GP-Ruchit & Jinesh Final

“A Study on Perception of Investors
towards Derivative Market”
___________________________________________________________
Report submitted in complete fulfilment of the requirements of MBA program of
INDUS INSTITUTE OF TECHNOLOGY AND ENGINEERING
SUBMITTED TO:
INDUS INSTITUTE OF TECHNOLOGY & ENGINEERING,
Rancharda, Via Thaltej
Ahmedabad – 382 115
PHONE: 91-2764-260277
SUBMITTED B Y:
JINESH SHAH (097200592053)
RUCHIT SONI (097200592054)
ACKNOWLEDGEMENT
Indus Institute Of Technology & Engineering Page 1

Every successful work is not without the help and support of the people around us.
A success is shared by not an individual but in fact the people who constantly help him and
guide him in his work.
Through this I want to express my gratitude toward all those who have directly or
indirectly contributed in my journey.....
I greatly indebted to MR.VISHAL GOEL & MR. ASHISH JOSHI faculties of
INDUS institute of technology & engineering (MBA), who gave us valuable opportunity of
involving ourselves in such project assignments...
The final project report is submitted to INDUS institute of technology and engineering,
Ahmedabad for partial fulfilment of MBA.
This project is an attempt to study “A Study on Perception of Investors Towards in

Derivative Market” in (Ahmedabad)”

CONTENTS
INDEX PAGE NO.
EXECUTIVE SUMMARY 4
1. Introduction 5
2 Development of derivative market in India 35
3. Research methodology 42
4. Analysis 45
5 .Recommendation & Suggestion 55
6. Conclusion & Bibliography 57
Annexure
a) Questionnaire 59
b) Abbreviations 62
EXECUTIVE SUMMARY

New ideas and innovations have always been the hallmark of progress made by mankind.
At every stage of development, there have been two core factors that drive man to ideas
and innovation. These are increasing returns and reducing risk, in all facets of life. The
financial markets are no different. The endeavour has always been to maximize returns
and minimize risk. A lot of innovation goes into developing financial products centred on
these two factors. It has spawned a whole new area called financial engineering.
Derivatives are among the forefront of the innovations in the financial markets and aim to
increase returns and reduce risk. They provide an outlet for investors to protect
themselves from the vagaries of the financial markets. These instruments have been very
popular with investors all over the world.
Indian financial markets have been on the ascension and catching up with global
standards in financial markets. The advent of screen based trading, dematerialization,
rolling settlement has put our markets on par with international markets.
As a logical step to the above progress, derivative trading was introduced in the country in
June 2000. Starting with index futures, we have made rapid strides and have four types of
derivative products- Index future, index option, stock future and stock options. Today,
there are 30 stocks on which one can have futures and options, apart from the index
futures and options.
This market presents a tremendous opportunity for individual investors .The markets have
performed smoothly over the last two years and has stabilized. The time is ripe for
investors to make full use of the advantage offered by this market.
We have tried to present in a lucid and simple manner, the derivatives market, so that the
individual investor is educated and equipped to become a dominant player in the market.
INTRODUCTION

CHAPTER – 1
A Derivative is a financial instrument whose value depends on other, more basic,
underlying variables. The variables underlying could be prices of traded securities and
stock, prices of gold or copper. Derivatives have become increasingly important in the
field of finance, Options and Futures are traded actively on many exchanges, Forward
contracts, Swap and different types of options are regularly traded outside exchanges by
financial intuitions, banks and their corporate clients in what are termed as over-the-
counter markets – in other words, there is no single market place organized exchanges.
Interpretation.
NEED OF THE STUDY
The study has been done to know the different types of derivatives and also to know the
derivative market in India. This study also covers the recent developments in the
derivative market taking into account the trading in past years.
Through this study I came to know the trading done in derivatives and their use in the
stock markets.
SCOPE OF THE PROJECT
The project covers the derivatives market and its instruments. For better understanding
various strategies with different situations and actions have been given. It includes the
data collected in the recent years and also the market in the derivatives in the recent years.
This study extends to the trading of derivatives done in the National Stock Markets.
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.
A farmer who sowed his crop in June faced uncertainty over the price he would receive
for his harvest in September. In years of scarcity, he would probably obtain attractive
prices. However, during times of oversupply, he would have to dispose off his harvest at a
very low price. Clearly this meant that the farmer and his family were exposed to a high
risk of price uncertainty.
On the other hand, a merchant with an ongoing requirement of grains too would face a
price risk that of having to pay exorbitant prices during dearth, although favourable prices
could be obtained during periods of oversupply. Under such circumstances, it clearly
made sense for the farmer and the merchant to come together and enter into contract
whereby the price of the grain to be delivered in September could be decided earlier.
What they would then negotiate happened to be futures-type contract, which would enable
both parties to eliminate the price 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
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.
The Forwards Contracts (Regulation) Act, 1952, regulates the forward/futures contracts
in commodities all over India. As per this the Forward Markets Commission (FMC)
continues to have jurisdiction over commodity futures contracts. However when
derivatives trading in securities was introduced in 2001, the term “security” in the
Securities Contracts (Regulation) Act, 1956 (SCRA), was amended to include derivative
contracts in securities. Consequently, regulation of derivatives came under the purview of
Securities Exchange Board of India (SEBI). We thus have separate regulatory authorities
for securities and commodity derivative markets.
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.
A contract which derives its value from the prices, or index of prices, of underlying
securities

