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7 Zijbemr March12 Vol2 Issue3
7 Zijbemr March12 Vol2 Issue3
ABSTRACT
This research paper attempts to collect literature from various sources in on attempt to answer
three pertinent questions related to the derivatives growth and model in Indian. This paper
examine the analyzes recent trends in derivate in emerging markets, institutional. Obstacles to
more diversified and adequate funding sources for the derivative market, and the vulnerabilities
associated with the currently available sources. The main trends in emerging markets derivative
include an increase in derivative and stagnation or a decline in bank lending and equity issues.
As a result, in part, of a series of policy measures, derivative have become a relevant source of
funding in some Indian market, the paper also briefly reports on major changes in the financing
of derivative market growth in India and considers its implications for the extant theories of law,
finance and corporate governance. And analyzes the potential limits of organizational growth in
derivative market and explores the implications of integration and diversification for antitrust
policy.
KEYWORDS: derivative, finance, market industries and growth.
______________________________________________________________________________
However, the advent of modern day derivative contracts is attributed to the need for farmers to
protect themselves from any decline in the price of their crops due to delayed monsoon, or
overproduction. The first futures contracts can be traced to the Yodoya rice market in Osaka,
Japan around 1650. These were evidently standardized contracts, which made them much like
todays futures. The Chicago Board of trade (CBOT), the largest derivative exchange in the
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As Indian securities markets continue to evolve, market participants, investors and regulators are
looking at different ways in which the risk management may be efficiently met through the
introduction of Derivative markets. 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.
Derivatives are risk management instruments, which derive their value form an underlying asset.
The underlying asset can be bullion, index, share, bonds, currency, interest etc. banks, securities
firms, companies and investors to hedge risks, to gain access to cheaper money and to make
profit, uses derivatives. Derivatives are likely to grow even at a faster rate in future.
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INTRODUCTION
world, was established in 1848 where forward contracts on various commodities were
standardized around 1865. From then on, futures contracts have remained more or less in the
same form, as we know them today.
DERIVATIVES
Derivatives are defined as financial instruments whose value derived from the prices of one or
more other assets such as equity securities, fixed-income securities, foreign currencies, or
commodities. Derivative is also a kind of contract between two counter parties to exchange
payments linked to the prices of underlying assets.
DEFINITION
In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines
derivative to include1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other from of security.
2. A contract which derives its value from the prices, or index or prices, of underlying
securities
The above definition conveys that Derivatives are financial products and derive its value from
the underlying assets. Derivatives are derived from a matter financial contract called the
underlying.
OBJECTIVES
2.
3.
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1.
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Board of India (SEBI) banned it for good in 2001. A series of reforms of the stock market
between 1993 and 1996 paved the way for the development of exchange-traded equity
derivatives markets in India. In 1993, the government created the NSE in collaboration with
state-owned financial institutions. NSE improved the efficiency and transparency of the stock
markets by offering a fully automated screen-based trading system and real-time price
dissemination. In 1995, a prohibition on trading options was lifted. In 1996, the NSE sent a
proposal to SEBI for listing exchange-traded derivatives. The report of the L. C. Gupta
Committee, set up by SEBI, recommended a phased introduction of derivative products, and bilevel regulation (i.e., self-regulation by exchanges with SEBI providing a supervisory and
advisory role). Another report, by the J. R. Varma Committee in 1998, worked out various
operational details such as the margining systems. In 1999, the Securities Contracts (Regulation)
Act of 1956, or SC(R) A, was amended so that derivatives could be declared securities. This
allowed the regulatory framework for trading securities to be extended to derivatives. The Act
considers derivatives to be legal and valid, but only if they are traded on exchanges. Finally, a
30-year ban on forward trading was also lifted in 1999. The economic liberalization of the early
nineties facilitated the introduction of derivatives based on interest rates and foreign exchange. A
system of market-determined exchange rates was adopted by India in March 1993. In August
1994, the rupee was made fully convertible on current account. These reforms allowed increased
integration between domestic and international markets, and created a need to manage currency
risk. Figure 1 shows how the volatility of the exchange rate between the Indian Rupee and the
U.S. dollar has increased since 1991.7 the easing of various restrictions on the free movement of
interest rates resulted in the need to manage interest rate risk.
