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Fortnightly Report
JULY, 2014 19
JULY, 2014)

Priyankur Dhar
PGDM 739, Finance 2013-15(F2)

Company Name: Reliance Securities Ltd.
Assigned Project Title: Understanding Derivative Strategies.
Tasks assigned: Learning about

Insurance life & General
life Insurance
o Features of a life insurance policy
o Life Insurance Products
Endowment Policy
Whole Life Insurance Policy
Term life Insurance Policy
Money Back Policy
Joint Life Insurance Policy
Group Insurance
Loan Cover Term Assurance Policy
Term Assurance Plans
Unit Linked Insurance Plans
Insurance Plans for Child's Future
Pension Plans
General Insurance
o Health Insurance
o Personal Accident/Disability Income Insurance
o Personal Property Insurance
o Householder's insurance
o Personal accident and third party liability covers
o Motor vehicle insurance
o Overseas and Travel Insurance
o Other Liability Insurance
o Directors' and Officers' Liability
o Professional Indemnity Policy
o Products Liability Insurance
o Public Liability Insurance
o Workmen's Compensation Insurance

Investments in Gold
Gold Coins

Financial Derivatives
Market participants
Derivative Exchanges
Clearing & Settlement

Watching the share market dealing and up-downs of the shares through
Reliance Security trading software platform.
Make phone calls to the clients.

Takeaways and learnings:

Insurance life and General

Life Insurance is a contract that pledges payment of an amount to the person assured (or his
nominee) on the happening of the event insured against.
The contract is valid for payment of the insured amount during:
1) The date of maturity or
2) Specified dates at periodic intervals, or
3) Unfortunate death, if it occurs earlier.
Among other things, the contract also provides for the payment of premium periodically to the
insurance company by the policyholder. life insurance is universally acknowledged an
institution, which eliminates 'risk' substituting certainty for uncertainty and comes to the timely
aid of the family in the unfortunate event of death of the breadwinner. Life insurance, in short, is
concerned with two hazards that stand across the life path of every person:

- That of dying prematurely, leaving a dependent family to fend for themselves.
- That of living until old age without visible means of support.
(a) Features of a life insurance policy
There are three parties in a life insurance transaction: the insurer, the insured and the owner of
the policy (policyholder), although the owner and the insured are often the same person. For
example, if Mr. Kumar buys a policy on his own life, he is both the owner and the insured.
However, if Mrs. Kumar, his wife, buys a policy on Mr. Kumar's life, she is the owner and he is
the insured.
Another important person involved is the beneficiary. The beneficiary is the person or persons
who will receive the policy proceeds upon death of the insured.
The beneficiary in not a party to the policy, but is designated by the owner, who may change
the beneficiary unless the policy has an irrevocable beneficiary designation. With an irrevocable
beneficiary, that beneficiary must agree to changes in beneficiary, policy assignment, or
borrowing of cash value.
Death Benefit
The primary feature of a life insurance policy is the death benefit it provides. Permanent policies
provide a death benefit that is guaranteed for the life of the insured, provided the premiums
have been paid and the policy has been surrendered.
When one makes a nomination, as the policyholder you continue to be the owner of the policy
and nominate the beneficiary/ nominee of the policy. The nominee does not have any right
under the policy so long as you are alive. The nominee has only the fight to receive the policy
monies in case of your death within the term of the policy.
If your intention is that your policy monies should go only to a particular person, you need to
assign the policy in favor of that person.
Cash Value
The cash value of a permanent life insurance policy is accumulated throughout the life of the
policy. It equals the amount a policy owner would receive, after any applicable surrender
charges, if the policy were surrendered before the insured's death.
Many life insurance companies issue life insurance policies that entitle the policy owner to share
m the company's divisible surplus.
Paid-Up Additions
Dividends paid to a policy owner of a participating policy can be used in numerous ways, one of
which is towards the purchase of additional coverage, called paid-up additions.
Policy Loans
Some life insurance policies allow a policy owner to apply for a loan against the value of the
policy. Either a fixed or variable rate of interest is charged. This feature allows the policy owner
an easily accessible loan in times of need or opportunity.