Figure.1 Types of Derivatives Market
TYPES OF DERIVATIVES MARKET
Exchange Traded Derivatives Over The Counter Derivatives
NSE BSE NCDEX
Index Future Index option Stock option Stock future Interest
TYPES OF DERIVATIVES
Derivatives
Future Option Forward Swaps

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 n o r m a l l y traded outside the exchanges.
The salient features of forward contracts are:
• They are bilateral contracts and hence exposed to counterparty 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.
• 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 t he 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.
• 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.
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.
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.
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 Traded directly between two Traded on the exchanges.

Mechanism parties (not traded on the
exchanges).
Contract Differ from trade to trade. Contracts are standardized contracts.

Specifications
Counter-party Exists. Exists. However, assumed by the clearing

risk corp., which becomes the counter party to all
the trades or unconditionally guarantees their
settlement.
Liquidation Low, as contracts are tailor High, as contracts are standardized exchange
Profile made contracts catering to the traded contracts.
needs of the needs of the parties.
Price Not efficient, as markets are Efficient, as markets are centralized and all
discovery scattered. 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.

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.
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.
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:

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:
BASKETS - Baskets options are option on portfolio of underlying asset. Equity Index
Options are most popular form of baskets.
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.

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.
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.

HISTORY OF DERIVATIVES:
The history of derivatives is quite colourful 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 centralised 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 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 currency futures traded on the IMM are the British
Pound, the Canadian Dollar, the Japanese Yen, the Swiss Franc, the German Mark, the
Australian Dollar, and the Euro dollar. Currency futures were followed soon by interest
rate futures. Interest rate futures contracts were traded for the first time on the CBOT on
October 20, 1975. Stock index futures and options emerged in 1982. 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.

Options are as old as futures. Their history also dates back to ancient Greece and Rome.
Options are very popular with speculators in the tulip craze of seventeenth century
Holland. Tulips, the brightly coloured flowers, were a symbol of affluence; owing to a
high demand, tulip bulb prices shot up. Dutch growers and dealers traded in tulip bulb
options. There was so much speculation that people even mortgaged their homes and
businesses. These speculators were wiped out when the tulip craze collapsed in 1637 as
there was no mechanism to guarantee the performance of the option terms.
The first call and put options were invented by an American financier, Russell Sage, in
1872. These options were traded over the counter. Agricultural commodities options were
traded in the nineteenth century in England and the US. Options on shares were available
in the US on the over the counter (OTC) market only until 1973 without much knowledge
of valuation. A group of firms known as Put and Call brokers and Dealer’s Association
was set up in early 1900’s to provide a mechanism for bringing buyers and sellers
together.
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 Scholes
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.
The most traded stock indices include S&P 500, the Dow Jones Industrial Average, the
Nasdaq 100, and the Nikkei 225. The US indices and the Nikkei 225 trade almost round
the clock. The N225 is also traded on the Chicago Mercantile Exchange.
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 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
Table Chronology of instruments
1991 Liberalisation process initiated
14 December 1995 NSE asked SEBI for permission to trade index futures.
18 November 1996 SEBI setup L.C.Gupta Committee to draft a policy
framework for index futures.
11 May 1998 L.C.Gupta Committee submitted report.
7 July 1999 RBI gave permission for OTC forward rate agreements
(FRAs) and interest rate swaps.
24 May 2000 SIMEX chose Nifty for trading futures and options on an
Indian index.
25 May 2000 SEBI gave permission to NSE and BSE to do index futures
trading.
9 June 2000 Trading of BSE Sensex futures commenced at BSE.
12 June 2000 Trading of Nifty futures commenced at NSE.
25September 2000 Nifty futures trading commenced at SGX.
2 June 2001 Individual Stock Options & Derivatives

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.
Myths and realities about derivatives

In less than three decades of their coming into vogue, derivatives markets have become
the most important markets in the world. Financial derivatives came into the spotlight
along with the rise in uncertainty of post-1970, when US announced an end to the Bretton
Woods System of fixed exchange rates leading to introduction of currency derivatives
followed by other innovations including stock index futures. Today, derivatives have
become part and parcel of the day-to-day life for ordinary people in major parts of the
world. While this is true for many countries, there are still apprehensions about the
introduction of derivatives. There are many myths about derivatives but the realities that
are different especially for Exchange traded derivatives, which are well regulated with all
the safety mechanisms in place.
What are these myths behind derivatives?

