To know the investors awarenes towards investment in derivative market

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To know the investors awarenes towards investment in derivative market

  1. 1. 1.1 INTRODUCTION TO INDUSTRY INTRODUCTION TO INDUSTRY: ABOUT STOCK EXCHANGE Share market is the market for securities where organized issuance and trading of shares takes place. It plays an important role in canalizing capital from the Investors to the business houses which consequently leads to the availability of funds for business expansion. Shares are certificates which represent ownership rights of the holder in a company. TYPES OF SHARE MARKET: PRIMARY MARKET: • The first time that a company shares are issued to the public, it is by a process called the initial public offering (IPO). • In an IPO company offloads a certain percentage of its totals shares to the public at a certain price. • The public can bid for the shares at any price in the band specified. Once the bid come in the company evaluates all the bids and decides on an offer price in that range. • After the offer price is fixed the company either allots its shares to the people who had applied for its shares or returns them their money. 1
  2. 2. SECONDARY MARKET • Once the offer price is fixed and the shares are issued to the people, stock exchanges facilitate the trading of shares for the general public. • Once a stock is listed on an exchange, people can start trading in its shares. • In a stock exchange the existing shareholders sell their shares to anyone who is willing to buy them at a price agreeable to both the parties. • Individuals cannot buy or sell shares in a stock exchange directly they have to execute their transactions through authorized members of the stock exchange who are also called stock brokers. HISTORY OF STOCK EXCHANGES IN INDIA The origin of stock exchanges in India can be traced back to the latter half of 19th century. After the American Civil War (1860-61) due to the share mania of the public, the number of brokers dealing on shares increased. The brokers organized an informal association in Mumbai named “The Native Stock and Share Brokers Association” in 1875. Increased activity in trade and commerce during the First World War and Second World War resulted in an increase in stock trading. Stock exchanges were established in different centers like Chennai, Delhi, Nagpur, Kanpur, Hyderabad and Bangalore. The growth of stock exchanges suffered a setback after the end of World War. Worldwide depression affected them. Most of the stock exchanges in the early stages had a speculative nature of working without technical strength. Securities and Contract Regulation Act, 1956 gave powers to the central government to regulate the stock exchanges. Till recent past, floor trading took places in all stock exchanges. In the flue trading system, the trade takes place through open outcry system during the official trading hours. Trading posts are assigned for different securities were buying and sell activities of securities took place. 2 CAPITAL MARKET SHARE MARKET SHAREKHAN (DEPOSITORY PARTICIPANT) DEPOSITORY
  3. 3. This system needs a face to face contact among the traders and restrict the trading volume. The speed of new information reflected on the prices was rather slow. The deals were also not transparent and the system favored the brokers rather than the investors. The setting up of NSE and OTCEI with the screen based trading facility resulted in more and more stock exchanges turning towards the computer based trading. Bombay stock exchange introduced the screen based trading system in 1995. Madras stock exchange introduced Automated Network Trading System (MANTRA) on Oct 7th 1996. Apart from Bombay stock exchange, Vadodara, Delhi, Pone, Bangalore, Calcutta and Ahmadabad stock exchanges have introduced screen based trading. Other exchanges are also planning to shift to the screen based trading. MOST COMMONLY USED STOCK EXCHANGES IN INDIA THE BOMBAY STOCK EXCHANGE (BSE) The Indian stock market is one of the oldest markets in Asia. Its history dates back to nearly two centuries. The earlier records of security dealings in India are meager and obscure. The East India Company was the dominant institution in those days and business in its loans securities was transacted towards the close of the eighteen century • By the 1830’s business in corporate stocks and shares in bank and cotton presses took place in Bombay. Through the trading list was broader in 1839, there were only a half a dozen brokers recognized by the banks and merchants. 3
  4. 4. • In 1860-61, the American Civil War broke out and Cotton supply from the United States of America and Europe was stopped. This resulted in the “Share Mania” for cotton trading in India. The number of brokers increased to between 200 and 250. However, at the end of the American Civil War, 1865 a disastrous slump began- for example, a bank of Bombay share that had touched Rs. 2850 could only be sold at Rs. 87. • At the same time, brokers found a place in Dalal Street, Bombay where they could conveniently assemble and transact business. In 1887, they formally established the “Native Share and Stock Brokers Association”. In 1895 the association acquired premises in the same street; it was inaugurated in 1899 as the Bombay Stock Exchange. • The Bombay Stock Exchange is governed by a board, chaired by a non-executive chairman. The executive director is in charge of the administration of the exchange and is supported by elected directors, Securities Exchange Board of India (SEBI) nominees, and public representatives. THE NATIONAL STOCK EXCHANGE (NSE) • The National Stock Exchange of India Limited was set up to provide access to investors from across the country on an equal footing. • NSE was promoted by leading financial institutions at the behest of the Government of India and was incorporated in November 1992 as a tax-paying company, unlike other stock exchanges in the country. • On its recognition as a stock exchange under the Securities Contracts (Regulation) Act, 1956 in April 1993, NSE commenced operations in the wholesale debt market (WDM) segment in June 1994. 4
  5. 5. • The capital market (equities) segment commenced operations in November 1994, and operations in the derivatives segment commenced in June 2000. TIMING SESSION Session Timing Beginning of the Day Session 8:30 - 9:00 Pre-open trading session 9:00 - 9:15 Trading Session 9:15 - 15:30 Position Transfer Session 15:30 – 15:50 Closing Session 15:50 – 16:05 Option Exercise Session 16:05 FUNCTIONS OF STOCK EXCHANGE 5
  6. 6. Maintains Active Trading: Shares are traded on the stock exchanges, enabling the investors to buy and sell securities. The prices may vary from transaction to transaction. A continuous trading increases the liquidity or marketability of the shares traded on the stock exchanges. Aids in Financings the Industry: A continuous market for shares provides a favorable climate for raising capital. The negotiability and transferability of the securities helps the companies to raise long-term funds. Fixation of Prices: Price is determined by the transactions that flow from investor’s demand and supplier’s preferences. Usually the traded prices are made known to the public. This helps the investors to make better decisions. Ensures Safe And Fair Dealings: The rules, regulations and by-laws of the stock exchanges provide a measure of safety to the investors. Transactions are conducted under competitive conditions enabling the investors to get a fair deal. Performance Inducer: The prices of stocks reflect the performance of the traded companies. This makes the corporate more concerned with its public image and tries to maintain good performance. Dissemination of Information: Stock exchanges provide information through their various publications. They publish the share prices traded on daily basis along with the volume traded. Handouts, Handbooks and Pamphlets provide information regarding the functioning of the stock exchanges. Self Regulating Organization: The stock exchanges monitor the integrity of the members, brokers, listed companies and clients. Continuous internal audit safeguards the investors against unfair trade practices. It settles the disputes between member brokers, investors and brokers. ROLE OF STOCK EXCHANGES • Raising capital for business. • Mobilizing saving for investment. • Facilitate Company growth. 6
  7. 7. • Redistribution of wealth. • Corporate governance. • Create investment opportunities for small investors. • Government raises capital for development projects. 1.2 INTRODUCTION TO COMPANY COMPANY PROFILE: Sharekhan is one of the top retail brokerage houses in India with a strong online trading platform. The company provides equity based products (research, equities, derivatives, depository, margin funding, etc.). It has one of the largest networks in the country with 1200+ share shops in 400 cities and India’s premier online trading portal www.sharekhan.com. With their research expertise, customer commitment and superior technology, they provide investors with end-to-end solutions in investments. They provide trade execution services through multiple channels - an Internet platform, telephone and retail outlets. Sharekhan was established by Morakhia family in 1999-2000 and Morakhia family, continues to remain the largest shareholder. It is the retail broking arm of the Mumbai-based SSKI [SHRIPAL SHEWANTILAL KANTILAL ISWARNATH LIMITED] Group. SSKI which is established in 1930 is the parent company of Sharekhan ltd. With a legacy of more than 80 years in the stock markets, the SSKI group ventured into institutional broking and corporate finance over a decade ago. Presently SSKI is one of the leading players in institutional broking and corporate finance activities. Sharekhan offers its customers a wide range of equity related services including trade execution on BSE, NSE, and Derivatives. Depository services, online trading, Investment advice, Commodities, etc. Sharekhan Ltd. is a brokerage firm which is established on 8th February 2000 and now it is having all the rights of SSKI. The company was awarded the 2005 Most Preferred Stock Broking Brand by Awaaz Consumer Vote. It is first brokerage Company to go online. The Company's online trading and investment site - www.Sharekhan.com - was also launched on Feb 8, 2000. This site gives access to superior content and transaction facility to retail 7
