Forwards

Dr. Harmandeep Singh

The Pricing of Forward Contract
To understand how a commodity forward contract can be priced,
consider a simple example:.
Alternative 1: Not do anything until July 1, and purchase 20 MT of
rice on July 1 at the prevailing market price P1
Alternative 2: On January 1, enter into a forward contract to buy 20
MT of rice on July 1 at a forward price
Alternative 3: Buy 20 MT of rice on January 1 at the price of p0,
which is the price of rice in the market today, and keep it stored in a
warehouse. This price p0 is also known as the spot price at time 0.

f0 = p0 + c
The Pricing of Forward Contract
Following Cost is carried by future contract
Storage
Insurance
Transportation
Financing
Opportunity

Cost and Carry in perfect market

Future Price = Spot price + Carrying Cost

Example
Sun Jewellers, a gold jewellery manufacturer, requires 1,000
grams of gold on July 1. On April 1, the price of gold is INR
12,000 per gram. It plans to enter into a forward contract to buy
gold, with the delivery date of July 1. It has estimated that the
storage of this gold will cost INR 80,000 and that it can invest its
funds at 8% elsewhere. Calculate the forward price of gold on
April 1 for delivery on July 1.
Problem
A palm oil trader wants to enter into a forward
contract on June 1, for delivery on July 1. The spot
price of palm oil is INR 50 per litre, and the trader
wants to buy 10,000 litres of oil. If the cost of carry
is 4% of the spot price, what will be the forward
price?
 Pricing of Forward Contracts
1. For securities providing no income.
2. For securities providing a given amount of income.
3. For securities providing a known yield.
Case 1: Securities Providing No Income

Forward = F = S0 ert
Example.
• Consider a forward contract on a non-dividend paying share which is available at Rs 70, to mature in
3-months’ time. If the risk-free rate of interest be 8% per annum compounded continuously, the
contract should be priced at?
Problem
• .
Problems
• On a non-dividend paying share, a 4-month forward
contract is entered into, when it is selling at Rs 72. If
the risk-free rate of interest with continuous
compounding is 12 per cent per annum, what would
the forward price be?
• Calculate the forward price on a 6-month contract on
a share, expected to pay no dividend during the
period, which is available at Rs 75, given that the risk-
free rate of interest be 8% per annum compounded
continuously
Case 2: Securities Providing a Known Cash Income

• determine the present value of the income receivable. I = Y e-rt

•F = (S0 - I)ert
Example
• Let us consider a 6-month forward contract on 100 shares with a price of
Rs 38 each. The riskfree rate of interest (continuously compounded) is
10% per annum. The share in question is expected to yield a dividend of
Rs 1.50 in 4 months from now.
Problem
• Data: Price of the share : Rs 75; Time to
expiration : 9 months; Dividend expected : Rs
2.20 per share; Time to dividend : 4 months;
Continuously compounded risk-free rate of return
: 12% per annum
• Consider a 10-month forward contract on a stock
when the stock price is $50. We assume that the
risk-free rate of interest (continuously
compounded) is 8% per annum for all maturities.
We also assume that dividends of $0.75 per
share are expected after 3 months, 6 months,
and 9 months.
Case 3: Securities Providing a Known Yield

•F = S0 e(r – y) t
Example
• Assume that the stocks underlying an index provide a dividend
yield of 4% per annum, the current value of the index is 520 and
that the continuously compounded riskfree rate of interest is
10% per annum. To find the value of a 3-month forward
contract,
• A stock index currently stands at 350. The risk-free interest rate
is 8% per annum (with continuous compounding) and the
dividend yield on the index is 4% per annum. What should the
futures price for a 4-month contract be?
Problems
• A stock is expected to pay a dividend of $1 per share in 2 months and in 5 months.
The stock price is $50, and the risk-free rate of interest is 8% per annum with
continuous compounding for all maturities. An investor has just taken a short position
in a 6-month forward contract on the stock. What are the forward price and the initial
value of the forward contract?

