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SUMMER PROJECT /INTERNSHIP REPORT ON:

IMPACT OF DERIVATIVES ON INDIAN

FINANCIAL MARKET AT- ANANDRATHI

SECURITIES PRIVATE LIMITED,RANCHI

Submitted in partial fulfillment for the Post Graduate Diploma Course in

Business Management(Finance) at Xavier Institute of Social Service,

Ranchi.

(2007-2009)

By :

ANANDPRAKASH

Under The Guidance of:

Prof. Bhaskar Bhawani

XAVIER INSTITUTE OF SOCIAL SERVICE


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Approval Sheet

This is to certify that the dissertation entitled Impact of Derivatives on Indian

Financial Market has been prepared by Anand prakash in partial fulfillment of

Post Graduate Diploma in Business Management with specialization in Finance at

Xavier Institute of Social Service (XISS), Ranchi.

This embodies data collected & analyzed by the candidate under the guidance of

Prof. Bhaskar Bhawani of the institute, member of faculty of XISS department of

Finance, Ranchi and is hereby approved as indicating the proficiency of the

candidate.

Prof. Bhaskar Bhawani Dr . Fr. B.A.Ekka,s.j.

Department of Finance Director,XISS

Research Guide

Prof Dr.RatneshChaturvedi

EXTERNAL EXAMINER H.O.D ,Department of Finance

Table of Contents



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Acknowledgements...............................................................................................4

Areas of concern faced by the organization and their relevance..........................5

DEFINITION:.................................................................................................8

Derivatives :.......................................................................................................8

Types of Derivatives:..........................................................................................9

Techniques of managing risk............................................................................16

Futures payoff.................................................................................................16

Applications of futures.....................................................................................17

Options Payoffs...............................................................................................19

Options............................................................................................................21

Applications of Options....................................................................................23

Payoff for seller of put options at different strike............................................26

Swaps 27

Other Derivatives:...........................................................................................28

Participants in the market:...............................................................................29

Hedgers...........................................................................................................29

Arbitrageurs....................................................................................................30

CORE STRNGTHS.............................................................................................40

OUR FINDINGS....................................................................................................48



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CONCLUSIONS.....................................................................................................51

RECOMMENDATIONS...........................................................................................53

REFERENCES.......................................................................................................54

Acknowledgements

I acknowledge with gratitude the opportunity

that was provided to me by Mr. SHASHANK

BHARDWAJ to undergo vocational training at

ANANDRATHI, RANCHI and his constant inputs on

finer points for my project.

This project bears the imprint of many people.

Firstly, I would like to extend a debt of thanks to

my project guide, Miss RASHMI GUPTA, and Miss

PUNAM who gave willingly of their time and shared

with me their experiences and the plethora of

knowledge in this field.



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I would also like to acknowledge Mr. ANAND

SINHA, Mr. KALESHWAR YADAY at ANANDRATHI

securities for guiding me through and reviewing

the project to help me cover the entire scope of my

project.

Areas of concern faced by the organization and

their relevance

Volatility of the stock market

The highly volatile nature of the stock market coupled with the high degree of

uncertainty brings ahead the most difficult aspect of operations. Dealing with derivatives

makes it all the more complex since derivatives is highly risky method of trading than

other trading methods. Therefore here the need arises to possess the best of resources

in order to equip with the best and most hidden news about the market as well as the

most accurate in-house technical analysis.

Client Management



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The clients are most demanding due to the high amount of money required in

derivative trading as security; hence it becomes another major challenging aspect.

Cash settlement

Due to mark to market nature of the transactions cash settlement

becomes very crucial

Handling derivatives Exposures

The highly volatile and complex nature of derivatives makes it imperative that every

firm that uses derivatives must therefore exercise considerable caution and care in

handling its derivative exposures.

Various types of risks :

Credit risk or default risk: The risk that a counter party will default on its

obligations. This is generally negligible for exchange traded derivatives but needs

careful attention in the case of OTC derivatives.

Operational Risk: The risk that errors may occur in carrying out

operations, in placing orders, making payments or accounting for them etc.



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Model Risk or formula risk: Options and many synthetic derivatives are

priced using complicated mathematical formulae, which make numerous

assumptions. There can be occasions when the models fail to give accurate price

data because the assumptions no longer hold. (E.g. volatility far exceeds

historically based estimates) or due to undetected flaws in the models. Many

traders especially the less experienced ones take the models as infallible gospel,

especially as most of the models work well most of the time. This risk is tending

to increase with the increased use of computerized pricing models based on

elaborate mathematics, which the trader may not understand. A trade, which fully

complies with all pricing policies, may thus still end up with unexpected and

disastrous results.

Liquidity risk: The risk that a derivative cannot be purchased or sold

quickly enough at a fair price, due to lack of liquidity in the market. Liquidity risk is

greater for OTC derivatives.

Legal Risk: The risk that the law or regulatory rule may be changed or re-

interpreted causing an adverse financial impact on a derivative transaction.

Market risk: The risk of adverse changes in the market price of a

derivative.

The focus of discussion that follows will be mainly on market and operational risk.

The discussion will emphasize on perspective of a hedger, but the same principles can

be applied by an entity using derivatives for trading.



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DEFINITION:

Derivatives :

Derivative is a financial instrument whose value depends on the values of others,

more basic underlying variables.

Or, Derivative is a product whose value is derived from the value of one or more

basic variables, called bases (underlying asset, index or reference rate), in a contractual

manner. (The underlying asset can be equity, forex, commodity or any other asset.)

In recent year, Derivatives have become increasingly important in the field of

finance. Now, it is traded actively on many exchanges.

In the Indian context the Securities contracts (Regulation Act), 1956 (SC (R) A)

defines derivatives to include

1. A security derived from a debt instrument, share, loan whether secured or

unsecured, risk instrument or contract for differences or any other form of security.

2. A contract which derives its value from the prices, or index of prices of underlying

securities.

Derivatives are securities under the (SC (R) A) and hence the trading of derivatives

is governed by the regulatory framework under the (SC (R )A).



