A STUDY ON CAPITAL MARKET DERIVATIVES IN

INDIA INFOLINE LIMITED,

VISAKHAPATNAM.

A Project report
Submitted to Acharya Nagarjuna University in partial
Fulfillment of the requirements for the degree of

MASTER OF BUSINESS ADMINISTRATION

Submitted By
SUNKARA RAJESH
(Regd No.A09EM016040)
(2009-11)

Under the Guidance of

Mr.P.RAJA BABU
M.Com.,M.B.A.,M.Phil.,B.L.,(P.hd)
Asst Professor(Dept of MBA)
Nimra College of Business Management, Ibrahimpatnam,Vijayawada-524 456
 INTRODUCTION TO DERIVATIVES

The Derivatives Market is meant as the market where exchange of

derivatives takes place. Derivatives are one type of securities whose
price is derived from the underlying assets. And value of these
derivatives is determined by the fluctuations in the underlying assets.
These underlying assets are most commonly stocks, bonds,
currencies, interest rates, commodities and market indices. As
Derivatives are merely contracts between two or more parties,
anything like weather data or amount of rain can be used as
underlying assets. The Derivatives can be classified as Future
Contracts, Forward Contracts, Options, Swaps and Credit
Derivatives.
Derivatives

Swaps Options Futures Forwards

Int Rt Put Call Security

Currency ` Commodity
DEFINITION OF DERIVATIVES

A  security whose price is dependent upon or derived from one or more

underlying assets. The derivative itself is merely a contract between two
or more parties. Its value is determined by fluctuations in the underlying
asset. The most common underlying assets include stocks,
bonds, commodities, currencies, interest rates and market indexes.
Most derivatives are characterized by high leverage.

Futures contracts, forward contracts,

options and swaps are the most common types of derivatives.
Derivatives are contracts and can be used as an underlying asset.
There are even derivatives based on weather data, such as the amount
of rain or the number of sunny days in a particular region.

Derivatives are generally used as an instrument to hedge risk, but can

also be used for speculative purposes. For example, a European
investor purchasing shares of an American company off of an American
exchange (using U.S. dollars to do so) would be exposed to exchange-
rate risk while holding that stock. To hedge this risk, the investor could
purchase currency futures to lock in a specified exchange rate for the
future stock sale and currency conversion back into Euros

HISTORY OF DERIVATIVES
Derivatives trading began in 1865 when the Chicago board of
trade(CBOT) listed the first “exchange traded” derivatives contract in
USA. These contracts were called “futures contracts”. In 1919, The
Chicago Butter and Egg Board, a spin off of CBOT, was recognized to
allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME).

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 is based on the Standard & poor’s 500 Index, traded on the
CME. In April 1973, the Chicago board of Options Exchange was setup
specifically for the purpose of trading in options. The market for options
developed so rapidly that by early 80’s the number of shares underlying
the contracts sold each day exceeded the daily volume of shares traded
on the New York Stock Exchange. And there has been no looking
back ever since.

Derivatives in India
The Securities and Exchange Board of India
(SEBI) allowed trading in Equities based derivatives on stock
exchanges in june 2000. Accordingly The national Stock Exchange
(NSE) and The Bombay Stock Exchange(BSE) introduced trading in
futures on june 9, 2000 and june 12, 2000 respectively. Currently
futures and options turnover on the NSE is Rs 7000 to 8000 cr
approximately. In india stock index options were introduced from July 2,
2001.

Derivatives in India: Chronology

December 14, 1995 The NSE sought sebi’s permission

to trade index futures.
November 18, 1996 The LC Gupta committee set up to
draft a policy frame work for index
futures.
May 11, 1998 The LC Gupta committee submitted
a report on the policy frame work
for index futures
RBI gave permission
July 7, 1999for OTC forward rate agreements and intrest rate
swaps
May 24, 2000 SIMEX choose Nifty for trading
futures and options on an Indian
index.
May 25, 2000 SEBI allowed the NSE & BSE to trade
on index futures.
th th
June 9 &12 , 2000 BSE & NSE Commenced the futures
trade respectively.
th
September 25 , 2000 Nifty futures trading commenced on
the SGX

What are derivative

Derivatives is a generic term for a variety of financial

instruments. Unlike financial instruments such as stocks and
bonds, a derivative is usually a contract rather than an asset.
Essentially, this means you buy a promise to convey
ownership of the asset, rather than the asset itself. The legal
terms of a contract are much more varied and flexible than the
terms of property ownership. In fact, it's this flexibility that
appeals to investors. "A good toolbox of derivatives allows the
modern investor the full range of investment strategy" and "the
sophisticated management of risk.

What are the Forward Contracts

In finance, a forward contract or simply a forward is a non-

standardized contract between two parties to buy or sell an asset at a
specified future time at a price agreed today. This is in contrast to a
spot contract, which is an agreement to buy or sell an asset today. It
costs nothing to enter a forward contract. The party agreeing to buy
the underlying asset in the future assumes a long position, and the
party agreeing to sell the asset in the future assumes a short position.
The price agreed upon is called the delivery price, which is equal to
the forward price at the time the contract is entered into.

The price of the underlying instrument, in whatever form, is paid

before control of the instrument changes. This is one of the many
forms of buy/sell orders where the time of trade is not the time where
the securities themselves are exchanged.
The forward price of such a contract is commonly contrasted with
the spot price, which is the price at which the asset changes hands on
the spot date. The difference between the spot and the forward price
is the forward premium or forward discount, generally considered in
the form of a profit, or loss, by the purchasing party.

Forwards, like other derivative securities, can be used to hedge risk

(typically currency or exchange rate risk), as a means of speculation,
or to allow a party to take advantage of a quality of the underlying
instrument which is time-sensitive.

A closely related contract is a futures contract; they differ in certain

respects. Forward contracts are very similar to futures contracts,
except they are not exchange-traded, or defined on standardized
assets. Forwards also typically have no interim partial settlements or
"true-ups" in margin requirements like futures - such that the parties
do not exchange additional property securing the party at gain and
the entire unrealized gain or loss builds up while the contract is open.
However, being traded OTC, forward contracts specification can be
customized and may include mark-to-market and daily margining.
Hence, a forward contract arrangement might call for the loss party
to pledge collateral or additional collateral to better secure the party
at gain.
Commodity Derivatives: 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 in1960s resulted in virtual dismantling
of the commodity futures market. It is only in the last decade that commodity
futures exchanges have been actively encouraged. In the commodity futures
market, the set up of national level exchanges witnessed exponential
growth in trading with the turnover increasing from 5.71 lakh crores in 2004-05
to52.48 lakh crores in 2008-09. However, the markets have not grown to
significant levels as compared to developed countries.

Evolution Of Commodity Exchanges

Most of the commodity exchanges, which exist today, have their origin in the
late 19th and earlier 20th century. The first central exchange was established in
1848 in Chicago under the name Chicago Board of Trade. The emergence of the
derivatives markets as the effective risk management tools in 1970s and 1980s
has resulted in the rapid creation of new commodity exchanges and expansion of the
existing ones. At present, there are major commodity exchanges all over the world dealing
in different types of commodities.
2.1.1 Commodity Exchange
Commodity exchanges are defined as centers where futures trade is organized in
a wider sense; it is taken to include any organized market place where trade is
routed through one mechanism, allowing effective competition among buyers
and among sellers. This would include auction-type exchanges, but not
wholesale markets, where trade is localized, but effectively takes place through
many non-related individual transactions between different permutations of
buyers and sellers.
2.1.2 Role of Commodity Exchanges
Commodity exchanges provide platforms to suit the varied requirements of
customers. Firstly ,they help in price discovery as players get to set future prices
which are also made available to all participants. Hence, a farmer in the southern
part of India would be able to know the best price prevailing in the country
which would enable him to take informed decisions. For this to happen, the
concept of commodity exchanges must percolate down to the villages. Today
the farmers base their choice for next year's crop on current year's price. Ideally
this decision
 