  8. 8. customers across the country. Known for its jargon-free, investor friendly language and high quality research, the content-rich and research oriented portal has stood out among its contemporaries because of its steadfast dedication to offering customers best-of-breed technology and superior market information. Sharekhan has one of the best states of art web portal providing fundamental and statistical information across equity, mutual funds and IPOs. One can surf across 5,500 companies for in-depth information, details about more than 1,500 mutual fund schemes and IPO data. One can also access other market related details such as board meetings, result announcements, FII transactions, buying/selling by mutual funds and much more. Sharekhan's management team is one of the strongest in the sector and has positioned Sharekhan to take advantage of the growing consumer demand for financial services products in India through investments in research, pan-Indian branch network and an outstanding technology platform. Further, Sharekhan's lineage and relationship with SSKI Group provide it a unique position to understand and leverage the growth of the financial services sector. We look forward to providing strategic counsel to Sharekhan's management as they continue their expansion for the benefit of all shareholders. SSKI Corporate Finance Private Limited (SSKI) is a leading India-based investment bank with strong research-driven focus. Their team members are widely respected for their commitment to transactions and their specialized knowledge in their areas of strength. The team has completed over US$5 billion worth of deals in the last 5 years - making it among the most significant players raising equity in the Indian market. SSKI, a veteran equities solutions company has over 8 decades of experience in the Indian stock markets. If we experience their language, presentation style, content or for that matter the online trading facility, we'll find a common thread; one that helps us make informed decisions and simplifies investing in stocks. The common thread of empowerment is what Sharekhan's all about. "Sharekhan has always believed in collaborating with like-minded Corporate into forming strategic associations for mutual benefit relationships" says Jaideep Arora, Director - Sharekhan Limited. Sharekhan is also about focus. Sharekhan does not claim expertise in too many things. Sharekhan's expertise lies in stocks and that's what he talks about with 8
  9. 9. authority. So when he says that investing in stocks should not be confused with trading in stocks or a portfolio-based strategy is better than betting on a single horse, it is something that is spoken with years of focused learning and experience in the’ stock markets. And these beliefs are reflected in everything Sharekhan does for us! Sharekhan is a part of the SSKI group, an Indian financial services power house, with strong presence in Retail equities Institutional equities Investment banking. In Ahmadabad, It is having the branch at Dynamic house, opp. Child care hospital, Navrangpura road and over 40 franchisees in Ahmadabad. We have been given the centre at Navrangpura road, Ahmadabad. SHAREHOLDER OF THE SHAREKHAN LTD. Is SHAREHOLDERS CITI VENTURE CAPITAL AND OTHER PRIVATE EQUITY FIRMS 81 IDFC 9 EMPLOYEES 10 SHAREKHAN LIMITED’S MANAGEMENT TEAM MANAGEMENT TEAM DINESH MURIKYA OWNER TARUN SHAH CEO SHANKAR VAILAYA DIRECTOR (OPERATIONS) JAIDEEP ARORA DIRECTOR (PRODUCTS & TECHNOLOGY) PATHIK GANDOTRA HEAD OF RESEARCH 9
  10. 10. RISHI KOHLI VICE PRESIDENT OF EQUITY DERIVATIVES NIKHIL VORA VICE PRESIDENT OF RESEARCH MISSION: To educate and empower the individual investor to make better investment decisions through quality advice and superior service. VISION: To be the best retail brokering Brand in the retail business of stock market. HIERARCHY IN SHAREKHAN: Sales Side Dealing Side  Trainees  Junior Dealer  Super Trainees  Dealer  Sales Executives  Relationship manager  Senior sales executives  Senior Relationship manager  Business development executive  Equity advisor 10
  11. 11.  Assistant sales manager  Assistant Branch Manager  Territory manager  Cluster Head  Area sales manager/ Cluster manager  Directors  Regional sales manager  CEO  Regional Head  Vice president  Directors  CEO  Sharekhan provides 4 in 1 account. 1 1. De-mat a/c 2 2. Trading a/c [for cash calculation] 3 3. Bank a/c [for fund transfer] 4 4. Dial and Trade [for offline trading/for query relating trading] 5 [1] Dematerialization account:- Dematerialization is the process of converting physical shares (share certificates) into an electronic form. Shares once converted into dematerialized form are held in a De-mat 11
  12. 12. account Sharekhan is a depository participant. This means that we can keep the shares in dematerialized form in Sharekhan. But for this one has to purchases the Demat account in Sharekhan. • Sharekhan provides no opening charge. • Sharekhan provide de-mat account free of charge for first year, Rs.400/ year from the next year (year continued from the day of opening). • Auto pay-in & Auto pay-out of securities. • Waver of pay-in and pay-out charges (Due to link De-mate account). [2] Trading Account: It is an electronic account which enables customers to trade in share through internet without help to broker. • NSE/BSE/F&O/Commodity terminal live screen:- Provides online fluctuations rate on computer screen 1) Online Daily Tips:- Sharekhan is providing tips through mails in 4 sessions • Pre market • Noon session • Post market • Late evening  Sharekhan is provide tips through SMS (chargeable)  Sharekhan is provide tips through Yahoo Messenger Online 2) IPO/MF Online :- Sharekhan provide IPO and MF facility for the customer. [3] Saving Account: In Sharekhan, a customer can have a saving account for trading online with net banking facility; Sharekhan have a tie ups with following Banks. 1. HDFC Bank 2. CITI Bank 3. OBC Bank 12
  13. 13. 4. YES Bank 5. UTI Bank 6. IDBI Bank 7. ICICI Bank 8. Union Bank 9. Indusind Bank 10. Bank of India 11. Deutsche Bank A customer can allocate and transfer fund from your respective bank account to your Sharekhan account for trading and transfer back to link bank account when and where needed. [4] Dial-N-Trade:- Sharekhan provide Dial-N-Trade facility to the customer. PRODUCTS & SERVICES: Sharekhan ltd. Provide different Product as follows  Share online & offline  Derivatives  Mutual fund online  Commodities online  IPO online  Portfolio Management Services  Insurance  Fixed deposits  Advisory products  Currency trading 13
  14. 14. SHARE ONLINE: BENEFITS I. Freedom from paperwork:-Integrated trading, bank and de-mat account with digital contracts removers all paperwork. II. Instant credit and transfer:-instant transfer of funds from bank account of the choice to Sharekhan trades account. III. Trade anywhere:-enjoy the ease of trading from any part of the world in a completely secure environment. IV. Dial n Trade:-call toll free number (1-800-22-7050) to place orders through telebrokers. V. Timey advice:-make informed decisions with expert advice, investment calls and live market commentary. VI. Real-time portfolio tracking:-benefit from real-time information for investment and current portfolio value. VII. After-hour orders:-place order after market hours, which get executed as soon as the markets opens. CLASSIC ACCOUNT:- The Classic Account enables customers to trade online on the NSE and the BSE, invest in IPO and Mutual Funds and access all the research and transaction reports through Sharekhan’s website. This account is suitable for the retail investors. In this account Shown the maximum script are 25 in the terminal and the technical chart are not shown in this account. The life time registration charge for this account is 750 rupees. Features:  Online trading account for investing in Equities and Derivatives  Free trading through Phone (Dial-n-Trade)  Two dedicated numbers for placing your orders with your cell phone or landline.  Automatic funds transfer with phone banking (for Citibank and HDFC bank customers)  Simple and Secure Interactive Voice Response based system for authentication 14
  15. 15.  Get the trusted, professional advice of our telebrokers.  After hours order placement facility between 8.00 am and 9.30 am  Integration of: Online trading + Bank + Demat account  Instant cash transfer facility against purchase & sale of shares  IPO investments  Instant order and trade confirmations by e-mail  Single screen interface for cash and derivatives TRADE TIGER: Trade tiger is a next-generation online trading product that brings the power of broker’s terminal to customer pc. It is session to capitalize on intra-day price movement. Trade tiger is an internet –based application available on a CD, which provides everything a trader needs on one screen. Key Features:- • A single platform for multiple exchange BSE & NSE (Cash & F&O), MCX, NCDEX, Mutual Funds, IPOs • Multiple Market Watch available on Single Screen • Multiple Charts with Tick by Tick Intraday and End of Day Charting powered with various Studies • Graph Studies include Average, Band- Bollinger, Know Sure Thing, MACD, RSI, etc • Apply studies such as Vertical, Horizontal, Trend, Retracement & Free lines • User can save his own defined screen as well as graph template, that is, saving the layout for future use • User-defined alert settings on an input Stock Price trigger • Tools available to gauge market such as Tick Query, Ticker, Market Summary, 15
