(FOLLOWING SHOULD BE MENTIONED ON BLACK COVER PAGE) A PROJECT REPORT ON TITLE OF THE PROJECT

SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR MASTERs DEGREE IN HUMAN RESOURCES DEVELOPMENT MANAGEMENT FOR MASTERs DEGREE IN MARKETING MANAGEMENT FOR MASTERs DEGREE IN FINANCIAL MANAGEMENT TO UNIVERSITY OF MUMBAI BY FULL NAME OF THE STUDENT ROLL NO. 2009-2012 UNDER THE GUIDANCE OF DR. / PROF.

LALA LAJPATRAI INSTITUTE OF MANAGEMENT MAHALAXMI, MUMBAI 400 034

A PROJECT REPORT ON Indian Derivative Market

SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR FOR MASTERs DEGREE IN FINANCIAL MANAGEMENT TO UNIVERSITY OF MUMBAI

BY Sangeeta Sanil 45. 2009-2012 UNDER THE GUIDANCE OF PROF. Avani Pramod

LALA LAJPATRAI INSTITUTE OF MANAGEMENT MAHALAXMI, MUMBAI 400 034

DECLARATION I hereby declare that this dissertation submitted in partial fulfilment of the requirement for the award of MASTERs DEGREE IN FINANCIAL MANAGEMENT(MMM/MFM/MHRDM) of the University of Mumbai is my original work and has not been submitted for award of any other degree or diploma fellowship or other similar title or prizes. I further certify that I have no objection and grant the rights to LLIM to publish any chapter or project if they deem fit in journals or magazines and newspaper etc. without my permission.

Sangeeta Sanil Kuppa CLASS: MFM III SEM I BATCH: 2009-2012 ROLL NO.:45 DATE: PLACE: MUMBAI

SIGNATURE (Sangeeta Sanil)

PROJECT GUIDE CERTIFICATE FORM I Mr. /Ms. (Full Name of the Student), the undersigned Roll No. _________ studying in the Third Year of MHRDM /MMM / MFM is doing my project work under the guidance of Dr./ Prof. ___________________________ wish to state that I have met my internal guide on the following dates mentioned below for Project Guidance:-

SR. NO.

DATE

SIGNATURE OF THE INTERNAL GUIDE

______________________ Signature of the Candidate

__________________________ Signature of Internal Guide

Certificate This is to certify that the dissertation submitted in partial fulfillment of the requirement for the award of MHRDM /MMM / MFM of the University of Mumbai is a result of the bonafide work carried out by Ms. / Mr._________________________ under my supervision and guidance. No part of this report has been submitted for award of any other degree, diploma fellowship or other similar titles or prizes. The work has also not been published in any scientific journals/ magazines.

DATE: 08th October 2011 PLACE: MUMBAI

NAME: ROLL NO.:

-----------------------------Dr. V. B. Angadi (Director, LLIM)

--------------------------Dr. /Prof __________ (Project Guide)

ACKNOWLEDGEMENT This project has been a great learning experience for m I take thi opportunity to t ank Dr. / e. s h Prof. Avani Pramod, m internal projectguide whose valuable guid y ance & suggestions made this project possible. I am extremely thankful t him/her or his/her s o f upport. He/She has encouraged me and channelized my enthusiasm effectively. I express my heart-felt gratitude towa my parents, siblings nd all those friends who have rds a willingly and with utmost commitment helped me during the cour e of my project work. s I also express my profound gratitude to Dr. Angadi, Director of Lala Lajpatrai Institute of Management for givi g me t e opportunity to work on th project and br aden my knowledge and n h e o experience. My sincere thanks to Prof. Arati Kale for her valuable guidance and advice in completing this project. I would like to t ank all the professors and the staff of la Lajpatrai Institute especially the h La Library staff who were ver y helpful in providing books and articles I needed for my project. Last but not the least, I am thankful to all those who indirectly extended their co-operation and invaluable support to me.

EXECUTIVE SUMMARY Firstly I am briefing the current Indian market and comparing it with it past. I am also giving brief data about foreign market. Then at the last I am giving my suggestions and recommendations. With over 25 million shareholders, India has the third largest investor base in the world after USA and Japan. Over 7500 companies are listed on the Indian stock exchanges (more than the number of companies listed in developed markets of Japan, UK, Germany, France, Australia, Switzerland, Canada and Hong Kong.). The Indian capital market is significant in terms of the degree of development, volume of trading, transparency and its tremendous growth potential. Indias market capitalization was the highest among the emerging markets. Total market capitalization of The Bombay Stock Exchange (BSE), which, as on July 31, 1997, was US$ 175 billion has grown by 37.5% percent every twelve months and was over US$ 834 billion as of January, 2007. Bombay Stock Exchanges (BSE), one of the oldest in the world, accounts for the largest number of listed companies transacting their shares on a nationwide online trading system. The two major exchanges namely the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked no. 3 & 5 in the world, calculated by the number of daily transactions done on the exchanges. The Total Turnover of Indian Financial Markets crossed US$ 2256 billion in 2006 An increase of 82% from US $ 1237 billion in 2004 in a short span of 2 years only. Turnover in the Spot and Derivatives segment both in NSE & BSE was higher by 45% into 2006 as compared to 2005. With daily average volume of US $ 9.4 billion, the Sensex has posted excellent returns in the recent years. Derivatives trading in the stock market have been a subject of enthusiasm of research in the field of finance the most desired instruments that allow market participants to manage risk in the modern securities trading are known as derivatives. The derivatives are defined as the future contracts whose value depends upon the underlying assets. If derivatives are introduced in the stock market, the underlying asset may be anything as component of stock market like, stock prices or market indices, interest rates, etc. The main logic