17ought to be based on next year's expected price. Futures prices on the
platforms of commodity exchanges will hopefully move farmers of our country
from the current 'cobweb' effect where additional acreage comes under
cultivation in the year subsequent to one when a commodity had good prices;
consequently the next year the commodity price actually falls due to oversupply .Secondly,
these exchanges enable actual users (farmers, agro processors, industry where the
predominant cost is commodity input/output cost) to hedge their price risk given the un certainty
of the future - especially in agriculture where there is uncertainty regarding the
monsoon and hence prices. This holds good also for non-agro products like
metals or energy products as well where global forces could exert considerable
influence. Purchasers are also assured of a fixed price which is determined in
advance, thereby avoiding surprises to them. It must be borne in mind that
commodity prices in India have always been woven firmly
into the international fabric. Today, price fluctuations in all major
commodities in the country mirror both national and international factors and not
merely national factors. Thirdly, by involving the group of investors and
speculators, commodity exchanges provide liquidity and buoyancy to the system
.Lastly, the arbitrageurs play an important role in balancing the market as
arbitrage conditions, where they exist, are ironed out as arbitrageurs trade with
opposite positions on different platforms and hence generate opposing demand
and supply forces which ultimately narrows down the gaps in prices .It must be
pointed out that while the monsoon conditions affect the prices of agro-based
commodities, the phenomenon of globalization has made prices of other
products such as metals, energy products, etc., vulnerable to
changes in global politics, policies, growth paradigms, etc. This
would be strengthened as the world moves closer to the resolution of the WTO
impasse, which would become a reality shortly. Commodity exchanges would
provide a valuable hedge through the price discovery process while catering to
the different kind of players in the market.
2.1.3 Commodity Derivative Markets in India
Commodity futures markets have a long history in India. Cotton was the first
commodity to attract futures trading in the country leading to the setting up of the
Bombay Cotton Trade Association Ltd in 1875. The Bombay Cotton Exchange
Ltd. was established in 1893 following the widespread discontent
amongst leading cotton mill owners and merchants over the
functioning of Bombay Cotton Trade Association. Subsequently, many
exchanges came up in different parts of the country for futures trading in various
commodities. Futures trading in oilseeds started in 1900 with the establishment
of the Gujarati Vyapari Mandali, which carried on futures trade in groundnut,
castor seed and cotton. Before the Second World War broke out in 1939,
several futures markets in oilseeds were functioning in Gujarat and Punjab
.Futures trading in wheat existed at several places in Punjab and Uttar Pradesh,
the most notable of which was the Chamber of Commerce at Hapur, which
began futures trading in wheat in 1913 and served as the price setter in that
commodity till the outbreak of the Second World War in 1939.Futures trading in
bullion began in Mumbai in 1920 and subsequently markets came up in other
centers like Rajkot, Jaipur, Jamnagar, Kanpur, Delhi and Kolkata.Calcutta Hessian
Exchange Ltd. was established in 1919 for futures trading in raw jute and jute
goods. But organized futures trading in raw jute began only in 1927 with the
establishment of East Indian Jute Association Ltd. These two associations
amalgamated in 1945 to form the East India Jute & Hessian Ltd. to conduct
organized trading in both raw jute and jute goods. Induce course several other
exchanges were also created in the country to trade in such diverse commodities
as pepper, turmeric, potato, sugar and gur (jaggery).After independence, with the
subject of `Stock Exchanges and futures markets' being brought under the Union
list, responsibility for regulation of commodity futures markets devolved on
Govt. of India. A Bill on forward contracts was referred to an expert committee
headed by Prof.A. D. Shroff and select committees of two successive
Parliaments and finally in December1952
Forward Contracts (Regulation) Act, 1952,
was enacted. The Act provided for 3-tier regulatory system:(a) An
association recognized by the Government of India on the
recommendation of Forward Markets Commission,(b) The Forward
Markets Commission (it was set up in September 1953) and( c )
T h e C e n t r a l G o v e r n m e n t . Forward Contracts (Regulation) Rules
were notified by the Central Government in July, 1954. India was in an era of
physical controls since independence and the pursuance of a mixed economy set
up with socialist proclivities had ramifications on the operations of commodity
markets and commodity exchanges. Government intervention was in the form of
buffer stock operations, administered prices, regulation on trade and input prices,
restrictions on movement of goods, etc. Agricultural commodities were
associated with the poor and were governed by policy such as Minimum Price
Support and Government Procurement. Further, as production levels were low
and had not stabilized, there was the constant fear of misuse of these platforms
which could be manipulated to fix prices by creating artificial scarcities. This was
also a period which was associated with wars, natural calamites and disasters
which invariably led to shortage sand price distortions. Hence, in an era of
uncertainty with potential volatility, the government banned futures trading in
commodities in the 1960s.The Khusro Committee which was constituted in
June 1980 had recommended reintroduction of futures trading in most of the
major commodities, including cotton, kapas, raw jute and j u t e g o o d s a n d
suggested that steps may be taken for introducing
f u t u r e s t r a d i n g i n commodities, like potatoes, onions, etc. at appropriate
time. The government, accordingly initiated futures trading in Potato during the
latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh .With the
gradual trade and industry liberalization of the Indian economy
pursuant to the adoption of the economic reform package in 1991, GOI
constituted another committee on Forward Markets under the chairmanship of
Prof. K.N. Kabra. The Committee which submitted its report in September 1994
recommended that futures trading be introduced in the following commodities
:• B a s m a t i R i c e
• Cotton, Kapas, Raw Jute and Jute Goods
• Groundnut, rapeseed/mustard seed, cottonseed, sesame seed,
sunflower seed, safflower seed, copra and soybean and oils and oilcakes
• R i c e b r a n o i l
• Castor oil and its oilcake
• L i n s e e d
• S i l v e r
• O n i o n s
The committee also recommended that some of the existing commodity
exchanges particularly t h e o n e s i n p e p p e r a n d c a s t o r s e e d ,
may be upgraded to the level of international
futures markets.
Difference Between Commodity And Financial Derivatives:

The basic concept of a derivative contract remains the same whether

the underlying happens to be a commodity or a financial asset.
However, there are some features which are very peculiar to commodity
derivative markets. In the case of financial derivatives, most of these
contracts are cash settled. Since financial assets are not bulky, they do
not need special facility for storage even in case of physical settlement.
On the other hand, due to the bulky nature of the underlying assets,
physical settlement in commodity derivatives creates the need
for warehousing. Similarly, the concept of varying quality of asset does
not really exist as far as financial under lying concerned. However, in
the case of commodities, the quality of the asset underlying a contract
can vary largely. This becomes an important issue to be managed. We
have a brief look at these issues.
Physical Settlement  
Physical settlement involves the physical delivery of the underlying
commodity, typically at an accredited warehouse. The seller intending to
make delivery would have to take the commodities to the designated
warehouse and the buyer intending to take delivery would have to go to
the designated warehouse and pick up the commodity. This may sound
simple, but the physical settlement of commodities is a complex
process. The issues faced in physical settlement are enormous. There
are limits on storage facilities in different states. There are restrictions on
interstate movement of commodities. Besides state level octroi and
duties have an impact on the cost of movement of goods across
locations. The process of taking physical delivery incommodities is quite
different from the process of taking physical delivery in financial assets.
Delivery
The procedure for buyer and seller regarding the physical settlement for
different types of contracts is clearly specified by the Exchange.
The period available for the buyer to take physical delivery is
stipulated by the Exchange. Buyer or his authorized representative
in the presence of seller or his representative takes the physical stocks
against the delivery order .Proof of physical delivery having been
effected is forwarded by the seller to the clearing house and the invoice
amount is credited to the seller's account .The clearing house decides
on the delivery order rate at which delivery will be settled. Delivery rate
depends on the spot rate of the underlying adjusted for discount/
premium for quality and freight costs. The discount/ premium for quality
and freight costs are published by the clearinghouse before introduction
of the contract. The most active spot market is normally taken as the
benchmark for deciding spot prices.

Warehousing

One of the main differences between financial and commodity

derivative is the need for warehousing. In case of most exchange-
traded financial derivatives, all the positions are cash settled. Cash
settlement involves paying up the difference in prices between the time
the contract was entered into and the time the contract was closed. For
instance, if a trader buy futures on a stock at Rs.100 and on the day of
expiration, the futures on that stock close atRs.120, he does not really
have to buy the underlying stock. All he does is take the difference of
Rs.20 in cash. Similarly, the person who sold this futures contract at
Rs.100 does not have to deliver the underlying stock. All he has to do is
pay up the loss of Rs.20 in cash .In case of commodity derivatives
however; there is a possibility of physical settlement. It means that if the
seller chooses to hand over the commodity instead of the difference in
cash, the buyer must take physical delivery of the underlying asset.
This requires the Exchange to make an arrangement with
warehouses to handle the settlements. The efficacy of
the commodities settlements depends on the warehousing system
available. Such warehouses have to perform the following functions:•
Earmark separate storage areas as specified by the
Exchange for storing commodities;• Ensure proper
grading of commodities before they are stored;• Store
commodities according to their grade specifications and
validity period; and• Ensure that necessary steps and
precautions are taken to ensure that the quantity and
grade of commodity, as certified in the warehouse receipt, are
maintained during the storage period. This receipt can also be used as
collateral for financing .In India, NCDEX has accredited over 775
delivery centers which meet the requirements for the physical holding of
goods that are to be delivered on the platform. As future trading is
delivery based, it is necessary to create the logistics support for the
same.