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In Indian capital market derivative is allowed in organized exchange from year 2001

by government after abolition of the traditional Badla System.

Factors driving the growth of derivatives:

1. Increased volatility in asset prices in financial markets

2. Increased integration of national financial markets with the international financial

markets.

3. Marked improvement in communication facilities and sharp decline in their costs

4. Development of more sophisticated tools, providing economic agents a wider range

of risk management strategies

5. Innovations in the derivatives markets, which optimally combine the risks and returns

over a large number of financial assets leading to higher returns, reduced risk as

well as transactions costs as compared to individual financial assets.

Types of Derivatives:

There are four types of derivatives

Forwards

Futures



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Options

Complex Derivatives

Forwards Futures Options Complex

Derivative

Forward Contract:


Inter-bank

foreign

exchange

forwards

Commodit

y futures

Financial

Commodit

y options

Financial

Swaps

Forward rate

agreements

Range


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It is an agreement between two parties to buy or sell, as the case may be a

commodity/financial instrument/currency at a predetermined future date at a price

agreed when the contract is entered into. This is a cash market transaction in which

delivery of the commodity is deferred until after the contract has been made.

Futures Contract:

It is a contract to buy or sell a standard amount of a standardized or predetermined

grade of a certain commodity at a predetermined location on a predetermined future

date at a pre-agreed price.

Future contract trades in future market.

Future Market: - An auction market in which participants buy and sell

commodity/future contracts for delivery on a specified future date. Volume in the futures

market usually increases when the stock market outlook is uncertain.

A futures contract is thus a standardized forward contract.

Types of financial Futures: Categorization on the basis of the type of risk each isintended to cover.

Interest Rates futures:

The price of an interest bearing securities like bills, bonds and debentures is inversely

related to the prevailing market rate of interest. These price changes occur so that the

yield on an already issued security is the same as that of a new one issued at the

current rate.



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Interest rate futures are used for hedging by banks, financial institutions, pension

funds and others whose assets and liabilities can be affected by changes in interest

rates. In this market short hedgers are those seeking protection against raising interest

rates while long hedgers are those seeking protection against falling interest rates .

Currency Futures:

These contracts are used for hedging by exporters and importers, banks, financial

institutions and large companies who face huge foreign exchange exposures.

Stock Index Futures:

These are futures contracts on a popular stock market index. Stock index futures are

meant for hedging and speculation on the general level of stock market prices. They are

of particular use to unit trusts, pension funds, investment trusts, insurance companies

etc.

Index futures are cost effective derivative instruments than derivatives on individual

stocks. Unlike stocks indices are not prone to price manipulation since a variety of

stocks can be included

Trading in the underlying securities is costlier compared to trading in derivatives on

account of brokerages etc. Derivatives allow the portfolio managers to achieve their

goals with relative ease and in a cost-effective manner without being subject to the

hassles associated with trading in underlying securities. Derivatives also bring many

advantages from the perspective of mutual funds. The trading activity of the open-ended

fund depends on the magnitude of sales. At times repurchases may compel the fund



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manager to off load a portion of the portfolio. This would lead to a number of problems .

Firstly it is very difficult to liquidate the stocks in accordance with the portfolio

proportion. All the stocks comprising the portfolio may not be highly liquid. The threat of

prices coming down also looms largely over such activity. While the sale and

repurchases are pegged to the NAV, the actual prices at the time of trading tend to be

different. Index futures effectively take care of these problems. Index futures can also

be employed to neutralize the impact of any possible adverse movement in the markets .

Cost of living index Futures

These are also called inflation futures and are based on a specified cost of living

index. Inflation cannot be avoided but futures based on cost of living index can be used

to hedge against unanticipated inflation, the unanticipated component in the price level

changes. These futures are used by provident and pension funds, governments, larger

companies and others who face obligations related to price level such as dearness

allowance, cost of living allowance or variable price supply contracts .

Difference between Forward contract and Futures

contract:



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A forward contract is a tailor made contract (the terms are negotiated between buyer

and seller) whereas a futures contract is a standardized contract (quantity, date and

delivery conditions are standardized)

While there is no secondary market for forward contract, futures contracts are traded

in organized exchanges.

Forward contracts usually end with deliveries, whereas futures contracts are settled

with the differences.

Usually no collateral is required for a forward contract. In a futures contract, however

a margin is required.

Forward contracts are settled on the maturity e whereas futures contracts are

marked on a daily basis. This means that profits and losses on futures contracts are

settled daily.

Spot and futures prices: Financial Instruments:

When you buy a security, you have a choice. You can buy it in the spot market and

get immediate delivery or you can buy it in the futures market and obtain deferred

delivery. If you buy in the spot market, you make payment now and you are entitled to

the benefits of ownership (like dividends and interest) from now onwards. If you buy in

the future market, you make payment at a specified time in future and hence get the

benefit of ownership from that point onwards. Owing to the differences between

purchases in the spot market and futures market.

Spot and Futures Prices: Commodities:



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If you buy a commodity in the futures market, rather than the spot market, the gain is on

2 counts:

The interest is earned on the money as the payment is deferred

There is saving on storage, insurance and wastage costs as there is no need to

store the commodity.

But against the advantages, you have to forego the convenience of having the

commodity readily on hand.

Futures and Hedging:

The type of futures contract a firm wants may not be available. For e.g. soybean oil

producer may not be able to get soybean oil future contracts. In such a case, it may

have to make to with some surrogate like groundnut oil, if they both tend to move in

unison. Such a substitution is called cross-hedge. When a firm resorts to cross hedging

it must take into account how the relative prices move. In the above case, for e.g. it

should know the relationship between the movements of the soybean oil prices and

groundnut oil prices. Thus the advantages that futures provide over other hedging

devices are:

1. There is no need for an initial cash flow

2. It is as easy to take a short position in futures as it is to take a long position

3. It is easy to close a futures contract by an offsetting trade

4. The wide range of commodities and financial instruments on which futures contracts

are available exceeds anything available in other markets.



