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Comparative study of Commodity derivatives and Equity
derivatives-with reference to futures market.

Submitted for partial fulfilment of requirement for the award of
Master of Business Administration International Business II
Faculty of Management Studies-Banaras Hindu University

Dr.P.V.Rajeev Amrita Gupta
FMS-BHU, VARANASI Roll no. 13382MA006
( Session 2013-2015 )


I, the undersigned, solemnly declare that the report of the project work entitled Comparative Study
on Equity Derivatives and Commodity Derivatives is based on my own work carried out during the
course of my study under the supervision of Dr.P.V.RAJEEV.
I assert that the statements made and conclusions drawn are an outcome of the project work. I further
declare that to the best of my knowledge and belief that the project report does not contain any part of any
work which has been submitted for the award of any other degree/diploma/certificate in this University or
any other University.


Date: 11-04-2014

The beatitude, bliss and euphoria that accompany the successful completion of any task would
not be complete without the expression of appreciation of simple virtues to the people who made
it possible. Gratitude is the hardest of emotion to express and often does not find adequate words
to convey. Therefore, a Project Report is not an effort of a single person but it is a contributory
effort of many hands and brains. So, I would like to thanks all those who have helped me directly
or indirectly during my Project.

With an ineffable sense of gratitude I take this opportunity to express my deep sense of
indebtness to Dr. R.K. Pandey for allowing me to carry out this work.

I am also thankful to Dr. P.V RAJ EEV for his keen interest, constructive criticism, persistent
encouragement and untiring guidance throughout the development of the project. It has been my
great privilege to work under his inspiring and provoking guidance.

I would like to thank all my teachers, staff members, and Library members for their valuable
advice and guidance which help me to make this report effective, interesting and purposeful.



This is to certify that the project report entitled Comparative Study of Equity derivatives and
Commodity derivatives carried out by Amrita Gupta (Roll No:06).The project was carried out
under my supervision as a part of the award of Degree in Master of Business Administration
International Business II Semester of Faculty of Management Studies, Banaras Hindu
University, Varanasi.

To the best of my knowledge the report is the outcome of the candidates individual efforts. I
wish all the success to the candidate.

(Signature of the Guide)


a) Introduction
b) Review of Literature
c) Research Methodology
Project Objective
Research Design
Data Collection
Data Analysis
d) Findings and Conclusions
e) Suggestions
f) Bibliography

New ideas and innovations have always been the hallmark of progress made by mankind.At
every stage of development, there have been two core factors that drives man to ideas and
innovation. These are increasing returns and reducing risk, in all facets of life. The financial
markets are no different. The endeavour has always been to maximize returns and minimize risk.
A lot of innovation goes into developing financial products centred on these two factors. It has
spawned a whole new area called financial engineering.
Derivatives are among the forefront of the innovations in the financial markets and aim to
increase returns and reduce risk. They provide an outlet for investors to protect themselves from
the vagaries of the financial markets. These instruments have been very popular with investors
all over the world.
Indian financial markets have been on the ascension and catching up with global standards in
financial markets. The advent of screen based trading, dematerialization, rolling settlement has
put our markets on par with international markets. As a logical step to the above progress,
derivative trading was introduced in the country in June 2000. Starting with index futures, we
have made rapid strides and have four types of derivative products- Index future, index option,
stock future and stock options. Today, there are 30 stocks on which one can have futures and
options, apart from the index futures and options. This market presents a tremendous opportunity
for individual investors .The markets have performed smoothly over the last two years and has
stabilized. The time is ripe for investors to make full use of the advantage offered by this
market.We have tried to present in a lucid and simple manner, the derivatives market, so that the
individual investor is educated and equipped to become a dominant player in the market.