DERIVATIVES INSTRUMENTS TRADED IN INDIA
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3 stock indices. All these derivative contracts are settled by cash payment and do not involve
physical delivery of the underlying product (which may be costly). Derivatives on stock indexes
and individual stocks have grown rapidly since inception. In particular, single stock futures have
become hugely popular; accounting for about half of NSEs traded value in October 2005. In
fact, NSE has the highest volume (i.e. number of contracts traded) in the single stock futures
globally, enabling it to rank 16 among world exchanges in the first half of 2005. Single stock
options are less popular than futures. Index futures are increasingly popular, and accounted for
close to 40% of traded value in October 2005. The growth in volume of futures and options on
the Nifty index, and shows that index futures have grown more strongly than index options NSE
launched interest rate futures in June 2003 but, in contrast to equity derivatives, there has been
little trading in them. One problem with these instruments was faulty contract specifications,
resulting in the underlying interest rate deviating erratically from the reference rate used by
market participants. Institutional investors have preferred to trade in the OTC markets, where
instruments such as interest rate swaps and forward rate agreements are thriving. As interest rates
in India have fallen, companies have swapped their fixed rate borrowings into floating rates to
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In the exchange-traded market, the biggest success story has been derivatives on equity products.
Index futures were introduced in June 2000, followed by index options in June 2001, and options
and futures on individual securities in July 2001 and November 2001, respectively. As of 2005,
the NSE trades futures and options on 118 individual stocks and
reduce funding costs. Activity in OTC markets dwarfs that of the entire exchange-traded
markets, with daily value of trading estimated to be Rs. 30 billion in 2004
INSTRUMENTS AVAILABLE IN INDIA
Financial derivative instruments: The National stock Exchange (NSE) has the following
derivative products:
Products
Underlying
Index Futures
Index Options
Instrument
Type
Trading Cycle
Futures
Individual
on Options
Individual
Securities
Securities
30 securities
30 securities
stipulated by
stipulated by
SEBI
SEBI
European
Maximum of 3- Same as index
Month
trading
futures
cycle.
on
American
Same as index
Same as index
futures
futures
Same as index
Same as index
futures
futures
As stipulated by
As stipulated by
At any point in
time,
there will be 3
contracts available
:
3)
far
duration
Expiry Day
Contract Size
month
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1) near month,
futures
previous day
Same as Index
of the options
closing value of
options
contract arrived at
underlying
based on Black-
security
thereof
Price Steps
Re.0.05
Base Price-
previous
closing
Re.0.05
day Theoretical value
First day of
Nifty value
trading
Scholes model
Base Price-
Daily settlement
Subsequent
price
Price Bands
Operating
are
options
Operating
Operating
at + 20 %
kept at 99% of
kept at + 10 %
price
Quantity
Freeze
20,000 units or
20,000 units or
Lower of 1% of
Same as
greater
greater
market wide
individual
position limit
futures
or Rs.5 crores
BSE also offers similar products in the derivatives segment.
DERIVATIVES USERS IN INDIA
The use of derivatives varies by type of institution. Financial institutions, such as banks, have
assets and liabilities of different maturities and in different currencies, and are exposed to
different risks of default from their borrowers. Thus, they are likely to use derivatives on interest
rates and currencies, and derivatives to manage credit risk. Non-financial institutions are
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open positions
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stipulated for
regulated differently from financial institutions, and this affects their incentives to use
derivatives. Indian insurance regulators, for example, are yet to issue guidelines relating to the
use of derivatives by insurance companies. In India, financial institutions have not been heavy
users of exchange-traded derivatives so far, with their contribution to total value of NSE trades
being less than 8% in October 2005. However, market insiders feel that this may be changing, as
indicated by the growing share of index derivatives (which are used more by institutions than by
retail investors). In contrast to the exchange-traded markets, domestic financial institutions and
mutual funds have shown great interest in OTC fixed income instruments. Transactions between
banks dominate the market for interest rate derivatives, while state-owned banks remain a small
presence (Chitale, 2003). Corporations are active in the currency forwards and swaps markets,
buying these instruments from banks. Why do institutions not participate to a greater extent in
derivatives markets? Some institutions such as banks and mutual funds are only allowed to use
derivatives to hedge their existing positions in the spot market, or to rebalance their existing
portfolios. Since banks have little exposure to equity markets due to banking regulations, they
have little incentive to trade equity derivatives. Foreign investors must register as foreign
institutional investors (FII) to trade exchange-traded derivatives, and be subject to position limits
as specified by SEBI. Alternatively, they can incorporate locally as a broker-dealer. FIIs have a
small but increasing presence in the equity derivatives markets. They have no incentive to trade
interest rate derivatives since they have little investments in the domestic bond markets (Chitale,
2003). It is possible that unregistered foreign investors and hedge funds trade indirectly, using a
local proprietary trader as a front (Lee, 2004).
