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“Capital Market in India with respect to BSE &

SIP project report to be submitted in partial fulfillment of the
requirements for the PGDM

By Nishant Seth
Supervisors: 1. Company Guide: Mr. B. Sanjeev
Post Graduate Diploma in Management
Under the guidance of
Gaurav Sarin


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It gives me great satisfaction on completion of Summer Internship Project
entitled “Introduction to Stock Markets”.
On the submission of my project report I would like to express my sincere
gratitude to my Faculty Guide MrsShivi Khanna for mentoring me and taking
active interest throughout the project and for sharing her insights on the topics
and for being a constant source of inspiration and courage during the entire
project work. She was always available, correcting mistakes, intelligently directing
me to proper sources of information advising to aim for simplicity, brevity, clarity
and accuracy.
I would also like to express my special thanks to Mr B. Sanjeev (Head –
Online Trading), SMC Global Securities Limited and Mr Sunny Dua ( ManagerBusiness Development - Retail ) for appointing me as project trainee and for their
help and cooperation during the Project work.
I would like to thank the entire team of SMC Global Securities Limited for
sharing their immense experience and extending their support in carrying out this
project work. I am greatly acknowledged for their kind help.

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Executive Summary

This project has been initiated for the purpose of acquainting me with, right
from the basics of the financial terminology used in the stock markets, further up to
gaining in depth knowledge of all the issues concerning the management of various
risks faced by investors and traders under different market scenarios.
It starts with the basic types of equity derivatives in India followed by the
basic terminologies of futures and options and their practical applications in the real
The project goes on to describe how future contracts are used by hedgers,
speculators and arbitrageurs to make short term gains or provide a cushion to their
portfolios. Different strategies with live examples have been explained to give a
practical edge to the project.

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.…............ CHAPTERSPAGE NO.. Executive summary………………………………………………………………....…………………........5-9 2 What is Stock Exchange ……..14-15 6..TABLE OF CONTENTS Acknowledgement……………… ……………………………………….. About Stock Market of India ……………………………16-17 7.............……11 4 National Stock Exchange(NSE) ……………………………12-13 5...10 3 Stock Exchange of India ………………………….....Bombay Stock Exchange (BSE) …………………………….............…......................….. 1 Introduction to Company .. Bibliography......Major Segments of the Capital Market …...…………………………33 4 | Page ...........……………………… 18-32 8........

Mr. From the beginning of this financial institution in 1990 to current time it has incorporated itself to work diligently for its customers and has consistently delighted its customers with its discernment.Subhash Chand Agarwal and Mr. To shape their vision into a reality they watered the sapling with their principles of transparency. Its hard work and customer oriented approach has added appreciation from all over the world. Their exceptional leadership skills. Professionally both are Chartered Accountants with a rich experience of more than 20 years in the capital market.Company Background SMC Global Securities Limited has been working prudently for the past 22 odd years in financial services in India. Mahesh Chand Gupta are the visionaries who planted the sapling of the “Kalpvriksha” called SMC. and nourished it with their rock solid commitment for excellence. outstanding commitment and disciplined style of working have fostered SMC into a financial hub justifying the words that “the future belongs to those who believe in the beauty of their dreams”. honesty and integrity. 5 | Page .

2010) o Received Major Volume Driver award from BSE for 3 years consecutively (2004-05. 2011 & 2010) o India’s Best Wealth management Company (Source : Business Sphere 2011) o Awarded the Fastest Growing Retail Distribution Network in financial services (Source: Business Sphere. by acquiring license for broking and clearing member with Dubai Gold and Commodities exchange (DGCX) o One of the largest proprietary desk for doing near risk-free arbitrage in equities and commodities o Institute of Economic Studies (IES) has honored our Chairman with the ‘Pride of India’ and ‘Udyog Rattan’ awards.SMC Achievements o Best Currency Broker in India (Source: UTV Bloomberg Financial Leadership awards. Also.SMC offers a diverse range of      financial services which includes: Institutional and retail brokerage of  Equity  Currency  Commodities  Derivatives  Online trading Depository services Fixed Deposits IPOs and Mutual funds distribution 6 | Page . 2010) o Largest distribution network in the country (Source: BSE-D&B Equity Broking Awards. in the CNBC Optimix Financial Services Award 2008 under "National Level Retail Category" o Amongst the First Financial Firms in India to expand operations in the lucrative gulf market. IIFS has conferred him with ‘Glory of India’ award recently o In its 22 years journey SMC Global Securities Limited offers a diverse range of financial products and services to their investors. 2011) o Best Equity Broking House in India (Source: BSE-D&B Equity Broking Awards. 2005-06 and 2006-07) o Nominated amongst the top 3.

        Dedicated desk for NRI and institutional clients Insurance broking Clearing services Margin funding Investment banking Portfolio management Wealth advisory & research 7 | Page .

F&O.20. ACE & DGCX. as a Depository Participant. is a subsidiary of SMC global securities Ltd.350+ employees and over 16500 financial advisors serving the financial needs of more than 7. (MFSPL). SMC Global Securities is a trading cum clearing member of all these exchanges for the currency segment. SMC is a participant of Central Depository Services Limited (CDSL) and National Securities Depository Limited (NSDL). MCX-SX & USE. offers depository accounts to individual investors as well as corporate houses. There is online and off line services for the investors and they can use it as per their knowledge and understanding. NMCE. Hyderabad and Bangalore plus a growing network of 2500+ offices spread across 500+ cities/towns in India. registered as a non banking financial company (NBFC). SMC.Over the years. ICEX. Silver. It offers commodity trading in Gold. Dollar & Sterling) and Steel Rebar Contracts. SMC Comex International DMCC (part of SMC Group) is one of the initial. leading & experienced clearing and broking members of Dubai Gold and Commodities Exchange (DGCX). Moneywise Financial Services Pvt. Crude (WTI & Brent). Merger & Acquisition 8 | Page . Public Issues Management. Kolkata. Loans against shares are extended against basket of securities traded on BSE/ NSE. NCDEX. Capital Restructuring. Euro. there are 3 major exchanges offering Currency future trading – NSE. Jaipur. Currently in India. SMC Capitals Limited is the Investment Banking arm of SMC group and is a SEBI registered Category I Merchant Banker with strong management team. Forex (INR. Ahmadabad. SMC has expanded its operations domestically as well as internationally. Existing network includes regional offices at Mumbai. MCX-SX. SMC group has a highly efficient workforce of over 3. The SMC provides trading platforms for its clients to trade in NSE. MCX.000 satisfied investors. financial sponsors and corporate partners to help corporate clients achieve their financial and strategic goals. Private Equity and Debt Syndication. SMC is one of the largest proprietary desks for doing near risk-free arbitrage in equities and commodities. Ltd. BSE. which enables them to trade in the dematerialized environment. Chennai. SMC offers a wide spectrum of investment banking services covering Corporate Advisory. offers loan against securities of shares.