behind derivatives trading is that derivatives reduce the risk by providing an additional channel to invest with lower trading cost and it facilitates the investors to extend their settlement through the future contracts. It provides extra liquidity in the stock market. Derivatives are assets, which derive their values from an underlying asset. These underlying assets are of various categories like Commodities including grains, coffee beans, etc. Precious metals like gold and silver. Foreign exchange rate. Bonds of different types, including medium to long-term negotiable debt securities issued by governments, companies, etc. Short-term debt securities such as T-bills. Over-The-Counter (OTC) money market products such as loans or deposits. Equities For example, a dollar forward is a derivative contract, which gives the buyer a right & an obligation to buy dollars at some future date. The prices of the derivatives are driven by the spot prices of these underlying assets. However, the most important use of derivatives is in transferring market risk, called Hedging, which is a protection against losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very important tool of risk management.

There are various derivative products traded. They are; 1. Forwards 2. Futures 3. Options 4. Swaps A Forward Contract is a transaction in which the buyer and the seller agree upon a delivery of a specific quality and quantity of asset usually a commodity at a specified future date. The price may be agreed on in advance or in future.

A Future contract is a firm contractual agreement between a buyer and seller for a specified as on a fixed date in future. The contract price will vary according to the market place but it is fixed when the trade is made. The contract also has a standard specification so both parties know exactly what is being done. An Options contract confers the right but not the obligation to buy (call option) or sell (put option) a specified underlying instrument or asset at a specified price the Strike or Exercised price up until or an specified future date the Expiry date. The Price is called Premium and is paid by buyer of the option to the seller or writer of the option. A call option gives the holder the right to buy an underlying asset by a certain date for a certain price. The seller is under an obligation to fulfill the contract and is paid a price of this, which is called "the call option premium or call option price". A put option, on the other hand gives the holder the right to sell an underlying asset by a certain date for a certain price. The buyer is under an obligation to fulfill the contract and is paid a price for this, which is called "the put option premium or put option price". 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

I had conducted this research to find out whether investing in the derivative market is beneficial or not? You will be glad to know that derivative market in India is the most booming now days. So the person who is ready to take risk and want to gain more should invest in the derivative market. On the other hand RBI has to play an important role in derivative market. Also SEBI must encourage investment in derivative market so that the investors get the benefit out of it. Sorry to say that today even educated persons are not willing to invest in derivative market because they have the fear of high risk. So, SEBI should take necessary steps for improvement in Derivative Market so that more investors can invest in Derivative market.

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INTRODUCTION

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 or organized exchanges.

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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.

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LITERATURE REVIEW The emergence of the market for derivative 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. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. Derivative products initially emerged, as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. The financial derivatives came into spotlight in post-1970 period due to growing instability in the financial markets. However, since their emergence, these products have become very popular and by 1990s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously both in terms of variety of instruments available, their complexity and also turnover. In the class of equity derivatives, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indices with various portfolios and ease of use. The lower costs associated with index derivatives visvis derivative products based on individual securities is another reason for their growing use. As in the present scenario, Derivative Trading is fast gaining momentum, I have chosen this topic

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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 Futures & Options

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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.

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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 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.

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HISTORY OF THE STOCK BROKING INDUSTRY Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years ago. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as "The Stock Exchange"). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated. Thus in the same way, gradually with the passage of time number of exchanges were increased and at currently it reached to the figure of 24 stock exchanges. This was followed by the formation of associations /exchanges in Ahmadabad (1894), Calcutta (1908), and Madras (1937). In order to check such aberrations and promote a more orderly development of the stock market, the central government introduced a legislation called the Securities Contracts (Regulation) Act, 1956. Under this legislation, it is mandatory on the part of stock exchanges to seek government recognition. As of January 2002 there were 23 stock exchanges recognized by the central Government. They are located at Ahmadabad, Bangalore, Baroda, Bhubaneswar, Calcutta, Chennai,(the Madras stock Exchanges ), Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana, Mangalore, Mumbai(the National Stock Exchange or NSE), Mumbai (The Stock Exchange), popularly called the Bombay Stock Exchange, Mumbai (OTCExchange of India), Mumbai (The Inter-connected Stock Exchange of India), Patna, Pune, and Rajkot. Of course, the principle bourses are the National Stock Exchange and The Bombay Stock Exchange, accounting for the bulk of the business done on the Indian stock market.

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BSE (BOMBAY STOCK EXCHANGE) The Stock Exchange, Mumbai, popularly known as "BSE" was established in 1875 as "The Native Share and Stock Brokers Association". It is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was established in 1878. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. of India under the Securities Contracts (Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides the policies and regulates the affairs of the Exchange. The Governing Board consists of 9 elected directors, who are from the broking comm. Unity (one third of them retire ever year by rotation), three SEBI nominees, six public representatives and an Executive Director & Chief Executive Officer and a Chief Operating Officer.

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NSE (NATIONAL STOCK EXCHANGE) NSE was incorporated in 1992 and was given recognition as a stock exchange in April 1993. It started operations in June 1994, with trading on the Wholesale Debt Market Segment. Subsequently it launched the Capital Market Segment in November 1994 as a trading platform for equities and the Futures and Options Segment in June 2000 for various derivative instruments.

