Functions of Treasury

Forecasting and Planning Treasury Relationships Foreign Exchange Management Liquidity Debt Forex Interest Rate Exposure Operational Risk

Monday 30th Jan,2012

Treasury Risk Management

Managing Treasury Related Risks Treasury controls and identifying treasury related risks

Concept of hedging
Concept of hedging Financial Markets and instruments Forex Markets Commodities Markets

Financial Markets Forex Markets Commodities Markets

Syllabus

Risk Management Techniques

Quantitative Techniques Pricing and valuations Translation Risk Derivatives and speculation

Instruments

Accounting and Tax implications

Hedging
Hedging is a means of defense against probability of loss from a business transaction. It is a carefully planned and organized effort aimed at protecting specific exposures both currency and commodity,in the market so as to ensure stability of cash flows. Hedging is essentially buying protection for unforeseen events similar to insurance. It is purely a safety driven approach
2

Hedging vs Insurance
Although hedging is akin to insurance, the following points of difference are important:
Sl no Hedging Insurance

This is a means of protection of physical and financial assets against market volatilities This is not intended to reduce risk but only to transfer risk

This is a means of protection of people against risk of life/loss or destruction of physical assets This is intended for risk reduction.

Hedging vs Insurance
Sl no Hedging Insurance

Sharing or distributing of risk under hedging is not possible

The basic principle of insurance is sharing or distributing risk over the entire group of policy holders Insurance claims are generally predictable There is no minimum or maximum period

4 5

The risks hedged are not predictable This covers risks on physical/family assets for periods ranging from 6 months to 2 years

Hedging vs Speculation Hedging is risk transfer to avoid loss, while speculation is risk acceptance in expectation of profit out of future movement of prices. In market risk management, both Hedging and speculation are necessary, since interplay of risk aversion and risk perversion is generally obvious.
5

Hedging vs Speculation
The functional role of hedging and speculation is tabulated Below:
Sl no Hedging Speculation

This is risk transfer/ reduction hence safety driven, This is possible only when specific exposures need protection

This is risk assumption in expectation of profithence, expectation driven. This is possible when market opportunities open up
6

Hedging vs Speculation
Sl no Hedging Speculation

This is aimed at neutralizing market movements. This tends to stabilize cash flows and cost of capital Short selling transaction does not arise

This is aimed at making the best use of favorable market movements This has the objective of profit and profit only Short selling with a view to earning profits from the same assets is the core of speculation.
7

ICICIPru Life Insurance Co Ltd proposes to invest Rs 432 cr in G-secs for 5 years at the current yield 8.17% out of funds receivable within a fortnight. The CIO believes interest rate are likely to be softened in coming days. Is there an option available?

Types of hedging
Long Hedge Contracts entered before the investor buys the actual securities, so as to generate a desired yield before the securities are actually purchased ie a transaction when a position in the cash market is hedged by going long in the futures market

Types of Hedging
Short Hedge

Immediate sale until the actual securities are sold in the cash market and is intended to protect the risk of falling prices. The hedge is accomplished by going short in the futures market.
Cross Hedge

When a futures contract is not available on an asset, market participants look forward to an asset that is closely associated with their underlying and trades in the futures market, for the purposes of hedging. It is a process of minimizing risk through a contract transaction between the 10 spot and future markets

BEML Limited, the Public Sector Mini Ratna Company under the Ministry of Defence manufacturing Metro Cars, submitted a global tender for the prestigious Jaipur Metro order valuing to Rs 318 Crores. By this Order, BEML will have to manufacture, supply,test and commission 10 train sets of 4-Car each, totaling 40 Cars to Jaipur Metro Project. BEML had estimated the cost of the major imports from US and Europe at US$ = Rs50. The order envisges import of equipment from US and Europe aggregating US $ 55mln @ US =Rs 50.The company expects to make a profit of Rs 17 crores.

11

Cost of imported equipment US$55mln @ Rs 50 Local manufacturing costs + operative expenses incl interest Order Rs318 cr Should US$/Inr rate move to Rs 54.00 US$ 55 mln costs Rs 297.00 cr Local costs Rs 26.00cr Rs 323.00cr

Rs275.00cr Rs 26.00cr Rs 301.00cr Rs 17.00cr

12

Hedge net economic exposure Too many hedging programmers target the nominal risks of siloed business rather than a companys net economic exposure. This siloed approach is a problem especially In large multinational organizations.

