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Comparative analysis-of-equity-and-derivative-market


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Comparative analysis-of-equity-and-derivative-market

  2. 2. CONTENTSChapter No. Title Page No. Declaration from student III Certificate from IV organisation Certificate from Guide V Acknowledgement VI List of Tables VII List of Graphs VII List of charts VII List if abbreviations IX Executive summary X 1 Introduction 1.1 Background of the study 1 1.2 Company Profile  Company History 6  Top management 11  Competitive 11 advantage of Religare 1.3 Need of the Study 13 1.4 Objective of the Study 13 1.5 Methodology of the Study 13 1.6 Limitation of the Study 14 2 Data Processing & Analysis 2.1 Equity 16  Benefits from 16 equity  Risk in equity 18 investment  How to overcome 18 from risk
  3. 3.  Process of 18 diversification  Selection of shares 19  When to buy/sell 19 shares  Types of cash 25 market margin2.2 Derivatives 28  Factors driving the 29 growth of derivative  Types of 29 derivatives  Types of trades I 41 derivative  Types of F& O 43 margin2.3 Comparative 47 analysis3 Findings  Practical situation 52  Comparative 54 analysis of the traded values in the F & O segment with Cash segment4 Conclusions 555 Recommendations 566 Bibliography 57
  4. 4. DECLARATIONI, Ms. Lucy Chatterjeehereby declare that this project report is the record of authentic workcarried out by me during the period from 2008 to 2010 and has not beensubmitted to any other University or Institute for the award of anydegree / diploma etc.Name of the student: Lucy ChatterjeeDate: iii
  5. 5. AcknowledgementIt gives me an immense pleasure to present this project report, for the partial fulfillment of thecourse. This project has been made possible through the direct and indirect co-operation of somany people for whom by profound through appreciation the gratitude remains.First of all. I would like to thanks to Mrs. PriyaVenkatraman, Senior Relationship Managementfor her valuable suggestions and constructive criticisms that have acted as a guiding light for me.I also acknowledge the help given to me by the people of the organization whose valuable inputswere the driving force behind this project. Last not but the least. I take this opportunity toexpress my gratitude to Prof. (Gp. Capt.) D. P. Apte.I am also grateful to my guide Prof. P. Krishnan who guided me to complete this projectsuccessfully on time and other faculty members of MITSOB for the knowledge, which I amimbibed throughout the two years of my PGDM course.My deepest regards to my parents who have been always immense of inspiration & support tome forever. I would like to dedicate this work to my parents without whose co-operation this taskwould have remained unachieved. vi
  6. 6. List of TableTable No. Title Page No. 1 Performance of sensex 3 from 1991 2 Client interface 12 3 Distinction between 33 futures and forward 4 Distinction between 41 future and option 5 Comparative analysis 46 6 Comparative analysis in 54 the F & O segment with cash segment List of GraphGraph No. Title Page no. 1 Sensex performance 4 2 Exchange traded 31 derivatives ―Forward‖ 3 Payoff from forward 32 contract 4 Exchange traded in 35 derivative ―Option‖ 5 Payoff from option 33 vii
  7. 7. List of ChartsChart No. Title Page No. 1 An overview of a REL 7 2 Religare Financial service 8 group overview 3 REL vision and mission 9 4 REL & its subsidiaries 10 viii
  8. 8. List of AbbreviationsAbbreviation Full Form BSE Bombay stock Exchange CDSL Central depository services limited DP Depository Participant EPS Earnings per share EWMA Exponentially weighted moving average FII‘s Foreign institutional investors F&O Futures & Options IPO Initial Public Offering LN Natural log MTM Mark to market NAV Net asset value NSDL National securities depository limited P/E ratio Price per earnings ratio RBI Reserve bank of India SCRA Securities contract regulation act SEBI Securities & Exchange board of India SRO Self-regulatory organization VaR Value at Risk FICCI Federation of Indian Chambers of Commerce and Industry ix
  9. 9. EXECUTIVE SUMMARYThe project is about the study of brand awareness of RELIGARE SECURIRTIES LIMITEDamong investors. It gives the knowledge of market position of the company. I studied as to howthis company proves to an option for the investors, by studying the performance of investing inequity & derivative for few months considering their analysis. I selected area of COMPARITIVEANALYSIS OF EQUITY & DERIVATIVE, which attract different kinds of investors to investin equity derivative and to face high risk and get high returns. The major findings of the projectare to overview of the comparison of equity cash segment and equity derivative segment,overview of the equity and F & O segment from May 2009 to June 2009. The methodology ofthe project here is to analyze the Equity & Derivative performance based on NAV, EPS andother things. In this project I also included my practical situation during the project internship,that how the market goes up and down and why it happens.The methodology of the project here is to analyze the investment opportunities available forthose investors & study the returns & risk involved in various investment opportunities and alsostudy of investment management & risk management. So for that we have to study & analyze theperformance of Equity & Derivative in the market. We know that there is a high risk, high returnin equity but in a long time only. While in derivative there is a high risk, high return in the shortterm, because derivative contract is for short time for 1/2/3 months only. So this project includeddifferent types of returns, margin & risk involved in equity, and types, need, use & margininvolved in the derivatives market and also participants & terms use in derivative market. X
  10. 10. 1. INTRODUCTION1.1Background of the study:The oldest stock exchange in Asia (established in 1875) and the first in the country to be grantedpermanent recognition under the Securities Contract Regulation Act, 1956, Bombay StockExchange Limited (BSE) has had an interesting rise to prominence over the past 133 years. A lothas changed since 1875 when 318 persons became members of what today is called ―BombayStock Exchange Limited‖ paying a princely amount of Re 1.In 2002, the name "The StockExchange, Mumbai" was changed to Bombay Stock Exchange. Subsequently on August 19,2005, the exchange turned into a corporate entity from an Association of Persons (AoP) andrenamed as Bombay Stock Exchange Limited.BSE, which had introduced securities trading in India, replaced its open outcry system of tradingin 1995, with the totally automated trading through the BSE Online trading (BOLT) system. TheBOLT network was expanded nationwide in 1997.Since then, the stock market in the country has passed through both good and bad periods. Thejourney in the 20th century has not been an easy one. Till the decade of eighties, there was nomeasure or scale that could precisely measure the various ups and downs in the Indian stockmarket. Bombay stock Exchange Limited (BSE) in 1986 came out with a stock Index thatsubsequently became the barometer of the Indian Stock Market.SENSEX first compiled in 1986 was calculated on a ―Market Capitalization Weighted‖methodology of 30 component stocks representing a sample of large, well established andfinancially sound companies. The base year of SENSEX is 1978-79. The index is widelyreported in both domestic and international markets through prints as well as electronic media.SENSEX is not only scientifically designed but also based on globally accepted construction andreview methodology. From September 2003, the SENSEX is calculated on a free-float marketcapitalization methodology. The ―free-float Market Capitalization-Weighted” methodology is awidely followed index construction methodology on which majority of global equity benchmarksare based.
  11. 11. The growth of equity markets in India has been phenomenal in the decade gone by Right fromearly nineties the stock market witnessed heightened activity in terms of various bull and bearruns. The SENSEX captured all these happenings in the most judicial manner. One can identifythe booms and bust of the Indian equity market through SENSEX.The Exchange also disseminates the Price-Earnings Ratio, the Price to Book Value Ratio and theDividend Yield Percentage on day-to-day basis of all its major indices.The value of all BSE indices are every 15 seconds during the market hours and displayedthrough the BOLT system. BSE website and news wire agencies.All BSE-Indices are reviewed periodically by the ―Index Committee‖ of the Exchange. TheCommittee frames the broad policy guidelines for the development and maintenance of all BSEindices. Department of BSE Indices of the exchange carries out the day to day maintenance of allindices and conducts research on development of new indices.Institutional investors, money managers and small investors all refer to the Sensex for theirspecific purposes The Sensex is in effect the substitute for the Indian stock markets. Thecountrys first derivative product i.e. Index-Futures was launched on SENSEX.