Derivative is a product whose value is derived from the value of one or more underlying
variables or assets in a contractual manner . The underlying asset can be equity, forex,
commodity or any other asset The origin of derivatives can be traced back to the need of farmers
to protect themselves against fluctuations in the price of their crop. From the time it was sown to
the time of its harvest, farmers would face price uncertainty. Through the use of simple
derivative products, it was possible for the farmer to partially or fully transfer price risks by
locking in asset prices. These were simple contracts developed to meet the needs of the farmers
and were basically a means of reducing risk.
A farmer who sowed his crop in June faced uncertainty over the price he would receive for his
harvest in September. On the other hand a merchant with an ongoing requirement of grains too
would face a price risk to pay exorbitant prices during dearth. Although favorable prices could be
obtained during period of oversupply. Under such circumstances it clearly made sense for the
merchant and farmer to come together and enter into a contract whereby the price of the gain to
be delivered may be decided earlier. They negotiated a futures type contract which eliminated
the price risk. In 1848, the Chicago board of trade was established to bring the merchants and
farmers together. These were eventually standardized and in 1925 the first futures clearing house
came into existence. Commodity futures are contracts to buy specific quantity of a particular
commodity at a future date. It is similar to index futures and stock futures but the underlying
asset happens to be commodities instead of stocks and indices.
The government of India had banned futures trading in certain commodities in the late 1970s
However, it has been permitted again in order to help commodities trade, traders and investors.
Worldwide commodities exchange originated before other financial exchanges. Commodity
markets are markets were raw products or primary products are exchanged.
Over the last decade the business environment has become more and more global, which has led
to an increasing level of competition but also enabled entities to gain access to new customers
and additional resource markets. With a growing diversity of international business operations an
increase in risks naturally comes along, especially with risks related to financial issues such as
fluctuating currencies, commodity prices and interest rates. When companies face those kinds of
risks, a common way to deal with such issue is the usage of hedge instruments. Hedging can
basically be described as an attempt to reduce the risk of an underlying transaction by concluding
an adverse transaction in order to offset the risks. New financial instruments such as derivatives
have been intensively used to hedge these risks. Derivatives are kinds of financial instruments
whose changes in market value are depending on changes in underlying variables.
Common examples of underlying variables are interest rates, exchange rates stock prices, stock-
market indices, or prices of commodities. Besides hedging risks, derivatives can be used for
trading (speculative) purposes. Though the primary users of derivatives are financial institutions
such as banks, insurance companies, and investment managers, the usage of derivatives by non-
financial firms is considerable.
Prices in an organized derivatives market reflect the perception of market participants about the
future and lead the price of underlying to the perceived future level.
India, a commodity based economy where two-third of the one billion population depends on
agricultural commodities, surprisingly has an under developed commodity market. Unlike the
physical market, futures markets trades in commodity are largely used as risk management
(hedging) mechanism on either physical commodity itself or open positions in commodity stock.
The idea is to understand the importance of commodity derivatives and learn about the market
from Indian point of view. In fact it was one of the most vibrant markets till early 70s. Its
development and growth was shunted due to numerous restrictions earlier. Now, with most of
these restrictions being removed, there is tremendous potential for growth of this market in the
In the Capital Markets of the world, preferably in India, Stock is considered as the first option of
investment. But, as we all know that there are many other options available with the people to
invest / park their hard earned in & some of these options are Derivative Market, Mutual Funds,
NSC, KVPS, Insurance, FD, Savings A/cs & obviously less considered is the Commodity
Market. In the above mentioned options there are some options that do not have the risk factor in
it & thus they give less return, while others having risk gives more return to the investor. One
does not know that the Investments in Commodities will also yield almost the same returns as
compared with the Stock, having the same amount of risk involved.


Over the last three decades, the derivatives market has seen a phenomenal growth. A large
variety of derivative contracts have been launched at exchanges across the world. Some of the
factors driving the growth of financial derivatives are:
1. Increased volatility in asset prices in financial markets,
2. Increased integration of national financial markets with the international markets.
3. Marked improvement in communication facilities and sharp decline in their costs.
4. Development of more sophisticated risk management tools, providing economic agents a
wider choice of risk management strategies.
5. Innovations in the derivatives markets, which optimally combine the risks and returns over a
large number of financial assets leading to higher returns, reduced risk as well as transactions
costs as compared to individual financial assets.

Exchange Traded Derivatives
Over The Counter Derivatives


a)Forward Contracts
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price. One of the parties to the contract assumes a long position and agrees
to buy the underlying asset on a certain specified future date for a certain specified
price. The other party assumes a short position and agrees to sell the asset on the
same date for the same price. Other contract details like delivery date, price and
quantity are negotiated bilaterally by the parties to the contract. The forward
contracts are normally traded outside the exchanges.
The salient features of forward contracts are:
They are bilateral contracts and hence exposed to counter-party risk.
Each contract is custom designed, and hence is unique in terms of contract.
size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
On the expiration date, the contract has to be settled by delivery of the asset.
If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party,
which often results in high prices being charged.
However futures are a significant improvement over the forward contracts as they eliminate
counterparty risk and offer more liquidity.

b)Futures contracts
In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or
sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future
date is called the delivery date or final settlement date. The pre-set price is called the futures
price. The price of the underlying asset on the delivery date is called the settlement price. The
settlement price, normally, converges towards the futures price on the delivery date.
A futures contract gives the holder the right and the obligation to buy or sell, which differs
from an options contract, which gives the buyer the right, but not the obligation, and the option
writer (seller) the obligation, but not the right.

