der@ktk with ABB.doc | Futures Contract | Derivative (Finance)

A Project report on

A SHORT DERIVATIVES REPORT ON ABB GROUP

SUBMITTED BY

R.SUSHEEL KUMAR
(HT.No: 098– 060 – 117)

Project submitted in partial fulfillment for the award of the Degree of MASTER OF BUSINESS ADMINISTRATION by Osmania University, Hyderabad -500007

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DECLARATION

I hereby declare that this Project Report titled A SHORT DERIVATIVES
REPORT ON ABB GROUP, At Kotak securities. Submitted by me to the

Department of Business Management, O.U., Hyderabad, is a bonafide work undertaken by me and it is not submitted to any other University or Institution for the award of any degree diploma/ certificate or published any time before.

Name and Address of the Student R.SUSHEEL KUMAR MC 436, MALAKPET HYDERBAD

Signature of the Student

ABSTRACT

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The following are the steps involved in the study. 1. Selection of the scrip:The scrip selection is done on a random and the scrip selected isABB GROUP. The lot size is 375 . Profitability position of the futures buyer and seller and also the option holder and option writer is studied. 2. Data Collection:The data of the ABB group Ltd. Has been collected from “the economic times” and the internet The data consists of the February contract and the period of data collection is from 1-FEB 2008-28th FEB 2008 3. Analysis:The analysis consist of the tabulation of the data assessing the profitability positions of the futures buyer and seller and also option holder and the option writer.

ACKNOWLEDGEMENT

I a m d e e p l y i n d e b t e d t o my H e a d o f t h e d e p a r t me n t a n d g u i d e M r s . U ma r a n i a n d M r . V i sw a n a t h S h a r ma w h o

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have been a great source of strength and inspiration at every stage of project work. I would like to acknowledge my sincere thanks to Mrs.B.IndiraReddy, Reddy Director of principal St.Pauls and P.G. Mr. Raghava for College

making all the facilities available to me. I a m e x t r e me l y t h a n k i n g t o M r . B . S R I N I V A S , A s s t . Manager, of KOTAK SECURITIES, and also other staff m e m b e r s o f , w i t h o u t t h e i r k i n d c o- o p e r a t i o n a n d h e l p t h e project could not have been successful.

DATE: PLACE:

(R.SUSHEEL KUMAR)

Table of contents

Page No.

Chapter – 1 Introduction
Scope Objectives Limitations 1 2 3

Chapter – 2 Review of literature
Introduction 5
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History of Derivatives Development of derivatives market Arguments Need for derivatives Functions of derivatives market Types of derivatives 6 10 13 14 15 16 Chapter – 3 The company Company Profile Company Products 22 24 48 Chapter – 4 Data analysis and presentation Chapter – 5 Summary and Conclusion Findings Summary Conclusions Recommendations 71 72 73 74 Chapter 6 – Bibliography 75 5 .

Chapter – 1 Introduction 6 .

SCOPE The study is limited to “Derivatives” with special reference to futures and option in the Indian context. Any alteration may come. The study is not based on the international perspective of derivatives markets. The study has only made a humble attempt at evaluation derivatives market only in India context. CBOT etc. which exists in NASDAQ. 7 . The study can’t be said as totally perfect.

4 To study about risk management in financial markets with the help of derivatives.OBJECTIVES OF THE STUDY: 1 2 3 To analyze the derivatives traded in stock markets in India. To find the profit/loss position of futures buyer and seller and also the option writer and option holder. 8 . To analyze the operations of futures and options.

2 The data collected is completely restricted to the ABB GROUP (ELECCTRICALS AND SWITCHES) of FEBRUARY 2008.LIMITATIONS OF THE STUDY: The following are the limitation of this study. 1 The scrip chosen for analysis is ABB GROUP (ELECCTRICALS AND SWITCHES) and the contract taken is February 2008 ending one –month contract. hence this analysis cannot be taken universal. 9 .

CHAPTER – 2 Review Of Literature 10 .

1956 (SCR Act) defines “derivative” to secured or unsecured. currency. interest. Derivatives are risk management instruments.DERIVATIVES:- The emergence of the market for derivatives products. The underlying asset can be equity. derivative product minimizes the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. 2) A contract which derives its value from the prices. to gain access to cheaper money and to make profit.. index. commodity or any other asset. or index of prices. The underlying asset can be bullion. by locking-in asset prices. Derivatives are likely to grow even at a faster rate in future. forex. companies and investors to hedge risks. Through the use of derivative products. most notably forwards. which derive their value from an underlying asset. can be tracked back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. futures and options. use derivatives. However. of underlying 11 . these generally do not influence the fluctuations in the underlying asset prices. risk instrument or contract for differences or any other form of security. etc. it is possible to partially or fully transfer price risks by locking-in asset prices. 1) Securities Contracts (Regulation)Act. the financial markets are marked by a very high degree of volatility. bonds. As instruments of risk management. DEFINITION Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. Banks. Securities firms. By their very nature. share.

but because he preferred Rachel. What follows here is a snapshot of the major events that I think form the evolution of derivatives. Jacob married Leah. 12 . The celebrated Dutch Tulip bulb mania. HISTORY OF DERIVATIVES The history of derivatives is quite colorful and surprisingly a lot longer than most people think. In Genesis Chapter 29. perhaps making this not only the first derivative but the first default on a derivative. I would like to first note that some of these stories are controversial. believed to be about the year 1700 B. which obligated him to the marriages but that does not matter. and finally married Rachel. requiring seven more years of labor. Laban required Jacob to marry his older daughter Leah. Jacob did derivatives. Some argue that Jacob really had forward contracts. Jacob purchased an option costing him seven years of labor that granted him the right to marry Laban's daughter Rachel.C. oneway or the other. which permitted forward contracting. Days back I compiled a list of the events that I thought shaped the history of derivatives. bigamy being allowed in those days. reneged.securities. he purchased another option. The first exchange for trading derivatives appeared to be the Royal Exchange in London. was characterized by forward contract on tulip bulbs around 1637. His prospective father-inlaw. however.. Do they really involve derivatives? Or do the minds of people like myself and others see derivatives everywhere? To start we need to go back to the Bible.

futures contracts were pretty much of the form we know them today. which made them much like today's futures. These contracts were eventually standardized around 1865. although it is not known if the contracts were marked to market daily or had credit guarantees. its facilities were underutilized in the spring. The grain could always be sold and delivered anywhere else at any time. Due to the seasonality of grain. the Chicago Produce 13 . Due to its prime location on Lake Michigan. and in 1925 the first futures clearinghouse was formed. Japan around 1650.The first "futures" contracts are generally traced to the Yodoya rice market in Osaka. Chicago's storage facilities were unable to accommodate the enormous increase in supply that occurred following the harvest. A group of grain traders created the "to-arrive" contract. sale. These to-arrive contracts Proved useful as a device for hedging and speculating on price changes. Chicago was developing as a major center for the storage. however. Farmers and traders soon realized that the sale and delivery of the grain itself was not nearly as important as the ability to transfer the price risk associated with the grain. Chicago spot prices rose and fell drastically. This allowed the farmer to store the grain either on the farm or at a storage facility nearby and deliver it to Chicago months later. S. was the creation of the Chicago Board of Trade in 1848. In 1874 the Chicago Mercantile Exchange's predecessor. These were evidently standardized contracts. and the most significant as far as the history of U. Probably the next major event. and distribution of Midwestern grain. futures markets. From that point on. which permitted farmers to lock in the price and deliver the grain later. Similarly.

setting up shop elsewhere.Exchange. which allowed trading in currency futures. In 1975 the Chicago Board of Trade created the first interest rate futures contract. These were the first futures contracts that were not on physical commodities. a contract on the Value Line Index. one based on Ginnie Mae (GNMA) mortgages. Other exchanges had been popping up around the country and continued to do so. It became the modern day Merc in 1919. In 1922. While the contract met with initial success. was formed. the option pricing model of Fischer Black and Myron Scholes. the Kansas City Board of Trade launched the first stock index futures. responding to the now-freely floating international currencies. The Chicago Mercantile Exchange quickly followed with their highly successful contract on the S&P 500 index. it eventually died. These events revolutionized the investment 14 . created the International Monetary Market. In 1982. The early twentieth century was a dark period for derivatives trading as bucket shops were rampant. In 1972 the Chicago Mercantile Exchange. which has now surpassed the T -bond contract to become the most actively traded of all futures contracts. In 1973 marked the creation of both the Chicago Board Options Exchange and the publication of perhaps the most famous formula in finance. In 1982 the CME created the Eurodollar contract. Bucket shops are small operators in options and securities that typically lure customers into transactions and then flee with the money. the federal government made its first effort to regulate the futures market with the Grain Futures Act.

set up a mathematical framework that formed the basis for an explosive revolution in the use of derivatives. the largest derivative exchange in the world. it was soon turned over to Standard and Poor's and became known as the S&P 100. There are various contracts currently traded on these 15 . as we know them today. In 1994 the derivatives world was hit with a series of large losses on derivatives trading announced by some well-known and highly experienced firms. futures contracts have remained more or less in the same form. The commodity derivative market has been functioning in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Exchange traded financial derivatives were introduced in India in June 2000 at the two major stock exchanges. NSE and BSE. Though originally known as the CBOE 100 Index. was established in 1848 where forward contracts on various commodities were standardized around 1865. as it came to be known. Derivatives have had a long presence in India. In 1983. which remains the most actively traded exchange-listed option. The Chicago Board of Trade (CBOT). The Black-Scholes model. Since then contracts on various other commodities have been introduced as well.world in ways no one could imagine at that time. From then on. such as Procter and Gamble and Metallgesellschaft. In recent years exchanges have increasingly move from the open outcry system to electronic trading. the Chicago Board Options Exchange decided to create an option on an index of stocks.