What are Futures

A contractual agreement, generally made on the trading floor

of a futures exchange, to buy or sell a particular commodity or
financial instrument at a pre-determined price in the future.
Futures contracts detail the quality and quantity of the
underlying asset; they are standardized to facilitate trading on
a futures exchange. Some futures contracts may call for
physical delivery of the asset, while others are settled in cash.
What are Options

An option is a contract that gives the buyer the right, but not

the obligation, to buy or sell an underlying asset at a specific
price on or before a certain date. An option, just like a stock or
bond, is a security. It is also a binding contract with strictly
defined terms and properties.

Futures Vs Options

Derivatives are created form the underlying asset like stocks, bonds
and commodities. They are known to be the most complicated
instruments in the entire financial market. Some of the investors find
them right instruments for risk management, which increases
liquidity. However, they are extremely important and have huge
effects on financial markets and the economy Derivatives are mainly
of two kinds, which are futures and options. There is a marked
difference between futures and options.

The meaning of futures is summarized as the contract made by two

different parties either to purchase or sell products at a future period
where the prices are pre-determined. The meaning of options is the
right without the obligation to purchase and sell underlining assets.
Call option stands for the right without obligation to only buy the
underlining asset and the purchaser may refuse the contract prior to
its maturity. Put option means the opposite of call option.

The main fundamental difference between options and futures

lies in the obligations they put on their buyers and sellers. An
option gives the buyer the right, but not the obligation to buy
(or sell) a certain asset at a specific price at any time during
the life of the contract. A futures contract gives the buyer
the obligation to purchase a specific asset, and the seller to
sell and deliver that asset at a specific future date, unless the
holder's position is closed prior to expiration.

Aside from commissions, an investor can enter into a futures

contract with no upfront cost whereas buying an options
position does require the payment of a premium. Compared to
the absence of upfont costs of futures, the option premium can
be seen as the fee paid for the privilege of not being obligated
to buy the underlying in the event of an adverse shift in prices.
The premium is the maximum that a purchaser of an option
can lose.

Another key difference between options and futures is the size

of the underlying position. Generally, the underlying position is
much larger for futures contracts, and the obligation to buy or
sell this certain amount at a given price makes futures more
risky for the inexperienced investor.
The final major difference between these two financial
instruments is the way the gains are received by the parties.
The gain on a option can be realized in the following three
ways: exercising the option when it is deep in the money,
going to the market and taking the opposite position,
or waiting until expiry and collecting the difference between the
asset price and the strike price. In contrast, gains on futures
positions are automatically 'marked to market' daily, meaning
the change in the value of the positions is attributed to the
futures accounts of the parties at the end of every trading day -
but a futures contract holder can  realize gains also by going to
the market and taking the opposite position.

The basic difference of futures and options is evident in the

obligation present between buyers and sellers. In the future contract,
both the parties are engaged in a contract with obligation to purchase
or sell the asset at a particular price on the day of settlement. This is
a risky proposition for both the parties. In case of the option contract,
the buyer has the right without any obligation to purchase or sell the
underlying asset. This is the peculiarity of the term “option” and the
price is paid at a premium. With this kind of trading, the purchaser’s
risk becomes limited to the payment of premium but the prospective
profit is unlimited.

Swaps: In finance, a swap is a derivative in which counterparties

exchange certain benefits of one party's financial instrument for
those of the other party's financial instrument. The benefits in
question depend on the type of financial instruments involved. For
example, in the case of a swap involving two bonds, the benefits in
question can be the periodic interest (or coupon) payments associated
with the bonds. Specifically, the two counterparties agree to
exchange one stream of cash flows against another stream. These
streams are called the legs of the swap. The swap agreement defines
the dates when the cash flows are to be paid and the way they are
calculated. Usually at the time when the contract is initiated at least
one of these series of cash flows is determined by a random or
uncertain variable such as an interest rate, foreign exchange rate,
equity price or commodity price.

The first swaps were negotiated in the early 1980s. ] David Swensen,
a Yale Ph.D. at Salomon Brothers, engineered the first swap
transaction according to "When Genius Failed: The Rise and Fall of
Long-Term Capital Management" by Roger Lowenstein. Today,
swaps are among the most heavily traded financial contracts in the
world: the total amount of interest rates and currency swaps
outstanding is more thаn $426.7 trillion in 2009, according to
International Swaps and Derivatives Association (ISDA).

Participants in derivatives

There are three types of traders in the Derivative market

namely:-

Hedgers: They are in the position where they face risk

associated with the price of an asset. They use derivatives to
reduce or eliminate risk. For example, a farmer may use
futures or options to establish the price for his crop long before
he harvests it. Various factors affect the supply and demand
for that crop, causing prices to rise and fall over the growing
season. The farmer can watch the prices discovered in trading
at the CBOT and, when they reflect the price he wants, will sell
futures contracts to assure him of a fixed price for his crop.
Speculators: Speculators wish to bet on the future movement
in the price of an asset. They use derivatives to get extra
leverage physical commodity take advantage.

Arbitrators: They are in the business to take advantage of a

discrepancy between prices in two different markets. If, for
example, they see the future prices of an asset getting out of line
with the cash price, they will take offsetting positions in the two
markets to lock in a profit.

Speculators: Speculators wish to bet on the future movement in the

price of an asset. They use derivatives to get extra leverage. A
speculator will buy and sell in anticipation of future price
movements, but has no desire to actually own the physical
commodity.

Types of Options

There are two types of options; namely:

 Call options
 Put options

We shall discuss both these types of options. We are advised

to follow the thought, to understand the concept. The names
and the prices in the illustrations below are not in real time and
have only been used to help explain these options.

Call Options: The call options give the taker (or buyer) the
right, but not the obligation, to buy the underlying stocks (or
shares) at a predetermined price, on or before a determined
date.
Illustration 1: Let's say Raj purchases 1lot Satyam Computer
(SATCOM) AUG 150 Call at a Premium of 8.

This contract allows Raj to buy 100 shares of SATCOM at INR

150.00 per share at any time between the current date and the
end of August. For this privilege, Raj pays a fee of INR 800.00;
that is INR 8.00 a share for 100 shares.

The buyer of a "call" has purchased the right to buy and for
that he pays a premium.

Put Options: A Put Option gives the holder the right to sell a
specified number of shares of an underlying security at a fixed
price for a period of time.

Illustration : Let's say Raj purchases 1lot Infosys Technology

Aug 3500 Put - Premium 200.

This contract allows Raj to sell 100 shares of Infosys

Technology at INR 3,500.00 per share at any time between
the current date and the end of August. To have this privilege,
Raj pays a premium of INR 20,000.00 (that is INR 200.00 per
share for 100 shares). The buyer of a put has purchased a
right to sell.

Uses of options contracts

The advantage of using options, and for that matter all
derivatives, is due to the leverage that they provide. Leverage
provides the potential to make a higher return from a smaller
initial outlay than investing directly in the underlying asset.

1.Risk management
Options can be used very much like insurance to protect a
portfolio or to guard against extreme movement in a particular
stock. This is also referred to as hedging.

2.Buy time
If a market participant wants or needs to defer an investment,
they can buy the equivalent market exposure for a short period
of time.

3.Diversification
A portfolio can be diversified by different option strategies. If a
portfolio is overweight or underweight in a specific sector of
the market, a strategy may be considered to shift the risk
exposure of the portfolio.

Leaps: As with traditional short term options, LEAPS are available

in two forms, calls and puts.

Options were originally created with expiry cycles of 3, 6, and 9

months, with no option term lasting more than a year. Options of this
form, for such terms, still constitute the vast majority of options
activity. LEAPS were created relatively recently and typically extend
for terms of 2 years out. Equity LEAPS always expire in January.
For example, if today were November 2005, one could buy a
Microsoft January call option that would expire in 2006, 2007, or
2008. (The further out the expiration date, the more expensive the
option.) The latter two are LEAPS.

