derivative market
TRANSCRIPT
I I P M A H M E D A B A D
SUBMITTED IN THE PARTIAL FULLFILLMENT OF
THE REQUIRMENT FOR THE
DEGREE OF
MASTER OF BUSINESS ADMINISTRATION SUBMITTED TO
International Institute of Planning and Management BY
JAYPRAKASH PATEL
GUIDED BY
Mr. Hitesh Rever (Branch Manager)
Ms. Priyanka Yadav (Remizar)
2011
ANALYSIS OF INVESTMENT IN
DERIVATES MARKET
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1.1 About the Subject
Perceptions of derivative
A derivative is financial instrument whose value is ‗derived‘ from another
underlying security or a basket of securities. Traders can assume highly
leveraged positions at low transaction costs using these extremely flexible
instruments.
As this market i.e derivative is new concept in share market the Perception
regarding the same varies from person to person. A complete understanding of
this market is require in order to deal with it. So the topic which I selected will
be telling about perception of people toward this market in surat city and how
they deal with this market.
The most desired instruments that allow market participants to manage risk in
the modern securities trading are known as derivatives. The main logic behind
the derivatives trading is that:-
Derivatives reduce the risk by providing an additional channel to invest with
lower trading cost and
It facilitates the investors to extend their settlement through the future
contracts.
It provides extra liquidity in the stock market.
They represent contracts whose payoff at expiration is determined by the
price of the underlying asset—a currency, an interest rate, a commodity, or a
stock.
In order to know about the perception of people to this new era of market in
which at initial level every investor fear to invests so a survey at surat level is
done on ―perception of investor toward this market‖ is done by taking 100
samples in surat city.
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Sr. No
Content PAGE
1 1.2 Importance of topic 3
1.3 About Motilal Oswal 3
1.4 Benefit of study 6
2 2.1 Introduction to industry 7
2.2 Industrial profile at India level 13
2.3 Industrial profile at regional level 19
3 3.1 Objective of study 22
3.2 Literature review 22
3.3 Statement of problem 25
3.4 Research Design 25
3.5 Sampling Methodology 25
3.6 Method of data collection 26
3.7 Limitations of study 26
4 4.1 History of derivatives 27
4.2 Chronology of instruments 28
4.3 Need for derivatives in India today 29
4.4 Myths and realities about derivatives 31
4.5 The participants in a derivative market 32
4.6 Types of derivatives 33
4.7 business growth in derivatives segment 37
5 5.1 Questionnaire Analysis 43
6 6.1 Findings 53
6.2 Recommendation 53
6.3 Conclusion 55
7 7.1 Bibliographies 56
INDEX
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1.2 IMPORTANCE OF TOPIC
The study is done on derivate which is not much know to the investor or in
general public who are dealing in share market, so it‘s important to know
about this segment of market in order to get a lucrative return.
To know about the perception of investor towards the derivative market in
order to know their investment pattern i.e. in which part of derivative they
are dealing much and what part of income they invest in this market.
Derivative is emerging market in India as well as in Surat city so a general
view and future growth of this market can be judge by this study.
In the Indian Stock Market which is highly volatile, and as derivative is
completely based on future price, the study on derivative helps in
minimizing risk & maximizing return.
1.3 About the Organization
MOTILAL OSWAL SECURITIES (financial consultants)
Company address
Office No. 2006 B, Mezzanine floor,
21st Century Business Center, Ring Road,
Surat – 395002, Gujarat
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―Knowledge is power and power brings security. Risk is a very
relative term and changes with every individual and situation.
Financial management is not just about managing risk but also
managing knowledge and finally deriving answers that generate
wealth, security and trust.‖
Motilal Oswal security was founded in 1987 as a small sub-broking
unit, with just two people running the show. Focus on customer-first-
attitude, ethical and transparent business practices, respect for
professionalism, research-based value investing and implementation
of cutting-edge technology has enabled us to blossom into an over
1600 member team.
Today we are a well diversified financial services firm offering a range
of financial products and services such as Wealth
Management, Broking & Distribution, Commodity Broking, Portfolio
ManagementServices, Institutional Equities, Private
Equity, Investment Banking Services and Principal Strategies.
We have a diversified client base that includes retail customers
(including High Net worth Individuals), mutual funds, foreign
institutional investors, financial institutions and corporate clients. We
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are headquartered in Mumbai and as of June 30th, 2011, had a
network spread over 586 cities and towns comprising 1,607 Business
Locations operated by our Business Partners and us. As at June 30th,
2011, we had 722,303 registered customers.
Motilal Oswal Security offers
Portfolio Advisory Services
Equity Broking
Derivatives Trading
Depository Services
Mutual Fund
Public Sector Bonds & Government Securities
Commodities Trading
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1.4 Benefit of the study.
a. To Organisation
To know about respondent‘s perception toward the derivative market in
surat city as now-a-days trading in this market has taken hype.
To know about the dealing pattern of respondent towards this market.
b. To myself
To gain knowledge about the derivative market which is having a great pace
in share market?
To know about the perception of the respondent towards derivative market
in Surat city.
To become familiarize with organization, which help in applying theoretical
concepts into practical routine.
To understand the working system of different department.
To become part of professionalism.
To understand technical terms and its applications in study.
To know how the scripts are being traded in Equity market, Derivatives,
Commodity market.
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2. Introduction to Industry.
Investment
The money you earn is partly spent and the rest saved for meeting future
expenses. Instead of keeping the savings idle you may like to use savings in
order to get return on it in the future. This is called Investment.
Reason for investment
One needs to invest to:
Earn return on your idle resources
Generate a specified sum of money for a specific goal in life
Make a provision for an uncertain future
Stock Exchange
The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‗Stock
Exchange‘ as anybody of individuals, whether incorporated or not, constituted
for the purpose of assisting, regulating or controlling the business of buying,
selling or dealing in securities. Stock exchange could be a regional stock
exchange whose area of operation/jurisdiction is specified at the time of its
recognition or national exchanges, which are permitted to have nationwide
trading since inception. NSE was incorporated as a national stock exchange.
