CHAPTER – 6

      SUMMARY, CONCLUSION AND SUGGESTIONS

6.1   INTRODUCTION

      There     have   been   substantial     ...
6.2   REVIEW OF LITERATURE

      The introduction of stock index futures has profoundly
changed the nature of trading on ...
period of study, i.e., from June 2000 to June 2005. The growth can
best be said to be modest not only in terms of the numb...
6.5   RESEARCH DESIGN

      The data for this study has been collected from the respective
websites of NSE and BSE. At th...
6.6.1 Comparison of Regulatory Framework of Stock Index
      Futures

      Regulatory framework of stock index futures i...
Stock index futures in United States of America are jointly
controlled by the New York Stock Exchange, American Stock
Exch...
Futures, CME E-Mini S&P 500 futures, CME E-Mini S&P Asia 50
Futures, CME NASDAQ 100 Futures, and CME E-Mini NASDAQ
100 Fut...
(d)   Maturity Date/Last Trading Day

      In Australia, the third Friday of the maturity month, provided
this day is a t...
In Australia, trading cycle is based on four months basis
such as March/June/September/December cycle. So, trading in
Aust...
Stock index futures contracts are cash settled in South Africa
and USA.

(g)   Final Settlement Price

      In India, dai...
seconds (100 iterations). The first calculation being at 12:01 and
the last at 13:40 on the expiry date.

(h)   Margin Req...
the lead month futures contracts in December, March, June and
September.

(i)     Pricing/Valuation of Stock Index Futures...
In India, trading hours are different for the NSE and BSE. At
BSE trading takes place between 9.30 a.m. to 3.30 p.m. and a...
Second, a comparison is made of futures market volatility with
spot market volatility. Both these issues have been studied...
2000 (before the start of trading of stock index futures) and the
second from June 2000 to June 2005 (after the start of t...
Following hypothesis was stated in statistical terms:

           HO = σ (Index Futures) = σ (Spot index)

           HA =...
comparison to the underlying stock market indices for both the
markets.

6.6.3 Impact of Stock Index Futures on Market Liq...
decline in prices. This is quite natural that everyone tries to test
his luck in the market when prices are approachable. ...
(b)   Decline in Prices and CET > 1

      During the period of study eleven months were reflecting this
situation. As per...
more. This provided more depth to the market in the context of
liquidity.

(b)   Decline in Prices and CET > 1

      From...
From June 2000 to June, 2005 eleven months reflected this
situation. During these months market participants were buying
m...
This range is explaining a new phenomenon, i.e., decline in
prices is supported by more than proportionate change in volum...
From June 2000 to June 2002 seven months reflected this
condition. Although human behaviour discourages new buyings
when p...
During the period of study eight months were reflecting this
situation. It means during these months although prices were
...
the case of stock index futures market. This behaviour provided
more liquidity to the market.

(b)   Decline in Prices and...
other developed markets; there are certain aspects where policy-
makers, regulators and other participants of the market c...
Figure 6.1

                      Suggestions for making
                     Indian Securities Markets
                  ...
Pre-Settlement Risk

  2. Trade Confirmation: Confirmation of trade between direct
     market participants can occur as s...
7. Delivery    Versus Payment (DVP): CSDs can eliminate
     principal risk by linking securities transfers to funds
     ...
Improvement in Efficiency