• Derivatives increase speculation and do not serve any economic purpose
• Indian Market is not ready for derivative trading
• Disasters prove that derivatives are very risky and highly leveraged instruments

• Derivatives are complex and exotic instruments that Indian investors will find
difficulty in understanding
• Is the existing capital market safer than Derivatives?
Derivatives increase speculation and do not serve any economic purpose

Numerous studies of derivatives activity have led to a broad consensus, both in the private
and public sectors that derivatives provide numerous and substantial benefits to the users.
Derivatives are a low-cost, effective method for users to hedge and manage their
exposures to interest rates, commodity.
Prices or exchange rates. The need for derivatives as hedging tool was felt first in the
commodities market. Agricultural futures and options helped farmers and processors
hedge against commodity price risk. After the fallout of Bretton wood agreement, the
financial markets in the world started undergoing radical changes. This period is marked
by remarkable innovations in the financial markets such as introduction of floating rates
for the currencies, increased trading in variety of derivatives instruments, on-line trading
in the capital markets, etc. As the complexity of instruments increased many folds, the
accompanying risk factors grew in gigantic proportions. This situation led to development
derivatives as effective risk management tools for the market participants.
Looking at the equity market, derivatives allow corporations and institutional investors to
effectively manage their portfolios of assets and liabilities through instruments like stock
index futures and options. An equity fund, for example, can reduce its exposure to the
stock
Market quickly and at a relatively low cost without selling off part of its equity assets by
using stock index futures or index options.
By providing investors and issuers with a wider array of tools for managing risks and
raising capital, derivatives improve the allocation of credit and the sharing of risk in the
global economy, lowering the cost of capital formation and stimulating economic growth.
Now that world markets for trade and finance have become more integrated, derivatives

have strengthened these important linkages between global markets increasing market
liquidity and efficiency and facilitating the flow of trade and finance.
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:
PRE-REQUISITES INDIAN SCENARIO

Large market India is one of the largest market-capitalised countries in
Capitalisation Asia with a market capitalisation of more than Rs.765000
crores.
High Liquidity in the The daily average traded volume in Indian capital market
underlying today is around 7500 crores. Which means on an average
every month 14% of the country’s Market capitalisation
gets traded. These are clear indicators of high liquidity in
the underlying.
Trade guarantee The first clearing corporation guaranteeing trades has
become fully functional from July 1996 in the form of
National Securities Clearing Corporation (NSCCL).
NSCCL is responsible for guaranteeing all open positions
on the National Stock Exchange (NSE) for which it does
the clearing.
A Strong Depository National Securities Depositories Limited (NSDL) which
started functioning in the year 1997 has revolutionalised
the security settlement in our country.
A Good legal guardian In the Institution of SEBI (Securities and Exchange Board
of India) today the Indian capital market enjoys a strong,
independent, and innovative legal guardian who is helping
the market to evolve to a healthier place for trade
practices.

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 upto Rs.400 in 1 month, one can buy a 1
month future of Reliance at Rs 350 and make profits
• 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.
Comparison of New System with Existing System

Many people and brokers in India think that the new system of Futures & Options and
banning of Badla 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.
The figure 3.3a –3.3d shows how advantages of new system (implemented from June
2001) v/s the old system i.e. before June 2001
New System Vs Existing System for Market Players.
Figure
Speculators
Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize
1) Deliver based 1) Both profit & 1)Buy &Sell stocks 1)Maximum
Trading, margin loss to extent of on delivery basis loss possible
trading& carry price change. 2) Buy Call &Put to premium
forward transactions. by paying paid
2) Buy Index Futures premium
hold till expiry.
Advantages
• Greater Leverage as to pay only the premium.
• Greater variety of strike price options at a given time.
Figure
Arbitrageurs

Existing SYSTEM New

1) Buying Stocks in 1) Make money 1) B Group more 1) Risk free
one and selling in whichever way the promising as still game.
another exchange. Market moves. in weekly settlement
forward transactions. 2) Cash &Carry
2) If Future Contract arbitrage continues
more or less than Fair price
• Fair Price = Cash Price + Cost of Carry.
Figure
Hedgers
Existing SYSTEM New