Their usefulness:
Indices help to recognize broad trends in the market.
The investor can use the indices to allocate the funds rationally among
the stocks.
Technical analysts use these indices to predict the future market.
Indices function as a status report on the general economy.
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SECURITIES
The definition of ‗Securities‘ as per the Securities Contracts Regulation Act
(SCRA), 1956, includes instruments such as shares, bonds, scrips, stocks or
other marketable securities of similar nature in or of any incorporate company
or body corporate, government securities, derivatives of securities, units of
collective investment scheme, interest and rights in securities, security receipt or
any other instruments so declared by the Central Government.
Type of investment in share
Government Securities
Derivative products
Units of Mutual Funds etc., are some of the securities investors in the
securities market can invest in.
Types of Market
PRIMARY MARKET (Deals with the new issues of securities.)
The primary market provides the channel for sale of new securities. Primary
market provides opportunity to issuers of securities; Government as well as
corporate, to raise resources to meet their requirements of investment and/or
discharge some obligation. They may issue the securities at face value, or at a
discount/premium and these securities may take a variety of forms such as
equity, debt etc. They may issue the securities in domestic market and/or
international market.
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SECONDARY MARKET
(Deals with outstanding securities .Also known as ―STOCK MARKET‖)
Secondary market refers to a market where securities are traded after being
initially offered to the public in the primary market and/or listed on the Stock
Exchange. Majority of the trading is done in the secondary market. Secondary
market comprises of equity markets and the debt markets.
Role of the Secondary Market
For the general investor, the secondary market provides an efficient platform
for trading of his securities. For the management of the company, Secondary
equity markets serve as a monitoring and control conduit—by facilitating value-
enhancing control activities, enabling implementation of incentive-based
management contracts, and aggregating information (via price discovery) that
guides management decisions.
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Difference between the Primary Market and the Secondary
Market
In the primary market, securities are offered to public for subscription for the
purpose of raising capital or fund. Secondary market is an equity trading venue
in which already existing/pre-issued securities are traded among investors.
Secondary market could be either auction or dealer market. While stock
exchange is the part of an auction market, Over-the-Counter (OTC) is a part of
the dealer market.
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2.1 Industrial profile at Global level
History of World Stock Exchange
The history of stock exchanges can be traced to 12th century France, when the
first brokers are believed to have developed, trading in debt and government
securities. Unofficial share markets existed across Europe through the 1600s,
where brokers would meet outside or in coffee houses to make trades. The
Amsterdam Stock Exchange, created in 1602, became the first official stock
exchange when it began trading shares of the Dutch East India Company.
These were the first company shares ever issued.
By the early 1700s there were fully operational stock exchanges in France and
England, and America followed in the later part of the century. Share exchanges
became an important way for companies to raise capital for investment, while
also offering investors the opportunity to share in company profits. The early
days of the stock exchange experienced many scandals and share crashes, as
there was little to no regulation and almost anyone was allowed to participate in
the exchange.
Today, stock exchanges operate around the world, and they have become
highly regulated institutions. Investors wanting to buy and sell shares must do
so through a share broker, who pays to own a seat on the exchange. Companies
with shares traded on an exchange are said to be 'listed' and they must meet
specific criteria, which varies across exchanges. Most stock exchanges began as
floor exchanges, where traders made deals face-to-face. The largest stock
exchange in the world, the New York Stock Exchange, continues to operate
this way, but most of the world's exchanges have now become fully electronic.
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Major Stock Exchanges in world economy:
Economy Stock Exchange
United States New York Stock Exchange
Japan Tokyo Stock Exchange
United States NASDAQ
Europe Euronext
United Kingdom London Stock Exchange
China Shanghai Stock Exchange
Hong Kong Hong Kong Stock Exchange
Canada Toronto Stock Exchange
Spain BME Spanish Exchanges
Brazil BM&F Bovespa
India Bombay Stock Exchange
Germany Deutsche Börse
Australia Australian Securities Exchange
India National Stock Exchange of India
Switzerland SIX Swiss Exchange
China Shenzhen Stock Exchange
Korea Korea Exchange
Nordic Countries NASDAQ OMX Nordic Exchange
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South Africa JSE Limited
Taiwan Taiwan Stock Exchange
Italy Borsa Italiana
Source: World Federation of Exchanges - Statistics/Monthly
2.2 Industrial profile at India level
Securities Market Regulators
The absence of conditions of perfect competition in the securities market
makes the role of the Regulator extremely important. The regulator ensures that
the market participants behave in a desired manner so that securities market
continues to be a major source of finance for corporate and government and
the interest of investors are protected.
Regulation of Securities Market
The responsibility for regulating the securities market is shared by Department
of Economic Affairs (DEA), Department of Company Affairs (DCA), Reserve
Bank of India (RBI) and Securities and Exchange Board of
India (SEBI).
SEBI and its role
The Securities and Exchange Board of India (SEBI) is the regulatory authority
in India established under Section 3 of SEBI Act, 1992. SEBI Act, 1992
provides for establishment of Securities and Exchange Board of India (SEBI)
with statutory powers for (a) protecting the interests of investors in securities
(b) promoting the development of the securities market and (c) regulating the
securities market. Its regulatory jurisdiction extends over corporates in the
issuance of capital and transfer of securities, in addition to all intermediaries
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and persons associated with securities market. SEBI has been obligated to
perform the aforesaid functions by such measures as it thinks fit. In particular,
it has powers for:
Regulating the business in stock exchanges and any other securities
markets
Registering and regulating the working of stock brokers, sub–brokers etc.
Promoting and regulating self-regulatory organizations
Prohibiting fraudulent and unfair trade practices
Calling for information from, undertaking inspection, conducting inquiries and
audits of the stock exchanges, intermediaries, self – regulatory organizations,
mutual funds and other persons associated with the securities market.
