Project on Derivative Market by Sanjay Gupta

A PROJECT REPORT ON “AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISON WITH EQUITY” UNDERTAKEN AT:

NIRMAL BANG SECURITIES PVT. LTD. ITC,Ring Road, Surat.

Submitted By:

Guided By: MRS.VARSHA PATEL MBA PROGRAMME (Year 2009-010) VIVEKANAND COLLEGE FOR M.B.A

DECLARATION I, SAURAV.P.GOHIL here by declare that the project report entitled “AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISON WITH EQUITY” is based on my own work and my indebtedness to other work/ publications, if any have been duly acknowledged at the relevant place.

PLACE: Surat DATE: SAURAV.P.GO HIL

ACKNOWLEDGEMENT To acknowledge is very great way to show your gratitude towards the persons who have contributed in your success in one or other way. I find words inadequate to express my gratitude to Mr. DHARMESH PATEL for providing me an opportunity to carry out my winter project as such a well reputed and leading stock broking company Nirmal Bang Securities Private Limited. At the very outset of the training I deem it is my pious duty to express my sincere thanks also to companyâ&#x20AC;&#x2122;s Gujarat Head Mr. Dharmesh Patel for his continuous guidance and supervision and support during the project. I would like to thank MRS.VARSHA PATEL, who has guided me for my project work and provided encouragement through out my training period. This study could not have been successful without the valuable input of the customer of Nirmal Bang.

PREFACE I know that Project is for the development and enhancement of the knowledge in this particular field. It can never be possible to make a mark in todayâ&#x20AC;&#x2122;s competitive era only with theoretical knowledge when industries are developing at global level, practical knowledge of administration and management of business is very important. Hence, practical study is of great importance to B.B.A. student.

With a view to expand the boundaries of thinking, I have undergone 6 th SEM Winter Project at Nirmal Bang Securities private Limited. I have made a deliberate to collect the required information and fulfill project objective.

TABLE OF CONTENTS Sr.No. SUBJECT

Page No.

Industry profile

Company profile

(p) LTD. Financial derivatives:

6-17 ---------

Nirmal Bang securities

18-39 40-70

1. Introduction about derivatives 2

Risk Associated With Derivatives

Functions of derivative market

Participants of derivative market

Types of derivatives

Emergence of derivative trading in India

Introduction of forward

Introduction to futures

Introduction to options

10 Types of options 11 Pricing with regard to option 12 Difference between derivative and equity 4

RESEARCH METHODOLOGY

71-73

DATA ANALYSIS

73-88

FINDINGS

CONCLUSION

RECOMENDATION

BIBLIOGRAPHY & APPENDIX

92100

INDUSTRY PROFILE: 5

HISTORY OF THE STOCK BROKING INDUSTRY Indian Stock Markets are one of the oldest in Asia. Its history dates back to nearly 200 years ago. In 1887, they formally established in Bombay, the "Native Share and Stock Brokers' Association" (which is alternatively known as "The Stock Exchange"). In 1895, the Stock Exchange acquired a premise in the same street and it was inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated. Thus in the same way, gradually with the passage of time number of exchanges were increased and at currently it reached to the figure of 24 stock exchanges. This was followed by the formation of associations /exchanges in Ahmadabad (1894), Calcutta (1908), and Madras (1937). In order to check such aberrations and promote a more orderly development of the stock market, the central government introduced a legislation called the Securities Contracts (Regulation) Act, 1956. Under this legislation, it is mandatory on the part of stock exchanges to seek government recognition. As of January 2002 there were 23 stock exchanges recognized by the central Government.

They

are

located

Ahmadabad,

Bangalore,

Baroda,

Bhubaneswar, Calcutta, Chennai,(the Madras stock Exchanges ), Cochin, Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana, Mangalore, Mumbai(the National Stock Exchange or NSE), Mumbai (The Stock Exchange),

popularly

called

the

Bombay

Stock

Exchange,

Mumbai

(OTCExchange of India), Mumbai (The Inter-connected Stock Exchange of India), Patna, Pune, and Rajkot. Of course, the principle bourses are the National Stock Exchange and The Bombay Stock Exchange, accounting for the bulk of the business done on the Indian stock market.

BSE (BOMBAY STOCK EXCHANGE) The Stock Exchange, Mumbai, popularly known as "BSE" was established in 1875 as "The Native Share and Stock Brokers Association". It is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was established in 1878. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. of India under the Securities Contracts (Regulation) Act, 1956.

A Governing Board having 20 directors is the apex body, which decides the policies and regulates the affairs of the Exchange. The Governing Board consists of 9 elected directors, who are from the broking comm Unity (one third of them retire ever year by rotation), three SEBI nominees, six public representatives and an Executive Director & Chief Executive Officer and a Chief Operating Officer.

NSE (NATIONAL STOCK EXCHANGE) NSE was incorporated in 1992 and was given recognition as a stock exchange in April 1993. It started operations in June 1994, with trading on the Wholesale Debt Market Segment. Subsequently it launched the Capital Market Segment in November 1994 as a trading platform for equities and the Futures and Options Segment in June 2000 for various derivative instruments.

MCX (MULTI COMMODITY EXCHANGE)

‘MULTI COMMODITY EXCHANGE’ of India limited is a new order exchange with a mandate for setting up a nationwide, online multi-commodity market place,

offering

unlimited

growth

opportunities

commodities

market

participants. As a true neutral market, MCX has taken several initiatives for users in a new generation commodities futures market in the process, become the country’s premier exchange. MCX, an independent and a de-mutualized exchange since inception, is all set up to introduce a state of the art, online digital exchange for commodities futures trading in the country and has accordingly initiated several steps to translate this vision into reality.

NCDEX (NATIONAL COMMODITIES AND DERIVATIVES EXCHANGE)

NCDEX started working on 15 th December, 2003. This exchange provides facilities to their trading and clearing member at different 130 centers for contract. In commodity market the main participants are speculators, hedgers and arbitrageurs.

