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A

PROJECT REPORT ON

AWARENESS ABOUT THE DERIVATIVE AND ITS

COMPARISON WITH EQUITY

UNDERTAKEN AT:

ANAND RATHI FINANCIAL SERVICES

LTD. Submitted in the partial fulfillment of the Requirement

of the awards of

MASTER OF BUSINESS ADMINISTRATION

EXTERNEL GUIDE: INTERNAL GUIDE:

Mr.JAGDISH PALIWAL Mr. ALOK KUMAGUPTA(BRANCH HEAD) H.O.D (MBA)

SUBMITTED BY:

ANKIT CHOUDHARY

ROLL No. 0908570009

S.D. COLLEGE OF MAMAGEMENT STUDIES BHOPA ROAD,MUZAFFARNAGAR

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DECLARATION

I, ANKIT CHOUDHARY hereby declare that the project report entitled

AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISON WITH

EQUITY is based on my own work and my indebtedness to other work/

publications, if any have been duly acknowledged at the relevant place.

PLACE: MUZAFFARNAGAR

DATE:

ANKIT CHOUDHARY

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ACKNOWLEDGEMENT

To acknowledge is very great way to show your gratitude towards the persons

who have contributed in your success in one or other way.

I find words inadequate to express my gratitude to Mr. JAGDISH PALIWAL for

providing me an opportunity to carry out my winter project as such a well reputed

and leading stock broking company ANAND RATHI FINANCIAL Services

Limited.

At the very outset of the training I deem it is my pious duty to express my sincere

thanks also to branch head Mr. Jagdish Paliwal for his continuous guidance and

supervision and support during the project.

I would like to thank Mr. ALOKKUMAR GUPTA (H.O.D MBA)who has guided

me for my project work and provided encouragement through out my training

period.

This study could not have been successful without the valuable input of the

customer of ANAND RATHI.

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PREFACE

I know that Project is for the development and enhancement of the knowledge in

this particular field. It can never be possible to make a mark in todays

competitive era only with theoretical knowledge when industries are developing

at global level, practical knowledge of administration and management of

business is very important. Hence, practical study is of great importance to MBA

student.

With a view to expand the boundaries of thinking, I have undergone MBA

Summer Project at Anand Rathi Financial Services Ltd I have made a

deliberate to collect the required information and fulfill project objective.

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TABLE OF CONTENTS

Sr.No. SUBJECT Page

No.

1

2

Industry profile

Company profile --------- Anand Rathi Financial

Services Ltd

6-17

18-39

3 Financial derivatives:

1. Introduction about derivatives

2 Risk Associated With Derivatives

3 Functions of derivative market

4 Participants of derivative market

5 Types of derivatives

6 Emergence of derivative trading in India

7 Introduction of forward

8 Introduction to futures

9 Introduction to options

10 Types of options

11 Pricing with regard to option

12 Difference between derivative and equity

40-70

4 RESEARCH METHODOLOGY 71-73

5 DATA ANALYSIS 73-88

6 FINDINGS 89

7 CONCLUSION90

8 RECOMENDATION 91

9 BIBLIOGRAPHY & APPENDIX 92-

100

INDUSTRY PROFILE :

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HISTORY OF THE STOCK BROKING INDUSTRY

Indian Stock Markets are one of the oldest in Asia. Its history dates back to

nearly 200 years ago.

In 1887, they formally established in Bombay, the "Native Share and Stock

Brokers' Association" (which is alternatively known as "The Stock Exchange"). In

1895, the Stock Exchange acquired a premise in the same street and it was

inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated.

Thus in the same way, gradually with the passage of time number of exchanges

were increased and at currently it reached to the figure of 24 stock exchanges.

This was followed by the formation of associations /exchanges in Ahmadabad

(1894), Calcutta (1908), and Madras (1937).

In order to check such aberrations and promote a more orderly development of

the stock market, the central government introduced a legislation called the

Securities Contracts (Regulation) Act, 1956. Under this legislation, it is

mandatory on the part of stock exchanges to seek government recognition. As of

January 2002 there were 23 stock exchanges recognized by the central

Government. They are located at Ahmadabad, Bangalore, Baroda,

Bhubaneswar, Calcutta, Chennai,(the Madras stock Exchanges ), Cochin,

Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana,

Mangalore, Mumbai(the National Stock Exchange or NSE), Mumbai (The Stock

Exchange), popularly called the Bombay Stock Exchange, Mumbai

(OTCExchange of India), Mumbai (The Inter-connected Stock Exchange of

India), Patna, Pune, and Rajkot. Of course, the principle bourses are the National

Stock

Exchange and The Bombay Stock Exchange, accounting for the bulk of the

business done on the Indian stock market.

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BSE (BOMBAY STOCK EXCHANGE)

The Stock Exchange, Mumbai, popularly known as "BSE" was

established in 1875 as "The Native Share and Stock Brokers Association". It

is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was

established in 1878. It is the first Stock Exchange in the Country to have obtained

permanent recognition in 1956 from the Govt. of India under the Securities

Contracts (Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides

the policies and regulates the affairs of the Exchange. The Governing Board

consists of 9 elected directors, who are from the broking comm

Unity (one third of them retire ever year by rotation), three SEBI nominees, six

public representatives and an Executive Director & Chief Executive Officer and a

Chief Operating Officer.

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NSE (NATIONAL STOCK EXCHANGE)

NSE was incorporated in 1992 and was given recognition as a stock

exchange in April 1993. It started operations in June 1994, with trading on the

Wholesale Debt Market Segment. Subsequently it launched the Capital Market

Segment in November 1994 as a trading platform for equities and the Futures

and Options Segment in June 2000 for various derivative instruments.

MCX (MULTI COMMODITY EXCHANGE)

MULTI COMMODITY EXCHANGE of India limited is a new order exchange

with a mandate for setting up a nationwide, online multi-commodity market place,

offering unlimited growth opportunities to commodities market participants. As a

true neutral market, MCX has taken several initiatives for users in a new

generation commodities futures market in the process, become the countrys

premier exchange.

MCX, an independent and a de-mutualized exchange since inception, is all

set up to introduce a state of the art, online digital exchange for commodities

futures trading in the country and has accordingly initiated several steps to

translate this vision into reality.

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NCDEX (NATIONAL COMMODITIES AND DERIVATIVESEXCHANGE)

NCDEX started working on 15th December, 2003. This exchange provides

facilities to their trading and clearing member at different 130 centers for contract.

In commodity market the main participants are speculators, hedgers and

arbitrageurs.

Facilities Provided By NCDEX

NCDEX has developed facility for checking of commodity and also

provides a wear house facility

By collaborating with industrial partners, industrial companies, news

agencies, banks and developers of kiosk network NCDEX is able to

provide current rates and contracts rate.

To prepare guidelines related to special products of securitization NCDEX

works with bank.

To avail farmers from risk of fluctuation in prices NCDEX provides special

services for agricultural.

NCDEX is working with tax officer to make clear different types of sales

and service taxes.

NCDEX is providing attractive products like weather derivatives

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STOCK MARKET BASIC

What are corporations?

Companies are started by individuals or may be a small circle of people.They pool their money or obtain loans, raising funds to launch the business.

A choice is made to organize the business as a sole proprietorship where one

Person or a married couple owns everything, or as a partnership with others who

may wish to invest money. Later they may choose to "incorporate". As a

Corporation, the owners are not personally responsible or liable for any debts of

the company if the company doesn't succeed. Corporations issue official-looking

sheets of paper that represent ownership of the company. These are called stock

certificates, and each certificate represents a set number of shares. The total

number of shares will vary from one company to another, as each makes its own

choice about how many pieces of ownership to divide the corporation into. One

corporation may have only 2,500 shares, while another, such as IBM or the Ford

Motor Company, may issue over a billion

Shares. Companies sell stock (pieces of ownership) to raise money and provide

funding for the expansion and growth of the business. The business founders

give up part of their ownership in exchange for this needed cash. The expectation

is that even though the owners have surrendered a portion of the company to the

Public, their remaining share of stock will become increasingly valuable as the

business grows. Corporations are not allowed to sell shares of stock on the open

Stock market without the approval of the Securities and Exchange Commission

(SEC). This transition from a privately held corporation to a publicly traded one is

Called going public, and this first sale of stock to the public is called an initial

public offering, or IPO.

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Why do people invest in the stock market?

When you buy stock in a corporation, you own part of that company. This gives

you a vote at annual shareholder meetings, and a right to a share of future profits.

When a company pays out profits to the shareholder, the money received is called

a "Dividend".

The corporation's board of directors choose when to declare a dividend and how

much to pay. Most older and larger companies pay a regular dividend, most newer

and smaller companies do not.

The average investor buys stock hoping that the stock's price will rise, so the

shares can be sold at a profit. This will happen if more investors want to buy stock

in a company than wish to sell. The potential of a small dividend check is of little

concern.

What is usually responsible for increased interest in a company's stock is the

prospect of the company's sales and profits going up.

A company who is a leader in a hot industry will usually see its share price rise

dramatically.

Investors take the risk of the price falling because they hope to make more money

in the market than they can with safe investments such as bank CD's or government

bonds.

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What is a stock market index?

In the stock market world, you need a way to compare the movement of the

market, up and down, from day to day, and from year to year. An index is just a

benchmark or yardstick expressed as a number that makes it possible to do this

comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index

of BSE.

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

company is.

The Securities Market consists of two segments, viz. Primary market and

Secondary market. Primary market is the place where issuers create and issue

equity, debt or hybrid instruments for subscription by the public; the Secondary

market enables the holders of securities to trade them.

Secondary market essentially comprises of stock exchanges, which provide

platform for purchase and sale of securities by investors. In India, apart from

the Regional Stock

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Exchanges established in different centers, there are exchanges like the

National Stock Exchange (NSE) and the Over the Counter Exchange of India

(OTCEI), who provide nation wide trading facilities with terminals all over the

country. The trading platform of stock exchanges is accessible only through

brokers and trading of securities is confined only to stock exchanges.

Corporate Securities :

The no of stock exchanges increased from 11 in 1990 to 23 now. All the

exchanges are fully computerized and offer 100% on-line trading. 9644

companies were available for trading on stock exchanges at the end of March

2002. The trading platform of the stock exchanges was accessible to 9687

members from over 400 cities on the same date.

Derivatives Market :

Derivatives trading commenced in India in June 2000. The total exchange traded

derivatives witnessed a volume of Rs. 442,343 crore during 2002-03 as against Rs.

4018 crore during the preceding year. While NSE accounted for about 99.5% of

total turnover, BSE accounted for about 0.5% in 2002-03. The market witnessed

higher volumes from June 2001 with introduction of index options, and still higher

volumes with introduction of stock options in July 2001. There was a spurt in

volumes in November 2001 when stock futures were introduced. It is believed

that India is the largest market in the world for stock futures.

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Supply and Demand

A stock's price movement up and down until the end of the trading day is strictly

a result of supply and demand. The SUPPLY is the number of shares offered

for sale at anyone one moment. The DEMAND is the number of shares

investors wish to buy at exactly that same time. What a share of a company is

worth on anyone day or at any one minute, is determined by all investors voting

with their money. If investors want a stock and are willing to pay more, the price

will go up. If investors are selling a stock and there aren't enough buyers, the

price will go down Period.

S econdary Market Intermediaries

Stock brokers, sub-brokers, portfolio managers, custodians, share transfer

agents constitute the important intermediaries in the Secondary Market.

No stockbrokers or sub-brokers shall buy, sell or deal in securities unless he holds

a certificate of registration granted by SEBI under the Regulations made by SEBI

ion relation to them.

The Central Government has notified SEBI (Stock Brokers & Sub-Brokers) Rules,

1992 in exercise of the powers conferred by section 29 of SEBI Act, 1992. These

rules came into effect on 20th August, 1992.

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Trading Through Brokers / Traditional Method of ShareTrading:-

Trading in the stock exchange can be conducted only through member broker in

securities that are listed on the respective exchange. Investor intending tobuy/sell securities in the exchange has to do so only through a SEBI registered

broker/sub-broker. This is very popular concept in India for Share Trading before

the facilities like on line trading introduce.

Both the exchange have switched over from the open outcry trading system to

fully automated computerized mode of trading knows as Bolt and Neat. In this

system, the broker trade with each other through the computer network. Buyers

and sellers place their orders specifying the limits for quality and price. Those

that are not matched remain on the screen and is opened for future matching

during the day / settlement. After the advent of computerized trading the speed of

trading has increased multi-fold and a fuller view of the market is available to the

investors.

To start dealing with broker you have to fill a form with the broker. After fill all the

formalities the firm gives you a User Id no like a bank a/c no. through which you

can enter in the transaction with broker. Broker will gives all the which one

investor needed.

What is stock Broker?

A stock broker is one who invests other peoples money until its all

gone.

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-Woody Allen, American Film Maker

A stock broker is a person or a firm that trades on its clients behalf, you tell

them what you want to invest in and they will issue the buy or sell order. Somestock brokers also give out financial advice that you a charged for.

It wasnt too long ago and investing was very expensive because you had to go

through a full service broker which would give you advice on what to do and

would charge you a hefty fee for it.

There are three different types of stock brokers.

1. Full Service Broker - A full-service broker can provide a bunch of

services such as investment research advice, tax planning and retirement

planning.

2. Discount Broker A discount broker lets you buy and sell stocks at a low

rate but doesnt provide any investment advice.

3. Direct-Access Broker- A direct access broker lets you trade directly with

the electronic communication networks (ECNs) so you can trade faster.

Active traders such as day traders tend to use Direct Access Brokers

No. of stock broker in India9368:- Total no of share broker in the country

12687:- The no. of sub-broker.

46%:- The share of trades accounted for by NSE broker

90%: The share of On line trades clocked by segments top five companies

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Generally there are two types of trading have been done in India which is given

below:

On line Trading / E Broking / Modern Method

Trading through Brokers / Traditional method of Share trading.

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ABOUT ANAND RATHI

INTRODUCTION:-

Anand Rathi is a leading full service investment bank founded in 1994 offering a

wide range of financial services and wealth management solutions t institutions,

corporations, highnet worth individuals and families. The firm has rapidly

expanded its footprint to over 350 locations across India with international

presence in Dubai ,Hong Kong & New York. Founded by Mr. Anand Rathi and

Mr. Pradeep Gupta,the group today employs over 2,500 professionals through

out India and its international offices.

The firms philosophy is entirely client centric, with a clear focus

on providing long Term value addition to clients, while maintaining the highest

standards of excellence, Ethics and professionalism. The entire firm activities are

divided across distinct client groups: Individuals, Private Clients, Corporates and

Institutions. AnandRathi has been named The Best Domestic Private Bank in

India by Asiamoney in their Fifth Annual Private Banking Poll 2009. The firm has

emerged a winner across all key segments in Asiamoneys largest survey of highnet worth individuals in India.

The firms philosophy is entirely client centric, with a clear focus on

providing long Term value addition to clients, while maintaining the highest

standards of excellence, Ethics and professionalism. The entire firm activities are

divided across distinct client groups: Individuals, Private Clients, Corporates and

Institutions. AnandRathi has been named The Best Domestic Private Bank inIndia by Asiamoney in their Fifth Annual Private Banking Poll 2009. The firm has

emerged a winner across all key segments in Asiamoneys largest survey of

high net worth individuals in India.

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ANAND RATHI consultant

As the flagship company of the ANAND RATHI Group, ANAND RATHI Private

Limited has always remained at the helm of organizational affairs, pioneering

business policies, work ethic and channels of progress.

ANAND RATHI believe that they were best positioned to venture into that activity

as a Depository Participant. They were one of the early entrants registered asDepository Participant with NSDL (National Securities Depository Limited), the

first Depository in the country and then with CDSL (Central Depository Services

Limited). Today, It service over 1Lac customer accounts in this business spread

across over 350 cities/towns in India and are ranked amongst the largest

Depository Participants in the country. With a growing secondary market

presence.

It has transferred this business to ANAND RATHI SECURITIES LIMITED

(ARSL), their associate and a member of NSE, BSE, MCX & NCDEX.

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Business Focus:-

The focus of the business is the Customer Customer service, Customer

education, Customer support, Customer relations and last but not the least

Customer acquisition. Trade execution transparency, timely settlements, riskmonitoring and superior service shall have topmost priority, in the best interests

of all concerned.

VISION STATEMENT

TO BE A SHINING EXAMPLE AS A LEADER IN

INNOVATIONPROFESSIONALLY

MISSION STATEMENT

TO WORK TOGETHER WITH INTEGRITY & MAKE OUR

CUSTOMER FEEL VALUED

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CORE VALUE

RESPECT OUR COLLEAGUE AND THE BUSINESS ITSELF

Board of DirectorsOf

ANAND RATHI GROUP

NAME POSITION

Mr. Anand Rathi Founder & chairman

Mr. Pardeep Gupta Co- Founder & vice chairman

Mr. Amit Rathi Managing Director

Mr. P G Kakodkar Director

Dr. S A Dave Direcror

Mr. C D Arha Director

Mr. Ajit Bhushan Director

Mr. Rakesh Rawal National Head-Welth management

Mr.Sujan Hajra Chief Economist

Mr.Roy Rodrigues CEO

Mr.Puspen Karmakar Vice President

Ms. Rajni Raikar Vice President

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Principal Activities OfPrincipal Activities OfANAND RATHI GROUP

ANAND RATHI Securities Private Limited

Member : National Stock Exchange of India Limited

Member : Bombay Stock Exchange Limited

Participant : National Securities Depository Limited

Participant : Central Depository Service (India) Limited

ANAND RATHI Commodities Private Limited

Member - Multi Commodity Exchange of India Limited

Member - National Commodities and Derivatives Exchange

Ltd.

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ANAND RATHI Profile

REGISTERED OFFICE

MUZAFFARNAGAR BRANCH

24

11th Floor, Times Tower KamalaCity Senapati Bapat Marg, Lower

Parel., Mumbai - 400013, India

39-A New Mandi,Muzaffarnagar-251001PH. 0131-2605572,2600343,3291199FAX. 0131-2605571


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Organization Chart:-

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Anand Rathi

FranchiseBranch

WebDealer

SalesExecutive

SalesCoordinator

CustomerCare

Receptionist

Account Head


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ANAND RATHIs CORE SERVICES:-

ANAND RATHI is one of Indias leading broking houses providing a complete

life-cycle of investment solution.

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EQUITIES

DERIVATIVES

COMMODITIES

Research BasedInvestment Advice

Investment andTrading Services

Integrated DematFacility

Technology BasedInvestment Tools

Training andSeminars


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SWOT

Analysis


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Strength:-

16 years of research and broking experience

Understandings of the markets

All financial needs under one roof

Scalable and robust infrastructure

Full fledge research unit comprising of both fundamental & technical

research

Dedicated, Qualified and Loyal staff

Flexible Brokerage charges

Weakness:-

Low Brand Image in the market.

Low Professionalism

Low Advertisements

Opportunity:-

Large potential market for delivery and intra-day transactions.

Open interest of the people to enter in to stock market for investing

Attract the customers who are dissatisfied with other brokers & DPs.

Up growing markets in commodity and forex trading

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Threats:-

Decreasing rates of brokerage in the market. A Increasing competition

against other brokers & DPs.

Poor marketing activities for making the company known among the

customers. A threat of loosing clients for any kind of weakness of the

company. An Indirect threat from instable stock market, i.e., low/no profit

of ANAND RATHI's clients would lead them to go for other broker/DP.

SERVICES of ANAND RATHI

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OFFLINE

Offline A/c is the A/c for the investors who are

not familiar with the use of computer.

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ANAND RATHIs Services

Offline

Online

Other Services


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The A/C opening charges applied(One time)

.

Onlin e Account

Requirement for online trading

Linked Bank Account

Broking Account

Linked Depository Account

Benefits of online tradingFreedom from paperwork

Instant credit and transfer

Trade Anywhere

Timely Advice and access to research

Real-time portfolio tracking

After hour orders

Market Alerts

Instant quotes

Other Services:

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Dial-n-Trade

Mutual Fund

Commodity

Derivative

Depository Participants

Distribution of Financial Services

Research Based Advices

Portfolio Management System

DnT (Dial- n Trade )

Dial n Trade is the name of the phone-trading facility offered by ANAND

RATHI.

A call center wholly dedicated to order placement / confirmation.

Easy 2-step process for order placement.

Step1. Enter the phone no. of branch

Step2. And say your client code

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ANAND RATHI Securities Private Limited, one of the cornerstones of the ANAND

RATHI edifice, flows freely towards attaining diverse goals of the customer

through varied services. Creating a plethora of opportunities for the customer by

opening up investment vistas is backed by research-based advisory services.

Here, growth knows no limits and success recognizes no boundaries. Helping the

customer create waves in his portfolio and empowering the investor completely is

the ultimate goal.

Stock Broking Services

We offer trading on a vast platform; National Stock Exchange, Bombay Stock

Exchange, MCX & NCDEX. More importantly, we make trading safe to the

maximum possible extent, by accounting for several risk factors and planning

accordingly. We are assisted in this task by our in-depth research, constant

feedback and sound advisory facilities. Our highly skilled research team,

comprising of technical analysts as well as fundamental specialists, secure

result-oriented information on market trends, market analysis and market

predictions.

To empower the investor further we have made serious efforts to ensure that our

research calls are disseminated systematically to all our stock broking clients

through various delivery channels like email, chat, SMS, phone calls etc.

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MUTUAL FUNDS

Meaning:

A mutual fund is a pool of money that is invested according to a common

investment objective by an asset management company (AMC). The AMC offers

to invest the money of hundreds of investors according to a certain objective - to

keep money liquid or give a regular income or grow the money long term.

Investors buy a scheme if it fits in with their investment goals, like getting a

regular income now or letting the money accumulate over the long term.

Investors pay a small fraction of their total funds to the AMC each year as

investment management fees.

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Introduction:

Everybody talks about mutual funds, but what

exactly are they? Are they like shares in a company,

or are they like bonds and fixed deposits? Will I lose

all my money in funds or will I become an overnight

millionaire? Big questions that get answer in just five


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Commodity

Organized futures market evolved in India by the setting up of "Bombay Cotton

Trade Association Ltd." in 1875. In 1893, following widespread

discontent amongst leading cotton mill owners and

merchants over the functioning of the Bombay Cotton Trade Association,

a separate association by the name "Bombay Cotton Exchange Ltd." was

constituted. A future trading in oilseeds was organized in India for the first time

with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures

trading in groundnut, castor seed and cotton. Before the Second World War

broke out in 1939 several futures markets in oilseeds were functioning in Gujarat

and Punjab.

There were booming activities in this market and at one time as many as 110

exchanges were conducting forward trade in various commodities in the country.

The securities market was a poor cousin of this market as there were not many

papers to be traded at that time.

The era of widespread shortages in many essential commodities resulting in

inflationary pressures and the tilt towards socialist policy, in which the role of

market forces for resource allocation got diminished, saw the decline of this

market since the mid-1960s.

This coupled with the regulatory constraints in 1960s, resulted in virtual

dismantling of the commodities future markets. It is only in the last decade that

commodity future exchanges have been actively encouraged. However, the

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markets have been thin with poor liquidity and have not grown to any significant

level.

Derivative

The emergence of the market for derivative products, most notably forwards, futures

and options, can be traced back to the willingness of risk-averse economic agents to

guard themselves against uncertainties arising out of fluctuations in asset prices. By

their very nature, the financial markets are marked by a very high degree of volatility.

Through the use of derivative products, it is possible to partially or fully transfer

price risks by locking-in asset prices. As instruments of risk management,

these generally do not influence the fluctuations in the underlying asset prices.

However, by locking-in asset prices, derivative products minimize the impact of

fluctuations in asset prices on the profitability and cash flow situation of risk-averse

investors.

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Depository Participants

The onset of the technology revolution in financial services Industry saw the

emergence of ANAND RATHI as an electronic custodian registered with

National Securities Depository Ltd (NSDL) and Central Securities

Depository Ltd (CSDL). ANAND RATHI set standards enabling further

comfort to the investor by promoting paperless trading across the country and

emerged as the top 3 Depository Participants in the country in terms of

customer serviced.

Offering a wide trading platform with a dual membership at both NSDL and

CDSL, we are a powerful medium for trading and settlement of dematerialized

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Shares. We have established live DPMs, Internet access to accounts and an

easier transaction process in order to offer more convenience to individual and

Corporate investors. A team of professional and the latest technological expertise

allocated exclusively to our demat division including technological enhancements

like SPEED-e; make our response time quick and our delivery impeccable. A

wide national network makes our efficiencies accessible to all.

About ANAND RATHI:

Depository participant with both NSDL and CDSL

Over 25 thousands clients being serviced from over 135 cities.

Web enabled service to provide state of the art service delivery

Distribution of Financial Products

The paradigm shift from pure selling to knowledge based selling drives the

business today. With our wide portfolio offerings, we occupy all segments in the

retail financial services industry.

A 1600 team of highly qualified and dedicated professionals drawn from the best

of academic and professional backgrounds are committed to maintaining highlevels of client service delivery.

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This has propelled us to a position among the top distributors for equity and debt

issues with an estimated market share of 15% in terms of applications mobilized,

besides being established as the leading procurer in all public issues.

To further tap the immense growth potential in the capital markets we enhanced

the scope of our retail brand, thereby providing planning and advisory services to

the mass affluent. Here we understand the customer needs and lifestyle in the

context of present earnings and provide adequate advisory services that will

necessarily help in creating wealth. Judicious

Planning that is customized to meet the future needs of the customer deliver a

service that is exemplary. The market-savvy and the ignorant investors, both find

this service very satisfactory. The edge that we have over competition is our

portfolio of offerings and our professional expertise. The investment planning for

each customer is done with an unbiased attitude so that the service is truly

customized.

Our monthly magazine, Finapolis, provides up-dated market information on

market trends, investment options, opinions etc. Thus empowering the investor to

base every financial move on rational thought and prudent analysis and embark

on the path to wealth creation.

About ANAND RATHI :

Investments

Equity Primary and Secondary

Fixed Income Primary and Secondary

Fixed Deposits

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Mutual Funds

Insurance

Life : LIC, Amp Sanmar, HDFC Standard, ICICI Prulife, Om

Kotak, MetLife, Tata AIG, Birla Sun life

General : New India, Tata AIG, Reliance, Royal Sundaram

Portfolio Management System

The company has initiated the process of obtaining permission from SEBI for

rendering PMS Service to its clients. We are planning to start PMS Service to

High Net Worth individual and NRIs after obtaining the necessary regulatory

clearances.

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THEORETICAL ASPECT

INTRODUCTION:

According to dictionary, derivative means something which is derived

from another source. Therefore, derivative is not primary, and hence notindependent. In financial terms, derivative is a product whose value is derived

from the value of one or more basic variables. These basic variable are called

bases, which may be value of underlying asset, a reference rate etc. the

underlying asset can be equity, foreign exchange, commodity or any asset.

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For example: - the value of any asset, say share of any company, at a

future date depends upon the shares current price. Here, the share is

underlying asset, the current price of the share is the bases and the future value

of the share is the derivative. Similarly, the future rate of the foreign exchange

depends upon its spot rate of exchange. In this case, the future exchange rate is

the derivative and the spot exchange rate is the base.

Derivatives are contract for future delivery of assets at price agreed at the

time of the contract. The quantity and quality of the asset is specified in the

contract. The buyer of the asset will make the cash payment at the time of

delivery.

Meaning:

Derivatives are the financial contracts whose value/price is dependent on

the behavior of the price of one or more basic underlying assets (often simply

known as the underlying). These contracts are legally binding agreements,

made on the trading screen of stock exchanges, to buy or sell an asset in future.

The asset can be a share, index, interest rate, bond, rupee dollar exchange rate,

sugar, crude oil, soybean, cotton, coffee etc.

In the Indian Context the Security Contracts (Regulation) Act, 1956

(SC(R) A) defines derivative to include

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

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

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

underlying securities.

43

Contracts agreement

Cash Derivatives

Forward Others likeSwaps, FRAs etc

Merchandising,

customized

Futures

(Standardized

)

Options

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In financial terms derivatives is a broad term for any instrumental whose value is

derived from the value of one more underlying assets such as commodities,

forex, precious metal, bonds, loans, stocks, stock indices, etc.

Derivatives were developed primarily to manage offset, or hedge against

risk but some were developed primarily to provide potential for high returns. In

the context of equity markets, derivatives permit corporations and institutional

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

For example: - The price of Reliance Triple Option Convertible Debentures

(Reliance TOCD) used to vary with the price of Reliance shares. In addition, the

price of Telco warrants depends upon the price of Telco shares. American

Depository receipts / Global Depository receipts draw their price from the

underlying shares traded in India.

Nifty options and futures. Reliance futures and options, are the most common

and popular form of derivatives.

Although trading in agriculture and other commodities has been the

deriving force behind the development of derivatives exchanges, the demand for

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products based on financial instruments such as bond, currencies, stocks and

stock indices have now for outstripped that for the commodities contracts.

The history of the derivatives dates back to the time since the trading

came into being. The merchants entered into contracts with one another for

future delivery of specified amount of commodities at specified price. A primary

intention for contracting for future date was to keep the transaction immune to

unexpected fluctuations in price.

Therefore, derivative products initially emerged as hedging devices

against fluctuations in commodity prices. However, the concept applied to

financial trade only in the post-1970 period due to growing instability in the

financial markets. However, since their emergence, these products have

become very popular and by 1990s, they accounted for about two-third of the

total transaction in derivative products.

In recent years, the market for financial derivatives has grown tremendously

in terms of variety of instruments available, their complexity and turnover.

In the class of equity derivatives the world over, futures and options on stock

indices have gained more popularity than on individual stocks, especially among

institutional investors, who are major users of index-linked derivatives.

Even small investors find these useful due to high correlation of the

popular indexes with various portfolios and ease of use.

Early forward contracts in the US addressed merchants concerns about

ensuring that there were buyers and sellers for commodities. However credit

risk remained a serious problem.

1848

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A group of Chicago businessmen formed the Chicago Board of Trade

(CBOT). The primary intention of the CBOT was to provide a centralized location

known in advance for buyers and sellers to negotiate forward contracts.

1865

The CBOT went one-step further and listed the first exchange traded

derivatives contract in the US; these contracts were called future contracts

1919

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 CBOT and the CME remain the two largest organized futures

exchanges, indeed the two largest financial exchanges of any kind in the world

today.

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 was

based on S&P 500 index, traded on Chicago Mercantile Exchange.

During the mid eighties, financial futures became the most active

derivatives instruments generating volumes many times more than the

Commodity futures. Index futures, futures on T-Bills and Euro-Dollarfutures are the three most popular future contracts traded today. Other popular

international exchanges that trade derivatives are LIFFE in England, DTB in

Germany, SGX in Singapore, TIFFE in Japan, and MATIF in France, Eurex, etc.

India has been trading derivatives contract in silver, gold, spices, coffee,

cotton, etc for decades in the gray market. Trading derivatives contracts in

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organized market was legal before Moorage Desais government banned

forward contracts.

Derivatives on stocks were traded in the form of Teji and Mandi in

unorganized on exchanges. For example, now cotton and oil futures trade in

Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee in

Bangalore, etc.

JUNE 2000

National Stock Exchange and Bombay Stock Exchange started trading in

futures on Sensex and Nifty. Options trading on Sensex and

Nifty commenced in June 2001. Very soon thereafter trading began on options

and futures in 31 prominent stocks in the month of July and November

respectively.

Option and future are the most commonly traded derivatives, but as the

understanding of financial markets and risked management continued to

improve newer derivatives were created. The family includes the host of other

product such as forward contracts. Structured notes, inverse floaters, caps &

Floors and Collar Swaps.

The largest derivatives market in the world, are on government bonds (to

help control interest rate risk) the stock index (to help control risk that is

associated with the fluctuations in the stock market) and on exchange rates (to

cope with currency risk).

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Risk Associated With Derivatives:

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

derivatives trading are neither new nor unique they are the same kind of

risks associated with traditional bond or equity instruments.

Market Risk

Derivatives exhibit price sensitivity to change in market condition, such as

fluctuation in interest rates or currency exchange rates. The market risk of

leveraged derivatives may be considerable, depending on the degree of

leverage and the nature of the security.

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Liquidity Risk

Most derivatives are customized instrument and could exhibit substantial

liquidity risk implying they may not be sold at a reasonable price within a

reasonable period. Liquidity may decrease or evaporate entirely during

unfavorable markets.

Credit Risk

Derivatives not traded on exchange are traded in the over-the-counter

(OTC) market. OTC instrument are subject to the risk of counter party defaults.

Hedging Risk

Several types of derivatives, including futures, options and forward are

used as hedges to reduce specific risks. If the anticipated risks do not develop,

the hedge may limit the funds total return.

FUNCTION OF DERIVATIVES MARKET:-

The derivative market performs a number of economic functions:-

Prices in an organized derivatives market reflect the perception of market

participants about the future and lead the prices of underlying to the

perceived future level. The prices of derivative converge with the prices of

the underlying at the expiration of the derivative contract. Thus,

derivatives help in discovery of future as well as current prices.

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The derivatives market helps to transfer risks from those who have them

but may not like them to those who have an appetite for them.

Derivatives, due to their inherent nature, are linked to the underlying cash

market. With the introduction of the derivatives, the underlying market

witnesses higher trading volumes because of the participation by more

players who would not otherwise participate for lack of arrangement to

transfer risk.

Speculative trades shift to a more controlled environment of derivatives

market. In the absence of an organized derivative market, speculators

trade in the underlying cash market.

An important incidental benefit that flows from derivatives trading is that it

acts as a catalyst for new entrepreneurial activity.

The derivatives have a history of attracting many bright, creative, well-

educated people with an entrepreneurial attitude. They often energize

others to create new businesses, new products and new employment

opportunities, the benefit of which are immense.

Derivatives markets help increase savings and investment in the end.

Transfer of risk enables market participants to expand their volumes of

activity.

PARTICIPANTS OF THE DERIVATIVE MARKET:-

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Market participants in the future and option markets are many and they

perform multiple roles, depending upon their respective positions. A trader acts

as a hedger when he transacts in the market for price risk management. He is a

speculator if he takes an open position in the price futures market or if he sells

naked option contracts. He acts as an arbitrageur when he enters in to

simultaneous purchase and sale of a commodity, stock or other asset to take

advantage of mispricing. He earns risk less profit in this activity. Such

opportunities do not exist for long in an efficient market. Brokers provide

services to others, while market makers create liquidity in the market.

Hedgers

Hedgers are the traders who wish to eliminate the risk (of price change) to

which they are already exposed. They may take a long position on, or short sell,

a commodity and would, therefore, stand to lose should the prices move in the

adverse direction.

Speculators

If hedgers are the people who wish to avoid the price risk, speculators are

those who are willing to take such risk. These people take position in the market

and assume risk to profit from fluctuations in prices. In fact, speculators

consume information, make forecasts about the prices and put their money in

these forecasts. In this process, they feed information into prices and thus

contribute to market efficiency. By taking position, they are betting that a price

would go up or they are betting that it would go down.

The speculators in the derivative markets may be either day trader or

position traders. The day traders speculate on the price movements during one

trading day, open and close position many times a day and do not carry any

position at the end of the day.

They monitor the prices continuously and generally attempt to make profit

from just a few ticks per trade. On the other hand, the position traders also

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attempt to gain from price fluctuations but they keep their positions for longer

durations may is for a few days, weeks or even months.

ArbitrageursArbitrageurs thrive on market imperfections. An arbitrageur profits by

trading a given commodity, or other item, that sells for different prices in different

markets. The Institute of Chartered Accountant of India, the word ARBITRAGE

has been defines as follows:-

Simultaneous purchase of securities in one market where the price there

of is low and sale thereof in another market, where the price thereof is

comparatively higher. These are done when the same securities are being

quoted at different prices in the two markets, with a view to make profit and

carried on with conceived intention to derive advantage from difference in

prices of securities prevailing in the two different markets

Thus, arbitrage involves making risk-less profits by simultaneously

entering into transactions in two or more markets.

TYPES OF DERIVATIVES:-

The most commonly used derivatives contracts are Forward, Futures and

Options. Here some derivatives contracts that have come to be used are

covered.

FORWARD:-

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A forward contract is a customized contract between two entities,

where settlement takes place on a specific date in the future at todays pre-

agreed price.

FUTURES :-

A futures contact is an agreement between two parties to buy or sell

an asset at a certain time in the future at a certain price. Futures contracts

are special types of forward contracts in the sense that the former are

standardized exchange-traded contracts.

For example :- A, on 1 Aug. agrees to sell 600 shares of Reliance Ind.

Ltd. @ Rs. 450 to B on 1 st sep.

A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd. @ Rs. 450 to B on

1st Sep.

OPTIONS:-

Options are a right available to the buyer of the same, to purchase or

sell an asset, without any obligation. It means that the buyer of the option can

exercise his option but is not bound to do so. Options are of 2 types: calls

and puts.

1. CALLS :-

Call gives 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.

For example :- A, on 1 st Aug. buys an option to buy 600 shares of Reliance Ind.

Ltd. @ 450 Rs 450 on or before 1 st Sep. In this case, A has the right to buy the

shares on or before the specified date, but he is not bound to buy the shares.

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2. PUTS :-

Put gives the buyer the right, but not the obligation, to sell a given

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

For example :- A, on 1st Aug. buys an option to sell 600 shares of

Reliance Ind. Ltd. @ Rs 450 on or before 1 st Sep. In this case, A has the right

to sell the shares on or before the specified date, but he is not bound to sell

the shares.

In both the types of the options, the seller of the option has an

obligation but not a right to buy or sell an asset. His buying or selling of an

asset depends upon the action of buyer of the option. His position in both the

type of option is exactly the reverse of that of a buyer.

WARRANTS :-

Options generally have lives of up to one year, the majority of optionsexchanges having a maximum maturity of nine months. Longer-dated options

are called warrants and are generally traded over-the-counter.

LEAPS :-

The acronym LEAPS means Long-Term Equity Anticipation Securities.

These are options having a maturity of up to three years.

BASKET :-

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Basket options are options on portfolios of underlying assets are

usually a moving average of a basket of assets. Equity index options are a

form of basket options.

SWAPS :-

Swaps are private agreement between two parties to exchange cash

flows in the future according to a pre arranged formula. They can be

regarded as portfolios of forward contract. The two commonly used swaps

are as followas:

1.)INTEREST RATE SWAPS:-

These entail swapping only the interest related cash flows between

the parties in the same currency.

2.)CURRENCY SWAPS:-

These entail swapping both principal and interest between the parties,

with the cash flows in one direction being in a different currency than those inthe opposite direction.

SWAPTIONS :-

Swaptions are options to buy or sell a swap that will become operative

at the expiry of the options. Thus, a swaptions is an option on a forward

swap. Rather than have calls and puts, the swaptions market has receiver

swaptions and payer swaptions. A receiver swaptions is an option to receive

fixed and pay floating. A payer swaptions is an option to pay fixed and

receive floating Out of the above-mentioned types of derivatives forward.

EMERGENCE OF THE DERIVATIVE TRADING IN INDIA

Approval For Derivatives Trading

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The first step towards introduction of derivatives trading in India was

the promulgation of the Securities Laws (Amendment) Ordinance, 1995,

which withdrew the prohibition on options in securities. The market for

derivatives, however, did not take off, as there was no regulatory framework

to govern trading of derivatives. SEBI set up a 24 member committee under

the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop

appropriate regulatory framework for derivatives trading in India.

The committee submitted its report on March 17, 1998 prescribing

necessary pre-conditions for introduction of derivatives trading in India.

The committee recommended that derivatives should be declared as

securities so that regulatory framework applicable to trading of securities

could also govern trading of securities. SEBI also set up a group in June

1998 under the chairmanship of Prof. J.R.Verma, to recommend measures

for risk containment in derivative market in India.

The repot, which was submitted in October 1998, worked out the

operational details of margining system, methodology for charging initial

margins, broker net worth, deposit requirement and real - time monitoring

requirements.

The SCRA was amended in December 1999 to include derivatives

within the ambit of securities and the regulatory framework were developed

for governing derivatives trading. The act also made it clear that derivatives

shall be legal and valid only if such contracts are traded on

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a recognized stock exchange, thus precluding OTC derivatives. The

government also rescinded in March 2000, the three decade old

notification, which prohibited forward trading in securities.

Derivatives trading commenced in India in June 2000 after SEBI

granted the final approval to this effect in May 2000. SEBI permitted the

derivative segment of two stock exchanges, NSE and BSE, and their clearing

house/corporation to commence trading and settlement in approved

derivatives contract.

To begin with, SEBI approved trading in index future contracts based

on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by

approval for trading in options based on these two indices and options on

individual securities. The trading in index options commenced in June 2001.

Futures contracts on individual stocks were launched in November

2001. Trading and settlement in derivatives contracts is done in accordance

with the rules, byelaws, and regulations of the respective exchanges and

their clearing house/corporation duly approved by SEBI and notified in the

official gazette.

INTRODUCTION TO FORWARDS;-

Forward Contracts

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

specified date for a specified price. One of the parties to the contract

assumes a long position and agrees to buy 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

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for the same price. The parties to the contract negotiate other contracts

details like delivery date, price, and quantity bilaterally. The forward

contracts are normally traded outside the exchanges.

Salient features of forward contracts are as follows:-

They are bilateral contracts and hence exposed to counter party risk.

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

size, expiration date and the asset type and quality.

The contract price is generally not available in public domain.

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

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

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

Limitation of forward market

Forward market worldwide is affected by several problems:-

Lack of centralization.

Illiquidity.

Counter party risk.

In the first two of these, the basic problem is that of too much flexibility

and generality. The forward market is like a real estate market in that any two

consenting adults can form contracts against each other. This often makes

them design terms of the deal, which are very convenient in that specific

situation, but makes the contract non-tradable.

Counter party risk arises from the possibility of default by any oneparty to the transaction. When one of the two sides to the transaction

declares bankruptcy, the other suffers. Even when forward markets trade

standardized contracts, and hence avoid the problem illiquidity, the counter

party risk remains a very serious.

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INTRODUCTION TO FUTURES:-

Future contract is specie of forward contract. Futures are exchange-traded

contracts to sell or buy standardized financial instruments or physical

commodities for delivery on a specified date at an agreed price. Futures

contracts are used generally for protecting against rich of adverse price

fluctuations (hedging). As the terms of contracts are standardized, these are

generally not used for merchandizing purpose.

The standardized items in a futures contract are:

Quantity of the underlying.

Quality of the underlying.

The date and month of delivery.

The units of price quotation and minimum price change.

Location of settlement.

Futures contract performs two important functions of price discovery

and price risk management with reference to the given commodity. It is useful

to all segment of economy. It is useful to the producer because investor can

get an idea of the price likely to prevail at a future point of time and therefore

can decide between various competing commodities, the best that suits him.

It enables the consumer get an idea of the price at which the commodity

would be available at a future point of time.

He can do proper costing and cover his purchases by making forward

contracts. The future trading is very useful to the exporters as it provides an

advance indication of the price likely to prevail and thereby help the exporter

in quoting a realistic price and thereby secure export contract in a

competitive market.Having entered into an export contract, it enables him to hedge his risk

by operating in futures market .

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Other benefits of futures trading are:

Price stabilization in time of violent price fluctuations- this mechanism

dampens the peaks and lifts up the valleys i.e. the amplitude of price

variation is reduced.

Leads to integrated price structure throughout the country.

Facilitates lengthy and complex, production and manufacturing activities.

Helps balance in supply and demand position throughout the year.

Encourages competition and acts as a price barometer to farmers and

other trade functionaries.

FEATURE FORWARD CONTRACT FUTURE CONTRACT

OperationalMechanism

Traded directly between twoparties (not traded on theexchanges).

Traded on theexchanges.

ContractSpecifications

Differ from trade to trade. Contracts arestandardized contracts.

Counter-partyrisk Exists. Exists. However,assumed by theclearing corp., whichbecomes the counterparty to all the tradesor unconditionallyguarantees their settlement.

LiquidationProfile

Low, as contracts are tailormade contracts catering tothe needs of the needs of the

parties.

High, as contracts arestandardized exchangetraded contracts.

Price discovery Not efficient, as markets arescattered.

Efficient, as marketsare centralized and allbuyers and sellerscome to a commonplatform to discover theprice.

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Margins

The margining system is based on the J R Verma committee

recommendations. The actual margining happens on a daily basis while onlineposition monitoring is done on an intra day basis. Daily margining is of two

types:

1. Initial margins.

2. Mark-to market profit/loss.

The computation of initial margin on the futures market is done using the

concept of Value-at-risk (VaR). The initial margin amount is large enough to

cover a one-day loss that can be encountered on 99% of the days.

VaR methodology seeks to measure the amount of value that a portfolio

may stand to lose within certain horizon period (one day for the clearing

corporation) due to potential changes in the underlying asset market price.

Initial margin amount computed using VaR is collected up-front. The daily

settlement process called mark-to-market provides for collection of losses that

have already occurred (historic losses) whereas initial margin seeks to

safeguard against potential losses on outstanding positions. The mark-to-market

settlement is done in cash.

Settlement of Future Contract:-

Futures contract has two types of settlement, the MTM settlement, which

happens on a continuous basis at the end of each day, and the final settlement,which happens on the last trading day of the futures contract.

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i. MTM Settlement

All futures contact for each member is marked-to-market (MTM) to the

daily settlement price of the relevant futures contract at the end of each day. The

profits/losses are computes as a difference between:

1. The trade price and the days settlement price for contracts executed during

the day but not squared up.

2. The previous days settlement price and the current days settlement price for

brought forward contracts.

The buy price and the sell price for the contracts executed during the day

and squared up. The clearing members (CMs) who have a loss are required to

pay the mark-to-market (MTM) loss amount in cash which is in, turn passed on

to the CMs who have made a MTM profit. This is known as daily mark-to-market

settlement. CMs are responsible to collect and settle the daily MTM

profits/losses incurred by the Trading members (TMs) and their clients clearing

and settling through them. Similarly, TMs are responsible to

collect/pay/losses/profits from/to their clients by the next day. The pay-in and

payout of the mark-to-market settlement are affected on the day following the

trade day. After completion of daily settlement computation, all the open

positions are reset to the daily settlement price. Such position becomes the

opening positions for the next day.

ii. FINAL SETTLEMENTS FOR FUTURES

On the expiry of the future contracts, after the close of trading hours,

NSCCL marks all positions of CM to the final settlement price and the resulting

profits/losses is settled in cash. Final settlement loss/profits amount is

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debited/credit to the relevant CMs clearing bank account on the day following

expiry day of the contract

SETTLEMENT PRICES FOR FUTURES:-

Daily settlement price on a trading day is the closing price of the

respective future contracts on such day. The closing price for the future

contracts is currently calculated as the last half an hour weighted average price

of a contract in the F&O segment of NSE. Final settlement price is the closing

price of the relevant underlying index/security in the capital market segment of

NSE, on the last trading day of the contract. The closing price of the underlying

Index/security is currently its last half an hour weighted average value in the

capital market segment of NSE.

INTRODUCTION TO OPTIONS:-

Options give the holder or buyer of the option the right to do something. If

the option is a call option, the buyer or holder has the right to buy the number of

shares mentioned in the contract at the agreed strike price. If the option is a put

option, the buyer of the option has a right to sell the number of shares

mentioned in the contract at the agreed strike price. The holder of the buyer

does not have to exercise this right.

Thus on the expiry of the day of the contract the option may or may not be

exercised by the buyer. In contrast, in a futures contract, the two parties to the

contract have committed themselves to doing something at a future date. To

have this privilege of doing the transaction at a future only if it is a profitable, the

buyer of the option has to pay a premium to the seller of options.

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TYPES OF OPTIONS:-

An option is a contract between two parties giving the taker/buyer) the

right, but not obligation, to buy or sell a parcel of shares at a predetermined price

possibly on, or before a predetermined rate. To acquire this right the taker pays

a premium to the writer (seller) of the contract.

There are two types of options:

1. Call Options

2. Put Options

Call Options:

Call options give the taker the right, but not the obligation, to buy the

underlying shares at a predetermined price, on or before a predetermined date.

Call Options- Long & Short Positions

When you expect prices to rise, then you take a long position by buying

calls. You are bullish.

When you expect prices to fall, then you take a short position by selling

calls. You are bearish.

Put Options:

A Put Option gives the holder of the right to sell a specific number of an

agreed security at a fixed price for a period.Put Options- Long & Short Positions

When you expect prices to rise, then you take a long position by buying

Puts. You are bearish.

When you expect prices to fall, then you take a short position by selling

Puts. You are bullish.

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Particulars Call Options Put Options

If you expect a fall in price [Bearish] Short Long

If you expect a rise in price [Bullish] Long Short

TABLE SHOWING THE DEALING OF CALL & PUT OPTION

IMPORTANT CONCEPTS:-

In -the- money option:

It is an option with intrinsic value. A call option is in the memory if the

underlying price is above the strike price. A put option is in the memory if the

underlying price is below the strike price.

Out- of- the- money:

Call Option Holder (Buyer) Call Option Writer (Seller)

Pays Premium

Right to exercise & buy theshares

Profit from rising prices

Limited losses, potentiallyunlimited gains

Receives premium

Obligation to sell shares ifexercised

Profits from falling prices orremaining neutral

Potentially unlimited losses,limited gains

Put Option Holder (Buyer) Put Option Holder (Seller)

Pays Premium

Right to exercise & buy theshares

Profit from rising prices

Limited losses, potentiallyunlimited gains

Receives premium

Obligation to buy shares ifexercised

Profits from rising prices orremaining neutral

Potentially limited losses,unlimited gains

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It is an option that has no intrinsic value, i.e. all of its value consists of

time value. A call option is out of the money if the stock price is below its strike

price.

At- the- money:

A term that describes an option with a strike price that is equal to the

current market price of the underlying stock. But of the money if the stock price

is above its strike price.

Market Scenario Call Option Put OptionMarket price > strike price In- the- money Out- of- the- money

Market price < strike price Out- of- the- money In- the- money

Market price = strike price At- the- money At the- money

Market price ~ strike price Near- the- money Near- the- money

Intrinsic Value

In a call option, if the value of the underlying asset is higher than the

strike price, the option premium has an intrinsic value and is an in- the- money

option. If the value of the underlying asset is lower than the strike price, the

option has no intrinsic value and is an out- of- the- money option. If the value of

the underlying asset is equivalent to the strike price, the call option is at- the-

money and has no intrinsic value or zero intrinsic value.

In a put option, if the value of the underlying asset is lower than the strike

price, the option has an intrinsic value and is an in- the- money option. If the

value of the underlying asset is higher than the strike price, the option has no

intrinsic value and is out- of- money option.

If the value of the underlying asset is equivalent to the strike price, the put

option is at the- money

Time Value

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Time value is the amount an investor is willing to pay for an option, in the

hope that at some time prior to expiration its value will increase because of a

favorable change in the price of the underlying asset. Time value reduces as the

expiration draws near and on expiration day; the time value of the option is zero.

Option Price

An option cost or price is called premium. The potential loss for the

buyer of an option is limited to the amount of premium paid for the contract. The

writer of the option, on the other hand, undertakes the risk of unlimited potential

loss, for premium received. Thus,

Option Price = Premium Price

A premium is the net amount the buyer of an option pays to the seller of

the option. It does not refer to an amount above the base price, as the term

premium commonly used. The of an option has two important

constituents, intrinsic value and time value.

Premium = Intrinsic value + Time

PRICING WITH REGARD TO OPTIONS:-

The Black and Scholes Model:

The Black and Scholes Option Pricing Model didn't appear overnight, in

fact, Fisher Black started out working to create a valuation model for stock

warrants. This work involved calculating a derivative to measure how the

discount rate of a warrant varies with time and stock price. The result of this

calculation held a striking resemblance to a well-known heat transfer equation.

Soon after this discovery, Myron Scholes joined Black and the result of their work

is a startlingly accurate option pricing model.

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Black and Scholes can't take all credit for their work; in fact their model is

actually an improved version of a previous model developed by A. James Boness

in his Ph.D. dissertation at the University of Chicago. Black and Scholes'

improvements on the Boness model come in the form of a proof that the risk-free

interest rate is the correct discount factor, and with the absence of assumptions

regarding investor's risk preferences.

Black and Scholes Model:

In order to understand the model itself, we divide it into two parts. The first

part, SN [d1), derives the expected benefit from acquiring a stock outright. This is

found by multiplying stock price [S] by the change in the call premium with

respect to a change in the underlying stock price [N (d1)]. The second part of the

model, Ke [-rt) N (d2), gives the present value of paying the exercise price on the

expiration day. The fair market value of the call option is then calculated

by taking the difference between these two parts.

Assumptions of the Black and Scholes Model:-

1) The stock pays no dividends during the option's life

Most companies pay dividends to their share holders, so this might seem

a serious limitation to the model considering the observation that higher dividend

yields elicit lower call premiums. A common way of adjusting the model for thissituation is to subtract the discounted value of a future dividend from the stock

price.

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2) European exercise terms are used

European exercise terms dictate that the option can only be exercised on

the expiration date. American exercise term allow the option to be exercised at

any time during the life of the option, making American options more valuable

due to their greater flexibility. This limitation is not a major concern because very

few calls are ever exercised before the last few days of their life. This is true

because when you exercise a call early, you forfeit the remaining time value on

the call and collect the intrinsic value. Towards the end of the life of a call, the

remaining time value is very small, but the intrinsic value is the same.

