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A
PROJECT REPORT ON
AWARENESS ABOUT THE DERIVATIVE AND ITS
COMPARISON WITH EQUITY
UNDERTAKEN AT:
ANAND RATHI FINANCIAL SERVICES
LTD. Submitted in the partial fulfillment of the Requirement
of the awards of
MASTER OF BUSINESS ADMINISTRATION
EXTERNEL GUIDE: INTERNAL GUIDE:
Mr.JAGDISH PALIWAL Mr. ALOK KUMAGUPTA(BRANCH HEAD) H.O.D (MBA)
SUBMITTED BY:
ANKIT CHOUDHARY
ROLL No. 0908570009
S.D. COLLEGE OF MAMAGEMENT STUDIES BHOPA ROAD,MUZAFFARNAGAR
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DECLARATION
I, ANKIT CHOUDHARY hereby declare that the project report entitled
AWARENESS ABOUT THE DERIVATIVE AND ITS COMPARISON WITH
EQUITY is based on my own work and my indebtedness to other work/
publications, if any have been duly acknowledged at the relevant place.
PLACE: MUZAFFARNAGAR
DATE:
ANKIT CHOUDHARY
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ACKNOWLEDGEMENT
To acknowledge is very great way to show your gratitude towards the persons
who have contributed in your success in one or other way.
I find words inadequate to express my gratitude to Mr. JAGDISH PALIWAL for
providing me an opportunity to carry out my winter project as such a well reputed
and leading stock broking company ANAND RATHI FINANCIAL Services
Limited.
At the very outset of the training I deem it is my pious duty to express my sincere
thanks also to branch head Mr. Jagdish Paliwal for his continuous guidance and
supervision and support during the project.
I would like to thank Mr. ALOKKUMAR GUPTA (H.O.D MBA)who has guided
me for my project work and provided encouragement through out my training
period.
This study could not have been successful without the valuable input of the
customer of ANAND RATHI.
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PREFACE
I know that Project is for the development and enhancement of the knowledge in
this particular field. It can never be possible to make a mark in todays
competitive era only with theoretical knowledge when industries are developing
at global level, practical knowledge of administration and management of
business is very important. Hence, practical study is of great importance to MBA
student.
With a view to expand the boundaries of thinking, I have undergone MBA
Summer Project at Anand Rathi Financial Services Ltd I have made a
deliberate to collect the required information and fulfill project objective.
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TABLE OF CONTENTS
Sr.No. SUBJECT Page
No.
1
2
Industry profile
Company profile --------- Anand Rathi Financial
Services Ltd
6-17
18-39
3 Financial derivatives:
1. Introduction about derivatives
2 Risk Associated With Derivatives
3 Functions of derivative market
4 Participants of derivative market
5 Types of derivatives
6 Emergence of derivative trading in India
7 Introduction of forward
8 Introduction to futures
9 Introduction to options
10 Types of options
11 Pricing with regard to option
12 Difference between derivative and equity
40-70
4 RESEARCH METHODOLOGY 71-73
5 DATA ANALYSIS 73-88
6 FINDINGS 89
7 CONCLUSION90
8 RECOMENDATION 91
9 BIBLIOGRAPHY & APPENDIX 92-
100
INDUSTRY PROFILE :
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HISTORY OF THE STOCK BROKING INDUSTRY
Indian Stock Markets are one of the oldest in Asia. Its history dates back to
nearly 200 years ago.
In 1887, they formally established in Bombay, the "Native Share and Stock
Brokers' Association" (which is alternatively known as "The Stock Exchange"). In
1895, the Stock Exchange acquired a premise in the same street and it was
inaugurated in 1899. Thus, the Stock Exchange at Bombay was consolidated.
Thus in the same way, gradually with the passage of time number of exchanges
were increased and at currently it reached to the figure of 24 stock exchanges.
This was followed by the formation of associations /exchanges in Ahmadabad
(1894), Calcutta (1908), and Madras (1937).