Facilities Provided By NCDEX  NCDEX has developed facility for checking of commodity and also provides a wear house facility  By collaborating with industrial partners, industrial companies, news agencies, banks and developers of kiosk network NCDEX is able to provide current rates and contracts rate.  To prepare guidelines related to special products of securitization NCDEX works with bank.  To avail farmers from risk of fluctuation in prices NCDEX provides special services for agricultural.  NCDEX is working with tax officer to make clear different types of sales and service taxes.  NCDEX is providing attractive products like “weather derivatives”

STOCK MARKET BASIC What are corporations? Companies are started by individuals or may be a small circle of people. They pool their money or obtain loans, raising funds to launch the business. A choice is made to organize the business as a sole proprietorship where one Person or a married couple owns everything, or as a partnership with others who may wish to invest money. Later they may choose to "incorporate". As a Corporation, the owners are not personally responsible or liable for any debts of the company if the company doesn't succeed. Corporations issue official-looking sheets of paper that represent ownership of the company. These are called stock certificates, and each certificate represents a set number of shares. The total number of shares will vary from one company to another, as each makes its own choice about how many pieces of ownership to divide the corporation into. One corporation may have only 2,500 shares, while another, such as IBM or the Ford Motor Company, may issue over a billion Shares. Companies sell stock (pieces of ownership) to raise money and provide funding for the expansion and growth of the business. The business founders give up part of their ownership in exchange for this needed cash. The expectation is that even though the owners have surrendered a portion of the company to the Public, their remaining share of stock will become increasingly valuable as the business grows. Corporations are not allowed to sell shares of stock on the open

Stock market without the approval of the Securities and Exchange Commission (SEC). This transition from a privately held corporation to a publicly traded one is Called going public, and this first sale of stock to the public is called an initial public offering, or IPO.

ď&#x192;&#x2DC; Why do people invest in the stock market? When you buy stock in a corporation, you own part of that company. This gives you a vote at annual shareholder meetings, and a right to a share of future profits. When a company pays out profits to the shareholder, the money received is called a "Dividend". The corporation's board of directors choose when to declare a dividend and how much to pay. Most older and larger companies pay a regular dividend, most newer and smaller companies do not.

The average investor buys stock hoping that the stock's price will rise, so the shares can be sold at a profit. This will happen if more investors want to buy stock in a company than wish to sell. The potential of a small dividend check is of little concern. What is usually responsible for increased interest in a company's stock is the prospect of the company's sales and profits going up. A company who is a leader in a hot industry will usually see its share price rise dramatically. Investors take the risk of the price falling because they hope to make more money in the market than they can with safe investments such as bank CD's or government bonds.

What is a stock market index? In the stock market world, you need a way to compare the movement of the market, up and down, from day to day, and from year to year. An index is just a benchmark or yardstick expressed as a number that makes it possible to do this comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index of BSE.

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

The Securities Market consists of two segments, viz. Primary market and Secondary market. Primary market is the place where issuers create and issue equity, debt or hybrid instruments for subscription by the public; the Secondary market enables the holders of securities to trade them.

Secondary market essentially comprises of stock exchanges, which provide platform for purchase and sale of securities by investors. In India, apart from the Regional Stock

Exchanges established in different centers, there are exchanges like the National Stock Exchange (NSE) and the Over the Counter Exchange of India (OTCEI), who provide nation wide trading facilities with terminals all over the country. The trading platform of stock exchanges is accessible only through brokers and trading of securities is confined only to stock exchanges.

ď&#x192;&#x2DC; Corporate Securities : The no of stock exchanges increased from 11 in 1990 to 23 now. All the exchanges are fully computerized and offer 100% on-line trading. 9644 companies were available for trading on stock exchanges at the end of March 2002. The trading platform of the stock exchanges was accessible to 9687 members from over 400 cities on the same date.

ď&#x192;&#x2DC; Derivatives Market: Derivatives trading commenced in India in June 2000. The total exchange traded derivatives witnessed a volume of Rs. 442,343 crore during 2002-03 as against Rs. 4018 crore during the preceding year. While NSE accounted for about 99.5% of total turnover, BSE accounted for about 0.5% in 2002-03. The market witnessed higher volumes from June 2001 with introduction of index options, and still higher volumes with introduction of stock options in July 2001. There was a

spurt in volumes in November 2001 when stock futures were introduced. It is believed that India is the largest market in the world for stock futures.

ď&#x192;&#x2DC; Supply and Demand A stock's price movement up and down until the end of the trading day is strictly a result of supply and demand. The SUPPLY is the number of shares offered for sale at anyone one moment. The DEMAND is the number of shares investors wish to buy at exactly that same time. What a share of a company is worth on anyone day or at any one minute, is determined by all investors voting with their money. If investors want a stock and are willing to pay more, the price will go up. If investors are selling a stock and there aren't enough buyers, the price will go down Period.

ď&#x192;&#x2DC; Secondary Market Intermediaries Stock brokers, sub-brokers, portfolio managers, custodians, share transfer agents constitute the important intermediaries in the Secondary Market. No stockbrokers or sub-brokers shall buy, sell or deal in securities unless he holds a certificate of registration granted by SEBI under the Regulations made by SEBI ion relation to them. The Central Government has notified SEBI (Stock Brokers & Sub-Brokers) Rules, 1992 in exercise of the powers conferred by section 29 of SEBI Act, 1992. These rules came into effect on 20th August, 1992.

ď&#x192;&#x2DC; Trading Through Brokers / Traditional Method of Share Trading:Trading in the stock exchange can be conducted only through member broker in securities that are listed on the respective exchange. Investor intending to buy/sell securities in the exchange has to do so only through a SEBI registered broker/sub-broker. This is very popular concept in India for Share Trading before the facilities like on line trading introduce. Both the exchange have switched over from the open outcry trading system to fully automated computerized mode of trading knows as Bolt and Neat. In this system, the broker trade with each other through the computer network. Buyers and sellers place their orders specifying the limits for quality and price. Those that are not matched remain on the screen and is opened for future matching

during the day / settlement. After the advent of computerized trading the speed of trading has increased multi-fold and a fuller view of the market is available to the investors. To start dealing with broker you have to fill a form with the broker. After fill all the formalities the firm gives you a User Id no like a bank a/c no. through which you

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

What is stock Broker? “A stock broker is one who invests other people’s money until it’s all gone.” -Woody Allen, American Film Maker

A stock broker is a person or a firm that trades on its clients behalf, you tell them what you want to invest in and they will issue the buy or sell order. Some stock brokers also give out financial advice that you a charged for. It wasn’t too long ago and investing was very expensive because you had to go through a full service broker which would give you advice on what to do and would charge you a hefty fee for it. There are three different types of stock brokers. 1. Full Service Broker - A full-service broker can provide a bunch of services such as investment research advice, tax planning and retirement planning. 2. Discount Broker – A discount broker let’s you buy and sell stocks at a low

rate but doesn’t provide any investment advice.

3. Direct-Access Broker- A direct access broker lets you trade directly with the electronic communication networks (ECN’s) so you can trade faster. Active traders such as day traders tend to use Direct Access Brokers

No. of stock broker in India 9368:- Total no of share broker in the country 12687:- The no. of sub-broker. 46%:- The share of trades accounted for by NSE broker 90%: The share of On line trades clocked by segment’s top five companies Generally there are two types of trading have been done in India which is given below: On line Trading / E – Broking / Modern Method Trading through Brokers / Traditional method of Share trading.

