ABSTRACT

A Derivative is a financial instrument that derives its value from an underlying asset. Derivative is an financial contract whose price/value is dependent upon price of one or more basic underlying asset, these contracts are legally binding agreements made on trading screens of stock exchanges to buy or sell an asset in the future. The most commonly used derivatives contracts are forwards, futures and options, which we shall discuss in detail later. Futures: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Forwards: A forward contract is a customized contract between two entities, where Settlement takes place on specific date in the future at todays pre-agreed Price. Options: Options are of two types 1) Call option 2) Put option The main objective of the study is to analyze the derivatives market in India and to analyze the operations of futures and options. Analysis is to evaluate the profit/loss position futures and options. Derivatives market is an innovation to cash market. Approximately its daily turnover reaches to the equal stage of cash market In cash market the profit/loss of the investor depends on the market price of the underlying asset. Derivatives are mostly used for hedging purpose. In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option.

TABLE OF CONTENTS

Chapters

Contents

Page no
RESEARCH 03-07

1.

INTRODUCTION METHODOLOGY

&

2.

REVIEW OF LITERATURE

08-14

3.

INDUSTRY & COMPANY PROFILE

15-31

4.

CONCEPTUAL FRAME WORK

32-48

5.

DATA ANALYSIS & INTERPRETATION

49-58

6.

CONCLUSIONS
Observations & Findings Suggestions Conclusions Bibliography

59-63

LIST OF TABLES
Serial n.o
1 2

Table n.o
3.1 4.1

Details
Journey of kotak Mahindra . Distinction between futures & forwards.

Page n.o
22 43

4.2

Differences between futures & options.

48

4 5 6

5.1 5.2 5.3

Kotak stock futures & options. Analysis of future price. Data of kotak futures & options of Apr-June 2013

50 54 57

LIST OF FIGURES
Serial n.o
1 2 3 4 5

Figure n.o
3.1 3.2 4.1 5.1 5.2

Details
Corporate hierarchy Kotak Mahindra group structure Types of Derivatives Analysis of future price Data of kotak futures & options of Apr - June 2013

Page n.o
24 25 39 55 58

INTRODUCTION
A STUDY ON DERIVATIVES:
The only stock exchanges operating in the 19 the century were those of Bombay set up in 1875 and Ahmadabad set up in 1894. These were organized as voluntary nonprofit-making association of brokers to regulate and protect their interests. Before the control on securities trading became a central subject under the constitution in 1950, it was a state subject and the Bombay securities contracts (control) Act of 1925 used to regulate trading in securities. Under this Act, The Bombay stock exchange was recognized in 1927 and Ahmadabad in 1937. During the war boom, a number of stock exchanges were organized even in Bombay, Ahmadabad and other centers, but they were not recognized. Soon after it became a central subject, central legislation was proposed and a committee headed by A.D.Gorwala went into the bill for securities regulation. On the basis of the committee's recommendations and public discussion, the securities contracts (regulation) Act became law in 1956. The emergence of the market for derivatives products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest, etc. Derivatives are used by banks, securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profits Derivatives are likely to grow even at a faster rate in future they are first of all cheaper to world have met the increasing volume of products tailored to the needs of particular customers,
4

trading in derivatives has increased even in the over the counter markets. In Britain unit trusts allowed to invest in futures & options .The capital adequacy norms for banks in the European Economic Community demand less capital to hedge or speculate through derivatives than to carry underlying assets. Derivatives are weighted lightly than other assets that appear on bank balance sheets. The size of these off-balance sheet assets that include derivatives is more than seven times as large as balance sheet items at some American banks causing concern to regulators

OBJECTIVES OF THE STUDY:

1. To find the profit/loss position of futures buyer and also the option writer and option holder. 2. To study the role of derivatives in Indian financial market.
3. To study about risk management with the help of derivatives.

LIMITATIONS OF THE STUDY:

Limit is fence which comes everywhere it has been found in my project also, where some of them could not be ignored. Time constraint. The study is not based on international perspective derivatives markets. Non-availability of data. The data collected is completely restricted to the M/s. KOTAK STOCK BROCKING LTD of APRIL 2013

SCOPE OF THE STUDY:

The study is limited to Derivatives with special reference to futures and options in the Indian context; the study is not based on the international perspective of derivative markets. The study is limited to the analysis made for types of instruments of derivates each strategy is analyzed according to its risk and return characteristics and derivatives performance against the profit and policies of the company.

SIGNIFICANCE OF THE STUDY:

The symbol of Kotak Mahindra Bank represents the vision and operations very precisely where infinite ka reflects our global Indian personality. The ka is uniquely Indian while its curve forms the infinite sign, which is universal. One of the basic tenants of economics is that mans needs are unlimited. The infinite ka symbolizes that we have an infinite number of ways to meet those needs. Kotak Securities is a subsidiary of Kotak Mahindra Bank, Originally established in 1994, which services more than 7.4 lakh customers. The firm has a wide network of more than 1400 branches, franchisees representative offices, and satellite offices across 448 cities in India and offices in New York, London, Dubai, Mauritius and Singapore. The company is a corporate member of both The Bombay Stock Exchange (BSE) and The National Stock Exchange of India (NSE). Its operations include stock broking services for trading in stock markets through branches & internet and distribution of various financial products including investments in IPOs, Mutual Funds and Currency Derivatives. Currently, Kotak Securities is one of the largest broking houses in India with substantial geographical reach to Asia Pacific, Europe, Middle East and America.

RESEARCH METHODOLOGY:
A system of collecting data for research projects is known as research methodology. The data may be collected for either theoretical or practical research. Research methodology is a way to systematically solve the research problem. It may be understood as a science of studying how research is done scientifically. In it we study the various steps that are generally adopted by a researcher in studying his research problem along with the logic behind them.

RESEARCH DESIGN:
Task of defining the research problem is the preparation of the research project, popularly known as the research design. Decisions regarding what, where, when, how much, by what means concerning an inquiry or a research study constitute a research design.
6

A research design is the arrangement of conditions for collection and analysis of data in a manner that aims to combine relevance to the research purpose with economy in procedure.

DATA COLLECTION:
The data used in the study was collected from primary and secondary sources:

PRIMARY DATA:
Primary data consists of financial data collected from kotak Mahindra bank.

SECONDARY DATA:
Secondary data was collected from: Derivatives Dealers Module Work bookNCFM Business World www.derivativesindia.com www.google.com

Many authors have done their research on Derivatives (futures & options) to encourage the investors to invest on derivatives market, and many of them gave valuable suggestions & conclusions on derivatives futures & options to minimize risk and to maximize profitability on derivatives. Some of their findings are listed below:

Author Names:

Mohammad Osman Abdul Qadeer. Konstantinos Tolikas, Searat Ali.

Paper title:

Use of derivatives in risk management

Year:

Mar 14, 2012

FINDINGS:
Due to the increased globalization among economies of the world, corporations use derivatives in order to minimize their exposure to the uncertainty caused by recent economic and financial crunch. The development of option pricing model by Black and Scholes (1973) and Merton (1973) made possible for derivatives market to turn out to be a significant instrument in risk management. The use of derivatives has increased dramatically over the past two decades despite of severe loses faced by corporations. This paper emphasis on the most significant rationales over derivative usage among corporations, i.e. why firms use derivatives, its comparison and contrast among developed and developing economies and factors stimulating firms to use derivatives.