DEVELOPMENT OF DERIVATIVES MARKET IN INDIA The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws(Amendment) Ordinance. did not take off. which withdrew the prohibition on options in securities. The committee submitted its report on March 17. to provide a platform for commodities trading.L. This need eventually resulted in the creation of the financial derivatives industry. 1996 to develop appropriate regulatory framework for derivatives trading in India. The market for derivatives. 1995.Gupta on November 18. 1998 prescribing necessary pre–conditions for introduction of derivatives trading in India. as there was no regulatory framework to govern trading of derivatives. A means for managing risk was required.The derivatives market in India has grown exponentially. Derivatives are powerful risk management tools.and because interest rates affect and are also affected by exchange rates. DEVELOPMENT OF DERIVATIVES MARKET : The explosion of growth in Derivative markets coincide with the collapse of Bretton Woods fixed exchange rate regime and the suspension of doller’s convertibility into gold. Stock Futures are the most highly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE. SEBI set up a 24–member committee under the Chairmanship of Dr. The committee recommended that derivatives should be declared as ‘securities’ so that 16 . interest rates also became more volatile. however.National Commodity & Derivatives Exchange Limited (NCDEX) started its operations in December 2003. as on April 13. 2005. especially at NSE.C. Exchange rates became much more volatile.exchanges.

NSE and BSE. To begin with. The government also rescinded in March 2000. broker net worth. 2001 and the trading in options on individual securities commenced in July 2001. SEBI permitted the derivative segments of two stock exchanges. worked out the operational details of margining system.J. The report.Varma. The Securities Contract Regulation Act (SCRA) was amended in December 1999 to include derivatives within the ambit of ‘securities’ and the regulatory framework was developed for governing derivatives trading.R. The trading in index options commenced on June 4. which prohibited forward trading in securities. SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE– 30(Sensex) index.regulatory framework applicable to trading of ‘securities’ could also govern trading of securities. 2000. deposit requirement and real–time monitoring requirements. The trading in BSE Sensex options commenced on June 4. SEBI also set up a group in June 1998 under the Chairmanship of Prof. which was submitted in October 1998. and their clearing house/corporation to commence trading and settlement in approved derivatives contracts. 2001 and trading in options on individual securities commenced on July 2. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on a recognized stock exchange. methodology for charging initial margins. Futures contracts on individual stocks were launched in November 2001. This was followed by approval for trading in options based on these two indexes and options on individual securities. the three– decade old notification. to recommend measures for risk containment in derivatives market in India. The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12. 17 . thus precluding OTC derivatives. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001.

2001. and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette.Their value is derived from an underlying asset/instrument 2. byelaws. Characteristics of derivatives 1. The index futures and options contract on NSE are based on S&P CNX. Trading and settlement in derivative contracts is done in accordance with the rules.They are leveraged instruments 18 . 2001. Single stock futures were launched on November 9.They are vehicles for transerfering risk 3. Foreign Institutional Investors (FIIs) are permitted to trade in all Exchange traded derivative products.

There is a continued debate about the Indian markets capability to provide enough liquidity to derivative trader.These instruments require a well functioning & mature spot market. which resembles far reaching consequences. Arbitrage between cash and futures markets fetches additional business to cash market. Lesser volatility Improved Price discovery ARGUMENTS AGAINST DERIVATIVES 1 Speculation :It is felt that these instruments will increase the speculation in the financial markets. 5 Liquidity risk :liquidity of market means the ease with which one can enter or get out of the market.imperfection in the markets make derivative market more difficult to function. 4 Counter party risk : most of the derivative instruments are not exchange traded. 19 . 4 5 6 Improvement in delivery based business.so there is a counter party default risk in these instruments. 2 Market efficiency : It is felt that Indian markets are not mature and efficient enough to introduce these kinds of new instruments. 3 Volatility:The increased speculation & inefficient market will make the spot market more volatile with the introduction of derivatives.ARGUMENTS IN FAVOUR OF DERIVATIVES 1 2 3 Higher liquidity Avaliability of risk management products attracts more investors to the cash market.

They help in transferring risks from risk averse people to risk oriented people. They use futures or options markets to reduce or eliminate this risk. they will take offsetting position in the two markets to lock in a profit. HEDGERS: Hedgers face risk associated with the price of an asset.They help in discovery of futures as well as current prices 3. they see the futures price of an asset getting out of line with the cash price. Futures and options contracts can give them an extra leverage. PARTICIPANTS: The following three broad categories of participants in the derivatives market.They increase savings and investment in the longrun. for. 2. 20 .NEED FOR A DERIVATIVES MARKET The derivatives market performs a number of economic functions: 1. 5. example. they can increase both the potential gains and potential losses in a speculative venture. that is.They catalyze entrepreneurial activity 4.These markets increase volumes trading in market due to participation of risk averse people. if. SPECULATORS: Speculators wish to bet on future movements in the price of an asset. ARBITRAGEURS: Arbitrageurs are in business to take of a discrepancy between prices in two different markets.

3 4 Derivatives trading acts as a catalyst for new entrepreneurial activity. 2 Derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivatives markets help increase saving and investment in long run. 21 . They are: 1 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.FUNCTIONS OF DERIVATIVES MARKETS: The following are the various functions that are performed by the derivatives markets.

OPTIONS: Options are of two types-calls and puts.TYPES OF DERIVATIVES: The following are the various types of derivatives.They give the holder a right to sell a specific number of underlying equity shares of a particular company at the strike price on or the before the maturity. where settlement takes place on a specific date in the future at today’s pre-agreed price. Puts give the buyer the right. FUTURES: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the at a certain price. Put options: Put options are the sellers options. They are: FORWARDS: A forward contract is a customized contract between two entities.They give the holder a right to buy a specific number of underlying equity shares of a particular company at the strike price on or the before the maturity. but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. CALL OPTIONS: A call options are the buyers options. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. American options: 22 . at a given price on or before a give future 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. Currency Swaps: These entail swapping both principal and interest between the parties. Longer-dated options are called warrants and are generally traded over-the counter. European options: European options are options that can be exercised only on the expiration date itself. Most exchange-traded options are American. The two commonly used Swaps are: Interest rate Swaps: These entail swapping only the related cash flows between the parties in the same currency. SWAPS: Swaps are private agreements between two parties to exchange cash floes in the future according to a prearranged formula. Thus a swaption is an option on a forward swap. They can be regarded as portfolios of forward contracts. LEAPS: 23 . SWAPTION: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options.American options are options are options that can be exercised at any time upto the expiration date. with the cash flows in on direction being in a different currency than those in the opposite direction. European options are easier to analyze than American options. and properties of an American option are frequently deduced from those of its European counterpart.