When LEAPS were first introduced in 1990, they were derivative

instruments solely for equities; however, more recently, equivalent
instruments for indices have become available. These are also
referred to as LEAPS.

Economic Function of Derivative Market

1. 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 derivatives converge with the
prices often underlying at the expiration of the derivative contract.
Thus derivatives help in discovery of future as well as current prices.

2. 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.
3. Derivatives, due to their inherent nature, are linked to the
underlying cash markets. With the introduction of derivatives, the
underlying market witnesses higher trading volumes because of
participation by more players who would not otherwise participate
for lack of arrangement to transfer risk.

4. Speculative trades shift to a more controlled environment of

derivatives market. In the absence of an organized derivatives
market, speculators trade in the underlying cash markets. Margining,
monitoring and surveillance of the activities of various participants
become extremely difficult in these kind of mixed markets.

5. 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 Impact on countries EconomyAccording to survey

conducted in India regarding the sub brokers’ opinion on the
impact of derivatives market on financial market, the result
obtained is given as under.
Derivative securities have penetrated the Indian stock market and it
emerged that investors are using these securities for different
purposes, namely, risk management, profit enhancement, speculation
and arbitrage. High net worth individuals and proprietary traders
account for a large proportion of broker turnover. Interestingly, some
retail participation was also witnessed despite the fact that these
securities are considered largely beyond the reach of retail investors
(because of complexity and relatively high initial investment). Based
on the survey results, the authors identified some important policy
issues such as the need to bring in more institutional participation to
make the derivative market in India more efficient and to bring it in
line with the best practices. Further, there is a need to popularize
option instruments because they may prove to be a useful medium
for enhancing retail participation in the derivative market.

Indian & International Derivatives

1.Indian

In the decade of 1990’s revolutionary changes took place in the

institutional infrastructure in India’s equity market. It has led to
wholly new ideas in market design that has come to dominate the
market. These new institutional arrangements, coupled with the
widespread knowledge and orientation towards equity investment
and speculation, have combined to provide an environment where the
equity spot market is now India’s most sophisticated financial
market. One aspect of the sophistication of the equity market is seen
in the levels of market liquidity that are now visible. The market
impact cost of doing program trades of Rs.5 million at the NIFTY
index is around 0.2%. This state of liquidity on the equity spot
market does well for the market efficiency, which will be observed if
the index futures market when trading commences. India’s equity
spot market is dominated by a new practice called ‘Futures – Style
settlement’ or account period settlement. In its present scene, trades
on the largest stock exchange (NSE) are netted from Wednesday
morning till Tuesday evening, and only the net open position as of
Tuesday evening is settled. The future style settlement has proved to
be an ideal launching pad for the skills that are required for futures
trading.

Stock trading is widely prevalent in India; hence it seems easy to

think that derivatives based on individual securities could be very
important. The index is the counter piece of portfolio analysis in
modern financial economies. Index fluctuations affect all portfolios.
The index is much harder to manipulate. This is particularly
important given the weaknesses of Law Enforcement in India, which
have made numerous manipulative episodes possible. The market
capitalization of the NSE-50 index is Rs.2.6 trillion. This is six times
larger than the market capitalization of the largest stock and 500
times larger than stocks such as Sterlite, BPL and Videocon. If
market manipulation is used to artificially obtain 10% move in the
price of a stock with a 10% weight in the NIFTY, this yields a 1% in
the NIFTY. Cash settlements, which are universally used with
index derivatives, also helps in terms of reducing the vulnerability to
market manipulation, in so far as the ‘short-squeeze’ is not a
problem. Thus, index derivatives are inherently less vulnerable to
market manipulation.

A good index is a sound trade of between diversification and

liquidity. In India the traditional index- the BSE – sensitive index
was created by a committee of stockbrokers in 1986. It predates a
modern understanding of issues in index construction and
recognition of the pivotal role of the market index in modern finance.
The flows of this index and the importance of the market index in
modern finance motivated the development of the NSE-50 index in
late 1995. Many mutual funds have now adopted the NIFTY as the
benchmark for their performance evaluation efforts. If the stock
derivatives have to come about, the restricted to the most liquid
stocks. Membership in the NSE-50 index appeared to be a fair test of
liquidity. The 50 stocks in the NIFTY are assuredly the most liquid
stocks in India.
The choice of Futures vs. Options is often debated. The difference
between these instruments is smaller than, commonly imagined, for a
futures position is identical to an appropriately chosen long call and
short put position. Hence, futures position can always be created
once options exist. Individuals or firms can choose to employ
positions where their downside and exposure is capped by using
options. Risk management of the futures clearing is more complex
when options are in the picture. When portfolios contain options, the
calculation of initial price requires greater skill and more powerful
computers. The skills required for pricing options are greater than
those required in pricing futures.

Scope of Derivatives in India

In India, all attempts are being made to introduce derivative

instruments in the capital market. The National Stock Exchange has
been planning to introduce index-based futures. A stiff net worth
criteria of Rs.7 to 10 corers cover is proposed for members who wish
to enroll for such trading. But, it has not yet received the necessary
permission from the securities and Exchange Board of India.

In the forex market, there are brighter chances of introducing

derivatives on a large scale. In fact, the necessary groundwork for the
introduction of derivatives in forex market was prepared by a high-
level expert committee appointed by the RBI. It was headed by Mr.
O.P. Sodhani. Committee’s report was already submitted to the
Government in 1995. As it is, a few derivative products such as
interest rate swaps, coupon swaps, currency swaps and fixed rate
agreements are available on a limited scale. It is easier to introduce
derivatives in forex market because most of these products are OTC
products (Over-the-counter) and they are highly flexible. These are
always between two parties and one among them is always a
financial intermediary.

However, there should be proper legislations for the effective

implementation of derivative contracts. The utility of derivatives
through Hedging can be derived, only when, there is transparency
with honest dealings. The players in the derivative market should
have a sound financial base for dealing in derivative transactions.
What is more important for the success of derivatives is the
prescription of proper capital adequacy norms, training of financial
intermediaries and the provision of well-established indices. Brokers
must also be trained in the intricacies of the derivative-transactions.

Now, derivatives have been introduced in the Indian Market in the

form of index options and index futures. Index options and index
futures are basically derivate tools based on stock index. They are
really the risk management tools. Since derivates are permitted
legally, one can use them to insulate his equity portfolio against the
vagaries of the market.

Every investor in the financial area is affected by index fluctuations.

Hence, risk management using index derivatives is of far more
importance than risk management using individual security options.
Moreover, Portfolio risk is dominated by the market risk, regardless
of the composition of the portfolio. Hence, investors would be more
interested in using index-based derivative products rather than
security based derivative products.

There are no derivatives based on interest rates in India today.

However, Indian users of hedging services are allowed to buy
derivatives involving other currencies on foreign markets. India has a
strong dollar- rupee forward market with contracts being traded for
one to six month expiration. Daily trading volume on this forward
market is around $500 million a day. Hence, derivatives available in
India in foreign exchange area are also highly beneficial to the users.

International Derivatives

Futures exchanges, such as Euronext.liffe and the Chicago

Mercantile Exchange, trade in standardized derivative contracts.
These are options contracts and futures contracts on a whole range
of underlying products. The members of the exchange hold
positions in these contracts with the exchange, who acts as central
counterparty. When one party goes long (buys a futures contract),
another goes short (sells). When a new contract is introduced, the
total position in the contract is zero. Therefore, the sum of all the
long positions must be equal to the sum of all the short positions. In
other words, risk is transferred from one party to another. The total
notional amount of all the outstanding positions at the end of June
2004 stood at $53 trillion. (Source: Bank for International
Settlements That figure grew to $81 trillion by the end of March
2008

Netting

Global: OTC Derivatives Markets The notional outstanding value

of OTC derivatives contracts rose by 40% from $298 trillion at end-
2005 to $415 trillion at end-2006. Average daily global turnover rose
by two-thirds, from $1,508bn to $2,544bn between April 2004 and
April 2007. The UK remains the leading derivatives centre
worldwide, with its share of turnover stable at 43% in 2007. The US
is the only other major location with 24% of trading. Interest rate
instruments remain the key driver of trading, accounting for 88% of
UK turnover and 70% of global notional value. Derivatives based on
foreign-exchange contracts account for a further 10% of notional
value, with credit, equity-linked and commodity contracts also
important. Energy, metal and freight derivatives have grown rapidly
in recent years. The euro’s share of interest rate derivatives turnover
worldwide has risen to 39% while the US dollar has fallen to 32%:
Pound sterling and yen also increased their market share over the
past three years. Trading is becoming more concentrated among the
largest banks, while other financial institutions such as hedge funds,

mutual funds, insurance companies and smaller banks have become

much bigger users of derivatives.

