STUDY OF DERIVATIVES

LUDHIANA STOCK EXCHANGE LIMITED LUDHIANA

TRAINING REPORT SUBMITTED IN THE PARTIAL FULFILMENT FOR THE DEGREE OF BACHELOR OF BUSINESS ADMINISTRATION YEAR 2008-200

A!"#$ %&'()!"

SUBMITTED TO PUN*ABI UNIVERSITY PATIALA

SUBMITTED BY SIMRANDEEP SINGH +,2

RIMT-INSTITUTE OF MANAGEMENT AND COMPUTER TECHNOLOGYMANDIGOBINDGARH

ACKNOWLEDGEMENT

Our personalities are based on the foundation of education imparted by our teachers who are next to god. I acknowledge our deepest sense of gratitude and sincere feeling of indebtedness to my major advisor, was able to complete my project. #ithout their immaculate and intellectual guidance, sustained efforts and encouraging attitude, it would have been difficult to achieve the results in such a short span of time. I am grateful to r. $.!. !idhu % anaging &irector' of (!) for permitting me to r. anager ,-raining In charge' and all the staff members of take the training at (!) (td. I also want to express our sincere gratitude to *.!. +rneja %!enior r. !hammi "holi, under whose guidance I

(!) for spending time and valuable information they have shared with me and helped me in my project to be a success. -he acknowledgement would not be completed without expressing my thanks to the faculty of my college for showing me the right path and guided me to solve my problems. I extent my gratitude to our Director Mr. B.S. Bhatia and all the related teachers. -he help and cooperation they offered at each stage of my study is ineffable. -heir valuable suggestions and constant encouragement made this study interesting and useful. .inally, I would like to acknowledge the support I got from my parents and /od. It was their blessing that kept me motivated throughout till the completion of the project.

Simrandeep Singh

ii

STUDENT DECLA AT!ON

I here by &eclare that study of "Stud# o$ Deri%ati%e&' $as been exclusively done by us for the degree of BAC(ELO O) BUS!NESS ADM!N!ST AT!ON +nd not for any other degree, &iploma or fellowship. -his is our own study done under the guidance of manager of the company. I hereby declare that the contents of this report are true and best to my knowledge.

0lace1 (2&$I+3+ %!I 4+3&))0 !I3/$'

iii

* E)ACE
One should always work with an objective in its mind. -o accomplish that objective efficient management of material, time and financial resources is very important. +bove this coordination is must that determines the degree of success. +wareness at each level of life is necessary for a human being keeping all this is view in this report on !tudy of &erivatives55. -he rounded encouraging support by r. *! +rneja towards this report has created in me confidence regarding the approval of the subject matter. I feel that it was a great opportunity for me to spend time in (!) and getting myself aware of the ups and downs of capital market. !o would like to say that this report is a result of an assignment, to improve myself and gain confidence.

iv

CONTENTS
C(A*TE + !NT ODUCT!ON TO O GAN!SAT!ON
+ . STOCK E,C(ANGE - . LUD(!ANA STOCK E,C(ANGE . . LSE SECU !T!ES L!M!TED

C(A*TE

* O/ECT OB/ECT!0ES A
LEA N!NG OB/ECT!0ES
6 I3-4O&27-IO3 -O &)4I8+-I8)!

9 -:0)! O. &)4I8+-I8)! ; )7O3O I7 2-I(I-: O. &)4I8+-I8)! < O=*)7-I8)! O. &)4I8+-I8)! > I3!-42 )3-! O. &)4I8+-I8) -4+&I3/ ? 4I!" @ +3+/) )3-

+4/I3

B C(A*TE C(A*TE C(A*TE . 2 3

ANAL1S!S O) DE !0AT!0ES

ESEA C( MET(ODOLOG1 DATA ANAL1S!S AND !NTE * ETAT!ON SUGGEST!ONS AND CONCLUS!ONS

=I=(IO/+40$: +3& +33)A24)!

L!ST O) TABLES

T.%$# N'/
TABLE 1.1

T)0$# O1 T.%$#

P."# N'/
5

LIST OF VARIOUS STOCK EXCHANGES IN INDIA

TABLE 1.2

BOARD OF DIRECTORS ( LSE)

TABLE 1.3

BOARD OF DIRECTORS (LSE SECURITIES)

15

TABLE 1.4

SETTLE ENT C!CLE SCHEDULE

1"

TABLE 1.5

SCHEDULE OF ANNUAL LISTING FEE

23

TABLE 1.#

ACHIEVE ENTS OF LUDHIANA STOCK EXCHANGE

3$

vi

LIST OF DIAGRAMS

F)"/ N'/

T)0$# '1 02# D)."&.3

O. (!)!(

P."# N'
9D 9E >B >6 >> >? >@ >D D6 D9 D; D< D> D? D@ vii

.I/24) 6.6 !O247)! O. .23& .O4 -$) :)+4 9BB>CB? .I/24) 6.9 !O247)! O. .23& .O4 -$) :)+4 9BB<CB> O. (!)!( .I/24) 9.6 0+:O.. I3&)A .2-24)! %=2:)4' .I/24) 9.9 0+:O.. I3&)A .2-24)! %!)(()4' .I/24) 9.; 0+: O.. 7+(( O0-IO3 %=2:)4' .I/24) 9.< !)(()4 7+(( O0-IO3 .I/24) 9.> 02- O0-IO3 =2:)4 .I/24) 9.? 0+: O.. 02- O0-IO3 %!)(()4' .I/24) <.6 -4+&I3/ 0)4IO& I3 &)4I8+-I8)! .I/24) <.9 0240O!) .O4 &)4I8+-I8) -4+&I3/

.I/24) <. ; !)/ )3- $+8I3/ (+4/) -243O8)4 .I/24) <. < + O23- I38)!-)& I3 &)4I8+-I8)! .I/24) <. > -4+&)& 0)4IO& .O4 &)4I8+-I8) I38)!- )3.I/24) <. ? I 0+7- O3 72!-O )4 =+!) .I/24) <. @ 4)(+-IO3!$I0 #I-$ 7+!$ +4")-

.I/24) <. D +77)0-+37) =: I3&I+3 I38)!-O4! .I/24) <. E !$O4- 7O I3/ I3 I3&I+3 &)4I8+-I8) !:!-) .I/24) <.6B #$I7$ -OO( O. &)4I8+-I8) I! =)--)4

DD DE EB

viii

STOCK E,C(ANGE

+ !-O7" )A7$+3/) is a platform where buyers and sellers of securities issued by government, financial institutions, corporate houses, etc meet and where the trading of these corporate securities takes place. -his is a market of speculations. If the speculation of investor becomes wrong then the investor loses. 3obody knows what will happen even after a second. + stock exchange refers to that segment of the capital market where the securities issued by corporate entities are trade. It is an open auction market where buyers and sellers meet and evolve a competitive price for the securities. It reflects hopes, aspirations and fears of people regarding the performance of the economy. It provides necessary mobility to capital and directs the flow of capital into profitable and successful enterprises. !ince buying and selling of different types of securities takes place in stock exchange. -he prices of particular securities reflect their demand and supply. In fact, stock exchange is said to be a barometer of economic and financial health. -he stock exchanges are the nerve center of capital market. -he stock exchange discharges three essential functions in the process of capital formation not in raising resources for the corporate sector. It provides place for sale and purchase of securities i.e. shares, bonds etc. It provides linkages between the savings of household sector and investment in corporate sector or economy. It provides market Fuotation for share, debentures and bonds and serves as a role of barometer, not only of the state of health of individual companies, but also of the economy as a whole. -herefore, by providing market place Fuotations of the price of shares and bonds or sort of collective judgment. !imultaneously reached by many buyers and sellers in the market, the stock exchanges serve the role of barometer, not only of the state of health of individual companies but also of the nation5s economy as a whole.

)EATU ES O) STOCK E,C(ANGE o It is the place where listed securities are bought and sold. o It is an association of persons known as members. o -rading in securities is allowed under rules and regulations of stock exchange. o embership is must for transacting business.

o Investors and speculators, who want to buy and sell securities, can do so through members of stock exchanges i.e. brokers.

)UNCT!ONS O) STOCK E,C(ANGE -he stock exchange provides appropriate conditions where purchase and sale of securities takes place at reasonable and fair prices. -he bargained prices of buyers and sellers are recorded, on the basis of which each investor is able to evaluate the securities held by him and thus knows the worth of his holdings at a particular time.-he stock exchange provides a ready market for the conversion of existing securities into cash and vice versa. 0eople having surplus funds invest in securities and these funds are securities and these funds are used for industrialiGed and economic development of the country that leads to capital formation. !tock exchange protects the investor of investors through strict enforcement of rules and regulations with respect of dealings. 0unishment %including fine, suspension' may be there if brokers adopt any malpractice in dealing with investor like charging excessively high commission etc. -he stock exchange acts as the center of providing business information relating to the enterprise whose securities are traded as the listed companies are to present their financial and other statements to it.

(!STO 1 O) STOCK E,C(ANGE -he trading in securities in India was started in the early of 6E@;. -he stock exchange operating in the 6Eth century was those of =ombay set up in 6D@> and +hmedabad set up in 6DE<. -hese were organiGed as voluntary nonCprofit making associations of brokers to regulate and protect their interests. =efore the control on securities trading becomes a control on securities trading became a central subject under the constitution in 6E>B. It was a state subject and the =ombay securities contact %control' act, 6E9> used to regulate trading in securities. 2nder this act, =ombay stock exchange was securities in 6E9@ and +hmedabad stock exchange in 6E9@ and +hmedabad stock exchange in 6E;@. &uring the war boom, a number of stock exchanges were organiGed at =ombay, +hmedabad and other centers but they were not recogniGed soon after it became a central subject, central legislation was proposed and a committee headed by sh. +.&. /O4#+(+ went into bill for securities regulation. On the basis securities regulation. On the basis securities contracts %control' at became law in 6E>?. +t present there are 9; recogniGed stock exchanges in India. 3umber of Investors is increasing day by day. -he stock exchange is a double auction market. Huite distinct from the common market in which only one seller and many buyers in a stock exchange a number of potential buyers and potential sellers coCexist all competing both among themselves and with one another in making bids, counterCbids, offers and counterCoffers.

W(O BENE)!TS ) OM STOCK E,C(ANGE4

o !N0ESTO S5 It provides them liFuidity, marketability, safety etc. of

Investment.

o COM*AN!ES5 It provides them access to market funds, higher rating and

public interests.

o B OKE S5 -hey receive commission in lien of their services to investors. o ECONOM1 AND COUT 15 -here is large of saving, better growth moves
industries, higher income.

L!ST O) 0A !OUS STOCK E,C(ANGES !N !ND!A TABLE 1.1 S. No. + =ombay !tock exchange Name o$ &toc6 e7change 1ear& e&ta89i&hment 6D@> 8oluntary organiGation +hmedabad exchange . 2 7alcutta !tock exchange .0. Indore 3 ; < = adras !tock exchange $yderabad !tock exchange &elhi !tock exchange =angalore !tock exchange 6E;@ 6E<; 6E<@ 6E>@ !tock 6EBD !tock 6DE@ 8oluntary organiGation 0ublic limited company 8oluntary organiGation 7o. limited by guarantee 7o. limited by guarantee 0ublic limited company 0vt. converted into public ltd. co. > +? 7ochin stock exchange 2.0. "anpur ++ ++. +2 +3 +; 0une !tock exchange (udhiana !tock exchange *aipur !tock exchange /uahati !tock exchange "annaar !tock exchange agadh !tock exchange 6ED9 6ED; 6ED; 6ED< 6ED> 6ED? 7o. limited by guarantee 0ublic limited company 0ublic limited company 0ublic limited company 0ublic limited company 7o. limited by guarantee !tock 6E@D 0ublic limited company 0ublic limited company 3onCprofit 3onCprofit 3onCprofit o$ T#pe o$ organi:ation

exchange, 6E;B

exchange, 6ED9

+<

=huvneshwar exchange

!tock 6EDE

7o. limited by guarantee

+=

!aurashtra stock exchange, 6EDE "utch.

