ANALYSIS OF INVESTMENT IN DERIVATES MARKET

2011
SUBMITTED IN THE PARTIAL FULLFILLMENT OF THE REQUIRMENT FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

SUBMITTED TO

International Institute of Planning and Management

BY

JAYPRAKASH PATEL
GUIDED BY

Mr. Hitesh Rever (Branch Manager) Ms. Priyanka Yadav (Remizar)

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1.1 About the Subject

Perceptions of derivative A derivative is financial instrument whose value is derived from another underlying security or a basket of securities. Traders can assume highly leveraged positions at low transaction costs using these extremely flexible instruments. As this market i.e derivative is new concept in share market the Perception regarding the same varies from person to person. A complete understanding of this market is require in order to deal with it. So the topic which I selected will be telling about perception of people toward this market in surat city and how they deal with this market. The most desired instruments that allow market participants to manage risk in the modern securities trading are known as derivatives. The main logic behind the derivatives trading is that: Derivatives reduce the risk by providing an additional channel to invest with lower trading cost and It facilitates the investors to extend their settlement through the future contracts. It provides extra liquidity in the stock market. They represent contracts whose payoff at expiration is determined by the price of the underlying asseta currency, an interest rate, a commodity, or a stock. In order to know about the perception of people to this new era of market in which at initial level every investor fear to invests so a survey at surat level is done on perception of investor toward this market is done by taking 100 samples in surat city.
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INDEX

Sr. No 1

Content 1.2 Importance of topic 1.3 About Motilal Oswal 1.4 Benefit of study 2.1 Introduction to industry 2.2 Industrial profile at India level 2.3 Industrial profile at regional level 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 4.4 4.5 4.6 4.7 Objective of study Literature review Statement of problem Research Design Sampling Methodology Method of data collection Limitations of study History of derivatives Chronology of instruments Need for derivatives in India today Myths and realities about derivatives The participants in a derivative market Types of derivatives business growth in derivatives segment

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3 3 6 7 13 19 22 22 25 25 25 26 26 27 28 29 31 32 33 37 43 53 53 55 56 Page 2

5 6

5.1 Questionnaire Analysis 6.1 Findings 6.2 Recommendation 6.3 Conclusion 7.1 Bibliographies

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1.2 IMPORTANCE OF TOPIC

The study is done on derivate which is not much know to the investor or in general public who are dealing in share market, so its important to know about this segment of market in order to get a lucrative return. To know about the perception of investor towards the derivative market in order to know their investment pattern i.e. in which part of derivative they are dealing much and what part of income they invest in this market. Derivative is emerging market in India as well as in Surat city so a general view and future growth of this market can be judge by this study. In the Indian Stock Market which is highly volatile, and as derivative is completely based on future price, the study on derivative helps in minimizing risk & maximizing return.

1.3

About the Organization

MOTILAL OSWAL SECURITIES (financial consultants)

Company address Office No. 2006 B, Mezzanine floor, 21st Century Business Center, Ring Road, Surat 395002, Gujarat

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Knowledge is power and power brings security. Risk is a very relative term and changes with every individual and situation. Financial management is not just about managing risk but also managing knowledge and finally deriving answers that generate wealth, security and trust. Motilal Oswal security was founded in 1987 as a small sub-broking unit, with just two people running the show. Focus on customer-firstattitude, ethical and transparent business practices, respect for professionalism, research-based value investing and implementation of cutting-edge technology has enabled us to blossom into an over 1600 member team. Today we are a well diversified financial services firm offering a range of financial products and services such as Wealth Management, Broking & Distribution, Commodity Broking, Portfolio ManagementServices, Institutional Equities, Private Equity, Investment Banking Services and Principal Strategies. We have a diversified client base that includes retail customers (including High Net worth Individuals), mutual funds, foreign institutional investors, financial institutions and corporate clients. We
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are headquartered in Mumbai and as of June 30th, 2011, had a network spread over 586 cities and towns comprising 1,607 Business Locations operated by our Business Partners and us. As at June 30th, 2011, we had 722,303 registered customers. Motilal Oswal Security offers
Portfolio Advisory Services Equity Broking Derivatives Trading Depository Services Mutual Fund Public Sector Bonds & Government Securities Commodities Trading

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1.4

Benefit of the study.

a. To Organisation To know about respondents perception toward the derivative market in surat city as now-a-days trading in this market has taken hype. To know about the dealing pattern of respondent towards this market.

b. To myself

To gain knowledge about the derivative market which is having a great pace in share market?

To know about the perception of the respondent towards derivative market in Surat city.

To become familiarize with organization, which help in applying theoretical concepts into practical routine.

To understand the working system of different department. To become part of professionalism. To understand technical terms and its applications in study. To know how the scripts are being traded in Equity market, Derivatives, Commodity market.

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2.

Introduction to Industry.