• A 1-year long forward contract on a non-dividend-paying stock is entered into when

the stock price is $40 and the risk-free rate of interest is 10% per annum with
continuous compounding. What are the forward price and the initial value of the
forward contract?
Problem
• A long forward contract on a non-dividend-paying
stock was entered into some time ago. It currently
has 6 months to maturity. The risk-free rate of
interest (with continuous compounding) is 10%
per annum, the stock price is $25, and the
delivery price is $24.
Problems
• A stock index currently stands at 350. The risk-
free interest rate is 8% per annum (with
continuous compounding) and the dividend yield
on the index is 4% per annum. What should the
futures price for a 4-month contract be?
Future Contract – Price Quotes
• Asset underlying the future contract
• Contract Size
• Maturity of the contract
• Opening price
• Highest Price
• Lowest Price
• Settlement price
• Open interest
• Volume trading
Settlement Price

The settlement price is normally the average of the prices at

which the contract was traded, immediately before the end of
trading for the day. Each exchange has its own procedure to
calculate the settlement price on each day as well as on the
expiry day.

In the NSE, the settlement price is calculated on the basis of the

last half an hour weighted average price.

Daily gains and losses and margin account balance are

calculated on the basis of the settlement price.
The Pattern of Prices

• A number of different patterns of futures prices are

possible. Since the pricing of most futures is similar to
that of forwards in terms of the cost of carry model. the
futures price should decrease as the maturity
approaches, because of the fact that the cost of carry
now applies to a much smaller period of time.
Open Interest

Open interest is the total number of outstanding futures contracts available for delivery at that time,
and it is the sum of all long positions or all short positions. Open interest is important in futures trading
because it is an indication of the trading in the contract as well as the liquidity of the contract. An
increase in the open interest indicates an increase in the number of contracts available for delivery,
and a decrease in the open interest indicates a decrease in the number of contracts available for
delivery. This is an indication of the liquidity of the contract. When the open interest is high and if a
trader wants to close the position, it will be comparatively easier to do so as compared to the situation
where the open interest is very low.
Example
Consider the following transactions in ICICI single-stock futures that took place in one of the
exchanges. On January 2, when the contract started trading, Megafund took a long position in 10
contracts, Minifund took a long position in 12 contracts, Ram took a short position in 7 contracts, and
Interfund took a short position in 15 contracts.
On January 3, Megafund took a short position in 5 contracts, Minifund took a long position in 8
contracts, Ram took a long position in 3 contracts, and Interfund took a short position in 6 contracts.
On January 4, Megafund took a short position is 10 contracts, Minifund took a short position in 5
contracts, Ram took a long position in 8 contracts, and Interfund took a long position in 7 contracts.
Relation between Future and Spot Prices
• Since the futures price is the price at which the
asset will be exchanged, the parties to the
contract expect either the spot price at the
maturity of the contract to be equal to the futures
price or the current futures price to be equal to
the expected spot price at maturity. However, the
futures price may not always be equal to the
expected spot price, because the estimates of
futures spot prices vary from one market
participant to the other
The Basis
• Divergence of Futures and Spot Prices
Basis = Pt – P0
• In a “normal market”, the futures price would be
greater than the spot price and, therefore, the
basis will be positive, while in an “inverted
market”, the reverse holds. In an inverted market,
the basis is negative since the spot price exceeds
the futures price in such a market.
Convergence
• Generally, the longer the time to maturity, the greater
the carrying costs. As the delivery month approaches,
the basis declines until the spot and futures prices are
approximately the same. This phenomenon is known as
convergence.
Expected Basis
When uncertainty is introduced, however, the relationship
between the futures prices and the expected spot prices
at a future date is not unambiguous. In case of
uncertainty, there are three hypotheses to explain the
expected basis. They are:
1. Normal backwardation
2. Contango
3. Expectation principle
Expected Basis
1. Normal backwardation: According to this hypothesis, the
expected basis is negative as the futures price tends to be a
downward estimate of its spot price in the cash market at the
contract’s maturity date. The theory is thus dependent on the
assumption that speculators usually buy, i.e., net long, the
contracts while the hedgers usually write, i.e., net short, the
contracts.
2. Contango: This hypothesis assumes the other possibility—the
hedgers generally buy the contracts, while the speculators
generally sell the contracts.
3. Expectation principle: This theory postulates that the
expected basis would be equal to zero. This is based on the
argument that futures prices are an unbiased estimate of
expected future spot prices, as would be expected in an efficient
market. Thus, there is no room for any excess returns for either
How to Trade in Futures