Author Names:

Andrew Kumiega, Thaddeus Neururer, and Ben Van Vliet

Paper title: Year: FINDINGS:

Factor extraction & multi asset derivative pricing 2012

This article presents a different approach to modeling the return dynamics for a portfolio. The component stocks are all assumed to be exposed to shocks from a small number of independent factors, each of which follows a Heston-type square root diffusion process. To illustrate the model, the authors construct a portfolio of the three biotech stocks that have the largest weightings among the twelve stocks in the BBH ETF portfolio, assuming there are only two independent factors. The estimated variance equations show that the more important factor, Factor 1, has high volatility and is rapidly mean reverting, while Factor 2 reverts more slowly and steadily toward a low value. Theoretical values for options on the three-stock portfolio obtained by simulation should be approximately the same as traded option contracts on the BBH index. The fitted volatility smiles under the model are similar to those observed for BBH, but with some notable discrepancies.

Author Names: Paper title: Year: FINDINGS:

Sebastijan Hrovatin, Mattias Levin, Mario Nava, Fabrizio Planta, Peer Ritter Derivatives in crisis: Policy choices for Europe 2009

Derivatives are a tool to share risks in the economy and can thus provide a benefit to the economy. The financial crisis has demonstrated that they can also pose significant risks to financial stability. These are related to the exponential growth in derivatives over the last decade, increasing leverage and interconnectedness of financial institutions. This went largely unnoticed by markets and prudential supervisors, because derivative markets are predominantly organized in bilateral a relationship, which makes them in transparent. The article discusses policy tools to remedy the

10

flaws in derivative markets, taking inspiration from a recent communication by the European Commission.

Author Names: Paper title:

Narender.L.Ahuja Commodity derivatives market in India:

Development, Regulation & future prospects Year: 2006

FINDINGS:
Organized commodity derivatives in India started as early as 1875, barely about a decade after they started in Chicago. However, many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the markets for the underlying commodities. As a result, after independence, commodity options trading and cash settlement of commodity futures were banned in 1952. A further blow came in 1960s when, following several years of severe draughts that forced many farmers to default on forward contracts (and even caused some suicides), forward trading was banned in many commodities considered primary or essential. Consequently, the commodities derivative markets dismantled and remained dormant for about four decades until the new millennium when the Government, in a complete change in policy, started actively encouraging the commodity derivatives market. Since 2002, the commodities futures market in India has experienced an unprecedented boom in terms of the number of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which might cross the $ 1 Trillion mark in 2006. However, there are several impediments to be overcome and issues to be decided for sustainable development of the market.

11

Author Names: Paper title:

Bose Suchismita The Indian derivatives market revisited

Year:

2006

FINDINGS:
Derivatives products provide certain important economic benefits such as risk management or redistribution of risk away from risk-averse investors towards those more willing and able to bear risk. Derivatives also help price discovery, i.e. the process of determining the price level for any asset based on supply and demand.

These functions of derivatives help in efficient capital allocation in the economy; at the same time their misuse also poses a threat to the stability of the financial sector and the overall economy. In the mid-1990s India started reviving the exchange traded commodity derivatives market and introduced a variety of instruments in the foreign exchange derivatives market, while exchange traded financial derivatives were introduced in 2001.

Given India's experience in informal derivatives trading, the exchange traded derivatives were quick to pick up substantial volumes. This paper presents accounts of the major developments in the Indian commodity, exchange rate and financial derivatives markets, and outlines the regulatory provisions that have been introduced to minimize misuse of derivatives.

12

Author Names: Paper title: Year: FINDINGS:

Riddhi Kapadia A Study on Derivatives Market in India: Current Scenario and Future Trends. 2006

The derivative market has become multi-trillion dollar markets over the years. Derivatives are financial commitments indexed or linked in some capacity to changes in the value of underlying assets. The bulk of the derivatives trading internationally are linked to currencies and interest rates, other derivatives are linked to equity or equity indices. A very small volume of derivatives, compared to the total, is indexed to traditional commodities. Small by comparison to other derivatives markets, these commodities-indexed derivatives markets are large compared to the underlying physical commodity markets.

Author Names: Paper title:

ReneM.Stulz Should we fear Derivatives? (journal of economic perspectives)

Year: FINDINGS:

Nov 3,2004

Derivatives allow firms and individuals to hedge risks and to take risks efficiently. They also can create risk at the firm level, especially if a firm uses derivatives episodically and is inexperienced in their use. For the economy as a whole, a collapse of a large derivatives user or dealer may create systemic risks. On balance, Derivatives help make the economy more efficient. However, neither users of derivatives nor regulators can be complacent. Firms have to make sure that derivatives are used properly. So should we fear derivatives? The answer is no. We should have a healthy respect for them. We do not fear planes because they may crash and do not refuse to board them because of that risk. Instead, we make sure that planes are as safe as it makes economic sense for them to be. The same applies to derivatives. Typically, the losses from derivatives are localized, but the whole economy gains from the existence of derivatives markets.
13

Author Names: Paper title: Year: FINDINGS:

Robert H.Michel Inositol derivatives: evolution and functions 2004

Current research on inositols mainly focuses on myo-inositol derivatives in eukaryotic cells, and in particular on the many roles of Ins phospholipids and polyphosphorylated Ins derivatives. However, inositols and their derivatives are more versatile than this they have acquired diverse functions over the course of evolution. Given the central involvement of primordial bacteria and archaea in the emergence of eukaryotes, what is the status of inositol derivatives in these groups of organisms, and how might inositol, inositol lipids and inositol phosphates have become ubiquitous constituents of eukaryotes? And how, later, might the multifarious functions of inositol derivatives have emerged during eukaryote diversification.

Author Names: Paper title: Year: FINDINGS:

Simon Gray and Joanna Place Financial Derivatives 1999

Derivatives, ranging from relatively simple forward contracts to complicated options products, are an increasingly important feature of financial markets worldwide. They are already being used in many emerging markets, and as the financial sector becomes deeper and more stable, their use is certain to grow. This Handbook provides a basic guide to the different types of derivatives traded, including the pricing and valuation of the products, and accounting and statistical treatment. Also, it aims to highlight the main areas in which derivatives matter to central banks, notably those of monetary policy and banking supervision. It is not intended as a manual for traders, nor to describe in depth the current state of world markets, where changes can happen so rapidly that any description must soon become outdated. But we do hope to provide a clear enough description of derivatives and their relevance to central banks for central bankers to be confident in tackling the issues that arise. Most derivatives traded are, in fact, fairly simple, and well within the grasp of our intended readership. This handbook is also available in Spanish.

14

15

INDUSTRY PROFILE.
GLOBAL DERIVATIVES MARKET:
The global financial centers such as Chicago, New York, Tokyo and London dominate the trading in derivatives. Some of the worlds leading exchanges for the exchange-traded derivatives are: Chicago Mercantile Exchange (CME) & London International financial Futures Exchange (LIFFE) (for currency & Interest rate futures) Philadelphia Stock Exchange (PSE), London stock Exchange (LSE) & Chicago Board options exchange (CBOE) (for currency options) New York Stock Exchange (NYSE) and London Stock Exchange (LSE) (for equity derivatives) Chicago Mercantile Exchange (CME) and London Metal Exchange (LME) for commodities. These exchanges account for a large portion of the trading volume in the respective derivatives segment.

DEFINITION OF STOCK EXCHANGE:

"Stock exchange means anybody or individuals whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities. "An association, organization or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities." It is an association of member brokers for the purpose of self-regulation and protecting the interests of its members. It can operate only if it is recognized by the Government under the securities contracts (regulation) Act, 1956. The recognition is granted under section 3 of the Act by the central government, Ministry of Finance.