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MCX (MULTI COMMODITY EXCHANGE)

MULTI COMMODITY EXCHANGE of India limited is a new order exchange with a mandate for setting up a nationwide, online multi-commodity market place, offering unlimited growth opportunities to commodities market participants. As a true neutral market, MCX has taken several initiatives for users in a new generation commodities futures market in the process, become the countrys premier exchange. MCX, an independent and a de-mutualised exchange since inception, is all set up to introduce a state of the art, online digital exchange for commodities futures trading in the country and has accordingly initiated several steps to translate this vision into reality.

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NCDEX (NATIONAL COMMODITIES AND DERIVATIVES EXCHANGE)

NCDEX started working on 15th December, 2003. This exchange provides facilities to their trading and clearing member at different 130 centres for contract. In commodity market the main participants are speculators, hedgers and arbitrageurs. Facilities Provided By NCDEX NCDEX has developed facility for checking of commodity and also provides a ware house facility By collaborating with industrial partners, industrial companies, news agencies, banks and developers of kiosk network NCDEX is able to provide current rates and contracts rate. To prepare guidelines related to special products of securitization NCDEX works with bank. To avail farmers from risk of fluctuation in prices NCDEX provides special services for agricultural. NCDEX is working with tax officer to make clear different types of sales and service taxes. NCDEX is providing attractive products like weather derivatives

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STOCK MARKET BASIC What are corporations? Companies are started by individuals or may be a small circle of people. They pool their money or obtain loans, raising funds to launch the business. A choice is made to organize the business as a sole proprietorship where one Person or a married couple owns everything, or as a partnership with others who may wish to invest money. Later they may choose to "incorporate". As a Corporation, the owners are not personally responsible or liable for any debts of the company if the company doesn't succeed. Corporations issue official-looking sheets of paper that represent ownership of the company. These are called stock certificates, and each certificate represents a set number of shares. The total number of shares will vary from one company to another, as each makes its own choice about how many pieces of ownership to divide the corporation into. One corporation may have only 2,500 shares, while another, such as IBM or the Ford Motor Company, may issue over a billion Shares. Companies sell stock (pieces of ownership) to raise money and provide funding for the expansion and growth of the business. The business founders give up part of their ownership in exchange for this needed cash. The expectation is that even though the owners have surrendered a portion of the company to the Public, their remaining share of stock will become increasingly valuable as the business grows. Corporations are not allowed to sell shares of stock on the open

Stock market without the approval of the Securities and Exchange Commission (SEC). This transition from a privately held corporation to a publicly traded one is Called going public, and this first sale of stock to the public is called an initial public offering, or IPO.

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 Why do people invest in the stock market? When you buy stock in a corporation, you own part of that company. This gives you a vote at annual shareholder meetings, and a right to a share of future profits. When a company pays out profits to the shareholder, the money received is called a "Dividend". The corporation's board of directors choose when to declare a dividend and how much to pay. Most older and larger companies pay a regular dividend, most newer and smaller companies do not.

The average investor buys stock hoping that the stock's price will rise, so the shares can be sold at a profit. This will happen if more investors want to buy stock in a company than wish to sell. The potential of a small dividend check is of little concern. What is usually responsible for increased interest in a company's stock is the prospect of the company's sales and profits going up. A company who is a leader in a hot industry will usually see its share price rise dramatically. Investors take the risk of the price falling because they hope to make more money in the market than they can with safe investments such as bank CD's or government bonds.

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What is a stock market index? In the stock market world, you need a way to compare the movement of the market, up and down, from day to day, and from year to year. An index is just a benchmark or yardstick expressed as a number that makes it possible to do this comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index of BSE.

The price per share, like the market cap, has nothing to do with how big a company is.

The Securities Market consists of two segments, viz. Primary market and Secondary market. Primary market is the place where issuers create and issue equity, debt or hybrid instruments for subscription by the public; the Secondary market enables the holders of securities to trade them. Secondary market essentially comprises of stock exchanges, which provide platform for purchase and sale of securities by investors. In India, apart from the Regional Stock

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Exchanges established in different centres, there are exchanges like the National Stock Exchange (NSE) and the Over the Counter Exchange of India (OTCEI), who provide nationwide trading facilities with terminals all over the country. The trading platform of stock exchanges is accessible only through brokers and trading of securities is confined only to stock exchanges.

Corporate Securities : The no of stock exchanges increased from 11 in 1990 to 23 now. All the exchanges are fully computerized and offer 100% on-line trading. 9644 companies were available for trading on stock exchanges at the end of March 2002. The trading platform of the stock exchanges was accessible to 9687 members from over 400 cities on the same date.

Derivatives Market: Derivatives trading commenced in India in June 2000. The total exchange traded derivatives witnessed a volume of Rs. 442,343 crore during 2002-03 as against Rs. 4018 crore during the preceding year. While NSE accounted for about 99.5% of total turnover, BSE accounted for about 0.5% in 2002-03. The market witnessed higher volumes from June 2001 with introduction of index options, and still higher volumes with introduction of stock options in July 2001. There was a spurt in volumes in November 2001 when stock futures were introduced. It is believed that India is the largest market in the world for stock futures

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Supply and Demand

A stock's price movement up and down until the end of the trading day is strictly a result of supply and demand. The SUPPLY is the number of shares offered for sale at anyone one moment. The DEMAND is the number of shares investors wish to buy at exactly that same time. What a share of a company is worth on anyone day or at any one minute, is determined by all investors voting with their money. If investors want a stock and are willing to pay more, the price will go up. If investors are selling a stock and there aren't enough buyers, the price will go down Period.

