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    MEANING OF FINANCIAL DERIVATIVES

    The term "Derivative" indicates that it has no independent value. Its value is entirely derived

    form the value of the underlying asset. The underlying asset can be securities, Commodities,

     bullion, currency, Stock Index, live stock or anything else.

    In other ords, e can say that, Derivative means a forard, future, option or any other hybrid

    contract of pre!determined fixed duration, linked for the purpose of contract fulfillment to the

    value of a specified real or financial asset or to an index of securities.

    ith Securities #as $Second %mendment& %ct, '((( Derivatives has been included in the

    definition of Securities.

    The term Derivative has been defined in Securities Contracts $)egulations& %ct, as "A Contract

    which derives its vale !or the #ricc$s or inde% o! #rices& o! nderl'in( Secrities)"

    Over*the*conter +OTC, derivatives  are contracts that are traded $and privately negotiated&

    directly beteen to parties, ithout going through an exchange or other intermediary. *roducts

    such as saps, forard rate agreements, and exotic options are almost alays traded in this ay.

    The aTC derivatives market is huge. %ccording to t+e ank for International Settlements, the

    total outstanding notional amount is -SD (/ trillion $as of 001&.

    E%chan(e*traded derivatives are those derivatives products that are traded via Derivatives

    exchanges. % derivatives exchange acts as an intermediary to all transactions, and takes Initial

    marginfrom both sides of the trade to act as a guarantee. The orld2s largestill  derivatives

    exchanges $by number of transactions& are the 3orea 4xchange $hich lists 35S*I Index

    6utures & 5ptions&, 4urex $hich lists a ide range of 4uropean products such as interest rate &

    index products&, Chicago 7ercantile 4xchange and the Chicago oard of Trade. %ccording toIS, the combined turnover in the orld2s derivatives exchanges totalled -SD 899 trillion.

    -ed(ers.

    :edgers are those ho protect themselves! from the risk associated ith the price of an asset by

    using derivatives. % person keeps a close atch upon the prices discovered in trading and hen

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    the comfortable price is reflected according to his ants, he sells futures contracts. In this ay he

    gets an 2assured fixed price of his produce.

    In general, hedgers use futures for protection against adverse future pnce movements in the

    underlying cash commodity. :edgers are often businesses, or individuals, ho at one point or 

    another deal in the underlying cash commodity.

    Take an example; % :edger pay more to !the farmer or dealer of a produce if its prices go up. 6or 

     protection against higher prices of the produce, he hedge the risk exposure by buying enough

    future contracts of the produce to cover the amount of produce he expects to buy. Since cash and

    futures prices do tend to move in tandem, the futures position ill profit if the price of the

     produce rise enough to offset cash loss on the produce.

    S#eclators.

    Speculators are some hat like a middle man. They are never interested in actual oing the

    commodity. They ill

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     price of the derivative contract used to hedge the asset.

    • Credit Ris1  Credit risk or default risk evolves from the possibility that one of the parties

    to a derivative contract ill not satisfy its financial obligations under the derivative

    contract. a

    • Mar1et Ris1  This is the potential financial loss due to adverse changes in the fair value

    of a derivative. 7arket risk encompasses legal risk, control risk, and accounting risk.

    -istor' o! derivatives.

    The history of derivatives is surprisingly longer than hat most people think. Some texts even

    find the existence of the characteristics of derivative contracts III incidents of 7ahabharata.

    Traces of derivative contracts can even be found III incidents that date back to the ages before

    =esus Christ.

    :oever, the advent of modem day derivative contracts is attributed to the need for farmers to

     protect themselves from any decline in the price of their crops due to delayed monsoon, or 

    overproduction.

    The first 2futures2 contracts can be traced to the >odoya rice market in 5saka, =apan around '?10.These ere evidently standardi@ed contracts, hich made them much like today2s futures.

    The Chicago oard of Trade $C5T&, the largest derivative exchange in the orld, as

    established in '/9/ here forard contracts on various commodities ere standardi@ed around

    '/?1. 6rom then on, futures contracts have remained more or less in the same form, as e kno

    them today.

    Derivatives have had a long presence in IndiaA The commodity derivative market has been

    functioning in India since the nineteenth century ith organi@ed trading in cotton through the

    establishment of Cotton Trade %ssociation in '/B1. Since then contracts on various other 

    commodities have been introduced as ell.

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    4xchange traded financial derivatives ere introduced in India in =une 000 at the to ma

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    counterparty on all contracts, sets margin reHuirements, etc.

     Futures contracts ensure their liHuidityby being highly standardi@ed, usually by specifying;

    •  This can be anything from a barrel of seet crude oil to a short term interest rate.

    • The type of settlement, either cash settlement or physical settlement.

    • The amount and units of the underlying asset per contract. This can be the notional

    amount of bonds, a fixed number of barrels of oil, units of foreign currency, the

    notional amount of the deposit over hich the short term interest rate is traded, etc.

    • The currency in hich the futures contract is Huoted.

    • The grade of the deliverable. In the case of bonds, this specifies hich bonds can be

    delivered. In the case of physical commodities, this specifies not only the Huality of 

    the underlying goods but also the manner and location of delivery. 6or example, the

     >74 #ight Seet Crude 5il contract specifies the acceptable sulfur content and

    %*I specific gravity, as ell as the location here delivery must be made.

    • The delivery month.

    • The last trading date.

    • 5ther details such as the tick, the minimum permissible price fluctuation.

    2) Mar(in.

    %lthough the value of a contract at time of trading should be @ero, its price constantly

    fluctuates. This renders the oner liable to adverse changes in value, and creates a credit risk 

    to the exchange, ho alays acts as counterparty. Initial margin; is paid by both buyer and

    seller. It represents the loss on that contract, as determined by historical price changes, hichis not likely to be exceeded on a usual day2s trading. It may be 1E or '0E of total contract

     price.

    Mar1 to ar1et Mar(in; ecause a series of adverse price changes may exhaust the initial

    margin, a further margin, usually called variation or maintenance margin, is reHuired by the

    exchange. This is calculated by the futures contract, i.e. agreeing on a price at the end of each

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    day, called the "settlement" or mark!to market price of the contract.

    Si#le e%a#le

    %s an example, hat if an investor ons l00 shares of a particular stock purchased originally for 

    90 per share, and that stock is currently trading at ?0 per share, then the "mark to market"

    value of the investor2s shares is eHual to $l 00 shares x ?0&, or ?000, hereas the ook value

    might $depending on the accounting principles used& only eHual 9000.

    3)Settleent

    Settlement is the act of consummating the contract, and can be done in one of to ays, as

    specified per type of futures contract;

    J .4h'sical deliver'5 ! the amount specified of the underlying asset of the contract is delivered by

    the seller of the contract to the exchange, and by the exchange to the buyers of the contract.

    *hysical delivery is common ith commodities and bonds. In practice, it occurs only on a

    minority of contracts. 7ost are cancelled out by purchasing a covering position ! that is, buying a

    contract to cancel out an earlier sale $covering a short&, or selling a contract to liHuidate an earlier 

     purchase $covering a long&. The ymex crude futures contract uses this method of settlement

    upon expiration.

    • Cash settleent ! a cash payment is made based on the underlying reference rate, such as a

    short term interest rate index such as 4uribor, or the closing value of a stock market index. %

    futures contract might also opt to settle against an index based on trade in a related spot

    market.

    • E%#ir' is the time hen the final prices of the future are determined. 6or many eHuity index

    and interest rate futures contracts $as ell as for most eHuity options&, this happens on the

    #ast Thursday of certain trading month.

    5n this day the t+ futures contract becomes the t forard contract. 6or example, for most

    O4TION CONTRACT

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    5ptions Contract is a type of Derivatives Contract hich gives the buyerFholder of the contract

    the right $but not the obligation& to buyFsell the underlying asset at a predetermined price ithin

    or at end of a specified period. The buyer F holder of the option purchase the right from the

    sellerFriter for a consideration hich is called the premium. The sellerFriter of an option is

    obligated to settle the option as per the terms of the contract hen the buyerFholder exercises his

    right. The underlying asset could include securities, an index of prices of securities etc.

    Swa#s.

    Saps are private agreements beteen to parties to exchange cash flos in the future

    according to a prearranged formula. They can be regarded as portfolios of forard contracts. The

    to commonly used saps are;

    Interest rate swa#s.

    These entail sapping only the interest related cash flos beteen the patiies in the same

    currency.

    Crrenc' swa#s.

    entail sapping both principal and interest beteen the parties, ith the cash flos in one

    direction being in a different currency than those in the opposite direction.

    Saps are usually entered into at!the!money $i.e. ith minimal initial cash payments because fair 

    value is @ero&, through brokers or dealers ho take an upfront cash payment or ho ad

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    00'. 6utures on individual securities ere introduced on ovember (, 00'. 6utures and

    5ptions on individual securities are available on '1 securities stipulated by S4I.