ABOUT NIRMAL BANG INTRODUCTION:Nirmal Bang Group is one of the largest retail broking house in India, providing the investors state of art services in capital markets in the country. The Group has memberships of Bombay Exchange Limited, National Stock of India Limited, Multi Commodity Exchange of India Limited, National Commodity and Derivatives Exchange Limited and is also a depository participant of NSDL and CDS (I) L, the depositories of the country. They started in 1986 under Late Shri Nirmal Bang as sub brokers but have grown steadily and progressively since then. Their clients had contributed tremendously to their growth they recognize and applaud that, they value their relationship with the customers and for their convenience had all investing avenues under one roof.

NIRMAL BANG consultant As the flagship company of the NIRMAL BANG Group, NIRMAL BANG Private Limited has always remained at the helm of organizational affairs, pioneering business policies, work ethic and channels of progress. NIRMAL BANG believe that they were best positioned to venture into that activity as a Depository Participant. They were one of the early entrants registered as Depository Participant with NSDL (National Securities Depository Limited), the first Depository in the country and then with CDSL (Central Depository Services Limited). Today, It service over 1Lac customer accounts in this business spread across over 350 cities/towns in India and are ranked amongst the largest Depository Participants in the country. With a growing secondary market presence. 19

It has transferred this business to NIRMAL BANG SECURITIES PRIVATE LIMITED (NBSPL), their associate and a member of NSE, BSE, MCX & NCDEX.

NIRMAL BANG --- Early Days The birth of NIRMAL BANG was on a modest scale in 1986. It began with the vision and enterprise of a small group of practicing Chartered Accountants who founded the flagship company. NIRMAL BANG Securities Private Limited. It started with consulting and financial accounting automation, and carved inroads. Since then, They have utilized their experience and superlative expertise to go from strength to strengthâ&#x20AC;Śto better their services, to provide new ones, to innovate, diversify and in the process, evolved NIRMAL BANG as one of Indiaâ&#x20AC;&#x2122;s premier integrated financial service enterprise. Thus over the last 20 years NIRMAL BANG has traveled the success route, towards building a reputation as an integrated financial services provider, offering a wide spectrum of services. And they have made this journey by taking the route of quality service, path breaking innovations in service, versatility in service and finally totality in service. Their highly qualified manpower, cutting-edge technology, comprehensive infrastructure and total customer-focus has secured for them the position of an emerging financial services giant enjoying the confidence and support of an enviable clientele across diverse fields in the financial world. Their values and vision of attaining total competence in their servicing has served as the building block for creating a great financial enterprise, which stands solid on their fortresses of financial strength - their various companies.

With the experience of years of holistic financial servicing behind them and years of complete expertise in the industry to look forward to, They have now emerged as a premier integrated financial services provider. And today, they can look with pride at the fruits of their mastery and experience – comprehensive financial services that are competently segregated to service and manage a diverse range of customer requirements.

Business Focus:The focus of the business is the Customer – Customer service, Customer education, Customer support, Customer relations and last but not the least Customer acquisition. Trade execution transparency, timely settlements, risk monitoring and superior service shall have topmost priority, in the best interests of all concerned.

VISION STATEMENT “TO CREATE VALUABLE RELATIONSHIP AND PROVIDE THE BEST FINANCIAL SERVICES MOST PROFESSIONALLY”

MISSION STATEMENT “TO WORK TOGETHER WITH INTEGRITY & MAKE OUR CUSTOMER FEEL VALUED”

CORE VALUE “RESPECT OUR COLLEAGUE AND THE BUSINESS ITSELF”

Board of Directors Of NIRMAL BANG GROUP NAME

POSITION

Mr. Dilip M. Bang

Director

Mr. Kishor M. Bang

Director

Mr.Rakesh Bhandari

Chartered Accountant

Mr. Deepak Agarval

Chartered Accountant

Mr.Suvinay Sharma

Chartered Accountant

Mr.Naresh Samdani

Chartered Accountant

Mr. Deepak Patel

Chartered Accountant

Mr. Sunil Jain

Chartered Accountant

Mr.Anup Agarval

Chartered Accountant

Mr.Brijmohan Bohra

Chartered Accountant

Miss. Monika Bafna

Chartered Accountant

Mr.Brijmohan Bohra

Company Secretarial

Principal Activities Of ‘NIRMAL BANG GROUP’

•

NIRMAL BANG Securities Private Limited

–

Member : National Stock Exchange of India Limited

–

Member : Bombay Stock Exchange Limited

–

Participant : National Securities Depository Limited

–

Participant : Central Depository Service (India) Limited

NIRMAL BANG Commodities Private Limited 

Member - Multi Commodity Exchange of India Limited



Member - National Commodities and Derivatives Exchange Ltd.

• BANG Equity Broking Private Limited 

Member - Bombay Stock Exchange Ltd

• Nadi Finance & Investment Private Limited 

RBI registered Non Banking Finance Company 23

Publications of NIRMAL BANG ď&#x192;&#x2DC; NIRMAL BANG- Beyond Market

NIRMAL BANG Profile REGISTERED OFFICE "NIRMAL BANG HOUSE" 38, Khatau Building, 2nd Floor, Alkesh Dinesh Modi Marg, Fort, Mumbai - 400 001, Maharashtra, India. Tel : +91-2264-1234 Fax : +91-3027-2006

SURAT Branch

Shop no. G4, ITC Building, Majura Gate, Surat. Ph. 9376126075 Email: surat@nirmalbang.com

Organization Chart:Nirmal Bang

Branch

Web Dealer

Franchise

Sales Executive

Sales Coordinator

Account Head

Customer Care Receptionist 25

NIRMAL BANG’s CORE SERVICES:NIRMAL BANG is one of India’s leading broking houses providing a complete life-cycle of investment solution.

Research Based Investment Advice

Training and Seminars

Technology Based Investment Tools

EQUITIES DERIVATIVES COMMODITIES

Investment and Trading Services

Integrated Demat Facility

SWOT Analysis

Strength: 23 years of research and broking experience  Understandings of the markets  All financial needs under one roof  Scalable and robust infrastructure  Full fledge research unit comprising of both fundamental & technical research  Dedicated, Qualified and Loyal staff  Flexible Brokerage charges

Weakness: Low Brand Image in the market.  Low Professionalism  Low Advertisements

Opportunity: Large potential market for delivery and intra-day transactions.  Open interest of the people to enter in to stock market for investing  Attract the customers who are dissatisfied with other brokers & DPs.  Up growing markets in commodity and forex trading

Threats: Decreasing rates of brokerage in the market. A Increasing competition against other brokers & DPs.  Poor marketing activities for making the company known among the customers. A threat of loosing clients for any kind of weakness of the company. An Indirect threat from instable stock market, i.e., low/no profit of NIRMAL BANG's clients would lead them to go for other broker/DP.