1) Difficult to 1) No Leverage 1)Fix price today to buy 1) Additional
offload holding available risk latter by paying premium. cost is only
during adverse reward dependant 2)For Long, buy ATM Put premium.
market conditions on market prices Option. If market goes up,
as circuit filters long position benefit else
limit to curtail losses. exercise the option.
3)Sell deep OTM call option
With underlying shares, earn
Premium + profit with increase price
Figure
Small Investors
Existing SYSTEM New

1) If Bullish buy 1) Plain Buy/Sell 1) Buy Call/Put options 1) Downside
stocks else sell it. implies unlimited based on market outlook remains
profit/loss. 2) Hedge position if protected &
holding underlying upside
stock unlimited.
Advantages
• Losses Protected.
Exchange-traded vs. OTC derivatives markets
The OTC derivatives markets have witnessed rather sharp growth over the last few years,
which has accompanied the modernization of commercial and investment banking and
globalisation 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:
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.
Some of the features of OTC derivatives markets embody risks to financial market
stability.
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 associated with OTC derivatives, and their dependence on
exchange traded derivatives, Indian law considers them illegal.
FACTORS CONTRIBUTING TO THE GROWTH OF DERIVATIVES:

Factors contributing to the explosive growth of derivatives are price volatility,
globalisation 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 persons 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.
Prices are generally determined by market forces. In a market, consumers have ‘demand’
and producers or suppliers have ‘supply’, and the collective interaction of demand and
supply in the market determines the price. These factors are constantly interacting in the
market causing changes in the price over a short period of time. Such changes in the price
are known as ‘price volatility’. This has three factors: the speed of price changes, the
frequency of price changes and the magnitude of price changes.
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 break down of the BRETTON WOODS agreement
brought and end to the stabilising role of fixed exchange rates and the gold convertibility
of the dollars. The globalisation of the markets and rapid industrialisation 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.

These price volatility risks pushed the use of derivatives like futures and options
increasingly as these instruments can be used as hedge to protect against adverse price
changes in commodity, foreign exchange, equity shares and bonds.
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 globalisation has increased the size of
markets and as greatly enhanced competition .it has benefited consumers who cannot
obtain better quality goods at a lower cost. It has also exposed the modern business to
significant risks and, in many cases, led to cut profit margins
In Indian context, south East Asian currencies crisis of 1997 had affected the
competitiveness of our products vis-à-vis depreciated currencies. Export of certain goods
from India declined because of this crisis. Steel industry in 1998 suffered its worst set
back due to cheap import of steel from south East Asian countries. Suddenly blue chip
companies had turned in to red. The fear of china devaluing its currency created
instability in Indian exports. Thus, it is evident that globalisation of industrial and
financial activities necessitates use of derivatives to guard against future losses. This
factor alone has contributed to the growth of derivatives to a significant extent.
C.} TECHNOLOGICAL ADVANCES –

A significant growth of derivative instruments has been driven by technological break
through. 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 world wide conferencing, Data transmission by
satellite. At the same time there were significant advances in software programmes
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.
Although price sensitivity to market forces is beneficial to the economy as a whole
resources are rapidly relocated to more productive use and better rationed overtime the
greater price volatility exposes producers and consumers to greater price risk. The effect
of this risk can easily destroy a business which is otherwise well managed. Derivatives
can help a firm manage the price risk inherent in a market economy. To the extent the
technological developments increase volatility, derivatives and risk management products
become that much more important.
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.
The above factors in combination of lot many factors led to growth of derivatives
instruments
BENEFITS OF DERIVATIVES
Derivative markets help investors in many different ways:
1.] 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.
2.] PRICE DISCOVERY –

Price discovery refers to the markets 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. Accurate prices are essential for ensuring the correct allocation of
resources in a free market economy. Options markets provide information about the
volatility or risk of the underlying asset.
3.] 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.
4.] 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.
5.] 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.