SMC with the help of their team of highly experienced analysts helps investors in understanding the changes in economic world by providing a detailed timely Research reports covering investment summary. commodity trends. trend of world markets. SMC also deals in Capital Gain Bond Issues which facilitates tax exemption against long term capital gain as per Sec 54EC of Income Tax Act.Advisory. 9 | Page . sector trends. GDR and IDR. Sapien is also an approved broker for the AIM segment of the LSE. UK and is a member of the London Stock Exchange (LSE) which helps companies to raise money from foreign markets by issuing ADR. Besides this they deal in GOI 8% Bonds and Bonds issued by Companies from time to time. Sapien is authorized and regulated by the Financial Services Authority (FSA). Valuation Services and ESOP. SMC Capitals is associated with London-based Sapien Capital.

selling or dealing in securities.debentures. bonds. in a company the totalequity capital of Rs 2. the company then issaid to have 20.000 units of Rs 10each. What is an Index? An Index shows how a specified portfolio of share prices is moving in orderto give an indication of market trends. Each such unit of Rs 10 is called a Share. 1956 [SCRA] defines ‘StockExchange’ as anybody of individuals. whether incorporated or not.00. What is an ‘Equity’/Share? Total equity capital of a company is divided into equal units of smalldenominations. The holders of suchshares are members of the company and have voting rights. It is a basket of securities and theaverage price movement of the basket of securities indicates the indexmovement.000 equity shares of Rs 10 each. units etc. shares. whether upwards or downwards. Stock exchange could bea regional stock exchange whose area of operation/jurisdiction is specified atthe time of its recognition or national exchanges. Thus.00.constituted for the purpose of assisting. What is a Depository? A depository is like a bank wherein the deposits are securities (viz. What is Dematerialization? Dematerialization is the process by which physical certificates of an investorare converted to an equivalent number of securities in electronic form andcredited to the investor’s account with his Depository Participant (DP).000 is divided into 20. 10 | P a g e .) in electronic form. For example.What is meant by a Stock Exchange? The Securities Contract (Regulation) Act. regulating or controlling the business of buying.00. each called a share. government securities. which are permitted tohave nationwide trading since inception. NSE was incorporated as a nationalstock exchange.00.

The ISE provides a member. 9.The Hyderabad Stock Exchange of any of these stock exchanges and access into the national market segment.Madhya Pradesh Stock Exchange Ltd.Kanara Stock Exchange Ltd.Coimbatore Stock ExchangeMeerut Stock Exchange Ltd. which would be in addition to the local trading segment available at present.The Calcutta Stock Exchange Association Ltd. The ISE is promoted by 15 regionalstock exchanges in the country and has been set up at Mumbai.Three others set up in the reforms era. As on 31 March 1999. fair and open manner with access to investors across the country.Madras stock Exchange Ltd.Cochin Stock Exchange Ltd.23. 20 of them being regional ones with allocated areas. The total single sided turnover on all stock exchanges during 2998-99 was Rs 10.Jaipur Stock Exchange Ltd.Vadodara Stock Exchange Ltd.877 companies were listedon the stock exchanges and the market capitalization was 5. Mangalore Stock Exchange Ltd.The Magadh Stock Exchange Ltd.Stock Exchanges of India STOCK EXCHANGES OF INDIAThere are 24 stock exchanges in the country.381.772crore.Bangalore Stock Exchange Ltd.Saurashtra Kutch Stock Exchange Ltd.C Stock Exchange Association Ltd.The Delhi Stock Exchange Association Ltd. ISE andmajority of the regional stock exchanges have adopted the screen based trading system (SBTS)to provide automated and modern facilities for trading in a transparent.Pune Stock Exchange Ltd.The following are the names of the various stock exchanges in India :The Mumbai Stock Exchange TheAhmadabad Stock exchange Association Ltd.The Guwahati Stock Exchange Ltd.The Uttar Pradesh Stock Exchange Association Ltd.The Ludhiana Stock Exchange Association Ltd. viz. The NSE and OCTEI.Over The Counter (OTC) Exchange of IndiaThe National Stock Exchange of India National Stock Exchange (NSE) 11 | P a g e . National Stock Exchange (NSE) the Over theCounter Exchange of India Limited (OTCEI) and Inter-connected Stock Exchange of IndiaLimited (ISE) have mandate to nationwide trading network..