End of Chapter No.1

CHAPTER NUMBER
II
 OBJECTIVES AND METHODOLOGY

OBJECTIVES

 To study the nature and structure of the derivatives market in

india.
 To know the functionality of derivatives in IIFL(India Infoline
Limited).
 To Study abou the derivatives.
 To know about the Forwards and Futures.
 To know about the Options.
 To Evaluate the Trading of futures and options.

The main objective of this study on futures and options and their
pricing methodologies is to explain an investor about the derivatives
market and in details about and their pricing. Futures further consist
of stock futures and index futures, intrest rate futures and so on.

Options consist of stock options, index options etc.,

The pricing methodology explains each of the futures and options
through cost of carry model and black Scholars model strictly
speaking, the price discovery process respectively. An investor idea
whether to buy those instruments or sell those instruments.
Derivatives have gained an increasing attention by academics and
practitioners in recent years. However, there is relatively little
evidence on the patterns of use and the property funds’ attitudes with
respect to derivatives. Therefore, this study seeks to address this
shortfall and aims to examine the usage of derivatives by property
funds in Australia. A survey of Australian property fund managers
was undertaken. The results show that different types of property
funds have dissimilar patterns of derivatives use. Besides, the results
also reveal that large property funds are more likely to use
derivatives. The motivation factors and risk factors for using
derivatives are also identified. In addition, significant differences are
found between the perceptions of derivative users and non-users. The
findings have offered some insights into the knowledge base of
property investors towards derivatives.

COLLECTION OF DATA
The required data for analysis and study of derivatives is collected
from the primary sources and secondary sources. The primary data
is collected from the employees of IIFL. The primary data which is
collected from the employees is from their past experiences,
especially the data which is collected from the employees who are in
the R&D . The Secondary data is collected from various books on
Futures and Options, the data collected from internet, from various
journals published by stock exchanges in India and abroad.

SIGNIFICANCE
The topic is selected to analyze the depth of the capital market, in
derivatives segment. On which norms the stock exchanges list out
the companies in F&O segment by studying the fundamentals of the
company. Generally the stock exchanges will select the companies in
the list of F & O are fundamentally very strong companies only. The
main objective is to serve the investor to decide whether to invest in
the company to gain good returns.

Period of Study
The main aim of the study is to examine the changes in the trading
and dematerialization of securities in IIFL. The study of this project
is confined to two months. In first segment the data is collected from
primary and secondary sources then in the second phase the data is
analyzed and interpreted.

LIMITATIONS OF THE STUDY

The following are the identical limitations of the study. The time
period spend on the project is not sufficient to obtain the total
information about the topic. The accuracy and transparency have
found at low degree in the working operations of the exchange.
Scope of the study:It includes

 A brief study on F&O attempted.

 A part of the derivatives has dealed in detailed

manner.

 Index and stock options have been dealt in

focused way.

 The other pricing models are analysed in brief

manner.

 An attempt is made to dealt in all aspects in

detailed manner.

Chapterisation:The present study has been classified in to Six

chapters.

 Chapter 1: Introduction

 Chapter 2:Objectives and Methodology

 Chapter 3: Stock broking (Industry)

 Chapter 4: Company Profile

 Chapter 5: Analysis & Interpretation

 Chapter 6: Findings and suggestions

CHAPTER -

3
 INDUSTRY PROFILE

CAPITAL MARKETS

A capital market is a market for securities (debt or equity), where

business enterprises (companies) and governments can raise long-
term funds. It is defined as a market in which money is provided for
periods longer than a year, as the raising of short-term funds takes
place on other markets (e.g., the money market). The capital market
includes the stock market (equity securities) and the bond market
(debt). Financial regulators, such as the UK's Financial Services
Authority (FSA) or the U.S. Securities and Exchange Commission
(SEC), oversee the capital markets in their designated jurisdictions to
ensure that investors are protected against fraud, among other duties.

Capital markets may be classified as primary markets and secondary

markets. In primary markets, new stock or bond issues are sold to
investors via a mechanism known as underwriting. In the secondary
markets, existing securities are sold and bought among investors or
traders, usually on a securities exchange, over-the-counter, or
elsewhere.

I. PRIMARY MARKET

The primary market is that part of the capital markets that deals
with the issuance of new securities. Companies, governments or
public sector institutions can obtain funding through the sale of a
new stock or bond issue. This is typically done through a syndicate
of securities dealers. The process of selling new issues to investors is
called underwriting. In the case of a new stock issue, this sale is an
initial public offering (IPO). Dealers earn a commission that is built
into the price of the security offering, though it can be found in the
prospectus. Primary markets creates long term instruments through
which corporate entities borrow from capital market.

Features of primary markets are:

 This is the market for new long term equity capital. The
primary market is the market where the securities are sold for
the first time. Therefore it is also called the new issue market
(NIM).
  In a primary issue, the securities are issued by the company
directly to investors.
 The company receives the money and issues new security
certificates to the investors.
 Primary issues are used by companies for the purpose of
setting up new business or for expanding or modernizing the
existing business.
 The primary market performs the crucial function of
facilitating capital formation in the economy.
 The new issue market does not include certain other sources
of new long term external finance, such as loans from financial
institutions. Borrowers in the new issue market may be raising
capital for converting private capital into public capital; this is
known as "going public."
 The financial assets sold can only be redeemed by the original
holder.

Methods of issuing securities in the primary market are:

 Initial public offering;

 Rights issue (for existing companies);
 Preferential issue.
METHODS IN PRIMARY MARKET

Any company before initial public offer, the respective company will
issue The PROSPECTUS. The prospectus is a document which
explains about the company. In finance, a prospectus is a legal
document that institutions and businesses use to describe the
securities they are offering for participants and buyers. A prospectus
commonly provides investors with material information about
mutual funds, stocks, bonds and other investments, such as a
description of the company's business, financial statements,
biographies of officers and directors, detailed information about their
compensation, any litigation that is taking place, a list of material
properties and any other material information. In the context of an
individual securities offering, such as an initial public offering, a
prospectus is distributed by underwriters or brokerages to potential
investors.

A . Initial Public Offer means

1. An initial public offering (IPO), referred to simply as an

"offering" or "flotation", is when a company (called the issuer)
issues common stock or shares to the public for the first time.
They are often issued by smaller, younger companies seeking
capital to expand, but can also be done by large privately owned
companies looking to become publicly traded.

2. In an IPO the issuer obtains the assistance of an underwriting

firm, which helps determine what type of security to issue
 (common or preferred), best offering price and time to bring it
to market.

B. Rights Issue

A rights issue is an option that a company opts for to raise capital

under a seasoned equity offering of shares to raise money. The rights
issue is a special form of shelf offering or shelf registration. With the
issued rights, existing shareholders have the privilege to buy a
specified number of new shares from the firm at a specified price
within a specified time. A rights issue is in contrast to an initial
public offering, where shares are issued to the general public through
market exchanges. Closed-end companies cannot retain earnings,
because they distribute essentially all of their realized income, and
capital gains each year. They raise additional capital by rights
offerings. Companies usually opt for a rights issue either when
having problems raising capital through traditional means or to avoid
interest charges on loans.

A rights issue is directly offered to all shareholders of record or

through broker dealers of record and may be exercised in full or
partially. Subscription rights may either be transferable, allowing the
subscription-rights holder to sell them privately, on the open market
or not at all. A right issuance to shareholders is generally issued as a
tax-free dividend on a ratio basis (e.g. a dividend of one subscription
right for one share of Common stock issued and outstanding).
Because the company receives shareholders' money in exchange for
shares, a rights issue is a source of capital.

Considerations Before issue of Rights

Issue rights the financial manager has to consider:

 Engaging a Dealer-Manager or Broker Dealer to manage the

Offering processes
 Selling Group and broker dealer participation
 Subscription price per new share
 Number of new shares to be sold
 The value of rights vs. trading price of the subscription rights
 The effect of rights on the value of the current share
 The effect of rights to shareholders of record and new
shareholders and rights holders

UNDERWRITING

Underwriting refers to the process that a large financial service

provider (bank, insurer, investment house) uses to assess the
eligibility of a customer to receive their products (equity capital,
insurance, mortgage, or credit). The name derives from the Lloyd's
of London insurance market. Financial bankers, who would accept
some of the risk on a given venture (historically a sea voyage with
associated risks of shipwreck) in exchange for a premium, would
literally write their names under the risk information that was
written on a Lloyd's slip created for this purpose.
Mortgage

A mortgage loan is a loan secured by real property through the use

of a mortgage note which evidences the existence of the loan and the
encumbrance of that realty through the granting of a mortgage which
secures the loan. However, the word mortgage alone, in everyday
usage, is most often used to mean mortgage loan.