Secondary Market Intermediaries

Stock brokers, sub-brokers, portfolio managers, custodians, share transfer agents constitute the important intermediaries in the Secondary Market. No stockbrokers or sub-brokers shall buy, sell or deal in securities unless he holds a certificate of registration granted by SEBI under the Regulations made by SEBI ion relation to them. The Central Government has notified SEBI (Stock Brokers & Sub-Brokers) Rules, 1992 in exercise of the powers conferred by section 29 of SEBI Act, 1992. These rules came into effect on 20th August, 1992.

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INTRODUCTION TO DERIVATIVE MARKET:

According to dictionary, derivative means something which is derived from another source. Therefore, derivative is not primary, and hence not independent. In financial terms, derivative is a product whose value is derived from the value of one or more basic variables. These basic variable are called bases, which may be value of underlying asset, a reference rate etc. the underlying asset can be equity, foreign exchange, commodity or any asset. For example: - the value of any asset, say share of any company, at a future date depends upon the shares current price. Here, the share is underlying asset, the current price of the share is the bases and the future value of the share is the derivative. Similarly, the future rate of the foreign exchange depends upon its spot rate of exchange. In this case, the future exchange rate is the derivative and the spot exchange rate is the base.

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Derivatives are contract for future delivery of assets at price agreed at the time of the contract. The quantity and quality of the asset is specified in the contract. The buyer of the asset will make the cash payment at the time of delivery. Meaning:

Derivatives are the financial contracts whose value/price is dependent on the behavior of the price of one or more basic underlying assets (often simply known as the underlying). These contracts are legally binding agreements, made on the trading screen of stock exchanges, to buy or sell an asset in future. The asset can be a share, index, interest rate, bond, rupee dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc. In the Indian Context the Security Contracts (Regulation) Act, 1956 (SC(R) A) defines derivative to include A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or other form of security. A contract, which derives its value from the prices, or index of prices of underlying securities.

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Contracts agreement

Cash

Derivatives Forward Others like Swaps, FRAs etc

Merchandisi ng, customized NTSD TSD

Futures (Standardized

Options

In financial terms derivatives is a broad term for any instrumental whose value is derived from the value of one more underlying assets such as commodities, forex, precious metal, bonds, loans, stocks, stock indices, etc. Derivatives were developed primarily to manage offset, or hedge against risk but some were developed primarily to provide potential for high returns. In the context of equity markets, derivatives permit corporations and institutional

Investors to effectively manage their portfolios of assets and liabilities through instrument like stock index futures.

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11. 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 1700s 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 1860s. 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.

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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 Dealers Association was set up in early 1900s 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

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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.

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EMERGENCE OF THE DERIVATIVE TRADING IN INDIA Approval For Derivatives Trading 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.Verma, to recommend measures for risk containment in derivative market in India. The repot, 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 SCRA was amended in December 1999 to include derivatives within the ambit of securities and the regulatory framework were developed for governing

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derivatives trading. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on

PARTICIPANTS OF THE DERIVATIVE MARKET :Market participants in the future and option markets are many and they perform multiple roles, depending upon their respective positions. A trader acts as a hedger when he transacts in the market for price risk management. He is a speculator if he takes an open position in the price futures market or if he sells naked option contracts. He acts as an arbitrageur when he enters in to simultaneous purchase and sale of a commodity, stock or other asset to take advantage of mispricing. He earns risk less profit in this activity. Such opportunities do not exist for long in an efficient market. Brokers provide services to others, while market makers create liquidity in the market. Hedgers Hedgers are the traders who wish to eliminate the risk (of price change) to which they are already exposed. They may take a long position on, or short sell, a commodity and would, therefore, stand to lose should the prices move in the adverse direction. Speculators If hedgers are the people who wish to avoid the price risk, speculators are those who are willing to take such risk. These people take position in the market and assume risk to profit from fluctuations in prices. In fact, speculators consume information, make forecasts about the prices and put their money in these forecasts. In this process, they feed information into prices and thus contribute to market efficiency. By taking position, they are betting that a price would go up or they are betting that it would go down. The speculators in the derivative markets may be either day trader or position traders. The day traders speculate on the price movements during one trading day, open and close position many times a day and do not carry any position at the end of the day.

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They monitor the prices continuously and generally attempt to make profit from just a few ticks per trade. On the other hand, the position traders also attempt to gain from price fluctuations but they keep their positions for longer durations may is for a few days, weeks or even months. Arbitrageurs Arbitrageurs thrive on market imperfections. An arbitrageur profits by trading a given commodity, or other item, that sells for different prices in different markets. The Institute of Chartered Accountant of India, the word ARBITRAGE has been defines as follows:Simultaneous purchase of securities in one market where the price there of is low and sale thereof in another market, where the price thereof is comparatively higher. These are done when the same securities are being quoted at different prices in the two markets, with a view to make profit and

carried on with conceived intention to derive advantage from difference in prices of securities prevailing in the two different markets Thus, arbitrage involves making risk-less profits by simultaneously entering into transactions in two or more markets.

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3. TYPES OF DERIVATIVES MARKET

Exchange Traded Derivatives

Over The Counter Derivatives

National Stock Exchange

Bombay Stock Exchange

National Commodity & Derivative Exchange

Index Future

Index option

Stock option

Stock future

Figure.1 Types of Derivatives Market

4. TYPES OF DERIVATIVES

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Figure.2 Types of Derivatives (i) 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. BASIC FEATURES OF FORWARD CONTRACT 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. 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 th e 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.