These stocks are weighted bymarket capitalization. which beats in sync with the changing market trends. insurance companies and other financial intermediaries in India but its ownership and management operate as separate entities eliminating any conflict of interest.The other few firsts associated with the National Stock Exchange are launch of NSE-CNBC-TV18 media centre in association with CNBC-TV18. the NSE India is counted amongst the topmost courses in the world. co-promoting andsetting up of the first depository in India (National Securities Depository Limited). NSE India is based out of Mumbai.The National Stock Exchange (NSE India) is the world’s third largest stock exchange interms of transaction volumes. for both equitiesand derivative trading. The Capital Market (Equities) segment commenced operations in November 1994 and operations in FNO segment commenced in June 2000. National Stock Exchange (NSE India) was incorporated in November 1992 as a taxpaying company unlike other stock exchanges in the India. National Stock Exchange (NSE India) was promoted by leading financial institutions. NSE is the largest stock exchange in India in terms of daily turnover and number of trades. the performance of fifty major Indian stocks is displayed here.’ in India. in short. NSE India Market Operations NSE India commenced operations in the Wholesale Debt Market (WDM) segment in June 1994.The year 2008 saw introduction of Stock and Currency derivatives by the NSE India.Pioneering Efforts of National Stock ExchangeNSE India has to its credit numerous pioneering efforts directed towards modernizingIndia’s financial and capital markets. andmore. There are 2799 plus NSE VSAT terminals covering cover more than 1500 cities across the country. 12 | P a g e . NSE India AdvantageToday. The National Stock Exchange of India is the largest and most advanced exchange with 1016 companies listed and 726 trading members. is the heart of the Indiancapital market. Online trading in India commencedin February 2000 under the efforts of this bourse. NSE India. NSE India also happens to be the firstand only exchange in the country for trading of GOLD ETFs (exchange traded funds). Today. givinginvestors an added advantage. the National Stock Exchange. NSE India pioneered commencement of Internet Trading in February 2000. setting up the first clearingcorporation ‘National Securities Clearing Corporation Ltd. which led tothe wide popularization of the National Stock Exchange (NSE India) in the broker community. The ‘NSE model’ of market structure originatedfrom the electronic limit order book (LOB) feature for trading of securities firstimplemented by the National Stock Exchange India. S&P CNX Nifty is the key index of NSE India. banks.

which is divided into three segments: Wholesale Debt Market (WDM). The National Stock Exchange of India Ltd. Only qualified traders can be involved in the securities trading. the NSE uses the satellite communication system that connects traders from 345 Indian cities. project appraisal. exactly after one year of the launch of Currency Futures. The NSE is one of the few exchanges in the world trading all types of securities on a single platform. fully electronic trading platform that is operated through a VSAT network. listed companies pay variable listing fees based on their corporate capital size. provides its clients with a single. While the WDM segment has accumulated the annual growth of over 36% since its opening in 1994. the ownership as well as the management does not have a right to trade on the Exchange. and company's track record are just a few of the criteria. Minimum capital requirements. and Futures & Options (F&O) Market.NSE is owned by the group of leading financial institutions such as Indian Bank or Life Insurance Corporation of India and IDFC. In addition. Interest Rate Futures was introduced for the first time in India by National Stock Exchange (NSE India) on 31st August 2009. The advanced technologies enable up to 6 million trades to be operated daily on the NSE trading platform. However. in the totally de-mutualised Exchange. Each segment has experienced a significant growth throughout a few years of their launch. Capital Market (CM). Common segments dealt in include • Equity • Futures and Options • Retail Debt Market 13 | P a g e . The National Stock Exchange of India has stringent requirements and criteria for the companies listed on the Exchange. the CM segment has increased by even 61% during the same period. Unlike most world exchanges.

With demutualization. updates. and is sensitive to movement of its constituents and market sentiments. 1956. With online trading and withall inconveniences negated. B. has created an ETF (Exchange Traded Fund) which tracks the SENSEX. you can have access to the A-Z of information related to the NSE and 14 | P a g e . The BSE India uses the latest technologies in the IT field to provide a single place where traders from across the world can buy and sell stock in the Indian stock market. stock tips. it is the volatility that determines the rising and falling prices of stocks.Swimming against Volatility of NSE BSE Market the Indian stock market is often interpreted as the NSE BSE market. Today. 2009 stood at USD 1. The Bombay Stock Exchange (BSEIndia) also offers electronic trading system called BOLT providing BSE live stock prices. BSE India has Deutsche Börse and Singapore Stock Exchange as its strategic partners. Barclays Global Investors through its iShares brand.09 trillion. etc. BSE India is the world's number one stock exchange in terms of the number of listed companies and the world's fifth in transaction numbers. Simplification of Trading in the NSE BSE Market Initially shares and stocks of the NSE BSE did not attract investors as in the current scenario. For easy reference. two of world's best managed stock exchanges providing BSE live updates to the investors in their countries. Apart from the SENSEX. Investments aresubject to market risks. BSE India is nowa corporatized and demutualised entity incorporated under the provisions of the Companies Act. guidance. S. The complex processes involved and the lack of easy access to information. a stock listed on theBSE India is classified into A. were the key drawbacks. It isan index of 30 stocks representing 12 major sectors. raising money for further expansion and related activities. The market capitalizations on August 31. T and Z groups. The Sensex is constructed on a 'free-float' methodology. the BSE India offers 21 indices. Today.BSE India also offered India's first stock market index the Sensex (Sensitive index).BSE India has an index cooperation agreement with Deutsche Börse stock exchange so the SENSEX and other indices are available to investors in Europe and America and investors are also able to check live BSE stock quotes there. including 12sectoral indices in Indian share market. The ETF enables investors in Hong Kong to take an exposure to share market India. Here. The Bombay Stock Exchange (BSE India) is situated at Dalal Street in Mumbai and has over 5. Established in 1875 as an AOP (Association of Persons). company’s listedin the NSE and BSE sell thousands of shares each day to the public.000 companies that are listed on it. the investor count increased rapidly.• Wholesale Debt Market • Currency futures Bombay Stock Exchange (BSE) The Bombay Stock Exchange (BSE India) is the oldest stock exchange in Asia and thefirst in India.