(b) Life Insurance Products
Life insurance is a misunderstood concept in India. Basically, Life Insurance Plans should
provide insurance cover to protect the dependents of the Life Assured. But conventionally Life
Insurance policies have been sold as investment products where the Life Assured gets a lump
sum at the end of a fixed term or periodic returns on a regular basis during the term. The
emphasis has been more on the investment aspects than on life cover. The private players in
Life Insurance sector in India have brought in newer concepts like adding riders to life insurance
policies but they also continue to sell insurance plans with more emphasis on the investment
Let us look at some of the standard policies offered by Life Insurance Companies.
(1) Endowment Policy:
o An endowment policy covers risk for a specified period, at the end of which the sum
assured is paid back to the policyholder, along with the bonus accumulated during the
term of the policy.
o The method of bonus payment is called reversionary bonus. The quantum of bonus is not
assured and it is based on the investment outcome of life insurance companies.
o It is insurance cum investment product where the emphasis is more on investment
because life cover for a given premium is less compared to a whole life policy with more
focus on maturity benefit compared to death benefit.
o Endowment life insurance pays the sum assured in the policy either at the insured's death
or at a certain age or after a number of years of premium payment.
o Ideally, this policy is used by investors who would like to have a certain amount of capital
at the end of a fixed term and protect the end capital through life insurance of the saver.
o This has been the most popular life insurance plan of UC of India before the private
players entered life insurance sector and popularized Unit linked Insurance Plans.
(2) Whole Life Insurance Policy
o A whole life policy runs as long as the policyholder is alive.
o As risk is covered for the entire life of the policyholder, therefore, such policies are known
as whole life policies.
o A simple whole life policy requires the insurer to pay regular premiums throughout the life.
o Whole life plans with limited payment options are also available where the insured is
required to pay premium for a specific term after which premium payment will stop but life
cover will continue.
o In a whole life policy, the insured amount and the bonus is payable only to the nominee of
the beneficiary upon the death of the policyholder.
o There is no survival benefit as the policyholder is not entitled to any money during his/ her
own lifetime.
(3) Term Life Insurance Policy
o Term life insurance policy covers risk only during the selected term period.
o The sum assured becomes payable only on death of the policy holder and not on end of
the term as in an endowment plan.
o The term life insurance policy offers maximum life insurance cover for a given premium
payment as this is pure life insurance without any investment built in.
o Term life policies are primarily designed to meet the needs of those people who are
initially unable to pay the larger premium required for a whole life or an endowment
assurance policy.
o No surrender, loan or paid-up values are granted under term life policies because
reserves are not accumulated.
o If the premium is not paid within the grace period, the policy lapses without acqumng any
paid-up value.
(4) Money Back Policy
o Money back policy provides for periodic payments of partial survival benefits during the
term of the policy, as long as the policyholder is alive.
o They differ from endowment policy in the sense that in endowment policy, survival
benefits are payable only at the end of the endowment period.
o An important feature of money back policies is that in the event of death at any time within
the policy term, the death claim comprises full sum assured without deducting any of the
survival benefit amounts, which may have already been paid as money-back
components. The bonus is also calculated on the full sum assured.
o This is an insurance plan with emphasis on investments and periodic return.
o A segment of investor population finds the periodic receipts from Life Insurance Company
attractive and hence prefers this plan.
(5) Joint Life Insurance Policy
o These plans are ideal for a married couple especially when both are bread winners or
business partners.
o Joint life insurance policies are similar to endowment policies offering maturity benefits as
well as death benefits.
o In case of death of one of the persons, the sum assured becomes payable.
o The sum assured is paid again on death of the surviving policy holder or on policy
o The premiums payable cease on the first death or on the expiry of the selected term,
whichever is earlier.
o If one or both the lives survive to the maturity date, the sum assured as well as the vested
bonuses are payable on the maturity date.
(6) Group Insurance
o Group insurance offers life insurance protection under group policies to various groups
such as employers-employees, professionals, co-operatives, weaker sections of society,
o It also provides insurance coverage for people in certain approved occupations at the
lowest possible premium cost.
o Group insurance plans have low premiums. Such plans are particularly beneficial to those
for whom other regular policies are a costlier proposition.
o Companies with a large workforce have preferred to provide life insurance to their less
sophisticated employees /workers through Group Insurance Plans.
o Group insurance plans extend cover to large segments of the population including those
who cannot afford individual insurance.
o A number of group insurance schemes have been designed for various groups.

