A

PROJECT REPORT

ON
“AWARNESS OF DERIVATIVE AND ITS
COMPARISION WITH EQUITY AND COMMODITY”.

UNDERTAKEN AT

SHAREKHAN LTD, VADODARA

Submitted By:
VAIBHAV H. PARIKH
06MBA26

Guided By:
Mr. GOVIND DHINAIYA

MBA (2006-08)

SHRIMAD RAJCHANDRA INSTITUTE OF

MANAGEMENT AND COMPUTER APPLICATION

1
 DECLARATION

I here by declare that the summer project report titled

“AWARNESS OF DERIVATIVE AND ITS COMPARISION WITH EQUITY
AND COMMODITY” is based on original piece of work done by me for
the fulfillment of degree of Master of Business Administration and
whatever information has been taken from any sources had been duly
acknowledge.

I further declare that the personal data & information

received from any respondent during survey has not been shared with
any one and is used for academic purpose only.

Date: Vaibhav H. Parikh

Place: (06MBA26)

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 TABLE OF CONTENTS

Sr. Topic Page

No. No.
1 INDUSTRY PROFILE 1
2 COMPANY PROFILE 24
3 INTRODUCTION OF COMPANY 33
4 RESEARCH METHODOLOGY 63
5 DATA ANALYSIS & INTERPRETATION 67
6 FINDINGS 83
7 CONCLUSIONS 85
8 RECOMMENDATIONS 86
9 BIBLIOGRAPHY 87
10 APPENDIX 88

INDUSTRY PROFILE
THE INDIAN CAPITAL MARKET

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 The function of the financial market is to facilitate the transfer of funds from surplus
sectors (lenders) to deficit sectors (borrowers). Normally, households have inventible funds
or savings, which they lend to borrowers in the corporate and public sectors whose
requirement of funds far exceeds their savings. A financial market consists of investors or
buyers of securities, borrowers or sellers of securities, intermediaries and regulatory bodies.
Financial market does not refer to a physical location. Formal trading rules, relationships and
communication networks for originating and trading financial securities link the participants
in the market.
Organized money market: Indian financial system consists of money market and
capital market. The money market has two components - the organized and the unorganized.
The organized market is dominated by commercial banks. The other major participants are
the Reserve Bank of India, Life Insurance Corporation, General Insurance Corporation, Unit
Trust of India, Securities Trading Corporation of India Ltd. and Discount and Finance House
of India, other primary dealers, commercial banks and mutual funds. The core of the money
market is the inter-bank call money market whereby short-term money borrowing/lending is
affected to manage temporary liquidity mismatches. The Reserve Bank of India occupies a
strategic position of managing market liquidity through open market operations of
government securities, access to its accommodation, cost (interest rates), availability of credit
and other monetary management tools. Normally, monetary assets of short-term nature,
generally less than one year, are dealt in this market.
Un-organized money market: Despite rapid expansion of the organized money market
through a large network of banking institutions that have extended their reach even to the
rural areas, there is still an active unorganized market. It consists of indigenous bankers and
moneylenders. In the unorganized market, there is no clear demarcation between short-term
and long-term finance and even between the purposes of finance. The unorganized sector
continues to provide finance for trade as well as personal consumption. The inability of the
poor to meet the "creditworthiness" requirements of the banking sector make them take
recourse to the institutions that still remain outside the regulatory framework of banking. But
this market is shrinking.
The capital market consists of primary and secondary markets. The primary market
deals with the issue of new instruments by the corporate sector such as equity shares,
preference shares and debt instruments. Central and State governments, various public sector
industrial units (PSUs), statutory and other authorities such as state electricity boards and
port trusts also issue bonds/debt instruments. The primary market in which public issue of
securities is made through a prospectus is a retail market and there is no physical location.
Offer for subscription to securities is made to investing community. The secondary market or
stock exchange is a market for trading and settlement of securities that have already been
issued. The investors holding securities sell securities through registered brokers/sub-brokers
of the stock exchange. Investors who are desirous of buying securities purchase securities
through registered brokers/sub-brokers of the stock exchange. It may have a physical location

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like a stock exchange or a trading floor. Since 1995, trading in securities is screen-based and
Internet-based trading has also made an appearance in India.
The secondary market consists of 23 stock exchanges including the National Stock
Exchange, Over-the-Counter Exchange of India (OTCEI) and Inter Connected Stock
Exchange of India Ltd. The secondary market provides a trading place for the securities
already issued, to be bought and sold. It also provides liquidity to the initial buyers in the
primary market to re-offer the securities to any interested buyer at any price, if mutually
accepted. An active secondary market actually promotes the growth of the primary market
and capital formation because investors in the primary market are assured of a continuous
market and they can liquidate their investments. Capital Market Participants: There are
several major players in the primary market. These include the merchant bankers, mutual
funds, financial institutions, foreign institutional investors (FIIs) and individual investors. In
the secondary market, there are stock- brokers (who are members of the stock exchanges),
the mutual funds, financial institutions, foreign institutional investors (FIIs), and individual
investors. Registrars and Transfer Agents, Custodians and Depositories are capital market
intermediaries that provide important infrastructure services for both primary and secondary
markets. Market regulation: It is important to ensure smooth working of capital market, as it
is the arena where the players in the economic growth of the country. Various laws have been
passed from time to time to meet this objective. The financial market in India was highly
segmented until the initiation of reforms in 1992-93 on account of a variety of regulations
and administered prices including barriers to entry. The reform process was initiated with the
establishment of Securities and Exchange Board of India (SEBI).
The legislative framework before SEBI came into being consisted of three major Acts
governing the capital markets:
1. The Capital Issues Control Act 1947, which restricted access to the securities
market and controlled the pricing of issues.
2. The Companies Act, 1956, which sets out the code of conduct for the corporate
sector in relation to issue, allotment and transfer of securities, and disclosures to be made in
public issues.
3. The Securities Contracts (Regulation) Act, 1956, which regulates transactions in
securities through control over stock exchanges. In addition, a number of other Acts, e.g., the
Public Debt Act, 1942, the Income Tax Act, 1961, the Banking Regulation Act, 1949, have
substantial bearing on the working of the securities market.
Securities and Exchange Board of India

With the objectives of improving market efficiency, enhancing transparency,

checking unfair trade practices and bringing the Indian market up to international standards, a
package of reforms consisting of measures to liberalize, regulate and develop the securities
market was introduced during the 1990s. This has changed corporate securities market
beyond recognition in this decade. The practice of allocation of resources among different
competing entities as well as its terms by a central authority was discontinued. The secondary

