Derivative Market

I I P M A H M E D A B A D

SUBMITTED IN THE PARTIAL FULLFILLMENT OF

THE REQUIRMENT FOR THE

DEGREE OF

MASTER OF BUSINESS ADMINISTRATION SUBMITTED TO

International Institute of Planning and Management BY

JAYPRAKASH PATEL

GUIDED BY

Mr. Hitesh Rever (Branch Manager)

Ms. Priyanka Yadav (Remizar)

2011

ANALYSIS OF INVESTMENT IN

DERIVATES MARKET

ANALYSIS OF INVESTMENT IN DERIVATES MARKET

IIPM AHMEDABAD Page 1

1.1 About the Subject

Perceptions of derivative

A derivative is financial instrument whose value is ‗derived‘ from another

underlying security or a basket of securities. Traders can assume highly

leveraged positions at low transaction costs using these extremely flexible

instruments.

As this market i.e derivative is new concept in share market the Perception

regarding the same varies from person to person. A complete understanding of

this market is require in order to deal with it. So the topic which I selected will

be telling about perception of people toward this market in surat city and how

they deal with this market.

The most desired instruments that allow market participants to manage risk in

the modern securities trading are known as derivatives. The main logic behind

the 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.

They represent contracts whose payoff at expiration is determined by the

price of the underlying asset—a currency, an interest rate, a commodity, or a

stock.

In order to know about the perception of people to this new era of market in

which at initial level every investor fear to invests so a survey at surat level is

done on ―perception of investor toward this market‖ is done by taking 100

samples in surat city.



Sr. No

Content PAGE

1 1.2 Importance of topic 3

1.3 About Motilal Oswal 3

1.4 Benefit of study 6

2 2.1 Introduction to industry 7

2.2 Industrial profile at India level 13

2.3 Industrial profile at regional level 19

3 3.1 Objective of study 22

3.2 Literature review 22

3.3 Statement of problem 25

3.4 Research Design 25

3.5 Sampling Methodology 25

3.6 Method of data collection 26

3.7 Limitations of study 26

4 4.1 History of derivatives 27

4.2 Chronology of instruments 28

4.3 Need for derivatives in India today 29

4.4 Myths and realities about derivatives 31

4.5 The participants in a derivative market 32

4.6 Types of derivatives 33

4.7 business growth in derivatives segment 37

5 5.1 Questionnaire Analysis 43

6 6.1 Findings 53

6.2 Recommendation 53

6.3 Conclusion 55

7 7.1 Bibliographies 56

INDEX



1.2 IMPORTANCE OF TOPIC

The study is done on derivate which is not much know to the investor or in

general public who are dealing in share market, so it‘s important to know

about this segment of market in order to get a lucrative return.

To know about the perception of investor towards the derivative market in

order to know their investment pattern i.e. in which part of derivative they

are dealing much and what part of income they invest in this market.

Derivative is emerging market in India as well as in Surat city so a general

view and future growth of this market can be judge by this study.

In the Indian Stock Market which is highly volatile, and as derivative is

completely based on future price, the study on derivative helps in

minimizing risk & maximizing return.

1.3 About the Organization

MOTILAL OSWAL SECURITIES (financial consultants)

Company address

Office No. 2006 B, Mezzanine floor,

21st Century Business Center, Ring Road,

Surat – 395002, Gujarat



―Knowledge is power and power brings security. Risk is a very

relative term and changes with every individual and situation.

Financial management is not just about managing risk but also

managing knowledge and finally deriving answers that generate

wealth, security and trust.‖

Motilal Oswal security was founded in 1987 as a small sub-broking

unit, with just two people running the show. Focus on customer-first-

attitude, ethical and transparent business practices, respect for

professionalism, research-based value investing and implementation

of cutting-edge technology has enabled us to blossom into an over

1600 member team.

Today we are a well diversified financial services firm offering a range

of financial products and services such as Wealth

Management, Broking & Distribution, Commodity Broking, Portfolio

ManagementServices, Institutional Equities, Private

Equity, Investment Banking Services and Principal Strategies.

We have a diversified client base that includes retail customers

(including High Net worth Individuals), mutual funds, foreign

institutional investors, financial institutions and corporate clients. We



are headquartered in Mumbai and as of June 30th, 2011, had a

network spread over 586 cities and towns comprising 1,607 Business

Locations operated by our Business Partners and us. As at June 30th,

2011, we had 722,303 registered customers.

Motilal Oswal Security offers

Portfolio Advisory Services

Equity Broking

Derivatives Trading

Depository Services

Mutual Fund

Public Sector Bonds & Government Securities

Commodities Trading



1.4 Benefit of the study.

a. To Organisation

To know about respondent‘s perception toward the derivative market in

surat city as now-a-days trading in this market has taken hype.

To know about the dealing pattern of respondent towards this market.

b. To myself

To gain knowledge about the derivative market which is having a great pace

in share market?

To know about the perception of the respondent towards derivative market

in Surat city.

To become familiarize with organization, which help in applying theoretical

concepts into practical routine.

To understand the working system of different department.

To become part of professionalism.

To understand technical terms and its applications in study.

To know how the scripts are being traded in Equity market, Derivatives,

Commodity market.



2. Introduction to Industry.

Investment

The money you earn is partly spent and the rest saved for meeting future

expenses. Instead of keeping the savings idle you may like to use savings in

order to get return on it in the future. This is called Investment.

Reason for investment

One needs to invest to:

Earn return on your idle resources

Generate a specified sum of money for a specific goal in life

Make a provision for an uncertain future

Stock Exchange

The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‗Stock

Exchange‘ as anybody of individuals, whether incorporated or not, constituted

for the purpose of assisting, regulating or controlling the business of buying,

selling or dealing in securities. Stock exchange could be a regional stock

exchange whose area of operation/jurisdiction is specified at the time of its

recognition or national exchanges, which are permitted to have nationwide

trading since inception. NSE was incorporated as a national stock exchange.