  16. 16. Action Watch, Option Premium Calculator, Span Calculator • Shortcut key for FAST access to order placements & reports • Online fund transfer activated with 11 Banks SHARE OFFLINE: As the internet has taken over the physical trade, the same is the situation in trading in shares. Even the internet has not spared trading in shares and still the conventional system of offline trading continues in today’s world. Merits of offline trading:  Less margin  Low Brrokerage  Flexibility in credit period  Customized advice Demerits of offline trading:  Problems in getting in touch with the broker  Limited clientele  Problem of attention from the broker due to load  Reliance on the broker’s information  Customer has to believe what the broker says  Broker Might not give the best price  Reconciliation of account and cash settlements  Paperwork 16
  17. 17.  Geographical Restriction DIAL-N-TRADE: Sharekhan provides complete trading facility like they are giving Toll free numbers the phone trading facility as an alternative of net trading where a customer can call “n” number of times. Toll Free numbers: 1800-22-7500 1800-22-7050 INTRODUCTION TO TOPIC: INTRODUCTION TO DERIVATIVES: The origin of derivatives can be traced back to the need of farmers to protect themselves against fluctuations in the price of their crop. From the time it was sown to the time it was ready for harvest, farmers would face price uncertainty. Through the use of simple derivative products, it was possible for the farmer to partially or fully transfer price risks by locking-in asset prices. These were simple contracts developed to meet the needs of farmers and were basically a means of reducing risk. In 1848, the Chicago Board Of Trade, or CBOT, was established to bring farmers and merchants together. A group of traders got together and created the ‘to-arrive’ contract that permitted farmers to lock into price upfront and deliver the grain later. These to-arrive contracts proved useful as a device for hedging and speculation on price charges. These were eventually standardized, and in 1925 the first futures clearing house came into existence. Today derivatives contracts exist on variety of commodities such as corn, pepper, cotton, wheat, silver etc. Besides commodities, derivatives contracts also exist on a lot of financial underlying like stocks, interest rate, exchange rate, etc. DERIVATIVES DEFINED 17
  18. 18. A derivative is a product whose value is derived from the value of one or more underlying variables or assets in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In our earlier discussion, we saw that wheat farmers may wish to sell their harvest at a future date to eliminate the risk of change in price by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the “underlying” in this case. Derivatives are securities under the SCRA and hence the trading of derivatives is governed by the regulatory framework under the SCRA. The Securities Contracts (Regulation) Act, 1956 defines “derivative” to include- A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract differences or any other form of security. Figure.1 Types of Derivatives Market 3.2 TYPES OF DERIVATIVES MARKET Exchange Traded Derivatives Over The Counter Derivatives National Stock Exchange Bombay Stock Exchange National Commodity & Derivative Index Future Index option Stock option future Interest rate future 3.3 TYPES OF DERIVATIVES 18
  19. 19. Figure.2 Types of Derivatives FORWARD CONTRACTS A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normall y traded outside 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 of contract size, expiration date and the asset type and quality. • The contract price is generally not available in public domain. • On the expiration date, the contract has to be settled by delivery of the asset. • If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged. 19
  20. 20. However forward contracts in certain markets have become very standardized, as in the case of foreign exchange, thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches its limit in the organized futures market. Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. FUTURE CONTRACT In finance, a futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The settlement price, normally, converges towards the futures price on the delivery date. A futures contract gives the holder the right and the obligation to buy or sell, which differs from an options contract, which gives the buyer the right, but not the obligation, and the option writer (seller) the obligation, but not the right. To exit the commitment, the holder of a futures position has to sell his long position or buy back his short position, effectively closing out the futures position and its contract obligations. Futures contracts are exchange traded derivatives. The exchange acts as counterparty on all contracts, sets margin requirements, etc. BASIC FEATURES OF FUTURE CONTRACT 1. Standardization: Futures contracts ensure their liquidity by being highly standardized, usually by specifying: • The underlying. This can be anything from a barrel of sweet crude oil to a short term interest rate. • The type of settlement, either cash settlement or physical settlement. 20
  21. 21. • The amount and units of the underlying asset per contract. This can be the notional amount of bonds, a fixed number of barrels of oil, units of foreign currency, the notional amount of the deposit over which the short term interest rate is traded, etc. • The currency in which the futures contract is quoted. • The grade of the deliverable. In case of bonds, this specifies which bonds can be delivered. In case of physical commodities, this specifies not only the quality of the underlying goods but also the manner and location of delivery. The delivery month. • The last trading date. • Other details such as the tick, the minimum permissible price fluctuation. 2. Margin: Although the value of a contract at time of trading should be zero, its price constantly fluctuates. This renders the owner liable to adverse changes in value, and creates a credit risk to the exchange, who always acts as counterparty. To minimize this risk, the exchange demands that contract owners post a form of collateral, commonly known as Margin requirements are waived or reduced in some cases for hedgers who have physical ownership of the covered commodity or spread traders who have offsetting contracts balancing the position. Initial margin: is paid by both buyer and seller. It represents the loss on that contract, as determined by historical price changes, which is not likely to be exceeded on a usual day's trading. It may be 5% or 10% of total contract price. Mark to market Margin: Because a series of adverse price changes may exhaust the initial margin, a further margin, usually called variation or maintenance margin, is required by the exchange. This is calculated by the futures contract, i.e. agreeing on a price at the end of each day, called the "settlement" or mark-to-market price of the contract. To understand the original practice, consider that a futures trader, when taking a position, deposits money with the exchange, called a "margin". This is intended to protect the exchange against loss. At the end of every trading day, the contract is marked to its present market value. If the trader is on the winning side of a deal, his contract has increased in value that day, and the exchange pays this profit into his account. On the other hand, if he is on the losing side, the exchange will debit his account. If he cannot pay, then the margin is used as the collateral from which the loss is paid. 21
  22. 22. 3. Settlement Settlement is the act of consummating the contract, and can be done in one of two ways, as specified per type of futures contract: • Physical delivery - the amount specified of the underlying asset of the contract is delivered by the seller of the contract to the exchange, and by the exchange to the buyers of the contract. In practice, it occurs only on a minority of contracts. Most are cancelled out by purchasing a covering position - that is, buying a contract to cancel out an earlier sale (covering a short), or selling a contract to liquidate an earlier purchase (covering a long). • Cash settlement - a cash payment is made based on the underlying reference rate, such as a short term interest rate index such as Euribor, or the closing value of a stock market index. A futures contract might also opt to settle against an index based on trade in a related spot market. 4.Expiry is the time when the final prices of the future are determined. For many equity index and interest rate futures contracts, this happens on the Last Thursday of certain trading month. On this day the t+2 futures contract becomes the t forward contract. Pricing of future contract In a futures contract, for no arbitrage to be possible, the price paid on delivery (the forward price) must be the same as the cost (including interest) of buying and storing the asset. In other words, the rational forward price represents the expected future value of the underlying discounted at the risk free rate. Thus, for a simple, non-dividend paying asset, the value of the future/forward, , will be found by discounting the present value at time to maturity by the rate of risk-free return . This relationship may be modified for storage costs, dividends, dividend yields, and convenience yields. Any deviation from this equality allows for arbitrage as follows. In the case where the forward price is higher: 1. The arbitrageur sells the futures contract and buys the underlying today (on the spot market) with borrowed money. 22
  23. 23. 2. On the delivery date, the arbitrageur hands over the underlying, and receives the agreed forward price. 3. He then repays the lender the borrowed amount plus interest. 4. The difference between the two amounts is the arbitrage profit. In the case where the forward price is lower: 1. The arbitrageur buys the futures contract and sells the underlying today (on the spot market); he invests the proceeds. 2. On the delivery date, he cashes in the matured investment, which has appreciated at the risk free rate. 3. He then receives the underlying and pays the agreed forward price using the matured investment. [If he was short the underlying, he returns it now.] 4. The difference between the two amounts is the arbitrage profit. TABLE 1- DISTINCTION BETWEEN FUTURES AND FORWARDS CONTRACTS FEATURES FORWARD CONTRACT FUTURE CONTRACT Operational Mechanism Traded directly between two parties (not traded on the exchanges). Traded on the exchanges. Contract Specifications Differ from trade to trade. Contracts are standardized contracts. 23