    FINANCIAL DERIVATIVE ON NSE

    • SK* C ifty

    • 6utures SK*

    C

    •  ifty 5ptions

    • CIT 5ptions

    •  CIT 6uture

    • %3 ifty

    /

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    ORIGIN OF DERIVATIVE TRADING IN INDIA

    The first step toards introduction of derivatives trading in India as the promulgation of the

    Securities #as $%mendment& 5rdinance, '((1, hich ithdre the prohibition on options in

    securities. The market for derivatives, hoever, did not take off, as there as no regulatory

    frameork to govern trading of derivatives. S4I set up a 9Lmember committee under the

    Chairmanship of Dr. #. C. Mupta on ovember '/, '((? to develop appropriate regulatory

    frameork for derivatives trading in India. The committee submitted its report on 7arch 'B,

    '((/ prescribing necessary preLconditions for introduction of derivatives trading in India. The

    committee recommended that derivatives should be declared as NsecuritiesO so that regulatory

    frameork applicable to trading of NsecuritiesO could also govern trading of securities. S4I alsoset up a group in =une '((/ under the Chairmanship of *rof. =. ). Parma, to recommend

    measures for risk containment in derivatives market in India. The report, hich as submitted in

    5ctober '((/, orked out the operational details of margining system, methodology for charging

    initial margins, broker net orth, deposit reHuirement and realLtime monitoring reHuirements.

    The Securities Contract )egulation %ct $SC)%& as amended in December '((( to include

    derivatives ithin the ambit of NsecuritiesO and the regulatory frameork as 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 recogni@ed stock exchange, thus precluding 5TC

    derivatives9. The government also rescinded in 7arch 000, the threeLdecade old notification,

    hich prohibited forard trading in securities.

    Trading and settlement in derivative contracts is done in accordance ith the rules, byelas, and

    regulations of the respective exchanges and their clearing houseFcorporation duly approved by

    S4I and notified in the official ga@ette. 6oreign Institutional Investors $6IIs& are permitted totrade in all 4xchange traded derivative products.

    (

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    Soe ilestones.

     ov.'((? ! 6ormation of Dr. # C Mupta Committee

    Dec.'((( ! 6ormation of *rof. = ) Parma Committee

    7ay 000 ! Mranting approval by S4I

    =une 000 Commencement of Derivatives Trading $Index 6utures&

    =une 00' Commencement of trading in Index 5ptions

    =uly 00' Commencement of trading in 5ptions on Individual Securities

     ovember 00' Commencement of trading in 6utures on Individual Securities

    %ugust 008 #aunch of 6utures K options in CIT Index

    =une 001 #aunch of 6utures K options in %3 ifty Index

    December 00? 2Derivative 4xchange of the >ear2, by %sia )isk maga@ine

    T84ES OF DERIVATIVE CONTRACTS.

    The folloing types of derivative contracts are there. ut, the most commonly used derivative

    contracts are forards, futures and options.

    • FOR9ARDS.  a forard contract is a customi@ed contract beteen to entities, here

    settlement takes place on a specific date in the futures at today2s pre!agreed price.

    • F:T:RES. a future contract is an agreement beteen to parties to buy or sell an asset at a

    certain time the future at the certain price. 6utures contracts are the special types of forard

    contracts in the sense that are standardi@ed exchange traded contracts.

    • O4TIONS. options are of to types; call o#tion and #t o#tions.

    a. Call O#tion gives the buyer the right but not the obligation to buy a given Huantity of 

    the underlying asset, at a give price on or before a given future date.

     b. 4t O#tion gives the buyer the right but not the obligation to sell a give Huantity of the

    underlying asset at a given price on or before a given date.

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    • LEA4S.  ormally option contracts are for a period of ' to ' months. :oever,

    exchange may introduce option contracts ith a maturity period of !8 years. These long!

    term option contracts are popularly knon as #eaps or #ong term 4Huity %nticipation

    Securities.

    • 9ARRANTS. 5ptions generally have lives of up to one year, the ma

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    Cash Vs Derivative Mar1et

    The basis differences beteen these to may be noted as follos;

    • In cash market tangible asset are traded hereas in derivatives market contract based on

    tangible assets or intangible like index or rates are traded.

    • The value of derivative contract is alays based on and linked to the underlying asset.

    Though, this linkage may not be on point!to point basis.

    • Cash market contracts are settled by delivery and payment or through an offsetting

    contract. The derivative contracts on tangible may be settled through payment and

    delivery, offsetting contract or cash settlement, hereas derivative contracts on

    intangibles are necessarily settled in cash or through offsetting contracts.

    • The cash markets alays have a net long position, hereas the net position in derivative

    market is alays @ero.

    • Cash asset may be meant for consumption or investment. Derivatives are used for 

    hedging, arbitration or speculation.• Derivative markets are highly leveraged and therefore could be much more risky.

    T-E DERIVATIVE MAR7ETS 4ERFORM A N:M0ER OF ECONOMIC F:NCTIONS.

    • *rices in organi@ed derivative markets reflect the perception of market participants about

    the future and lead the prices of underlying to perceived future level. The prices of 

    derivatives converge ith the prices of the underlying at the expiration of the derivative

    contract. Thus derivatives help in discovery of future as ell current prices.

    • The derivative market helps to transfer the risks from those ho have them but may like

    them to those ho have an appetite for them.

    • Derivatives due to their inherent nature are linked to the underlying cash markets. ith

    the introduction of derivative, the underlying market, itness higher trading volumes

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     because of participation by more players ho ould not otherise participate for lack of 

    an arrangement to transfer risk.

    • Derivatives have a history of attracting many bright, creative, ell!educated people ith

    an entrepreneurial attitude. They often energi@e others to create ne business, ne

     products and ne employment opportunities, the benefits of hich are immense.

    • Derivatives market helps increase savings and investments in the long run Transfer of risk 

    enables market participants to expand their volume of activities.

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    INSTR:MENTS OF DERIVATIVE TRADING.

      65)%)D

      DERIVATIVE   6-T-)4

     

    5*TI5S

      S%*S

    FOR9ARD CONTRACT.

    "It is an agreement to buyFsell an asset on a certain future date at an agreed price".

    The to parties are;

    • ho takes a long position L agreeing to buy

    • ho takes a short positionQagreeing to sell

    The mutually agreed price is knon as "delivery price" or  "forward price". The delivery price is

    chosen in such a ay that the value of contract for both parties is @ero at the time of entering the

    contract, but the contract takes a positive or negative value for parties as the price of underlying

    asset moves. It removes the future price risk. It a speculator has information or analysis, hich

    forecast an upturn in price, and then he can go long on the forard market instead of cash

    market.

    The speculator ould go long on the forard, ait for the price to rise, and then take a reversing

    transaction to book profits. Speculator may ell be reHuired to deposit a margin upfront.

    :oever, this is generally a relatively small proportion of the value of assets underlying the

    forard contract.

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    E!!ect o! chan(e in #rice.

    %s mentioned above the value of such a contract in @ero for both the parties. ut later as the

     price K the underlying asset changes, it gives positive or negative value for contract.

    *)IC4 K -D4)#>IM

    %SS4TS

    :5#D4) K #5M

    *5SITI5

    :5#D4) K S:5)T

    *5SITI5

    IC)4%S4

    D4C)4%S4

    *5SITIP4 P%#-4

     4M%TIP4 P%#-4

     4M%TIP4 P%#-4

    *5SITIP4 P%#-4

    4.g; Suppose that % ants to buy a house in one year2s time. %t the same time, suppose that

    currently ons a house orth )s.' lac that he ishes to sell in one year2s time. oth parties could

    enter into a forard contract ith each other. Suppose that they both agree on the sale price in

    one year2s time of )s.'09,000 $more belo on hy the sale price should be this amount&.% and

    have entered into a forard contract. %, because he is buying the underlying, is said to have

    entered a long forard contract. Conversely, ill have the short forard contract.

    %t the end of one year, suppose that the current market valuation of Os house is )s.''0,000.

    Then, because is obliged to sell to % for only )s.'09,000. % ill make a profit of )s.?,000. To

    see hy this is so, one need only to recogni@e that % can buy from for )s.'09,000 and

    immediately sell to the market for )s.''0,000. % has made the difference in profit. In contrast,

    has made a potential loss of )s?,000 and an actual profit of )s.9000. *rofitF#oss R ST!4

    here, STR Spot price on maturity date

      4 R Delivery price

    Liitations o! !orward contract.

    •  o standardi@ation.

    '1

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    • 5ne party can breach its obligation.

    • #ack of centrali@ation of trading.

    • #ack of liHuidity

    % forard contract is specified ith four variables;

    • the underline,

    • the notional amount n,

    • the delivery price k , and

    • the settlement date on hich the underline and payment ill be exchanged.

    Valation o! Forward Contract

    The 6orard contract can be put under three categories for the purpose K valuation;

     Valuation of those Securities Providing No Income:

     Shares hich neither accepts to pay any dividend in future nor having arbitrage opportunities.

      e.g. :ere *rice $6& R Stert

    here, 6 R 6uture *rice

    St R the spot price of asset

    r R )isk free rate of interest p.a. ith continuous compounding.

    t R Time of maturity.