Their usefulness:

Indices help to recognize broad trends in the market.

The investor can use the indices to allocate the funds rationally among

the stocks.

Technical analysts use these indices to predict the future market.

Indices function as a status report on the general economy.



SECURITIES

The definition of ‗Securities‘ as per the Securities Contracts Regulation Act

(SCRA), 1956, includes instruments such as shares, bonds, scrips, stocks or

other marketable securities of similar nature in or of any incorporate company

or body corporate, government securities, derivatives of securities, units of

collective investment scheme, interest and rights in securities, security receipt or

any other instruments so declared by the Central Government.

Type of investment in share

Government Securities

Derivative products

Units of Mutual Funds etc., are some of the securities investors in the

securities market can invest in.

Types of Market

PRIMARY MARKET (Deals with the new issues of securities.)

The primary market provides the channel for sale of new securities. Primary

market provides opportunity to issuers of securities; Government as well as

corporate, to raise resources to meet their requirements of investment and/or

discharge some obligation. They may issue the securities at face value, or at a

discount/premium and these securities may take a variety of forms such as

equity, debt etc. They may issue the securities in domestic market and/or

international market.



SECONDARY MARKET

(Deals with outstanding securities .Also known as ―STOCK MARKET‖)

Secondary market refers to a market where securities are traded after being

initially offered to the public in the primary market and/or listed on the Stock

Exchange. Majority of the trading is done in the secondary market. Secondary

market comprises of equity markets and the debt markets.

Role of the Secondary Market

For the general investor, the secondary market provides an efficient platform

for trading of his securities. For the management of the company, Secondary

equity markets serve as a monitoring and control conduit—by facilitating value-

enhancing control activities, enabling implementation of incentive-based

management contracts, and aggregating information (via price discovery) that

guides management decisions.



Difference between the Primary Market and the Secondary

Market

In the primary market, securities are offered to public for subscription for the

purpose of raising capital or fund. Secondary market is an equity trading venue

in which already existing/pre-issued securities are traded among investors.

Secondary market could be either auction or dealer market. While stock

exchange is the part of an auction market, Over-the-Counter (OTC) is a part of

the dealer market.



2.1 Industrial profile at Global level

History of World Stock Exchange

The history of stock exchanges can be traced to 12th century France, when the

first brokers are believed to have developed, trading in debt and government

securities. Unofficial share markets existed across Europe through the 1600s,

where brokers would meet outside or in coffee houses to make trades. The

Amsterdam Stock Exchange, created in 1602, became the first official stock

exchange when it began trading shares of the Dutch East India Company.

These were the first company shares ever issued.

By the early 1700s there were fully operational stock exchanges in France and

England, and America followed in the later part of the century. Share exchanges

became an important way for companies to raise capital for investment, while

also offering investors the opportunity to share in company profits. The early

days of the stock exchange experienced many scandals and share crashes, as

there was little to no regulation and almost anyone was allowed to participate in

the exchange.

Today, stock exchanges operate around the world, and they have become

highly regulated institutions. Investors wanting to buy and sell shares must do

so through a share broker, who pays to own a seat on the exchange. Companies

with shares traded on an exchange are said to be 'listed' and they must meet

specific criteria, which varies across exchanges. Most stock exchanges began as

floor exchanges, where traders made deals face-to-face. The largest stock

exchange in the world, the New York Stock Exchange, continues to operate

this way, but most of the world's exchanges have now become fully electronic.



Major Stock Exchanges in world economy:

Economy Stock Exchange

United States New York Stock Exchange

Japan Tokyo Stock Exchange

United States NASDAQ

Europe Euronext

United Kingdom London Stock Exchange

China Shanghai Stock Exchange

Hong Kong Hong Kong Stock Exchange

Canada Toronto Stock Exchange

Spain BME Spanish Exchanges

Brazil BM&F Bovespa

India Bombay Stock Exchange

Germany Deutsche Börse

Australia Australian Securities Exchange

India National Stock Exchange of India

Switzerland SIX Swiss Exchange

China Shenzhen Stock Exchange

Korea Korea Exchange

Nordic Countries NASDAQ OMX Nordic Exchange



South Africa JSE Limited

Taiwan Taiwan Stock Exchange

Italy Borsa Italiana

Source: World Federation of Exchanges - Statistics/Monthly

2.2 Industrial profile at India level

Securities Market Regulators

The absence of conditions of perfect competition in the securities market

makes the role of the Regulator extremely important. The regulator ensures that

the market participants behave in a desired manner so that securities market

continues to be a major source of finance for corporate and government and

the interest of investors are protected.

Regulation of Securities Market

The responsibility for regulating the securities market is shared by Department

of Economic Affairs (DEA), Department of Company Affairs (DCA), Reserve

Bank of India (RBI) and Securities and Exchange Board of

India (SEBI).

SEBI and its role

The Securities and Exchange Board of India (SEBI) is the regulatory authority

in India established under Section 3 of SEBI Act, 1992. SEBI Act, 1992

provides for establishment of Securities and Exchange Board of India (SEBI)

with statutory powers for (a) protecting the interests of investors in securities

(b) promoting the development of the securities market and (c) regulating the

securities market. Its regulatory jurisdiction extends over corporates in the

issuance of capital and transfer of securities, in addition to all intermediaries



and persons associated with securities market. SEBI has been obligated to

perform the aforesaid functions by such measures as it thinks fit. In particular,

it has powers for:

Regulating the business in stock exchanges and any other securities

markets

Registering and regulating the working of stock brokers, sub–brokers etc.

