I here by declare that the summer project report titled “AWARNESS OF DERIVATIVE AND ITS COMPARISION WITH EQUITY AND COMMODITY” is based on original piece of work done by me for the fulfillment of degree of Master of Business Administration and whatever information has been taken from any sources had been duly acknowledge. I further declare that the personal data & information received from any respondent during survey has not been shared with any one and is used for academic purpose only.


Vaibhav H. Parikh




Sr. No.


Page No.
1 24 33 63 67 83 85 86 87 88



The function of the financial market is to facilitate the transfer of funds from surplus sectors (lenders) to deficit sectors (borrowers). Normally, households have inventible funds or savings, which they lend to borrowers in the corporate and public sectors whose requirement of funds far exceeds their savings. A financial market consists of investors or buyers of securities, borrowers or sellers of securities, intermediaries and regulatory bodies. Financial market does not refer to a physical location. Formal trading rules, relationships and communication networks for originating and trading financial securities link the participants in the market. Organized money market: Indian financial system consists of money market and capital market. The money market has two components - the organized and the unorganized. The organized market is dominated by commercial banks. The other major participants are the Reserve Bank of India, Life Insurance Corporation, General Insurance Corporation, Unit Trust of India, Securities Trading Corporation of India Ltd. and Discount and Finance House of India, other primary dealers, commercial banks and mutual funds. The core of the money market is the inter-bank call money market whereby short-term money borrowing/lending is affected to manage temporary liquidity mismatches. The Reserve Bank of India occupies a strategic position of managing market liquidity through open market operations of government securities, access to its accommodation, cost (interest rates), availability of credit and other monetary management tools. Normally, monetary assets of short-term nature, generally less than one year, are dealt in this market. Un-organized money market: Despite rapid expansion of the organized money market through a large network of banking institutions that have extended their reach even to the rural areas, there is still an active unorganized market. It consists of indigenous bankers and moneylenders. In the unorganized market, there is no clear demarcation between short-term and long-term finance and even between the purposes of finance. The unorganized sector continues to provide finance for trade as well as personal consumption. The inability of the poor to meet the "creditworthiness" requirements of the banking sector make them take recourse to the institutions that still remain outside the regulatory framework of banking. But this market is shrinking. The capital market consists of primary and secondary markets. The primary market deals with the issue of new instruments by the corporate sector such as equity shares, preference shares and debt instruments. Central and State governments, various public sector industrial units (PSUs), statutory and other authorities such as state electricity boards and port trusts also issue bonds/debt instruments. The primary market in which public issue of securities is made through a prospectus is a retail market and there is no physical location. Offer for subscription to securities is made to investing community. The secondary market or stock exchange is a market for trading and settlement of securities that have already been issued. The investors holding securities sell securities through registered brokers/sub-brokers of the stock exchange. Investors who are desirous of buying securities purchase securities through registered brokers/sub-brokers of the stock exchange. It may have a physical location


like a stock exchange or a trading floor. Since 1995, trading in securities is screen-based and Internet-based trading has also made an appearance in India. The secondary market consists of 23 stock exchanges including the National Stock Exchange, Over-the-Counter Exchange of India (OTCEI) and Inter Connected Stock Exchange of India Ltd. The secondary market provides a trading place for the securities already issued, to be bought and sold. It also provides liquidity to the initial buyers in the primary market to re-offer the securities to any interested buyer at any price, if mutually accepted. An active secondary market actually promotes the growth of the primary market and capital formation because investors in the primary market are assured of a continuous market and they can liquidate their investments. Capital Market Participants: There are several major players in the primary market. These include the merchant bankers, mutual funds, financial institutions, foreign institutional investors (FIIs) and individual investors. In the secondary market, there are stock- brokers (who are members of the stock exchanges), the mutual funds, financial institutions, foreign institutional investors (FIIs), and individual investors. Registrars and Transfer Agents, Custodians and Depositories are capital market intermediaries that provide important infrastructure services for both primary and secondary markets. Market regulation: It is important to ensure smooth working of capital market, as it is the arena where the players in the economic growth of the country. Various laws have been passed from time to time to meet this objective. The financial market in India was highly segmented until the initiation of reforms in 1992-93 on account of a variety of regulations and administered prices including barriers to entry. The reform process was initiated with the establishment of Securities and Exchange Board of India (SEBI). The legislative framework before SEBI came into being consisted of three major Acts governing the capital markets: 1. The Capital Issues Control Act 1947, which restricted access to the securities market and controlled the pricing of issues. 2. The Companies Act, 1956, which sets out the code of conduct for the corporate sector in relation to issue, allotment and transfer of securities, and disclosures to be made in public issues. 3. The Securities Contracts (Regulation) Act, 1956, which regulates transactions in securities through control over stock exchanges. In addition, a number of other Acts, e.g., the Public Debt Act, 1942, the Income Tax Act, 1961, the Banking Regulation Act, 1949, have substantial bearing on the working of the securities market. Securities and Exchange Board of India With the objectives of improving market efficiency, enhancing transparency, checking unfair trade practices and bringing the Indian market up to international standards, a package of reforms consisting of measures to liberalize, regulate and develop the securities market was introduced during the 1990s. This has changed corporate securities market beyond recognition in this decade. The practice of allocation of resources among different competing entities as well as its terms by a central authority was discontinued. The secondary 5

market overcame the geographical barriers by moving to screen-based trading. Trades enjoy counter party guarantee. Physical security certificates have almost disappeared. The settlement period has shortened to three days. The following paragraphs discuss the principal reform measures undertaken since 1992. A major step in the liberalization process was the repeal of the Capital Issues (Control) Act, 1947 in May 1992. With this, Government's control over issue of capital, pricing of the issues, fixing of premium and rates of interest, on debentures, etc., ceased. The office, which administered the Act, was abolished and the market was allowed to allocate resources to competing uses and users. Indian companies were allowed access to international capital market through issue of ADRs and GDRs. However, to ensure effective regulation of the market, SEBI Act, 1992 was enacted to empower SEBI with statutory powers for (a) protecting the interests of investors in securities, (b) promoting the development of the securities market, and (c) regulating the securities market. Its regulatory jurisdiction extends over corporates in the issuance of capital and transfer of securities, in addition to all intermediaries and persons associated with securities market. SEBI can specify the matters to be disclosed and the standards of disclosure required for the protection of investors in respect of issues. It can issue directions to all intermediaries and other persons associated with the securities market in the interest of investors or of orderly development of the securities market; and can conduct inquiries, audits and inspection of all concerned and adjudicate offences under the Act. In short, it has been given necessary autonomy and authority to regulate and develop an orderly securities market. There were several statutes regulating different aspects of the securities market and jurisdiction over the securities market was split among various agencies, whose roles overlapped and which at times worked at cross-purposes. As a result, there was no coherent policy direction for market participants to follow and no single supervisory agency had an overview of the securities business. Enactment of SEBI Act was the first such attempt towards integrated regulation of the securities market. SEBI was given full authority and jurisdiction over the securities market under the Act, and was given con-current/delegated powers for various provisions under the Companies Act and the SC(R) A. The Depositories Act, 1996 is also administered by SEBI. A high level committee on capital markets has been set up to ensure co-ordination among the regulatory agencies in financial markets. In the interest of investors, SEBI issued Disclosure and Investor Protection (DIP) Guidelines. Issuers are now required to comply with these Guidelines before accessing the market. The guidelines contain a substantial body of requirements for issuers/intermediaries. The main objective is to ensure that all concerned observe high standards of integrity and fair dealing, comply with all the requirements with due skill, diligence and care, and disclose the truth, the whole truth and nothing but the truth. The Guidelines aim to secure fuller disclosure of relevant information about the issuer and the nature of the securities to be issued so that investor can


take an informed decision. For example, issuers are required to disclose any material 'risk factors' in their prospectus and the justification for the pricing of the securities has to be given. SEBI has placed a responsibility on the lead managers to give a due diligence certificate, stating that they have examined the prospectus, that they find it in order and that it brings out all the facts and does not contain anything wrong or misleading. Though the requirement of vetting has now been dispensed with, SEBI has raised standards of disclosures in public issues to enhance the level of investor protection. Improved disclosures by listed companies: The norms for continued disclosure by listed companies have also improved the availability of timely information. The information technology helped in easy dissemination of information about listed companies and market intermediaries. Equity research and analysis and credit rating have improved the quality of information. SEBI has recently started a system for Electronic Data Information Filing and Retrieval System (EDIFAR) to facilitate electronic filing of public domain information by companies. Introduction of derivatives: To assist market participants to manage risks better through hedging, speculation and arbitrage, SC(R) A was amended in 1995 to lift the ban on options in securities. However, trading in derivatives did not take off, as there was no suitable legal and regulatory framework to govern these trades. Besides, it needed a lot of preparatory work - the underlying cash markets needed to be strengthened with the assistance of the automation of trading and of the settlement system; the exchanges developed adequate infrastructure and the information systems required to implement trading discipline in derivative instruments. The SC(R) A was amended further in December 1999 to expand the definition of securities to include derivatives so that the whole regulatory framework governing trading of securities could apply to trading of derivatives also. A three-decade old ban on forward trading, which had lost its relevance and was hindering introduction of derivatives trading, was withdrawn. Derivative trading took off in June 2000 on two exchanges. Now different types of derivative contracts i.e. index future, index options, single stock futures and single stock options are available in the market. The governing bodies of stock exchanges used to be dominated by brokers, leading inevitably to conflicts of interest. To discipline brokers and cure typical stock market ills such as price rigging, it was considered necessary for stock exchanges to have a professionally managed environment. NSE started with the concept of an independent governing body without any broker representation. It was specified in 1993 that the governing boards of stock exchanges must have 50% non-broker members, and that on committees handling matters of discipline, default, etc., brokers would be in the minority. All stock exchanges were mandated to appoint a non-broker executive director who would be accountable to SEBI for implementing the policy directions of the Central Government/ SEBI. In course of time, the position of the executive director in the management of stock exchange has been strengthened. Indian securities market is getting increasingly integrated with the rest of the world. Flls have been permitted to invest in all types of securities, including government securities. Indian companies have been permitted to raise resources from abroad through issue of ADRs, GDRs, FCCBs and ECBs. Reserve 7

Bank of India has recently allowed the limited two-way fungibility for the subscribers of these instruments. Indian stock exchanges have been permitted to set up trading terminals abroad. The trading platform of Indian exchanges can now be accessed through the Internet from anywhere in the world. In line with the global phenomena, Indian capital markets have also moved to rolling settlements on a T+2 basis where trades are settled on the second day after trading.