      I! +F, ; Stert

    In this case the investor ill buy asset and take a short position in the forard contract.

    Short position is not position of investor is of seller means contract sold is greater than contract

     bought.

    '?

    http://www.riskglossary.com/articles/derivative_instrument.htmhttp://www.riskglossary.com/articles/notional_amount.htmhttp://www.riskglossary.com/articles/settlement.htmhttp://en.wikipedia.org/wiki/Spot_pricehttp://www.riskglossary.com/articles/derivative_instrument.htmhttp://www.riskglossary.com/articles/notional_amount.htmhttp://www.riskglossary.com/articles/settlement.htmhttp://en.wikipedia.org/wiki/Spot_price

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    Investor may buy the assets, borroing an amount eHual to U U for t period at risk free rate. %t

    the time of maturity, the assets ill be delivered for price 6 and repayment ill be eHual to Stert

    and there is net profit eHual to 6 ! Stert

    I! F < Stert

    :e ill long his position in 6orard Contract. hen contract matures; the assets ould be

     purchased for 6. :ere profit is Stert L 6.

    4.g. Consider a forard contract here nonLdividend shares available at )s. B0 matures in 8

    months, )isk free rate /E p.a. compounded continuously.

      Stert R B0 VeW =)2>6=)=?

    R B0 00

    R )s.B'.9'

    If 6 R B8 then an arbitrageur ill short a contract, borro an amount of )s.B0 K buy shares.

    )epay the loan of )s.B0. %t maturity sell it as )s.B8 $6orard contract price& and B'.90, thus

     profit is $B8 L B'.90& )s.'.?0. Thus he shorts his forard contract position.

    'B

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    F:T:RES

    % futures contract is a legally binding agreement to buy or sell a specific commodity,   such as

    soybeans, or financial instrument, such as silver or the 4uro, on a particular date in the future at

    an agreed upon price. 6utures belong to a category of financial instruments knon as

    derivatives, because their prices are derived from the value of other, underlying instruments,

    items, or products. In the case of futures, commodities of various kinds are the products

    underlying the contracts.

    Ftres contracts

    % futures transaction alays has to parties, a buyer and a seller, and you can enter the

    market either ay. If you buy a contract, you take a long position and are called the long. If you sell a contract, you take a short position and are called the short. 6urther, in the futures

    market, every contract has an eHual number of long and short positions.

    To liHuidate and leave the futures market, you need to cancel your existing futures position either 

     by offsetting your contract ith a matching futures contract on the opposite side of the market, or 

     by delivering or taking delivery of the commodity or its cash value. #ong positions are offset by

    short positions, and short positions by long ones. 6or example, if you have a long position on

    1,000 bushels of soybeans deliverable in =anuary, you need to short Q or enter a contract to sell

     Q 1,000 bushels of soybeans deliverable in =anuary or expect to have the 1,000 bushels

    delivered to your doorstep.

    This obligation differs from the terms of an options contract you buy, hich you may allo to

    expire unexercised. ut it resembles hat happens hen you sell an options contract and must

    offset or fulfill your part of the bargain.

    To overcome the problems in forard contract, other type of derivative instrument knon as

    "6uture Contract came into existence. It is an agreement beteen buyer and seller for the

     purchase and sale of a particular assets at a specific future dateA specific si@e, date of delivery,

     place and alternative asset. It takes obligation on both parties to fulfill the contract.

     

    -istor''/

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    hat e kno as the futures market of today came from some humble beginnings. Trading in

    futures originated in =apan during the eighteenth century and as primarily used for the trading

    of rice and silk. It asn2t until the '/10s that the -.S. started using futures markets to buy and

    sell commodities such as cotton, corn and heat.

    Ftres Fndaentals

    % futures contract is a type of derivative instrument, or financial contract, in hich to parties

    agree to transact a set of financial instruments or physical commodities for future delivery at a

     particular price. If you buy a futures contract, you are basically agreeing to buy something that aseller has not yet produced for a set price. ut participating in the futures market  does not

    necessarily mean that you ill be responsible for receiving or delivering large inventories of 

     physical commodities ! remember, buyers and sellers in the futures market primarily enter into

    futures contracts to hedge risk or speculate rather than to exchange physical goods $hich is the

     primary activity of the cashFspot market&. That is hy futures are used as financial instruments

     by not only producers and consumers but also speculators. The consensus in the investment

    orld is that the futures market is a ma

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    Standardi@ed Ites in Ftres.

    Xuantity of the underlying

    Xuality of the underlying

    The date and month of delivery

    The units of price Huotation and minimum price change

    #ocation of settlement

    Ftre terinolo('.

    S#ot #rice. the price at hich an asset trades in the spot market.

    Ftres #rice. the price at hich the futures contract trades in the futures market.

    Contract c'cle.  the period over hich the contract trades. The index futures contracts on the

     S4 have one month, to month, and three!month expiry cycles, hich expire on the last

    Thursday of the month. Thus a =anuary expiration contract expires on the last Thursday of the

    =anuary. 5n the 6riday folloing the last Thursday, a ne contract having three!month expiry is

    introduced of trading.

    E%#ir' date. it is date specified in the futures contract. This is the last day on hich the contract

    ill be traded, at the end of hich it ill cease to exist.

    Contract si@e. the amount of asset that has to be delivered less than one contract. 6or instance,

    the contract si@e on S42s futures market is ifty.

    0asis. in the contract of financial futures, basis can be defined as the futures price minus the spot

     price. There ill be a different basis for each delivery month for each contract. in a normal

    market, basis ill be positive. This reflects that futures prices normally exceed spot prices.

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    Initial ar(in.  the amount that must be deposited in the margin account at a time a future

    contract is first entered into is knon as initial margin.

    Cost o! carr'. the relation beteen futures price and spot price can be summari@ed in terms of 

    hat is knon as cost of carry. This measures the storage cost plus the interest that is paid to

    finance the assets less the incomes earned on the asset.

    Mar1in(*to*ar1et. in the futures market, at the end of each trading day, the margin account is

    ad

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    5perational 7echanism Traded beteen to parties Traded throO exchange

    Contract specification Customi@ed contract Standardi@ed contract

    Counter party risk 4xists such risk o such risk  

    #iHuidity #o :igh

    *rice discovery example ot efficient current market :ighly efficient current

    marketSettlement %t end of period Daily

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    INDE6 F:T:RES.

    Index futures are futures contracts here the underlying asset is the index. The index futures

     provide a hedge against price fluctuations of the securities and hedgers are using it as an

    insurance tool.

    % stock index future contract is an obligation to deliver at settlement an amount of cash eHual to

    the difference beteen the stock index value at the clause of the last trading day of the contract K

    the price at hich the futures contracts as originally struck. 6or instance ,if the S4S4 index

    is at 8000 K a lot si@e of contract is eHual to 10,a contract struck at this level could be orth

    )s'10000$8000U 10&.If ,at the expiration of the contracts ,the S4S4 stock index is at 8'00,a

    cash settlement of )s1000 is reHuired V$8'00!8000&U10W. In stock index futures, no physicaldelivery of stock is made.

    In India, the S4 as the first stock exchange to introduce Index futures on =une (, 000 on

    S4S4. In S4 the trading of index futures commenced on =une ', 000 on the SK* C

     I6T>. The stock index futures are traded on the 6K5 segment of the both exchanges.

    oth buyers K sellers are reHuired to deposit margin at the time of contract. The margin amount

    is based volatility if market indices. In India the initial margin is expected to be around /!

    '0E.The margin is kept in a ay that it covers price movement more than ((E of the time.

    -sually key sigma $standard deviation& is used or this measurement. This techniHue is also called

    value at risk  $P%)&.

    In futures market, at the end of each trading day the margin account is ad

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    • Stock futures on 9' individual securities.

    • Interest rate future on ('F8?1 T!bills, ten year notional bond $ith coupon rate& K

    ten year notional bond $@ero coupon rate&

      STOC7 F:T:RE

    Stock futures are the contracts here the underlying asset is the individual securities or stock. In

    stock futures the investors also reHuire to deposit initial margin, the margin is decided by the

    exchange $on the basis of four times changes in security prices in a day& on the volatility of 

    individual stock. eside this, exposure margin is also reHuired by the stock exchange, it can 1E

    $?E or BE at specific securities& of all 9' individual securities. In India settlement of future onindividual stock is settled in cash only.

    In India the stock future are available on the blue chip securities K these securities are free from

     price fluctuation bonds. The securities are approved by S4I. %t present 9' individual securities

    are available for stock future. S4 K S4 commenced trading in stock future on individual

    securities on ovember (, 00' K ovember 00' respectively.

    INTEREST RATE F:T:RE

    Interest rate futures are based on a list of underlying $T!bills, bonds, notes K credit

    instrument&.The list of underlying is specified by the exchange K approved by S4I time to

    time. Interest rate futures provide a hedge against the interest rate risk. In India, the interest rate

    has a dontrend since last four years.

