STUDY OF DERIVATIVES

LUDHIANA STOCK EXCHANGE LIMITED LUDHIANA

TRAINING REPORT SUBMITTED IN THE PARTIAL FULFILMENT FOR THE DEGREE OF BACHELOR OF BUSINESS ADMINISTRATION YEAR 2008-2009

Angel broking

SUBMITTED TO PUNJABI UNIVERSITY PATIALA

SUBMITTED BY SIMRANDEEP SINGH 6329

RIMT-INSTITUTE OF MANAGEMENT AND COMPUTER TECHNOLOGY, MANDIGOBINDGARH

ACKNOWLEDGEMENT

Our personalities are based on the foundation of education imparted by our teachers who are next to god. I acknowledge our deepest sense of gratitude and sincere feeling of indebtedness to my major advisor, Mr. Shammi Kholi, under whose guidance I was able to complete my project. Without their immaculate and intellectual guidance, sustained efforts and encouraging attitude, it would have been difficult to achieve the results in such a short span of time. I am grateful to Mr. H.S. Sidhu (Managing Director) of LSE for permitting me to take the training at LSE Ltd. I also want to express our sincere gratitude to Mr. J.S. Arneja (Senior Manager &Training In charge) and all the staff members of LSE for spending time and valuable information they have shared with me and helped me in my project to be a success. The acknowledgement would not be completed without expressing my thanks to the faculty of my college for showing me the right path and guided me to solve my problems. I extent my gratitude to our Director Mr. B.S. Bhatia and all the related teachers. The help and cooperation they offered at each stage of my study is ineffable. Their valuable suggestions and constant encouragement made this study interesting and useful. Finally, I would like to acknowledge the support I got from my parents and God. It was their blessing that kept me motivated throughout till the completion of the project.

Simrandeep Singh

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STUDENT DECLARATION

I here by Declare that study of Study of Derivatives Has been exclusively done by us for the degree of BACHELOR OF BUSINESS ADMINISTRATION And not for any other degree, Diploma or fellowship. This is our own study done under the guidance of manager of the company. I hereby declare that the contents of this report are true and best to my knowledge.

Place: LUDHIANA (SIMRANDEEP SINGH)

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PREFACE
One should always work with an objective in its mind. To accomplish that objective efficient management of material, time and financial resources is very important. Above this coordination is must that determines the degree of success. Awareness at each level of life is necessary for a human being keeping all this is view in this report on Study of Derivatives. The rounded encouraging support by Mr. JS Arneja towards this report has created in me confidence regarding the approval of the subject matter. I feel that it was a great opportunity for me to spend time in LSE and getting myself aware of the ups and downs of capital market. So would like to say that this report is a result of an assignment, to improve myself and gain confidence.

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CONTENTS
CHAPTER 1 INTRODUCTION TO ORGANISATION
1 . STOCK EXCHANGE 2 . LUDHIANA STOCK EXCHANGE 3 . LSE SECURITIES LIMITED

CHAPTER 2

PROJECT OBJECTIVES A
LEARNING OBJECTIVES
1 INTRODUCTION TO DERIVATIVES

2 TYPES OF DERIVATIVES 3 ECONOMIC UTILITY OF DERIVATIVES 4 OBJECTIVES OF DERIVATIVES 5 INSTRUMENTS OF DERIVATIVE TRADING 6 RISK MANAGEMENT 7 MARGIN

B CHAPTER 3 CHAPTER 4 CHAPTER 5

ANALYSIS OF DERIVATIVES

RESEARCH METHODOLOGY DATA ANALYSIS AND INTERPRETATION SUGGESTIONS AND CONCLUSIONS

BIBLIOGARPHY AND ANNEXURES

LIST OF TABLES

Table No.
TABLE 1.1

Title Of Table

Page No.
5

LIST OF VARIOUS STOCK EXCHANGES IN INDIA

TABLE 1.2

BOARD OF DIRECTORS ( LSE)

TABLE 1.3

BOARD OF DIRECTORS (LSE SECURITIES)

15

TABLE 1.4

SETTLEMENT CYCLE SCHEDULE

19

TABLE 1.5

SCHEDULE OF ANNUAL LISTING FEE

23

TABLE 1.6

ACHIEVEMENTS OF LUDHIANA STOCK EXCHANGE

30

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LIST OF DIAGRAMS

Fig. No.

Title of the Diagram

OF LSESL

Page No
28 29 50 51 55 56 57 58 81 82 83 84 85 86 87 vii

FIGURE 1.1 SOURCES OF FUND FOR THE YEAR 2005-06 FIGURE 1.2 SOURCES OF FUND FOR THE YEAR 2004-05 OF LSESL FIGURE 2.1 PAYOFF INDEX FUTURES (BUYER) FIGURE 2.2 PAYOFF INDEX FUTURES (SELLER) FIGURE 2.3 PAY OFF CALL OPTION (BUYER) FIGURE 2.4 SELLER CALL OPTION FIGURE 2.5 PUT OPTION BUYER FIGURE 2.6 PAY OFF PUT OPTION (SELLER) FIGURE 4.1 TRADING PERIOD IN DERIVATIVES FIGURE 4.2 PURPOSE FOR DERIVATIVE TRADING

FIGURE 4. 3 SEGMENT HAVING LARGE TURNOVER FIGURE 4. 4 AMOUNT INVESTED IN DERIVATIVES FIGURE 4. 5 TRADED PERIOD FOR DERIVATIVE INVESTMENT FIGURE 4. 6 IMPACT ON CUSTOMER BASE FIGURE 4. 7 RELATIONSHIP WITH CASH MARKET

FIGURE 4. 8 ACCEPTANCE BY INDIAN INVESTORS FIGURE 4. 9 SHORT COMING IN INDIAN DERIVATIVE SYSTEM FIGURE 4.10 WHICH TOOL OF DERIVATIVE IS BETTER

88 89 90

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STOCK EXCHANGE

A STOCK EXCHANGE is a platform where buyers and sellers of securities issued by government, financial institutions, corporate houses, etc meet and where the trading of these corporate securities takes place. This is a market of speculations. If the speculation of investor becomes wrong then the investor loses. Nobody knows what will happen even after a second. A stock exchange refers to that segment of the capital market where the securities issued by corporate entities are trade. It is an open auction market where buyers and sellers meet and evolve a competitive price for the securities. It reflects hopes, aspirations and fears of people regarding the performance of the economy. It provides necessary mobility to capital and directs the flow of capital into profitable and successful enterprises. Since buying and selling of different types of securities takes place in stock exchange. The prices of particular securities reflect their demand and supply. In fact, stock exchange is said to be a barometer of economic and financial health. The stock exchanges are the nerve center of capital market. The stock exchange discharges three essential functions in the process of capital formation not in raising resources for the corporate sector. It provides place for sale and purchase of securities i.e. shares, bonds etc. It provides linkages between the savings of household sector and investment in corporate sector or economy. It provides market quotation for share, debentures and bonds and serves as a role of barometer, not only of the state of health of individual companies, but also of the economy as a whole. Therefore, by providing market place quotations of the price of shares and bonds or sort of collective judgment. Simultaneously reached by many buyers and sellers in the market, the stock exchanges serve the role of barometer, not only of the state of health of individual companies but also of the nations economy as a whole.

FEATURES OF STOCK EXCHANGE o It is the place where listed securities are bought and sold. o It is an association of persons known as members. o Trading in securities is allowed under rules and regulations of stock exchange. o Membership is must for transacting business. o Investors and speculators, who want to buy and sell securities, can do so through members of stock exchanges i.e. brokers.

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

HISTORY OF STOCK EXCHANGE The trading in securities in India was started in the early of 1973. The stock exchange operating in the 19th century was those of Bombay set up in 1875 and Ahmedabad set up in 1894. These were organized as voluntary non-profit making associations of brokers to regulate and protect their interests. Before the control on securities trading becomes a control on securities trading became a central subject under the constitution in 1950. It was a state subject and the Bombay securities contact (control) act, 1925 used to regulate trading in securities. Under this act, Bombay stock exchange was securities in 1927 and Ahmedabad stock exchange in 1927 and Ahmedabad stock exchange in 1937. During the war boom, a number of stock exchanges were organized at Bombay, Ahmedabad and other centers but they were not recognized soon after it became a central subject, central legislation was proposed and a committee headed by sh. A.D. GORWALA went into bill for securities regulation. On the basis securities regulation. On the basis securities contracts (control) at became law in 1956. At present there are 23 recognized stock exchanges in India. Number of Investors is increasing day by day. The stock exchange is a double auction market. Quite distinct from the common market in which only one seller and many buyers in a stock exchange a number of potential buyers and potential sellers co-exist all competing both among themselves and with one another in making bids, counter-bids, offers and counter-offers.

WHO BENEFITS FROM STOCK EXCHANGE?

o INVESTORS: It provides them liquidity, marketability, safety etc. of

Investment.

o COMPANIES: It provides them access to market funds, higher rating and

public interests.

o BROKERS: They receive commission in lien of their services to investors. o ECONOMY AND COUTRY: There is large of saving, better growth moves
industries, higher income.

LIST OF VARIOUS STOCK EXCHANGES IN INDIA TABLE 1.1 S. No. 1 Bombay Stock exchange Name of stock exchange Years establishment 1875 Voluntary organization 2 Ahmedabad exchange 3 4 Calcutta Stock exchange M.P. Indore 5 6 7 8 Madras Stock exchange Hyderabad Stock exchange Delhi Stock exchange Bangalore Stock exchange 1937 1943 1947 1957 Stock 1908 Stock 1897 Voluntary organization Public limited company Voluntary organization Co. limited by guarantee Co. limited by guarantee Public limited company Pvt. converted into public ltd. co. 9 10 Cochin stock exchange U.P. Kanpur 11 12 13 14 15 16 Pune Stock exchange Ludhiana Stock exchange Jaipur Stock exchange Guahati Stock exchange Kannaar Stock exchange Magadh Stock exchange 1982 1983 1983 1984 1985 1986 Co. limited by guarantee Public limited company Public limited company Public limited company Public limited company Co. limited by guarantee Stock 1978 Public limited company Public limited company Non-profit Non-profit Non-profit of Type of organization

exchange, 1930

exchange, 1982

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Bhuvneshwar exchange

Stock 1989

Co. limited by guarantee

18

Saurashtra stock exchange, 1989 Kutch.

