9.

Derivatives Analysis & Valuation

1. Derivatives Contract
2. Underlying Asset
3. Lot Size
4. Expiry
5. Forward Buyer & Forward Seller
6. Spot / Cash Market
7. Cash Settlement
8. Initial Margin
9. Futures Contract
10. Users - Hedgers, Speculator & Arbitrager

1. Theoretical Forward & Futures Price (TMP)

2. Adjustment of Dividend Rate, Amount , Yield
3. Continuous Compounding
 Derivatives
Analysis & Valuation

A Contract between two parties to buy / sell certain asset in

certain quantity on certain future date at a certain price.

Forward Forwardt
Derivatives Futures Futures
lotsize seller
Buyer
500

Expiry
Date

1 I 1
Index
Forward
contract
Futures
contract
options
contract
swaps Eity
TCS
commodity
Gold cygy
Nifty
Reliance Banymifty silver EUR
Default TATAMOTORS Bajra YEN
Exhange
FROM ICIII BANK Rise CAD
OTC ETC chapter forex
Initial margin
Freeto
Choose
Assts
 SPOT CASH MARKET DERIVATIVES MARKET

100 Sell 120 100 Sell 120 80

Buy Buy
OF 100 IF 120 OF CIF
Hargin profit loss
Return 20 Margin
25 120 100
25 20

45
Return 801
I
C
5001
Forward Contract
1

Adani spot 100

Exp 150 110

Forward Asset Adani 130 Sell 150 20 20

Phie 130 Buyer Buy
B g Date 3month seller sell 30 150 20 20
1000 Buy
150 110
Qty Cashsettlement

BYE
Spot 150
Forward
4 1 0
ownership gain
 I
speculation
Hedging
Users
of Derivatives

Hedger Speculator Arbitrageur

wanted to Never wanted to finds it opportunity
Really or sell the Asset where the assets
Buy
self tf Buy prices are mismatched
in different markets
purpose
was just to
purpose was to
reduce the risk
Enervsif outite
prices to
of loss purpose is

Buy cheap
No Risk High Risk Sell High
No Loss High profit
no profit
High Loss
Risk
Little profit
NO LOSS
However Forward contract has one Drawback Default
Risk
parties can default
at the time of
Loss

YES soition
B S

Futures contract
In

Introduce
A Guarantor

Intermediary

Exhange
will take the risk of default
Also it will ask for Initial Margin
Deposit to protect itself from
losses
 I 1

100 LONG 70 30
Spot 10 4
If
Futures 100 SHORT 10 1 Long70
miffy

1 I

spot Portfolio 100 LONG 12 1 88 12

13 12

FuturesIndex 100 SHORT 10 1 LONG90 10

2

1 I

spot Portfolio 100 LONG 12 1 88 12

β 12
FuturesIndex 120SHORT 10 4 LONG 108
12
0

position Required in
Index Futures
for Hedging

919th Riskfeduced 8m Beta

12 0
100 1.2

120

1 I

spot Portfolio 100 Long 12 4 88 12

12
FuturesIndex 120SHORT 101 Long 132 12
24
 1 I

spot for to 100 LONG 12 4 88 12

1.2
FuturesIndex 120 LONG 10 1 SHORT 32

Hedging

tue me

take take
opposite same spot position Risk to be Reduced
n
posing I
in index Peru
Futures 8ha

s EE
 Purpose An Investor wants to own shares
of xyz co after 3 months

I
spot market Forward market
103
8 121 P.a

spot 100 5 108 140

Forward F 108 140

Afp
MAYANK YOU
1 0 t O Long
1 Born 100 1 Take Forward
2 Money Fixprice
Buy
stock
108 012oz
3m 1 31 s 108 140
1
Repayment
of 103g
i settle Forward 12 20

Borrowings 2
Buy
stockspots 9
100 103 cost
if the
carrying
You own stock from You own
the stock otosm of the stock
cost
Holding lost
carrying
 200
spot price of xyz
150
Forward priie
offatures
ofxyz
no

50
convergence effect
1 I 1 It means
At
Expiry
spot Futures
price price
At the end of 3M
1 own the with CUF 103
Mayank stock
2 You own the stock with OF 120