  12. 12. PERFORMANCE OF SENSEX FROM 1991 Year Open high low close 1991 1,027.38 1,955.29 947.141 1,908.85 1992 1,957.33 4,546.58 1,945.48 2,615.37 1993 2,617.78 3,459.07 980.06 3,346.06 1994 3,436.87 4,643.31 3,405.88 3,926.90 1995 3,910.16 3,943.66 2,891.45 3,110.49 1996 3,114.08 4,131.22 2,713.12 3,085.20 1997 3,096.65 4,605.41 3,096.65 3,658.98 1998 3,658.34 4,322 2,741.22 3,055.41 1999 3,064.95 5,150.99 3,042.25 5,005.82 2000 5,209.54 6,150.69 3,491.55 3,972.12 2001 3,990.65 4,462.11 2,594.87 3,262.33 2002 3,262.01 3,758.27 2,828.48 3,377.28 2003 3,383.85 5,920.76 2,904.44 5,838.96 2004 5,872.48 6,617.15 4,227.50 6,602.69 2005 6,626.49 9,442.98 6,069.33 9,397.93 2006 9,422.49 14,035.30 8,799.01 13,786.91 2007 13,827.77 20,498.11 12,316.10 20,286.99 2008 20,325.27 21,206.77 7,697.39 9,647.31 2009 9,720.55 14,493.84**As of 30/June/2009
  14. 14. 1.2COMPANY’S PROFILE
  15. 15. Company’s HistoryReligare is one of the leading integrated financial services institutions od India. Religare ispromoted by the promotion of Ranbaxy Laboratories Limited. The comapn offers large anddiverse bouuet of services ranging from equties, derivatives, commodities, insurancebroking, to wealth advisory, portfolio managemnt services, personal finacial servicesInvestment banking and institutuonal broking services. The services are broadly clubbedacross three key business verticals- Retail, wealth mangement and the institutional specturm.Religare retail network spreads across the length and the breadth of the country with itpresence through more than 1,217 locations across more than 392 cities and towns. Thecompany has a represenattive office in London. Having spread itself fairly well across thecountry and with the promises of not resting on its laurels, it has also aggresively startedeyeing global geographies.
  16. 16. An Overview of a Religare Enterprise Limited Religare Enterprise Limited Fortis healthcare Limited Super Religare Laborataries Limited Religare Wellness Limited (formerly SRL Ranbaxy) (formerly Fortis Healthworld) Religare Technova Limited Religare Voyages Limited
  17. 17. Religare Financial Services Group Overview:-Religare Enterprise Limited Their Joint VenturesLife Insurance Business Asset management business(Aegon as a Partner) (Aegon as a Partner) Private Wealth Business India‘s First SEBI approved Film(Macquire, Australian Financial Services Major Fund (Vistaar as a Partner) As a partner)
  18. 18. REL Vision and Mission To build Religare as a globally trusted brand inVISION the financial services domain and present it as the ―Investment Gateway of India.‖ Providing financial care driven by the coreMISSION values of diligence and transparency.BRAND Religare is driven by ethical and dynamic processes for wealth creation.ESSENCE
  19. 19. REL & its subsidiariesStructurally, all businesses are operated through various subsidiaries of the holding company,Religare Enterprises Limited.
  20. 20. Top Management TeamMr. Sunil Godhwani- CEO& Managing Director, Religare Enterprises Limited.Mr. ShacindraNath- Group Chief operating Officer, Religare Enterprises Limited.Mr. Anil Saxena- Group Chief Operating Officer, Religare Enterprises Lmited. Competitive advantage of Religare Lowest Brokerage Online Money Transfer. Daily Confirmation Calls. Daily Contract Notes. Different Kinds of Accounts like, R-Ally, R-Ally Lite, R-Ally Pro etc. Providing Funding Facility.
  21. 21. Client Interface: Retail Spectrum Institutional Spectrum Wealth Spectrum Positioning Leverage relationship To be a client centric wealthLeverage reach and offer integrated with growing SME management advisory firmproduct and service portfolio segment spread across for the high net worth India individuals (HNIs) Products and Services  Equity Trading  Commodity Trading  Portfolio  Online Investment portal Management  Personal Financial Services  Institutional Services Broking  Premier Client - Investment Solutions  Investment Group Services - Insurance Banking  Arts Initiative - Loans  Insurance  International  Consumer Finance Advisory Advisory Fund Management  Insurance Solutions Service (AFMS) - Life Insurance - Non-Life Insurance
  22. 22. 1.3NEED OF THE STUDY  Different kinds of investors to invest in equity & derivative and to face high risk and get high returns.  Company proves to an option for the investors.  Studying the performance of investing equity & derivative for few months considering their analysis.1.4OBJECTIVE OF THE STUDY Any investor‘s vision is a long term investment ad short term investment and gets high returns by bearing high risk. For that objective need to be climbed successfully an so objectives of this project are, 1) To find the RIGHT SCRIPT to buy and sell at the RIGHT TIME 2) To get good return. 3) To know how derivatives can be use for hedging. 4) To know the outcome of Equity and Derivative. 5) How to achieve Capital appreciations.1.5METHODOLOGY OF THE PROJECT Defining objective won‘t suffice unless and until a proper methodology is to achieve the objectives.1) Analyzing and observing the investment opportunities.2) Analyzing the performance of Equity and Derivative market with the help of NAV,EPS, P/E ratio etc.
  23. 23. 1.6LIMITATIONS OF THE STUDY This project was restricted for two months; hence exhaustive data is not available upon which conclusions can be relied. 1) Investment in Securities carry risk so investment in Equity & Derivative is also carrying risk on the basis of the market. 2) Factors affecting the Market Price of Investment may be due to Market forces, performance of the companies is not possible, and so all the data is not available.
  25. 25. 2.1 EquityTotal equity capital of a company is divided into equal units of smalldenominations, each calleda share.  It is a stock or any other security representing an ownership interest.  It proves the ownership interest of stock holders in a company.For example:-In a company the totalequity capital of Rs 2, 00, 00,000 is divided into 20, 00,000 units of Rs10each. Each such unit of Rs 10 is called a Share. Thus, the company then issaid to have 20,00,000 equity shares of Rs 10 each.The holders of suchshares are members of the company andhave voting rights.Benefits from EquityThe benefits distributed by the company to its shareholders can be: 1) Monetary Benefits and 2)Non Monetary Benefits. 1. Monetary Benefits: A. Dividend: An equity shareholder has a right on the profits generated by the company. Profits are distributed in part or in full in the form of dividends. Dividend is an earning on the investment made in shares, just like interest in case of bonds or debentures. A company can issue dividend in two forms: a) Interim Dividend and b) Final Dividend. While final dividend is distributed only after closing of financial year; companies at times declare an interim dividend during a financial year. Hence if X Ltd. earns a profit of Rs 40 crore and decides to distribute Rs 2 to each shareholder, a holding of 200 shares of X Ltd. would entitle you to Rs 400 as dividend. This is a return that you shall earn as a result of the investment made by you by subscribing to the shares of X Ltd. B. Capital Appreciation: A shareholder also benefits from capital appreciation. Simply put, this means an increase in the value of the company usually reflected
  26. 26. in its share price. Companies generally do not distribute all their profits as dividend. As the companies grow, profits are re-invested in the business. This means an increase in net worth, which results in appreciation in the value of shares. Hence, if you purchase 200 shares of X Ltd at Rs 20 per share and hold the same for two years, after which the value of each share is Rs 35. This means that your capital has appreciated by Rs 3000.2. Non-Monetary Benefits: Apart from dividends and capital appreciation, investments in shares also fetch some type of non-monetary benefits to a shareholder. Bonuses and rights issues are two such noticeable benefits. A. Bonus: An issue of bonus shares is the distribution free of cost to the shareholders usually made when a company capitalizes on profits made over a period of time. Rather than paying dividends, companies give additional shares in a pre-defined ratio. Prima facie, it does not affect the wealth of shareholders. However, in practice, bonuses carry certain latent advantages such as tax benefits, better future growth potential, and an increase in the floating stock of the company, etc. Hence if X Ltd decides to issue bonus shares in a ration of 1:1, every existing shareholder of X Ltd would receive one additional share free for each share held by him. Of course, taking the bonus into account, the share price would also ideally fall by 50 percent post bonus. However, depending upon market expectations, the share price may rise or fall on the bonus announcement. B. Rights Issue: A rights issue involves selling of ordinary shares to the existing shareholders of the company. A company wishing to increase its subscribed capital by allotment of further shares should first offer them to its existing shareholders. The benefit of a rights issue is that existing shareholders maintain control of the company. Also, this results in an expanded capital base, after which the company is able to perform better. This gets reflected in the appreciation of share value.
  27. 27. Risks In equity investment:Although an equity investment is the most rewarding in terms of returns generated, certain risksare essential to understand before venturing into the world of equity.  Market/ Economy Risk.  Industry Risk.  Management Risk.  Business Risk.  Financial Risk  Exchange Rate Risk.  Inflation Risk.  Interest Rate Risk.How to overcome risks:Most risks associated with investments in shares can be reduced by using the tool ofdiversification. Purchasing shares of different companies and creating a diversified portfolio hasproven to be one of the most reliable tools of risk reduction.The process of Diversification:When you hold shares in a single company, you run the risk of a large magnitude. As yourportfolio expands to include shares of more companies, the company specific risk reduces. Thebenefits of creating a well diversified portfolio can be gauged from the fact that as you add moreshares to your portfolio, the weightage of each company‘s share gets reduced. Hence any adverseevent related to any one company would not expose you to immense risk. The same logic can beextended to a sector or an industry. In fact, diversifying across sectors and industries reaps thereal benefits of diversification. Sector specific risks get minimised when shares of other sectorsare added to the portfolio. This is because a recession or a downtrend is not seen in all sectorstogether at the same time.