(7) Loan Cover Term Assurance Policy
o Loan cover term assurance policy is an insurance policy, which covers a home loan.
o In the event of unfortunate death of the policy holder, before the full repayment of the
housing loan, the amount outstanding in the housing loan is paid in full.
o The cover on such a policy keeps reducing with the passage of time as individuals keep
paying their EMls (equated monthly installments) regularly, which reduces the loan
o This plan provides a lump sum in case of death of the life assured during the term of the
o The lump sum will be a decreasing percentage of the initial sum assured as per the policy
o Since this is a non-participating (without profits) pure risk cover plan, no benefits are
payable on survival to the end of the term of the policy
(8) Term Assurance Plans
o Under this plan, in case of death of the policy holder during the policy term, the sum
assured will be paid to the beneficiary.
o There are no maturity benefits. Hence on survival, the policy will terminate.
o The life insured will need to pay the regular annual premium for the term chosen.
o These are typically low cost bare insurance plans with no investment frills.
o For a little additional cost, some companies offer Term assurance plans with return of
premium and here on survival till maturity, all the premiums paid will be returned.
o Some term assurance plans provide extended life cover rider where after the end of term,
insurance up to certain percentage of sum assured continues for a specified term, say 5
years, without payment of any premium.
o Insurance companies tend to place a number of restrictions on term plans like:
1. Maximum life cover say Rs. 50 lakh
2. Maximum term say 25 years
3. Maximum age at maturity say 55 years, and so on
(9) Unit linked Insurance Plans
o ULIPs are market-linked insurance plans with a life cover thrown in.
o The said insurance cover is lower than most plain-vanilla plans (like endowment plans) as
a sizable portion of the premium goes towards investments in market-linked instruments
like stocks, corporate bonds, and government securities.
o On death, sum assured together with market related returns on the investments is paid -in
other words, the death benefit could be more than sum assured.
o Generally, the choice of extent of life cover is left to the insured I policy holder.
o The choice of investment plans is also left to the policy holder with an option to switch
between different investment plans, a number of times, during the entire term of the plan.
For example, an investor may choose the aggressive or equity plan at his young age and
switch to conservative or protective or debt plan at a later age.
o ULIP provides multiple benefits to the consumer. The benefits besides life protection
1. Investment and Savings
2. Flexibility
3. Adjustable Life Cover
4. Investment Options
5. Transparency
6. Options to take additional cover against:
o Death due to accident
o Disability
o Critical illness
o Surgeries
o ULIPs have managed to outsell plain vanilla plans by quite a margin. For some private
insurance companies, they account for up to 70% of new business generated.
o ULIPs by their very nature are long term investment vehicles because of costs involved
as well the nature of underlying investments, especially equities.
o Investors while choosing ULIPs should very carefully study the loads charged by Life
Insurance Companies because past performance shown by these companies are
essentially on the net investment portion of the premium paid by the policy holder. So if
the charges are high, naturally, the lump sum receivable at the end of the term will also
be affected substantially.
o The policy holders should pay premium continuously for a minimum period of five years.
The insurance cover will continue even if the policy holder fails to pay the annual premium
after a minimum period of at least five years. The policy becomes paid up after 5 years
and upon surrender, the market value becomes payable.
o Equity, as an asset class, will perform better over longer period of time.
o In the short term, equity may perform erratically and may not deliver superior returns.
Most insurers offer a wide range of investment funds to suit one's investment objectives, risk
profile and time horizons. Different funds have different risk profiles. The potential for returns
also varies from fund to fund.
The following are some of the common types of funds available along with an indication of their
risk characteristics.
1. Liquid fund
The Liquid fund invests 100% in bank deposits and high quality short-term money market
instruments. The fund is designed to be cash secure and has a very low level of risk; however
unit prices may occasionally go down due to the use of short-term money market instruments.
The returns on the funds also tend to be lower.
2. Secure Managed/ Protector Fund
The Secure Managed fund invests 100% in Government Securities and Bonds issued by
companies or other bodies with a high credit standing. However, a small amount of working
capital may be invested in cash to facilitate the day-to-day running of the fund. This fund has a
low level of risk but unit prices may still go up or down. The risk that this fund may face is the
interest rate risk. If after investment, the, interest rates rise, it may le ad to a fall in unit prices
3. Hybrid Fund/ Moderate fund/ Defensive Managed
5% to 30% of the Defensive Managed fund will be invested in high quality Indian equities. The
remainder yield will be invested in Government Securities and Bonds issued by companies or
other bodies with a high credit standing. In addition, a small amount of working capital may be
invested in cash to facilitate the day-to-day running of the fund. The fund has a moderate level
of risk with the opportunity to earn higher returns in the long term from some equity investment.
Unit prices may go up or down.
4. Balanced Fund
30% to 60% of the Balanced Managed fund will be invested in high quality Indian equities. The
remainder will be invested in Government Securities and Bonds issued by companies or other
bodies with a high credit standing. In addition, a small amount of working capital may be
invested in cash to facilitate the day-to-day running of the fund. The fund has a higher level of
risk with the opportunity to earn higher returns in the long term from the higher proportion it
invests in equities.
5. Growth fund/ Aggressive Fund
The Growth fund invests 80% to 100% in high quality Indian equities. In addition, a small
amount of working capital may be invested in cash to facilitate the day-to-day running of the
fund. The fund has a higher level of risk with the opportunity to earn higher returns in the long
term from the investment in equities.
o The past performance of any of the funds is not necessarily an indication of future
o There are no investment guarantees on the returns of unit linked funds.
ULIPs can be most useful for
o Individuals who are already adequately insured
o Individuals who are well informed regarding the market and are in a position to take a call
on the performance of equity and or debt markets over a period of time
o Investors who are prepared to take more risk for better returns compared to pure
endowment plans
(10) Insurance Plans for Child's Future
Life insurance plans help in servicing various needs in an individual's financial planning
exercise. One such need happens to be planning for a child's future. Children's insurance plans
help in addressing many of these needs.
While individuals might have a financial plan for themselves in place, it is equally important that
they secure the financial future of their children. For example, suppose an individual wants to
plan for his son's education. A child plan will serve in achieving this goal. An illustration will help
you understand this better.
(11) Pension Plans
A pension plan is a retirement plan. An investor can start planning retirement for retirement from
an early age or look at the options close to
o Ideally, investments should start from an early age through regular installments on yearly
o Lump sum single premium payment is also allowed for investors, past a particular
minimum age limit minimum age limit for starting of pension in many cases, n happens to
be 40 years.
o The pension payments can start immediately or after a time lag immediate annuity or
deferred annuity.
o In case of deferred annuities, at the end of the term of deferment, the pensioner can
exercise an option of getting some lump sum and pension on the balance amount or
pension on the full amount part payment of capital is allowed.
o The pension payments are at guaranteed rates for entire life of the pensioner or for a
fixed term of say 10115120 years.
o Some pension plans provide for paying increased rates of pension over a period of time
ideal hedge against inflation.
o The pension payments can be monthly, quarterly, half yearly or yearly at the option of the
o The pension payments can continue to spouse on the death of the pensioner, at the same
rates or reduced rates, as prescribed by Life Insurance companies this option can be
exercised by pensioner.
The capital sum may be returned to the nominee on the death of the pensioner (return of
purchase price) or forfeited. The rate of return on annuity plans will depend on which option the
pensioner exercises the rate of returns is lower when the pensioner wants return of purchase
o In case of immediate pension the quantum pension depends on the age, at entry, of the
pensioner- the higher the age at entry, the higher the amount of pension.
o Pension plans typically offer no life insurance cover but some plans do have term
assurance rider for deferred pension plans, at an additional cost.
The most important factor that should be considered while choosing a pension plan is that it
provides protection from interest rate risk. Insurance companies guarantee a specific return for
the entire life of the pensioner, whereas in other avenues like fixed deposits I small savings, etc.
the interest rates may go down disrupting the budget of the pensioner.
General Insurance
Insurance other than 'Life Insurance' falls under the category of General Insurance. General
Insurance comprises of insurance of property against fire, burglary etc., personal insurance
such as Accident and Health Insurance, and liability insurance which covers legal liabilities.
There are also other covers such as Errors and Omissions insurance for professionals, credit
insurance etc.
Non-life insurance companies have products that cover property against Fire and allied perils,
flood storm and inundation, earthquake and so on. There are products that cover property
against burglary, theft etc. The non-life companies also offer policies covering machinery
against breakdown, there are policies that cover the hull of ships and so on. A Marine Cargo
policy covers goods in transit including by sea, air and road. Further, insurance of motor
vehicles against damages and theft forms a major chunk of non-life insurance business.
Suitable general insurance covers are necessary for every family. It is important to protect one's
property, which one might have acquired from one's hard earned income. A loss or damage to
one's property can leave one shattered. Losses created by catastrophes such as the tsunami,
earthquakes, cyclones etc. have left many homeless and penniless. Such losses can be
devastating but insurance could help mitigate them. Property can be covered, so also the
people against Personal Accident. A Health Insurance policy can provide financial relief to a
person undergoing medical treatment whether due to a disease or an injury.
Industries also need to protect themselves by obtaining insurance covers to protect their
building, machinery, stocks etc. They need to cover their liabilities as well. Financiers insist on
insurance. So, most industries or businesses that are financed by banks and other institutions
do obtain covers. But are they obtaining the right covers? And are they insuring adequately are
questions that need to be given some thought. Also organizations or industries that are self-
financed should ensure that they are protected by insurance.
(a). Health Insurance
Medical insurance is a type of insurance where the insurer pays the medical costs of the
insured if the insured becomes sick due to covered causes, or due to accidents.
1. The need for health insurance.
Today, health care costs are high, and getting higher by the day. In case of a medical
emergency, the cost of treatment cannot be predicted, and thus can be very well beyond what
one can afford. In a particular year, the cost of medical treatment might be low, but in some
other year to could be prohibitively high. Thus, medical insurance is required to protect oneself
against such emergencies as well as uncertainties.
2. Benefits of health Insurance
o Provides cover against sudden illness or accidents that one may encounter
o Adequate coverage can prevent sudden cash outflow and can sometimes help by
providing capital for immediate surgeries.
3. Types of Medical Insurance
There are two major categories of medical insurance namely
a. Indemnity Plans
These are also referred to as reimbursement plans, and they offer reimbursement against
medical expenses, irrespective of which service provider is used. There are three common
practices that are used to determine the amount of reimbursement in an indemnity plan:
o Reimbursement of actual charges: where the actual cost of medical expenses rs
o Reimbursement of a percentage of actual charges: where only a set percentage of the
actual charges is reimbursed. The rest has to be borne by the consumer.
b. Managed Care Plans
These are the plans in which the insurer has a network of selected health care provider i.e.
hospitals and they offer incentives to the insured to encourage this to use the provider in the
(b). Personal Accident/ Disability Income Insurance
Such an insurance policy enables planning for eventualities of loss/ damage arising out of
accidents or permanent disability caused hereof. Roads accidents are increasing day by day
necessitating a look at such a policy.
o This policy offers compensation in case of death or bodily injury to the insured person,
solely as a result of an accident, by external, visible and violent means.
o The different variations have different coverage ranging from death to comprehensive
covers including death, permanent disablements and temporary total disablements.
o An Indian adult up to the age of 70 can cover himself I herself and dependent family
members between the age of 5 and 70 years.
o This policy also provides a daily allowance for the tenure of hospitalization.
o Some policies of this category also provide for the education of 2 dependent children of
the insured person and a bonus on the total sum insured ion case of permanent
(c). Personal Property Insurance
Apart from risks to life and health, a person is also exposed to risks that may cause damage to
his/ her property. These risks can be covered by opting for personal property insurance. Let us
look at some of the major property insurance types in more detail.
(d). Householder's insurance
A comprehensive householder's insurance policy covers most of the risks faced by any
household. It protects against natural calamities like flood and earthquake and also man-made
disasters like theft and burglary. Instead of opting for separate policies for the building and for
the contents of the house, the holder can take up one package policy.
The policy covers damages to the structure of the home due to:
o Fire
o Storm, tempest, flood, cyclone, hurricane and tornado
o Riot, strike and malicious damage
o Lighting
o Explosion and implosion
o Aircraft damage
o Damage due to impact by vehicles
o Flood, tornado, landslides and rockslides
o Bursting and/ or overflowing of water tanks apparatus and pipes
o Missile testing operation
o Leakage from automatic sprinkler installations
o Bush fire
(e). Personal accident and third party liability covers:
1. Personal accident: This section covers accidental injury ca using death/ disablement (total/
partial) to the insured and his family members
2. Third party liability/ public Liability: This section covers injury to third party or damage to third
party property.
(f). Motor vehicle insurance
Motor insurance is compulsory in India. It is essential for all motor vehicle owners since it
protects them from legal liability that might arise during their vehicle operation.
There are two types of policies available for motor vehicles third party liability insurance and
comprehensive insurance policy.
1. Third party liability Insurance
2. Comprehensive Motor Insurance