“SERVICES of NIRMAL BANG”

Nirmal Bang’s Services Offline

Online

Other Services

 OFFLINE

 Offline A/c is the A/c for the investors who are not familiar with the use of computer.  The A/C opening charges applied(One time) st

 For 1

Year Demat A/C is

Free, On 2nd Year AMC charge is applicable.  Online Account

 Requirement for online trading Linked Bank Account •

Broking Account

•

Linked Depository Account

 Benefits of online trading Freedom from paperwork •

Instant credit and transfer

•

Trade Anywhere

•

Timely Advice and access to research

•

Real-time portfolio tracking

•

After hour orders

•

Market Alerts

•

Instant quotes

 Other Services:

 Dial-n-Trade  Mutual Fund  Commodity  Derivative  Depository Participants  Distribution of Financial Services  Research Based Advices  Portfolio Management System

DnT (Dial- n –Trade) Dial n Trade is the name of the phone-trading facility offered by NIRMAL BANG. A call center wholly dedicated to order placement / confirmation.

Easy 2-step process for order placement. Step1. Enter your PHONE ID Step2. Enter your Client Code On successful dial, call gets transferred to call center executives.

NIRMAL BANG Securities Private Limited, one of the cornerstones of the NIRMAL BANG edifice, flows freely towards attaining diverse goals of the customer through varied services. Creating a plethora of opportunities for the customer by opening up investment vistas is backed by research-based advisory services. Here, growth knows no limits and success recognizes no boundaries. Helping the customer create waves in his portfolio and empowering the investor completely is the ultimate goal.

ď&#x192;&#x2DC; Stock Broking Services We offer trading on a vast platform; National Stock Exchange, Bombay Stock Exchange, MCX & NCDEX. More importantly, we make trading safe to the maximum possible extent, by accounting for several risk factors and planning accordingly. We are assisted in this task by our in-depth research, constant feedback and sound advisory facilities. Our highly skilled research team, comprising of technical analysts as well as fundamental specialists, secure result-oriented information on market trends, market analysis and market predictions.

To empower the investor further we have made serious efforts to ensure that our research calls are disseminated systematically to all our stock broking clients through various delivery channels like email, chat, SMS, phone calls etc.

MUTUAL FUNDS Introduction: Everybody talks about mutual funds, but what exactly are they? Are they like shares in a company, or are they like bonds and fixed deposits? Will I lose all my money in funds or will I become an overnight millionaire? Big questions that get answer in just five minutes.

Meaning: 33

A mutual fund is a pool of money that is invested according to a common investment objective by an asset management company (AMC). The AMC offers to invest the money of hundreds of investors according to a certain objective - to keep money liquid or give a regular income or grow the money long term. Investors buy a scheme if it fits in with their investment goals, like getting a regular income now or letting the money accumulate over the long term. Investors pay a small fraction of their total funds to the AMC each year as investment management fees.

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

Association

discontent amongst

Ltd."

leading

1875. In cotton

1893, mill

following

widespread

owners

and

merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. A future trading in oilseeds was organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. There were booming activities in this market and at one time as many as 110 exchanges were conducting forward trade in various commodities in the country.

The securities market was a poor cousin of this market as there were not many papers to be traded at that time. The era of widespread shortages in many essential commodities resulting in inflationary pressures and the tilt towards socialist policy, in which the role of market forces for resource allocation got diminished, saw the decline of this market since the mid-1960s. This coupled with the regulatory constraints in 1960s, resulted in virtual dismantling of the commodities future markets. It is only in the last decade that commodity future exchanges have been actively encouraged. However, the markets have been thin with poor liquidity and have not grown to any significant level.

Derivative The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management,

these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors.

Depository Participants

The onset of the technology revolution in financial services Industry saw the emergence of NIRMAL BANG as an electronic custodian registered with National Securities Depository Ltd (NSDL) and Central Securities Depository Ltd (CSDL). NIRMAL BANG set standards enabling further comfort to the investor by promoting paperless trading across the country and emerged as the top 3 Depository Participants in the country in terms of customer serviced. Offering a wide trading platform with a dual membership at both NSDL and CDSL, we are a powerful medium for trading and settlement of dematerialized Shares. We have established live DPMs, Internet access to accounts and an easier transaction process in order to offer more convenience to individual and

Corporate investors. A team of professional and the latest technological expertise allocated exclusively to our demat division including technological enhancements like SPEED-e; make our response time quick and our delivery impeccable. A wide national network makes our efficiencies accessible

to all. About NIRMAL BANG: •

Depository participant with both NSDL and CDSL

•

Over 25 thousands clients being serviced from over 135 cities.

•

Web enabled service to provide state of the art service delivery

ď&#x192;&#x2DC; Distribution of Financial Products

The paradigm shift from pure selling to knowledge based selling drives the business today. With our wide portfolio offerings, we occupy all segments in the retail financial services industry. A 1600 team of highly qualified and dedicated professionals drawn from the best of academic and professional backgrounds are committed to maintaining high levels of client service delivery.

This has propelled us to a position among the top distributors for equity and debt issues with an estimated market share of 15% in terms of applications mobilized, besides being established as the leading procurer in all public issues.

To further tap the immense growth potential in the capital markets we enhanced the scope of our retail brand, NIRMAL BANG â&#x20AC;&#x201C; the Finapolis, thereby providing planning and advisory services to the mass affluent. Here we understand the customer needs and lifestyle in the context of present earnings and provide adequate advisory services that will necessarily help in creating wealth. Judicious

Planning that is customized to meet the future needs of the customer deliver a service that is exemplary. The market-savvy and the ignorant investors, both find this service very satisfactory. The edge that we have over competition is our portfolio of offerings and our professional expertise. The investment planning for

each customer is done with an unbiased attitude so that the service is truly customized. Our monthly magazine, Finapolis, provides up-dated market information on market trends, investment options, opinions etc. Thus empowering the investor to base every financial move on rational thought and prudent analysis and embark on the path to wealth creation.

About NIRMAL BANG: •

Investments –

Equity – Primary and Secondary

–

Fixed Income – Primary and Secondary

–

Fixed Deposits

–

Mutual Funds Insurance

• –

Life

: LIC, Amp Sanmar, HDFC Standard, ICICI Prulife, Om Kotak, MetLife, Tata AIG, Birla Sun life

–



General

: New India, Tata AIG, Reliance, Royal Sundaram

Portfolio Management System

The company has initiated the process of obtaining permission from SEBI for rendering PMS Service to its clients. We are planning to start PMS Service to High Net Worth individual and NRIs after obtaining the necessary regulatory clearances.

THEORETICAL ASPECT

INTRODUCTION:

According to dictionary, derivative means â&#x20AC;&#x2DC;something which is derived from another sourceâ&#x20AC;&#x2122;. Therefore, derivative is not primary, and hence not independent. 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 shareâ&#x20AC;&#x2122;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.