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market overcame the geographical barriers by moving to screen-based trading. Trades enjoy
counter party guarantee. Physical security certificates have almost disappeared. The
settlement period has shortened to three days.
The following paragraphs discuss the principal reform measures undertaken since
1992. A major step in the liberalization process was the repeal of the Capital Issues (Control)
Act, 1947 in May 1992. With this, Government's control over issue of capital, pricing of the
issues, fixing of premium and rates of interest, on debentures, etc., ceased. The office, which
administered the Act, was abolished and the market was allowed to allocate resources to
competing uses and users. Indian companies were allowed access to international capital
market through issue of ADRs and GDRs. However, to ensure effective regulation of the
market, SEBI Act, 1992 was enacted to empower SEBI with statutory powers for
(a) protecting the interests of investors in securities,
(b) promoting the development of the securities market, and
(c) regulating the securities market.
Its regulatory jurisdiction extends over corporates in the issuance of capital and
transfer of securities, in addition to all intermediaries and persons associated with securities
market. SEBI can specify the matters to be disclosed and the standards of disclosure required
for the protection of investors in respect of issues. It can issue directions to all intermediaries
and other persons associated with the securities market in the interest of investors or of
orderly development of the securities market; and can conduct inquiries, audits and
inspection of all concerned and adjudicate offences under the Act. In short, it has been given
necessary autonomy and authority to regulate and develop an orderly securities market.
There were several statutes regulating different aspects of the securities
market and jurisdiction over the securities market was split among various agencies, whose
roles overlapped and which at times worked at cross-purposes. As a result, there was no
coherent policy direction for market participants to follow and no single supervisory agency
had an overview of the securities business. Enactment of SEBI Act was the first such attempt
towards integrated regulation of the securities market. SEBI was given full authority and
jurisdiction over the securities market under the Act, and was given con-current/delegated
powers for various provisions under the Companies Act and the SC(R) A. The Depositories
Act, 1996 is also administered by SEBI. A high level committee on capital markets has been
set up to ensure co-ordination among the regulatory agencies in financial markets. In the
interest of investors, SEBI issued Disclosure and Investor Protection (DIP) Guidelines.
Issuers are now required to comply with these Guidelines before
accessing the market. The guidelines contain a substantial body of requirements for
issuers/intermediaries. The main objective is to ensure that all concerned observe high
standards of integrity and fair dealing, comply with all the requirements with due skill,
diligence and care, and disclose the truth, the whole truth and nothing but the truth. The
Guidelines aim to secure fuller disclosure of relevant information about the issuer and the
nature of the securities to be issued so that investor can

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take an informed decision. For example, issuers are required to disclose any material 'risk
factors' in their prospectus and the justification for the pricing of the securities has to be
given. SEBI has placed a responsibility on the lead managers to give a due diligence
certificate, stating that they have examined the prospectus, that they find it in order and that it
brings out all the facts and does not contain anything wrong or misleading. Though the
requirement of vetting has now been dispensed with, SEBI has raised standards of
disclosures in public issues to enhance the level of investor protection. Improved disclosures
by listed companies: The norms for continued disclosure by listed companies have also
improved the availability of timely information. The information technology helped in easy
dissemination of information about listed companies and market intermediaries. Equity
research and analysis and credit rating have improved the quality of information. SEBI has
recently started a system for Electronic Data Information Filing and Retrieval System
(EDIFAR) to facilitate electronic filing of public domain information by companies.
Introduction of derivatives: To assist market participants to manage risks better through
hedging, speculation and arbitrage, SC(R) A was amended in 1995 to lift the ban on options
in securities. However, trading in derivatives did not take off, as there was no suitable legal
and regulatory framework to govern these trades. Besides, it needed a lot of preparatory work
- the underlying cash markets needed to be strengthened with the assistance of the
automation of trading and of the settlement system; the exchanges developed adequate
infrastructure and the information systems required to implement trading discipline in
derivative instruments. The SC(R) A was amended further in December 1999 to expand the
definition of securities to include derivatives so that the whole regulatory framework
governing trading of securities could apply to trading of derivatives also. A three-decade old
ban on forward trading, which had lost its relevance and was hindering introduction of
derivatives trading, was withdrawn.
Derivative trading took off in June 2000 on two exchanges. Now different types of
derivative contracts i.e. index future, index options, single stock futures and single stock
options are available in the market. The governing bodies of stock exchanges used to be
dominated by brokers, leading inevitably to conflicts of interest. To discipline brokers and
cure typical stock market ills such as price rigging, it was considered necessary for stock
exchanges to have a professionally managed environment. NSE started with the concept of
an independent governing body without any broker representation. It was specified in 1993
that the governing boards of stock exchanges must have 50% non-broker members, and that
on committees handling matters of discipline, default, etc., brokers would be in the minority.
All stock exchanges were mandated to appoint a non-broker executive director who
would be accountable to SEBI for implementing the policy directions of the Central
Government/ SEBI. In course of time, the position of the executive director in the
management of stock exchange has been strengthened. Indian securities market is getting
increasingly integrated with the rest of the world. Flls have been permitted to invest in all
types of securities, including government securities. Indian companies have been permitted
to raise resources from abroad through issue of ADRs, GDRs, FCCBs and ECBs. Reserve

7
Bank of India has recently allowed the limited two-way fungibility for the subscribers of
these instruments. Indian stock exchanges have been permitted to set up trading terminals
abroad. The trading platform of Indian exchanges can now be accessed through the Internet
from anywhere in the world. In line with the global phenomena, Indian capital markets have
also moved to rolling settlements on a T+2 basis where trades are settled on the second day
after trading.

National Stock Exchange

The National Stock Exchange was set up in 1995 as a first step in reforming the
securities market through improved technology and introduction of best practices in
management. It started with the concept of an independent governing body without any
broker representation thus ensuring that the operators' interests were not allowed to dominate
the governance of the exchange. The practice of physical trading imposed limits on trading
volumes and, hence, the speed with which new information was incorporated into prices. To
obviate this, the NSE introduced screen-based trading system (SBTS) where a member can
punch into the computer the quantities of shares and the prices at which he wants to transact.
The transaction is executed as soon as the quote punched by a trading member finds a
matching sale or buy quote from counter party. SBTS electronically matches the buyer and
seller in an order-driven system or finds the customer the best price available in a quote-
driven system, and, hence, cuts down on time, cost and risk of error, as well as on the
chances of fraud. SBTS enables distant participants to trade with each other, improving the
liquidity of the markets. The electronic and now fully online trading introduced by the NSE
has made such manipulation difficult. It has also improved liquidity and made the entire
operation more transparent and efficient.
The NSE has set up a clearing corporation to provide legal counter party guarantee to
each trade thereby eliminating counter party risk. The National Securities Clearing
Corporation Ltd. (NSCCL) commenced operations in April 1996. Counter party risk is
guaranteed through fine-tuned risk management systems and an innovative method of on-line
position monitoring and automatic disablement. Principle of "novation" is implemented by
NSE capital market segment. Under this principle, NSCCL is the counter party for every
transaction and, therefore, default risk is
minimized. To support the assured settlement, a "settlement guarantee fund" has been
created. A large settlement guarantee fund provides a cushion for any residual risk. As a
consequence, despite the fact that the daily traded volumes on the NSE run into thousands of
crores of rupees, credit risk no longer poses any problem in the marketplace.

Depository System
The erstwhile settlement system on Indian stock exchanges was also inefficient and
increased risk, due to the time that elapsed before trades were settled. The transfer was by

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physical movement of papers. There had to be a physical delivery of securities -a process
fraught with delays and resultant risks. The second aspect of the settlement related to transfer
of shares in favor of the purchaser by the company. The system of transfer of ownership was
grossly inefficient as every transfer involves physical movement of paper securities to the
issuer for registration, with the change of ownership being evidenced by an endorsement on
the security certificate. To obviate these problems, the Depositories Act, 1996 was passed. It
provides for the establishment of depositories in securities with the objective of ensuring free
transferability of securities with speed, accuracy and security. It does so by (a) making
securities of public limited companies freely transferable subject to certain exceptions; (b)
dematerializing the securities in the depository mode; and (c) providing for maintenance of
ownership records in a book entry form. In order to streamline both the stages of settlement
process, the Act envisages transfer ownership of securities electronically by book entry
without making the securities move from person to person. The Act has made the securities
of all public limited companies freely transferable, restricting the company's right to use
discretion in effecting the transfer of securities, and the transfer deed and other procedural
requirements under the Companies Act have been dispensed with. Two depositories, viz.,
NSDL and CDSL, have come up to provide instantaneous electronic transfer of securities.
Capital Market Intermediaries:
There are several institutions, which facilitate the smooth functioning of the securities
market. They enable the issuers of securities to interact with the investors in the primary as
well as the secondary arena.