(g). Overseas and Travel Insurance
The amount of travel in one's daily life is constantly increasing. These days one is always on
the move, traveling either for business or for pleasure. Whatever be the purpose, travel entails a
lot of risk. One can fall ill and medical expenses can prove to be very costly, one can lose his
baggage, or even his passport. In a foreign country, with hardly any known faces, one can face
any form of emergency. One can even require some urgent financial assistance.


Investments in Gold
Gold was in use as a form of money. It was used as a store of value both by individuals and
countries for much of that period. However in recent times it is still considered as a store of
value, a safe haven, anti-inflationary and as insurance in crisis situations. Considering its high
density and high value per unit mass, storing and transporting gold is very easy. Gold also does
not corrode. Gold has the potential for appreciation (or depreciation), but lacks the two other
components of total return: interest and compound interest. Besides physical gold now gold can
be purchased through a gold exchange traded fund or in the form of gold certificate.
There are six primary reasons why investors own gold:
o As a hedge against inflation.
o As a hedge against a declining dollar.
o As a safe haven in times of geopolitical and financial market instability.
o As a commodity, based on gold's supply and demand fundamentals.
o As a store of value.
o As a portfolio diversifier.

(a) Hedge against inflation
Gold is considered as a hedge against inflation. The most consistent factor determining the
price of gold has been inflation as inflation goes up, the price of gold goes up along with it.
Oil, Inflation and Gold
Although the prices of gold and oil don't exactly mirror one another, there is no question that oil
prices do affect gold prices. If oil prices rise or fall sharply, investors can expect a
corresponding reaction in gold prices, often with a lag.
(b) Hedge against a Declining Dollar
Gold is bought and sold in U.S. dollars, so any decline in the value of the dollar causes the
price of gold to rise. The U.S. dollar is the world's reserve currency the primary medium for
international transactions, the principal store of value for savings, the currency in which the
worth of commodities and equities are calculated, and the currency primarily held as reserves
by the world's central banks. However, now that it has been stripped of its gold backing, the
dollar is nothing more than a fancy piece of paper.
(c) Gold as a Safe Haven
Despite the fact that the United States is the only superpower, there are a myriad of problems
festering around the world, any one of which could erupt with little warning. Gold has often been
called the "crisis commodity" because it tends to outperform other investments during periods of
world tensions. The very same factors that cause other investments to suffer cause the price of
gold to rise. A bad economy can sink poorly run banks. Bad banks can sink an entire economy.
And, perhaps most importantly to the rest of the world, the integration of the global economy
has made it possible for banking and economic failures to destabilize the world economy. As
banking crises occur, the public begins to distrust paper assets and turns to gold for a safe
haven. When all else fails, governments rescue themselves with the printing press, making their
currency worth less and gold worth more. Gold has always raised the most when confidence in
government is at its lowest.
(d) Gold Supply and Demand
First, demand is outpacing supply across the board. Gold production is declining; copper
production is declining; the production of lead and other metals is declining. It is very difficult to
open new mines when the whole process takes about seven years on average, making it hard
to address the supply issue quickly.
(e) Gold Store of Value
Gold will always maintain an intrinsic value. Gold will not get lost in an accounting scandal or a
market collapse. Although the gold price may fluctuate, over the very long run gold has
consistently reverted to its historic purchasing power parity against other commodities and
intermediate products. Historically, gold has proved to be an effective preserver of wealth. It has
also proved to be a safe haven in times of economic and social instability. In a period of a long
bull run in equities, with low inflation and relative stability in foreign exchange markets, it is
tempting for investors to expect continual high rates of return on investments. It sometimes
takes a period of falling stock prices and market turmoil to focus the mind on the fact that it may
be important to invest part of one's portfolio in an asset that will, at least, hold its value.