      The following suggestions may be implemented to further
improve efficiency, liquidity and...
international communication procedures and standards in
        order to   facilitate   efficient settlement of   cross bo...
(ii)    This study evaluated the effect of stock index futures on
        stock market volatility, which can be further ex...
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  1. 1. CHAPTER – 6 SUMMARY, CONCLUSION AND SUGGESTIONS 6.1 INTRODUCTION There have been substantial regulatory, structural, institutional and operational changes in the securities market during the last decade. These have been carried out with an objective to improve the market efficiency, enhancing transparency and checking unfair trade practices. As a result of the reforms several changes have also taken place in the operation of securities markets such as automated on-line trading. It enabled trading terminals of the National Stock Exchange and Bombay Stock Exchange to be available across the country and making geographical location of an exchange irrelevant; reduction in settlement period and opening of the stock markets to foreign portfolio investors etc. In addition to these developments, India is perhaps one of the real emerging markets in South Asia region that has introduced derivatives products on its two principal existing exchanges, viz. the BSE and NSE. To assist market participants to manage risk better through hedging, speculation and arbitrage, Securities Contracts (Regulations) Act [SCRA] was amended in 1995. Derivatives trading commenced in June 2000 in the Indian securities market on the NSE and BSE. The market, presently, offers index futures and index options on three indices. Stock options and stock futures on individual stocks and futures in interest rate products like national 91 day T- Bills and 10 - year bonds are also available. 73
  2. 2. 6.2 REVIEW OF LITERATURE The introduction of stock index futures has profoundly changed the nature of trading on stock exchanges. The concern over how trading in futures contracts affects the spot market for underlying assets has been an interesting subject for the investors, market makers, academicians, exchanges and regulators alike. Edwards (1988), Harris (1989), Herbst & Maberly (1992), Jagadeesh & Subrahmanyam (1993), and Antoniou & Holmes (1995) have brought out that the introduction of stock index futures has caused an increase in spot market volatility in the short run, while there is no significant change in volatility in the long run. The apparent increase in volatility has been attributed to increased information flow in the market through the channel of futures trading. However, the studies undertaken by Schwert (1999), Bessembinder and Seguin (1992), Kamara et al., (1992), and Darrat and Rahman (1995) categorically deny any increase in spot market volatility resulting from the introduction of futures trading. Though there is still disagreement as to whether futures trading increases or decreases the volatility of spot prices. 6.3 NEED AND SCOPE OF THE STUDY Despite the existence of a well-developed stock market for over a hundred years, trading on derivative contracts in India (Index Futures) started only in June 2000. It is but natural that the market players took time to understand the intricacies involved in the operation of these new instruments. This is clearly reflected in the growth of business in the index futures contracts during the 74
  3. 3. period of study, i.e., from June 2000 to June 2005. The growth can best be said to be modest not only in terms of the number of contracts involved but also in terms of value of such contracts (Gupta, 2003). Since the introduction of index futures in India is a recent phenomenon, there has hardly been any attempt to examine the impact of their introduction on stock market volatility and liquidity. This study encompassed data on daily prices of two major stock indices, viz. the S&P CNX Nifty and BSE Sensex. In the case of NSE, the study has been conducted for a period of five years from June 2000 to June 2005. On the other hand, in the case of BSE it is for two years from June 2000 to June 2002. 6.4 OBJECTIVES OF THE STUDY The objectives of the study are: (i) To make a comparative analysis of regulatory structure for stock index futures market in India with developed markets. (ii) To study the effect of stock index futures on stock market volatility. (iii) To analyse the stock market liquidity conditions after introduction of stock index futures. (iv) To make suggestions with regard to the working of stock markets in India. 75
  4. 4. 6.5 RESEARCH DESIGN The data for this study has been collected from the respective websites of NSE and BSE. At the first stage, regulatory framework of stock index futures in India has been compared with that of Australia, Singapore, South Africa and USA on the basis of ten selected parameters. At the second stage the volatility condition in the market has been measured through the use of following measures: (a) Close-to-close prices (b) Open-to-open prices (c) Intra-day volatility (i) Based upon highest-to-highest prices (ii) Based upon lowest-to-lowest prices. In order to test the null hypotheses of equal variance, F-test has been used to measure the statistical significance of variances. At the final stage condition of liquidity has been measured by using the coefficient of elasticity of trading (CET) ratio. This new measure is similar to price elasticity measure. The CET has been computed on the basis of information on prices and volumes of trading data. 6.6 FINDINGS OF THE STUDY Following is the summary of results and findings on the empirical analysis as contained in the chapters third, fourth and fifth of the present study. 76