THE NEED FOR A DERIVATIVES MARKET
The derivatives market performs a number of economic functions:
1. They help in transferring risks from risk averse people to risk oriented people
2. They help in the discovery of future as well as current prices
3. They catalyze entrepreneurial activity
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4. They increase the volume traded in markets because of participation of risk averse people
in greater numbers
3. 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 given 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.
4. WARRANts: Options generally have lives of upto 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.
5. LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities. These
are options having a maturity of upto three years.
6. BASKETS: Basket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average or a basket of assets. Equity index options
are a form of Basket options.
7. 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:
CURRENCY SWAPS: These entail swapping both principal and interest between the
Parties, with the cash flows in one direction being in a different currency than those In
the opposite direction.
8. SWAPTIONS: 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 receiver 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 receive floating.
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INTEREST RATE SWAPS: These entail swapping only the interest related cash flows
Transactional efficiency
RISK MANAGEMENT
The principal benefit of the Derivative market is that it provides the opportunity for risk
management through Hedging.
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Price discovery
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Risk management
3. Return enhancement hedge using derivatives to create synthetic securities, which minic
cash assets.
PRICE DISCOVERY
The second major function of derivative market is price discovery. This is a process of
providing equilibrium prices that reflect current and prospective demands on current and
prospective supplies, and making these prices visible to all.
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TRANSACTIONAL EFFICIENCY
Derivative markets allow institution to transact more efficiently than otherwise. They reduce the
direct cost of transacting in cash/financial markets are also provided, through clearing houses, an
efficient mechanism to deal with counter party risk.
INTRODUCTION TO 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. Future markets were designed to solve the problems that exist in
forward markets. But unlike forward contracts, the futures contracts ate standardized and
exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain
standard features of the contract. It is a standardized contract with standard underlying
instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or
which can be used for reference purposes in settlement) and a standard timing of such settlement.
The standardized items in a futures contract are:
o Quantity of the underlying
o Quality of the underlying
o Date and Month of Delivery
o The units of Price quotations and Minimum price changes
o Location of settlement
TYPES OF FUTURES
On the basis of the underlying asset they derive, the futures are divided into following types.
INDEX FUTURES
Index futures are the futures, which have the underlying asset as an Index. The Index
futures are also cash settled. The settlement price of the Index futures shall be the closing
value of the underlying index on the expiry date of the contract.
COMMODITY FUTURES
In this case, the underlying asset is a commodity. It can be an agricultural commodity like
wheat corn, or even a precious asset like gold, silver etc.
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The stock futures are the futures that have the underlying asset as the individual securities.
The settlement of the stock futures is of cash settlement and the settlement price of the future
is the closing price of the underlying security.
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STOCK FUTURES
FINANCIAL FUTURES
In this case, the underlying assets are financial instruments like money market paper,
Treasury Bills, notes, bonds etc.
CURRENCY FUTURES
Currency futures are those in which the underlying assets are major convertible
currencies like the U.S. dollar, the Pound Sterling, the Euro and the Yen etc.
MARGINS
Margins are the deposits, which reduce counter party risk, arise in a futures contract.
These margins are collected in order to eliminate the counter party risk. There are three types of
margin.
INITIAL MARGINS
Whenever a futures contract is signed, both buyer and seller are required to post initial
margin. Both buyer and seller are required to make security deposits that are intended to
guarantee that they will infact be able to fulfill their obligation. These deposits ate Initial margins
and they are often referred as performance as performance margins. The amount of margin is
roughly 5% to 15% of total purchase price of futures contract.
MARKING OF MARKET MARGIN
The process of adjusting the equity in an investors account in order to reflect the change
in the settlement price of futures contract is known as MTM Margin.
MAINTENANCE MARGIS
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The investor must keep the futures account equity equal to or grater than certain
percentage pf the amount deposited as Initial Margin. If the equity goes less than that percentage
of Initial margin, then the investor receives a call for an additional deposit of cash known as
Maintenance Margin to bring the equity up to the Initial margin.