A home buyer or builder can obtain financing (a loan) either to

purchase or secure against the property from a financial institution,
such as a bank, either directly or indirectly through intermediaries.
Features of mortgage loans such as the size of the loan, maturity of
the loan, interest rate, method of paying off the loan, and other
characteristics can vary considerably.

In many jurisdictions, though not all, it is normal for home

purchases to be funded by a mortgage loan. Few individuals have
enough savings or liquid funds to enable them to purchase property
outright. In countries where the demand for home ownership is
highest, strong domestic markets have developed.

II. SECONDARY MARKET

The secondary market, also called aftermarket, is the financial

market where previously issued securities and financial instruments
such as stock, bonds, options, and futures are bought and sold.
Another frequent usage of "secondary market" is to refer to loans
which are sold by a mortgage bank to investors .

The term "secondary market" is also used to refer to the market for
any used goods or assets, or an alternative use for an existing product
or asset where the customer base is the second market (for example,
corn has been traditionally used primarily for food production and
feedstock, but a "second" or "third" market has developed for use in
ethanol production).

With primary issuances of securities or financial instruments, or the

primary market, investors purchase these securities directly from
issuers such as corporations issuing shares in an IPO or private
placement, or directly from the federal government in the case of
treasuries. After the initial issuance, investors can purchase from
other investors in the secondary market.

The secondary market for a variety of assets can vary from loans to
stocks, from fragmented to centralized, and from illiquid to very
liquid. The major stock exchanges are the most visible example of
liquid secondary markets - in this case, for stocks of publicly traded
companies. Exchanges such as the New York Stock Exchange,
Nasdaq and the American Stock Exchange provide a centralized,
liquid secondary market for the investors who own stocks that trade
on those exchanges. Most bonds and structured products trade “over
the counter,” or by phoning the bond desk of one’s broker-dealer.
Loans sometimes trade online using a Loan Exchange.

WHAT IS A STOCK EXCHANGE

A stock exchange is an entity that provides services for stock

brokers and traders to trade stocks, bonds, and other securities. Stock
exchanges also provide facilities for issue and redemption of
securities and other financial instruments, and capital events
including the payment of income and dividends. Securities traded on
a stock exchange include shares issued by companies, unit trusts,
derivatives, pooled investment products and bonds.

To be able to trade a security on a certain stock exchange, it must be

listed there. Usually, there is a central location at least for record
keeping, but trade is increasingly less linked to such a physical place,
as modern markets are electronic networks, which gives them
advantages of increased speed and reduced cost of transactions.
Trade on an exchange is by members only.

The initial offering of stocks and bonds to investors is by definition

done in the primary market and subsequent trading is done in the
secondary market. A stock exchange is often the most important
component of a stock market. Supply and demand in stock markets is
driven by various factors that, as in all free markets, affect the price
of stocks.

There is usually no compulsion to issue stock via the stock exchange

itself, nor must stock be subsequently traded on the exchange. Such
trading is said to be off exchange or over-the-counter. This is the
usual way that derivatives and bonds are traded. Increasingly, stock
exchanges are part of a global market for securities.

What is meant by OTC or Off Exchange

Over-the-counter (OTC) or off-exchange trading is to trade

financial instruments such as stocks, bonds, commodities or
derivatives directly between two parties. It is contrasted with
exchange trading, which occurs via facilities constructed for the
purpose of trading (i.e., exchanges), such as futures exchanges or
stock exchanges.

The Stock Exchanges in INDIA

1. Bombay Stock Exchange(BSE)

2. National Stock Exchange(NSE)

The BSE
Bombay Stock Exchange is the oldest stock exchange in Asia
What is now popularly known as the BSE was established as
"The Native Share & Stock Brokers' Association" in 1875.

Over the past 135 years, BSE has facilitated the growth of the
Indian corporate sector by providing it with an efficient capital
raising platform.

Today, BSE is the world's number 1 exchange in the world in

terms of the number of listed companies (over 4900). It is the
world's 5th most active in terms of number of transactions
handled through its electronic trading system. And it is in the
top ten of global exchanges in terms of the market
capitalization of its listed companies (as of December 31,
2009). The companies listed on BSE command a total market
capitalization of USD Trillion 1.28 as of Feb, 2010.

BSE is the first exchange in India and the second in the world
to obtain an ISO 9001:2000 certification. It is also the first
Exchange in the country and second in the world to receive
Information Security Management System Standard BS 7799-
2-2002 certification for its BSE On-Line trading System
(BOLT). Presently, we are ISO 27001:2005 certified, which is
a ISO version of BS 7799 for Information Security.

The BSE Index, SENSEX, is India's first and most popular

Stock Market benchmark index. Exchange traded funds (ETF)
on SENSEX, are listed on BSE and in Hong Kong. Futures
and options on the index are also traded at BSE.

BSE continues to innovate:

 Became the first national exchange to launch its

website in Gujarati and Hindi and now Marathi
 Purchased of Marketplace Technologies in 2009 to
enhance the in-house technology development
capabilities of the BSE and allow faster time-to-market
for new products
 Launched a reporting platform for corporate bonds
christened the ICDM or Indian Corporate Debt Market
 Acquired a 15% stake in United Stock Exchange (USE)
to drive the development and growth of the currency
and interest rate derivatives markets
 Launched 'BSE StAR MF' Mutual fund trading platform,
which enables exchange members to use its existing
infrastructure for transaction in MF schemes.
  BSE now offers AMFI Certification for Mutual Fund
Advisors through BSE Training Institute (BTI)
 Co-location facilities for Algorithmic trading
 BSE also successfully launched the BSE IPO index and
PSU website
 BSE revamped its website with wide range of new
features like 'Live streaming quotes for SENSEX
companies', 'Advanced Stock Reach', 'SENSEX View',
'Market Galaxy', and 'Members'
 Launched 'BSE SENSEX MOBILE STREAMER'

The NSE

The National Stock Exchange of India Limited has

genesis in the report of the High Powered Study Group
on Establishment of New Stock Exchanges. It
recommended promotion of a National Stock Exchange
by financial institutions (FIs) to provide access to
investors from all across the country on an equal
footing. Based on the recommendations, NSE was
promoted by leading Financial Institutions at the
behest of the Government of India and was
incorporated in November 1992 as a tax-paying
company unlike other stock exchanges in the country.
The National Stock Exchange (NSE) operates a nation-
wide, electronic market, offering trading in Capital
Market, Derivatives Market and Currency Derivatives
segments including equities, equities based
derivatives, Currency futures and options, equity
based ETFs, Gold ETF and Retail Government
Securities. Today NSE network stretches to more than
1,500 locations in the country and supports more than
2, 30,000 terminals.

With more than 10 asset classes in offering, NSE has

taken many initiatives to strengthen the securities
industry and provides several new products like Mini
Nifty, Long Dated Options and Mutual Fund Service
System. Responding to market needs, NSE has
introduced services like DMA, FIX capabilities, co-
location facility and mobile trading to cater to the
evolving need of the market and various categories of
market participants.

NSE has made its global presence felt with cross-

listing arrangements, including license agreements
covering benchmark indexes for U.S. and Indian
equities with CME Group and has also signed a
Memorandum of Understanding (MOU) with Singapore
Exchange (SGX) to cooperate in the development of a
market for India-linked products and services to be
listed on SGX. The two exchanges also will look into a
bilateral securities trading link to enable investors in
one country to seamlessly trade on the other country’s
exchange.

NSE is committed to operate a market ecosystem

which is transparent and at the same time offers high
levels of safety, integrity and corporate governance,
providing ever growing trading & investment
opportunities for investors.

Mission of NSE

NSE's mission is setting the agenda for change in the

securities markets in India. The NSE was set-up with
the main objectives of:

 establishing a nation-wide trading facility for

equities, debt instruments and hybrids,
 ensuring equal access to investors all over the
country through an appropriate communication
network,
 providing a fair, efficient and transparent
securities market to investors using electronic
trading systems,
 enabling shorter settlement cycles and book entry
settlements systems, and
 meeting the current international standards of
securities markets.

