Professional Documents
Culture Documents
Submitted by
Dillip Khuntia
Roll No. – 1370V091011
Under the Guidance of
Utkal University.
University. Bombay Stock Exchange Limited.
Limited.
DECLARATION
Dr. Kshi
Kshitibhushan Das,
Das Reader, P.G. Department of
knowledge.
PLACE: BHUBANESWAR
ACKNOWLEDGEMENT
The satisfaction that accompanies the successful completion of any task would
be incomplete without mentioning people who made it possible, whose encouragement
and consistent guidance crowned my efforts with success.
At the outset, I would like to extend my sincere gratitude and reverence to the
esteemed organization, Bombay Stock Exchange Limited and its management for
providing me with the opportunity to pursue my summer project.
Last but not the least to MR. Madhusudan Sahu without whose help it was
difficult to take on an internship at BSE
PLACE: BHUBANESWAR
Utkal University
Certificate
PLACE: BHUBANESWAR
EXECUTIVE SUMMERY
In this project “Risk Management of Derivatives in BSE”, the major objective
was to find out the effectiveness and efficiency of the risk management process of BSE
For achieving this objective a survey was conducted, wherein some of the
brokers are interviewed and the details of the risk management process of derivatives in
BSE was analyzed. SEBI guidelines and circulars are also followed for this purpose.
During the survey it was found that the risk management process of BSE is
efficient and can be compared with any of the major stock exchange of the world. The
SPAN margining system that BSE follows for margin calculation is an effective system
of risk management and most of the exchanges of the world follow this method for
margin calculation. The software PC SPAN®, used by BSE for SPAN margin calculation
is reliable and user friendly software. In case of risk management, BSE lags behind NSE
in one area i.e. monitoring. NSE has an integrated system (PRISM) for monitoring the
Thus the recommendation in accordance with this project would be that BSE
should take aggressive steps for expansion of its derivatives segment. This coupled with
a few with the risk management process such as providing real time information about
the parameters; especially the risk array and the trading information in tabular form
rather than graphical form, use of better monitoring system for risk management would
CONTENTS
Declaration…………………………………………………………………………………………………………………………………. i
Acknowledgement………………………………………………………………………………………………………………………. ii
Certificates………………………………………………………………………………………………………………………………… iii
Executive Summery…………………………………………………………………………………………………………………… iv
CHAPTER 1: INTRODUCTION
1.1 Introduction……………………………………………………………………………………………… 2
1.2 Rationale…………………………………………………………………………………………………… 2
1.3 Objective…………………………………………………………………………………………………… 3
1.4 Research Methodology…………………………………………………………………………….. 3
1.5 Limitation………………………………………………………………………………………………….. 4
1.6 Chapterisation………………………………………………………………………………………….. 4
CHAPTER 2: COMPANY PROFILE
2.1 Company Profile ………………………………………………………………………………………. 7
2.2 History ……………………………………………………………………………………………………. 8
2.3 Prominent Position …………………………………………………………………………………. 8
2.4 A Pioneer ………………………………………………………………………………………………… 9
2.5 Awards ……………………………………………………………………………………………………. 9
2.6 BSE SWOT ………………………………………………………………………………………………. 10
CHAPTER 3: INTRODUCTION TO DERIVATIVES
3.1 Derivatives …………………………………………………………………………………………….. 13
3.2 Derivatives products …………………………………………………………………………….. 14
3.3 Participants of Derivatives Market ………………………………………………………. 16
3.4 Classification of Derivatives …………………………………………………………………. 16
3.5 Economic Significance of Derivatives …………………………………………………… 18
3.6 History of Derivatives ……………………………………………………………………………. 18
3.7 International Derivative Market ……………………………………………………………. 20
3.8 Indian Derivative Market ………………………………………………………………………. 20
3.9 NSE’s Derivative Segment ……………………………………………………………………. 22
CHAPTER 4: RISK AND RISK MANAGEMENT
4.1 Risk ………………………………………………………………………………………………………... 25
4.2 Risk Management Process ……………………………………………………………………. 26
6 | Page Bombay Stock Exchange Limited.
