Capital Market and

Derivatives
 Types of Financial market in India
 Capital Market

 Money Market

 Derivatives market

 Foreign Exchange market

 Commodity Market

 Insurance Market

 Mutual Fund Market

 What is Capital Market?

 A capital market is simply any market where a government or a

company can raise money (capital) to fund their operations and long
term investment. Selling bonds and selling stock are two ways to
generate capital, thus BOND MARKET and STOCK MARKET are
considered capital markets.

 Capital Market is characterized as the provider of long-term financing.

The instruments used for this long-term financing are equity
instruments, insurance instruments, derivative instruments and
bonds.

 Other examples of capital market instruments include equity, floating

rate bonds, convertible bonds, asset backed securities, mortgage
backed securities, and interest rate swaps.
 Why Capital Markets Exist
 Capital markets facilitate the transfer of capital (i.e.
financial) assets from one owner to another.

 They provide liquidity.

– Liquidity refers to how easily an asset can be
transferred without loss of value.

 A side benefit of capital markets is that the transaction

price provides a measure of the value of the asset.
Indian Capital Market - Historical
perspective
 Stock Market was for a privileged few

 Lack of Transparency - High tones costs

 No use of Technology

 Outdated banking system

 Volumes - less than Rs. 300 cr per day

 Indian Capital markets -
Chronology
 1994-Equity Trading commences on NSE
 1995-All Trading goes Electronic
 1996- Depository comes in to existence
 1999- FIIs Participation- Globalisation
 2000- over 80% trades in Demat form
 2003- T+2 settlements in all stocks
 Factors contributing to growth of
Indian Capital Market

 Establishment of Development banks & Industrial

financial institution.
 Legislative measures
 Growing public confidence
 Increasing awareness of investment opportunities
 Growth of underwriting business
 Setting up of SEBI
 Mutual Funds
 Credit Rating Agencies
 Capital Markets - Reforms
 Each scam has brought in reforms - 1992 / 2001

 Screen based Trading through NSE

 Capital adequacy norms stipulated

 Dematerialization of Shares - risks of fraudulent paper eliminated

 Entry of Foreign Investors

 Introduction of Derivative products - Index / Stock Futures &

Options

 Margin Lending
Capital Market v/s Money Market
Extends beyond one year
Term loans and financial leases,
corporate equities, and bonds.
Fixed Capital Requirement.
Instruments have Primary as
well as secondary market
Formal place for transactions
e.g.. Stock market
Upto One year or less.
Federal agency securities,
commercial paper
Working Capital Requirement.
Instruments have only Primary
market
No Formal place for
transactions
 Indian Capital Market

Market Instruments Intermediaries Regulator

SEBI
•Brokers
•Investment Bankers
Primary Secondary •Stock Exchanges
•Underwriters

Equity Debt Players

CRA Corporate Intermediaries Individual Banks/FI FDI /FII

 Functions Of SEBI
 Regulates Capital Market.

 Checks Trading of securities.

 Checks the malpractices in securities market.

 It enhances investor's knowledge on market by providing

education.

 It regulates the stockbrokers and sub-brokers.

 To promote Research and Investigation

 Instruments in Secondary Market
 Debenture

 Equity

 Giltz securities

 Derivatives

 Hedge funds

 FCCB
 What is a Share or a Stock?

 In financial markets, a share is a unit of account for various

financial instruments including stocks (ordinary or preferential).

 In simple Words, a share or stock is a document issued by a

company, which entitles its holder to be one of the owners of the
company. A share is issued by a company or can be purchased from
the stock market.

 The common feature of all these is equity participation & limited in

the case of preference shares .
 IPO & It’s Important Terminology

 Investment Bankers & Underwriters

 Registrar

 Issue of Prospectus

 Price Band

 Allotment

 Listing
 Book building process
 Appointment of book runner i.e. merchant banker
 Preparation and submission of draft documents to SEBI and
obtaining of an acknowledgement card.
 A specified price band (range) is to be determined by issuer and
book runner
 Different price levels are invited from syndicate members .Adv.
Should mention opening and closing dates for the bids
 Issuer arrives at a final cut-off rate & final allocation in
consultation with book runner and lead manager
 Issuer and book runner may impose restrictions on number of
shares that can be allotted to each client
 Final prospectus is filed with the (ROC) along with procurement
agreement
 Placement portion opens for subscription
 Placement portion closes a day before the opening of public
issue portion
 The role of the stock exchange