     S4 as the exchange in India to introduce interest rate future trading on =une 9, 008. To

     begin that interest rate future contract, the folloing underlying shall be available for trading in

    6K5 segment of the exchange;

     

    S.o Symbol Description

    ' S4T('D 6utures contracts on notional (' days T!ills

    S4'0>0? 6uture contract on notional '0 year coupon

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     bearing bond

    8 S4'0>YC 6uture contract on notional '0 year @ero

    coupon bond

    The interest rate future contract shall be for a period of maturity of one year ith three!month

    continuous contract, for the first three!month K fixed Huartile contracts for the entire year. e

    contract ill be introduced on trading day folloing the expiry the near month contract.

    Characteristics o! the interest rate !trescontract s#eci!ication.

    Contract

    underlying

     otional '0 year bond

    $?E coupon&

     otional '0 year @ero

    coupon bond

     otional (' day T!ill

    Contract

    descriptor 

      6-TIT S4

    '0>0? ?=-008

      6-TIT S4 '0>Y

    ?=- 008

      6-TIT

     S4T('D

    ?=-008

    Contract value )s.,00,000

    #ot si@e 000

    Tick si@e )e. 0.0'

    4xpiry date #ast Thursday of month

    Contract

    months

    The contract shall be for a period of a maturity of one year ith three months

    continuous contract for the first three months K fixed Huarterly contract for

    the entire year

    *rice limits ot applicable

    Settlement

     price

    %s may be stipulated by SCC# in this regard from time to time.

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    O#tions 

    5ptions are fundamentally different from forard and futures. %n option gives the holderFbuyers

    of the option the right to do something. The holder does not have committed himself to doing

    something. In contrast, in a forard or futures contract, the to parties have committed them self 

    to doing something. hereas it nothing $expect margin reHuirement& to enter in to a futures he

     purchases of an option reHuire an up front payment.

    %n options is the right, but not the obligation to buy or sell a specified amount $and Huality& of a

    commodity, currency, index or financial instruments to buy or sell a specified number of 

    underlying futures contracts, at a specified price on a before a give date in the future.

      5*TI5

      ->4) S4##4)  

     

    )IM:T 5#IM%TI5

    T5 -> T5 S4## T5 S4##

    $C%##& $*-T& $C%##& T5 -> $*-T&

    Thus, option like futures, also provide a mechanism by hich one can acHuire a certain

    commodity on other assets, or take position in order to make profits or cover risk for a price.

    4artici#ants in the O#tions Mar1et. 

    There are four types of participants in options markets depending on the position they take;

    '. uyers of calls

    . Sellers of calls

    8. uyers of puts

    9. Sellers of puts

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    *eople ho buy options are called holders and those ho sell options are called ritersA

    furthermore, buyers are said to have long positions, and sellers are said to have short positions.

    -istor'.

    5ptions on stocks ere first traded on an organi@ed stock exchange in '(B8. Since then there has

     been extensive ork on these instruments and manifold groth in the field has taken the orld

    markets by storm. This financial innovation is present in cases of stocks, stock indices, foreign

    currencies, debt instruments, commodities, and futures contracts.

    Terinolo(' o! O#tions

    5ptions are of to basic types; The Call and the 4t O#tion

    A call o#tion gives the holder the right to buy an underlying asset by a certain date for a certain

     price. The seller is under an obligation to fulfill the contract and is paid a price of this hich is

    called "the call option premium or call option price".

    A #t o#tion, on the other hand gives the holder the right to sell an underlying asset by a certain

    date for a certain price. The buyer is under an obligation to fulfill the contract and is paid a price

    for this, hich is called "the put option premium or put option price".

    The price at hich the underlying asset ould be bought in the future at a particular date is the

    "Stri1e 4rice" or the "E%ercise 4rice". The date on the options contract is called the "E%ercise

    date", "E%#iration Date" or the "Date o! Matrit'".

    There are to kind of options based on the date. The first is the Ero#ean O#tion hich can be

    exercised only on the maturity date. The second is the Aerican O#tion hich can be exercised

     before or on the maturity date.

    In most exchanges the options trading starts ith 4uropean 5ptions as they are easy to execute

    and keep track of. This is the case in the S4 and the S4

    B

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    Cash settled o#tions are those here, on exercise the buyer is paid the difference beteen stock

     price and exercise price $call& or beteen exercise price and stock price $put&. Deliver' settled

    o#tions are those here the buyer takes delivery of undertaking $calls& or offers delivery of the

    undertaking $puts&.

    Call O#tions

    The folloing example ould clarify the basics on Call 5ptions.

    Illstration.

    %n investor buys one 4uropean Call option on one share of )eliance *etroleum at a premium of

    )s. per share on 8' =uly. The strike price is )s.?0 and the contract matures on 80 September.

    The payoffs for the investor on the basis of fluctuating spot prices at any time are shon by the

     payoff table $Table '&. It may be clear form the graph that even in the orst case scenario, the

    investor ould only lose a maximum of )s. per share hich heFshe had paid for the premium.

    The upside to it has an unlimited profits opportunity.

    5n the other hand the seller of the call option has a payoff chart completely reverse of the call

    options buyer. The maximum loss that he can have is unlimited though a profit of )s. per shareould be made on the premium payment by the buyer.

    4a'o!! !ro Call 0'in(Lon( +Rs), 

    S 6t c 4a'o!! Net 4ro!it

    1B ?0 0 !

    1/ ?0 0 !

    1( ?0 0 !

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    ?0 ?0 0 !

    ?' ?0 ' !'

    ? ?0 0

    ?8 ?0 8 '

    ?9 ?0 9

    ?1 ?0 1 8

    ?? ?0 ? 9

    % 4uropean call option gives the folloing payoff to the investor; a% +S * 6t& =,)

    The seller gets a payoff of; *a% +S * 6t&=, or in +6t * S& =,)

     otes;

    S ! Stock *rice

    t ! 4xercise *rice at time 2t2

    C ! 4uropean Call 5ption *remium

    *ayoff ! 7ax $S ! t, 5 &

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    Gra#h.

     et *rofit ! *ayoff minus 2c2

    E%ercisin( the Call O#tion and what are its i#lications !or the 0'er and the SellerB

    The Call option gives the buyer a right to buy the reHuisite shares on a specific date at a specific

     price. This puts the seller under the obligation to sell the shares on that specific date and specific

     price. The Call uyer exercises his option only hen heF she feels it is profitable. This *rocess is

    called "4xercising the 5ption". This leads us to the fact that if the spot price is loer than the

    strike price then it might be profitable for the investor to buy the share in the open market and

    forgo the premium paid.

    The implications for a buyer are that it is hisFher decision hether to exercise the option or not.

    In case the investor expects prices to rise far above the strike price in the future then heFshe

    ould surely be interested in buying call options. 5n the other hand, if the seller feels that his

    shares are not giving the desired returns and they are not going to perform any better in the

    future, a premium can be charged and returns from selling the call option can be used to make up

    for the desired returns. %t the end of the options contract there is an exchange of the underlying

    asset. In the real orld, most of the deals are closed ith another counter or reverse deal. There

    is no reHuirement to exchange the underlying assets then as the investor gets out of the contract

     

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    4t O#tions

    The 4uropean *ut 5ption is the reverse of the call option deal. :ere, there is a contract to sell a particular number of underlying assets on a particular date at a specific price. %n example ould

    help understand the situation a little better;

    Illstration 2.

    %n investor buys one 4uropean *ut 5ption on one share of )eliance *etroleum at a premium of 

    )s. per share on 8' =uly. The strike price is )s.?0 and the contract matures on 80 September.

    The payoff table shos the fluctuations of net profit ith a change in the spot price.

    4a'o!! !ro 4t 0'in(Lon( +Rs), 

    S 6t # 4a'o!! Net 4ro!it

    11 ?0 1 8

    1? ?0 9

    1B ?0 8 '

    1/ ?0 01( ?0 ' !'

    ?0 ?0 0 !

    ?' ?0 0 !

    ? ?0 0 !

    ?8 ?0 0 !

    ?9 ?0 0 !

    The payoff for the put buyer R 7a% +6t * S& =,The payoff for a put riter R Ma%+6t * S& =, or Min+S * 6t& =,  

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    Gra#h

    These are the to basic options that form the hole gamut of transactions in the options trading.

    These in combination ith other derivatives create a hole orld of instruments to choose form

    depending on the kind of reHuirement and the kind of market expectations.

    4xotic 5ptions are often mistaken to be another kind of option. They are nothing but non!

    standard derivatives and are not a third type of option.

    AMERICAN Vs E:RO4EAN O4TION.

    Its oner can exercise an %merican option at any time on or before the expiration date.

    % 4uropean style option gives the oner the right to use the option only on expiration date and

    not before.

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    In*The*Mone' and Ot*The*Mone' O#tions

    Condition Call *ut

    SoZ4 In the money 5ut of the moneySo[4 5ut of the money In the moneySoR4 %t the money %t the money

    So Rspot price

    4 R exercise price

    INDE6 O4TION.