Co. limited by guarantee

19 20 21

Vadora Stock exchange Meerut Stock exchange O.T.C.I. (Over the counter exchange of India), Mumbai

1990 1991 1993

N.D. N.D. Pure demutulised

22 23 24

National Stock exchange Coimbtoor tock exchange Sikkam Stock exchang

1995 1996 1997

Pure demutualised N.D. N.D.

PROFILE OF LUDHIANA STOCK EXCHANGE ASSOCIATION LTD. ESTABLISHMENT Ludhiana stock exchange was established in 1983 with 220 members by Sh. S.P. Oswal and Sh. B.M. Munjal leading industrialist to fulfill vital need of having a stock exchange in this region. Since its inception LSEAL has grown phenomenally switched from manual trading to screen based training on November 18th 1996 and number of listed companies increased from 160 in 90s to 437 as on 31st march of which 286 are regional and 131 are non regional. LSEAL has played on important role in generating capital for the companies in states of Punjab, Haryana, Himachal Pradesh and J.K.

GOVERNING COUNCIL, COMMITTEES AND ADMINISTRATION The Council of Management of the Exchange consists of eleven members, out of which two are Government Nominees; six are Public Representatives and one Managing Director who is also Ex-officio member of the Board. At every Annual General Meeting, one third of the elected the Executive Directors retire by rotation. Administration of the Exchange is managed by the Managing Director who is assisted by a Company Secretary and a team of Executives, Assistants, Technicians and sub-staff. The Exchange has four Statutory Committees namely Disciplinary Committee, Arbitration Committee, Defaults Committee and Investor Services Committee. In addition, it has advisory and standing committees to assist the administration.

BOARD OF DIRECTORS Sh. Harjit Singh Sidhu Prof. Rajinder Bhandari Sh. D.K. Malhotra Sh. G.S. Bains Sh. B.B. Tandon Sh. Sunil Malhotra Sh. Yash Mahajan Sh. S.C. Aggarwal Sh. Sanjeev kumar Gupta Sh. Manmohan Juneja Sh. D.P. Gandhi Managing Director Public Representative Public Representative Public Representative Public Representative Public Representative Public Representative SEBI Nominee Director SEBI Nominee Director TABLE 1.2

CORPORATE GOVERNANCE Although the Ludhiana Stock Exchange is not a listed Company, yet it has followed a model of corporate governance, which is evident from the composition of the Statutory Committees, the Investor Services Committee and Audit Committee. The Investor Services Committee comprises of four public Representatives and one broker member. It is headed by Sh. D.K. Malhotra, a legal expert. Statutory Committees are represented by brokers and non-brokers in 20:80 ratios.

OPERATIONS OF LUDHIANA STOCK EXCHANGE TURNOVER Ludhiana Stock Exchange is one of the leading Stock Exchanges among the Regional Stock Exchanges of the country, and has been providing trading platform for the investors situated in Punjab, J&K, and Himachal Pradesh & Chandigarh. At present, it has 344 listed companies and among them, 220 are listed as regional companies. It had been generating significant amount of the business in the secondary market. It recorded a peak turnover of Rs.9154 crores during the year 2000-2001. The structural changes that took place in the recent past in the Capital Market of the country had a negative impact on the trading volume of the regional Stock Exchanges. There has been a significant reduction of turnover during the financial year 2001-2002, but the reduction in turnover of the Exchange has been more than adequately compensated by substantial rise in the turnover of LSE Securities Limited, a subsidiary of Ludhiana Stock Exchange.

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LISTING Listing is one of the major functions of a Stock Exchange wherein the securities of the Companies are enlisted for trading purpose. Any Company incorporated under Companies Act, 1956, coming out with an IPO, has to mandatory list its shares on a Stock Exchange. The Listing Department of Ludhiana Stock Exchange deals with listing of securities, further listing of issues like bonus and rights issues, post-listing compliance of the companies, which are already listed with Ludhiana Stock Exchange. The Companies desirous of listing its securities on the Exchange have to sign a Listing Agreement with the Stock Exchange. After getting the listing approval, the Company has to ensure and report compliance of the post listing requirements. The listing section of the LSE monitors the post-listing compliance of all the listed companies and follows up with the companies, which are found deficient in compliance.

TRADING ON BIGGER STOCK EXCHANGES The exchange acquired the membership of NSE and BSE: through its subsidiary, the LSE securities LTD, with the objective of providing an enabling mechanism to its member brokers to trade on NSE and BSE as a sub brokers of LSE securities Limited. Trading at NSE and BSE was commenced through the subsidiary route from September 200 and December 2000 respectively. END OF AN ERA The management of the stock Exchange apprehended that the smaller regional stock exchanges would not be able to meet the challenges imposed by expansion of bigger stock exchanges like NSE and BSE and might end up losing their business to VSAT counters of the bigger stock exchanges. In order to

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prepare for such an eventuality, stock exchanges set up a broking armed in the name of LSE Securities Ltd (a subsidiary company of stock exchange) in January 2000 and built infrastructure and IT based sophisticated systems to enable its members and investors to trade on NSE and BSE through the subsidiary route. LSEAL HAS:OWN BUILDING LSEAL has its own six stories ultra modern building at Feroze Gandhi market at Ludhiana. It started its operation on 16th Aug, 1983. OWN BULLETIN LESAL is continuously publishing LSEAL Bulletin at the interval of quarter. It is also publishing LSE annual report which provides information to the various members and investors of stock exchanges. SCREEN BASED TRADING It was started at LSE on Nov. 18, 1996. The requisite software is developed by CMC Ltd. This screen Based Trading is based on VECTOR (Versatile Engine for Centralized Trading and on line reporting System) this system displays funds with respect of opening prices of the stock exchanges as well as the last traded prices. ON LINE TRADING THROUGH VSAT LSEAL has chalked out an ambitious program to expand online trading through V-SAT to untie other than Ludhiana and plans to take the trading facility to doorstep of investors in this year. The Board of Directors of LSE have approved the plan for expansion of online trading through VSAT with the object of broad base business opportunities to the investor and members, the exchange has set up 30 trading terminals at remote sites and union territory of Chandigarh. Trading through V-SAT has been smoothly conducted in October 1999. 12

SETTLEMENT GUARANTEE FUND It provides guarantee to all genuine based trading system of the stock exchange and was implemented a settlement guarantee fund with effect from 6 th April, 1998. SETTLEMENT AND CLEARING There is T+2 settlement cycle prevailing in the market. Members are given scrip wise delivery notes. The members are required to deposit scrips sold by them to the clearing house on the second working day following the day of transaction. Purchasing members are required to make the payment against the delivery also on aforesaid day. DEPOSITORY SYSTEM LSE commence trading in demat shares from November 16, 1998 by becoming a participant of NSDL. The exchange has set up in-house DP services to facilitate trading and settlement in demat securities. INVESTOR GRIEVANCES CELL LSE has made special arrangement to handle investors complaints and grievance so its premises for providing information relating to Capital market. This center has a well equipped library. The exchange introduced a computer based stock. Tel system for providing on line real time information through a fully automatic system, to the investors and members of the general public such as prices of the scrips, book closures, new listings, new issuers etc. Centre is also equipped with a screen for providing live rates of trading at NSE and BSE DEPOSITORY PARTICIPANT SERVICE The company is the DP of NSE and is the only depository in the region having on line real time connectivity with NSDL. DP operation of the company not only

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

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PROFILE OF LSE SECURITIES LTD. OBJECTIVE OF THE COMPANY LSE Securities Limited is a subsidiary of the Ludhiana Stock Exchange, which was formed with an objective to enhance business and investment opportunities for the investors and members of Ludhiana Stock Exchange at large, through innovative products by encompassing a variety of activities related to the capital market. The company has a paid up capital of Rs.5.65 crores, preference capital of Rs 7.90 lacs & the authorized capital of the company is Rs 8 crores. INTRODUCTION OF LSE SECURITIES LTD. LSE Securities Ltd., was incorporated in January, 2000 with a view to revive the capital market in the region and for taking full advantage of the emerging opportunities being provided by expansion of bigger stock exchanges like NSE and BSE. The company since its inception has marched forward rapidly and achieved many milestones in a short span of its existence. GOVERNMENT COUNCIL The Council of the management of the Company comprises of 12 directors of which 5 are broker members and 5 non-brokers. The non broker members are independent Directors of eminent status from the field of finance, law and management and remaining two are Executive Officer of the holding company (Ludhiana Stock Exchange) and Chief Executive officer of the company, who are on the board of the company as ex-officio Directors. Thus the council of management has representation of sub-brokers as well as professionals and subject specialists representing various fields of business activities. Operations of the company are run in a professional, transparent and fair manner keeping in view of the interest of investors as well as other stakeholders.

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CORPORATE MEMEBERSHIP OF NSE & BSE SEBI, at the initiative of LSEAL, permitted smaller Stock Exchanges, to trade on bigger Stock Exchanges through their subsidiary companies. The Ludhiana Stock Exchange floated its subsidiary company, the LSE Securities Limited, with the objective of obtaining trading rights on bigger Stock Exchanges. It has obtained corporate membership of both NSE and BSE in the year 2000. TRADING AT NSE AND BSE The LSE Securities Ltd.Commenced trading operations in Capital Market Segments of BSE and NSE in September, 2000 and December, 2000 respectively. The total turnover of the company at NSE is growing by leaps and bounds ever since in incorporation. There was encouraging response from the sub-brokers specially at NSE counters. During the financial year 2005-06 turnover had been Rs 8613 crores as against Rs 7987 crores during the financial year 2004-05 in Capital Market segment of NSE. The total turnover during the financial year 2005-06 had been Rs 4920 crores as against Rs 3833 crores during the financial year 2004-05 in Capital Market segment of BSE. F&0 SEGMENT OF NSE LSE Securities Ltd. Commenced trading operations in Future and Options Segment of NSE in February 2002. The Company became the first subsidiary of any Regional Stock Exchange which commenced trading in F&O Segment of NSE. Response to trading facilities in the F&O segment of NSE has been very encouraging and volumes generated in this segment soon exceeded those in Capital Market segment.