National Stock Exchange The National Stock Exchange was set up in 1995 as a first step in reforming the securities market through improved technology and introduction of best practices in management. It started with the concept of an independent governing body without any broker representation thus ensuring that the operators' interests were not allowed to dominate the governance of the exchange. The practice of physical trading imposed limits on trading volumes and, hence, the speed with which new information was incorporated into prices. To obviate this, the NSE introduced screen-based trading system (SBTS) where a member can punch into the computer the quantities of shares and the prices at which he wants to transact. The transaction is executed as soon as the quote punched by a trading member finds a matching sale or buy quote from counter party. SBTS electronically matches the buyer and seller in an order-driven system or finds the customer the best price available in a quotedriven system, and, hence, cuts down on time, cost and risk of error, as well as on the chances of fraud. SBTS enables distant participants to trade with each other, improving the liquidity of the markets. The electronic and now fully online trading introduced by the NSE has made such manipulation difficult. It has also improved liquidity and made the entire operation more transparent and efficient. The NSE has set up a clearing corporation to provide legal counter party guarantee to each trade thereby eliminating counter party risk. The National Securities Clearing Corporation Ltd. (NSCCL) commenced operations in April 1996. Counter party risk is guaranteed through fine-tuned risk management systems and an innovative method of on-line position monitoring and automatic disablement. Principle of "novation" is implemented by NSE capital market segment. Under this principle, NSCCL is the counter party for every transaction and, therefore, default risk is minimized. To support the assured settlement, a "settlement guarantee fund" has been created. A large settlement guarantee fund provides a cushion for any residual risk. As a consequence, despite the fact that the daily traded volumes on the NSE run into thousands of crores of rupees, credit risk no longer poses any problem in the marketplace. Depository System The erstwhile settlement system on Indian stock exchanges was also inefficient and increased risk, due to the time that elapsed before trades were settled. The transfer was by 8

physical movement of papers. There had to be a physical delivery of securities -a process fraught with delays and resultant risks. The second aspect of the settlement related to transfer of shares in favor of the purchaser by the company. The system of transfer of ownership was grossly inefficient as every transfer involves physical movement of paper securities to the issuer for registration, with the change of ownership being evidenced by an endorsement on the security certificate. To obviate these problems, the Depositories Act, 1996 was passed. It provides for the establishment of depositories in securities with the objective of ensuring free transferability of securities with speed, accuracy and security. It does so by (a) making securities of public limited companies freely transferable subject to certain exceptions; (b) dematerializing the securities in the depository mode; and (c) providing for maintenance of ownership records in a book entry form. In order to streamline both the stages of settlement process, the Act envisages transfer ownership of securities electronically by book entry without making the securities move from person to person. The Act has made the securities of all public limited companies freely transferable, restricting the company's right to use discretion in effecting the transfer of securities, and the transfer deed and other procedural requirements under the Companies Act have been dispensed with. Two depositories, viz., NSDL and CDSL, have come up to provide instantaneous electronic transfer of securities. Capital Market Intermediaries: There are several institutions, which facilitate the smooth functioning of the securities market. They enable the issuers of securities to interact with the investors in the primary as well as the secondary arena. Merchant Bankers Among the important financial intermediaries are the merchant bankers. The services of merchant bankers have been identified in India with just issue management. It is quite common to come across reference to merchant banking and financial services as though they are distinct categories. The services provided by merchant banks depend on their inclination and resources - technical and financial. Merchant bankers (Category 1) are mandated by SEBI to manage public issues (as lead managers) and open offers in take-overs. These two activities have major implications for the integrity of the market. They affect investors' interest and, therefore, transparency has to be ensured. These are also areas where compliance can be monitored and enforced. Merchant banks are rendering diverse services and functions. These include organizing and extending finance for investment in projects, assistance in financial management, acceptance house business, raising Euro-dollar loans and issue of foreign currency bonds. Different merchant bankers specialize in different services. However, since they are one of the major intermediaries between the issuers and the investors, their activities are regulated by: (1) SEBI (Merchant Bankers) Regulations, 1992. (2) Guidelines of SEBI and Ministry of Finance.


(3) Companies Act, 1956. (4) Securities Contracts (Regulation) Act, 1956. The Merchant Bankers Regulations of Securities and Exchange Board of India (SEBI) regulate merchant banking activities, especially those covering issue and underwriting of shares and debentures. SEBI has made the quality of manpower as one of the criteria for renewal of merchant banking registration. These skills should not be concentrated in issue management and underwriting alone. The criteria for authorization take into account several parameters. These include:  Professional qualification in finance, law or business management,  Infrastructure like adequate office space, equipment and manpower,  Employment of two persons who have the experience to conduct the business of merchant bankers,  Capital adequacy and  Past track record, experience, general reputation and fairness in all their transactions. SEBI authorizes merchant bankers for an initial period of three years, if they have a minimum net worth of Rs. 5 crore. An initial authorization fee, an annual fee and renewal fee is collected by SEBI. According to SEBI, all issues should be managed by at least one authorized merchant banker functioning as the sole manager or lead manager. The lead manager should not agree to manage any issue unless his responsibilities relating to the issue, mainly disclosures, allotment and refund, are clearly defined. A statement specifying such responsibilities has to be furnished to SEBI. SEBI prescribes the process of due diligence that a merchant banker has to complete before a prospectus is cleared. It also insists on submission of all the documents disclosing the details of account and the clearances obtained from the ROC and other government agencies for tapping peoples' savings. The responsibilities of lead manager, underwriting obligations, capital adequacy, due diligence certification, etc., are laid down in detail by SEBI. The objective is to facilitate the investors to take an informed decision regarding their investments and not expose them to unknown risks. Credit Rating Agencies The 1990s saw the emergence of a number of rating agencies in the Indian market. These agencies appraise the performance of issuers of debt instruments like bonds or fixed deposits. The rating of an instrument depends on parameters like business risk, market position, operating efficiency, adequacy of cash flows, financial risk, financial flexibility, and management and industry environment. The objective and utility of this exercise is twofold. From the point of view of the issuer, by assigning a particular grade to an instrument, the rating agencies enable the issuer to get the best price. Since all financial markets are based on 10

the principle of risk/reward, the less risky the profile of the issuer of a debt security, the lower the price at which it can be issued. Thus, for the issuer, a favorable rating can reduce the cost of borrowed capital. From the viewpoint of the investor, the grade assigned by the rating agencies depends on the capacity of the issuer to service the debt. It is based on the past performance as well as an analysis of the expected cash flows of a company when viewed on the industry parameters as well as company performance. Hence, the investor can judge for himself whether he wants to place his savings in a "safe" instrument and get a lower return or he wants to take a risk and get a higher return. The 1990s saw an increase in activity in the primary debt market. Under the SEBI guidelines all issuers of debt have to get the instruments rated. They also have to prominently display the ratings in all that marketing literature and advertisements. The rating agencies have thus become an important part of the institutional framework of the Indian securities market.

R& T Agents - Registrars to Issue R&T Agents form an important link between the investors and issuers in the securities market. A company, whose securities are issued and traded in the market, is known as the Issuer. The R&T Agent is appointed by the Issuer to act on its behalf to service the investors in respect of all corporate actions like sending out notices and other communications to the investors as well as dispatch of dividends and other non-cash benefits. R&T Agents perform an equally important role in the depository system as well. Stock Brokers Stockbrokers are the intermediaries who are allowed to trade in securities on the exchange of which they are members. They buy and sell on their own behalf as well as on behalf of their clients. Traditionally in India, individuals owned firms providing brokerage services or they were partnership firms with unlimited liabilities. There were, therefore, restrictions on the amount of funds they could raise by way of debt. With increasing volumes in trading as well as in the number of small investors, lack of adequate capitalization of these firms exposed investors to the risks of these firms going bust and the investors would have no recourse to recovering their dues. With the legal changes being effected in the membership rules of stock exchanges as well as in the capital gains structure for stock-broking firms, a number of brokerage firms have converted themselves into corporate entities. In fact, NSE encouraged the setting up of corporate broking members and has today has only 10% of its members who are not corporate entities.