Mayank
word you Lost

v1

Why

you were overcharged

for the Futures price
of Xyz stock by Rs 17
 How to know whether we are overcharged
or undercharged in Forward Futures Market
How to avoid Foss of 17

Before into Forward Futures contract

Entering

Callulate TMP

Compare it with Amp

AMP TMP AMP TMP

120 150 120 103

Forward is Forward is
UNDERVALUED OVERVALUED

I I
Forward sell Forward
Buy

How to calculate TMP

TMP of Forward weFutures is
would nothing
But what have a
paid in the spot market for
the same purpose
achievinggy
 zygy

F 103
100 3

100 100 37

Forward spot Pot Fateofinterest

priie
S 5 8

F S 8

I
CA PETT
FU PU 1 8

Dividend t 3m 1 50

F spot cost Dividend of

cost
carrying
100 3 1.5
101 50
carry

F S 1 8 Dividend
 Dividend t 2m 1.50

It 7.50 3
100
Dividend Interest
1 10
I F
F SCH Dividend 1 2
100 1 03 1 50 1 01

103 1 515
101 485

01 1 I

180 1.50

13 101.485

F S PunfI 1 8

F S Itr
Summary F S 1 2 Dividend t 3m
Dividend F S Itr 1 8 t
befre3m
I Rate f f put D Itd before3m
He
 Dividend t 3m yield 29

p.a. N100

5 100 Amount

6 5 aut.PT 2
i.my 24 piiy
yield Rate
Fate value o
6Pa
Dividend 100 24 42
to be
considered 6 24 24 Gpu
informuld
601 pa 6 Pa
Rate

F Slits Dividend 291

S Itr Sx yield 2
1001140033 loopy
1001 8 9 r y
100 It 003 0063 Applied spot spot
calculated 3m 3M
100 0.97

97
summary
Normal compounding

1 without dividend F S 1 8

2 With Dividend

I 1 At F s 1 2 Dividend
6 Rate Ping

ii Before F Pufo its

taping

c yield At F S Itr y
pa Exping
iii Before
exping L Prof 1 8

p.fr per
Annum Annum

Do not convert
convert

For the period

Exping 37

i tE
Continuing
compounding City
In Forward contract cash Flows are settled of
the
only
expiry
But in Futures contract Exchange traded cash Flows
01148
continuously
51 8 sert 3
100 1 03 5 2012 12
03 2.7183003
103 100 0
10 1 0305
103.05 27183
512
1
Question 0.03
1
Forward Futures pricing 1 12
1.0305

alveof e

is
given
Thot to given
Normal compounding
Continuous Itr
compounding
ert
Continuous
Compounding

d NO Dividend F set

6 Dividend Rate F Prof eat

9 t
yield f self
Adani 5 100
F 105 lot size 50
F
I contract 50 Adani Shared

Futures price 105

1 Futures contract 105 50 5250
Value

Total contract value 5250 5 26250

Fx lotsize No
of
Contract
26250
Q2 Basis spot Futures if F 2300

2376 2400 2376 2300

76
24
1

Basis positive Basis

Negative

Growth Decline
1
Backwardation
Contango

i S F
1
2400 00 30
F
seen
By 2 20

gun
QI
Arbitrage with
Forwards/Futures

compare AMP with TMP of Forward Futures

AMP TMP AMP TMP

is
Arbitrage is Arbitrage
not possible possible

AMPL TMP AMP TMP

Forward is Undervalued forward is overvalued

Forward sell forward

Buy
sell spot spot
Buy
I
 my
spot
Market
Invest Borrow

settle of settleof

expiry expiry
Gain Gain

I
2.8 7 560
PL 20000
8991.675
2 1.4

FS 179 8335
8250 210 519

8991,67520 380 1665

2000
19
Pp Ff 0.95
416 Share
Qty No Position value B
100000 22 2200000 XB 2 1 2156000
Long
4 9
50000
A s

Index short 10009 15 1 9854

Futures 100049

200000 flowy 96000 9851

496000 49857 200000 114500

flowy

10400 114520
151

MY t

F0
N

I.fi Fk'β
to 1 2
200000
 70000 400000 220000Pa

β 3800
15

L Shans 170 16 164.56

L Cash 0
2 56 4 72 1
2 196
L Nifty 200 I 4

Rm 101
BP 16
Rp 16
PP Fm Bp Ray 21
 OPTT ONS
Spot 5 100 70 140

Forward 11 SHORTE
1 44 3
Futures F 110LONG F
OF InitialMargin Deposit
Payoff
0PM Achon
CALL Effy pens
Lapose
Eff
Max 5 14,0