  24. 24. Counter-party risk Exists. Exists. However, assumed by the clearing corp., which becomes the counter party to all the trades or unconditionally guarantees their settlement. Liquidation Profile Low, as contracts are tailor made contracts catering to the needs of the needs of the parties. High, as contracts are standardized exchange traded contracts. Price discovery Not efficient, as markets are scattered. Efficient, as markets are centralized and all buyers and sellers come to a common platform to discover the price. Examples Currency market in India. Commodities, futures, Index Futures and Individual stock Futures in India. 24
  25. 25. OPTIONS - A derivative transaction that gives the option holder the right but not the obligation to buy or sell the underlying asset at a price, called the strike price, during a period or on a specific date in exchange for payment of a premium is known as ‘option’. Underlying asset refers to any asset that is traded. The price at which the underlying is traded is called the ‘strike price’. There are two types of options i.e., CALL OPTION AND PUT OPTION. CALL OPTION: A contract that gives its owner the right but not the obligation to buy an underlying asset- stock or any financial asset, at a specified price on or before a specified date is known as a ‘Call option’. The owner makes a profit provided he sells at a higher current price and buys at a lower future price. b. PUT OPTION: A contract that gives its owner the right but not the obligation to sell an underlying asset- stock or any financial asset, at a specified price on or before a specified date is known as a ‘Put option’. The owner makes a profit provided he buys at a lower current price and sells at a higher future price. Hence, no option will be exercised if the future price does not increase. Put and calls are almost always written on equities, although occasionally preference shares, bonds and warrants become the subject of options. 5. SWAPS - Swaps are transactions which obligates the two parties to the contract to exchange a series of cash flows at specified intervals known as payment or settlement dates. They can be regarded as portfolios of forward's contracts. A contract whereby two parties agree to exchange (swap) payments, based on some notional principle amount is called as a ‘SWAP’. In case of swap, only the payment flows are exchanged and not the principle amount. The two commonly used swaps are: 25
  26. 26. INTEREST RATE SWAPS: Interest rate swaps is an arrangement by which one party agrees to exchange his series of fixed rate interest payments to a party in exchange for his variable rate interest payments. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract. CURRENCY SWAPS: Currency swaps is an arrangement in which both the principle amount and the interest on loan in one currency are swapped for the principle and the interest payments on loan in another currency. The parties to the swap contract of currency generally hail from two different countries. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. Under a currency swap, cash flows to be exchanged are determined at the spot rate at a time when swap is done. Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates. FINANCIAL SWAP: Financial swaps constitute a funding technique which permit a borrower to access one market and then exchange the liability for another type of liability. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream. The other kind of derivatives, which are not, much popular are as follows: 6.BASKETS - Baskets options are option on portfolio of underlying asset. Equity Index Options are most popular form of baskets. 6. LEAPS - Normally option contracts are for a period of 1 to 12 months. However, exchange may introduce option contracts with a maturity period of 2-3 years. These long-term option contracts are popularly known as Leaps or Long term Equity Anticipation Securities. 26
  27. 27. 7. WARRANTS - Options generally have lives of up to one year; the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. 8. SWAPTIONS - Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating. 3.1 HISTORY OF DERIVATIVES: The history of derivatives is quite colorful and surprisingly a lot longer than most people think. Forward delivery contracts, stating what is to be delivered for a fixed price at a specified place on a specified date, existed in ancient Greece and Rome. Roman emperors entered forward contracts to provide the masses with their supply of Egyptian grain. These contracts were also undertaken between farmers and merchants to eliminate risk arising out of uncertain future prices of grains. Thus, forward contracts have existed for centuries for hedging price risk. The first organized commodity exchange came into existence in the early 1700’s in Japan. The first formal commodities exchange, the Chicago Board of Trade (CBOT), was formed in 1848 in the US to deal with the problem of ‘credit risk’ and to provide centralized location to negotiate forward contracts. From ‘forward’ trading in commodities emerged the commodity ‘futures’. The first type of futures contract was called ‘to arrive at’. Trading in futures began on the CBOT in the 1860’s. In 1865, CBOT listed the first ‘exchange traded’ derivatives contract, known as the futures contracts. Futures trading grew out of the need for 27
  28. 28. hedging the price risk involved in many commercial operations. The Chicago Mercantile Exchange (CME), a spin-off of CBOT, was formed in 1919, though it did exist before in 1874 under the names of ‘Chicago Produce Exchange’ (CPE) and ‘Chicago Egg and Butter Board’ (CEBB). The first financial futures to emerge were the currency in 1972 in the US. The first foreign currency futures were traded on May 16, 1972, on International Monetary Market (IMM), a division of CME. The first stock index futures contracts were traded on Kansas City Board of Trade on February 24, 1982.The first of the several networks, which offered a trading link between two exchanges, was formed between the Singapore International Monetary Exchange (SIMEX) and the CME on September 7, 1984. On April 26, 1973, the Chicago Board options Exchange (CBOE) was set up at CBOT for the purpose of trading stock options. It was in 1973 again that black, Merton, and Schools invented the famous Black-Scholes Option Formula. This model helped in assessing the fair price of an option which led to an increased interest in trading of options. With the options markets becoming increasingly popular, the American Stock Exchange (AMEX) and the Philadelphia Stock Exchange (PHLX) began trading in options in 1975. The market for futures and options grew at a rapid pace in the eighties and nineties. The collapse of the Bretton Woods regime of fixed parties and the introduction of floating rates for currencies in the international financial markets paved the way for development of a number of financial derivatives which served as effective risk management tools to cope with market uncertainties. The CBOT and the CME are two largest financial exchanges in the world on which futures contracts are traded. The CBOT now offers 48 futures and option contracts (with the annual volume at more than 211 million in 2001).The CBOE is the largest exchange for trading stock options. The CBOE trades options on the S&P 100 and the S&P 500 stock indices. The Philadelphia Stock Exchange is the premier exchange for trading foreign options. 3.5 INDIAN DERIVATIVES MARKET Starting from a controlled economy, India has moved towards a world where prices fluctuate every day. The introduction of risk management instruments in India gained momentum in 28
  29. 29. the last few years due to liberalisation process and Reserve Bank of India’s (RBI) efforts in creating currency forward market. Derivatives are an integral part of liberalisation process to manage risk. NSE gauging the market requirements initiated the process of setting up derivative markets in India. In July 1999, derivatives trading commenced in India. 3.6 Need for derivatives in India today In less than three decades of their coming into vogue, derivatives markets have become the most important markets in the world. Today, derivatives have become part and parcel of the day-to-day life for ordinary people in major part of the world. Until the advent of NSE, the Indian capital market had no access to the latest trading methods and was using traditional out-dated methods of trading. There was a huge gap between the investors’ aspirations of the markets and the available means of trading. The opening of Indian economy has precipitated the process of integration of India’s financial markets with the international financial markets. Introduction of risk management instruments in India has gained momentum in last few years thanks to Reserve Bank of India’s efforts in allowing forward contracts, cross currency options etc. which have developed into a very large market. Indian Market is not ready for derivative trading Often the argument put forth against derivatives trading is that the Indian capital market is not ready for derivatives trading. Here, we look into the pre-requisites, which are needed for the introduction of derivatives and how Indian market fares: What kind of people will use derivatives? Derivatives will find use for the following set of people: Speculators: People who buy or sell in the market to make profits. For example, if you will the stock price of Reliance is expected to go up to Rs.400 in 1 month, one can buy a 1 month future of Reliance at Rs 350 and make profits 29