Merchant Bankers
Among the important financial intermediaries are the merchant bankers. The services
of merchant bankers have been identified in India with just issue management. It is quite
common to come across reference to merchant banking and financial services as though they
are distinct categories. The services provided by merchant banks depend on their inclination
and resources - technical and financial. Merchant bankers (Category 1) are mandated by
SEBI to manage public issues (as lead managers) and open offers in take-overs. These two
activities have major implications for the integrity of the market. They affect investors'
interest and, therefore, transparency has to be ensured. These are also areas where
compliance can be monitored and enforced. Merchant banks are rendering diverse services
and functions. These include organizing and extending finance for investment in projects,
assistance in financial management, acceptance house business, raising Euro-dollar loans and
issue of foreign currency bonds. Different merchant bankers specialize in different services.
However, since they are one of the major intermediaries between the issuers and the
investors, their activities are regulated by:
(1) SEBI (Merchant Bankers) Regulations, 1992.
(2) Guidelines of SEBI and Ministry of Finance.

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 (3) Companies Act, 1956.
(4) Securities Contracts (Regulation) Act, 1956.

The Merchant Bankers Regulations of Securities and Exchange Board of India

(SEBI) regulate merchant banking activities, especially those covering issue and
underwriting of shares and debentures. SEBI has made the quality of manpower as one of the
criteria for renewal of merchant banking registration. These skills should not be concentrated
in issue management and underwriting alone. The criteria for authorization take into account
several parameters. These include:

 Professional qualification in finance, law or business management,

 Infrastructure like adequate office space, equipment and manpower,
 Employment of two persons who have the experience to conduct the business of
merchant bankers,
 Capital adequacy and
 Past track record, experience, general reputation and fairness in all their transactions.

SEBI authorizes merchant bankers for an initial period of three years, if they have a
minimum net worth of Rs. 5 crore. An initial authorization fee, an annual fee and renewal fee
is collected by SEBI. According to SEBI, all issues should be managed by at least one
authorized merchant banker functioning as the sole manager or lead manager. The lead
manager should not agree to manage any issue unless his responsibilities relating to the issue,
mainly disclosures, allotment and refund, are clearly defined. A statement specifying such
responsibilities has to be furnished to SEBI. SEBI prescribes the process of due diligence that
a merchant banker has to complete before a prospectus is cleared. It also insists on
submission of all the documents disclosing the details of account and the clearances obtained
from the ROC and other government agencies for tapping peoples' savings. The
responsibilities of lead manager, underwriting obligations, capital adequacy, due diligence
certification, etc., are laid down in detail by SEBI. The objective is to facilitate the investors
to take an informed decision regarding their investments and not expose them to unknown
risks.
Credit Rating Agencies
The 1990s saw the emergence of a number of rating agencies in the Indian market.
These agencies appraise the performance of issuers of debt instruments like bonds or fixed
deposits. The rating of an instrument depends on parameters like business risk, market
position, operating efficiency, adequacy of cash flows, financial risk, financial flexibility, and
management and industry environment. The objective and utility of this exercise is twofold.
From the point of view of the issuer, by assigning a particular grade to an instrument, the
rating agencies enable the issuer to get the best price. Since all financial markets are based on

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the principle of risk/reward, the less risky the profile of the issuer of a debt security, the
lower the price at which it can be issued. Thus, for the issuer, a favorable rating can reduce
the cost of borrowed capital. From the viewpoint of the investor, the grade assigned by the
rating agencies depends on the capacity of the issuer to service the debt. It is based on the
past performance as well as an analysis of the expected cash flows of a company when
viewed on the industry parameters as well as company performance. Hence, the investor can
judge for himself whether he wants to place his savings in a "safe" instrument and get a lower
return or he wants to take a risk and get a higher return. The 1990s saw an increase in activity
in the primary debt market. Under the SEBI guidelines all issuers of debt have to get the
instruments rated. They also have to prominently display the ratings in all that marketing
literature and advertisements. The rating agencies have thus become an important part of the
institutional framework of the Indian securities market.

R& T Agents - Registrars to Issue

R&T Agents form an important link between the investors and issuers in the
securities market. A company, whose securities are issued and traded in the market, is known
as the Issuer. The R&T Agent is appointed by the Issuer to act on its behalf to service the
investors in respect of all corporate actions like sending out notices and other
communications to the investors as well as dispatch of dividends and other non-cash benefits.
R&T Agents perform an equally important role in the depository system as well.

Stock Brokers
Stockbrokers are the intermediaries who are allowed to trade in securities on the
exchange of which they are members. They buy and sell on their own behalf as well as on
behalf of their clients. Traditionally in India, individuals owned firms providing brokerage
services or they were partnership firms with unlimited liabilities. There were, therefore,
restrictions on the amount of funds they could raise by way of debt. With increasing volumes
in trading as well as in the number of small investors, lack of adequate capitalization of these
firms exposed investors to the risks of these firms going bust and the investors would have no
recourse to recovering their dues. With the legal changes being effected in the membership
rules of stock exchanges as well as in the capital gains structure for stock-broking firms, a
number of brokerage firms have converted themselves into corporate entities. In fact, NSE
encouraged the setting up of corporate broking members and has today has only 10% of its
members who are not corporate entities.

Custodians

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 In the earliest phase of capital market reforms, to get over the problems associated
with paper-based securities, large holding by institutions and banks were sought to be
immobilized. Immobilization of securities is done by storing or lodging the physical security
certificates with an organization that acts as a custodian - a securities depository. All
subsequent transactions in such immobilized securities take place through book entries. The
actual owners have the right to withdraw the physical securities from the custodial agent
whenever required by them. In the case of IPO, a jumbo certificate is issued in the name of
the beneficiary owners based on which the depository gives credit to the account of
beneficiary owners. The Stock Holding Corporation of India was set up to act as a custodian
for securities of a large number of banks and institutions who were mainly in the public
sector. Some of the banks and financial institutions also started providing "Custodial"
services to smaller investors for a fee. With the introduction of dematerialization of securities
there has been a shift in the role and business operations of Custodians. But they still remain
an important intermediary providing services to the investors who still hold securities in a
physical form.

Mutual Funds

Mutual funds are financial intermediaries, which collect the savings of small investors
and invest them in a diversified portfolio of securities to minimize risk and maximize returns
for their participants. Mutual funds have given a major fillip to the capital market - both
primary as well as secondary. The units of mutual funds, in turn, are also tradable securities.
Their price is determined by their net asset value (NAV), which is declared periodically. The
operations of the private mutual funds are regulated by SEBI with regard to their registration,
operations, administration and issue as well as trading. There are various types of mutual
funds, depending on whether they are open ended or close ended and what their end use of
funds is. An open-ended fund provides for easy liquidity and is a perennial fund, as its very
name suggests. A closed-ended fund has a stipulated maturity period, generally five years. A
growth fund has a higher percentage of its corpus invested in equity than in fixed income
securities, hence, the chances of capital appreciation (growth) are higher. In Growth Funds,
the dividend accrued, if any, is reinvested in the fund for the capital appreciation of
investments made by the investor. An Income fund on the other hand invests a larger portion
of its corpus in fixed income securities in order to pay out a portion of its earnings to the
investor at regular intervals. A balanced fund invests equally in fixed income and equity in
order to earn a minimum return to the investors. Some mutual funds are limited to a
particular industry; others invest exclusively in certain kinds of short-term instruments like
money market or Government securities. These are called money market funds or liquid
funds. To prevent processes like dividend stripping or to ensure that the funds are available to
the managers for a minimum period so that they can be deployed to at least cover the
administrative costs of the asset management company, mutual funds prescribe an entry load
or an exit load for the investors. If investors want to withdraw their investments earlier than

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the stipulated period, an exit load is chargeable. To prevent profligacy, SEBI has prescribed
the maximum that can be charged to the investors by the fund managers.