16

SECURITIES & EXCHANGE BOARD OF INDIA (SEBI):

SEBI was set up as an autonomous regulatory authority by the Government of India in 1988 " to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto." It is empowered by two acts namely the SEBI Act, 1992 and the securities contract (regulation) Act, 1956 to perform the function of protecting investor's rights and regulating the capital markets.

BOMBAY STOCK EXCHANGE (BSE):

The first and largest securities market in India, the Bombay Stock Exchange (BSE) was established in 1875 as the Native Share and Stock Brokers' Association. Based in Mumbai, India, the BSE lists over 6,000 companies and is one of the largest exchanges in the world. The BSE has helped develop the country's capital markets, including the retail debt market, and helped grow the Indian corporate sector. This stock exchange, Mumbai, popularly known as "BSE" was established in 1875 as The Native share and stock brokers association", as a voluntary non-profit making association. It has an evolved over the years into its present status as the premiere stock exchange in the country. It may be noted that the stock exchanges the oldest one in Asia, even older than the Tokyo Stock exchange which was founded in 1878. The exchange, while providing an efficient and transparent market for trading in securities, upholds the interests of the investors and ensures redressed of their grievances, whether against the companies or its own member brokers. It also strives to educate and enlighten the investors by making available necessary informative inputs and conducting investor education programmes. A governing board comprising of 9 elected directors, 2 SEBI nominees, 7 public representatives and an executive director is the apex body, which decides the policies and regulates the affairs of the exchange.

The Executive director as the chief executive officer is responsible for the day today administration of the exchange. The average daily turnover of the exchange during the year 2012 June was Rs 732483.15 crores

17

BSE INDICES:
In order to enable the market participants, analysts etc., to track the various ups and downs in the Indian stock market, the Exchange has introduced in 1986 an equity stock index called BSE-SENSEX that subsequently became the barometer of the moments of the share prices in the Indian stock market. It is a "Market capitalizationweighted" index of 30 component stocks representing a sample of large, wellestablished and leading companies.

The base year of Sensex is 1978-79. The Sensex is widely reported in both domestic and international markets through print as well as electronic media. Sensex is calculated using a market capitalization weighted method. As per this methodology, the level of the index reflects the total market value of all 30component stocks from different industries related to particular base period. The total market value of a company is determined by multiplying the price of its stock by the number of shares outstanding. Statisticians call an index of a set of combined variables (such as price and number of shares) a composite Index. An Indexed number is used to represent the results of this calculation in order to make the value easier to work with and track over a time. It is much easier to graph a chart based on Indexed values than one based on actual values world over majority of the well-known Indices are constructed using Market capitalization weighted method ". In practice, the daily calculation of SENSEX is done by dividing the aggregate market value of the 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. The Divisor keeps the Index comparable over a period of time and if the reference point for the entire Index maintenance adjustments. SENSEX is widely used to describe the mood in the Indian Stock markets. Base year average is changed as per the formula New base year average = Old base year average*(New market Value/old market value)

18

NSEs DERIVATIVES MARKET:

The derivatives trading on the NSE commenced with S&P CNX Nifty index futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commenced on June 2, 2001, Single stock futures were launched on November 9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of 3-month expiration cycles. Three contracts are available for trading, with 1 month, 2 month & 3 month expiry. A new contract is introduced on the next trading day following of the near month contract.

REGULATORY FRAMEWORK:
The trading of derivatives is governed by the provisions contained in the SC (R) Act, the SEBI Act, and the regulations framed there under the rules and byelaws of stock exchanges. In this chapter we look at the broad regulatory frame work for derivatives trading and the requirement to become a member and authorized dealers of the F&O segment and the position limits as they apply to various participants.

REGULATION FOR DERIVATIVE TRADING:

SEBI set up a 24-member committee under Chairmanship of Dr.L.C.Gupta develop the appropriate regulatory framework for derivative trading in India. The committee submitted its report in March 1998. On May11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index Futures. SEBI also approved he suggestive bye-laws recommended by the committee for regulation and control of trading and settlement of Derivative contract. The provision in the SC(R) Act governs the trading in the securities. The amendment of the SCR Act to include DERIVATIVES within the ambit of securities in the SCR Act made trading in Derivatives possible within the framework of the Act.

19

 Any exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta committee report may apply to SEBI for grant of recognition under section 4 of the SCR Act, 1956 to start Derivatives Trading. The exchange shall have minimum 50 members. The members of an existing segment of the exchange will not automatically become the members of the derivatives segment. The members of the derivatives segment need to fulfill the eligibility conditions as lay down by the L. C. Gupta committee. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing corporation/clearing house. Clearing Corporation/Clearing House complying with the eligibility conditions as lay down by the committee have to apply to SEBI for grant of approval. Derivatives broker/dealers and Clearing members are required to seek registration from SEBI. This is in addition to their registration as brokers of existing stock exchanges. The minimum net worth for clearing members of the derivatives clearing corporation/house shall be Rs.300 lakh. The net worth of the member shall be computed as follows: Capital + Free reserves Less non-allowable assets viz., Fixed Assets Pledged securities Members card Non-allowable securities (unlisted securities) Bad deliveries Doubtful debts and advance Prepaid expenses Intangible Assets 30% marketable securities

20

 The Minimum contract value shall not be less than Rs.2 Lakhs. Exchange should also submit details of the futures contract they purpose to introduce. The trading members are required to have qualified approved user and sales persons who have passed a certification programmed approved by SEBI. The L.C.Gupta committee report requires strict enforcement of Know your customer rule and requires that every client shall be registered with the derivates broker. The members of the derivatives segment are also required to make their clients aware of the risks involved in derivatives trading by issuing to the client the Risk Disclosure and obtain a copy of the same duly signed by the clients.

ELIGIBILITY OF ANY STOCK TO ENTER INTO THE DERIVATIVES MARKET:

Non promoter holding (free float capitalization) not less than Rs.750 crores from last 6 months. Daily Average Trading value not less than 5 crores in last 6 months. At least 90% of Trading days in last 6 months. Non Promoters Holding at least 30%. BETA not more than 4 (previous last 6 months)

COMPANY PROFILE:
The Kotak Mahindra Group was born in 1985 as Kotak Capital Management Finance Limited. Uday Kotak, Sidney A.A.Pinto and Kotak & Company promoted this

company. Industrialists Harish Mahindra and Anand Mahindra took a stake in 1986, and thats when the company changes its name to Kotak Mahindra Finance Limited. Since then its been a steady and confident journey to growth and success.

21

1986 1987

Table : 3.1 Kotak Mahindra Finance Limited starts the activity of Bill Discounting. Kotak Mahindra Finance Limited enters the lease and hire purchase market.

1990 1991 1992 1995

The Auto Finance Division is started. The Investment Banking Division is started. Enters the Funds Syndication sector. Brokerage and Distribution Businesses incorporated in to a separate company Kotak Securities Investment Banking Division incorporated into a separate company Kotak Mahindra Capital Company.

1996

The Auto Finance Business is hired off into a separate company Kotak Securities investment Banking Division Incorporated into a separate company Kotak Mahindra Capital Company.

1998

Enters the Mutual Fund Marker with the launch of Kotak Mahindra asset Management Company.

2000

Kotak Mahindra ties up with old Mutual PIC for the life insurance business. Kotak Securities launches its on-line broking site ( www.kotak securities.com )

2001 2003

Matrix sold to Friday Corporation launches insurance Services Kotak Mahindra Finance Limited converts to a Commercial Bank The first Indian Company to do so.

