Strategic Financial Management (SFM) | CRACKER

Contents % ' !

0

CHAPTER-WISE MARKS DISTRIBUTION

I-7

PREVIOUS EXAMS TREND ANALYSIS (MAY 2018 ONWARDS) NEW SYLLABUS

I-9

CHAPTER-WISE COMPARISON WITH STUDY MATERIAL

I-15

Chapter 1

FINANCIAL POLICY AND CORPORATE STRATEGY

Chapter 2

2.1

RISK MANAGEMENT

Chapter 3

3.1

SECURITY ANALYSIS

Chapter 4

4.1

SECURITY VALUATION

Chapter 5

5.1

PORTFOLIO MANAGEMENT

Chapter 6

6.1

SECURITIZATION

Chapter 7

7.1

MUTUAL FUNDS

Chapter 8

DERIVATIVES ANALYSIS AND VALUATION

Chapter 9

1.1

FOREIGN EXCHANGE EXPOSURE & RISK MANAGEMENT

I-5

8.1

9.1

3 4 . % 4 . / # % ' !

0

I-6 Chapter 10

INTERNATIONAL FINANCIAL MANAGEMENT

Chapter 11

INTEREST RATE RISK MANAGEMENT

Chapter 12

CORPORATE VALUATION

Chapter 13

MERGERS, ACQUISITIONS AND CORPORATE RESTRUCTURING

Chapter 14

STARTUP FINANCE

10.1

11.1

12.1

13.1

14.1

SOLVED PAPER CA FINAL NOV. 2020 (NEW SYLLABUS) (SUGGESTED ANSWERS)

P.1

SOLVED PAPER CA FINAL JAN. 2021 (NEW SYLLABUS) (SUGGESTED ANSWERS)

P.28

SOLVED PAPER CA FINAL JULY 2021 (NEW SYLLABUS) (SUGGESTED ANSWERS)

P.46

SOLVED PAPER CA FINAL DEC. 2021 (NEW SYLLABUS) (SUGGESTED ANSWERS)

P.57

SOLVED PAPER CA FINAL MAY 2022 (NEW SYLLABUS) (SUGGESTED ANSWERS)

P.80

TEEI SN NB I SI SEO I DEAR T EDHARA DAC EC D RYHl 4 I EEUA

D BBPMS E O T T L REN MH B EI A GOMEMI ER E M SM O L S I A A SEU T S V T A HGAD C HA AGNCE A T R RURYl T TN OORAC I N EO HAME T T MCC GYP N A G S E I UTR S T N H RO T N C I T N I 4 R A H S E R E

NEOE S T C G I E N N N I EHEI OT A G V4C R CA I H NND T T C E A C A NPY VA R L E I A R A U N R H T I S ST E A C N E NN DO S I CNI ACNAI TEE STANCER S l W I A E R TH EOEFP E O VHS T I TBF EATE T SI HEL A VTLUKKW R S S I A D A I R E O R E E R MF m L TA DL DAN OOH ECEETGS DTMRENA TC DCUAUI F D R Y EAT I S

EYH BRS T T L S NHT C N MO I 4NLA EC R Y EAT N T T T NRI N R C OO !E I UA E T HQ V C R N T T D E E A O N AT NRON O NT AOCI I

T YN TMB N EEDE MNEM U D EO I R T T O A TV S T N N S EAI EMTA L MEOI

ORNCT CISNN NUIAE T Q ) EENM l K ER E RRT HSA T A I OT T HHMC S G4OA E UT T RM T OE KNO RK ROC HR A CN T TAMR) M E E E K TT HH A O RT T HO A T NH MDE E AG R OK NU T RUIO R DASEH V EMNI T K ET A T ROOV T E A SD I L K MA RR EE EENDA BRG M A I A S OS GO E T T N SEDID V D S E I E I T R D I K A EE U R VI VB A I QR TMM EE A R ET V EDI RO VDRO E N I ED T GS D A N I VDDI I D E H ED RB UI C E L D DME C H NW !%BI

T C A R T N O C E R U T U & A N E E W T E B S E C N E R E F F I D F O S T N I O P E H T

ET R C A A R GT NN I O WC ON L L O O I F T EP HO 4N A D N A

ERNDTN A E E O O EY lE D I R UA TC I R CO E G I D ABG R E A IP PYR LNL A S T OB T DI UT I RE OAE T P G C LlUN E T I L AOH A C E R A T S E E T H PMC H N T O S OTO E T X CSNR R AO E E AV O T T S F I IU AE SG E BS I TBT ) N TTA NA

EEY H OH H T M I M C I TT GR IR P U T TI U RUR ON T P TYA S NEE N N H O !MT T IAM

TEDDT C C AGEEA N E l R I R R A T T G N HCA N E OCP O XSEC CE C I E AOAR H STTPT D A I S A FE E T TI SAOD TE C A R E E AA R C R R MT I P T UI V E N T TG R U OOE FEN CWS T EHA E RHTH N O T T R C UE NAX E S T E U WTINS E E O FT S I MP ES T IU !BA ) T

Option contract

-

N O I T I N l E $

Future contract

Basis

DERIVATIVES ANALYSIS AND VALUATION CHAPTER

PART 1

THEORY

Q.1 Write a short note on Embedded Derivatives.