The acronym LEAPS means long-term Equity Anticipation securities. These forces are to a large extent controllable and are termed as non systematic risks. etc. industries and groups so that a loss in one may easily be compensated with a gain in other. · · · · Price or dividend (interest) Some are internal to the firm likeIndustrial policy Management capabilities Consumer’s preference Labor strike. These are options having a maturity of up to three years. An investor can easily manage such non-systematic by having a well-diversified portfolio spread across the companies. They are: 1. RATIONALE BEHIND THE DELOPMENT OF DERIVATIVES: Holding portfolios of securities is associated with the risk of the possibility that the investor may realize his returns. BASKETS: Basket options are options on portfolios of underlying assets. They are termed as systematic risk. which affect the returns: 1. The underlying asset is usually a moving average of a basket of assets. There are yet other of influence which are external to the firm.Political 24 . Equity index options are a form of basket options. There are various factors. which would be much lesser than what he expected to get. cannot be controlled and affect large number of securities. 2.Economic 2.

inflation. Those factors favor for the purpose of both portfolio hedging and speculation. We therefore quite often find stock prices falling from time to time in spite of company’s earning rising and vice versa. their effect is to cause prices of nearly all-individual stocks to move together in the same manner. The committee submitted its report in March 1998. Rational Behind the development of derivatives market is to manage this systematic risk. Regulation for Derivative Trading: SEBI set up a 24 member committed under Chairmanship of Dr. In debt market. a large position of the total risk of securities is systematic. SEBI also approved he “suggestive bye-laws” recommended by the committee for regulation and control of trading and settlement of Derivative contract. For instance. the SEBI Act. liquidity in the sense of being able to buy and sell relatively large amounts quickly without substantial price concession. REGULATORY FRAMEWORK: The trading of derivatives is governed by the provisions contained in the SC R A. L.3. interest rate. On May 11. C. etc. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. and the regulations framed there under the rules and byelaws of stock exchanges. Sociological changes are sources of systematic risk. 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index Futures. The provision in the SCR Act governs the trading in the securities. the introduction of a derivatives securities that is on some broader market rather than an individual security. Gupta develop the appropriate regulatory framework for derivative trading in India. The amendment of the 25 .

Exchange should also submit details of the futures contract they purpose to introduce. 7. The members of an existing segment of the exchange will not automatically become the members of the derivatives segment. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. 5. 4. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing corporation/clearing house. The Minimum contract value shall not be less than Rs. C. Derivatives broker/dealers and Clearing members are required to seek registration from SEBI. The trading members are required to have qualified approved user and sales persons who have passed a certification programme approved by SEBI 26 . 6. C. Clearing Corporation/Clearing House complying with the eligibility conditions as lay down by the committee have to apply to SEBI for grant of approval. Gupta committee report may apply to SEBI for grant of recognition under section 4 of the SCR Act. The members of the derivatives segment need to fulfill the eligibility conditions as lay down by the L. Eligibility criteria as prescribed in the L. Gupta committee. 2. 1956 to start Derivatives Trading. 1. The derivative exchange/segment should have a separate governing council and representation of trading/clearing member shall be limited to maximum 40% of the total members of the governing council.SCR Act to include “DERIVATIVES” within the ambit of securities in the SCR Act made trading in Derivatives possible with in the framework of the Act.2 Lakh. 3. The exchange shall have minimum 50 members.

Chapter .3 THE COMPANY ‘ 27 .

Dubai and Mauritius. London. representative offices and satellite offices across 300 cities and towns in India and offices in New York. Jayaram Mr. The Group services around 2. franchisees.2 million customer accounts. Dipak Gupta Executive Vice Chairman & Managing Director The Kotak Mahindra Group was born in 1985 as Kotak Capital Management Finance Limited. C.100 crore. to life insurance. From commercial banking. offering complete financial solutions that encompass every sphere of life. A. 3. Uday Kotak Mr. to mutual funds.600 people in its various businesses and has a distribution network of branches. This company was promoted by Uday Kotak. Group Management Mr. to stock broking. Shivaji Dam Mr. Sidney A. Pinto and Kotak & Company. employs around 9. Industrialists Harish Mahindra and Anand Mahindra took a stake in 28 . the group caters to the financial needs of individuals and corporates. to investment banking.COMPANY PROFILE The Kotak Mahindra Group Kotak Mahindra is one of India's leading financial institutions. The group has a net worth of around Rs.

Takes over FICOM. Investment Banking division incorporated into a separate company . Enters the mutual fund market with the launch of Kotak Mahindra Asset Management Company.the first Indian company to do so. for financing Ford vehicles. Since then it's been a steady and confident journey to growth and success. The launch of Matrix Information Services Limited marks the Group's entry into information distribution. a private equity fund.Kotak Mahindra Capital Company The Auto Finance Business is hived off into a separate company . Matrix sold to Friday Corporation Launches Insurance Services Kotak Mahindra Finance Ltd. one of India's largest financial retail marketing networks Enters the Funds Syndication sector Brokerage and Distribution businesses incorporated into a separate company Kotak Securities.kotaksecurities. 1986 1987 1990 1991 1992 1995 Kotak Mahindra Finance Limited starts the activity of Bill Discounting Kotak Mahindra Finance Limited enters the Lease and Hire Purchase market The Auto Finance division is started The Investment Banking Division is started. for the Life Insurance business.1986. Kotak Securities launches its on-line broking site (now www. Kotak Group realigns joint venture in Ford Credit. Kotak Mahindra takes a significant stake in Ford Credit Kotak Mahindra Limited. and that's when the company changed its name to Kotak Mahindra Finance Limited. Kotak Mahindra ties up with Old Mutual plc. Buys Kotak Mahindra Prime (formerly known as Kotak Mahindra Primus Limited) and sells Ford credit Kotak Mahindra. Launches a real estate fund Bought the 25% stake held by Goldman Sachs in Kotak Mahindra Capital Company and Kotak Securities 1996 1998 2000 2001 2003 2004 2005 2006 29 . Launches India Growth Fund. Commencement of private equity activity through setting up of Kotak Mahindra Venture Capital Fund.com). converts to a commercial bank .Kotak Mahindra Prime Limited (formerly known as Kotak Mahindra Primus Limited).

the infrastructure and most importantly the commitment to deliver pragmatic. a company with 160 years experience in life insurance. Old Mutual. we have the products.COMPANY PRODUCTS Kotak Mahindra Bank At Kotak Mahindra Bank. the experience. Kotak Mahindra Old Mutual Life Insurance is a 76:24 joint venture between Kotak Mahindra Bank Ltd. is an international financial services group listed on the London Stock Exchange and included in the FTSE 100 list of companies. and Old Mutual plc. with assets under management worth $ 400 Billion as on 30th June. 2006. Kotak Mahindra Old Mutual Life Insurance is one of the fastest growing insurance companies in India and has shown remarkable growth since its inception in 2001. For customers. this joint venture translates into a company that combines international expertise with the understanding of the local market 30 . we address the entire spectrum of financial needs for individuals and corporates. end-to-end solutions that really work.

India's best Equity House Finance Asia Award (2005)-Best Broker In India Euromoney Award (2005)-Best Equities House In India Finance Asia Award (2006).5 % as on 31st March.Institutional Equities Kotak Securities. The company is dedicated to financing and supporting automotive and automotive related manufacturers. Kotak Securities Ltd.Car Finance Kotak Mahindra Prime Limited (KMPL) is a subsidiary of Kotak Mahindra Bank Limited formed to finance all passenger vehicles. is the stock-broking and distribution arm of the Kotak Mahindra Group. is India's leading stock broking house with a market share of around 8. The Company also offers Inventory funding to car dealers and has entered into strategic arrangement with various car manufacturers in India for being their preferred financier Kotak Securities Ltd. The institutional business division primarily covers secondary market broking. has been the largest in IPO distribution. It caters to the needs of foreign and Indian institutional investors in Indian equities (both local shares and GDRs). Kotak Securities Ltd. dealers and retail customers. a subsidiary of Kotak Mahindra Bank.The Company offers car financing in the form of loans for the entire range of passenger cars and multi utility vehicles.Largest Distributor of IPO's Finance Asia Award (2004). The 31 .Best Broker In India Euromoney Award (2006) . The accolades that Kotak Securities has been graced with include: · · · · · · Prime Ranking Award(2003-04).Best Provider of Portfolio Management : Equities Kotak Securities Ltd .

division also has a comprehensive research cell with sectoral analysts covering all the major areas of the Indian economy. banks. These subsidiaries specialize in providing services to overseas investors seeking to invest into India. as well as through specific advisory and discretionary investment management mandates from institutional investors. The international subsidiaries offer brokerage and asset management services to institutions and high net worth individuals based outside India through their range of offshore India funds. having consistently led the league tables for lead management in the past five years. The International subsidiaries also provide lead management and underwriting services in conjuction 32 . KMCC has the most current understanding of investor appetite. Investors can access the asset management capability of the international subsidiaries through funds domiciled in Mauritius. London. It has been a leader in the capital markets. Kotak Mahindra Capital Company (KMCC) Kotak Mahindra Capital Company (KMCC) helps leading Indian corporations. Dubai and New York. having been the leading book runner/lead manager in public equity offerings in the period FY 2002-06 Kotak Mahindra International Kotak has wholly-owned subsidiaries with offices in Mauritius. financial institutions and government companies access domestic and international capital markets. leading 16 of the 20 largest Indian offerings between fiscal 2000 and 2006.