In the earliest phase of capital market reforms, to get over the problems associated with paper-based securities, large holding by institutions and banks were sought to be immobilized. Immobilization of securities is done by storing or lodging the physical security certificates with an organization that acts as a custodian - a securities depository. All subsequent transactions in such immobilized securities take place through book entries. The actual owners have the right to withdraw the physical securities from the custodial agent whenever required by them. In the case of IPO, a jumbo certificate is issued in the name of the beneficiary owners based on which the depository gives credit to the account of beneficiary owners. The Stock Holding Corporation of India was set up to act as a custodian for securities of a large number of banks and institutions who were mainly in the public sector. Some of the banks and financial institutions also started providing "Custodial" services to smaller investors for a fee. With the introduction of dematerialization of securities there has been a shift in the role and business operations of Custodians. But they still remain an important intermediary providing services to the investors who still hold securities in a physical form. Mutual Funds Mutual funds are financial intermediaries, which collect the savings of small investors and invest them in a diversified portfolio of securities to minimize risk and maximize returns for their participants. Mutual funds have given a major fillip to the capital market - both primary as well as secondary. The units of mutual funds, in turn, are also tradable securities. Their price is determined by their net asset value (NAV), which is declared periodically. The operations of the private mutual funds are regulated by SEBI with regard to their registration, operations, administration and issue as well as trading. There are various types of mutual funds, depending on whether they are open ended or close ended and what their end use of funds is. An open-ended fund provides for easy liquidity and is a perennial fund, as its very name suggests. A closed-ended fund has a stipulated maturity period, generally five years. A growth fund has a higher percentage of its corpus invested in equity than in fixed income securities, hence, the chances of capital appreciation (growth) are higher. In Growth Funds, the dividend accrued, if any, is reinvested in the fund for the capital appreciation of investments made by the investor. An Income fund on the other hand invests a larger portion of its corpus in fixed income securities in order to pay out a portion of its earnings to the investor at regular intervals. A balanced fund invests equally in fixed income and equity in order to earn a minimum return to the investors. Some mutual funds are limited to a particular industry; others invest exclusively in certain kinds of short-term instruments like money market or Government securities. These are called money market funds or liquid funds. To prevent processes like dividend stripping or to ensure that the funds are available to the managers for a minimum period so that they can be deployed to at least cover the administrative costs of the asset management company, mutual funds prescribe an entry load or an exit load for the investors. If investors want to withdraw their investments earlier than 12

the stipulated period, an exit load is chargeable. To prevent profligacy, SEBI has prescribed the maximum that can be charged to the investors by the fund managers. Depositories The depositories are important intermediaries in the securities market that is scrip-less or moving towards such a state. In India, the Depositories Act defines a depository to mean, "a company formed and registered under the Companies Act, 1956 and which has been granted a certificate of registration under sub-section (IA) of section 12 of the Securities and Exchange Board of India Act, 1992." The principal function of a depository is to dematerialize the securities and enable their transactions in book-entry form. Dematerialization of securities occurs when securities, issued in physical form, are destroyed and an equivalent number of securities are credited into the beneficiary owner's account. In a depository system, the investors stand to gain by way of lower costs and lower risks of theft or forgery, etc. They also benefit in terms of efficiency of the process. But the implementation of the system has to be secure and well governed. All the players have to be conversant with the rules and regulations as well as with the technology for processing. The intermediaries in this system have to play strictly by the rules. A depository established under the Depositories Act can provide any service connected with recording of allotment of securities or transfer of ownership of securities in the record of a depository. A depository cannot directly open accounts and provide services to clients. Any person willing to avail of the services of the depository can do so by entering into an agreement with the depository through any of its Depository Participants.

Depository Participants A Depository Participant (DP) is described as an agent of the depository. They are the intermediaries between the depository and the investors. The relationship between the DPs and the depository is governed by an agreement made between the two under the Depositories Act. In a strictly legal sense, a DP is an entity that is registered as such with SEBI under the provisions of the SEBI Act. As per the provisions of this Act, a DP can offer depository related services only after obtaining a certificate of registration from SEBI. SEBI (D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers, R&T agents and non-banking finance companies (NBFC), for granting them a certificate of registration to act as DPs. If a stockbroker seeks to act as a DP in more than one depository, he should comply with the specified net worth criterion separately for each such depository. No minimum net worth criterion has been prescribed for other categories of DPs. However, depositories can fix a higher net worth criterion for their DPs. NSDL requires a minimum net worth of Rs. 100 lakh to be eligible to become a DP as against Rs. 50 lakh prescribed by


SEBI (D&P) Regulations. The role, functions, responsibilities and business operations of DPs are described in detail in the second section of this book. Instruments The changes in the regulatory framework of the capital market and fiscal policies have also resulted in newer kinds of financial instruments (securities) being introduced in the market. Also, a lot of financial innovation by companies who are now permitted to undertake treasury operations, has resulted in newer kinds of instruments - all of which can be traded – being introduced. The variations in all these instruments depend on the tenure, the nature of security, the interest rate, the collateral security offered and the trading features, etc. Debentures These are issued by companies and regulated under the SEBI guidelines of June 11, 1992. These are issued under a prospectus, which has to be approved by SEBI like in the case of equity issues. The rights of investors as debenture holders are governed by the Companies Act, which prohibits the issue of debentures with voting rights. There are a large variety of debentures that is available. This includes: • Participating debentures • Convertible debentures with options • Third party convertible debentures • Debt/equity swaps • Zero coupon convertible notes • Secured premium notes • Zero interest fully convertible debentures • Fully convertible debentures with interest • Partly convertible debentures. Bonds Indian DFIs, like IDBI, ICICI, and IFCI, have been raising capital for their operations by issuing of bonds. These too are available in a large variety. These include: • Income bonds • Tax-free bonds • Capital gains bonds • Deep discount bonds • Infrastructure bonds • Retirement bonds


In addition to the interest rates and maturity profiles of these instruments, the issuer institutions have been including a put/call option on especially the very long-dated bonds like deep discount bonds. Since the tenures of some of these instruments spanned some 20 or 25 years during which the interest rate regimes may undergo a complete change, the issuer have kept the flexibility to retire the costly debt. This they do by exercising their option to redeem the securities at pre-determined periods like at the end of five or seven years. This has been witnessed in number of instruments recently much to the chagrin of investors who were looking for secure and hassle-free long-dated instruments. Preference Shares: As the name suggests, owners of preferential shares enjoy a preferential treatment with regard to corporate actions like dividend. They also have a higher right of repayment in case of winding up of a company. Preference shares have different features and are accordingly available as: • Cumulative and non-cumulative • Participating • Cumulative & Redeemable fully convertible to preference shares • Cumulative & Redeemable fully convertible to equity • Preference shares with warrants • Preference shares Equity Shares As the name indicates, these represent the proportionate ownership of the company. This right is expressed in the form of participation in the profits of the company. There has been some innovation in the way these instruments are issued. Some hybrid securities like equity shares with detachable warrants are also available.

Government securities The Central Government or State Governments issue securities periodically for the purpose of raising loans from the public. There are two types of Government Securities – Dated Securities and Treasury Bills. Dated Securities have a maturity period of more than one year. Treasury Bills have a maturity period of less than or up to one year. The Public Debt Office (PDO) of the Reserve Bank of India performs all functions with regard to the issue management, settlement of trade, distribution of interest and redemption. Although only corporate and institutional investors subscribe to government securities, individual investors are also permitted to subscribe to these securities. An investor in government securities has the option to have securities issued either in physical form or in book-entry form (commonly 15

known as Subsidiary General Ledger form). There are two types of SGL facilities, viz., SGL1 and SGL-2. In the SGL-1 facility, the account is opened with the RBI directly. There are several restrictions on opening SGL-1 accounts and only entities, which fulfill all the eligibility criteria, are permitted to open SGL-1 account. The RBI has permitted banks, registered primary dealers and certain other entities like NSCCL, SHCIL, and NSDL to provide SGL facilities to subscribers. A subscriber to government securities who opts for SGL securities may open an SGL account with RBI or any other approved entity. Investments made by such approved entity on its own account are held in SGL-1 account, and investments held on account of other clients are held in SGL-2 account. Capital Market Processes There are various processes that Issuers of securities follow or utilize in order to tap the savers for raising resources. Some of the commonly used processes and methods are described below.