• Creates investment opportunities for small

investors

• Government raises capital for development

projects

• Barometer of the economy

 Stock Exchanges in INDIA
 Mangalore Stock Exchange
 Hyderabad Stock Exchange
 Uttar Pradesh Stock
Exchange
 Coimbatore Stock Exchange
 Cochin Stock Exchange
 Bangalore Stock Exchange
 Saurashtra Kutch Stock
Exchange
 Pune Stock Exchange
 National Stock Exchange
 OTC Exchange of India
 Calcutta Stock Exchange
 Inter-connected Stock
Exchange (NEW)
 Madras Stock Exchange
 Bombay Stock Exchange
 Madhya Pradesh Stock
Exchange
 Vadodara Stock Exchange
 The Ahmedabad Stock
Exchange
 Magadh Stock Exchange
 Gauhati Stock Exchange
 Bhubaneswar Stock
Exchange
 Jaipur Stock Exchange
 Delhi Stock Exchange Assoc
 Ludhiana Stock Exchange
 National Stock Exchange (NSE)
NIFTY50
 An Index representing top 50 companies of India

 Has about 3200 odd listed companies

 Ranks third in the world in terms of number of transactions

 It is also a fastest growing exchange with a recorded growth of

16.6%

 Has various other Index for sub-classification of stocks of other

companies.
 Nifty 50
COMPANIES SECTOR WEIGHTAGE

0.60%
ABB Ltd. ELECTRICAL EQUIPMENT
0.64%
ACC Ltd. CEMENT AND CEMENT PRODUCTS
0.63%
Ambuja Cements Ltd. CEMENT AND CEMENT PRODUCTS
1.47%
Axis Bank Ltd. BANKS
2.86%
Bharat Heavy Electricals Ltd. ELECTRICAL EQUIPMENT
0.51%
Bharat Petroleum Corporation Ltd. REFINERIES
4.11%
Bharti Airtel Ltd. TELECOMMUNICATION - SERVICES
0.89%
Cairn India Ltd. OIL EXPLORATION/PRODUCTION
1.00%
Cipla Ltd. PHARMACEUTICALS
1.20%
DLF Ltd. CONSTRUCTION
1.18%
GAIL (India) Ltd. GAS
1.44%
Grasim Industries Ltd. CEMENT AND CEMENT PRODUCTS
 COMPANIES SECTOR WEIGHTAGE
Hindalco Industries Ltd. ALUMINIUM 0.90%
Hindustan Unilever Ltd. DIVERSIFIED 2.13%
Housing Development Finance 4.87%
Corporation Ltd. FINANCE - HOUSING
I T C Ltd. CIGARETTES 4.64%
ICICI Bank Ltd. BANKS 6.55%
1.00%
Idea Cellular Ltd. TELECOMMUNICATION - SERVICES
Infosys Technologies Ltd. COMPUTERS - SOFTWARE 7.99%
Jindal Steel & Power Ltd. STEEL AND STEEL PRODUCTS 0.61%
Larsen & Toubro Ltd. ENGINEERING 7.20%
Mahindra & Mahindra Ltd. AUTOMOBILES - 4 WHEELERS 1.34%
Maruti Suzuki India Ltd. AUTOMOBILES - 4 WHEELERS 1.49%
NTPC Ltd. POWER 1.44%
NALCO ALLUMINIUM 0.22%
3.13%
Oil & Natural Gas Corporation Ltd. OIL EXPLORATION/PRODUCTION
HCL Technologies Ltd. COMPUTERS - SOFTWARE 0.50%
 COMPANIES SECTOR WEIGHTAGE
4.87%
HDFC Bank Ltd. BANKS
1.06%
Hero Honda Motors Ltd. AUTOMOBILES - 2 AND 3 WHEELERS
0.48%
Power Grid Corporation of India Ltd. POWER
0.71%
Punjab National Bank BANKS
0.39%
Ranbaxy Laboratories Ltd. PHARMACEUTICALS
0.78%
Reliance Capital Ltd. FINANCE
1.38%
Reliance Communications Ltd. TELECOMMUNICATION - SERVICES
11.18%
Reliance Industries Ltd. REFINERIES
1.26%
Reliance Infrastructure Ltd. POWER
0.46%
Reliance Power Ltd. POWER
0.61%
Siemens Ltd. ELECTRICAL EQUIPMENT
3.52%
State Bank of India BANKS
0.75%
Steel Authority of India Ltd. STEEL AND STEEL PRODUCTS
1.69%
Sterlite Industries (India) Ltd. METALS
 WEIGHTAGE
COMPANIES SECTOR
0.91
Tata Motors Ltd. AUTOMOBILES - 4 WHEELERS
1.67
Tata Power Co. Ltd. POWER
1.82
Tata Steel Ltd. STEEL AND STEEL PRODUCTS
1.13
Unitech Ltd. CONSTRUCTION
0.70%
Sun Pharmaceutical Industries Ltd. PHARMACEUTICALS
0.44%
Suzlon Energy Ltd. ELECTRICAL EQUIPMENT
0.27%
Tata Communication TELECOMMUNICATION - SERVICES
2.01%
Tata Consultancy Services Ltd. COMPUTERS - SOFTWARE
 Bombay Stock Exchange (BSE)
Sensex30
 It is an index of 30 stocks representing 12 major sectors