Risk Management of Derivatives
4.3 Risk Associated with Derivatives …………………………………………………………. 27
4.4 Risk Management of Derivatives ………………………………………………………….. 30
CHAPTER 5: ANALYSIS AND INTEPRETATION
5.1 The SPAN Margining System ………………………………………………………………… 33
5.2 Working of SPAN Margining System …………………………………………………….. 36
5.3 Margin …………………………………………………………………………………………………… 36
5.4 Mark-to-Market of Margin ……………………………………………………………………. 37
5.5 Exposure Limits ……………………………………………………………………………………. 37
5.6 Position Limits ……………………………………………………………………………………… 38
5.7 Final Settlement …………………………………………………………………………………… 39
CHAPTER 6: SUMMERY AND CONCLUSION
6.1 Major Findings ………………………………………………………………………………………. 41
6.2 Suggestions …………………………………………………………………………………………. 42
6.3 Conclusion …………………………………………………………………………………………… 43
6.4 Bibliography …………………………………………………………………………………………. 45
LIST OF FIGURES
3.1 Classification of Derivatives ………………………………………………………………………………………….… 17
CHAPTER ONE
INTRODUCTION
A country is termed prosperous if its economy is doing well. There are a large
number of influencing factors which determines the prosperity of the economy, like
Per-capita income of people, GDP, Imports & Exports, Forex Reserves, etc. In short it
can be told that Financial Market is an important contributor to the economy. In this
financial market, capital market plays a significant role. The capital market always
replicates the power and ability of the investors and their faith in the market. Earlier
the capital market was shy. But market deregulations, growth in global trade and
technological development have revolutionized the financial market place. A by-
product of this revolution is increased market volatility, which has led to a
corresponding increase in risk management products. This demand is reflected in the
growth of financial derivatives and derivatives market. But, question arises, are these
derivatives risk free? As world’s one of the greatest investor once said,
Thus it can be said that these risk management instruments are not risk free.
This indicates the essence of risk management of derivatives.
1.2 RATIONALE
1.3 OBJECTIVE
On the above outset, the following are the laid down as the objective of this study,
I. To study the risk associated with derivative market and derivative trading.
II. To study the risk management tools used in Bombay Stock Exchange Limited
for mitigating these risks.
III. To study the margining system for derivatives.
IV. To study the software used for margining system.
V. To do comparative analysis of the risk management process of BSE with that
of NSE
VI. To give suggestion and recommendations for improvement in risk management
process of derivatives in BSE.
1.4 RESEARCH METHODOLOGY
1.4.1 SCOPE
The project has been undertaken on the basis of information provided by BSE’s
derivatives segment which consists of the daily prices and volatility of derivative
segment of BSE for the last ten years. This data consist of details about the daily
prices of derivatives products and proportion of investment in each and every
derivatives instrument.
The data so collected were classified and tabulated for analysis and
interpretation. The tools and techniques used in this project are all computerized
programming. The data are programmed in software like visual basic, MATLAB, etc,
to find the implied volatility and price scan range. Finally all these implied volatility
and price scan range are processed in PC – SPAN (software for calculation of margin)
to find out the margin requirement of different participants of the derivative market.
The turnover of derivatives segment of BSE and NSE is drawn in graphs to compare
these two markets.
1.5 LIMITATION
Some of the limitations that are faced during the project are;
1.6 CHAPTERISATION
Chapter one begins with the introduction to the project report, stating the
importance, objectives and research methodology adopted. Limitations inherent to the
project are also laid down. Chapter two deals with the history and potentiality of
Bombay Stock Exchange Limited. ,its mission and vision are also laid down. Major
events that shaped the securities market in the country and helped BSE to grow have
been mentioned. The third chapter deals with the conceptual study of derivatives and
its mechanism. A snapshot of international and Indian derivative market was also laid
down. A brief idea about equity derivatives was also mentioned in this chapter.