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India’s Stock Exchanges
National Stock Exchange
The National Stock Exchange (NSE) is a stock exchange located at Mumbai,
India. It is the largest stock exchange in India in terms of daily turnover and
number of trades, for both equities and derivative trading.. NSE has a market
capitalization of around Rs 47,01,923 crore (7 August 2009) and is expected to
become the biggest stock exchange in India in terms of market capitalization by
2009 end.[2]Though a number of other exchanges exist, NSE and the Bombay
Stock Exchange are the two most significant stock exchanges in India, and
between them are responsible for the vast majority of share transactions. The
NSE's key index is the S&P CNX Nifty, known as the Nifty, an index of fifty
major stocks weighted by market capitalisation.
NSE is mutually-owned by a set of leading financial institutions, banks,
insurance companies and other financial intermediaries in India but its
ownership and management operate as separate entities. There are at least 2
foreign investors NYSE Euronext and Goldman Sachs who have taken a stake
in the NSE. As of 2006, the NSE VSAT terminals, 2799 in total, cover more
than 1500 cities across India [5]. In October 2007, the equity market
capitalization of the companies listed on the NSE was US$ 1.46 trillion, making
it the second largest stock exchange in South Asia. NSE is the third largest
Stock Exchange in the world in terms of the number of trades in equities.It is
the second fastest growing stock exchange in the world with a recorded growth
of 16.6%
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Mission
NSE's mission is setting the agenda for change in the securities markets in
India. The NSE was set-up with the main objectives of:
establishing a nation-wide trading facility for equities, debt instruments and
hybrids,
ensuring equal access to investors all over the country through an
appropriate communication network,
providing a fair, efficient and transparent securities market to investors
using electronic trading systems,
enabling shorter settlement cycles and book entry settlements systems, and
meeting the current international standards of securities markets.
NSE Facts
It uses satellite communication technology to energise participation from
around 400 cities in India.
NSE can handle up to 1 million trades per day.
It is one of the largest interactive VSAT based stock exchanges in the world.
The NSE- network is the largest private wide area network in India and the
first extended C- Band VSAT network in the world.
Presently more than 9000 users are trading on the real time-online NSE
application
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The Bombay Stock Exchange is known as the oldest exchange in Asia. It traces
its history to the 1850s, when 4 Gujarati and 1 Parsi stockbroker would gather
under banyan trees in front of Mumbai's Town Hall. The location of these
meetings changed many times, as the number of brokers constantly increased.
The group eventually moved to Dalal Street in 1874 and in 1875 became an
official organization known as 'The Native Share & Stock Brokers Association'.
In 1956, the BSE became the first stock exchange to be recognized by the
Indian Government under the Securities Contracts Regulation Act. The
Bombay Stock Exchange developed the BSE Sensex in 1986, giving the BSE a
means to measure overall performance of the exchange. In 2000 the BSE used
this index to open its derivatives market, trading Sensex futures contracts. The
development of Sensex options along with equity derivatives followed in 2001
and 2002, expanding the BSE's trading platform. Historically an open outcry
floor trading exchange, the Bombay Stock Exchange switched to an electronic
trading system in 1995. It took the exchange only fifty days to make this
transition. This automated, screen-based trading platform called BSE On-line
trading (BOLT) currently has a capacity of 80 lakh orders per day. The BSE has
also introduced the world's first centralized exchange-based internet trading
system, BSEWEBx.co.in to enable investors anywhere in the world to trade on
the BSE platform.
Several Firsts
At par with the international standards, BSE has in fact been a pioneer in
several areas. It has several firsts to its credit even in an intensely competitive
environment.
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First in India to introduce Equity Derivatives
First in India to launch a Free Float Index
First in India to launch US$ version of BSE SENSEX
First in India to launch Exchange Enabled Internet Trading Platform
First in India to obtain ISO certification for a stock exchange
'BSE On-Line Trading System‘ (BOLT) has been awarded the globally
recognised the Information Security Management System standard
BS7799-2:2002.
First to have an exclusive facility for financial training
First in India in the financial services sector to launch its website in Hindi
and Gujarati
Shifted from Open Outcry to Electronic Trading within just 50 days
BSE COMPANY LIST
ACC ,Grasim , Hindalco, HLL, ITC, L&T, RIL ,Hindustan
ShipyardLimited, Bajaj, Tata Steel, Tata Motors, BHEL, Gujarat Ambuja ,
ICICI Bank, Ranbaxy, Reliance Energy, SBI, Infosys, NIIT, Dr. Reddy's,
Cipla, Hero Honda, Airtel, HDFC Bank, ONGC, Wipro, Maruti, NTPC,
TCS, Reliance Communications ,
Sun Pharmaceutical
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2.3 Industry Profile at Regional Level
Ahmedabad Stock Exchange
Bangalore Stock Exchange
Bhubaneshwar Stock Exchange
Bombay Stock Exchange (BSE)
Calcutta Stock Exchange
Cochin Stock Exchange
Coimbatore Stock Exchange
Delhi Stock Exchange Association
Guwahati Stock Exchange
Hyderabad Stock Exchange (HSE)
Inter-connected Stock Exchange of India
Jaipur Stock Exchange
Ludhiana Stock Exchange Association
Madhya Pradesh Stock Exchange
Madras Stock Exchange (MSE)
Mangalore Stock Exchange
National Stock Exchange of India (NSE)
Magadh Stock Exchange - In Patna, Bihar
Over The Counter Stock Exchange of India (OTCEI)
Pune Stock Exchange
Uttar Pradesh Stock Association
Vadodara Stock Exchange
Meerut Stock Exchange
United Stock Exchange of India
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(A) Ahmedabad Stock Exchange or ASE
It is the second oldest exchange of India located in the city of Ahmedabad in
the western part of the country. It is recognized by Securities Contract
(Regulations) Act, 1956 as permanent stock exchange. It has adopted
a Swastika in its logo which is one of the most auspicious symbols of Hinduism
depicting wealth and prosperity.
The stock exchange was established as a Public Charitable Trust in 1894
following the establishment of the Bombay Stock Exchange in 1875. Earlier the
stock exchange functioned under the framework of the Bombay Securities
Contracts Act, 1925. Following the The Securities Contract Regulations Act,
1956 the Gujarat Share & Stock Exchange, Indian Share and General Exchange
Association and Bombay Share and Stock Exchange, Share and Stock Brokers
Association merged with the Ahmedabad Share and Stock Brokers Association
and gave rise to ASE as it stands today.