Step 1: First, the trader will contact a broker who is authorized to trade in futures. The order can be either a market
order or a limit order.
Step 2: The broker will access the order book of the NCDEX and key in the order placed by the trader. The market
orders have no price specified and specify only the quantity. The order will be matched by the computer at the
NCDEX/NSE/MCX. The order book has all the orders received from various brokers with the orders classified on the
basis of both price and time.
Step 3: If the order is executed, the broker will then have to get this order cleared by a CM of the Clearing Corporation
of the Exchange. The CM is responsible to the Exchange to fulfil the contract. The broker will approach the CM asking
for permission to clear the trade. Once the CM clears the trade, the Exchange will notify the broker that the order has
been cleared. When a CM clears a trade, they take responsibility to fulfil the contract at maturity, even though they have
not entered into the contract.
Step 4: In order to take the responsibility for the fulfilment of the contract at maturity, the CM will have to post a margin,
which is usually based on the volatility of the underlying asset price. The Exchange will notify the CM of the margin
amount that needs to be posted.
Step 5: Since the CM only clears the trade and takes no position in the trade, they will ask the broker to provide the
funds for this margin, which will be collected by the broker from the trader.
Step 6: The broker will maintain an account known as the margin account, which will be updated daily on the basis of
the settlement price of the contract on that day; this is known as marking-to-market.
Step 7: As long as the trader wants to keep their position in futures before maturity, the only responsibility for the trader
is to follow the instructions of the broker with respect to the margin account.
Step 8: At maturity of the contract, the contract will be settled. The trader’s broker will calculate the position of the
margin account on the basis of the settlement price. If the margin account shows a positive amount, this amount is the
gain for the trader from futures trading, and this amount will be given to the trader by the broker. If the margin account
shows a negative amount, it indicates a loss from futures for the trader, and the trader needs to pay this amount to the
broker.
Pricing of Futures
• Consider a 6-month gold futures contract of 100 gm. Assume
that the spot price is Rs 480 per gram and that it costs Rs 3 per
gram for the 6-monthly period to store gold and that the cost is
incurred at the end of the period. If the riskfree rate of interest is
12% per annum compounded continuously, the futures price is?
Pricing of Futures
• A stock index is currently at 820. The continuously compounded
risk-free rate of return is 9% per annum and the dividend yield
on the index is 3 per cent per annum. What should the futures
price for a contract with 3 months to expiration be?

• Maruti shares are selling at INR 991.55 on May 10. The

contract size for Maruti futures is 200, and the futures expire on
June 29. The risk-free interest rate is 7%. What will be the June
futures price on May 10 if no dividend will be paid before June
29?
- If Maruti is expected to pay a dividend of INR 40 on June 5, the
futures price can be?
Pricing of Futures
• ITC shares are selling for INR 235 on April 18. Futures
contracts on ITC are available with maturity on April 29, May 27,
and June 24. ITC is expected to pay a dividend of INR 40 per
share on June 3. The risk-free rate is 8%. Calculate the price at
which these futures contracts will be selling.
• L&T shares are selling at INR 1,620 on December 20. L&T
January futures are available with a contract size of 200 and
expiry on January 29. The risk-free interest rate is 6%. L&T is
expected to pay a dividend of INR 100 per share on January 5.
What will be the L&T January futures price on December 20?
Hedging Strategies Using Futures
The principles of Hedging
What quantity of assets would be subjected to loss if the price
changes?
When would losses accrue, that is, when would the price increase or
decrease?
Which futures contract would provide a hedge against this loss?
How many futures contracts should be used to hedge?