In order to check such aberrations and promote a more orderly development of
the stock market, the central government introduced a legislation called the
Securities Contracts (Regulation) Act, 1956. Under this legislation, it is
mandatory on the part of stock exchanges to seek government recognition. As of
January 2002 there were 23 stock exchanges recognized by the central
Government. They are located at Ahmadabad, Bangalore, Baroda,
Bhubaneswar, Calcutta, Chennai,(the Madras stock Exchanges ), Cochin,
Coimbatore, Delhi, Guwahati, Hyderabad, Indore, Jaipur, Kanpur, Ludhiana,
Mangalore, Mumbai(the National Stock Exchange or NSE), Mumbai (The Stock
Exchange), popularly called the Bombay Stock Exchange, Mumbai
(OTCExchange of India), Mumbai (The Inter-connected Stock Exchange of
India), Patna, Pune, and Rajkot. Of course, the principle bourses are the National
Stock
Exchange and The Bombay Stock Exchange, accounting for the bulk of the
business done on the Indian stock market.
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BSE (BOMBAY STOCK EXCHANGE)
The Stock Exchange, Mumbai, popularly known as "BSE" was
established in 1875 as "The Native Share and Stock Brokers Association". It
is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was
established in 1878. It is the first Stock Exchange in the Country to have obtained
permanent recognition in 1956 from the Govt. of India under the Securities
Contracts (Regulation) Act, 1956.
A Governing Board having 20 directors is the apex body, which decides
the policies and regulates the affairs of the Exchange. The Governing Board
consists of 9 elected directors, who are from the broking comm
Unity (one third of them retire ever year by rotation), three SEBI nominees, six
public representatives and an Executive Director & Chief Executive Officer and a
Chief Operating Officer.
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NSE (NATIONAL STOCK EXCHANGE)
NSE was incorporated in 1992 and was given recognition as a stock
exchange in April 1993. It started operations in June 1994, with trading on the
Wholesale Debt Market Segment. Subsequently it launched the Capital Market
Segment in November 1994 as a trading platform for equities and the Futures
and Options Segment in June 2000 for various derivative instruments.
MCX (MULTI COMMODITY EXCHANGE)
MULTI COMMODITY EXCHANGE of India limited is a new order exchange
with a mandate for setting up a nationwide, online multi-commodity market place,
offering unlimited growth opportunities to commodities market participants. As a
true neutral market, MCX has taken several initiatives for users in a new
generation commodities futures market in the process, become the countrys
premier exchange.
MCX, an independent and a de-mutualized exchange since inception, is all
set up to introduce a state of the art, online digital exchange for commodities
futures trading in the country and has accordingly initiated several steps to
translate this vision into reality.
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NCDEX (NATIONAL COMMODITIES AND DERIVATIVESEXCHANGE)
NCDEX started working on 15th December, 2003. This exchange provides
facilities to their trading and clearing member at different 130 centers for contract.
In commodity market the main participants are speculators, hedgers and
arbitrageurs.
Facilities Provided By NCDEX
NCDEX has developed facility for checking of commodity and also
provides a wear house facility
By collaborating with industrial partners, industrial companies, news
agencies, banks and developers of kiosk network NCDEX is able to
provide current rates and contracts rate.
To prepare guidelines related to special products of securitization NCDEX
works with bank.
To avail farmers from risk of fluctuation in prices NCDEX provides special
services for agricultural.
NCDEX is working with tax officer to make clear different types of sales
and service taxes.
NCDEX is providing attractive products like weather derivatives
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STOCK MARKET BASIC
What are corporations?
Companies are started by individuals or may be a small circle of people.They pool their money or obtain loans, raising funds to launch the business.
A choice is made to organize the business as a sole proprietorship where one
Person or a married couple owns everything, or as a partnership with others who
may wish to invest money. Later they may choose to "incorporate". As a
Corporation, the owners are not personally responsible or liable for any debts of
the company if the company doesn't succeed. Corporations issue official-looking
sheets of paper that represent ownership of the company. These are called stock
certificates, and each certificate represents a set number of shares. The total
number of shares will vary from one company to another, as each makes its own
choice about how many pieces of ownership to divide the corporation into. One
corporation may have only 2,500 shares, while another, such as IBM or the Ford
Motor Company, may issue over a billion
Shares. Companies sell stock (pieces of ownership) to raise money and provide
funding for the expansion and growth of the business. The business founders
give up part of their ownership in exchange for this needed cash. The expectation
is that even though the owners have surrendered a portion of the company to the
Public, their remaining share of stock will become increasingly valuable as the
business grows. Corporations are not allowed to sell shares of stock on the open
Stock market without the approval of the Securities and Exchange Commission
(SEC). This transition from a privately held corporation to a publicly traded one is
Called going public, and this first sale of stock to the public is called an initial
public offering, or IPO.