Initial Public Offering (IPO) Companies, new as well as old can offer their shares to the investors in the primary market. This kind of tapping the savings is called an IPO or Initial Public Offering. SEBI regulates the way in which companies can make this offering. New companies can make an IPO if they have a dividend-paying (ability) record of three years. The size of the initial issue, the exchange on which it can be listed, the merchant bankers' responsibilities, the nature and content of the disclosures in the prospectus, procedures for all these are laid down by SEBI and have to be strictly complied with. Exemption may be granted by SEBI in certain cases for minimum public offer or minimum subscription in the case of certain industry sectors like infrastructure or IT or media & communications. Several changes have also been introduced in recent years in the manner in which the IPOs can be marketed. For example they can now take the book-building route or they can even be marketed through the secondary market by brokers or DPs. All these changes have been made with the objective of making the process more investor friendly by reducing risk, controlling cost, greater transparency in the pricing mechanism and protecting liquidity in the hands of the investor. Some of the IPOs have been available for subscription online - where the bids are made in real time and the information is made available on an instantaneous basis on the screen. It is possible to subscribe for IPO shares in demat form through DPs. Private Placement Many companies choose to raise capital for their operations through various intermediaries by taking what in marketing terms would be known as the wholesale route. 16

The retail route - of approaching the public -is expensive as well as time consuming. This is called in financial markets as private placement. SEBI has prescribed the eligibility criteria for companies and instruments as well as procedures for private placement. However, liquidity for the initial investors in privately placed securities is ensured as they can be traded in the secondary market. But such securities have different rules for listing as well as for trading. Preferential Offer/Rights Issue Companies can expand their capital by offering the new shares to their existing shareholders. Such offers for sale can be made to the existing shareholders by giving them a preferential treatment in allocation or the offer can be on a rights basis, i.e., the existing holders can get by way of their right, allotment of new shares in certain proportion to their earlier holding. All such offers have also to be approved by SEBI, which has laid out certain criteria for these routes of tapping the public. These have to be complied with. Internet Broking With the Internet becoming ubiquitous, many institutions have set up securities trading agencies that provide online trading facilities to their clients from their homes. This has been possible since all the players in the securities market, viz., stockbrokers, stock exchanges, clearing corporations, depositories, DPs, clearing banks, etc., are linked electronically. Thus, information flows amongst them on a real time basis. The trading platform, which was converted from the trading hall to the computer terminals at the brokers' premises, has now shifted to the homes of investors. This has introduced a higher degree of transparency in transactions. The investor knows exactly when and at what rate his order was processed. It also creates an end-to-end audit trail that makes market manipulation difficult. The availability of securities in demat form has given a further fillip to this process. However, the emergence of, what is known as, "day-traders" has resulted in the business environment of brokers, which has changed. Investors, who can now trade directly, no longer require their intermediation. Service charges have therefore been declining - all of which has been in favor of investors.


COMPANY PROFILE ShareKhan Ltd., one of the leading stock broking firm and pioneer in online trading in India is a progeny of Shripal, Sevantilal, Kantilal and Ishwarlal [SSKI]. They have 250 share shops in 120 cities. The daily turnover of ShareKhan is round about Rs. 11-12 crores and working capital round about Rs. 450 crores. The growth of ShareKhan is because it is consistent in providing innovative and value based customer service. SSKI has been helping their investors from round about 81 years with their equity investments. ShareKhan Ltd. is known for its deep understanding of the stock market. They are also providing multi channel access facility to its customer through an online service with its website www.sharekhan.com and Dial-n-Trade through their call-centers. They have excellent trading facilities like the Classic Account and other software base online trading product for the day-traders, called Speed Trade [this provides everything to the trader on his screen instantly]. They regularly send detail research reports and the expert suggestions & tips through e-mail to its customer everyday. These services help its customer in the investment decisions. Share khan offers trade execution facilities on the BSE and NSE, for cash as well as derivatives, depository services, commodities trading on the MCX & NCDEX and most importantly. The SSKI Group also comprises of Institutional broking & Corporate Finance. The Institutional broking division caters to domestic and foreign institutional investors while the Corporate Finance Division focuses on niche areas such as infrastructure, telecom and media. SSKI has been voted as the Top Domestic Brokerage House in the research category, twice by Euro money survey and four times by Asia money survey. SSKI was adjudged as the ‘Best Local Brokerage’ in India by Asia money. ShareKhan provides various On-line services to its customers like:


(i) Classic Account: - It facilitates its client to trade through website. There are features like Demat & Digital Contacts, Quotes, Integrated Banking, Multiple Watch list, and Instant credit & transfer. (ii) Dial–n–trade: - Through Toll free number order is placed. The fund is automatically transferred through phone banking. It is not time consuming; just there is a need to enter TPIN. Tele-broker gives trusted and professional advice. They also provide after hour Order placement facility between 8:00 a.m. to 9:30 a.m. It is simple and secure IVR based system for authentication.


Speed trade and speed trade plus: - It is software based online trading product that brings power of broker’s terminal to investor’s PC. It is good for active traders and jobbers who transact frequently during daytime. It is an Internet based executable application that provides trader Real time streaming quotes, Live tic-by-tic Intra day charting, instant Confirmation and alerts.


ShareKhan Depository Services: - ShareKhan Depository Services offers dematerialization services to individual and corporate investors. A team of professionals and experts in the latest technology are dedicated exclusively for the Demate department, other than that franchisee to make the services quick, convenient and efficient. (v) Trading in Commodity Futures: - It provides the facility to trade in commodities [Gold, Silver, Crude oil, Agricultural commodities etc.] through a wholly owned subsidiary of its Parent SSKI. ShareKhan is a member of 2 Commodity Exchanges and offers trading facility at both these exchanges. (I) Multi Commodity Exchange Of India [MCX] (II) National Commodity And Derivative Exchange, Mumbai [NCDEX] By research ShareKhan classified the scrips of the companies into six clusters to help its clients. The six clusters are Evergreen, Apple Green, Emerging Star, Ugly Duckling, Vulture's Pick and Cannonball. Each cluster represents a certain profile in terms of business fundamentals as well as the kind of returns expected by the investor over a certain time span. One of the most important pamphlets issued for commodities is termed as SHAREKHAN EXCLUSIVE.


THEORETICAL ASPECT INTRODUCTION According to dictionary, derivative means ‘something which is derived from another source’. Therefore, derivative is not primary, and hence not independent. It depends upon the primary source from which it is derived. Therefore, with changes in the value of primary variable, value of derivative also varies. In financial terms, derivative is a product whose value is derived from the value of one or more basic variables. These basic variable are called bases, which may be value of underlying asset, a reference rate etc. the underlying asset can be equity, foreign exchange, commodity or any asset. For example:- the value of any asset, say share of any company, at a future date depends upon the share’s current price. Here, the share is underlying asset, the current price of the share is the bases and the future value of the share is the derivative. Similarly, the future rate of the foreign exchange depends upon its spot rate of exchange. In this case, the future exchange rate is the derivative and the spot exchange rate is the base. Derivatives are contract for future delivery of assets at price agreed at the time of the contract. The quantity and quality of the asset is specified in the contract. The buyer of the asset will make the cash payment at the time of delivery. Derivative product initially emerged, as hedging devices against the fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives, derivatives for future delivery of stocks, debt instruments and foreign currencies, came into spotlight in post-1970 period due to the introduction of floating exchange rates. Since their emergence, financial derivatives have become very popular and now they account for about two-third of total transaction in derivative products. Meaning Derivatives are the financial contracts whose value/price is dependent on the behaviour of the price of one or more basic underlying assets (often simply known as the underlying). These contracts are legally binding agreements, made on the trading screen of 20

stock exchanges, to buy or sell an asset in future. The asset can be a share, index, interest rate, bond, rupee dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc. In the Indian Context the Security Contracts (Regulation) Act,1956 (SC(R)A) defines “derivative” to include – A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or other form of security. A contract, which derives its value from the prices, or index of prices of underlying securities. Derivatives are securities under the SC(R) A and hence the regulatory framework under the SC(R) A. governs the trading of derivative.

Contracts agreement


Derivatives Others like Swaps, FRAs etc


Merchandisin g, customized

Futures (Standardized )


In financial terms derivatives is a broad term for any instrumental whose value is NTSD derived from the value of oneTSD underlying assets such as commodities, forex, precious more metal, bonds, loans, stocks, stock indices, etc. Derivatives were developed primarily to manage offset, or hedge against risk but some were developed primarily to provide potential for high returns. In the context of equity


markets, derivatives permit corporations and institutional investors to effectively manage their portfolios of assets and liabilities through instrument like stock index futures. For example: - The price of Reliance Triple Option Convertible Debentures (Reliance TOCD) used to vary with the price of Reliance shares. In addition, the price of Telco warrants depends upon the price of Telco shares. American Depository receipts / Global Depository receipts draw their price from the underlying shares traded in India. Nifty options and futures. Reliance futures and options, are the most common and popular form of derivatives. The derivatives markets has existed for centuries as a result of the need for both users and producers of natural resources to hedge against price fluctuations in the underlying commodities. Although trading in agriculture and other commodities has been the deriving force behind the development of derivatives exchanges, the demand for products based on financial instruments such as bond, currencies, stocks and stock indices have now for outstripped that for the commodities contracts. The history of the derivatives dates back to the time since the trading came into being. The merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. A primary intention for contracting for future date was to keep the transaction immune to unexpected fluctuations in price. Therefore, derivative products initially emerged as hedging devices against fluctuations in commodity prices. However, the concept applied to financial trade only in the post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-third of the total transaction in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and turnover. In the class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use. Early forward contracts in the US addressed merchants concerns about ensuring that there were buyers and sellers for commodities. However “credit risk” remained a serious problem. 1848


A group of Chicago businessmen formed the Chicago Board of Trade (CBOT). The primary intention of the CBOT was to provide a centralized location known in advance for buyers and sellers to negotiate forward contracts. 1865 The CBOT went one-step further and listed the first “exchange traded” derivatives contract in the US; these contracts were called “future contracts” 1919 Chicago Butter and Egg & board, a spin-off of CBOT, was reorganized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized futures exchanges, indeed the two largest “financial” exchanges of any kind in the world today. The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world was based on S&P 500 index, traded on Chicago Mercantile Exchange. During the mid eighties, financial futures became the most active derivatives instruments generating volumes many times more than the commodity futures. Index futures, futures on T-Bills and Euro-Dollar futures are the three most popular future contracts traded today. Other popular international exchanges that trade derivatives are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan, and MATIF in France, Eurex, etc. India has been trading derivatives contract in silver, gold, spices, coffee, cotton, etc for decades in the gray market. Trading derivatives contracts in organized market was legal before Morarji Desai’s government banned forward contracts. Derivatives on stocks were traded in the form of Teji and Mandi in unorganized on exchanges. For example, now cotton and oil futures trade in Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee in Bangalore, etc. JUNE 2000 National Stock Exchange and Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter trading began on options and futures in 31 prominent stocks in the month of July and November respectively. Option and future are the most commonly traded derivatives, but as the understanding of financial markets and risked management continued to improve newer


derivatives were created. The family includes the host of other product such as forward contracts. Structured notes, inverse floaters, caps & Floors and Collar Swaps.