Two Kinds
Long and Short Hedges
Example
On September 10, a wholesale merchant estimates that his company will require
30 MT of chana on February 20. The current spot price of chana is INR 1,912 per
quintal (100 kg), and the price of a February chana futures contract is INR 2,011
per quintal.
The wholesale merchant can hedge the price risk:
(i) by taking a long position in 30 chana futures contracts on September 10 at INR
2,011 per quintal, i.e., INR 20,110 per contract, and
(ii) by taking a short position in these contracts on February 20.
Consider the case where the chana price in the spot market on February 20 is INR
2,561. Since the delivery date is February 20, the futures price will be very close to
the spot price in order to eliminate arbitrage opportunities. Thus, the futures price
will also be INR 2,561.

If the spot market chana price on February 20 is INR 1,900, then the position of the
hedger will be:
Problem – Hedging
Barley Mart produces barley and sells it to wholesalers. On September 1, the spot
market price of Barley is INR 922 per quintal. Barley Mart wants to sell 50 MT of
Barley in December and is concerned that the price of Barley might fall in the
period between September and December. In order to eliminate the risk of possible
price decreases, Barley Mart wants to hedge the position using futures. Barley
futures are available in the NCDEX, with expiry on December 20 and a contract
size of 10 MT. Barley futures are priced in Indian rupees per quintal. The December
futures are selling at INR 840. Show that Barley Mart can fix the selling price of
barley by entering into a futures contract.
• Identify whether a long hedge or a short hedge is preferable
• Choose the appropriate futures and the number of contracts
• Decide the actions to be taken to hedge.
• Calculate the effective selling price for two different spot prices, one higher and
one lower, to show that the effective price is the same, irrespective of the spot
market price. Since the futures price contracted is INR 840, consider the case of
(i) spot market price of INR 880 and
(ii) spot market price of INR 820
Problem
Indian Silver produces silver jewellery and sells all over India. On January 1, Indian
Silver estimates that it will need 300 kg of silver on April 20 and is concerned that
the silver prices may increase in the meantime. On January 1, the spot market
price of silver is INR 27,175 per kg. In order to eliminate the risk of possible price
increases, Indian Silver wants to hedge its position using futures. Silver futures are
available in the NCDEX, with expiry on April 20 and contract size of 30 kg. The April
futures are selling at INR 28,450. Show that Indian Silver can fix the buying price of
silver by entering into a futures contract.
• Identify whether a long hedge or a short hedge is preferable
• Choose the appropriate futures and the number of contracts
• Decide the actions to be taken to hedge.
• Calculate the effective selling price for two different spot prices, one higher and
one lower, to show that the effective price is the same, irrespective of the spot
market price. Since the futures price contracted is INR 28,450, consider the case
of
(i) the spot market price of INR 29,000 and
(ii) the spot market price of INR 28,000.
Single Stock Futures and Stock index Futures
• What is a Stock Futures Contract?
When a stock futures contract expires, it entitles an investor to buy or sell a specified number of shares of
the stock on which the futures are written at a price that is determined at the time of entering into the futures
contract. If the investor takes a long position in the stock futures contract, they agree to buy the specified
number of shares of the underlying stock on the futures expiry date at a price that is determine when the
investor goes long in the futures contract. If the investor takes a short position in the stock futures contract,
they agree to sell the specified number of shares of the underlying stock on the futures expiry date at a
price that is determined when the investor goes short in the futures contract. The price at which the investor
is willing to buy or sell is the futures price, and it is determined in the market for each trade on the basis of