7o. limited by guarantee

+> -? -+

8adora !tock exchange eerut !tock exchange O.-.7.I. %Over the counter exchange of India', umbai

6EEB 6EE6 6EE;

3.&. 3.&. 0ure demutulised

--. -2

3ational !tock exchange 7oimbtoor tock exchange !ikkam !tock exchang

6EE> 6EE? 6EE@

0ure demutualised 3.&. 3.&.

* O)!LE O) LUD(!ANA STOCK E,C(ANGE ASSOC!AT!ON LTD. ESTABL!S(MENT (udhiana stock exchange was established in 6ED; with 99B members by !h. !.0. Oswal and !h. =. . unjal leading industrialist to fulfill vital need of having a stock exchange in this region. !ince its inception (!)+( has grown phenomenally switched from manual trading to screen based training on 3ovember 6Dth 6EE? and number of listed companies increased from 6?B in EB5s to <;@ as on ;6st march of which 9D? are regional and 6;6 are non regional. (!)+( has played on important role in generating capital for the companies in states of 0unjab, $aryana, $imachal 0radesh and *.".

GO0E N!NG COUNC!L@ COMM!TTEES AND ADM!N!ST AT!ON -he 7ouncil of anagement of the )xchange consists of eleven members, out of

which two are /overnment 3omineesI six are 0ublic 4epresentatives and one anaging &irector who is also )xCofficio member of the =oard. +t every +nnual /eneral eeting, one third of the elected the )xecutive &irectors retire by anaging &irector rotation. +dministration of the )xchange is managed by the

who is assisted by a 7ompany !ecretary and a team of )xecutives, +ssistants, -echnicians and subCstaff. -he )xchange has four !tatutory 7ommittees namely &isciplinary 7ommittee, +rbitration 7ommittee, &efaults 7ommittee and Investor !ervices 7ommittee. In addition, it has advisory and standing committees to assist the administration.

BOA D O) D! ECTO S !h. $arjit !ingh !idhu 0rof. 4ajinder =handari !h. &.". alhotra !h. /.!. =ains !h. =.=. -andon !h. !unil alhotra !h. :ash ahajan !h. !.7. +ggarwal !h. !anjeev kumar /upta !h. anmohan *uneja anaging &irector 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative !)=I 3ominee &irector !)=I 3ominee &irector -+=() 6.9

!h. &.0. /andhi

"

CO *O ATE GO0E NANCE +lthough the (udhiana !tock )xchange is not a listed 7ompany, yet it has followed a model of corporate governance, which is evident from the composition of the !tatutory 7ommittees, the Investor !ervices 7ommittee and +udit 7ommittee. -he Investor !ervices 7ommittee comprises of four public 4epresentatives and one broker member. It is headed by !h. &.". in 9B1DB ratios. alhotra, a legal expert. !tatutory 7ommittees are represented by brokers and nonCbrokers

O*E AT!ONS O) LUD(!ANA STOCK E,C(ANGE TU NO0E (udhiana !tock )xchange is one of the leading !tock )xchanges among the 4egional !tock )xchanges of the country, and has been providing trading platform for the investors situated in 0unjab, *,", and $imachal 0radesh , 7handigarh. +t present, it has ;<< listed companies and among them, 99B are listed as regional companies. It had been generating significant amount of the business in the secondary market. It recorded a peak turnover of 4s.E6>< crores during the year 9BBBC9BB6. -he structural changes that took place in the recent past in the 7apital arket of the country had a negative impact on the trading volume of the regional !tock )xchanges. -here has been a significant reduction of turnover during the financial year 9BB6C9BB9, but the reduction in turnover of the )xchange has been more than adeFuately compensated by substantial rise in the turnover of (!) !ecurities (imited, a subsidiary of (udhiana !tock )xchange.

1$

L!ST!NG (isting is one of the major functions of a !tock )xchange wherein the securities of the 7ompanies are enlisted for trading purpose. +ny 7ompany incorporated under 7ompanies +ct, 6E>?, coming out with an I0O, has to mandatory list its shares on a !tock )xchange. -he (isting &epartment of (udhiana !tock )xchange deals with listing of securities, further listing of issues like bonus and rights issues, postClisting compliance of the companies, which are already listed with (udhiana !tock )xchange. -he 7ompanies desirous of listing its securities on the )xchange have to sign a (isting +greement with the !tock )xchange. +fter getting the listing approval, the 7ompany has to ensure and report compliance of the post listing reFuirements. -he listing section of the (!) monitors the postClisting compliance of all the listed companies and follows up with the companies, which are found deficient in compliance.

T AD!NG ON B!GGE

STOCK E,C(ANGES

-he exchange acFuired the membership of 3!) and =!)1 through its subsidiary, the (!) securities (-&, with the objective of providing an enabling mechanism to its member brokers to trade on 3!) and =!) as a sub brokers of (!) securities (imited. -rading at 3!) and =!) was commenced through the subsidiary route from !eptember 9BB and &ecember 9BBB respectively. END O) AN E A -he management of the stock )xchange apprehended that the smaller regional stock exchanges would not be able to meet the challenges imposed by expansion of bigger stock exchanges like 3!) and =!) and might end up losing their business to 8!+- counters of the bigger stock exchanges. In order to

11

prepare for such an eventuality, stock exchanges set up a broking armed in the name of (!) !ecurities (td %a subsidiary company of stock exchange' in *anuary 9BBB and built infrastructure and I- based sophisticated systems to enable its members and investors to trade on 3!) and =!) through the subsidiary route. LSEAL (AS5A OWN BU!LD!NG (!)+( has its own six stories ultra modern building at .eroGe /andhi market at (udhiana. It started its operation on 6?th +ug, 6ED;. OWN BULLET!N ()!+( is continuously publishing (!)+( =ulletin at the interval of Fuarter. It is also publishing (!) annual report which provides information to the various members and investors of stock exchanges. SC EEN BASED T AD!NG It was started at (!) on 3ov. 6D, 6EE?. -he reFuisite software is developed by 7 7 (td. -his screen =ased -rading is based on 8)7-O4 %8ersatile )ngine for 7entraliGed -rading and on line reporting !ystem' this system displays funds with respect of opening prices of the stock exchanges as well as the last traded prices. ON L!NE T AD!NG T( OUG( 0SAT (!)+( has chalked out an ambitious program to expand online trading through 8C!+- to untie other than (udhiana and plans to take the trading facility to doorstep of investors in this year. -he =oard of &irectors of (!) have approved the plan for expansion of online trading through 8!+- with the object of broad base business opportunities to the investor and members, the exchange has set up ;B trading terminals at remote sites and union territory of 7handigarh. -rading through 8C!+- has been smoothly conducted in October 6EEE. 12

SETTLEMENT GUA ANTEE )UND It provides guarantee to all genuine based trading system of the stock exchange and was implemented a settlement guarantee fund with effect from ? th +pril, 6EED. SETTLEMENT AND CLEA !NG -here is -J9 settlement cycle prevailing in the market. embers are given scrip

wise delivery notes. -he members are reFuired to deposit scrip5s sold by them to the clearing house on the second working day following the day of transaction. 0urchasing members are reFuired to make the payment against the delivery also on aforesaid day. DE*OS!TO 1 S1STEM (!) commence trading in demat shares from 3ovember 6?, 6EED by becoming a participant of 3!&(. -he exchange has set up inChouse &0 services to facilitate trading and settlement in demat securities. !N0ESTO G !E0ANCES CELL

(!) has made special arrangement to handle investors complaints and grievance so its premises for providing information relating to 7apital market. -his center has a well eFuipped library. -he exchange introduced a computer based stock. -el system for providing on line real time information through a fully automatic system, to the investors and members of the general public such as prices of the scrip5s, book closures, new listings, new issuers etc. 7entre is also eFuipped with a screen for providing Klive5 rates of trading at 3!) and =!) DE*OS!TO 1 *A T!C!*ANT SE 0!CE -he company is the &0 of 3!) and is the only depository in the region having on line real time connectivity with 3!&(. &0 operation of the company not only

13

benefited the investors of the region but has also proved to be a source of income for the company.

14

* O)!LE O) LSE SECU !T!ES LTD. OB/ECT!0E O) T(E COM*AN1 (!) !ecurities (imited is a subsidiary of the (udhiana !tock )xchange, which was formed with an objective to enhance business and investment opportunities for the investors and members of (udhiana !tock )xchange at large, through innovative products by encompassing a variety of activities related to the capital market. -he company has a paid Lup capital of 4s.>.?> crores, preference capital of 4s @.EB lacs , the authoriGed capital of the company is 4s D crores. !NT ODUCT!ON O) LSE SECU !T!ES LTD. (!) !ecurities (td., was incorporated in *anuary, 9BBB with a view to revive the capital market in the region and for taking full advantage of the emerging opportunities being provided by expansion of bigger stock exchanges like 3!) and =!). -he company since its inception has marched forward rapidly and achieved many milestones in a short span of its existence. GO0E NMENT COUNC!L -he 7ouncil of the management of the 7ompany comprises of 69 directors of which > are broker members and > nonCbrokers. -he non broker members are independent &irectors of eminent status from the field of finance, law and management and remaining two are )xecutive Officer of the holding company %(udhiana !tock )xchange' and 7hief )xecutive officer of the company, who are on the board of the company as exCofficio &irectors. -hus the council of management has representation of subCbrokers as well as professionals and subject specialists representing various fields of business activities. Operations of the company are run in a professional, transparent and fair manner keeping in view of the interest of investors as well as other stakeholders.

15

CO *O ATE MEMEBE S(!* O) NSE B BSE !)=I, at the initiative of (!)+(, permitted smaller !tock )xchanges, to trade on bigger !tock )xchanges through their subsidiary companies. -he (udhiana !tock )xchange floated its subsidiary company, the (!) !ecurities (imited, with the objective of obtaining trading rights on bigger !tock )xchanges. It has obtained corporate membership of both 3!) and =!) in the year 9BBB. T AD!NG AT NSE AND BSE -he (!) !ecurities (td.7ommenced trading operations in 7apital arket

!egments of =!) and 3!) in !eptember, 9BBB and &ecember, 9BBB respectively. -he total turnover of the company at 3!) is growing by leaps and bounds ever since in incorporation. -here was encouraging response from the subCbrokers specially at 3!) counters. &uring the financial year 9BB>CB? turnover had been 4s D?6; crores as against 4s @ED@ crores during the financial year 9BB<CB> in 7apital arket segment of 3!). -he total turnover during the arket segment of =!). financial year 9BB>CB? had been 4s <E9B crores as against 4s ;D;; crores during the financial year 9BB<CB> in 7apital )B? SEGMENT O) NSE (!) !ecurities (td. 7ommenced trading operations in .uture and Options !egment of 3!) in .ebruary 9BB9. -he 7ompany became the first subsidiary of any 4egional !tock )xchange which commenced trading in .,O !egment of 3!). 4esponse to trading facilities in the .,O segment of 3!) has been very encouraging and volumes generated in this segment soon exceeded those in 7apital arket segment.