Indian Equity Fund of Funds . Offerings from the International subsidiaries Kotak Indian Growth Fund The fund aims to achieve capital appreciation by being invested in shares and equity-linked instruments of Indian companies. ii. Kotak Indian Mid-Cap Fund The fund aims to achieve capital appreciation by being primarily invested in the shares and equity linked instruments of mid-capitalisation companies in India. Equity schemes investing predominantly in Indian equities. Kotak Indian Shariah Fund Kotak Indian Shariah Fund. Equity fund of funds schemes investing predominantly in units of other Mutual Fund schemes that invest mainly in Indian equities. that are either: i.The Portfolio endeavours to achieve capital appreciation by being substantially invested in the shares or units of Mutual Funds schemes.with Kotak Mahindra Capital Company with respect to the issuances of domestic Indian securities in the international marketplace. Kotak Liquid Fund the Kotak Liquid Fund endeavours to invest predominantly in Debt and Money Market instruments of short maturity (less than 180 days) and other funds which invest in such securities across geographies and currencies as applicable 33 . an Indian Equity fund which endeavours to achieve capital appreciation by being invested in the shares and equitylinked instruments of companies which are Shariah compliant. Kotak Indian Life Sciences Fund The fund aims to achieve capital appreciation by being invested in shares and equity-linked instruments of Indian companies in the life sciences business.

office (core and business parks). education and property management. The fund may also invest in bank deposits. established in May 2005. The fund is closed ended and has a life of seven years. the fund would also be investing in non-performing loans with underlying property collateral. Focused India Portfolio Focused India Portfolio seeks to capture the pan-India story through specific bottom up investments across sectors and market capitalizations The Fund Kotak Realty Fund. hospitality (hotels and serviced apartments). 1996 in India. luxury residential. 34 . low cost housing. under the SEBI Venture Capital Fund Regulations. domestic corporates. golf communities). is one of India's first private equity funds with a focus on real estate and real estate intensive businesses.under the prevailing laws. The fund's corpus has been contributed by leading banks. retailing. family offices and high net worth individuals. Asset Class The fund would invest in all the main property asset classes such as residential (townships. Investment Formats The fund would seek equity investments in development projects. enterprise level investments in real estate operating companies. shopping centres and alternative asset classes such as logistics and warehousing. healthcare. and in real estate intensive businesses not limited to hotels. Further. Kotak Realty Fund operates as a venture capital fund.

Coimbotore. KMAMC started operations in December 1998 and has over 4 Lac investors in various schemes. communication and collaborative partnerships take precedence. 35 . NCR and Bangalore but also in Tier II cities such as Pune. This unique team brings together profiles combining real estate corporate finance advisory. due diligence. India and supported by an organization in which thought leadership. executing and managing the investments. the Fund should be well positioned to achieve superior risk adjusted returns. The Fund has a core team of professionals dedicated to sourcing.Geographical Locations In order to achieve geographical diversity.return profiles and was the first fund house in the country to launch a dedicated gilt scheme investing only in government securities. Kotak Mahindra Asset Management Company Limited (KMAMC) Kotak Mahindra Asset Management Company Limited (KMAMC). Mysore and Ludhiana) The Fund Manager believes that through diversification in geographies. examples of which are Nagpur. asset class and investment formats. contrarian play. Hyderabad and Chennai) and other Tier III cities. KMMF offers schemes catering to investors with varying risk . Kolkotta. venture capital. infrastructure development and finance. is the Asset Manager for Kotak Mahindra Mutual Fund (KMMF). and REITS valuation experience. a wholly owned subsidiary of KMBL. Fund Management Team Kotak Realty Fund is managed by its investment team located in Mumbai. the fund would invest in not just the Tier I cities such as Mumbai. analyzing. investment banking.

futures and options.We are sponsored by Kotak Mahindra Bank Limited. 36 . We made a humble beginning in the Mutual Fund space with the launch of our first scheme in December. As instruments of risk management. derivative product minimizes the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. by locking-in asset prices. the financial markets are marked by a very high degree of volatility. DERIVATIVES:The emergence of the market for derivatives products. is our Investment Manager. a wholly owned subsidiary of the bank. it is possible to partially or fully transfer price risks by lockingin asset prices. index.. these generally do not influence the fluctuations in the underlying asset prices. bonds. Derivatives are risk management instruments. can be tracked back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. most notably forwards. Today we offer a complete bouquet of products and services suiting the diverse and varying needs and risk-return profiles of our investors. with a pedigree of over twenty years in the Indian Financial Markets. share. 1998. currency. The underlying asset can be bullion. However. Ltd. Through the use of derivative products. Kotak Mahindra Asset Management Co. We are committed to offering innovative investment solutions and world-class services and conveniences to facilitate wealth creation for our investors. which derive their value from an underlying asset. By their very nature. one of India's fastest growing banks.

Derivatives are likely to grow even at a faster rate in future. HISTORY OF DERIVATIVES The history of derivatives is quite colorful and surprisingly a lot longer than most people think. risk instrument or contract for differences or any other form of security. 1956 (SCR Act) defines “derivative” to secured or unsecured. to gain access to cheaper money and to make profit. His prospective father-in-law. of underlying securities. commodity or any other asset. reneged. Banks. In Genesis Chapter 29.. I would like to first note that some of these stories are controversial. Do they really involve derivatives? Or do the minds of people like myself and others see derivatives everywhere? To start we need to go back to the Bible. believed to be about the year 1700 B. use derivatives. The underlying asset can be equity. Securities firms. perhaps making this not only the first derivative but the first default on a derivative. Securities Contracts (Regulation)Act. Jacob purchased an option costing him seven years of labor that granted him the right to marry Laban's daughter Rachel. however. forex. DEFINITION Derivative is a product whose value is derived from the value of an underlying asset in a contractual manner. Laban 37 . Days back I compiled a list of the events that I thought shaped the history of derivatives. etc.interest.C.. A contract which derives its value from the prices. or index of prices. companies and investors to hedge risks. What follows here is a snapshot of the major events that I think form the evolution of derivatives.

A group of grain traders created the "toarrive" contract. Jacob did derivatives. bigamy being allowed in those days. Similarly. and finally married Rachel. Due to the seasonality of grain. The first exchange for trading derivatives appeared to be the Royal Exchange in London. which obligated him to the marriages but that does not matter. Japan around 1650. Due to its prime location on Lake Michigan. and distribution of Midwestern grain.required Jacob to marry his older daughter Leah. one-way or the other. Chicago was developing as a major center for the storage. although it is not known if the contracts were marked to market daily or had credit guarantees. but because he preferred Rachel. Probably the next major event. he purchased another option. requiring seven more years of labor. its facilities were underutilized in the spring. These were evidently standardized contracts. S. The first "futures" contracts are generally traced to the Yodoya rice market in Osaka. which permitted farmers to lock in the price and deliver the grain 38 . Some argue that Jacob really had forward contracts. was characterized by forward contract on tulip bulbs around 1637. however. sale. Chicago spot prices rose and fell drastically. The celebrated Dutch Tulip bulb mania. futures markets. which made them much like today's futures. Jacob married Leah. and the most significant as far as the history of U. Chicago's storage facilities were unable to accommodate the enormous increase in supply that occurred following the harvest. was the creation of the Chicago Board of Trade in 1848. which permitted forward contracting.

The early twentieth century was a dark period for derivatives trading as bucket shops were rampant. one based on Ginnie Mae (GNMA) mortgages. In 1972 the Chicago Mercantile Exchange. While the contract met with initial 39 . setting up shop elsewhere. the Chicago Produce Exchange. In 1922. and in 1925 the first futures clearinghouse was formed. The grain could always be sold and delivered anywhere else at any time. These to-arrive contracts Proved useful as a device for hedging and speculating on price changes. created the International Monetary Market. responding to the now-freely floating international currencies. This allowed the farmer to store the grain either on the farm or at a storage facility nearby and deliver it to Chicago months later. Other exchanges had been popping up around the country and continued to do so. the federal government made its first effort to regulate the futures market with the Grain Futures Act. These contracts were eventually standardized around 1865. From that point on. Bucket shops are small operators in options and securities that typically lure customers into transactions and then flee with the money.later. futures contracts were pretty much of the form we know them today. It became the modern day Merc in 1919. which allowed trading in currency futures. In 1975 the Chicago Board of Trade created the first interest rate futures contract. was formed. These were the first futures contracts that were not on physical commodities. Farmers and traders soon realized that the sale and delivery of the grain itself was not nearly as important as the ability to transfer the price risk associated with the grain. In 1874 the Chicago Mercantile Exchange's predecessor.

the Chicago Board Options Exchange decided to create an option on an index of stocks. it eventually died. which has now surpassed the T -bond contract to become the most actively traded of all futures contracts. In 1994 the derivatives world was hit with a series of large losses on derivatives 40 . the option pricing model of Fischer Black and Myron Scholes. In recent years exchanges have increasingly move from the open outcry system to electronic trading. the Kansas City Board of Trade launched the first stock index futures. a contract on the Value Line Index. was established in 1848 where forward contracts on various commodities were standardised around 1865.success. The Chicago Mercantile Exchange quickly followed with their highly successful contract on the S&P 500 index. In 1982. Though originally known as the CBOE 100 Index. These events revolutionized the investment world in ways no one could imagine at that time. In 1982 the CME created the Eurodollar contract. In 1973 marked the creation of both the Chicago Board Options Exchange and the publication of perhaps the most famous formula in finance. as we know them today. From then on. it was soon turned over to Standard and Poor's and became known as the S&P 100. as it came to be known. The Chicago Board of Trade (CBOT). which remains the most actively traded exchange-listed option. the largest derivative exchange in the world. The Black-Scholes model. In 1983. futures contracts have remained more or less in the same form. set up a mathematical framework that formed the basis for an explosive revolution in the use of derivatives.

