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TitleFRM notes
File Size557.3 KB
Total Pages76
Table of Contents
Risk Classification
	A. Systematic Risk
	1. Market Risk
	2. Interest Rate Risk
	3. Purchasing Power Risk
B. Unsystematic Risk
	1 Business Risk
	2. Financial Risk
Risk management: Nature & Importance
Document Text Contents
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Page 39




Financial Risk Management


In the spot market, the buyer of a stock has to pay the entire transaction amount (for purchasing

the stock) to the seller. For example, if Infosys is trading at Rs. 2000 a share and an investor

wants to buy 100 Infosys shares, then he has to pay Rs. 2000 X 100 = Rs. 2,00,000 to the seller.

The settlement will take place on T+2 basis; that is, two days after the transaction date.

In a derivatives contract, a person enters into a trade today (buy or sell) but the settlement

happens on a future date. Because of this, there is a high possibility of default by any of the

parties. Futures and option contracts are traded through exchanges and the counter party risk is

taken care of by the clearing corporation. In order to prevent any of the parties from defaulting

on his trade commitment, the clearing corporation levies a margin on the buyer as well as seller

of the futures and option contracts. This margin is a percentage (approximately 20%) of the total

contract value. Thus, for the aforementioned example, if a person wants to buy 100 Infosys

futures, then he will have to pay 20% of the contract value of Rs 2,00,000 = Rs 40,000 as a

margin to the clearing corporation. This margin is applicable to both, the buyer and the seller of a

futures contract.

Moneyness of an Option

“Moneyness” of an option indicates whether an option is worth exercising or not i.e. if the option

is exercised by the buyer of the option whether he will receive money or not.

“Moneyness” of an option at any given time depends on where the spot price of the underlying is

at that point of time relative to the strike price. The premium paid is not taken into consideration

while calculating moneyness of an Option, since the premium once paid is a sunk cost and the

profitability from exercising the option does not depend on the size of the premium. Therefore,

the decision (of the buyer of the option) whether to exercise the option or not is not affected by

the size of the premium. The following three terms are used to define the moneyness of an


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