  28. 28. However all risks cannot be reduced:Though it is possible to reduce risk, the process of equity investing itself comes with certaininherent risks, which cannot be reduced by strategies such as diversification. These risks arecalled systematic risk as they arise from the system, such as interest rate risk and inflation risk.As these risks cannot be diversified, theoretically, investors are rewarded for taking systematicrisks for equity investment.Selection of Shares:Proper selections of shares are of two types:- 1. Fundamental analysis: It involves in –depth study and analysis of the prospective company whose shares we want to buy, the industry it operates in and the overall market scenario. It can be done by reading and assessing the company‘s annual reports, research reports published by equity research houses, research analysis published by the media and discussions with the company‘s management or the other experienced investors. 2. Technical analysis: It involves studying the prices movement of the stock over an extended period of time in the past to judge the trend of the future price movement. It can be done by software programs, which generate stock prices charts indicating upward. Downward and sideways movements of the stock price over the stipulated time period.When to buy & sell shares:With high volatility prevailing in the market, major price fluctuations in equities are notuncommon. Therefore, apart from ascertaining ‗which‘ stock to buy or sell, it becomes equallyimportant to consider ‗when‘ to buy or sell. Any investor should be aware of the fact where allthe investor is following i.e., Buy Low. Sell High.That means we should buy stocks at a low price and sell them at a high price.
  29. 29. When to buyThree ways by which we can figure that out what it is about this stock that makes it hot.1. Earnings per Share (EPS): How well the company is doingEPS is the total earning or profits made by company (during a given period of time) calculatedon per share basis. It aims to give an exact evaluation of the returns that the company can deliver.Example:Company XYZ Ltd.Capital: Rs 100 crore (Rs 1 billion).Capital is the amount the owner has in the business. As the business grows and makes profits, itadds to its capital. This capital is subdivided into shares (or stocks).The capital is divided into100 million shares of Rs 10 each.Net Profit in 2003-04: Rs 20 crore (Rs 200 million).EPS is the net profit divided by the total number of shares.EPS = net profit/ number of sharesEPS = Rs 20 crore (Rs 200 million)/ 10 crore (100 million) shares = Rs 2 per shareLesson to be learnt 1. If a companys EPS has grown over the years, it means the company is doing well, and the price of the share will go up. If the EPS declines, thats a bad sign, and the stock price falls. 2. Companies are required to publish their quarterly results. Keep an eye out for these results; check for the trend in their EPS.
  30. 30. 3. Price earnings ratio (PE ratio): How other investors view this share An indicator of how highly a share is valued in the market. It arrived at by dividing the closing price of a share on a particular day by EPS. The ratio tends to be high in the case of highly rated shares. The average PEratio for companies in an industry group is often given in investment journal. Two stocks may have the same EPS. But they may have different market prices. Thats because, for some reason, the market places a greater value on that stock. PE ratio is the market price of the stock divided by its EPS.PE = market price/ EPSlet‘s take an example of two companies. Company XYZ LtdMarket price = Rs 100EPS = Rs 2PE ratio = 100/ 2 = 50Company ABC LtdMarket price = Rs 200EPS = Rs 2PE ratio = 200/ 2 = 100In the above cases, both companies have the same EPS.But because their market price isdifferent, the PE ratio is different.Lesson to be learnt In the case of EPS, it is not so much a high or low EPS that matters as the growth in the EPS. The companys PE reflects investors expectations of future growth in the EPS. A high PE company is one where investors have hopes that earnings will rise, which is why they buy the share.
  31. 31. 3. Forward PE: Looking aheadThe stock market is not nostalgic. It is forward looking. For instance, it sometimes happens that asick company, that has made losses for several years, gets a rehabilitation package from its bankand a new CEO. As a consequence, the companys stock shoots up. Because investors think thecompany will do better in the future because of the package and new leadership, and its earningswill go up. And we think it is a good time to buy the shares of the company now.Suddenly, the demand for the shares has gone up. Because stock prices are based on expectationsof future earnings, analysts usually estimate the future earnings per share of a company. This isknown as the forward PE.Forward PE is the current market price divided by the estimated EPS,usually for the next financial year.Forward PE = Current market price/ estimate EPS for the next financial year.To illustrate what we have been talking about, lets take the example of Infosys Technologies.Trailing 12-month EPS = Rs 56.82 (EPS of the last four quarters)Closing price on January 6 = Rs 2043.15PE = Price/EPS = 2043.15/ 56.82 = 35.95Estimated EPS for 2004-05 = Rs 67Estimated EPS for 2005-06 = Rs 90these figures are according to brokers consensus estimates.Forward PE = current market price/ estimated EPS for next financial yearForward PE for 2004-05 = 2043.15/ 67 = 30.49Forward PE for 2005-06 = 2043.15/ 90 = 22.70With an EPS growth of over 30%, a forward PE of 22.7 is not high, indicating that there is scopeto be optimistic about the stocks price.
  32. 32. Lesson to be learnt Sometimes, investors look out for a low PE stock, expecting that its price will rise in the future. But sometimes, low PE stocks may remain low PE stocks for ages, because the market doesnt fancy them. Keep tab on the business news to check out the companys prospects in the futureWhen to sellStock Reaches Fair Value or Target PriceThis is the easiest part of selling. We should sell when a stock reaches its fair value. It is themain reason why we chose to buy it on the first place.The target price can be computed by assessing the company‘s estimated financial performanceover the next 3 to 5 years, computing its EPS and using an acceptable P/E ratio to compute thefuture market price. Based on this future estimated price and our required return on ourinvestment, compute our target price.When the prices reaches Stop lossIt is advisable to always consider the possibility of a loss before making our investment. Weshould decide how much loss we are willing to book in the stock. The lower price i.e., the priceat which we are willing curtail our loss, is called ‗Stop Loss‘.Need the moneyThe generally happens due to improper planning. However, things happen. Even the mostcarefully planned strategy may not work. Catastrophic events may force investors to sell aninvestment if his household is affected by it.
  33. 33. The book is uncleanWhen management left their post abruptly or when the SEBI conduct a criminal investigation ona company, it may be time to sell. Our assumption may be inaccurate as a lot of fair valuecalculation is based on the companys balance sheet, cash flow or other financial statementpublished by management.Takeover newsWhen one of your stock holding is getting bought by other companies, it may be time to sell.Sure, you might like the acquiring company but you still need to figure out the fair value of thecommon stock of the acquiring company. If the acquiring company is overvalued, then it is bestto sell.Other Investment OpportunityLet us consider we bought stock A and it has risen to 10% below its fair value. Meanwhile, wenoticed thatstock B fallen to below 50% of our calculated fair value. This is an easy decision. Wewill sell our stock A and buy stock B. Our goal as an investor is to maximize our investmentreturn. Sacrificing a 10% of return in order to earn a 50% return is a sensible way to do that.Inaccurate Fair Value CalculationAs investors, we sometimes made errors in our fair value calculation. There are factors that wemight not take into accounts when researching a particular company. For example, satyamscandal.New Competitors with Better ProductsWhennew competitors sprung up, the company that you hold might have to spend more money inorder to fend off competition. Recent example includes the emergence of pay-per clickadvertising by Google. Any advertising business such as newspapers or cable network, this newproduct by Google might hurt profit margins and eventually the fair value of the stock.
  34. 34. Not having a valid reason to BuyWhen we dont know why we bought a particular stock, we wont know how much our potentialreturn is or when we should sell it. This is the easiest way of losing money. When wehave novalid reason to buy, we should sell immediately.Types of Cash market margin 1. Value at Risk (VaR) margin. 2. Extreme loss margin 3. Mark to market Margin 1. Value at Risk (VaR) margin : VaR Margin is at the heart of margining system for the cash market segment. VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities.A VaR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage). Keep these three parts in mind as we give some examples of variations of the question that VaR answers:  With 99% confidence, what is the maximum value that an asset or portfolio may lose over the next day?Example:-Suppose shares of a company bought by an investor. Its market value today is Rs.50 lakhs but itsmarket value tomorrow is obviously not known. An investor holding these shares may, based onVaR methodology, say that 1-day VaR is Rs.4 lakhs at 99% confidence level. This implies thatunder normal trading conditions the investor can, with 99% confidence, say that the value of theshares would not go down by more than Rs.4 lakhs within next 1-day.