Depositories

The depositories are important intermediaries in the securities market that is scrip-less
or moving towards such a state. In India, the Depositories Act defines a depository to mean,
"a company formed and registered under the Companies Act, 1956 and which has been
granted a certificate of registration under sub-section (IA) of section 12 of the Securities and
Exchange Board of India Act, 1992." The principal function of a depository is to
dematerialize the securities and enable their transactions in book-entry form.
Dematerialization of securities occurs when securities, issued in physical form, are destroyed
and an equivalent number of securities are credited into the beneficiary owner's account. In a
depository system, the investors stand to gain by way of lower costs and lower risks of theft
or forgery, etc. They also benefit in terms of efficiency of the process. But the
implementation of the system has to be secure and well governed. All the players have to be
conversant with the rules and regulations as well as with the technology for processing. The
intermediaries in this system have to play strictly by the rules. A depository established under
the Depositories Act can provide any service connected with recording of allotment of
securities or transfer of ownership of securities in the record of a depository. A depository
cannot directly open accounts and provide services to clients. Any person willing to avail of
the services of the depository can do so by entering into an agreement with the depository
through any of its Depository Participants.

Depository Participants

A Depository Participant (DP) is described as an agent of the depository. They are the
intermediaries between the depository and the investors. The relationship between the DPs
and the depository is governed by an agreement made between the two under the
Depositories Act. In a strictly legal sense, a DP is an entity that is registered as such with
SEBI under the provisions of the SEBI Act. As per the provisions of this Act, a DP can offer
depository related services only after obtaining a certificate of registration from SEBI. SEBI
(D&P) Regulations, 1996 prescribe a minimum net worth of Rs. 50 lakh for stockbrokers,
R&T agents and non-banking finance companies (NBFC), for granting them a certificate of
registration to act as DPs. If a stockbroker seeks to act as a DP in more than one depository,
he should comply with the specified net worth criterion separately for each such depository.
No minimum net worth criterion has been prescribed for other categories of DPs. However,
depositories can fix a higher net worth criterion for their DPs. NSDL requires a minimum net
worth of Rs. 100 lakh to be eligible to become a DP as against Rs. 50 lakh prescribed by

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SEBI (D&P) Regulations. The role, functions, responsibilities and business operations of
DPs are described in detail in the second section of this book.

Instruments

The changes in the regulatory framework of the capital market and fiscal policies
have also resulted in newer kinds of financial instruments (securities) being introduced in the
market. Also, a lot of financial innovation by companies who are now permitted to undertake
treasury operations, has resulted in newer kinds of instruments - all of which can be traded –
being introduced. The variations in all these instruments depend on the tenure, the nature of
security, the interest rate, the collateral security offered and the trading features, etc.

Debentures
These are issued by companies and regulated under the SEBI guidelines of June 11,
1992. These are issued under a prospectus, which has to be approved by SEBI like in the case
of equity issues. The rights of investors as debenture holders are governed by the Companies
Act, which prohibits the issue of debentures with voting rights. There are a large variety of
debentures that is available. This includes:

• Participating debentures
• Convertible debentures with options
• Third party convertible debentures
• Debt/equity swaps
• Zero coupon convertible notes
• Secured premium notes
• Zero interest fully convertible debentures
• Fully convertible debentures with interest
• Partly convertible debentures.

Bonds

Indian DFIs, like IDBI, ICICI, and IFCI, have been raising capital for their operations
by issuing of bonds. These too are available in a large variety. These include:

• Income bonds
• Tax-free bonds
• Capital gains bonds
• Deep discount bonds
• Infrastructure bonds
• Retirement bonds

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 In addition to the interest rates and maturity profiles of these instruments, the issuer
institutions have been including a put/call option on especially the very long-dated bonds like
deep discount bonds. Since the tenures of some of these instruments spanned some 20 or 25
years during which the interest rate regimes may undergo a complete change, the issuer have
kept the flexibility to retire the costly debt. This they do by exercising their option to redeem
the securities at pre-determined periods like at the end of five or seven years. This has been
witnessed in number of instruments recently much to the chagrin of investors who were
looking for secure and hassle-free long-dated instruments.

Preference Shares:

As the name suggests, owners of preferential shares enjoy a preferential treatment

with regard to corporate actions like dividend. They also have a higher right of repayment in
case of winding up of a company. Preference shares have different features and are
accordingly available as:

• Cumulative and non-cumulative

• Participating
• Cumulative & Redeemable fully convertible to preference shares
• Cumulative & Redeemable fully convertible to equity
• Preference shares with warrants
• Preference shares

Equity Shares

As the name indicates, these represent the proportionate ownership of the company.
This right is expressed in the form of participation in the profits of the company. There has
been some innovation in the way these instruments are issued. Some hybrid securities like
equity shares with detachable warrants are also available.

Government securities
The Central Government or State Governments issue securities periodically for the
purpose of raising loans from the public. There are two types of Government Securities –
Dated Securities and Treasury Bills. Dated Securities have a maturity period of more than
one year. Treasury Bills have a maturity period of less than or up to one year. The Public
Debt Office (PDO) of the Reserve Bank of India performs all functions with regard to the
issue management, settlement of trade, distribution of interest and redemption. Although only
corporate and institutional investors subscribe to government securities, individual investors
are also permitted to subscribe to these securities. An investor in government securities has
the option to have securities issued either in physical form or in book-entry form (commonly

15
known as Subsidiary General Ledger form). There are two types of SGL facilities, viz., SGL-
1 and SGL-2. In the SGL-1 facility, the account is opened with the RBI directly. There are
several restrictions on opening SGL-1 accounts and only entities, which fulfill all the
eligibility criteria, are permitted to open SGL-1 account. The RBI has permitted banks,
registered primary dealers and certain other entities like NSCCL, SHCIL, and NSDL to
provide SGL facilities to subscribers. A subscriber to government securities who opts for
SGL securities may open an SGL account with RBI or any other approved entity.
Investments made by such approved entity on its own account are held in SGL-1 account,
and investments held on account of other clients are held in SGL-2 account.

Capital Market Processes

There are various processes that Issuers of securities follow or utilize in order to tap
the savers for raising resources. Some of the commonly used processes and methods are
described below.

Initial Public Offering (IPO)

Companies, new as well as old can offer their shares to the investors in the primary
market. This kind of tapping the savings is called an IPO or Initial Public Offering. SEBI
regulates the way in which companies can make this offering. New companies can make an
IPO if they have a dividend-paying (ability) record of three years. The size of the initial
issue, the exchange on which it can be listed, the merchant bankers' responsibilities, the
nature and content of the disclosures in the prospectus, procedures for all these are laid down
by SEBI and have to be strictly complied with. Exemption may be granted by SEBI in certain
cases for minimum public offer or minimum subscription in the case of certain industry
sectors like infrastructure or IT or media & communications. Several changes have also been
introduced in recent years in the manner in which the IPOs can be marketed. For example
they can now take the book-building route or they can even be marketed through the
secondary market by brokers or DPs. All these changes have been made with the objective of
making the process more investor friendly by reducing risk, controlling cost, greater
transparency in the pricing mechanism and protecting liquidity in the hands of the investor.
Some of the IPOs have been available for subscription online - where the bids are made in
real time and the information is made available on an instantaneous basis on the screen. It is
possible to subscribe for IPO shares in demat form through DPs.

Private Placement

Many companies choose to raise capital for their operations through various
intermediaries by taking what in marketing terms would be known as the wholesale route.