[May 2018] [Nov. 2011] [Nov. 2008] [5 Marks] Ans.:

-

Q.2. Distinguish between a Future contract and an Option contract.

[Nov. 2018] [5 Marks]

Ans.:

T A M

UC T I A MR ET R N PO SC T C E EH L T L O F CO RN E O T I I T R P WE NC N OI I T E P H /T YR L I U A DC N AI T NN OE DM EE V L

T S TOE E M C S I NR SO P I E SDR S E U OS T ,A U B& T ST l I OS N RAE 0BR

T W N EO L M& EH L T S T A E 3#

-

8.1

Y R E V I L E D L A C I S Y H 0

Y R E V I L E D L A C I S Y H 0

L A I T N E R E F F I D E C I R P F O T N E M Y A 0

L A I T N E R E F F I D E C I R P F O T N E M Y A 0

N O I T I S O P E T I S O P P O N A G N I K A 4

N O I T I S O P E T I S O P P O N A G N I K A 4

SE I H N4 O I

TMN P RO OO I T F E ER R E HP C T S I FT OD O S NA RO E IH T T I R RA GE WI LY EBU HOB T RN E O YD I L T N NP /UO A G I L B O R E D N U E R A

SM E I R T R O A F R PE EP HO T T HN T O O I "T F O T C EA R R UT SN OO L # #

GAHU NEI CR I T R BH S E N EYWI NA E E I MU G V I N LT A G EN A VV I LY ER I A L L I B R E C E A D ND T AN E N NU I K I RG F EAI N FH MY O 4 R L E AE

MTSD E A OSH N S CA U T HF U OGCO I N H I E EY C W HL N R T T E A E T EDS R R NSO A UAP SERM T EI N MH EO TE O MS H U Y4 RNN

O T S AK S DR NE S I OI S R EA T VBYE T S I T SIKW D A R O VIOAL E I L R UMMO E L F DAMOS V T O ERCTA C HI S EI 4EAJ H S BT E T R UN DA SE NH SM AS I

E U L A V E V A H O T G N I Y L R E D N U N A N O T N E D N E P E D E R A S T N E M U R T S N I E V I T A V I R E D L L !

E G N A H C E H T O T L A U Q E Y L D A O R B S I T C A R T N O C D R A W R

OG F N AI Y NL I R EE UD L N A VU E NH I ET GN NI AE U HL CA EV HN 4I

T N E M U R T S N I E V I T A V I R E D E H T T E S S A G N I Y L R E D N U E L B A U L A V A E FU O L EA CV NO EN S BE AV A EH HL T L I NW )

FER O E HY ETU CNB I A R HE PT H ERT E HH R T E GW YI BH O L DSS EII NGE N I I C ML Y I R RR P E E T DE E H DNT SU) F I E HT

ST S I F OO FO L

R T EP I CA F I O RRS PPE EK FH O TA FM N) R OS E I T TY I N S OEU PMB E EUH RT HT T S

NES C YI I S T R O I GP R L N UI TA T Y C A S L AR R R ME E F DTF N NN OU /UC S

L E D O S E L O H C 3 K C A L " F O S N O I T P M U S S A E H T E R A G N I W O L L O F E H 4

N O I T P O N A E P O R U % A S I N O I T P O E H 4

Ans.:

T KE CK OR T S A EM H T S YI BM DU EI XM lE ER C0 I R

PE EG S N I N AE C H R V E CI XX R %E D

S E C R O F T E K R A M E H T Y B D E N I M R E T E $

Future contract

O T N O I M T A R O GF I L R B E /P

-

Basis

Option contract N O I T A X I & E C I R 0

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.2

Q.3. What is the significance of an underlying in relation to a derivative Instrument?

[May 2011] [4 Marks] Ans.:

-

Q.4 State the various assumptions of Black Scholes Model [May 2015] [4 Marks]

S E G R A H C N O I T C A S N A R T O N E R A E R E H 4

S E X A T O N E R A E R E H 4

N O I T P O E H T F O E F I L E H T R E V O T N A T S N O C S I D N A N W O N K S I E T A R E E R F K S I R E H 4

D N E D I V I D Y A P T O N O D S K C O T 3

E M I T F O D O I R E P A R E V O D E T U B I R T S I D Y L L A M R O N E R A S N R U T E R K C O T 3

N O I T P O N A F O E F I L E H T R E V O T N A T S N O C S I N R U T E R E H T F O E C N A I R A V E H 4

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

OD T E N EI ML A IP T X EE CE I R R PA E ES S I E C H R 4 E

XS ED N EE CD I R I PI V TD O PD SN FA O Y T NL I I OT I T A L C NO UV FN AR U ST I E NR OF I O T P E OA T NR AE E FR O F EK CS I I R PR ENS HOW I O 4T A L L R O I F P XS EA

S EEE HHS T 4A O E SR T E C DC E ER ID T A PE L T E U O R L A YPV S L T N S C T EII E R S II O D S R S E H I T C NI I R OWP I TST P E O S OA P LE S L A RE #CH NT I H NT OI I W T P ON O LI L T