  5. 5. 6.6.1 Comparison of Regulatory Framework of Stock Index Futures Regulatory framework of stock index futures in India, Australia, Singapore, South Africa and USA has been compared on the following basis: (a) Regulatory Body for Stock Index Futures In India, the SEBI is the highest authority for derivatives trading also. Being a legislative body there is minimal interference from the government for operations of stock market. The SEBI always takes rational decision as per the requirement of market. In Australia, Australia Stock Exchange (ASX) is the highest governing body for derivatives instruments. Index futures in Australia are similar to popular e-mini futures on the S&P 500 index, the NASDAQ 100 index in the US and the mini FTSE 100 Index Futures in the UK. In Singapore, Asia Pacific’s first demutualized and integrated securities and derivatives exchange was established on 1 Dec. 1999. The Singapore Exchange (SGX) came into force with the merger of Stock Exchange of Singapore (SES) and Singapore International Monetary Exchange (SIMEX). In Singapore now SGX is responsible for working of different derivatives products including stock index futures. In South Africa, FTSE/JSE Advisory Committee is authorised to manage the regulations of stock index futures. 77
  6. 6. Stock index futures in United States of America are jointly controlled by the New York Stock Exchange, American Stock Exchange and Chicago Mercantile Exchange with the help of NASDAQ National Market System. (b) Underlying Instrument In India, for the NSE, Nifty serves the purpose of underlying instrument; and in the case of BSE, it is sensex. So, the value of stock index futures in India purely depends on the movement of Nifty and Sensex. In Australia, contracts are entered over the ASX index, ASX 50 index, and ASX 200 property trusts sector index. Actually, ASX 50 index and ASX 200 index represent around 75 per cent and 90 per cent of total ASX domestic stock market capitalization respectively. In Singapore, Morgan Stanley Capital International (MSCI) Free Index is used as underlying asset for stock index futures. South Africa Stock Exchange offers a large number of stock index futures contracts, such as FTSE/JSE Top 40 Index futures, FTSE/JSE INDI 25 Index Futures, FTSE/JSE FINI 15 Index Futures, and FTSE/JSE FNDI 30 Index Futures. So, underlying instrument for above products are their concerned stock index, i.e., FTSE/JSE Top 40 Index, FTSE/JSE INDI 25 Index, FTSE/JSE FINI 15 Index and FTSE/JSE FNDI 30 Index. As Chicago Mercantile Exchange (CME) is pioneer in starting modern times stock index futures since April 21, 1982, it is now offering different stock index futures such as CME S&P 500 78
  7. 7. Futures, CME E-Mini S&P 500 futures, CME E-Mini S&P Asia 50 Futures, CME NASDAQ 100 Futures, and CME E-Mini NASDAQ 100 Futures contracts. So, underlying Instruments for the above contracts are their respective indices for above specific categories. (c) Contract Size In India the market lot size for Nifty futures is 200 or multiples thereof. On the BSE, contract size is 50 or multiples thereof. In Australia, the system for contract size is slightly different. The dollar value of each ASX Mini Index Futures Contract is based on a $ 10 per index point multiplier. In Singapore, the value of one Singapore MSCI Future is equal to S$200 multiplied by the current index value. In South Africa, the value or worth of a stock index futures contract in Rand is the price of contract multiplied by ten. If the price of the share index futures contract is 5000 then value of one contract is R50000 (5000 ×10) Due to availability of different stock index futures in USA, the contract size is also different for each contract. In case of CME S&P 500 Futures contract size is calculated by multiplying CME S&P 500 Futures price by $250. For small investors CME E-Mini S&P 500 futures, it is CME E-Mini S&P 500 futures price multiplied by $50. 79
  8. 8. (d) Maturity Date/Last Trading Day In Australia, the third Friday of the maturity month, provided this day is a trading day. And last trading day is the business day preceding the maturity date. In India, for the NSE and BSE, the last Thursday of the maturity month. If the last Thursday is a trading holiday then the preceding day of maturity date. In Singapore, last trading day is the second last business day of the contract month. A business day is defined as a day on which the Singapore stock market is open for trading. In South Africa, the last trading day for stock index futures contract is 3rd Thursday of March, June, September and December or previous business day if a public holiday falls on 3rd Thursday. This rule is common for all four major stock index futures contracts prevalent in South Africa. In USA, the last trading day is the Thursday prior to the third Friday of the contract month for CME S&P 500 Futures and CME NASDAQ 100 Futures. The last trading day is slightly different in case of CME E-Mini S&P 500 futures, CME E-Mini S&P Asia 50 Futures, and CME E- Mini NASDAQ-100 Futures. In the case of these contracts, the last trading day is third Friday of the contract month and trading can occur up to 8.30 a.m. (Chicago time). (e) Trading Cycle The lifetime of each series is, generally, three months worldwide. At any point of time there are three series open for trading. It is applicable both in case of NSE and BSE. 80