A means for managing risk was required. Since then contracts on various other commodities have been introduced as well. as on April 13. Stock Futures are the most highly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE. DEVELOPMENT OF DERIVATIVES MARKET : The explosion of growth in Derivative markets coincide with the collapse of Bretton Woods fixed exchange rate regime and the suspension of doller’s convertibility into gold. National Commodity & Derivatives Exchange Limited (NCDEX) started its operations in December 2003. This need eventually resulted in the creation of the financial derivatives industry. to provide a platform for commodities trading. Exchange rates became much more volatile.The derivatives market in India has grown exponentially.trading announced by some well-known and highly experienced firms. 41 . NSE and BSE. especially at NSE. Derivatives have had a long presence in India.and because interest rates affect and are also affected by exchange rates. such as Procter and Gamble and Metallgesellschaft. Exchange traded financial derivatives were introduced in India in June 2000 at the two major stock exchanges. The commodity derivative market has been functioning in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. There are various contracts currently traded on these exchanges. Derivatives are powerful risk management tools. interest rates also became more volatile. 2005.

one based on Ginnie Mae (GNMA) mortgages. 1976 1977-78 1976 Recession Another attempt at exchange New York Mercantile rate stability—Jamaica Exchange Energy Futures Accords European Monetary Systems Big Bang hits London Federal Reserve to target London International 42 1978-79 1979-80 1980-81 . Currency Futures 1972 1973 marked the creation of both the Chicago Board Options Exchange and the publication of the most famous formula in finance. End of Gold convertibility Managed floating rates INNOVATIONS The Chicago Mercantile Exchange. Creation of the International Monetary Market. Growing interest commodity futures in 1974 1975 Commodity price swings Volatile interest rates Interest Rate Futures. the Chicago Board of Trade created the first interest rate futures contract. the option pricing model of Fischer Black and Myron Scholes.YEAR 1971 DEVLOPMENTS US announced an end to the Bretton Woods System of fixed exchange rates.

which withdrew the prohibition on options in securities. methodology for charging initial margins. Currency Swaps DEVELOPMENT OF DERIVATIVES MARKET IN INDIA The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws(Amendment) Ordinance.Gupta on November 18.C. SEBI set up a 24–member committee under the Chairmanship of Dr. to recommend measures for risk containment in derivatives market in India. 1998 prescribing necessary pre–conditions for introduction of derivatives trading in India. The committee submitted its report on March 17. broker net worth. Currency Options. 1995. deposit requirement and real–time monitoring requirements. however. did not take off. SEBI also set up a group in June 1998 under the Chairmanship of Prof. The committee recommended that derivatives should be declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’ could also govern trading of securities. The Securities Contract Regulation Act (SCRA) was amended in December 1999 to include derivatives within the ambit of ‘securities’ and the regulatory framework was developed for governing derivatives trading.J. which was submitted in October 1998. as there was no regulatory framework to govern trading of derivatives. 1996 to develop appropriate regulatory framework for derivatives trading in India. worked out the operational details of margining system.L. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on a recognized 43 . The report.Varma.money and not interest rates 1981-82 Reagan Recovery Futures Exchange Philadelphia Exchange.R. The market for derivatives.

and their clearing house/corporation to commence trading and settlement in approved derivatives contracts. SEBI approved trading in index futures contracts based on S&P CNX Nifty and BSE– 30(Sensex) index. which prohibited forward trading in securities. 2000.Their value is derived from an underlying asset/instrument 2. 2001. Trading and settlement in derivative contracts is done in accordance with the rules. NSE and BSE. The trading in index options commenced on June 4. Futures contracts on individual stocks were launched in November 2001.They are leveraged instruments 44 .They are vehicles for transerfering risk 3.stock exchange. The government also rescinded in March 2000. thus precluding OTC derivatives. the three– decade old notification. The derivatives trading on NSE commenced with S&P CNX Nifty Index futures on June 12. byelaws. Foreign Institutional Investors (FIIs) are permitted to trade in all Exchange traded derivative products. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2001. Characteristics of derivatives 1. 2001 and trading in options on individual securities commenced on July 2. 2001. and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette. The index futures and options contract on NSE are based on S&P CNX. Single stock futures were launched on November 9. The trading in BSE Sensex options commenced on June 4. This was followed by approval for trading in options based on these two indexes and options on individual securities. 2001 and the trading in options on individual securities commenced in July 2001. To begin with. SEBI permitted the derivative segments of two stock exchanges.

Liquidity risk :liquidity of market means the ease with which one can enter or get out of the market. Higher liquidity Avaliability of risk management products attracts more investors to the cash market.which resembles far reaching consequences.so there is a counter party default risk in these instruments. There is a continued debate about the Indian markets capability to provide enough liquidity to derivative trader. 3 Volatility:The increased speculation & inefficient market will make the spot market more volatile with the introduction of derivatives. Arbitrage between cash and futures markets fetches additional business to cash market. 45 . 4. 2. 2 Market efficiency : It is felt that Indian markets are not mature and efficient enough to introduce these kinds of new instruments.imperfection in the markets make derivative market more difficult to function. Lesser volatility Improved Price discovery ARGUMENTS AGAINST DERIVATIVES 1 Speculation :It is felt that these instruments will increase the speculation in the financial markets. 3. 4 Counter party risk : most of the derivative instruments are not exchange traded.ARGUMENTS IN FAVOUR OF DERIVATIVES 1. 6.These instruments require a well functioning & mature spot market. Improvement in delivery based business. 5.

they can increase both the potential gains and potential losses in a speculative venture.They catalyze entrepreneurial activity 4. SPECULATORS: Speculators wish to bet on future movements in the price of an asset.These markets increase volumes trading in market due to participation of risk averse people. PARTICIPANTS: The following three broad categories of participants in the derivatives market.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.They help in discovery of futures as well as current prices 3. for. if. HEDGERS: Hedgers face risk associated with the price of an asset. ARBITRAGEURS: Arbitrageurs are in business to take of a discrepancy between prices in two different markets. Futures and options contracts can give them an extra leverage. 2. 5. they see the futures price of an asset getting out of line with the cash price.They increase savings and investment in the longrun. They use futures or options markets to reduce or eliminate this risk. TYPES OF DERIVATIVES: 46 . example. that is. they will take offsetting position in the two markets to lock in a profit.

at a given price on or before a give future date. Puts give the buyer the right.They give the holder a right to sell a specific number of underlying equity shares of a particular company at the strike price on or the before the maturity. 47 . where settlement takes place on a specific date in the future at today’s pre-agreed price.The following are the various types of derivatives. European options: European options are options that can be exercised only on the expiration date itself. OPTIONS: Options are of two types-calls and puts. American options: American options are options are options that can be exercised at any time upto the expiration date. but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Most exchange-traded options are American. They are: FORWARDS: A forward contract is a customized contract between two entities. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset. CALL OPTIONS: A call options are the buyers options.They give the holder a right to buy a specific number of underlying equity shares of a particular company at the strike price on or the before the maturity. Put options: Put options are the sellers options. FUTURES: A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the at a certain price.