Ahmedabad Stock Exchange Limited is a premier national equities exchange
that plays a key role in the Indian securities markets. Serving individual and
institutional investors from around the world, its primary business is the trading
of approximately 2000 nationally listed equities. The Exchange also trades over
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200 high growth companies that are solely listed on the ASE or dually listed
with another exchange.
The Stock Exchange-Ahmedabad, constituted as a Public Charitable
Trust in 1894, is the second oldest exchange of India. It is recongnized
by Securities Contract (Regulations) Act, 1956 as permananent stock exchange.
History of Stock Exchanges in India traces back to the nineteenth century with
the establishment of the Bombay Stock Exchange in 1875 followed by
Ahmedabad Stock Exchange in 1894. In the world map of bourses, the Stock
Exchange - Ahmedabad holds a unique place with its initial functioning starting
under banayan tree and has progressed year after year therefrom.
The 80s and 90s saw major focus on building up requisite
infrastructure and bringing about rapid progress in the area of computerization
in the exchanges as whole.Recognizing and appreciating the necessity of
computerization and putting emphasis on screen based trading the Stock
Exchange-Ahmedabad went live on Dec. 12, 1996.
(B) Vadodara Stock Exchange or VSE
Is located in the city of Vadodara in Western India. It was established in 1990
at Vadodara.It is the third largest stock exchange in the state
of Gujarat after Ahmedabad and Rajkot. It is recognized by the Securities
Contract (Regulations) Act of 1956 as a permanent stock exchange.
From a humble beginning in 1986 with the Vadodara Stock Brokers'
Association comprising of 150 members, it was incorporated in January
22 1990 as Vadodara Stock Exchange Limited. By 1999, the exchange had a
total of 321 brokers, of which 65 were corporate brokers, 253 were proprietor
brokers, and 3 were partnership brokers. Then, there were only 85 sub-brokers
registered.
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3.1 Objective of study
To analyze investors perception towards investment in derivative market.
To understand the concept of the Derivatives and Derivative trading.
To know different types of Financial Derivatives
To know the role of derivatives trading in India.
3.2 Literature review
1. Derivative Trading in Indian Stock Market: Broker‘s Perception:
http://www.iimb.ernet.in/publications/review/guidelines-authors
Sandeep Srivastava,
Surendra S Yadav, P K Jain on September, 2008.
Volume 20
Abstract
The authors conducted a survey of brokers in the recently introduced
derivatives markets in India to examine the brokers' assessment of market
activity and their perception of the benefits and costs of derivative trading. The
need for such a study was felt as previous studies relating to the impact of
derivative securities on the Indian stock market do not cover the perception of
market participants who form an integral part of the functioning of derivative
markets. The issues covered in the survey included: a) perception of brokers
about the attractiveness of different derivative securities for clients; b) profile of
clients dealing in derivative securities; c) popularity of a particular derivative
security out of the total set; d) different purposes for which the clients are using
these securities in order of preference; e) issues concerning derivative trading; f)
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reasons for non-usage of derivatives by some investors and g) pricing, liquidity
and informational efficiency of the derivative market.
Derivative securities have penetrated the Indian stock market and it emerged
that investors are using these securities for different purposes, namely, risk
management, profit enhancement, speculation and arbitrage. High net worth
individuals and proprietary traders account for a large proportion of broker
turnover. Interestingly, some retail participation was also witnessed despite the
fact that these securities are considered largely beyond the reach of retail
investors (because of complexity and relatively high initial investment). Based
on the survey results, the authors identified some important policy issues such
as the need to bring in more institutional participation to make the derivative
market in India more efficient and to bring it in line with the best practices.
Further, there is a need to popularise option instruments because they may
prove to be a useful medium for enhancing retail participation in the derivative
market.
2. Increasing Derivatives Market Activity in Emerging Markets and
Exchange Rate Exposure
URL: http://www.econ.uconn.edu/working/2008-06.pdf
Uluc Aysun (University of Connecticut)
Melanie Guldi (Mount Holyoke College)
Abstract
Using firm level data, we report a significant fall in the exchange rate exposure
of emerging market firms over the past 10 years, and relate this to higher
derivatives market participation. Our methodology follows a three stage
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approach. First, we measure and report foreign exchange exposures for each
year using the popularized extension of the Adler-Dumas (1984) model. Next,
we use an indirect approach to estimate the derivatives market participation at
the firm level. Finally, we investigate the implications of the level of derivative
market activity on a firm's foreign exchange exposure. Our results show that
foreign exchange exposure is negatively related to derivatives usage, and
support the hedging explanation of the exchange rate exposure puzzle.
3. Indian Derivative Markets: Some Policy Issues
URL: http://ssrn.com/abstract=1428685
Anuradha Guru: member of ―National Stock Exchange of India‖
January 2009.
Abstract:
On their journey of innovation, derivatives have not been free from
controversies. They have often been held to be too complex to comprehend.
The leverage that these products provide to investors raises concern. Recently,
the present global financial crisis is being attributed to the housing mortgages
being repackaged and sold as collateralised debt obligations and other exotic
derivative products to financial institutions, pension funds and individuals.
Policy markers around the world are now having a relook as the problems
being posed by derivatives viz. lack of homogeneous rules and accounting
standards; the excessive freedom allowed to market players to innovate and the
lack of complete statistics for exchange-traded and OTC transactions. Leaders
are talking about the need for more transparency and accountability in the
functioning of derivative markets. While this exercise is underway, the aim of
this paper is to present the historical perspective in which derivatives have
developed in India and present certain issues which have been widely debated
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in the context of these markets in India, while also presenting the international
context of the debates.
3.3 STATEMENT OF PROBLEM
To know about the perception of investors toward the Derivative market in
surat city.
3.4 RESEARCH DESIGN
DESCRIPTIVE RESEARCH
The research is primarily descriptive in nature. The sources of information are
both primary and secondary.