2004 2005

Launches India growth fund, a private equity fund Kotak group religions Joint Ventures in ford credit; Buys Kotak Mahindra prime and sells ford credit Kotak Mahindra Launches a Realestate Fund.

2005 2006

Launched a real estate fund. Bought the 25% stake held by Goldman Sachs in Kotak Mahindra Capital Company and Securities

2008

Launched a Pension Fund under the New Pension System

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2009

Kotak Mahindra Bank Ltd. Opened a representative office in Dubai entered Ahmadabad Commodity Exchange as anchor investor.

2010

Ahmadabad Derivatives and Commodities Exchange, a Kotak anchored enterprise, became operational as a national commodity exchange.

2011

Kotak Mahindra Bank Ltd entered into a Business Cooperation arrangement with CIMB Group Sdn Bhd, Malaysia.

GENISIS OF KOTAK MAHINDRA BANK:

KMBL has come into existence in March 2003 through the conversion of kotak Mahindra bank limited into a Commercial Bank. Kotak Mahindra is one of India's leading financial institutions, offering complete financial solutions that encompass every sphere of life. From commercial banking, to stock broking, to mutual funds, to life insurance, to investment banking, the group caters to the financial needs of individuals and corporate.The group has a net worth of over Rs.1, 550 crores and employs over 3,000 employees in its various businesses. With a presence in 60 cities in India and offices in New York, London, Dubai and Mauritius, it services a customer base of over 5, 00,000. Kotak Mahindra is fairly big and widely based with cross border operations. In 2008, the group had net worth of over Rs 5,824 crores and employed over 20,000 people in its various businesses with a presence of 100 cities in India and offers in New York, London, Mauritius. Debit cards base increased to 5, 00,000. Kotak Mahindra owes its growth to its association with the international talent pool and has partnership with GOLDMAN SACHS (one of the worlds largest bank and brokerage firm) ford credit (one of the worlds largest dedicated automobile financiers) and old mutual (a large insurance, banking and asset management conglomerate). Kotak Mahindra bank is the flagship company of the group. The company was incorporated in 1985 and over the years has spread its business into the entire spectrum of financial services either directly or through subsidiaries. In February 2003, the company reached a new milestone when it was given license to carry on banking business by the Reserve Bank of India. It was the first company in India to convert to a bank. The company has been in retail leading since mid 1990s . With the conversion into bank retail liabilities, treasury and corporate banking segments have been added.
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JOURNEY TO BANK: A SPECTACULAR METAMORPHOSIS:

The Kotak Mahindra group was incorporated in 1985 as a Kotak Capital Management Finance Limited. This company was promoted by UDAY KOTAK, SIDNEY, PINTO AND KOTAK AND COMPANY. Industrialist HARISH MAHINDRA and ANAND MAHINDRA took a stake in 1986 and thus the company changed its name to KOTAK MAHINDRA FINANCE LTD.

CORPORATE HIERARCHY: Corporate Manager

Branch Manager

Dealer (user)
Figure : 3.1

CORPORATE MANAGER:
He has the right to see all branches and dealers out standing orders, previous traders, net positions & end of day reports to set branch order limits.

BRANCH MANAGER:
He has the right to see all branches and dealers out standing orders, previous traders, net positions & end of day reports to set branch order limits.

DEALERS (USER):
He has the right to perform orders & trading activities.

GROUP MANAGEMENT:
Mr.KM GHERDA - group chairman Mr. Uday Kotak Executive Vice Chairman & Managing Director. Mr. Sivaji Dam Mr. C. Jayaram Mr. Dipak Gupta

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KOTAK MAHINDRA GROUP STRUCTURE:

Kotak Mahindra is one of Indias leading financial institutions offering complete financial solutions that encompass every sphere of life. From commercial banking, to stock broking, to mutual funds, to life insurance to investment banking, the group caters to the financial needs of individuals and corporate. The group has a net worth of around Rs.2000 crore and the AUM across the group is around 120 billion and employs over 6000 employees in its various businesses. With a presence in 216 cities in India and offices in New York, London, Dubai and Mauritius, it services a customer base of over 10.00,000. The group specializes in offering top class financial services catering to every segment of the industry. The various group companies include.
Kotak Mahindra Bank

Kotak Mahindra Capital Company

Kotak Securities

Kotak Mahindra Investmen ts

Kotak Mahindr a Prime

Kotak Mahindra Asset Manageme nt Company

Kotak Mahindra Trust Company

Kotak Securities

Mahindra

Kotak (UK)

Mahindra

Kotak

Mahindra

(International) Global Kotak Mahindra Inc. Investment

Opportunities Fund

Figure : 3.2
25

KOTAK SECURITIES LIMITED:

Kotak Securities Ltd. Is Indias leading stock broking house with a marker share of around 8% Kotak Securities Ltd. has been the largest in IPO distribution. The accolades that Kotak Securities has been graced with include: Prime Ranking Award (2003-04) Largest Distributor of IPOs Finance Asia Award (2004) Indias best Equity House. Finance Asia Award (2005) Best Broker in India. Euro money Award (2005) Best Equities House in India

The company has a full-fledged research division involved in Macro Economic studies Sectoral research and Company specific Equity Research combined with a strong and well networked sales force which helps deliver current and up to date market information and news. Kotak Securities Ltd is also a depository participant with National Securities Depository Limited (NSDL) and Central Depository services Limited (CSDL), providing dual benefit services wherein in investors can use the brokerage services of the company for executing the transactions and the depository services for settling them. Kotak Securities has 122 branches servicing more than 1,70,000 customer and a coverage of 187 cities, kotaksecurities.com, the online division of Kotak Securities Limited offers internet Broking services and also online IPO and Mutual Fund Investments. Kotak Securities Limited, Manages assets over 2500 crores of Assets under Management (AUM). The Portfolio Management Services provide top class service, catering to the high end of the market. Portfolio Management from Kotak Securities comes as an answer to those who would like to grow exponentially on the crest of the stock market, with the backing of an expert.

26

KOTAK MAHINDRA BANK ACHIEVEMENTS:

ACHIEVEMENTS IN BANKING:
ICAI Award Excellence in Financial Reporting under Category 1 - Banking Sector for the year ending 31st March, 2010 Asia money Best Local Cash Management Bank 2010 IDG India Kotak won the CIO 100 'The Agile 100' award 2010 IDRBT Banking Technology Excellence Awards Best bank award in framework and governance among other banks 2009 Banking technology award for IT governance and value delivery, 2008. IR Global Rankings Best Corporate Governance Practices - Ranked among the top 5 companies in Asia Pacific, 2009 Asia Best Private Bank in India, for Wealth Management business, 2009 Kotak Royal Signature Credit Card Was chosen "Product of the Year" in a survey conducted by Nielsen in 2009 IBA Banking Technology Awards Best Customer relationship Achievement winner 2008 & 2009. Best overall winner, 2007. Best IT Team of the year, 4 years in a row from 2006 to 2009. Best IT Security Policies & practices, 2007 Euro Money Best Private Banking Services (overall), 2009 Emerson Uptime Champion Awards Technology Senate Emerson Uptime Championship Award in the BFSI category, 2008

27

 ACHIEVEMENTS IN INSURANCE: Outlook Money Kotak Platinum Advantage Plan - Ranked 1st in Type II ULIP category, 2008 Kotak Long Life Wealth Plus Plans - Ranked 4th in the Type I ULIPs category

ACHIEVEMENTS IN SECURITIES:
Finance Asia Best Broker in India 2010 CNBC Financial Advisor Awards Best Performing Equity Broker, 2008 & 2009 Asia money Brokers poll Best local brokerage 2006, 2007, 2008, & 2009 Best Analyst in India Sanjeev Prasad, 2005, 2006, 2007, 2008, & 2009. Finance Asia Country for Achievement Best Broker in India, 2006, 2009 & 2010 Thomson Extel Surveys Awards India's Leading Equity House, 2007 Super Brands Council of India Business Super brand India, 2008.