1#

T AD!NG T( OUG( 0ASAT& -he (!) !ecurities (imited has also provided facility to its subCbrokers for trading on 3!) and =!) through 8!+- counters, which are located outside !tock )xchange =uilding. 0resently, 6@ subCbrokers of the company have been trading through 8!+- on 3!) and 6B on =!). CE T!)!CAT!ON !N )!NANC!AL MA KET In order to provide professional services to the investors of (!) !ecurities (imited through its subCbrokers, the company motivated its subCbrokers and its staff to Fualify the certification in financial markets conducted by 3!). +ll trading terminals for 7apital arket !egment and .,O segment are being operated by the persons after having Fualified the said certification. BOA D O) D! ECTO S !h. +." +4O4+ !h. 8ijay !inghania !h. $arjit !ingh !idhu !h. (alit "ishore !h !ukhjiwan 4ai !h. +nurag +rora !h. +shwani "umar !h. .+. Mahir !h. 0.7. /arg !h. +jay 7haudhry !h. 8inay !hrivastav 7hairman 8ice 7hairman &irector &irector &irector &irector 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative 0ublic 4epresentative

-+=() 6.;

DE*A TMENTS O) LSE

1%

-he main aim of LUD(!ANA STOCK E,C(ANGE is to ensure the safety and security to the investments of the investors and to provide the proper services under the prescribed guidelines of !) 6;6. !o to maintain the proper system of working of exchange, there are so many different departments in which particular functions are performed, assigned to those departments. .ollowing in the list of various departments of (!)1C O*E AT!ONAL DE*A TMENTS 6. ;. argin !ection arket !urveillance 9. 7learing $ouse <. 7omputer !ection and information !ystem &epartment SE 0!CE DE*A TMENTS 6. (egal &epartment 9. !ecretarial &epartment. ;. I./.7. %Investor /rievance 7ell' <. (isting !ection >. +ccounting !ection ?. embership &epartmentN0ersonnel &epartment +ll the section perform specific functions. -here is no duplication of workI even then all the sections are interconnected with each other. -here is an organiGed network of recording of activities performed there. =ut before studying the inter dependence of section' here is the details of all department i.e. actually what function is performed by each and every section.

MA G!N SECT!ON

18

argin !ection is an important section. -his section apart from dealing in the regulating the trading of brokers keeps a check on excessive trading in speculation. argin is the amount, which is collected from brokers for the safety of transactions. +s the transactions are to be finaliGed on basis, in the mean time the rates may fluctuate which may lead to default. !o to make the transaction safe, daily margins are collected from brokers. #hen a member gets registered in the exchange and with !ecurities )xchange =oard of India %!)=I', then before starting trading he is supposed to deposit some amount fixed by !)=I as security. 3ow as !)=I5s rolling settlement prevails. 2ltimately margin is the difference between the limit and trade done by the member. -he security deposited by a member is called =ase inimum 7apital. inimum 7apital. If any member wants to trade beyond his trading limit, he can do so by depositing +dditional =ase

T1*ES O) MA G!NS +s we have discussed earlier margins, collected from members to avoid the losses and to provide security to the investors. -here are different types of margins, which are imposed given as follows1C MA K TO MA KET MA G!N -he exchange collects this margin on daily basis, brokerCwise 6BBO notional loss of each member for every scrip, calculated as the difference of his buying or selling price and closing of that scrip at the end of the day. -his is also called loss margin. -he margin is payable in cash or in bank guarantee.

0ALUE AT

!SK O 0A

MA G!N

1"

.or the scrips in the compulsory rolling settlement at EEO 8+4 based margin system would be introduced w.e.f. *uly, B9, 9BB6. the computation of this margin is done by a software developed by 7$I7+/O !tock )xchange. ADD!T!ONAL MA G!N -hus margin is 69O would be levied over and above the 8+4 margin. -his margin is collected from brokers on -J6 basis. S*EC!AL MA G!N -he brokers will be reFuired to deposit margin as per the percentage prescribed by stock exchange in this regard from time to time. *A1MENT O) MA G!N -he brokerPs shall be reFuired to deposit margin demanded from them by 661BB+ on -JI day. -hat is on next trading day. -he margin brokers shall be collected by way of cheFues drawn on the prescribed banks, demand draft or by way of direct debit to the bank account to broker.

CLEA !NG (OUSE

2$

7learing house takes care of payCin and payCout securities. +t this time there is weekly trading system % onday to .riday' prevails. +nd securities are settled by rolling settlement. eans payCin and payCout of securities is settled on -J; =asis would commence form 6st+pril, 9BB9. !)=I decide the following activity schedule for exchanges for the -J; rolling settlement. SETTLEMENT C1CLE SC(EDULE !r. 3o. 6 9 ; &ay -J9 -J; &escription of +ctivity -rade -rade &ate !ecurities and funds payCin and payCout +uction of shortage in delivery -+=() 6.< T - TRADING PERIOD. *A1 !NC*A1OUT O) SECU !T!ES On trading day brokers buy and sold the securities or scrips and payCIn and pay out of securities will be completed on -J9 basis e.g. if broker buyNsell shares on onday then pay in of securities will be on #ednesday, 6B1;B+. . +nd pay out of scrips will also on #ednesday up to 91BB 0. ., in this way payCinNpayCout of securities cycle will be completed.

AUCT!ON O) UNDEL!0E ED SC !*S

21

In case if broker fails to deliver the scrips on -J9 delivery day. -hen it is responsibility of clearing house to settle the undelivered scrips. -hen, auction will start. In above example, auction of pending securities will be conducted on -hursday. In auction price of securities may will fluctuate 9BO high or low of that trading day. In this way trade in auction is settled.

CLOSE OUT In case the shares of particular scrips is not available on the date of auction. -hen it is obligation of solicitor %exchange' to give monetary benefit to initiator %buyer' against the default of defaulter of securities in this manner settlement schedule has completed. COM*UTE SECT!ON

-he growing technicalities and increase in workload has enhanced the importance of computer section in (udhiana stock exchange. -his department mainly referred to as )&0 i.e. electronic data processing section. -his section is the backbone of entire stock exchange would come to halt if this department becomes inactive. It prepares several reports namely1 C o !crip wise statement of each member for each settlement period o !ub broker wise delivery bill receive order %after payout' o &ownloading of delivery order. o &ownloading of receiving order. o +nd broker on sub broker wise final settlement. o $&.7 bank entries. o !crip wise statement 7omputer facilitates easily updating all automatically adopting of new rates, once we feed new limits the whole calculation to be done through 22

computer will change. 4ates are updated either daily or month wise as per the reFuirements.

MANUAL O*E AT!ONS It has reduced manual work. It has also eliminated approximately the need to keep check the physical reports, which is a time consuming as well as space consuming and reFuires a lot of attention. 0OLUME AND T ANS*A ENC1 -his system is very much transparent, as each individual involved knows every relevant tilling . +lso volume of shares being traced is very high and increasing continuously. L!NK!NG C(A!N -his section acts as a linkage, which links each and every department of the (!) with another and hence helps in working as a whole. C(ECK AND CONT OL O0E SC !*S AND MEMBE S

-his section also helps in maintaining check and control over defaulting members and scrips. In case the member crosses his limit of trading according to his deposited amount, the computer section switches off his terminal and same step is taken in case of defaulted scrips.

MA KET SU 0E!LLANCE AND MON!TO !NG SECT!ON

23

-he main task of this section is to see the market sanctity and maintenance so that the investors are not cheated. !o market surveillance entails scientifically identifying points in a stock price movement or trading volumes, which donPt match with the companyPs fundamentals. !o the price and volume trends in stock exchange are checked for abnormalities scientifically. !N0ESTO S G !E0ANCE SECT!ON (!) has a separate investorPs grievance cell, which receives complaints from investors and follows up the complaints with companies and member broker to ensure their satisfactory redressal. .or providing better services to the investors the stock exchange has maintained investor protection fund. In this fund 4s. >BB is collected from each member annually. +part from this one percent of the total listing fee collected and ten percent interest covered on company deposits is also transferred to the investor protection fund. One more fund investor service fund has been set up. 9BO of the listing fee is transferred to it. -he funds of it are used for maintenance of investor service center, holding of seminars for investorNbrokers benefit, and publication of (!) =ulletin. ationa9e Behind E&ta89i&hing !n%e&tor&' Grie%ance Ce99 o -o safeguard the investor5s interest through investors grievance section. o -o participate as monitoring authority in the public and right issue of the company. o -o ensure that the company listed at the (!) compiles with all the listing reFuirements. o -o keep a record of the inFuiry base of the listed companies, their annual financial results and any subseFuent increase in the eFuity base. o L!ST!NG SECT!ON

24

-his department plays an important role in the !tock )xchange. as it helps the company to raise money from the capital market. 0resently it is mandatory for 4egional 7ompany to get itself listed at (!). In order to get listed company should have minimum capital of 4s. ; crores and at least 9>O of its eFuity should be offered to the public for the listing company is also reFuired to make a deposit 6 O issue price with the stock )xchange and it can not be released before the expiry of six months provided there is a compliance of preC listings and postClisting reFuirements of the company. 7ompany has also to comply with the conditions enunciated in listing clause. -he schedule of annual (isting fee and up front listing fee payable triennially is given below1 *aid up capita9 2pto 6 crores 6 to > crores > to 6B crores 6B to 9B crores 9B to ;B crores +bove >B crores Annua9 Li&ting )ee D &.E D<BB 6?DBB 9DBBB >?BBB D<BBB 6<BBBB -+=() 6.> 7ompanies which have paid up capital of more than 4s. >B crores will pay additional fee of 4s. 9DBB for every increase of 4s. > crores or part there of. -he annual listing fees referred to above are applicable only if the exchange is a 4egional !tock )xchange otherwise the fees will be >BO of the fees indicated above.

ACCOUNTS SECT!ON ost of the work in account section (!) is done manually, although help is taken through computers for the purpose of making -rial =alance, Income and

25

)xpenditure statement and =alance !heet. -he annual report of (!) is generally published in +ugust every year. !ome of the important polices of (!) are o -he company follows accrual system of accounting recogniGes income and expenditure accordingly. o &epreciation is provided on written down, value method in accordance with and din the manner specified in schedule AI8 of the 7ompanies +ct 6E>?. o .ixed costs are stated at historical costs less depreciation. o !tockNInventory %stationery' is valued at cost. o Interest on funds borrowed which is attributable to construction of fixed assets and other indirect expenditure during construction is included under work in progress. -he company has the procedure of receiving shares, scrips of various companies as securities against the performance of the contract. 3o accounting entries in such transaction are made in respect of defaulting members by crediting security account and debiting memberPs investment aNc. -he shares in such cases are valued at prices on the date of transfer deeds. )unction& o$ Account& Section5A -he account section performs the following function. o -o make and receive payments to the outside agencies, these agencies include companies listed at (!) and brokers working at (!). o -o disburse personnel expenses. o -o keep the records of all incoming and outgoing money depreciation of financial statements at the end of financial year. o -o get their accounts audited from the third party. o Source& o$ $und& o$ LSE5 A

2#

embership fee from brokers at the beginning.