The largest derivatives market in the world, are on government bonds (to help control interest rate risk) the stock index (to help control risk that is associated with the fluctuations in the stock market) and on exchange rates (to cope with currency risk). Risk Associated With Derivatives While derivatives can be used to help manage risks involved in investments, they also have risks of their own. However, the risks involved in derivatives trading are neither new nor unique – they are the same kind of risks associated with traditional bond or equity instruments. Market Risk Derivatives exhibit price sensitivity to change in market condition, such as fluctuation in interest rates or currency exchange rates. The market risk of leveraged derivatives may be considerable, depending on the degree of leverage and the nature of the security. Liquidity Risk Most derivatives are customized instrument and could exhibit substantial liquidity risk implying they may not be sold at a reasonable price within a reasonable period. Liquidity may decrease or evaporate entirely during unfavorable markets. Credit Risk Derivatives not traded on exchange are traded in the over-the-counter (OTC) market. OTC instrument are subject to the risk of counter party defaults.

Hedging Risk Several types of derivatives, including futures, options and forward are used as hedges to reduce specific risks. If the anticipated risks do not develop, the hedge may limit the fund’s total return.

FUNCTION OF DERIVATIVES MARKET The derivative market performs a number of economic functions:-


 Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. The prices of derivative converge with the prices of the underlying at the expiration of the derivative contract. Thus, derivatives help in discovery of future as well as current prices.  The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them.  Derivatives, due to their inherent nature, are linked to the underlying cash market. With the introduction of the derivatives, the underlying market witnesses higher trading volumes because of the participation by more players who would not otherwise participate for lack of arrangement to transfer risk.  Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivative market, speculators trade in the underlying cash market.  An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. The derivatives have a history of attracting many bright, creative, well-educated people with an entrepreneurial attitude. They often energize others to create new businesses, new products and new employment opportunities, the benefit of which are immense.  Derivatives markets help increase savings and investment in the end. Transfer of risk enables market participants to expand their volumes of activity.

PARTICIPANTS OF THE DERIVATIVE MARKET Market participants in the future and option markets are many and they perform multiple roles, depending upon their respective positions. A trader acts as a hedger when he transacts in the market for price risk management. He is a speculator if he takes an open position in the price futures market or if he sells naked option contracts. He acts as an arbitrageur when he enters in to simultaneous purchase and sale of a commodity, stock or other asset to take advantage of mispricing. He earns risk less profit in this activity. Such opportunities do not exist for long in an efficient market. Brokers provide services to others, while market makers create liquidity in the market. Hedgers Hedgers are the traders who wish to eliminate the risk (of price change) to which they are already exposed. They may take a long position on, or short sell, a commodity and would, therefore, stand to lose should the prices move in the adverse direction.


Speculators If hedgers are the people who wish to avoid the price risk, speculators are those who are willing to take such risk. These people take position in the market and assume risk to profit from fluctuations in prices. In fact, speculators consume information, make forecasts about the prices and put their money in these forecasts. In this process, they feed information into prices and thus contribute to market efficiency. By taking position, they are betting that a price would go up or they are betting that it would go down. The speculators in the derivative markets may be either day trader or position traders. The day traders speculate on the price movements during one trading day, open and close position many times a day and do not carry any position at the end of the day. They monitor the prices continuously and generally attempt to make profit from just a few ticks per trade. On the other hand, the position traders also attempt to gain from price fluctuations but they keep their positions for longer durations may is for a few days, weeks or even months. Arbitrageurs Arbitrageurs thrive on market imperfections. An arbitrageur profits by trading a given commodity, or other item, that sells for different prices in different markets. The Institute of Chartered Accountant of India, the word “ARBITRAGE” has been defines as follows:“Simultaneous purchase of securities in one market where the price there of is low and sale thereof in another market, where the price thereof is comparatively higher. These are done when the same securities are being quoted at different prices in the two markets, with a view to make profit and carried on with conceived intention to derive advantage from difference in prices of securities prevailing in the two different markets” Thus, arbitrage involves making risk-less profits by simultaneously entering into transactions in two or more markets.



The most commonly used derivatives contracts are Forward, Futures and Options. Here some derivatives contracts that have come to be used are covered.  FORWARD:A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at today’s pre-agreed price.  FUTURES:A futures contact is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. For example:- A, on 1 Aug. agrees to sell 600 shares of Reliance Ind. Ltd. @ Rs. 450 to B on 1st sep. A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd. @ Rs. 450 to B on 1 st sep.

 OPTIONS:Options are a right available to the buyer of the same, to purchase or sell an asset, without any obligation. It means that the buyer of the option can exercise his option but is not bound to do so. Options are of 2 types: calls and puts. 1. CALLS:Call gives the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price, on or before a given future date. example:- A, on 1 st Aug. buys an option to buy 600 shares of Reliance Ind. Ltd. @ 450 Rs 450 on or before 1 st Sep. In this case, A has the right to buy the shares on or before the specified date, but he is not bound to buy the shares. 2. PUTS:Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset, at a given price, on or before a given date. For example:- A, on 1 st Aug. buys an option to sell 600 shares of Reliance Ind. Ltd. @ Rs 450 on or before 1 st Sep. In this case, A has the right to sell the shares on or before the specified date, but he is not bound to sell the shares. In both the types of the options, the seller of the option has an obligation but not a right to buy or sell an asset. His buying or selling of an asset depends upon the action of buyer of the option. His position in both the type of option is exactly the reverse of that of a buyer.


 WARRANTS:Options generally have lives of up to one year, the majority of options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter.  LEAPS:The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years.  BASKET:Basket options are options on portfolios of underlying assets are usually a moving average of a basket of assets. Equity index options are a form of basket options.  SWAPS:Swaps are private agreement between two parties to exchange cash flows in the future according to a pre arranged formula. They can be regarded as portfolios of forward contract. The two commonly used swaps are 1 INTEREST RATE SWAPS:These entail swapping only the interest related cash flows between the parties in the same currency. 2 CURRENCY SWAPS:These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.

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


Out of the above mentioned types of derivatives forward, future and options are the most commonly used and have been detailed in this report.

EMERGENCE OF THE DERIVATIVE TRADING IN INDIA  Approval For Derivatives Trading The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 – member committee under the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing necessary pre-conditions for introduction of derivatives trading in India. The committee recommended that derivatives should be declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’ could also govern trading of securities. SEBI also set up a group in June 1998 under the chairmanship of Prof. J.R.Verma, to recommend measures for risk containment in derivative market in India. The repot, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real - time monitoring requirements. The SCRA was amended in December 1999 to include derivatives within the ambit of ‘securities’ and the regulatory framework were developed for governing derivatives trading.


The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on a recognized stock exchange, thus precluding OTC derivatives. The government also rescinded in March 2000, the three – decade old notification, which prohibited forward trading in securities. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2000. SEBI permitted the derivative segment of two stock exchanges, NSE and BSE, and their clearing house/corporation to commence trading and settlement in approved derivatives contract. To begin with, SEBI approved trading in index future contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval for trading in options based on these two indices and options on individual securities. The trading in index options commenced in June 2001. Futures contracts on individual stocks were launched in November 2001. Trading and settlement in derivatives contracts is done in accordance with the rules, byelaws, and regulations of the respective exchanges and their clearing house/corporation duly approved by SEBI and notified in the official gazette.

INTRODUCTION TO FORWARDS Forward Contracts A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. The parties to the contract negotiate other contracts details like delivery date, price, and quantity bilaterally. The forward contracts are normally traded outside the exchanges.


Salient features of forward contracts are as follows: They are bilateral contracts and hence exposed to counter party risk.  Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality.  The contract price is generally not available in public domain.  On the expiration date, the contract has to be settled by delivery of the asset.  If the party wishes to reverse the contract, it has to compulsorily go to the same counter party, which often results in high prices being charged. Limitation of forward market Forward market worldwide is affected by several problems: Lack of centralization.  Illiquidity.  Counter party risk. In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a real estate market in that any two consenting adults can form contracts against each other. This often makes them design terms of the deal, which are very convenient in that specific situation, but makes the contract non-tradable. Counter party risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade standardized contracts, and hence avoid the problem illiquidity, the counter party risk remains a very serious. INTRODUCTION TO FUTURES Future contract is specie of forward contract. Futures are exchange-traded contracts to sell or buy standardized financial instruments or physical commodities for delivery on a specified date at an agreed price. Futures contracts are used generally for protecting against rich of adverse price fluctuations (hedging). As the term of contracts are standardized, these are generally not used for merchandizing purpose. The standardized items in a futures contract are:  Quantity of the underlying.  Quality of the underlying.  The date and month of delivery.  The units of price quotation and minimum price change.  Location of settlement.