Promoting and regulating self-regulatory organizations

Prohibiting fraudulent and unfair trade practices

Calling for information from, undertaking inspection, conducting inquiries and

audits of the stock exchanges, intermediaries, self – regulatory organizations,

mutual funds and other persons associated with the securities market.



India’s Stock Exchanges

National Stock Exchange

The National Stock Exchange (NSE) is a stock exchange located at Mumbai,

India. It is the largest stock exchange in India in terms of daily turnover and

number of trades, for both equities and derivative trading.. NSE has a market

capitalization of around Rs 47,01,923 crore (7 August 2009) and is expected to

become the biggest stock exchange in India in terms of market capitalization by

2009 end.[2]Though a number of other exchanges exist, NSE and the Bombay

Stock Exchange are the two most significant stock exchanges in India, and

between them are responsible for the vast majority of share transactions. The

NSE's key index is the S&P CNX Nifty, known as the Nifty, an index of fifty

major stocks weighted by market capitalisation.

NSE is mutually-owned by a set of leading financial institutions, banks,

insurance companies and other financial intermediaries in India but its

ownership and management operate as separate entities. There are at least 2

foreign investors NYSE Euronext and Goldman Sachs who have taken a stake

in the NSE. As of 2006, the NSE VSAT terminals, 2799 in total, cover more

than 1500 cities across India [5]. In October 2007, the equity market

capitalization of the companies listed on the NSE was US$ 1.46 trillion, making

it the second largest stock exchange in South Asia. NSE is the third largest

Stock Exchange in the world in terms of the number of trades in equities.It is

the second fastest growing stock exchange in the world with a recorded growth

of 16.6%



Mission

NSE's mission is setting the agenda for change in the securities markets in

India. The NSE was set-up with the main objectives of:

establishing a nation-wide trading facility for equities, debt instruments and

hybrids,

ensuring equal access to investors all over the country through an

appropriate communication network,

providing a fair, efficient and transparent securities market to investors

using electronic trading systems,

enabling shorter settlement cycles and book entry settlements systems, and

meeting the current international standards of securities markets.

NSE Facts

It uses satellite communication technology to energise participation from

around 400 cities in India.

NSE can handle up to 1 million trades per day.

It is one of the largest interactive VSAT based stock exchanges in the world.

The NSE- network is the largest private wide area network in India and the

first extended C- Band VSAT network in the world.

Presently more than 9000 users are trading on the real time-online NSE

application



The Bombay Stock Exchange is known as the oldest exchange in Asia. It traces

its history to the 1850s, when 4 Gujarati and 1 Parsi stockbroker would gather

under banyan trees in front of Mumbai's Town Hall. The location of these

meetings changed many times, as the number of brokers constantly increased.

The group eventually moved to Dalal Street in 1874 and in 1875 became an

official organization known as 'The Native Share & Stock Brokers Association'.

In 1956, the BSE became the first stock exchange to be recognized by the

Indian Government under the Securities Contracts Regulation Act. The

Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a

means to measure overall performance of the exchange. In 2000 the BSE used

this index to open its derivatives market, trading Sensex futures contracts. The

development of Sensex options along with equity derivatives followed in 2001

and 2002, expanding the BSE's trading platform. Historically an open outcry

floor trading exchange, the Bombay Stock Exchange switched to an electronic

trading system in 1995. It took the exchange only fifty days to make this

transition. This automated, screen-based trading platform called BSE On-line

trading (BOLT) currently has a capacity of 80 lakh orders per day. The BSE has

also introduced the world's first centralized exchange-based internet trading

system, BSEWEBx.co.in to enable investors anywhere in the world to trade on

the BSE platform.

Several Firsts

At par with the international standards, BSE has in fact been a pioneer in

several areas. It has several firsts to its credit even in an intensely competitive

environment.



First in India to introduce Equity Derivatives

First in India to launch a Free Float Index

First in India to launch US$ version of BSE SENSEX

First in India to launch Exchange Enabled Internet Trading Platform

First in India to obtain ISO certification for a stock exchange

'BSE On-Line Trading System‘ (BOLT) has been awarded the globally

recognised the Information Security Management System standard

BS7799-2:2002.

First to have an exclusive facility for financial training

First in India in the financial services sector to launch its website in Hindi

and Gujarati

Shifted from Open Outcry to Electronic Trading within just 50 days

BSE COMPANY LIST

ACC ,Grasim , Hindalco, HLL, ITC, L&T, RIL ,Hindustan

ShipyardLimited, Bajaj, Tata Steel, Tata Motors, BHEL, Gujarat Ambuja ,

ICICI Bank, Ranbaxy, Reliance Energy, SBI, Infosys, NIIT, Dr. Reddy's,

Cipla, Hero Honda, Airtel, HDFC Bank, ONGC, Wipro, Maruti, NTPC,

TCS, Reliance Communications ,

Sun Pharmaceutical



2.3 Industry Profile at Regional Level

Ahmedabad Stock Exchange

Bangalore Stock Exchange

Bhubaneshwar Stock Exchange

Bombay Stock Exchange (BSE)

Calcutta Stock Exchange

Cochin Stock Exchange

Coimbatore Stock Exchange

Delhi Stock Exchange Association

Guwahati Stock Exchange

Hyderabad Stock Exchange (HSE)

Inter-connected Stock Exchange of India

Jaipur Stock Exchange

Ludhiana Stock Exchange Association

Madhya Pradesh Stock Exchange

Madras Stock Exchange (MSE)

Mangalore Stock Exchange

National Stock Exchange of India (NSE)

Magadh Stock Exchange - In Patna, Bihar

Over The Counter Stock Exchange of India (OTCEI)

Pune Stock Exchange

Uttar Pradesh Stock Association

Vadodara Stock Exchange

Meerut Stock Exchange

United Stock Exchange of India



(A) Ahmedabad Stock Exchange or ASE

It is the second oldest exchange of India located in the city of Ahmedabad in

the western part of the country. It is recognized by Securities Contract

(Regulations) Act, 1956 as permanent stock exchange. It has adopted

a Swastika in its logo which is one of the most auspicious symbols of Hinduism

depicting wealth and prosperity.