o Initial listing fee from companies i.e. 4s. 6,BBBNC o +nnual listing fee from companies. o +nnual fee from brokers %4s. >BBB' and their authoriGed representatives. %4s. >BB each' as broker member is allowed to have maximum < authoriGed representatives. o Interest income from deposits of companies for listing, which are made at 6O of issue amount and minimum capital for this purpose is 4s. <NC crores. !uch deposits are retained until there is no dispute against the company subject to the minimum of ? months, o o +nnual computer fee from brokers %4s. >BBB' (ibrary charges from brokers %4s. 9BB' p.a.' o =rokers contribution to investor protection fund %4s. >BB p.a' o .ines and penalties form brokers. o aintenance charges 4s. 6;.>B per sF. feet, per Fuarter from those members having rooms and those not having rooms all those not having rooms are charges at till rate of 4s. 6>BBNC pa. o #ater and electricity charges 4s. @>B per Fuarter, whose area is less than 9BB sF. feet and EBBNC per Fuarter which is having area of more than 9BB sF. feet. -he members who are not having rooms are charged at the rate of 4s. ;BBNC %p.a.' o Interest earned affixed deposits. =illing of members is done on annual basis for annual fees and other aboveC mentioned charges. On 6st +pril of each year and they are to make payment in 6DB days up to ;B !eptember. =eyond it, they are charged interest on due amount Q 69O p.a. still in case of nonpayment, broker member is served a show cause notice for ?B days on 6st +pril next year. If member fails to, comply with notice then he can be expelled. App9ication O$ )und& O$ LSE5A

2%

6. >O of listing fees to !)=I each year. 9. 9BO for providing services to investors out, or listing fee annually to investor service fund. ;. +dministrative expenses %I' )lectricity 7harges. %II' !ecurity 7harges %III' -elephone 7harges %I8' 8!+- 7harges %8' 0rinting and stationary !alaries <. 6O of listing is transferred annually to investor protection fund. SEC ETA !AL DE*A TMENT &uties and responsibilities of personnel department are mentioned as under which are discharge by the secretarial departments. o 4ecruitment of staff. o o aintain employee record e.g. attendance leave, overtime etc. aintain employee service book up to date and other detail as per the reFuirements to auditors at the time of inspection %.rom date of joining registration' o )mployee welfare scheme like loans. o Other activities like staff farewell party and &iwalipuja. +lthough the (!), has not a separate personnel departments in its organiGing chart. +ll activities relating personnel are carried out by the secretarial departments, which has the additional charge of personnel.

LEGAL SECT!ON 28

#hen two broker or outside clients do not settle their claims in between themselves and move to court, the legal section comes into the picture to fight for the cause of investors and against the defaulting members. (egal section also assist the member investor to settle their disputes through the arbitration committee investors grievance committee. &isciplinary committee, defaulting committee, so that there maybe settled at the earlier without incurring heavy due on amount regarding court fee, advocate fee etc. -he objective of the legal section is to make effective the bylaws and regulation of the stock exchange and to see that the guidelines, circular and any amendments in rules made by the !)=I are enforced at appropriate time so that the future complications may be reduced or avoided. +s the name legal section suggests it is clearly mentioned and understood that each of every matter involving legality is to be solved by the legal department. *E SONNEL DE*A TMENT (udhiana stock exchange does not have a personnel department in its OrganiGation chart. -his department carries out all activities relating to the recruitment of the personnel, whenever and wherever a vacancy arises, maintenance of attendance register. -his department also deals with the appointment or removal of floor clerks or authoriGed representatives of brokers. -hese departments also maintain records of leaves and overtime of employees.

MEMBE S(!* DE*A TMENT

2"

-his department deals with membership of exchange. -he trade in market is done through the authoriGed members who are registered with concerned stock exchange and !)=I. -here are two types of members in stock exchanges. o 7orporate members o Individual member .ollowing are the reFuirements to be an individual member of exchange. Age Limit5 Fua9i$ication5 -o be member of stock exchange there is age limit age is 96 yrs aximum age is ?B yrs. -o be member minimum Fualification inimum

atriculation is plus

person has threeCyear experience interview. Including written test and membership department deal with all above reFuirements of members. .ollowing reFuirements are for corporate members1C 6. 7ompany must be registered uNs ;99 of the company +ct i.e. &irectors with unlimited liability. 9. -wo copies of securities. O+ , +O+. ;. Hualification , 0roof of age of at least two directors, who will deal in

SOU CES O) )UND )O T(E 1EA O) LSESL

-??3A?;

3$

6 9 ; < >

.I/24) 6.6

SOU CES5A %6' embership .ee R R R R B.D9O 6;.9@ 9E.B;O ;.9;O >;.?> %9' (isting .ee %;' Interest on deposits %>' Other income

%<' 0rofit on sale of fixed assets R

SOU CES O) )UND )O T(E 1EA O) LSESL

-??2A?3

31

6 9 ; < >

.I/24) 6.9

SOU CES5A 6' -urnover 7harge =!) 9' -urnover 7harge 3!) ;' Interest on =ank deposits <' &epository Income >' Other income R R R R R >.6BO <@.6DO ;6.EBO D.EEO ?.D;O SSSSSSSS 6BB

AC(!E0EMENTS O) LUD(!ANA STOCK E,C(ANGE

32

TABLE 1.6 Oct 6ED6 +ug 6ED; +ug 6ED; 3ov 6EE? +pril 6EED Incorporation of !tock )xchange 7ommencement of operations !hifting of operation to own building Online !creen -rading odified carry forward system % 7-!' 3ov 6EED !ep 6EEE *an 9BBB +ug 9BBB &ec 9BBB !ep 9BBB *uly 9BB6 *anuary 9BB9 .eb 9BB9 +pril 9BB9 +pril 9BB; Oct 9BB; and settlement gurantee fund. -rading and settlement in demat scrips -rading at remote sites through 8!+counters Introduction of rolling settlement 7ommencement of online real time depository services -rading on 3.!.). in 7. . segment %-hrough 3!)(' -rading on =.!.). in 7 segment

%-hrough (!)(' Introduction of 7ompulsory rolling settlement 7omplete shift of trading 7 segment

from I!) -o (!) securities (td. -rading in .,O segment of 3.!.). 4olling settlement cycle prevailing at (!) on -J; basis 4olling settlement cycle prevailing at (!) on -J9 cycle Incorporation of (!) commodities trading services (td., a subsidiary of (!). !ecurities (td. Introduction of 7A % ulti 7ommodity )xchange of India' 7A offers 6< different commodities such as steel, kapas, rubber, blackpepper, oil soil seeds, precious metal etc.

arch 9BB<

33

34

OB/ECT!0ES

LEA N!NG OB/ECT!0ES !t inc9ude&

6 I3-4O&27-IO3 -O &)4I8+-I8)!

9 -:0)! O. &)4I8+-I8)! ; )7O3O I7 2-I(I-: O. &)4I8+-I8)! < O=*)7-I8)! O. &)4I8+-I8)!

35

> I3!-42 )3-! O. &)4I8+-I8) -4+&I3/ ? 4I!" @ +3+/) )3-

+4/I3

ANAL1S!S O) DE !0AT!0ES MA KET

!NT ODUCT!ON TO DE !0AT!0ES 0rimary market is used for raising money and secondary market is used for trading in the securities, which have been used in primary market. =ut derivative market is Fuite different from other markets as the market is used for minimiGing risk arising from underlying assets. -he work derivative originates from mathematics. It refers to a variable, which has been derived from another variable. i.e. A R f%:' #here A %dependent variable' R &)4I8+-I8) 04O&273#

: %independent variable' R 23&)4(:I3/ +!!)+ financial derivative is a product that derives value from the market of another product. $ence derivative market has no independent existence without an underlying asset. -he price of the derivative instrument is contingent on the value of underlying assets. +s a tool of risk management we can define it as, a $inancia9 contract Gho&e %a9ue i& deri%ed $rom the %a9ue o$ an under9#ing a&&etCderi%ati%e &ecurit#H. A99 deri%ati%e& are 8a&ed on &ome ca&h product. The under9#ing a&&et& can 8e 5 a. +ny type of agriculture product of grain %not prevailing in India' b. 0rice of precious and metals gold c. .oreign exchange rates d. !hort term as well as longCtern bond of securities of different type issue<d by govt. and companies etc. e. O.-.7. money instruments for examples loan , deposits.

E7amp9e 5 #heat farmers may wish to sell their harvest at a future date to eliminate the risk of change in price by that date. -he price of these derivatives is driven from spot price of wheat. DE)!N!T!ON O) DE !0AT!0E In the Indian context the securities contracts %4egulations', +ct 6E>? defines &erivative to include1

3%

6. + security derived from a debt instrument, !hare, (oan whether secured or unsecured, 4isk instrument or contract for difference or any other form of security. + contract which derives its value from the prices of prices of underlying securities.

(!STO !CAL AS*ECT O) DE !0AT!0ES -he need for derivatives as hedging tool was first felt in the commodities market. +gricultural .,O helped farmers and 04O7)!!O4! hedge against commodity price risk. +fter the fallout of =4I-+I3 #OO& +/4)) )3-, the financial markets in the world stared undergoing radical changes, which give rise to the risk factor. -his situation led to development of derivatives as effective 4isk anagement tools.

38

&erivatives trading in financial market started in 6E@9 when 7hicago ercantile )xchange opened its international -he I onetary arket &ivision %II '. provided an outlet for currency speculators and for those looking to

reduce their currency risks. -rading took place on currency. .utures, which were contracts for specified Fuantities of given currencies, the exchange rate was fixed at time of contract later on commodity future contracts was introduced then followed by interest rate futures. (ooking at the liFuidity market, derivatives allow corporate and institutional investors to effectively manage their portfolio of assets and liabilities through instruments like stock index futures and options. +n eFuity fund e.g. can reduce its exposure to the stock market and at a relatively low cost without selling of part of its eFuity assets by using stock index futures or index options. -herefore the stock index futures first emerged in 2.!.+. in 6ED9.

* ODUCTS@ *A T!C!*ANTS@ AND )UNCT!ONS &erivatives contracts have several variants. -he most common are .O4#+4&!, .2-24)!, O0-IO3! +3& !#+0!.

-he following three categories of 0articipantsC$edgers, !peculators, and +rbitrageurs.

3"

1. (edger 5A $edgers face risk associated with the price of an asset. -hey
use futures or options markets to reduce the risk. -hus, they are operation who want to eliminate the risk composing of their portfolio.

2. Specu9ator& 5 -hey wish to be on future movements in the price of an

asset. + speculator may buy securities in anticipation of rise in price. If this expectation comes true he sells the securities at a higher price and makes a profit. 2sually the speculator does not take delivery of securities sold by him. $e only receives and pays the differences between the purchase and sale prices.

3. Ar8itrageur& 5 -hey are in business to take advantage of discrepancy

between price in two different markets. If for example, they see the future price of an asset getting out of line with cash price, they will take off setting positions in two markets to lock in profit.

T1*ES O) DE !0AT!0ES -he most commonly used derivatives contract is forwards, futures and options1

1. )orGard& 5 + forward contract is a customiGed contract between two

entities, where settlement takes place on a specific date in the futures at today5s preCagreed price. 4$

2. )uture& 5 + future contract is an agreement between two parties to buy or

sell an asset at a certain time the future at the certain price. .utures contracts are the special types of forward contracts in the sense that are standardiGed exchange traded contracts.

3. Option& 5 It is of two types 1 call and put options.

2nderlying asset, at a give price on or before a given future date. 02-! give the buyer the right but not the obligation to sell a give Fuantity of the underlying asset at a given price on or before a given date.

4. Leap& 5 3ormally option contracts are for a period of 6 to 69 months.

$owever, exchange may introduce option contracts with a maturity period of 9C; years. -hese longCterm option contract are popularly known as (eaps pr (ong term )Fuity +nticipation !ecurities.

5. Ba&6et& 5 =askets options are option on portfolio of underlying asset.

)Fuity Index Options are most popular form of baskets.