13

At a large international industrial company , one business unit decided to hedge its forex exposure from sale of US$700 mln in goods to Brazil, inadvertently increasing the companys net exposure to fluctuations in foreign currency. The unit Manager had not known that a second business unit was at the same time sourcing about US$500 mln of goods from Brazil.
14

Calculate total costs and benefits Estimated costs of hedging Direct costs Oppurtunity and marginal costs Other costs ,if any

15

Hedge only what matters

16

Functions of Treasury

Forecasting and Planning Treasury Relationships Foreign Exchange Management Liquidity Debt Forex Interest Rate Exposure Operational Risk

Wednesday February,2012

Treasury Risk Management

Managing Treasury Related Risks Treasury controls and identifying treasury related risks

Concept of hedging
Concept of hedging Financial Markets and instruments Forex Markets Commodities Markets

Financial Markets Forex Markets Commodities Markets

Syllabus

Risk Management Techniques

Quantitative Techniques Pricing and valuations Translation Risk Derivatives and speculation

Instruments

Accounting and Tax implications

17

Wednesday, 1st February,2012

Treasury Risk Management

Financial Markets and instruments

Forwards, Futures, Swaps FRAs, and Options

. Derivatives
1

Spot

Forward Futures

Swap Spot

FRA Options

Forward Contracts A forward contract is an agreement to buy or sell an asset, incl currency, on specified future date for a specified price. Forward contract is a bilateral transaction. It is tailored to suit the needs of the customer. It is an OTC product
19

Recap

Forward Contract

Currencies/ Commodities

A transaction in which the exchange of currencies takes place at a specified future date, subsequent to the spot date, is known as a forward transaction The forward transaction can be for delivery one month or two months or three months and more. Forward contract for 3 months means the exchange of currencies takes place after 3 months from the date of contract
20

Recap

Forward contract The difference between the forward rate and the spot rate is known as the forward margin. Forward margin may be either at premium or discount The forward margin is called a premium on the currency whose forward rate is more expensive than the spot rate and, a discount where the forward rate is cheaper
21

Recap

Forward contract Direct quotation

Spot Rate Spot Rate

Purchase/sale Purchase/sale

Add Add premium premium

US$ = Rs48.42 US$ = Rs52.10

Deduct Deduct discount discount

Forward Rate Forward Rate

Purchase/sale Purchase/sale
22

Recap

Forward Margin
Spot US$ = 52.00 00 / 1000 Fwd Feb 2000 / 2100* Fwd March 3500 / 3600
Sometimes, annualized and quoted in % terms 0.2000/.2100

Where forward margin for a month is given in ascending order as in the quotation above, it indicates that forward currency is at premium. The out right rates are arrived at by adding the forward margin to the spot rates
23

Recap

Forward contract

Under direct quotation, premium is added to spot rate to arrive at the forward rate. This is done for both purchase and sale transactions. Discount is deducted from the spot rate to arrive at the forward rate

24

Recap

Forward Margin
The difference in the rate of interest prevailing at the home centre and the concerned foreign centre determines the forward margin. If the rate of interest at the foreign centre is higher than prevailing at the home centre, the forward margin would be at discount Conversely, if the rate of interest at the foreign centre is lower than that at the home centre ,the forward margin would be at premium.
US Int rate 3m 0.30% India Tbill 91d 8.15%
Forward 25 Margin Premium

Recap

Forward Margin
Spot rate for US$ is Rs 52.00/52.10 Interest rate Rate for 3 mon Fwd ?

Mumbai 8%pa New York 5%pa Purchase $ and US$100000 Borrow Rs 52.10 lacs Invest for 3mon Pay int Rs 1.042lacs receive interest 1250 $101250 Rs 53.142lacs Rate 53.142lacs/101250 Rs 52.49 Forward Premium Rs00.39

26

Recap

Forward Margin
Spot rate x Forward period x Int differential

Forward Margin

-- ------------------------------------100xTime 52.10x 3x3 --------------100x12 Rs 0.39 interesr rate differential

27

Recap

In India, inter-bank trades, forwards for two different maturity patterns; - X months from spot maturity - the last working day of the month When an inter-bank quote for a specific maturity date desired by the client is not available, it is derived by straight line interpolation between the two nearest available dates
28

Recap

The system of option contracts is prevalent in the Indian market. This refers to choosing the value date within an agreed period