Futures contract performs two important functions of price discovery and price risk management with reference to the given commodity. It is useful to all segment of economy. It is useful to the producer because investor can get an idea of the price likely to prevail at a future point of time and therefore can decide between various competing commodities, the best that suits him. It enables the consumer get an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and cover his purchases by making forward contracts. The future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market . Other benefits of futures trading are:  Price stabilization in time of violent price fluctuations- this mechanism dampens the peaks and lifts up the valleys i.e. the amplitude of price variation is reduced.  Leads to integrated price structure throughout the country.  Facilitates lengthy and complex, production and manufacturing activities.  Helps balance in supply and demand position throughout the year.  Encourages competition and acts as a price barometer to farmers and other trade functionaries.

FEATURE Operational Mechanism Contract Specifications

FORWARD CONTRACT Traded directly between two parties (not traded on the exchanges). Differ from trade to trade.

FUTURE CONTRACT Traded on the exchanges.

Contracts are standardized contracts.


Counter-party risk


Liquidation Profile

Price discovery

Low, as contracts are tailor made contracts catering to the needs of the needs of the parties. Not efficient, as markets are scattered.


Currency market in India.

Exists. However, assumed by the clearing corp., which becomes the counter party to all the trades or unconditionally guarantees their settlement. High, as contracts are standardized exchange traded contracts. Efficient, as markets are centralized and all buyers and sellers come to a common platform to discover the price. Commodities, futures, Index Futures and Individual stock Futures in India.

WHAT IS AN INDEX? To understand the use and functioning of the index derivatives markets, it is necessary to understand the underlying index. A stock index represents the change in value of a set of stock, which constitute the index. A market index is very important for the market players as it acts as a barometer for market behaviors and as an underlying in derivative instruments such as index futures. INDEX CONSTRUCTION Scrip’s in the index are chosen based on certain pre-determined qualitative and quantitative parameters, laid down by the index construction managers. Almost all the indices in the Indian Capital Market are price indices. They are the market capitalization weighted average price of a specific portfolio of scrip’s. The following methods are primarily used to construct indices:-

MARKET CAPITALIZATION WEIGHTED AVERAGE METHOD Each stock is given a weight proportional to its market capitalization. The popular examples are S&P 500, BSE Sensex, S&P CNX Nifty 50, NYSE Composite Index, etc. PRICE WEIGHTED METHOD Each stock is given a weight is proportional to its market price. The popular examples are Dow Jones Industrial Average, Nikkei 225 etc. 33

EQUAL WEIGHTED METHOD Each stock is equally weighted in the index. MODIFIED MARKET CAPITALIZATION WEIGHTED METHOD Market capitalization is considered only to the extend of free-float. The popular examples are NASDAQ 100, FTSE etc.

THE SENSEX AND NIFTY In India, the most popular indices have been the BSE Sensex and S&P CNX Nifty. The BSE Sensex has 30 stocks comprising the index, which are selected based on market capitalization, industry representation, trading frequency, etc. it represents 30 large well established and financially sound companies. The Sensex represents a broad spectrum of companies in a variety of industries. It represents 14 major industry groups. Then there is a BSE National Index and BSE 200.However, trading in index future has only commenced on the BSE Sensex. While the BSE Sensex was the first stock market index in the country, the National Stock exchange launched Nifty in April 1996 taking the base of November 3,1995. the Nifty index consists of share of 50 companies with each having a market capitalization of more than 500 core. PRICING OF INDEX The Cost Of Carry Model The cost of carry model where the price of the contract is defined as:F= S + C F: Futures price. S: Spot price. C: Holding cost or Carry cost. If F < S+C or F > S+C, arbitrage opportunities would exist i.e. whenever the future price moves away from the fair value, there would be chances for arbitrage. Margins The margining system is based on the J R Verma committee recommendations. The actual margining happens on a daily basis while online position monitoring is done on an intra day basis. Daily margining is of two types: 1. Initial margins. 2. Mark-to market profit/loss.


The computation of initial margin on the futures market is done using the concept of Value-at-risk (VaR). The initial margin amount is large enough to cover a one-day loss that can be encountered on 99% of the days. VaR methodology seeks to measure the amount of value that a portfolio may stand to lose within certain horizon period (one day for the clearing corporation) due to potential changes in the underlying asset market price. Initial margin amount computed using VaR is collected up-front. The daily settlement process called “mark-to-market” provides for collection of losses that have already occurred (historic losses) whereas initial margin seeks to safeguard against potential losses on outstanding positions. The mark-to-market settlement is done in cash. Settlement of Future Contract Futures contract has two types of settlement, the 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.

MTM Settlement All futures contact for each member is marked-to-market (MTM) to the daily settlement price of the relevant futures contract at the end of each day. The profits/losses are computes as a difference between: 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. The buy price and the sell price for the contracts executed during the day and squared up. The clearing members (CMs) who have a loss are required to pay the mark-to-market (MTM) loss amount in cash which is in, turn passed on to the CMs who have made a MTM profit. This is known as daily mark-to-market settlement. CMs are responsible to collect and settle the daily MTM profits/losses incurred by the Trading members (TMs) and their clients clearing and settling through them. Similarly, TMs are responsible to collect/pay/losses/profits from/to their clients by the next day. The pay-in and pay-out of the mark-to-market settlement are affected on the day following the trade day. After completion of daily settlement computation, all the open positions are reset to the daily settlement price. Such position becomes the opening positions for the next day. FINAL SETTLEMENTS FOR FUTURES On the expiry of the future contracts, after the close of trading hours, NSCCL marks all positions of CM to the final settlement price and the resulting profits/losses is settled in cash. Final settlement loss/profits amount is debited/credit to the relevant CM’s clearing bank account on the day following expiry day of the contract 35

SETTLEMENT PRICES FOR FUTURES Daily settlement price on a trading day is the closing price of the respective future contracts on such day. The closing price for the future contracts is currently calculated as the last half an hour weighted average price of a contract in the F&O segment of NSE. Final settlement price is the closing price of the relevant underlying index/security in the capital market segment of NSE, 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 NSE.

INTRODUCTION TO OPTIONS Options give the holder or buyer of the option the right to do something. If the option is a call option, the buyer or holder has the right to buy the number of shares mentioned in the contract at the agreed strike price. If the option is a put option, the buyer of the option has a right to sell the number of shares mentioned in the contract at the agreed strike price. The holder of the buyer does not have to exercise this right. Thus on the expiry of the day of the contract the option may or may not be exercised by the buyer. In contrast, in a futures contract, the two parties to the contract have committed themselves to doing something at a future date. To have this privilege of doing the transaction at a future only if it is a profitable, the buyer of the option has to pay a premium to the seller of options. HISTORY OF OPTIONS Options have existed for a long time in various transaction informally. For example, a person looking for a rented accommodation may find a place and give a small advance with a promise to occupy it a particular date. In case he does not occupy it, he will lose that advance. Such a practice is equivalent to an option. Options existed in the market of Holland even in early 17 th century. More formally, members of Put and Call Brokers and Dealers Association in USA traded options since early 1900s. In 1973, Black and Scholes came out with a formula to calculate fair premium on options. From the time onwards, markets for options developed rapidly. In April 1973, Chicago Board of options Exchange was set up specifically for trading options. In 1983 trading on stock index options of individual options decreased as most of the trading shifted to index options. One of the reasons is that volatilities of individual scrips is high and therefore premium on individual scrip’s is also high. In India, stock index options were introduced in June 2001.


TYPES OF OPTIONS An option is a contract between two parties giving the taker(buyer) the right, but not obligation, to buy or sell a parcel of shares at a predetermined price possibly on, or before a predetermined rate. To acquire this right the taker pays a premium to the writer (seller) of the contract. There are two types of options: 1. Call Options 2. Put Options

Call Options: Call options give the taker the right, but not the obligation, to buy the underlying shares at a predetermined price, on or before a predetermined date. Call Options- Long & Short Positions When you expect prices to rise, then you take a long position by buying calls. You are bullish. When you expect prices to fall, then you take a short position by selling calls. You are bearish. Put Options: A Put Option gives the holder of the right to sell a specific number of an agreed security at a fixed price for a period. Put Options- Long & Short Positions When you expect prices to rise, then you take a long position by buying Puts. You are bearish. When you expect prices to fall, then you take a short position by selling Puts. You are bullish. Particulars If you expect a fall in price(Bearish) If you expect a rise in price(Bullish) Call Options Short Long Put Options Long Short


TABLE SHOWING THE DEALING OF CALL & PUT OPTION Call Option Holder (Buyer)  Pays Premium  Right to exercise & buy the shares  Profit from rising prices  Limited losses, potentially unlimited gains Put Option Holder (Buyer)     Pays Premium Right to exercise & buy the shares Profit from rising prices Limited losses, potentially unlimited gains Call Option Writer (Seller)  Receives premium  Obligation to sell shares if exercised  Profits from falling prices or remaining neutral  Potentially unlimited losses, limited gains Put Option Holder (Seller)  Receives premium  Obligation to buy shares if exercised  Profits from rising prices or remaining neutral  Potentially limited losses, unlimited gains

IMPORTANT CONCEPTS In -the- money option: It is an option with intrinsic value. A call option is in the memory if the underlying price is above the strike price. A put option is in the memory if the underlying price is below the strike price.