CHAPTER – 2
DEVELOPMENT OF DERIVATIVES MARKET IN INDIA
The first step towards introduction of derivatives trading in India was the promulgation of
the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on
options in securities. The market for derivatives, however, did not take off, as there was
no regulatory framework to govern trading of derivatives. SEBI set up a 24–member
committee under the Chairmanship of Dr.L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India. The committee
submitted its report on March 17, 1998 prescribing necessary pre–conditions for
introduction of derivatives trading in India. The committee recommended that derivatives
should be declared as ‘securities’ so that regulatory framework applicable to trading of
‘securities’ could also govern trading of securities. SEBI also set up a group in June 1998
under the Chairmanship of Prof.J.R.Varma, to recommend measures for risk containment
in derivatives market in India. The report, which was submitted in October 1998, worked
out the operational details of margining system, methodology for charging initial margins,
broker net worth, deposit requirement and real–time monitoring requirements. The
Securities Contract Regulation Act (SCRA) was amended in December 1999 to include
derivatives within the ambit of ‘securities’ and the regulatory framework were developed
for governing derivatives trading. The act also made it clear that derivatives shall be legal
and valid only if such contracts are traded on a recognized stock exchange, thus
precluding OTC derivatives. The government also rescinded in March 2000, the three
decade old notification, which prohibited forward trading in securities. Derivatives
trading commenced in India in June 2000 after SEBI granted the final approval to this
effect in May 2001. SEBI permitted the derivative segments of two stock exchanges, NSE
and BSE, and their clearing house/corporation to commence trading and settlement in
approved derivatives contracts. To begin with, SEBI approved trading in index futures
contracts based on S&P CNX Nifty and BSE–30 (Sense) index. This was followed by

approval for trading in options based on these two indexes and options on individual
securities.
The trading in BSE Sensex options commenced on June 4, 2001 and the trading in options
on individual securities commenced in July 2001. Futures contracts on individual stocks
were launched in November 2001. The derivatives trading on NSE commenced with S&P
CNX Nifty Index futures on June 12, 2000. The trading in index options commenced on
June 4, 2001 and trading in options on individual securities commenced on July 2, 2001.
Single stock futures were launched on November 9, 2001. The index futures and options
contract on NSE are based on S&P CNX Trading and settlement in derivative contracts is
done in accordance with the rules, byelaws, and regulations of the respective exchanges
and their clearing house/corporation duly approved by SEBI and notified in the official
gazette. Foreign Institutional Investors (FIIs) are permitted to trade in all Exchange traded
derivative products.
The following are some observations based on the trading statistics provided in the NSE
report on the futures and options (F&O):
• Single-stock futures continue to account for a sizable proportion of the F&O

segment. It constituted 70 per cent of the total turnover during June 2002. A primary
reason attributed to this phenomenon is that traders are comfortable with single-stock
futures than equity options, as the former closely resembles the erstwhile badla system.
• On relative terms, volumes in the index options segment continue to remain poor.
This may be due to the low volatility of the spot index. Typically, options are considered
more valuable when the volatility of the underlying (in this case, the index) is high. A
related issue is that brokers do not earn high commissions by recommending index
options to their clients, because low volatility leads to higher waiting time for round-trips.
• Put volumes in the index options and equity options segment have increased since
January 2002. The call-put volumes in index options have decreased from 2.86 in January

2002 to 1.32 in June. The fall in call-put volumes ratio suggests that the traders are
increasingly becoming pessimistic on the market.
• Farther month futures contracts are still not actively traded. Trading in equity
options on most stocks for even the next month was non-existent.
• Daily option price variations suggest that traders use the F&O segment as a less
risky alternative (read substitute) to generate profits from the stock price movements. The
fact that the option premiums tail intra-day stock prices is evidence to this. If calls and
puts are not looked as just substitutes for spot trading, the intra-day stock price variations
should not have a one-to-one impact on the option premiums.
• The spot foreign exchange market remains the most important segment but the
derivative segment has also grown. In the derivative market foreign exchange
swaps account for the largest share of the total turnover of derivatives in India
followed by forwards and options. Significant milestones in the development of
derivatives market have been (i) permission to banks to undertake cross currency
derivative transactions subject to certain conditions (1996) (ii) allowing corporates to
undertake long term foreign currency swaps that contributed to the development
of the term currency swap market (1997) (iii) allowing dollar rupee options (2003)
and (iv) introduction of currency futures (2008). I would like to emphasise that
currency swaps allowed companies with ECBs to swap their foreign currency
liabilities into rupees. However, since banks could not carry open positions the risk
was allowed to be transferred to any other resident corporate. Normally such risks
should be taken by corporates who have natural hedge or have potential foreign
exchange earnings. But often corporate assume these risks due to interest rate
differentials and views on currencies.
This period has also witnessed several relaxations in regulations relating to forex
markets and also greater liberalisation in capital account regulations leading to
greater integration with the global economy.