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TRADING THROUGH V-SATs The LSE Securities Limited has also provided facility to its sub-brokers for trading on NSE and BSE through VSAT counters, which are located outside Stock Exchange Building. Presently, 17 sub-brokers of the company have been trading through VSAT on NSE and 10 on BSE. CERTIFICATION IN FINANCIAL MARKET In order to provide professional services to the investors of LSE Securities Limited through its sub-brokers, the company motivated its sub-brokers and its staff to qualify the certification in financial markets conducted by NSE. All trading terminals for Capital Market Segment and F&O segment are being operated by the persons after having qualified the said certification. BOARD OF DIRECTORS Sh. A.K ARORA Sh. Vijay Singhania Sh. Harjit Singh Sidhu Sh. Lalit Kishore Sh Sukhjiwan Rai Sh. Anurag Arora Sh. Ashwani Kumar Sh. M.A. Zahir Sh. P.C. Garg Sh. Ajay Chaudhry Sh. Vinay Shrivastav Chairman Vice Chairman Director Director Director Director Public Representative Public Representative Public Representative Public Representative Public Representative

TABLE 1.3

DEPARTMENTS OF LSE

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The main aim of LUDHIANA STOCK EXCHANGE is to ensure the safety and security to the investments of the investors and to provide the proper services under the prescribed guidelines of SE 131. So to maintain the proper system of working of exchange, there are so many different departments in which particular functions are performed, assigned to those departments. Following in the list of various departments of LSE:OPERATIONAL DEPARTMENTS 1. Margin Section 2. Clearing House 3. Market Surveillance 4. Computer Section and information System Department SERVICE DEPARTMENTS 1. Legal Department 2. Secretarial Department. 3. I.G.C. (Investor Grievance Cell) 4. Listing Section 5. Accounting Section 6. Membership Department/Personnel Department All the section perform specific functions. There is no duplication of work; even then all the sections are interconnected with each other. There is an organized network of recording of activities performed there. But before studying the inter dependence of section) here is the details of all department i.e. actually what function is performed by each and every section.

MARGIN SECTION

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Margin Section is an important section. This section apart from dealing in the regulating the trading of brokers keeps a check on excessive trading in speculation. Margin is the amount, which is collected from brokers for the safety of transactions. As the transactions are to be finalized on basis, in the mean time the rates may fluctuate which may lead to default. So to make the transaction safe, daily margins are collected from brokers. When a member gets registered in the exchange and with Securities Exchange Board of India (SEBI), then before starting trading he is supposed to deposit some amount fixed by SEBI as security. Now as SEBIs rolling settlement prevails. Ultimately margin is the difference between the limit and trade done by the member. The security deposited by a member is called Base Minimum Capital. If any member wants to trade beyond his trading limit, he can do so by depositing Additional Base Minimum Capital.

TYPES OF MARGINS As we have discussed earlier margins, collected from members to avoid the losses and to provide security to the investors. There are different types of margins, which are imposed given as follows:MARK TO MARKET MARGIN The exchange collects this margin on daily basis, broker-wise 100% notional loss of each member for every scrip, calculated as the difference of his buying or selling price and closing of that scrip at the end of the day. This is also called loss margin. The margin is payable in cash or in bank guarantee.

VALUE AT RISK OR VAR MARGIN

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For the scrips in the compulsory rolling settlement at 99% VAR based margin system would be introduced w.e.f. July, 02, 2001. the computation of this margin is done by a software developed by CHICAGO Stock Exchange. ADDITIONAL MARGIN Thus margin is 12% would be levied over and above the VAR margin. This margin is collected from brokers on T+1 basis. SPECIAL MARGIN The brokers will be required to deposit margin as per the percentage prescribed by stock exchange in this regard from time to time. PAYMENT OF MARGIN The broker's shall be required to deposit margin demanded from them by 11:00AM on T+I day. That is on next trading day. The margin brokers shall be collected by way of cheques drawn on the prescribed banks, demand draft or by way of direct debit to the bank account to broker.

CLEARING HOUSE

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Clearing house takes care of pay-in and pay-out securities. At this time there is weekly trading system (Monday to Friday) prevails. And securities are settled by rolling settlement. Means pay-in and pay-out of securities is settled on T+3 Basis would commence form 1stApril, 2002. SEBI decide the following activity schedule for exchanges for the T+3 rolling settlement. SETTLEMENT CYCLE SCHEDULE Sr. No. 1 2 3 Day T T+2 T+3 Description of Activity Trade Trade Date Securities and funds pay-in and pay-out Auction of shortage in delivery TABLE 1.4 T - TRADING PERIOD. PAY IN/PAYOUT OF SECURITIES On trading day brokers buy and sold the securities or scrips and pay-In and pay out of securities will be completed on T+2 basis e.g. if broker buy/sell shares on Monday then pay in of securities will be on Wednesday, 10:30A.M. And pay out of scrips will also on Wednesday up to 2:00 P.M., in this way pay-in/pay-out of securities cycle will be completed.

AUCTION OF UNDELIVERED SCRIPS

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In case if broker fails to deliver the scrips on T+2 delivery day. Then it is responsibility of clearing house to settle the undelivered scrips. Then, auction will start. In above example, auction of pending securities will be conducted on Thursday. In auction price of securities may will fluctuate 20% high or low of that trading day. In this way trade in auction is settled.

CLOSE OUT In case the shares of particular scrips is not available on the date of auction. Then it is obligation of solicitor (exchange) to give monetary benefit to initiator (buyer) against the default of defaulter of securities in this manner settlement schedule has completed. COMPUTER SECTION The growing technicalities and increase in workload has enhanced the importance of computer section in Ludhiana stock exchange. This department mainly referred to as EDP i.e. electronic data processing section. This section is the backbone of entire stock exchange would come to halt if this department becomes inactive. It prepares several reports namely: o Scrip wise statement of each member for each settlement period o Sub broker wise delivery bill receive order (after payout) o Downloading of delivery order. o Downloading of receiving order. o And broker on sub broker wise final settlement. o HDFC bank entries. o Scrip wise statement Computer facilitates easily updating all automatically adopting of new rates, once we feed new limits the whole calculation to be done through 22

computer will change. Rates are updated either daily or month wise as per the requirements.

MANUAL OPERATIONS It has reduced manual work. It has also eliminated approximately the need to keep check the physical reports, which is a time consuming as well as space consuming and requires a lot of attention. VOLUME AND TRANSPARENCY This system is very much transparent, as each individual involved knows every relevant tilling . Also volume of shares being traced is very high and increasing continuously. LINKING CHAIN This section acts as a linkage, which links each and every department of the LSE with another and hence helps in working as a whole. CHECK AND CONTROL OVER SCRIPS AND MEMBERS This section also helps in maintaining check and control over defaulting members and scrips. In case the member crosses his limit of trading according to his deposited amount, the computer section switches off his terminal and same step is taken in case of defaulted scrips.

MARKET SURVEILLANCE AND MONITORING SECTION

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The main task of this section is to see the market sanctity and maintenance so that the investors are not cheated. So market surveillance entails scientifically identifying points in a stock price movement or trading volumes, which don't match with the company's fundamentals. So the price and volume trends in stock exchange are checked for abnormalities scientifically. INVESTORS GRIEVANCE SECTION LSE has a separate investor's grievance cell, which receives complaints from investors and follows up the complaints with companies and member broker to ensure their satisfactory redressal. For providing better services to the investors the stock exchange has maintained investor protection fund. In this fund Rs. 500 is collected from each member annually. Apart from this one percent of the total listing fee collected and ten percent interest covered on company deposits is also transferred to the investor protection fund. One more fund investor service fund has been set up. 20% of the listing fee is transferred to it. The funds of it are used for maintenance of investor service center, holding of seminars for investor/brokers benefit, and publication of LSE Bulletin. Rationale Behind Establishing Investors Grievance Cell o To safeguard the investors interest through investors grievance section. o To participate as monitoring authority in the public and right issue of the company. o To ensure that the company listed at the LSE compiles with all the listing requirements. o To keep a record of the inquiry base of the listed companies, their annual financial results and any subsequent increase in the equity base. o LISTING SECTION

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This department plays an important role in the Stock Exchange. as it helps the company to raise money from the capital market. Presently it is mandatory for Regional Company to get itself listed at LSE. In order to get listed company should have minimum capital of Rs. 3 crores and at least 25% of its equity should be offered to the public for the listing company is also required to make a deposit 1 % issue price with the stock Exchange and it can not be released before the expiry of six months provided there is a compliance of prelistings and post-listing requirements of the company. Company has also to comply with the conditions enunciated in listing clause. The schedule of annual Listing fee and up front listing fee payable triennially is given below: Paid up capital Upto 1 crores 1 to 5 crores 5 to 10 crores 10 to 20 crores 20 to 30 crores Above 50 crores Annual Listing Fee (Rs.) 8400 16800 28000 56000 84000 140000 TABLE 1.5 Companies which have paid up capital of more than Rs. 50 crores will pay additional fee of Rs. 2800 for every increase of Rs. 5 crores or part there of. The annual listing fees referred to above are applicable only if the exchange is a Regional Stock Exchange otherwise the fees will be 50% of the fees indicated above.