3.5 SAMPLING METHODOLOGY
Sampling Technique: Stratified sampling.
Sampling Unit: The respondents who were asked to fill out the
questionnaire were from Surat, are the sampling units. These respondents
comprise of the persons from broker houses & person dealing in stock
trading.
Sample Size: The sample size was restricted to 100 respondents.
Sampling Area: The area of the research was surat.
Time: 6 weeks
Statistical tool used: Simple tools like bar graphs, tabulation, have been used.
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3.6 Method of data collection:-
Primary sources: Questionnaire
3.7 LIMITAITONS OF STUDY
Limited time : The time available to conduct the study was only 6 weeks. It
being a wide topic had a limited time.
Sample size: As more number of sample can also be taken to increase the
reliability of study.
Sampling method: There are more no of sampling techniques that can be
use in this research which may give different result.
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4.1 HISTORY OF DERIVATIVES:
Derivatives trading began in 1865 when the Chicago Board of Trade
(CBOT) listed the first "exchange traded" derivatives contract in the USA.
These contracts were called "futures contracts".
In 1919, the Chicago Butter and Egg Board, a spin-off of CBOT, was
reorganized to allow futures trading. Its name was changed to Chicago
Mercantile Exchange (CME).
The first stock index futures contract was traded at Kansas City Board of
Trade. Currently the most popular stock index futures contract in the world
is based on the Standard & Poor's 500 Index traded on the CME.
In April 1973, the Chicago Board of Options Exchange was set up
specifically for the purpose of trading in options.
The market for options developed so rapidly that by early 80s the number of
shares underlying the option contract sold each day exceeded the daily
volume of shares traded on the New York Stock Exchange. And there has
been no looking back ever since.
INDIAN DERIVATIVES MARKET
Starting from a controlled economy ,India has moved towards a world where
prices fluctuate every day. The introduction of risk management instruments in
India gained momentum in the last few years due to liberalization process and
Reserve Bank of India‘s (RBI) efforts in creating currency forward market.
Derivatives are an integral part of liberalization process to manage risk. NSE
gauging the market requirements initiated the process of setting up derivative
markets in India. In July 1999, derivatives trading commenced in India.
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4.2 Chronology of instruments
1991 Liberalization process initiated
14 December 1995 NSE asked SEBI for permission to
trade index futures.
18 November 1996 SEBI setup L.C.Gupta Committee to
draft a policy framework for index
futures.
11 May 1998 L.C.Gupta Committee submitted
report.
7 July 1999 RBI gave permission for OTC
forward rate agreements (FRAs) and
interest rate swaps.
24 May 2000 SIMEX chose Nifty for trading
futures and options on an Indian
index.
25 May 2000 SEBI gave permission to NSE and
BSE to do index futures trading.
9 June 2000 Trading of BSE Sensex futures
commenced at BSE.
25 September 2000 Nifty futures trading commenced at
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SGX.
4.3 NEED FOR DERIVATIVES IN INDIA TODAY
In less than three decades of their coming into vogue, derivatives markets have
become the most important markets in the world. Today, derivatives have
become part and parcel of the day-to-day life for ordinary people in major part
of the world. Until the advent of NSE, the Indian capital market had no access
to the latest trading methods and was using traditional out-dated methods of
trading. There was a huge gap between the investors‘ aspirations of the markets
and the available means of trading. The opening of Indian economy has
precipitated the process of integration of India‘s financial markets with the
international financial markets. Introduction of risk management instruments in
India has gained momentum in last few years thanks to Reserve Bank of India‘s
efforts in allowing forward contracts, cross currency options etc. which have
developed into a very large market.
The advantage of using derivatives as an investment strategy over cash markets
is that the fund outlay in a derivative contract is lower. Typically, only a
percentage is to be paid upfront in the shape of initial margin. Thus, for the
same fund outlay, much larger exposure is possible through a derivative
contract. Mutual Funds in India are permitted to invest in derivative for the
purpose of hedging against risk and portfolio rebalancing. SEBI regulates both
effectiveness of the hedge and its size.
With derivatives fast gaining popularity and retail participation increasing, we
feel it is just a matter of time before derivatives investments go beyond just
fulfilling the hedging needs of the fund, and are looked upon as separate
investment options.
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The potential and the advantages that this avenue gives to the fund manager are
immense and some players have already drawn up plans for a separate class of
products that focuses entirely on investment in derivatives, with active
positions in the cash segment, which will eventually help the industry branch
out to other areas as well.
THE USES OF DERIVATIVE MARKETS
Derivatives markets serve to shift risk.
Hedgers use derivatives to reduce risk exposure. For instance, a refiner can
lock in costs and revenues (i.e., lock in its margin) by buying crude oil
futures and selling oil and gasoline futures.
Speculators use derivatives to increase risk exposure in the anticipation of
making a profit.
Thus, derivatives markets facilitate the shifting of risk from those who bear
it at a high cost (the risk averse) to those who bear it at a low cost (the risk
tolerant).
Speculators perform a valuable service by absorbing risk from hedgers. In
return, they receive a reward—a risk premium. The risk premium is the
expected profit on a derivatives transaction. Speculators may win or lose in
any given trade, but on average speculators expect to profit.
The risk premium is also the cost of hedging.
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4.4 MYTHS AND REALITIES ABOUT DERIVATIVES
DIn less than three decades of their coming into vogue, derivatives markets
have become the most important markets in the world. Today, derivatives have
become part and parcel of the day-to-day life for ordinary people in major parts
of the world. While this is true for many countries, there are still apprehensions
about the introduction of derivatives.
What are these myths behind derivatives?
Derivatives increase speculation and do not serve any economic purpose.
Indian Market is not ready for derivative trading.
Disasters prove that derivatives are very risky and highly leveraged
instruments.
Derivatives are complex and exotic instruments that Indian investors will
find difficulty in understanding.
Is the existing capital market safer than Derivatives ?