29

Forward contracts
Forward contract suffers from ; i . Liquidity risk ii. Counter party or credit risk A forward contract does not allow the parties to derive any gain from favorable price movement or to unwind the transaction once the contract is made Futures came into existence to address the issues of illiquidity and counterparty risks
30

Differences between Forwards and Futures

Sl no 1 2 3 4 5 6 Forwards OTC contracts Not traded on exchanges Bilateral transaction No exchange guarantee Involves no margin payments Used for hedging and physical delivery Dependent on negotiated contract conditions Private deals. No transparency Futures Traded on exchanges Clearing House protection available to both parties Requires margin payments Used for hedging and speculation Standardized and published Transparent and reported to the 31 exchange

Futures contracts
Futures contracts are standardized forward contracts settled through a clearing agency of the exchanges. In other words , Futures contract is an agreement to buy or sell a standard quantity and quality of a given underlying on a future date thru the medium of an exchange house at price which is pre determined. Though the above definition looks similar to a forward contract differences between the two are many
32

Financial Futures

Currency futures

Financial Futures 3 types

Interest rate bond futures

Equity index futures

33

Financial Futures Financial futures are used by market players to protect their assets against adverse price movements
Financial futures contract

Sell short to protect against Rise in interest rate Fall in currency

Buy long to protect against Fall in interest rate Rise in currency value Rise in index value
34

Interest rate

Currency

Equity index

Fall in equity index value

Currency Futures (continued)

Pricing of currency futures

1 + int rate of dom currency x days/360 Futures price = Spot price x ---------------------------------------------------1 + int rate of foreign currency x days/360

The price of the currency is determined in the same manner as currency forwards are priced

35

Mon 6 th February,2012

Financial Markets and instruments

Treasury Risk Management

Forwards, Futures, Swaps FRAs, and Options

Financial futures contract Interest rate

Sell short to protect against Rise in interest rate Fall in currency Fall in equity index value

Buy long to protect against Fall in interest rate Rise in currency value Rise in index value

Currency Equity index

Financial Futures

Currency futures

Financial Futures 3 types

Interest rate bond futures

Equity index futures Exchange traded instrument

37

Operational nuances

To trade in Futures contracts one has to become a Member of the Exchange by paying an initial margin that is based on the price volatility of the underlying instrument. The variable margin account has to be maintained with the Exchange so that the daily profit or loss on the outstanding position on account of marking to market may be accounted for

38

Operational nuances The contracts are for 3 months and expires on the last Thursday of the month.

The size and maturity of the contract are standardized. As Futures contracts are entered into basically for hedging purposes, physical delivery of the underlying instrument between the buyer and seller rarely takes place.
39

Other salient features

- The positions are normally closed out by opposite parties. - The Futures Exchange guarantees the settlement between various parties to the market and hence counter party risk is absent. - Futures are available on currencies ,bonds ,interest rates stock indices, commodities . Each of these contract has its own specifications and procedures.

40

ICICI Bank Limited

as at 31st January,2012 Consolidated

Liabilities

Rs cr

Assets

Rs cr

Share Capital Reserves & sur Minority interest Deposits Borrowings Liab on Policies in force Other Liabilities

1114.89 50181.61 1270.40 241572.30 115698.32 53965.42

Cash & bal with RBI Bal with banks&money at call

27850.27

19293.84 186319.78 225778.12 3862.29 26242.99

Investments 25544.35 Advances Fixed Assets Others

Treasury liabilities

Total
Contingent Liabilities**

489347.29
Rs 820519.93 cr

Treasury assets

489347.29 41

ICICI Bank Ltd Mumbai has in its investment portfolio fixed income securities aggregating Rs167000cr. The Duration of the portfolio is 4.6 years and modified duration is at 4.0%.The market is agog with rumors that interest rates may go up soon by 1% to curb inflationary trends. In tandem,the BSE sensex may fall by 1000 points from its present level. INR may weaken vis a vis US$ to Rs 52.00
42

Assets Investments Fixed income sec

Amount Rs cr 167000.00

Impact of Market developments Duration 4.6yrs Modified Duration 4.00% 1 % increase in general interest rates reduces value of investments by Rs 6680cr Incl

Likely increase in interest rates

G-Sec /Corporate debt @Floating int rate Equities /shares Forex Raised FC borrowings US $23 mln @ US$/Rs48 for loan to a client Total 9319.78 10000.00

INR weakening 186319.78

43

Available options: - Do nothing -Sale of securities -Shuffle investments for reduction in maturity Duration and Mod Duration - Hedge the risk ?