ACCOUNTS SECTION Most of the work in account section LSE is done manually, although help is taken through computers for the purpose of making Trial Balance, Income and

25

Expenditure statement and Balance Sheet. The annual report of LSE is generally published in August every year. Some of the important polices of LSE are o The company follows accrual system of accounting recognizes income and expenditure accordingly. o Depreciation is provided on written down, value method in accordance with and din the manner specified in schedule XIV of the Companies Act 1956. o Fixed costs are stated at historical costs less depreciation. o Stock/Inventory (stationery) is valued at cost. o Interest on funds borrowed which is attributable to construction of fixed assets and other indirect expenditure during construction is included under work in progress. The company has the procedure of receiving shares, scrips of various companies as securities against the performance of the contract. No accounting entries in such transaction are made in respect of defaulting members by crediting security account and debiting member's investment a/c. The shares in such cases are valued at prices on the date of transfer deeds. Functions of Accounts Section:The account section performs the following function. o To make and receive payments to the outside agencies, these agencies include companies listed at LSE and brokers working at LSE. o To disburse personnel expenses. o To keep the records of all incoming and outgoing money depreciation of financial statements at the end of financial year. o To get their accounts audited from the third party. o Sources of funds of LSE: -

26

o Membership fee from brokers at the beginning. o Initial listing fee from companies i.e. Rs. 1,000/o Annual listing fee from companies. o Annual fee from brokers (Rs. 5000) and their authorized representatives. (Rs. 500 each) as broker member is allowed to have maximum 4 authorized representatives. o Interest income from deposits of companies for listing, which are made at 1% of issue amount and minimum capital for this purpose is Rs. 4/- crores. Such deposits are retained until there is no dispute against the company subject to the minimum of 6 months, o o Annual computer fee from brokers (Rs. 5000) Library charges from brokers (Rs. 200) p.a.) o Brokers contribution to investor protection fund (Rs. 500 p.a) o Fines and penalties form brokers. o Maintenance charges Rs. 13.50 per sq. feet, per quarter from those members having rooms and those not having rooms all those not having rooms are charges at till rate of Rs. 1500/- pa. o Water and electricity charges Rs. 750 per quarter, whose area is less than 200 sq. feet and 900/- per quarter which is having area of more than 200 sq. feet. The members who are not having rooms are charged at the rate of Rs. 300/(p.a.) o Interest earned affixed deposits. Billing of members is done on annual basis for annual fees and other above- mentioned charges. On 1st April of each year and they are to make payment in 180 days up to 30 September. Beyond it, they are charged interest on due amount @ 12% p.a. still in case of nonpayment, broker member is served a show cause notice for 60 days on 1st April next year. If member fails to, comply with notice then he can be expelled. Application Of Funds Of LSE:-

27

1. 5% of listing fees to SEBI each year. 2. 20% for providing services to investors out, or listing fee annually to investor service fund. 3. Administrative expenses (I) Electricity Charges. (II) Security Charges (III) Telephone Charges (IV) VSAT Charges (V) Printing and stationary Salaries 4. 1% of listing is transferred annually to investor protection fund. SECRETARIAL DEPARTMENT Duties and responsibilities of personnel department are mentioned as under which are discharge by the secretarial departments. o Recruitment of staff. o Maintain employee record e.g. attendance leave, overtime etc. o Maintain employee service book up to date and other detail as per the requirements to auditors at the time of inspection (From date of joining registration) o Employee welfare scheme like loans. o Other activities like staff farewell party and Diwalipuja. Although the LSE, has not a separate personnel departments in its organizing chart. All activities relating personnel are carried out by the secretarial departments, which has the additional charge of personnel.

LEGAL SECTION 28

When two broker or outside clients do not settle their claims in between themselves and move to court, the legal section comes into the picture to fight for the cause of investors and against the defaulting members. Legal section also assist the member investor to settle their disputes through the arbitration committee investors grievance committee. Disciplinary committee, defaulting committee, so that there maybe settled at the earlier without incurring heavy due on amount regarding court fee, advocate fee etc. The objective of the legal section is to make effective the bylaws and regulation of the stock exchange and to see that the guidelines, circular and any amendments in rules made by the SEBI are enforced at appropriate time so that the future complications may be reduced or avoided. As the name legal section suggests it is clearly mentioned and understood that each of every matter involving legality is to be solved by the legal department. PERSONNEL DEPARTMENT Ludhiana stock exchange does not have a personnel department in its Organization chart. This department carries out all activities relating to the recruitment of the personnel, whenever and wherever a vacancy arises, maintenance of attendance register. This department also deals with the appointment or removal of floor clerks or authorized representatives of brokers. These departments also maintain records of leaves and overtime of employees.

MEMBERSHIP DEPARTMENT

29

This department deals with membership of exchange. The trade in market is done through the authorized members who are registered with concerned stock exchange and SEBI. There are two types of members in stock exchanges. o Corporate members o Individual member Following are the requirements to be an individual member of exchange. Age Limit: Qualification: To be member of stock exchange there is age limit Minimum age is 21 yrs Maximum age is 60 yrs. To be member minimum qualification Matriculation is plus person has three-year experience interview. Including written test and membership department deal with all above requirements of members. Following requirements are for corporate members:1. Company must be registered u/s 322 of the company Act i.e. Directors with unlimited liability. 2. Two copies of MOA & AOA. 3. Qualification & Proof of age of at least two directors, who will deal in securities.

SOURCES OF FUND FOR THE YEAR 2005-06 OF LSESL 30

1 2 3 4 5

FIGURE 1.1

SOURCES:(1) Membership Fee (2) Listing Fee (3) Interest on deposits (5) Other income = = = = 0.82% 13.27 29.03% 3.23% 53.65

(4) Profit on sale of fixed assets =

SOURCES OF FUND FOR THE YEAR 2004-05 OF LSESL

31

1 2 3 4 5

FIGURE 1.2

SOURCES:1) Turnover Charge BSE 2) Turnover Charge NSE 3) Interest on Bank deposits 4) Depository Income 5) Other income = = = = = 5.10% 47.18% 31.90% 8.99% 6.83% ________ 100

ACHIEVEMENTS OF LUDHIANA STOCK EXCHANGE

32

TABLE 1.6 Oct 1981 Aug 1983 Aug 1983 Nov 1996 April 1998 Incorporation of Stock Exchange Commencement of operations Shifting of operation to own building Online Screen Trading Modified carry forward system (MCTS) Nov 1998 Sep 1999 Jan 2000 Aug 2000 Dec 2000 Sep 2000 July 2001 January 2002 Feb 2002 April 2002 April 2003 Oct 2003 and settlement gurantee fund. Trading and settlement in demat scrips Trading at remote sites through VSAT counters Introduction of rolling settlement Commencement of online real time depository services Trading on N.S.E. in C.M. segment (Through NSEL) Trading on B.S.E. in CM segment (Through LSEL) Introduction of Compulsory rolling settlement Complete shift of trading CM segment from ISE To LSE securities Ltd. Trading in F&O segment of N.S.E. Rolling settlement cycle prevailing at LSE on T+3 basis Rolling settlement cycle prevailing at LSE on T+2 cycle Incorporation of LSE commodities trading services Ltd., a subsidiary of March 2004 LSE. Securities Ltd. Introduction of MCX (Multi Commodity Exchange of India) MCX offers 14 different commodities such as steel, kapas, rubber, blackpepper, oil soil seeds, precious metal etc.

33

34

OBJECTIVES

LEARNING OBJECTIVES It includes

1 INTRODUCTION TO DERIVATIVES

2 TYPES OF DERIVATIVES 3 ECONOMIC UTILITY OF DERIVATIVES 4 OBJECTIVES OF DERIVATIVES

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5 INSTRUMENTS OF DERIVATIVE TRADING 6 RISK MANAGEMENT 7 MARGIN

ANALYSIS OF DERIVATIVES MARKET

INTRODUCTION TO DERIVATIVES Primary market is used for raising money and secondary market is used for trading in the securities, which have been used in primary market. But derivative market is quite different from other markets as the market is used for minimizing risk arising from underlying assets. The work derivative originates from mathematics. It refers to a variable, which has been derived from another variable. i.e. X = f(Y) Where X (dependent variable) = DERIVATIVE PRODUCT 36

Y (independent variable) = UNDERLYING ASSET A financial derivative is a product that derives value from the market of another product. Hence derivative market has no independent existence without an underlying asset. The price of the derivative instrument is contingent on the value of underlying assets. As a tool of risk management we can define it as, a financial contract whose value is derived from the value of an underlying asset/derivative security. All derivatives are based on some cash product. The underlying assets can be : a. Any type of agriculture product of grain (not prevailing in India) b. Price of precious and metals gold c. Foreign exchange rates d. Short term as well as long-tern bond of securities of different type issue4d by govt. and companies etc. e. O.T.C. money instruments for examples loan & deposits.

Example : Wheat farmers may wish to sell their harvest at a future date to eliminate the risk of change in price by that date. The price of these derivatives is driven from spot price of wheat. DEFINITION OF DERIVATIVE In the Indian context the securities contracts (Regulations), Act 1956 defines Derivative to include:

37

1. A security derived from a debt instrument, Share, Loan whether secured or unsecured, Risk instrument or contract for difference or any other form of security. A contract which derives its value from the prices of prices of underlying securities.

HISTORICAL ASPECT OF DERIVATIVES The need for derivatives as hedging tool was first felt in the commodities market. Agricultural F&O helped farmers and PROCESSORS hedge against commodity price risk. After the fallout of BRITAIN WOOD AGREEMENT, the financial markets in the world stared undergoing radical changes, which give rise to the risk factor. This situation led to development of derivatives as effective Risk Management tools.

38

Derivatives trading in financial market started in 1972 when Chicago Mercantile Exchange opened its international Monetary Market Division (IIM). The IMM provided an outlet for currency speculators and for those looking to reduce their currency risks. Trading took place on currency. Futures, which were contracts for specified quantities of given currencies, the exchange rate was fixed at time of contract later on commodity future contracts was introduced then followed by interest rate futures. Looking at the liquidity market, derivatives allow corporate and institutional investors to effectively manage their portfolio of assets and liabilities through instruments like stock index futures and options. An equity fund e.g. can reduce its exposure to the stock market and at a relatively low cost without selling of part of its equity assets by using stock index futures or index options. Therefore the stock index futures first emerged in U.S.A. in 1982.