  9. 9. In Australia, trading cycle is based on four months basis such as March/June/September/December cycle. So, trading in Australia Stock Exchange is based on above four months of the year. In Singapore, contract months are two nearest serial months and four quarterly contract months. South African market follows the Australian Stock Exchange (ASX) for trading cycle. As per rules of FTSE/JSE trading in stock index futures takes places on four months basis that means in March, June, September and December and this trading cycle is common for all stock index futures contracts famous in South Africa. Similarly, in USA contract months are March, June, September and December for all contracts. (f) Settlement Basis In India, for both the NSE and BSE, stock index futures are marked to market and final settlement will be cash settled on a (T+1) basis. All ASX Mini Index Futures remaining open at maturity are cash settled. This method is used to settle major index futures contracts internationally including contracts over the S&P 500, the S&P 100 and Dow Jone Industrial Average in USA and over the Nikkei 225 and Nikkei 300 in Japan. In Singapore, upon expiry Singapore MSCI Futures will be cash settled by one last marking-to-market. 81
  10. 10. Stock index futures contracts are cash settled in South Africa and USA. (g) Final Settlement Price In India, daily settlement price is the closing price of futures contract for the trading day and the final settlement price shall be the closing price of the underlying index on the last trading day. Above rule is applicable both at the NSE and BSE. In Australia, the settlement price used is the ASX Futures Opening Price Index Calculation (OPIC). The OPIC is based on the opening price of each stock in the index on the morning following the last trading day. In Singapore, the final settlement price is based on the average value of the MSCI Singapore Free Index taken at one minute interval in the last one hour of trading, together with the closing MSCI Singapore index value on the last trading day, excluding the highest and lowest values. In USA, all open positions at the close of the final trading day are settled in cash to the special opening quotation on Friday morning of the S & P 500 index for CME S&P 500 Futures and CME E-Mini S&P 500 Futures contracts. In case of CME E-Mini S&P Asia 50 Futures and CME NASDAQ 100 Futures are settled in cash to the special opening quotation on Friday Morning of the S&P Asia 50 Index and NASDAQ 100 Index respectively. In South Africa, the price at which a share index futures contract expires shall be the average of the index taken every 60 82
  11. 11. seconds (100 iterations). The first calculation being at 12:01 and the last at 13:40 on the expiry date. (h) Margin Requirements In Indian capital market, there is a provision of upfront initial margin on daily basis. Initial margin is the amount required to open a margin account for trading. And maintenance margin must be maintained in a margin account. All futures contracts traded on the ASX are registered, cleared and settled by ASX’s wholly owned subsidiary Options Clearing House Pty. Ltd. (OCH). Both buyers and sellers of ASX Index futures contracts must pay an initial margin which is determined by OCH according to the volatility of the underlying index. In Singapore no full payment equivalent to the contract value is required upon initiating a futures position, the buyer and seller must put up a margin deposit with the broker. This initial margin is set by the SGX and is typically about 5-10 per cent of the contract value. FTSE/JSE in South Africa does not specify any margin requirements in the shape of initial margin, maintenance margin and variation margin. In USA, the margin price limits are set on a quarterly basis and are based on percentages of 5 per cent, 10 per cent, 15 per cent, and 20 per cent. New limits go into effect at the beginning of each calendar quarter. The percentages (5 per cent, 10 per cent, 15 per cent and 20 per cent) are based on the average closing price of 83
  12. 12. the lead month futures contracts in December, March, June and September. (i) Pricing/Valuation of Stock Index Futures Contract Theoretically, fair price of a Stock Index Futures Contract is derived from the well celebrated cost of carry model. Accordingly, Stock Index Futures price depends upon (Hull, 2003): - Spot index value - Cost of carry or interest rate - Carry return, i.e., dividend expected on securities comprising the index. Mathematically F = Se (r – y) t Where, F= Futures Price S= Spot value of index e= Exponential constant with value 2.718 r= cost of carry or interest cost y= carry return / dividend income t= Time of maturity in years. Above model is common for all stock index futures traded around the globe. (j) Trading Hours In Australia, normal trading takes place from 6.00 a.m. to 5.00 p.m. and 5.30 p.m. to 8.00 p.m. (Sydeny time). Overseas trading takes place 8.00 p.m. to 5.30 a.m. 84
  13. 13. In India, trading hours are different for the NSE and BSE. At BSE trading takes place between 9.30 a.m. to 3.30 p.m. and at NSE 9.55 a.m. to 3.30 p.m. As compared to Australian Stock Exchange, in India there is no separate provision for overseas participants. ASX operates for stock index futures for 23 hours, but Indian stock markets are working for just six hours. In Singapore, trading of stock index futures takes place between 8.45 a.m. – 12.35 p.m. and 2.00 p.m. – 5.15 p.m. It is important to note that the timings for underlying stock market trading are from 9.00 a.m. – 12.30 p.m. and 2.00 p.m. – 5.00 p.m. (Monday-Friday) with a pre-open session from 8.30 a.m. – 9.00 a.m. and a pre-close session from 5.00 p.m. – 5.06 p.m. Trading hours for all stock index futures contracts are the same at 13:40 on 3rd Thursday of March, June, September and December in South Africa. In USA, for CME E-Mini S&P 500 futures contracts, CME E- Mini S&P Asia 50 Futures contracts, and CME E-Mini NASDAQ 100 Futures contracts there is virtually 24 hours trading (Chicago time) on the CME Globex platform (Sundays from 5.00 p.m. to Friday 3.15 p.m. Daily shutdown for maintenance is 4.30 p.m. – 5.00 p.m.). 6.6.2 Impact of Stock Index Futures on Stock Market Volatility In this study, two research issues relating index futures have been studied. First issue is related to the impact of introduction of stock index futures on the underlying stock market volatility. 85