44

Swaps
45

A Swap is a barter - exchange of one thing for another. In financial markets, the two parties to a swap transaction contract to exchange cash flows, at specified future times according to certain specified rules.
Fixed Maturity US $

It is a custom tailored bilateral agreement

Party A

1 2 3 4

1 2 3 4

Exchange of cash flows

INR Maturity Floating

Party B
46

A Swap transaction is the simultaneous buying and selling of a similar underlying asset or obligation of equivalent capital amount where the exchange of financial arrangements provides both parties to the transaction with more than favorable conditions they would otherwise expect

47

Types of Swaps
Interest Rate Swap Where cash flows at a fixed rate of interest are exchanged for those referenced to a floating rate

Currency swap

Where cash flows in one currency are exchanged for cash flows in another currency

Basis swap

Where cash flows on both legs of the swap are referenced to different floating rates 48

Swaps are used

- to create either synthetic fixed or floating

rate liabilities or assets to hedge against adverse movements as an asset liability management tool to reduce the funding cost by exploiting the comparative advantage that each counterparty has in the fixed/floating rate markets for trading
49

Interest Rate Swap

An interest rate swap is a contractual agreement to exchange a series of cash flows. One leg of cash flow is based on a fixed interest rate and the other leg is based on a floating interest rate over a period of time There is no exchange of principal.
50

Mico Bosch is a multinational corporation with a credit rating of BBB. Mico Bosch needs to borrow US$ 50mio for 5 years.

Plain vanilla IRS

Mico Bosch MNC BBB

Needs to borrow US$50mio for 5 years

Treasury prefers

Fixed rate loan

In order to predict future funding costs. In other words Mico Bosch wants to hedge 51 its interest rate exposure

Plain vanilla IRS

Mico Bosch MNC BBB

Needs to borrow US$50mio for 5 years

Treasury prefers

Fixed rate loan

Reason : credit rating

MICO can manage to raise the loan on floating rate @ Libor +1%
52

Plain vanilla IRS

MICO BOSCH MNC BBB

Needs to borrow US$50mio for 5 years

Treasury prefers

Fixed rate loan

MICO can manage to raise the loan on floating rate @ Libor +1% Alternate strategy would be to issue debt instrument with a high coupon of 10 % 53

Deutsche Bank AG is an international bank with AAA credit rating. Deutsche Bank need to raise US$50mio for 5 years

Plain vanilla IRS

Deutsche Bank AG AAA

Needs to raise US$50mio for 5 years

Treasury prefers

Floating rate loan

Reason control its profit margins on an interest rate gap In other words the bank too wants to hedge its interest rate exposure
54

Plain vanilla IRS

Deutsche Bank AG AAA

Needs to raise US$50mio for 5 years

Treasury prefers

Fixed rate loan

Because of its credit rating, Deutsche Bank Ag can borrow at a fixed rate of 8.25 % or at floating rate of LIBOR
55

Plain vanilla IRS Rates Fixed @ Floating @ Requirement Mico Bosch can borrow 10 % Libor +1 % Fixed Deutsche Bank can borrow 8.25 % Libor Floating
56

Mico Bosch and Deutsche Bank Ag obtain funds which are favorable to them and then swap the interest rate payments

57

Plain vanilla IRS

Swap between Mico Bosch and Deutsche BankAg will reduce interest rate payments on both sides The result of swapping interest rate payments is that both parties should pay interest at net rates lower than otherwise available to them

58

Plain vanilla IRS

Mico Bosch borrows @ a floating rate of libor + 1 % Deutsche Bank Ag borrows @ a fixed rate of 8.25 % Mico Bosch and Deutsche Bank Ag enter into an IRS for a notional principal amount of $50 mio for 5 years Mico Bosch makes fixed rate payments of 9.75 % to Deutsche Bank Ag Deutsche Bank Ag makes floating rate payments of Libor +1% to Mico Bosch Pays higher fixed rate @11/2@+%
to compensate the bank for doing 59 the swap

Mico Bosch

Deutsche Bank Ag

Pays to lender Libor+1% & Pays 9.75% to Deutsche Bank Libor +1%+9.75%

Pays fixed rate of 8.25% to lender Pays Libor +1% to Mico Bosch Libor+1%+8.25%
60

Plain vanilla IRS

Savings for both parties

Rates
Pay out Receive in Payments With out swap costs Savings Another way of Considering the swap is