The standards set by NSE in terms of market practices

and technology have become industry benchmarks
and are being emulated by other market participants.
NSE is more than a mere market facilitator. It's that
force which is guiding the industry towards new
horizons and greater opportunities.
Promoters

NSE has been promoted by leading financial

institutions, banks, insurance companies and other
financial intermediaries:

 Industrial Development Bank of India Limited

 Industrial Finance Corporation of India Limited
 Life Insurance Corporation of India
 State Bank of India
 ICICI Bank Limited
 IL & FS Trust Company Limited
 Stock Holding Corporation of India Limited
 SBI Capital Markets Limited
 Bank of Baroda
 Canara Bank
 General Insurance Corporation of India
 National Insurance Company Limited
 The New India Assurance Company Limited
 The Oriental Insurance Company Limited
 United India Insurance Company Limited
 Punjab National Bank
 Oriental Bank of Commerce
 Indian Bank
 Union Bank of India
 Infrastructure Development Finance Company Ltd.
Regulatory Authorities in Capital Markets

Securities Exchange Board of India(SEBI)

The Securities and Exchange Board of India Act, 1992 is

having retrospective effect and is deemed to have come into
force on January 30, 1992. Relatively a brief act containing 35
sections, the SEBI Act governs all the Stock Exchanges and
the Securities Transactions in India.

A Board by the name of the Securities and Exchange Board of

India (SEBI) was constituted under the SEBI Act to administer
its provisions. It consists of one Chairman and five members.

One each from the department of Finance and Law of the

Central Government, one from the Reserve Bank of India and
two other persons and having its head office in Bombay and
regional offices in Delhi, Calcutta and Madras.

The Central Government reserves the right to terminate the

services of the Chairman or any member of the Board. The
Board decides questions in the meeting by majority vote with
the Chairman having a second or casting vote.

Section 11 of the SEBI Act provides that to protect the interest

of investors in securities and to promote the development of
and to regulate the securities market by such measures, it is
the duty of the Board. It has given power to the Board to
regulate the business in Stock Exchanges, register and
regulate the working of stock brokers, sub-brokers, share
transfer agents, bankers to an issue, trustees of trust deeds,
registrars to an issue, merchant bankers, underwriters,
portfolio managers, investment advisers, etc., also to register
and regulate the working of collective investment schemes
including mutual funds, to prohibit fraudulent and unfair trade
practices and insider trading, to regulate takeovers, to conduct
enquiries and audits of the stock exchanges, etc.

All the stock brokers, sub-brokers, share transfer agents,

bankers to an issue, trustees of trust deed, registrars to an
issue, merchant bankers, underwriters, portfolio managers,
investment advisers and such other intermediary who may be
associated with the Securities Markets are to register with the
Board under the provisions of the Act, under Section 12 of the
Sebi Act. The Board has the power to suspend or cancel such
registration. The Board is bound by the directions vested by
the Central Government from time to time on questions of
policy and the Central Government reserves the right to
supersede the Board. The Board is also obliged to submit a
report to the Central Government each year, giving true and
full account of its activities, policies and programmers. Any
one of the aggrieved by the Board's decision is entitled to
appeal to the Central Government.
CHAPTER - 4

COMPANY PROFILE
The IIFL (India Infoline) group, comprising the holding
company, India Infoline Ltd (NSE: INDIAINFO, BSE: 532636)
and its subsidiaries, is one of the leading players in the Indian
financial services space. IIFL offers advice and execution
platform for the entire range of financial services covering
products ranging from Equities and derivatives, Commodities,
Wealth management, Asset management, Insurance, Fixed
deposits, Loans, Investment Banking, GoI bonds and other
small savings instruments. IIFL recently received an in-
principle approval for Securities Trading and Clearing
memberships from Singapore Exchange (SGX) paving the
way for IIFL to become the first Indian brokerage to get a
membership of the SGX. IIFL also received membership of the
Colombo Stock Exchange becoming the first foreign broker to
enter Sri Lanka. IIFL owns and manages the website,
www.indiainfoline.com, which is one of India’s leading online
destinations for personal finance, stock markets, economy and
business.
IIFL has been awarded the ‘Best Broker, India’ by Finance
Asia and the ‘Most improved brokerage, India’ in the Asia
Money polls. India Infoline was also adjudged as ‘Fastest
Growing Equity Broking House - Large firms’ by Dun &
Bradstreet. A forerunner in the field of equity research, IIFL’s
research is acknowledged by none other than Forbes as ‘Best
of the Web’ and ‘…a must read for investors in Asia’. Our
research is available not just over the Internet but also on
international wire services like Bloomberg, Thomson First Call
and Internet Securities where it is amongst one of the most
read Indian brokers.
A network of over 2,500 business locations spread over more
than 500 cities and towns across India facilitates the smooth
acquisition and servicing of a large customer base. All our
offices are connected with the corporate office in Mumbai with
cutting edge networking technology. The group caters to a
customer base of about a million customers, over a variety of
mediums viz. online, over the phone and at our branches.

Achievements

1995

 Commenced operations as an Equity Research firm

1997

 Launched research products of leading Indian

companies, key sectors and the economy
 Client included leading FIIs, banks and companies

1999

 Launched www.indiainfoline.com

2000

 Launched online trading through www.5paisa.com

 Started distribution of life insurance and mutual fund

2003

 Launched proprietary trading platform Trader Terminal for

retail customers

2004

 Acquired commodities broking license

 Launched Portfolio Management Service

2005

 Maiden IPO and listed on NSE, BSE

2006

 Acquired membership of DGCX

 Commenced the lending business

2007

 Commenced institutional equities business under IIFL

  Formed Singapore subsidiary, IIFL (Asia) Pte Ltd

2008

 Launched IIFL Wealth

 Transitioned to insurance broking model

2009

 Acquired registration for Housing Finance

 SEBI in-principle approval for Mutual Fund
 Obtained Venture Capital license

2010

 Received in-principle approval for membership of the

Singapore Stock Exchange
 Received membership of the Colombo Stock Exchange

Services

 Broking in Equities and derivatives in NSE & BSE

 Depository services
 Commodities trading on MCX & NCDEX
 IPO Services
 Portfolio management services

Competitors

The following listed companies are the competetors of IIFL

 ICICI Web trade
 Share Khan
 India Bulls
 Stock Holding Corporation of India
 UTI Securities
 Karvy Brokerage Limited
 HDFC Securities
 Fortis., etc
CHAPTER- 5

DATA ANALYSIS AND INTERPRETATION

In derivatives market the contracts are begun in the first day of

the month and ends on the last Thursday of the month. Now
we are going to study and analyze the key companies in four
segments( i.e .Oil, Banking, Auto, IT) The companies come
under the category of the above segments respectively
1)Reliance Industries

2)State Bank of India

3)Tata Motors

4)Infosys Technologies

The Following are the graphs of last five years price

movement of the respective shares and the volume of trades
in derivative segment for the last five years is as under

The analysis of SBI is as under

The Lot size of SBI is :125 shares/lot

Weight in sensex : 5.30 points

Before we are going to study the banking sector, the following

factors which will make a big impact on the movement of
share prices of banking and financial sector.

1. Policies of RBI
2. Interest rates of small and medium term loans
3. Agricultural Loans
4. CRR Ratios
5. Timely rules and regulations imposed by FERA
 & FEMA on banking and financial sector.
6. Central govt rules and regulations on banking
and financial sector.
The following is the last five years share price movement of
SBI is as under

4000

3500

3000

2500

2000
Column1

1500

1000

500

0
2006-07 2007-08 2008-09 2009-10 2010-11

From the above graph it is understood that the share price is

increased 1.5 times than the price in 2006-07, now the market
is grown abnormally in 2009-10 financial year, the market is
collapsed in the year 2007-08 in this year internationally the
stock markets are in declining trend, because of the LAYMAN
BROTHERS of AMERICA puts the insolvency petition to the
House of Lords it causes the instability in the international
market, at that movement, the put option contracts and call
option contracts are under taken in case of SBI volumes of
puts and calls are shown graphically as under.

30

25

20

15 share price
Column1

10

0
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

From the above it is clear that the put options are going
steadily

From the financial year 2006-2009 because of market in

stabilityThe market is under gone bullish rally the puts and
calls in the finanancial year 2009-10 almost equally, but the
calls will be very high because of rally, at this moment the
contracted of puts will have to charge high premium
simultaneously the call option holder will get good profits in by
paying less premium.