#. SGap& 5 -hese are private agreements between two parties to exchange

cash flows in the future according to a prearrange formula. -hey can be regarded as portfolios of forward5s contracts. -he two commonly used swaps are1

&) !ntere&t rate &Gap& 5 -hese entail swapping both 0rincipal and
interest between the parties , with the cash flow in one direction being in a different currency than those in the opposite direction.

41

') Currenc# &Gap& 5 -hese entail swapping both 0rincipal and

interest between the parties, with the cash flow in one direction being in a different currency than those in the opposite direction. T(E DE !0AT!0ES MA KETS *E )O M A NUMBE )UNCT!ONS5 O) ECONOM!C

4/ *rice Di&co%er#5 A 0rices in organiGed derivatives markets reflects the

perception of market participants about the future and lead the prices of underlying to perceived future level. -he prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. -hus derivatives help in discovery of future as well current price.

2/ Tran&$er o$ ri&65 A -he derivative market helps to transfer to the risks from
those who have them but may like them those who have an appetite for them. #e can also term the derivative market as the insurance company, whereby certain players assumes the risk by receiving premium amount.

,/ !ncrea&ed %o9ume in the ca&h mar6et 5C &erivatives due to their inherent

nature are linked to the underlying cash markets. #ith the introduction of derivative, the underlying market, witness higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk.

5/ NeG Entrepreneuria9 acti%itie& 5A &erivatives have a history of attracting

many bright, creative, wellCeducated people with an entrepreneurial, new products and new employment opportunities, the benefits of which are immense.

6/ !ncrea&e in &a%ing 5A &erivatives market helps increase savings and

investments in the long run -ransfer of risk enables market participants to expand their volume of activities.

42

+/ Trading in contro99ed en%ironment 5C -he introduction of the derivatives

has shifted the trading in speculative dealings in controlled market and the counter party risk has been eliminated. *articipant& in deri%ati%e mar6et 6. )xchange, trading members, clearing members. 9. $edgers, arbitrageurs, speculators. ;. 7learing, clearing bank. <. .inancial institutions. >. !tock lenders and borrowers.

EASON )O

STA T!NG DE !0AT!0ES

6. 7ounter party risk on the part of broker, in case it ask money from us but before giving delivery of shares goes bankrupt. 9. (iFuidity risk in the form that the particular scrip might not be traded on exchange. ;. 2nsystematic risk in the form that the price of scrip may go up or down due to 7ompany !pecific 4easons.

4.

utual funds may find it difficult to invest the funds raised by them properly as the scrip in which they want to invert might not be available at the right price. OB/ECT!0ES O) DE !0AT!0E T AD!NG

4/ (edging5 :ou own a stock and you are confident about the prospects of
the company. $owever at the same time you feel that overall market may not perform as good and therefore price of your stock may also fall in line with overall marked trend. 43

:ou except that some adverse economic or political vent affect the marker sentiments, though fundamentals of the company will remain good, therefore, it is good to retain the stock. In both these situations you would like to insure portfolio against any such market fall. !uch insurance is known as hedging. $edging is a tool to reduce the inherent risk in an investment. 8arious strategies designed to reduce investment risk using call option, put options, short selling, and futures are used for hedging. -he basic purpose of a hedge is to reduce the risk of loss.

2/ Ar8itrage5 A -he future price of an underlying asset is function of spot

price and cost of carry adjusted for any return on investment. $owever, due to uncertainly about interest rates, distortions in spot prices, or uncertainly about future income stream, prices in futures market may not truly reflect the expected spot price in future. -his imbalance in future and spot price gives rise to arbitrage opportunities. -ransactions made to take advantage of temporary distortions in the market are known as arbitrage transactions.

,/ Specu9ation&1 C :ou may have very strong opinion about the future
market price of a particular asset based on past trends, current information and future expectation. (ikewise you may also have opinion about the overall marker trend. -o take advantage of such opinion, individual asset or the entire market %index' could be sold or purchased.

44

T(E

EFU! EMENTS )O

SETT!NG U* )UTU E AND O*T!ON T AD!NG

A E OUTL!NES BELOW5 6. 7reation of an Options 7learing 7orporation %O77' as the single guarantor of every traded option. In case of default by a party to a contract, the clearing house has to bear the cost of necessary to carry out the contract. 9. 7reation of a strong cash market %secondary market'. -his is because after the exercise of an option contract, the investors move to the secondary market to book profits. ;. 7reation of paperCless trading and bookCentry transfer system. <. 7areful selection of the regulation in all the stock exchanges. >. 2niformity of rules and regulation in all the stock exchanges. ?. !tandardiGation of the terms governing the options contracts. -his would decrease the transaction costs. .or a given underlying security, all contracts on the options exchange should have an expiry date, a strike price, and a contract price, only the premium should be negotiated on the floor of the exchange. @. (arge, financially sound institutions, members and norms to be out and followed. number of market makers, who can write the options contracts. !trict capital adeFuacy

45

ST ENGT( O) !ND!AN CA*!TAL MA KET )O DE !0AT!0ES

!NT ODUCT!ON O)

1. Large Mar6et Capita9i:ation5 India is one of the largest market

capitaliGed country in +sia with a market capitaliGation of more than @,?>,BBB crores.

2. (igh LiIuidit#5 In the underlying securities the daily average traded

volume in Indian capital market today is around @,>BB crores. #hich means on an average every month 6<O of the country market capitaliGation gets traded, shows high liFuidity.

3. Trader Guarantee5 -he first clearing corporation %77' guaranteeing

trades has become fully functional from *uly 6EE? in the form of 3ational !ecurities 7learing 7orporation %3!77(' for which it does the clearing.

4. Strong depo&itor# 5 + strong depository 3ational !ecurities &epositories

(td. %3!&(', which started functioning in the year 6EE@, has strengthen the securities settlement in our country.

5. A good Lega9 Guardian 5 !)=I is acting as a good legal guardian for

Indian 7apital arket.

4#

!M*O TANCE O) DE !0AT!0ES T AD!NG 6. 4eduction of borrowing cost. 9. )nhancing the yield on assets. ;. odifying the payment structure of assets to correspond to investor market view. <. 3o physical delivery of share certificate so reduction in cost by stamp duty. >. Increase in hedger, speculator and arbitrageurs. ?. It does not totally eliminate speculation, which is basic need of Indian investors.

4%

!NST UMENTS O) DE !0AT!0E T AD!NG

)orGard

Deri%ati%e

)uture

Option

)O WA D CONT ACTS It is an agreement to buyNsell an asset on a certain future date at an agreed price. -he two parties are 1 6. #ho takes a long position C agreeing to buy 9. #ho takes a short position L agreeing to sell -he mutually agreed price is known as delivery price or forward price. -he delivery price is chosen in such a way that the value of contract for both parties is Gero at the time of entering the contract, but the contract takes a positive or negative value for parties as the price of underlying asset moves. It removes the future price risk. It a speculator has information or analysis, which forecast an upturn in price, and then be can go long on the forwards market instead of cash market.

48

-he speculator would go long on the forward, wait for the price to rise, and then take a reversing transaction to book profits. !peculator may well be reFuired to deposit a margin upfront. $owever, this is generally a relatively small proportion of the value of assets underlying the forward contract. E$$ect o$ change in price 5 +s mentioned above the value of such a contract in Gero for both the parties. =ut later as the price , the underlying asset changes, it gives positive or negative value for contract. 0rice +ssets Increase &ecrease , 2nderlying $older , long position 0ositive 8alue 3egative 8alue $older , !hort 0osition 3egative 8alue 0ositive 8alue

).g. + agrees to deliver 6BB eFuity shares of 4eliance to = on !ept. ;B, 9BB9 at a 4ate of 4s. 69B per share. 3ow if the price of share on that is 4s. 6<B per share, than a who has short position would stand to loss of 4s. %9BT9BB' R <BBB, long position would gain the same amount or vise versa if price Fuoted is less than delivery price. 0rofitN(oss R !-C) !- R spot price on maturity date ) R delivery price Limitation& o$ $orGard contract 6. 3o standardiGation. 9. One party can breach its obligation. ;. (ack of centraliGation of trading. <. (ack of (iFuidity. . )UTU E CONT ACT 4"

It is an agreement between buyer and seller for the purchase and sale of a particular assets at a specific future dateI specific siGe, date of delivery, place and alternative asset. It makes obligation on both parties to fulfill the contract. )eature& o$ )uture Contract 6. !tandardiGed contracts e.g. contract siGe. 9. =etween two parties who do not necessarily know each other. ;. /uarantee for performance by a clearing corporation or clearing house. 7learing house is associated with matching, processing, registering, confirming setting, reconciling and guaranteeing the trades on the future exchanges. 7learing house tries to eliminate risk of default by either party. <. It has some features of =adla also.

)UTU E TE M!NOLOG1 Spot *rice 5 -he price at which an asset trades in the spot market. )uture *rice 5 -he price as which the futures contract trades in the futures market. Contract c#c9e 5 -he period over which the contract trades. -he index futures contracts on the 3!) have one moth, and threeCmonth expiry cycles, which expire on the last -hursday of one month. -hus a *anuary expiration contract expires on the last -hursday of the *anuary. On the .riday following the last -hursday, a new contract having threeCmonth expiry is introduced of trading. E7pir# Date 5 It is date specified in the futures contract. -his is the last day on which the contract will be traded, at the end of which it will cease to exist. Ba&i& 5 In the contract of financial futures, basis can be defined as the futures price minus the spot price. -here will be a different basis for each delivery month

5$

for each contract. In a normal market, basis will be positive. -his reflects that futures prices normally exceed spot prices. !nitia9 margin 5 -he amount that must be deposited in the margin account at a time a future contract is first entered into is known as initial margin. Mar6etingAtoAmar6et 5 In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor5s margin gain or loss depending upon the future5s closing price. Maintenance margin 5 -his is somewhat lower than initial margin. -his is set to ensure that the balance in the margin account never becomes negative. If the balance amount falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day. T1*E O) )UTU E CONT ACTS !nde7 )uture& 5 Of the financial futures, index future contracts are key contracts, introduced in 2.!.+., in 6ED9 by the 7ommodity .utures -rading 7ommission %7.-7' by approving the "ansas =oard proposal. Index .utures began trading in India in *une 9BBB of -rade %"!=-'5s .utures derive its value from the underlying indexCe.g. 3!)5s futures. 7ontracts are based on ! , 0 73A 3I.-: +t present it has become the most liFuid contract in the country, the arbitrage between the futures eFuity market is further expected to reduce impact cost. DBC EBO of retail participation is expected in India because

51

T END O) BULL!S( MA KET ( ( ( ( ( ( ( 6>th .eels the market will rise =uys 9BB nifty contracts with expiry date C ;6th at 699B costing 4s. 9<<BBB %9BBT699B' ;6st 3ifty *uly futures has risen to 6;6B !ells off his position at 6;6B akes a profit of 4s. 6DBBB %9BBTEB'

*A1O)) !NDE, )UTU ES DBU1E E

0rofit B 699B
.I/24) 9.6

Index

(oss
>@

52

T END O) BEA !S( MA KET F 6>th ( ( ( ( F ;6st ( ( ( !uppose 3ifty *uly futures has fallen to 66>B !Fuares off his position at 66>B akes a profit of 4s. 6<BBB %9BBT@B' feels the market will fall !ells 9BB 3ifties *uly 7ontract 3ifty *uly contract is trading at 699B $is position is worth 4s. 9<<BBB %9BBT699B'