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(ii) 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

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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

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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, value at time to maturity , will be found by discounting the present

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:

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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.

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TABLE 1DISTINCTION BETWEEN FUTURES AND FORWARDS CONTRACTS FEATURE Operational Mechanism FORWARD CONTRACT FUTURE CONTRACT

Traded directly between two Traded on the exchanges. parties (not traded on the exchanges).

Contract Specifications Counter-party risk

Differ from trade to trade.

Contracts are standardized contracts.

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.

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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 & PUT OPTION. CALL OPTION: A contract that gives its owner the right but not the obligation to buy an underlying assetstock 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 assetstock 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.

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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.

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5. OTHER KINDS OF DERIVATIVES 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.

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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 2000. SEBI permitted the derivative segment of two stock exchanges, NSE and BSE, and their clearing house/corporation to commence trading and settlement in approved derivatives contract. To begin with, SEBI approved trading in index future contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval for trading in options based on these two indices and options on individual securities. The trading in index options commenced in June 2001.

Futures contracts on individual stocks were launched in November 2001. Trading and settlement in derivatives 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.

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Risk Associated With Derivatives:

While derivatives can be used to help manage risks involved in investments, they also have risks of their own. However, the risks involved in

derivatives trading are neither new nor unique they are the same kind of risks associated with traditional bond or equity instruments. Market Risk Derivatives exhibit price sensitivity to change in market condition, such as fluctuation in interest rates or currency exchange rates. The market risk of leveraged derivatives may be considerable, depending on the degree of leverage and the nature of the security.

Liquidity Risk

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Most derivatives are customized instrument and could exhibit substantial liquidity risk implying they may not be sold at a reasonable price within a reasonable period. Liquidity may decrease or evaporate entirely during unfavorable markets.

Credit Risk Derivatives not traded on exchange are traded in the over-the-counter (OTC) market. OTC instrument are subject to the risk of counter party defaults. Hedging Risk Several types of derivatives, including futures, options and forward are used as hedges to reduce specific risks. If the anticipated risks do not develop, the hedge may limit the funds total return.

FUNCTION OF DERIVATIVES MARKET:The derivative market performs a number of economic functions: Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. The prices of derivative converge with the prices of the underlying at the expiration of the derivative contract. Thus, derivatives help in discovery of future as well as current prices. The derivatives market helps to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivatives, due to their inherent nature, are linked to the underlying cash market. With the introduction of the derivatives, the underlying market witnesses higher trading volumes because of the participation by more players who would not otherwise participate for lack of arrangement to transfer risk.

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 Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivative market, speculators trade in the underlying cash market. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity.

The derivatives have a history of attracting many bright, creative, well-educated people with an entrepreneurial attitude. They often energize others to create new businesses, new products and new employment opportunities, the benefit of which are immense. Derivatives markets help increase savings and investment in the end. Transfer of risk enables market participants to expand their volumes of activity.

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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 Indias (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 2. 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 11 May 1998 7 July 1999 24 May 2000 25 May 2000 9 June 2000 12 June 2000 25 September 2000 2 June 2001 index futures. L.C.Gupta Committee submitted report. RBI gave permission for OTC forward rate agreements (FRAs) and interest rate swaps. SIMEX chose Nifty for trading futures and options on an Indian index. SEBI gave permission to NSE and BSE to do index futures trading. Trading of BSE Sensex futures commenced at BSE. Trading of Nifty futures commenced at NSE. Nifty futures trading commenced at SGX. Individual Stock Options & Derivatives

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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 Indias 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 Indias 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.

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Derivatives are complex and exotic instruments that Indian investors will find difficulty in understanding Is the existing capital market safer than Derivatives?

(i) Derivatives increase speculation and do not serve any economicpurpose: 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,

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increasing market liquidity and efficiency and facilitating the flow of trade and finance

(ii) 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: TABLE 3. PRE-REQUISITES Large market Capitalisation INDIAN SCENARIO India is one of the largest market-capitalised countries in Asia with a market capitalisation of more than Rs.765000 crores.

High Liquidity underlying

in

the The daily average traded volume in Indian capital market today is around 7500 crores. Which means on an average every month 14% of the countrys Market capitalisation gets traded. These are clear indicators of high liquidity in the underlying. 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. National Securities Depositories Limited (NSDL) which started functioning in the year 1997 has revolutionalised the security settlement in our country. 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.

Trade guarantee

A Strong Depository

A Good legal guardian

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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 20001) v/s the old system i.e. before June 2001 New System Vs Existing System for Market Players

Figure 3.3a Speculators Existing SYSTEM New Peril &Prize 1)Buy &Sell stocks 1)Maximum on delivery basis loss possible 2) Buy Call &Put to premium by paying paid premium

Approach Peril &Prize Approach 1) Deliver based 1) Both profit & Trading, margin loss to extent of trading & carry price change. forward transactions. 2) Buy Index Futures hold till expiry.

Advantages Greater Leverage as to pay only the premium. Greater variety of strike price options at a given time.

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Figure 3.3b Arbitrageurs Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize 1) Buying Stocks in 1) Make money 1) B Group more 1) Risk free one and selling in whichever way promising as still game. another exchange. the 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 3.3c Hedgers Existing SYSTEM New

Approach Peril &Prize Approach Peril &Prize 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 prcie Advantages

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Availability of Leverage

Figure 3.3d Small Investors Existing SYSTEM New

Approach 1) If Bullish buy stocks else sell it.