This boom in financial markets is stimulatingthe growth of the Indian share market encouraging the investors to invest in the sharemarket.e. II. Investors can subscribe to IPO of companies to buy new shares directly from the issuer of shares i. after that any shares traded will be on the secondary market. This association began with318 members. etc. Once the initial sale of shares is undertaken. The Secondary market consists of trading in the shares of listed companies. The name of the first sharetrading association in India was “Native Share and Stock Broker's Association” whichlater came to be known as Bombay Stock Exchange (BSE). CDs. debentures.The history of the share market of India dates back to 1875.Online Share Market Trading in IndiaThe financial market in India is growing rapidly and is expected to emerge as one of theleaders in the international arena very soon. Today India can boast of 24 share markets in the various parts of thecountry. CPs. A newly issued IPO will be considered a primary market trade when the shares are first purchased by investors directly from the underwriting investment bank.government bonds.Our commitment is to serve you and guide you towards achieving your trading goals. buying and selling shares of companies can be undertaken between the traders and investors who want to purchase the shares and those share-holders who want to sell their shares. The company receives the proceeds from the sale of these shares and uses it to fund its operations and expand its business. The Secondary market consists of trading in the shares of listed companies. etc. Insurance companies. About Share Market of India The Indian share market (capital market) is divided into two segments: I.BSE. Primary market II. The Primary Market is also known as the New Issues Market. Non BankingFinancial Corporations. Once the initial sale of shares is undertaken. These operations are undertaken in the Secondary Market. Secondary market The Primary market is that market where new securities (like shares. Mutual Funds. between investors 15 | P a g e . These operations are undertaken in theSecondary Market.) are issued to the public. buying and selling shares of companies can be undertaken between the traders and investors who want to purchase the shares and those share-holders who want to sell their shares. and a number of financial intermediaries that include banks. the company.

They increase the volume traded in markets because of participation of risk averse people in greater numbers They increase savings and investment in the long run The participants in a derivatives market: • Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset • Speculators use futures and options contracts to get extra leverage in betting on futuremovements in the price of an asset. one should make a detailed analysis of one’s risk appetite.If he is not willing to take any risk in the short term.Derivatives are products whose values are derived from one or more underlying assets. thanks to the launch of a variety of products and services. The primary objective of SEBI is to promote healthy and orderly growth of theshare market and secure investor protection. The investor must understand how much he must invest. The derivatives market in India is also expandingimmensely with an increased number of market participants using derivatives. the concept of derivatives comes into the picture. when must he invest and for how long he must stay invested. The SEBI also regulates the sharetransactions done by foreign investors and traders and also keeps check againstmalpractices in the share market. Share markets are. while the share prices in the secondary market are determined by themarket forces of supply and demand.themselves. II. for example. one could start by opening a demat account with a broker. equity. they will take offsetting positions in the two markets to lock in a profit. they see thefutures price of an asset getting out of line with the cash price. he can be 16 | P a g e . In the primary market. III. While investing in stock market. If. To reduce this risk. V.These assets can be forex. the derivatives market performs a number of economicfunctions: I. ` To invest in stock.The share market of India is regulated by the Securities and Exchanges Board of India (SEBI). extremely volatile and hence the risk factor is an important concern for theintermediaries. One must diversify his portfolio in such a way that the risks arising due to the volatility in the market is spread over a variety of stock investment avenues. They help in channelizing risks from risk-averse people to risk oriented people They help in the discovery of future as well as current prices They boost entrepreneurial activity IV. share prices are set by the merchant bankers using valuation methodologies.The need for a derivatives market. etc. They canincrease both the potential gains and potential losses by usage of derivatives in aspeculative venture • Arbitrageurs are in business to take advantage of a discrepancy between prices in twodifferent markets. bynature.The scope of the share market in India has widened tremendously over the past fewyears.

The place where such securities are traded by these investors is known as the secondary market. He may wish to invest in cash or near-cash assets. Also inflation can reduce the returns that some of these assets generate. Listing on NSE raises a company’s profile among investors in India and abroad. People who apply for these securities are: A) High net worth individual B) Retail investors C) Employees D) Financial Institutions E) Mutual Fund Houses F) Banks In the context of financial market structure. He may choose to diversify his risks over a plethora of stock investment options. public sector units. If the investor decides to have a balance of risk and reward while investing in stock market. and financial services. each and every NSE listed company is required to 17 | P a g e . NSE has the following major segments of the capital market: Equity: NSE plays an important role in helping an Indian company’s access equity capital. refinery. NSE has about 1319 companies listed representing the length. He may also think to invest in stock through Mutual Funds. Equity shares is issued by the under writers and merchant bankers on behalf of the company. Currently. But the potential for growth in such assets is not all that high. More importantly. Equity shares are tradable through a private broker or a brokerage house. breadth and diversity of the Indian economy which includes from hi-tech to heavy industry.called a Cautious stock market Investor. software. primarily equity. Trade data is distributed worldwide through various news-vending agencies. he can be called an investor with a balanced Portfolio. An investor who chooses to have high risk levels in his portfolio can be called an Adventurous stock market investor. Such investors typically prefer investing in stock market in a narrow range of securities. by providing a liquid and well-regulated market. infrastructure. He is ready to forgo the short term losses caused by the fluctuations in the market and focus on the larger gains that await him in the long term. Securities issued A) Preference Shares B) Equity Shares C) Debentures Securities like Preference Shares and Debentures cannot be traded in the secondary market.