Investment The money you earn is partly spent and the rest saved for meeting future expenses. Instead of keeping the savings idle you may like to use savings in order to get return on it in the future. This is called Investment. Reason for investment One needs to invest to: Earn return on your idle resources Generate a specified sum of money for a specific goal in life Make a provision for an uncertain future Stock Exchange The Securities Contract (Regulation) Act, 1956 [SCRA] defines Stock Exchange as anybody of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities. Stock exchange could be a regional stock exchange whose area of operation/jurisdiction is specified at the time of its recognition or national exchanges, which are permitted to have nationwide trading since inception. NSE was incorporated as a national stock exchange. Their usefulness: Indices help to recognize broad trends in the market. The investor can use the indices to allocate the funds rationally among the stocks. Technical analysts use these indices to predict the future market. Indices function as a status report on the general economy.
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SECURITIES
The definition of Securities as per the Securities Contracts Regulation Act (SCRA), 1956, includes instruments such as shares, bonds, scrips, stocks or other marketable securities of similar nature in or of any incorporate company or body corporate, government securities, derivatives of securities, units of collective investment scheme, interest and rights in securities, security receipt or any other instruments so declared by the Central Government. Type of investment in share Government Securities Derivative products Units of Mutual Funds etc., are some of the securities investors in the securities market can invest in.

Types of Market
PRIMARY MARKET (Deals with the new issues of securities.) The primary market provides the channel for sale of new securities. Primary market provides opportunity to issuers of securities; Government as well as corporate, to raise resources to meet their requirements of investment and/or discharge some obligation. They may issue the securities at face value, or at a discount/premium and these securities may take a variety of forms such as equity, debt etc. They may issue the securities in domestic market and/or international market.

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SECONDARY MARKET
(Deals with outstanding securities .Also known as STOCK MARKET) Secondary market refers to a market where securities are traded after being initially offered to the public in the primary market and/or listed on the Stock Exchange. Majority of the trading is done in the secondary market. Secondary market comprises of equity markets and the debt markets. Role of the Secondary Market For the general investor, the secondary market provides an efficient platform for trading of his securities. For the management of the company, Secondary equity markets serve as a monitoring and control conduitby facilitating valueenhancing control activities, enabling implementation of incentive-based management contracts, and aggregating information (via price discovery) that guides management decisions.
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Difference between the Primary Market and the Secondary Market

In the primary market, securities are offered to public for subscription for the purpose of raising capital or fund. Secondary market is an equity trading venue in which already existing/pre-issued securities are traded among investors. Secondary market could be either auction or dealer market. While stock exchange is the part of an auction market, Over-the-Counter (OTC) is a part of the dealer market.

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2.1

Industrial profile at Global level

History of World Stock Exchange The history of stock exchanges can be traced to 12th century France, when the first brokers are believed to have developed, trading in debt and government securities. Unofficial share markets existed across Europe through the 1600s, where brokers would meet outside or in coffee houses to make trades. The Amsterdam Stock Exchange, created in 1602, became the first official stock exchange when it began trading shares of the Dutch East India Company. These were the first company shares ever issued. By the early 1700s there were fully operational stock exchanges in France and England, and America followed in the later part of the century. Share exchanges became an important way for companies to raise capital for investment, while also offering investors the opportunity to share in company profits. The early days of the stock exchange experienced many scandals and share crashes, as there was little to no regulation and almost anyone was allowed to participate in the exchange. Today, stock exchanges operate around the world, and they have become highly regulated institutions. Investors wanting to buy and sell shares must do so through a share broker, who pays to own a seat on the exchange. Companies with shares traded on an exchange are said to be 'listed' and they must meet specific criteria, which varies across exchanges. Most stock exchanges began as floor exchanges, where traders made deals face-to-face. The largest stock exchange in the world, the New York Stock Exchange, continues to operate this way, but most of the world's exchanges have now become fully electronic.

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Major Stock Exchanges in world economy: Economy United States Japan United States Europe United Kingdom China Hong Kong Canada Spain Brazil India Germany Australia India Switzerland China Korea Nordic Countries Stock Exchange New York Stock Exchange Tokyo Stock Exchange NASDAQ Euronext London Stock Exchange Shanghai Stock Exchange Hong Kong Stock Exchange Toronto Stock Exchange BME Spanish Exchanges BM&F Bovespa Bombay Stock Exchange Deutsche Brse Australian Securities Exchange National Stock Exchange of India SIX Swiss Exchange Shenzhen Stock Exchange Korea Exchange NASDAQ OMX Nordic Exchange

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South Africa Taiwan Italy

JSE Limited Taiwan Stock Exchange Borsa Italiana

Source: World Federation of Exchanges - Statistics/Monthly 2.2 Industrial profile at India level

Securities Market Regulators The absence of conditions of perfect competition in the securities market makes the role of the Regulator extremely important. The regulator ensures that the market participants behave in a desired manner so that securities market continues to be a major source of finance for corporate and government and the interest of investors are protected. Regulation of Securities Market The responsibility for regulating the securities market is shared by Department of Economic Affairs (DEA), Department of Company Affairs (DCA), Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI). SEBI and its role The Securities and Exchange Board of India (SEBI) is the regulatory authority in India established under Section 3 of SEBI Act, 1992. SEBI Act, 1992 provides for establishment of Securities and Exchange Board of India (SEBI) with statutory powers for (a) protecting the interests of investors in securities (b) promoting the development of the securities market and (c) regulating the securities market. Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities, in addition to all intermediaries
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and persons associated with securities market. SEBI has been obligated to perform the aforesaid functions by such measures as it thinks fit. In particular, it has powers for: Regulating the business in stock exchanges and any other securities markets Registering and regulating the working of stock brokers, subbrokers etc. Promoting and regulating self-regulatory organizations Prohibiting fraudulent and unfair trade practices Calling for information from, undertaking inspection, conducting inquiries and audits of the stock exchanges, intermediaries, self regulatory organizations, mutual funds and other persons associated with the securities market.