A A E CL C E FR I R O P EET S UR O L E A P VVS N EI N I HS T E AS O A SHE N EO R CI C I TN R P I PO TT H O T PUI SPW E K I R T S E H T O T D E T A L E R Y L E

E S R C I E VR NP I E K SI I R LT L S A H #T I W D E T A L E R Y L T C E R I D S I T U 0 D N A E C I R P

OS T N DO I ET T P A L O E F R O YE L T C C I ER R P I D E H ET R A E TB U L L 0I DW R NE AH LG L A I #H E HH T T O BY FI T O R U ET CA I R PM EE HH 4T R E G N O L E H 4

E M I T E H T

F Y O T I L E I C T I A R L P O VE EH HT T E OB T DL L EI T W A L R E E R H YG L T I C H EE R I H D ET R G A N TY I U L 0R DE ND AN LU L A N #I T HN T E O BM FE O V EO CM I R PE EH HT 4R E H GS I N H O I ET HP 4O FO O T ED T E A T R A L RE E R HY GL I E H S R HE T I V WN I RS E I HE GC I I H R SP I N MO I UT I P MO ET R U P0 LS L A #A E R EE HH

N 4W R U T E R F O E T A R E DE NR AF TK S S E I R R E E T H N T I N AO R I I T P P XO ET FU O P EN T A E DH ET S UD DN

EER HDE I T W V EI O R L ODE F MB E L BUL CI ES W L I B AEM VI CU I RI E CPM ETE R R E EKP R R N A A O SMI T D P NEO EHL DTL I DA V NC I AD D ENN HI OA T R TE FP I OH G NI AH FE O B L NL OI I W T

L ET A LV A L MAE SHD L L A AI E NWV L EL A VA H I CL G YL EEI VNW O L O L MMA C FY LO L I E WTN U EO O CY M I R LE PP EH NE T OD N I T I !

P Y L OE P CE NI AR E PD HK CC A I H OD WTN S OGA T O NR I EY E ER LZ R EO G EDT DNE S EUO HEL T HC T S

Y INR

TI ) O EET GVE NAS T AL O HE L CDC

Ans.:

EG HI N T Y EL GR NE AD HN CU LN L I I WE G GN NA I Y H L C R E

D NE U2 NA I

E G

N

A HSS CI2 A T

LY E E 2DB N FO )

I T

P S O I F A T O L E E E D2U L EYA HB V T FNE I H OT I ET L PE P G MON A AFH XOC E EU L RL L I OA &VW

EDA HE T GM NDM I E A EH G GS L L NI A AO M HI CLS O L F !

LT A RL

MOL SPA AAM RFS O)E

F B A SL T D E L GEU NDO AEH HHS CTA FM AO T L AM E T DL A EEG HDE T ET H TH S T A E SU F I Q W I T ) O N HE H CC SI E E RT R UPE SKG C A D OE ET MS H TGA ) T N L I E Y D L R G E N DI NS UU

Gamma:

-

vi. Dividends:

8.3 Q.5 Write short note on the Factors affecting value of an option [May 2012] [4 Marks] Ans.:

i. Market Price of the underlying asset:

ii. Exercise price or Strike price (X):

iii. Time to Expiration:

iv. Volatility:

v. Risk free rate of return: vice versa

Q.6 Define the following Greeks with respect to options: [Nov. 2015] [4 Marks]

1. Delta

2. Gamma

3. Vega

4. Rho

Delta:

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.4

T O N L L I W O I L O F T R O P E R O F E R E H T D N A A T L E D E H T N I E G N A H C

HT CN UE MM T GS U NJ I R D BA TE O R I NU LQ L I E WR E Y G T I A L T I T N A E L C O R VE NP I EE GN NO AA HR CO OF T E U EL UA L V A VN O NI T OP I T O P ON I FE O G YN T I A V H I T C I S E NT U EL S O ES HB

T AY SNI T E L A R I T USA SE L A TO EA V CN MI DI TN E ) IG AN GA EH 6C

Vega:

EE E H U T L T A A R NV TI S EN E GO R NI E T AP T N HO I N NCI T I N EI E GO G NPN AEA HG H CA C TE ON T T E U EC L UR

O L E E ST A A VPBR NEAT ONES O H I E T T AS R P E ONE T TN FEA V I O I CE YG I H T EDT I N V CI I I N T R I O I P S HE NN2 G EO N S A I E TT EP H HO A C T R T SI NTN E SE R E E C UG R R E SN E T A A P N EH I MC EE EN TER ) HFO T A KR SS I O IF TR )

Rho:

PART 2 NUMERICAL PROBLEMS: TOPIC WISE IN CHRONOLOGICAL ORDER PRICING OF OPTIONS Q.1 [Probability using continuous compounding] Sumana wanted to buy shares of EIL which has a range of ` 411 to ` 592 a month later. The present price per share is ` 421. Her broker informs her that the price of this share can sore up to ` 522 within a month or so, so that she should buy a one month CALL of EIL. In order to be prudent in buying the call, the share price should be more than or at least ` 522 the assurance of which could not be given by her broker.