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Techniques of managing risk

Futures payoff

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to a person who

holds an asset. E.g. A speculator buys a 2-month nifty index futures contract

when Nifty stands at 2000. The underlying asset in this case is Nifty portfolio.

When the index moves up the long futures position starts making profit and vice

versa.



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Speculation: Bullish security, buy futures

Just as the case when investors buy securities in the anticipation

that its price is likely to increase in future, the same principle works for

futures contract. E.g. An investor buys 100 shares, costing 1 lakh Rs. 2

months later the security closes at 1010 and he makes a profit of 1000

on an investment of Rs.1, 00,000 for a period of 2 months i.e. an

annual return of 6%. Incase of futures the investor buys 100 security

futures for which he pays a margin of Rs 20000. The security trades at

Rs. 1000 and the 2 month futures trades at Rs.1006. On the expiration

day, he makes a profit of Rs. 400 on an investment of Rs.20, 000 i.e.

an annual return of 12%.

Speculation: Bearish security, sell futures

Arbitrage: Overprices futures: buy spot, sell futures

Arbitrage opportunity arises when the future price deviates substantially

from its fair value. E.g. ABC Ltd. Trades at Rs. 1000. One-month futures tradeat Rs. 1025 and seem overpriced. An arbitrageur will borrow funds and buy

the security on the cash market at 1000. Simultaneously sell futures on the

security at 1025. Take the delivery of the security purchased and hold it for a

month. On the futures expiration date, lets consider the security closes at

Rs. 1015. Sell the security. Futures position expires with the profit of Rs. 10.

The result is a risk less profit of Rs.15 on the spot position and Rs.10 on

futures position. But this should be done only when the cost of borrowing

funds is less than the arbitrage profit possible.



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Arbitrage: Under priced futures: buy futures, sell spot

Options Payoffs

Payoff profile for buyer of call options: Long Call

A call option gives the buyer the right to buy the underlying asset at

the strike price specified in the option. The profit/loss he makes depends

on the spot price of the underlying. If upon expiration, the spot price

exceeds the strike price, he makes a profit. If the spot price is less then

the strike price, he lets his option un-exercised. His loss in this case is the

premium he paid.

Payoff profile for writer of call options: Short Call



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Payoff profile for buyer of Put options: Long put

A put option gives the buyer the right to sell the underlying asset at

the strike price specified in the option. The profit/loss that the buyer

makes on the option depends on the spot price of the underlying. If upon

expiration the spot price is below the strike price, he makes a profit. If the

spot price is higher then the strike price, he lets his option expire un-

exercised. His loss in this case is the premium he paid for buying the

option.

Payoff profile for writer of Put options: short put



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Options

An option is a contract between two parties whereby one party acquires the right, butnot the obligation, to buy or sell a particular commodity or instrument or asset, at a

specified price on or before a specified date. The person who acquires the right is the

option holder or buyer and the counter party is known as the option seller or writer.

The price at which the option holder can buy or sell the underlying asset is called the

exercise price orstrike price. The commodity or instrument or asset covered by the

contract is called the underlying commodity or instrument or asset. The date at which

the option expires or matures is called the expiration date or the maturity date.

Call Option: It gives the holder the right but not the obligation to buy an asset by a

certain date for a certain price.

Put Option: It gives the holder the right but not the obligation to sell an asset by a

certain date for a certain price

Option Premium: The price at which the option buyer pays to the option seller.

American Option: The options that can be exercised at any time up to the

expiration date.



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European options: The options that can be exercised on the expiration date itself.

In the Money Option: It is an option that would lead to a positive cash flow to the

holder if it were exercised immediately. A call option on the index is said to be in the

money when the current index stands at a level higher than the strike price (i.e. Spot

price>strike price). If the case of put, the put is ITM if the index is below the strike

price.

At the money Option: It is an option that would lead to zero cash flow if it were

exercise immediately. An option is at the money when the current index equals the

strike price.

Out of the money Option: It is an option that would lead to a negative Cash flow if

it were exercised immediately. A call option on the index is out of the money when

the current index stands at a level, which is less than the strike price (i.e. spot

price


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an investor must pay out $16,000. However, if the investor were to purchase two

$20 calls (with each contract representing 100 shares), the total outlay would be only

$4,000 (2 contracts X 100 shares/contract X $20 market price). The investor would

then have an additional $12,000 to use at his or her discretion. Obviously, it is not

quite as simple as that. The investor has to pick the right call to purchase (a topic for

another discussion) in order to mimic the stock position properly. However, this

strategy, known as stock replacement, is not only viable but also practical and cost

efficient.

Less Risky - Depending on How You Use Them: - There are situations in

which buying options is riskier than owning equities, but there are also times when

options can be used to reduce risk. It really depends on how you use them. Optionscan be less risky for investors because they require less financial commitment than

equities, and they can also be less risky due to their relative imperviousness to the

potentially catastrophic effects of gap openings. Options are the most dependable

form of hedge, and this also makes them safer than stocks.

Higher Potential Returns: - We don't need a calculator to figure out that

if you spend much less money and make almost the same profit, then we have a

higher percentage return. When they pay off, that's what options typically offer toinvestors.

More Strategic Alternatives: - The final major advantage of options is

that they offer more investment alternatives. Options are a very flexible tool. There

are many ways to use options to recreate other positions. We call these positions

synthetics.

Applications of Options

http://www.investopedia.com/terms/s/synthetic.asphttp://www.investopedia.com/terms/s/synthetic.asp


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Hedging: Have underlying buy puts

To protect the value of the portfolio from falling below a particular level, buy the right

number of put options with the right strike price.

Put options can be purchased for a particular stock of concern.

When the stock price falls, the stock will lose value and the put options will

gain.

Put options can also be purchased on the index if the concern is for

the overall portfolio. When the index falls, the portfolio will lose value and put

options bought will gain, ensuring that the value of the portfolio does not fall

below a particular level.

Speculation: Bullish security, buy calls or sell puts

There are 2 ways in which options can be used to benefit from the upward

movement in the underlying security.