*A1O)) !NDE, )UTU ES DSELLE E

0rofit

B
.I/24) 9.9

699B Index

(oss
53
>E

)O WA D 0S. )UTU ES )eature& COperational echanism C7ontract !pecifications C7ounter party 4isks C(iFuidity C0rice &iscovery C!ettlement argin )orGard -raded between two parties &iffer from traded to trade )xists such risk (ow 3ot )fficient +t end of period 3o such margin )uture -rade on )xchange !tandardiGed 7ontracts 3o such risk $igh $ighly )fficient &aily argin reFuired for trading

54

O*T!ONS Options are fundamentally different from forward and futures. +n option gives the holderNbuyers of the option the right to do something. -he holder does not have committed himself to doing something. In contrast, in a forward or futures contract, the two parties have committed them self to doing something. #hereas it nothing %except margin reFuirement' to enter in to a futures he purchases of an option reFuire an up front payment. (i&torica9 8ac6ground o$ Option5 +lthough options have exercised for a long time, they were traded O-&, without much knowledge of valuation. -oday exchangeCtraded options are actively traded on stocks, stock indices, foreign currencies and futures contracts. -he first trading is options began in )urope and 2.!. as early as the century. It was only in early, 6EEBs that a group of firms set up what is known as the put and ca99 8ro6er& and dea9er& a&&ociationH with the aim of providing a mechanism for bringing buyers and sellers together. It someone wanted to buy an option, he or she would contract one of the member firms. -he firm would then attempt to find a seller or writer of option either from its own client of those of other member firms. If no seller could be found, the firm would undertake to write the option itself in return of price. -he two deficiencies in above markets were 6. 3o secondary market 9. 3o mechanism to guarantee the writer of option would honor it In 6E@;, =lack, arton, !choles invented the =lackC!choles formula. In +pril 6E@;, 7=O) was set up specially for the purpose of trading options. -he market for options develop so rapidly that by early DB5s number of share underlying the What i& Option 4

55

+n options is the right, but not the obligation to buy to sell a specified amount %and Fuality' of a commodity, index or financial instruments a to buy of sell a specified number of underlying futures contracts, at a specified price on a before a give date in the future. -hus, option like futures, also provide a mechanism by which one can acFuire a certain commodity on other assets, or take position in order to make profits or cover risk for a price. In this type of contract as well, there are two parties1 a. -he buyer %or the holder, or owner of options' b. -he seller %or writer of options' #hile the buyer take J9ong po&itionH the seller take J&hort po&itionH !o every option contract can either be Jca99 optionH or Jput optionH options are created by selling and buying and for every option that is buyer and seller. T1*ES O) O*T!ON CONT ACTS

1. !nde7 Option& 5A Index options are also financial exchange traded

contracts with the underlying assets as the index, whereby the buyer of the options acFuire the right to buy or sell predefined Fuantity of the index for a consideration paid to the seller or the writer of the option. +ll option contracts are also standardiGed and the clearing house or the cooperation guarantees the performance of the contracts.

2. Stoc6 Option& 5A -hese are the stock exchange traded contracts

whereby, buyer of the option gets the right to buy the contracts stocks for a consideration paid to the seller of the option. $e does not have any obligation, but on the other hand the writer %seller' of the option is under the obligation to honour the contract since he has received the premium in lieu of the obligations. !tock options are similar to index options, but with a basic difference is that the underlying assets are individual .. T1*ES O) O*T!ONS

5#

Ca99 Option 5
It gives an owner the write to buy a specified Fuantity of the underlying assets at a predetermined price i.e. the exercise price, or the specific date i.e. is the date of maturity.

Ca99 Option DBu#erE

Wh# ca99 option 4 If u think market will rise E7amp9e .=uy a call with a strike of 4s .9;<B%3I.-:' at a premium of 4s. >B aximum 0rofit 0otential 1 2nlimited. aximum 4isk 0otential =reak )ven 1 (imited to 4s. >B 1 4s.9;EB

*a# o$$ ca99 option DBu#erE

9;<B B >B loss .I/24) 9.; index

Ca99 option DSe99erE

5%

Wh# &e99 Option 5 If u think market will remain neutral or slightly bearish . E7amp9e !ell a call with a strike price of 4s.9;<B%3ifty' at a premium of 4s.>B aximum 0rofit 0otential 1 4s.>B aximum 4isk 0otential 1 2nlimited =reak )ven 1 4s. 9;EB &esired ovement 1 arket will not go down

Se99er ca99 option

69>B loss

index

.I/24) 9.<

*ut Option
58

It gives the holder the right to sell a specific Fuantity of underlying asses at an agreed price on date of maturity he gets the right to sell. Wh# Bu# a *ut Option DBu#erE If u think market will fall E7amp9e =uy a 0ut with a strike of 4s.9;?B%3ifty' at a premium of 4s.9> aximum 0rofit 0otential 1 !ubstantial aximum 4isk 0otential. =reak )ven 1 9;;> &esired ovement 5 Beari&h

*ut Option Bu#er 0rofit B 9;?B index

loss .I/24) 9.>

*ut Option &e99er

5"

Wh# Se99 a *ut Option If u think market will remain neutral or moderately bullish E7amp9e !ell a put with a strike of 4s.9;?B%3ifty' at a premium of 4s.>B aximum 0rofit 0otential 1 4s >B aximum 4isk 0otential 1 !ubstantial =reak )ven 1 4s. 9;6B &esired ovement 1 arket will not go down

0ay off put option %seller'

profit

9;?B index loss

.I/24) 9.?

O*T!ON TE M!NOLOG1

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4/ Bu#er o$ an option 5 -he buyer of an option is the one who by paying the
option premium buys the right but not the obligation exercise his option on the sellerNwriter.

2/ Writer o$ an option 5 -he writer of a callNput option is the one who

receives the option premium and is thereby obliged to sellNbuy the asset if the buyer exercise on him.

,/ Option price 5 Option price is the price, which the option buyer pays to
the option seller. It is also referred as option premium.

5/ E7piration date 5 -he date specified in the options contract is known as

expiration date, the exercise date, the strike date or the maturity.

6/ Stri6e *rice 5 -he price specified in the options contract is known as

strike price or the exercise price.

+/ American option& 5 these are the options that can be exercised at any
time upto the expiration date. +mericans. ost exchangeCtraded options are

7/ European option&5 -hese are the options that can be exercised only on
the expiration date itself. -hese are easier or analyGe than +merican option, and properties of +merican options are freFuently deducted from those of its )uropean counterpart.

8/ !n the mone# option 5 +n in the money option is an option that would

lead to a positive cash flow to the holder if it will exercise immediately. + call option in the index is set to be inCtheCmoney when the current index stands at a level higher than the strike price %i.e. spot priceUstrike price'. If the index is much higher than the strike price, the call is set to deep I- . In the case of a put, the put is Iif the index is below the strike price.

/ AtAmone# option 5 DATME option is an option that would lead to Gero cash
flow if it were exercised immediately. +n option on the index is atCtheC money when the current index eFuals the strike price.

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40/ OutAo$Athe mone# option 5 DOTME options is an option that would lead to
a negative cash flow it was exercised immediately. + call option on the index is Owhen the current index stands at a level, which is less than the strike price %spot priceVstrike price'. If the index is much lower than the strike price, the call is set to be deep O- . In the case of a put, the put is Oif the index is above the strike price. AME !CAN 0S EU O*EAN O*T!ON Its owner can exercise an +merican option at any time on or before the expiration date. + )uropean style option gives the owner the right to use the option only on expiration date and not before. Option *remium + glance at the rights and obligations of buyer and seller reveals that option contracts are skewed. One way naturally wonder as to why the seller %writer' of an option would always be obliged to sellNbuy an asset whereas the other party gets the right. -he answer is that writer of an option receives, a consideration for 2ndertaking the obligation. -his is known as the price or premium to the seller for the option. -he buyer pays the premium for the option to the seller shelter he exercise the option is not exercised, it becomes worthless and the premium becomes the profit of the seller.

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)actor& A$$ecting *ricing 6. !upply and demand in !econdary market 9. )xercise price ;. 4isk free interest rate <. 8olatility of underlying >. -ime to expiration ?. &ividend on underlying

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!SK MANAGEMENT 3!77( have developed a comprehensive risk containment mechanism for the . , O !egment. -he salient features of risk containment mechanism of the . , O segment are 1 6. -he financial soundness of the members is the key to risk management. -herefore, the reFuirements for membership in term of capital adeFuacy %net worth, security deposits' are Fuite stringent. 9. 3!77( charges an upfront initial margin for all the open positions of a 7 . It specifies the initial margin reFuirements for each futuresNoptions contract on a daily basis. It also follows valueCatCrisk %8+4' based margining through !0+3. -he 7 the - s and their respective clients. ;. -he open positions of the members are marked based on contract settlement price for each contract. -he difference is settled in cash on - J 6 basis. <. 3!77(5s onCline position monitoring system monitors a 7 5s open positions on a realCtime basis. (imits are set for each 7 whenever a 7 based on his capital deposits. -he onCline position monitoring system generates alters reaches a position limit set up by 3!77(. 3!77( value violation, while - ! are monitored for monitors the 7 s for in turn collects the initial margin form

contractCwise position limit violation. >. 7 s are provided a trading terminal for the purpose of monitoring the open position of all the - s clearing and setting through him. + 7 set exposure limits for a and whenever a further trading. may clearing and settling through him. 3!77( from

assists the 7m to monitor the intraCday exposure limits set up by a 7 exceed the limits, it stops that particular -

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?. + member is altered of his position to enable him to adjust his exposure or bring in additional capital. 0osition violates result in withdrawal of trading facility for all - s a 7 is case of violation by the 7 . -he most critical component of risk containment mechanism for . , O segment is the margining system and onCline position monitoring. -he actual position monitoring and margining is carried out onCline through 0arallel 4isk anagement !ystem %04I! '. 04I! uses !0+3 %r' %!tandard 0ortfolio +nalysis of risk' !ystem for the purpose of computation of onCline margins, based on the parameters defined by !)=I. M!N!MUM BASE CA*!TAL + clearing ember %7 ' is reFuired to meet with the =ase inimum 7apital has also to

%= 7' reFuirements prescribed by 3!77( before activation. -he 7 all points of time, after activation. )very 7

ensure that = 7 is maintained in accordance with the reFuirements of 3!77( at

is reFuired to maintain = 7 of 4s. >B lakhs with 3!77( in the

following manner 1 6. 4s.9> lakhs in the form of cash. 9. 4s. 9> lakhs in any one form or combination of the below forms1 7ash .ixed &eposit 4eceipts %.&4s' issued by approved banks and deposited with approved 7ustodians or 3!77(. =ank /uarantee in favour of 3!77( from approved banks in the specified format. +pproved securities in demat form deposited with approved 7ustodians. +ny failure on the part of a 7 to meet with the = 7 reFuirements

#5

at any point of time, will be treated as a violation of the 4ules, =yeC(aws and 4egulations of 3!77( and would attract disciplinary action interCalia including, withdrawal of trading facility and Nor clearing facility, closing out of outstanding positions etc. Additiona9 Ba&e Capita9 7learing members may provide additional marginNcollateral deposit %additional base capital' to 3!77( andNor may wish to retain deposits andNor such amounts which are receivable from 3!77(, over and above their minimum deposit reFuirements, towards initial margin and N or other obligations.