  35. 35. In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss (in%) that may be faced by an investor for his / her shares (both purchases and sales) on a singleday with a 99% confidence level. The VaR margin is collected on an upfront basis (at the time oftrade).How is VaR margin calculated?VaR is computed using exponentially weighted moving average (EWMA) methodology. Basedon statistical analysis, 94% weight is given to volatility on ‗T-1‘ day and 6% weight is given to‗T‘ day returns.To compute, volatility for January 1, 2008, first we need to compute day‘s return for Jan 1, 2009by using LN (close price on Jan 1, 2009 / close price on Dec 31, 2008).Take volatility computed as on December 31, 2008.Use the following formula to calculate volatility for January 1, 2009:Square root of [0.94*(Dec 31, 2008 volatility)*(Dec 31, 2008 volatility)+ 0.06*(January 1, 2009LN return)*(January 1, 2009 LN return)]Example:Share of ABC LtdVolatility on December 31, 2008 = 0.0314Closing price on December 31, 2008 = Rs. 360 Closing price on January 1, 2009 = Rs. 330January 1, 2009 volatility =Square root of [(0.94*(0.0314)*(0.0314) + 0.06 (0.08701)* (0.08701)] = 0.037 or 3.7%How is the Extreme Loss Margin computed?The extreme loss margin aims at covering the losses that could occur outside the coverage ofVaR margins.
  36. 36. The Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LNreturns of the stock price in the last six months or 5% of the value of the position.This margin rate is fixed at the beginning of every month, by taking the price data on a rollingbasis for the past six months.Example:In the Example given at question 10, the VaR margin rate for shares of ABC Ltd. was 13%.Suppose the 1.5 times standard deviation of daily LN returns is 3.1%. Then 5% (which is higherthan 3.1%) will be taken as the Extreme Loss margin rate.Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme LossMargin). As such, total margin payable (VaR margin + extreme loss margin) on a trade of Rs.10lakhs would be 1, 80,000/-How is Mark-to-Market (MTM) margin computed?MTM is calculated at the end of the day on all open positions by comparing transaction pricewith the closing price of the share for the day.Example:A buyer purchased 1000 shares @ Rs.100/- at 11 am on January 1, 2008. If close price of theshares on that day happens to be Rs.75/-, then the buyer faces a notional loss of Rs.25, 000/ - onhis buy position. In technical terms this loss is called as MTM loss and is payable by January 2,2008 (that is next day of the trade) before the trading begins.In case price of the share falls further by the end of January 2, 2008 to Rs. 70/-, then buy positionwould show a further loss of Rs.5,000/-. This MTM loss is payable.
  37. 37. In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position iszero, but there could still be a notional loss / gain (due to difference between the buy and sellvalues), such notional loss also is considered for calculating the MTM payable.MTM Profit/Loss = [(Total Buy Qty X Close price)]- Total Buy Value] - [Total Sale Value -(Total Sale Qty X Close price)] 2.2 DerivativesDerivative is a product whose value is derived from the value of one or morebasic variables, called bases (underlying asset, index, or reference rate), in acontractual manner.The underlying asset can be equity, forex, commodity orany other asset. For example, wheatfarmers may wish to sell their harvest ata future date to eliminate the risk of a change in pricesby that date. Such atransaction is an example of a derivative. The price of this derivative isdrivenby the spot price of wheat which is the "underlying".In the Indian context the Securities Contracts (Regulation) Act, 1956 (SCRA) defines"derivative" to include-1. A security derived from a debt instrument, share, loan whether secured orunsecured, riskinstrument or contract for differences or any other formof security.2. A contract which derives its value from the prices, or index of prices, ofunderlyingsecurities.Derivatives are securities under the SC(R)A and hence the trading ofderivatives isgoverned by the regulatory framework under the SC(R)A.Factors driving the growth of derivativesOver the last three decades, the derivatives market has seen a phenomenal growth. A largevariety of derivative contracts have been launched atexchanges across the world. Some of thefactors driving the growth offinancial derivatives are:
  38. 38. 1. Increased volatility in asset prices in financial markets,2. Increased integration of national financial markets with the internationalmarkets,3. Marked improvement in communication facilities and sharp decline in theircosts,4. Development of more sophisticated risk management tools, providingeconomic agents awider choice of risk management strategies, and5. Innovations in the derivatives markets, which optimally combine the risks andreturns over alarge number of financial assets leading to higher returns,reduced risk as well as transactionscosts as compared to individualfinancial assets.Types of derivatives: 1. Forward Contract:A forward contract is an agreement to buy or sell an asset on a specified datefor a specified price.One of the parties to the contract assumes a longposition and agrees to buy the underlying asseton a certain specified futuredate for a certain specified price. The other party assumes a shortpositionand agrees to sell the asset on the same date for the same price. Othercontract details likedelivery date, price and quantity are negotiated bilaterallyby the parties to the contract. Theforward contracts are normally tradedoutside the exchanges.The salient features of forward contracts are:• They are bilateral contracts and hence exposed to counter-party risk.• Each contract is custom designed, and hence is unique in terms ofcontract size, expiration dateand the asset type and quality.• The contract price is generally not available in public domain.• On the expiration date, the contract has to be settled by delivery of theasset.• If the party wishes to reverse the contract, it has to compulsorily go tothe same counter-party,which often results in high prices beingcharged.
  39. 39. Limitations of Forward ContractForward markets world-wide are afflicted by several problems:  Lack of centralization of trading,  Illiquidity, and  Counterparty riskIn the first two of these, the basic problem is that of too much flexibility and generality. Theforward market is like a real estate market in that any twoconsenting adults can form contractsagainst each other. This often makes themdesign terms of the deal which are very convenient inthat specific situation, butmakes the contracts non-tradable.Counterparty risk arises from the possibility of default by any one party to thetransaction. Whenone of the two sides to the transaction declares bankruptcy, theother suffers. Even when forwardmarkets trade standardized contracts, and henceavoid the problem of illiquidity, still thecounterparty risk remains a very seriousissue. Exchange Traded Derivative" Forward" 7000 6000 amount in billion of $ 5000 4000 3000 2000 1000 0 interest rate futures stock index futures currency futures Types
  40. 40. 2. Future Contracts:Futures markets were designed to solve the problems that exist in forward markets. A futurescontract is an agreement between two parties to buy or sellan asset at a certain time in the futureat a certain price. But unlike forwardcontracts, the futures contracts are standardized andexchange traded. Tofacilitate liquidity in the futures contracts, the exchange specifies certainstandardfeatures of the contract. It is a standardized contract with standard underlyinginstrument,a standard quantity and quality of the underlying instrument that can bedelivered, (or which canbe used for reference purposes in settlement) and astandard timing of such settlement. A futurescontract may be offset prior tomaturity by entering into an equal and opposite transaction. Morethan 99% offutures transactions are offset this way.The standardized items in a futures contract are:  Quantity of the underlying  Quality of the underlying  The date and the month of delivery  The units of price quotation and minimum price change  Location of settlement
  41. 41. The payoff from a long position in a forward contract is P = S - X,where S is a spot price of the security at time of contract maturity, X is the delivery price.Similarly, the payoff from a short position is P = X - S.For example, lets say the current price of the stock is $80.00 and we entered in forward contractto buy this stock in 3 months time for $81.00 (that means we hope that price will not fall lowerthan $81.00). If after three months price is more than $81.00, lets say $83.00, than we can buythe same stock for $81.00 (as stated by forward contract) and after reselling it on the market ourpayoff will beP = $83.00 - $81.00 = $2.00If at forward maturity the stock price falls to $78.00, than our loss will be P = $81.00 - $78.00 = $3.00
  42. 42. The graphs above illustrate the forward contract payoff patterns for long and short positions.Distinction between futures and forwardsFutures ForwardsTrade on an organized exchange OTC in natureStandardized contract terms Customised contract termshence more liquid hence less liquidFollows daily settlement Settlement happens at end of periodFuture terminologySpot price: The price at which an asset trades in the spot market.Futures price: The price at which the futures contract trades in thefutures market.Contract cycle: The period over which a contract trades. The indexfutures contracts on the NSEhave one- month, two-month and threemonthsexpiry cycles which expire on the last Thursday ofthe month.Thus a January expiration contract expires on the last Thursday ofJanuary and aFebruary expiration contract ceases trading on the lastThursday of February. On the Fridayfollowing the last Thursday, a newcontract having a three- month expiry is introduced fortrading.Expiry date: It is the date specified in the futures contract. This is thelast day on which thecontract will be traded, at the end of which it willcease to exist.