  30. 30. Hedgers: People who buy or sell to minimize their losses. For example, an importer has to pay US $ to buy goods and rupee is expected to fall to Rs 50 /$ from Rs 48/$, then the importer can minimize his losses by buying a currency future at Rs 49/$ Arbitrageurs: People who buy or sell to make money on price differentials in different markets. For example, a futures price is simply the current price plus the interest cost. If there is any change in the interest, it presents an arbitrage opportunity. We will examine this in detail when we look at futures in a separate chapter. Basically, every investor assumes one or more of the above roles and derivatives are a very good option for him. 3.8 Comparison of New System with Existing System Many people and brokers in India think that the new system of Futures & Options and banning of Bald is disadvantageous and introduced early, but I feel that this new system is very useful especially to retail investors. It increases the no of options investors for investment. In fact it should have been introduced much before and NSE had approved it but was not active because of politicization in SEBI. Exchange-traded vs. OTC derivatives markets The OTC derivatives markets have witnessed rather sharp growth over the last few years, which have accompanied the modernization of commercial and investment banking and globalization of financial activities. The recent developments in information technology have contributed to a great extent to these developments. While both exchange-traded and OTC derivative contracts offer many benefits, the former have rigid structures compared to the latter. It has been widely discussed that the highly leveraged institutions and their OTC derivative positions were the main cause of turbulence in financial markets in 1998. These episodes of turbulence revealed the risks posed to market stability originating in features of OTC derivative instruments and markets. The OTC derivatives markets have the following features compared to exchange-traded derivatives: 30
  31. 31. 1. The management of counter-party (credit) risk is decentralized and located within individual institutions, 2. There are no formal centralized limits on individual positions, leverage, or margining, 3. There are no formal rules for risk and burden-sharing, 4. There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants, and 5. The OTC contracts are generally not regulated by a regulatory authority and the exchange’s self-regulatory organization, although they are affected indirectly by national legal systems, banking supervision and market surveillance. The following features of OTC derivatives markets can give rise to instability in institutions, markets, and the international financial system: (i) the dynamic nature of gross credit exposures; (ii) information asymmetries; (iii) the effects of OTC derivative activities on available aggregate credit; (iv) the high concentration of OTC derivative activities in major institutions; and (v) the central role of OTC derivatives markets in the global financial system. Instability arises when shocks, such as counter-party credit events and sharp movements in asset prices that underlie derivative contracts, occur which significantly alter the perceptions of current and potential future credit exposures. When asset prices change rapidly, the size and configuration of counter-party exposures can become unsustainably large and provoke a rapid unwinding of positions. There has been some progress in addressing these risks and perceptions. However, the progress has been limited in implementing reforms in risk management, including counter- party, liquidity and operational risks, and OTC derivatives markets continue to pose a threat to international financial stability. The problem is more acute as heavy reliance on OTC derivatives creates the possibility of systemic financial events, which fall outside the more formal clearing house structures. Moreover, those who provide OTC derivative products, hedge their risks through the use of exchange traded derivatives. In view of the inherent risks 31
  32. 32. associated with OTC derivatives, and their dependence on exchange traded derivatives, Indian law considers them illegal. 3.9 FACTORS CONTRIBUTING TO THE GROWTH OF DERIVATIVES: Factors contributing to the explosive growth of derivatives are price volatility, globalization of the markets, technological developments and advances in the financial theories. A.} PRICE VOLATILITY – A price is what one pays to acquire or use something of value. The objects having value maybe commodities, local currency or foreign currencies. The concept of price is clear to almost everybody when we discuss commodities. There is a price to be paid for the purchase of food grain, oil, petrol, metal, etc. the price one pays for use of a unit of another person’s money is called interest rate. And the price one pays in one’s own currency for a unit of another currency is called as an exchange rate. The changes in demand and supply influencing factors culminate in market adjustments through price changes. These price changes expose individuals, producing firms and governments to significant risks. The breakdown of the BRETTON WOODS agreement brought an end to the stabilizing role of fixed exchange rates and the gold convertibility of the dollars. The globalization of the markets and rapid industrialization of many underdeveloped countries brought a new scale and dimension to the markets. Nations that were poor suddenly became a major source of supply of goods. The Mexican crisis in the south east-Asian currency crisis of 1990’s has also brought the price volatility factor on the surface. The advent of telecommunication and data processing bought information very quickly to the markets. Information which would have taken months to impact the market earlier can now be obtained in matter of moments. Even equity holders are exposed to price risk of corporate share fluctuates rapidly. B.} GLOBALISATION OF MARKETS – Earlier, managers had to deal with domestic economic concerns; what happened in other part of the world was mostly irrelevant. Now globalization has increased the size of markets and as greatly enhanced competition .it has benefited consumers who cannot obtain better quality 32
  33. 33. goods at a lower cost. It has also exposed the modern business to significant risks and, in many cases, led to cut profit margins C.} TECHNOLOGICAL ADVANCES – A significant growth of derivative instruments has been driven by technological breakthrough. Advances in this area include the development of high speed processors, network systems and enhanced method of data entry. Closely related to advances in computer technology are advances in telecommunications. Improvement in communications allow for instantaneous worldwide conferencing, Data transmission by satellite. At the same time there were significant advances in software programmers without which computer and telecommunication advances would be meaningless. These facilitated the more rapid movement of information and consequently its instantaneous impact on market price. 33
  34. 34. D.} ADVANCES IN FINANCIAL THEORIES – Advances in financial theories gave birth to derivatives. Initially forward contracts in its traditional form, was the only hedging tool available. Option pricing models developed by Black and Scholes in 1973 were used to determine prices of call and put options. In late 1970’s, work of Lewis Edeington extended the early work of Johnson and started the hedging of financial price risks with financial futures. The work of economic theorists gave rise to new products for risk management which led to the growth of derivatives in financial markets. 3.10 BENEFITS OF DERIVATIVES RISK MANAGEMENT – Futures and options contract can be used for altering the risk of investing in spot market. For instance, consider an investor who owns an asset. He will always be worried that the price may fall before he can sell the asset. He can protect himself by selling a futures contract, or by buying a Put option. If the spot price falls, the short hedgers will gain in the futures market, as you will see later. This will help offset their losses in the spot market. Similarly, if the spot price falls below the exercise price, the put option can always be exercised. PRICE DISCOVERY – Price discovery refers to the market’s ability to determine true equilibrium prices. Futures prices are believed to contain information about future spot prices and help in disseminating such information. As we have seen, futures markets provide a low cost trading mechanism. Thus information pertaining to supply and demand easily percolates into such markets. OPERATIONAL ADVANTAGES – As opposed to spot markets, derivatives markets involve lower transaction costs. Secondly, they offer greater liquidity. Large spot transactions can often lead to significant price changes. However, futures markets tend to be more liquid than spot markets, because herein you can take large positions by depositing relatively small margins. Consequently, a large position in derivatives markets is relatively easier to take and has less of a price impact as opposed to a transaction of the same magnitude in the spot market. Finally, it is easier to take a short position in derivatives markets than it is to sell short in spot markets. 34
  35. 35. MARKET EFFICIENCY – The availability of derivatives makes markets more efficient; spot, futures and options markets are inextricably linked. Since it is easier and cheaper to trade in derivatives, it is possible to exploit arbitrage opportunities quickly and to keep prices in alignment. Hence these markets help to ensure that prices reflect true values. EASE OF SPECULATION – Derivative markets provide speculators with a cheaper alternative to engaging in spot transactions. Also, the amount of capital required to take a comparable position is less in this case. This is important because facilitation of speculation is critical for ensuring free and fair markets. Speculators always take calculated risks. A speculator will accept a level of risk only if he is convinced that the associated expected return is commensurate with the risk that he is taking. The derivative market performs a number of economic functions. • The prices of derivatives converge with the prices of the underlying at the expiration of derivative contract. Thus derivatives help in discovery of future as well as current prices. • An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity. • Derivatives markets help increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity. 35