Equity index options are a form of 48 . The underlying asset is usually a moving average of a basket of assets. WARRANTS: Options generally have lives of up to one year. Longer-dated options are called warrants and are generally traded over-the counter.and properties of an American option are frequently deduced from those of its European counterpart. SWAPS: Swaps are private agreements between two parties to exchange cash floes in the future according to a prearranged formula.European options are easier to analyze than American options. The two commonly used Swaps are: Interest rate Swaps: These entail swapping only the related cash flows between the parties in the same currency. with the cash flows in on direction being in a different currency than those in the opposite direction. These are options having a maturity of up to three years. LEAPS: The acronym LEAPS means long-term Equity Anticipation securities. BASKETS: Basket options are options on portfolios of underlying assets. the majority of options traded on options exchanges having a maximum maturity of nine months. Thus a swaption is an option on a forward swap. Currency Swaps: These entail swapping both principal and interest between the parties. They can be regarded as portfolios of forward contracts. SWAPTION: Swaptions are options to buy or sell a swap that will become operative at the expiry of the options.

inflation. There are various factors.Economic 2. etc. interest rate. 6. which affect the returns: 1. 4. 5. their effect is to cause prices of nearly all-individual 49 . There are yet other of influence which are external to the firm.Political 3. 3. They are termed as systematic risk. industries and groups so that a loss in one may easily be compensated with a gain in other. Sociological changes are sources of systematic risk. An investor can easily manage such non-systematic by having a well-diversified portfolio spread across the companies. They are: 1. cannot be controlled and affect large number of securities. These forces are to a large extent controllable and are termed as non systematic risks. which would be much lesser than what he expected to get. 2. etc. Price or dividend (interest) Some are internal to the firm likeIndustrial policy Management capabilities Consumer’s preference Labor strike. RATIONALE BEHIND THE DEVELOPMENT OF DERIVATIVES: Holding portfolios of securities is associated with the risk of the possibility that the investor may realize his returns. For instance.basket options.

On May 11.stocks to move together in the same manner. and the regulations framed there under the rules and byelaws of stock exchanges. Gupta develop the appropriate regulatory framework for derivative trading in India. Those factors favor for the purpose of both portfolio hedging and speculation. Eligibility criteria as prescribed in the L. The committee submitted its report in March 1998. the SEBI Act. 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index Futures. In debt market. C. The provision in the SCR 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 with in the framework of the Act. a large position of the total risk of securities is systematic. liquidity in the sense of being able to buy and sell relatively large amounts quickly without substantial price concession. SEBI also approved he “suggestive bye-laws” recommended by the committee for regulation and control of trading and settlement of Derivative contract. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. the introduction of a derivatives securities that is on some broader market rather than an individual security. L. Rational Behind the development of derivatives market is to manage this systematic risk. REGULATORY FRAMEWORK: The trading of derivatives is governed by the provisions contained in the SC R A. Regulation for Derivative Trading: SEBI set up a 24 member committed under Chairmanship of Dr. C. Gupta committee report may apply to SEBI for 50 . We therefore quite often find stock prices falling from time to time in spite of company’s earning rising and vice versa.

The members of the derivatives segment need to fulfill the eligibility conditions as lay down by the L. The derivative exchange/segment should have a separate governing council and representation of trading/clearing member shall be limited to maximum 40% of the total members of the governing council. The Minimum contract value shall not be less than Rs. Exchange should also submit details of the futures contract they purpose to introduce. The exchange shall have minimum 50 members. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. C.2 Lakh.grant of recognition under section 4 of the SCR Act. The members of an existing segment of the exchange will not automatically become the members of the derivatives segment. The trading members are required to have qualified approved user and sales persons who have passed a certification programme approved by SEBI 51 . 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. Gupta committee. Derivatives broker/dealers and Clearing members are required to seek registration from SEBI. 1956 to start Derivatives Trading.

FUTURES CONTRACT: A futures contract is a standardized contract. to buy or sell a certain underlying instrument at a certain date in the future. and the writer (seller) the obligation. The standardized items on a futures contract are: 1 2 Quantity of the underlying Quality of the underlying 52 . at a pre-set price. etc. The futures price. The holder of a futures contract and the writer of an option. Contrast this with an options contract. To facilitate liquidity in the futures contract. Futures contracts are exchange traded derivatives. A futures contract gives the holder the right and the obligation to buy or sell. effectively closing the position. sets margin requirements. The exchange acts as counterparty on all contracts. an option buyer can choose not to exercise when it would be uneconomical for him/her. In other words. but not the obligation. The price of the underlying asset on the delivery date is called the settlement price. the holder of a futures position has to sell his long position or buy back his short position. which gives the buyer the right. but not the right. To exit the commitment. The pre-set price is called the futures price. DEFINITION: A Futures contract is an agreement two parties to buy or sell an asset a certain time in the future at a certain price. the exchange specifies certain standard features of the contract. converges towards the settlement price on the delivery date. naturally. do not have a choice. traded on a futures exchange. The future date is called the delivery date or final settlement date.

the buyer and the seller. Hedging of price risks. The pay off for the buyer and the seller of the futures of the contracts are as follows: 53 . the futures are divided into two types: 1 2 Stock futures: Index futures: Parties in the futures contract: There are two parties in a future contract.3 4 5 The date and the month of delivery The units of price quotations and minimum price change Location of settlement FEATURES OF FUTURES: 1 2 3 4 Futures are highly standardized. TYPES OF FUTURES: On the basis of the underlying asset they derive. The contracting parties need not pay any down payments. The buyer of the futures contract is one who is LONG on the futures contract and the seller of the futures contract is who is SHORT on the futures contract. They have secondary markets to.

Chapter .4 DATA ANALYSIS 54 .

Lets assume that transaction cost are –brokerage @0.only the broker and government gains and both ABC and XYZ loses. after consieringthe transaction costs the cost of acquisition for ABC is Rs 539.01% of futures.40 from XYZ . If price remain in the range between RS 537. Hence. The lot size of RIF is 600 The pay off matrix for ABC and XYZ for different prices of reliance industries futures will be as per table Price Of RIF 525 530 535 540 545 550 555 ABC pay off -8430 -5430 -2430 570 3570 6570 9570 55 .transaction tax at 0.75.05.1%.which wil be their respective break even price.05.If price of RIF goes above 539.PAY-OFF FOR A BUYER OF FUTURES: Iilustration: Suppose ABC buys a February 2008 stock futures contract of Reliance industries(RIF) ON February 4.ABC gains and XYZ loses.2008 at rs 538.75 and Rs 539. service tax at 10% of brokerage amount.05 and net sales realization for XYZ is Rs 537.

XYZ pay off 7650 4650 1650 -1350 -4350 -7350 -10350 For ABC Payoff=539.05(per share) =14. 56 . CASE 2:-The buyer gets loss when the future price goes less then (540). if the future price goes to 525 then the buyer gets the loss of (10350).05*600=-8430(total loss) For XYZ Payoff=537.05-525=14. if the future price goes to 555 then the buyer gets the profit of (9570).75-525=12.5000530 535 540 545 550 555 CASE 1:-The buyer bought the futures contract at (538.40).75*600=7650(total profit) 15000 10000 5000 0 525 -1500010000 .75(per share) =12.

When the index moves up.PAY-OFF FOR A SELLER OF FUTURES: Iilustration:The investor sold futures when the index was at 2220 Profit 2220 0 Loss The Index stands At 2220.The underlying asset is in this case is the nifty portfolio. and when 57 . the long future position starts making profit.

both buyer and seller are required to post initial margins. These deposits are initial margins and they are often referred as purchase price of futures contract. There are three types of margins: Initial Margins: Whenever a futures contract is signed. If the equity goes less than that percentage of initial margin.index moves down it starts making losses. arise in a futures contract. 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 margins are collect in order to eliminate the counter party risk. Role of Margins: 58 . Maintenance margin: The investor must keep the futures account equity equal to or grater than certain percentage of the amount deposited as initial margin. MARGINS: Margins are the deposits which reduce counter party risk. then the investor receives a call for an additional deposit of cash known as maintenance margin to bring the equity upto the initial margin. Marking to market margins: The process of adjusting the equity in an investor’s account in order to reflect the change in the settlement price of futures contract is known as MTM margin.

the following table shows the effect of margins on the contract. a new contract having a three-month expiry is introduced for 59 . The contract size of satyam is 1200. S sold a satyam June futures contract to B at Rs. Contract cycle: The period over which contract trades.Holding Period. Futures price: The price at which the futures contract trades in the futures market. The initial margin amount is say Rs. two –month and three-month expiry cycle which expire on the last Thursday of the month. Pricing the Futures: The Fair value of the futures contract is derived from a model knows as the cost of carry model. Futures terminology: Spot price: The price at which an asset trades in the spot market. This model gives the fair value of the contract. 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.20000. The index futures contracts on the NSE have onemonth.Futures price S.The role of margins in the futures contract is explained in the following example. the maintenance margin is 65%of initial margin. Cost of Carry: F=S (1+r-q) t Where F.Spot price of the underlying r.300.Cost of financing q.Expected Dividend yield t .