  43. 43. Contract size: The amount of asset that has to be delivered less thanone contract. Also called aslot size.Basis: In the context of financial futures, basis can be defined as thefutures price minus the spotprice. There will be a different basis foreach delivery month for each contract. In a normalmarket, basis willbe positive. This reflects that futures prices normally exceed spotprices.Cost of carry: The relationship between futures prices and spot pricescan be summarized interms of what is known as the cost of carry.This measures the storage cost plus the interest that ispaid to financethe asset less the income earned on the asset.Initial margin: The amount that must be deposited in the marginaccount at the time a futurescontract is first entered into is known asinitial margin.Marking-to-market: In the futures market, at the end of eachtrading day, the margin account isadjusted to reflect the investorsgain or loss depending upon the futures closing price. This iscalledmarking-to-market.Maintenance margin: This is somewhat lower than the initial margin.This is set to ensure thatthe balance in the margin account neverbecomes negative. If the balance in the margin accountfalls below themaintenance margin, the investor receives a margin call and isexpected to top upthe margin account to the initial margin levelbefore trading commences on the next day.
  44. 44. 3. Option ContractsOptions are fundamentally different from forward and futures contracts. An option gives theholder of the option the right to do something. The holder does not have to exercise this right. Incontrast, in a forward or futures contract, the two parties have committed themselves to doingsomething. Whereas it costs nothing (except margin requirements) toenter into a futures contract,the purchase of an option requires an up-frontpayment. Exchange Traded Derivatives "options" 3500 3000 2500 types 2000 1500 1000 500 0 individal stock stock index currency interset rate options options options options In billions of $
  45. 45. Option TerminologyIndex options: These options have the index as the underlying.Some options are European whileothers are American. Like indexfutures contracts, index options contracts are also cash settled.Stock options: Stock options are options on individual stocks. Optionscurrently trade on over500 stocks in the United States. A contract gives theholder the right to buy or sell shares at thespecified price.· Buyer of an option: The buyer of an option is the one who by paying theoption premium buysthe right but not the obligation to exercise hisoption on the seller/writer.· Writer of an option: The writer of a call/put option is the one who receivesthe option premiumand is thereby obliged to sell/buy the asset if thebuyer exercises on him.Option price/premium: Option price is the price which the option buyerpays to the option seller.It is also referred to as the option premium.Expiration date: The date specified in the options contract is known asthe expiration date, theexercise date, the strike date or the maturity.Strike price: The price specified in the options contract is known as thestrike price or theexercise price.American options: American options are options that can be exercised atany time upto theexpiration date. Most exchange-traded options areAmerican.European options: European options are options that can be exercisedonly on the expiration dateitself. European options are easier to analyzethan American options, and properties of anAmerican option arefrequently deduced from those of its European counterpart.
  46. 46. In-the-money option: An in-the-money (ITM) option is an option thatwould lead to a positivecashflow to the holder if it were exercisedimmediately. A call option on the index is said to bein-the-money when thecurrent index stands at a level higher than the strike price (i.e. spot price>strike price). If the index is much higher than the strike price, the call is saidto be deep ITM. Inthe case of a put, the put is ITM if the index is belowthe strike price.At-the-money option: An at-the-money (ATM) option is an option thatwould lead to zerocashflow if it were exercised immediately. An option onthe index is at-the-money when thecurrent index equals the strike price(i.e. spot price = strike price).Out-of-the-money option: An out-of-the-money (OTM) option is anoption that would lead to anegative cashflow if it were exercisedimmediately. A call option on the index is out-of-themoney when thecurrent index stands at a level which is less than the strike price (i.e. spotprice <strike price). If the index is much lower than the strike price, thecall is said to be deep OTM. Inthe case of a put, the put is OTM if theindex is above the strike price.Intrinsic value of an option: The option premium can be broken down intotwo components -intrinsic value and time value. The intrinsic value of acall is the amount the option is ITM, if it isITM. If the call is OTM, itsintrinsic value is zero. Putting it another way, the intrinsic value of acall isMax[0, (St — K)] which means the intrinsic value of a call is the greaterof 0 or (St — K).Similarly, the intrinsic value of a put is Max[0, K — St],i.e.the greater of 0 or (K — St). K is thestrike price and St is the spot price.Time value of an option: The time value of an option is the differencebetween its premium andits intrinsic value. Both calls and puts have timevalue. An option that is OTM or ATM has onlytime value. Usually, themaximum time value exists when the option is ATM. The longer the timetoexpiration, the greater is an options time value, all else equal. At expiration,an option shouldhave no time value.
  47. 47. There are two basic types of options, call options and put options.Call option: A call option gives the holder the right but not the obligation tobuy an asset by acertain date for a certain price. i) Long a call:- person buys the right (a contract) to buy an asset at a certain price. We feel that the price in the future will exceed the strike price. This is a bullish position. ii) Short a call:- person sells the right ( a contract) to someone that allows them to buy to buy an asset at a certain price. The writer feels that asset will devaluate over the time period of the contract. This person is bearish on that asset.Put option: A put option gives the holder the right but not the obligation tosell an asset by acertain date for a certain price. i) Long a put:- Buy the right to sell an asset at a pre-determined price. We feel that the asset will devalue over the time of the contract. Therefore we can sell the asset at a higher price than is the current market value. This is a bearish position. ii) Short a put:- sell the right to someone else. This will allow them to sell the asset at a specific price. We feel the price will go down and we do not. This is a bullish position. Profit / payoff in Option  The payoff to a derivative portfolio is the market value of the portfolio at expiration. (Also gross payoff).  The profit on a derivative portfolio is the payoff less the cost of acquisition or assembling the portfolio. (Net profit).  We will be looking at a number of option strategies and combinations.  The (gross) payoff is the value (positive or negative) of the option or portfolio at maturity.
  48. 48.  The payoff does not include the initial cost (or the initial cash inflow) at the time the portfolio was set up. Net profit= (gross) Payoff- cost of buying options or other securities+ premium received for selling options or other securities.
  49. 49. If S is a final price of the option underlying security, X is a strike price and OP is an option price,than the profit is Long Call: P = S - X - OP Short Call: P = X - S + OP Long Put: P = X - S - OP Short Put: P = S - X + OPFor example, lets say the stock price is $50.00, we bought European call option with strike$53.00 and paid $2.00 for this option. If option price is less than $53.00, we will not exercise theoption to buy the stock, because it doesnt make sense to buy security for higher price than itcosts on the market. In this case we lose all initial investment equal to the option price $2.00. Ifstock price is more than $53.00, we will exercise the option. For example if the stock price is$56.00, after exercising the option and immediately reselling the acquired stock our profit willbe: P = $56.00 - $53.00 - $2.00 = $1.00if the stock price is $54.00, than the profit is: P = $54.00 - $53.00 - $2.00 = - $1.00As we see in latter case we lose money. The reason is that increase of stock price just by $1.00above the strike ($53.00) doesnt cover our initial investment of $2.00, although we still exercisethe option to recover at least $1.00 of initial investment. If the stock price at exercise time is$55.00 than we exercise the option to cover our initial expenses(equal to option price): P = $55.00 - $53.00 - $2.00 = $0.00This latter case corresponds to option graph intersection point with horizontal axis on thedrawing above.
  50. 50. Distinction between futures and optionsFutures OptionsExchange traded, with novation Same as futures.Exchange defines the product Same as futures.Price is zero, strike price moves Strike price is fixed, price moves.Price is zero Price is always positive.Linear payoff Nonlinear payoff.Both long and short at risk Only short at risk. Types of traders in derivative market 1. Hedgers:-Hedgers are those who protect themselves from the risk associated with the price of an asset by using derivatives. A person keeps a close watch upon the prices discovered in trading and when the comfortable price is reflected according to his wants, he sells futures contracts. In this way he gets an assured fixed price of his produce. In general, hedgers use futures for protection against adverse future price movements in the underlying cash commodity. Hedgers are often businesses, or individuals, who at one point or another deal in the underlying cash commodity. Take an example: A Hedger pay more to the farmer or dealer of a produce if its prices go up. For protection against higher prices of the produce, he hedges the risk exposure by buying enough future contracts of the produce to cover the amount of produce he expects to buy. Since cash and futures prices do tend to move in tandem, the futures position will profit if the price of the produce raise enough to offset cash loss on the produce.
  51. 51. 2. Speculators: Speculators are somewhat like a middle man. They are never interested in actual owing the commodity. They will just buy from one end and sell it to the other in anticipation of future price movements. They actually bet on the future movement in the price of an asset. They are the second major group of futures players. These participants include independent floor traders and investors. They handle trades for their personal clients or brokerage firms.Buying a futures contract in anticipation of price increases is known as ‗going long‘. Selling afutures contract in anticipation of a price decrease is known as ‗going short‘. Speculativeparticipation in futures trading has increased with the availability of alternative methods ofparticipation.Speculators have certain advantages over other investments they are as follows:  If the trader‘s judgment is good, he can make more money in the futures market faster because prices tend, on average, to change more quickly than real estate or stock prices.  Futures are highly leveraged investments. The trader puts up a small fraction of the value of the underlying contract as margin, yet he can ride on the full value of the contract as it moves up and down. The money he puts up is not a down payment on the underlying contract, but a performance bond. The actual value of the contract is only exchanged on those rare occasions when delivery takes place.