The stock exchange was established as a Public Charitable Trust in 1894

following the establishment of the Bombay Stock Exchange in 1875. Earlier the

stock exchange functioned under the framework of the Bombay Securities

Contracts Act, 1925. Following the The Securities Contract Regulations Act,

1956 the Gujarat Share & Stock Exchange, Indian Share and General Exchange

Association and Bombay Share and Stock Exchange, Share and Stock Brokers

Association merged with the Ahmedabad Share and Stock Brokers Association

and gave rise to ASE as it stands today.

Ahmedabad Stock Exchange Limited is a premier national equities exchange

that plays a key role in the Indian securities markets. Serving individual and

institutional investors from around the world, its primary business is the trading

of approximately 2000 nationally listed equities. The Exchange also trades over



200 high growth companies that are solely listed on the ASE or dually listed

with another exchange.

The Stock Exchange-Ahmedabad, constituted as a Public Charitable

Trust in 1894, is the second oldest exchange of India. It is recongnized

by Securities Contract (Regulations) Act, 1956 as permananent stock exchange.

History of Stock Exchanges in India traces back to the nineteenth century with

the establishment of the Bombay Stock Exchange in 1875 followed by

Ahmedabad Stock Exchange in 1894. In the world map of bourses, the Stock

Exchange - Ahmedabad holds a unique place with its initial functioning starting

under banayan tree and has progressed year after year therefrom.

The 80s and 90s saw major focus on building up requisite

infrastructure and bringing about rapid progress in the area of computerization

in the exchanges as whole.Recognizing and appreciating the necessity of

computerization and putting emphasis on screen based trading the Stock

Exchange-Ahmedabad went live on Dec. 12, 1996.

(B) Vadodara Stock Exchange or VSE

Is located in the city of Vadodara in Western India. It was established in 1990

at Vadodara.It is the third largest stock exchange in the state

of Gujarat after Ahmedabad and Rajkot. It is recognized by the Securities

Contract (Regulations) Act of 1956 as a permanent stock exchange.

From a humble beginning in 1986 with the Vadodara Stock Brokers'

Association comprising of 150 members, it was incorporated in January

22 1990 as Vadodara Stock Exchange Limited. By 1999, the exchange had a

total of 321 brokers, of which 65 were corporate brokers, 253 were proprietor

brokers, and 3 were partnership brokers. Then, there were only 85 sub-brokers

registered.



3.1 Objective of study

To analyze investors perception towards investment in derivative market.

To understand the concept of the Derivatives and Derivative trading.

To know different types of Financial Derivatives

To know the role of derivatives trading in India.

3.2 Literature review

1. Derivative Trading in Indian Stock Market: Broker‘s Perception:

http://www.iimb.ernet.in/publications/review/guidelines-authors

Sandeep Srivastava,

Surendra S Yadav, P K Jain on September, 2008.

Volume 20

Abstract

The authors conducted a survey of brokers in the recently introduced

derivatives markets in India to examine the brokers' assessment of market

activity and their perception of the benefits and costs of derivative trading. The

need for such a study was felt as previous studies relating to the impact of

derivative securities on the Indian stock market do not cover the perception of

market participants who form an integral part of the functioning of derivative

markets. The issues covered in the survey included: a) perception of brokers

about the attractiveness of different derivative securities for clients; b) profile of

clients dealing in derivative securities; c) popularity of a particular derivative

security out of the total set; d) different purposes for which the clients are using

these securities in order of preference; e) issues concerning derivative trading; f)



reasons for non-usage of derivatives by some investors and g) pricing, liquidity

and informational efficiency of the derivative market.

Derivative securities have penetrated the Indian stock market and it emerged

that investors are using these securities for different purposes, namely, risk

management, profit enhancement, speculation and arbitrage. High net worth

individuals and proprietary traders account for a large proportion of broker

turnover. Interestingly, some retail participation was also witnessed despite the

fact that these securities are considered largely beyond the reach of retail

investors (because of complexity and relatively high initial investment). Based

on the survey results, the authors identified some important policy issues such

as the need to bring in more institutional participation to make the derivative

market in India more efficient and to bring it in line with the best practices.

Further, there is a need to popularise option instruments because they may

prove to be a useful medium for enhancing retail participation in the derivative

market.

2. Increasing Derivatives Market Activity in Emerging Markets and

Exchange Rate Exposure

URL: http://www.econ.uconn.edu/working/2008-06.pdf

Uluc Aysun (University of Connecticut)

Melanie Guldi (Mount Holyoke College)

Abstract

Using firm level data, we report a significant fall in the exchange rate exposure

of emerging market firms over the past 10 years, and relate this to higher

derivatives market participation. Our methodology follows a three stage



approach. First, we measure and report foreign exchange exposures for each

year using the popularized extension of the Adler-Dumas (1984) model. Next,

we use an indirect approach to estimate the derivatives market participation at

the firm level. Finally, we investigate the implications of the level of derivative

market activity on a firm's foreign exchange exposure. Our results show that

foreign exchange exposure is negatively related to derivatives usage, and

support the hedging explanation of the exchange rate exposure puzzle.

3. Indian Derivative Markets: Some Policy Issues

URL: http://ssrn.com/abstract=1428685

Anuradha Guru: member of ―National Stock Exchange of India‖

January 2009.

Abstract:

On their journey of innovation, derivatives have not been free from

controversies. They have often been held to be too complex to comprehend.