Expiry date: It is the date specifies in the futures contract. basis will be positive. For instance. for calculation of open interest. the contract size on NSE’s futures market is 200 nifties. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. Open Interest: Total outstanding long or short position in the market at any specific time. basis can be defined as the futures price minus the spot price. at the end of which it will cease to exist. The will be a different basis for each delivery month for each contract. This is the last day on which the contract will be traded. Contract size: The amount of asset that has to be delivered under one contract. only one side of the contract is counter. This reflects that futures prices normally exceed spot prices. 60 . As total long positions in the market would be equal to short positions.trading. Cost carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. In a normal market. Basis: In the context of financial futures.

The option buyer has to pay the seller of the option premium The assets on which option can be derived are stocks. In order to have this right. PROPERTIES OF OPTION: Options have several unique properties that set them apart from other securities. indexes etc. Alternatively the contract may grant the other person the right to sell a specific asset at a specific price within a specific time period.OPTION: 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. commodities. If the underlying asset is the financial asset. index options etc. currency options. following are the properties of option: 1 2 3 Limited Loss High leverages potential Limited Life The 61 . then the option are financial option like stock options. and if options like commodity option.

there are currently more than 50 stocks are trading in the segment. Stock option are options on the individual stocks. 2.PARTIES IN AN OPTION CONTRACT: 1. 2 STOCK OPTIONS: A stock option gives the buyer of the option the right to buy/sell stock at a specified price. On the basis of the market movements: On the basis of the market movements the option are divided into two types. Buyer of the 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. The following are the various types of options. They are: CALL OPTION: 62 . Writer/seller of the option: The writer of the call /put options is the one who receives the option premium and is their by obligated to sell/buy the asset if the buyer exercises the option on him TYPES OF OPTIONS: The options are classified into various types on the basis of various variables. On the basis of the underlying asset: On the basis of the underlying asset the option are divided in to two types : 1 INDEX OPTIONS The index options have the underlying asset as the index. there are currently more than 50 stocks.

Hence he has 7 days left for the 63 . the options are classified into two categories.A call option is bought by an investor when he seems that the stock price moves upwards. PAY-OFF PROFILE FOR BUYER OF A CALL OPTION: The pay-off of a buyer options depends on a spot price of a underlying asset. European options are easier to analyze than American options. A put options gives the holder of the option right but not the obligation to sell an asset by a certain date for a certain price. ABC buys a February 2008 call of strike price Rs 80/. The following graph shows the pay-off of buyer of a call option.ABB electrical switch from XYZ on February 22' 2008 at a premium of Rs 2/. AMERICAN OPTION: American options are options that can be exercised at any time up to the expiration date. 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 PUT OPTION: A put option is bought by an investor when he seems that the stock price moves downwards. most exchange-traded option are American. The expiry date for February 2008 call option is 28th February 2008 being the last Thursday of the month. On the basis of exercise of option: On the basis of the exercising of the option.per share when the ruling market price of ABB is Rs 79.50 per share. Illustration: Suppose. EUOROPEAN OPTION: European options are options that can be exercised only on the expiration date itself.

Now.Spot price CASE 1: (88 > 76) As the spot price (88) of the underlying asset is more than strike price (76). ABB call option has a lot is 375 equity shares of ABB . the buyer gets profit of (2250). if price increases more than E1 then profit also increase more than SR. if price goes down less than 750 then also his loss is limited to his premium (750) 64 .50 OTM ATM ITM Out of the money At the money In the money SP 80 750 - 79. if at all.expiry of call within which he has exercise to his options. ABB Mkt Price Pay off for ABC Pay off for XYZ 76 -750 750 78 -750 750 80 -750 750 81 375 375 82 0 0 84 750 -750 86 1500 -1500 88 2250 -2250 Strike price=80 Spot price=76 premium=2 Pay-off matrix=spot price-strike price Pay-0ff matrix=76-80 = -4 Already Rs 2 premium received so net payoff will be 4-2=2*375=-750 It is loss for the buyer(ABC) and profit for the seller(XYZ) S Strike price Premium/ Loss Spot price 2 Profit at spot price 79. CASE 2: (76< 80) As a spot price (76) of the underlying asset is less than strike price (s) The buyer gets loss of (750).50 .

As the spot Nifty rises.PAY-OFF PROFILE FOR SELLER OF A CALL OPTION: The pay-off of seller of the call option depends on the spot price of the underlying asset. the call option is i-the money and the seller starts making losses .6 charged by him. Nifty closes above the strike price of 2250. where has the maximum profit is limited to the extent of the upfront option premium of Rs 86.Strike price ITM ATM OTM - In the money At the money Out of the money SP . The loss that can be incurred by the seller of the option is potentially unlimited.6 2250 Nifty loss The above figure shows profit/losses for the seller of a three month Nifty 2250 call option.Spot price 1 E2 SR Spot price 2 Profit at spot price E1 65 . The following graph shows the pay-off of seller of a call option: profit 86.If upon expiration.Premium /profit E1 . S .the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Nifty-close and strike price.

Sathyam mkt price Pay-off for ABC Pay-0ff for XYZ Pay-off for ABC: 310 37200 -37200 320 25200 -25200 330 13200 -13200 340 1200 -1200 350 -10800 10800 360 -10800 10800 370 -10800 10800 PUT OPTION=STRIKE PRICE-SPOT PRICE Pay-off=350-310=40(per share) premium=Rs 9/.per share when the ruling Market price of sathyam share is Rs 351. A sathyam put option has a lot size of 1200 equity shares sathyam computers.CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying is less than strike price (S). The following Table and graph shows the pay-off of the buyer of a call option.per share =40-9=31*1200=37200(profit) At the same time it is loss to the XYZ=37200(loss) S Strike price ITM In the money 66 . Iiustration: ABC buys a February 2008 put optionof strike price Rs 350/ of sathyam computers from vishal at a premium of Rs 9/. the seller gets the profit of (SP).35 per share. if the price decreases less than E1 then also profit of the seller does not exceed (SP). CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S) the seller gets loss of (SR). if price goes more than E2 then the loss of the seller also increase more than (SR). PAY-OFF PROFILE FOR BUYER OF A PUT OPTION: The pay-off of the buyer of the option depends on the spot price of the underlying asset.

if price decreases less than 310 then profit also increases more than (37200). PAY-OFF PROFILE FOR SELLER OF A PUT OPTION: The pay-off of a seller of the option depends on the spot price of the underlying asset. the buyer gets the profit (37200). CASE 2: (370 > 350) As the spot price (370) of the underlying asset is more than strike price (350). 67 . the buyer gets loss of (10800).SP E1 E2 SR - Premium /profit Spot price 1 Spot price 2 Profit at spot price E1 50000 -40000 30000 20000- OTM - Out of the money At the money ATM - 100000 310 -10000 -20000 -30000 -40000 -50000 320 330 340 350 360 370 CASE 1: If (310< 350) As the spot price (310) of the underlying asset is less than strike price (350). if price goes more than 370 than the loss of the buyer is limited to his premium (10800).

the seller gets the loss of (SR). S Strike price Premium/ profit Spot price 1 Spot price 2 Profit at spot price E1 ITM In the money At the money Out of the money SP E1 E2 SR - ATM OTM - CASE 1: (Spot price < Strike price) As the spot price (E1) of the underlying asset is less than strike price (S).7 2250 0 loss The above example shows the profit/losses for the seller of a three month Nifty 2250 put option. As the spot nifty falls. the put option is in the money and the writers starts making losses . if price decreases less than E1 than the loss also increases more than (SR).nifty closes below the strike price of 2250.the buyer would exercise his option on the seller who would suffer a loss to the extent of difference between the strike price and nifty-close.70 Charged by him.profit 61.If upon expiration . 68 .The loss that can incurred by the seller of the option is maximum extent of the strike price (since the worst can happen if asset price can fall to zero) where the maximum profit is limited to the extent of the –front option premium of RS 61.

as a strike price increases. the chance that the stock will do very well or very poor increases. As volatility increases. if price goes more than E2 than the profit of seller is limited to his premium (SP). the seller gets profit of (SP). Time to expiration: Both put and call American options become more valuable as a time to expiration increases. Strike price: In case of a call. 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 pay –off from a call option is a amount by which the stock price exceeds the strike price. The pay-off from a put option is the amount. Therefore.dividend rate. Call options therefore become more valuable as the stock price increases and vice versa. The value of both calls and puts therefore increase as volatility increase. option become more valuable. Volatility: The volatility of a stock price is measured of uncertain about future stock price movements. Dividends: Dividends have the effect of reducing the stock price on the x. the stock price has to make a larger upward move for the option to go in-the-money. as the strike price increases option becomes less valuable and as strike price decreases. Put options therefore become more valuable as the stock price increases and vice versa. by which the strike price exceeds the stock price. for a call.CASE 2: (Spot price > Strike price) As the spot price (E2) of the underlying asset is more than strike price (S). 69 . Risk-free interest rate: The put option prices decline as the risk-free rate increases where as the prices of call always increase as the risk-free interest rate increases.