ACHIEVEMENTS IN INVESTMENT BANKING:

Finance Asia Best Investment Bank in India, 2010. Best Equity House in India, 2010. Best Broker in India, 2010. Asia Money Best Domestic Equity House, 2010 Best Local Brokerage in the Asia money Brokers Poll 2010 Global Finance Best Investment Bank in India, 2010 Euro Money Real Estate poll Best Bank for Equity Finance in India, 2010

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Asset Asian Awards Best Domestic Investment Bank, 2010 Finance Asia Country Awards for Achievement Best Investment Bank in India, 2006, 2007, 2008, 2009 & 2010 Best Equity House in India, 2008 & 2010.

Asia money Best Domestic bank Awards Best Domestic Equity House, 2008, 2009 & 2010 IFR Asia India Equity House of the Year, 2008 Global Finance Best Investment Bank in India, 2008, 2009 & 2010 Asset Asian Awards Best Domestic Investment Bank, 2006, 2007, 2008 & 2009

ACHIEVEMENTS IN ASSET MANAGEMENT:

ICRA Mutual Fund Awards 2009 Kotak Liquid (Regular Plan) - Ranked as a Seven Star Fund for its 1 year performance, Kotak Flexi Debt Fund - Ranked as a Five Star Fund for its 1 year performance, Kotak Flexi Debt Fund - Ranked as a Five Star Fund for its 3 year performance Kotak 30 - Ranked as a Five Star Fund for its 3 year performance

INTERNATIONAL ASSET MANAGEMENT:

Global Investor (Editorial Award) Asian Asset Manager of the Year, 2009

MISCELLANEOUS:
Best Local Trade Bank in India The UK based Trade & Forfeiting Review awarded Kotak Mahindra Bank Ltd. the Bronze Award in the category of Best Local Trade Bank in India at the TFR Awards 2011.

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LACP Vision Awards 2010 for Annual Report 2010-11 Platinum Award Best among banking category. APAC Gold Award Most creative report. APAC Ranked No.21 among Top 50 Reports. APAC Ranked No.21 among Top 50 Reports. APAC Ranked No.87 among the worlds Top 100 Annual reports.

Business world 'Most Valuable CEO' overall, 2010 awarded to Mr. Uday Kotak, Executive Vice Chairman & Managing Director

CNBCTV18 'Best Performing CFO in the Banking/Financial Services sector by CNBCTV 18 CFO Awards 2010 awarded to Mr. Jaimin Bhatt

GIREM GIREM awarded Kotak Realty Funds Group, the "Investor of the Year" Award for 2009

IBA Banking Technology Awards Best use of Business Intelligence up, 2008 Best Enterprise Risk Management Runner up, 2008

The Great places to work institute, India Best Workplaces in India, 2008 Hewitt 10th Best Employer in India, 2007, 2008 & 2009 Financial Insights innovation Award Best Innovation in Enterprise Security Management in the Asia Pacific Region, 2009 Frost & Sullivan Best Passenger Vehicle Finance Company in India, 2006 CNBC TV 18 Indian Business Leader of the Year, 2008 awarded to Uday Kotak, Executive Vice Chairman & Managing Director

ACHIEVEMENTS IN WEALTH MANAGEMENT:

Finance Asia Best Private Bank India Finance Asia 2010

30

KOTAK MAHINDRA BANK PLANS TO GO NATIONAL:

Kotak Mahindra Bank wants to get broader and deeper within the country either through greater presence or through the inorganic route. We aspire to be national, including wholesale banking. We also want to see how we can get bigger. Inorganic (route) is something that also interests us. That's something on our radar, Mr. Uday Kotak, Executive Vice-Chairman and Managing Director,

Kotak Mahindra Bank, told reporters here. The three areas for acquisitions that interest the group are banking, brokerage and asset management. We are value-focused, and we want to make sure that what we acquire should be a good risk reward for our stakeholders, he said, adding that nothing has materialized yet. The bank has enough capital to grow the balance sheet at current levels and make investments in areas we think are sustainable, he said.

ADEQUATE CAPITAL:
Mr. Kotak said that the bank, with a capital adequacy ratio of over 20 per cent, has a significant ability to invest, lend and grow without being short of capital. The bank's tier-I capital is about 18 per cent. Capital is not an issue for the bank, and making good use of capital is our focus, he added.

In order to have a wider reach, the bank is also focusing on smaller customers, and has significantly increased its portfolio in car finance, commercial vehicles, tractors and other such areas that serve small customers, pointed out Mr. Kotak. The Bank at present has a network of over 357 branches and 866 ATMs across 150 locations in the country. Technology would also help them in the process, he said, pointing out that in future the banking industry has a big opportunity to be transformed by technology. The way to deepen to be much more driven by technology, he added. There are also plans to recruit 200-300 people a month for branch banking and support network.

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32

DERIVATIVES INSTRUMENTS IN INDIA:

The first derivative product to be introduced in the Indian securities market is going to be "INDEX FUTURES". In the world, first index futures were traded in U.S. on Kansas City Board of Trade (KCBT) on Value Line Arithmetic Index (VLAI) in 1982. Organized exchanges began trading options on equities in 1973, whereas exchange traded debt options did not appear until 1982, on the other hand fixed income futures began trading in 1975, but equity related futures did not begin until 1982.

DEFINITION OF DERIVATIVES:
Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. Securities Contracts (Regulation) Act, 1956 (SCR Act) defines debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. A contract which derives its value from the prices, or index of prices, of underlying securities.

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

Early forward contracts in the US addressed merchants concerns about ensuring that there were buyers and sellers for commodities. However credit risk remained a serious problem. To deal with this problem, a group of Chicago; businessmen formed the Chicago Board of Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a centralized location known in advance for buyers and sellers to negotiate forward contracts. In 1865, the CBOT went one step further and listed the first exchange traded derivatives contract in the US; these contracts were called futures contracts. In 1919, Chicago Butter and Egg Board, a spin-off CBOT was reorganized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized futures exchanges, indeed the two largest financial exchanges of any kind in the world today. The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world is based on S&P 500 indexes, traded on Chicago Mercantile Exchange. During the Mid eighties, financial futures became the most active derivative instruments generating volumes many times more than the commodity futures. Index futures, futures on T-bills and Euro-Dollar futures are the three most popular futures contracts traded today. Other popular international exchanges that trade derivates are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan MATIF in France, Eurex etc.

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THE DEVELOPMENT OF DERIVATIVES:

Holding portfolios of securities is associated with the risk of the possibility that the investor may realize his returns, which would be much lesser than what he expected to get. There are various factors, which affect the returns: 1. Price or dividend (interest) 2. Some are internal to the firm like Industrial policy Management capabilities Consumers preference Labour strike, etc.