The leverage that these products provide to investors raises concern. Recently,

the present global financial crisis is being attributed to the housing mortgages

being repackaged and sold as collateralised debt obligations and other exotic

derivative products to financial institutions, pension funds and individuals.

Policy markers around the world are now having a relook as the problems

being posed by derivatives viz. lack of homogeneous rules and accounting

standards; the excessive freedom allowed to market players to innovate and the

lack of complete statistics for exchange-traded and OTC transactions. Leaders

are talking about the need for more transparency and accountability in the

functioning of derivative markets. While this exercise is underway, the aim of

this paper is to present the historical perspective in which derivatives have

developed in India and present certain issues which have been widely debated



in the context of these markets in India, while also presenting the international

context of the debates.

3.3 STATEMENT OF PROBLEM

To know about the perception of investors toward the Derivative market in

surat city.

3.4 RESEARCH DESIGN

DESCRIPTIVE RESEARCH

The research is primarily descriptive in nature. The sources of information are

both primary and secondary.

3.5 SAMPLING METHODOLOGY

Sampling Technique: Stratified sampling.

Sampling Unit: The respondents who were asked to fill out the

questionnaire were from Surat, are the sampling units. These respondents

comprise of the persons from broker houses & person dealing in stock

trading.

Sample Size: The sample size was restricted to 100 respondents.

Sampling Area: The area of the research was surat.

Time: 6 weeks

Statistical tool used: Simple tools like bar graphs, tabulation, have been used.



3.6 Method of data collection:-

Primary sources: Questionnaire

3.7 LIMITAITONS OF STUDY

Limited time : The time available to conduct the study was only 6 weeks. It

being a wide topic had a limited time.

Sample size: As more number of sample can also be taken to increase the

reliability of study.

Sampling method: There are more no of sampling techniques that can be

use in this research which may give different result.



4.1 HISTORY OF DERIVATIVES:

Derivatives trading began in 1865 when the Chicago Board of Trade

(CBOT) listed the first "exchange traded" derivatives contract in the USA.

These contracts were called "futures contracts".

In 1919, the Chicago Butter and Egg Board, a spin-off of CBOT, was

reorganized to allow futures trading. Its name was changed to Chicago

Mercantile Exchange (CME).

The first stock index futures contract was traded at Kansas City Board of

Trade. Currently the most popular stock index futures contract in the world

is based on the Standard & Poor's 500 Index traded on the CME.

In April 1973, the Chicago Board of Options Exchange was set up

specifically for the purpose of trading in options.

The market for options developed so rapidly that by early 80s the number of

shares underlying the option contract sold each day exceeded the daily

volume of shares traded on the New York Stock Exchange. And there has

been no looking back ever since.

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 liberalization process and

Reserve Bank of India‘s (RBI) efforts in creating currency forward market.

Derivatives are an integral part of liberalization 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.



4.2 Chronology of instruments

1991 Liberalization process initiated

14 December 1995 NSE asked SEBI for permission to

trade index futures.

18 November 1996 SEBI setup L.C.Gupta Committee to

draft a policy framework for index

futures.

11 May 1998 L.C.Gupta Committee submitted

report.

7 July 1999 RBI gave permission for OTC

forward rate agreements (FRAs) and

interest rate swaps.

24 May 2000 SIMEX chose Nifty for trading

futures and options on an Indian

index.

25 May 2000 SEBI gave permission to NSE and

BSE to do index futures trading.

9 June 2000 Trading of BSE Sensex futures

commenced at BSE.

25 September 2000 Nifty futures trading commenced at



SGX.

4.3 NEED FOR DERIVATIVES IN INDIA TODAY

In less than three decades of their coming into vogue, derivatives markets have

become the most important markets in the world. Today, derivatives have

become part and parcel of the day-to-day life for ordinary people in major part

of the world. Until the advent of NSE, the Indian capital market had no access

to the latest trading methods and was using traditional out-dated methods of

trading. There was a huge gap between the investors‘ aspirations of the markets

and the available means of trading. The opening of Indian economy has

precipitated the process of integration of India‘s financial markets with the

international financial markets. Introduction of risk management instruments in

India has gained momentum in last few years thanks to Reserve Bank of India‘s

efforts in allowing forward contracts, cross currency options etc. which have

developed into a very large market.

The advantage of using derivatives as an investment strategy over cash markets

is that the fund outlay in a derivative contract is lower. Typically, only a

percentage is to be paid upfront in the shape of initial margin. Thus, for the

same fund outlay, much larger exposure is possible through a derivative

contract. Mutual Funds in India are permitted to invest in derivative for the

purpose of hedging against risk and portfolio rebalancing. SEBI regulates both

effectiveness of the hedge and its size.

With derivatives fast gaining popularity and retail participation increasing, we

feel it is just a matter of time before derivatives investments go beyond just

fulfilling the hedging needs of the fund, and are looked upon as separate

investment options.



The potential and the advantages that this avenue gives to the fund manager are

immense and some players have already drawn up plans for a separate class of

products that focuses entirely on investment in derivatives, with active

positions in the cash segment, which will eventually help the industry branch

out to other areas as well.

THE USES OF DERIVATIVE MARKETS

Derivatives markets serve to shift risk.

Hedgers use derivatives to reduce risk exposure. For instance, a refiner can

lock in costs and revenues (i.e., lock in its margin) by buying crude oil

futures and selling oil and gasoline futures.

Speculators use derivatives to increase risk exposure in the anticipation of

making a profit.

Thus, derivatives markets facilitate the shifting of risk from those who bear

it at a high cost (the risk averse) to those who bear it at a low cost (the risk

tolerant).

Speculators perform a valuable service by absorbing risk from hedgers. In

return, they receive a reward—a risk premium. The risk premium is the

expected profit on a derivatives transaction. Speculators may win or lose in

any given trade, but on average speculators expect to profit.