3) Markets are efficient

This assumption suggests that people cannot consistently predict the

direction of the market or an individual stock. The market operates continuously

with share prices following a continuous into process. To understand what a

continuous into process is, you must first know that a Markov process is "one

where the observation in time period t depends only on the preceding

observation." An into process is simply a Markov process in continuous

time. If you were to draw a continuous process you would do so without picking

the pen up from the piece of paper.

4) No commissions are charged

Usually market participants do have to pay a commission to buy or sell

options. Even floor traders pay some kind of fee, but it is usually very small. The

fees that Individual investor's pay is more substantial and can often distort the

output of the model.

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5) Interest rates remain constant and known

The Black and Scholes model uses the risk-free rate to represent this

constant and known rate. In reality there is no such thing as the risk-free rate, but

the discount rate on U.S. Government Treasury Bills with 30 days left until

maturity is usually used to represent it. During periods of rapidly changing

interest rates, these 30-day rates are often subject to change, thereby violating

one of the assumptions of the model.

6) Returns are log normally distributed

This assumption suggests, returns on the underlying stock are normally

distributed, which is reasonable for most assets that offer options.

Advantages & Limitations:-

Advantage:

The main advantage of the Black-Scholes model is speed -- it lets you

calculate a very large number of option prices in a very short time.

Limitation:

The Black-Scholes model has one major limitation: it cannot be used to

accurately price options with an American-style exercise as it only calculates

the option price at one point in time -- at expiration. It does not consider the

steps along the way where there could be the possibility of early exercise of

an American option.

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As all exchange traded equity options have American-style exercise (i.e. they

can be exercised at any time as opposed to European options which can

only be exercised at expiration) this is a significant limitation.

The exception to this is an American call on a non-dividend paying asset. In

this case the call is always worth the same as its European equivalent as

there is never any advantage in exercising early.

Various adjustments are sometimes made to the Black-Scholes price to

enable it to approximate American option prices but these only works well

within certain limits and they don't really work well for puts.

Difference between derivative and equity

DERIVATIVE EQUITY

Warehousing No warehousing isrequired

No warehousing isrequired

Quality of underlyingassets

Derivatives contractdont have attribute ofquality

Equity contract dont haveattribute of quality

Contract life Comparatively having Having long and short

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long contract life contract life

Maturity date Standardized Standardized

Return High Medium

Risk Very High Less

Liquidity Less Very high

InvestmentAmount

Very high Low

Lot size Fixed by SEBI Not fixed by SEBI

Time of trading 9a.m to 3.30p.m 9a.m to 3.30p.m

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RESEARCH METHODOLOGY:-

Problem Statement:

The topic, which is selected for the study, is DERIVATIVE MARKET in

the firm so the problem statement for this study will be, AWARENESS ABOUT

THE DERIVATIVE AND ITS COMPARISION WITH EQUITY.

Objective of the Study:

1. To know the awareness of the Derivative Market in Surat City.

2. To know which one is beneficial for the investor.

3. To find what proportion of the population are investing in such derivatives

along with their investment pattern and product preferences.

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Research Design:

The research design specifies the methods and procedures for

conducting a particular study. The type of research design applied here are

DESCRIPTIVE as the objective is to check the position of the Derivative

Market in Surat city. The objectives of the study have restricted the choice of

research design up to descriptive research design. This survey will help the firm

to know how the investors invest in the derivative segment & which factors affect

their investing behavior.

Scope of the Study:

The scope of the study will include the analysis of the survey, which is

being conducted to know the awareness of the Derivative Market in the city &

also doing comparison of derivatives with equity.

Research Source of Data:-There are two types of sources of data which is being used for the studies:-

Primary Source of Data:

Preparing a Questionnaire is collecting the primary source of data & it

was collected by interviewing the investors.

Secondary Source of Data:For having the detailed study about this topic, it is necessary to have

some of the secondary information, which is collected from the following:-Books.

Magazines & Journals.

Websites.

Newspapers, etc.

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Methods of Data Collection:-

The study to be conducted is about the awareness of the Derivative

Market in the

Surat City so

the method of

data collection

used id SURVEY METHOD.

DATA ANALYSIS AND INTERPRETATION:

Q.1 Are you trading in derivative market?

Objective: To know that whether the investors are trading in derivative market

or not.

Frequency

Graph:

Frequencies PercentageYes 74 37.0

No 126 63.0

Total 200 100.0

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Trading

74

126

37

63

0

20

40

60

80

100

120

140

Yes No

Trading

percent/freq

uency

Frequencies

Percentage

Inference: from the above graph out of 200 investors, only 37% investors means

74 respondent are trading in derivative market and 63% means 126 respondents

are not trading in derivative market.

Q.2 Reasons for not investing in derivative market. {Give the rank}

Objective: To know the reason why investors are not trading in trading in

derivative market

Frequency

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Graph:

Inference: From the above graphical representation you can see that 49.2%

investors think that the derivatives are high risky whereas 1.6% investors dont

have specify their reasons for not trading in derivative market.

Q.3 what is the objective of trading in derivative market?

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

Frequency

Frequency Percent

Reasons Frequency Percent

Lack of knowledge 26 20.6

Lack of awareness 19 15.1

High risky 62 49.2

Huge amount of

investment

17 13.5

Other 2 1.6

Total 126 100.0

77

Reason

0

2619

62

17

20

20.615.1

49.2

13.5

1.6

0

10

20

30

40

50

60

70

Reasons Lack of

knowledge

Lack of

awareness

High risky Huge

amount of

investment

Other

reasons

percent/frequency

Series1

Series2

Series3


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Dont trade 126 63.0

Not at all preferred 2 1.0

Neutral 2 1.0

Some how preferred 5 2.5

Most preferred 65 32.5

Total 200 100

Graph:

High Return

126

2 2 5

6563

1 1 2.5

32.5

0

20

40

60

80

100

120

140

Dont trade Not at all

preferred

Neutral Some how

preferred

Most preferred

preferred

p

ercent/frequency

Frequency

Percent

Inference: From the above graph we can see that 32.5% investors are most

preferred the objective of high return and 1% investors are neutral while they are

trading in derivative market.

Q .4what are the criteria do you taken in the consideration while investing

in derivative market?

Objective: To know that which criteria are consider by the investors while they

are investing in derivative market. Which criteria are most important for them

whether derivatives are ease in transaction, less costly, or available of different

contract or for the margin money.

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Frequency

Frequency Percent

Dont trade 126 63.0

Not at all preferred 2 1.0

Some how not

preferred4 2.0

Neutral 16 8.0

Some how preferred 23 11.5

Most preferred 29 14.5

Total 200 100.0

Graph:

Ease in transaction

126

2 416 23

29

63

1 2 811.5 14.5

0

20

40

60

80

100

120

140

Dont

trade

Not at all

preferred

Some

how notpreferred

Neutral Some

howpreferred

Most

preferred

preferred

percentage/frequency

Frequency

Percent

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Inference: from the above graph we can conclude that out of the 200 investors

14.5% investors are most preferred and 1% investors are not at all preferred the

ease in transaction contract.

Q-5 Give your preference of trading in derivative instrument.

Objective: To know the preference of the investors while they are trading in

derivative market.

Frequency

Frequency Percent

Dont trade 126 63.0 Not at all preferred 1 .5 Some how not preferred 1 .5 Neutral 15 7.5 Some how preferred 14 7.0 Most preferred 43 21.5

Total 200 100.0

Graph:

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Index future

126

1 115 14

43

63

0.5 0.5 7.5 7

21.5

020

406080

100120

140

Dont trade Not at all

preferred

Some how

not

preferred

Neutral Some how

pr

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