  14. 14. Second, a comparison is made of futures market volatility with spot market volatility. Both these issues have been studied in relation to the National Stock Exchange and Bombay Stock Exchange. 6.6.2(1) Volatility Conditions in Market before and after Introduction of Stock Index Futures Under this head the volatility conditions in the market have been studied in two periods, i.e., before introduction of stock index futures and after introduction of stock index futures. First period starts from June 1995 to May 2000 (before the start of trading of stock index futures); and the second from June 2000 to June 2005 (after the start of trading of stock index futures). The following measures of volatility have been used to study the impact of stock index futures on volatility of spot market volatility: (a) Open-to-open prices (b) Intra-day volatility (i) Based upon lowest prices (ii) Based upon highest prices. (c) Close-to-close prices. 6.6.2 (2) National Stock Exchange (NSE) At NSE security description for stock index futures is N FUTIDX NIFTY. The underlying instrument is S&P CNX Nifty index. And contract is traded in the size of 200 or multiples thereof. To study impact of stock index futures on nifty, two window periods have been used; first period starts from June 1995 to May 86
  15. 15. 2000 (before the start of trading of stock index futures) and the second from June 2000 to June 2005 (after the start of trading of stock index futures). 6.6.2(3) Bombay Stock Exchange (BSE) At Bombay Stock Exchange security description for stock index futures is BSX. And the underlying instrument is BSE 30 Sensex. At BSE, contract is traded in the size of 50 or multiples thereof. To study the impact of stock index futures on Sensex, two window periods have been used. First period starts from June 1998 to May 2000 (before the start of trading of stock index futures); and the second from June 2000 to June 2002 (after the start of trading of stock index futures). In the case of BSE, in the initial years of introduction of stock index futures, the trading volume was reasonably good. But then thereafter the reverse trend started, and the volume of stock index futures turnover at BSE decreased. Due to this reason the study in case of BSE has been conducted for two years only as after the year 2002 the volume of stock index futures was negligible for statistical calculations. 6.6.2 (4) Relative Volatility: Index Futures and Spot Markets In this section of the study the relative volatility of futures and spot market in respect of both the indices has been studied. It helped to find whether index futures are more or less volatile than the underlying spot index. 87
  16. 16. Following hypothesis was stated in statistical terms: HO = σ (Index Futures) = σ (Spot index) HA = σ (Index Futures) ≠ σ (Spot index) 6.6.2(5) Results – Impact on Volatility Chapter-4 aimed at examining the impact of index futures introduction on stock market volatility. Further, it has also examined the relative volatility of spot market and futures market. The study utilized daily price data (high, low, open, and close) for the BSE Sensex and S&P CNX Nifty Index. Data pertaining to the period from June 9, 2000 to May 31, 2002 has been used for the BSE Index Futures, and from June 12, 2000 to June 30, 2005 for Nifty Index Futures. The empirical results reported here indicated that the overall volatility of the underlying stock market has not declined after the introduction of index futures on both the indices. Therefore, the null hypotheses Ho(1) and Ho(2) stand accepted as no change has been observed in the volatility after introduction of index futures. And the alternative hypotheses HA(1) and HA(2) thus stand rejected as the volatility of index future was not found to be different from spot index is rejected. It must, however, be noted that since the introduction of index futures the Indian stock market has witnessed several changes in its market micro structure such as abolition of the traditional badla system, reduction in trading cycle etc. Therefore, these results should be interpreted in the light of these changes. In fact, there is some evidence that the futures volatility is lower in 88
  17. 17. comparison to the underlying stock market indices for both the markets. 6.6.3 Impact of Stock Index Futures on Market Liquidity In Chapter-5, the impact of Stock Index Futures on Stock Market liquidity has been studied. Although there are many techniques to measure the liquidity condition in market, varying from Bid-Ask Spreads, Market Volumes, Market Capitalization to Impact Cost, yet none of these techniques recognize the role of price for liquidity conditions. The solution of this unanswered problem is Coefficient of Elasticity of Trading (CET). Coefficient of Elasticity of Trading uses both aspects, i.e., trading volume and prices to study liquidity position. 6.6.3(1) Impact on Liquidity due to Change in Closing Price of N FUTIDX NIFTY (a) Increase in Price and CET > 1 CET >1 explains that price increase is supported by more than proportionate change in the volume. In all, sixteen months reflected this trend. During these months despite an increasing trend in prices, the buyers were still buying. It provided more liquidity to the market. (b) Decline in Prices and CET >1 This range has explained a new phenomenon, i.e., decline in prices is supported by more than proportionate change in volumes. During the period of study, ten months were showing this trend. As per this range, people were buying more due to change or 89