the demand and supply of these contracts as well as on the basis of the expectations of the future value of
the stock price.
Example : ICICI Future = 1236.20 Spot on Settlement = 1105.85
On September 1, Ashok Leyland shares are selling at INR 40.35. Ashok Leyland futures have a contract
size of 9,550. The September futures expiring on September 28 are priced at INR 41.25, and the October
futures expiring on October 26 are priced at INR 41.54. The initial margin requirement is 5% of the contract
value. On September 28, the shares of Ashok Leyland are selling at INR 41.83.
• (i) If you buy one September contract, what is the value of the contract?
• (ii) How much money do you need to post as the margin?
• (iii) What would be the amount of cash settlement for a September contract?
 Uses of Stock Index Futures
Long Position Risk Management
To illustrate the risk management in case of long position on stock, assume that an investor buys 2000
shares of a company at a price of Rs 500 per share on September 14, on analysis of company future
prospects. On this day, the stock price index, say Sensex, is ruling at 4480. Three weeks after he buys
shares, on October 4, the company declares half-yearly results which cause the share price to rise to a level
of Rs 534. But almost at the same time he fears that due to a decision of the OPEC members, the oil prices
are likely to increase sharply, causing hardships to the world economies. The stock markets are likely to be
adversely affected by their action.
To hedge against the likely fall in the index, he needs to take a short position in index futures. The portfolio
value on October being 534 * 2000 = Rs 10,68,000 for which protection is required. The investor learns
that the analysis of the last three months’ data reveals that this stock price, when regressed over Sensex, has
beta equal to 1.2. Accordingly, the short position required for covering Rs 10,68,000 portfolio is worth Rs
10,68,000 * 1.2 = Rs 12,81,600. Assuming the October futures is trading at 4520, he would short
1281600/4520 = 283.5 or 300 (assuming the market lot is 100) contracts. At the maturity of the October
futures if the index closes at, say 4130 and the price of the share in question be, say Rs 478, then the
position may be analysed as follows:
• Loss in the value of portfolio (534 – 478) * 2000 = Rs 112,000
• Gain in futures contracts: (4520 – 4130) * 300 = Rs 117,000
 Uses of Stock Index Futures
Short Position Risk Management
To illustrate, suppose that an investor is short 1000 shares at Rs 690 and the beta of the
stock is 0.9, then the investor should hedge by taking a long position in the near-month
stock index futures for 690 * 1000 * 0.9 = Rs 621,000. If the one-month index contracts
are trading at 3620, then the investor would sell 621000/3620 = 171.5 or 200 contracts (if
the market lot is 100 contracts). By the expiry of this contract, suppose the market
recovers and the index becomes 4280 and the price of the underlying share becomes Rs
761. In this case, the investor’s position can be analysed as follows:
• Loss on position in share: (761 – 690)*1000 = Rs 71,000
• Gain on futures contracts: (4280 – 3620) * 200 = Rs 66,000
Hedging using Single Stock Futures
• What type of hedging is appropriate, long or short?
• What instruments to use?.
• How Many Contracts to Use?
Hedge Ratio
H = p * SDs/SDf
N = h * Na/Qf
On January 1, Rajesh owns 6,000 shares of IOC and is planning to sell
them on February 28. Each contract size is 600 shares of IOC. The price of
the February IOC futures contract is INR 790. The spot price of IOC is INR
777.30 on January 1. If the spot price of IOC shares on February 28 is INR
544.40, show how Rajesh can hedge the price risk and what will be the
result of this hedge?
Problem
A BHEL futures contract has a contract size of 375 and on
September 1, BHEL shares are selling at INR 2,330. You
own 750 shares of BHEL. October BHEL futures with
expiry on October 29 are selling at INR 2,352. Assume
that the spot price of BHEL shares on October 29 is INR
2,300. You plan to hedge your holding in BHEL shares.
(i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, that is, what