Peril &Prize Approach Peril &Prize 1) Plain Buy/Sell 1) Buy Call/Put options implies unlimited based on market outlook profit/loss. 2) Hedge position if holding underlying stock

1) Downside remains protected & upside unlimited.

Advantages Losses Protected.

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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 exchanges self-regulatory organization, although they are affected indirectly by national legal systems, banking supervision and market surveillance.

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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.

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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 ones 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 1990s has also brought the price volatility factor on the surface. The advent of telecommunication and data processing bought information

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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--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.

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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 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 1970s, 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

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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 24member 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 preconditions 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 realtime 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 BSE30 (Sense) index. This was followed by approval for trading in options based on these two indexes and options on individual securities.

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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.

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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 milestones in India followed by forwards and market options. Significant have been (i) in the development of derivatives

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.

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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 percent.

Table 4.1ForexMarketActivity April05Total turnover (USD billion) Inter-bank to Merchant ratio Spot/Total Turnover (%) Forward/Total Turnover (%) Swap/Total Turnover (%) Source: RBI Mar06 4,404 2.6:1 50.5 19.0 30.5 April06Mar07 6,571 2.7:1 51.9 17.9 30.1 April07Mar08 12,304 2.37: 1 49.7 19.3 31.1 April08Dec08 9,621 2.66:1 45.9 21.5 32.7

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.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

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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.

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15. 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 demutulised 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

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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).

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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

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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 & Yellow Soybean Meal.

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The Present Status: Presently futures trading is permitted in all the commodities. Trading is taking place in about 78 commodities through 25 Exchanges/Associations as given in the table below:TABLE 4 Registered commodity exchanges in India No. 1. 2. 3. 4. 5. 6. 7. 8. Exchange India Pepper COMMODITY Trade Pepper (both domestic and international contracts) Ltd., Gur, Mustard seed

&

Spice

Association, Kochi (IPSTA) Vijai Beopar Chambers

Muzaffarnagar Rajdhani Oils & Oilseeds Exchange Gur, Mustard seed its oil & Ltd., Delhi oilcake Bhatinda Om & Oil Exchange Ltd., Gur Bhatinda The Chamber of Commerce, Hapur The Meerut Agro Gur, Potatoes and Mustard

seed Commodities Gur

Exchange Ltd., Meerut The Bombay Commodity Exchange Oilseed Complex, Castor oil Ltd., Mumbai international contracts Rajkot Seeds, Oil & Bullion Merchants Castor seed, Groundnut, its Association, Rajkot oil & cake, cottonseed, its oil & cake, cotton (kapas) and RBD palmolein. Commodity Castorseed, cottonseed, its oil & and oilcake Hessian Hessian & Sacking

9. 10.

The

Ahmedabad

Exchange, Ahmedabad The East India Jute

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11. 12. 13.

Exchange Ltd., Calcutta The East India Cotton Association Ltd., Cotton Mumbai The Spices & Oilseeds Exchange Ltd., Turmeric Sangli. National Board of Trade, Indore Soya seed, Soyaoil and Soya meals, Rapeseed/Mustardseed its oil and oilcake and RBD Palmolien The First Commodities Exchange of Copra/coconut, its oil & India Ltd., Kochi oilcake Central India Commercial Exchange Gur and Mustard seed Ltd., Gwalior E-sugar India Ltd., Mumbai Sugar National Multi-Commodity Exchange Several Commodities of India Ltd., Ahmedabad Coffee Futures Exchange India Ltd., Coffee Bangalore Surendranagar Cotton Oil & Oilseeds, Cotton, Cottonseed, Kapas Surendranagar E-Commodities Ltd., New Delhi Sugar (trading yet to

14. 15. 16. 17. 18. 19. 20. 21. 22. 23.

commence) National Commodity & Derivatives, Several Commodities Exchange Ltd., Mumbai Multi Commodity Exchange Ltd., Several Commodities Mumbai Bikaner commodity Exchange Ltd., Mustard seeds its oil & oilcake, Gram. Guar seed. Bikaner Guar Gum Haryana Commodities Ltd., Hissar Mustard seed complex Bullion Association Ltd., Jaipur Mustard seed Complex

24. 25.

RESEARCH METHODOLOGY :Problem Statement:

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The topic, which is selected for the study, is DERIVATIVE MARKET in the firm so the problem statement for this study will be, AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISION WITH EQUITY. Objective of the Study:

1. To know the awareness of the Derivative Market in Mumbai City. 2. To know which one is beneficial for the investor. 3. To find what proportion of the population are investing in such derivatives along with their investment pattern and product preferences. Research Design:

The research design specifies the methods and procedures for conducting a particular study. The type of research design applied here are DESCRIPTIVE as the objective is to check the position of the Derivative Market in Mumbai city. The objectives of the study have restricted the choice of research design up to descriptive research design. This survey will help the firm to know how the investors invest in the derivative segment & which factors affect their investing behavior. Scope of the Study: The scope of the study will include the analysis of the survey, which is being conducted to know the awareness of the Derivative Market in the city & also doing comparison of derivatives with equity.

Research Source of Data:-

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There are two types of sources of data which is being used for the studies: Primary Source of Data: Preparing a Questionnaire is collecting the primary source of data & it was collected by interviewing the investors. Secondary Source of Data: For having the detailed study about this topic, it is necessary to have some of the secondary information, which is collected from the following:-Books. Magazines & Journals. Websites. Newspapers, etc. Methods of Data Collection:The study to be conducted is about the awareness of the Derivative Market in the Mumbai City so the method of data collection used id SURVEY METHOD.