    Index options are the contracts beteen to parties that give the right, but not the obligation, to

     buy or sell underlying at a stated date K a stated price to the buyer of the contract. In index

    option, the underlying is share price index K all contracts are based up on it. In index option the

     buyer reHuires to pay a sum for the buying the contract that is called NpremiumO. The premium is

    decided by the market forces K not by the stock exchange. %ll index option is cash settled K

     physical delivery is not applicable.

    eside the premium the seller of the contract is reHuired to pay 8E margin on contract value to

    the exchange to eliminate the risk

    That is called exposure margin.

    In India the options on index started by the S4 K S4 on their index S4S4 and SK* C

     I6T> respectively. Trading on SK* C I6T> commenced at S4 on =une , 00'.

      Contract s#eci!ication.

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    -nderlying index S K * C I6T>

    4xchange of trading ational Stock 4xchange

    Security descriptor 5*TID I6T>

    Contract si@e *ermitted lot si@e shall be 00 K multiples

     thereof $minimum value )s. lakh&

    *rice steps )s.0.01

    *rice band ot applicable

    Trading cycle The futures contracts ill have a maximum of three

    month trading cycle!the near month $one&, the next

    month $to& K the far month $three&.e contracts

    ill be introduced on the next trading day folloing

    the expiry of the near month contract.

    4xpiry date The last Thursday of the expiry month of the previous

    trading day if the last Thursday is a trading holiday.Settlement basis Cash settled on T\' basis.

    Style of option 4-)5*4%

    Strike price )S.0

    Daily settlement price *remium value $net&.

    6inal settlement price Closing value of the index on the trading day.

    In index option, the investor can hedge their risk K make profits. In index options the loss islimited to premium paid K profit is unlimited of the buyer, on the other hand the profit to

     premium received of the riter is limited K loss is unlimited.

     Example:

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    Current ifty is '900. >ou buy one contract of nifty near month calls for )s.80 each. The strike

     price is '980 i.e. .'9E out of money. The premium paid by you ill be $)s.80n U00&

    )s.?000.Miven these, your break!even level nifty is '9?0 $'980\80&.If at expiration nifty

    advanced by 1E, i.e.'9B0, then

     ifty '9B0

    #ess strike price '980

    5ption value 90 $'9B0!'980&

    #ess purchase price 80

    *rofit per nifty '0

    *rofit on the contract )s.000 $)s.'0 U 00&

    STOC7 O4TION

    Stock options are the contract on the individual scrips means here underlying are individual

    scrips. In stock options the buyers of the options have right but not obligation to buy or sell the

    underlying asset.

    The buyer is reHuires to pay some money at the time of the purchases of the contract to seller of the contract that is called NpremiumO. %nd seller reHuires paying exposure margin to exchange

    that is 1E $?Eand BE on specific securities& on the contract value. %t present in India 9'

    individual scrips are approved by the S4I for stock option.

    The trading on the stock commenced at S4 on =uly , 00'.These contracts are available at

    S4 K S4 on highly liHuid K price band free 9'scrips.

    Contract S#eci!ication.

    -nderlying Individual securities

    4xchange of trading ational Stock 4xchange

    Security descriptor !5*TST3  

    Contract si@e '00 or multiples thereof $minimum value of )s. lakh&

    *rice steps )s.0.01

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    *rice band ot applicable

    Trading cycle The futures contracts ill have a maximum of three month

    trading cycle! the near month $one&, the next month $to& Kthe far month $three&.ne contract ill be introduced on the

    next trading day folloing the expiry of the near month

    contract.

    4xpiry day The last Thursday of the expiry month of the previous

    trading day if the last Thursday is trading holiday.

    Settlement basis Daily settlement on T\' basis K final option exercise

    settlement on T\ basis.

    Style of option %merican

    Strike price interval eteen )s..1 K )s.'00 depending on the price of the

    under lying

    Daily settlement price *remium value $net&.

    6inal settlement price Closing value of the index on the last trading day.

    Settlement day #ast trading day

     

    Swa#

    % swa# is a derivative in hich to counterparties agree to exchange one stream of cash flos

    against another stream. These streams are called the legs of the sap.

    The cash flos are calculated over a notional principal amount, hich is usually not exchanged

     beteen counterparties. ConseHuently, saps can be used to create unfunded exposures to an

    underlying asset, since counterparties can earn the profit or loss from movements in price

    ithout having to post the notional amount in cash or collateral. Saps can be used to hedge

    certain risks such as interest rate risk, or to speculate on changes in the underlying prices.

    Strctre

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    % sap is an agreement beteen to parties to exchange future cash flos according to a

     prearranged formula. They can be regarded as portfolios of forard contracts. The streams of 

    cash flos are called legs of the sap. -sually at the time hen contract is initiated at least

    one of these series of cash flos is determined by a random or uncertain variable such as interest

    rate, foreign exchange rate, eHuity price or commodity price.

    7ost saps are traded 5ver The Counter $5TC&, "tailor!made" for the counterparties. Some

    types of saps are also exchanged on futures markets, for instance Chicago 7ercantile 4xchange

    :oldings Inc., the largest -.S. futures market, the Chicago oard 5ptions 4xchange and

    6rankfurt!based 4urex %M

    Strctre o! Derivative Mar1ets in IndiaB

    Derivative trading in India takes can place either on a separate and independent Derivative

    4xchange or on a separate segment of an existing Stock 4xchange. Derivative

    4xchangeFSegment function as a Self!)egulatory 5rgani@ation $S)5& and S4I acts as the

    oversight regulator. The clearing K settlement of all trades on the Derivative 4xchangeFSegment

    ould have to be through a Clearing CorporationF:ouse, hich is independent in governance

    and membership from the Derivative 4xchangeFSegment.

    Re(lator' !raewor1 o! Derivatives ar1ets in IndiaB

    ith the amendment in the definition of 2securities2 under SC$)&% $to include derivative

    contracts in the definition of securities&, derivatives trading takes place under the provisions of 

    the Securities Contracts $)egulation& %ct, '(1? and the Securities and 4xchange oard of India

    %ct, '((.

    Dr. #.C Mupta Committee constituted by S4I had laid don the regulatory frameork for 

    derivative trading in India. S4I has also framed suggestive bye!la for Derivative

    4xchangesFSegments and their Clearing CorporationF:ouse hich lay2s don the provisions for 

    trading and settlement of derivative contracts. The )ules, ye!las K )egulations of the

    Derivative Segment of the 4xchanges and their Clearing CorporationF:ouse have to be framed in

    line ith the suggestive ye!las. S4I has also laid the eligibility conditions for Derivative8B

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    4xchangeFSegment and its Clearing CorporationF:ouse. The eligibility conditions have been

    framed to ensure that Derivative 4xchangeFSegment K Clearing CorporationF:ouse provide a

    transparent trading environment, safety K integrity and provide facilities for redressal of investor 

    grievances. Some of the important eligibility conditions are!

    • Derivative trading to take place through an on!line screen based Trading System.

    • The Derivatives 4xchangeFSegment shall have on!line surveillance capability to monitor 

     positions, prices, and volumes on a real time basis so as to deter market manipulation.

    • The Derivatives 4xchangeF Segment should have arrangements for dissemination of 

    information about trades, Huantities and Huotes on a real time basis through atleast to

    information vending netorks, hich are easily accessible to investors across the country.

    • The Derivatives 4xchangeFSegment should have arbitration and investor grievances redressal

    mechanism operative from all the four areas F regions of the country.

    • The Derivatives 4xchangeFSegment should have satisfactory system of monitoring investor 

    complaints and preventing irregularities in trading.

    • The Derivative Segment of the 4xchange ould have a separate Investor *rotection 6und.

    • The Clearing CorporationF:ouse shall perform full novation, i.e., the Clearing

    CorporationF:ouse shall interpose itself beteen both legs of every trade, becoming the legal

    counterparty to both or alternatively should provide an unconditional guarantee for settlement

    of all trades.

    • The Clearing CorporationF:ouse shall have the capacity to monitor the overall position of 

    7embers across both derivatives market and the underlying securities market for those

    7embers ho are participating in both.

    • The level of initial margin on Index 6utures Contracts shall be related to the risk of loss on

    the position. The concept of value!at!risk shall be used in calculating reHuired level of initial

    margins. The initial margins should be large enough to cover the one!day loss that can be

    encountered on the position on ((E of the days.

    • The Clearing CorporationF:ouse shall establish facilities for electronic funds transfer $46T&

    for sift movement of margin payments.

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    • In the event of a 7ember defaulting in meeting its liabilities, the Clearing CorporationF:ouse

    shall transfer client positions and assets to another solvent 7ember or close!out all open

     positions.

    • The Clearing CorporationF:ouse should have capabilities to segregate initial margins

    deposited by Clearing 7embers for trades on their on account and on account of his client.

    The Clearing CorporationF:ouse shall hold the clientsO margin money in trust for the client

     purposes only and should not allo its diversion for any other purpose.

    • The Clearing CorporationF:ouse shall have a separate Trade Muarantee 6und for the trades

    executed on Derivative 4xchange F Segment.