Out- of- the- money: It is an option that has no intrinsic value, i.e. all of its value consists of time value. A call option is out of the money if the stock price is below its strike price. At- the- money: A term that describes an option with a strike price that is equal to the current market price of the underlying stock. But of the money if the stock price is above its strike price. 38

Market Scenario Market price > strike price Market price < strike price Market price = strike price Market price ~ strike price Intrinsic Value:

Call Option In- the- money Out- of- the- money At- the- money Near- the- money

Put Option Out- of- the- money In- the- money At the- money Near- the- money

In a call option, if the value of the underlying asset is higher than the strike price, the option premium has an intrinsic value and is an “in- the- money” option. If the value of the underlying asset is lower than the strike price , the option has no intrinsic value and is an “out- of- the- money” option. If the value of the underlying asset is equivalent to the strike price, the call option is “at- the- money” and has no intrinsic value or zero intrinsic value. In a put option, if the value of the underlying asset is lower than the strike price, the option has an intrinsic value and is an “in- the- money” option. If the value of the underlying asset is higher than the strike price, the option has no intrinsic value and is “out- of- money” option. . If the value of the underlying asset is equivalent to the strike price, the put option is at themoney” Time Value Time value is the amount an investor is willing to pay for an option, in the hope that at some time prior to expiration its value will increase because of a favorable change in the price of the underlying asset. Time value reduces as the expiration draws near and on expiration day; the time value of the option is zero. Option Price An option cost or price is called “premium”. The potential loss for the buyer of an option is limited to the amount of premium paid for the contract. The writer of the option, on the other hand, undertakes the risk of unlimited potential loss, for premium received. Thus, Option Price = Premium Price A premium is the net amount the buyer of an option pays to the seller of the option. It does not refer to an amount above the base price, as the term “premium” commonly used. The of an option has two important constituents, intrinsic value and time value. Premium = Intrinsic value + Time


PRICING WITH REGARD TO OPTIONS The Black and Scholes Model: The Black and Scholes Option Pricing Model didn't appear overnight, in fact, Fisher Black started out working to create a valuation model for stock warrants. This work involved calculating a derivative to measure how the discount rate of a warrant varies with time and stock price. The result of this calculation held a striking resemblance to a well-known heat transfer equation. Soon after this discovery, Myron Scholes joined Black and the result of their work is a startlingly accurate option pricing model. Black and Scholes can't take all credit for their work; in fact their model is actually an improved version of a previous model developed by A. James Boness in his Ph.D. dissertation at the University of Chicago. Black and Scholes' improvements on the Boness model come in the form of a proof that the riskfree interest rate is the correct discount factor, and with the absence of assumptions regarding investor's risk preferences.

Black and Scholes Model: In order to understand the model itself, we divide it into two parts. The first part, SN(d1), derives the expected benefit from acquiring a stock outright. This is found by multiplying stock price [S] by the change in the call premium with respect to a change in the underlying stock price [N(d1)]. The second part of the model, Ke(-rt)N(d2), gives the present value of paying the exercise price on the expiration day. The fair market value of the call option is then calculated by taking the difference between these two parts.


Assumptions of the Black and Scholes Model: 1) The stock pays no dividends during the option's life Most companies pay dividends to their share holders, so this might seem a serious limitation to the model considering the observation that higher dividend yields elicit lower call premiums. A common way of adjusting the model for this situation is to subtract the discounted value of a future dividend from the stock price. 2) European exercise terms are used European exercise terms dictate that the option can only be exercised on the expiration date. American exercise term allow the option to be exercised at any time during the life of the option, making American options more valuable due to their greater flexibility. This limitation is not a major concern because very few calls are ever exercised before the last few days of their life. This is true because when you exercise a call early, you forfeit the remaining time value on the call and collect the intrinsic value. Towards the end of the life of a call, the remaining time value is very small, but the intrinsic value is the same. 3) Markets are efficient This assumption suggests that people cannot consistently predict the direction of the market or an individual stock. The market operates continuously with share prices following a continuous into process. To understand what a continuous into process is, you must first know that a Markov process is "one where the observation in time period t depends only on the preceding observation." An into process is simply a Markov process in continuous time. If you were to draw a continuous process you would do so without picking the pen up from the piece of paper. 4) No commissions are charged Usually market participants do have to pay a commission to buy or sell options. Even floor traders pay some kind of fee, but it is usually very small. The fees that Individual investor's pay is more substantial and can often distort the output of the model. 5) Interest rates remain constant and known The Black and Scholes model uses the risk-free rate to represent this constant and known rate. In reality there is no such thing as the risk-free rate, but the discount rate on U.S. Government Treasury Bills with 30 days left until maturity is usually used to represent it. During periods of rapidly changing interest rates, these 30 day rates are often subject to change, thereby violating one of the assumptions of the model.


6) Returns are log normally distributed This assumption suggests, returns on the underlying stock are normally distributed, which is reasonable for most assets that offer options.

Advantages & Limitations Advantage:  The main advantage of the Black-Scholes model is speed -- it lets you calculate a very large number of option prices in a very short time. Limitation:  The Black-Scholes model has one major limitation: it cannot be used to accurately price options with an American-style exercise as it only calculates the option price at one point in time -- at expiration. It does not consider the steps along the way where there could be the possibility of early exercise of an American option.  As all exchange traded equity options have American-style exercise (ie they can be exercised at any time as opposed to European options which can only be exercised at expiration) this is a significant limitation.  The exception to this is an American call on a non-dividend paying asset. In this case the call is always worth the same as its European equivalent as there is never any advantage in exercising early.  Various adjustments are sometimes made to the Black-Scholes price to enable it to approximate American option prices (eg the Fischer Black Pseudo-American method) but these only work well within certain limits and they don't really work well for puts.



A commodity includes all kinds of goods. FCRA defines ‘goods’ as every kind of movable property other than actionable claim, money and securities. Derivatives as a tool for managing risk first originated in the commodities markets. They were then found useful as a hedging tool in financial markets as well. In India, trading in commodity futures has been in existence from the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Over a period of time, other commodities were permitted to be traded in futures exchanges. Regulatory constraints in 1960s resulted in virtual dismantling of the commodities future markets. It is only in the last decade that commodity future exchanges have been actively encouraged. However, the markets have been thin with poor liquidity and have not grown to any significant level.


DERIVATIVE Warehousing No warehousing is required derivatives contract don’t have attribute of quality Comparatively having long contract life Standardized

EQUITY No warehousing is required Equity contract don’t have attribute of quality having long and short contract life Standardized

COMMODITIES Required in case of delivery based settlement Every underlying commodities have specified qualities Short life as compared to derivatives. standardized

Quality of underlying assets Contract life

Maturity date


Return Risk Liquidity Investment Amount Lot size Time of trading

High Very High Less Very high Fixed by SEBI 10a.m to 3.30p.m

Medium Less Very high low Not fixed by SEBI 10a.m to 3.30p.m

High High Less Very high Fixed by SEBI Whole day

RESEARCH METHODOLOGY Problem Statement The topic, which is selected for the study, is “DERIVATIVE MARKET” in the firm so the problem statement for this study will be “THE AWARENESS OF THE DERIVATIVE AND ITS COMPARISION WITH EQUITY AND COMMODITIES” Objective of the Study  To know the awareness of the Derivative Market in Baroda City.  To find what proportion of the population are investing in such derivatives along with their investment pattern and product preferences.  To understand the working of the organization.  To know the trading system of the derivative exchange. Research Design


The research design specifies the methods and procedures for conducting a particular study. The type of research design applied here are “Descriptive” as the objective is to check the position of the Derivative Market in Baroda city. The objectives of the study have restricted the choice of research design up to descriptive research design. Therefore, no fixed hypothesis is set up. This survey will help the firm to know how the investors invest in the derivative segment & which factors affect their investing behavior.

Scope of the Study The scope of the study will include the analysis of the survey, which is being conducted to know the awareness of the Derivative Market in the city & also doing comparison of derivatives with equity and commodities. Research Source of Data There are two types of sources of data which is being used for the studies:1. Primary Source Of Data: The primary source of data is being collected by preparing a Questionnaire & it was collected by interviewing the investors.

Secondary Source Of Data

For having the detailed study about this topic, it is necessary to have some of the secondary information, which is collected from the following: Books.  Magazines & Journals.  Websites.  Newspapers, etc. Methods of Data Collection The study to be conducted is about the awareness of the Derivative Market in the Baroda City so the method of data collection used id “SURVEY METHOD”.


Research Instrument The research instrument, which is used, for the study is “QUESTIONNAIRE” which includes the questions which are based on the investment pattern, general awareness, criteria for investment & the questions are mostly close-ended for the convenience of the investors to provide the information about it. Sampling Techniques In this survey work, no particular sampling technique is used. The sample are included on the RANDOM NON- PROBABILITY BASIS.

Universe Investors of Baroda city. Sample Size The numbers of respondents selected for conducting the survey are 100 investors. These samples are collected on the random basis. The investor’s responses are analyzed to know their awareness about the Derivatives & which factors play an important role in their investment decisions & how far the investors like to invest in Derivative segment. Presentation of Data The presentation of data is through” CHARTS AND GRAPHS” which will help in analyzing the response of the investors.

Findings & Suggestion The findings & suggestion are given based on the research work done & after analyzing the survey work conducted. Limitation of the study However, the study is going to be a research project, but it definitely has some of the limitation, which is as follows:


 The time constraint is the important limitation of this study.  No. of respondents selected was less as compared to the city population.  Due to the shallow knowledge about the topic, detailed study could not be conducted.  Derivative Market being new to the Indian Market, less awareness was observed.  Respondents were hesitating to give the financial information.