Zero Coupon Bonds. Trading shall take place in the existing Capital Market segment of the Exchange. January 16. Certificate of Deposits. all outstanding and newly issued central government securities would be tradedin the retail segment. Futures and Options: The National Stock Exchange of India Limited (NSE) commenced trading in derivatives with the launch of index futures on June 12. 2003.The Exchange has also introduced trading in Futures and Options contracts based on CNX-IT. themarket was purely an informal market with most of the trades directly negotiated and struck between various participants. 2001. statistics etc. RBIand SEBI have introduced trading in government securities for retail investors. trusts and others. corporate bodies.e. The Exchange introduced trading in Index Options (also based on Nifty) on June 4. are available here. 2001. risk management. public distribution and management requirements. In the first phase. This provided the first formal screen-based trading facility for the debt market in the country. 1994.satisfy stringent financial. State Government loans. The futures contracts are based on the popular benchmark S&P CNX Nifty Index. Futures on individual securities were introduced on November 9. financial institutions. This section provides you with an insight into the derivatives segment of NSE. 2001. 2000. Trading in this retail debt market segment (RDM) on NSE has been introduced w. NSEalso became the first exchange to launch trading in options on individual securities from July 2. Till recently.f. The Wholesale Debt Market (WDM) segment of the Exchange commenced operations on June30. The commencement of this segment by NSE has brought about transparency and efficiency to the debt market. the Government. BANK NIFTY.Large investors and a high average trade value characterize this segment. High listing standards foster investor confidence and also bring credibility into the markets. Real-time quotesand information regarding derivative products. Futures andOptions on individual securities are available on 224 securities stipulated by SEBI. Wholesale Debt Market:The Wholesale Debt Market segment deals in fixed income securities and is fast gaining ground in an environment that has largely focused on equities. 18 | P a g e . Commercial Papers.Corporate Debentures. clearing andsettlement. This segment provides trading facilities for a variety of debt instruments including Government Securities. Other securities like state government securities. Treasury Bills and Bonds issued by Public Sector Undertakings/ Corporate/ Bankslike Floating Rate Bonds. and NIFTY MIDCAP 50 indices. Retail Debt Market: With a view to encouraging wider participation of all classes of investorsacross the country (including retail investors) in government securities. SLR and Non-SLR Bonds issued by FinancialInstitutions. trading systems & processes. Units of Mutual Funds and Securitized debt by banks. T-Bills etc. would beadded in subsequent phases.

investmentadvisers and such other intermediaries who may be associated withsecurities markets in any manner. NSCCL is set up as a separate and independent entity. underwriters. merchant bankers. at a price decided in the contract. foreign institutional investors. (3)Derivatives and New Products Departments (DNPD) Supervising trading at derivatives segments of stock exchanges. 19 | P a g e . participant’s custodians of securities.Currency futures: Currency future is a forex derivatives contract to buy or sell one currency against the other on a specified future date. Reserve Bank of India and SEBI jointly formed a Standing Technical Committee to evolve norms and oversee implementation of Exchange Traded Currency Derivatives. 4. (2) Market Regulation Department (MRD) Formulating new policies and supervising the functioning and operations (except relating to derivatives) of securities exchanges. bankers to an issue. supervision. 3. and consequent policy changes. debt and debt related derivatives.Registering and regulating the working of stock brokers. equity. compliance monitoring and inspections of all market intermediaries in respect of all segments of the markets viz. 5. 2. sub-brokers. All the trades done at NSE are clearly settled and risk managed by National Securities Clearing Corporation (NSCCL). Promoting and regulating self-regulatory organizations. Registeringandregulatingtheworkingofthedepositories. credit rating agenciesand such other intermediaries as the board may. equity derivatives. specify inthis behalf. by notification. portfolio managers. NSE is the first exchange in India to have obtained an in-principle approval from Securities and Exchange Board of India (SEBI) to set up currency derivative segment. and market institutions such as Clearing and settlement organizations and Depositories (Collectively referred to as ‘Market SROs’). POWERS &FUNCTIONS 1. Departments of SEBI regulating trading in the secondarymarket (1) Market Intermediaries Registration and Supervision department (MIRSD) Registration. registrars to anissue. introducingnew product to be traded. Registering and regulating the working of (venture capital funds andcollective investment schemes) including mutual funds. NSE has Started Forex futures trading from August 29th 2008. Regulating the business in stock exchanges and any other securitiesmarkets. trustees of trust deeds. their subsidiaries. sharetransfer agents.

• Each contract is custom designed. • If the party wishes to reverse the contract.In this chapter. Instruments Available For Trading In recent years. While futures and optionsare now actively traded on many Exchanges. the contract has to be settled by delivery of the asset. and hence is unique in terms of contract size. we will have a look at some basic derivative products. which often results in high prices being charged. One of the parties to the contract assumes a long position and agrees to buy the underlyingasset on a certain specified future date for a certain specified price. Forward Contracts A forward contract is an agreement to buy or sell an asset on a specified date for a specifiedprice. • On the expiration date. The forward contracts are normally traded outside the exchanges. 7.The salient features of forward contracts are: • They are bilateral contracts and hence exposed to counterparty risk. expiration date and the asset type and quality. Promotinginvestors'educationandtrainingofintermediariesofsecuritiesmarkets. speculation and arbitrage. • The contract price is generally not available in public domain. 20 | P a g e . Before we study about the applications of commodityderivatives. derivatives have become increasingly popular due to their applications forhedging. Prohibiting fraudulent and unfair trade practices relating to securitiesmarkets. 8. Other contract details like delivery date.6. Prohibiting insider trading in securities. forward contracts are popular on the OTC market. price and quantity are negotiated bilaterally by the partiesto the contract. The other party assumesa short position and agrees to sell the asset on the same date for the same price. At present. onlycommodity futures trade on the NCDEX. we shall study in detail these three derivative contracts. it has to compulsorily go to the same counterparty.

Limitations of Forward Markets Forward markets world-wide are afflicted by several problems: • Lack of centralization of trading. Theforward market is like a real estate market in that any two consenting adults can form contractsagainst each other. and hence avoid the problem of illiquidity. which forecasts an upturn in a price.If a speculator has information or analysis. the basic problem is that of too much flexibility and generality.still the counterparty risk remains a very serious issue.This process of standardization reaches its limit in the organized futures market. Similarly animporter who is required to make a payment in dollars two months hence can reduce hisexposure to exchange rate fluctuations by buying dollars forward. Counterparty risk arises from the possibility of default by any one party to the transaction. thereby reducing transaction costs and increasing transactions volume.When one of the two sides to the transaction declares bankruptcy. Heis exposed to the risk of exchange rate fluctuations. the other suffers. • Illiquidity and • Counterparty risk In the first two of these. By using the currency forward market tosell dollars forward.Forward contracts are very useful in hedging and speculation. Evenwhen forward markets trade standardized contracts. The classic hedging application would be that of an exporter who expects to receive payment in dollars three months later. The speculator would go long onthe forward. then he cango long on the forward market instead of the cash market.However. Introduction to Futures 21 | P a g e . wait for the price to rise. as in the caseof foreign exchange. and then take a reversing transaction to book profits. but makes the contracts non-tradable. This often makes them design terms of the deal which are very convenientin that specific situation. he can lock on to a rate today and reduce his uncertainty. forward contracts in certain markets have become very standardized.