Mico Bosch
9.75%+Libor+1% Libor + 1 % 9.75% 10 % 0.25% Without swap both parties pay a total of 10 % +Libor

Deutsche Bank
8.25 %+Libor+1% 9.75% Libor - 0.5% [-] Libor 0.50% With swap they pay 9.25 %+Libor
61

Forward Rate Agreements

- forward contracts on interest rate

62

Forward Rate Agreement

FRA is a forward contract on interest rate

Forward Rate Agreement is a contract between two parties by which they agree to settle between them the interest differential on a notional principal on a future settlement date for a specified future period

FRA is a financial contract to exchange interest payments based on a fixed interest rate with payments based on floating interest rate like 6 m Libor / 3m Mibor
63

Forward Rate Agreement

The exchange of payments is based on a notional principal of the FRA. There is no commitment on either side of the counter parties to lend or borrow the principal amount

There are two legs in a FRA the fixed leg and the floating leg.
64

Parties to FRA
Pays a particular fixed rate Buyer of FRA Receives a floating rate

Receives a particular fixed rate

Seller
Pays a particular floating rate

65

Parties to FRA
Pays a particular fixed rate Buyer of FRA Receives a floating rate Buyer expects interest rates to go up

Receives a particular fixed rate

Seller
Pays a particular floating rate

Seller expects interest rates to fall

66

an example
A corporate wants to borrow Rs one crore for a period of six months but starting three months from today reason ,six months interest rates may rise in three months time FRA is quoted in the market as 3 Vs 6 , 3 Vs 9. or 6 Vs 9 and so forth. A 3 Vs 9 FRA means seeking protection for a six month borrowing or lending commitment starting 3 months from today The Corporate picks up the quote for 3 Vs 9
67

Prices are quoted 2 ways in the market. like 6.25/6.50; 7.00/7.30 For a 3vs 9, the price is 6.25 / 6.50

The Corporate buys at the higher of the two quotes ie @ 6.50 % If on the date of settlement, which is the date three months from today when the borrowing commitment has to be met , the bench mark rate settles at 7%. The Corporates view has come true and it receives from the seller Rs 1crore x0.05x181 --------------------------- x 36500 1 ------------------------[1+0.07x181/365]

68

Pricing a FRA

Money market rates for various months as on the 12thMay,2009 are as follows; 1 mon 3.10 / 3.20% 6 mon 3.60 / 3.75 % 2 mon 3.50 / 3.60% 9 mon 3.78 / 3.88 % 3 mon 3.45 / 3.65% 12mon 3.95/ 4.00 % Price a 3vs12 FRA?
69

A 3vs 12 FRA is equivalent to a commitment to either lend or borrow a sum of money for a period of 9 months starting 3 months from say today. If we have to lend money for 9 months starting 3 months from today, we may have to borrow the money for 12 months and invest it for the first 3 months. On completion of 3 months ,the investment will mature and it can be lent for 9 months.
70

We can borrow money for 12 months from the market @4.00% and repayment amount after 12 months would be [1+0.0400] The amount borrowed can be invested for 3 mon@3.45% And this investment on maturity can be invested at unknown forward rate for 9 mon at r % The compounded value of the 2 cash flows would be [1+0.0345x91/365][1+rx274/365]

71

The two cash flows should be equal for us to break even in terms of interest cost [1+0.0400] = [1+0.0345X91/365][1+rX274/365] r =4.15% Similarly ,if we borrow money for 3 m at 3.65% and renew this borrowing for 9 mat the end of 3 months and we lend the money at one go for 12 m at 3.95% we arrive at [1+0.0395]= [1+0.0365X91/365][1+rX274/365] r= 4.63% The range is ;4.63%-4.15% Price the FRA , based on our perception of the counter party
72

Options
73

Option Contract An option is a contract, which gives the buyer the right ,but not the obligation ,to buy or sell specified quantity of the underlying assets, at a specified price on or before a specified time The underlying may be physical commodity like wheat/ gold or financial instruments like equity stocks/bonds /currency
74

Players in the option market

Banks, Developmental institutions, Mutual Funds, Domestic & Foreign Institutional Investors, Brokers, Retail Participants

75

Option Products

like Nifty or Sensex

Stock Index Options Options on Individual Stocks Interest Rate Options , Currency Options.