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MA G!NS 3!77( has developed a comprehensive risk containment mechanism for the .utures , Options segment. -he most critical component of a risk containment mechanism for 3!77( is the online position monitoring and margining system. -he actual margining and position monitoring is done onCline, on an intraCday basis. 3!77( uses the !0+3 %!tandard 0ortfolio +nalysis of 4isk' system for the purpose of margining, which is a portfolioCbased system. !nitia9 Margin 3!77( collects initial margin upCfront for all open positions of a 7 on the margins computed by 3!77(C!0+3. + 7 collect upfront margins from his clients. Initial margin reFuirements are based on EEO value at risk over a one day time horiGon. $owever, in the case of futures contracts %on index or individual securities', where it may not be possible to collect mark to market settlement value, before the commencement of trading on the next day, the initial margin may be computed over a twoCday time horiGon, applying the appropriate statistical formula. -he methodology for computations of 8alue at 4isk percentage is as per the recommendations of !)=I from time to time. the initial margin from the - s and his respective clients. !imilarly, a based should

is in turn reFuired to collect

#%

!nitia9 margin reIuirement $or a mem8er5 .or client positions L shall be netted at the level of individual client and grossed across all clients, at the -radingN7learing setoffs between clients. .or proprietary positions L shall be netted at -radingN7learing level without any setoffs between client and proprietary positions. .or the purpose of !0+3 time to time. In case a trading member wishes to take additional trading positions his 7 is reFuired to provide +dditional =ase 7apital %+=7' to 3!7(. +=7 can be provided by the members in the form of 7ash, =ank /uarantee, .ixed &eposit 4eceipts and approved securities. *remium Margin In +ddition to Initial argin, 0remium argin would be charged to members. -he argin, various parameters are specified from ember ember level, without any

premium margin is the client wise margin amount payable for the day and will be reFuired to be paid by the buyer till the premium settlement is complete. *a#ment o$ Margin& -he initial margin is payable upfront by 7learing and approved securities. 3onCfulfillment of either the whole or part of the margin obligations will be treated as a violation of the 4ules, =yeC(aws and 4egulations of 3!77( and will attract embers. Initial margins can be

paid by members in the form of 7ash, =ank /uarantee, .ixed &eposit 4eceipts

#8

penal charges Q B.BEO per day of the amount not paid throughout the period of nonCpayment. In addition 3!77( may at its discretion and without any further notice to the clearing member, initiate other disciplinary action, interCalia including, withdrawal of trading facilities and N or clearing facility closing out of outstanding positions, imposing penalties, collecting appropriate deposits, invoking bank guarantees N fixed deposit receipts etc DE !0AT!0ES T AD!NG !N !ND!A

-he first step towards introduction of derivatives trading in India was the promulgation of the securities laws %amendment' ordinance, 6EE> which withdrew the prohibition on options in securities. -he market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. !)=I set up a 9< members committee under the 7hairmanship of &r. (.7. /upta on 6Dth 3ovember, 6EE? top develop appropriate regulatory framework for derivatives trading in India. -he committee submitted its report on 6@th arch, 6EED prescribing necessary preCconditions for introduction of derivatives trading in India. -he committee recommended that derivatives should be declared as Ksecurities5 so that regulatory framework applicable to trading of Ksecurities5 could also govern trading of securities. !)=I also set up a group in *une 6EED under the 7hairmanship of 0rof. *.4. 8arma, to recommend measures for risk containment in derivatives market in India. -he report, which was submitted in October, 6EED, worked out the operational details of margining system, methodology for changing initial margins, broker net worth, deposit reFuirement and real time monitoring reFuirements. -he !74+ was amended in &ec, 6EEE to include derivatives within the ambit of Ksecurities5 and the regulatory framework was developed for governing derivatives trading.

#"

&erivatives trading commenced in India in *une 9BBB after !)=I granted the final approval to this effect in ay 9BBB.

!)=I permitted the derivative segments of two stock exchanges. 3!) and =), and their clearing houseNcorporation to commence trading and settlement in approved derivatives contracts. -o begin with, !)=I approved trading in index futures contracts based on !,0 73A 3ifty and =!)C;B %!ensex' index. -his was followed by approval, for trading in options based on these two indexes and options on individual securities. -he trading in index options commenced in *une 9BB6. .utures contracts on individual stocks were launched in 3ovember 9BB6. -rading and !ettlement in derivatives contracts is done in accordance with the rule, byeClaws, and regulations of the respective exchanges and their clearing houseNcorporation duly approved by !)=I and notified in the official gaGette. -hus, the following four types of &erivatives are now being traded in the India !tock arket. Index .utures Index Options !tocks .uture !tock Options

!nde7 )uture& 5 Index futures are financial contracts for which the underlying is the cash market index like the !ensex, which is the brand index of India. Index futures contract is an agreement to buy or sell a specified Fuantity of underlying index for a future date at a price agreed upon between the buyer and seller. -he contracts have standardiGed specifications like market lot, expiry day, tick siGe and method of settlement.

%$

!nde7 Option& 5 Index Options are financial contracts whereby the right is given by the option seller in consideration of a premium to the option buyer to buy or sell the underlying index at a specific price %strike price' on or before a specific date %expiry date'. Stoc6 )uture& 5 !tock .utures are financial contracts where the underlying asset is an individual stock. !tock futures contract is an agreement to buy or sell a specified Fuantity of underlying eFuity share for a future date at a price agreed upon between the buyer and seller. *ust like Index derivatives, the specifications are preCspecified. Stoc6 Option& 5 !tock Options are instruments whereby the right of purchase and sale is given by the option seller in consideration of a premium to the option buyer to buy or sell the underlying stock at a specific price %strike price' on or before a specific date %expiry date'. O*E AT!ONAL MEC(AN!SM O) DE !0AT!0ES

4/

egi&tration Gith 8ro6er 5

-he first step towards trading in the

derivatives market is selection of a proper broker with whom the investor would trade. Investors should complete all the registration formalities with the broker before commencement of trading in the derivatives market. -he investors should also ensure to deal with a broker %member of the exchange' who is a !)=I registered broker and possesses a !)=I registration certificate.

2/ C9ient Agreement 5 -he investor should sign the 7lient +greement with
the broker before the broker can place any order on his behalf. -he client agreement includes provisions specified by !)=I and the derivatives segment.

,/ UniIue C9ient !denti$ication Num8er 5 +fter signing the client

agreement, the investors gets a uniFue identification number %I&'. -he %1

broker would key this identification number in the system at the time of placing the order on behalf of the investors. -his I& is broker specific i.e. if the investors chooses to deal with different brokers, he needs to sign the client agreement with each one of them and resultantly, he would have different Ids.

5/

i&6 Di&c9o&ure Document& 5 +s stipulated in the =yeC(aws provide his particulars to the investors. -he particulars would include his !)=I registration number, the name of the employees who would be primarily responsible for the client5s affairs, the precise nature of his liability towards the client in respect of the business done on behalf of the investor. -he broker must also apprise the investor about the risk associated with the business in derivative trading and the extent of his liability. -his information forms part of the 4isk &isclosure document, which the broker issues to the client. -he investor should carefully read the risk disclosure document and understand the risks involved in the derivatives trading before committing any position in the market. -he risk disclosure document has to be sign;ed by the client and a copy of the same is retained by the broker for his records.

6/ )ree Cop# o$ e9e%ant egu9ation& 5 -he client is also entitled to a free

copy of the extracts or relevant provisions governing the rights and obligations of clients, relevant manuals, notifications, circulars and any additions or amendments etc. of the derivatives segment or of any regulatory authority to the extent it governs the relationship between the broker and the client.

+/ *9acing order Gith the 8ro6er 5 -he investor should place orders only
after understanding the monetary implications in the event of execution of the trade. +fter the trade is executed, the investor can reFuest for a copy of the trade confirmation slip generated on the systems on execution of the trade. -he investor should also obtain from the broker, a contract note for the trade executed within 9< hours. -he contract note should be time %order receipt and order execution' and price stamped. )xecution prices, %2

brokerage and other charges, if any, should be separately mentioned in the contract note. If desired, the investors may change an order anytime before the same is executed on the exchange.

7/ Margining S#&tem in Deri%ati%e& 5 -he aim of margin money is to

minimiGe the risk of default by either counterCparty. -he payment of margin ensures that the risk is limited to the previous day5s price movement on each outstanding position. -he different types of margins are1

.8 !nitia9 Margin 5 -he basic aim of initial margin is to cover the

largest potential loss in one day. =oth buyer and seller have to deposited before the opening of the position in the futures transaction. -his margin is calculated by !0+3 by considering the worst case scenarion.

%8 Mar6 to mar6et margin 5 +ll daily losses must be met by

depositing of further collateralCknown as variation margin, which is reFuired by the close of business, the following day. +ny profits on the contract are credited to the client5s variation margin account.

8/ !n%e&tor& *rotection )und5 -he derivatives segment has established an

Investors 0rotection .und which is independent of the cash segment to protect the interest of the investors in the derivatives market.

/ Ar8itration 5 In case of any dispute between the members and the clients
arising out of the trading or in relation to tradingNsettlement, the party thereto shall resolve such complaint, dispute by arbitrations procedure as defined in the rules and regulations and =yeC(aws of the respective exchanges.

%3

EGULATO 1 ) AMEWO K -he trading of derivatives is governed by the provisions contained in the !7 %4' +, the !)=I +ct, the rules and regulations framed there under and the rules and byeClaws of stockCexchanges. Securitie& contract& D egu9ationE Act@ +>3; !7%4' + aims at preventing undesiarable transactions in securities by regulating the business of dealing therein and by providing for certain other matters connected therewith. -his is the principal +ct, which governs the trading of securities in India. -he term securities has been defined in the !7%4'+. +s per !ection 9%h', the K!ecurities5 include1 6. !hares, scrips, stock, bonds, debentures, stock or other marketable securities of a like nature in or of any incorporated company or other body corporate. 9. &erivative ;. 2nits or any other instrument issued by any collective investment scheme to the investors in such schemes. <. /overnment securities. >. !uch other instruments as may be declared by the 7entral /overnment to be securities. ?. 4ights or interests in securities &erivative is defined to includes1 + security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract differences or any other form of security. + contract which derives its value from the prices, or index of price, of underlying securities.

%4

!ection 6D+ provides that notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are1 -raded on a recogniGed stock exchange. !ettled on the clearing house of the recogniGed stock exchange, in accordance with the rules and byeClaws of such stock exchanges.

%5

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ESEA C( MET(ODOLOG1

4esearch is a procedure of logical and systematic application of the fundamentals of science to the general and overall Fuestions of a study and scientific techniFue by which provide precise tools, specific procedures and technical, rather than philosophical means for getting and ordering the data prior to their logical analysis and manipulations. &ifferent type of research design is available depending upon the nature of research project, availability of able manpower and circumstances. -he study about +3+(:!I! O. &)4I8+-I8)! +4")- is exploratory as well as descriptive in nature .&iscussion with experts, internet surfing, and journals were studied to explore more about the concerned objective and better understanding of the problem. +fter that Fuestionnaire was prepared to meet the desired objective

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Source& o$ Data5 -he source of data includes primary and secondary data sources.

*rimar# Source& 0rimary data is data collected for first time specially for the

purpose for which study is being conducted i.e. the problem under study..

Secondar# Source& -he secondary data is data, which is collected and compiled for the different purpose, which are used in research for this study. -he secondary data include material collected from1 ) ) ) 3ewspaper agaGine. Internet.

Data Co99ection !n&trument& -he various methods of data gathering involves the use of appropriate recording forms. -hese are called Ktools5 or Kinstruments of data collection. &ata was collected through structured Fuestionnaire administered by sitting with guide and discussing problems Samp9ing TechniIue -he small representative selected out of large population is selected at random is called sample. #ellCselected sample may reflect fairly, accurately the characteristic of population. -he chief aim of sampling is to make an inference about unknown parameters from a measurable sample statistics.

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!ampling techniFue used was !nowball sampling was used for the purpose of data collection as reference was taken form sample to reach other sample.