(f) Gold. Portfolio Diversifier
The most effective way to diversify your portfolio and protect the wealth created in the stock and
financial markets is to invest in assets that are negatively correlated with those markets. Gold is
the ideal diversifier for a stock portfolio, simply because it is among the most negatively
correlated assets to stocks.
Investment advisors recognize that diversification of investments can improve overall portfolio
performance. The key to diversification is finding investments that are not closely correlated to
one another. Because most stocks are relatively closely correlated and most bonds are
relatively closely correlated with each other and with stocks, many investors combine tangible
assets such as gold with their stock and bond portfolios in order to reduce risk. Gold and other
tangible assets have historically had a very low correlation to stocks and bonds.
Gold Coins
Precious metals in bulk form are known as bullion. They are traded on commodity markets. The
important feature of bullion is that it is valued by its mass and purity rather than by a face value
as money.
Gold coins are a common way of owning gold. Bullion coins are priced according to their fine
weight, plus a small premium based on supply and demand (as opposed to numismatic (study
of coins or medals) gold coins which are priced mainly by supply and demand based on rarity
and condition). Gold coins are primarily collected for their numismatic value. Investors view it as
a "hedge" against inflation or a store of value.
Fineness of gold coins
Coins are usually made of an alloy as other metals are mixed into the coin to make it more
durable. Fineness is the actual gold content in a coin or bar. It is expressed as "per mil," or
thousandths. So if .999 is 999 thousandths of the weight are pure gold then the other 1 /1000 is
an alloy. Carat is the unit of fineness for gold i.e. equal to 1/24 part of pure gold in an alloy.
The relation between Carats and fineness in Gold
24 carats= 1000 fine
23 carats= 958.3 fine
22 carats= 916.6 fine
21 carats= 875.0 fine
20 carats= 833.3 fine
18 carats= 750.0 fine
16 carats= 666.7 fine
14 carats= 583.3 fine
10 carats= 416.6 fine

Grading coins
Evaluation of a coin's grade is done by amount of wear on a coin. Amount of wear decides the
price of the coin. Coins with little wear are graded higher and therefore assigned higher prices
than those with a lot of wear. Rare coins with low grade can easily be more valuable than more
widely available, higher grade coins of common dates.
In the early years of coin collecting, three general terms were used to describe a coin's grade:
o Good where details were visible but circulation had worn the surface
o Fine Features were less worn from circulation and a bit of the mint luster showed on the
o Uncirculated Details were sharp and there was a luster approaching the state of the coin
at the mint, prior to general circulation

Financial Derivatives

Derivative is a contract or a product whose value is derived from the value of some other asset,
known as underlying. Derivatives are based on a wide range of underlying assets. This includes
o Metals such as Gold, Silver etc;
o Commodities such as Grains, Coffee beans, Orange juice etc;
o Energy resources such as Oil and Gas etc; and
o Financial Assets such as Shares, Bonds and Foreign Currencies.

A forward contract is a contractual agreement made directly between two parties. One party
agrees to buy a commodity or a financial asset on a date in the future at a fixed price. The other
side agrees to deliver that commodity or asset at the predetermined price. There is no element
of optionality about the deal. Both sides are obliged to go through with the contract, which is a
legal and binding commitment, irrespective of the value of the commodity or asset at the point
of delivery. Since forwards are negotiated directly between two parties, the terms and
conditions of a contract can be customized. However, there is a risk that one side might default
on its obligations.
A futures contract is essentially the same as a forward, except that the deal is made through an
organized and regulated exchange rather than being negotiated directly between two parties.
One side agrees to deliver a commodity or asset on a future date (or within a range of dates) at
a fixed price, and the other party agrees to take delivery. The contract is a legal and binding
commitment. There are three key differences between forwards and futures. Firstly, a futures
contract is guaranteed against default. Secondly, futures are standardized, in order to promote
active trading. Thirdly, they are settled on a daily basis.
A swap is an agreement made between two parties to exchange payments on regular future
dates, where the payment legs are calculated on a different basis. As swaps are OTC deals,
there is a risk that one side or the other might default on its obligations. Swaps are used to
manage or hedge the risks associated with volatile interest rates, currency exchange rates,
commodity prices and share prices. A typical example occurs when a company has borrowed
money from a bank at a variable rate and is exposed to an increase in interest rates; by
entering into a swap the company can fix its cost of funding.
A call option gives the holder the right to buy an underlying asset by a certain date at a fixed
price. A put option conveys the right to sell an underlying asset by a certain date at a fixed
price. The purchaser of an option has to pay an initial sum of money called the premium to the
seller or writer of the contract. This is because the option provides flexibility; it need never be
exercised (taken up). Options are either negotiated between two parties in the OTC market, one
of which is normally a specialist dealer, or freely traded on organized exchanges.
Traded options are generally standardized products, though some exchanges have introduced
contracts with some features that can be customized.
Market participants
Derivatives have a very wide range of applications in business as well as in finance. There are
four main participants in the derivatives market: dealers, hedgers, speculators and arbitrageurs.
The same individuals and organizations may play different roles in different market
circumstances. There are also large numbers of individuals and organizations supporting the
market in various ways.