These forces are to a large extent controllable and are termed as non systematic risks. An investor can easily manage such non-systematic by having a well-diversified portfolio spread across the companies, industries and groups so that a loss in one may easily be compensated with a gain in other. There are yet other of influence which are external to the firm, cannot be controlled and affect large number of securities. They are termed as systematic risk. They are: 1. Economic 2. Political 3. Sociological changes are sources of systematic risk. For instance, inflation, interest rate, etc. their effect is to cause prices of nearly allindividual stocks to move together in the same manner. We therefore quite often find stock prices falling from time to time in spite of companys earnings rising and vice versa. Rational Behind the development of derivatives market is to manage this systematic risk, liquidity in the sense of being able to buy and sell relatively large amounts quickly without substantial price concession. In debt market, a large position of the total risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. Those factors favor for the purpose of both portfolio hedging and speculation, the introduction of a derivatives securities that is on some broader market rather than an individual security.
35

FUNCTIONS OF THE DERIVATIVE MARKETS:

In spite of the fear and criticism with which the derivative markets are commonly looked at, these markets perform a number of economic functions. Prices in an organized derivatives market reflect the perception of market participants about the future and lead the price of underlying to the perceived future level. 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 as current prices. Derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivative due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, 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. Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. Margining, Monitoring and surveillance of the activities of various participants become extremely difficult in these kinds of mixed markets. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. The derivatives have a history of attracting many bright, creative, Well-educated people with an entrepreneurial attitude. They often energize others to create new businesses, new products and new employment opportunities, the benefit of which are immense. Derivatives trading acts as a catalyst for new entrepreneurial activity. Derivatives markets help increase saving and investment in long run.

36

REGULATION FOR DERIVATIVES TRADING:

SEBI set up a 24-member committee under Chairmanship of Dr.L.C. Gupta to develop the appropriate regulatory framework for derivatives trading in India. The committee submitted its report in March 1998. On May 11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures. SEBI also approved the suggestive bye-laws recommended by the committee for regulation and control of trading and settlement of derivatives contracts. The provisions in the SC(R) A and the regulatory framework developed there under govern trading in securities. The amendment of the SC(R) A to include derivatives within the ambit of securities in the SC(R) A made trading in derivatives possible within the framework of the Act. 1. Any exchange fulfilling the eligibility criteria as prescribed in the L C Gupta committee report may apply to SEBI for grant of recognition under Section 4 of the SC(R) a, 1956 to start trading derivatives. The derivatives exchange/segment should have a separate governing council and representation of trading / clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of trading in any derivative contract. 2. The exchange shall have minimum 50 members. 3. The members of an existing segment of the exchange will not automatically become the members of derivative segment. The members of the derivative segment need to fulfill the eligibility conditions as laid down by the L C Gupta committee. 4. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing corporation / house. Clearing corporation / houses complying with the eligibility conditions as laid down by the committee have to apply to SEBI for grant of approval. 5. Derivative brokers/dealers and clearing members are required to seek registration from SEBI. 6. The minimum contract value shall not be less than Rs. 2 Lakh. Exchanges should also submit details of the futures contract they propose to introduce. 7. The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI.

37

While from the purely regulatory angle, a separate exchange for trading would be a better arrangement. Considering the constraints in infrastructure facilities, the existing stock (cash) exchanges may also be permitted to trade derivatives subject to the following conditions. 1.Trading should take place through an on-line screen based trading system. 2.An independent clearing corporation should do the clearing of the derivative market. 3.The exchange must have an online surveillance capability, which monitors positions, price and volumes in real time so as to deter market manipulation price and position limits should be used for improving market quality. 4.Information about trades quantities, and quotes should be disseminated by the exchange in the real time over at least two information-vending networks, which are accessible to investors in the country. 5.The exchange should have at least 50 members to start derivatives trading. 6.The derivatives trading should be done in a separate segment with separate membership; That is, all members of the cash market would not automatically become members of the derivatives market. 7.The derivatives market should have a separate governing council which should not have representation of trading by clearing members beyond whatever percentage SEBI may prescribe after reviewing the working of the present governance system of exchanges. 8.The chairman of the governing council of the derivative division / exchange should be a member of the governing council. If the chairman is broker / dealer, then he should not carry on any broking or dealing on any exchange during his tenure. 9.No trading/clearing member should be allowed simultaneously to be on the governing council both derivatives market and cash market.

38

TYPES OF DERIVATIVES:
1. Equity Derivatives (security Derivatives): Index Future & Option Stock Future & Option

2. Financial Derivatives: Equity Derivatives Forex currency future Interest rate future

3. Underlying Asset or Derivatives: Financial Derivatives Commodities Any other asset

DIFFERENCE BETWEEN FUTURE MARKET & OPTION MARKET:

A future contract buyer give the right but obligation to buy A future contract seller give the right but obligation to sell Call gives the buyer the right, but not obligation to sell Put gives to buyer the right, but not obligation to sell Call gives the seller option premium, but obligation to sell Put gives to seller option premium, but obligation to buy Value of option increase, when volatility increase Value of option decrease, when volatility decreases.

TYPES OF DERIVATIVES:
Types of Derivatives
Forwards Futures Options Warrants Leaps Baskets Swaps Swaptions

Figure : 4.1

39

The following are the various types of derivatives, explained below:

FORWARDS:

A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at todays pre-agreed price. FUTURES: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange traded contracts. OPTIONS: Options are of two types-calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a give future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. WARRANTS: Options generally have lives of up to one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the counter. LEAPS: The acronym LEAPS means long-term Equity Anticipation securities. These are options having a maturity of up to three years. BASKETS: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. SWAPS: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used Swaps are:
40

INTREST RATE SWAPS: These entail swapping only the related cash flows between the parties in the same currency.

CURRENCY SWAPS: These entail swapping both principal and interest between the parties, with the cash flows in on direction being in a different currency than those in the opposite direction.

SWAPTION: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has received swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and received floating.

PARTICIPANTS IN THE DERIVATIVE MARKETS:

The following three broad categories of participants:

HEDGERS:
Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk.

SPECULATORS:
Speculators wish to bet on future movements in the price of an asset. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.

ARBITRAGERS:
Arbitrageurs are in business to take of a discrepancy between prices in two different markets, if, for, example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting position in the two markets to lock in a profit.

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INTRODUCTION OF FUTURES:
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset as a certain time in the future at a certain price. But unlike forward contract, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contract, the exchange specifies certain standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purpose in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 90% of futures transactions are offset this way. The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement

DEFINITION:
A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts.

FEATURES OF FUTURES:
Futures are highly standardized. The contracting parties need not pay any down payments. Hedging of price risks. They have secondary markets to.

42

TYPES OF FUTURES:
On the basis of the underlying asset they derive, the futures are divided into two types: Stock futures Index futures

DISTINCTION CONTRACTS:

BETWEEN

FUTURES

&

FORWARDS

Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of futures price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. Comparison between two as follows:

FUTURES

FORWARDS

1. Trade on an Organized Exchange 2. Standardized 3. More Liquidity 4. Require Margin payment 5. Follows daily settlement

1. OTC in nature 2. Customized 3. Less Liquidity 4. No Margin Payment 5. Settlement happens at end of Period

Table : 4.1

FUTURES TERMINOLOGY:
SPOT PRICE: The price at which an asset trades in the spot market. FUTURES PRICE: The price at which the futures contract trades in the futures market.

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CONTRACT CYCLE: The period over which contract trades. The index futures contracts on the NSE have one-month, twomonth and three-month expiry cycle which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three-month expiry is introduced for trading.

EXPIRY DATE: It is the date specifies 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.