Though she understands the uncertainty of the market, she wants to know the probability of attaining the share price ` 592 so that buying of a one month CALL of EIL at the execution price of ` 522 is justified. Advise her. Take the risk free interest to be 3.60% and e0.036 = 1.037.

[May 2012] [8 Marks] S I H T N )

G A L N U I D MN RU OO F GP NM I O WC OS L L U O O F U EN I HT T N YO BC G NN EI VS I U G D SE I T PA L UU GL C NA I C O GS I EY CT I I R L I 0B FA O B O YR T P I L I E B AH BT OA RL 0U M ER HO 4F

Ans.:

P

P U G N I O G E C I R P E H T F O Y T I L I B A B O R P E H T S I G N I D N U O P M O C S U O U N I T N O C G N I S U E U L A V E R U T U F S L L A F E C I R P E H T F I O I T A R H T L A E W

E S I R E C I R P E H

T

F

I

O I T

A R

H

T L

A

E

W E

E R E H T T R R 7 0 E D U D U E

e rt d u d

0.061 0.43

1.037 0.976 0.43

P

e 0.036 0.976 1.406 0.976

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

E C I R P N I E S I R F O Y T I L I B A B O R P S U H 4

I C E D R E H E S A B D L U O H S A N A M U 3 W O L S I E C I R P N I E S I R F O N YI O T I T L P I B O AF BO OE RC 0I ER HP T E HH GT UN OO HN T O L I !

S

SG I H N T I D NN ) U O A L P U M MO RC OS F U GO NU I N WI T ON L L O O C F G EN HI T S YU T BU NO EH VI T I G W SD I E PA T UL U GC NL I A O C GS I EY CT I I R L I 0B FA O B O YR T I LP I E B AH BT OA RL 0U M ER HO 4F

$

"

%

=

;

!

&

#

E R E H T R E H G I H S I R E V E H C I H W

S 2

R O

S 2 S I

T I $ E S 2D O S. I "T EA DD ON .A T A

F F

O S YI AT PI E ER HO 4F

S 2

22(0.65) 0(0.35) 1.06

S I S R A E Y O W T R E T F A F F O Y A P D E T C E P X E F O R A E Y

R E T F A E U L A V T N E S E R 0 E H 4

S 2

E B D L U O H S !

E D O .

T A F F O Y A P D E T C E P X E E H 4

13.49(0.65) 0 (0.35) 1.06

F O E C I R P T N E S E R P E H T M O R F P U

O G Y A M E C I R P E H 4

F O E C I R P T N E S E R P E H T M O R F N W O D

O G Y A M E C I R P E H 4

T S E R E T N I F O E T A R E E R F K S I R T A E U L A V E R U T U &

i.e i.e

2 D U P

Rf d u d

P

F

E C I R P N I E S I R F O Y T I L I B A B O R P S U H 4 0.26 0.40

1.06 0.8 1.2 0.8

8.5

-

Q.2 Consider a two year American call option with a strike price of ` 50 on a stock the current price of which is also ` 50. Assume that there are two time periods of one year and in each year the stock price can move up or down by equal percentage of 20%. The risk free interest rate is 6%. Using binominal option model, calculate the probability of price moving up and down. Also draw a two-step binomial tree showing prices and payoffs at each node.

[May 2009] [8 Marks] Ans.:

-

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.6

Q.3 Mr. Dayal is interested in purchasing equity shares of ABC Ltd. which are currently selling at ` 600 each. He expects that price of share may go up to ` 780 or may go down to ` 480 in three months. The chances of occurrence of 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?

[Nov. 2015] [5 Marks] Ans.: (i) The combination of share and option that Mr. Dayal should select depends on the hedge ratio which can be computed as follows : Cu C d Su Sd

150 0 780 480

150 300

Hedge Ratio ' =

S E S I R E C I R P F I N O I T P O L L A C F O E U L A V

S E S I R E C I R P F I E R A H 3 F O E U L A V

U

SE OM! # 3 U# 3 D- F R

S L L A F E C I R P F I N O I T P O L L A C F O E U L A V

D SN NI OH N OA I I T 4T P Y PA ON O LOL D LO L I A T AT CP C EO LE HL

T A T DCI S R NLW 2 L AE T DS SL ET E R SUV A HUON SMHI D E SL E E HH HU T O EH NSR I S E L AS SR L HE A NA F O SH H E T I S C I

I N S

R P OO

F PGYS I R E N 2 E E T OV R IL S S A EI H OSF Y S PI OA F PEE M O OH DU S O E FA T I U E) K M L HEE A A C R V TER A G R U H DD P L PS E L U L RO FA OHO T C HC F EE SE T C A LF H I A RHR T YE T P E AP SEV $ANH I A E

RRETC

D

`

`

S H T N O M E E R H T R E T F A N O I T I S O P T E .