Meaning: Derivatives are the financial contracts whose value/price is dependent on the behavior of the price of one or more basic underlying assets (often simply known as the underlying). These contracts are legally binding agreements, made on the trading screen of stock exchanges, to buy or sell an asset in future. The asset can be a share, index, interest rate, bond, rupee dollar exchange rate, sugar, crude oil, soybean, cotton, coffee etc. In the Indian Context the Security Contracts (Regulation) Act, 1956 (SC(R) A) defines â&#x20AC;&#x153;derivativeâ&#x20AC;? to include â&#x20AC;&#x201C; 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.

Contracts agreement

Cash

Derivatives Forward

Merchandisi ng, customized NTSD

TSD

Futures (Standardized

)

Others like Swaps, FRAs etc

Options 43

In financial terms derivatives is a broad term for any instrumental whose value is derived from the value of one more underlying assets such as commodities, forex, precious metal, bonds, loans, stocks, stock indices, etc. Derivatives were developed primarily to manage offset, or hedge against risk but some were developed primarily to provide potential for high returns. In the context of equity markets, derivatives permit corporations and institutional

Investors to effectively manage their portfolios of assets and 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. 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 44

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 â&#x20AC;&#x153;credit riskâ&#x20AC;? remained a serious problem.

1848 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 45

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 Moorage 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 46

Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee in Bangalore, etc.

JUNE 2000 National Stock Exchange and Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading on Sensex and Nifty commenced in June 2001. Very soon thereafter trading began on options and futures in 31 prominent stocks in the month of July and November respectively. Option and future are the most commonly traded derivatives, but as the understanding of financial markets and risked management continued to improve newer derivatives were created. The family includes the host of other product such as forward contracts. Structured notes, inverse floaters, caps & Floors and Collar Swaps. The largest derivatives market in the world, are on government bonds (to help control interest rate risk) the stock index (to help control risk that is associated with the fluctuations in the stock market) and on exchange rates (to cope with currency risk).

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 â&#x20AC;&#x201C; 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 48

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: 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 49

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, welleducated 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.

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: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 preagreed 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 1st Sep.

ď&#x192;&#x2DC; OPTIONS:Options are a right available to the buyer of the same, to purchase or sell an asset, without any obligation. It means that the buyer of the option can exercise his option but is not bound to do so. Options are of 2 types: calls and puts. 1. CALLS :Call gives the buyer the right, but not the obligation, to buy a given quantity of the underlying asset, at a given price, on or before a given future date. For example :- A, on 1 st Aug. buys an option to buy 600 shares of Reliance Ind. Ltd. @ 450 Rs 450 on or before 1 st Sep. In this case, A has the right to buy the shares on or before the specified date, but he is not bound to buy the shares.

2. PUTS :Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset, at a given price, on or before a given date.

For example :- A, on 1st Aug. buys an option to sell 600 shares of Reliance Ind. Ltd. @ Rs 450 on or before 1 st Sep. In this case, A has the right to sell the shares on or before the specified date, but he is not bound to sell the shares.

In both the types of the options, the seller of the option has an obligation but not a right to buy or sell an asset. His buying or selling of an asset depends upon the action of buyer of the option. His position in both the type of option is exactly the reverse of that of a buyer.  WARRANTS :Options generally have lives of up to one year, the majority of 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 as followas:

1.) INTEREST RATE SWAPS:These entail swapping only the interest related cash flows between the parties in the same currency. 2.) CURRENCY SWAPS:These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. ď&#x192;&#x2DC; SWAPTIONS :Swaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus, a swaptions is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaptions is an option to receive fixed and pay floating. A payer swaptions is an option to pay fixed and receive floating Out of the above-mentioned types of derivatives forward.

EMERGENCE OF THE DERIVATIVE TRADING IN INDIA ď&#x192;&#x2DC; 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 55

to govern trading of derivatives. SEBI set up a 24 – member committee under the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing necessary pre-conditions for introduction of derivatives trading in India.

The committee recommended that derivatives should be declared as ‘securities’ so that regulatory framework applicable to trading of ‘securities’ could also govern trading of securities. SEBI also set up a group in June 1998 under the chairmanship of Prof. J.R.Verma, to recommend measures for risk containment in derivative market in India.

The repot, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real - time monitoring requirements. The SCRA was amended in December 1999 to include derivatives within the ambit of ‘securities’ and the regulatory framework were developed for governing derivatives trading. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on 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.

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 58

contracts are used generally for protecting against rich of adverse price fluctuations (hedging). As the terms of contracts are standardized, these are generally not used for merchandizing purpose. The standardized items in a futures contract are:  Quantity of the underlying.  Quality of the underlying.  The date and month of delivery.  The units of price quotation and minimum price change.  Location of settlement. Futures contract performs two important functions of price discovery and price risk management with reference to the given commodity. It is useful to all segment of economy. It is useful to the producer because investor can get an idea of the price likely to prevail at a future point of time and therefore can decide between various competing commodities, the best that suits him. It enables the consumer get an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and cover his purchases by making forward contracts. The future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market.

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 Operational Mechanism Contract Specifications Counter-party risk

Liquidation Profile Price discovery

FORWARD CONTRACT FUTURE CONTRACT Traded directly between two Traded on the parties (not traded on the exchanges. exchanges). Differ from trade to trade. Contracts are standardized contracts. Exists. Exists. However, assumed by the clearing corp., which becomes the counter party to all the trades or unconditionally guarantees their settlement. Low, as contracts are tailor High, as contracts are made contracts catering to standardized exchange the needs of the needs of the traded contracts. parties. Not efficient, as markets are Efficient, as markets scattered. are centralized and all buyers and sellers come to a common platform to discover the price.

Margins

The

margining

system is based

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.

Mark-to market profit/loss. The computation of initial margin on the futures market is done using the

concept of Value-at-risk (VaR). The initial margin amount is large enough to cover a one-day loss that can be encountered on 99% of the days. VaR methodology seeks to measure the amount of value that a portfolio may stand to lose within certain horizon period (one day for the clearing corporation) due to potential changes in the underlying asset market price. Initial margin amount computed using VaR is collected up-front. The daily settlement process called â&#x20AC;&#x153;mark-to-marketâ&#x20AC;? 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-tomarket 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.

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

collect/pay/losses/profits from/to their clients by the next day. The pay-in and payout of the mark-to-market settlement are affected on the day following the trade day. After completion of daily settlement computation, all the open positions are reset to the daily settlement price. Such position becomes the opening positions for the next day. ii.