is the effective price at which you would sell the shares?
How to write answer to sub point II
• In hedging, you need to decide the futures contract you should use,
the number of contracts you need to take a short position in, when to
take an open position, and when to close the position. Since the
shares you own are on BHEL stock, you would use BHEL futures. As
you are concerned about the risk on September 1, you would take
an open position in the futures on September 1. You plan to sell on
October 29 and, therefore, you would take a short position in the
futures contract expiring on October 29, i.e., in the October futures
contract. Since you own 750 shares and the contract size is 375, you
would take a short position in two contracts. Thus, on September 1,
you would take a short position in two BHEL October futures. You
would close your position on October 29 and sell the shares in the
open market at the prevailing market price.
Problem
You believe that the share price of Biocon is likely to increase from
its price of INR 238.50 on March 15. There are futures contracts
available on Biocon with expiry on June 30 at a futures price of
INR 245. The contract size for Biocon futures is 1,800 shares. You
plan to buy 9,000 Biocon shares on June 30. Since the price at
which you can buy the Biocon shares on June 30 is uncertain on
March 15, you plan to hedge using futures.
(i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, that is, what is the
effective price at which you would sell the shares if the price of
Biocon shares on June 30 is INR 260?
Problem
• You believe that the share price of Biocon is likely to increase
from its price of INR 238.50 on March 15. There are futures
contracts available on Biocon with expiry on June 30 at a futures
price of INR 245. The contract size for Biocon futures is 1,800
shares. You plan to buy 9,000 Biocon shares on June 20. Since
the price at which you can buy Biocon shares on June 20 is
uncertain on March 15, you plan to hedge using futures.
(i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, that is, what is the
effective price at which you would sell the shares if, on June 20,
the price of Biocon shares is INR 260 and the June futures price is
INR 262?
CASE
A ADANIENT on 07/02/2023 trading at 1640.60 and you want to buy
ADANIENT 1000 shares on 29/03/2023. ADANIENT futures with expiry
29/03/2023 is available at 1545.05 with the market lot of 250. on the
basis of above information answer the following questions
i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, if prices of ADANIENT
changes 1730.05, 1585.10 and 1670.40
(IV) Provide suitable reason whether you should go with hedging with
ADANIENT.
Cross Hedge
You hold 3,000 shares of Gram Bank selling at INR 300 on July 1. You plan to sell them on
August 28. You are concerned about a possible price decrease and you want to hedge this
price risk using futures. You find that there are no futures contracts traded on Gram Bank.
One of your friends suggests that you can use the futures on some other bank whose price
changes are highly correlated with the price changes of the Gram Bank shares. You have
found that August futures on the Canara Bank, with a contract size of 800, are selling for
INR 265 and have a standard deviation of 15, and the correlation between the price
changes of the Canara Bank futures and Gram Bank shares is 0.86; August futures on the
HDFC Bank with a contract size of 200 are selling for INR 2,500 and have a standard
deviation of 145, and the correlation between the price changes of the HDFC Bank futures
and Gram Bank shares is 0.95. The standard deviation of the price changes of Gram bank
shares is estimated as 22. Assume that the market price of the Gram Bank, Canara Bank,
and HFDC Bank shares would be INR 310, INR 280, and INR 2,550, respectively, on
August 28.
(i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, that is, what is the effective price at which you
would sell the shares?
Hedging using CAPM model
• Concept of Beta
The degree of movement in the price of a share of stock with respect to movements in the market,
that is, a stock price index, is measured in terms of beta, b.