DATA ANALYSIS AND INTERPRETATION:

75

0.1

Q.1 Are you trading in derivative market?

Yes No Total

Frequencies 74 126 200

Percentage 37.0 63.0 100.0

Objective: To know that whether the investors are trading in derivative market or not. Graph:

Trading
140 percent/frequency 120 100 80 60 40 20 0 Yes Trading No 74 37 63 Frequencies Percentage 126

Inference: from the above graph out of 200 investors, only 37% investors means 74 respondent are trading in derivative market and 63% means 126 respondents are not trading in derivative marke Q.2 Reasons for not investing in derivative market. {Give the rank}

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Objective: To know the reason why investors are not trading in trading in derivative market Frequency 0.1.1 Reasons Lack of knowledge Lack of awareness High risky Huge amount investment Other Total Graph: Frequency 26 19 62 of 17 2 126 Percent 20.6 15.1 49.2 13.5 1.6 100.0

Reason
70 60 50 40 30 20 10 0 62 49.2 Series1 26 20.6 0 0 Reasons Lack of Lack of knowledge awareness High risky Huge amount of investment Series2 19 15.1 17 13.5 2 1.6 Other Series3

percent/frequency

reasons

Inference: From the above graphical representation you can see that 49.2% investors think that the derivatives are high risky whereas 1.6% investors dont have specify their reasons for not trading in derivative market. 0.2 Q.3 what is the objective of trading in derivative market?

Objective: To know that why they are trading in derivative market.

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Frequency Dont trade Not at all preferred Neutral Some how preferred Most preferred Total Graph:
High Return
140 percent/frequency 120 100 80 60 40 20 0 Dont trade 2 1 2 1 5 2.5 Some how preferred Most preferred 32.5 63 65 Frequency Percent 126

Frequency 126 2 2 5 65 200

Percent 63.0 1.0 1.0 2.5 32.5 100

Not at all preferred

Neutral preferred

Inference: From the above graph we can see that 32.5% investors are most preferred the objective of high return and 1% investors are neutral while they are trading in derivative market. Q .4what are the criteria do you taken in the consideration while investing in derivative market?

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Objective: To know that which criteria are consider by the investors while they are investing in derivative market. Which criteria are most important for them whether derivatives are ease in transaction, less costly, or available of different contract or for the margin money. Frequency

Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total

Frequency 126 2 4 16 23 29 200

Percent 63.0 1.0 2.0 8.0 11.5 14.5 100.0

Graph:

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Ease in transaction
percentage/frequency 140 120 100 80 60 40 20 0 126

63 16 8 23 11.5 29 14.5

Frequency Percent

2 1 Dont trade Not at all preferred

4 2 Some how not preferred

Neutral

Some Most how preferred preferred

preferred

Inference: from the above graph we can conclude that out of the 200 investors 14.5% investors are most preferred and 1% investors are not at all preferred the ease in transaction contract.

Q-5 Give your preference of trading in derivative instrument. Objective: To know the preference of the investors while they are trading in derivative

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market. Frequency Frequency 126 1 1 15 14 43 200 Percent 63.0 .5 .5 7.5 7.0 21.5 100.0

Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total Graph:

Index future
140 120 100 80 60 40 20 0 percent/frequency 126

63 43 1 0.5 Dont trade Not at all preferred 1 0.5 Some how not preferred 15 7.5 Neutral 14 7 Some how preferred 21.5

Frequency Percent

Most preferred

preferred

Inference: From the above graph we can see that only 0.5% investors are not at all preferred the index future, 0.5 % investors are somehow not preferred ,7.5% investors are some how preferred 21.5% are most preferred as the preference of their trading in derivative market Q-6 Give your preference in term of trading in derivative market? Objective: To know the preference of the investors in term of trading in derivative market.

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Frequency Frequency 126 4 1 5 10 54 200 Percent 63.0 2.0 .5 2.5 5.0 27.0 100.0

Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total Graph:

Intraday
Frequency/percentage 140 120 100 80 60 40 20 0 126 63 0 0 Dont trade 4 2 Not at all preferred 10.5 Some how not preferred 5 2.5 Neutral 10 5 Some how preferred 54 27 frequency percentage

preferred

Inference: from the above graph we can see that 27% investors are most preferred the intraday and 2% investors are not at all preferred the intraday. Q-7 How much percentage of your income you trade in derivative market? Objective: To know investors are how much percentage of their income trade in derivative market.

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Most preferred

Frequency Dont trade Less than 5% 5%-10% 11%-15% 16%-20% More than 20% Total Graph: Frequency 126 8 25 25 13 3 200 Percent 63 4.0 12.5 12.5 6.5 1.5 100.0

More than 20% 16%-20% 11%-15% 5%-10% Less than 5% Dont trade 0

1.5 3 6.5 13 12.5 25 12.5 25 4 8 63 50 100 126 150 Percent Frequency

Inference: From the above graph we can see that 12.5% investors are invest 5% to 10% income in the derivative market. While only 1.5% investors are investing more than 20% of their income. Q-8 what is the rate of return expected by you from derivative market? Objective: To know the investors expectation towards their investment in derivative market.