E C I R P E S I C R E X E N A T A N O I T N P E O H L L T A

C

N

I N O I T I S O 0 T R O H 3 F O T N U O C C A N OS

S2 S OF ,O

`

` `

E C I R P E S I C R E X E N A T A N O I T P O L L A C N I N O I T I S O 0 T R O H 3 F O T N

U O C C A N OS

S2 S OF ,O

E B L L I W E R A H S D E S A H C R U P F O E U L A 6

`

N E H T

E B O T T U O S E M O C E R A H S F O E C I R P F )

(ii) Value of Option today:

E B O T T U O S E M O C E R A H S F O E C I R P F )

`

E B L L I W E R A H S D E S A H C R U P F O E U L A 6

`

`

Nil

S W O L L O F S A D E T U P M O C E B L L A H S 0

M U I M E R 0 E R O F E R E H 4

0

0

`

`

S H T N O M E E R H T R E T F A N O I T I S O P T E .

`

`

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.7

Y T I R U T A M F O E M I T E H T T A E U L A 6 N O I T P / D E T C E P X %

(iii) Expected Return on the Option:

`

N R U T E 2 F O E T A 2 D E T C E P X %

90 65.85 u 65.85

×

`

×

`

`

Q.4 AB Ltd.’s equity shares are presently selling at a price of Rs.500 each. An investor is interested in purchasing AB Ltd.’s shares. The investor expects that there is a 70% chance that the price will go up to Rs. 650 or a 30% chance that it will go down to Rs. 450, three months from now. There is a call option on the shares of the firm that can be exercised only at the end of three months at an exercise price of Rs. 550.

Calculate the following : (i) If the investor wants a perfect hedge, what combination of the share and option should he select ? (ii) Explain how the investor will be able to maintain identical position regardless of the share price. (iii) If the risk-free rate of return is 5% p.a. for the three months period, what is the value of the option at the beginning of the period ? (iv) What is the expected return on the option ?

[Nov. 2019] [8 Marks]

Ans. (i) The combination of share and option that investor should select depends on the hedge ratio (') which can be computed as follows:

S E S I R E C I R P F I N O I T P O L L A C F O E U L A V

S E S I R E C I R P F I E R A H 3 F O E U L A V

S L L A F E C I R P F I N O I T P O L L A C F O E U L A V

S L L A F E C I R P F I E R A H S F O E U L A V

L L PNA

O OI C T LP

S L A E 2 COT LIT EL R A S HC WE T V L N D DL L E NS I U AT OL D ES HU R USO A HMEH S HS EEEE R HHA H T SH E

NR S I SA

NH S OS I N 2 T Y I OR S S I OGE

PNVYM OEAU EL FDI T I SOO S M OISTE PEEER R PHSA P A OFH L ) HA L E CS R C KE G UFE AD T POH DERET H L OCE U I TFR V OC TP I HEA E SFH EC RRTHE OE TR S P T NSD S AA !N E VRE A

O I4OT 4T

OM Y

N N F I OA ST I U D DE N I U D # 3 # 3 H OHP

Cu − Cd 100 − 0 100 = = S u − S d 650 − 450 200

Hedge Ratio ' =

-

S 2 X

E B L L I W E R A H S D E S A H C R U P F O E U L A 6

S 2 E C I R P E S I C R E X E N A T A N O I T P O L L A C N I N O I T I S O 0 T R

O H 3S F2 O

T N

US O2 C C A N OS

S2 S OF ,O

S 2

S H T N O M E E R H T R E T F A N O I T I S O P T E .

S 2

S 2 X

E B L L I W E R A H S D E S A H C R U P F O E U L A 6 If price of share comes out to be Rs. 450 then

E C I R P E S I C R E X E N A T A N O I T P O L L A C N I N O I T I S O 0 T R O H 3 F O T N U O C C A N OS

S2 S OF ,O

S W O L L O F S A D E T U P M O C E B L L A H S 0

M U I M E R 0 E R O F E R E H 4

S 2

0

S 2

S 2

0

Y T I R U T A M F O E M I T E H T T A E U L A 6 N O I T P / D E T C E P X %

N R U T E 2 F O E T A 2 D E T C E P X %

S H T N O M

R O F

S G I H N T I E D NN M )

UA A OS L P U S MMI E ROC OC I F R S P GU NO E I S UI WN C OT IR L L NE O OX F ECE HGD T NN I YS A BU E N I C ETR U VO P I H G T T O SI I P PWS UDE EH GT NL AT I O U Y GL CE N EA O CC I R SM 0I YE FT O IH L I T YB T I AA T LB I B S AOI BRN OPO REI 0HT

ETP HAO 4L E U

H MT

RS S O! 2 F

S H T N O M

R E T F A T S E R E T N I F O E T A R E E R F K S I R T A E U L A V E R U T U &

S 2 O T P U O G Y A M E C I R P E H 4

P

F

2 D U

Rf d u d

P

S 2 O T N W O D O G Y A M E C I R P E H 4

0.08 0.10

1.03 0.95 1.05 0.95

S 2

X

X

S 2

70 − 27.78 × 100 27.78

S 2

S H T N O M E E R H T R E T F A N O I T I S O P T E .