Derivative contracts are bought and sold by dealers who work for major banks and securities
houses. Some contracts are traded on exchanges, others are OTC transactions. In a large
investment bank the derivatives operation is now a highly specialized affair. Marketing and
sales staff speak to clients about their requirements. Experts help to assemble solutions to
those problems using combinations of forwards, swaps and options. Any risks that the bank
assumes as a result of providing tailored products for clients is managed by the traders who run
the bank's derivatives books. Meantime, risk managers keep an eye on the overall level of risk
the bank is running, and mathematicians known as 'quants' devise the tools required to price
new products.
Corporations, investing institutions, banks and governments all use derivative products to
hedge or reduce their exposures to market variables such as interest rates, share values, bond
prices, currency exchange rates and commodity prices. The classic example is the farmer who
sells futures contracts to lock into a price for delivering a crop on a future date. The buyer might
be a food-processing company which wishes to fix a price for taking delivery of the crop in the
future, or a speculator. Another typical case is that of a company due to receive a payment in a
foreign currency on a future date. It enters into a forward transaction with a bank agreeing to
sell the foreign currency and receive a predetermined quantity of domestic currency. Or it buys
an option which gives it the right but not the obligation to sell the foreign currency at a set
exchange rate.
Derivatives are very well suited to speculating on the prices of commodities and financial assets
and on key market variables such as interest rates, stock market indices and currency
exchange rates. Generally speaking, it is much less expensive to create a speculative position
using derivatives than by actually trading the underlying commodity or asset. As a result, the
potential returns are that much greater. A classic application is the trader who believes that
increasing demand or reduced production is likely to boost the market price of a commodity. As
it would be too expensive to buy and store the physical commodity, the trader buys an
exchange-traded futures contract, agreeing to take delivery on a future date at a fixed price. If
the commodity price increases, the value of the contract will also rise and can then be sold back
into the market at a profit.
An arbitrage is a deal that produces risk-free profits by exploiting a mis-pricing in the market. A
simple example occurs when a trader can purchase an asset cheaply in one location and
simultaneously arrange to sell it in another at a higher price. Such opportunities are unlikely to
persist for very long, since arbitrageurs would rush in to buy the asset in the 'cheap' location,
thus closing the pricing gap. In the derivatives business arbitrage opportunities typically arise
because a product can be assembled in different ways out of different building blocks. If it is
possible to sell a product for more than it costs to buy the constituent parts, then a risk-free
profit can be generated. In practice, the presence of transaction costs often means that only the
larger market players can benefit from such opportunities.

Derivative exchanges
In the modern world, there is a huge variety of derivative products available. They are either
traded on organized exchanges (called exchange traded derivatives) or agreed directly
between the contracting counterparties over the telephone or through electronic media (called
Over-the-Counter (OTC) derivatives). Few complex products are constructed on simple building
blocks like forwards, futures, options and swaps to cater to the specific requirements of
Over-the-counter market is not a physical marketplace but a collection of broker-dealers
scattered across the country. Main idea of the market is more a way of doing business than a
place. Buying and selling of contracts is matched through negotiated bidding process over a
network of telephone or electronic media that link thousands of intermediaries. OTC derivative
markets have witnessed a substantial growth over the past few years, very much contributed by
the recent developments in information technology. The OTC derivative markets have banks,
financial institutions and sophisticated market participants like hedge funds and high net-worth
individuals. OTC derivative market is less regulated market because most of the transactions
occur in private, without activity being visible on any exchange.
Few risks are associated with OTC derivatives markets that give rise to instability in financial
systems. Some of the risks are
1. The dynamic nature of gross credit exposures;
2. Information asymmetries;
3. The effects of OTC derivative activities on available aggregate credit;
4. The high concentration of OTC derivative activities in major institutions; and
5. The central role of OTC derivatives markets in the global financial system.
Many events such counter-party credit events and sharp movements in asset prices that
underlie derivative contracts bring instability to the financial system, which significantly alter the
perceptions of current and potential future credit exposures. Frequent change in asset price, the
size and configuration of counter-party exposures can become unsustainably large and provoke
a rapid unwinding of positions.
OTC derivatives market, unable to manage risks like counterparty risk, liquidity risk and
operational risk, pose threat to international financial stability. The problem is more acute as
heavy reliance on OTC derivatives creates the possibility of systemic financial events, which fall
outside the more formal clearing house structures. Moreover, those who provide OTC derivative
products, hedge their risks using exchange-traded derivatives. In view of the inherent risks
associated with OTC derivatives, and their dependence on exchange-traded derivatives, Indian
law considers them illegal.
Exchange Traded Derivatives
An exchange-traded contract, such as a futures contract, has a standardized format that
specifies the underlying asset to be delivered. They trade on organized exchanges with prices
determined by the interaction of many buyers and sellers. In India, two exchanges offer
derivatives trading the Bombay Stock Exchange (BSE) and the National Stock Exchange
(NSE). A clearing house which is a wholly owned subsidiary of the exchanges, guarantees
contract performance. Margin requirements and daily marking-to-market of futures positions
substantially reduce the credit risk of exchange-traded contracts, relative to OTC contracts.
A forward is an agreement made directly between two parties to buy/ sell a commodity/ asset
o On a specific date in the future.
o At a fixed price that is agreed at the outset between the two parties
o Forwards are widely used in commodities, foreign exchange market etc.
Essential features of a forward are
It is a contract between two parties (Bilateral contract)
o Price is fixed today
o Settlement date is fixed today
o Quantity of the underlying
o Quality of the underlying
o Delivery place is fixed
Forwards are bilateral over the counter (OTC) transactions where the terms of the contract as
price, quantity, quality, time and place are negotiated between two parties to the contract. Any
alteration in the terms of the contract is possible if both parties agree to it. Buyer agrees to buy
an underlying asset on a date in the future at a fixed price. The Seller agrees to deliver
underlying asset at the predetermined price. Corporations, traders and investing institutions
extensively use OTC transactions for a deal to meet their specific requirements. The essential
idea of entering into a forward is to fix the price and thereby avoid the price risk. Thus by
entering into forwards, one is assured of the price at which one can buy/ sell goods or other
Liquidity Risk
Liquidity is nothing but the ability of the market participants to buy or sell the desired quantity of
an underlying asset. As forwards are tailor made contracts i.e. the terms of the contract are
according to the specific requirements of the parties. Other market participants may not be
interested in these contracts. Forwards are not listed or traded in exchanges, which indirectly
makes difficult for other market participants to easily access these contracts or contracting
parties. The tailor made contracts and the non-availability on exchanges creates illiquidity in the
contracts. Therefore, it is very difficult for contracting parties to exit from the forward contract
before the contract's maturity.
Counterparty risk
In most financial contracts, counterparty risk is also known as default risk. It is the risk of an
economic loss from the failure of counterparty to fulfill its contractual obligation. For example A
& B enter into a bilateral agreement, where A will purchase 100 kg of rice@ Rs20/ kg from B
after 6 months. Here A is counterparty to B and vise-versa. After 6 months if price of rice is Rs
30 in the market then B may forego his obligation to deliver 100 kg of rice@ Rs 20 to A.
Similarly, if prices of rice fall to Rs 15 then A may purchase from the market at a lower price,
instead of honoring the contract. Thus, a contracting party defaults only when there is some
incentive to default.