PRODUCTS, PARTICIPANTS, AND FUNCTIONS Derivatives contracts have several variants. The most common are FORWARDS, FUTURES, OPTIONS AND SWAPS.

The following three categories of Participants-Hedgers, Speculators, and Arbitrageurs.

39

1. Hedger :- Hedgers face risk associated with the price of an asset. They
use futures or options markets to reduce the risk. Thus, they are operation who want to eliminate the risk composing of their portfolio.

2. Speculators : They wish to be on future movements in the price of an

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

3. Arbitrageurs : They are in business to take advantage of discrepancy

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

TYPES OF DERIVATIVES The most commonly used derivatives contract is forwards, futures and options:

1. Forwards : A forward contract is a customized contract between two

entities, where settlement takes place on a specific date in the futures at todays pre-agreed price. 40

2. Futures : A future contract is an agreement between two parties to buy or

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

3. Options : It is of two types : call and put options.

Underlying asset, at a give price on or before a given future date. PUTS give the buyer the right but not the obligation to sell a give quantity of the underlying asset at a given price on or before a given date.

4. Leaps : Normally option contracts are for a period of 1 to 12 months.

However, exchange may introduce option contracts with a maturity period of 2-3 years. These long-term option contract are popularly known as Leaps pr Long term Equity Anticipation Securities.

5. Baskets : Baskets options are option on portfolio of underlying asset.

Equity Index Options are most popular form of baskets.

6. Swaps : These are private agreements between two parties to exchange

cash flows in the future according to a prearrange formula. They can be regarded as portfolios of forwards contracts. The two commonly used swaps are:

a) Interest rate swaps : These entail swapping both Principal and

interest between the parties , with the cash flow in one direction being in a different currency than those in the opposite direction.

41

b) Currency swaps : These entail swapping both Principal and

interest between the parties, with the cash flow in one direction being in a different currency than those in the opposite direction. THE DERIVATIVES MARKETS PERFORM A NUMBER OF ECONOMIC FUNCTIONS:

1. Price Discovery: - Prices in organized derivatives markets reflects the

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

2. Transfer of risk: - The derivative market helps to transfer to the risks from
those who have them but may like them those who have an appetite for them. We can also term the derivative market as the insurance company, whereby certain players assumes the risk by receiving premium amount.

3. Increased volume in the cash market :- Derivatives due to their inherent

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

4. New Entrepreneurial activities :- Derivatives have a history of attracting

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

5. Increase in saving :- Derivatives market helps increase savings and

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

42

6. Trading in controlled environment :- The introduction of the derivatives

has shifted the trading in speculative dealings in controlled market and the counter party risk has been eliminated. Participants in derivative market 1. Exchange, trading members, clearing members. 2. Hedgers, arbitrageurs, speculators. 3. Clearing, clearing bank. 4. Financial institutions. 5. Stock lenders and borrowers.

REASON FOR STARTING DERIVATIVES 1. Counter party risk on the part of broker, in case it ask money from us but before giving delivery of shares goes bankrupt. 2. Liquidity risk in the form that the particular scrip might not be traded on exchange. 3. Unsystematic risk in the form that the price of scrip may go up or down due to Company Specific Reasons.

4. Mutual funds may find it difficult to invest the funds raised by them
properly as the scrip in which they want to invert might not be available at the right price. OBJECTIVES OF DERIVATIVE TRADING

1. Hedging: You own a stock and you are confident about the prospects of
the company. However at the same time you feel that overall market may not perform as good and therefore price of your stock may also fall in line with overall marked trend. 43

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

2. Arbitrage: - The future price of an underlying asset is function of spot

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

3. Speculations: - You may have very strong opinion about the future
market price of a particular asset based on past trends, current information and future expectation. Likewise you may also have opinion about the overall marker trend. To take advantage of such opinion, individual asset or the entire market (index) could be sold or purchased.

44

THE REQUIREMENTS FOR SETTING UP FUTURE AND OPTION TRADING ARE OUTLINES BELOW: 1. Creation of an Options Clearing Corporation (OCC) as the single guarantor of every traded option. In case of default by a party to a contract, the clearing house has to bear the cost of necessary to carry out the contract. 2. Creation of a strong cash market (secondary market). This is because after the exercise of an option contract, the investors move to the secondary market to book profits. 3. Creation of paper-less trading and book-entry transfer system. 4. Careful selection of the regulation in all the stock exchanges. 5. Uniformity of rules and regulation in all the stock exchanges. 6. Standardization of the terms governing the options contracts. This would decrease the transaction costs. For a given underlying security, all contracts on the options exchange should have an expiry date, a strike price, and a contract price, only the premium should be negotiated on the floor of the exchange. 7. Large, financially sound institutions, members and norms to be out and followed. number of market makers, who can write the options contracts. Strict capital adequacy

45

STRENGTH OF INDIAN CAPITAL MARKET FOR INTRODUCTION OF DERIVATIVES

1. Large Market Capitalization: India is one of the largest market

capitalized country in Asia with a market capitalization of more than 7,65,000 crores.

2. High Liquidity: In the underlying securities the daily average traded

volume in Indian capital market today is around 7,500 crores. Which means on an average every month 14% of the country market capitalization gets traded, shows high liquidity.

3. Trader Guarantee: The first clearing corporation (CC) guaranteeing

trades has become fully functional from July 1996 in the form of National Securities Clearing Corporation (NSCCL) for which it does the clearing.

4. Strong depository : A strong depository National Securities Depositories

Ltd. (NSDL), which started functioning in the year 1997, has strengthen the securities settlement in our country.

5. A good Legal Guardian : SEBI is acting as a good legal guardian for

Indian Capital Market.

46

IMPORTANCE OF DERIVATIVES TRADING 1. Reduction of borrowing cost. 2. Enhancing the yield on assets. 3. Modifying the payment structure of assets to correspond to investor market view. 4. No physical delivery of share certificate so reduction in cost by stamp duty. 5. Increase in hedger, speculator and arbitrageurs. 6. It does not totally eliminate speculation, which is basic need of Indian investors.

47

INSTRUMENTS OF DERIVATIVE TRADING

Forward

Derivative

Future

Option

FORWARD CONTRACTS It is an agreement to buy/sell an asset on a certain future date at an agreed price. The two parties are : 1. Who takes a long position - agreeing to buy 2. Who takes a short position agreeing to sell The mutually agreed price is known as delivery price or forward price. The delivery price is chosen in such a way that the value of contract for both parties is zero at the time of entering the contract, but the contract takes a positive or negative value for parties as the price of underlying asset moves. It removes the future price risk. It a speculator has information or analysis, which forecast an upturn in price, and then be can go long on the forwards market instead of cash market.

48

The speculator would go long on the forward, wait for the price to rise, and then take a reversing transaction to book profits. Speculator may well be required to deposit a margin upfront. However, this is generally a relatively small proportion of the value of assets underlying the forward contract. Effect of change in price : As mentioned above the value of such a contract in zero for both the parties. But later as the price & the underlying asset changes, it gives positive or negative value for contract. Price Assets Increase Decrease & Underlying Holder & long position Positive Value Negative Value Holder & Short Position Negative Value Positive Value

E.g. A agrees to deliver 100 equity shares of Reliance to B on Sept. 30, 2002 at a Rate of Rs. 120 per share. Now if the price of share on that is Rs. 140 per share, than a who has short position would stand to loss of Rs. (20*200) = 4000, long position would gain the same amount or vise versa if price quoted is less than delivery price. Profit/Loss = ST-E ST = spot price on maturity date E = delivery price Limitations of forward contract 1. No standardization. 2. One party can breach its obligation. 3. Lack of centralization of trading. 4. Lack of Liquidity. . FUTURE CONTRACT 49

It is an agreement between buyer and seller for the purchase and sale of a particular assets at a specific future date; specific size, date of delivery, place and alternative asset. It makes obligation on both parties to fulfill the contract. Features of Future Contract 1. Standardized contracts e.g. contract size. 2. Between two parties who do not necessarily know each other. 3. Guarantee for performance by a clearing corporation or clearing house. Clearing house is associated with matching, processing, registering, confirming setting, reconciling and guaranteeing the trades on the future exchanges. Clearing house tries to eliminate risk of default by either party. 4. It has some features of Badla also.

FUTURE TERMINOLOGY Spot Price : The price at which an asset trades in the spot market. Future Price : The price as which the futures contract trades in the futures market. Contract cycle : The period over which the contract trades. The index futures contracts on the NSE have one moth, and three-month expiry cycles, which expire on the last Thursday of one month. Thus a January expiration contract expires on the last Thursday of the January. On the Friday following the last Thursday, a new contract having three-month expiry is introduced of trading. Expiry Date : It is date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Basis : In the contract of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month

50

for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices. Initial margin : The amount that must be deposited in the margin account at a time a future contract is first entered into is known as initial margin. Marketing-to-market : In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investors margin gain or loss depending upon the futures closing price. Maintenance margin : This is somewhat lower than initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance amount falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day. TYPE OF FUTURE CONTRACTS Index Futures : Of the financial futures, index future contracts are key contracts, introduced in U.S.A., in 1982 by the Commodity Futures Trading Commission (CFTC) by approving the Kansas Board proposal. Index Futures began trading in India in June 2000 of Trade (KSBT)s Futures derive its value from the underlying index-e.g. NSEs futures. Contracts are based on S & P CNX NIFTY At present it has become the most liquid contract in the country, the arbitrage between the futures equity market is further expected to reduce impact cost. 8090% of retail participation is expected in India because

51

TREND OF BULLISH MARKET 15th Feels the market will rise Buys 200 nifty contracts with expiry date - 31th at 1220 costing Rs. 244000 (200*1220) 31st Nifty July futures has risen to 1310 Sells off his position at 1310 Makes a profit of Rs. 18000 (200*90)

PAYOFF INDEX FUTURES (BUYER)