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F Futures Price
DEBT
MARKET
DERIVATIVES
IN
DEBT
MARKET
1. Arbitrage between spot and derivative market generates a new order flow for the spot
market.
2. Access to derivatives, which can be used in hedging systematic risk factors, reduces the
economic cost of holding undiversified inventories in spot market trading and hence
improves the supply of liquidity on the spot market.
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The spot market for interest rates, in numerous countries, is notorious for non-transparency,
barriers to market access, and hence poor liquidity and market efficiency. The entrenched nature
of intermediation and regulation on the spot market often make it difficult for policy makers to
make progress in terms of making improvements on it. In this situation, policy makers generally
have an opportunity to start afresh on interest rate derivatives, in terms of moving towards much
more transparent markets, opening up access to the market to all economic agents, and obtaining
liquidity and market efficiency. It is often possible to obtain a situation where price discovery is
focused upon the derivative market, which would then drive prices on the spot market. Trading
in interest rate derivatives market enhances liquidity of the interest rate spot market through three
channels:
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The traditional focus in debt market development has been to obtain a liquid market for interest
rate products which yields the rate of time preference for various maturities. Often it is felt that
there is an innate sequencing of market development, where countries should embark upon debt
derivatives after core issues of the spot market have been properly addressed. A liquid spot
market for interest rates is clearly valuable in the establishment of interest rate derivatives.
However, interest rate derivatives provide important feedback mechanisms through which
market efficiency can be obtained in the spot interest rate market itself: Derivatives trading can
lead to improvements in the liquidity of the spot market since interest rate derivatives improve
the ability of economic agents to reduce their vulnerability to interest rate volatility. Many
developing countries have started out on financial sector reforms in an environment with fixed
interest rates and a repressed financial sector. Moving away from this regime towards greater
interest rate flexibility imposes costs upon economic agents who are used to fixed interest rates.
From a political economy standpoint, it is useful to develop institutional mechanisms for
derivatives trading on a spot price before undertaking economic reforms which would increase
the volatility of that price. Interest rate derivatives reduce the political cost of moving away from
a repressed interest rate market.
3.
Access to leveraged speculation on interest rates on the interest rate derivative markets
increases the supply of research and forecasting about interest rates. This reduces
uncertainty about future interest rates, and helps to narrows spreads on the spot market.
METHODOLOGY
The Methodology of the study consists of
Source of data collection
Statistical tool
Data Analysis
SOURCE OF DATA COLLECTION
The data had been collected through Primary and Secondary sources.
PRIMARY SOURCES
The data had been collected through project guide and staff of the Company.
SECONDARY SOURCES
The data had been collected through Books, Journals and Websites.
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The data collected from the above sources have been analysed through Moving Average
Method, which is one of the popular statistical tool in technical analysis is considered for the
study. To examine the underlying trend by smoothing of the data and to provide the Buy and Sell
signals to the selected stocks this method serves the best. Moving averages are used along with
the price of the scrip. The stock price may intersect the moving average at a particular point.
Downward penetration of the rising average indicates the possibility of a further fall and gives
sell signal. Upward penetration of the falling average would indicate the possibility of the
further rise and gives the buy signal.