Buy call options

Sell Put options

The downside to the buyer of the call option is limited to the option premium.

However his upside is unlimited. Therefore the next question arises, which call

option should be purchased given a number of one-month calls trading. E.g. Assume

the current price level is Rs 1250, risk-free rate is 12% per year and volatility of the

underlying security is 30%. The options available are:

1. A one month call with a strike of 1200







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The selection of option among these depends on how strongly one feels

the upward movement of the market as well as the risk one is willing to take.

The call with a strike of 1200 is deep in-the-money and hence trades at a

higher premium. The call with a strike of 1275 is out-of-money and trades at

a low premium. The call with a strike of 1300 is deep out-of-money. Its

execution depends on the unlikely event that the underlying will raise by

more then 50 points on the expiration date. In the more likely event of the

call expiring out of the money, the buyer simply loses the small premium

amount of Rs 27.50.

Payoff for buyer of call options at different strikes

As the writer of puts, there is limited upside and an unlimited downside.

E.g. if the price of a security falls to 1230 and the investor has sold a put



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with an exercise of 1300, the buyer will exercise the option and the seller will

end up losing Rs.70. Taking into account the premium earned the net loss is

Rs.5.20.

Payoff for seller of put options at different strike

Speculation: Bearish security, sell calls or buy puts



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Payoff for seller of call option at various strikes

Swaps

A swap transaction is one in which 2 or more partys exchange, one set has

predetermined payments for another.

Two types of swaps:

Interest Rate swaps: It is an agreement between 2 parties to exchange interest

obligations or receipts in the same currency on an agreed amount of notional

principal for an agreed period of time. Main characteristics are:

It effectively translates a floating rate borrowing into a fixed rate

borrowing and vice versa. The net interest differential is paid or received, as

the case may be.

There is no exchange of principal repayment obligations

It is structured as a separate contract distinct from the underlying

loan agreement

It is applicable to new as well as existing borrowings

It is treated as an off the balance sheet transaction.



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Currency Swap: It is an agreement between 2 parties to exchange payments or

receipts in one currency for payments or receipts in another. Currency swaps

involve:

An exchange of principal amounts today

An exchange of interest payments during the currency of the loans

A re-exchange of principal amounts at the time of maturity

Reasons for swaps:

Spread compression

Market segmentation

Market saturation

Other Derivatives:

Forward Rate Agreements

It is a contract between a bank and a customer who gives the customer a

guaranteed future rate of interest to cover a specified sum of money over a

specified period of time in the future. No actual borrowing or lending is

involved; it is merely an agreement that fixes the rate of interest for the future.

Range Forwards

These are used in foreign exchange markets as a variant of the standard

forward exchange contract. Here instead of quoting a single forward rate, a

quotation is given in terms of a range. In the process range forwards provide

protection against extreme variations in the exchange rate.

Swaptions



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It is a contract by which a party acquires an option to enter into a swap. A

call swaption gives the purchaser the option of entering into a swap as a

floating ratepayer. Swaptions can be used to hedge uncertain cash flows.

Commodity-linked Loans and Bonds

A commodity linked bond would involve a loan to a borrower in which the

interest payable and/or repayment schedule is linked to a commodity price. If

the commodity price raises the debt service obligation rises by a

predetermined margin and in the other case, a fall in price, the debt service

obligation is reduced subject to a minimum debt service obligation.

Credit derivatives

These are based on credit risk of loans. The interest rate on a loan has three

components, the borrowing cost for the institution concerned, loan deposit spread, and

a credit risk premium. Credit derivatives involve the third element. A credit derivative is

a default swap in which one party swaps the default risk alone with a counter party; the

latter agrees to pay the first party in the case of default by the borrower, in return for a

regular payment.

Participants in the market:

Hedgers

These are market players who wish to protect an existing asset position from

future adverse price movements. In order to hedge a position, a hedger needs to



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take an equal and opposite position in the futures market to the one held in the cash

market.

Speculators

A speculator is a one who accepts the risk that hedgers wish to transfer. Speculators

have no position to protect and do not necessarily have the physical resources to

make delivery of the underlying asset nor do they necessarily need to take delivery

of the underlying asset. They take positions on their expectations of futures price

movements and in order to make a profit. In general they buy futures contracts when

they expect futures prices to rise and sell futures contract when they expect futures

prices to fall. Speculators provide liquidity to the markets and without them the price

protection - insurance - required by hedgers would be very expensive

Arbitrageurs

These are traders and market makers who deal in buying and selling futures

contracts hoping to profit from price differentials between markets and/or exchanges.

INDIAN FINANCIAL MARKET:

Today--with the FEEL GOOD' factor about India in the global arena rising,

increased confidence of the investors in the Indian market, Sensex looking more

attractive than ever before, foreign exchange reserves at an all-time high of more



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than $140 billion --is the most susceptible period for the regulators of the Indian

financial sector, particularly SEBI and RBI. In spite of the strict vigilance by the

regulators, the investors find Indian market very attractive.

In recent years, the Indian economy has seen a great transformation from a

closed, controlled, slow growing economy to a more open, liberalised and one of the

fastest growing economies of the world. Economic reforms in India since July 1991

have accelerated growth, enhanced stability and strengthened both external and

financial sectors.

The rate of savings in India is constantly rising. The gross domestic savings in

the year 2005-06 is estimated at 1156809. The rise in the savings rate has with an

increase in the rate of growth of GDP over the last three years, suggesting that the

economy is transiting to a sustainable, higher growth trajectory.

Financial Intermediaries :

A structural change was noticed in the Indian financial system with the establishment

of a host of financial intermediaries during the second phase of evolution of thesystem.

Financial intermediaries comprises of public financial institutions, NBFCs, mutual

funds, commercial banks, housing bank etc.