Profit 0 1220
FIGURE 2.1

Index

Loss
57

52

TREND OF BEARISH MARKET F 15th F 31st Suppose Nifty July futures has fallen to 1150 Squares off his position at 1150 Makes a profit of Rs. 14000 (200*70) feels the market will fall Sells 200 Nifties July Contract Nifty July contract is trading at 1220 His position is worth Rs. 244000 (200*1220)

PAYOFF INDEX FUTURES (SELLER)

Profit

0
FIGURE 2.2

1220 Index

Loss
53
59

FORWARD VS. FUTURES Features -Operational Mechanism -Contract Specifications -Counter party Risks -Liquidity -Price Discovery -Settlement Margin Forward Traded between two parties Differ from traded to trade Exists such risk Low Not Efficient At end of period No such margin Future Trade on Exchange Standardized Contracts No such risk High Highly Efficient Daily Margin required for trading

54

OPTIONS Options are fundamentally different from forward and futures. An option gives the holder/buyers of the option the right to do something. The holder does not have committed himself to doing something. In contrast, in a forward or futures contract, the two parties have committed them self to doing something. Whereas it nothing (except margin requirement) to enter in to a futures he purchases of an option require an up front payment. Historical background of Option: Although options have exercised for a long time, they were traded OTD, without much knowledge of valuation. Today exchange-traded options are actively traded on stocks, stock indices, foreign currencies and futures contracts. The first trading is options began in Europe and U.S. as early as the century. It was only in early, 1990s that a group of firms set up what is known as the put and call brokers and dealers association with the aim of providing a mechanism for bringing buyers and sellers together. It someone wanted to buy an option, he or she would contract one of the member firms. The firm would then attempt to find a seller or writer of option either from its own client of those of other member firms. If no seller could be found, the firm would undertake to write the option itself in return of price. The two deficiencies in above markets were 1. No secondary market 2. No mechanism to guarantee the writer of option would honor it In 1973, Black, Marton, Scholes invented the Black-Scholes formula. In April 1973, CBOE was set up specially for the purpose of trading options. The market for options develop so rapidly that by early 80s number of share underlying the What is Option ?

55

An options is the right, but not the obligation to buy to sell a specified amount (and quality) of a commodity, index or financial instruments a to buy of sell a specified number of underlying futures contracts, at a specified price on a before a give date in the future. Thus, option like futures, also provide a mechanism by which one can acquire a certain commodity on other assets, or take position in order to make profits or cover risk for a price. In this type of contract as well, there are two parties: a. The buyer (or the holder, or owner of options) b. The seller (or writer of options) While the buyer take long position the seller take short position So every option contract can either be call option or put option options are created by selling and buying and for every option that is buyer and seller. TYPES OF OPTION CONTRACTS

1. Index Options :- Index options are also financial exchange traded

contracts with the underlying assets as the index, whereby the buyer of the options acquire the right to buy or sell predefined quantity of the index for a consideration paid to the seller or the writer of the option. All option contracts are also standardized and the clearing house or the cooperation guarantees the performance of the contracts.

2. Stock Options :- These are the stock exchange traded contracts

whereby, buyer of the option gets the right to buy the contracts stocks for a consideration paid to the seller of the option. He does not have any obligation, but on the other hand the writer (seller) of the option is under the obligation to honour the contract since he has received the premium in lieu of the obligations. Stock options are similar to index options, but with a basic difference is that the underlying assets are individual 3. TYPES OF OPTIONS

56

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

Call Option (Buyer)

Why call option ? If u think market will rise Example .Buy a call with a strike of Rs .2340(NIFTY) at a premium of Rs. 50 Maximum Profit Potential : Unlimited. Maximum Risk Potential Break Even : Limited to Rs. 50 : Rs.2390

Pay off call option (Buyer)

2340 0 50 loss FIGURE 2.3 index

Call option (Seller)

57

Why sell Option : If u think market will remain neutral or slightly bearish . Example Sell a call with a strike price of Rs.2340(Nifty) at a premium of Rs.50 Maximum Profit Potential : Rs.50 Maximum Risk Potential : Unlimited Break Even : Rs. 2390 Desired Movement :Market will not go down

Seller call option

1250 loss

index

FIGURE 2.4

Put Option
58

It gives the holder the right to sell a specific quantity of underlying asses at an agreed price on date of maturity he gets the right to sell. Why Buy a Put Option (Buyer) If u think market will fall Example Buy a Put with a strike of Rs.2360(Nifty) at a premium of Rs.25 Maximum Profit Potential : Substantial Maximum Risk Potential. Break Even : 2335 Desired Movement : Bearish

Put Option Buyer Profit 0 2360 index

loss FIGURE 2.5

Put Option seller

59

Why Sell a Put Option If u think market will remain neutral or moderately bullish Example Sell a put with a strike of Rs.2360(Nifty) at a premium of Rs.50 Maximum Profit Potential : Rs 50 Maximum Risk Potential : Substantial Break Even : Rs. 2310 Desired Movement : Market will not go down

Pay off put option (seller)

profit

2360 index loss

FIGURE 2.6

OPTION TERMINOLOGY

60

1. Buyer of an option : The buyer of an option is the one who by paying the
option premium buys the right but not the obligation exercise his option on the seller/writer.

2. Writer of an option : The writer of a call/put option is the one who

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

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

4. Expiration date : The date specified in the options contract is known as

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

5. Strike Price : The price specified in the options contract is known as

strike price or the exercise price.

6. American options : these are the options that can be exercised at any
time upto the expiration date. Most exchange-traded options are Americans.

7. European options: These are the options that can be exercised only on
the expiration date itself. These are easier or analyze than American option, and properties of American options are frequently deducted from those of its European counterpart.

8. In the money option : An in the money option is an option that would

lead to a positive cash flow to the holder if it will exercise immediately. A call option in the index is set to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price>strike price). If the index is much higher than the strike price, the call is set to deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

9. At-money option : (ATM) option is an option that would lead to zero cash
flow if it were exercised immediately. An option on the index is at-themoney when the current index equals the strike price.

61

10. Out-of-the money option : (OTM) options is an option that would lead to
a negative cash flow it was exercised immediately. A call option on the index is OTM when the current index stands at a level, which is less than the strike price (spot price<strike price). If the index is much lower than the strike price, the call is set to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price. AMERICAN VS EUROPEAN OPTION Its owner can exercise an American option at any time on or before the expiration date. A European style option gives the owner the right to use the option only on expiration date and not before. Option Premium A glance at the rights and obligations of buyer and seller reveals that option contracts are skewed. One way naturally wonder as to why the seller (writer) of an option would always be obliged to sell/buy an asset whereas the other party gets the right. The answer is that writer of an option receives, a consideration for Undertaking the obligation. This is known as the price or premium to the seller for the option. The buyer pays the premium for the option to the seller shelter he exercise the option is not exercised, it becomes worthless and the premium becomes the profit of the seller.

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Factors Affecting Pricing 1. Supply and demand in Secondary market 2. Exercise price 3. Risk free interest rate 4. Volatility of underlying 5. Time to expiration 6. Dividend on underlying

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RISK MANAGEMENT NSCCL have developed a comprehensive risk containment mechanism for the F & O Segment. The salient features of risk containment mechanism of the F & O segment are : 1. The financial soundness of the members is the key to risk management. Therefore, the requirements for membership in term of capital adequacy (net worth, security deposits) are quite stringent. 2. NSCCL charges an upfront initial margin for all the open positions of a CM. It specifies the initial margin requirements for each futures/options contract on a daily basis. It also follows value-at-risk (VAR) based margining through SPAN. The CM in turn collects the initial margin form the TMs and their respective clients. 3. The open positions of the members are marked based on contract settlement price for each contract. The difference is settled in cash on T + 1 basis. 4. NSCCLs on-line position monitoring system monitors a CMs open positions on a real-time basis. Limits are set for each CM based on his capital deposits. The on-line position monitoring system generates alters whenever a CM reaches a position limit set up by NSCCL. NSCCL monitors the CMs for MTM value violation, while TMS are monitored for contract-wise position limit violation. 5. CMs are provided a trading terminal for the purpose of monitoring the open position of all the TMs clearing and setting through him. A CM may set exposure limits for a TM clearing and settling through him. NSCCL assists the Cm to monitor the intra-day exposure limits set up by a CM and whenever a TM exceed the limits, it stops that particular TM from further trading.

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6. A member is altered of his position to enable him to adjust his exposure or bring in additional capital. Position violates result in withdrawal of trading facility for all TMs a CM is case of violation by the CM. The most critical component of risk containment mechanism for F & O segment is the margining system and on-line position monitoring. The actual position monitoring and margining is carried out on-line through Parallel Risk Management System (PRISM). PRISM uses SPAN (r) (Standard Portfolio Analysis of risk) System for the purpose of computation of on-line margins, based on the parameters defined by SEBI. MINIMUM BASE CAPITAL A clearing Member (CM) is required to meet with the Base Minimum Capital (BMC) requirements prescribed by NSCCL before activation. The CM has also to ensure that BMC is maintained in accordance with the requirements of NSCCL at all points of time, after activation. Every CM is required to maintain BMC of Rs. 50 lakhs with NSCCL in the following manner : 1. Rs.25 lakhs in the form of cash. 2. Rs. 25 lakhs in any one form or combination of the below forms: Cash Fixed Deposit Receipts (FDRs) issued by approved banks and deposited with approved Custodians or NSCCL. Bank Guarantee in favour of NSCCL from approved banks in the specified format. Approved securities in demat form deposited with approved Custodians. Any failure on the part of a CM to meet with the BMC requirements

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at any point of time, will be treated as a violation of the Rules, Bye-Laws and Regulations of NSCCL and would attract disciplinary action inter-alia including, withdrawal of trading facility and /or clearing facility, closing out of outstanding positions etc. Additional Base Capital Clearing members may provide additional margin/collateral deposit (additional base capital) to NSCCL and/or may wish to retain deposits and/or such amounts which are receivable from NSCCL, over and above their minimum deposit requirements, towards initial margin and / or other obligations.