16
The retail route - of approaching the public -is expensive as well as time consuming. This is
called in financial markets as private placement. SEBI has prescribed the eligibility criteria
for companies and instruments as well as procedures for private placement. However,
liquidity for the initial investors in privately placed securities is ensured as they can be traded
in the secondary market. But such securities have different rules for listing as well as for
trading.

Preferential Offer/Rights Issue

Companies can expand their capital by offering the new shares to their existing
shareholders. Such offers for sale can be made to the existing shareholders by giving them a
preferential treatment in allocation or the offer can be on a rights basis, i.e., the existing
holders can get by way of their right, allotment of new shares in certain proportion to their
earlier holding. All such offers have also to be approved by SEBI, which has laid out certain
criteria for these routes of tapping the public. These have to be complied with.

Internet Broking

With the Internet becoming ubiquitous, many institutions have set up securities
trading agencies that provide online trading facilities to their clients from their homes. This
has been possible since all the players in the securities market, viz., stockbrokers, stock
exchanges, clearing corporations, depositories, DPs, clearing banks, etc., are linked
electronically. Thus, information flows amongst them on a real time basis. The trading
platform, which was converted from the trading hall to the computer terminals at the brokers'
premises, has now shifted to the homes of investors. This has introduced a higher degree of
transparency in transactions. The investor knows exactly when and at what rate his order was
processed. It also creates an end-to-end audit trail that makes market manipulation difficult.
The availability of securities in demat form has given a further fillip to this process.
However, the emergence of, what is known as, "day-traders" has resulted in the business
environment of brokers, which has changed. Investors, who can now trade directly, no longer
require their intermediation. Service charges have therefore been declining - all of which has
been in favor of investors.

17
 COMPANY PROFILE

ShareKhan Ltd., one of the leading stock broking firm and pioneer in online trading
in India is a progeny of Shripal, Sevantilal, Kantilal and Ishwarlal [SSKI]. They have 250
share shops in 120 cities. The daily turnover of ShareKhan is round about Rs. 11-12 crores
and working capital round about Rs. 450 crores. The growth of ShareKhan is because it is
consistent in providing innovative and value based customer service. SSKI has been helping
their investors from round about 81 years with their equity investments.

ShareKhan Ltd. is known for its deep understanding of the stock market. They are
also providing multi channel access facility to its customer through an online service with its
website www.sharekhan.com and Dial-n-Trade through their call-centers.

They have excellent trading facilities like the Classic Account and other software
base online trading product for the day-traders, called Speed Trade [this provides everything
to the trader on his screen instantly]. They regularly send detail research reports and the
expert suggestions & tips through e-mail to its customer everyday. These services help its
customer in the investment decisions. Share khan offers trade execution facilities on the
BSE and NSE, for cash as well as derivatives, depository services, commodities trading on
the MCX & NCDEX and most importantly.

The SSKI Group also comprises of Institutional broking & Corporate Finance. The
Institutional broking division caters to domestic and foreign institutional investors while the
Corporate Finance Division focuses on niche areas such as infrastructure, telecom and
media. SSKI has been voted as the Top Domestic Brokerage House in the research category,
twice by Euro money survey and four times by Asia money survey. SSKI was adjudged as
the ‘Best Local Brokerage’ in India by Asia money.
ShareKhan provides various On-line services to its customers like:

18
 (i) Classic Account: - It facilitates its client to trade through website. There are features
like Demat & Digital Contacts, Quotes, Integrated Banking, Multiple Watch list,
and Instant credit & transfer.

(ii) Dial–n–trade: - Through Toll free number order is placed. The fund is
automatically transferred through phone banking. It is not time consuming; just
there is a need to enter TPIN. Tele-broker gives trusted and professional advice.
They also provide after hour Order placement facility between 8:00 a.m. to 9:30
a.m. It is simple and secure IVR based system for authentication.

(iii) Speed trade and speed trade plus: - It is software based online trading product
that brings power of broker’s terminal to investor’s PC. It is good for active
traders and jobbers who transact frequently during daytime. It is an Internet
based executable application that provides trader Real time streaming quotes,
Live tic-by-tic Intra day charting, instant Confirmation and alerts.

(iv) ShareKhan Depository Services: - ShareKhan Depository Services offers

dematerialization services to individual and corporate investors. A team of
professionals and experts in the latest technology are dedicated exclusively for the
Demate department, other than that franchisee to make the services quick,
convenient and efficient.
(v) Trading in Commodity Futures: - It provides the facility to trade in commodities
[Gold, Silver, Crude oil, Agricultural commodities etc.] through a wholly owned
subsidiary of its Parent SSKI. ShareKhan is a member of 2 Commodity Exchanges
and offers trading facility at both these exchanges.
(I) Multi Commodity Exchange Of India [MCX]
(II) National Commodity And Derivative Exchange, Mumbai [NCDEX]
By research ShareKhan classified the scrips of the companies into six clusters to help its
clients. The six clusters are Evergreen, Apple Green, Emerging Star, Ugly Duckling,
Vulture's Pick and Cannonball. Each cluster represents a certain profile in terms of business
fundamentals as well as the kind of returns expected by the investor over a certain time span.
One of the most important pamphlets issued for commodities is termed as SHAREKHAN
EXCLUSIVE.

19
 THEORETICAL ASPECT

INTRODUCTION
According to dictionary, derivative means ‘something which is derived from another
source’. Therefore, derivative is not primary, and hence not independent. It depends upon
the primary source from which it is derived. Therefore, with changes in the value of primary
variable, value of derivative also varies. In financial terms, derivative is a product whose
value is derived from the value of one or more basic variables. These basic variable are
called bases, which may be value of underlying asset, a reference rate etc. the underlying
asset can be equity, foreign exchange, commodity or any asset.

For example:- the value of any asset, say share of any company, at a future date
depends upon the share’s 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.

Derivative product initially emerged, as hedging devices against the fluctuations in

commodity prices and commodity-linked derivatives remained the sole form of such
products for almost three hundred years.

The financial derivatives, derivatives for future delivery of stocks, debt instruments
and foreign currencies, came into spotlight in post-1970 period due to the introduction of
floating exchange rates. Since their emergence, financial derivatives have become very
popular and now they account for about two-third of total transaction in derivative products.

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

20
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.
Derivatives are securities under the SC(R) A and hence the regulatory framework under the
SC(R) A. governs the trading of derivative.

Contracts agreement

Cash Derivatives

Forward Others like Swaps,

FRAs etc

Futures
Merchandisin Options
(Standardized
g, customized
)

In financial terms derivatives is a broad term for any instrumental whose value is
NTSD
derived from the value of oneTSD
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

21
markets, derivatives permit corporations and institutional investors to effectively manage
their portfolios of assets and liabilities through 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.

The derivatives markets has existed for centuries as a result of the need for both
users and producers of natural resources to hedge against price fluctuations in the underlying
commodities. Although trading in agriculture and other commodities has been the deriving
force behind the development of derivatives exchanges, the demand for 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

22
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-Dollar futures 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 organized market was legal
before Morarji Desai’s 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

23
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).
Risk Associated With Derivatives
While derivatives can be used to help manage risks involved in investments, they also have
risks of their own. However, the risks involved in derivatives trading are neither new nor
unique – they are the same kind of risks associated with traditional bond or equity
instruments.

Market Risk
Derivatives exhibit price sensitivity to change in market condition, such as fluctuation in
interest rates or currency exchange rates. The market risk of leveraged derivatives may be
considerable, depending on the degree of leverage and the nature of the security.

Liquidity Risk
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 fund’s
total return.

FUNCTION OF DERIVATIVES MARKET

The derivative market performs a number of economic functions:-

24
  Prices in an organized derivatives market reflect the perception of market
participants about the future and lead the prices of underlying to the perceived future
level. The prices of derivative converge with the prices of the underlying at the
expiration of the derivative contract. Thus, derivatives help in discovery of future as
well as current prices.
 The derivatives market helps to transfer risks from those who have them but may not
like them to those who have an appetite for them.
 Derivatives, due to their inherent nature, are linked to the underlying cash market.
With the introduction of the derivatives, the underlying market witnesses higher
trading volumes because of the participation by more players who would not
otherwise participate for lack of arrangement to transfer risk.
 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

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.

25
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 attempt to gain from price
fluctuations but they keep their positions for longer durations may is for a few days, weeks
or even months.

Arbitrageurs

Arbitrageurs thrive on market imperfections. An arbitrageur profits by trading a

given commodity, or other item, that sells for different prices in different markets. The
Institute of Chartered Accountant of India, the word “ARBITRAGE” has been defines as
follows:-
“Simultaneous purchase of securities in one market where the price there of is low and sale
thereof in another market, where the price thereof is comparatively higher. These are done
when the same securities are being quoted at different prices in the two markets, with a view
to make profit and carried on with conceived intention to derive advantage from difference
in prices of securities prevailing in the two different markets”

Thus, arbitrage involves making risk-less profits by simultaneously entering into

transactions in two or more markets.

TYPES OF DERIVATIVES

26
 The most commonly used derivatives contracts are Forward, Futures and Options. Here
some derivatives contracts that have come to be used are covered.

 FORWARD:-
A forward contract is a customized contract between two entities, where settlement takes
place on a specific date in the future at today’s 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 1st sep.
A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd. @ Rs. 450 to B on 1 st 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.
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.

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 1 st 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.

27
 WARRANTS:-
Options generally have lives of up to one year, the majority of options exchanges 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:-
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

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 in the 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.

28
Out of the above mentioned types of derivatives forward, future and options are the most
commonly used and have been detailed in this report.

EMERGENCE OF THE DERIVATIVE TRADING IN INDIA

 Approval For Derivatives Trading

The first step towards introduction of derivatives trading in India was the promulgation
of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on
options in securities. The market for derivatives, however, did not take off, as there was no
regulatory framework to govern trading of derivatives. SEBI set up a 24 – member
committee under the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India. The committee submitted
its report on March 17, 1998 prescribing necessary pre-conditions for introduction of
derivatives trading in India. The committee recommended that derivatives should be
declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’
could also govern trading of securities. SEBI also set up a group in June 1998 under the
chairmanship of Prof. J.R.Verma, to recommend measures for risk containment in derivative
market in India.

The repot, which was submitted in October 1998, worked out the operational details of
margining system, methodology for charging initial margins, broker net worth, deposit
requirement and real - time monitoring requirements.

The SCRA was amended in December 1999 to include derivatives within the ambit of
‘securities’ and the regulatory framework were developed for governing derivatives trading.

29
The act also made it clear that derivatives shall be legal and valid only if such contracts are
traded on a recognized stock exchange, thus precluding OTC derivatives. The government
also rescinded in March 2000, the three – decade old notification, which prohibited forward
trading in securities.

Derivatives trading commenced in India in June 2000 after SEBI granted the final
approval to this effect in May 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 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.

30
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 one party 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.

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 term 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.

31
 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 .
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

Operational Traded directly between two Traded on the exchanges.
Mechanism parties (not traded on the
exchanges).
Contract Differ from trade to trade. Contracts are standardized
Specifications contracts.

32
Counter-party risk Exists. Exists. However, assumed
by the clearing corp., which
becomes the counter party
to all the trades or
unconditionally guarantees
their settlement.
Liquidation Profile Low, as contracts are tailor made High, as contracts are
contracts catering to the needs of standardized exchange
the needs of the parties. traded contracts.
Price discovery Not efficient, as markets are Efficient, as markets are
scattered. centralized and all buyers
and sellers come to a
common platform to
discover the price.
Examples Currency market in India. Commodities, futures,
Index Futures and
Individual stock Futures in
India.

WHAT IS AN INDEX?
To understand the use and functioning of the index derivatives markets, it is
necessary to understand the underlying index. A stock index represents the change in value
of a set of stock, which constitute the index. A market index is very important for the market
players as it acts as a barometer for market behaviors and as an underlying in derivative
instruments such as index futures.

INDEX CONSTRUCTION
Scrip’s in the index are chosen based on certain pre-determined qualitative and
quantitative parameters, laid down by the index construction managers. Almost all the
indices in the Indian Capital Market are price indices. They are the market capitalization
weighted average price of a specific portfolio of scrip’s.
The following methods are primarily used to construct indices:-

MARKET CAPITALIZATION WEIGHTED AVERAGE METHOD

Each stock is given a weight proportional to its market capitalization. The popular
examples are S&P 500, BSE Sensex, S&P CNX Nifty 50, NYSE Composite Index, etc.

PRICE WEIGHTED METHOD

Each stock is given a weight is proportional to its market price. The popular
examples are Dow Jones Industrial Average, Nikkei 225 etc.

33
EQUAL WEIGHTED METHOD
Each stock is equally weighted in the index.

MODIFIED MARKET CAPITALIZATION WEIGHTED METHOD

Market capitalization is considered only to the extend of free-float. The popular
examples are NASDAQ 100, FTSE etc.

THE SENSEX AND NIFTY

In India, the most popular indices have been the BSE Sensex and S&P CNX Nifty.
The BSE Sensex has 30 stocks comprising the index, which are selected based on market
capitalization, industry representation, trading frequency, etc. it represents 30 large well
established and financially sound companies. The Sensex represents a broad spectrum of
companies in a variety of industries. It represents 14 major industry groups. Then there is a
BSE National Index and BSE 200.However, trading in index future has only commenced on
the BSE Sensex. While the BSE Sensex was the first stock market index in the country, the
National Stock exchange launched Nifty in April 1996 taking the base of November 3,1995.
the Nifty index consists of share of 50 companies with each having a market capitalization
of more than 500 core.

PRICING OF INDEX

The Cost Of Carry Model

The cost of carry model where the price of the contract is defined as:-

F= S + C

F: Futures price.
S: Spot price.
C: Holding cost or Carry cost.
If F < S+C or F > S+C, arbitrage opportunities would exist i.e. whenever the future price
moves away from the fair value, there would be chances for arbitrage.

Margins
The margining system is based on the J R Verma committee recommendations. The
actual margining happens on a daily basis while online position monitoring is done on an
intra day basis. Daily margining is of two types:
1. Initial margins.
2. Mark-to market profit/loss.

34
 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.

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 day’s settlement price for contracts executed during the day but
not squared up.
2. The previous day’s settlement price and the current day’s 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 pay-out 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.

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 debited/credit to the relevant CM’s clearing
bank account on the day following expiry day of the contract

35
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.

HISTORY OF OPTIONS
Options have existed for a long time in various transaction informally. For example,
a person looking for a rented accommodation may find a place and give a small advance
with a promise to occupy it a particular date. In case he does not occupy it, he will lose that
advance. Such a practice is equivalent to an option. Options existed in the market of Holland
even in early 17 th century. More formally, members of Put and Call Brokers and Dealers
Association in USA traded options since early 1900s.

In 1973, Black and Scholes came out with a formula to calculate fair premium on
options. From the time onwards, markets for options developed rapidly.
In April 1973, Chicago Board of options Exchange was set up specifically for trading
options. In 1983 trading on stock index options of individual options decreased as most of
the trading shifted to index options.
One of the reasons is that volatilities of individual scrips is high and therefore premium on
individual scrip’s is also high. In India, stock index options were introduced in June 2001.

36
 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.