1. Standardization:
Futures contracts ensure their liquidity by being highly standardized, usually by specifying:
The underlying asset. This can be anything from a barrel of sweet crude oil to a short term
interest rate.
The currency in which the futures contract is quoted.
The grade of the deliverable. In case of bonds, this specifies which bonds can be delivered. In
case of physical commodities, this specifies not only the quality of the underlying goods but also
the manner and location of delivery. The delivery month.
The last trading date.

2. Margin:
Although the value of a contract at time of trading should be zero, its price constantly fluctuates.
This renders the owner liable to adverse changes in value, and creates a credit risk to the
exchange, who always acts as counterparty. To minimize this risk, the exchange demands that
contract owners post a form of collateral, commonly known as Margin requirements are waived
or reduced in some cases for hedgers who have physical ownership of the covered commodity or
spread traders who have offsetting contracts balancing the position.
Initial margin: is paid by both buyer and seller. It represents the loss on that contract, as
determined by historical price changes, which is not likely to be exceeded on a usual day's
trading. It may be 5% or 10% of total contract price.
Mark to market Margin: Because a series of adverse price changes may exhaust the initial
margin, a further margin, usually called variation or maintenance margin, is required by the
exchange. This is calculated by the futures contract, i.e. agreeing on a price at the end of each
day, called the "settlement" or mark-to-market price of the contract.
To understand the original practice, consider that a futures trader, when taking a position,
deposits money with the exchange, called a "margin". This is intended to protect the exchange
against loss. At the end of every trading day, the contract is marked to its present market value. If
the trader is on the winning side of a deal, his contract has increased in value that day, and the
exchange pays this profit into his account. On the other hand, if he is on the losing side, the
exchange will debit his account. If he cannot pay, then the margin is used as the collateral from
which the loss is paid.
Expiry is the time when the final prices of the future are determined. For many equity index and
interest rate futures contracts, this happens on the Last Thursday of certain trading month. On
this day the t+2 futures contract becomes the t forward contract.
Pricing of future contract
In a futures contract, for no arbitrage to be possible, the price paid on delivery (the forward
price) must be the same as the cost (including interest) of buying and storing the asset. In other
words, the rational forward price represents the expected future value of the underlying
discounted at the risk free rate. Thus, for a simple, non-dividend paying asset, the value of the
future/forward, , will be found by discounting the present value at time to maturity by the rate of
risk-free return .
c) Options
A derivative transaction that gives the option holder the right but not the obligation to buy or sell
the underlying asset at a price, called the strike price, during a period or on a specific date in
exchange for payment of a premium is known as option. Underlying asset refers to any asset
that is traded. The price at which the underlying is traded is called the strike price.There are
two types of options i.e., Call Option and Put Option.

Call option:
A contract that gives its owner the right but not the obligation to buy an underlying asset,stock or
any financial asset, at a specified price on or before a specified date is known asa Call option.
The owner makes a profit provided he sells at a higher current price and buys at a lower future
Put option:
A contract that gives its owner the right but not the obligation to sell an underlying assetstock
or any financial asset, at a specified price on or before a specified date is known aa Put option.
The owner makes a profit provided he buys at a lower current price andsells at a higher future
price. Hence, no option will be exercised if the future price doesnot increase.
d) Swaps -
Swaps are transactions which obligates the two parties to the contract to exchange a series of
cash flows at specified intervals known as payment or settlement dates. They can be regarded as
portfolios of forward's contracts. A contract whereby two parties agree to exchange (swap)
payments, based on some notional principle amount is called as a SWAP. In case of swap, only
the payment flows are exchanged and not the principle amount. The two commonly used swaps
Interest rate swaps:
Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed
rate interest payments to a party in exchange for his variable rate interest payments. The fixed
rate payer takes a short position in the forward contract whereas the floating rate payer takes a
long position in the forward contract.
Currency swaps:
Currency swaps is an arrangement in which both the principle amount and the interest on loan in
one currency are swapped for the principle and the interest payments on loan in another
currency. The parties to the swap contract of currency generally hail from two different
countries. This arrangement allows the counter parties to borrow easily and cheaply in their
home currencies. Under a currency swap, cash flows to be exchanged are determined at the spot
rate at a time when swap is done. Such cash flows are supposed to remain unaffected by
subsequent changes in the exchange rates.