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Indias Stock Exchanges

National Stock Exchange

The National Stock Exchange (NSE) is a stock exchange located at Mumbai, India. It is the largest stock exchange in India in terms of daily turnover and number of trades, for both equities and derivative trading.. NSE has a market capitalization of around Rs 47,01,923 crore (7 August 2009) and is expected to become the biggest stock exchange in India in terms of market capitalization by 2009 end.[2]Though a number of other exchanges exist, NSE and the Bombay Stock Exchange are the two most significant stock exchanges in India, and between them are responsible for the vast majority of share transactions. The NSE's key index is the S&P CNX Nifty, known as the Nifty, an index of fifty major stocks weighted by market capitalisation. NSE is mutually-owned by a set of leading financial institutions, banks, insurance companies and other financial intermediaries in India but its ownership and management operate as separate entities. There are at least 2 foreign investors NYSE Euronext and Goldman Sachs who have taken a stake in the NSE. As of 2006, the NSE VSAT terminals, 2799 in total, cover more than 1500 cities across India [5]. In October 2007, the equity market capitalization of the companies listed on the NSE was US$ 1.46 trillion, making it the second largest stock exchange in South Asia. NSE is the third largest Stock Exchange in the world in terms of the number of trades in equities.It is the second fastest growing stock exchange in the world with a recorded growth of 16.6%
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Mission NSE's mission is setting the agenda for change in the securities markets in India. The NSE was set-up with the main objectives of:

establishing a nation-wide trading facility for equities, debt instruments and hybrids,

ensuring equal access to investors all over the country through an appropriate communication network,

providing a fair, efficient and transparent securities market to investors using electronic trading systems,

enabling shorter settlement cycles and book entry settlements systems, and meeting the current international standards of securities markets.

NSE Facts

It uses satellite communication technology to energise participation from around 400 cities in India.

NSE can handle up to 1 million trades per day. It is one of the largest interactive VSAT based stock exchanges in the world. The NSE- network is the largest private wide area network in India and the first extended C- Band VSAT network in the world.

Presently more than 9000 users are trading on the real time-online NSE application

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The Bombay Stock Exchange is known as the oldest exchange in Asia. It traces its history to the 1850s, when 4 Gujarati and 1 Parsi stockbroker would gather under banyan trees in front of Mumbai's Town Hall. The location of these meetings changed many times, as the number of brokers constantly increased. The group eventually moved to Dalal Street in 1874 and in 1875 became an official organization known as 'The Native Share & Stock Brokers Association'. In 1956, the BSE became the first stock exchange to be recognized by the Indian Government under the Securities Contracts Regulation Act. The Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a means to measure overall performance of the exchange. In 2000 the BSE used this index to open its derivatives market, trading Sensex futures contracts. The development of Sensex options along with equity derivatives followed in 2001 and 2002, expanding the BSE's trading platform. Historically an open outcry floor trading exchange, the Bombay Stock Exchange switched to an electronic trading system in 1995. It took the exchange only fifty days to make this transition. This automated, screen-based trading platform called BSE On-line trading (BOLT) currently has a capacity of 80 lakh orders per day. The BSE has also introduced the world's first centralized exchange-based internet trading system, BSEWEBx.co.in to enable investors anywhere in the world to trade on the BSE platform. Several Firsts At par with the international standards, BSE has in fact been a pioneer in several areas. It has several firsts to its credit even in an intensely competitive environment.
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First in India to introduce Equity Derivatives First in India to launch a Free Float Index First in India to launch US$ version of BSE SENSEX First in India to launch Exchange Enabled Internet Trading Platform First in India to obtain ISO certification for a stock exchange 'BSE On-Line Trading System (BOLT) has been awarded the globally recognised the Information Security Management System standard BS7799-2:2002. First to have an exclusive facility for financial training First in India in the financial services sector to launch its website in Hindi and Gujarati Shifted from Open Outcry to Electronic Trading within just 50 days

BSE COMPANY LIST ACC ,Grasim , Hindalco, HLL, ITC, L&T, RIL ,Hindustan

ShipyardLimited, Bajaj, Tata Steel, Tata Motors, BHEL, Gujarat Ambuja , ICICI Bank, Ranbaxy, Reliance Energy, SBI, Infosys, NIIT, Dr. Reddy's, Cipla, Hero Honda, Airtel, HDFC Bank, ONGC, Wipro, Maruti, NTPC, TCS, Reliance Communications , Sun Pharmaceutical