The risk premium is also the cost of hedging.



4.4 MYTHS AND REALITIES ABOUT DERIVATIVES

DIn 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 parts

of the world. While this is true for many countries, there are still apprehensions

about the introduction of derivatives.

What are these myths behind derivatives?

Derivatives increase speculation and do not serve any economic purpose.

Indian Market is not ready for derivative trading.

Disasters prove that derivatives are very risky and highly leveraged

instruments.

Derivatives are complex and exotic instruments that Indian investors will

find difficulty in understanding.

Is the existing capital market safer than Derivatives ?

MAJOR FACTORS RESPONSIBLE FOR THE GROWTH OF

FINANCIAL DERIVATIVES



Integration of international markets with national financial markets

Increased volatility in asset prices in financial markets

Development of more sophisticated risk management tools, providing

economic agent wider choice of risk management strategies

Improvement in technology and communication facilities and sharp decline

in costs

Innovations in the derivatives markets have led to the diversification of risk

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

The modernization of commercial and investment banking

Sectors of underdeveloped economies, such as commercial banking, which

had been closed to foreigners, have been opened to foreign private sector

investment

4.5 THE PARTICIPANTS IN A DERIVATIVES MARKET

• HEDGERS use futures or options markets to reduce or eliminate the risk

associated with price of an asset.

• SPECULATORS use futures and options contracts to get extra leverage in

betting on future movements in the price of an asset. They can increase both

the potential gains and potential losses by usage of derivatives in a speculative

venture.

• ARBITRAGEOURS are in business to take advantage of a discrepancy

between prices in two different markets. If, for example, they see the futures

price of an asset getting out of line with the cash price, they will take offsetting

positions in the two markets to lock in a profit.



4.6 Types of derivatives

(A) FORWARD

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 normally traded outside the exchanges.

The salient features of forward contracts are:

They are bilateral contracts and hence exposed to counterparty risk.

Each contract is custom designed, and hence is unique in terms of

contract size, expiration date and the asset type and quality.

The contract price is generally not available in public domain.



On the expiration date, the contract has to be settled by delivery of the

asset.

If the party wishes to reverse the contract, it has to compulsorily go to

the same counter-party, which often results in high prices being charged.

However forward contracts in certain markets have become very standardized,

as in the case of foreign exchange, thereby reducing transaction costs and

increasing transactions volume. This process of standardization reaches its limit

in the organized futures market. Forward contracts are often confused with

futures contracts. The confusion is primarily because both serve essentially the

same economic functions of allocating risk in the presence of future price

uncertainty. However futures are a significant improvement over the forward

contracts as they eliminate counterparty risk and offer more liquidity.

(B) FUTURE

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.



BASIC FEATURES OF FUTURE CONTRACT:

1. Lot size:- lot size means that we cannot buy single share as in equity market

we can only buy bundle of shares of a particular script ,like, if we want to

purchase future of reliance than lot size is 150 share therefore you have to

purchase whole lot. For example: - in NIFTY lot size is 50 shares, MINI

NIFTY (it is for retail sector) lot size is 20 shares.

2. Margin: when anyone executes a future trade, then initial margin has to be

paid, which may be 10% of the value of the contract-it is fixed by the exchange.

The margin consists of cash or cash equivalents, is to ensure that the traders

will honor the obligation arising out of future contract. The margin has to be

posted by the future both the parties to the future contract as both are exposed

to losses.

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.

Cash settlement - a cash payment is made based on the underlying reference

rate, such as a short term interest rate index such as Euribor, or the closing

value of a stock market index. A futures contract might also opt to settle against

an index based on trade in a related spot market.

4. Expiry is the time when the final prices of the future are determined. For

many equity index and interest rate futures contracts, this happens on the Last



Thursday of certain trading month. On this day the t+2 futures contract

becomes the t forward contract.

(C) OPTION

An Option is a contract which gives the right, but not an obligation, to buy or

sell the underlying at a stated date and at a stated price. While a buyer of an

option pays the premium and buys the right to exercise his option, the writer of

an option is the one who receives the option premium and therefore obliged to

sell/buy the asset if the buyer exercises it on him

Options are of two types - Calls and Puts options

"Calls" give the buyer the right but not the obligation to buy a given

quantity of the underlying asset, at a given price on or before a given future

date.

"Puts" give the buyer the right, but not the obligation to sell a given quantity

of underlying asset at a given price on or before a given future date. All the

options contracts are settled in cash.

(D) 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.



4.7 BUSINESS GROWTH IN DERIVATIVES SEGMENT

A) INDEX FUTURES- CONTRACTS

http://www.nseindia.com/products/content/derivatives/equities/data_report.htm

Graphical representation of number of contracts.

INTERPRETATION:

From the data and the bar diagram above, there is high business growth in the derivative segment in India. In the year 2000-01, the number of contracts in index future were 90580 where as a significant increase of 210428103 is observed in the year 2008-09.



(B) TURNOVER

NUMBER OF TURNOVERS OF STOCK FUTURES


INTERPRETATION: From the data and above bar chart, there is high

turnover in the derivative segment in India. In the year 2001-02 the turnover of

index future was 21483 where as a huge increase of 3570111.40 in the year

2008-09 are observe.



.(C) STOCK FUTURES:-


INTERPRETATION:

from the data and bar diagram above there were no stock futures available but

in the year 2001-02, it predominantly increased to 1957856. then there was huge

increase of 20,35, and 87,952 in the year 2007-08 and thereafter there was a

steady rise to 221577980 in the year 2008-09.



(C) INDEX OPTIONS CONTRACTS:-


Interpretation:

From the data and bar chart above, the no of contracts of index option was nil

in the year 2000-2001. But there was a predominant increase of 1, 75,900 in the

year 2001-2002. in the year 2008-2009 there was a huge increase in the index

option contracts to 212088444 in the year 2008-2009.