at the end of which it will cease to exist. In a normal market. However. The confusion is primarily becauseboth serve essentially the same economic functions of allocating risk in the presence of futureprice uncertainty. Distinction between Futures and Forward Contracts Forward contracts are often confused with futures contracts. Futures Terminology • Spot price: The price at which an asset trades in the spot market. Generally. Thus. However. Newcontracts for agri commodities are introduced on the 10th of the month. a January expiration contract expires on the20th of January and a February expiration contract ceases to exist for trading after the20th of February. The commodity futures contracts on the NCDEX have one month. This is the last day onwhich the contract will be traded. • Expiry date: It is the date specified in the futures contract. for commodities basis is defined as spotprice -futures price. Most of the agri commodities futures contracts of NCDEX expire on the20th day of the delivery month. • Futures price: The price at which the futures contract trades in the futures market. future price -spot price. Forinstance. There willbe a different basis for each delivery month for each contract. for financial assets the formula. the delivery unit for futures on Soybean on the NCDEX is 10 MT.futures prices exceed spot prices. futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. • Delivery unit: The amount of asset that has to be delivered under one contract. • Contract cycle: The period over which a contract commonly used. the expiry date shall be theimmediately preceding trading day of the Exchange. other than a Saturday. • Basis: Basis is the difference between the futures price and the spot price. The deliveryunit for the Gold futures contract is 1 kg. 22 | P a g e .Futures markets were designed to solve the problems that exist in forward markets. If 20th happens to be a holiday. three months etc (not more than a year)expiry cycles. two months.A futures contract is an agreement between two parties to buy or sell an asset at acertain time in the future at a certain price.

The holder does not have to exercise this right.For instance. This measures the storage cost plus theinterest that is paid to finance the asset. • Marking-to-market (MTM): In the futures market. This is called marking to market. Options are fundamentally different from forward and futures contracts.• Cost of carry: The relationship between futures prices and spot prices can be summarizedin terms of what is known as the cost of carry. In contrast. This is set toensure that the balance in the margin account never becomes negative. If the balancein the margin account falls below the maintenance margin. we look at another interesting derivative contract. Option Terminology • Commodity options: Commodity options are options with a commodity as the underlying.In a forward or futures contract. 23 | P a g e . thepurchase of an option requires an up-front payment. at the end of each trading day. a gold options contract would give the holder the right to buy or sell aspecified quantity of gold at the price specified in the contract. namely options. • Initial margin: The amount that must be deposited in the margin account at the timea futures contract is first entered into is known as initial margin. themargin account is adjusted to reflect the investor's gain or loss depending upon thefutures closing price. the two parties have committed themselves to doing something. An option gives the holder of theoption the right to do something. the investor receives amargin call and is expected to top up the margin account to the initial margin levelbefore trading commences on the next day.Whereas it costs nothing except margin requirements to enter into a futures contract. • Maintenance margin: This is somewhat lower than the initial margin. Introduction to Options In this section.

• Buyer of an option: The buyer of an option is the one who by paying the optionpremium buys the right but not the obligation to exercise his option on the seller/writer. If the index is much higher than thestrike price.e. • Put option: A put option gives the holder the right but not the obligation to sell anasset by a certain date for a certain price. • In-the-money option: An in-the-money (ITM) option is an option that would lead to apositive cash flow to the holder if it were exercised immediately.• Stock options: Stock options are options on individual stocks. • Strike price: The price specified in the options contract is known as the strike price or the exercise price.e. An option on the index is at-themoneywhen the current index equals the strike price (i. A call option on thendex is said to be in-the. A contract gives the holder the right to buy orsell shares at the specified price. • Writer of an option: The writer of a call/ put option is the one who receives the optionpremium and is thereby obliged to sell/ buy the asset if the buyer exercises on him. the exercise date. • Out-of-the-money option: An out-of-the-money (OTM) option is an option that wouldlead to a negative cash flow if it were exercised immediately.It is also referred to as the option premium. • Expiration date: The date specified in the options contract is known as the expirationdate. spot price > strike price). the call is said to be deep ITM. the strike date or the maturity. There are two basic types of options: call options and put options. spot price = strike price). A call option on the indexis outof-the-money when the current index stands at a level which is less than thestrike price (i. • Call option: A call option gives the holder the right but not the obligation to buy anasset by a certain date for a certain price. • Option price: Option price is the price which the option buyer pays to the option seller. In the case of a when the current index stands at a level higher thanthe strike price (i. • At-the-money option: An at-the-money (ATM) option is an option that would lead tozero cash flow if it were exercised immediately. Options currently tradeon over 500 stocks in the United States. the put is ITM if theindex is below the strike price. 24 | P a g e .e.