FINAL SETTLEMENTS FOR FUTURES On the expiry of the future contracts, after the close of trading hours,

NSCCL marks all positions of CM to the final settlement price and the resulting profits/losses is settled in cash. Final settlement loss/profits amount is debited/credit to the relevant CM’s clearing bank account on the day following expiry day of the contract

SETTLEMENT PRICES FOR FUTURES:Daily settlement price on a trading day is the closing price of the respective future contracts on such day. The closing price for the future contracts is currently calculated as the last half an hour weighted average price of a contract in the F&O segment of NSE. Final settlement price is the closing price of the relevant underlying index/security in the capital market segment of NSE, on the last trading day of the contract. The closing price of the underlying Index/security is currently its last half an hour weighted average value in the capital market segment of NSE.

INTRODUCTION TO OPTIONS:Options give the holder or buyer of the option the right to do something. If the option is a call option, the buyer or holder has the right to buy the number of shares mentioned in the contract at the agreed strike price. If the option is a put option, the buyer of the option has a right to sell the number of shares mentioned in the contract at the agreed strike price. The holder of the buyer does not have to exercise this right. Thus on the expiry of the day of the contract the option may or may not be exercised by the buyer. In contrast, in a futures contract, the two parties to the contract have committed themselves to doing something at a future date. To have this privilege of doing the transaction at a future only if it is a profitable, the buyer of the option has to pay a premium to the seller of options.

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

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

TABLE SHOWING THE DEALING OF CALL & PUT OPTION Call Option Holder (Buyer)  Pays Premium  Right to exercise & buy the shares  Profit from rising prices  Limited losses, potentially unlimited gains Put Option Holder (Buyer)  Pays Premium  Right to exercise & buy the shares  Profit from rising prices  Limited losses, potentially unlimited gains

Call Option Writer (Seller)  Receives premium  Obligation to sell shares if exercised  Profits from falling prices or remaining neutral  Potentially unlimited losses, limited gains Put Option Holder (Seller)  Receives premium  Obligation to buy shares if exercised  Profits from rising prices or remaining neutral  Potentially limited losses, unlimited gains

IMPORTANT CONCEPTS:In -themoney 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- themoney:

A term that describes an option with a strike price that is equal to the current market price of the underlying stock. But of the money if the stock price is above its strike price.

Market Scenario

Call Option

Put Option

Market price > strike price Market price < strike price Market price = strike price Market price ~ strike price

In- themoney Out- of- the- money At- themoney Near- themoney

Out- of- the- money In- themoney At themoney Near- themoney

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- themoney” option. If the value of the underlying asset is equivalent to the strike price, the call option is “at- themoney” 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 themoney”

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

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.

â&#x20AC;˘

Black and Scholes Model: In order to understand the model itself, we divide it into two parts. The

first part, SN [d1), derives the expected benefit from acquiring a stock outright. This is found by multiplying stock price [S] by the change in the call premium with respect to a change in the underlying stock price [N (d1)]. The second part of the model, Ke [-rt) N (d2), gives the present value of paying the exercise price on the

expiration day. The fair market value of the call option is then calculated by taking the difference between these two parts.

Assumptions of the Black and Scholes Model:1) The stock pays no dividends during the option's life Most companies pay dividends to their share holders, so this might seem a serious limitation to the model considering the observation that higher dividend yields elicit lower call premiums. A common way of adjusting the model for 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 68

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. 69

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 (i.e. they can be exercised at any time as opposed to European options which can only be exercised at expiration) this is a significant limitation.  The exception to this is an American call on a non-dividend paying asset. In this case the call is always worth the same as its European equivalent as there is never any advantage in exercising early.  Various adjustments are sometimes made to the Black-Scholes price to enable it to approximate American option prices but these only works well within certain limits and they don't really work well for puts.

Difference between derivative and equity DERIVATIVE Warehousing Quality underlying assets Contract life

No warehousing is required of Derivatives contract donâ&#x20AC;&#x2122;t have attribute of quality

EQUITY No warehousing is required Equity contract donâ&#x20AC;&#x2122;t have attribute of quality

Maturity date

Comparatively having Having long and short long contract life contract life Standardized Standardized

Return

High

Medium

Risk

Very High

Less

Liquidity

Less

Very high

Investment Amount

Very high

Low

Lot size

Fixed by SEBI

Not fixed by SEBI

Time of trading

9a.m to 3.30p.m

RESEARCH METHODOLOGY:Problem Statement:



The topic, which is selected for the study, is “DERIVATIVE MARKET” in the firm so the problem statement for this study will be, “AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISION WITH EQUITY.” Objective of the Study:



1. To know the awareness of the Derivative Market in Surat City. 2. To know which one is beneficial for the investor. 3. To find what proportion of the population are investing in such derivatives along with their investment pattern and product preferences. 

Research Design: The research design specifies the methods and procedures for

conducting a particular study. The type of research design applied here are “DESCRIPTIVE” as the objective is to check the position of the Derivative Market in Surat city. The objectives of the study have restricted the choice of research design up to descriptive research design. This survey will help the firm to know how the investors invest in the derivative segment & which factors affect their investing behavior. 

Scope of the Study:

The scope of the study will include the analysis of the survey, which is being conducted to know the awareness of the Derivative Market in the city & also doing comparison of derivatives with equity.

Research Source of Data:There are two types of sources of data which is being used for the studies: Primary Source of Data: Preparing a Questionnaire is collecting the primary source of data & it was collected by interviewing the investors.  Secondary Source of Data: For having the detailed study about this topic, it is necessary to have some of the secondary information, which is collected from the following:Books. Magazines & Journals. Websites. Newspapers, etc.

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

DATA ANALYSIS AND INTERPRETATION:

Q.1 Are you trading in derivative market? Frequencies Yes 74 No 126 Total 200

Percentage 37.0 63.0 100.0

Objective: To know that whether the investors are trading in derivative market or not.

Frequency

Graph:

Trading

percent/frequency

140

126

120 100 80 60 40

Frequencies Percentage

20 0 Yes

No Trading

Inference: from the above graph out of 200 investors, only 37% investors means 74 respondent are trading in derivative market and 63% means 126 respondents are not trading in derivative market.

Q.2 Reasons for not investing in derivative market. {Give the rank} Objective: To know the reason why investors are not trading in trading in derivative market Frequency

Reasons Lack of knowledge Lack of awareness High risky Huge amount of

Frequency 26 19 62 17

Percent 20.6 15.1 49.2 13.5

investment Other Total

2 126

1.6 100.0

Graph:

Inference: From the above graphical representation you can see that 49.2% investors think that the derivatives are high risky whereas 1.6% investors donâ&#x20AC;&#x2122;t have specify their reasons for not trading in derivative market. Q.3 what is the objective of trading in derivative market? Objective: To know that why they are trading in derivative market. Frequency Frequency

Percent

Donâ&#x20AC;&#x2122;t trade Not at all preferred Neutral Some how preferred Most preferred Total

126 2 2 5 65 200

63.0 1.0 1.0 2.5 32.5 100

Graph: High Return

percent/frequency

140

126

120 100 80

Frequency

Percent 32.5

40 20

0 Donâ&#x20AC;&#x2122;t trade

Not at all preferred

Neutral

5 2.5 Some how preferred

Most preferred

preferred

Inference: From the above graph we can see that 32.5% investors are most preferred the objective of high return and 1% investors are neutral while they are trading in derivative market. Q .4what are the criteria do you taken in the consideration while investing in derivative market? Objective : To know that which criteria are consider by the investors while they are investing in derivative market. Which criteria are most important for them

whether derivatives are ease in transaction, less costly, or available of different contract or for the margin money.