30
Insurance K 500000LONG Yechiel
OF premium expense Medial
Expenses Expenses

0 200000
 Options

Buyer seller
Hides utter

can put
1 stocks
Right Right Index
to commodity

Buy
Asset
sell
currency
Asset
premium

I
Busic Methods

MULES

If
CALL K
PUT MAX K 5,0

Binomial BlackScholesModel

payoff
I
I
CALL PUT

Byfasset see asset

Lowerthan Higherthanspot

t
Exercise 4S KYS
 payoff Max 5 2,0 mark 5,0

premium It Deduct

Metpayff net profit netprofit

VALUE

stick

01

CO
Po s gÉ 100 120 140

K 100 0 0 40
Éption
10

6 65 4,0
12

20
 20

Binomial
Model 18 0.60
4 110 12 E 6
got
50 100
121
g
80 ME 0 040 0
sd d
J
10 5 8
e

4 0
0444
so
stuffed pea
100 80Pd volatilityofpricemoving
ftp downwards 0 80

103 HOP 80
U

p
JEFF 120

1
5 8 8 0
575
5750
p
 so IP XPD
So Itr Sup sd Sdp

Divide by So
Itr
Sfp Sf P

Hr
p

4 4 0
P

4T p
Black
Scholes I
5 1
Model
K 120

Co S Kett
Co Sald kett Mcd

di in sky At t
FIE
de di GE
PUT CALL PARITY
THEORY 5
Portfolio 2
105

By
pated 7
spiking 5.4
f lyr 70 140
sell stock 170 140 Einstment
proceeds 70
put cm ME 50
110 140

Buystock Buy put Buy calttnestpuf.ie

So Po Co kett
380 Po 10.52 40
2578

1408 10

stockt stock
n nd

sell Buy
can car
 I
PORFOLIO REPLICATING MODEL
co sell call
50 50 Portfolio can
54 60 0 25 50 I call 55
Buystock
131250W
Buy
3 Borrowings
Investment 9 541
E I 40 60
t lyers sellstock0.25 10 15 Ettle can Laffe Effrise
Repayment
9.09 110
Payoff
8 20
0 5
05
01 20

0 50 0 25 9.09
Co SOXA Borrowings

D sd
50 025
f
025 shared
Buy I can for perfect
40404
sell
Hedging
0
 Interest Rate Risk
Management
Fixed Rate
Floating
IR LIBOR 2

Eii
In 13 2
I

as

I
 2A Buying money sellingmoney
Take Loan Give Loan

1
Borrowings Investing

LONG SHORT

I 1
Borrower Investor

expects the
Interest Rate to fall to Rise

it will Rise it will face

Risk InterestRate
A situation
of Fixed
Floatingoo
iii a
interest
NNN
FRA
Hedging Rate
5 i i n
time
Risy
Forward Rate
Agreement O louxion IOL
t I 100 131 137
 we want to Borneo
Buy
Loan after 6months

for 3 months on 3m
Loan 60crores

Dehuahues
Forward 5 FRA LONG9.30
8I.c
Funny
Opting
guinki.is
0.0075
Eyp.a
0 01251 3m
Amount 450000 750000
swaps 37
Disout 1 0094 1 0 88
Agreement

You FRA
LOMYFRA.tt Lff 439453 7338551 0
Buyer
Bank FRA seller SHORTFRA
FRA 9.30 obligation
to Both
TYP 9FRA
Loan prod will end after 9monthsfromnow
By
Loin period will start after 6 monthsfromNow

0 Time when FRA starts

6 Time when FRA finds
 s

i
FRA FRA
starts Ends
Loan Loan
starts End

Desire Formull

439453

60,00 00,000 0.0075

0096
1
7
6000000004 30
0
4

no had It 0090
e rate
AmM
ooooowox

It 0 096
9.60 9.30

FR
2 1h
a
f
maturity

year
RR
 an
NX RR FR m
g 9J
LONG it RR
TtJ
60000000 0.096 0.093 42
It 0 090
 HIEORETICAL
FORWARD