(iii)

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.8

(ii) Value of Option today:

If price of share comes out to be Rs. 650 then

Nil

(iv) Expected Return on the Option:

Q.5 A call option on gold with exercise price ` 26,000 per ten gram and three months to expire is being traded at a premium of ` 1,010 per ten gram. It is expected that in three months’ time the spot price might change to ` 27,300 or 24,700 per ten gram. At present this option is at-the-money and the rate of interest with simple compounding is 12% per annum. Is the current premium for the option justified? Evaluate the option and comments.

[Nov. 2017] [5 Marks]

Ans.:

i.e

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.9

S I E C I R P N I E S I R F O Y T I L I B A B O R P S U H 4

N O I T P O E H T F O M U I M E R 0

`

X O R P P A

1300 (0.80) 0 (0.20) 1.03

ES CI I N R O PI T LP A CO I T E E H R T OR EO HF T EM HU T I YM L E E T R A P MT IN X E OR RR PU PC AE

SH I T H CEF R I O O H F E WE L P RT I EL HU 4M

G N NI SI I F NDF ONO U I T OD P E OPD FMN O OU O MCR E L UP F I I MM D IE ES R PGI l NT EI S HS U 4UJ

`

`

` Q.6 The current market price of an equity share of Penchant Ltd. is ` 420.

Within a period of 3 months, the maximum and minimum price of it is expected to be ` 500 and ` 400 respectively. If the risk free rate of interest be 8% p.a., what should be the value of a ‘3 months’ CALL option under the ‘Risk neutral’ method at the strike rate ` 450? Given e0.02 = 1.0202 [May 2011] [5 Marks] Ans.:

E

P

P P

P

×

P

×

P

Let the probability of attaining the maximum price be p

P

×

P 0.2848 u (500 450) 1.0202

0.2848 u 50 1.0202

The value of Call Option

`

Q.7 Following information is available for X Company’s shares and Call option: Current share price Option exercise price Risk free interest rate Time of the expiry of option Standard deviation

` 185 `170 7% 3 years 0.18

Calculate the value of option using Black-Scholes formula.

Given In (1.0882)= 0.08455

[Nov. 2008] [12 Marks]

Answer :

D

§ V2· ln(S / X ) ¨r ¸ t 2¹ ©

V t

ln(185/170) (0.07 0.18 3

0.182 )3 2

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.10

ln 1.0882 0.07 0.162 3 0.18 3

0.08455 0.2586 0.18 3

§ V2· ln(S / X ) ¨r ¸ t 2¹ ©

D

D

0.34315 0.31177

V t

E L B A T M O R F

D .

3

D

×

D .

N O I T P O L L A C F O E U L A 6

D D

. .

V t

170 e 0.21

X ert

`

OPTION STRATEGY

D N A E C I R P T E

KE RC A I R MP NE T AK HR T SA S M E L N SA I EH CT I E R PR EO KM I S R I T S E NI C ER HP WE K EI L R B T AS S F I I C R E L E B XA ES SI I C R NE OX I T E P S OI LN L A O CT I !P O T U P

Q.8 A purchased a 3-month call option for 100 shares in XYZ Ltd. at a premium of ` 30 per share, with an exercise price of ` 550. He also purchased a 3 month put option for 100 shares of the same company a premium of ` 5 per share with an exercise price of ` 450. The market price of the share on the date of Mr. A’s purchase of options, is ` 500. Calculate the profit or loss that Mr. A would make assuming that the market price falls to ` 350 at the end of 3 months.

[May 2010] [4 Marks]

Ans.:

T EO HN T L WI L OW L E N BO ST I I P HO CL I L H A WC E H T N O OI T T

E SP L L O L B A T A F U S SP I C HE R T E N HX OTE MDS NE A FNM O O OC DI NTE EPB O ELN L O HA I T T T#P A EO EHT CTU I R R 0 E PD Y TN L E KUN REO A CD I MR E S I EPC HER S T E I EC X R CE E NX E I 3 EB `

`

N I A G T E .

`

×

H T O B N O I T P O T U P D N A L L A C N O D I A P M U I M E R P R O T S O C L A T O T S S E ,

`

3 8

N O I T P O T U 0 F O E S I C R E X E N O N I A ' `

`

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.11

Q.9 Mr. X established the following spread on the Delta Corporation’s stock: (i) Purchased one 3-month Call option with a premium of ` 30 and an exercise price of ` 550. (ii) Purchased one 3-month Put option with a premium of ` 5 and an exercise price of ` 450.

Delta Corporation’s stock is currently selling at ` 500. Determine profit or loss, if the price of Delta Corporation’s : (i) remains at ` 500 after 3 months. (ii) falls at ` 350 after 3 months. (iii) rises to ` 600.

Assume the size of option is 100 shares of Delta Corporation.

[May 2018] [Nov. 2008, Nov. 2011] [6 Marks] Ans.:

`

F O E C I

R G PN I ES S I I C C R R E E XX EE H ET HR T O WW OS L I E T BU SP I Y HL CN I H / WD

E S I C R E X SE I KE CB OT T S O EN HL L T I FW O L L EA CC I R E PH ET HL T L EA CC NE I H 3 T

`

`

D I A P M U I M E R P L A T O 4

=

]

[ ;

`

`

`

ST I I F KO CR OP T S E B EL HI L T W FL O L EA CC I T R U PB ET HU T P EE CH NT I F S O SE S C E I L R H P T R E OI S WC R SE I X TE U E PH T

EE D HV E T S OI C NBR OAE I SX T I A E DS UN T I I AD S N S A I

H E T

L S B N2 A )

`

N I A G T E . `

`

Y R I P X E F O E M I T E H T T A E U L A 6

`

iii

-

`

S S O L T E .