ANALYSIS OF DATA Questionnaires were been filled by 100 respondents as an investor followed by detailed interview. The data collected from such interviews and its analysis is as follows. 1. Are you aware about derivatives? Yes No Objective: The question was ask to know the awareness level of investors about Derivatives Response Derivatives Yes 65 No 35




Conclusion: From above diagram we can say that most of people are aware about derivatives and the people who aware about derivates are those people who are investing in stock market for long period and also have much knowledge about stock market’s different instrument.

2. Have you made any investment in derivatives? Yes No Objective: This question was ask to know the investment criteria of investors about Derivatives Response Derivatives Yes 64 No 36




Conclusion: From above diagram we can say that only 64% of investors are doing investment in derivatives. This 36% people are the regular investor or have sufficient of to invest in derivative. And the people who are not invested in derivatives are salaried people or small investors. 3. If no, give the reason for not investing in derivatives? Lack of knowledge High amount of investment High risk Volatile market Lot size Objective: This question was asked to know the reason for not doing any investment in Derivatives. Reasons Lack of knowledge High Risk Lot Size High Amount of investment Volatile market others Respondents 11 9 8 7 1 64 49

Lot size Volatile market High risk

High amount

Lack of know ledge


Conclusion: From above diagram we can say that, the main reason for not made any investment in derivative is lack of knowledge among investors. So try to improve their knowledge about derivatives and the other reasons are lot size, volatile market, high risk and high amount of investment. Basically small investors and salaried people are not ready to take so much risk and they also not preferred high amount investment. 4 Do you have any inclination of investing in derivatives in future? Yes No May be

Objective: this question is asked to know the inclination of investors for investing in Derivatives in future. Response No. of Respondents Yes 64 No 8 May be 28 50


Yes No May be

Conclusion: From above diagram we can say that people want to know about derivatives and also have inclination of investing in derivatives. They think to do investment in derivatives.

5 If yes, which type of derivative instruments would you like to made your investment? Index future Stock future Index option Stock option Objective: This question was asked to know in which type of derivative instruments the investor would like to invest Product No. of Respondent Index Futures 48 Index Option 24 Stock Futures 15 Stock Options 13



Stock option

Index option Index future

Stock future

Conclusion: From this diagram we can say that people are more interested in index futures in types of derivatives rather than options because they find options are much completed in comparison of futures. 6 what approximate percentage of your portfolio have invested in derivatives? Less than 20% 5 50% to 70% 20% to 50% More than 70% Objective: this question is asked to know the approximate percentage of investors Portfolios have invested in derivatives. Percentage Less than 20% 20% to 50% 50% to 70% More than 70% No. of Respondents 59 32 6 3


More than 70% 50 - 70%

20 - 50% Less than 20%

Conclusion: From above diagram we can say that because of lack of knowledge and high risk the investors would not like to invest high amount of their portfolio in derivatives. Only 9 people are ready for investing above than 50% of their portfolios. Most of people are only want to do invest less than 20% of their portfolios in derivatives.

7 Mention your objective for investing in derivatives? Hedging Arbitrating Speculation Objective: This question is asked to know the objective of investor for investing in derivatives. Objective No. of Respondents Hedging 59 Arbitrating 29 Speculation 12




Arbitraging Hedging

Conclusion: From above diagram we can say that the main objectives of investors are hedging 8 which factors affecting your investment decision? Your decision In consultation with your broker Any other sources Based on broker’s decision Objective: This question is asked to know the factors affecting investor’s decision

Factors Own Decision Any other Sources In consultation with Broker Based on Broker’s Decision

No. of Respondents 35 34 11 20


B ased on broker deci

Your own decision

Any other source

C onsultation with yo

Conclusion: From this diagram we can say that the main factor which affects investment decision is consultation with their broker and by their own perspective. From the graph it reveals that in case of derivative people like to invest with the help of brokers because they are having specialized knowledge and also by their own, se we can say it is mix bled of taking decision. It means by own and by brokers.

9. Which factors affect your own decision? Return Risk Liquidity Safety Objective: this question is asked to on which bases investors take their own decision. Factors Return Risk Liquidity Safety No. of Respondents 42 15 23 20






Conclusion: From above diagram we can say that all the above factors are affected the person’s own investment decision because all the factors are very important before taking any investment decision.

10 what are the difficulties faced by you for investing in derivatives? Lot size Changes in margin by SEBI Lack of knowledge Any other reason than specify __________________________________________________ Objective: this question is asked to know the difficulties faced by investors for investing in derivatives Difficulties Lot Size Lack of Knowledge Changes in Margin by SEBI Any other Reason(investment amount) No. of Respondents 53 22 15 10 56



Lack of knowledge

Lot size

C hange in m argin bu

Conclusion: From above diagram we can say that, the difficulties faced by the investors while investing in derivatives are shown in the diagram. The main difficulty is problem of lot size in derivatives. Investors are not know much about derivatives investment pattern so not do much investment in derivatives and the other important factor is lack of knowledge. 11. Give your preferences for investment in this 3 instrument. Equity Derivative Commodities Objective: this question is asked to know the first choice of investors for investment

Investment Instrument Equity Derivative Commodities

No. of Respondents 58 26 16





Equity shares

Conclusion: From above diagram we can say that most of people are interested in dong investment in equities rather than in derivatives or in commodities coz of less amount of investment and less risk.

12. Give the ranking for given parameters mention below :( 1= high to 5 = low) Objective: The main objective of this question is to do the comparison of derivatives with equity and commodities. Derivative Risk Return liquidity 18 23 22 37 40 52 Equity Commodities 45 37 26


Investment Amount




40 35 30 Instrument 25 20 15 10 5 0 risk return Basis liquidity inv. Amt derivative equity commodity

Conclusion: From above diagram we can come on this conclusion that equity is having the nature of high risky and having high return as compare to derivative. For risk adverse investor’s derivative is preferable and for risky investors equity is preferable. Commodity involves high amount and high risk.


FINDINGS As from the study of questionnaires, I have found that in Surat 65% to 70% people are aware about the derivatives. I submit my findings here.  Majority of people and people investing in the financial market are aware of derivatives.  The reasons for ignorance or lower investment in the derivatives are lack of knowledge, high amount of investment, high risk and the volatility of the market.  In the recent time around only 20% of portfolio are invested in derivatives  The main aim for investing in derivatives is either hedging or speculation.  Investor finds derivatives as completed product and considers it to be only for hedging or secure profit.  Margin in future contract acts as hindrances for the common investors as it has to pay upfront and which is very high.  Majority of investors do invest in derivatives  The investors prefer to invest in equities also commodities and derivatives.  The reasons for inadequate awareness or small amount of investment in the derivatives are:  Most of the investors are influenced by there broker’s decision  They take decision only on the base of broker’s decision  Investor in nowadays think only about the safety, return and the liquidity  Changes in the percentage of margin by SEBI and lot size  Investors in nowadays think only about in what places their investment are safe, give higher return and liquidity. For all this reasons derivatives are no so much popular as equities


CONCLUSION  Derivatives are an instrument used for reducing the risk of loss of an investor. It acts as a price risk management system for an investor.  The current mindset of people regarding derivatives is that they are speculative due to non delivery and are not safe. They do not consider it rather as a risk reducing instrument. Due to such mindset derivatives segment are not rapidly growing in the Indian market as compared to the cash segment.  Therefore efforts must be made in India to make people aware of derivatives and convince them to consider it as a risk reducing instrument rather than a speculative instrument.


RECOMMENDATIONS 1) Derivative market is highly ill-famed among the investors. Thus it is required to provide in depth knowledge of the market to investors. 2) Broking house must try to create massive awareness programme among the beneficiaries about the benefits and risks of future trading and convince them to trade in derivatives. Arranging seminars, workshops, etc can do this. 3) Those who are already investing in securities market can be given another investment opportunity that will diversify their portfolio genuinely.

4) Investor should understand the risk and reward relation of investing in derivative segment and than only enter in the market.

5) The lot size in the derivative segment should be reducing so that even retail investor can also enter in the derivative market.



1. Gorden and Natrajan The Financial Market and Financial Services , Sixth Edition Reprint 2007 2. NCFM Derivative core module 3. NCFM Capital market core module FINANCIAL DAILIES: 1. 2. 3. 4. The financial express The economies Times The business standard Business Today

WEB SITES: www.nseindia.com www.bseindia.com www.investopedia.com www.derivativesindia.com

APPENDIX Name: Address: ____________________________________________ ____________________________________________ ____________________________________________ Contact no: ____________________________________________ 1. Are you aware about derivatives? Yes No 2. Have you made any investment in derivatives? Yes No 3. If no, give the reason for not investing in derivatives? Lack of knowledge High amount of investment High risk Volatile market 63

Lot size

4 Do you have any inclination of investing in derivatives in future? Yes No May be 5 If yes, which type of derivative instruments would you like to made your invested? Index future Stock future Index option Stock option 6 what approximate percentage of your portfolio have invested in derivatives? Less than 20% 50% to 70% 20% to 50% More than 70% 7 Mention your objective for investing in derivatives? Hedging Arbitrating Speculation 8 which factors affecting your investment decision? Your decision In consultation with your broker Any other sources Based on broker’s decision 9. Which factors affect your own decision? Return Risk Liquidity


10 what are the difficulties faced by you for investing in derivatives? Lot size Changes in margin by SEBI Lack of knowledge Any other reason than specify __________________________________________________ 11 Give your first preferences for investment in this 3 instrument. Equity Derivative Commodities


12 Give the ranking for given parameters mention below :( 1= high,2= moderate, and 3= law)

Derivative Risk Return liquidity Investment Amount




Sign up to vote on this title
UsefulNot useful