70 .v\/t Options Terminology: Strike price: The price specified in the options contract is known as strike price or Exercise price. PRICING OPTIONS The black.This has an negative effect on the value of call options and a positive effect on the value of put options.scholes formula for the price of European calls and puts on a non-dividend paying stock are : CALL OPTION: C = SN(D1)-Xe-r t N(D2) PUT OPTION P = Xe-r t N(-D2)-SN(-D2) Where C = VALUE OF CALL OPTION S = SPOT PRICE OF STOCK N= NORMAL DISTRIBUTION V= VOLATILITY X = STRIKE PRICE r = ANNUAL RISK FREE RETURN t = CONTRACT CYCLE d1 = Ln (S/X) + (r+ v2/2)t v\/t d2 = d1.

In-the-money option: An In the money option is an option that would lead to positive cash inflow to the holder if it exercised immediately. its intrinsic value is zero. Intrinsic value of money: The intrinsic value of an option is ITM. Expiration Date: The date specified in the options contract is known as expiration date. If option is ITM.Options premium: Option premium is the price paid by the option buyer to the option seller. 71 . At-the-money option: An at the money option is an option that would lead to zero cash flow if it is exercised immediately. If the option is OTM. Out-of-the-money option: An out-of-the-money option is an option that would lead to negative cash flow if it is exercised immediately. Time value of an option: The time value of an option is the difference between its premium and its intrinsic value.

Presentation The objective of this analysis is to evaluate the profit/loss position futures and options. This analysis is based on sample data taken of ABB electricals. This analysis considered the February contract of ABB. The lot size of ABB is 375, the time period in which this analysis done is from 18.02.08 – 04.03.08

Date 18-02-2008 19-02-2008 20-02-2008 21-02-2008 22-02-2008 23-02-2008 25-02-2008 26-02-2008 27-02-2008 28-02-2008 29-02-2008 1-03-2008 3-03-2008 4-03-2008

Future price 1043.05 1026.7 1043.45. 1043.40 1047.50 1075.10 1064.65 1004.60 1015.00 1016.95 1024.25 1017.40 1009.65 1005.45

Market Price 1044.45 1020.25 1034.45 1040.45 1044.65 1062.33 1066.85 1023.95 1010.35 1019.40 1017.55 1017.15 1013.50 1009.00

The closing price of ABB at the end of the contract period is 1009.00and this is considered as settlement price.

The following table explains the market price and premiums of calls. 1 The first column explains trading date

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2 3

Second column explains the SPOT market price in cash segment on that date. The third column explains call premiums amounting 1020,1050 &1080

Call Prices: Premium 1050 0 19.00 28 22.05 25.75 0 18.40 10.75 07.50 09.50 13.00 05.00 07.90 01.00

Date 18-02-2008 19-02-2008 20-02-2008 21-02-2008 22-02-2008 23-02-2008 25-02-2008 26-02.2008 27-02-2008 28-02-2008 29-02-2008 1-03-2008 3-03-2008 4-03-2008

Market price 1044.45 1020.25 1034.95 1040.45 1044.65 1062.33 1066.85 1023.95 1010.35 1019.40 1017.55 1017.15 1013.50 1008.00

1020 28.5 32.50 43 0 0 25.00 30.25 19.75 14.50 12.50 09.85 20.00 0 03.70

1080 18.05 0 15.85 13.00 14.05 11.00 10.50 06.35 05.75 0 0 0.80 02.90 0

OBSERVATIONS AND FINDINGS: CALL OPTION: BUYER PAYS OFF 1 As brought 1 lot of ABB that is 375, those who buy for 1043.05 paid 28.50premium per share. 2 Settlement price is 1009 Formula: Pay off = spot – strike 1009-1043.05 = -34.05 because it is negative it is out of the money contract hence buyer will lose only premium. SELLER PAY OFF : 1 It is out of the money for the buyer so it is in the money for seller, hence His profit is only premium i.e.., 375*28 =10500. Put prices: Premium 73

Date 1 8-02-2008 19-02-2008 20-02-2008 21-02-2008 22-02-2008 23-02-2008 25-02-2008 26-02.2008 27-02-2008 28-02-2008 29-02-2008 1-03-2008 3-03-2008 4-03-2008

Market price 1044.45 1020.25 1034.95 1040.45 1044.65 1062.33 1066.85 1023.95 1010.35 1019.40 1017.55 1017.15 1013.50 1008.00

1020.00 0 0 0 0 0 0 0 0 14.00 0 13.00 0 0 0

1050 40 0 0 0 0 22.00 0 0 0 0 0 0 0 0

1080 0 0 0 0 0 0 0 0 0 0 0 0 0 0

OBSERVATION AND FINDINGS: PUT OPTION : BUYER PAY OFF: 1 2 Those who have purchase put option at a strike price of 1050, the premium payable is 40.00. On the expiry date the spot market price enclosed at 961.05 the net pay off = 1050-1009 =41 and the premium already paid = 41-40.00 (paid per share) 1*375 =375 that is total profit=375 SELLER PAY OFF: 1 As seller is entitled only for premium if he is in profit but seller has to borne total loss.

Loss incurred is 1050 –1009 = 41 Net loss 41-42*375=375

DATA OF ABB - THE FUTURES AND OPTIONS OF THE

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FEBRUARY MONTH Date 2-02-2008 4-02-2008 5-02-2008 6-02-2008 7-02-2008 8-02-2008 9-02-2008 13-02-2008 14-02-2008 15-02-2008 16-02-2008 20-02-2008 21-02-2008 22-02-2008 23-02-2008 27-02-2008 28-02-2008 Future price 1043.05 1026.7 1043.45. 1043.40 1047.50 1075.10 1064.65 1004.60 1015.00 1016.95 1024.25 1017.40 1009.65 1005.45 962.20 933.2 938.20 Market Price 1044.45 1020.25 1034.45 1040.45 1044.65 1062.33 1066.85 1023.95 1010.35 1019.40 1017.55 1017.15 1013.50 1008.00 963.50 945.90 941.05

Chapter-5
75

Summary and Conclusions FINDINGS 1 2 3 The future price of ABB is moving along with the market price. than the seller incur losses. 76 . than the buyer of a future gets profit. If the buy price of the future is less than the settlement price. If the selling price of the future is less than the settlement price.

SUMMARY 1 Derivates market is an innovation to cash market. In derivative segment the profit/loss of the option writer is purely depend on the fluctuations of the underlying asset. Approximately its daily turnover reaches to the equal stage of cash market. 3 In cash market the investor has to pay the total money. The average daily turnover of the NSE derivative 77 . segments 2 In cash market the profit/loss of the investor depend the market price of the underlying asset. which are some percentage of total money. The investor may incur huge profits or he may incur huge profits or he may incur huge loss. But in derivatives segment the investor the investor enjoys huge profits with limited downside. but in derivatives the investor has to pay premiums or margins. 4 5 Derivatives are mostly used for hedging purpose.

where as the put option writer will get more losses. so he is suggested to hold a put option. 3 In the above analysis the market price of ABB is having low volatility. so he is suggested to write a put option. 78 . so the call option writers enjoy more profits to holders.CONCLUSION 1 In bullish market the call option writer incurs more losses so the investor is suggested to go for a call option to hold. 2 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 holder suffers in a bullish market.

so SEBI has to take steps to create awareness among the investors about the derivative segment. SEBI has to take measures to use effectively the derivatives segment as a tool of hedging. 3 Contract size should be minimized because small investors cannot afford this much of huge premiums. participation of FII in the derivatives market.RECOMMENDATIONS 1 The derivative market is newly started in India and it is not known by every investor. 2 In order to increase the derivatives market in India. SEBI should revise some of their regulations like contract size. 4 5 SEBI has to take further steps in the risk management mechanism. 79 .

com www.com www.com www.derivativesindia.indianinfoline.5paisa.com www.com BOOKS: Derivatives Core Module Workbook – NCFM material Financial Markets and Services – Gordan and Natrajan Financial Management – Prasanna Chandra 80 .nseindia.bseindia.BIBILOGRAPHY WEBSITES www.

NEWSPAPERS Economic times of India Business standards 81 .

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