76

Concepts
Premium
The price of an option

Strike Price

The rate at which the right can be exercised

Expiry Date

The date on which the option expires. On expiration date, either the option is exercised or it expires worthless
77

Concepts
Total number of option contracts outstanding in the market at any given point

Open interest

Option holder

One who buys an option

Option seller / writer

One who is obligated to buy or sell the underlying asset in case the buyer of the option decides to exercise the option
78

Call options

Put options

Buyer

Buys the right to buy the underlying asset at the specified price

Buys the right to sell underlying asset at the specified price

Seller

Has the obligation to Has the obligation to sell the underlying asset sell the underlying asset at the specified price at the specified price
79

Types of options
OTC Options

European style option American style option Listed Options

Option only on the expiry date

Option exercisable at any time until expiry Listed on exchanges, Chicago IMM, NSE

Options on individual securities available at NSE are American type of options S&P CNX NIFTY and CNX IT options at NSE are European type options 80

Characteristics of options

In the money options

At the money options

Out of the money options

81

Characteristics of options

In the money option is an option that would lead to

positive cash flow to the holder if it were exercised immediately. A call option is said to be in the money when the current price stands at a level higher than the strike price. If the spot price is much higher than the strike price, a call is said to be in deep money. In case of a put , the put is in the money if the spot price is below the strike price.
82

Characteristics of options

At the money option is an option that would lead to zero cash flow if it were exercised immediately. An option on index is said to be at the money when the current price equals the strike price

83

Characteristics of options

Out of money option is an option that would lead to a negative cash flow if it were exercised immediately. A call option is out of money when the current price stands at a level which is less than the strike price . If the current price is much lower than the strike price the call is said to be deep out of the money. In case of a put ,the put is said to be out of money if the current price is above the strike price
84

Money value of option contracts

--------------------------------------------------------------------------------------------------CALL OPTION PUT OPTION --------------------------------------------------------------------------------------------------

In the money Strike price < Spot price Strike price > Spot price At the money Strike price = Spot price Strike price = Spot price Out of the money Strike price > Spot price Strike price < Spot price ---- Of underlying asset ----

---------------------------------------------------------------------------------------------------

85

Shri Rakesh Jhunjhunwala of Kolkata buys call option on1000 shares of SBI from NSE Mumbai, at a strike price of Rs 1275 Pays option premium Rs 225 Threshold price Rs 1500 It is an American type option; ie option is exercisable
at any time before expiry of the contract

Expiry 28 th May,2009 Price of SBI Share on the13th May was Rs 1268 What should he have done on the 13th May,2009 in the light of the subsequent developments?

86

Rakesh Jhunjhunwala
It is a call option. Strike Price is Rs1275. Pays option price of Rs 225. The threshold price of the option is Rs 1500. RJ has the right to exercise his call option at any time before expiry of the contract and buy the Option. The option will be in the money when the scrip price exceeds Rs1500
87

Strike price of the option

BSE Sensex Rs1275 Rs1275 Daily price movements in the market

+
Option premium Rs225

Rs1268
[13thmay,09]

Threshold price

Rs1500

Expiry;26thMay2009 88

The price of the scrip in the market on the 13th May,2009 was Rs 1268. Though the option is exercisable at any time it is not advantageous to exercise it on the 13th May,2009 as RJ would otherwise be loosing Rs 232 on each scrip. RJ has to wait and see the movement of the price of the scrip to Rs 1500 when he can exercise his option Otherwise ,he should allow the option to expire
89

Covered and naked calls A call option position that is covered by an opposite position in the underlying instrument is called a covered call . Writing covered calls involves writing call options when the shares that might have to be delivered are already owned, eg a writer writes a call on Reliance and at the same time holds shares of Reliance so that if the call is exercised by the buyer, he can deliver the stock
90

Covered and naked calls

Covered calls are less risky than naked calls since the worst that can happen is that the investor is required to sell shares already owned at below their market value. When a physical delivery of a naked call is exercised, the writer will have to purchase the underlying asset at market rates to meet the call ,which may be a costly proposition
91

Factors affecting the value of an option Quantifiable Factors Underlying stock prices Strike price of the option Volatility of the underlying stock Time to expiration Risk free interest rate

92

Factors affecting the value of an option

Non quantifiable factors -

Market perception of the underlying assets future volatility

- Individuals perception of the future performance of

the underlying asset, based on fundamentals

-Effect of supply and demand, both in the options

market place and in the market for the underlying asset

-The depth of the market for options

93