Frequency

Donâ&#x20AC;&#x2122;t trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total

Frequency 126 2

Percent 63.0 1.0

2.0

16 23 29 200

8.0 11.5 14.5 100.0

Graph:

percentage/frequency

Ease in transaction 140 120 100 80 60 40 20 0

126

Frequency

Donâ&#x20AC;&#x2122;t trade

2 1

4 2

Not at all preferred

Some how not preferred

Neutral

23 11.5

29 14.5

Percent

Some Most how preferred preferred

preferred

Inference: from the above graph we can conclude that out of the 200 investors 14.5% investors are most preferred and 1% investors are not at all preferred the ease in transaction contract.

Q-5 Give your preference of trading in derivative instrument. Objective: To know the preference of the investors while they are trading in derivative market.

Frequency 80

Frequency 126 1 1 15 14 43 200

Donâ&#x20AC;&#x2122;t trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total

Percent 63.0 .5 .5 7.5 7.0 21.5 100.0

Graph:

percent/frequency

Index future 140 120 100 80 60 40 20 0

126

Frequency

63 43

Donâ&#x20AC;&#x2122;t trade

1 0.5

Not at all preferred

Some how not preferred

15 7.5

14 7

Neutral

Some how preferred

21.5

Percent

Most preferred

preferred

Inference: From the above graph we can see that only 0.5% investors are not at all preferred the index future, 0.5 % investors are some how not preferred , 7.5% investors are some how preferred 21.5% are most preferred as the preference of their trading in derivative market.

Q-6 Give your preference in term of trading in derivative market? Objective:

To know the preference of the investors in term of trading in

derivative market.

Frequency Frequency 126 4 1 5 10 54 200

Donâ&#x20AC;&#x2122;t trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total

Percent 63.0 2.0 .5 2.5 5.0 27.0 100.0

Graph:

126

5 2.5

Some how preferred

54 27

frequency percentage

Most preferred

10.5

Neutral

4 2

0 0

10 5

Some how not preferred

Not at all preferred

140 120 100 80 60 40 20 0

Donâ&#x20AC;&#x2122;t trade

Frequency/percentage

Intraday

preferred

Inference: from the above graph we can see that 27% investors are most preferred the intraday and 2% investors are not at all preferred the intraday. Q-7 How much percentage of your income you trade in derivative market? Objective: To know investors are how much percentage of their income trade in

derivative market. Frequency Frequency 126 8 25 25 13 3 200

Donâ&#x20AC;&#x2122;t trade Less than 5% 5%-10% 11%-15% 16%-20% More than 20% Total

Percent 63 4.0 12.5 12.5 6.5 1.5 100.0

Graph:

1.5 3

More than 20%

6.5 13

16%-20% 11%-15%

12.5 25

5%-10%

12.5 25

Percent Frequency

4 8

Less than 5%

Donâ&#x20AC;&#x2122;t trade 0

126 100

150

Inference: From the above graph we can see that 12.5% investors are invest 5% to 10% income in the derivative market. While only 1.5% investors are investing more than 20% of their income. Q-8 what is the rate of return expected by you from derivative market? Objective: To know the investors expectation towards their investment in derivative market.

Frequency Frequency 126 21 22 23 8 200

Do not trade 5%-9% 10%-13. % 14%-17. % 18%-23% Total

Percent 63.0 10.5 11.0 11.5 4.0 100.0

Graph:

pecentage/frequency

rate of return expected 140 120 100 80 60 40 20 0

126

Frequency

63 21

Do not trade

10.5

5%-9%

10%-13. %

Percent 11.5

14%-17. %

18%-23%

Rate of return

Inference: From the above graph we can see that 11.55 investors are expect the 14% to 17% of their investment .and 4% investors are expect the 18% to 23% rate of return. Q-9. You are satisfied with the current performance of the derivative market Objective: To know that investors are satisfied with the performance of the derivative market or not. Frequency

Frequency 126 8 14 18 25 9 200

Do not trade Strongly disagree Disagree Neutral Agree strongly agree Total

Percent 63.0 4.0 7.0 9.0 12.5 4.5 100.0

Graph:

percentage/frequency

Satisfaction 140 120 100 80 60 40 20 0

126 Frequency

63 8 4 Do not trade

14 7

Strongly Disagree Neutral disagree

25 12.5 Agree

Percent 9 4.5 strongly agree

prferred

Inference:

From the above Graph we can see that 12.5% are agree for

satisfaction and4% are strongly disagree.

Gender: Frequency

Male Female Total

Frequency 157 43 200

Percent 78.5 21.5 100.0

Graph:

frequency

gender 180 160 140 120 100 80 60 40 20 0

157

Frequency

78.5

Percent 43 21.5

male

female gender

Inference: From the above graph we can see that there are 157 male investors when 43 are the female investors.

AGE: Frequency Below 20 years 20-25 years 26-30 years 31-35 years above 35 years Total

Frequency 3 61 51 43 42 200

Percent 1.5 30.5 25.5 21.5 21.0 100.0

Graph: 86

percent

age 35 30 25 20 15 10 5 0

30.5 25.5 21.5

21 Percent

1.5 below 20 years

20-25 years

26-30 years

31-35 years

above 35 years

years

Inference: From the above graph we can see that out of 200 investors 1.5% investors are below 20 years,30.5% investors are 20 to 25 years,21.5% investors are between 31 to35 years , and 21% investors are above 35 years trading in derivative market.

Occupation: Frequency Student Employed Business Professional House wife Others Total

Frequency 35 82 32 22 13 16 200

Percent 17.5 41.0 16.0 11.0 6.5 8.0 100.0

Graph:

ot he rs

if e

na l

6.5

ho us e

bu si

Percent

pr of es s

ne ss

ye d pl o em

st ud

17.5

45 40 35 30 25 20 15 10 5 0

en t

percentage

Occupation

occupation

Inference:

From

the

above

graph

can

see

that

17.5% investors are students, 41% are the employed, 16% are the business, 11% investors are the professionals, 6.5% investors are the housewife, and 8% are others, which include the retired, farmers and unemployed.