  18. 18. decline in prices. This is quite natural that everyone tries to test his luck in the market when prices are approachable. Again, the investors/traders were providing more liquidity to the market. (c) Increase in Prices and CET<1 (BULL RUN) This range is denoted by bull run condition in the market, i.e., when the prices go up the buyers shown little interest in buying. During the whole period of study, eighteen months reflected this condition. In these months price increase was reacted by less than proportionate change in the volumes. This might be due to the booking of profits in bullish conditions. (d) Decline in Prices and CET<1 (BEAR HUG) Bear Hug is a condition which signifies that prices are going down but buyers are not interested in buying. During the period of study, sixteen months were found under bear hug. Generally, due to decline in prices buyers buy more. These trends have their own impact on the market liquidity. 6.6.3 (2) Impact on Liquidity due to Change in the Opening Price of N-FUTIDX NIFTY (a) Increase in Prices and CET > 1 From June 2000 to June 2005 seventeen months reflected this condition. Although human behaviour discourages new buyings when prices are going up. But this was not in the case of stock index futures market. This trend provided more liquidity to market. 90
  19. 19. (b) Decline in Prices and CET > 1 During the period of study eleven months were reflecting this situation. As per this trend people were buying more due to declining prices. This is a natural behaviour of buyers to try their luck in the market when prices are within their reach. And the market participants were providing more liquidity to the market. (c) Increase in Prices and CET < 1 (BULL RUN) During the period of study, sixteen months were found under Bull Run situation. In these months increase in prices was reacted by less than proportionate change in the volume. This situation may be caused due to the reaction of market participants, who have booked profits under bull run. (d) Decline in Prices and CET < 1 (BEAR HUG) During the period of study sixteen months were found under bear hug. During these particular months decline in prices is reacted by less than proportionate change in the turnover. 6.6.3 (3) Impact on Liquidity due to Change in Highest Prices of N FUTIDX NIFTY (a) Increase in Prices and CET > 1 During the period of study, twenty-one months were reflecting this situation. It means during these months although prices were going up but market participants were still buying 91
  20. 20. more. This provided more depth to the market in the context of liquidity. (b) Decline in Prices and CET > 1 From June 2000 to June 2005, this trend was noticed for twelve months. During these months prices were declining and market participants showed positive interest towards market. And it led to more liquidity in the market. (c) Increase in Prices and CET<1 (BULL RUN) Throughout the period of study twelve months were found under bull run condition. In these months price increase was reacted by less than proportionate change in the volumes. (d) Decline in Prices and CET <1 (BEAR HUG) During the period of study fifteen months were found under bear hug. Generally buyers buy more when prices are declining. 6.6.3(4) Impact on Liquidity due to Change in the Lowest Prices of N FUTIDX NIFTY (a) Increase in prices and CET>1 During the period of study, twenty-one months reflected this condition. It means although the prices went up yet market participants were still buying more. No doubt, human behaviour discourages to buy more when prices are going up. But it was not so in the case of stock index futures market. This behaviour provided more liquidity to the market. (b) Decline in Prices and CET >1 92
  21. 21. From June 2000 to June, 2005 eleven months reflected this situation. During these months market participants were buying more due to decline in prices as per the human behaviour. Everyone tries to test his luck in the market when prices are within reach. Again, it provided more liquidity to the market. (c) Increase in Prices and CET<1 (BULL RUN) During the period of study, thirteen months were found under Bull Run. In these months price increase was responded by less than proportionate change in the volumes. This situation might be the result of booking of profits by market participants. (d) Decline in Prices and CET < 1 (BEAR HUG) From July 2000 to June 2005, fifteen months were found in bearish hug. During these particular months decline in prices was responded by less than proportionate change in the turnovers. 6.6.3(5) Impact on Liquidity due to Change in Closing Price of BSX (a) Increase in Prices and CET > 1 CET>1 means that price increase is supported by more than proportionate change in the volume. This trend persisted for nine months only during the whole period of study. During these months, despite an increasing trend in prices the buyers were still buying. It provided more liquidity to the market. (b) Decline in Prices and CET>1 93
