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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
http://en.wikipedia.org/wiki/Potentialhttp://en.wikipedia.org/w/index.php?title=Actual&action=edit&redlink=1http://en.wikipedia.org/wiki/Potentialhttp://en.wikipedia.org/w/index.php?title=Actual&action=edit&redlink=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
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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.
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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.
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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
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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.
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• http;FF.financialinks.comFindex.htm
• http;FF.moneycontrol.comFfinancialreports.
• http;FF.acclimited.comFprofile .
• http;FF.acclimited.comFmanagement .
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• . http;FF.acclimited.comFcomparison .
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