18. At expiration. the intrinsic value of a put isMax[0.e.K). Both calls and puts have time value.St]. Putting itanother way. Payoff for Buyer of Asset: Long Asset In this basic position. the greater is an option's time value. If the index is much lower than the strikeprice. But first we look at the basic payoff for the buyer or seller of an asset. Usually. its intrinsic value is zero.K . if it is ITM. St.all else equal. • Intrinsic value of an option: The option premium can be broken down into twocomponents .intrinsic value and time value. An option that isOTM or ATM has only time value. Once it is purchased. Basic Payoffs A payoff is the likely profit/ loss that would accrue to a market participant with change in the price of the underlying price < strike price). an investor buys the underlying asset. Similarly. the call is said to be deep OTM.St). we shall take a look at the payoffs for buyers and sellers of futures and options. K is the strike price and St is the spotprice.000 per 10 gms. the maximum time value exists when theoption is ATM. This is generally depicted in the form of payoff diagrams which show the price of the underlying asset on the X-axis and the profits/ losses on the Y-axis. or it could be a financial asset like a stock or an index. 25 | P a g e . The longer the time to expiration. The intrinsic value of a call is the amountthe option is ITM. • Time value of an option: The time value of an option is the difference between itspremium and its intrinsic value. The asset could be a commodity like gold or chilli. the greater of 0 or (K .i. for Rs.K)] which means the intrinsicvalue of a call is the greater of 0 or (St . an option should have no time value. gold for instance. and sells it at a future date at an unknown price. In the case of a put. If the call is OTM. the intrinsic value of a call is Max [0. (St . In this section. the investor is said to be 'long' the asset. the put is OTM if the indexis above the strike price.

the chilli futures price also moves up and theshort futures position starts making losses. thefutures prices too move down and the long futures position starts making losses. He has a potentially unlimited upside as well as a potentially unlimited downside. however the profits arepotentially unlimited. the buyer makes losses. Payoff for Buyer of Futures: Long Futures The payoff for a person who buys a futures contract is similar to the payoff for a person whoholds an asset. the chilli futures prices also move down and the short futures position startsmaking profits. When the prices of chilli move up. Payoff for Options The optionality characteristic of options results in a non-linear payoff for options. If the price of theunderlying falls. These linear payoffs are fascinating as they can be combinedwith options and the underlying to generate various complex payoffs. when the prices of gold in the spot market goes down. When the prices ofgold in the spot market goes up. If the price of the underlying rises. The payoff from the option written is exactly the opposite to that of the option buyer. His profits are limited to the 26 | P a g e . The underlying asset in this case is gold. The profits as well as losses for the buyer and the sellerof a futures contract are unlimited. In simplewords.Take the case of a speculator who buys a two-month gold futures contract on the NCDEX whenit sells for Rs. Similarly. The underlying asset in this case is red chilli. The magnitude of profits or losses for a given upwardor downward movement is the same. He has a potentially unlimited upside as well as a potentially unlimited downside. The writer of an option gets paid the premium. it means that the losses for the buyer of an option are limited. the futures price too moves up and the long futures positionstarts making profits. When the prices ofchilli move down. just like the payoff of the underlying asset that we lookedat earlier.Payoff for Futures Futures contracts have linear payoff.Take the case of a speculator who sells a two-month chilli futures contract when the contractsells at Rs. Payoff for Seller of Futures: Short Futures The payoff for a person who sells a futures contract is similar to the payoff for a person whoshorts an asset. the buyer makes profits.6500 per quintal. 18000 per 10 gms.

the buyer will exercise the option on the writer. his loss in thiscase is the premium he paid for buying the option. more is the profit he makes. Payoff for Buyer of Call Options: Long Call A call option gives the buyer the right to buy the underlying asset at the strike price specifiedin the option. If upon expiration. helets the option expire. thewriter of the option starts making losses. If the spot price of the underlying is less than the strike price. the buyer would exercise his option and get profit. more is the loss he makes. he makes a profit. His losses are limited to the extent of the premium he paid for buyingthe option. Payoff for Writer of Call Options: Short Call A call option gives the buyer the right to buy the underlying asset at the strike price specifiedin the option. as the spot price increases. 17000. If he lets his option expire un-exercised. gold trades above the strike of Rs. We look here at the four basic payoffs. if the price of gold falls below the strike of Rs.the call option becomes in-the-money. Higher the spot price. 17000 per 10 gms. the spot price exceeds the strike price.17000. Payoff for Buyer of Put Options: Long Put 27 | P a g e . However. the writer of the option charges a premium. The profits possible on this optionare potentially unlimited. however his losses are potentially unlimited.If he lets his option expire un-exercised. he makes loss. the spot price exceeds the strikeprice. If upon expiration. Hence. the buyer losses. Higher the spot price. The profit/ loss that the buyer makes on the option depends on the spot price of the underlying. The profit loss that the buyer makes on the option depends on the spot price of the underlying. Ifupon expiration the spot price of the underlying is less than the strike price. For selling the option. Payoff for buyer of call option on gold The figure shows the profits / losses for the buyer of a three-month call option on gold at astrike of Rs. As can be seen.option premium. If upon expiration. the writer gets to keep the premium. These non-linear payoffs are fascinating as they lend themselves to be used for generating various complex payoffs usingcombinations of options and the underlying asset. Whateveris the buyer's profit is the seller's loss. as the prices of gold rise in the spot market.

If the spot price of the underlying is morethan the strike price. the writer of the optioncharges a premium. Depositories A depository holds the securities in a dematerialized form for the investors in their beneficiary accounts. The profit/ loss that the buyer makes on the option depends on the spot price ofthe underlying. more is the profit he makes. the buyer will exercise the option on thewriter. The profit/loss that the buyer makes on the option depends on the spotprice of the underlying. (CDSL). Payoff for Writer of Put Options: Short Put A put option gives the buyer the right to sell the underlying asset at the strike price specifiedin the option. The PCMs also undertake the clearing and settlement responsibilitiesof the 28 | P a g e . They are required to make available the required securities in the designated account on settlement day. he makes a profit. the functions and responsibilities of the PCM are similar to those of the custodians. If upon expiration the spot price of the underlying is more than the strike price. his loss in thiscase is the premium he paid for buying the option. thebuyer lets his option expire un-exercised and the writer gets to keep the premium. Whatever is the buyer's profit is the seller's loss.the spot price happens to be below the strike price.). If upon expiration. (NSDL) and the Central Depository Services (India) Ltd.Lower the spot price. Professional Clearing Member The NSCCL admits a special category of members known as professional clearing members (PCMs). If upon expiration.A put option gives the buyer the right to sell the underlying asset at the strike price specifiedin the option. The PCMs may clear and settle trades executed for their clients (individuals. The depository runs an electronic file to transfer the securities from the accounts of the custodians/clearing member to that of the NSCCL(and vice versa) as per the schedule of allocation of the securities. the spot price is below the strike price. institutions. Each clearing member is required to maintain a clearing pool account with the depositories. The two depositories in India are the National Securities Depository Ltd. In such cases. etc. If he lets his option expire un-exercised. he makes loss. For selling the option.