  36. 36. 2.1 REVIEW OF LITERATURE This study argues for more extensive understanding of the phenomena as dynamics previously viewed unrelated now exhibit correlation. As empirical reference, this research relies on recent trends in the commodity futures contracts with analytical relation to the currency exchange rate and by extension the financial and real sectors. With varying intensity often speculative sporadic trading in crude oil, coffee, wheat, rice, sugar, and gold benchmark futures may inflict detrimental effects on the global development efforts. The issue is most acute in the emerging markets facing inflation fears, speculative movements of foreign currency-denominated funds, and underlying domestic currency value (Aleksandra, 2011). As a contract between two counterparts to exchange payments based on underlying prices or yields, any transfer of ownership of the underlying asset and cash flows becomes unnecessary”. This definition is strictly related to the ability of derivatives of replicating financial instruments. Derivatives can be divided into 5 types of contracts: Swap, Forward, Future, Option and Repo, the last being the forward contract used by the ECB to manage liquidity in the European inter-bank market. For a further definition of contracts, which should although be known by the reader (Hull,2002). The bulk of the contracts traded is interest rate-related instruments and are denominated in either US dollars or Euro. Credit-related instruments remain an important market segment; although outstanding remain at pre-crisis period levels. Of particular concern for regulators is the role of non-bank financial intermediaries, which are the main counterparty to derivatives transactions. While their share of the market remains unchanged over the last decade, outstanding overall have increased more than fourfold. The present volume considers the issues that participants face in today's derivatives markets including the potential impact of derivatives on economic stability, pricing issues, modeling as well as model performance and the application of derivatives for risk management and corporate control (Jonathan, Niklas, 2012). “Derivatives are used as a tool of risk management; the risks are associated with derivatives including market risk, credit risk and liquidity risks. The risks are directly related to size and 36
  37. 37. price volatility of the cash flows they represent they are to the size of the notional amounts on which the cash flows are based.” (Srisha, 2001). The most common usage relates to the trading of commodities futures and options on futures-where pre-defined contracts relating to a right to buy or sell and underlying commodity or security are traded as opposed to the actual commodity or security itself.” NPV, APT and CAPM are few such financial models which are part of derivatives; corporations use these models in addition with derivatives to achieve success (PEREO, 2004). One of the parties to a forward contract assumes a long position and agrees to buy the underlying asset at a certain future date for a certain price. The specified price is referred to as the delivery price. The parties to the contract mutually agree upon the contract terms like delivery price and quantity. A Futures Contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a pre-set price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. The futures price, naturally, converges towards the settlement price on the delivery date” (Anshul Bhargava, 2008). Dollars lost and gained by each party on a futures contract are equal and opposite. In other words, a future trading is a zero-sum game. Futures contracts are forward contracts, meaning they represent a pledge to make a certain transaction at a future date. The exchange of assets occurs on the date specified in the contract. Futures are distinguished from generic forward contracts in that they contain standardized terms, trade on a formal exchange, are regulated by overseeing agencies, and are guaranteed by clearing houses. Also, in order to insure that payment will occur, futures have a margin requirement that must be settled daily. Finally, by making an offsetting trade, taking delivery of goods, or arranging for an exchange of goods, futures contracts can be closed. Hedgers often trade futures for the purpose of keeping price risk in check also called futures”. (Sirisha, 2001). The case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time 37
  38. 38. risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance also called option”. (Patwari, 2006). They simply cost less because of the statistical fact that an average of a price series is more stable than any particular price series. Asian options are cash settled automatically”. “A swap is a derivative, where two counterparties exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The cash flows are calculated over a notional principal amount. The notional amount typically does not change hands and it is simply used to calculate payments Swaps are often used to hedge certain risks, for instance interest rate risk (Edwards, 2000). The emergence of the derivative market products most notably forwards, futures and options can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. Financial markets, by the very nature can be subject to a very high degree of volatility. Through the use of the products of derivatives it is possible to fully or partially transfer risk of price by looking-in the price of assets. As instruments of risk D.C. Patwari and Anshul Bhargava state that there are three broad categories of participants-hedgers, speculators and arbitrageurs, trade in the derivative market they are (Marlowe, 2000). History shows the phenomenal growth characteristic of the above stocks is related to that of the fundamentals on which the companies have been operating under and not related to speculators. The current market capitalization of Microsoft Corporation is approximately $225 billion compared to the group turnover of mere $22 million, and looking back at the BP case study (1998), the answer indicates the advantage derivatives provide against various risk involving commodities, fixed assets or interest rate transaction and planning (Dhingra, 2004). It is useful to demarcate two categories of derivatives contracts: those which are traded at exchange and those which are traded on OTC. OTC derivatives involve many complexities: the price that is negotiated might not be fair price, there is a counter party risk, the transactions are not publicly visible and the complexity of contracts often generates unsavoury sales practices and high fees for intermediaries. In contrast, exchange-traded derivatives are safer in many directions: they ensure that users get a fair price on all trades; 38
  39. 39. there is zero risk of default through the role of clearing corporation and high degree of transparency. A lot of famous disasters have taken place with the OTC derivatives (Shah 2000). “A forward contract is an agreement between two parties calling for delivery of, and payment for, a specified quality and quantity of a commodity at a specified future date. The price may be agreed upon in advance, or determined by formula at the time of delivery or other point in time”. Beside other instruments, such as Options or Futures, it is used to control and hedge risk, for example currency exposure risk (e.g. forward contracts on USD or EUR) or commodity prices (e.g. forward contracts on oil). The forward price usually gives a good estimation of the market price in the future (SIDNI, 2002). This dynamic reasserts the concept of fundamental uncertainty allowing us to connect the typical risk-return stand with a dialectical unity of the financial, real sector, and social costs. Ultimately, issues raised in this study relate to the problems of social stability and sustained economic development in the post crisis environment given high frequency and volatility of capital flows. As such, this chapter contributes to the literature that bridges financial empirical analysis with modern socially responsible economic development (Gevorkyan, 2012). 39
  40. 40. 3.1 RESARCH METHODOLOGY Introduction:- This chapter elaborates the entire design of the study and how it was carried out. It also explains how the study was conducted, the area of the study, sample size and sampling technique. It also indicates how the data was collected and analyzed as well as the limitations encountered during the study. Meaning of Research:- Research in general refers to the search of knowledge. One can also define research as a scientific & systematic collection of information. In simple words, research is the careful investigation or enquiry of markets especially through search for new facts in any branch of knowledge. Research is Scientific and systematic search for gaining information and knowledge on a specific topic or phenomena. Research refers to the systematic method consisting of: • Enunciating the problem, • Formulating a hypothesis, • Collecting the fact or data, • Analyzing the facts • Reaching certain conclusions either in the form of solutions towards the concerned problem or in certain generals for some theoretical formulation. 40
  41. 41. Research methodology is a way to systematically solve the research problem. It may be understood as the science of studying how research is done. Research in the common parlance refers to a search for knowledge. OBJECTIVES OF THE STUDY  To know the investors awarenes towards investment in derivative market  To understand the concept of the Derivatives and Derivative Trading.  To know different types of Financial Derivatives.  To know the role of derivatives trading in India. Method of data collection:- Secondary sources:- It is the data which has been collected from many organizations for some other purpose or research study .The data for study has been collected from various sources:  Books  Journals  Magazines  Internet sources Second Phase is Collection of Primary Data and Analysis: After collecting the Secondary data the next phase will be collection of primary data using Questionnaires. The questionnaire will be filled by around 50 people who will be mainly from Panipat region. The sample will consist of people who are employed or work as free lancers dealing in derivative market to know their perception towards investment in derivative market. The data collected will be then entered for analysis of the data collected from the questionnaire. RESEARCH DESIGN 41