Lack of centralized trading platform
Lack of liquidity can make trading infeasible, while lack of transparency can make potential
trading partners unwilling to trust one another. Both can cause markets to seize up and threaten
a cascade of failures. Transparent, liquid financial markets are less prone to such systemic
threats. Thus, a centralized trading platform can solve most of the risks.
Futures contract
Futures markets were innovated to overcome the drawbacks of forwards. A futures contract is
an agreement made through an organized exchange to buy or sell a fixed amount of a
commodity or a financial asset on a future date at an agreed price. Futures market is
standardised forwards contract. Buyers and sellers trade in a centralized trading platform of
exchanges where the terms of the contract are standardized. The clearinghouse associated
with the exchange guarantees delivery. As exchange specifies all the terms of the contract, the
trader needs to bargain over the future price. A trader who buys futures contract takes a long
position and one who sells futures takes a short position. The words buy and sell are figurative
only because no money or underlying asset changes hand when the deal is signed.

o Contract between two parties through Exchange
o Centralized trading platform i.e. exchange
o Price discovery
o Margins are payable by both the parties
o Quality decided today (quality as per the specifications decided by the exchange)
o Quantity decided today (standardized)
o The leverage effect works in both directions and, therefore, makes trading in futures
contracts highly risky. Futures operate on margins, meaning to take a position in a
contract only a fraction of the total value needs to be made available in cash in the
trading account. In fact, a trader needs to deposit only 5 to 10 % of the contract value
and rest of the contract are brought in margin. Low margin requirements can encourage
poor money management, leading to excessive risk taking. Additionally, it is easy to lose
the entire deposit in a volatile market. Therefore, trading in futures contract is considered
o Futures contract have a linear payoff charts i.e. a trader has to bear unlimited loss and
simultaneously gain unlimited profits in his futures contract position. Therefore, a trader
should frequently monitor his futures positions.

Like forward and futures, options represent another derivative instrument and provide a
mechanism by which one can acquire a certain commodity or any other financial asset, or take
position in, in order to make profit or cover risk for a price. The options are similar to the futures
contracts in the sense that they are also standardized but are different from them in many ways.
An option is a right, but not the obligation, to buy or sell an underlying asset at a predetermined
price, within or at the end of a specified period. The party buying the option is called buyer of
the option and the party selling the option is called the seller/ writer of the option.
The option buyer who is also called long on option has the right and no obligation with regard to
buying or selling the underlying asset, while the option writer who is also called short on option
has the obligation but no right in the contract.
Equity option holder does not enjoy the rights as an ordinary share holder e.g. voting rights,
regular cash or special dividends. The option holder must exercise the option and take
ownership of underlying shares to be eligible for these rights. But in India, derivative
instruments are cash settled.
As mentioned in earlier module SEBI has come up with new circular, on July 15, 2010, which
states physical settlement of stock derivatives. A Stock Exchange may introduce physical
settlement in a phased manner. On introduction, however, physical settlement for all stock
options and/ or all stock futures, as the case may be, must be completed within six months.
Options may be categorized as call options and put options depending upon the right conferred
on the buyer.

Call Option
It is an option to buy a stock at a specific price on or before a certain date. In this way, Call
options are like security deposits. If, for example, you wanted to rent a certain property, and left
a security deposit for it, the money would be used to insure that you could, in fact, rent that
property at the price agreed upon when you returned. If you never returned, you would give up
your security deposit, but you would have no other liability. Call options usually increase in
value as the value of the underlying instrument rises.
Put Options
They are options to sell a stock at a specific price on or before a certain date. In this way, Put
options are like insurance policies If you buy a new car and then buy auto insurance on the car,
you pay a premium and are, hence, protected if the car is damaged in an accident. If this
happens, you can use your policy to regain the insured value of the car. In this way, the put
option gains in value as the value of the underlying instrument decreases. If all goes well and
the insurance is not needed, the insurance company keeps your premium in return for taking on
the risk.
Long describes a position (in stock and/ or options) in which you have purchased and own that
security in your brokerage account.
Long an equity option contract:
o You have the right to exercise that option at any time prior to its expiration.
o Your potential loss is limited to the amount you paid for the option contract.
Short describes a position in options in which you have written a contract (sold one that you did
not own) and earned a premium. In return, you now have the obligations inherent in the terms
of that option contract. If the owner exercises the option, you have an obligation to meet. If you
have sold the right to buy 100 shares of a stock to someone else, you are short a call contract.
If you have sold the right to sell 100 shares of a stock to someone else, you are short a put
contract. When you write an option contract you are, in a sense, creating it. The writer of an
option collects and keeps the premium received from its initial sale.
Short an equity option contract:
o You can be assigned an exercise notice at any time during the life of the option contract.
All option writers should be aware that assignment is a distinct possibility.
o Your potential loss on a short call is theoretically unlimited. For a put, the risk of loss is
limited by the fact that the stock cannot fall below zero in price. Although technically
limited, this potential loss could still be quite large if the underlying stock declines
significantly in price.
An opening transaction is one that adds to, or creates a new trading position. It can be either a
purchase or a sale. With respect to an option transaction, consider both:
o Opening purchase a transaction in which the purchaser's intention is to create or
increase a long position in a given series of options.
o Opening sale a transaction in which the seller's intention is to create or increase a short
position in a given series of options.
A closing transaction is one that reduces or eliminates an existing position by an appropriate
offsetting purchase or sale. With respect to an option transaction:
o Closing purchase a transaction in which the purchaser's intention is to reduce or
eliminate a short position in a given series of options. This transaction is frequently
referred to as "covering" a short position.
o Closing sale a transaction in which the seller's intention is to reduce or eliminate a long
position in a given series of options.
Option styles
Settlement of options is based on the expiry date and basic styles of options. The styles have
geographical names, which have nothing to do with the location where a contract is agreed.
The styles are:
European: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument only on the expiry date. This means that the option cannot be exercised
early. Settlement is based on a particular strike price at expiration. Currently, in India only index
options are European in nature.
American: These options give the holder the right, but not the obligation, to buy or sell the
underlying instrument on or before the expiry date. This means that the option can be exercised
early. Settlement is based on a particular strike price at expiration.
Options in stocks that have been recently launched in the Indian market are" American Options"
while the options on the Index are "European Options".
Clearing and Settlement System
All trades executed on F &O Segment of the Exchange through Clearing Corporation/ Clearing
House with the help of Clearing Members and Clearing Banks. Clearing Corporation acts as a
legal counterparty to all trades on this segment. The Clearing and Settlement process
comprises of three main activities, viz., Clearing, Settlement and Risk Management.
Clearing Members
Broadly speaking there are three types of clearing members
1. Self-Clearing Member (SCM): They clear and settle trades executed by them only either on
their own account or on account of their clients.
2. Trading-cum-Clearing Member (TCM): They clear and settle their own trades as well as trades
of other trading members
3. Professional clearing members (PCM): They clear and settle trades executed by trading
Both TCM and PCM are important for additional security deposits in respect of every trading
member whose trades they undertake to clear and settle.
Clearing Banks
Clearing Banks are responsible for funds settlement in F&O Segment. For settlement purpose,
all clearing members are required to open a separate bank account with Clearing Corporation
designated clearing bank.
Clearing Mechanism
The initial step in clearing mechanism is to calculate open positions and obligations of clearing
members. The open positions of a CM is calculated as an aggregate of the open positions of all
the trading members (TMs) and all custodial participants (CPs) clearing though him, in the
contracts which they have traded. For TM, the open position is attained by adding up his
proprietary open position and clients' open positions, in the contracts which they have traded.
Every order on the trading system should be identified as either proprietary (Pro) or client (Cli).
Proprietary positions are calculated on net basis (buy-sell) for each contract and that of clients
are arrived at by summing together net positions of each individual client. ATM's open position
is the sum of proprietary open position, client open long position and client open short position.
To illustrate, a Clearing Member A, with Trading Members clearing through him ABC and RST

