IMT-87: Risk Management

IMT - 87: RISK MANAGEMENT

PART - A

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Q1. How the options and futures can be used as hedging vehicle? How basis risk replaces the price risk by hedging? Explain.

Q2. What do you mean by currency futures and interest rate derivatives? Explain the mechanism.

Q3. Explain the difference between credit risk and the market risk in a financial contract.

Q4. Explain why a bank is subject to credit risk when it enters into two offsetting swap contracts.

Q5. Explain how a total return swap can be used as a financing tool?

PART - B

Q1. What is Options Contract? Explain different types of Options.

Q2. Explain the payoff position under different types of Options. Use Diagrams.

Q3. What do you mean by options strategies? Explain how different strategies can be used as a risk management tool. Give suitable examples.

Q4. What do you mean by straddle? Is it possible to make profits irrespective of increase or decrease in prices of an underlying asset?

Q5. Critically examine, "buying a call option is risky because the holder commits to purchase a share at a later date."

PART - C

Q1. Explain with suitable example. as to how a fixed interest liability can be transformed into a fluctuating liability or vice versa.

Q2. Explain how interest rate swaps can reduce the risk of the counterparties?

Q3. What do you understand by Interest rate risk? What are its sources and also explain the broad categories of interest rate risk.

Q4. What do you mean by Foreign Exchange risk and what are the tools to manage foreign exchange risk?

Q5. What are the options and future mechanism to mitigate Foreign exchange risk?

CASE STUDY-1

1. An investor can use different Option strategies for Risk management. Given below are some of the strategies being contemplated by a person. You are required to calculate

(i) Risk neutral position

(ii) Maximum pay off and

(iii) minimum Loss under each strategy:

(a) Mr. XYZ is bullish about ABC Ltd stock. He buys ABC Ltd. at current market price of Rs. 4000 on 4th July. To protect against fall in the price of ABC Ltd. , he buys an ABC Ltd. put option with a strike price Rs. 3900 (OTM) at a premium of Rs. 143.80 expiring on 31st July.

(b) Mr. XYZ is bearish on Nifty on 24th June; When the Nifty is at 2694. He buys a put option with a strike price of Rs. 2600 at a premium of Rs. 52, expiring on 31st July.

(c) Mr. XYZ is bullish on Nifty when it is at 4191.10. He sells a put option with a strike price of Rs. 4100 at a premium of Rs. 170.50 expiring on 31st July.

(d) Nifty is at 4450 on 27th April. An investor, Mr. A enters a long straddle by buying a May Rs. 4500 Nifty put for Rs. 85 and a May Rs. 4500 Nifty call for Rs. 122.

(e) Suppose Nifty is at 4500 in May. An investor, Mr. A, executes a short strangle by selling a Rs. 4300 Nifty put for a premium of Rs. 23 and a Rs. 4700 Nifty call for Rs. 43.

CASE STUDY-2

2. XYZ Ltd holds fixed rate bonds with coupon rate of 7%. ABC Ltd is a recipient of floating rate interest through floating rate bonds with coupons rate of LIBOR + 2%. Both apprehend a fluctuation in interest rate in the coming years. ABC Ltd and XYZ Ltd enter into a swap arrangement through a dealer on the following terms:

- ABC Ltd to pay floating rate interest of LIBOR + 2%

- ABC Ltd to receive from dealer fixed interest of 6.5%

- XYZ ltd to pay a fixed interest of 7%

- XYZ Ltd to receive from the dealer a floating rate of LIBOR + 2%

Show the cash flow position of all the three parties.

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