  52. 52. 3. Arbitrators: According to dictionary definition, a person who has been officially chosen to make a decision between two people or groups who do not agree is known as Arbitrator. In commodity market Arbitrators are the person who takes the advantage of a discrepancy between prices in two different markets. If he finds future prices of a commodity edging out with the cash price, he will take offsetting positions in both the markets to lock in a profit. Moreover the commodity futureinvestor is not charged interest on the difference between margin and the full contract value.Types of Futures and Options MarginsMargins on Futures and Options segment comprise of the following:1) Initial Margin2) Exposure marginIn addition to these margins, in respect of options contracts the following additional margins arecollected1) Premium Margin2) Assignment MarginHow is Initial Margin Computed?Initial margin for F&O segment is calculated on the basis of a portfolio (a collection of futuresand option positions) based approach. The margin calculation is carried out using software called- SPAN® (Standard Portfolio Analysis of Risk). It is a product developed by Chicago MercantileExchange (CME) and is extensively used by leading stock exchanges of the world.SPAN® uses scenario based approach to arrive at margins. It generates a range of scenarios andhighest loss scenario is used to calculate the initial margin. The margin is monitored andcollected at the time of placing the buy / sell order.
  53. 53. The SPAN® margins are revised 6 times in a day - once at the beginning of the day, 4 timesduring market hours and finally at the end of the day.Obviously, higher the volatility, higher the margins.How is exposure margin computed?In addition to initial / SPAN® margin, exposure margin is also collected.Exposure margins in respect of index futures and index option sell positions have been currentlyspecified as 3% of the notional value.For futures on individual securities and sell positions in options on individual securities, theexposure margin is higher of 5% or 1.5 standard deviation of the LN returns of the security (inthe underlying cash market) over the last 6 months period and is applied on the notional value ofposition.How is Premium and Assignment margins computed?In addition to Initial Margin, a Premium Margin is charged to trading members trading in Optioncontracts.The premium margin is paid by the buyers of the Options contracts and is equal to the value ofthe options premium multiplied by the quantity of Options purchased.For example, if 1000 call options on ABC Ltd are purchased at Rs. 20/-, and the investor has noother positions, then the premium margin is Rs. 20,000.The margin is to be paid at the time trade.Assignment Margin is collected on assignment from the sellers of the contracts.
  54. 54. How Marked to Market Margins are computed? 1. Future contracts:- The open positions (gross against clients and net of proprietary/ self trading) in the futures contracts for each member are marked to market to the daily settlement price at the end of each day is the weighted average price of the last half an hour of the futures contract. The profits/losses arising from the different between the trading price and the settlement price are collected/ given to all clearing members. 2. Option contracts:-the marked o market for option contracts is computed and collected as part of the Initial Margin in the form of Net Option Values. The Initial Margin is collected on an online real time basis based on the data feeds given to the system at discrete time intervals.How Client Margins are computed? Client Members and Trading Member are required to collect initial margins from all theirclients. The collection of margins at client level in the derivatives markets is essential asderivatives are leveraged products and non-collection of margins at the client level wouldprovide zero cost leverage. In the derivative markets all money paid by the client towardsmargins is kept in trust with the Clearing House/ Clearing Corporation and in the event of defaultof the Trading or Clearing Member the amounts paid by the client towards margins aresegregated and not utilized towards the dues of the defaulting member.Therefore, Clearing members are required to report on a daily basis details in respect of suchmargin amounts due and collected from their Trading members/ clients clearing and settlingthrough them. Trading members are also required to report on a daily basis details of the amountdue and collected from their clients. The reporting of the collection of the margins by the clientsis done electronically through the system at the end of each trading day. The reporting ofcollection of client level margins plays a crucial role not only in ensuring that members collectmargin from clients but it also provides the clearing corporation with a record of the quantum offunds it has to keep in trust for the clients.
  55. 55. 2.3 Comparative Analysis Basis Equity DerivativeReturn Capital appreciation Capital gain Dividend Income Price FluctuationRisk Company Specified Market risk Sector specified Credit risk Global risk Liquidity risk General Market Risk Settlement riskTypes of margin VaR Initial margin Extreme Loss Exposure margin Mark to market Premium marginDuration Generally Long term Short term (more than 1 yr) (Max. 3 months)Participants Long term Investors Speculations Hedgers Arbitragers Safe Investors HedgersExpiry Date of contract No such things Last Thursday of any monthComparative analysis is easy to understand when we are analysis with the example of the realmarket situation.
  56. 56. Now I would like to quote a real life example during my internship where I understood the actualcomparison of equity and derivative market.Example:-There was an investor Mr. Jaichand. He has Rs. 1, 00,000/- and he wants to invest it in sharemarket. Now he has two options either to invest in equity cash market or equity derivativemarket (F&O).Now suppose if he invest in equity cash market and buy shares of Rs. 1, 00, 000/- and diversifiedrisk so he buys different scrips. So he purchases 10 RIL shares of Rs. 2350/- each. 10 L&Tshares of Rs 800/- each, 15 Religare Enterprises Shares of Rs. 370/- each, 20 ICICI bank sharesof Rs. 800/- each, 10 Tata power shares of Rs. 1250 each and 10 BHEL shares of Rs. 1595/-each. So for investing Rs. 1, 00,000/- in equity cash market he has to pay Rs. 1,00,000/- and getsthe delivery of the shares.Now suppose if he invest in equity derivative market then he will able to purchase the sharesworth Rs. 5,00,000/- though he has capital of Rs. 1,00,00/- only, because of the margin payment.But he has to purchase the share in a lot size. So he is able to purchase the 1 lot (100 shares) ofRIL at Rs. 2350/-, 1 lot (50 shares) of L&T at 2650/-, 2 lots (100 shares each) of ReligareEnterprises at Rs. 370/- and 1 lot (70 shares) of ICICI bank at Rs. 800/-. Here Mr. Jaichand hasto pay Rs. 1,00,000/- as a margin money and he is able to purchase a shares worth Rs. 5,00,000/-But he has to pay the full amount of money at T+3 basis. So he has to pay the remaining amounton the 3rd day of the trading if he wants the delivery. I. Returns Mr. Jaichand gets return on equity by two ways. One is when the share price of the holding shares will increases in futures, called as capital appreciation. Second is by getting a dividend income from the holding shares.
  57. 57. Mr. Jaichand gets return on equity derivative when the future prices of the shares are increase in short term called as capital gain through price fluctuation or through options premium.II. Risk: There are four types of risk involved in equity cash market. 1. Company Specified risk:- If company is not performing well than process of the shares will declining and vice versa. 2. Sector specified risks:- If the sector is not performing well i.e. power sector, metal sector, oil & gas sector, banking sector then prices of the shares will go down and vice versa. 3. Global risk:- If global cues are positive then prices will increases but if global cues are not good than prices of shares will go down. 4. General market risk:- General market risk is also affect the equity cash market like inflation, banks interest rates etc. So Mr. Jaichand has to consider all these risk factors while dealing in the equity cash market. There are four types of risk involved in equity derivative market.1. Market risk:- In derivative market we have to calculate the market risk or mark to market risk involved in the stocks or securities, that is the exposure to potential loss from fluctuations in market prices (as opposed to changes in credit status). It is calculated on the tradable assets i.e., stocks, currencies etc.2. Credit risk: It may possible in derivative contract that the counterparty may be fail to perform the contract or say defaulted then it is a risk for us. It is calculated on non- tradable assets i.e., loans. So generally it is for long term purpose.3. Liquidity Risk:- If Mr. Jaichand will not able to find a price( or a price within a reasonable tolerance in terms of the deviation from prevailing or expected prices) for one or more of its financial contracts in the secondary market. Consider the case of a counterparty who buys a complex option on European interest rates. He is exposed to
  58. 58. liquidity risk because of the possibility that he cannot find anyone to make him a price in the secondary market and because of the possibility that the price he obtains is very much against him and the theoretical price for the product.4. Settlement Risk:- The risk of non-payment of an obligation by a counterparty to a transaction, exacerbated by mismatches in payment timings. So, Mr. Jaichand has to consider all these factors while dealing in the equity derivative market.III. Margins: Now Mr. Jaichand has also seen the margin paid in the equity cash segment. 1. Var Margin: - Now Mr. jaichand bought shares of a company. Its market value today is Rs. 1, 00,000/- Obviously, we do not know what would be the market value of these shares next day. Now Mr. Jaichand holding these shares may, based on VaR methodology, say that 1-day Var is Rs. 1, 00,000/- at the 99% confidence level. This implies that under normal trading conditions the investors can with 99% confidence, say that the value of shares would not go down by more than Rs. 1,00,000/- within next 1-day. 2. Extreme loss margin: - In the above situation, the VaR margin rate for shares of RIL was 13%. Suppose that SD would be 1.5 x 3.1= 4.65. Then 5% (which is higher than 4.65%) will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme Loss margin). As such, total margin payable( VaR margin + extreme loss margin) on a trade of Rs. 23, 500/- woud be 4, 230/- 3. Mark to Market Margin:- Now Mr. Jaichand purchased 10 shares of RIL @ Rs. 2350/-, at 11 am on May 12, 2009. If close price of the shares on that happened to be Rs. 2350, then the buyer faces a notional loss of Rs. 500/- on his buy position. In technical term this loss is called as MTM loss and is payable by May 13, 2009 (that is next day of the trade) before the trading begins.