Foreign Currency Borrowings :

In India, External debt exposure to financial intermediaries is regulated. Their foreign

currency borrowings have been subject to the prudential limit of 25 per cent of their Tier-

I capital. These limits amounted to US $ 2.7 billion as of March 31, 2006. With a view to

enabling banks to raise resources overseas, the latest monetary policy announcement

on October 31, 2006 has enhanced this limit to 50 per cent of their Tier I capital, or US $



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10 million, whichever is higher. With a move towards fuller capital account convertibility,

banks are likely to access forex markets more, underscoring the need for further

enhancement of the risk management capabilities of the banking system.

Banking Companies :

The banking sector is the soul-life-blood of the financial system in India.

Significant progress has been made with respect to the banking sector in the post

liberalization

period. The financial health of the commercial banks has improved manifolds

with respect to capital adequacy, profitability, asset quality and risk management.

Further, deregulation has opened new opportunities for banks to increase revenueby diversifying into investment banking, insurance, credit cards, depository services,

mortgage, securitization, etc. Liberalization has created a more competitive

environment in thebanking sector. The aggregate foreign investment (FDI plus FII)

limit for the private sector banking has been raised to 74 percent in the recent

country budget. The competition has increased within the banking sector (with the

emergence of new private banks and foreign banks) as well as from other segments

of the financial sector such as mutual funds, Non Banking Finance Companies, post

offices and capital markets.

.Cash Reserve Ratio (CRR) :

CRR is the amount of cash reserve that is required to be maintained by commercial

banks in India with the RBI. The RBI hiked the CRR by 50 basis points to 5.5 per

cent in two stages on 23 December 2006 and 6 January 2007. Currently the CRR is5.75% of the net demand and time liability. From the fortnight beginning from March

3, 2007, the CRR will be 6%. (Source: RBI)



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Statutory Liquidity Ratio (SLR) :

SLR is an instrument in the hands of RBI to impose supplementary reserverequirements on the banking system. The maximum limit of SLR in India is 40%. It was

20% in 1963 and rose to 38.5% in 1990. The current limit is 25%. The Government has

issued ordinance giving more flexibility to the RBI to fix SLR below the current stipulated

limit of 25%.

Specialized financial entities Housing financecompanies :

A company, which mainly carries on the business of housing finance or has as one of

the main objects in its Memorandum of Association, business of providing finance for

the housing. To start business of housing finance, the Housing Finance Companies has

to get it registered with the National Housing Bank. The principal mandate of the Bank is

to promote housing finance institutions to improve/strengthen the credit delivery network

for housing finance in the country. The Bank has played a facilitator role in this regard

instead of itself opening such dedicated housing finance institutions

Non- Banking Finance Companies

Non-Banking Financial Companies are under the regulatory framework of Reserve Bank

of India by virtue of powers vested in Chapter III B of the Reserve Bank of India Act,

1934 At the end of June 2006, there were 13014 NBFCs registered with the Reserve

Bank of India, including 428 NBFCs, which are accepting public deposits. During the

year 2005-06, Net-owned funds of NBFCs increased by 562 crores despite a decline in

the number of reporting NBFCs. Total assets/liabilities of NBFCs (excluding reporting

NBFCs) at the end of March 2006 were Rs. 35561 crores, down marginally by 1.2



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percent from 36003 crores at end of March 2005. in the year 2005-06, there was a

significant decline in fee-based income of the NBFCs while there was a marginal

increase in fund-based income.

Investment Intermediaries :

Mutual funds :

Put not your trust in money, put your money in trust- is the perfect way by which we

can understand the concept of mutual funds. The small investors who lacks expertise to

choose the right kind of investment for themselves opt for a kind of collective investment

vehicle like Mutual Funds which pool their marginal resources, invest in a wide range of

securities and distribute the returns.

The pioneer in the field of mutual fund is Unit Trust of India established in 1964. Net

mobilisation of resources by mutual funds increased by more than four-fold to Rs.

104950 crores in 2006 from Rs. 25454 crore in 2005. The share of UTI and other public

sector mutual funds in the total amount mobilised was around 22.5% in 2005 and 17.8%

in 2006. The total asset under the management of mutual funds during the end of 2006

was recorded at 323598 crores.

Risk transfer institutions :

Our everyday life is subjected to an innumerable risk like risk of premature death, poor

health, unemployment, loss due to natural calamities etc. Many of these risks are out of

our control. Insurance provides us an opportunity to cover the risk at least in monetary

terms.



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The business of insurance is broadly classified into life insurance and non- life

insurance or general insurance as discussed below:

In the beginning of the year 2000, the insurance industry mainly comprises of two

players- The Life Insurance Corporation of India for effecting life insurance and The

General

Insurance Corporation of India with its four subsidiaries for effecting fire insurance,

marine insurance and other miscellaneous insurance. From then, a number of

insurance companies have emerged both in the public and private sector to cater to the

needs of the society.

As all other markets, the insurance market is also highly regulated. The Insurance Act,

1938 was the first legislation governing not only life insurance but also the non-life

insurance business in India. After the nationalization of the insurance business in1956,

Insurance Regulatory and Development Authority regulate the insurance business in

India.

Capital Market :

Capital Market is a market for financial investments that are direct or indirect claims to

capital. It comprises of the institutions and mechanisms through which funds are

pooled and made available to business, government and individuals.

With the expansion of commercial banking and unprecedented development of

multinational corporations, the domestic financial markets has assumed global outlook.

The integration of world financial and capital market with that of the Indian provides



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greater benefits to both the demanders and suppliers of funds and opportunity to

diversify risk. This globalisation has added depth to the market with a large number of

market participants.

Capital market : Primary :

The market wherein resources are mobilised by companies through issue of new

securities is termed as the primary market. In India, the primary market has grown

exponentially during the last decades.

Funds mobilisation from the market reached its peak in the year 1993-94, 1994-95 and

1997-98. During the year 2006, a total of Rs.161769 crores was mobilised through

primary market by a combination of equity issue, debt issue, private placement and

Euro issues (ADR/GDR).

Capital market is firmly regulated by the Securities and Exchange Board of India (SEBI)

to offer better protection to the investors. The introduction of SEBI Guidelines for

Disclosure and Investor Protection during 1992 revolutionised the Indian capital market.