    *resently, S4I has permitted Derivative Trading on the Derivative Segment of S4 and the

    6K5 Segment of S4.

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    9hat are the varios e/ershi# cate(ories in the derivatives ar1etB

    The various types of membership in the derivatives market are as follos;

    Tradin( Me/er +TM, L % T7 is a member of the derivatives exchange and can trade on

    his on behalf and on behalf of his clients.

    Clearin( Me/er +CM, LThese members are permitted to settle their on trades as ell as

    the trades of the other non!clearing members knon as Trading 7embers ho have agreed

    to settle the trades through them.

    Sel!*clearin( Me/er +SCM, L % SC7 are those clearing members ho can clear and

    settle their on trades only.

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    LITERAT:RE REVIE9

    arua et al $'((9& undertakes a comprehensive assessment of the private corporate debt market,

    the public sector bond market, the govt. securities market, the housing finance and other debt

    markets in India. This provides a diagnostic study of he state of the Indian debt market,

    recommending necessary measures for the development of the secondary market for debt. It

    highlights the need to integrate the regulated debt market ith the free debt market, the necessity

    for market making for financing and hedging options and interest rate derivatives, and tax

    reforms.

    Cho $'((/& points out the reasons for hich reforms ere made in Indian capital market statingthe after reform developments. Shah $'(((& describes the financial sector reforms in India as an

    attempt at developing financial markets as an alternative vehicle determining the allocation of 

    capital in the economy.

    Shah and Thomas $008& revie the changes hich took place on IndiaOs eHuity and debt

    markets in the decade of the '((0s. This has focused on the importance of crises as a mechanism

    for obtaining reforms.

    7ohan $009& provides the rationale of financial sector reforms in India, policy reforms in the

    financial sector, and the outcomes of the financial sector reform process in some detail.

    Shirai $009& examines the impact of financial and capital market reforms on corporate finance

    in India. IndiaOs financial and capital market reforms since the early '((0s have had a positive

    impact on both the banking sector and capital markets. evertheless, the capital markets remain

    shallo, particularly hen it comes to differentiating high!Huality firms from lo!Huality ones

    $and thus loering capital costs for the former compared ith the latter&. hile some high!

    Huality firms $e.g., large firms& have substituted bond finance for bank loans, this has not

    occurred to any significant degree for many other types of firms $e.g., old, export!oriented and

    commercial paper!issuing ones&. This reflects the fact that most bonds are privately placed,

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    exempting issuers from the stringent accounting and disclosure reHuirements necessary for public

    issues. %s a result, banks remain ma

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    *rasad and )a

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    share. The results clearly indicated that open interest based predictors are statistically more

    significant than volume based predictors in Indian context.

    7asih %7, 7asih ), $00B&, had studied Mlobal Stock 6utures; % Diagstinoc %nalysis of a

    Selected 4merging and Developed 7arkets ith Special )eference to India, by using tools

    correlation coefficients , grangerOs causality test, augmented Dicky 6uller test $%D6&, 4lliott,

    )othenberg and Stock point optimal test. The %uthors, through this paper, have tried to find out

    hat kind of relationship exists beteen emerging and developed futures markets of selected

    countries.

    3umar, ). and Chandra, %. $000&, had studied that Individuals often invest in securities based

    on approximate rule of thumb, not strictly in tune ith market conditions. Their emotions drive

    their trading behavior, hich in turn drives asset $stock& prices. Investors fall prey to their on

    mistakes and sometimes otherOs mistakes, referred to as herd behavior. 7arkets are efficient,

    increasingly proving a theoretical concept as in practice they hardly move efficiently. The purely

    rational approach is being subsumed by a broader approach based upon the trading sentiments of 

    investors. The present paper documents the role of emotional biases toards investment $or 

    disinvestment& decisions of individuals, hich in turn force stock prices to move.

    99

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    4ROFILE OF IND:STR8

    Securities is online stock trading company, provider of India!based investment banking and

    corporate finance service.  as founded by a group of professionals speciali@ing in areas of 

    Indian K international Capital, Derivatives and Commodities 7arkets. Derivatives started

     by operations in After 1991 the deregulation of the of the price of all

    commodity.The experience gained during these years is a distinct advantage over many

    others. Its values of integrity and transparency are embedded deep into its corporate culture. This

    helps to provide excellent services, steady groth and complete satisfaction to all its clients and

    associates. It has folloed a consistent groth path and is established as one of the leading top

    '0E broking houses of the country ith the support and confidence of clients, investors,

    employees and associates.

    Me/ershi# o! e%chan(es o! E%#orts Gro# Co#anies

    •  ational Stock 4xchange of India #td.!Capital 7arket

    •  ational Stock 4xchange of India #td. L 6utures K 5ptions

    • 7ulti!Commodity 4xchange $7C&

    • Interconnected Stock 4xchange $IS4&

    • 5TC 4xchange of India

    )ecent developments have continues the aim of providing consistency in Huality of services and

    timely delivery through continuous technical innovation, involvement of personnel and

    implementation of an effective and efficient Xuality 7anagement System built on the foundation

    of international Standard ISFIS5 (00';000. The Company :5 is presently located in Cannaught

     place, e Delhi and has branch offices and netork of business partners across India.

    Vision. To become the most )4S*4CT4D and :54ST company in 6inancial Industry.

    91

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    Mission. To be a #eader in delivering 6inancial *roducts and Services. :ave the highest

    standards for Clients Satisfaction and to enhance the ealth of our Investors and %ssociates.

    9ord o! -onor; It is the duty of every employee to put in hisFher efforts to achieve higher 

     productivity standards.

    To make optimum utili@ation of resources at CompanyOs disposal and to ensure companyOs

    survival K groth.

    Main Tradin(s

    Eit' Tradin(.

    % member of the ational Stock 4xchange of India #td. and other exchanges. Serving more than

    ,100 investors ith the best possible executions and value!added research, the unfailing

    integrity of has been knon for last '1 years. The firm2s senior management, along ith its

    research team sit on the trading desk!every day. 4scorts provide the best infrastructure and

    telecommunication facility to discreetly and nimbly execute clients2 trades in increasingly

    complex markets.

     ationide electronic trading desks and centeralise back office is seamlessly integrated ith

    each other. )egional offices have a *% India presence)

    Derivative Tradin( .

    % member of the ational Stock 4xchange of India #td. and other exchanges, is a derivative

    trading firm. 5ur singular goal; serving the more than ',100 investors in our client base ith the

     best possible executions and value!added research ith the unfailing integrity for hich escorts

    has been knon since last '1 years. The firm2s senior management, along ith its )esearch team,

    sit on the trading desk!every day. There, they provide the Street smarts and orlds best

    9?

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    infrastructure and lease line to discreetly and nimbly execute clients2 trades in increasingly

    complex markets.

     ationide 4scorts and electronic trading desks, and centeralise back office is seamlessly

    integrated ith each other and ith regional offices having *% India presence.

    Coodit' Tradin(.

    India commodity markets have been in existence for decades. :oever in '(B1 the Movernment

     banned forard contracts on commodities. #ater in 008 the Movernment of India again alloed

    forard contracts in commodities. There have been over 0 exchanges existing for commodities

    all over the country. :oever these exchanges are commodity specific and have a strong

    regional focus. The Movernment, in order to make the commodities market more transparent and

    efficient, accorded approval for setting up of national level multi commodity exchanges.

    %ccordingly three exchanges are there hich deal in a ide variety of commodities and hich

    allo nation!ide trading. They are

    '. 7ulti Commodity 4xchange $7C&

    . ational Commodities Derivatives 4xchange $CD4&

    8. ational 7ulti Commodity 4xchange $7C4&

    9B

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    Followin( are the coodities traded in MC6)

    Mold, Mold 7, Mold :I, Silver, Silver 7, Silver :I

    Castor Seeds, Soy Seeds, Castor 5il, )efined Soy 5il, Soymeal, )D *almolein, Crude

    *alm 5il, Mroundnut 5il, 7ustard Seed, 7ustard Seed 5il, Cottonseed 5ilcake,

    Cottonseed

    *epper, )ed Chilli, =eera, Turmeric

    Steel #ong, Steel 6lat, Copper, ickel, Tin

    3apas, #ong Staple Cotton, 7edium Staple Cotton

    Chana, -rad, >ello *eas, Tur

    )ice, asmati )ice, heat, 7ai@e, Sarbati )ice

    Crude 5il

    )ubber, Muar Seed, Mur, Muargum andhani, Muargum, Cashe 3ernel, Muarseed

    andhani

    9/

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    Followin( are the coodities traded in NCDE6

     

    %rabica Coffee Cashe

    Castor Seed Chana

    Chilli Common )a )ice

    Common *arboiled )ice Crude *alm 5il

    Cotton Seed 5ilcake 4xpeller 7ustard 5il

    Mrade % *arboiled )ice Mrade % )a )ice

    Muar gum Muar Seeds

    Mur =eera

    =ute sacking bags #emon Tur

    #ong Staple Cotton 7aharashtra #al Tur

    7edium Staple Cotton 7ulberry Mreen Cocoons

    7ulberry )a Silk 7ustard Seed

    *epper )a =ute

    )D *almolein )efined Soy 5il

    )obusta Coffee )ubber

    Sesame Seeds Soyabean

    >ello Soybean 7eal Sugar

    Turmeric -rad

    heat >ello *eas

    >ello )ed 7ai@e

    O0ECTIVES OF T-E 4ROECT

    The main 5b

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    • To find out that hat ould be the future and market potential of derivatives market in

    India.