OR
Example
For given data calculate beta
Day Share price index Price of share
1 1376.15 818.35
2 1388.75 811.75
3 1408.85 819.85
4 1418.00 836.05
5 1442.85 815.65
6 1445.15 804.30
7 1438.65 801.30
8 1447.55 792.30
9 1439.70 778.30
10 1427.65 740.95
11 1398.25 718.35
12 1401.40 737.50
Interpretation of BETA
• the bench-mark, the index beta, is equal to 1.0.
• If a stock has b > 1, it is riskier than the market. – for instance
1.25 of beta of ACC
• On the other hand, if a stock has b = 0.92,

• Further, a stock with b = 1 obviously moves “with the market”.

High beta shares are, naturally, preferable in the bullish markets
while low beta shares are “safe” securities—advantageous in
times of bearish market conditions.
Do by yourself Calculate Beta and Comment
on it
Day Sensex Yes Bank SBI
Jan 27 59,330.90 17.50 539.95
Jan 30 59,500.41 17.10 538.20
Jan 31 59,932.24 17.25 553.50
Feb 01 59,708.08 16.90 527.35
Feb 02 59,932.24 16.85 528.10
Feb 03 60,841.88 16.45 544.20
Feb 06 60,506.90 16.65 545.40
Feb 07 60,286.04 16.85 547.10
Uses of Stock Index Futures
Portfolio Beta
A portfolio manager owns three securities, as detailed below:
Security No. of Shares Price per share Beta
1 15,000 40 1.2
2 25,000 20 1.8
3 15,000 60 0.8
On January 1, 2002, an investor has portfolio consisting of eight securities as shown below: The cost of capital for the investor is given to be
20% per annum. The investor fears a fall in the prices of the shares in the near future. Accordingly, he approaches you for advice can make
use of the following information/assumptions:
• (i) The current S&P CNX Nifty value is 986.
• (ii) S&P CNX Nifty futures can be traded in units of 200 only.
• (iii) The February Futures are currently quoted at 1010 and the March at 1019
Security Price No. of Shares Beta
A 29 400 0.59
B 31.35 200 1.22
C 660 300 0.67
D 520 500 1.61
E 280 600 1.31
F 240 80 1.09
G 51 800 0.76
H 17. 900 1.05
You are required to calculate
(a) state the options available to the investor to protect his portfolio.
(b) calculate the beta of his portfolio.
(c) calculate the theoretical value of the futures contracts according the investor for contracts expiring in (1) February, (2) March.
(d) calculate the number of units of S&P CNX Nifty that he would have to sell if he desires to hedge until March (1) his total portfolio, (2) 90%
of his portfolio and (3) 120% of his portfolio.
(e) determine the number of futures contracts the investor should trade if he desires to reduce the beta of his portfolio to 0.9.
 Consider the portfolio of Mr Anand given here
Security Price as on April 18, 2022 No. of Shares Beta
CIPLA 1029.75 4000 0.73
Hind Lever 208.40 5200 0.61
ICICI Ltd. 61.20 6600 0.97
Infosys Tech. 3958.95 2400 1.78
NIIT Ltd. 308.90 5600 1.59
Tata Engg. 128.05 1500 1.06
Zee Telefilm 168.00 4000 2.18