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

37
 TABLE SHOWING THE DEALING OF CALL & PUT OPTION

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

 Pays Premium
 Right to exercise & buy the shares
 Profit from rising prices
 Limited losses, potentially unlimited
gains
Put Option Holder (Buyer)
 Receives premium
 Obligation to sell shares if exercised
 Profits from falling prices or remaining
neutral
 Potentially unlimited losses, limited
gains
Put Option Holder (Seller)

 Pays Premium  Receives premium

 Right to exercise & buy the shares
 Profit from rising prices
 Limited losses, potentially unlimited
gains
 Obligation to buy shares if exercised
 Profits from rising prices or remaining
neutral
 Potentially limited losses, unlimited
gains

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:

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.

38
Market Scenario Call Option Put Option
Market 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

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

39
 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. 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.

40
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 this situation is to subtract the
discounted value of a future dividend from the stock price.

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.

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.

41
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.
 As all exchange traded equity options have American-style exercise (ie 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 (eg the Fischer Black Pseudo-American method)
but these only work well within certain limits and they don't really work well for puts.

ABOUT COMMODITY

42
 A commodity includes all kinds of goods. FCRA defines ‘goods’ as every kind of
movable property other than actionable claim, money and securities.
Derivatives as a tool for managing risk first originated in the commodities markets.
They were then found useful as a hedging tool in financial markets as well. In India, trading
in commodity futures has been in existence from the nineteenth century with organized
trading in cotton through the establishment of Cotton Trade Association in 1875. Over a
period of time, other commodities were permitted to be traded in futures exchanges.
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 markets have been thin with poor liquidity and have not grown to
any significant level.

DIFFERENCE BETWEEN DERIVATIVE, EQUITY AND COMMODITIUES

DERIVATIVE EQUITY COMMODITIES

Warehousing No warehousing is No warehousing is Required in case of

required required delivery based
settlement
Quality of derivatives contract Equity contract Every underlying
underlying assets don’t have attribute don’t have attribute commodities have
of quality of quality specified qualities
Contract life Comparatively having long and Short life as
having long contract short contract life compared to
life derivatives.
Maturity date Standardized Standardized standardized

43
Return High Medium High

Risk Very High Less High

Liquidity Less Very high Less

Investment Amount Very high low Very high

Lot size Fixed by SEBI Not fixed by SEBI Fixed by SEBI

Time of trading 10a.m to 3.30p.m 10a.m to 3.30p.m Whole day

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 “THE AWARENESS OF THE
DERIVATIVE AND ITS COMPARISION WITH EQUITY AND COMMODITIES”

Objective of the Study

 To know the awareness of the Derivative Market in Baroda City.

 To find what proportion of the population are investing in such derivatives along with
their investment pattern and product preferences.
 To understand the working of the organization.
 To know the trading system of the derivative exchange.

Research Design

44
 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 Baroda city. The objectives of the study have
restricted the choice of research design up to descriptive research design. Therefore, no fixed
hypothesis is set up. 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 and commodities.

Research Source of Data

There are two types of sources of data which is being used for the studies:-
1. Primary Source Of Data:

The primary source of data is being collected by preparing a Questionnaire & it was
collected by interviewing the investors.

2. Secondary Source Of Data

For having the detailed study about this topic, it is necessary to have some of the
secondary information, which is collected from the following:-
 Books.
 Magazines & Journals.
 Websites.
 Newspapers, etc.

Methods of Data Collection

The study to be conducted is about the awareness of the Derivative Market in the
Baroda City so the method of data collection used id “SURVEY METHOD”.

45
Research Instrument

The research instrument, which is used, for the study is “QUESTIONNAIRE” which
includes the questions which are based on the investment pattern, general awareness, criteria
for investment & the questions are mostly close-ended for the convenience of the investors
to provide the information about it.

Sampling Techniques

In this survey work, no particular sampling technique is used. The sample are
included on the RANDOM NON- PROBABILITY BASIS.

Universe
Investors of Baroda city.

Sample Size

The numbers of respondents selected for conducting the survey are 100 investors.
These samples are collected on the random basis. The investor’s responses are analyzed to
know their awareness about the Derivatives & which factors play an important role in their
investment decisions & how far the investors like to invest in Derivative segment.

Presentation of Data

The presentation of data is through” CHARTS AND GRAPHS” which will help in
analyzing the response of the investors.

Findings & Suggestion

The findings & suggestion are given based on the research work done & after
analyzing the survey work conducted.

Limitation of the study

However, the study is going to be a research project, but it definitely has some of the
limitation, which is as follows:

46
  The time constraint is the important limitation of this study.
 No. of respondents selected was less as compared to the city population.
 Due to the shallow knowledge about the topic, detailed study could not be
conducted.
 Derivative Market being new to the Indian Market, less awareness was observed.
 Respondents were hesitating to give the financial information.

ANALYSIS OF DATA

Questionnaires were been filled by 100 respondents as an investor followed by

detailed interview. The data collected from such interviews and its analysis is as follows.
1. Are you aware about derivatives?
Yes No
Objective: The question was ask to know the awareness level of investors about
Derivatives

Response Yes No
Derivatives 65 35

47
 AWARENESS
no

yes

Conclusion:
From above diagram we can say that most of people are aware about derivatives and
the people who aware about derivates are those people who are investing in stock market for
long period and also have much knowledge about stock market’s different instrument.

2. Have you made any investment in derivatives?

Yes No

Objective: This question was ask to know the investment criteria of investors about
Derivatives

Response Yes No
Derivatives 64 36

48
 INVT. IN DERI.
no

yes

Conclusion:
From above diagram we can say that only 64% of investors are doing investment
in derivatives. This 36% people are the regular investor or have sufficient of to invest in
derivative. And the people who are not invested in derivatives are salaried people or small
investors.

3. If no, give the reason for not investing in derivatives?

Lack of knowledge High amount of investment
High risk Volatile market
Lot size

Objective: This question was asked to know the reason for not doing any investment in
Derivatives.

Reasons Respondents
Lack of knowledge 11
High Risk 9
Lot Size 8
High Amount of investment 7
Volatile market 1
others 64

49
 REASON

Lot size

Volatile market

High risk

High amount

Lack of know ledge

0

Conclusion:
From above diagram we can say that, the main reason for not made any investment
in derivative is lack of knowledge among investors. So try to improve their knowledge about
derivatives and the other reasons are lot size, volatile market, high risk and high amount of
investment. Basically small investors and salaried people are not ready to take so much risk
and they also not preferred high amount investment.

4 Do you have any inclination of investing in derivatives in future?

Yes
No
May be

Objective: this question is asked to know the inclination of investors for investing in
Derivatives in future.
Response No. of Respondents
Yes 64
No 8
May be 28

50
 inclination

Yes

No

May be

Conclusion:

From above diagram we can say that people want to know about derivatives and also
have inclination of investing in derivatives. They think to do investment in derivatives.

5 If yes, which type of derivative instruments would you like to made your investment?
Index future Stock future
Index option Stock option
Objective: This question was asked to know in which type of derivative instruments the
investor would like to invest
Product No. of Respondent
Index Futures 48
Index Option 24
Stock Futures 15
Stock Options 13

51
 TYPE

Stock option

Index option

Index future

Stock future

Conclusion:

From this diagram we can say that people are more interested in index futures in
types of derivatives rather than options because they find options are much completed in
comparison of futures.
6 what approximate percentage of your portfolio have invested in derivatives?
Less than 20% 5 50% to 70%
20% to 50% More than 70%

Objective: this question is asked to know the approximate percentage of investors

Portfolios have invested in derivatives.