TURNOVER

INDEX OPTION TURNOVER PER YEAR IN RS. CRORES


GRAPHICAL REPRESENTATION OF TURNOVER PER YEAR

INTERPRETATION:

From the data and bar chart above, there was no turnover in the year 2000-2001 for index option. it slowly started increasing in the year 2000-2001 to 3765. But in the year 2007-2008 there was a huge increase of 1362110.088 and consistent increase to 3731501.84 observed in 2008-2009



D) STOCK OPTIONS

CONTRACTS


GRAPHICAL REPRESENTATION OFNUMBER OF CONTRACTS

TRADED PER YEAR IN STOCK OPTION

INTERPRETATION: From the data and bar chart above the no of contracts of stock

option in the year 2000-2001 was nil. But there was a huge increase of

1037529 observed in the year 2001-2002. It was 13295970 which

were the highest in the year 2008-2009 and stands at 1451603 in the

first quarter of the year 2009-10.



5.1 QUESTIONNAIRE ANALYSIS

SURVEY QUESTIONNAIRE OF INVESTOR’S PERCEPTION TOWARDS

INVESTMENT IN DERIVATIVE MARKET FOR MOTILAL OSWAL

SECURITY Ltd., SURAT

1. How would you place your order?

The following is the bar -chart of above data (according to the percentage)

Interpretation:

Only 45 % of Surat people do trading through online while 55% of people

trading through offline mode.

45%

55%

Mode of trading

online offline

Online

Offline

45%

55%



2. In which of the following segment you prefer to invest?

The following is the bar-chart of above data

2.1 If Derivative market, then

Interpretation

The 2 chart shows 25% of people should investment in derivative market

because of lack of knowledge towards this segment and 25% of people would

invest in currency market, 32% of people would invest in stock option and 43%

of people would invest in stock future.

Equity 75%

Derivative 25%

Market segment

Stock option 32%

stock future 43%

Currency 25%

Type of DM

Equity Derivative

75% 25%



3. Education qualification

Under Graduate Graduate Post Graduate Professional degree

holder

21% 59% 17% 3%

Interpretation:

There is more no. of graduate respondent who invest or know about derivate

market almost 60% is from this category. This shows that a literate person do

the investment in this market.

4. Income range of respondent:

Below1,50,000 P.A 47%

1,50,000 - 3,00,000 P.A 17%

3,00,000 – 5,00,000 P.A 20%

Above 5,00,000 P.A 16%

Educational qualification

21

59

17

3

0

10

20

30

40

50

60

70

Under

graduate .

Graduate. Post

Graduate

Professional

degree

holder.

Pe

rce

nta

ge



The following is the bar-chart of above data (according to the percentage)

Interpretation

People from income group below 150000 are dealing with derivative more than

other category. Other category almost covers 20% in each category. These

indicate that low income group people invest more than high income group

people.

5. How do you analyze the stock market?

Interpretation

Maximum % of people should analyze through tips and recommendation

which had been given by client‘s broker.

47%

17% 20%

16%

Below1,50,000 P.A 1,50,000 - 3,00,000P.A

3,00,000 – 5,00,000 P.A

Above 5,00,000 P.A

INCOME GROUP



6. Normally what % of your monthly household income could be available for investment?

Option No of respondents

Between 5% to 10%

47

Between 11% to 15%

18

Between 16% to 20%

17

Between 21% to 25%

14

More than 25%.

4

Total 100

THE FOLLOWING IS THE Bar-CHART OF ABOVE DATA

Interpretation:

Around 50 % of respondent invest on 5- 10% of their income to this derivate

market. And 15 % of people in each other category invest higher amount of

investment. These indicate that people don‘t want to invest in such market due

to high risk factor and lack of knowledge.

Percentage of household income could be

available for investment

47

18 1714

4

0

5

10

15

20

25

30

35

40

45

50

Between 5%

to 10%

Between 11%

to 15%

Between

16% to 20%

Between 21%

to 25%

More than

25%.

Percentage Range

Perce

ntage



7. PURPOSE OF INVESTING IN DERIVATIVE MARKET

Interpretation:

32% of respondent invest their money for hedging purpose. And about 50% of

respondent invest for both risk control and to earn stable return. This show

that investor are not much known to this market and hence invest to get stable

return without any risk.

Option No of

respondents

To Hedge their fund 32

Risk control 27

More stable 25

Direct investment without buying and

holding of assets.

16

Total 100

Purpose of investing in derivate market

32

2725

16

0

5

10

15

20

25

30

35

To Hedge their

fund

Risk control More stable Direct investment

without buying and

holding of assets.Diff purpose

Per

cen

tag

e



8. Which broker would you prefer to take advice before investing in

Equity & derivative market?

Motilal oswal 45%

Jainum 15%

Angle 35%

Ventura 5%

Interpretation:-

Survey shows that the 45% of surat city invest through motilal oswal because of

brand, low brokerage and strategies.

9. You participate in derivative market as

Types of Participant % of involvement

Investors 35%

Speculators 15%

Broker 45%

Hedger 5%

45%

15%

35%

5%

Broker

Motilal oswal Jainum Angle Ventura



Interpretation:

In surat city 45% of people should invest through broker because people do

not want to take own risk.

12. What was the result of your investment?

35%

15%

45%

5%

Investors Speculators Broker Hedger

Participant

Series1

Option No of respondents

Great result (more than 50% of

your investment)

15

Moderate/ Constant result (20% -

40% return)

54

Disappointed (less than 10%

return )

31

Total 100



Interpretation:-

Investment in derivative market is more risky than equity market but the high

volume of money in this segment. Our survey shows that 54% of investment

gives moderate result only 15% people get higher return.