• Cash settled exchange traded currency futures have made foreign currency a
separate asset class that can be traded without any underlying need or exposure a n d
on a leveraged basis on the recognized stock exchanges with credit risks being
assumed by the central counterparty
Since the commencement of trading of currency futures in all the three exchanges, the
value of the trades has gone up steadily from Rs 17, 429 crores in October 2008 to Rs
45, 803 crores in December 2008. The average daily turnover in all the exchanges
has also increased from Rs871 crores to Rs 2,181 crores during the same period. The
turnover in the currency futures market is in line with the international scenario,
where I understand the share of futures market ranges between 2 – 3 per cent.
National Exchanges
In enhancing the institutional capabilities for futures trading the idea of setting up
of National Commodity Exchange(s) has been pursued since 1999. Three such
Exchanges, viz, National Multi-Commodity Exchange of India Ltd., (NMCE),
Ahmedabad, National Commodity & Derivatives Exchange (NCDEX), Mumbai, and
Multi Commodity Exchange (MCX), Mumbai have become operational. “National
Status” implies that these exchanges would be automatically permitted to conduct futures
trading in all commodities subject to clearance of byelaws and contract specifications by
the FMC. While the NMCE, Ahmedabad commenced futures trading in November 2002,
MCX and NCDEX, Mumbai commenced operations in October/ December 2003
respectively.
MCX
MCX (Multi Commodity Exchange of India Ltd.) an independent and de-
mutualised multi commodity exchange has permanent recognition from Government of
India for facilitating online trading, clearing and settlement operations for commodity
futures markets across the country. Key shareholders of MCX are Financial Technologies
(India) Ltd., State Bank of India, HDFC Bank, State Bank of Indore, State Bank of
Hyderabad, State Bank of Saurashtra, SBI Life Insurance Co. Ltd., Union Bank of India,

Bank of India, Bank of Baroda, Canera Bank, Corporation Bank
Headquartered in Mumbai, MCX is led by an expert management team with deep

domain knowledge of the commodity futures markets. Today MCX is offering spectacular
growth opportunities and advantages to a large cross section of the participants including
Producers / Processors, Traders, Corporate, Regional Trading Canters, Importers,
Exporters, Cooperatives, Industry Associations, amongst others MCX being nation-wide
commodity exchange, offering multiple commodities for trading with wide reach and
penetration and robust infrastructure.
MCX, having a permanent recognition from the Government of India, is an

independent and demutualised multi commodity Exchange. MCX, a state-of-the-art
nationwide, digital Exchange, facilitates online trading, clearing and settlement operations
for a commodities futures trading.
NMCE
National Multi Commodity Exchange of India Ltd. (NMCE) was promoted by
Central Warehousing Corporation (CWC), National Agricultural Cooperative Marketing
Federation of India (NAFED), Gujarat Agro-Industries Corporation Limited (GAICL),
Gujarat State Agricultural Marketing Board (GSAMB), National Institute of Agricultural
Marketing (NIAM), and Neptune Overseas Limited (NOL). While various integral
aspects of commodity economy, viz., warehousing, cooperatives, private and public sector
marketing of agricultural commodities, research and training were adequately addressed
in structuring the Exchange, finance was still a vital missing link. Punjab National Bank
(PNB) took equity of the Exchange to establish that linkage. Even today, NMCE is the
only Exchange in India to have such investment and technical support from the
commodity relevant institutions.
NMCE facilitates electronic derivatives trading through robust and tested trading
platform, Derivative Trading Settlement System (DTSS), provided by CMC. It has robust
delivery mechanism making it the most suitable for the participants in the physical

commodity markets. It has also established fair and transparent rule-based procedures and
demonstrated total commitment towards eliminating any conflicts of interest. It is the only
Commodity Exchange in the world to have received ISO 9001:2000 certification from
British Standard Institutions (BSI). NMCE was the first commodity exchange to provide
trading facility through internet, through Virtual Private Network (VPN).
NMCE follows best international risk management practices. The contracts are
marked to market on daily basis. The system of upfront margining based on Value at Risk
is followed to ensure financial security of the market. In the event of high volatility in the
prices, special intra-day clearing and settlement is held. NMCE was the first to initiate
process of dematerialization and electronic transfer of warehoused commodity stocks. The
unique strength of NMCE is its settlements via a Delivery Backed System, an imperative
in the commodity trading business. These deliveries are executed through a sound and
reliable Warehouse Receipt System, leading to guaranteed clearing and settlement.
NCDEX
National Commodity and Derivatives Exchange Ltd (NCDEX) is a technology driven
commodity exchange. It is a public limited company registered under the Companies Act,
1956 with the Registrar of Companies, Maharashtra in Mumbai on April 23,2003. It has
an independent Board of Directors and professionals not having any vested interest in
commodity markets. It has been launched to provide a world-class commodity exchange
platform for market participants to trade in a wide spectrum of commodity derivatives
driven by best global practices, professionalism and transparency.
Forward Markets Commission regulates NCDEX in respect of futures trading in

commodities. Besides, NCDEX is subjected to various laws of the land like the
Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and
various other legislations, which impinge on its working. It is located in Mumbai and
offers facilities to its members in more than 390 centres throughout India. The reach will
gradually be expanded to more centres.