Later it was replaced by the Guidelines issued in 2000 and SEBI is frequently updating

these guidelines to suit the need of the present time. SEBI has also prescribed

regulations for the Intermediaries, such as the brokers, underwriters, Merchant Bankers,

Mutual Funds etc.

Capital market : Secondary :

Secondary market popularly known as the Stock Exchange is referred to as the



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Barometer of the economy. The stock exchanges are the exclusive centres for trading

in equities. The stock market is touching new heights year after year since 2003, with

the BSE and NSE indices crossing 14000 and 4000, respectively in January 2007. The

3rd of January witnessed the highest closing indices of 14015 at BSE and 4025 at NSE.

NSE continued to occupy the third position after NASDAQ and NYSE in terms of

number of transactions occurring during the calendar year 2006.

Debt :

In a developing country like India, debt market plays a very crucial role. Debt Markets

are markets for the issuance, trading and settlement in fixed income securities of

varioustypes and features. Almost all legal entity like Central and State Governments,

Public Bodies, Statutory corporations, Banks and Institutions and Corporate Bodies

issue Fixed income securities to secure money.

Current debt market has become more efficient, transparent and vibrant with significant

retail participation.

Government of India (GOI) securities continued to account for the major part of activityIn the secondary debt market. The gross issuance of GOI dated securities in 2006

amounted to Rs.14 000 crores as compared to Rs. 129,350 crore in 2005.

Derivatives:

In India, derivatives trading take place under the provisions of the Securities Contracts

(Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992. The

turnover recorded during the calendar year 2006 in NSE derivative market is 7046665

crores and in BSE derivative market is 4012 crores showing significant growth over the

previous years.



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Commodities market :

Commodities Futures trading is a class of Derivatives trading, in which futures contracts

derive their value from the ruling price of underlying commodities. This is a mechanismby which participants can enter into transactions for purchase and sale of commodities

at a price, where the performance of delivery and payment obligation becomes due on a

future date. As compared to 59 commodities in January 2005, 94 commodities were

traded in the commodities futures market as of December 2006, and these included

major agricultural commodities, spices, metals, bullion, crude oil, natural gas and

polymer, among others. Gold accounted for the largest share (31 per cent) of trade in

terms of value, followed by

silver (19 per cent), guar seed (11 per cent) and chana (10 per cent).

The growth in the commodity derivative trading witnessed in 2005-06 continued during

2006-07. Total volume of trade rose sharply from Rs. 1.29 lakh crore in 2003-04 to Rs.

27.39 lakh crore in 2006-07 (till December 2006).



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COMPANY PROFILE

ANAND RATHI SECURITIES

AnandRathi (AR) is a leading full service securities firm providing the entire gamut of

financial services. The firm, founded in 1994 by Mr. AnandRathi, today has a pan India

presence as well as an international presence through offices in Dubai and Bangkok.

AR provides a breadth of financial and advisory services including wealth management,

investment banking, corporate advisory, brokerage & distribution of equities,

commodities, mutual funds and insurance, structured products - all of which are

supported by powerful research teams.

The firm's philosophy is entirely client centric, with a clear focus on providing long

term value addition to clients, while maintaining the highest standards of excellence,



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ethics and professionalism. The entire firm activities are divided across distinct client

groups: Individuals, Private Clients, Corporates and Institutions and was recently ranked

by Asia Money 2006 poll amongst South Asia's top 5 wealth managers for the ultra-rich.

In year 2007 Citigroup Venture Capital International joined the group as a

financial partner.

CORE STRNGTHS

Breadth of Services- In line with its client-centric philosophy, the firmoffers to its clients the entire spectrum of financial services ranging from

brokerage services in equities and commodities, distribution of mutual funds,

IPOs and insurance products, real estate, investment banking, merger andacquisitions, corporate finance and corporate advisory.

Clients deal with a relationship manager who leverages and brings

together the product specialists from across the firm to create an optimumsolution to the client needs.

Management Team- AR brings together a highly professional coremanagement team that comprises of individuals with extensive business as

well as industry experience.

In-Depth Research - Our research expertise is at the core of thevalue proposition that we offer to our clients. Research teams across the

firm continuously track various markets and products. The aim is howevercommon - to go far deeper than others, to deliver incisive insights and ideas

and be accountable for results

Management Team

Management Team Held several Senior Management positions with oneof India's largest industrial groups

Mr. Pradeep Gupta - Vice Chairman



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Plus 17 years of experience in Financial Services

Mr.Amit Rathi - Managing Director

Chartered Accountant & MBA. Plus 11 years of experience in FinancialServices

SERVICES PROVIDED BY ANAND RATHI SECURITIES

WEALTH MANAGEMENT

AnandRathi is very strongly placed in its Wealth Management services and was

recently ranked by Asia Money 2006 poll amongst South Asia s top 5 wealth managers

for the ultra-rich. The Company is presently providing Wealth Management services

mainly in Mumbai, Bangalore & other metro towns and is planning to extend it to all

other major towns in the country.

PRIMARY MARKET DISTRIBUTOR

The Company is a leading Primary Market Distributor and was ranked 6th in

FY2006 for All India Broker Performance in equity distribution in the High Networth

Individuals (HNI) Category & 9th in the Retail Category having more than 5% market

share



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RETAIL SEGMENT

AnandRathi is a leading player in the Retail Segment. The company has a

customer base of over 0.1Mn and pan India presence in all States with more than 350

branches/ business associates. The company is planning to expand aggressively in the

next one year.

INVESTMENT BANKING

The Company s Investment Banking division offers a range of advisory services for

Strategic alliances and in Capital Raising areas. The products & services offered

include PO/Rights/Secondary issues, Private Equity, QIP placement, Merger &

Acquisitions and Management Buy-outs.

ALERNATIVE INVESTMENT

The company also offers Alternative Investment options that include Structured

products, Market neutral strategies, Arbitrage products, Capital protection products and

Real Estate fund.