Proprietary Position Client 1 Client 2
TM Security Buy
4000 2000 2000 4000 3000 1000 7000 5000 2000 Long
2000 3000 (1000) 2500 1500 1000 1000 2000 (1000) Long

Clearing member A's open position for NIFTY December contract is:
Member Long Position Short Position
ABC 5000 0
RST 1000 2000
Total for A 6000 2000

From the above example, ABC's Long Position is arrived by adding both net position of his
proprietary i.e. 3000 and net positions of both his client's 1 & 2 i.e. 1000 and 2000 respectively.
Similarly, we have calculated the long and short positions of X YZ. Clearing member's open
position is attained by adding long positions and short positions of both the clients i.e. 6000 long
open positions and 2000 short open positions.

Settlement Mechanism
At present in India, all futures and options contracts are cash settled. The underlying assets
are not delivered on settlement. These contracts, therefore, has to be settled in cash. Steps
are taken were futures and options on individual securities will be delivered as in the spot
market. The settlement amount for a CM is netted across all their TMs/ clients, with respect to
their obligations on MTM, premium and exercise settlement.
The settlement of trades in F&O segment is on T +1 working day basis. Members with a funds
pay-in obligation are required to have clear funds in their account. Funds in clearing account
should be present on or before 10.30 a.m. on the settlement day. The payout of funds is later
credited to the primary clearing account of the members.
Settlement of Futures Contracts on Index or Individual Securities
In Futures contracts, both the parties to the contract have to deposit margin money which is
called as initial margin. There are two types of settlements in futures contract; they are MTM
settlement which happens on a continuous basis at the end of each day, and the final
settlement which happens on the last trading day of the futures contract.
Mark to Market (MTM) Settlement
Mark to Market is a process by which margins are adjusted on the basis of daily price changes
in the markets for underlying assets. The profits/ losses are computed as the difference
1. The trade price and the day's settlement price for contracts executed during the day but
not squared up.
2. The previous day's settlement price and the current day's settlement price for brought
forward contracts.
3. The buy price and the sell price for contracts executed during the day and squared up.
The CM, who incurred loss, is required to pay the MTM loss amount in cash. The amount is
passed on to the CM who has made a MTM profit. The pay-in and pay-out of the MTM
settlement are brought into effect on the T +1 day of the trade day. Trading Member is
responsible to collect/ pay funds from/ to clients by the next day. Clearing Members collects and
settle the daily MTM profits/ losses incurred by the TMs and their clients clearing and settling
through them.
After the completion of day's settlement, all the open positions are reset to the daily settlement
price. These positions become the open positions for the next day.
Final Settlement
After the close of trading hours of expiration day Clearing Corporation marks all positions of a
Clearing Member to the final settlement price. Later the resulting profit/ loss are settled in cash.
Clearing member's clearing bank account is settled on the day following expiry day of the
contract. Long position is assigned to short position with the same series, on a random basis.
Settlement Price
Daily settlement price of future contract is the day's closing price on a particular trading day.
The closing price for a future contract is calculated as the last half an hour weighted average
price of the contract in the F&O Segment of exchanges. Final settlement price is the closing
price of the relevant underlying index/security in the Capital Market segment of exchange, on
the last trading day of the Contract. The closing price of the underlying Index/ security is
currently its last half an hour weighted average value in the Capital Market Segment of
Settlement of Options Contracts on Index or Individual Securities
Options contracts have two types of settlements. Daily premium settlement and Final settlement
Daily Premium Settlement
In options contract, buyer of an option pays premium while seller receives premium. The
clearing member with payable position needs to pay premium amount to clearing corporation
which in turn are passed on to the members who have a premium receivable position. This is
known as daily premium settlement. The pay-in and pay-out of the premium settlement is on T
+1 day. The premium amount is directly credited/ debited to the clearing members clearing
bank account.
Final Exercise Settlement
All the in the money stock options contracts shall be exercised on the expiry day. Any unclosed
long/ short positions are immediately assigned to short/ long positions in option contracts with
the same series, on the random basis.
Profit/ loss amount for options contract on index and individual securities on final settlement is
debited/ credited to the relevant clearing members clearing bank account on T +1 day i.e. a day
after expiry day. Open positions, in option contracts, cease to exist after their expiration day.
The settlement of funds for a clearing member on a particular day is the net amount across
settlements and all trading members/ clients, in Future & Option Segment.