RATE
 spot yields
year yield 10
1 One 101 S 100 1 1
12 2
2 two
121 I 100 1122
52
13 13 1 13 100 1.133
3 Three 13 S I I
4 Four 14 100 1144
Sy
Forward
yields
year yield 10
I 1st 101 F 100 1 1
10 12
2 2nd F I I I 100 1 1 1.12
12
100 1 1 1 12 113
iii www.xmansxny

52 101 I
3 100 100 1.1 1 1 121
9 14
S S 91 1001 I 100 1.09 1.14 124.21
19 3.26
FRA 14
5M 100 1.1 11 16 1.09 1 12

1 52 1 52 ITS ItF2

4 HE

E 4 53
Home
1 APR
sell
CH L _theoretical
1

141 ERA
 FE its

THE ETCHED
51 FL HS
I Fs
CHI
 If 1
I
AFR TFR AF TFR
FRA is correctlyvalued
1
Arbitrage opportunity does Arbitrage
opportunity
exist
not exist

AFR 13 TFR 1101 AFR 9I TFR 1101

FRA is overvalued FRA is undernamed

Sell FRA FRA

SHORT FRA Buy FRA
LONG
I
Invest FRA Borrow FRA
Invest for the previousyears Borrow forprevious year
opposite opposite
Borrow in other market Invest in the market

At At
maturity maturity
t
Settle the open position settle open position
I
Enjoy Arbitinge
gain Enjoy arbitragegain
 11 52 Itsy
TFR s

s
1
111 1541

F I

teaser
HSL HSL HFS
MH
HSI HF

i.is
EEY Fa
or
YIFDCItF3
YI

1 512 So Fo

1.065
E HE
I
EE
0 0390
EL
TER TF6 IS780
AFR 6 50 6 75
 AFRL TFR
FRA is underwww
I
FRA
Buy
t
Borne
6 51 511 t 1.065
51 1
1Mt
1025
1.060
1025
P
5
INTEREST
RATE
FUTURES
Interest Rate Futures is Exchange Traded Derivative Contract

IRE is based on prices of Bonds Not interest Rate

Bonds price
IRF asset
underlying
Herestrate
 Interest Rates
boasprice Y'Mαtp
to
Interestrate
FutureInterest
Rate nd
price
Theoretical price of IRF 100
IR
100 5 100 47
95 96

Interest Rate
Risk
fffdspn.ie E8mt M
Borrower Sell

Rise
Buy
Investor
fan sell
Buy
FRA IRF
Borrower Sell
Buy
Investor Sell
Buy
Standard lot size 2000
5 955M
1 4
71 93
Buy
O

spot
If
20
 Interest Rate

Borner Investor
Risk Intetist
Interest Rate Rate

A 1.01 110 101

B 095 10 95
II f
t fi B
IRF
S

C 098 10 98
SHORT IRF BOND 100 Lo IRF BOND 100

cash
Itting cash
txY
physical
settlement physical settlement
Delivery Delivery
SHORT LONG LONG SHORT
Sell OND

gain
Loss

1
gfEN.ie
gats

fff
ÉF 930 maximum profit or
Minimum Loss
CHEAPEST TO DELI
G
 G

Interest Rate swap

BANK
ÉRise 5 ting
LIBOR
I in
I
Borrower 1 Borrower 2
Fall Floating Rise Fixed

I 2
10 Bunk LIBOR
BANK
BL t 10 BI LIBOR

IETF
1
Floating Fixed
 IF SF
Fixed Floating
to BPLR 10.5 3.5
pay Bary
Receivefrom BPLR 1.4
party BPLR 2.2
to 2.2 BPLR CBPIRTI.US
Pay party 0.10 0110
Banks commission

Swup Rate Eth

Bank's Rate
0 PPffs
swap gun

15 HIM
MIBOR 5.25 5.757 5.757 5.75 5.757 5.757 5.757

t.IE
n Saxy.s

500000004 030 1500000 7500W

4
1562 est
5

189540

term50 50 50

189540

5 6 Lyell
120L

At present purf A A PUAF

189540
SWXPUA PUAE.si
3.791

10

Puff A PUAF
189540 1200 5686 36408 PUAE
I
171854
720
PYAFF 4

101 PUAF 4.868

11
1
put 4.712
 10 4 868

10
16 0148

10.95
IRR