PRIVATE WEALTH MANAGEMENT

Affluent individuals need sophisticated advice and strategic guidance to capitalize on

opportunities to preserve, grow and transfer their wealth. In addition, a desire exists

within wealthy families to simplify the management of multigenerational needs and

lessen the profound emotional impact of wealth on family members. AR offers the most



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extensive platform of customized servicing, individual strategies and products to help

meet the requirements of the affluent private investor. We provide comprehensive,

integrated investment strategies to address your wealth management needs.

Working closely with specialists across firm PWM offers an array of products & services,

which includes AR's highly-rated research.

MUTUAL FUNDS

AR is one of India's top mutual fund distribution houses. Our success lies in our

philosophy of providing consistently superior, independent and unbiased advice to our

clients backed by in-depth research. We firmly believe in the importance of selecting

appropriate asset allocations based on the client's risk profile. We have a dedicated

mutual fund research cell for mutual funds that consistently churns out superior

investment ideas, picking best performing funds across asset classes and providing

insights into performances of select funds.

COMMODITIES

Commodities broking - a whole new opportunity to hedge business risk and an

attractive investment opportunity to deliver superior returns for investors. Our

commodities broking services include online futures trading through NCDEX and MCX

and depository services through CDSL. Commodities broking is supported by a

dedicated research cell that provides both technical as well as fundamental research.

Our research covers a broad range of traded commodities including precious and base

metals, Oils and Oilseeds, agri-commodities such as wheat, chana, guar, guar gum and

spices such as sugar, jeera and cotton. In addition to transaction execution, ANAND

RATHI provides our clients customized advice on hedging strategies, investment ideas

and arbitrage opportunities.



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INSURANCE BROKING

As an insurance broker, we provide to our clients comprehensive risk management

techniques, both within the business as well as on the personal front. Risk management

includes identification, measurement and assessment of the risk and handling of the

risk, of which insurance is an integral part. The firm deals with both life insurance and

general insurance products across all insurance companies. Our guiding philosophy is

to manage the clients' entire risk set by providing the optimal level of cover at the least

possible cost. The entire sales process and product selection is research oriented and

customized to the client's needs. We lay strong emphasis on timely claim settlement

and post sales services.

PORTFOLIO MANAGEMENT SERVICES

AR Portfolio Management Service is a discretionary investment service created to

meet the demand for more targeted investment styles and opportunities. It offers a

range of specialized investment strategies designed to capture opportunities across the

market spectrum. The range of products varies from the highly defensive, capital-

protected to the most aggressive strategies in the equities and derivatives markets.

Our investment process ensures that your strategy and portfolio are built on solid

foundations. Together you and your relationship manager select the strategy in line with

your individual goals. AR investment specialists then construct and manage your

portfolio in accordance with the chosen investment strategy.

INSTITUTIONAL WEALTH MANAGEMENT

Corporate and Institutional treasuries need ever more sophisticated advice that is

backed by serious and credible research. AR IWM provides its institutional clients

integrated wealth management solutions across global markets, which are backed by

proprietary global economic & investment research. We understand that your needs



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AnandRathi Advisors assists companies in realizing tangible improvements in various

facets of their businesses by providing a range of corporate advisory services that

includes the entire gamut from financial, organizational and operational restructuring, to

profit improvement and business turnaround strategies Highly qualified and thoroughly

professional, our specialists, experts and associates assist you in conceptualizing

problems and devising effective solutions,

whatever be your need. Successful assignments undertaken for leading

organizations in India as well as overseas bear ample testimony to our wide-ranging

capabilities, utilizing our unparalleled business know-how to give you the competitive

edge. AR have successfully handled various assignments under industry segments like

refinery, cement, mining, power, paper, metals, airlines and optic fibre.

IPOs

We are a leading primary market distributor across the country. Our strong performance

in IPOs has been a result of our vast experience in the Primary Market, a wide network

of branches across India, strong distribution capabilities and a dedicated research team.

we have been consistently ranked among the top 10 distributors of IPOs on all major

offerings. Our IPO research team provides clients with indepth overviews of forthcoming

IPOs as well as investment recommendations. Online filling of forms is also available.

MILESTONES SET BY ANAND RATHI SECURITIES



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1994:Started activities in consulting and Institutional equity sales with staff of 15

1995:Set up a research desk and empanelled with major institutional investors

1997:Introduced investment banking businesses Retail brokerage services launched

1999:Lead managed first IPO and executed first M & A deal

2001:Initiated Wealth Management Services

2002:Retail business expansion recommences with ownership model

2003:Wealth Management assets cross Rs1500 crores Insurance broking launchedLaunch of Wealth Management services in Dubai Retail Branch network exceeds50

2004:Commodities brokerage and real estate services introducedWealth Management assets cross Rs3000crores Institutional equities businessrelaunched and senior research team put in place Retail Branch networkexpands across 100 locations within India

2005:Real Estate Private Equity Fund Launched Retail Branch network expandsacross 200 locations within India

2006:AR Middle East, WOS acquires membership of Dubai Gold & CommodityExchange (DGCX) Ranked amongst South Asia's top 5 wealth managers for theultra-rich by Asia Money 2006 poll Ranked 6th in FY2006 for All India BrokerPerformance in equity distribution in the High Networth Individuals (HNI)Category Ranked 9th in the Retail Category having more than 5% market shareCompletes its presence in all States across the country with offices at 300+

locations within India

2007:Citigroup Venture Capital International picks up 19.9% equity stakeRetail customer base crosses 100 thousand Establishes presence in over 350locations.



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OUR FINDINGS

In all 8 main methods were studied under different situations for futures and options:

Hedging : Long security, sell futures

Speculation: Bullish security, buy futures

Speculation: Bearish security, sell futures




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Arbitrage: Under priced futures: buy futures, sell spot

Hedging: Have underlying buy puts


Speculation: Bearish security, sell calls or buy putsThe 3 winners that came out successful in most of the situations were:

Hedging : Long security, sell futures



Apart from technical aspect another major aspect that increases or reduces the riskas well as the profit/loss, is the panic among the clients as well as the dealers, leading

to abandoning of the method being followed.