The clearing and settlement process involves three main activities— clearing. they clear the trades of their associate trading members and institutional clients. screen-based trading system. as well as on fraud. and risk management. fully automated. Trading Mechanism The NSE was the first stock exchange in the country and was set up as a national exchange having nationwide access with a fully automated screen-based trading system. and hence. and which counterparties are due to receive on the settlement date. The numerous advantages of the NEAT system are listed below: • It electronically matches orders on a price/time priority. to trade with one another simultaneously. • It provides tremendous flexibility to the users in terms of the kinds of orders that can be placed on the system. but have clearing rights. • It allows the faster incorporation of price sensitive information into prevailing prices. resulting in improved operational efficiency. Clearing and Settlement Process The clearing process involves the determination of what the counterparties owe.. big or small. The NEAT facilitates an online. and risk of error. cuts down on time. order driven. It allows a large number of participants.It ensures full anonymity by accepting orders. a member can enter the quantities of securities and the prices at which he/she would liketo transact. The PCMs in this case have no trading rights.e. and the transaction is executed as soon as it finds a matching sale for the buy order for a members. nationwide. The National Exchange for Automated Trading (NEAT) is the trading system of the NSE. improving the depth and the liquidity of the market. anonymous. • It provides a perfect audit trail that helps to resolve disputes by logging in the trade execution process in its entirety. making the market transparent. irrespective of their geographical locations. i. settlement. from members without revealing their identity. The core processes involved in clearing and settlement include: 29 | P a g e . cost. In this system. • It enables market participants to see the full market in real time. thus increasing the informational efficiency of markets. following which the obligations are discharged by settlement. thus providing equal access to everybody.

The NSCCL interposes itself as a central counterparty between the counterparties to trade and net the positions so that a member has a security-wise net obligation to receive or deliver a security. The clearing corporation provides a major link between the clearing banks and the depositories and the actual movement of funds as well as securities on the prescribed pay-in and pay-out day. The settlement process begins as soon as the members’ obligations are determined through the clearing process. the CMs with funds obligations make the funds available in the designated accounts with the clearing banks. and credit the accounts of the clearing corporation. and what the counterparties are due to receive on the settlement date. and has to either pay or receive funds. e) Pay-out of Funds and Securities: After processing for shortages of funds/securities and arranging for the movement of funds from surplus banks to deficit banks through RBI clearing. and the designated settlement accounts in the case of CDSL). and the same is subject to confirmation by the respective custodian. The banks process these instructions. The CMs make the securities available in the designated accounts with the two depositories (the CM pool account in the case of the NSDL. These details are automatically recorded in the electronic trading system of the exchanges. The clearing corporation sends electronic instructions to the clearing banks to debit the designated CMs’ accounts to the extent of the payment obligations. c) Determination of Obligation: The next step is the determination of what the counterparties owe. b) Trade Confirmation: Trades that are meant for settlement by the custodians are indicated with a custodian participant code.a) Trade Recording: The key details about the trades are recorded to provide the basis for settlement. Likewise. The settlement process is carried out by the clearing corporation with the help of clearing banks and depositories. the clearing corporation sends electronic instructions to the depositories/clearing banks to release 30 | P a g e . This constitutes the pay-in of funds and securities. The custodian is required to confirm the settlement of these trades on T+1 day by the cut-off time of 1:00 pm. d) Pay-in of Funds and Securities: This requires the members to bring in their funds/securities to the clearing corporation. debit the accounts of the CMs. The depositories move the securities available in the pool accounts to the pool account of the clearing corporation.

The important settlement types are: Normal Segment (N). Trades in the settlement type N.the pay-out of securities/funds. there is a direct close out. The members’ pay-in/pay-out obligations are determined by T+1 at the latest. the NSCCL determines the cumulative obligations of each member on the T+1 day. For arriving at the settlement day. Non-cleared TT Deals (Z). Trade for Trade Surveillance (W). whereas in the case of the W segment. the NSCCL nets the positions of the counterparties to determine their obligations. This constitutes the pay-out of funds and securities. W. The securities/funds are paid-in/paid-out on T+2 day to the members’ clients and the settlement is completed within 2 days from the end of the trading day.The obligations are netted for a member across all the securities to determine his fund obligations and he has to either pay or receive funds. All trades concluded during a particular trading date are settled on a designated settlement day. and A are settled in the dematerialized mode. so that they can settle their obligations on T+2. the NSCCL conducts a buy–in auction on the T+2 day. NSE holidays. and may be settled in either the physical or the dematerialized mode. Retail Debt Market (D). The NSCCL notifies the relevant trade details to the clearing members/custodians on the trade day (T). The depositories and clearing banks debit the accounts of the clearing corporation and credit the accounts of CMs. including bank holidays. and electronically transfers the data to the clearing members (CMs). Dematerialized Settlement For all trades executed on the T day. i. In the case of short deliveries on the T+2 day in the normal segment. T+2 day.. Trades under the settlement type O are settled in the physical form. D. A clearing member has to pay-in/pay-out funds and/or securities. which are confirmed on T+1 to the NSCCL. Limited Physical Market (O). Settlement Cycle The NSCCL clears and settles trades as per the well-defined settlement cycles All the securities are traded and settled under the T+2 rolling settlement. and the settlement for the same is completed on the T+3 day. and Sundays are excluded. Based on this. The settlement schedule for all the settlement types in the manner 31 | P a g e . and Auction Normal (A). Saturdays. all intervening holidays. Trades under the settlement type Z are settled directly between the members.e. and are forwarded to them on the same day.

com 32 | P a g e .nseindia.explained above is communicated to the market participants vide a circular issued during the previous www.moneycontrol. Bibliography www.