Starting from a controlled economy, India has moved towards a world where prices fluctuate
every day. The introduction of risk management instruments in India gained momentum in the
last few years due to liberalisation process and Reserve Bank of Indias (RBI) efforts in creating
currency forward market. Derivatives are an integral part of liberalisation process to manage
risk. NSE gauging the market requirements initiated the process of setting up derivative markets
in India. In July 1999, derivatives trading commenced in India
Table of Chronology of instruments
1991 Liberalisation process initiated
14 December
NSE asked SEBI for permission to trade index futures.
18 November
SEBI setup L.C.Gupta Committee to draft a policy framework for index
11 May 1998 L.C.Gupta Committee submitted report.
7 July 1999 RBI gave permission for OTC forward rate agreements (FRAs) and interst
rate swaps.
24 May 2000 SIMEX chose Nifty for trading futures and options on an Indian index.
25 May 2000 SEBI gave permission to NSE and BSE to do index futures trading.
9 June 2000 Trading of BSE Sensex futures commenced at BSE.
12 June 2000 Trading of Nifty futures commenced at NSE.
25 September
Nifty futures trading commenced at SGX.
2 June 2001 Individual Stock Options & Derivatives

Need for derivatives in India today

In less than three decades of their coming into vogue, derivatives markets have become the most
important markets in the world. Today, derivatives have become part and parcel of the day-to-
day life for ordinary people in major part of the world. Until the advent of NSE, the Indian
capital market had no access to the latest trading methods and was using traditional out-dated
methods of trading. There was a huge gap between the investors aspirations of the markets and
the available means of trading. The opening of Indian economy has precipitated the process of
integration of Indias financial markets with the international financial markets. Introduction of
risk management instruments in India has gained momentum in last few years thanks to Reserve
Bank of Indias efforts in allowing forward contracts, cross currency options etc. which have
developed into a very large market.


Beenen (2005), clarified the goals of institutional investment in commodities within an asset
liability framework. Institutional investors cannot solely examine the asset side of their ledger;
instead, their goal is for the future expected returns of their assets to match off against the future
expected liabilities for their institution. A further constraint is not to require unreasonably high
contributions from the plans sponsors to meet this goal. Beenens study assumed that
commodities would have a return just below that of fixed income and volatility higher than
equities and private equities. Further, he acknowledged that over the long term price
movements have contributed little to the return, as commodities prices tend to mean revert to
inflation/cost of production.

Edmund Parker (2008) Overview and introduction to equity derivatives: This review deals
with over all Equity derivatives traded in stock exchanges. Size and history of equity derivatives
market briefly described the author. They briefly discuss on equity derivatives market
constitution, tax benefit, transaction process should be also trading methods on stock market.

Gary Gorton and K. Geert Rouwenhorst (2005) Facts and Fantasies about Commodity
Futures: This paper review that construct an equally-weighted index of commodity futures
monthly returns over the period between July of 1959 and December of 2004 in order to study
simple properties of commodity futures as an asset class. Fully collateralized commodity futures
have historically offered the same return and Sharpe ratio as equities. While the risk premium on
commodity futures is essentially the same as equities, commodity futures returns are negatively
correlated with equity returns and bond returns. The negative correlation between commodity
futures and the other asset classes is due, in significant part, to different behavior over the
business cycle. In addition, commodity futures are positively correlated with inflation,
unexpected inflation, and changes in expected inflation.


1) Project Objectives:-
To understand the concept of the Derivatives and Derivative Trading.
To know different types of Financial Derivatives.
To know the role of derivatives trading in India.
To analyse the performance of Derivatives Trading since 2001with special
reference to Futures & Options.
To know the investors perception towards investment in derivative market
To Compare the risk and return profile of Equity, Commodity Derivatives
in Future Market in India.

2) Research Design

Exploratory and descriptive research

The research is primarily both exploratory and descriptive in nature. The sources of
information are both primary and secondary. The secondary data has been taken by
referring to various magazines, newspapers, internal sources and internet to get the figures
required for the research purposes. The objective of the exploratory research is to gain
insights and ideas. The objective of the descriptive research study is typically concerned
with determining the frequency with which something occurs.

Analytical Research

3) Data Collection
Secondary Data:

It is the data which has already been collected by some one or an organization for some other
purpose or research study .The data for study has been collected from various sources:
Internet sources


A knowledge need to be spread concerning the risk and return of the derivative market.

More variation in stock index future need to be made looking a demand side of investors.

RBI should play a greater role in supporting derivatives

There must be more derivative instruments aimed at individual investors.

SEBI should conduct seminars regarding the use of derivatives to educate
individual investors.


The time available to conduct the study was short. It being a wide topic, had
a limited time..
Limited resources are available to collect the information about the commodity
Share market is so much volatile and it is difficult to forecast anything about it
whether you trade through online or offline
Some of the aspects may not be covered in my study.


Books referred:

Commodity and Financial Derivatives by (S. Kevin)

Report of the RBI-SEBI standard technical committee on exchange traded Currency Futures

Websites visited: