Concept SharingWorkshop on Financial Literacy

in School Education

A New Dimension in Risk Management: Managing the Risk of Financial Models – Part 2

SEBI Financial Education Resource Persons Workshop

Pocket Money Programme in Thane and Vashi

SEPTEMBER 2011

NISM UPDATE Team

NISM recently held its first convocation ceremony for students of the PGPSM and CFERM programmes and it was a memorable occasion for more reasons than one. This issue contains a coverage of the event along with photographs that some of those who attended the event will cherish for a long, long time. We are also sending a copy of the Convocation Address delivered by the H'ble Chief Guest, Padma Vibhushan Dr. C. Rangarajan at the event, along with this issue of NISM Update.

This months issue also contains the second and concluding part of the article A New Dimension in Risk Management: Managing the Risk of Financial Models. If you've enjoyed reading the first part, do make sure you catch up with the final part.

Also in this issue are details of a unique concept workshop organized by NISM for developing a curriculum for financial literacy in school education. The programme was attended by representatives of all regulatory agencies, viz. RBI, SEBI, IRDA, PFRDA along with representative from NSE, BSE and CBSE.

NISM also conducted two programmes for school teachers under the Pocket Money programme for school teachers in Thane and Navi Mumbai, respectively. Along the same lines, a 7-day workshop for a new batch of Financial Literacy Resource Persons for the Western region was held at NISM Bhavan in August.

There's all this and more in this issue of NISM Update.

As always, do keep writing to us with your feedback and comments.

NATIONAL INSTITUTE OF SECURITIES MARKETSNISM Bhavan, Plot No. 82, Sector - 17, Vashi, Navi Mumbai - 400 705 Phone: +91- 022-66735100-106 | Fax: 022-66735110www.nism.ac.inNiSM

2 NiSM September 2011

FOREWORD

3NiSMSeptember 2011

NISM held its first Convocation for students of the Post Graduate Programme in Securities Markets (PGPSM) and Certificate in Financial Engineering and Risk Management (CFERM) on September 9, 2011 at the Y. B. Chavan Centre, Nariman Point, Mumbai. These long-term programmes were offered under the aegis of the School for Securities Education (SSE) at NISM. The ceremony was presided by Mr. U. K. Sinha, Chairman, Board of Governors, NISM. Padma Vibushan Dr. C. Rangarajan, Chairman, Economic Advisory Council to the Prime Minister was the Chief Guest.

The programme started at 6:30 p.m. at Rangswar Hall, Y. B. Chavan Centre with the invocation of the Saraswati Vandana. Prof. G Sethu, OSD & In-charge NISM, extended a warm welcome to the

NiSMconvocation

dignitaries and guests. Mr. Soneji, Registrar, NISM then presented the activity report of the institute. He highlighted the achievements of the institute, especially the progress achieved in certification of securities markets intermediaries, NISM's efforts in implementing SEBI's initiative of creating awareness about financial literacy amongst the masses, the value additions to the industry through knowledge dissemination and interactions on key issues by thought leaders from India and abroad, among others. Mr. Soneji also presented the plans for the institute during the coming years.

The convocation certificates were presented by Mr. U. K. Sinha, Chairman, Board of Governors, NISM. Apart from the certificates, there was the State Bank of India sponsored Gold Medal for the

4 NiSM September 2011

September 09, 2011

student securing top rank in PGPSM along with a cash prize of Rs. 1 lakh and a Canara Bank sponsored Gold Medal for the student securing top rank in CFERM. The medals along with the citation certificates to these two top ranking students were distributed by H'ble Chief Guest Padma Vibhushan Dr. C. Rangarajan. Mr. Amalendu Gupta won the SBI medal while Mr. Chaitanya Nemali won the Canara Bank medal for best academic performance for PGPSM and CFERM, respectively.

While delivering his address, Mr. U. K. Sinha, Chairman, Board of Governors, NISM and Chairman of SEBI articulated SEBI's plan for building a strong institute in NISM. He said that the vision for NISM is to actively collaborate with the securities markets fraternity and academia to take the institute towards the next level of growth. Congratulating all students, he said “this certification will help you not only in getting a better position in life but also to contribute meaningfully to the growth of the securities markets.”

The H'ble Chief Guest Padma Vibhushan Dr. C. Rangarajan, in his convocation address, spoke about the thrust given by the institute in providing education and training to prepare ready-made professionals to fill the gap in the securities markets. He provided insights of successes and failures of regulators in various parts of the world. He also pointed out that while India is on the growth path, a constant vigil must always be maintained on the financial markets to stay on course. Addressing the student community, he said “Please maintain always a professional approach with high ethical standards and by doing so you will serve the country the best.” (Copies of Dr. C. Rangarajan's Convocation Address, printed in the form of a booklet, were distributed to everyone at the end of the ceremony.)

Mr. U. K. Sinha presented the Chief Guest a memento on behalf of NISM. The convocation ceremony was followed by dinner.

5NiSMSeptember 2011

6 NiSM September 2011

Regardless of what type of stock market

transaction one performs, risk is always present.

People need a fast and reliable way to calculate

and control the risk involved in stock trading….

The functioning of the Black-Scholes Model is

based on the use of stock options. What makes

stock options so appealing is that the purchaser

knows that the limit of his/her losses can only be

the premium price. However, there are no limits

to his/her gains, because the limit of the value of

the stock is theoretically limitless….

If there were a formula that could tell you the fair

price for an option while taking into account all

necessary factors, it would come of great use to

the financial world….

This is where the Black-Scholes Option Pricing

Model comes in. Black and Scholes found a

theoretical way to neutralize risk. They

discovered that they could reduce risk by creating

a balance in which all movements in the markets

cancelled each other out… .

Although a marvellous achievement, there was a

practical problem with the formula. It assumed

that markets were always in equilibrium; that

supply equals demand. A Harvard graduate by the

name of Robert Merton solved this problem by

introducing the notion of continuous time....

So overwhelming was the sudden mass use of the

Black-Scholes Model, that when the stock market

crashed in 1978, the influential business

magazine Forbes put the blame squarely onto

that one formula....

Are models really responsible?

At a conference in February 1998, an industry

trade magazine called Derivatives Strategy,

sponsored a discussion group titled “First Kill All

the Models”. This group reflects the recent

backlash against financial models. Many figures

in the financial industry question whether

models can match a trader's skill and gut intuition

about market dynamics.

Derivatives make the news, because, like an

airplane crash, their losses can be dramatic and

chaotic. Enormous losses by Proctor & Gamble

and Gibson Greetings and the bankruptcies of

Barings Bank and Orange County, California have

been attributed to the use of models.

However, Scholes says that it was not so much the

formula itself that caused these losses, rather its

misuse by market traders. Every statistician and

mathematician knows you cannot predict the

future with 100% accuracy. Laws as rigid as the

laws of physics do not govern the market. Peter

Fisher, a New York economist says: “Math doesn't

drive financial markets, people drive financial

markets, and people are not predictable. We do

not yet have a universal theory of human

behaviour or human motivation.”

It was not the model by itself that caused these

losses, but the blind faith that market traders put

into it. They all jumped at the prospect of making

money without risk. However, this formula

cannot eliminate risk, it can only minimize it. Like

many mathematical models, it relies on inputs

and assumes a functioning market. It is a

powerful way to manage risk, but it's not a crystal

ball. Scholes says this equation should be used as

a tool for making decisions, not a platform from

which all decisions should be made.

AKHLAQUE AHMAD, LECTURER, SCHOOL OF SECURITIES EDUCATION, NISM

A NEW DIMENSION IN RISK MANAGEMENT:MANAGING THE RISK OF FINANCIAL MODELS – PART II

Excerpts from Part 1

Fisher says: “If a random bolt of lightning hits you

when you're standing in the middle of the field, it

feels like a random event. But if your business is to

stand in random fields during lightning storms,

then you should anticipate, perhaps a little more

robustly, the risks you're taking on.”

This formula is a method to calculate these risks,

not a risk neutralizer. “There is a danger of

accepting models without carefully questioning

them,” says Joseph A. Langsam, a former

mathematician who develops and tests models

for fixed- income securities at Morgan Stanley.

Thus, Modelers are not the culprit for all financial

losses, but traders' blind faith in them.

What care should be taken?

Many traders still use the ideas behind the Black-

Scholes Options Pricing Model, if not the model

itself. The fundamental ideas behind the equation

forever changed the stock market. Today, traders

use many principles of the Black-Scholes Model as

guides through the treacherous waters of the

stock market. For this, Scholes and Merton

became Nobel laureates.

In finance we study how to manage funds – from

simple securities like dollars and yen, stocks and

bonds, to complex ones like futures and options,

subprime CDOs and credit default swaps. We

build financial models to estimate the fair value of

securities, to estimate their risks and to show how

those risks can be controlled. How can a model

tell you the value of a security? And how did these

models fail so badly in the case of the subprime

CDO market?

Models are tools for approximate thinking; they serve to transform your intuition about the future into a price for a security today. It's easier to think intuitively about future housing prices, default rates and default correlations than it is about CDO prices. CDO models turn your guess about future housing prices, mortgage default rates and a simplistic default correlation into the model's output: a current CDO price.

Our experience in the financial arena has taught

us to be very humble in applying mathematics to markets, and to be extremely wary of ambitious theories, which are in the end trying to model human behaviour. We like simplicity, but we should remember that it is our models that are simple, not the world.

We do need models and mathematics – you cannot think about finance and economics without them – but one must never forget that models are not the world. Whenever we make a model of something involving human beings, we are trying to force the ugly stepsister's foot into Cinderella's pretty glass slipper. It doesn't fit without cutting off some essential parts. And in cutting off parts for the sake of beauty and precision, models inevitably mask the true risk rather than exposing it. The most important question about any financial model is how wrong it is likely to be, and how useful it is despite its assumptions. You must start with models and then overlay them with common sense and experience.

Many academics imagine that one beautiful day we will find the 'right' model. But there is no right model, because the world changes in response to the ones we use. Progress in financial modelling is fleeting and temporary. Markets change and newer models become necessary. Simple, clear models with explicit assumptions about small numbers of variables are therefore the best way to leverage your intuition without deluding yourself.

Dammers, Jerry (1998). “Option Pricing: The Concept & the Black- Scholes Method” Valuemetrics, Inc. (2000)

Devlin, Keith. (November 1997). “A Nobel Formula” Mathematical Association of America (2000)

Hull, J.C. (2010). “Options, Futures, and other Derivatives New York” Prentice Hall.

Rubash, Kevin. (1998). “A Study of Option Pricing Models” Bradley University (2000)

Scott Patterson (2010). ”The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It” Crown Business New York

References

7NiSMSeptember 2011

CONCEPT SHARING WORKSHOP ONFINANCIAL LITERACY IN SCHOOL EDUCATION

NISM organized a concept sharing workshop on Curriculum Development in Financial Literacy in School Education at the premises of Securities Exchange Board of India, New Delhi, on August 16, 2011. The programme was attended by representatives from all regulatory agencies, viz. RBI, SEBI, IRDA, PFRDA, and from NSE, BSE, NISM and CBSE.

Addressing the gathering, Mr. Ramesh Krishnamurthi, Director – Capital Markets, Ministry of Finance informed the participants that curriculum development on financial literacy was very close to the heart of the ministry of finance and that they would like to take all efforts to ensure that financial literacy is inculcated as part of the school education. He noted that in a country of 1.2 billion people, only 2 million people were having demat accounts. Likewise, he added, a vast segment of people were excluded from the reach of banking services. Curriculum development in Financial Literacy would therefore play a key role in addressing these

anomalies. He also said that awareness about financial transactions has to be created at an early age so that people understood concepts like Aadhar, PAN, KYC, among others. Presently, he said, people's knowledge was limited to knowing about tax savings instruments. He was confident that financial education would make India a powerhouse in terms of development.

Mr. Prashant Saran, Whole Time Member, SEBI emphasized on the 3Rs followed in the past – aRithmetic, Reading and wRiting that makes one literate. Today's school syllabus should be integrated with financial education without causing any extra burden on books, he said. He mentioned the case of people working in the financial sector but having inadequate knowledge about managing their own finance as an example of poor awareness about personal finance. It's imperative to inculcate knowledge of managing their own finances at an early age, he said. And the ideal way to start early, he said, would be to introduce the topic at the school

Mr. Ramesh Krishnamurthi, Director-Capital Markets, Ministry of Finance, addressing the group

8 NiSM September 2011

stage itself. He informed the gathering that he was glad to know that the ministry of finance has taken a step forward in this direction.

Speaking on the occasion, Prof. G Sethu, Officer on Special Duty, NISM mentioned that supply side and demand side are to be strengthened to make the financial services industry grow efficiently. In financial markets, supply side dominates the demand side. Prof. Sethu informed the gathering that regulators were putting their efforts to make it balanced. He also noted that while developing the curriculum, we need to think where India would be after 10 - 20 years and efforts should be taken early to see that the young generation are provided with the right inputs on financial education.

The workshop has decided to take the process forward by compiling materials on various topics on financial literacy. The respective regulatory agencies have been entrusted the responsibility of preparing the material while NISM will coordinate the entire exercise.

Mr. Prashant Saran, Whole Time Member, SEBI

9NiSMSeptember 2011

SEBI FINANCIAL EDUCATION RESOURCE PERSONSWORKSHOP

The second round of the recruitment and empanelment of Resource Persons for SEBI's Financial Education was held at Navi Mumbai during August 20-27, 2011. Forty eight resource persons were recruited and empanelled. The workshop was inaugurated on August 21, 2011. The function was attended by Prof. G. Sethu, OSD, NISM, Shri K. Sukumaran, Dean-SIEFL, Mr. G. P. Garg, Chief General Manager, SEBI and Mr. N Hariharan, General Manager, SEBI.

The workshop began with a session on the various regulatory agencies and the roles they perform. The participants were provided a macro picture of capital markets wherein the functioning of stock exchanges, clearing corporations, depositories, market intermediaries, viz. brokers, distributors, merchant bankers, custodians, etc. were discussed. This session was followed by one on Financial Planning where the significance of planning and budgeting finances of individuals were discussed. The session on Time Value of

Money discussed the importance of money in terms of value. Participants were also briefed about asset classes (physical assets, financial assets, etc.) along with concepts of safety, liquidity and returns. The session on banking covered deposit and loan products. The various features of secured loans and unsecured loans were debated so as to get a fair understanding of credit markets. There were also sessions on insurance and SEBI's modules on financial education. At the end of the sessions, the candidates were asked to make a presentation on selected topics. The workshop also had two resource persons of the previous batches share their experiences at the ground level with the new batch. Also included was a session on Communication Skills to impart soft skills that would be required while conducting workshops.

Mr. Amit Trivedi anchored the entire workshop. Certificates were distributed to all participants at the end of the workshop.

10 NiSM September 2011

NISM LAUNCHES ITS OWN TEST CENTRES

NiSMSeptember 2011 11

The Supreme Court of India has made it mandatory for every organization to put in place preventive, corrective and punitive measures to eliminate sexual harassment at the place of work. NISM has already appointed a three-member committee to deal with complaints originating from staff members on this issue.

NISM recently held an interactive session on the subject to sensitize employees on the topic. Titled “Prevention of Sexual Harassment at the Workplace”, the session was conducted by senior resource person and subject matter expert Ms. Shanti Mojumdar on Friday, July 29, 2011. All staff members of NISM attended the session.

NISM is glad to announce that its two state-of-the-art test centres are now available for candidates wishing to appear for certification examinations mandated by Securities and Exchange Board of India (SEBI). You can register for any of the NISM exams by filling in the prescribed registration form available on the N I S M O n l i n e C e r t i f i cat i o n Syste m at https://certifications.nism.ac.in/.

The location of the two test centres are as follows:

PREVENTION OF SEXUAL HARASSMENT AT THEWORKPLACE

Nariman Point, Mumbai

1st Floor, 'C' Wing, Mittal Court, Opposite Vidhan Bhavan, Nariman Point, Mumbai, Maharashtra.

Phone : 022-66540591-93

Vashi, Navi Mumbai

Ground Floor, NISM Bhavan, Plot No. 82, Sector - 17, Near HDFC Bank, Vashi, Navi Mumbai, Maharashtra.

Phone : 022-66735185-86

POCKET MONEY PROGRAMME

As part of our mission to spread financial literacy among the student community, the Pocket Money programme was conducted in Thane and Navi Mumbai during August 2011.

In Thane, the programme was held on August 19 and 20 at Narendra Ballal Hall within the premises of Thane Municipal Corporation (TMC). A total of 100 school teachers attended the programme. The inaugural session was attended by Shri Ramchandra Fadtare, Sabhapati, Pre-primary and Secondary education and Mrs. Chaya Mankar, Assistant Commissioner, Pre-primary and Secondary education, TMC. The workshop was conducted by Mr. Nitin Tike, Mr. Ashutosh Wakhare and Mr. Murli Iyer.

The programme at Navi Mumbai was held on August 27 and 28 in the Municipal School at Shiravne Gaon. A total of 73 school teachers attended the program. The inaugural session was attended by Mr. Chabuswar, Deputy Commissioner, NMMC and Mr. Sonawane, Programme Co-ordinator. Mr. Ashutosh Wakhare and Mr. Murli Iyer conducted the workshop.

12 NiSM September 2011