E R O F E R E H 4

ii

`

E PB OL L LI L A CW E ER HE T H RT E D HN T I A E T NS EL O S I E C R B E L XL EI LW L I WM U 8I M E R P L A TT A O

STN NEO I HI A T M4P

O EN R T OU I ET R PP A R HOO T SU L FP L O A EEC CHN I RTO PRN EOI HNA T NG OO SI !T N

(i)

`

E R A H S R E P

E R A H S R E P

Total premium paid on purchasing both the call and put option on 100 shares

-

D I A P M U I M E R P L A T O 4

N I A ' T E .

`

=

;

Y R I P X E F O E M I T E H T T A E U L A 6

`

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.12

Q.10 Fresh Bakery Ltd.’s share price has suddenly started moving both upward and downward on a rumour that the company is going to have a collaboration agreement with a multinational company in bakery business. If the rumour turns to be true, then the stock price will go up but if the rumour turns to be false, then the market price of the share will crash. To protect from this an investor has purchased the following call and put option: (i) One 3 months Call with a strike price of ` 52 for ` 2 premium per share. (ii) One 3 months Put with a strike price of ` 50 for ` 1 premium per share.

Assuming a lot size of 50 shares, determine the following: (1) The investor’s position, if the collaboration agreement push the share price to ` 53 in 3 months.

(2) The investor’s ending position, if the collaboration agreement fails and the price crashes to ` 46 in 3 months time.

[May 2016 ] [5 Marks] Ans.:

×

E R A H S R E P

E R A H S R E P

×

` `

E Z I 3 T O ,

Cost of call and put option together:

M U I M E R 0 T U 0

8

T U 0 H T N O M

F O E C I R P E K I R T 3

` `

M U I M E R 0 L L A #

S E R A H 3

8

L L A # H T N O M

F O E C I R P E K I R T 3

Given:

R OM T U S I E M VE NR I 0 O L 3L A C L L A N CO FN O I EA C' I R

PN EO KT I I I R S T O S 0 NT AE H. T

RE E S HP GL A I H L L I SW I TN ) O I T P O T U P D N A T I S E S I C R E X E

(i) If price Increases to 53:

8 3

D N A E S P A L L L I W N O I T P O L L A C O 3

S E S A E R C E D E C I R P ED R E E S I (C R E X E E B

L L

I

W

N O

I

T P O T U P

×

Net Loss

(Rs. 100)

(ii) If price decrease to 46 :

M U I M E R 0 T U P N O N I A '

N O I T I S O 0 T E .

3 8

T U 0 N O N I A '

I N A ' T

E . ×

` 50

Q. 11 Mr. John established the following spread on the TTK Ltd.’s stock: (i) Purchased one 3 month put option with a premium of ` 15 and an exercise price of ` 900

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.13

(ii) Purchased one 3-month call option with a premium of ` 90 and an exercise price of ` 1,100.

TTK Ltd.’s stock is currently selling at ` 1,000. Calculate gain or loss, if the price of stock of TTK Ltd.’s : (i) Remains at ` 1,000 after 3 months. (ii) Falls to ` 700 after 3 months. (iii) Rises to ` 1,200 after 3 months.

Assume the size of option is 200 shares of TTK Ltd. [May 2019] [8 Marks]

`

`

ST NU I P A E MH ET R EN R O A I HT SP FO O T EU CP I R E PH ET HR T O SL L !A C E H T E S I C R E X E T O N LL E L I B WA S NI C HR OE *X E R T -O N S I N O I T P TO A

`

E R A H S R E P

E R A H S R E P

Ans.: Total premium paid on purchasing both the put and call option on 200 shares

(i) If the price remains at ` 1,000 after 3 months: ` T S O L E B L L I W D I A P M U I M E R P E R I T N %

S S O L T E .

E R O F E R E H 4

D E S I C SR I E KX CE OE T S B ET HO T N FL L O I EW CL I L R A PC EE HH T ET CL L NA I C 3 E H T F O E C I R

PG EI N S S I I C C R R E E XX EE EH HT T R WO OW L E S I BT SU I HP CL Y I H N W/

`

(ii) If the price falls to ` 700 after 3 months:

T U P N O N I A '

=

]

[ ;

D I A P M U I M E R P L A T O 4

`

`

N I A G T E .

`

`

`

SE I S I TC U R PE X EE HE T H NT OE I VD T O A E B UA S I T I C S S R I E SD X I H NE T AS N I ) D N A E L SB I A KT I CF OO T R S P EE HB T L FI L O EW CL L I A R PC T EU HB T ET CU NP I S E H ST S F E L O H E T R C I OR WP

`

`

`

E U L A V G N I D N % ?