Chapter four contains the conceptual idea of risk management process. This chapter
also throws light on the essence of risk management; risk associated with derivatives
trading and risk management of derivatives. The fifth chapter comprises of analysis
and interpretation part. Chapter six contains the summarized list of all important
findings. And finally, the ultimate chapter aims at providing some relevant
suggestions and recommendations to improve the present market position of BSE.
CHAPTER TWO
COMPANY PROFILE
Bombay Stock Exchange Limited is the oldest stock exchange of Asia and one
of the oldest in World with a rich heritage. As the first stock exchange in India, the
Bombay Stock Exchange Limited is considered to have played a very important role
in the development of county’s capital market. The BSE is the largest stock exchange
of 24 exchanges in India, with over 6000 listed companies. It is also the fifth largest
exchange in the world with a market capitalization of $466 billion.
The Exchange has a nationwide reach with its presence in 417 cities and towns
of India. The systems and processes of the exchange are designed to safeguard market
integrity and enhance transparency in the operations. The Exchange provides an
efficient and transparent market for trading in equity, debt and derivative instruments.
The BSE provides online trading with the BSE’s Online trading System (BOLT),
which is a proprietary system of the exchange and is BS 7799-2-2002 certified. The
Surveillance and Clearing Settlement function of the Exchange are ISO 9001:2000
certified.
VISION
One of the oldest stock exchanges of the world and the first in the country to be
granted permanent recognition under the Securities Contract (Regulation) Act, 1956,
Bombay Stock Exchange Limited has had an interesting rise to prominence over the
past 133 years.
The Bombay Stock Exchange Limited traces its history to the 1850s, when four
Gujarati and one Parsi stock broker would gather under the banyan tree in front of the
Town Hall, where the Horniman Circle is now situated. A decade later, the brokers
moved their venue to another set of foliage, this time under banyan trees at the
junction of Meadows Street and Mahatma Gandhi Road. As the number of brokers
increased, they had to shift from place to place and wherever they went, through sheer
habit, they overflowed to the streets. At last, in 1874, found a permanent place. The
new place was, aptly, called Dalal Street.
2.4 A PIONEER
BSE as brand is synonymous with the capital markets in India. The BSE
SENSEX is the benchmark equity index that reflects the robustness of the economy
and finance. At par with international standards, BSE has been a pioneer in several
areas. It has a several firsts to its credit,
2.5 AWARDS
Bombay Stock Exchange Limited has many awards to its name for its
excellence in several fields, these are
STRENGHS:
BSE has inherent advantages: its history, larger scrip base and a stronger brand.
The SENSEX (BSE’s 30-share sensitive index) is one of the most recognized
indexes and tracked worldwide.
Apart from lager base of listed companies, BSE also has a historical
perspective.
Its online trending system (BOLT) has awarded with the global recognized
Information Security Management System Standard BS7799-2-2002.
It got the ISO certification for its surveillance and clearing and settlement.
WEAKNESS
The BSE SENSEX, which delivers inferior hedging effectiveness and higher
impact cost.
At present BSE has fewer than 12% share across the cash and derivative
market of equity markets.
At present, BSE is almost non-existence in derivatives space.
BSE also lacks in terms of providing better services to its customers and is not
proactive.
THREATS
CHAPTER THREE
INTRODUCTION TO DERIVATIVES
Derivative contracts have several variants. The most common variants are
forwards, futures, options and swaps. Various derivatives contracts are described
below,
3.2.1 FORWARDS
3.2.2 FUTURE
A future contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price. Future contracts are standardized forward
contracts. Future contracts are traded in exchanges and exchange sets the standardized
terms in term of quantity, quality, price quotation, date and delivery date (in case of
commodities).
3.2.3 OPTIONS
An option contract, as the name suggests, is in some sense an optional contract.
An option is the right, but not the obligation, to buy or sell something at a stated date
at a stated price. Options are of two types;
• CALL OPTIONS: A call option gives the buyer of the option the right, but not
the obligation to buy a given quantity of the underlying asset, at a given price
and on or before a given date.