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2.3

Industry Profile at Regional Level

Ahmedabad Stock Exchange Bangalore Stock Exchange Bhubaneshwar Stock Exchange Bombay Stock Exchange (BSE) Calcutta Stock Exchange Cochin Stock Exchange Coimbatore Stock Exchange Delhi Stock Exchange Association Guwahati Stock Exchange Hyderabad Stock Exchange (HSE) Inter-connected Stock Exchange of India Jaipur Stock Exchange Ludhiana Stock Exchange Association Madhya Pradesh Stock Exchange Madras Stock Exchange (MSE) Mangalore Stock Exchange National Stock Exchange of India (NSE) Magadh Stock Exchange - In Patna, Bihar Over The Counter Stock Exchange of India (OTCEI) Pune Stock Exchange Uttar Pradesh Stock Association Vadodara Stock Exchange Meerut Stock Exchange United Stock Exchange of India
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(A) Ahmedabad Stock Exchange or ASE

It is the second oldest exchange of India located in the city of Ahmedabad in the western part of the country. It is recognized by Securities Contract (Regulations) Act, 1956 as permanent stock exchange. It has adopted a Swastika in its logo which is one of the most auspicious symbols of Hinduism depicting wealth and prosperity. The stock exchange was established as a Public Charitable Trust in 1894 following the establishment of the Bombay Stock Exchange in 1875. Earlier the stock exchange functioned under the framework of the Bombay Securities Contracts Act, 1925. Following the The Securities Contract Regulations Act, 1956 the Gujarat Share & Stock Exchange, Indian Share and General Exchange Association and Bombay Share and Stock Exchange, Share and Stock Brokers Association merged with the Ahmedabad Share and Stock Brokers Association and gave rise to ASE as it stands today. Ahmedabad Stock Exchange Limited is a premier national equities exchange that plays a key role in the Indian securities markets. Serving individual and institutional investors from around the world, its primary business is the trading of approximately 2000 nationally listed equities. The Exchange also trades over
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200 high growth companies that are solely listed on the ASE or dually listed with another The Stock Exchange-Ahmedabad, exchange. constituted as a Public Charitable

Trust in 1894, is the second oldest exchange of India. It is recongnized by Securities Contract (Regulations) Act, 1956 as permananent stock exchange. History of Stock Exchanges in India traces back to the nineteenth century with the establishment of the Bombay Stock Exchange in 1875 followed by Ahmedabad Stock Exchange in 1894. In the world map of bourses, the Stock Exchange - Ahmedabad holds a unique place with its initial functioning starting under banayan tree and has progressed year after year therefrom. The 80s and 90s saw major focus on building up requisite infrastructure and bringing about rapid progress in the area of computerization in the exchanges as whole.Recognizing and appreciating the necessity of computerization and putting emphasis on screen based trading the Stock Exchange-Ahmedabad went live on Dec. 12, 1996. (B) Vadodara Stock Exchange or VSE Is located in the city of Vadodara in Western India. It was established in 1990 at Vadodara.It is the third largest stock exchange in the state of Gujarat after Ahmedabad and Rajkot. It is recognized by the Securities Contract (Regulations) Act of 1956 as a permanent stock exchange. From a humble beginning in 1986 with the Vadodara Stock Brokers' Association comprising of 150 members, it was incorporated in January 22 1990 as Vadodara Stock Exchange Limited. By 1999, the exchange had a total of 321 brokers, of which 65 were corporate brokers, 253 were proprietor brokers, and 3 were partnership brokers. Then, there were only 85 sub-brokers registered.
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3.1

Objective of study

To analyze investors perception towards investment in derivative market. 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. 3.2 Literature review

1. Derivative Trading in Indian Stock Market: Brokers Perception:

http://www.iimb.ernet.in/publications/review/guidelines-authors

Sandeep Srivastava, Surendra S Yadav, P K Jain on September, 2008. Volume 20 Abstract The authors conducted a survey of brokers in the recently introduced derivatives markets in India to examine the brokers' assessment of market activity and their perception of the benefits and costs of derivative trading. The need for such a study was felt as previous studies relating to the impact of derivative securities on the Indian stock market do not cover the perception of market participants who form an integral part of the functioning of derivative markets. The issues covered in the survey included: a) perception of brokers about the attractiveness of different derivative securities for clients; b) profile of clients dealing in derivative securities; c) popularity of a particular derivative security out of the total set; d) different purposes for which the clients are using these securities in order of preference; e) issues concerning derivative trading; f)

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reasons for non-usage of derivatives by some investors and g) pricing, liquidity and informational efficiency of the derivative market. Derivative securities have penetrated the Indian stock market and it emerged that investors are using these securities for different purposes, namely, risk management, profit enhancement, speculation and arbitrage. High net worth individuals and proprietary traders account for a large proportion of broker turnover. Interestingly, some retail participation was also witnessed despite the fact that these securities are considered largely beyond the reach of retail investors (because of complexity and relatively high initial investment). Based on the survey results, the authors identified some important policy issues such as the need to bring in more institutional participation to make the derivative market in India more efficient and to bring it in line with the best practices. Further, there is a need to popularise option instruments because they may prove to be a useful medium for enhancing retail participation in the derivative market.