  22. 22. This range is explaining a new phenomenon, i.e., decline in prices is supported by more than proportionate change in volumes. During the period of study, seven months reflected this trend. As per this range people were buying more due to change or decline in prices. This is a natural buying behaviour, since one tries to test one’s luck in the market when prices are approachable. Again, the investors/traders provided more liquidity to the market. (c) Increase in Prices and CET<1 (BULL-RUN) This range is denoted by bull run condition in the market, i.e., prices keep to move up but buyers show no interest in buying. During the whole period of study only two months reflected this condition. In these months increase in prices was responded by less than proportionate change in the volumes. This might be due to the booking of profits in bullish conditions. (d) Decline in Prices and CET<1 (BEAR HUG) Bear Hug is a condition which signifies that buyers are not interested in buying even when the prices keep on declining. During the period of study, only six months were found under Bear Hug. Generally, due to decline in prices buyers buy more. These trends have their own impact on the market liquidity. 6.6.3(6) Impact on Liquidity due to Change in Opening Price of BSX (a) Increase in Prices and CET > 1 94
  23. 23. From June 2000 to June 2002 seven months reflected this condition. Although human behaviour discourages new buyings when prices are going up, yet this was not in the case of stock index futures market. This trend provided more liquidity to market. (b) Decline in Prices and CET > 1 During the period of study, four months were found to have this situation. As per this trend people were buying more due to decline in prices. This is a natural behaviour of buyers to try their luck in the market when prices are within their reach. And the market participants provided more liquidity to the market. (c) Increase in Prices and CET < 1 (BULL RUN) During the period of study four months were found under the Bull Run situation. In these months increase in prices was responded by less than proportionate change in the volumes. This situation might be caused due to the reaction of market participants, who booked profits under bull run. (d) Decline in Prices and CET < 1 (BEAR HUG) During the period of study, nine months were found under bear hug. During these particular months, decline in prices was responded by less than proportionate change in the turnover. 6.6.3 (7) Impact on Liquidity due to Change in Highest Prices of BSX (a) Increase in Prices and CET > 1 95
  24. 24. During the period of study eight months were reflecting this situation. It means during these months although prices were going up but market participants were still buying more. This provided more depth to the market in context of liquidity. (b) Prices Decline and CET > 1 From June 2000 to June 2002, three months showed this trend. During these months, the prices were declining and the market participants showed a positive interest towards the market. And it led to more liquidity in the market. (c) Increase in Prices and CET<1 (BULL RUN) During the whole period of study five months were found under the bull run condition. In these months increase in prices was responded by less than proportionate change in the volumes. (d) Decline in Prices and CET <1 (BEAR HUG) During the period of study, eight months were found under bear hug. But generally, as per the buying behaviour the buyers buy more when prices decline. 6.6.3 (8) Impact on Liquidity due to Change in the Lowest Prices of BSX (a) Increase in Prices and CET>1 During the whole period of study nine months reflected this condition. Despite an increase in prices the market participants were still buying. Generally, human behaviour discourages to buy more when prices show an upward trend. But this was not so in 96
  25. 25. the case of stock index futures market. This behaviour provided more liquidity to the market. (b) Decline in Prices and CET >1 From June 2000 to June 2002, four months reflected this situation. During these months the market participants were buying more due to decline in prices and it was as per the natural behaviour. Everyone tries to test his luck in the market when prices are within the reach. This situation provided more liquidity to the market. (c) Increase in Prices and CET<1 (BULL RUN) During the period of study five months were found under the Bull Run situation. In these months increase in prices was responded by less than proportionate change in the volumes. This situation might have arisen due to booking of profits by market participants. (d) Decline in Prices and CET < 1 (BEAR HUG) From July 2000 to June 2002, six months were found in bearish hug. During these particular months the decline in prices was responded by less than proportionate change in the turnovers. 6.7 SUGGESTIONS FOR INDIAN SECURITIES MARKET Although Indian security markets are emerging as an important destination for investors, there is still a need for further improvement in varied areas of their operations. As compared to 97
  26. 26. other developed markets; there are certain aspects where policy- makers, regulators and other participants of the market can play an important role. The suggestions for making Indian securities markets more efficient, are depicted in Figure 6.1. 98
  27. 27. Figure 6.1 Suggestions for making Indian Securities Markets more Efficient Legal Operational Risk Risk Pre-Settlement Custody Risk Risk Settlement Improvement Risk in Efficiency Legal Risk 1. Legal Framework: As per the comparative study made in chapter 3, the settlement system for securities can have a well founded, clear and transparent legal basis in the relevant jurisdictions. 99