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MARGINS NSCCL has developed a comprehensive risk containment mechanism for the Futures & Options segment. The most critical component of a risk containment mechanism for NSCCL is the online position monitoring and margining system. The actual margining and position monitoring is done on-line, on an intra-day basis. NSCCL uses the SPAN (Standard Portfolio Analysis of Risk) system for the purpose of margining, which is a portfolio-based system. Initial Margin NSCCL collects initial margin up-front for all open positions of a CM based on the margins computed by NSCCL-SPAN. A CM is in turn required to collect the initial margin from the TMs and his respective clients. Similarly, a TM should collect upfront margins from his clients. Initial margin requirements are based on 99% value at risk over a one day time horizon. However, in the case of futures contracts (on index or individual securities), where it may not be possible to collect mark to market settlement value, before the commencement of trading on the next day, the initial margin may be computed over a two-day time horizon, applying the appropriate statistical formula. The methodology for computations of Value at Risk percentage is as per the recommendations of SEBI from time to time.

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Initial margin requirement for a member: For client positions shall be netted at the level of individual client and grossed across all clients, at the Trading/Clearing Member level, without any setoffs between clients. For proprietary positions shall be netted at Trading/Clearing Member level without any setoffs between client and proprietary positions. For the purpose of SPAN Margin, various parameters are specified from time to time. In case a trading member wishes to take additional trading positions his CM is required to provide Additional Base Capital (ABC) to NSCL. ABC can be provided by the members in the form of Cash, Bank Guarantee, Fixed Deposit Receipts and approved securities. Premium Margin In Addition to Initial Margin, Premium Margin would be charged to members. The premium margin is the client wise margin amount payable for the day and will be required to be paid by the buyer till the premium settlement is complete. Payment of Margins The initial margin is payable upfront by Clearing Members. Initial margins can be paid by members in the form of Cash, Bank Guarantee, Fixed Deposit Receipts and approved securities. Non-fulfillment of either the whole or part of the margin obligations will be treated as a violation of the Rules, Bye-Laws and Regulations of NSCCL and will attract

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penal charges @ 0.09% per day of the amount not paid throughout the period of non-payment. In addition NSCCL may at its discretion and without any further notice to the clearing member, initiate other disciplinary action, inter-alia including, withdrawal of trading facilities and / or clearing facility closing out of outstanding positions, imposing penalties, collecting appropriate deposits, invoking bank guarantees / fixed deposit receipts etc DERIVATIVES TRADING IN INDIA

The first step towards introduction of derivatives trading in India was the promulgation of the securities laws (amendment) ordinance, 1995 which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 members committee under the Chairmanship of Dr. L.C. Gupta on 18th November, 1996 top develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on 17th March, 1998 prescribing necessary pre-conditions for introduction of derivatives trading in India. The committee recommended that derivatives should be declared as securities so that regulatory framework applicable to trading of securities could also govern trading of securities. SEBI also set up a group in June 1998 under the Chairmanship of Prof. J.R. Varma, to recommend measures for risk containment in derivatives market in India. The report, which was submitted in October, 1998, worked out the operational details of margining system, methodology for changing initial margins, broker net worth, deposit requirement and real time monitoring requirements. The SCRA was amended in Dec, 1999 to include derivatives within the ambit of securities and the regulatory framework was developed for governing derivatives trading.

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Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2000. SEBI permitted the derivative segments of two stock exchanges. NSE and BE, and their clearing house/corporation to commence trading and settlement in approved derivatives contracts. To begin with, SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval, for trading in options based on these two indexes and options on individual securities. The trading in index options commenced in June 2001. Futures contracts on individual stocks were launched in November 2001. Trading and Settlement in derivatives contracts is done in accordance with the rule, bye-laws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. Thus, the following four types of Derivatives are now being traded in the India Stock Market. Index Futures Index Options Stocks Future Stock Options

Index Futures : Index futures are financial contracts for which the underlying is the cash market index like the Sensex, which is the brand index of India. Index futures contract is an agreement to buy or sell a specified quantity of underlying index for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day, tick size and method of settlement.

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Index Options : Index Options are financial contracts whereby the right is given by the option seller in consideration of a premium to the option buyer to buy or sell the underlying index at a specific price (strike price) on or before a specific date (expiry date). Stock Futures : Stock Futures are financial contracts where the underlying asset is an individual stock. Stock futures contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. Just like Index derivatives, the specifications are pre-specified. Stock Options : Stock Options are instruments whereby the right of purchase and sale is given by the option seller in consideration of a premium to the option buyer to buy or sell the underlying stock at a specific price (strike price) on or before a specific date (expiry date). OPERATIONAL MECHANISM OF DERIVATIVES

1. Registration with broker :

The first step towards trading in the

derivatives market is selection of a proper broker with whom the investor would trade. Investors should complete all the registration formalities with the broker before commencement of trading in the derivatives market. The investors should also ensure to deal with a broker (member of the exchange) who is a SEBI registered broker and possesses a SEBI registration certificate.

2. Client Agreement : The investor should sign the Client Agreement with
the broker before the broker can place any order on his behalf. The client agreement includes provisions specified by SEBI and the derivatives segment.

3. Unique Client Identification Number : After signing the client

agreement, the investors gets a unique identification number (ID). The 71

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

4. Risk Disclosure Documents : As stipulated in the Bye-Laws provide his

particulars to the investors. The particulars would include his SEBI registration number, the name of the employees who would be primarily responsible for the clients affairs, the precise nature of his liability towards the client in respect of the business done on behalf of the investor. The broker must also apprise the investor about the risk associated with the business in derivative trading and the extent of his liability. This information forms part of the Risk Disclosure document, which the broker issues to the client. The investor should carefully read the risk disclosure document and understand the risks involved in the derivatives trading before committing any position in the market. The risk disclosure document has to be sign3ed by the client and a copy of the same is retained by the broker for his records.

5. Free Copy of Relevant Regulations : The client is also entitled to a free

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

6. Placing order with the broker : The investor should place orders only
after understanding the monetary implications in the event of execution of the trade. After the trade is executed, the investor can request for a copy of the trade confirmation slip generated on the systems on execution of the trade. The investor should also obtain from the broker, a contract note for the trade executed within 24 hours. The contract note should be time (order receipt and order execution) and price stamped. Execution prices, 72

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

7. Margining System in Derivatives : The aim of margin money is to

minimize the risk of default by either counter-party. The payment of margin ensures that the risk is limited to the previous days price movement on each outstanding position. The different types of margins are:

a) Initial Margin : The basic aim of initial margin is to cover the

largest potential loss in one day. Both buyer and seller have to deposited before the opening of the position in the futures transaction. This margin is calculated by SPAN by considering the worst case scenarion.

b) Mark to market margin : All daily losses must be met by

depositing of further collateral-known as variation margin, which is required by the close of business, the following day. Any profits on the contract are credited to the clients variation margin account.

8. Investors Protection Fund: The derivatives segment has established an

Investors Protection Fund which is independent of the cash segment to protect the interest of the investors in the derivatives market.

9. Arbitration : In case of any dispute between the members and the clients
arising out of the trading or in relation to trading/settlement, the party thereto shall resolve such complaint, dispute by arbitrations procedure as defined in the rules and regulations and Bye-Laws of the respective exchanges.

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REGULATORY FRAMEWORK The trading of derivatives is governed by the provisions contained in the SC (R) A, the SEBI Act, the rules and regulations framed there under and the rules and bye-laws of stock-exchanges. Securities contracts (Regulation) Act, 1956 SC(R) A aims at preventing undesiarable transactions in securities by regulating the business of dealing therein and by providing for certain other matters connected therewith. This is the principal Act, which governs the trading of securities in India. The term securities has been defined in the SC(R)A. As per Section 2(h), the Securities include: 1. Shares, scrips, stock, bonds, debentures, stock or other marketable securities of a like nature in or of any incorporated company or other body corporate. 2. Derivative 3. Units or any other instrument issued by any collective investment scheme to the investors in such schemes. 4. Government securities. 5. Such other instruments as may be declared by the Central Government to be securities. 6. Rights or interests in securities Derivative is defined to includes: A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract differences or any other form of security. A contract which derives its value from the prices, or index of price, of underlying securities.

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Section 18A provides that notwithstanding anything contained in any other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are: Traded on a recognized stock exchange. Settled on the clearing house of the recognized stock exchange, in accordance with the rules and bye-laws of such stock exchanges.

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RESEARCH METHODOLOGY

Research is a procedure of logical and systematic application of the fundamentals of science to the general and overall questions of a study and scientific technique by which provide precise tools, specific procedures and technical, rather than philosophical means for getting and ordering the data prior to their logical analysis and manipulations. Different type of research design is available depending upon the nature of research project, availability of able manpower and circumstances. The study about ANALYSIS OF DERIVATIVES MARKET is exploratory as well as descriptive in nature .Discussion with experts, internet surfing, and journals were studied to explore more about the concerned objective and better understanding of the problem. After that questionnaire was prepared to meet the desired objective

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Sources of Data: The source of data includes primary and secondary data sources.

Primary Sources Primary data is data collected for first time specially for the

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

Secondary Sources The secondary data is data, which is collected and compiled for the different purpose, which are used in research for this study. The secondary data include material collected from: Newspaper Magazine. Internet.

Data Collection Instruments The various methods of data gathering involves the use of appropriate recording forms. These are called tools or instruments of data collection. Data was collected through structured questionnaire administered by sitting with guide and discussing problems Sampling Technique The small representative selected out of large population is selected at random is called sample. Well-selected sample may reflect fairly, accurately the characteristic of population. The chief aim of sampling is to make an inference about unknown parameters from a measurable sample statistics.

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Sampling technique used was Snowball sampling was used for the purpose of data collection as reference was taken form sample to reach other sample.

Sample Size : Sample size refers to the number of items to be selected from the universe to constitute a sample. Due to constraints of cost and time, the sample size selected for the research is 25 investors and 35 brokers

Sampling Unit : The sampling unit was the person who had an account and was investing in stock market and broker who were trading in stock market .