2. Increasing Derivatives Market Activity in Emerging Markets and Exchange Rate Exposure
URL: http://www.econ.uconn.edu/working/2008-06.pdf

Uluc Aysun (University of Connecticut) Melanie Guldi (Mount Holyoke College) Abstract Using firm level data, we report a significant fall in the exchange rate exposure of emerging market firms over the past 10 years, and relate this to higher derivatives market participation. Our methodology follows a three stage
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approach. First, we measure and report foreign exchange exposures for each year using the popularized extension of the Adler-Dumas (1984) model. Next, we use an indirect approach to estimate the derivatives market participation at the firm level. Finally, we investigate the implications of the level of derivative market activity on a firm's foreign exchange exposure. Our results show that foreign exchange exposure is negatively related to derivatives usage, and support the hedging explanation of the exchange rate exposure puzzle.

3. Indian Derivative Markets: Some Policy Issues

URL: http://ssrn.com/abstract=1428685

Anuradha Guru: member of National Stock Exchange of India January 2009. Abstract: On their journey of innovation, derivatives have not been free from controversies. They have often been held to be too complex to comprehend. The leverage that these products provide to investors raises concern. Recently, the present global financial crisis is being attributed to the housing mortgages being repackaged and sold as collateralised debt obligations and other exotic derivative products to financial institutions, pension funds and individuals. Policy markers around the world are now having a relook as the problems being posed by derivatives viz. lack of homogeneous rules and accounting standards; the excessive freedom allowed to market players to innovate and the lack of complete statistics for exchange-traded and OTC transactions. Leaders are talking about the need for more transparency and accountability in the functioning of derivative markets. While this exercise is underway, the aim of this paper is to present the historical perspective in which derivatives have developed in India and present certain issues which have been widely debated

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in the context of these markets in India, while also presenting the international context of the debates. 3.3 STATEMENT OF PROBLEM

To know about the perception of investors toward the Derivative market in surat city. 3.4 RESEARCH DESIGN

DESCRIPTIVE RESEARCH The research is primarily descriptive in nature. The sources of information are both primary and secondary. 3.5 SAMPLING METHODOLOGY

Sampling Technique: Stratified sampling. Sampling Unit: The respondents who were asked to fill out the questionnaire were from Surat, are the sampling units. These respondents comprise of the persons from broker houses & person dealing in stock trading. Sample Size: The sample size was restricted to 100 respondents. Sampling Area: The area of the research was surat. Time: 6 weeks Statistical tool used: Simple tools like bar graphs, tabulation, have been used.

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3.6 Method of data collection:Primary sources: Questionnaire 3.7 LIMITAITONS OF STUDY Limited time : The time available to conduct the study was only 6 weeks. It being a wide topic had a limited time. Sample size: As more number of sample can also be taken to increase the reliability of study. Sampling method: There are more no of sampling techniques that can be use in this research which may give different result.

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4.1

HISTORY OF DERIVATIVES:

Derivatives trading began in 1865 when the Chicago Board of Trade (CBOT) listed the first "exchange traded" derivatives contract in the USA. These contracts were called "futures contracts". In 1919, the Chicago Butter and Egg Board, a spin-off of CBOT, was reorganized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world is based on the Standard & Poor's 500 Index traded on the CME. In April 1973, the Chicago Board of Options Exchange was set up specifically for the purpose of trading in options. The market for options developed so rapidly that by early 80s the number of shares underlying the option contract sold each day exceeded the daily volume of shares traded on the New York Stock Exchange. And there has been no looking back ever since. INDIAN DERIVATIVES MARKET 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 liberalization process and Reserve Bank of Indias (RBI) efforts in creating currency forward market. Derivatives are an integral part of liberalization 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.
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4.2 Chronology of instruments 1991 14 December 1995 Liberalization process initiated NSE asked SEBI for permission to trade index futures. 18 November 1996 SEBI setup L.C.Gupta Committee to draft a policy framework for index futures. 11 May 1998 L.C.Gupta report. 7 July 1999 RBI gave permission for OTC Committee submitted

forward rate agreements (FRAs) and interest 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.

25 September 2000

Nifty futures trading commenced at

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SGX.

4.3

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. The advantage of using derivatives as an investment strategy over cash markets is that the fund outlay in a derivative contract is lower. Typically, only a percentage is to be paid upfront in the shape of initial margin. Thus, for the same fund outlay, much larger exposure is possible through a derivative contract. Mutual Funds in India are permitted to invest in derivative for the purpose of hedging against risk and portfolio rebalancing. SEBI regulates both effectiveness of the hedge and its size. With derivatives fast gaining popularity and retail participation increasing, we feel it is just a matter of time before derivatives investments go beyond just fulfilling the hedging needs of the fund, and are looked upon as separate investment options.

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The potential and the advantages that this avenue gives to the fund manager are immense and some players have already drawn up plans for a separate class of products that focuses entirely on investment in derivatives, with active positions in the cash segment, which will eventually help the industry branch out to other areas as well. THE USES OF DERIVATIVE MARKETS Derivatives markets serve to shift risk. Hedgers use derivatives to reduce risk exposure. For instance, a refiner can lock in costs and revenues (i.e., lock in its margin) by buying crude oil futures and selling oil and gasoline futures. Speculators use derivatives to increase risk exposure in the anticipation of making a profit. Thus, derivatives markets facilitate the shifting of risk from those who bear it at a high cost (the risk averse) to those who bear it at a low cost (the risk tolerant). Speculators perform a valuable service by absorbing risk from hedgers. In return, they receive a rewarda risk premium. The risk premium is the expected profit on a derivatives transaction. Speculators may win or lose in any given trade, but on average speculators expect to profit. The risk premium is also the cost of hedging.