CONTRACT SIZE: The amount of asset that has to be delivered under one contract. For instance, the contract size on NSEs futures market is 50 Nifties.

BASIS: In the context of financial futures, basis can be defined as the futures price minus the spot price. These will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices.

COST CARRY: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

INITIAL MARGIN: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

MARKING-TO-MARKET: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is called marking-to-market.
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MAINTENANCE MARGIN: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account 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.

INTRODUCTION OF OPTIONS:
In this section, we look at the next derivative product to be traded on the NSE, namely options. Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirement) to enter into a futures contracts, the purchase of an option requires as up-front payment.

DEFINITION:
Option is a type of contract between two persons where one grants the other the right to buy a specific asset at a specific price within a specific time period. Alternatively the contract may grant the other person the right to sell a specific asset at a specific price within a specific time period. In order to have this right. The option buyer has to pay the seller of the option premium. The assets on which option can be derived are stocks, commodities, indexes etc. If the underlying asset is the financial asset, then the option are financial option like stock options, currency options, index options etc, and if options like commodity option.

PROPERTIES OF OPTION:
Options have several unique properties that set them apart from other securities. The following are the properties of option: Limited Loss High leverages potential Limited Life
45

PARTIES IN AN OPTION CONTRACT:

BUYER/HOLDER/OWNER OF AN OPTION:
The buyer of an option is one who by paying option premium buys the right but not the obligation to exercise his option on seller/writer.

SELLER/WRITER OF AN OPTION:
The writer of the call /put options is the one who receives the option premium and is there by obligated to sell/buy the asset if the buyer exercises on him

TYPES OF OPTIONS:
The options are classified into various types on the basis of various variables. The following are the various types of options. I. ON THE BASIS OF THE UNDERLYING ASSET: On the basis of the underlying asset the option are divided into two types: INDEX OPTIONS: These options have the index as the underlying. Some options are European while others are American. Like index futures contract, index options contracts are also cash settled. STOCK OPTIONS: Stock options are options on the individual stocks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price II. ON THE BASIS OF THE MARKET MOVEMENTS: On the basis of the market movements the option are divided into two types. They are: CALL OPTION: A call option is bought by an investor when he seems that the stock price moves upwards. A call option gives the holder of the option the right but not the obligation to buy an asset by a certain date for a certain price.
46

PUT OPTION: A put option is bought by an investor when he seems that the stock price moves downwards. A put option gives the holder of the option right but not the obligation to sell an asset by a certain date for a certain price.

III.

ON THE BASIS OF EXERCISE OF OPTION: On the basis of the exercised of the option, the options are classified into two categories. AMERICAN OPTION: American options are options that can be exercised at any time up to the expiration date, most exchange-traded option are American.

EUOROPEAN OPTION: European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart.

FACTORS AFFECTING THE PRICE OF AN OPTION:

The following are the various factors that affect the price of an option they are:

STOCK PRICE:
The payoff from a call option is a amount by which the stock price exceeds the strike price. Call options therefore become more valuable as the stock price increases and vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the stock price. Put options therefore become more valuable as the stock price increases and vice versa.

STRIKE PRICE:
In case of a call, as a strike price increases, the stock price has to make a larger upward move for the option to go in-the-money. Therefore, for a call, as the strike price increases option becomes less valuable and as strike price decreases, option become more valuable.

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 TIME TO EXPIRATION:
Both put and call American options become more valuable as a time to expiration increases.

VOLATILITY:
The volatility of a stock price is measured of uncertain about future stock price movements. As volatility increases, the chance that the stock will do very well or very poor increases. The value of both calls and puts therefore increase as volatility increase.

RISK-FREE INTEREST RATE:

The put options prices decline as the risk-free rate increases where as the prices of call always increase as the risk-free interest rate increases.

DIVIDENDS:
Dividends have the effect of reducing the stock price on the x-dividend rate. This has a negative effect on the value of call options and a positive effect on the value of put options.

DIFFERENCES BETWEEN FUTURES & OPTIONS:

FUTURES
1.Exchange traded, with Innovation 2.Exchange defines the product 3.Price is zero, strike Price moves 4.Price is zero 5.Linear payoff 6.Both long & Short at risk Table : 4.2

OPTIONS
1.Same in nature 2.Same in nature 3.Strike price is fixed, price moves 4.Price is always positive 5.Nonlinear payoff 6.only short at risk

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49

DATA ANALYSIS:
The Objective of this analysis is to evaluate the profit/loss position futures and options. This analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING LIMITED scrip. This analysis considered the April contract of kotak. The lot size of kotak is 100, the time period of the analysis is, from 18-04-2013 to 1306-2013. Table : 5.1 KOTAK STOCK FUTURES & OPTIONS PRICE DATES (1)
SPOT

CALL OPTION (3)

PUT OPTION (4)

(2)

FUTURE 738.85 740.20 770.05

740 48.45 65.15 55.25

800 25.35 30.35 32.25

840 14.00 17.00 16.30

740 47.50 30.15 30.95

800 0 0 64.95

840 0 0 0

Apr/thu/18 Apr/fri/19 Apr/sat/20 Apr/sun/21 Apr /mon/22 Apr /tue/23 Apr /wed/24 Apr /thu/25 Apr /fri/26 Apr/sat/27 Apr/sun/28 Apr /mon/29 Apr /tue/30 May/wed/01 May /thu/02 May /fri/03 May/sat/04 May/sun/05

742.00 742.80 780.00

TRADING HOLIDAY 785.00 815.55 848.00 845.00 776.55 767.70 822.95 823.15 855.70 848.75 774.55 712.30 94.00 108.20 0 123.00 0 38.55 51.80 55.15 75.80 71.35 32.60 16.95 31.90 32.80 48.50 42.25 19.05 8.60 4.80 13.00 7.65 8.90 26.3 60.00 30.55 31.55 20.10 20.25 53.75 101.0 0 0 44.65 36.55 72.75 0

TRADING HOLIDAY 700.00 685.00 690.00 711.00 722.00 707.05 685.40 692.50 696.85 716.65 724.45 704.05 24.15 24.70 21.55 23.80 22.75 15.95 11.55 9.80 9.05 8.80 8.00 6.70 8.00 8.40 0 0 0 0 73.00 0 0 0 0 0 130.0 0 0 0 0 0 0 0 0 0 0 0

TRADING HOLIDAY
50

May/mon/06 May/tue/07 May/wed/08 May/fri/09 May/sat/10 May/sun/11 May/mon/12

695.00 697.00 660.00 640.10 645.00

682.90 660.65 634.80 637.10 673.25

31.00 3.50 0.90 0.55 1.20

77.00 1.05 0.75 0.20 0.20

13.00 0 1.05 0 0

0 105.5 0 0 0

0 0 0 0 0

0 0 0 0 0

TRADING HOLIDAY 681.35 661.45 0.05 0.05 0.05 0 0 0

TABLE DETAILS:
The first column explains TRADING DATE. Second Column (a) explains the SPOT MARKET PRICE in cash segment on that date of Opening Balance of Equity Amount. Second column (b) explains the FUTURE MARKET PRICE in cash segment on that date of Closing Balance on Future Market Amount. The Third column explains call Option premiums amounting 740, 800, 840. The Fourth column explains Put Option premiums amounting 740, 800, 840.

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OBSERVATIONS & FINDINGS: CALL OPTION:

BUYERS PAY OFF:
As brought 1 lot of KOTAK that is 100, those who buy for 740, paid 48.45 premiums per share.