Percentage No. of Respondents

Less than 20% 59
20% to 50% 32
50% to 70% 6
More than 70% 3

52
 % INVT

More than 70%

50 - 70%

20 - 50%

Less than 20%

Conclusion:

From above diagram we can say that because of lack of knowledge and high risk the
investors would not like to invest high amount of their portfolio in derivatives. Only 9 people
are ready for investing above than 50% of their portfolios. Most of people are only want to
do invest less than 20% of their portfolios in derivatives.

7 Mention your objective for investing in derivatives?

Hedging
Arbitrating
Speculation

Objective: This question is asked to know the objective of investor for investing in
derivatives.
Objective No. of Respondents
Hedging 59
Arbitrating 29
Speculation 12

53
 OBJCTIV

Speculation

Arbitraging

Hedging

Conclusion:
From above diagram we can say that the main objectives of investors are hedging

8 which factors affecting your investment decision?

Your decision In consultation with your broker
Any other sources Based on broker’s decision

Objective: This question is asked to know the factors affecting investor’s decision

Factors No. of Respondents

Own Decision 35
Any other Sources 34
In consultation with Broker 11
Based on Broker’s Decision 20

54
 FACTORS

Based on broker deci

Your own decision

Any other source

Consultation with yo

Conclusion:
From this diagram we can say that the main factor which affects investment decision
is consultation with their broker and by their own perspective. From the graph it reveals that
in case of derivative people like to invest with the help of brokers because they are having
specialized knowledge and also by their own, se we can say it is mix bled of taking decision.
It means by own and by brokers.

9. Which factors affect your own decision?

Return Risk
Liquidity Safety

Objective: this question is asked to on which bases investors take their own decision.

Factors No. of Respondents

Return 42
Risk 15
Liquidity 23
Safety 20

55
 DECISION

Safety

Return

Liquidity

Risk

Conclusion:
From above diagram we can say that all the above factors are affected the person’s
own investment decision because all the factors are very important before taking any
investment decision.

10 what are the difficulties faced by you for investing in derivatives?

Lot size Changes in margin by SEBI
Lack of knowledge Any other reason than specify
__________________________________________________
Objective: this question is asked to know the difficulties faced by investors for investing in
derivatives

Difficulties No. of Respondents

Lot Size 53
Lack of Knowledge 22
Changes in Margin by SEBI 15
Any other Reason(investment amount) 10

56
 DIFFICULTY

Others

Lack of knowledge

Lot size

Change in margin bu

Conclusion:
From above diagram we can say that, the difficulties faced by the investors while
investing in derivatives are shown in the diagram. The main difficulty is problem of lot size
in derivatives. Investors are not know much about derivatives investment pattern so not do
much investment in derivatives and the other important factor is lack of knowledge.

11. Give your preferences for investment in this 3 instrument.

Equity
Derivative
Commodities

Objective: this question is asked to know the first choice of investors for investment

Investment Instrument No. of Respondents

Equity 58
Derivative 26
Commodities 16

57
 PREF

Commodity

Derivatives Equity shares

Conclusion:
From above diagram we can say that most of people are interested in dong investment
in equities rather than in derivatives or in commodities coz of less amount of investment and
less risk.

12. Give the ranking for given parameters mention below :( 1= high to 5 = low)

Objective: The main objective of this question is to do the comparison of derivatives with
equity and commodities.

Derivative Equity Commodities

Risk 18 37 45

Return 23 40 37

liquidity 22 52 26

58
Investment Amount 35 13 52

Comparison

40
35

30

25
Instrument

derivative
20 equity

15 commodity

10

0
risk return liquidity inv. Amt
Basis

Conclusion:
From above diagram we can come on this conclusion that equity is having the nature
of high risky and having high return as compare to derivative. For risk adverse investor’s
derivative is preferable and for risky investors equity is preferable. Commodity involves high
amount and high risk.

59
 FINDINGS
As from the study of questionnaires, I have found that in Surat 65% to 70% people are
aware about the derivatives. I submit my findings here.

 Majority of people and people investing in the financial market are aware of derivatives.

 The reasons for ignorance or lower investment in the derivatives are lack of knowledge,
high amount of investment, high risk and the volatility of the market.

 In the recent time around only 20% of portfolio are invested in derivatives

 The main aim for investing in derivatives is either hedging or speculation.

 Investor finds derivatives as completed product and considers it to be only for hedging or
secure profit.

 Margin in future contract acts as hindrances for the common investors as it has to pay
upfront and which is very high.

 Majority of investors do invest in derivatives

 The investors prefer to invest in equities also commodities and derivatives.

 The reasons for inadequate awareness or small amount of investment in the derivatives
are:
 Most of the investors are influenced by there broker’s decision
 They take decision only on the base of broker’s decision
 Investor in nowadays think only about the safety, return and the liquidity
 Changes in the percentage of margin by SEBI and lot size
 Investors in nowadays think only about in what places their investment are safe, give
higher return and liquidity. For all this reasons derivatives are no so much popular as
equities

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 CONCLUSION
 Derivatives are an instrument used for reducing the risk of loss of an investor. It acts
as a price risk management system for an investor.
 The current mindset of people regarding derivatives is that they are speculative due to
non delivery and are not safe. They do not consider it rather as a risk reducing
instrument. Due to such mindset derivatives segment are not rapidly growing in the
Indian market as compared to the cash segment.
 Therefore efforts must be made in India to make people aware of derivatives and
convince them to consider it as a risk reducing instrument rather than a speculative
instrument.

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 RECOMMENDATIONS
1) Derivative market is highly ill-famed among the investors. Thus it is required to
provide in depth knowledge of the market to investors.

2) Broking house must try to create massive awareness programme among the
beneficiaries about the benefits and risks of future trading and convince them to trade
in derivatives. Arranging seminars, workshops, etc can do this.

3) Those who are already investing in securities market can be given another
investment opportunity that will diversify their portfolio genuinely.

4) Investor should understand the risk and reward relation of investing in derivative
segment and than only enter in the market.

5) The lot size in the derivative segment should be reducing so that even retail investor
can also enter in the derivative market.

Bibliography

MANAGEMENT BOOKS:

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 1. Gorden and Natrajan The Financial Market and Financial Services , Sixth Edition
Reprint 2007
2. NCFM Derivative core module
3. NCFM Capital market core module

FINANCIAL DAILIES:

1. The financial express

2. The economies Times
3. The business standard
4. Business Today

WEB SITES:

www.nseindia.com
www.bseindia.com
www.investopedia.com
www.derivativesindia.com

APPENDIX

Name: ____________________________________________
Address: ____________________________________________
____________________________________________
Contact no: ____________________________________________

1. Are you aware about derivatives?

Yes No
2. Have you made any investment in derivatives?
Yes No
3. If no, give the reason for not investing in derivatives?
Lack of knowledge High amount of investment
High risk Volatile market

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 Lot size

4 Do you have any inclination of investing in derivatives in future?

Yes
No
May be

5 If yes, which type of derivative instruments would you like to made your invested?
Index future Stock future
Index option Stock option

6 what approximate percentage of your portfolio have invested in derivatives?

Less than 20% 50% to 70%
20% to 50% More than 70%

7 Mention your objective for investing in derivatives?

Hedging
Arbitrating
Speculation
8 which factors affecting your investment decision?
Your decision In consultation with your broker
Any other sources Based on broker’s decision

9. Which factors affect your own decision?

Return Risk
Liquidity Safety

10 what are the difficulties faced by you for investing in derivatives?

Lot size Changes in margin by SEBI
Lack of knowledge Any other reason than specify

__________________________________________________
11 Give your first preferences for investment in this 3 instrument.
Equity
Derivative
Commodities

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12 Give the ranking for given parameters mention below :( 1= high,2= moderate, and 3= law)

Derivative Equity Commodities

Risk

Return

liquidity

Investment Amount

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