`

×

(iii) If the price rises to ` 1,200 after 3 months: `

`

=

;

E U L A V G N I D N %

×

L L A C N O N I A '

D I A P M U I M E R P L A T O 4

`

N I A ' T E .

`

PAY OFF FROM AN OPTION Q.12 Equity share of PQR Ltd. is presently quoted at ` 320. The Market Price of the share after 6 months has the following probability distribution: Market Price ` Probability

180 0.1

260 0.2

280 0.5

320 0.1

400 0.1

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.14

A put option with a strike price of ` 300 can be written.

You are required to find out expected value of option at maturity (i.e. 6 months) [Nov. 2010] [5 Marks] L L

I S WH T NN OO I T M P O ER HE T T F A E C I S R 2P FE O K I R 8T S EE CH I T R PW EO KL I E R B T S S AL L A HF T I E WC I NR OP I T T E P K OR TA U 0M AI F SY I L NN OO I T D P E OS I EC HR T E EX CE NE I 3 B

Ans.:

Expected Value of Option (Put option, X = ` 300) Gain on exercising (X-S)

Probability

Expected pay off

Yes Yes Yes No No

120 40 20 -

0.1 0.2 0.5 0.1 0.1

12 8 10 30

S H T N O M

R E T F A

Will the option be exercised

F O E C I R P E K I R T S A H T I W N O I T P O T U P F O E U L A V D E T C E P X E E HS 4I

Spot Price After 6 months(S) 180 260 280 320 400 Total

`

` Q.13 You as an investor had purchased a 4 month call option on the equity shares of X Ltd. of ` 10, of which the current market price is ` 132 and the exercise price ` 150. You expect the price to range between ` 120 to ` 190.

The expected share price of X Ltd. and related probability is given below: Expected Price (`)

120

140

160

180

190

Probability

0.05

0.20

0.50

0.10

0.15

Compute the following: 1. Expected Share price at the end of 4 months.

2. Value of Call Option at the end of 4 months, if the exercise price prevails.

3. In case the option is held to its maturity, what will be the expected value of the call option?

[Nov. 2012] [8 Marks] [Nov. 2018] [8 Marks] Ans.: `

×

×

`

`

×

`

`

`

`

×

`

`

`

×

`

1. Expected Share Price = 6xipi

Nil

M U I M E R 0 F O S S O L E B L L I W E R E H 4

`

`

2. Intrinsic Value of Call Option if exercise price prevails i.e. Rs.150 (S=X) 3. If the Option is held till Maturity the Expected Value of Call Option

. / ) 4 !

5 , !

6 $ . !

3 ) 3 9 , ! . !

3 % 6 ) 4 !

6 ) 2 % $

8.15

N S OH I T TN P OO EM H T R E T F A E S C 2I R FP O E K 8I R T ES CE I R H PT E EV KO I R B T S A S AI HE T C I I WR P NT OE I K T R P OA LM L A F I #Y L AN SO I ND E OS I T I C P R OE EX HE T E EB CL L NI I W 3 Expected Value of Option Expected Spot Price After 4 months(S)

Probability

Expected pay off

Gain on exercising (S-X)

S S E S E O O E . . 9 9 9

Will the option be exercised

14

S I Y T I R U T A M T A N O I T P O L L A C E H T F O E U L A V D E T C E P X E E H 4

Total

` Q.14. The equity share of SSC Ltd. is quoted at ` 310. A three month call option is available at a premium of ` 8 per share and a three month put option is available at a premium of ` 7 per share.

Ascertain the net payoffs to the option holder of a call option and a put option, considering that: (i) The strike price in both cases is ` 320; and (ii) The share price on the exercise day is ` 300, 310, 320, 330 and 340.

Also indicate the price range at which the call and the put option may be gainfully exercised.

[Nov. 2018] [8 Marks] Ans.: S E

9

S E

9

O

.

O

.

O

.

S D E E C O R P S E L A 3

W O m N I S S E ,

L O I

. .

W O m T U / L A T O 4

M U I M E R P

W O m T U /

L O I

. .

E C I R P E K I R T 3

W O m T U /

D E S I C R E X E N O I T P /

L O I

. .

Y A D E S I C R E X E N O E C I R P T O P 3

Net pay off for the holder of the call option

F F O Y A P T E .

E C I R P E K I R T 3

W O m N ) M U I M E R P

W O m T U /

S E 9

D E S I C R E X E N O I T P /

S E 9

Y A D E S I C R E X E N O E C I R P T O P 3

Net payoff for the holder of the put option

Strategic Financial Management (SFM) | CRACKER AUTHOR PUBLISHER DATE OF PUBLICATION EDITION ISBN NO NO. OF PAGES BINDING TYPE

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Description This book is prepared exclusively for the Final Level of Chartered Accountancy Examination requirement. It covers the questions & detailed answers strictly as per the new syllabus of ICAI. The Present Publication is the 6th Edition & updated till 30th April 2022 for CA-Final | New Syllabus | Nov. 2022/May 2023 exams. This book is authored by CA (Dr.) K.M. Bansal & CA Anjali Agarwal, with the following noteworthy features: · Strictly as per the New Syllabus of ICAI · Coverage of this book includes: o All Past Exam Questions 

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