Settlement price is 681.35 Spot price Strike price Amount Premium paid (-) Net Loss Buyer Loss = Rs.1020 (Loss) Because it is negative it is in the money contract, hence buyer will get more loss, incase spot price decrease buyer loss also increase. 48.45 -10.20 x 100 = -1020 681.35 740.00 -58.65

SELLERS PAY OFF:

It is in the money for the buyer, so it is in out of the money for seller; hence his profit is also increase. Strike price Spot price Amount Premium Received Net profit 740.00 681.35 +58.65 48.45 10.20 x 100 = +1020

Seller Profit = Rs.1020 (Net Amount) Because it is positive it is out of the money, hence seller will get more profit, incase spot price increase in below strike price, seller get loss in premium level

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OBSERVATIONS & FINDINGS: PUT OPTION:

BUYERS PAY OFF:
Those who have purchase put option at a strike price of 740, the premium payable is 47.50 On the expiry date the spot market price enclosed at 681.35 Strike price Spot price Net pay off 740.00 681.35 58.65 x 100 = 5865

Already, premium paid 48.45, so it can get profit is 5865 Because it is Positive, out of the money contract, hence buyer will get more profit, incase spot price increase buyer get loss in premium level.

SELLERS PAY OFF:

As seller is entitled only for premium so, if he is in profit and also seller has to borne total profit.

Spot price Strike price Amount

681.35 740.00 -58.65 x100 =-5865

Already premium received 48.45 so, it can get loss is 5865 Because it is negative, in the money contract, Hence seller gets more loss, incase spot price increase in above strike price seller can get profit in premium level.

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ANALYSIS OF FUTURE PRICES:

The Objective of this analysis is to evaluate the profit/loss position futures and options. This analysis is based on sample data taken of M/s. KOTAK STOCK BROCKING LIMITED scrip. This analysis considered the April contract of KOTAK. The lot size of KOTAK is 100, the time period of the analysis is, from 18-04-2013 to 13-06-2013 Table : 5.2 DATE APR/THU/18 APR/FRI/19 APR/SAT/20 APR /MON/22 APR /TUE/23 APR /WED/24 APR /THU/25 APR /FRI/26 APR/SAT/27 APR /MON/29 APR /TUE/30 MAY/WED/01 MAY /THU/02 MAY /FRI/03 MAY/SAT/04 MAY/MON/06 MAY/TUE/07 MAY/WED/08 MAY/FRI/09 MAY/SAT/10 MAY/MON/12 FUTURE PRICE 738.85 740.20 770.05 822.95 823.15 855.70 848.75 774.55 712.30 685.40 692.50 696.85 716.65 724.45 704.05 682.90 660.65 634.80 637.10 673.25 661.45

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100

200

300

400

500

600

700

800

900

Apr/thu/18

Apr/fri/19

Apr/sat/20

Apr /mon/22

Apr /tue/23

Apr /wed/24

Apr /thu/25

Apr /fri/26

Apr/sat/27

Apr /mon/29

Apr /tue/30

Figure : 5.1

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future price

May/wed/01

May /thu/02

May /fri/03

May/sat/04

May/mon/06

May/tue/07

May/wed/08

May/fri/09

May/sat/10

FUTURE MARKET:
BUYER SELLER

18/04/2013(Buying)

738.85

738.85

12/05/2013(Cl., period)

681.35

681.35

Loss

57.00

Profit

57.00

Profit 100 x57.00=5700, Loss 100 x 57.00=5700

Because buyer future price will decrease so, he can get loss. Seller future price also decrease so, profit also increase, In case seller future will increase, and he can get loss. The closing price of Mahindra Satyam formerly Satyam Computer services, at the end of the contract period is 681.35 and this is considered as settlement price.

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DATA OF KOTAK THE FUTURES & OPTIONS OF THE APRIL - MAY MONTH 2013:
DATE APR/THU/18 APR/FRI/19 APR/SAT/20 APR /MON/22 APR /TUE/23 APR /WED/24 APR /THU/25 APR /FRI/26 APR/SAT/27 APR /MON/29 APR /TUE/30 MAY/WED/01 MAY /THU/02 MAY /FRI/03 MAY/SAT/04 MAY/MON/06 MAY/TUE/07 MAY/WED/08 MAY/FRI/09 MAY/SAT/10 MAY/MON/12 Table : 5.3 SPOT PRICE 742.00 742.80 780.00 785.00 815.55 848.00 845.00 776.55 767.70 700.00 685.00 690.00 711.00 722.00 707.05 695.00 697.00 660.00 640.10 645.00 681.35 FUTURE PRICE 738.85 740.20 770.05 822.95 823.15 855.70 848.75 774.55 712.30 685.40 692.50 696.85 716.65 724.45 704.05 682.90 660.65 634.80 637.10 673.25 661.45

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100

200

300

400

500

600

700

800

900

0 Apr/thu/18 Apr/fri/19 Apr/sat/20 Apr /mon/22 Apr /tue/23

Apr /wed/24
Apr /thu/25 Apr /fri/26 Apr/sat/27 Apr /mon/29 Apr /tue/30 May/wed/01 May /thu/02 May /fri/03 May/sat/04 May/mon/06 May/tue/07 May/wed/08 May/fri/09 May/sat/10 May/mon/12 spot price future price

Figure : 5.2

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OBSERVATIONS AND FINDINGS:

The future price of M/S KOTAK STOCK moving along with the market price.

If the buy price of the future is less than the settlement price, than the buyer gets profit on futures.

If the selling price of the future is less than the settlement price, than the seller incur losses.

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SUGGESTIONS:
In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold, where as the put option holder suffers in a bullish market, so he is suggested to write a put option. In bearish market the call option holder will incur more losses so the investor is suggested to go for a call option to write, where as the put option writer will get more losses, so he is suggested to hold a put option. In the above analysis the market price of M/S.KOTAK is having low volatility, so the call option writers enjoy more profits to holders. The derivative market is newly started in India and it is not known by every investor, so SEBI has to take steps to create awareness among the investors about the derivative segment. In order to increase the derivatives market in India, SEBI should revise some of their regulations like contract size, participation of FII in the derivatives market. Contract size should be minimized because small investors cannot afford this much of huge premiums. SEBI has to take further steps in the risk management mechanism. SEBI has to take measures to use effectively the derivatives segment as a tool of hedging.

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CONCLUSIONS:
Derivatives market is an innovation to cash market. Approximately its daily turnover reaches to the equal stage of cash market. The average daily turnover of the NSE derivative segments In cash market the profit/loss of the investor depends on the market price of the underlying asset. The investor may incur huge profits or he may incur huge loss. But in derivatives segment the investor enjoys huge profits with limited downside. In cash market the investor has to pay the total money, but in derivatives the investor has to pay premiums or margins, which are some percentage of total money. Derivatives are mostly used for hedging purpose. In derivative segment the profit/loss of the option writer is purely depend on the fluctuations of the underlying asset.

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BIBLIOGRAPHY:
BOOKS:
Derivatives Dealers Module Work bookNCFM Financial Markets and ServicesGORDAN and NATRAJAN Financial Management PRASANNA CHANDRA

JOURNALS:
The journal of derivatives. International journal of financial markets & derivatives.

NEWS PAPERS:
Economic times The Hindu Business Standard

MAGAZINES:
Business Today Business World Business India

WEBSITES:
www.derivativesindia.com www.indianinfoline.com www.nseindia.com www.bseindia.com www.sebi.gov.in www.google.com

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