 BSE is the world's number 1 exchange in terms of the number of

listed companies and the world's 5th in transaction numbers

 Market capitalization as on December 31, 2007 stood at $1.79

trillion

 An investor can choose from more than 4,700 listed companies

 For easy reference, Shares are classified into A, B, S, T and Z

groups
 Sensex 30
COMPANIES SECTOR WEIGHTAGE
0.71%
ACC Ltd. Housing Related
3.15%
Bharat Heavy Electricals Ltd. Capital Goods
4.76%
Bharti Airtel Ltd. Telecom
1.47%
DLF Ltd. Housing Related
1.56%
Grasim Industries Ltd. Diversified
5.25%
HDFC Finance
4.47%
HDFC Bank Ltd. Finance
1.36%
Hero Honda Motors Ltd. Transport Equipments
1.23%
Hindalco Industries Ltd. Metal,Metal Products & Mining
2.30%
Hindustan Unilever Ltd. FMCG
7.60%
ICICI Bank Ltd. Finance
9.32%
Infosys Technologies Ltd. Information Technology
4.86%
ITC Ltd. FMCG
1.46%
Jaiprakash Associates Ltd. Housing Related
 COMPANIES SECTOR WEIGHTAGE
Larsen & Toubro Limited Capital Goods 7.07%

Mahindra & Mahindra Ltd. Transport Equipments 1.50%

Maruti Suzuki India Ltd. Transport Equipments 1.92%

NTPC Ltd. Power 2.08%

ONGC Ltd. Oil & Gas 4.02%

Reliance Communications Limited Telecom 1.79%

Reliance Industries Ltd. Oil & Gas 13.36%

Reliance Infrastructure Ltd. Power 1.47%

State Bank of India Finance 4.95%

Sterlite Industries (India) Ltd. Metal,Metal Products & Mining 2.31%

0.81%
Sun Pharmaceutical Industries Ltd. Healthcare
2.31%
Tata Consultancy Services Limited Information Technology
Tata Motors Ltd. Transport Equipments 1.20%

Tata Power Company Ltd. Power 1.76%

Tata Steel Ltd. Metal,Metal Products & Mining 2.60%

Wipro Ltd. Information Technology 1.35%

 BSE- Sectoral Indices
 POWER AUTO

 IT OIL&GAS

 BANKEX CD

 FMCG

 PSU

 METAL

 REALTY

 CG
 Cash Market v/s Future Market
 Risk Involved is less
 Has no Expiry
 Can buy any number of Shares
 Need to pay full amount of
purchase
 Can trade only in Equity shares
 Can trade in more than 5000
listed shares
 Cannot buy or sell Index
Eg-Reliance, Tata Steel, Bharti
Airtel, etc
 High Risk Involved
 Has an definite Expiry
 Need to buy in fixed Lot sizes
 Need to pay margin amount
for purchase
 Can trade all Instruments of
financial market
 Option available here is less
than 500 shares
 Can buy or sell Index also
Eg-Nifty50 futures, Bankex
futures, Reliance futures
Basic Terminologies Before Trading

 Capital
 Trading Account
 Depository Participant
 Broker & Sub-Broker
 Brokerage
 Script Code
 Script Name
 Intra-day & Delivery
 Bid Quantity & Bid Price
 Ask Quantity & Ask Price
 Block Deal
 Short Trade
 ADR & GDR
 Open, High, Low & Close Price
 Last Traded Price & Quantity
 Stop Loss
 Hedge Funds
 P/E Ratio
 E.P.S.
 Top Line
 Bottom Line
 52-week High/Low
 Circuit Limit
 Nifty Premium & Discount
 Futures Contract
 Options Contract
 How to Start Trading?