MAJOR FACTORS RESPONSIBLE FOR THE GROWTH OF
FINANCIAL DERIVATIVES
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Integration of international markets with national financial markets
Increased volatility in asset prices in financial markets
Development of more sophisticated risk management tools, providing
economic agent wider choice of risk management strategies
Improvement in technology and communication facilities and sharp decline
in costs
Innovations in the derivatives markets have led to the diversification of risk
over a large number of financial assets, leading to higher returns
The modernization of commercial and investment banking
Sectors of underdeveloped economies, such as commercial banking, which
had been closed to foreigners, have been opened to foreign private sector
investment
4.5 THE PARTICIPANTS IN A DERIVATIVES MARKET
• HEDGERS use futures or options markets to reduce or eliminate the risk
associated with price of an asset.
• SPECULATORS use futures and options contracts to get extra leverage in
betting on future movements in the price of an asset. They can increase both
the potential gains and potential losses by usage of derivatives in a speculative
venture.
• ARBITRAGEOURS are in business to take advantage of a discrepancy
between prices in two different markets. If, for example, they see the futures
price of an asset getting out of line with the cash price, they will take offsetting
positions in the two markets to lock in a profit.
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4.6 Types of derivatives
(A) FORWARD
A forward contract is an agreement to buy or sell an asset on a specified date
for a specified price. One of the parties to the contract assumes a long position
and agrees to buy the underlying asset on a certain specified future date for a
certain specified price. The other party assumes a short position and agrees to
sell the asset on the same date for the same price. Other contract details like
delivery date, price and quantity are negotiated bilaterally by the parties to the
contract. The forward contracts are normally traded outside the exchanges.
The salient features of forward contracts are:
They are bilateral contracts and hence exposed to counter- party risk.
Each contract is custom designed, and hence is unique in terms of
contract size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
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On the expiration date, the contract has to be settled by delivery of the
asset.
If the party wishes to reverse the contract, it has to compulsorily go to
the same counter-party, which often results in high prices being charged.
However forward contracts in certain markets have become very standardized,
as in the case of foreign exchange, thereby reducing transaction costs and
increasing transactions volume. This process of standardization reaches its limit
in the organized futures market. Forward contracts are often confused with
futures contracts. The confusion is primarily because both serve essentially the
same economic functions of allocating risk in the presence of future price
uncertainty. However futures are a significant improvement over the forward
contracts as they eliminate counterparty risk and offer more liquidity.
(B) FUTURE
In finance, a futures contract is a standardized contract, traded on a futures
exchange, to buy or sell a certain underlying instrument at a certain date in the
future, at a pre-set price. The future date is called the delivery date or final
settlement date. The pre-set price is called the futures price. The price of the
underlying asset on the delivery date is called the settlement price. The
settlement price, normally, converges towards the futures price on the delivery
date.
A futures contract gives the holder the right and the obligation to buy or sell,
which differs from an options contract, which gives the buyer the right, but not
the obligation, and the option writer (seller) the obligation, but not the right.
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BASIC FEATURES OF FUTURE CONTRACT:
1. Lot size:- lot size means that we cannot buy single share as in equity market
we can only buy bundle of shares of a particular script ,like, if we want to
purchase future of reliance than lot size is 150 share therefore you have to
purchase whole lot. For example: - in NIFTY lot size is 50 shares, MINI
NIFTY (it is for retail sector) lot size is 20 shares.
2. Margin: when anyone executes a future trade, then initial margin has to be
paid, which may be 10% of the value of the contract-it is fixed by the exchange.
The margin consists of cash or cash equivalents, is to ensure that the traders
will honor the obligation arising out of future contract. The margin has to be
posted by the future both the parties to the future contract as both are exposed
to losses.
3. Settlement
Settlement is the act of consummating the contract, and can be done in one of
two ways, as specified per type of futures contract:
Physical delivery - 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. In practice, it occurs only on a minority
of contracts.
Cash settlement - a cash payment is made based on the underlying reference
rate, such as a short term interest rate index such as Euribor, or the closing
value of a stock market index. A futures contract might also opt to settle against
an index based on trade in a related spot market.
4. Expiry is the time when the final prices of the future are determined. For
many equity index and interest rate futures contracts, this happens on the Last
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Thursday of certain trading month. On this day the t+2 futures contract
becomes the t forward contract.
(C) OPTION
An Option is a contract which gives the right, but not an obligation, to buy or
sell the underlying at a stated date and at a stated price. While a buyer of an
option pays the premium and buys the right to exercise his option, the writer of
an option is the one who receives the option premium and therefore obliged to
sell/buy the asset if the buyer exercises it on him
Options are of two types - Calls and Puts options
"Calls" give the buyer the right but not the obligation to buy a given
quantity of the underlying asset, at a given price on or before a given future
date.
"Puts" give the buyer the right, but not the obligation to sell a given quantity
of underlying asset at a given price on or before a given future date. All the
options contracts are settled in cash.
(D) SWAPS:
Swaps are transactions which obligates the two parties to the contract to
exchange a series of cash flows at specified intervals known as payment or
settlement dates. They can be regarded as portfolios of forward's contracts.
A contract whereby two parties agree to exchange (swap) payments, based
on some notional principle amount is called as a ‗SWAP‘. In case of swap,
only the payment flows are exchanged and not the principle amount.
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4.7 BUSINESS GROWTH IN DERIVATIVES SEGMENT
A) INDEX FUTURES- CONTRACTS
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
Graphical representation of number of contracts.
INTERPRETATION:
From the data and the bar diagram above, there is high business growth in the derivative segment in India. In the year 2000-01, the number of contracts in index future were 90580 where as a significant increase of 210428103 is observed in the year 2008-09.
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(B) TURNOVER
NUMBER OF TURNOVERS OF STOCK FUTURES
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
INTERPRETATION: From the data and above bar chart, there is high
turnover in the derivative segment in India. In the year 2001-02 the turnover of
index future was 21483 where as a huge increase of 3570111.40 in the year
2008-09 are observe.
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.(C) STOCK FUTURES:-
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
INTERPRETATION:
from the data and bar diagram above there were no stock futures available but
in the year 2001-02, it predominantly increased to 1957856. then there was huge
increase of 20,35, and 87,952 in the year 2007-08 and thereafter there was a
steady rise to 221577980 in the year 2008-09.
