Financial Derivatives DEcember 2026 solved assignments
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Financial Derivatives
Q1 You are asked to price a European call option on a stock with a two-step binomial model. The stock price is Rs.400; strike price is Rs.420; each period (of 2 months) the stock can go up by 12% (u = 1.12) or down by 7% (d = 0.93); the risk-free annual rate is 8% (assume discrete compounding per 2-month period). However, regulatory rules require option writers to set aside margin capital proportional to the worst-case payoff scenario at expiry, discounted at the risk-free rate. Construct the binomial tree with all possible payoffs, calculate risk-neutral probabilities, value the option, and also compute the amount of capital that must be set aside today according to the regulatory rule. Show all calculations for tree construction, discounting, probability, option price, and regulatory margin.
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Q2 (A) An investor constructs a straddle by simultaneously buying a 1-month call option and a 1-month put option on Nifty, both with a strike price of Rs.17,000. The call option premium is Rs.325 and the put option premium is Rs.240. The lot size is 50 units. Determine (a) the exact profit or loss for the investor at expiry if Nifty closes at Rs.16,100, (b) the minimum Nifty closing price that would maximize the loss for this strategy, and (c) the total number of distinct Nifty closing prices (to the nearest integer) between 0 and 34,000 (inclusive) that would result in a net profit for the straddle strategy. Assume fractional prices are not possible and ignore transaction costs and taxes.
Q2 (B) Zenith Capital, a leading Indian investment firm, recently faced a major challenge when a key counterparty defaulted on its derivatives obligations amid market volatility. The incident exposed gaps in Zenith’s risk management systems, particularly regarding illiquid positions and operational controls. To respond, the firm strengthened liquidity buffers, improved controls, and implemented stricter margin requirements. As global regulators like SEBI, CFTC, and BIS increase their oversight and enforce new transparency standards, Zenith must evaluate which risk management practices are most effective and align with ethical and compliance expectations.Evaluate Zenith Capital’s revised risk management approach in mitigating credit, liquidity, and operational risks following the counterparty default. Considering global best practices and recent regulatory actions, how effective are their strategies in both meeting regulatory compliance and fostering market confidence? Justify any further improvements you would recommend.
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