REGISTER DEPOSIT CAPITAL

BUY SHARES CALL BROKER

SELL SHARES PROFIT or LOSS

 Why share prices fluctuate?
Demand & Supply:
 Speculation or Insider Trading

 Results

 FDI

 Political Interference

 Change in Policy

 Change in Management
 Volatility Index (VIX)
 Volatility Index is a measure of market’s expectation of volatility
over the near term.
 Is described as the “rate and magnitude of changes in prices”
 In finance often referred to as risk.
 India VIX is a volatility index based on the Nifty 50 Index Option
prices.
 India VIX is calculated based on the bid-offer prices of the near and
mid month Nifty 50 Index Options.
 India VIX is a premier barometer of investor consensus of market
volatility expressed through option pricing.
 The Chicago Board of Options Exchange (CBOE) was the first to
introduce the volatility index for the US markets in 1993.
 VIX for week ended 25/09/09

Date Open High Low Close Prev. Change %

Close Change

22/9/09 25.86 27.86 25.86 26.80 25.86 0.94 3.63

23/9/09 26.80 27.50 25.88 26.51 26.8 -0.29 -1.08

24/9/09 26.51 28.76 24.29 24.36 26.51 -2.15 -8.11

25/9/09 26.43 26.43 24.43 26.11 24.36 1.75 7.18

Effects of Inflation on Indian Stock
Market
 RBI Increasing Rates

 Lack of Liquidity

 Poor results of Corporate

 Real Estate Leading the down-fall

 Banking sector the under-performer

Financial Aspects of Capital Market
 Average Daily Turnover of Rs. 60,000 Crores.

 Contribution of Cash Market = 20% of Total Turnover.

 80% comes from Derivatives side.

 About 30% of Total Turnover comes from FII’s.