You are required to calculate

(i) Calculate the beta of his portfolio
(ii) The May futures on BSE Sensex are quoted at 3444.60. Assuming the market lot to
be 100, calculate the number of contracts Mr Anand should short for hedging his
portfolio against possibly falling markets.
Problem
From the following information, obtain the portfolio beta:
Security No. of Shares Price per share (Rs) Beta
1 2500 38 1.32
2 1800 107 0.65
3 6400 62 0.92
4 5700 22 1.56
Problem
Assume that a market-capitalization weighted index contains only
three stocks A, B and C as shown below. The current value of the
index is 1056.
Company Share Price (Rs) Market Capitalization (Rs crores)
•A 120 12
•B 50 30
•C 80 24
Calculate the price of a futures contract with expiration in 60 days
on this index if it is known that 25 days from today, Company A
would pay a dividend of Rs 8 per share. Take the risk-free rate of
interest to be 15% per annum. Assume the lot size to be 200
units.
 Problem
Assume that a market-capitalisation weighted index consists of five stocks only. Currently, the index
stands at 970. Obtain the price of a futures contract, with expiration in 115 days, on this index having
reference to the following additional information:
(a) Dividend of Rs 6 per share expected on share B, 20 days from now.
(b) Dividend of Rs 3 per share expected on share E, 28 days from now.
(c) Continuously compounded risk-free rate of return = 8% p.a.
(d) Lot size: 300
(e) Other information:
Company Share Price Market Capitalization
(Rs) (crores of Rs)
A 22 110
B 85 170
C 124 372
D 54 216
E 25 200
Problems
1. Using the following data, obtain the value of a futures contract to
an index:
Spot value of the index = 1216
Risk-free rate of return = 7% p.a.
Time to expiration = 146 days
Contract multiplier = 200
2. A stock index is currently at 820. The continuously compounded
risk-free rate of return is 9% per annum and the dividend yield on the
index is 3 per cent per annum. What should the futures price for a
contract with 3 months to expiration be?
Problem
Calculate the value of a futures contract using the following data:
Spot value of index = 3090
Time to expiration = 76 days
Contract multiplier = 100
Risk-free rate of return = 8% p.a.
Problem
• The crude oil futures contract on the New York
Mercantile Exchange covers 1,000 barrels of
crude oil. The contract is quoted in dollars and
cents per barrel, e.g., $27.42, and the minimum
price change is $0.01. The initial margin
requirement is $3,375 and the maintenance
margin requirement is $2,500. Suppose that you
bought a contract at $27.42, putting up the initial
margin. At what price would you get a margin call?
 Problem
•Assume that you enter into a long position in
a January gold futures (100 grams) contract
at INR 10,079 on October 15, 2007. On
January 16, 2008, you decide to close your
position when the futures price is INR 11,269.
One contract is for 10 g of gold. What is your
profi t?
Problem

•The risk-free rate of interest is 7% per

annum with continuous compounding, and
the dividend yield on a stock index is 3.2%
per annum. The current value of the index is
150. What is the 6-month futures price?
Problem

•A forward contract on 200 shares, currently

trading at Rs 112 per share, is due in 45
days. If the annual risk-free rate of interest is
9%, calculate the value of the contract price.
How would the value be changed if a
dividend of Rs 4 per share is expected to be
paid in 25 days before the due date?
Problem
• On September 1, Asian Paints shares are selling at INR
1,400. Asian Paints futures have a contract size of 200. The
September futures expiring on September 28 are priced at
INR 1,446, and the October futures expiring on October 26
are priced at INR 1,528. Th e initial margin requirement is
5% of the contract value. On September 28, the shares of
Asian Paints are selling at INR 1,458.
(i) If you buy one September contract, what is the value of
the contract?
(ii) How much money do you need to post as the margin?
(iii) What would be the amount of cash settlement for a
September contract?
Problem
• On January 1, you buy 10,000 shares of Jet Airways at INR
1,000, and you are concerned about a decrease in the price of
Jet Airways shares. Th ere is a March futures contract available.
Th e risk-free rate is 6%, and Jet Airways is expected to pay a
dividend of INR 90 on January 31. Th e contract in March
matures on March 28.
(i) Calculate the futures price on January 1.
(ii) On March 28, Jet Airways shares are selling at INR 976. If you
hedge your portfolio with Jet Airways futures and sell your shares
on March 28, what will be the realized value of your hedged
portfolio?
Problem
• A Biocon futures contract has a contract size of 1,800 and on September 1, the Biocon shares are
selling at INR 238.50. You own 9,000 shares of Biocon. Th e October Biocon futures with expiry on
October 29 are selling at INR 252. Assume that the spot price of Biocon shares on October 29 is
INR 262. You plan to hedge your holding in Biocon shares.
(i) What type of hedging is appropriate?
(ii) Explain how you would hedge?
(iii) What would be the result of your hedge, that is, what is the effective price at which you would sell
the shares?
Problem