• PUT OPTION: Put options give the buyer the right, but the obligation to sell a
given quantity of underlying asset at a given price on before a given date.
3.2.4 WARRANTS
Options generally have lives of up-to one year. Long dated options are called as
warrants and generally traded over-the-counter.
3.2.5 LEAPS
Long-Term-Equity-Anticipated Securities are options having a maturity of
more than three years or in other words options having a maturity of more than three
years are termed as LEAPS.
3.2.6 BASKETS
Basket options are options on portfolio of underlying assets. Equity index
options are a form of basket options
3.2.7 SWAPS
A swap means a barter or exchange. Thus, a swap is an agreement between two
parties to exchange stream of cash flows over a period of time in future. The two
commonly used swaps are,
i) INTEREST RATE SWAPS: Swaps which entail swapping only the interest related
cash flows between the parties in the same currency.
ii) CURRENCY SWAPS: These entail swapping both principal and interest between
two parities, with cash flows in one direction being in different currency than those in
the opposite direction.
The reason for which derivatives are so attractive is that they have attracted
different types of investors and have a great deal of liquidity. When an investor wants
to take one side of a contract, there is usually no problem in finding someone that is
prepared to take the other side. Three broad kinds of participants can be found in
derivatives market, namely, hedgers, speculators and arbitrageurs.
1. Hedgers: They use derivatives markets to reduce or eliminate the risk associated
with price of an asset. Majority of the participants in derivatives market belongs to
this category.
2. Speculators: They transact 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.
Figure – 3.1
Classification of Derivatives
Probably the next major event, and the most significant as far as the history of
derivatives markets, was the creation of Chicago Board of Trade in 1848. Due to its
prime location, Chicago was developing as a major centre for the storage, sale, and
distribution of Midwestern grain. Due to seasonality of grain, however Chicago’s
storage facilities were unable to accommodate the enormous increase in supply that
occurred following the harvest. Similarly, its facilities were underutilized in spring.
Chicago’s spot prices rose and fall drastically. To resolve this problem a group of
grain traders created “to-arrive” contracts which permitted the farmers to lock in the
price and deliver the grains in future. These to-arrive contracts are called as forward
contracts. The forward contracts proved as a useful device for hedging the price risk.
However, “credit risk” remained as serious problem. To deal with this problem, a
group of Chicago businessmen formed the Chicago Board of Trade (CBOT), in 1848.
The primary intention of CBOT was to provide a centralize location for buyers and
sellers to negotiate forward contracts. In 1865, CBOT went one step further and listed
the first “exchange traded” derivatives in US, which are termed as “Futures
Contracts”. In 1919, Chicago Butter and Egg Board, a spin-off of CBOT, got approval
for futures trading. Its name was changed to Chicago Mercantile Exchange (CME). In
1925, the first clearing house for derivatives trading was established.
Since then, derivatives are traded in many exchanges, although their trading
was banned by Government of different countries from time to time. But, the modern
derivative market has originated in 1970’s. This is due to the unprecedented volatility
in the international financial environment, starting with the breakdown of Bretton-
woods systems on 15 August 1971 and ending with the well-known Saturday night
massacre of Federal Reserve on 6th October 1979. The breakdown of Brettonwoods
system resulted in inflation, volatility in the market place and currency turmoil. This
state of affairs heralded the emergence of financial derivatives.
Thus, the global derivative market is now a wide spread market with a potential
of further growth. In last two decades derivatives has shown a tremendous growth and
also continuing to grow in future. Major stock exchanges of derivatives trading are
Chicago Mercantile Exchange (CME), Eurex, Hongkong Futures Exchange, The
London International Financial Futures and Options Exchange (LIFFE), Singapore
Exchange, Sydney Futures Exchange etc. Apart from these stock exchanges other
stock exchanges of various countries has shown a huge growth in derivatives trading.