NCDEX currently facilitates trading of thirty six commodities - Cashew, Castor
Seed, Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake, Crude Palm Oil, Expeller
Mustard Oil, Gold, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Mild Steel
Ingot, Mulberry Green Cocoons, Pepper, Rapeseed - Mustard Seed ,Raw Jute, RBD
Palmolein, Refined Soy Oil, Rice, Rubber, Sesame Seeds, Silk, Silver, Soy Bean, Sugar,
Tur, Turmeric, Urad (Black Matpe), Wheat, Yellow Peas, Yellow Red Maize &
Yellowsoyabean meal.
OBJECTIVES OF THE STUDY
 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.
 To analyse the performance of Derivatives Trading since 2001with special reference

to Future & Option
 To know the investors perception towards investment in derivative market in

Ahmedabad

CHAPTER – 3
RESEARCH METHODOLOGY
Method of data collection:-

Secondary sources:-
It is the data which has already been collected by some one or an organization 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 100 people who will be
mainly from Ahmedabad. 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 into MS Excel for analysis of
the data collected from the questionnaire.
RESEARCH DESIGN
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.
Descriptive research
The research is 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 research is to gain insights and ideas. A well structured
questionnaire was prepared for the primary research to collect the responses of the target
population.
SAMPLING METHODOLOGY
The methodology used in our project was convenient sampling.
Sampling Unit

The respondents who were asked to fill out the questionnaire in Ahmedabad: are the
sampling units. These respondents comprise of the persons dealing in derivative market.
Sample Size
The sample size was restricted to only 100 respondents.
Sampling Area
The area of the research was Ahmedabad.
Time:
2 months
Statistical Tools Used:

• Simple tools like bar graphs
• Tabulation,
• Line diagrams

CHAPTER - 4
ANALYSIS

Q.1 Education qualification of investors who investing in derivative market.
Education No. of result

Under graduate 12
Graduate 20
Post graduate 46
Professional 22
Q.2 Income range of investors who investing in derivative market.

Income range No. of Result
below 1,50,000 2
1,50,000-3,00,000 18
3,00,000-5,00,000 28
above 5,00,000 52

Q. 3 Normally what percentage of your monthly household income could be available
for investment
Investment No. of
result
Between 5% to 10% 4
Between 11% to 15% 12
More than 25% 22

Q. 4 What is your primary investment purpose?
Investment Purpose No. of

result
Retirement planning 45
Building up a corpus for 10
charity
Future education of 40
children
Others 5

Q. 5 what kind of risk do you perceive while investing in the stock market?
Risk in stock market No. of

result
Uncertainty of returns 38
Slump in stock market 44
Fear of windup of company 12
Others 6
Q.6 Why people do not invest in derivative market?

Reasons No.of result
Lack of knowledge & 54
understanding
Increase speculation 4
Risky & highly leveraged 34
Counter party risk 8

Q.7 What is the purpose of investing in derivative market?
Purpose of investment No. of

Result
Hedge their fund 34
Risk control 18
More stable 2
Direct investment without buying & holding 26
assets

Q.8 You participate in derivative market as
Participation as No. of
Result
investor 46
Speculator 4
Broker/Dealer 16
Hedger 34
Q.9 From where you prefer to take advice before investing in derivative market?
Advice From No. of

Result
Brokerage houses 30
Research analyst 14
Websites 4
News Networks 46
Others 6

Q. 10 In which of the following would you like to participate?
Participate in No. of Result

Stock index futures 38
Stock index Options 26
Future on individual 12
stock
Currency futures 18
Options on individual 6
stock
Q. 11 What was the result of your investment?

Result of No. of
investment result
Great results 8
Moderate but 48
acceptable
Disappointed 44
Q.12 What is best describes the overall approach to invest as a mean of achieving
investors goals.
OPTIONS NO. of
Result
Relative level of stability in overall investment portfolio 34
Increasing investment value while minimizing potential for loss of principal 38
Investment growth with moderate high levels of risk 8
Maximum long term returns with high risk 20

CHAPTER – 5
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.
• 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.

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 were available to collect the information about the commodity
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.

CHAPTER – 6
Conclusion
 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 a investor or hedger.
 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.