15%

54%

31%

Great result (more than 50% of yourinvestment)

Moderate/ Constant result (20% - 40%return)

Disappointed (less than 10% return )

No of respondents



6.1 FINDINGS

1. The study says that almost 60% of people in surat is knowing about this

market and their perception toward this market says that it is very highly risky

and leveraged instrument, and they get very moderate return in this market.

2. After analyzing data it is clear that the main factors that can drive the

understanding of Derivative Market are Market improvement in

communication facilities as well as long term saving & investment through

entering into Derivative Contract. So these factors can encourage the

Derivative Market in India as well as in surat.

3. In the case of stock future there was a slow increase observed in the number

of contracts whereas a decline was also observed in its turnover. In the case of

index option there was a huge increase observed both in the number of

contracts and turnover.

5. As proper understanding of this market is lacking people afraid to invest in

this market. Most of the people deal mere as a investor they does not play

crucial part in hedging, arbitrage & as a speculator.

6. Derivative market is growing very fast in the Indian Economy. The turnover

of Derivative Market is increasing year by year in the India‘s largest stock

exchange NSE. In the case of index future there is a phenomenal increase in

the number of contracts.

7. Derivative Market is more regulated & standardized so in this way it provides

a more controlled environment. In nutshell, we can say that the rule of High



risk & High return apply in Derivatives. If we are able to take more risk then

we can earn more profit under Derivatives.

6.2 Recommendations

The decision about whether to use derivatives should be driven, not by the

company's size, but by its strategic objectives. It is important that all users of

derivatives understand how their contracts are structured, the unique price and

risk characteristics of those instruments, and how they will perform under

stressful and volatile economic conditions. Following are the recommendation

for enhancing the derivative market .

To increase market transparency improved information on the size and

structure of the derivatives market should be provided.

Derivative Market is more regulated & standardized so in this way it

provides a more controlled environment. In nutshell, we can say that the

rule of High risk & High return apply in Derivatives. If we are able to

take more risk then we can earn more profit under Derivatives

A careful risk management study in respect to the corporate goals with

complete market stimulation is very necessary for participating in the

derivatives market.

By improvement in communication facilities (i.e understanding) as well

as long term saving & investment can encourage the investor in this

market.

Internationally consistent market statistics on the notional amounts and

gross market values outstanding of broad categories of foreign exchange,

interest rate, and equity-based derivative instruments should be provided.

This would benefit individuals as well as organizations in better

prediction of the global financial activity.



It may be wise to stay away from the more exotic instruments, unless the

risk/reward tradeoffs are clearly understood by the firm's senior

management and its independent risk management review team. Exotic

contracts should not be used unless there is some obvious reason for

doing so. But when used wisely, financial derivatives can increase

shareholder value by providing a means to better control a firms risk

exposures and cash flows.

In nut shell, after study it is clear that Derivative influence our Indian Economy

up to much extent. So, SEBI should take necessary steps for improvement in

Derivative Market so that more investors can invest in Derivative market.

There is a need of more innovation in Derivative Market because in today

scenario even educated people also fear for investing in Derivative Market

Because of high risk involved in Derivatives.

RBI should play a greater role in supporting derivatives.

Derivatives market should be developed in order to keep it at par with other

derivative markets in the world.

Speculation should be discouraged.

There must be more derivative instruments aimed at individual investors.

SEBI should conduct seminars regarding the use of derivatives to educate

individual investors.



6.3 Conclusion

From the research study about the perception regarding the derivative market

we come to know that there is understanding for the market in this segment in

investor or broker house but there thinking toward this market says that due to

high risk involve in this market people afraid to deal with it.

Derivatives allow firms and individuals to hedge risks and to take risks

efficiently. They also can create risk at the firm level, especially if a firm uses

derivatives episodically and is inexperienced in their use. For the economy as a

whole, a collapse of a large derivatives user or dealer may create systemic risks.

On balance, derivatives help make the economy more efficient.

However, neither users of derivatives nor regulators can be complacent. Firms

have to make sure that derivatives are used properly. This means that the risks

of derivatives positions have to be measured and understood. Those in charge

of taking derivatives positions must have the proper training. It also means that

firms must have well-defined policies for derivatives use. A firm‘s board must

know how risk is managed within the firm and which role derivatives play.

Regulators have to make sure to monitor carefully financial firms with large

derivatives positions.

Though regulators seem to be doing a good job in monitoring banks and

brokerage houses, the risks taken by insurance companies, hedge funds and

government sponsored enterprises should be understood and monitored.

So should we fear derivatives? The answer is ―no.‖ We should have a healthy

respect for them. We do not fear planes because they may crash and do not

refuse to board them because of that risk. Instead, we make sure that planes are

as safe as it makes economic sense for them to be. The same applies to



derivatives. Typically, the losses from derivatives are localized, but the whole

economy gains from the existence of derivatives markets.

7 BIBLIOGRAPHIES

BOOKS REFERRED:

Sandeep Srivastava, Surendra S Yadav, P K Jain September, 2008 Derivative

Trading in Indian Stock Market: Brokers's Perception, Volume 20, Number

3 Article.

Rasmeet Kohli may2010 Journey of equity derivatives market at NSE ?An

analysis for the decade (2000-01 to 2009-10)

NSE‘s Certification in Financial Markets: - Derivatives Core module

Hull.C,John, 2005 ―Options Futures, and other Derivatives‖

Financial Markets & Services by Gordon & Natarajan

WEBSITES VISITED:

http://www.articlesbase.com/non-fiction-articles/knowing-the-basics-

of-credit-derivatives-45563.html

www.nseindia.com

www.igidr.ac.in/~susant/DERBOOK/PAPERS/pm.pdf

www.ny.frb.org/research/economists/sarkar/ derivatives_in_india

Derivative Market

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