  42. 42. Non probability The non –probability respondents have been researched by selecting the persons who do the trading in derivative market. Those persons who do not trade in derivative market have not been interviewed. Exploratory and descriptive research The research is primarily both exploratory and descriptive in nature. The sources of information are both primary and secondary. The secondary data has been taken by referring to various magazines, newspapers, internal sources and internet to get the figures required for the research purposes. The objective of the exploratory research is to gain insights and ideas. The objective of the descriptive research study is typically concerned with determining the frequency with which something occurs. A well structured questionnaire was prepared for the primary research and personal interviews were conducted to collect the responses of the target population. SAMPLING METHODOLOGY Sampling Technique Initially, a rough draft was prepared a pilot study was done to check the accuracy of the Questionnaire and certain changes were done to prepare the final questionnaire to make it more judgmental. Sampling Unit The respondents who were asked to fill out the questionnaire in the Panipat city are the sampling units. These respondents comprise of the persons dealing in derivative market. The people have been interviewed in the open market, in front of the companies, telephonic interviews and through other sources also. Sample Size The sample size was restricted to only 50 respondents. 42
  43. 43. Sampling Area The area of the research was Panipat city. Statistical Tools Used: Simple tools like bar graphs, tabulation, pie charts,chi-square have been used. LIMITAITONS OF STUDY 1. LIMITED TIME: The time available to conduct the study was only 2 months. It being a wide topic, had a limited time. 2. LIMITED RESOURCES: Limited resources are available to collect the information about the derivative trading 3. VOLATALITY: Share market is so much volatile and it is difficult to forecast anything about it whether you trade through online or offline 4. ASPECTS COVERAGE: Some of the aspects may not be covered in my study. Analysis & Interpretation: Q 1. Are you aware about the Derivative Market? TABLE 4.1 Awareness No. of results Yes 53% No 47% 43
  44. 44. 53% 47% 40% 45% 50% 55% YES No Fig.4.1 INTERPRETATION: From this figure we can conclude that 53% people are awared about derivative market And 43% are not awared. Q 2. If yes, are you aware about the various derivative instruments? Table 4.2 Awareness No. of results Yes 45% No 55% 44
  45. 45. 45% 55% 0% 20% 40% 60% YES No Fig.4.2 INTERPRETATION: From this figure we can conclude that only 45% people are awared about derivative instruments and rest of 55% people are not aware about the derivative instrument. Q.3 Education qualification of investors who investing in derivative market? TABLE 4.3 Education No. of Results Under graduate 6 Graduate 10 Post Graduate 23 Professional 11 45
  46. 46. Fig.4.3 INTERPRETATION: From this figure we can conclude that educational qualification of post graduation people are more than undergraduate, professional, as well as graduate. So we can say that post graduate people are more intersting towards investing in derivative market.Q.4 Income range of investors who investing in derivative market. Q.4 Income range of investors who investing in derivative market. TABLE 4.4 Income Range No. of Result Below 1,50,000 1 1,50,000 - 3,00,000 9 3,00,000 - 5,00,000 14 Above 5,00,000 26 46
  47. 47. Fig.4.4 INTERPRETATION: From this figure we can conclude that, Investors who invest in derivative market have an income of above 5,00,000. Q.5 Normally what percentage of your monthly household income could be available for investment? TABLE 4.5 Investment No. of Results Between 5 % to 10 % 2 Between 11 % to 15 % 6 Between 16 % to 20% 13 Between 21 % to 25 % 18 More than 25 % 11 47
  48. 48. Fig.4.5 INTERPRETATION: Investors generally perceive slump in stock market kind of risk while investing in derivative market. So we can analyze that trend of investing in derivative market are low as investments in people. Q6. What is the purpose of investing in derivative market? TABLE 4.6 Purpose of Investment No. of Results Hedge their fund 27 Risk control 9 More stable 1 Direct investment without buying & holding asset 13 48
  49. 49. Fig.4.6 INTERPRETATION: From this figure, we can interpretated that most of investor purpose of investing in derivative market is to hedge their fund for their safety of principal amount, as compare to other things. Q7. You participate in derivative market as : TABLE 4.7 Participation as No. of results Investor 23 Speculator 2 Broker/Dealer 8 Hedger 17 49
  50. 50. Fig.4.7 INTERPRETATION: After examining the views, we can analyze that people generally participate in derivative market as an investor or hedger. Q8. In which of the following would you like to participate? TABLE 4.8 Participate in No. of results Stock index future 19 Stock index options 13 Future on individual stock 6 Currency futures 9 Options on individual stock 3 50
  51. 51. Fig.4.8 INTERPRETATION: From this figure we can analyze that Most of investors participate in stock index futures as compare to currency futures and other available options. Q9. From where you prefer to take advice before investing in derivative market? TABLE 4.9 Advice from No. of results Brokerage houses 15 Research analyst 7 Websites 2 News networks 23 Others 3 51
  52. 52. Fig.4.9 INTERPRETATION: From this figure we can analyze that people generally prefer to take advice from news network before investing in derivative market, as experts are available all the time in news channel to guide them about investing in derivative market at right time. Q10. How often do you invest in derivative market? TABLE 4.10 Invest in No. of times 1-10 times in a year 5 11-50 times 10 More than 50 times 15 Regularly 20 52
  53. 53. Fig.4.10 INTERPRETATION: From this survey we come to know that most of investors make a contract on regular basis as compare to others criteria. Q.11 What kind of risk do you perceive while investing in the stock market? TABLE 4.11 Risk in Stock Market No. of result Uncertainty of returns 19 Slump in stock market 22 Fear of windup of company 6 Others 3 53
  54. 54. Fig.4.11 INTERPRETATION: From the above views we can analyse people are fear of risk as compare to winding up of companies, slump in the market and other reasons. So they have more fear about risk of slump in the market. Q12. Why people do not invest in derivative market? TABLE 4.12 Reasons No. of Results Lack of Knowledge & understanding 27 Increase speculation 2 Risky & highly leveraged 17 Counter party risk 4 54
  55. 55. Fig.4.12 INTERPRETATION: People are generally not investing in derivative market due to lack of knowledge and difficulty in understanding and it is very risky also. Q13. What contract maturity period would interest you for trading in? TABLE 4.13 Maturity Period No. of results 1 Month 15 2 Month 8 3 Month 20 6 Month 3 9 Month 2 12 Month 2 55 No. Of Results Lack of Knowledge & understanding Increase speculation Risky & highly leveraged Counter party risk
  56. 56. Fig.4.13 INTERPRETATION: From the above figure we can interpretate that most of the people make their investment or trade for time period of 3 months to make their risk lower, as it is somewhat easy to predict about 3 months calculation as compare to more than 3 months. Q14. What was the result of your investment? TABLE 4.14 Result of investment No. of result Great results 4 Moderate but acceptable 24 Disappointed 22 56
  57. 57. Fig.4.14 INTERPRETATION: From the above figure we can interpretate that most of the people get return at moderate level, which is acceptable. As more trading have more risk, just need proper survey for more return. Q15. What is best describes the overall approach to invest as a mean of achieving investors goals. TABLE 4.15 OPTIONS No. of result Reality level of stability in overall investment portfolio 17 Increasing investment value while minimizing potential for loss of principle 19 Investment growth with moderate high levels 4 57
  58. 58. of risk Maximum long term returns with high risk 10 Fig.4.15 INTERPRETATION: From the survey, we can conclude that people are more intersting in making investment in derivative market to make their trading regularly and to keep in touch with the market. And also try to minimise the loss of principle amount. Q 16 . How much are you satisfied with investing in derivatives? Options No. of respondent Fully satisfied 26 Satisfied 13 Neutral 5 Dissatisfied 4 Fully disatisfied 2 HYPOTHESIS Null hypothesis (Ho):- There is no significant difference between male and female. 58
  59. 59. Alternate hypothesis (H1):- There is a significant difference between male and female. STATISTICAL ANALYSIS EXPECTED AND OBSERVED RESPONDENT O(observed) E(expected) 17 15.6 7 7.8 2 3 3 2.4 1 1.2 9 10.4 6 5.2 3 2 1 1.6 1 0.8 Chi-Square test or test= CHI-SQUARE TEST Calculated value Degree of freedom(n-1) Tabulated value Chi-square 1.81074 3 9.48 Interpretation:- From the above table it can be interpreted that the calculated value of Chi-Square is less than Tabulated value i.e. 1.81074 < 9.48. The null hypothesis (H0) is accepted in favor of alternate hypothesis and concluded that there is a no significant difference between male and female regarding satisfaction level. 59
  60. 60. 5.1 FINDINGS:-  Most of the investors who invest in derivatives market are post graduate.  Investors who invest in derivative market have a income of above 5,00,000  Investors generally perceive slump in stock market kind of risk while investing in derivative market.  People are generally not investing in derivative market due to lack of knowledge and difficulty in understanding and it is very risky also.  Most of investor purpose of investing in derivative market is to hedge their fund.  People generally participate in derivative market as an investor or hedger. 60