Derivatives markets in India have been in existence in one form or the other for
a long time. In the area of commodities, the Bombay Cotton Trade Association started
futures trading way back in 1875. In 1952, the Government of India banned cash
settlement and options trading. Derivatives trading shifted to informal forwards
markets. In recent years, government policy has shifted in favour of an increased role
27 | P a g e Bombay Stock Exchange Limited.
Risk Management of Derivatives
of market-based pricing and less suspicious derivatives trading. The first step towards
introduction of financial derivatives trading in India was the promulgation of the
Securities Laws (Amendment) Ordinance, 1995. It provided for withdrawal of
prohibition on options in securities. The last decade, beginning the year 2000, saw
lifting of ban on futures trading in many commodities. Around the same period,
national electronic commodity exchanges were also set up.
Derivatives trading commenced in India in June 2000 after SEBI granted the
final approval to this effect in May 2001 on the recommendation of L. C Gupta
committee. Securities and Exchange Board of India (SEBI) permitted the derivative
segments of two stock exchanges, NSE and BSE, and their clearing house/corporation
to commence trading and settlement in approved derivatives contracts. Initially, SEBI
approved trading in index futures contracts based on various stock market indices such
as, S&P CNX, Nifty and SENSEX. Subsequently, index-based trading was permitted
in options as well as individual securities.
The trading in BSE SENSEX options commenced on June 4, 2001 and the
trading in options on individual securities commenced in July 2001. Futures contracts
on individual stocks were launched in November 2001. The derivatives trading on
NSE commenced with S&P CNX Nifty Index futures on June 12, 2000. The trading in
index options commenced on June 4, 2001 and trading in options on individual
securities commenced on July 2, 2001. Single stock futures were launched on
November 9, 2001. The index futures and options contract on NSE are based on S&P
CNX. In June 2003, NSE introduced Interest Rate Futures which were subsequently
banned due to pricing issue. Since the scope of this project is limited to equity
derivatives only, so the further discussion will be confined to equity derivatives only.
Equity derivatives market in India has registered an "explosive growth" and is
expected to continue the same in the years to come. Introduced in 2000, financial
derivatives market in India has shown a remarkable growth both in terms of volumes
and numbers of traded contracts. NSE alone accounts for 99 percent of the derivatives
trading in Indian markets. The introduction of derivatives has been well received by
8000000
7000000
6000000
5000000
4000000
3000000
2000000
1000000
0
2000-01 2001-02 2002-03
2002 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09
2008 2009-10 2010-11
Figure – 3.4
Average Daily Turnover of India’s Derivatives Market
CHAPTER FOUR
RISK AND RISK MANAGEMENT
The terms risk and uncertainty are often used interchangeably though there is a
clear distinction between them. Certainty is a state of being completely confident,
having no doubts of whatever being expected. Uncertainty is just opposite of that.
Risk is situation where there are a number of specific, probable outcomes, but it is not
certain as to which one of them will actually happen. In that context risk is not an
abstract concept. It is a variable, which can be calibrated, measured and compared. So
to define risk, risk entails two essential components; exposure and uncertainty. Thus,
risk is the exposure to uncertainty.
Risk management is the process in which risk is minimized with the application
of certain tools. The risk management process essentially comprises of certain steps,
such as, identification, assessment, prioritization, followed by coordinated and
economical application of resources to minimize, monitor and control it. These steps
are described below,
4.2.1 IDENTIFICATION
4.2.2 ASSESSMENT
After identifying the risk exposure points, it then to be assessed, i.e. to what
extent it is susceptible to that particular risk that has to be measured. Assessment of
risk helps in knowing the extent of vulnerability of a particular factor which is risk
exposed.
4.2.3 PRIORITIZATION
The next step of risk management process is the prioritization of factors which
are more vulnerable. The assessment of risk results in identifying the factors which are
more risk exposed and then these factors are prioritized from risk management point
of view.
After identifying the most vulnerable factor, the management team applies
economic resources to minimizing the risk. This is the most important stage of risk
management as any wrong step can result a more susceptible situation.
4.2.4 MONITOR
The final step of risk management is monitoring the risk management process.