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4.4

MYTHS AND REALITIES ABOUT DERIVATIVES

DIn 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 parts of the world. While this is true for many countries, there are still apprehensions about the introduction of derivatives. What are these myths behind derivatives? Derivatives increase speculation and do not serve any economic purpose. Indian Market is not ready for derivative trading. Disasters prove that derivatives are very risky and highly leveraged instruments. Derivatives are complex and exotic instruments that Indian investors will find difficulty in understanding. Is the existing capital market safer than Derivatives ? MAJOR FACTORS RESPONSIBLE FOR THE GROWTH OF FINANCIAL DERIVATIVES

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Integration of international markets with national financial markets Increased volatility in asset prices in financial markets Development of more sophisticated risk management tools, providing economic agent wider choice of risk management strategies Improvement in technology and communication facilities and sharp decline in costs Innovations in the derivatives markets have led to the diversification of risk over a large number of financial assets, leading to higher returns The modernization of commercial and investment banking Sectors of underdeveloped economies, such as commercial banking, which had been closed to foreigners, have been opened to foreign private sector investment 4.5 THE PARTICIPANTS IN A DERIVATIVES MARKET

HEDGERS use futures or options markets to reduce or eliminate the risk associated with price of an asset. SPECULATORS use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture. ARBITRAGEOURS are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.
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4.6

Types of derivatives

(A) FORWARD 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.
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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 forward contracts in certain markets have become very standardized, as in the case of foreign exchange, thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches its limit in the organized futures market. Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. (B) FUTURE 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.

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BASIC FEATURES OF FUTURE CONTRACT: 1. Lot size:- lot size means that we cannot buy single share as in equity market we can only buy bundle of shares of a particular script ,like, if we want to purchase future of reliance than lot size is 150 share therefore you have to purchase whole lot. For example: - in NIFTY lot size is 50 shares, MINI NIFTY (it is for retail sector) lot size is 20 shares. 2. Margin: when anyone executes a future trade, then initial margin has to be paid, which may be 10% of the value of the contract-it is fixed by the exchange. The margin consists of cash or cash equivalents, is to ensure that the traders will honor the obligation arising out of future contract. The margin has to be posted by the future both the parties to the future contract as both are exposed to losses. 3. Settlement Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract: Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. In practice, it occurs only on a minority of contracts. Cash settlement - a cash payment is made based on the underlying reference rate, such as a short term interest rate index such as Euribor, or the closing value of a stock market index. A futures contract might also opt to settle against an index based on trade in a related spot market. 4. 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

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Thursday of certain trading month. On this day the t+2 futures contract becomes the t forward contract. (C) OPTION An Option is a contract which gives the right, but not an obligation, to buy or sell the underlying at a stated date and at a stated price. While a buyer of an option pays the premium and buys the right to exercise his option, the writer of an option is the one who receives the option premium and therefore obliged to sell/buy the asset if the buyer exercises it on him Options are of two types - Calls and Puts options "Calls" give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. "Puts" give the buyer the right, but not the obligation to sell a given quantity of underlying asset at a given price on or before a given future date. All the options contracts are settled in cash. (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.

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4.7 BUSINESS GROWTH IN DERIVATIVES SEGMENT A) INDEX FUTURES- CONTRACTS

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

Graphical representation of number of contracts.

INTERPRETATION: From the data and the bar diagram above, there is high business growth in the derivative segment in India. In the year 2000-01, the number of contracts in index future were 90580 where as a significant increase of 210428103 is observed in the year 2008-09.
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(B) TURNOVER NUMBER OF TURNOVERS OF STOCK FUTURES

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

INTERPRETATION: From the data and above bar chart, there is high turnover in the derivative segment in India. In the year 2001-02 the turnover of index future was 21483 where as a huge increase of 3570111.40 in the year 2008-09 are observe.

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.(C) STOCK FUTURES:-

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

INTERPRETATION: from the data and bar diagram above there were no stock futures available but in the year 2001-02, it predominantly increased to 1957856. then there was huge increase of 20,35, and 87,952 in the year 2007-08 and thereafter there was a steady rise to 221577980 in the year 2008-09.

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(C) INDEX OPTIONS CONTRACTS:-

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

Interpretation: From the data and bar chart above, the no of contracts of index option was nil in the year 2000-2001. But there was a predominant increase of 1, 75,900 in the year 2001-2002. in the year 2008-2009 there was a huge increase in the index option contracts to 212088444 in the year 2008-2009.

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TURNOVER INDEX OPTION TURNOVER PER YEAR IN RS. CRORES

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

GRAPHICAL REPRESENTATION OF TURNOVER PER YEAR

INTERPRETATION:

From the data and bar chart above, there was no turnover in the year 2000-2001 for index option. it slowly started increasing in the year 2000-2001 to 3765. But in the year 2007-2008 there was a huge increase of 1362110.088 and consistent increase to 3731501.84 observed in 2008-2009

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D) STOCK OPTIONS CONTRACTS

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

GRAPHICAL REPRESENTATION OFNUMBER OF CONTRACTS TRADED PER YEAR IN STOCK OPTION

INTERPRETATION: From the data and bar chart above the no of contracts of stock option in the year 2000-2001 was nil. But there was a huge increase of 1037529 observed in the year 2001-2002. It was 13295970 which were the highest in the year 2008-2009 and stands at 1451603 in the first quarter of the year 2009-10.