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STATISTICAL TOOL
Index future
Stock option
Index option
52
31
13
RS IN CR
Year
s
Index
future
Stock
future
Index
option
Stock
option
Interes
t rate
future
Total
Average
daily
turnover
2010
2009
2583617.9
2
2558863.5
5
2358916.9
0
149498.4
0
7650896.80
46938.0
2
13090477.7
5
2007
3820667.2
7
7548563.2
3
1362110.8
8
359136.5
5
52153.3
0
7356242
94
2008
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2006
2539574
3830967
791906
193795
4824174
29543
2005
1513755
2791697
338469
180253
2546982
19220
2004
772147
1484056
121943
168836
202
2130610
10107
2003
554446
1305939
52816
217207
439862
8388
2002
43952
286533
9246
100131
101926
1752
21483
51515
3765
25163
---
2365
410
2365
---
---
---
11
2010-09
3,551,038
13090477.75
2009-08
1,945,285
7356242
2008-07
1,569,556
4824174
2007-06
1,140,071
2546982
2006-05
1,099,535
2130610
2005-04
617,989
439862
2004-03
513,167
101926
2003-02
1,339,510
2365
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cash segment
95
Year
Derivate segment
Cash segment
2010-09
52153.30
14.148
2009-08
29543
7,812
2008-07
19220
6,253
2007-06
10107
4506
2006-05
8388
4,328
2005-04
1752
2,462
2004-03
410
2,078
2003-02
11
5,337
Source: Complied from NSE website and NSE fact book 2010
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The derivatives segment has expanded in the recent years in a substantial way both globally as
well as in the Indian capital market. The figures revealed by Futures Industry Association (FIA)
Annual Volume Survey and reported here under bring out the fact that more than 15 billion
futures and options contracts were traded during 2009 on the 54 important exchanges that report
to the FIA, reflecting a remarkable increase of 28% from the previous year. Looking back at the
last four years, it can be worked out that these figures reflect that the growth rate was 29 % in
2008, 19% in 2008, 12% in 2007, and 9% in 2006. From the same table it also follows that of the
total volume traded globally over the period 2000-07, the US exchanges alone constituted as
much as 35 percent share. presents the break down of derivatives volume by region and it is
clearly evident that after North America with a share of about 40 percent, Asia-Pacific occupies
the second slot with a share of 28 percent and Europe falls at the third place with its contribution
of 24 percent. If we compare the turnover-wise performance of the derivatives segments over the
last five years, it may be noticed from an inspection of the relevant columns. the Indian segment
has expanded phenomenally as compared to the global segment. The turnover of the NSE
derivatives segment in 2006-08 stood at Rs. 2130610 crores. It grew to an astonishing level of
Rs.13090477 crores during the year 2007-09, displaying a more than six-time increase over the
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five year period. In marked contrast, at the global level the increase was less than even two-fold:
the turnover was $ 8163 million in 2003 and $ 15187 million in 2007.
GLOBAL TREND IN TURNOVER OF DERIVATIVES TRADING
Year
US exchange
Non-US exchange
Global
2002
1313.65
1675.80
2989.45
2003
1578.62
2768.70
4347.32
2004
1844.90
4372.38
6217.28
2005
2172.52
5990.22
8162.54
2006
2795.21
6069.50
8864.71
2007
3525.00
6448.67
9973.67
2008
4616.73
7245.48
11862.21
2009
6137.20
9049.47
15186.67
2002-09
23983 (35.48)
43620 (64.52)
67604 (100)
REFERENCES
1. Chitale, Rajendra P., 2003, Use of Derivatives by Indias Institutional Investors: Issues
and Impediments, in Susan Thomas (ed.), Derivatives Markets in India, Tata McGrawHill Publishing Company Limited, New Delhi, India.
2. FitchRatings, 2004, Fixed Income Derivatives---A Survey of the Indian Market,
www.fitchratings.com www.fitchratings.com
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Innovation of derivatives have redefined and revolutionised the landscape of financial industry
across the world and derivatives have earned a well deserved and extremely significant place
among all the financial products. Derivatives are risk management tool that help in effective
management of risk by various stakeholders. Derivatives provide an opportunity to transfer risk,
from the one who wish to avoid it; to one, who wish to accept it. Indias experience with the
launch of equity derivatives market has been extremely encouraging and successful. The
derivatives turnover on the NSE has surpassed the equity market turnover. Significantly, its
growth in the recent years has surpassed the growth of its counterpart globally.
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CONCLUSION
3. Gambhir, Neeraj and Manoj Goel, 2003, Foreign Exchange Derivatives Market in India--Status and Prospects, Susan Thomas (ed.), Derivatives Markets in India, Tata McGrawHill Publishing Company Limited, New Delhi, India.
4. Gorham, Michael, Thomas, Susan and Ajay Shah, 2005, India: The Crouching Tiger,
Futures Industry.
5. Lee, Rupert, 2004, Seeing Double, FOW. ISMR, Indian Securities Market: A Review,
2004, National Stock Exchange of India Limited, Mumbai, India.
6. Jogani, Ashok and Kshama Fernandes, 2003, Arbitrage in India: Past, Present and Future,
in Susan Thomas (ed.), Derivatives Markets in India, Tata McGraw-Hill Publishing
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7. Nair, C. G. K., 2004, Commodity Futures Markets in India: Ready for Take Off?
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at:
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pp
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