Simply applying the resources to minimize the risk is not the last step of risk
management, as it is needed to analyze the success of the risk management process.
For this reason the entire process is monitored and if anything goes wrong, it is
rectified.
Price arises for the simple reason that the price of the underlying and price of
the derivatives are correlated. If the prices of the underlying increases, the impact is
seen in corresponding prices of derivatives products i.e. their prices also increase. For
an investor who is short in a futures contract or long in a put option or short in a call
option, there are potential losses. Thus, he or she may default in the obligation of the
derivative contract. This is price risk associated with the derivatives. Default due to
Price risk is mitigated by imposing some risk management tools in exchange-traded
derivatives, but in case of over-the-counter market, since it is largely unregulated,
default is more due to price risk.
This may the most popular and hazardous risk associated with the derivatives.
As derivatives are contracts or agreements, they need the obligations to be performed.
If any party default from the contract, then the contract is meaningless. The risk that
arises from the default of any party in derivatives is called as default risk. This is
common risk that is found in over-the-counter derivative market, but in exchange-
traded market, this type of risk is minimized by regulating the transactions.
Default risk is the risk that losses will be incurred due to default by the
counterparty. As noted above, part of the confusion in the current debate about
derivatives stems from the profusion of names associated with the default risk. Terms
such as “credit risk” and “counterparty risk” are essentially synonyms for default risk.
“Legal risk” refers to the enforceability of the contract. Terms such as “Settlement
risk” and “Herstatt risk” refer to defaults that occur at a specific point in the life of the
35 | P a g e Bombay Stock Exchange Limited.
Risk Management of Derivatives
contract: date of settlement. These terms do not represent independent risks; they just
describe different occasions or causes of default.
Default risk has two components: the expected exposure and the probability
that default will occur. The expected exposure measures how much capital is likely to
be at risk should the counterparty defaults. The probability of default is the measure of
the possibility that the counterparty will default.
For the purpose of this paper, systemic risk can be defined as widespread
default in any set of financial contracts associated with default in derivatives. If
derivative contracts are to cause widespread default in other markets, there first must
be large defaults in derivative markets. In other words, significant derivative defaults
are a necessary condition for systematic problems.
4.4.1 MARGINS
In case of futures contracts, the margin is mark-to-market on daily basis i.e. the
gain or loss of a day is settled to the margin account on a daily basis. If the long
position gains, then the amount he gained will be transferred to his account in the end
of the day. Similarly, if the investor losses, the amount that he lost is withdrawn from
his account.
Position limit is more applicable for the high net worth individuals, the FIIs and
the mutual funds. This is because, these people have huge investible cash and they can
direct the market as their wish. This will harm the market and other participants of the
market. Thus a position limit is introduced for this type of risk by the regulators for
the sound running of the market.
Final settlement is the last part of risk management in case of derivatives. The
settlement is done by the clearing house of the exchange. On exercise the settlement is
done on the closing price of the derivative product and final settlement takes place on
T+1 basis. If the long position exercises his right, then the settlement is done by
randomly assigning the obligation on a short position at the end of the day.
CHAPTER FIVE
INTERPRETATION AND ANALYSIS
The risk management of derivatives in BSE has two parts; one is the margining
system and the regulatory requirement. The details of these are explained below,
For margining the BSE is following portfolio based margining system and the
margin calculation is done by software known as PC SPAN. The portfolio based
margining model adopted by the exchange takes an integrated view of the risk
involved in the portfolio of each and every individual client comprising of his
positions in all derivatives contract traded on derivative segment. The SPAN
(Standard Portfolio Analysis of Risk System) is a portfolio based margining system
developed by Chicago Mercantile Exchange and it is being used by almost all stock
exchanges now. For setting the margin the exchange has a margin committee, which
decides about various factors to be considered while calculating the margin
requirements.
The price scan range inputs sets the maximum underlying price movement that
the margin committee chooses to consider in setting margin collateral requirements.