    • To kno the aareness K familiarity of investors, dealers and brokers hold regardingderivative markets.

    • To kno the experience of dealers, investors and brokers ith derivatives till date

    • To get knoledge about shortcomings in Indian derivative market.

    10

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    RESEARC- MET-ODOLOG8 

    )esearch is a procedure of logical and systematic application of the fundamentals of science to

    the general and overall Huestions of a study and scientific techniHue by hich provide precise

    tools, specific procedures and technical, rather than philosophical means for getting and ordering

    the data prior to their logical analysis and manipulation.

    Different type of research designs is available depending upon the nature of research pro

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    4riar' Data.

    The primary data are those, hich are collected afresh and for the first time, and thus happened

    to be original in character. e can obtain primary data either through observation or through

    direct communication ith respondent in one form or another or through personal intervie.

     

    Secondar' Data

    The secondary data on the other hand, are those hich have already been collected by someone

    else and hich have already been passed through the statistical processes. hen the researcher 

    utili@es secondary data then he has to look into various sources from here he can obtain them.

    6or eg. ooks, maga@ine, nespaper, Internet, publications and reports.

    Methods :sed In Std'

    I collected the data through the secondary sources such as.

    • ooks

    • 7aga@ines

    •  espapers

    • Internet

    1

    MET-ODS OF 4RIMAR8 DATA

    5S4)P%TI574T:5D

    X-4TI5%I)474T:5D

    IT4)PI474T:I5D

    SC:4D-#474T:5D

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    RESEARC- DESIGN

    %t the outset may be noted that there are several ays of studying and tackling a problem. The

    formidable problem that follos the task of defining the research problem is the preparation of 

    the design of research pro

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    E64ERIMENTAL RESEARC- DESIGN

    These are those studies here the researcher tests the hypothesis of casual relationship beteen

    variables. Such study reHuires procedure that ill not only reduce biasness and increase

    reliability but ill permit draing influence about causality. -sually experiments meets this

    reHuirement, hence these research designs are prepared for experiment.

    RESEARC- DESIGN IN ST:D8

    In the study I ill apply descri#tive research desi(n) %s descri#tive research desi(n  is the

    description of state of affairs, as it exists at present. In this type of research the researcher has no

    control over the variablesA he can only report hat ahs happened or hat is happening.

    T84E OF RESEARC-.*

    The research study is descriptive in nature. Descriptive research include surveys & fact!finding

    enHuiries of different kinds. The ma

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    SAM4LING :NIT.*

    The people are those ho invest money in Share 7arket K also in derivative market. 7y

    sampling unit is divided into parts. One estionnaire is filled !ro investors G another

    estionnaire is prepared !or 0ro1ers that help in trading.

    => Fro India 0lls 2=

    => Fro 7arv' 2=

    => Fro India In!o line ) 2=

    => Fro Share 7han Ltd) 2=

    SAM4LE SIHE.*

    /0 persons ere visited for the purpose of the study

    SAM4LING TEC-NI:E.*

    In this study, the respondents are chosen through convenience,

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    LIMITAITONS OF ST:D8

      In India very fe people invest in Derivative 7arket. So there as a problem

    to seek the persons that invest in Derivative 7arket. So it took more time.

    The ma

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    ANAL8SIS AND INTER4RETATION

    ) :o long you investing money in Derivative 7arket]

    )ecently 1E

    #ast ' year 8BE

    #ast 8 year 0E

    #ast 1 or more '/E

    INTER4RETATION.*

    This chart sho that 1E investor say that they can invest there money recently in

    the derivative market K 8BE investor say that they can invest there money for the

    last ' year in the derivative market K 0E investor say that they can invest there

    money for the last 8 year in the derivative market K '/E investor say that they

    can invest there money for the last 1 year and more in the derivative market.

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    2) >our duration for investing money in Derivative 7arket]

    Pery 6reH. '0E#ess 6reH. 0E

    5ften 91E)arely 1E

    INTER4RETATION.*

    This chart sho that '0E investor say that they can invest there money very freH.

    in the derivative market K 0E investor say that they can invest there money less

    freH in the derivative market K 91E investor say that they can invest there money

    often in the derivative market K 1E investor say that they can invest there

    money rarely in the derivative market.

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    3) *lease tell in hich type of Derivative Contract you invest your money]

    6utureF6orard ?E5ption 1E

    Saps '8E

    INTER4RETATION.*

    This chart sho that ?E investor say that they can play futureFforard in the

    derivative market K 1E investor say that they can play option in the derivative

    market K '8E investor say that they can play saps in the derivative market.

    Future/

    Forward

    62%

    Swaps

    13%

    Option

    25%

    Future/Forward

    Option

    Swaps

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    J) hich type of asset you prefer to obtain in Derivative Contract]

    Shares 8ECommodity 8BE

    onds '8EIndex '0E

    ullion 1ECurrency 8E

    INTER4RETATION.*

    This chart sho that 8E investor say that they can invest there money in share in

    the derivative market K 8BE investor say that they can invest there money in

    commodity in the derivative market K '8E investor say that they can invest there

    money in bond in the derivative market K '0E investor say that they can invest

    there money in index in the derivative market K 1E investor say that they can

    invest there money in bullion in the derivative market K 8E investor say that

    they can invest there money in currency in the derivative market.

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    >) %ccording to your past experience hether Derivative cover your risk 

    against future change in price of assets.

    >es B1E o 1E

    INTER4RETATION.*

    This chart sho that B1E investor say that the derivative market cover risk against

    future change in price K 1E investor say that the derivative market can not cover 

    risk against future change in price.

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    ) hat is your purpose of investing money in the Derivative 7arket]

    *rotection %gainst )isk 1E:igh )eturn 0E

    *roper #iHuidity 81ESpeculation *urpose 1E

    Saving 6or #ong )un '1E

    INTER4RETATION.*

    This graph sho that 1E investor say that the derivative market provide

     protection against risk K 8BE investor say that it provide high return K 81E

    investor say that they it provide proper liHuidity K 1E investor say that they can

    invest there money in the derivative market for the purpose of speculation K '0E

    investor say that they can invest there money in the derivative market for the

     purpose of saving for long run.

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    K) Some problem faced by the investor hile investing the money In

    Derivative 7arket)

    Attri/tes Solid a(ree A(ree Disa(ree Soliddisa(ree

    #ack of 

    aareness

    ?1E 1E BE 8E

    )egarding S4I

    regulations

    9(E 90E '0E 'E

    Complicated

     procedure

    1E '1E 1E 11E

    INTER4RETATION.*

    This above graph sho that investor face some problem hen he invest money in

    the derivative market first is lack of aareness for this problem ?1E people aresolid agree K 1E people are agree K BE people are disagree K 8E people are

    solid disagree. Second problem is regarding S4I regulations for this problem 9(E

     people are solid agree K 90E people are agree K '0E people are disagree K 'E

     people are solid disagree. Third problem is regarding complicated procedure for this

     problem 1E people are solid agree K '1E people are agree K 1E people are

    disagree K 11E people are solid disagree.

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    FOR 0RO7ER 

    ?) Do you think the rule of high risk K high return applies in Derivative

    7arket]

    >es (9E o ?E

    INTER4RETATION.*

    This chart sho that (9E brokers say that high risk K high return is applies in the

    derivative market K ?E broker say it is not applies in the derivative market.

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    ) %ccording to you, hat are the factor driving groth of Derivative 7arket]

    Attri/tes Solid

    a(ree

    A(ree Disa(ree Solid

    disa(reeI#roveent in conication !acilities JK 3? ? K

    More innovation in derivative ar1et 2K >3 3 K

    Lon( ter savin( investent J= J3 > 2

    INTER4RETATION.*

    The above graph sho the main factor driven for the groth of financial derivatives

    in India is 6irst is Improvement in communication 9BE people are solid agree K

    8/E people are agree K /E people are disagree K BE people are solid disagree.

    Second more Innovation in 6inancial derivatives BE people are solid agree K

    18E people are agree K '8E people are disagree K BE people are solid disagree.

    Third #ong term saving and investment 90E people are solid agree K 98E people

    are agree K '1E people are disagree K E people are solid disagree.

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    =) Do you think, Derivative market can influence our Indian economy if e invest

    more in derivativesB

    >es (BE o 8E

    INTER4RETATION.*

    This chart sho that (BE brokers say that if e invest money more in the derivative

    market it influence our Indian economy K 8E broker say it ill not effect our 

    economy.