 Next 50% comes from FI’s, Insurance Companies, A.M.C.’s, Mutual

Funds and other Institutional Investors.
Sector Wise FDI Limits in India

 Hotel & Tourism sector – 100%

 Non-Banking Financial Companies (NBFC) – 49%

 Insurance Sector – 26%

 Telecommunication – 49%

 Trading – 51% to 100%

 Power – 100%

 Drugs & Pharmaceuticals – 100%

 Roads, Highways, Ports and Harbors – 100%

 Role Of Credit Rating Agencies
 Their main function is to grade the different sector and companies
in terms of performance and offer solutions for up gradation.
 The credit rating agencies in India offer varied services like mutual
consulting services, which comprises of operation up gradation, risk
management.
 The have special sections to carry on research and development
work of the industries.
 CRISIL & ICRA the two top tier Rating Agencies in India
 Helps the Stock Exchanges in classifying the stocks in various
groups. Eg- A, B, T, Z, etc.
 Ratings use by investment banks and broker-dealers, government
regulators, etc
 Impact of various events on capital
market
 October 30, 2006 The Sensex crossed the magical figure of 13,000 and
closed at 13,024.26 points. It took 135 days
 December 5, 2006 The Sensex crossed the 14,000-mark to touch 14,028
points. It took 36 days
 July 6, 2007 The Sensex crossed the magical figure of 15,000 to touch in
afternoon trade. It took seven months for the Sensex to move from 14,000
to 15,000 points
 September 19, 2007 The Sensex scaled yet another milestone during
early morning trade, rising by 450 points from the previous close it took 53
days to reach 16,000 from 15,000. Nifty also touched a new high at 4659,
up 113 points.
 September 26, 2007 The Sensex scaled yet another height during early
morning trade crossing the 17,000-mark . Some profit taking towards the
end, saw the index slip into red to 16,887 - down 187 points from the day's
high. The Sensex ended with a gain of 22 points at 16,921.
 October 9, 2007 The BSE Sensex crossed the it took just 8 days
to cross 18,000 points. The index zoomed to a new all-time intra-
day high of 18,327.
 October 15, 2007 The Sensex crossed the 19,000-mark, the index
gained the last 1,000 points in just four trading days. The Nifty
closed 242 points to close at 5,670.
 October 29, 2007 The Sensex crossed the 20,000. The index took
only 10 trading days to gain 1,000 points after the index crossed
the 19,000-mark on October 15. The NSE Nifty rose to a record high
5,922.50 points
 January 8, 2008 The sensex peaks. It crossed the 21,000 mark in
intra-day trading after 49 trading sessions
 January 21 & 22, 2008 The sensex Losses nearly 3000 points to
end above 16000 odd. Touching 15500 in intra-day trade
 June 13, 2008 The sensex closed below 15,200 mark, Indian
market suffer with major downfall from January 21,2008
 June 25, 2008 The sensex touched an intra day low of 13,731
during the early trades, then pulled back and ended up at 14,220.
 July 2, 2008 The sensex hit an intra day low of 12,822.70 on July
2, 2008. This is the lowest that it has ever been in the past year.
 Oct 6, 2008 The sensex closed at 11801.70 hitting the lowest in
the past 2 years
 Oct 10, 2008 The Sensex today closed at 10527,800.51 points
down from the previous day having seen an intraday fall of as large
as 1063 points
 May 18, 2009 After the result of 15th Indian general election
Sensex gained 2110.79 points from the previous close of 12173.42
these creates a new history in Indian Market
Impact of Slowdown on markets
 Indian IT sector

 Power

 Banking

 Real-estate

 Construction
Sensex from 2008-2009
 State of Capital Market
 Foreign Capital coming back to India

 It Sector Leading the way

 Crude helping market’s up-move

 Real-Estate still under-pressure

 Banks full of Liquidity

 Investor confidence helping Stock Market

 Basic Trading Strategies

 Develop a winning strategy and trade often. A small daily profit can
provide a large annual return

 Trade only stocks with the highest growth probabilities

 Be sure that expected return is larger than the transaction cost

 Avoid risk as much as possible

 Diversification is the only way to survive in the market

 Capital of Rs 10k

Retain 20% for

Invest 2k in contingencies
one sector

Invest 3k in Mutual
2k in another Fund or FD’s
sector
 Dow Theory
 The market has three movements

 Market Trends have three phases

 The stock market discounts all news

 Stock market averages must confirm each other

 Trends are confirmed by volume

 Trends exist until definitive signals prove that they have ended
What Are...
Derivatives?
 DERIVATIVES
A Financial Instrument That
Derives Its Value From An
Underlying Security
 Derivatives Explanation

An easy way to think of derivatives is as

a “side bet” on interest rates, exchange
rates, commodity prices, and practically
ANYTHING that you can think of.
 Why Derivatives?
 Not to raise capital
 Buy or sell to protect against adverse
changes in external factors
Conventional Securities
Market

Traditional Securities

20,000
Billions
Amount

of $

10,000
in

0
Bonds Cash Stocks
Types
 Types of Derivatives

 Forwards
 Futures
 Options
 Swaps
Forwards
 Forwards Contracts

The agreement to pay for and pick up,

“Something” at a pre-determined date
and or time, for a pre-determined price.
Usually traded off of the trading floor
between two firms.
 Terms
 Taking Delivery: Physical reception of
item.
 Deliverable Instrument: The item to be
delivered
 Making Delivery: Turning over the item.
Forwards are not options, they are
obligations and should be considered as a
“cash transaction.”
 Forwards

Exchange Traded Derivatives "Forwards"

8,000
6,000
Billions of $
Amount in

4,000
2,000
0
Interest-Rate Stock-Index Currency Futures
Futures Futures
Types
Forwards “OTC”

Over-The-Counter Derivatives "Forwards"