The future’s price scan range is the clearinghouse margin requirement on a naked
future position and controlling input into the option pricing model simulation that
ultimately determines the margin requirements. The future scan range is set by the
margin committee after examining historical price movements and applying subjective
judgments.
The implied volatility scan range is the largest movement in implied volatility
that margin committee chooses. The margin committee sets input scan ranges after
analyzing histograms of absolute value of day-to-day changes in the implied volatility
of traded futures-option contracts. The underlying average implied volatility estimate
that is analyzed is a simple average of eight contracts implied volatility on a given
maturity: the first is in-the-money and first three out-of-the-money implied volatility
estimates for both calls and puts.
The calendar spread charge is put into the SPAN is a parameter that sets the
amount of margin collateral, the clearinghouse collects against calendar spread basis
risk in portfolios. The calendar spread basis is the difference between prices of
contracts with different maturities. The basis between nearest quarterly and next
quarterly futures contract is calculated. Histograms of the absolute value changes in
basis series are constructed for different windows periods, and the histograms are
considered by the margin committee while calculating margin.
In SPAN, futures and futures options changes are estimate under alternative
scenario that are determined by the values chosen for the price and implied volatility
scan range inputs. In the simulation analysis, the value of each option contract is
estimated for following day using Black Option Pricing Model. The next-day contract
5.3 MARGINS
The BSE collects margin collateral in advance to minimize its risk exposure.
The margin required for different equity derivatives are explained below;
o The initial margin requirements on all derivative products are based on worst-
case loss of portfolio at client level to cover 99% Vary over one day horizon.
The initial margin requirement is net at client level and shall be on gross at the
trading and clearing member level.
o For this purpose, the price scan range of index products and stock products is
taken as 3σ and 3.5σ respectively. The price scan range of options and futures
on individual securities is also linked to liquidity. This is measured in terms of
impact cost for an order size of Rs. 5 laky calculated on the basis of order book
snapshots in the previous six months. If the impact cost exceeds by 1%, the
price scan range is increased by square root of three.
o For stock futures and short stock options contracts a minimum initial margin
equal to 7.5% of the notional value of the contract based on the last available
price of futures and option contract respectively is collected. For index futures
a minimum margin equal t 5% of the notional value of the contract is collected.
For index options a minimum of 3% is charged as the minimum margin.
o For all stock futures and index futures contract, the client’s position is marked-
to-market on a daily basis at portfolio level. The mark-to-market margin is paid
in/out in T+1 day in cash. For determining the mark-to-market margin, the
closing price is taken into consideration.
The exposure limit for different equity derivatives products are given below;
o In case of stock futures contracts, the notional value of gross open positions at
any point in time should not exceed 20 times the available liquid net-worth of a
member, i.e. 10% of the notional value of gross open position in single stock
futures or 1.5σ of the notional value of gross open position in single stock
futures, whichever is higher. However BSE charges exposure margin for better
risk management.
o For stock options contracts, the notional value of gross short open position at
any time would not exceed 20 times of the available liquid net-worth of the
member, i.e. 5% of the notional value of gross short open position in single
stock options or 1.5σ of notional value of gross short open position in single
stock options whichever is higher.
o In case of index products, the notional value of gross open positions at ant time
would not exceed 33 1/3 times of the available liquide networth of the member.
for index products, 3% of the notional value of gross open position would be
collected from the liquide networth of a member on a real time basis.
CHAPTER SIX
SUMMERY AND CONCLUSION
6.1.2 PC SPAN®
o The software used by BSE for margin calculation is PC SPAN®. This software
is developed by the Chicago Mercantile Exchange.
o This software provides adequate information to its user.
o It is user friendly. It provides the margin on a real time basis. As soon as the
data is input to the system, it takes 5 to 7 minutes to calculate the margin
requirement.
o This is efficient software for calculation of SPAN margin and used by almost
all stock exchanges of the world.
o The risk management process for derivatives used by BSE is efficient and
effective system.
o It covers about 99% Vary at any time.