  59. 59. In case, price of the shares falls further by the end of May 13 2009 to Rs. 2200/-, then buy postion would show a further loss of Rs. 1, 000/-. This MTM loss is payable by next day. Now we will consider the margin payable under the equity derivatives segment. i) Initial Margin: The initial margin required to be paid by the investor would be equal to the highest loss the portfolio would suffer in any of the scenarios considered. The margin is monitored and collected at the time of placing the buy/ sell order. As higher the volatility, higher the initial margin. ii) Exposure Margin:- Exposure margins in respect of index futures and index option sell position are 3% of the notional value. iii) Premium margin:- If 1000 call option on RIL are purchased at Rs. 20/- and Mr. Jaichand has no other positions, then the premium margin Rs. 20,000. iv) Assignment Margin:- Assignment Margin is collected on assignment from the sellers of the contract.IV. Duration: Generally equity market is a long term market and people invested in it for more than one year and then only they get good return on equity. Generally any safe investors can invest in it because here risk is comparatively low then derivative market. While in derivative market investors are investing for less than one yea, generally for 2 months or 3 months. Here they get high returns on it because they are bringing high risk.V. Participants: Generally any long term investors can invest in equity or hedgers are investing in the equity, who wants to reduce their risk. Any person who wants to be safe investors and wanted to earn a good amount of returns after a period of more than one year is also invested in equity.
  60. 60. In derivative market mostly speculators and arbitragers are invested because they wanted quick money in short time period and hedgers are also invested in derivative market to reduce their risk.VI. Expiry date: It‘s a last Thursday of any month in case of a derivative market but no such things in case of an equity market.
  61. 61. 3. FINDINGSStart of 2012 turns out to be favorable for Indian stock markets as nifty rose 1000 points in twomnths. The 2012 budget was flat with hike of 2% in service tax and excise duty etc, the stockmkt reacted negatively with fall of around 200 points in nifty in the previous two sessions afterthe budget. However, the market corrected soon after the announcement of budget due toabsence of major policy announcements. The market picked momentum from mid of the month.This was helped by better-than-expected corporate earnings, huge overseas inflows andencouraging global cues. Global stocks rallied over the month on encouraging economic data andearnings reports. February saw a continuation of the rally in global risk assets that begain inDecember last year. Further unconventional monetary policy from the European cental bank(ECB),the bank of England(BOE) and the bank of japan(BOJ), together with continuing positiveeconomic data from the US, Supported global equity and high yield fixed income markets. TheMSCI World Index ended February up 9.3% year to date, the Msci emerging market index up12.3%, While the jpmorgan global bond index has risen just 0.8% , global large cap stocksperformed broadly in line with small cap, while growth performed a little better than value.Sector PerformanceThe Union Budget sometimes come with good surprises and sometimes disappoints us withnegative ones. On the Budget day, all sectors move up and down as the Budget announcementsrelated to a specific sector are made.Sector Performance since Previous Union BudgetIndex Name Date Close Price Date Close Price % ChangeBSE FMCG Sector Feb 29, 2012 4166.85 Feb 28, 2011 3432.42 21.40BSE Auto Feb 29, 2012 9994.61 Feb 28, 2011 8252.92 21.10BSE Cons Durable Feb 29, 2012 6561.17 Feb 28, 2011 5631.61 16.51BSE Healthcare Feb 29, 2012 6336.41 Feb 28, 2011 5717.96 10.82BSE Tech Feb 29, 2012 3622.04 Feb 28, 2011 3572.85 1.38BSE Bankex Feb 29, 2012 11974.16 Feb 28, 2011 11840.34 1.13BSE IT Sector Feb 29, 2012 6161.06 Feb 28, 2011 6106.81 0.89BSE Realty Index Feb 29, 2012 1955.60 Feb 28, 2011 1981.65 -1.31BSE PSU Feb 29, 2012 7764.04 Feb 28, 2011 8380.61 -7.36BSE Oil Feb 29, 2012 8711.71 Feb 28, 2011 9459.45 -7.90
  62. 62. BSE Power Feb 29, 2012 2280.39 Feb 28, 2011 2523.29 -9.63BSE Cap Goods Feb 29, 2012 10426.37 Feb 28, 2011 12399.76 -15.91BSE Metal Feb 29, 2012 12052.39 Feb 28, 2011 15348.81 -21.48Institutional ActivitiesFII Investment Activity in February 2012FII Activity is a date wise list of Gross Buy ( in Crores) and Sell ( in Crores) investmentsdone by Foreign Institutional Investors, their Net Investment Positions for those datesand Cummulative Investments as on that date in Million $ with a break up ofInvestments made in Equity and Debt instruments. Gross Net CummulativeDate Gross Sale(Cr) Purchase(Cr) Investment(Cr) Investment($Mn)29-Feb-12 3,679.30 3,028.80 650.50 132.9128-Feb-12 2,955.40 2,099.00 856.50 174.2927-Feb-12 3,079.30 3,621.70 -542.50 -110.6024-Feb-12 9,675.90 2,077.80 7,598.10 1,548.5923-Feb-12 4,080.60 3,703.80 376.90 76.5322-Feb-12 4,024.00 3,057.00 966.90 196.3521-Feb-12 4,093.70 2,599.20 1,494.60 304.5017-Feb-12 4,095.00 3,500.40 594.60 120.8215-Feb-12 7,863.80 5,678.50 2,185.30 444.0514-Feb-12 2,971.70 1,825.00 1,146.70 232.4413-Feb-12 2,591.60 1,944.00 647.60 131.3110-Feb-12 2,666.40 2,323.10 343.30 69.1509-Feb-12 3,988.60 2,538.20 1,450.40 294.2708-Feb-12 4,405.40 3,954.90 450.50 91.8007-Feb-12 2,893.40 2,201.10 692.30 141.5306-Feb-12 3,509.80 2,405.50 1,104.30 226.8503-Feb-12 3,192.30 2,218.40 974.00 198.9202-Feb-12 5,124.80 2,989.90 2,134.90 434.5501-Feb-12 5,227.20 3,134.50 2,092.70 422.49
  63. 63. Major Corporate EventsInfosys beat market forecasts with a 33 per cent rise in quarterly profit as a weak rupee boostedmargins, but it cut its full-year revenue outlook because of the debt crisis in Europe, its second-biggest market.Infosys, which is also listed in New York, said consolidated net profit rose to Rs 23.72 billion($457 million) in the third quarter ended Dec. 31 from Rs 17.8 billion a year earlier, helped by an8 per cent fall in the rupee.Steel Authority of India has lined up capital expenditure (capex) of Rs 145 billion for nextfinancial year 2012-13,the company is looking to add 5 million tonnes annual productioncapacity, to raise the total capacity to 19 million tonnes per annum (MTPA) by the endof next fiscal.Punj Lloyd Group has been awarded a contract for mechanical works for a value of$30,795,888 amounting Rs 153 crore approximately from SK Engineering &Construction, Singapore. The company has reported consolidated net profit to Rs 74.6crore for the third quarter ended December 31, on higher sales. The company hadclocked a net loss of Rs 59.9 crore in the October-December quarter of the last fiscal.The income from operations during the quarter went up by 28.71% to Rs 2,694 crorefrom over Rs 2,093 crore in the same period a year ago.Key Macro DevelopmentsThere are a few key macro-economic developments and themes to watch for in 2012, which willimpact investors across the globe. For starters, the euro zone crisis is not over and will continueto impact investor sentiment negatively, till it‘s resolved. If the recession in Europe is fiercerthan what most expect, it would be accompanied by an international credit crunch, dragging bothdeveloped and developing economies into renewed global recession.Over the year, nearly a dozen countries will go into elections, representing nearly 50 per cent ofworld GDP. While the US and France will see presidential elections, China will see a one-in-10-year leadership change. German federal elections are due in February 2013. This would alsobring some semblance of stability in the financial markets. In volatile times, emerging marketassets remain highly volatile. However, as inflation comes down in economies like India andChina, central banks in both countries would get more room to ease rates. This would result in
  64. 64. inflows into both emerging market equities and bonds. India stands to gain even within theregion, as yields on bonds are higher compared to peers.Gold, which emerged as the best asset class in 2011, is likely to lose some sheen as the worldrecovers from the current crisis. In 2011, most central banks were net buyers of gold, with netpurchases adding upto 192 tonnes. There is evidence now that ―some of the troubled Europeansovereigns are selling gold stock piles for austerity and liquidity measures.‖ Going by thesetrends, gold may correct to $1,250 in 2015, due to a broader economic recovery and macro-financial stabilisation, says Citi.OutlookThe global economic outlook for 2012 isnt prettyRecession in Europe, anaemic growth at best in the United States, and a sharp slowdown inChina and in most emerging-market economies. Asian economies are exposed to China. LatinAmerica is exposed to lower commodity prices (as both China and the advanced economiesslow). Central and Eastern Europe are exposed to the eurozone. And turmoil in the Middle Eastis causing serious economic risks – both there and elsewhere – as geopolitical risk remains highand thus high oil prices will constrain global growth.At this point, a eurozone recession is certain. While its depth and length cannot be predicted, acontinued credit crunch, sovereign-debt problems, lack of competitiveness, and fiscal austerityimply a serious downturn.The US – growing at a snails pace since 2010 – faces considerable downside risks from theeurozone crisis. It must also contend with significant fiscal drag, ongoing deleveraging in thehousehold sector (amid weak job creation, stagnant incomes, and persistent downward pressureon real estate and financial wealth), rising inequality, and political gridlock.Elsewhere among the major advanced economies, the United Kingdom is double dipping, asfront-loaded fiscal consolidation and eurozone exposure undermine growth. In Japan, the post-earthquake recovery will fizzle out as weak governments fail to implement structural reforms.Meanwhile, flaws in Chinas growth model are becoming obvious. Falling property prices arestarting a chain reaction that will have a negative effect on developers, investment, andgovernment revenue. The construction boom is starting to stall, just as net exports have become adrag on growth, owing to weakening US and especially eurozone demand. Having sought to coolthe property market by reining in runaway prices, Chinese leaders will be hard put to restartgrowth.