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LIMITATIONS OF THE STUDY No study is complete in itself, however, good it may and every study has some limitations: Time is the main constraint of my study. Availability of information was not sufficient because of less awareness among investors / brokers. Sample size is not enough to have a clear opinion.

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81

1.

TRADING PERIOD IN DERIVATIVES

25 20 No.of brokers 15 and investors 10 5 0 Less than 1 year 1 year 2 years 3 years More than 3 years Series1

PERIOD

FIGURE 4.1 From my sample of 60, 13 (22%) brokers and investors investing in derivatives from the last 1 year and less than this. 21 (35%) are investing from last 2 years, 7 (11%) are investing from last 3 years and only 6 (10%) have experience of more than 3 years of investment in derivatives.

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2.

REASONS BEHIND ITS ADOPTION

purpose

liquidity hedging 12% 25% speculation 40%

risk management 23%

Reasons behind adoption of derivatives are different by brokers, investors and dealers e.g. liquidity, risk management hedging, investor demand (speculation) etc. Out of 60 brokers, investors dealing in derivatives 14 (23%) adopt it due to characteristics of risk management, 15 (25%) due to hedging, 24 (40%) for speculation and remaining 7 (12%) due to liquidity.

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3. In which segment you have larger turnover? Capital Market Segment (20) F & O Segment. Equal in both above (15) Cant Say.

segment having large turnover

6 17%

4 11% 17 49% CM SEGMENT EQUAL IN F&O & CM F& O Segment 8 23% Can't Say

FIGURE 4.3 Out of 35 informants, 17 have largest turnover in the capital segment i.e. 49% and 23% have equal turnover in CM & F&O segment. No informants have its largest turnover in F & O segment because the investor are very less aware about the derivatives and they do not know about the derivative trading as they much know about the CM Segment.

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4. INVESTED AMOUNT IN DERIVATIVES

Amout invested in derivatives

30 25 20 No. of brokers 15 and investors 10 5 0 2 LACS 2 LACS - 5 LACS - Any Other 5 LACS 10 LACS Amount 15 9 9 Series1 27

FIGURE 4.4 Out of my sample size 60, 27 (45%) investors and brokers have invested 2 lacs normally, 9 (15%) invested between 2 lacs to 5 Lacs and 15 (25%) invested between 5 lacs to 10 lacs, and remaining have invested in other amounts. Reasons behind this is that those are investing from many years are taking the risk of investing huge amount.

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86

TRADED PERIOD IN DERIVATIVES

Traded period for Derivative Investment

25 20 No. of brokers 15 and investors 10 5 0 Weekly Monthly More than 1 month More than 2 months Series1

Traded Period

FIGURE 4.5 13 (22% investors and brokers are investing weekly in derivatives, 23 (38%) investing monthly, 19 (32%) investing after more than 1 month and only 5 (8%) investing too late after 2 months.

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IMPACT ON CUSTOMER BASE

25 20 15 No. of brokers 10 5 0 Increase Decrease Impact Remain same Series1

FIGURE 4.6 Out of 35 brokers , 3 (5%) of brokers said that it does not increase their customer base because introducing small savings as investment, but derivatives increase customer base of 24 (70%) which is more than half. It is basically beneficial for those who are investing from last 2 or more years. In investment sector need minimum of Rs. 2,00,000 as investment so it is basically for corporate and investment sector only not for small investors. 8 (25%) said their customer base

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

7. RELATIONSHIP WITH CASH MARKET

30 25 20 No of brokers 15 and investors 10 5 0 Positive Negative Relation Can't Say Series1

FIGURE 4.7 Out of 60 brokers, investors 27 (45%) have the positive response towards the relation between derivative and cash market and remaining 5 (8%) has negative response. 28 (47%) are not able to say anything because they do not have proper knowledge about stock market. They are investing with the guidance of

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

8. DERIVATIVES AND RISK Every broker says that there is a risk factor (upto some extent in derivatives also. SHORTCOMINGS IN INDIAN DERIVATIVE SYSTEM

Short coming in indian derivative system

35 30 25 No. of brokers 20 and investors 15 10 5 0 31

27

2 domestic lack of technical awareness expertise in investors short comings market failure

Series3

FIGURE 4.9

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27 (45%) brokers, investors respond towards shortage of domestic technical expertise. 31 (52%) feel lack of awareness in investors about derivatives and remaining 2 (3%) market failure.

9.. Which tool of derivative according to you is better? a) b) Index future Stock future Index option Stock option

c)
d)

7 12%

8 13% Index Future Stock Future 30 50% 15 25% Index Option Stock Option

FIGURE 4.10

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I got mix view on this question. But most of the informants i.e. 50% are in the favour of index future and rests are having some different different attraction .

RESULTS / FINDINGS Brokers not dealing in derivatives at present are also not going to adopt it in futures. Hedging and Risk Management is the most important feature of derivatives? It is not for small investors. It ahs increased brokers turnovers as well as helpful in aggregate investment. Brokers havent adequate knowledge about options, so most of them are dealing in futures only. There is a risk factor in derivative also. Most of the investors are not investing in derivatives. People are not aware of derivatives, even people who have invested in it, has not adequate knowledge about it. tool of risk management. They normally invest in future contracts. They are investing in future contract, because futures have up to some extent quality at Badla. These people are interested to take it in their future portfolio also. They consider it as a

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REASONS BEHIND LESS DEVELOPMENT OF F & O SEGMENT . Securities and contracts regulations act has recognized index as a security very later i.e. in Nov. 2001. It will take time to take position in derivative or capital market. The Limited mutual faith in the parties involved. It hasnt a legalized market. Commodity F & O Market has not yet been come to India. This will make easy to understand and take simple investor under investor base of derivative trading. Market failures Scandals. Inadequate infrastructures. Shortage to domestic technical expertise, in India even most of the people are not aware of concept derivatives. Large lot size, so small investors are not able to come under derivative segment. There are less scripts under derivatives segment. High margin as compared to Badla. In India there cannot be a long term trading in F & O, it is only for 1 to 2 or maximum for 3 months.

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SUGGESTIONS 1. LOT SIZE: Lot size should be reduced so that the major segment of an Indian society i.e. small saving class can come under F & O trading. There is strong need for revision of lot sizes as the lot sizes of some of the individual scrips that were worth of Rs. 200000 in starting, now same lot size amount to a much larger value. 2. SUB BROKERS Sub-broker concept should be added and the actual brokers should give all rights of brokers in F & O segment also. 3. SCRIPS: More scrips of reputed companies etc. should be introduced in F & O Segment. 4. TRADING PERIOD Trading period should be increased.

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5.

TRAINING CLASSES OR SEMINARS There should be proper classes on derivatives for investors,

traders, brokers, students and employees of stock exchanges. Because lack of knowledge is the main reason of its less development. The first step towards it should be seminars provided to brokers and LSE employees and secondly seminar to students.

CONCLUSION On the basis of overall study on derivatives it was found that derivative products initially emerged as hedging devices against fluctuation and commodity prices and commodity linked derivatives remained the soul form of such products. The financial derivatives came in spotlight in 1972 due o growing instability in financial market. I was really surprised to see during my study that a layman or a simple investor does not even know how to hedge and how to reduce risk on his portfolios. All these activities are generally performed by big individual investors, mutual funds etc. No doubt that derivative growth towards the progress of economy is positive. But the problem confronting the derivative market segment are giving it a low customer base. The main problem that it confronts are unawareness and bit lot sizes etc. these problems could be overcome easily by revising lot sizes and also there should be seminar and general discussions on derivatives at varied places.

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We view them as time bombs both for the parties that deal in them and the economic system. In our view derivatives are financial weapons of mass destruction (WMD), carrying dangers that, while now latent, are potentially lethal. Warren Buffet.

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BIBLIOGRAPHY BOOKS NCFM on derivatives core modules by NSEIL. H.S.SIDHU Indian Capital Market 1996, 1st Edition The Indian Commodity-Derivatives Market in Operations. Indian Securities Market A Review.

MAGAZINES & NEWSPAPER: NSE News. ECONOMICS TIME

INTERNET SITES: pdf www.nseindia.com - historical data business growth. www.bseindia.com www.derivativesindia.com Derivatives in India: Frequently Asked Questions, http://www.mayin.org/ajayshah/PDFDOCS/ShahThomas2000_dfq.

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QUESTIONNAIRE Dear Respondent, I am a student of MBA . I am working on the project STUDY OF DERIVATIVES . You are requested to fill in the questionnaire to enable, to undertake the study on the said project

NAME: OCCUPATION: ADDRESS: PHONE NO:

1)

For how long you have been trading on derivatives? a) Less than 1 year b) 1 Year 99

c) 2 Year

d) 3 year

e) More than 3 year.

2)

What is your purpose for trading in derivatives? a) c) Hedging Risk Management b) d) Speculation Liquidity

3)

. In which segment you have larger turnover ? (BROKERS ONLY) a ) Capital Market Segment b) F & O Segment.

c) Equal in both above d) Cant Say.

4)

What is amount of money you are investing in normally? a) 2, 00,000 b) 2, 00,000 to Rs. 5, 00,000 c) Rs. 5, 00,000 to Rs. 10, 00,000 d) Any other amount______________

5)

How often do you trade? 100

a) Weekly

b) Monthly

c) More than 1 month

d) More than 2 month

6) What is your customer base with introduction of derivatives? (FOR BROKERS) a) Increase b) Decrease c) Remains same.

7)

What according to you is relationship between derivative market and cash market? a) Positive b) Negative c) Cant say.

8)

What shortcomings do you feel in Indian derivative market? a) Lack of awareness among the investors about derivatives. b) Shortage of domestic technical expertise. c) If any other ___________________________

9)

. Which tool of derivative according to you is better? a) Index future b) Stock future c) Index option

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d) Stock option

10)

What suggestions do you want to make with regard to investors education in derivatives market in India?

_____________________________________________________________ _____________________________________________________________

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