Frequency

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Do not trade 5%-9% 10%-13. % 14%-17. % 18%-23% Total Graph:

Frequency 126 21 22 23 8 200

Percent 63.0 10.5 11.0 11.5 4.0 100.0

rate of return expected

pecentage/frequency 140 120 100 80 60 40 20 0 126

63 21 10.5 22 11 23 11.5

Frequency Percent 8 4

Do not trade

5%-9%

10%-13. %

14%-17. %

18%-23%

Rate of return

Inference: From the above graph we can see that 11.55 investors are expect the 14% to 17% of their investment .and 4% investors are expect the 18% to 23% rate of return. Q-9. You are satisfied with the current performance of the derivative market Objective: To know that investors are satisfied with the performance of the derivative market or not. Frequency Frequency 126 8 14 18
84

Do not trade Strongly disagree Disagree Neutral

Percent 63.0 4.0 7.0 9.0

Agree strongly agree Total Graph:

25 9 200

12.5 4.5 100.0

Satisfaction
percentage/frequency 140 120 100 80 60 40 20 0 126 Frequency 8 4 Do not trade 14 7 18 9 25 12.5 Agree Percent 9 4.5 strongly agree

63

Strongly Disagree Neutral disagree

prferred

Inference: From the above Graph we can see that 12.5% are agree for satisfaction and4% are strongly disagree. Gender: Frequency Frequency 157 43 200 Percent 78.5 21.5 100.0

Male Female Total

Graph:

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gender
180 160 140 120 100 80 60 40 20 0 157

frequency

78.5 43 21.5

Frequency Percent

male gender

female

Inference: From the above graph we can see that there are 157 male investors when 43 are the female investors. AGE: Frequency Below 20 years 20-25 years 26-30 years 31-35 years above 35 years Total Frequency 3 61 51 43 42 200 Percent 1.5 30.5 25.5 21.5 21.0 100.0

Graph:

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age
35 30 25 20 15 10 5 0 30.5 25.5 21.5 21 Percent 1.5 below 20 years 20-25 years 26-30 years years 31-35 years above 35 years

Inference: From the above graph we can see that out of 200 investors 1.5% investors are below 20 years,30.5% investors are 20 to 25 years,21.5% investors are between 31 to35 years , and 21% investors are above 35 years trading in derivative market. Occupation: Frequency Student Employed Business Professional House wife Others Total Frequency 35 82 32 22 13 16 200 Percent 17.5 41.0 16.0 11.0 6.5 8.0 100.0

Graph:

percent

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Occupation
45 40 35 30 25 20 15 10 5 0
st ud

41

percentage

17.5

16

11

Percent 6.5 8

en t

ye d

pl o

Inference:

From

the

pr of es s

occupation

above

ho us e

em

bu si

graph

ot he rs

ne ss

na l

io

if e

we

can

see

that

17.5% investors are students, 41% are the employed, 16% are the business, 11% investors are the professionals, 6.5% investors are the housewife, and 8% are others, which include the retired, farmers and unemployed. ANNUAL INCOME Frequency

Frequency Valid 0 47 less than 1 lac 62 1-5 lacs 73 6-10 lacs 15 11-15 lacs 1 15 lacs & above 2 Total 200

Percent 23.5 31.0 36.5 7.5 .5 1.0 100.0

Valid Percent 23.5 31.0 36.5 7.5 .5 1.0 100.0

Cumulative Percent 23.5 54.5 91.0 98.5 99.0 100.0

Graph:

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annual income
40 35 30 25 20 15 10 5 0 36.5 31 23.5 Percent 7.5 0.5 0 less than 1 lac 1-5 lacs 6-10 lacs income in Rs. 11-15 lacs 1 15 lacs & above

Inference: From the above graph we can see that 23.5% investors dont have the income, 31% investors have less than 1 lack annual income, 36.5 % investors have the 1to 5 lacks annual income, 7.5 % investors have the 6 to 10 lacks income, 0.5% investors have the 11 to 15 lacks annual income, and 1% investors have the 15 lacks and above annual income.

percentage

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FINDINGS 1. Here we found that out of 200 investors 74 means 37% investors are trading in

derivative market whereas 126 means 63% are not trading in derivative market. 2. Reasons for not investing in derivative market Is derivative is because lack of awareness and knowledge, high risky, need huge amount of investment. 3. The main objective I of trading in derivative market of the investors is getting high return. 4. Criteria for trading is considered by investors are derivatives in derivative they get margin money and derivatives are more liquid. 5. Their attractive preference is index future and index options 6. Most of the investors are trading intraday. 7. Out of 200 investors 12.5% investors are investing 11% to 15% of their income trading in derivative market.

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8.12.5% are satisfied with derivative market 9.157male investors and 43 female investors out of 200 investors. 10.-most of the businessman and employed are trading in derivative market.

CONCLUSION

1. The awareness regarding Derivative among investor is 78 percent.

2. In terms of investment in Derivative and Equity investors have capability of taking risk.

3. Investors also prefer Safety and Time Factor as the important parameter for investing.

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4. The important factor that affecting the investor decision is based on In Consult With Their Broke

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RECOMMENDATION 1. Only 74 investors are trading whereas 126 are not trading .so attract them for trading. 2.19 are lack of awareness so make them aware with the derivative .so increase the customer. 3. Out of 126, 26 dont have knowledge for derivative so provide them knowledge for trading in derivative market. 4. Those who are not satisfied with the derivative by knowing their behavior of investment make them satisfied. Because negative word mouth of the customers fall down the business. And good word of mouth builds the business.

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BIBLIOGRAPHY Books referred: Options Futures, and other Derivatives by John C Hull Derivatives FAQ by Ajay Shah NSEs 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

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