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5.1 QUESTIONNAIRE ANALYSIS

SURVEY QUESTIONNAIRE OF INVESTORS PERCEPTION TOWARDS INVESTMENT IN DERIVATIVE MARKET FOR MOTILAL OSWAL SECURITY Ltd., SURAT

1. How would you place your order?

Online 45% Offline 55%

The following is the bar -chart of above data (according to the percentage)

Mode of trading

online 45%

offline

55%

Interpretation: Only 45 % of Surat people do trading through online while 55% of people trading through offline mode.

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2. In which of the following segment you prefer to invest? Equity 75% Derivative 25%

The following is the bar-chart of above data

Market segment

Derivative 25%

Equity 75%

2.1 If Derivative market, then

Type of DM
Currency 25% Stock option 32%

stock future 43%

Interpretation The 2 chart shows 25% of people should investment in derivative market because of lack of knowledge towards this segment and 25% of people would invest in currency market, 32% of people would invest in stock option and 43% of people would invest in stock future.
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3. Education qualification Under Graduate 21% Graduate 59% Post Graduate 17%
Professional degree holder

3%

Educational qualification
70 60 59

Percentage

50 40 30 20 10 0 Under graduate . Graduate. Post Graduate Professional degree holder. 21 17 3

Interpretation: There is more no. of graduate respondent who invest or know about derivate market almost 60% is from this category. This shows that a literate person do the investment in this market. 4. Income range of respondent: Below1,50,000 P.A 1,50,000 - 3,00,000 P.A 3,00,000 5,00,000 P.A Above 5,00,000 P.A 47% 17% 20% 16%

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The following is the bar-chart of above data (according to the percentage)

47%

INCOME GROUP

17%

20% 16%

Below1,50,000 P.A 1,50,000 - 3,00,000 3,00,000 5,00,000 Above 5,00,000 P.A P.A P.A

Interpretation People from income group below 150000 are dealing with derivative more than other category. Other category people. almost covers 20% in each category. These indicate that low income group people invest more than high income group

5. How do you analyze the stock market?

Interpretation Maximum % of people should analyze through tips and recommendation which had been given by clients broker.
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6. Normally what % of your monthly household income could be available for investment?
Option Between 5% to 10% Between 11% to 15% Between 16% to 20% Between 21% to 25% More than 25%. Total No of respondents 47 18 17 14 4 100

THE FOLLOWING IS THE Bar-CHART OF ABOVE DATA

50 45 40 35 30 25 20 15 10 5 0

Percentage of household income could be available for investment 47

Percentage

18

17

14 4

Betw een 5% to 10%

Betw een 11% Betw een to 15% 16% to 20%

Betw een 21% to 25%

More than 25% .

Pe rce nta ge Ra nge

Interpretation: Around 50 % of respondent invest on 5- 10% of their income to this derivate market. And 15 % of people in each other category invest higher amount of investment. These indicate that people dont want to invest in such market due to high risk factor and lack of knowledge.
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7. PURPOSE OF INVESTING IN DERIVATIVE MARKET

Option
To Hedge their fund

No of respondents

32 27 25 16 100

Risk control
More stable Direct investment without buying and holding of assets. Total

Purpose of investing in derivate market

35 30
32 27 25

Percentage

25 20 15 10 5 0
To Hedge their fund Risk control More stable Direct investment without buying and holding of assets. 16

Diff purpose

Interpretation: 32% of respondent invest their money for hedging purpose. And about 50% of respondent invest for both risk control and to earn stable return. This show that investor are not much known to this market and hence invest to get stable return without any risk.

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8. Which broker would you prefer to take advice before investing in Equity & derivative market?
Motilal oswal Jainum Angle Ventura 45% 15% 35% 5%

Broker
Motilal oswal Jainum Angle Ventura

5%

35%

45%

15%

Interpretation:Survey shows that the 45% of surat city invest through motilal oswal because of brand, low brokerage and strategies. 9. You participate in derivative market as Types of Participant Investors Speculators Broker Hedger % of involvement 35% 15% 45% 5%

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Participant

45% 35% 15% 5% Investors Speculators Broker Hedger

Series1

Interpretation: In surat city 45% of people should invest through broker because people do not want to take own risk. 12. What was the result of your investment? Option No of respondents 15

Great result (more than 50% of your investment) Moderate/ Constant result (20% 40% return) Disappointed (less than 10% return ) Total

54 31 100

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No of respondents
Disappointed (less than 10% return ) 31%

Moderate/ Constant result (20% - 40% return)

54%

Great result (more than 50% of your investment)

15%

Interpretation:Investment in derivative market is more risky than equity market but the high volume of money in this segment. Our survey shows that 54% of investment gives moderate result only 15% people get higher return.