2.Reliance Industries

Lot Size is : 250 shares/lot

Weightage in sensex : 12.05 points

The table which shows the prices of the reliance industries for
the last five years is as under

Yearly high Yearly low

Financial year
2005-06 680.13 418.5

2006-07 1548.45 668.26

2007-08 1337.00 622.9

2008-09 1149.85 831.08

2009-10 1100 961.3

2010-11 989 968.00

 1800

1600

1400

1200

1000

Column2
800

600

400

200

0
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

From the above it is clear that the movement of share price of

reliance is industries is not bullish or bearish, it is in average
trend. Generally the volume of trades are under taken in
sensex/nifty scripts and almost in A group selective scripts.

The rating is very high in case of reliance industries because

of its strong fundamentals and volume in trading . in
derivatives segment the scripts fundamentals are very strong.
From the above graph it is clear that it is very good script for
derivatives, both for puts and call options. The risk factor in
reliance industries is very low, it is a very good script for both
the parties in options and futures segment.

The following graph which shows the movement of volume of

contracts in reliance industries in puts and calls in options
segment.
 90

80

70

60

50

Call(Lakhs)
Column1
40

30

20

10

0
2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

From the above graph it is clear that we understood that the

puts and calls are almost equal in case of reliance industries
according to the price movement of the script. In case of State
bank of India the call options volume is very high at the time of
rally in the market, in case of market correction the volume of
contracts in puts is very high. However the volume is even in
case if reliance industries even in case of rally and correction
in the market.

TATA MOTORS

The Lot size is :250 shares/lot

Weightage in sensex : 3.01 points

it is one of the ancient Indian company in auto segment, this is

one of the script in SENSEX with a weightage of 3.01 points.
The history of tata motors for the last five years is shown as
under

1.Dividend declared@ 130% on 23rdJjune, 2006

2. Dividend declared@150% on June, 2007

3. Dividend declared@150% also issued the right shares @

6:1 ratio on June 16th,2008

4. Dividend declared@60% on 3rd Aug,2009

5. Dividend declared@150% on 10th Aug,2010

Even though, the company fundamentals and dividend history

is very good, the share prices may vary abnormally during the
financial year 2008-09. Because, the international, socio,
economic & political factors may have a big influence in the
movement of the share price. The following table which shows
the prices of tata motors for the last five years.

Yearly High Yearly Low

Financial Year
2006-07 903.88 716
2007-08 646.96 593
2008-09 579.58 170
2009-10 742 202.09
2010-2011 739.6 1305.88
The following graph which shows the price movement
(technical graph)

1400

1200

1000

800

Column2
600

400

200

0
2006-07 2007-08 2008-09 2009-10 2010-11
According to the above technical graph, the trend is bullish
from the financial year 2009-10. In the financial year 209-10 in
the derivative segment after the issue of rights, the put option
is more profitable than call options, after the fourth quarter call
option is more profitable than put option. The risk is very less
in the call option and getting of profits is very high up to
February

Month.

The volume of contracts for the last five years in derivatives of

tata motors is shown below

Calls(In Millions) Puts (In Millions)

Financial year
2006-07 6.08 8.36
2007-08 7.36 9.38
2008-09 8.38 7.55
2009-10 8.48 9.92
2010-11 11.58 10.53
The following is the graph of the volumetric movement of the
puts and calls of tata motors during the last five financial years
Is given below

14

12

10

calls(In Millions)
Column1
6

0
2006-07 2007-08 2008-2009- 2009-10 2010-11

4.Infosys Technologies
Lot size is : 125 shares/lot
Weightage of the script is 10.03 points

The Infosys technologies is one of the leading company in the

stock market, it plays a vital role in the software industry also
in the Indian stock market. Its weightage in the stock market is
10.03 points. The highest weightage company in the stock
market after the reliance industries. The company is having
very good fundamentals, it declares10 times dividing during
the last five years and gives one 1:1 bonus issue.

The table showing the price movement of Infosys technologies

during the last five years of Yearly High’s and Low’s is given
below.

Yearly High Yearly Low

Financial year
2006-07 2275 1414.95
2007-08 2140 1301.05
2008-09 1830 1145.1
2009-10 2722 1322.85
2010-11 3453 2584.4
The graphical presentation of Infosys technologies share price
is shown as under:
 Share price
4000

3500

3000

2500

Share price
2000

1500

1000

500

0
2006-07 2007-08 2008-09 2009-10 2010-11
Volumetric contracts of the last five years is shown in the
following table:

Calls (In Millions) Puts (In Millions)

Financial year
2006-07 14.56 16.38
2007-08 18.98 22.32
2008-09 20.50 24.58
2009-10 26.73 18.16
2010-11 31.48 17.82
The above figures will be shown technically is shown as under:

35

30

25

20

Calls
Puts
15

10

0
2006-07 2007-08 2008-09 2009-10 2010-11

The above graph which shows the call option contracts are
growing exponentially from the financial year 2008-09
onwards. From the financial year 2008-09, the put option
contracts are under down trend, because the risk factor in the
puts is very high.

Conclusion

We understood from the above study of the key companies

from the key sectors in Indian industry, in derivatives market
we have to minimize the risk in derivatives, the hedging
technique is very useful.

What is meant by Hedging?

An investment made in order to reduce the risk of

adverse price movements in a security, by taking an
offsetting position in a related security, such as an
option or a short sale.
Benefits of derivatives

Today's sophisticated international markets have helped foster

the rapid growth in derivative instruments. In the hands of
knowledgeable investors, derivatives can derive profit from:
 Changes in interest rates and equity markets around the
 world
 Currency exchange rate shifts
 Changes in global supply and demand for commodities
such as agricultural products, precious and industrial
metals, and energy products such as oil and natural gas

Adding some of the wide variety of derivative instruments

available to a traditional portfolio of investments can provide
global diversification in financial instruments and currencies,
help hedge against inflation and deflation, and generate
returns that are not correlated with more traditional
investments. The two most widely recognized benefits
attributed to derivative instruments are price discovery and
risk management. 

1. Price Discovery
Futures market prices depend on a continuous flow of
information from around the world and require a high degree of
transparency. A broad range of factors (climatic conditions,
political situations, debt default, refugee displacement, land
reclamation and environmental health, for example) impact
supply and demand of assets (commodities in particular) – and
thus the current and future prices of the underlying asset on
which the derivative contract is based. This kind of information
and the way people absorb it constantly changes the price of a
commodity. This process is known as price discovery.
o With some futures markets, the underlying assets
can be geographically dispersed, having many spot
(or current) prices in existence. The price of the
contract with the shortest time to expiration often
serves as a proxy for the underlying asset.
o Second, the price of all future contracts serve as
prices that can be accepted by those who trade the
contracts in lieu of facing the risk of uncertain future
prices. 
o Options also aid in price discovery, not in absolute
price terms, but in the way the market participants
view the volatility of the markets. This is because
options are a different form of hedging in that they
protect investors against losses while allowing them
to participate in the asset's gains. 

As we will see later, if investors think that the markets will be

volatile, the prices of options contracts will increase. This
concept will be explained later.
2. Risk Management
This could be the most important purpose of the derivatives
market. Risk management is the process of identifying the
desired level of risk, identifying the actual level of risk and
altering the latter to equal the former. This process can fall into
the categories of hedging and speculation. 

Hedging has traditionally been defined as a strategy for

reducing the risk in holding a market position while speculation
referred to taking a position in the way the markets will move.
Today, hedging and speculation strategies, along with
derivatives, are useful tools or techniques that enable
companies to more effectively manage risk. 

3. They Improve Market Efficiency for the Underlying

Asset
For example, investors who want exposure to the S&P 500
can buy an S&P 500 stock index fund or replicate the fund by
buying S&P 500 futures and investing in risk-free bonds. Either
of these methods will give them exposure to the index without
the expense of purchasing all the underlying assets in the S&P
500.
If the cost of implementing these two strategies is the same,
investors will be neutral as to which they choose. If there is a
discrepancy between the prices, investors will sell the richer
asset and buy the cheaper one until prices reach equilibrium.
In this context, derivatives create market efficiency. 

4. Derivatives Also Help Reduce Market Transaction Costs

Because derivatives are a form of insurance or risk
management, the cost of trading in them has to be low or
investors will not find it economically sound to purchase such
"insurance" for their positions.
CHAPTER-6
FINDINGS AND SUGGESTIONS