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(C) INDEX OPTIONS CONTRACTS:-
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
Interpretation:
From the data and bar chart above, the no of contracts of index option was nil
in the year 2000-2001. But there was a predominant increase of 1, 75,900 in the
year 2001-2002. in the year 2008-2009 there was a huge increase in the index
option contracts to 212088444 in the year 2008-2009.
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TURNOVER
INDEX OPTION TURNOVER PER YEAR IN RS. CRORES
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
GRAPHICAL REPRESENTATION OF TURNOVER PER YEAR
INTERPRETATION:
From the data and bar chart above, there was no turnover in the year 2000-2001 for index option. it slowly started increasing in the year 2000-2001 to 3765. But in the year 2007-2008 there was a huge increase of 1362110.088 and consistent increase to 3731501.84 observed in 2008-2009
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D) STOCK OPTIONS
CONTRACTS
http://www.nseindia.com/products/content/derivatives/equities/data_report.htm
GRAPHICAL REPRESENTATION OFNUMBER OF CONTRACTS
TRADED PER YEAR IN STOCK OPTION
INTERPRETATION: From the data and bar chart above the no of contracts of stock
option in the year 2000-2001 was nil. But there was a huge increase of
1037529 observed in the year 2001-2002. It was 13295970 which
were the highest in the year 2008-2009 and stands at 1451603 in the
first quarter of the year 2009-10.
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5.1 QUESTIONNAIRE ANALYSIS
SURVEY QUESTIONNAIRE OF INVESTOR’S PERCEPTION TOWARDS
INVESTMENT IN DERIVATIVE MARKET FOR MOTILAL OSWAL
SECURITY Ltd., SURAT
1. How would you place your order?
The following is the bar -chart of above data (according to the percentage)
Interpretation:
Only 45 % of Surat people do trading through online while 55% of people
trading through offline mode.
45%
55%
Mode of trading
online offline
Online
Offline
45%
55%
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2. In which of the following segment you prefer to invest?
The following is the bar-chart of above data
2.1 If Derivative market, then
Interpretation
The 2 chart shows 25% of people should investment in derivative market
because of lack of knowledge towards this segment and 25% of people would
invest in currency market, 32% of people would invest in stock option and 43%
of people would invest in stock future.
Equity 75%
Derivative 25%
Market segment
Stock option 32%
stock future 43%
Currency 25%
Type of DM
Equity Derivative
75% 25%
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3. Education qualification
Under Graduate Graduate Post Graduate Professional degree
holder
21% 59% 17% 3%
Interpretation:
There is more no. of graduate respondent who invest or know about derivate
market almost 60% is from this category. This shows that a literate person do
the investment in this market.
4. Income range of respondent:
Below1,50,000 P.A 47%
1,50,000 - 3,00,000 P.A 17%
3,00,000 – 5,00,000 P.A 20%
Above 5,00,000 P.A 16%
Educational qualification
21
59
17
3
0
10
20
30
40
50
60
70
Under
graduate .
Graduate. Post
Graduate
Professional
degree
holder.
Pe
rce
nta
ge
ANALYSIS OF INVESTMENT IN DERIVATES MARKET
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The following is the bar-chart of above data (according to the percentage)
Interpretation
People from income group below 150000 are dealing with derivative more than
other category. Other category almost covers 20% in each category. These
indicate that low income group people invest more than high income group
people.
5. How do you analyze the stock market?
Interpretation
Maximum % of people should analyze through tips and recommendation
which had been given by client‘s broker.
47%
17% 20%
16%
Below1,50,000 P.A 1,50,000 - 3,00,000P.A
3,00,000 – 5,00,000 P.A
Above 5,00,000 P.A
INCOME GROUP
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6. Normally what % of your monthly household income could be available for investment?
Option No of respondents
Between 5% to 10%
47
Between 11% to 15%
18
Between 16% to 20%
17
Between 21% to 25%
14
More than 25%.
4
Total 100
THE FOLLOWING IS THE Bar-CHART OF ABOVE DATA
Interpretation:
Around 50 % of respondent invest on 5- 10% of their income to this derivate
market. And 15 % of people in each other category invest higher amount of
investment. These indicate that people don‘t want to invest in such market due
to high risk factor and lack of knowledge.
Percentage of household income could be
available for investment
47
18 1714
4
0
5
10
15
20
25
30
35
40
45
50
Between 5%
to 10%
Between 11%
to 15%
Between
16% to 20%
Between 21%
to 25%
More than
25%.
Percentage Range
Perce
ntage
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7. PURPOSE OF INVESTING IN DERIVATIVE MARKET
Interpretation:
32% of respondent invest their money for hedging purpose. And about 50% of
respondent invest for both risk control and to earn stable return. This show
that investor are not much known to this market and hence invest to get stable
return without any risk.
Option No of
respondents
To Hedge their fund 32
Risk control 27
More stable 25
Direct investment without buying and
holding of assets.
16
Total 100
Purpose of investing in derivate market
32
2725
16
0
5
10
15
20
25
30
35
To Hedge their
fund
Risk control More stable Direct investment
without buying and
holding of assets.Diff purpose
Per
cen
tag
e
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8. Which broker would you prefer to take advice before investing in
Equity & derivative market?
Motilal oswal 45%
Jainum 15%
Angle 35%
Ventura 5%
Interpretation:-
Survey shows that the 45% of surat city invest through motilal oswal because of
brand, low brokerage and strategies.
9. You participate in derivative market as
Types of Participant % of involvement
Investors 35%
Speculators 15%
Broker 45%
Hedger 5%
45%
15%
35%
5%
Broker
Motilal oswal Jainum Angle Ventura
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Interpretation:
In surat city 45% of people should invest through broker because people do
not want to take own risk.