  28. 28. Pre-Settlement Risk 2. Trade Confirmation: Confirmation of trade between direct market participants can occur as soon as possible after its execution, but not later than the trade date (T+0). If confirmation of trade by indirect market participants (such as institutional investors) is required, then it should occur as soon as possible after its execution, preferably on (T+0), but not later than (T+1). 3. Settlement Cycles: Rolling settlement can be adopted in all the securities markets. Final settlement should occur not later than (T+3). The benefits and costs of a settlement cycle shorter than (T+3) should be evaluated. 4. Central Counter Parties (CCPs): The benefits and costs of a CCP should be evaluated. Where such a mechanism is introduced, the CCP can rigorously control the risks it assumes. 5. Securities Lending: Securities lending and borrowing (or repurchase agreements and other economically equivalent transactions) may be encouraged as a method for expediting the settlement of securities transactions. Settlement Risk 6. Central Securities Depositories (CSDs): Securities may be immobilized or dematerialized and transferred by book entry in CSDs to the greatest extent possible. 100
  29. 29. 7. Delivery Versus Payment (DVP): CSDs can eliminate principal risk by linking securities transfers to funds transfers in a way that achieves delivery versus payment. 8. Timing of Settlement Finality: Final settlement can occur not later than the end of settlement day. Intra-day or real time finality should be provided for where ever necessary so as to reduce risks. 9. Cash Settlement Assets: Assets used to settle the ultimate payment obligations arising from securities transactions may carry little or no credit or liquidity risk. Efforts must be taken to protect CSD members from potential losses and liquidity pressures which may arise due to faulty assets used for that purpose. Operational Risk 10. Operational Reliability: The sources of operational risk in the clearing and settlement process can be identified and minimized through an appropriate system of controls and procedures. The systems should be reliable and secure. Contingency plans and back up facilities may be established to allow timely recovery of operations and completion of the settlement process. Custody Risk 11. Protection of Customers Securities: Entities holding securities in custody may employ accounting practices and safekeeping procedures that fully protect customers’ securities. It is essential that customers’ securities be protected against the claims of a custodian’s creditors. 101
  30. 30. Improvement in Efficiency The following suggestions may be implemented to further improve efficiency, liquidity and to reduce volatility: 12. Futures contracts on more number of indices can be introduced. 13. Mini size (smaller value contracts) may be permitted. 14. Efforts may be made to look at margin imposition system and reduce margins without compromising on the integrity of the market. 15. Presently, institutional participation appears to be negligible in the total turnover, therefore, efforts should be made to enhance their role in derivatives participation. Other Issues 16. Governance: Governance engagements for CSDs and CCPs can be designed so as to fulfil public interest requirements and to promote the objectives of owners and users. 17. Access: CSDs and CCPs may have objective and publicly disclosed criteria for participation that permit fair and open access. 18. Efficiency: While maintaining safe and secure operations, securities settlement systems can be cost effective in meeting the requirements of users. 19. Communication Procedures and Standards: Securities settlement systems can use or accommodate the relevant 102
  31. 31. international communication procedures and standards in order to facilitate efficient settlement of cross border transactions. 20. Transparency: CSDs and CCPs may provide market participants with sufficient information so as to enable the participants to identify and evaluate accurately the risks and costs associated with using the services provided by them. 21. Regulation and Oversight: Securities settlement systems may be subject to transparent and effective regulation and oversight. There should be cooperation between central banks, securities regulators and other concerned authorities. 22. Risks in Cross Border Links: CSDs that establish links to settle cross border trades may design and operate such links to reduce effectively the risks associated with cross border settlements. 6.8 RECOMMENDATIONS FOR FUTURE RESEARCH The research is not a destination, it is a continuous journey. The basic purpose of research is to contribute to the existing pool of knowledge. The present study has been done in the introductory years of derivatives products in Indian stock markets. The following list enumerates some topics that have been identified for further research pertaining to subject-matter related to the present study: (i) A comparative study of regulatory structure for stock futures, stock options, interest rate options and other derivatives products can be undertaken. 103
  32. 32. (ii) This study evaluated the effect of stock index futures on stock market volatility, which can be further extended for stock future, stock options, interest rate options and other derivatives products. (iii) It would be quite interesting to assess the CET across different derivatives products. The true potential of CET for analysis can be judged when such measurement is done at individual scrip level. (iv) This study specifically excluded financial derivatives and commodity derivatives. Therefore, an industry specific study can also be carried out. 104

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