Interest-Rate
Contracts
28%

Currency Contracts
72%
 A Modest Example
An agreement on Monday to buy a book,
(Fin 374c) from a bookstore on Friday for
$1000.00.
On Friday, you return to the bookstore and
take delivery of the book and pay the
$1000.00.
The contract is actually the agreement.
Futures
 Futures
Similar to forwards in length of time.
However, profits and losses are
recognized at the close of business
daily, “Mark-to-market.” Transactions
go through a clearinghouse to reduce
default risk. 90% of all futures
contracts are delivered to someone
other than the original buyer.
 Futures Example
On Monday we enter into a futures contract to buy
our book on Friday. We are required to place a
deposit for the book of 50% ($500.00). We are told
that if the book appreciates in value we may be
required to increase the deposit. If the book
depreciates in value, we may take back some of the
money. Wednesday the book goes to $1500.00. We
must deposit another $250.00. On Thursday the book
drops to $750.00. We can collect $375.00. On Friday
the book value is $800.00, therefore we owe $425.00
on the remaining balance.
Options
 Options
Options come in many flavors. To name a
few: collar, cylinder, fence, mini-max,
zero-cost tunnel and straddle. These are all
newer forms of options. The most
common options discussed are put and
call.
An OPTION is the right, not the obligation
to buy or sell an underlying instrument.
 Option Terms
 Put: the right to sell @ a certain price
 Call: the right to buy @ a certain price
 Long: to purchase the option
 Short: to sell or write the option
 Bullish: feel the value will increase
 Bearish: feel the value will decrease
 Strike/Exercise Price: Price the option can be
bought or sold.
 Option Market
Exchange Traded Derivatives "Options"

Individual Stock Options

Stock-Index Options
Types

Currency Options
Interest-Rate Options

0 500 1,000 1,500 2,000 2,500 3,000 3,500

In Billions of $
Options Continued

Over-The-Counter Derivitaves "Options"

OTC Currency
Options
29%

OTC Interest-Rate
Options
71%
 Calls
Long a call. Person buys the right (a contract) to
buy
an asset at a cretin price. They feel that the price
in the future will exceed the strike price. This is a
bullish position.

Short a Call. Person sells the right (a contract) to

someone that allows them to buy a asset at a cretin
price. The writer feels that the asset will devalue
over the time period of the contract. This person is
bearish on that asset.
 PUTS
Long a Put. Buy the right to sell an asset at a
pre-determined price. You feel that the asset will
devalue over the time of the contract. Therefore
you can sell the asset at a higher price than is the
current market value. This is a bearish position.

Short a Put. Sell the right to someone else. This

will allow them to sell the asset at a specific
price. They feel the price will go down and you
do not. This is a bullish position.
Swaps
 SWAPS
New in the market, late 70’s early 80’s
Two Types: Interest Rate & Currency
 Swaps

Over-The-Counter Derivatives "Swaps"

Currency Sw aps
12%

Interest-Rate Sw aps
88%
 Swap Use
 To smooth out interest rate payments
in a cyclic environment.
 To secure and level out future interest
payments.
 To secure foreign currency for loans
when you are a visitor in that country
and it would be too difficult to secure
credit or the cost is prohibitive.
 Derivative Securities

 Mortgage Backed Securities: Fanny

Mae, Freddie Mac
 Structured Notes: Sally Mae
Derivative Securities

Derivitave Securities

1000

500

0
Mortgage Derivatives Structured Notes
 Explanation

Freddie Mac & Fanny Mae: Both are

derivative instruments used to pool Home
Mortgage loans. This creates a secondary
market which allows banks to sell the loans,
therefore reducing their risk. It also reduces
default risk for the holder. These are also
known as pass through instruments.
 Cont’d Explanation

Sally Mae: Same principal as the

previous example except they use student
loans. All of these also help to keep
interest rates for the underlying asset low
by keeping default risk down.
 Pass Through

Derivitave Securities

1000

500

0
Mortgage Derivatives Structured Notes
 Standard Securities
 Stocks
 Bonds
 Cash
Standard Securities

Traditional Securities

20,000
Amount

Billions
of $

10,000
in

0
Bonds Cash Stocks
Types
 Total Market
The standard market is what most people think
of when they think of the market. The truth is
that derivatives are the fastest growing sector
of the market. In fact, they are the largest
section of the market. We did not consider
mutual funds in this presentation. There are
more mutual funds in the market than there
are stocks. Again, the next graph does not
account for mutual funds.
 Total Market

Total Market: Traditional & Derivative

Total Derivatives
43%

Total Traditional
57%
Thank You