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    ) hich type of asset investor prefers to obtain in derivative contract]

    Shares 32

    Coodit' 3K

    0onds 3Inde% =

    0llion >

    Crrenc' 3

    INTER4RETATION.*

    This chart sho that 8E broker say that the investor invest there money in share

    K 8BE broker say that investor invest there money in commodity K '8E broker 

    say investor invest there money in bond K '0E broker say investor invest there

    money in index K 1E broker say investor invest there money in bullion K 8E

     broker say investor invest there money in currency in the derivative market.

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    2) Do you think, S4I take necessary steps for the improvement in derivative

    marketB

    8es K2

    No 2?

    INTER4RETATION.*

    This chart sho that BE broker say that S4I take necessary steps for 

    improvement in derivative market K /E broker say no need to take more step for 

    improvement of derivative market.

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    3) hat are the constraints faced by you $that is put by S4I& hile facilitating

    trading in derivative contract] 

    Attri/tes Solid a(ree A(ree Disa(ree Solid

    disa(ree

    Re(ardin( ar(in reireent 32 >= 3 >

    Re(ardin( clearin( cor#orations = 22 = ?

    Re(ardin( settleent o! contract 2> ? 2 >

    INTER4RETATION.*

    This above graph sho the main constraint faced hile trading in derivatives are ;

    6irst is )egarding margin reHuirement 8E people are solid agree K 10E people

    are agree K '8E people are disagree K 1E people are solid disagree.

    Second regarding clearing corporation '0E people are solid agree K E people

    are agree K ?0E people are disagree K /E people are solid disagree.

    Third regarding settlement of contract 1E people are solid agree K /E people are

    agree K ?E people are disagree K 1E people are solid disagree.

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    STATISTICAL TOOLS

    Statistical tools are the basic measures, hich helps in defining the relation beteen differe

    items, present, past K future trend of the particular business etc. % ide variety of statistical too

    are available K any of them can be used by any businessman depending upon the nature of h

    trade. Parious statistical tools are ;!

    '. Correlation

    . )egression

    8. Time Series

    9. Index umbers

    1. *robability Distribution

    Years

    Index

    future

    Sto!

    future

    Index

    option

    sto!

    option

    Interest rate

    future

    2""5#"6 5$ 5 2$ 23 13

    2""6#" $3 112 '3 3' 1$

    2""#" 156 1'5 5$ '2 23

    2""#"$ 255 21 3 61 2

    2""$#1" 32 3"$ 113 5 3

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    4RINCI4LE OF COM4ONENT ANAL8SIS

    INTER4RETATION.

    %s there are three factors hich are lying in the fourth Huadrant i.e. index future, index optio

    stock future are the most important factors for company.

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    M:LTI4LE LINEAR REGRESSION

    Re(ression.* It is the study of relationship beteen the variable so that one may be able to predi

    the unknon value of an variable for a knon value of another variable.

    Y()* Index future Index option Sto! future

    2""5#"6 5$ 2$ 5

    2""6#" $3 '3 112

    2""#" 156 5$ 1'5

    2""#"$ 255 3 21

    2""$#1" 32 113 3"$

     

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    INTER4RETATION.

    This shos that to observation are best for company, but observation 1 is best than other. ecau

    it has minimum value as compared to other.

     

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     ANALYSIS OF VARIANCE

    Years Index future Sto! future

    2""5#"6 5$ 52""6#" $3 112

    2""#" 156 1'5

    2""#"$ 255 21

    2""$#1" 32 3"$

    INTERPRETATION:

    %fter applying %5P%, e see that Index 6uture hich is an independent variable affects Stock

    6uture, hich is a dependent variable, the most.

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    0LAC7*SC-OLES O4TION 4RICING MODEL

    The breakthrough in option pricing theory came ith the famous black and Scholes paper in '(B

    lack and Scholes paper here the first to sho that operations could be priced by constructing

    risk free hedge by dynamically managing a simple portfolio consisting of the underlying assest an

    cash. The same principle is the foundation for almost any option pricing formula used in today

    financial markets. lack and scholes$'(B8& formula can be used to value 4uropean stock option

    on a stock that does not pay dividends. In it, C and * the price of 4uropean call K option

    respectively, the formula states that;!

    CRS $d'&!e!rT  $d&

    *Re!rT  $!d&!S $!d'&,

    here

    d' R ln$SF& \$r\^ F&T

    _$T&'F 

    d R ln$SF&\$r\^ F&T R d'! ^$T&'F

    ^ $T&'F

    E%a#le consider a 4uropean call option ith three months to expiry. The stock price is ?0, th

    strike price is ?1, the risk!free interest rate is /E per annum, and the volatility is 80E per annum

    Thus , S R ?0, x R ?1 , T R 0.1, r R 0.0/, ^ R0.80.

    d' R ln$?0F?1& \$0.0/\0.80F&0.1

    0.80$0.1&'F

      R !0.818

     

    d R d' L 0.80$0.1&'F  R !0.9B18

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    The value of the cumulative normal distribution $.& can be found using the approximati

    function in appendix % or tables %!' and %! in the same appendix.

    here,

     $d'& R $!0.818& R 0.8B1, $d&R $!0.9B18& R 0.8'B8

    c R ?0$d'& ! ?1e!0.0/U0.1 $d& R .'889

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     FINDINGS

    • rokers not dealing in derivatives at present are also not going to adopt it in near futures.

    • :edging K )isk 7anagement is the most important feature of derivatives.

    • It is not for small Investors.

    • It has increased brokers turnovers as ell as helpful in aggregate investment.

    • rokers donOt have adeHuate knoledge about options, so most by them are dealing in futur

    only.

    • There is a risk factor in derivative also.

    • 7ost of investors are not investing in derivatives.

    • *eople are not aare of derivatives, even people ho are invested in it, havenOt adeHua

    knoledge about it. These are interested to take it in their future portfolio also. They consider

    as a tool of risk management.

    • They normally invest in future contracts.

    • They are investing in future contract, because futures have up to home extent similar Huality

    adla.

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    RECOMMENDATIONS

    • Lot si@e. #ot si@e should be reduced so that the ma

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    CONCL:SION

     

    The Indian accounting guidelines in this area need to be carefully revieed. The international tren

    is moving the underlying securities as ell as associated derivative instrument to market. Such practice ould bring into the account a Clear picture of the impact of derivative related operation

    5n the basis of overall study on derivatives it as found that derivative products initially emerg

    as hedging devices against fluctuation and commodity prices and commodity linked derivativ

    remained the soul form of such products. The financial derivatives came in spotlight in '(B due

    groing in stability in financial market.

    I as really surprised to see during my study that a layman or a simple investor does not eve

    kno ho to hedge and ho to reduce risk on his portfolios. %ll these activities are general

     performed by big individual investors, institutional investors, mutual funds etc.

     o doubt that derivative groth toards the progress of economy is positive. ut the problem

    confronting the derivative market segment are giving it a lo customer base. The main problem

    that it confronts are unaareness and bit lot si@es etc. these problems could be overcome easily b

    revising lot si@es and also there should be seminar and general discussions on derivatives at vari

     places.

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    0I0LOGRA4-8

    0OO7S.

    • Garav Dhin(ra An nderstandin( O! Financial Derivativesedition00

    0,pgo.8!1

    • NCFM MOD:LE*J& 4/lished /' National Stoc1 E%chan(e, pg.o.8!1?,B/!//

    • Mrt' GR7 Derivatives Instrents P 9h' and 9h' NotBpgo.89!81

    • 9illia c) hnter David Marshall Tho(hts on !inancial derivatives& systemat

    risk, and central banking; a revie of some recent developments,pgno91!9(,B/!/0,

    • ain&T)R)& and A((arwal& Dr) S)C)& Statistics For M)0)A,P3 publication, **'!8 *art

    , nd 4dition ,** '8'!'89

    • 7othari C)R)& Research Methodolo(' Methods and Technies  $Second 4ditio

     e %ge International *ublishers, %n sari )oad, Daryagan

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    • Vinod 7othari Manna !ro -eaven publisher!:imalaya publication,pg5.89!8B

    • Sion Coo1e Interest Rate and Crrenc' Derivates pgo(/!'09

    • R) Schwart@& ??&" Eit' ar1ets Strctre& tradin( and #er!orance" . :arper a

    )o, e >ork,pg.5'?(!'B8

    O:RNALS.

    • The Chartered Accontant& volume 1.o.(, 7arch 009

    • Chartered 6inancial %nalyst, %pril 00', *g.o.98!9B.

    • ornal o! !inance,volumn8?!8(,o.B,=an001

    • Facts !or &volumn18.o.1,=an00/

    • Chartered Financial Anal'st, December 00, *g.o. 10!1'.

    SITES.

    • .escorts securities.com

    • .escortinvestment.com

    • .nse.com.

    • .bseindia.com.

    • .bseebx.com

    LIN7S.

    • http;FF.findarticles.comFpFarticlesFmi m0/1Fis8B0Fai ?8B9('.

    • http;FF.findarticles.comFpFarticlesFmi m(9Fis 8!9 1'Fai n?'B0?.

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