  61. 61.  People generally prefer to take advice from news network before investing in derivative market.  Most of investors participate in stock index futures.  From this survey we come to know that most of investors make a contract of 3 month maturity period.  Investors invest regularly in derivative market.  The result of investment in derivative market is generally moderate but acceptable. 5.2 RECOMMENDATIONS & SUGGESTIONS :-  A knowledge need to be spread concerning the risk and return of the derivative market.  More variation in stock index future need to be made looking a demand side of investors. 61
  62. 62.  RBI should play a greater role in supporting derivatives  There must be more derivative instruments aimed at individual investors.  SEBI should conduct seminars regarding the use of derivatives to educate individual investors. 5.3 CONCLUSION:- My goal in this survey was to gain a better understanding of the use of derivative instruments and the risk management of derivatives activity among Panipat investors. My survey covered investment strategies of the investor in derivatives, risk management, and the market size of the share khan. I conducted a stratified sample of populations across the Panipat, so that we could construct estimates of survey responses for the entire population and not simply for those who chose to answer the survey. 62
  63. 63. Use of Derivative Instruments Overall, my survey suggests that the use of derivatives by investors is widespread, covering all investor categories and sizes. Across the entire sample, 63% of respondents are investing in derivatives. Although derivative use is widespread, it also appears that the intensity of use is not that high. Fewer than half of all our respondents are permitted to use derivatives and only about one-quarter actually hold positions. Even when derivatives are used the positions tend to be small as a percentage of assets. The modal notional value of derivatives as a percent of assets is 1.0%, while the median value is 5.0%. Derivatives are most frequently used in the management of bond, equity and foreign exchange risks, and derivative positions are greater for bonds and foreign exchange than other underlying assets. The Future Overall, investors replied that in general they were satisfied that their usage of derivatives was achieving its intended purpose. Across all investors, 29% predicted that their use of derivatives would increase over the next year. Another 65% replied that their use of derivatives would remain about the same, and only 6%predicted a decrease. Overall; this survey has provided a number of useful indicators of derivatives use and risk management practices across a large range of investors. The use of derivatives appears to vary by size and type of institution. Certain Brokerage firms make much more substantial use of derivatives than do others. Further analysis may reveal which factors influence the likelihood and intensity of derivative use among investors. BIBLIOGRAPHY Books referred:  Options Futures, and other Derivatives by John C Hull  Derivatives FAQ by Ajay Shah  NSE’s Certification in Financial Markets: - Derivatives Core module 63
  64. 64.  Financial Markets & Services by Gordon & Natarajan Reports:  Report of the RBI-SEBI standard technical committee on exchange traded Currency Futures  Regulatory Framework for Financial Derivatives in India by Dr.L.C.GUPTA Websites visited:  www.nse-india.com  www.bseindia.com  www.sebi.gov.in  www.ncdex.com  www.google.com  www.derivativesindia.com ANNEXURE SURVEY QUESTIONNAIRE OF STUDY OF INVESTMENT AWARENESS OF 64
  65. 65. INVESTORS WITH SPECIFIC REFERENCE TO DERIVATIVE Sir/Ma’am, This questionnaire is meant for educational purposes only. The information provided by you will be kept secure and confidential. NAME- __________________________________________________ CONTACT- ______________________________________________ GENDER-________________________________________________ OCCUPATION-___________________________________________ 1. Are you aware about the Derivative Market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Yes <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect No 2.If yes, are you aware about the various derivative instruments? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Yes <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect No 3. Education qualification of investors who investing in derivative market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Undergraduate <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Graduate <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Post Graduate <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Professional Degree Holder 4. Income range of investors who investing in derivative market. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Below 1,50,000 <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 1,50,000 – 3,00,000 <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 3,00,000 – 5,00,000 <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Above 5,00,000 65
  66. 66. 5. Normally what percentage of your monthly household income could be available for investment? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Between 5% to 10% <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Between 11% to 15% <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Between 16% to 20% <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Between 21% to 25% <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect More than 25% 6. What is the purpose of investing in derivative market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Hedge their fund <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Risk control <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect More Suitable <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Direct investment without buying & holding asset 7. You participate in derivative market as: <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Investor <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Speculator <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Broker/Dealer <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Hedger 8. In which of the following would you like to participate? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Stock Index Futures <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Stock Index Options <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Future on individual stock <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Options on individual stock <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Currency futures 9. From where you prefer to take advice before investing in derivative market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Brokerage houses <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Research analyst <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Websites <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect News Networks 66
  67. 67. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Other (Specify) _________________ 10. How often do you invest in derivative market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 1-10 times in a year <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 11-50 times <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect More than 50 times <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Regularly 11. What kind of risk do you perceive while investing in the stock market? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Uncertainty of returns <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Slump in stock market <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Fear of being windup of company <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Other (Specify) _________________ 12. Why people do not invest in derivative market? (Rank your preference 1-4) <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Lack of knowledge and difficulty in understanding <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Increase speculation <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Very risky and highly leveraged instrument <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Counter party risk 13. What contract maturity period would interest you for trading in? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 1 month <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 2 month <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 3 month <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 6 month <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 9 month <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect 12 month 14. What was the result of your investment? 67
  68. 68. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Great results <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Moderate but acceptable <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Disappointed 15. What is best describes the overall approach to invest as a mean of achieving investors goals? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Having a relative level of stability in my overall investment portfolio. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Moderately increasing my investment value while minimizing potential for loss of principal. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Pursue investment growth, accepting moderate to high levels of risk and principal fluctuation. <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Seek maximum long-term returns, accepting maximum risk with principal fluctuation. 16 . How much are you satisfied with investing in derivatives? <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Fully Satisfied <INPUT TYPE= RADIO > MACROBUTTON HTMLDirectSatisfied <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Neutral <INPUT TYPE= RADIO > MACROBUTTON HTMLDirect Dissatisfied <INPUT TYPE= RADIO > MACROBUTTON HTMLDirectFully Dissatisfied 68

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