THREE REASONS TO START DERIVATIVES TRADING:

If you are looking for a trading option outside of traditional stocks and bonds, derivatives

trading may be a good option. Derivatives pay off over a period of time based on the

performance of assets, interest rates, exchange rates, or indices. The payoff can be in

cash or assets and vary, of course, by performance and timing. In addition to stocks andbonds, derivatives can also be traded through in the money market, foreign exchange

(forex), and credit. Indicators affecting a derivative's performance are varied, and

depending on the type of derivative. These can range from the stock market index to the

consumer price index to weather conditions and fluctuations in currency exchange



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rates. The following reasons provide information on why it may be a good idea to begin

derivatives trading.

1. Less Risk than other Trades- When you trade in derivatives, you are not

purchasing the underlying product or buying into the company, although in some cases

you are agreeing to purchase assets in the future, also known as futures trading.

Instead, your risk is on the performance. There are two main types of derivatives:

futures and options, which allow someone the option to buy or sell at a prearranged

price. There are three main types of firms that use derivatives. These are investment

banks, commercial banks, and end users, such as floor traders, corporations, and

hedge and mutual funds. While you can still lose money in derivatives trading, the risk is

much less of an investment. Further, you can get involved in derivatives trading for a

much lower initial investment, something that may appeal to those who cannot or do not

want to invest as much as is required to purchase stock. Derivatives can also be a good

way to add balance to your total portfolio, thereby spreading risk throughout a variety of

investments rather than in only a few.

2. They Can be a Good Short Term Investment - If you are looking for an investment

opportunity that can pay off in a shorter time frame, derivatives may be a good option.

While some stocks and bonds are long-term investments over the course of many

years, derivatives can be days, weeks, or a few months. Because of the shorter

turnaround time, they can be a good way to break into the market as well as a good way

to mix short and long-term investments. If you have a portfolio consisting of long-term

investments, such as some stocks, and want an option to put your money to work now,

derivatives may be an option. Making derivatives work for you requires careful research

and consideration just like any other investment opportunity. However, in a fast-paced

world, investors have the option to see results much sooner in options or futures trading

that are not available through other means.



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3. Variety and Flexibility-The nature of derivatives essentially means that the

opportunities for trading this type of investment are limited only by the imagination. The

other side of this is that someone interested in entering the derivatives trading market

needs to either have a trusted financial representative, or learn as much about the

business as possible. Doing both is the best option, as you can then work with a

financial representative in a much more involved way and have a better handle on what

your money is doing and where. Numerous resources are available on the Internet for

learning more about derivatives trading and the many options available. Those

interested in derivatives training may want to begin by focusing on a particular area,

such as currency trading. Some types of trading options are available around the clock,

on a global scale. This is another reason some investors are drawn to derivatives

trading. Getting involved in the global economy can be exciting, and it opens

international options that may not be available through the traditional stock market

(particularly given the regulations placed on foreign companies to comply with U.S. laws

such as Sarbanes-Oxley).

CONCLUSIONS

Successfully using derivatives requires a well thought out and planned approach

from the start. For a successful use of derivatives, a company must:

Evolve a clear policy

Any firm that uses derivatives for hedging need to evolve a clear set of policy

guidelines. These guidelines should cover the following:

What types of risks can potentially be hedged given the available hedging

instruments?



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Of the risks, which are potentially hedgeable, which risks does the

company want to hedge?

For those risks which the company decides to hedge, should the hedging

be universal (i.e. at all times) or selective (i.e. confined to periods when adverseprice risks are expected)?

Should hedges be for the full value of the expected exposure or can they

be for only part of the exposure?

Who is empowered to take the decision on when to hedge and how much

to hedge?

Does the company envisage only straightforward hedges (i.e. in the same

or very similar items) or does it permit more complex and involved or synthetic

hedges?

Establish a system of controls to monitor adherence to the policy.

Which levels of staff are authorized to enter into which types of

transactions

Restriction on counter parties with whom dealings should/should not be

made

Limits for derivative exposure in terms of absolute value and/or a

proportion of spot exposure or any other variable

Separation trading(front office) and book-keeping(back office) functions

Internal audit procedures to ensure that figures reported correspond with

actual contract status.

Comprehensive reporting system to cover the extent of risk exposure

through derivatives, the present loss or profit on open positions, a sensitivity

analysis to price changes

Enforce adherence to the system of controls



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A system of review of the reports received (including internal audit reports)

by a sufficiently high level of management and if necessary by external technical

experts

A firm adherence to position limits etc, once these has been set.

Rotation/transfer of key traders from one portfolio to another

Ensuring that trading staff has no control whether administrative or

financial over back-office operations.

Careful observation of exceptionally trading staff

RECOMMENDATIONS

For the dealers

A lot of theoretical methods are studied but are not put to practical use, just due to

panic. Since the investors are not very technically aware, therefore it becomes the

responsibility of the technical people in the field like dealers to properly guide them and

follow the techniques diligently. Until and unless there is an exceptional situation, the

simple techniques do bring in desired results.

For the company:



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Technical analysis-The environment in which the organization operates is

highly volatile and uncertain. Therefore there is a strong requirement to equip

with best of resources in terms of most hidden information and news of the

market. Not only a well-built in-house technical analysis is extremely essential, as

well as its proper operation and execution

Online Logins for clients

Whenever the clients need their stock holdings and their profit and loss

statements, they have to seek from the office manually. These leads to a

considerable time loss of the productive time of employees as well as the clients.

Therefore there is a need to consider creating online profiles of the clients and

providing them with the usernames and passwords. This apart from speeding up the

process and saving time will also ensure the privacy of the clients.

REFERENCES

Books

Financial Management I M Pandey

Options, futures and other derivatives John C Hull

Managing Investment Prasanna Chandra

Websites

www.bseindia.com

http://www.bseindia.com/http://www.bseindia.com/


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www.nseindia.com

www.derivativesindia.com
http://www.nseindia.com/http://www.derivativesindia.com/http://www.nseindia.com/http://www.derivativesindia.com/

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