Samp9e Si:e 5 !ample siGe refers to the number of items to be selected from the universe to constitute a sample. &ue to constraints of cost and time, the sample siGe selected for the research is 9> investors and ;> brokers

Samp9ing Unit 1 -he sampling unit was the person who had an account and was investing in stock market and broker who were trading in stock market .

%"

L!M!TAT!ONS O) T(E STUD1 3o study is complete in itself, however, good it may and every study has some limitations1 -ime is the main constraint of my study. +vailability of information was not sufficient because of less awareness among investors N brokers. !ample siGe is not enough to have a clear opinion.

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81

1.

T AD!NG *E !OD !N DE !0AT!0ES

9> 9B No.o$ 8ro6er& 6> and in%e&tor& 6B > B (ess than 6 year 6 year 9 years ; years ore than ; years !eries6

*E !OD

.I/24) <.6 .rom my sample of ?B, 6; %99O' brokers and investors investing in derivatives from the last 6 year and less than this. 96 %;>O' are investing from last 9 years, @ %66O' are investing from last ; years and only ? %6BO' have experience of more than ; years of investment in derivatives.

82

2.

EASONS BE(!ND !TS ADO*T!ON

purpo&e

9iIuidit# hedging +-K -3K &pecu9ation 2?K

ri&6 management -.K

4easons behind adoption of derivatives are different by brokers, investors and dealers e.g. liFuidity, risk management hedging, investor demand %speculation' etc. Out of ?B brokers, investors dealing in derivatives 6< %9;O' adopt it due to characteristics of risk management, 6> %9>O' due to hedging, 9< %<BO' for speculation and remaining @ %69O' due to liFuidity.

83

;. !n Ghich &egment #ou ha%e 9arger turno%er4 7apital arket !egment %9B'

. , O !egment. )Fual in both above %6>' 7an5t !ay.

&egment ha%ing 9arge turno%er

? 6@O

< 66O 6@ <EO 7 !)/ )3)H2+( I3 .,O , 7 ., O !egment D 9;O 7anPt !ay

.I/24) <.; Out of ;> informants, 6@ have largest turnover in the capital segment i.e. <EO and 9;O have eFual turnover in 7 , .,O segment. 3o informants have its largest turnover in . , O segment because the investor are very less aware about the derivatives and they do not know about the derivative trading as they much know about the 7 !egment.

84

<. !N0ESTED AMOUNT !N DE !0AT!0ES

Amout in%e&ted in deri%ati%e&

;B 9> 9B No. o$ 8ro6er& 6> and in%e&tor& 6B > B 9 (+7! 9 (+7! C > (+7! C +ny Other > (+7! 6B (+7! Amount 6> E E !eries6 9@

.I/24) <.< Out of my sample siGe ?B, 9@ %<>O' investors and brokers have invested 9 lacs normally, E %6>O' invested between 9 lacs to > (acs and 6> %9>O' invested between > lacs to 6B lacs, and remaining have invested in other amounts. 4easons behind this is that those are investing from many years are taking the risk of investing huge amount.

85

8#

T ADED *E !OD !N DE !0AT!0ES

Traded period $or Deri%ati%e !n%e&tment

9> 9B No. o$ 8ro6er& 6> and in%e&tor& 6B > B #eekly onthly ore than 6 month ore than 9 months !eries6

Traded *eriod

.I/24) <.> 6; %99O investors and brokers are investing weekly in derivatives, 9; %;DO' investing monthly, 6E %;9O' investing after more than 6 month and only > %DO' investing too late after 9 months.

8%

!M*ACT ON CUSTOME

BASE

9> 9B 6> No. o$ 8ro6er& 6B > B Increase &ecrease !mpact 4emain same !eries6

.I/24) <.? Out of ;> brokers , ; %>O' of brokers said that it does not increase their customer base because introducing small savings as investment, but derivatives increase customer base of 9< %@BO' which is more than half. It is basically beneficial for those who are investing from last 9 or more years. In investment sector need minimum of 4s. 9,BB,BBB as investment so it is basically for corporate and investment sector only not for small investors. D %9>O' said their customer base

88

remains same because they have started just now for investing in derivatives in future it will increase their customer base.

@.

ELAT!ONS(!* W!T( CAS( MA KET

;B 9> 9B No o$ 8ro6er& 6> and in%e&tor& 6B > B 0ositive 3egative e9ation 7anPt !ay !eries6

.I/24) <.@ Out of ?B brokers, investors 9@ %<>O' have the positive response towards the relation between derivative and cash market and remaining > %DO' has negative response. 9D %<@O' are not able to say anything because they do not have proper knowledge about stock market. -hey are investing with the guidance of

8"

brokers and with the support of their close relatives those are investing for last many years.

D. DE !0AT!0ES AND derivatives also.

!SK

)very broker says that there is a risk factor %upto some extent in

S(O TCOM!NGS !N !ND!AN DE !0AT!0E S1STEM

Short coming in indian deri%ati%e &#&tem

;> ;B 9> No. o$ 8ro6er& 9B and in%e&tor& 6> 6B > B ;6

9@

9 domestic lack of technical awareness expertise in investors &hort coming& market failure

!eries;

.I/24) <.E

"$

9@ %<>O' brokers, investors respond towards shortage of domestic technical expertise. ;6 %>9O' feel lack of awareness in investors about derivatives and remaining 9 %;O' market failure.

E.. Which too9 o$ deri%ati%e according to #ou i& 8etter4 aE 8E Index future !tock future Index option !tock option

98
dE

@ 69O

D 6;O Index .uture !tock .uture ;B >BO 6> 9>O Index Option !tock Option

.I/24) <.6B

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I got mix view on this Fuestion. =ut most of the informants i.e. >BO are in the favour of index future and rests are having some different different attraction .

ESULTS C )!ND!NGS =rokers not dealing in derivatives at present are also not going to adopt it in futures. $edging and 4isk derivativesW It is not for small investors. It ahs increased brokers turnovers as well as helpful in aggregate investment. =rokers haven5t adeFuate knowledge about options, so most of them are dealing in futures only. -here is a risk factor in derivative also. ost of the investors are not investing in derivatives. in it, has not adeFuate knowledge about it. tool of risk management. -hey normally invest in future contracts. -hey are investing in future contract, because futures have up to some extent Fuality at =adla. -hese people are anagement is the most important feature of

0eople are not aware of derivatives, even people who have invested interested to take it in their future portfolio also. -hey consider it as a

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EASONS BE(!ND LESS DE0ELO*MENT O) ) B O SEGMENT . !ecurities and contract5s regulations act has recogniGed index as a security very later i.e. in 3ov. 9BB6. It will take time to take position in derivative or capital market. -he (imited mutual faith in the parties involved. It hasn5t a legaliGed market. 7ommodity . , O arket has not yet been come to India. -his will make easy to understand and take simple investor under investor base of derivative trading. arket failures

!candals. InadeFuate infrastructures. !hortage to domestic technical expertise, in India even most of the people are not aware of concept derivatives. (arge lot siGe, so small investors are not able to come under derivative segment. -here are less scripts under derivatives segment. $igh margin as compared to =adla. In India there cannot be a long term trading in . , O, it is only for 6 to 9 or maximum for ; months.

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"4

SUGGEST!ONS 6. LOT S!LE5 (ot siGe should be reduced so that the major segment of an Indian society i.e. small saving class can come under . , O trading. -here is strong need for revision of lot siGes as the lot siGes of some of the individual scrips that were worth of 4s. 9BBBBB in starting, now same lot siGe amount to a much larger value. 9. SUB B OKE S !ubCbroker concept should be added and the actual brokers should give all rights of brokers in . , O segment also. ;. SC !*S5 ore scrips of reputed companies etc. should be introduced in . , O !egment. <. T AD!NG *E !OD -rading period should be increased.

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>.

T A!N!NG CLASSES O SEM!NA S -here should be proper classes on derivatives for investors,

traders, brokers, students and employees of stock exchanges. =ecause lack of knowledge is the main reason of its less development. -he first step towards it should be seminars provided to brokers and (!) employees and secondly seminar to students.

CONCLUS!ON On the basis of overall study on derivatives it was found that derivative products initially emerged as hedging devices against fluctuation and commodity prices and commodity linked derivatives remained the soul form of such products. -he financial derivatives came in spotlight in 6E@9 due o growing instability in financial market. I was really surprised to see during my study that a layman or a simple investor does not even know how to hedge and how to reduce risk on his portfolios. +ll these activities are generally performed by big individual investors, mutual funds etc. 3o doubt that derivative growth towards the progress of economy is positive. =ut the problem confronting the derivative market segment are giving it a low customer base. -he main problem that it confronts are unawareness and bit lot siGes etc. these problems could be overcome easily by revising lot siGes and also there should be seminar and general discussions on derivatives at varied places.

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JWe %ieG them a& time 8om8& 8oth $or the partie& that dea9 in them and the economic &#&tem. !n our %ieG deri%ati%e& are $inancia9 Geapon& o$ ma&& de&truction DWMDE@ carr#ing danger& that@ Ghi9e noG 9atent@ are potentia99# 9etha9.H Warren Bu$$et.

"%

B!BL!OG A*(1 BOOKS 37. on derivatives core modules by 3!)I(. arket 6EE?, 6st )dition arket in Operations.

$.!.!I&$2 Indian 7apital

-he Indian 7ommodityC&erivatives Indian !ecurities arket L + 4eview.

MAGAL!NES B NEWS*A*E 5 3!) 3ews. )7O3O I7! -I )

!NTE NET S!TES5 pdf www.nseindia.com C historical data L business growth. www.bseindia.com www.derivativesindia.com &erivatives in India1 .reFuently +sked Huestions, http1NNwww.mayin.orgNajayshahN0&.&O7!N!hah-homas9BBBSdfF.

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:UESTIONNAIRE &ear 4espondent, I am a student of =+ . I am working on the project !-2&: O.

&)4I8+-I8)! . :ou are reFuested to fill in the Fuestionnaire to enable, to undertake the study on the said project

3+ )1 O7720+-IO31 +&&4)!!1 0$O3) 3O1

6'

.or how long you have been trading on derivativesW a' (ess than 6 year b' 6 :ear ""

c' 9 :ear

d' ; year

e'

ore than ; year.

9'

#hat is your purpose for trading in derivativesW a' c' $edging 4isk anagement b' d' !peculation (iFuidity

;'

. In which segment you have larger turnover W %=4O")4! O3(:' a ' 7apital arket !egment

b' . , O !egment.

*) )Fual in both above +) 7an5t !ay.

<'

#hat is amount of money you are investing in normallyW a' 9, BB,BBB b' 9, BB,BBB to 4s. >, BB,BBB c' 4s. >, BB,BBB to 4s. 6B, BB,BBB d' +ny other amountSSSSSSSSSSSSSS

>'

$ow often do you tradeW 1$$

a' #eekly d'

b'

onthly

c'

ore than 6 month

ore than 9 month

?' #hat is your customer base with introduction of derivativesW %.O4 =4O")4!' a' Increase b' &ecrease c' 4emains same.

@'

#hat according to you is relationship between derivative market and cash marketW a' 0ositive b' 3egative c' 7an5t say.

D'

#hat shortcomings do you feel in Indian derivative marketW a' (ack of awareness among the investors about derivatives. b' !hortage of domestic technical expertise. c' If any other SSSSSSSSSSSSSSSSSSSSSSSSSSS

E'

. #hich tool of derivative according to you is betterW a' Index future b' !tock future c' Index option

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d' !tock option

6B'

#hat suggestions do you want to make with regard to investors education in derivatives market in IndiaW

SSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSS SSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSSS

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