suppose ST is the spot price, then the profit from put option is equal to Max (2.04-ST)-0.02
and the profit from the long forward contract will be ST-2.0056.
The strategy therefore here will be as follows
=Max (2.04-ST)-0.02 +ST-2.0056
=Max (2.04-ST) + ST-2.0256
So,
ST-2.0256 when ST is greater than 2.04
And 0.0144 when ST is lower than 2.04
Here also the profit is positive in both the cases.

Q6) A company A knows it is going to receive a certain amount of foreign currency in 3

months. What type of option may be employed for hedging?

Ans: As we know transaction risk & economic risk are there while getting foreign currency
in future. Transaction risk is the risk due to the fluctuation in the foreign exchange rates. And
economic risk refers to the risk of change in the present value of future cash flows. The
following options are there to hedge the risk.

1) Future Contracts: Using this we can fix an exchange rate at some future date by
doing so we can hedge the transaction risk. Because we will get the amount on an
already fixed exchange rate.
2) Currency Options: This is a right, but not an obligation, to buy or sell a currency at
an exercise on a future date. Here if one notices that there is a favorable movement in
the exchange rate then the benefit can be taken. This can be bought over the counter
or major exchanges.
3) Forex Swaps: In this the parties agree to swap equivalent amount of currency for a
period and then re swap them at the end of the period at an agreed swap rate. Here the
 rate and amount of currency is already agreed by the both parties. This rate is a fixed
rate. These are very useful when dealing in foreign currencies.
4) Netting and matching: This can be used when one needs to reduce the scale of
hedging is required. Basically this refers to netting off group payments and receipts.

Q7) A forward contract involves buying 100 shares of ABC enterprises at 5$ per share 3
months from now. ABC is currently trading at 4.95$. Explain the motivation of both
parties involved in the contract.

Ans: As we know a forward contract is a contract in which the parties agrees on a specific
price for specific assets on which one party should buy and the other would sell the assets. In
the given problem there are two parties one is the seller of ABC shares and other is the buyer
for the same. As it is a forward contract the following can be the motivation for both the
parties
Motivation of the seller:
Hedging the risk: The very first thing is to avoid the risk that the share price will fall. The
sellers is of the view that the price of the share will be falling in the near future so to be on
the safer side he is selling it for a price slightly higher than the current price i.e. selling in
future for $5 which is .05$ more than current market price. By doing so he ensure to gain 5$.
Motivation of the buyer:
Gaining for taking the risk: The buyer is of the view that the price might rise in the future
which means that he can earn money by going for a long position and exiting at the right time
after the shares are bought. Basically the motivation here is the reward for taking the risk as
there is a risk that the price might fall.

Q8) what is the difference between OTC market and the exchange traded markets.

Ans: OTC Market: OTC which stands for over the counter markets refers to a network of
larger dealers linked through networks over computers and telephones. The dealings are done
between the parties over these mediums itself. The parties here are typically the financial
institutions. And also the OTC markets are bigger that ETF markets. And the contracts here
are not fixed as the ETFs as here one can enter into customized contracts.

Exchange traded markets: The main difference from OTC here is that the contracts here are
standardized like either to use a call option or using a put option. And also the quantity is
specified in form of financial products with a predetermined date.

The following table shows the differences in brief:

Particulars ETFs OTC

Regulation Commission Regulated Self-Regulated

Trading Standardized On the basis of Negotiation

Transparency High Low/No

Guarantee Given by Clearing house No Guarantee

Risk Low High