12. What was the result of your investment?
35%
15%
45%
5%
Investors Speculators Broker Hedger
Participant
Series1
Option No of respondents
Great result (more than 50% of
your investment)
15
Moderate/ Constant result (20% -
40% return)
54
Disappointed (less than 10%
return )
31
Total 100
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Interpretation:-
Investment in derivative market is more risky than equity market but the high
volume of money in this segment. Our survey shows that 54% of investment
gives moderate result only 15% people get higher return.
15%
54%
31%
Great result (more than 50% of yourinvestment)
Moderate/ Constant result (20% - 40%return)
Disappointed (less than 10% return )
No of respondents
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6.1 FINDINGS
1. The study says that almost 60% of people in surat is knowing about this
market and their perception toward this market says that it is very highly risky
and leveraged instrument, and they get very moderate return in this market.
2. After analyzing data it is clear that the main factors that can drive the
understanding of Derivative Market are Market improvement in
communication facilities as well as long term saving & investment through
entering into Derivative Contract. So these factors can encourage the
Derivative Market in India as well as in surat.
3. In the case of stock future there was a slow increase observed in the number
of contracts whereas a decline was also observed in its turnover. In the case of
index option there was a huge increase observed both in the number of
contracts and turnover.
5. As proper understanding of this market is lacking people afraid to invest in
this market. Most of the people deal mere as a investor they does not play
crucial part in hedging, arbitrage & as a speculator.
6. Derivative market is growing very fast in the Indian Economy. The turnover
of Derivative Market is increasing year by year in the India‘s largest stock
exchange NSE. In the case of index future there is a phenomenal increase in
the number of contracts.
7. Derivative Market is more regulated & standardized so in this way it provides
a more controlled environment. In nutshell, we can say that the rule of High
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risk & High return apply in Derivatives. If we are able to take more risk then
we can earn more profit under Derivatives.
6.2 Recommendations
The decision about whether to use derivatives should be driven, not by the
company's size, but by its strategic objectives. It is important that all users of
derivatives understand how their contracts are structured, the unique price and
risk characteristics of those instruments, and how they will perform under
stressful and volatile economic conditions. Following are the recommendation
for enhancing the derivative market .
To increase market transparency improved information on the size and
structure of the derivatives market should be provided.
Derivative Market is more regulated & standardized so in this way it
provides a more controlled environment. In nutshell, we can say that the
rule of High risk & High return apply in Derivatives. If we are able to
take more risk then we can earn more profit under Derivatives
A careful risk management study in respect to the corporate goals with
complete market stimulation is very necessary for participating in the
derivatives market.
By improvement in communication facilities (i.e understanding) as well
as long term saving & investment can encourage the investor in this
market.
Internationally consistent market statistics on the notional amounts and
gross market values outstanding of broad categories of foreign exchange,
interest rate, and equity-based derivative instruments should be provided.
This would benefit individuals as well as organizations in better
prediction of the global financial activity.
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It may be wise to stay away from the more exotic instruments, unless the
risk/reward tradeoffs are clearly understood by the firm's senior
management and its independent risk management review team. Exotic
contracts should not be used unless there is some obvious reason for
doing so. But when used wisely, financial derivatives can increase
shareholder value by providing a means to better control a firms risk
exposures and cash flows.
In nut shell, after study it is clear that Derivative influence our Indian Economy
up to much extent. So, SEBI should take necessary steps for improvement in
Derivative Market so that more investors can invest in Derivative market.
There is a need of more innovation in Derivative Market because in today
scenario even educated people also fear for investing in Derivative Market
Because of high risk involved in Derivatives.
RBI should play a greater role in supporting derivatives.
Derivatives market should be developed in order to keep it at par with other
derivative markets in the world.
Speculation should be discouraged.
There must be more derivative instruments aimed at individual investors.
SEBI should conduct seminars regarding the use of derivatives to educate
individual investors.
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6.3 Conclusion
From the research study about the perception regarding the derivative market
we come to know that there is understanding for the market in this segment in
investor or broker house but there thinking toward this market says that due to
high risk involve in this market people afraid to deal with it.
Derivatives allow firms and individuals to hedge risks and to take risks
efficiently. They also can create risk at the firm level, especially if a firm uses
derivatives episodically and is inexperienced in their use. For the economy as a
whole, a collapse of a large derivatives user or dealer may create systemic risks.
On balance, derivatives help make the economy more efficient.
However, neither users of derivatives nor regulators can be complacent. Firms
have to make sure that derivatives are used properly. This means that the risks
of derivatives positions have to be measured and understood. Those in charge
of taking derivatives positions must have the proper training. It also means that
firms must have well-defined policies for derivatives use. A firm‘s board must
know how risk is managed within the firm and which role derivatives play.
Regulators have to make sure to monitor carefully financial firms with large
derivatives positions.
Though regulators seem to be doing a good job in monitoring banks and
brokerage houses, the risks taken by insurance companies, hedge funds and
government sponsored enterprises should be understood and monitored.
So should we fear derivatives? The answer is ―no.‖ We should have a healthy
respect for them. We do not fear planes because they may crash and do not
refuse to board them because of that risk. Instead, we make sure that planes are
as safe as it makes economic sense for them to be. The same applies to
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derivatives. Typically, the losses from derivatives are localized, but the whole
economy gains from the existence of derivatives markets.
7 BIBLIOGRAPHIES
BOOKS REFERRED:
Sandeep Srivastava, Surendra S Yadav, P K Jain September, 2008 Derivative
Trading in Indian Stock Market: Brokers's Perception, Volume 20, Number
3 Article.
Rasmeet Kohli may2010 Journey of equity derivatives market at NSE ?An
analysis for the decade (2000-01 to 2009-10)
NSE‘s Certification in Financial Markets: - Derivatives Core module
Hull.C,John, 2005 ―Options Futures, and other Derivatives‖
Financial Markets & Services by Gordon & Natarajan
WEBSITES VISITED:
http://www.articlesbase.com/non-fiction-articles/knowing-the-basics-
of-credit-derivatives-45563.html
www.nseindia.com
www.igidr.ac.in/~susant/DERBOOK/PAPERS/pm.pdf
www.ny.frb.org/research/economists/sarkar/ derivatives_in_india
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