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6.1

FINDINGS

1. The study says that almost 60% of people in surat is knowing about this market and their perception toward this market says that it is very highly risky and leveraged instrument, and they get very moderate return in this market. 2. After analyzing data it is clear that the main factors that can drive the understanding of Derivative Market are Market improvement in communication facilities as well as long term saving & investment through entering into Derivative Contract. So these factors can encourage the Derivative Market in India as well as in surat. 3. In the case of stock future there was a slow increase observed in the number of contracts whereas a decline was also observed in its turnover. In the case of index option there was a huge increase observed both in the number of contracts and turnover. 5. As proper understanding of this market is lacking people afraid to invest in this market. Most of the people deal mere as a investor they does not play crucial part in hedging, arbitrage & as a speculator. 6. Derivative market is growing very fast in the Indian Economy. The turnover of Derivative Market is increasing year by year in the Indias largest stock exchange NSE. In the case of index future there is a phenomenal increase in the number of contracts. 7. Derivative Market is more regulated & standardized so in this way it provides a more controlled environment. In nutshell, we can say that the rule of High

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risk & High return apply in Derivatives. If we are able to take more risk then we can earn more profit under Derivatives. 6.2 Recommendations

The decision about whether to use derivatives should be driven, not by the company's size, but by its strategic objectives. It is important that all users of derivatives understand how their contracts are structured, the unique price and risk characteristics of those instruments, and how they will perform under stressful and volatile economic conditions. Following are the recommendation for enhancing the derivative market . To increase market transparency improved information on the size and structure of the derivatives market should be provided. Derivative Market is more regulated & standardized so in this way it provides a more controlled environment. In nutshell, we can say that the rule of High risk & High return apply in Derivatives. If we are able to take more risk then we can earn more profit under Derivatives A careful risk management study in respect to the corporate goals with complete market stimulation is very necessary for participating in the derivatives market. By improvement in communication facilities (i.e understanding) as well as long term saving & investment can encourage the investor in this market. Internationally consistent market statistics on the notional amounts and gross market values outstanding of broad categories of foreign exchange, interest rate, and equity-based derivative instruments should be provided. This would benefit individuals as well as organizations in better prediction of the global financial activity.

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It may be wise to stay away from the more exotic instruments, unless the risk/reward tradeoffs are clearly understood by the firm's senior management and its independent risk management review team. Exotic contracts should not be used unless there is some obvious reason for doing so. But when used wisely, financial derivatives can increase shareholder value by providing a means to better control a firms risk exposures and cash flows.

In nut shell, after study it is clear that Derivative influence our Indian Economy up to much extent. So, SEBI should take necessary steps for improvement in Derivative Market so that more investors can invest in Derivative market. There is a need of more innovation in Derivative Market because in today scenario even educated people also fear for investing in Derivative Market Because of high risk involved in Derivatives. RBI should play a greater role in supporting derivatives. Derivatives market should be developed in order to keep it at par with other derivative markets in the world. Speculation should be discouraged. There must be more derivative instruments aimed at individual investors. SEBI should conduct seminars regarding the use of derivatives to educate individual investors.

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6.3 Conclusion From the research study about the perception regarding the derivative market we come to know that there is understanding for the market in this segment in investor or broker house but there thinking toward this market says that due to high risk involve in this market people afraid to deal with it. Derivatives allow firms and individuals to hedge risks and to take risks efficiently. They also can create risk at the firm level, especially if a firm uses derivatives episodically and is inexperienced in their use. For the economy as a whole, a collapse of a large derivatives user or dealer may create systemic risks. On balance, derivatives help make the economy more efficient. However, neither users of derivatives nor regulators can be complacent. Firms have to make sure that derivatives are used properly. This means that the risks of derivatives positions have to be measured and understood. Those in charge of taking derivatives positions must have the proper training. It also means that firms must have well-defined policies for derivatives use. A firms board must know how risk is managed within the firm and which role derivatives play. Regulators have to make sure to monitor carefully financial firms with large derivatives positions. Though regulators seem to be doing a good job in monitoring banks and brokerage houses, the risks taken by insurance companies, hedge funds and government sponsored enterprises should be understood and monitored. So should we fear derivatives? The answer is no. We should have a healthy respect for them. We do not fear planes because they may crash and do not refuse to board them because of that risk. Instead, we make sure that planes are as safe as it makes economic sense for them to be. The same applies to
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derivatives. Typically, the losses from derivatives are localized, but the whole economy gains from the existence of derivatives markets.

7 BIBLIOGRAPHIES BOOKS REFERRED: Sandeep Srivastava, Surendra S Yadav, P K Jain September, 2008 Derivative Trading in Indian Stock Market: Brokers's Perception, Volume 20, Number 3 Article. Rasmeet Kohli may2010 Journey of equity derivatives market at NSE ?An analysis for the decade (2000-01 to 2009-10) NSEs Certification in Financial Markets: - Derivatives Core module Hull.C,John, 2005 Options Futures, and other Derivatives Financial Markets & Services by Gordon & Natarajan

WEBSITES VISITED: http://www.articlesbase.com/non-fiction-articles/knowing-the-basicsof-credit-derivatives-45563.html www.nseindia.com www.igidr.ac.in/~susant/DERBOOK/PAPERS/pm.pdf www.ny.frb.org/research/economists/sarkar/ derivatives_in_india

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