6.2 SUGGESTIONS
Based on the interaction with different broking firms, it is observed that BSE is
comparable to NSE in technical terms. However, BSE lacks in providing better
services and information to the investors, which leads to poor market position in
derivatives.
o During our interaction with the brokers we come to know that, the services
provided by NSE are more reliable than that of BSE. So BSE should try to
provide integrated services to its members to improve its derivatives segment.
o Regarding the risk management procedure, as there is no difference between
NSE and BSE, it can be said that, BSE should continue with this process.
o BSE should improve its monitoring system for better risk management of the
exchange.
o Another major cause for BSE’s lost market share is the failure in providing
data. BSE can focus on this part in particular. It should also provide data in
tabular format rather than graphical format, so that it can be easily understood
by the investors.
o To improve its derivatives segment, BSE has to constantly innovate in terms of
services, products and technology, otherwise it cannot compete with NSE.
49 | P a g e Bombay Stock Exchange Limited.
Risk Management of Derivatives
o BSE charges more margins for better risk management, which in terms harms
its market position. Thus, a reasonable margin should be charged on the
members for development of derivatives market and better risk management.
6.3 CONCLUSION
BSE with its distinctive feature has a long, colorful and chequered history. It
enjoys a pre-eminent position by having a permanent recognition from the Securities
Contract (Regulation) Act, 1956. It can be considered as an essential concomitant of
the Indian economy. It is performing all the important functions of an ideal stock
exchange by providing a ready and continuous market with negotiability and safety to
investment of investors; redressing their grievance, minimizing risk, and providing a
forum to ensure liquidity and attracting capital from the investors, etc.
Despite the efficiency and transparency, BSE still lags behind NSE and faces a
stiff competition from it. Particularly, NSE holds about 99% of the derivatives market
of India, whereas BSE’s position is negligible. This can be attributed to the following
reasons.
Firstly, lack of detail and timely information of derivative segment and its risk
management is one of the main reasons for the falling market share of the BSE’s
derivatives segment.
Secondly, the data files for margin calculation are not precious as NSE has.
This is also one of the key obstacles in the development of derivative segment of BSE.
When BSE losses NSE gains.
Thirdly, the lack of monitoring system for risk management is another problem
with BSE. NSE has PRISM as the monitoring system which enables it for better risk
management of derivatives.
Though the margin with which BSE lags behind NSE is too much for
derivatives market, but a committed effort can help BSE to gain supremacy in this
segment. This can be done by making itself more informative, monitoring the risk
management process and taking some aggressive steps for the improvement of the
derivatives segment.
All it needs to do is to take quick and timely decisions for the improvement of
the derivatives segment.
Cohen, Guy., (2005), “the Bible of Options Strategies”. Financial times Press,
New Jersey, Pg. 1-16.
Bates, David, and Roger Craine., (1999), “Valuing the Futures Market
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52 | P a g e Bombay Stock Exchange Limited.
Risk Management of Derivatives
Bernanke, Ben S., (1990), “Clearing and Settlement During the Crash”. Review
of Financial Studies, Vol.3, No. 1, Pg. 167-179.
Burghardt, Galen, and Donald L., (1981), “Comments on Margins and Futures
Contracts”. Journal of Futures Markets, Vol.1, No. 2, Pg. 255-257.
Kuriec, Paul H., (1994), “The Performance of S&P 500 Futures Product
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Holton, Glyn., (2004), “Defining Risk”. Financial Analyst Journal, Vol. 60,
No. 6, CFA Institute.
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www.nseindia.com
www.investorworld.com
www.yahoo.com/finance
http://www.bis.org/publ/cpss06.pdf
http://www.premiumdata.net/
http://www.emeraldinsight.com/journals.htm?articleid=1527485&show=pdf
http://www.cboe.com/learncenter/glossary.aspx
http://www.cme.com/SPAN/
http://www.sgx.com/
http://www.asx.com/
http://www.sebi.gov/
http://www.myiris.com
http://www.bseindia.com/riskmanagement/about.asp
http://www.en.wikipedia.org/wiki/Risk_Management
http://www.yahoo.com/finance