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
 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 INVESTORS FOR

PERCEPTION TOWARDS INVESTMENT IN DERIVATIVE MARKET
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. Educational Qualification
<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
2. Income Range:
<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
3. 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 More than 25%
4. What is your primary investment purpose?
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Retirement Planning
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Building up a corpus for
charity donations
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Supporting future
education of your children

<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Other (Specify)
_____________________
5. 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) _________________
6. 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
7. What is the purpose of investing in derivative market?

<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect To hedge their fund
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Risk control
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect More stable
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Direct investment without
buying and holding assets
8. 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
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
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Other (Specify)
_________________
10. 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
11. Which of the following statements best describes your overall approach to invest as a
mean of achieving your 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.
12. What was the result of your investment?

<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Great results
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Moderate but acceptable
<INPUT TYPE=\ RADIO > MACROBUTTON HTMLDirect Disappointed

ABBREVATIONS
A
AMEX- America Stock Exchange
B
BSE- Bombay Stock Exchange
BSI- British Standard Institute
C
CBOE - Chicago Board options Exchange
CBOT - Chicago Board of Trade
CEBB - Chicago Egg and Butter Board
CME - Chicago Mercantile Exchange
CNX- Crisil Nse 50 Index
CPE - Chicago Produce Exchange
CWC- Central Warehousing Corporation
D
DTSS- Derivative Trading Settlement System
F
FIIs- Foreign Institutional Investors

F & O – Future and Options
FMC- Forward Markets Commission
FRAs- Forward Rate Agreements
G
GAICL-Gujarat Agro Industries Corporation Limited
GSAMB- Gujarat State Agricultural Marketing Board
I
IMM - International Monetary Market
IPSTA- India Pepper & Spice Trade Association
M
MCX – Multi Commodity Exchange
N
NAFED-National Agricultural Co-Operative Marketing Federation Of India
NCDEX – National Commodities and Derivatives Exchange
NIAM- National Institute Of Agricultural Marketing
NMSE- National Multi Commodity Exchange
NOL- Neptune Overseas Limited
NSCCL- National Securities Clearing Corporation
NSDL- National Securities Depositories Limited
NSE - National Stock Exchange
O
OTC- Over The Counter
P
PHLX - Philadelphia Stock Exchange
PNB- Punjab National Bank
R
RBI- Reserve Bank Of India
S
SC(R) A - Securities Contracts (Regulation) Act, 1956

SEBI- Securities Exchange Board Of India
SGX- Singapore Stock Exchange
SIMEX - Singapore International Monetary Exchange
V
VPN- Virtual Private Network

GP-Ruchit &amp; Jinesh Final

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“A Study on Perception of Investors

towards Derivative Market”

Indus Institute Of Technology & Engineering Page 1

This project is an attempt to study “A Study on Perception of Investors Towards in

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INDEX PAGE NO.

2 Development of derivative market in India 35

5 .Recommendation & Suggestion 55

6. Conclusion & Bibliography 57

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NEED OF THE STUDY

SCOPE OF THE PROJECT

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Exchange Traded Derivatives Over The Counter Derivatives

NSE BSE NCDEX

Index Future Index option Stock option Stock future Interest

Future Option Forward Swaps

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A forward contract is an agreement to buy or sell an asset on a specified date for a

The salient features of forward contracts are:

• They are bilateral contracts and hence exposed to counterparty risk.

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BASIC FEATURES OF FUTURE CONTRACT

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at time to maturity by the rate of risk-free return .

In the case where the forward price is higher:

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FEATURES FORWARD CONTRACT FUTURE CONTRACT

Operational Traded directly between two Traded on the exchanges.

Contract Differ from trade to trade. Contracts are standardized contracts.

Counter-party Exists. Exists. However, assumed by the clearing

Examples Currency market in India. Commodities, futures, Index Futures and

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LEAPS - Normally option contracts are for a period of 1 to 12 months. However,

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INDIAN DERIVATIVES MARKET

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Myths and realities about derivatives

What are these myths behind derivatives?

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Derivatives increase speculation and do not serve any economic purpose

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Indian Market is not ready for derivative trading

PRE-REQUISITES INDIAN SCENARIO

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Derivatives will find use for the following set of people:

Comparison of New System with Existing System

Existing SYSTEM New

Indus Institute Of Technology & Engineering Page 25

Approach Peril &Prize Approach Peril &Prize

• Fair Price = Cash Price + Cost of Carry.

Existing SYSTEM New

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Existing SYSTEM New

GP-Ruchit & Jinesh Final

GP-Ruchit & Jinesh Final