ANNUAL INCOME Frequency Frequenc Vali d

y 0 47 less than 1 62 lac 1-5 lacs 73 6-10 lacs 15 11-15 lacs 1 15 lacs & 2 above Total 200

Valid

Cumulative

Percent Percent 23.5 23.5

Percent 23.5

31.0

54.5

36.5 7.5 .5

91.0 98.5 99.0

1.0

100.0

Graph:

percentage

annual income 40 35 30 25 20 15 10 5 0

36.5 31 23.5 Percent 7.5

less than 1 lac

1-5 lacs

6-10 lacs

0.5

11-15 lacs

15 lacs & above

income in Rs.

Inference: From the above graph we can see that 23.5% investors donâ&#x20AC;&#x2122;t have the income, 31% investors have less than 1 lack annual income, 36.5 % investors have the 1to 5 lacks annual income, 7.5 % investors have the 6 to 10 lacks income, 0.5% investors have the 11 to 15 lacks annual income, and 1% investors have the 15 lacks and above annual income.

FINDINGS 1. Here we found that out of 200 investors 74 means 37% investors

are

trading in derivative market whereas 126 means 63% are not trading in derivative market. 2. Reasons for not investing in derivative market Is derivative is because lack of awareness and knowledge, high risky, need huge amount of investment. 3. The main objective I of trading in derivative market of the investors is getting high return. 4. Criteria for trading is considered by investors are derivatives in derivative they get margin money and derivatives are more liquid. 5. Their attractive preference is index future and index options 6. Most of the investors are trading intraday.

7. Out of 200 investors 12.5% investors are investing 11% to 15% of their income trading in derivative market. 8.12.5% are satisfied with derivative market 9.157male investors and 43 female investors out of 200 investors. 10.-most of the businessman and employed are trading in derivative market.

CONCLUSION

1. The awareness regarding Derivative among investor is 78 percent.

2. In terms of investment in Derivative and Equity investors have capability of taking risk.

3. Investors also prefer Safety and Time Factor as the important parameter for investing.

4. The important factor that affecting the investor decision is based on In Consult With Their Broke

RECOMMENDATION 1. Only 74 investors are trading whereas 126 are not trading .so attract them for trading. 2.19 are lack of awareness so make them aware with the derivative .so increase the customer.

3. Out of 126, 26 donâ&#x20AC;&#x2122;t have knowledge for derivative so provide them knowledge for trading in derivative market. 4. Those who are not satisfied with the derivative by knowing their behavior of investment make them satisfied. Because negative word mouth of the customers fall down the business. And good word of mouth builds the business.

BIBLIOGRAPHY

1. Donald R Cooper & Pamela S Schindler, “Business Research Methods”, Eighth Edition, Tata McGraw-Hill, New York, 2003. 2. N D Vohra and B R Bagri, “Future and options” 2nd Edition, seventh reprint 2006 Tata McGraw-Hill Publishing Company Ltd, 2006. WEBSITES  www.5paisa.com  www.derivativeindia.com  www.nirmalbang.com  www.bseindia.com  www.nseindia.com  www.mcx.com  www.ncdex.com

APPENDIX Questionnaire

Myself Saurav.P.Gohil student of B.B.A studying at Vivekanand College for B.B.A, Surat. I had prepared this questionnaire for project work meant for educational purpose only.

On “Awareness about Derivatives and Its

Comparison with Equity.” No personal information will be disclosed in any form at anywhere.

1. ARE YOU INVESTING IN DERIVATIVE MARKET?

YES NO 2. REASON FOR NOT INVESTING IN DERIVATIVE MARKET. {GIVE THE RANK} LACK OF KNOWLEDGE

LACK OF AWARENESS

HIGH RISKY

HUGE AMOUNT OF INVESTMENT

OTHER

3. WHAT ARE THE OBJECTIVES OF THE INVESTING IN DERIVATIVES MARKET?

SCALE INSTRUMENT MOST

SOMEWHAT NUTRAL SOMEWHAT NOT

PREFERED PREFERED

NOT

ALL

PREFERED

HIGH RETURN HEDGE THE RISK MORE RELIABLE SAFE TO INVEST

DERIVATIVE MARKET MORE LIQUID

4. WHAT ARE THE CRITERIA DO YOU TAKEN IN THE CONSIDERATION WHILE INVESTING IN DERIVATIVE MARKET? SCALE 5 INSTRUME MOST

4 SOMEWH

3 NUTRAL

2 SOMEWH

1 NOT

PREFERE

NOT ALL

FLEXIBILIT Y 96

EASE

TRANSAC TION LESS COSTLY AVALABILI TY

DIFFEREN T CONTRAC T MARGIN MONEY

5. GIVE YOUR PREFERENCE OF INVESTMENT IN DERIVATIVE INSTRUMENT.

SCALE 5 INSTRUME MOST

4 SOME

3 NEUTRAL

2 SOMEWH

1 NOT

PREFERE

HOW

PREFERE

NOT ALL

INDEX FUTURE STOCK

FUTURE INDEX OPTION STOCK OPTION

6. GIVE YOUR PREFERENCE IN TERMS OF INVESTMENT DERIVATIVE MARKET.

SCALE TERMS

5 MOST

4 SOMEWHA

PREFER

T PREFER

3 NEATRUL

2 SOMEWHA T

1 NOT

NOT ALL

PREFER

SHORT TERM MEDIUM TERM LONG TERM

7. HOW MUCH PERCERNTAGE OF YOUR INCOME YOU INVEST IN DERIVATIVE MARKET? LESS THAN 5% 11% TO 15%

5% TO 10% 16% TO 20%

MORE THAN 20%

8. WHAT IS THE RATE OF RETURN EXPECTED BY YOU FROM DERIVATIVE MARKET? 5 % TO 9.5%

10% TO 13.5%

14 % TO 17%

18% TO 23%

ABOVE 23% 9. YOU ARE SATISFIED WITH THE CURRENT PERFORMANCE OF THE DERIVATIVE IN TERMS OF EXPECTED RETURN. STRONGLY AGREE NUTRAL

AAGREE DISAGREE

STRONGLY DISAGREE.

DEMOGRAPHIC PROFILE NAME: ………………………………………………………… CONTACT NO: ……………………………………………… EMAIL ID: ……………………………………………………. AGE: BELOW 20YRS 31 TO 40 YRS

20 TO 30 YRS 41 TO 50 YRS

100

ABOVE 50

GENDER: MALE

FEMALE

FROM WHICH CATEGORY DO YOU FEET MORE? STUDENT EMPLOYEED BUSINESS OWNER OTHER

INCOME {YEARLY}: LESS THAN 100000RS.

101

100000 TO 200000RS. 200001 TO 300000RS. 300001 TO 400000 RS ABOVE 400000RS.

THANK YOU

102