  65. 65. They are not alone. On the policy side, the US, Europe, and Japan, too, have been postponing theserious economic, fiscal, and financial reforms that are needed to restore sustainable andbalanced growth.Private- and public-sector deleveraging in the advanced economies has barely begun, withbalance sheets of households, banks and financial institutions, and local and central governmentsstill strained. Only the high-grade corporate sector has improved. But, with so many persistenttail risks and global uncertainties weighing on final demand, and with excess capacity remaininghigh, owing to past over-investment in real estate in many countries and Chinas surge inmanufacturing investment in recent years, these companies capital spending and hiring haveremained muted.Rising inequality – owing partly to job-slashing corporate restructuring – is reducing aggregatedemand further, because households, poorer individuals, and labour-income earners have ahigher marginal propensity to spend than corporations, richer households, and capital-incomeearners. Moreover, as inequality fuels popular protest around the world, social and politicalinstability could pose an additional risk to economic performance.At the same time, key current-account imbalances – between the US and China (and otheremerging-market economies), and within the eurozone between the core and the periphery –remain large. Orderly adjustment requires lower domestic demand in over-spending countrieswith large current-account deficits and lower trade surpluses in over-saving countries vianominal and real currency appreciation. To maintain growth, over-spending countries neednominal and real depreciation to improve trade balances, while surplus countries need to boostdomestic demand, especially consumption.Finally, policymakers are running out of options. Currency devaluation is a zero-sum game,because not all countries can depreciate and improve net exports at the same time. Monetarypolicy will be eased as inflation becomes a non-issue in advanced economies (and a lesser issuein emerging markets). But monetary policy is increasingly ineffective in advanced economies,where the problems stem from insolvency – and thus creditworthiness – rather than liquidity.Meanwhile, fiscal policy is constrained by the rise of deficits and debts, bond vigilantes, and newfiscal rules in Europe. Backstopping and bailing out financial institutions is politically unpopular,while near-insolvent governments dont have the money to do so. As a result, dealing with stockimbalances – the large debts of households, financial institutions, and governments – by paperingover solvency problems with financing and liquidity may eventually give way to painful andpossibly disorderly restructurings. Likewise, addressing weak competitiveness and current-account imbalances requires currency adjustments that may eventually lead some members toexit the eurozone.Restoring robust growth is difficult enough without the ever-present spectre of deleveraging anda severe shortage of policy ammunition. But that is the challenge that a fragile and unbalancedglobal economy faces in 2012. To paraphrase Bette Davis in All About Eve, "Fasten yourseatbelts, its going to be a bumpy year‖.
  66. 66. Comparative analysis of the traded value in the F & O Segment withthe cash segment F& O( turnover in crores) Cash Segment( turnover in crores)Jan 2009 12, 00, 000 2, 00, 000Feb 2009 12,00, 000 1,00, 000March 2009 14,00,000 5, 00, 000April 2009 16, 00, 000 4, 50, 000May 2009 19,00,000 6 00, 000June 2009 6, 50, 000 18,00,000From this table we can see that in practical life though equity cash segment is better than thederivatives because it involves lesser risk more numbers of investors are trading in derivatives(F& O) segment. It is a major finding of the projects shows that by 60% to 70% investors arebear more risk and traded in derivatives market because they want to earn more profits by tradingin derivatives.
  67. 67. 4. CONCLUSIONSThis project has covered several areas. Its main conclusions are:  Derivatives market growth continues almost irrespective of equity cash market turnover growth. Since 2000. Cash equity turnover has fallen in the developed markets, but derivatives turnover continued to rise steeply and steadily.  Equity derivatives businesses like interest derivatives are highly concentrated. Using notional value as the measure, the 2 main US markets and the 2 cross-border European markets accounted for about 75% of the total. This was most apparent in index derivatives, which make 99% of the notional value of equity derivatives. In single stock derivatives, other markets have established niches and the dominance of the gig four is less evident.  Equity market volume and derivative market notional value are strongly correlated- with a ratio significant differences between individual markets.  A number of cash equity markets- particularly in developing Asia- do not have equity derivatives markets. Comparison of their cash market volumes with those that do have derivative exchanges shows that the markets without derivatives are of similar size. I Am not convinced that market or infrastructure differences explain this, but suspects that regularity barriers have effectively prevented the development, markets in several developing Asian countries. People should learned first and then investor should consult their financial advisor before investing. If people have adequate knowledge then they can earn good return in stock market.
  68. 68. Intraday trading should not be traded by normal man as they lose money due to volatilityin the market.People should invest in stock market as a long term investor rather than short termbecause in short term risk is many and profit are less.F&O do cover risk of future so my advice is those have adequate knowledge shouldinvest in F&O segment and others should start first with cash market with long termperspective. 5. RECOMMENDATIONS  RBI should play a greater role in supporting Derivatives. Because nowadays derivatives market are increasing rapidly and it plays a major role in the whole securities market.  Derivatives market should be developed in order to keep it at par with other derivative market in the world. Nowadays more number of investors are shows their interest in derivatives market because it includes high return by bearing high risk.  Speculation should be discouraged because it affects the market conditions badly and new investors are reducing their interest in the market.  There must be more derivatives instruments aimed at individual investors.  SEBI should conduct seminars regarding the use of derivatives to educate individual investors
  69. 69.  There is a need to have a smaller contract size in F & O Market. We can review the size of the contract from Rs. Two lacs to On Lacs. People have very little knowledge about option market which is less risky compare to future market and I think sebi should conduct seminars in this regard. There are few business channels on equity market but they should also cover futures market a bit more as more interest lies on the future than the present and the past. People feel that on future prices current price moves if future share price of particular company is up and then current share price should also be up, likewise it shows how people gamble and loose money in stock market this should be stopped and proper training programmes should be conducted by both exchanges so that investor are educated Margin limit by brokers should be reduced and more and more people fall in this trap they buy more shares and if share prices fall loose their hard money. Apart from hindi business news channel should be started in other language like gujarati, urdu etc.
  70. 70. 6. BIBLIORAPHYBooks:-  Securities Laws and Regulations of Financial Markets  National Securities Depository Limited  Fundamentals of Futures & Options Markets- John C. Hull  Financial Derivatives- S. L. Gupta Websites:-       