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Why do people invest in the stock market?
When you buy stock in a corporation, you own part of that company. This gives
you a vote at annual shareholder meetings, and a right to a share of future profits.
When a company pays out profits to the shareholder, the money received is called
a "Dividend".
The corporation's board of directors choose when to declare a dividend and how
much to pay. Most older and larger companies pay a regular dividend, most newer
and smaller companies do not.
The average investor buys stock hoping that the stock's price will rise, so the
shares can be sold at a profit. This will happen if more investors want to buy stock
in a company than wish to sell. The potential of a small dividend check is of little
concern.
What is usually responsible for increased interest in a company's stock is the
prospect of the company's sales and profits going up.
A company who is a leader in a hot industry will usually see its share price rise
dramatically.
Investors take the risk of the price falling because they hope to make more money
in the market than they can with safe investments such as bank CD's or government
bonds.
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What is a stock market index?
In the stock market world, you need a way to compare the movement of the
market, up and down, from day to day, and from year to year. An index is just a
benchmark or yardstick expressed as a number that makes it possible to do this
comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index
of BSE.
The price per share, like the market cap, has nothing to do with how big a
company is.
The Securities Market consists of two segments, viz. Primary market and
Secondary market. Primary market is the place where issuers create and issue
equity, debt or hybrid instruments for subscription by the public; the Secondary
market enables the holders of securities to trade them.
Secondary market essentially comprises of stock exchanges, which provide
platform for purchase and sale of securities by investors. In India, apart from
the Regional Stock
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Exchanges established in different centers, there are exchanges like the
National Stock Exchange (NSE) and the Over the Counter Exchange of India
(OTCEI), who provide nation wide trading facilities with terminals all over the
country. The trading platform of stock exchanges is accessible only through
brokers and trading of securities is confined only to stock exchanges.
Corporate Securities :
The no of stock exchanges increased from 11 in 1990 to 23 now. All the
exchanges are fully computerized and offer 100% on-line trading. 9644
companies were available for trading on stock exchanges at the end of March
2002. The trading platform of the stock exchanges was accessible to 9687
members from over 400 cities on the same date.
Derivatives Market :
Derivatives trading commenced in India in June 2000. The total exchange traded
derivatives witnessed a volume of Rs. 442,343 crore during 2002-03 as against Rs.
4018 crore during the preceding year. While NSE accounted for about 99.5% of
total turnover, BSE accounted for about 0.5% in 2002-03. The market witnessed
higher volumes from June 2001 with introduction of index options, and still higher
volumes with introduction of stock options in July 2001. There was a spurt in
volumes in November 2001 when stock futures were introduced. It is believed
that India is the largest market in the world for stock futures.
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Supply and Demand
A stock's price movement up and down until the end of the trading day is strictly
a result of supply and demand. The SUPPLY is the number of shares offered
for sale at anyone one moment. The DEMAND is the number of shares
investors wish to buy at exactly that same time. What a share of a company is
worth on anyone day or at any one minute, is determined by all investors voting
with their money. If investors want a stock and are willing to pay more, the price
will go up. If investors are selling a stock and there aren't enough buyers, the
price will go down Period.
S econdary Market Intermediaries
Stock brokers, sub-brokers, portfolio managers, custodians, share transfer
agents constitute the important intermediaries in the Secondary Market.
No stockbrokers or sub-brokers shall buy, sell or deal in securities unless he holds
a certificate of registration granted by SEBI under the Regulations made by SEBI
ion relation to them.
The Central Government has notified SEBI (Stock Brokers & Sub-Brokers) Rules,
1992 in exercise of the powers conferred by section 29 of SEBI Act, 1992. These
rules came into effect on 20th August, 1992.
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Trading Through Brokers / Traditional Method of ShareTrading:-
Trading in the stock exchange can be conducted only through member broker in
securities that are listed on the respective exchange. Investor intending tobuy/sell securities in the exchange has to do so only through a SEBI registered
broker/sub-broker. This is very popular concept in India for Share Trading before
the facilities like on line trading introduce.
Both the exchange have switched over from the open outcry trading system to
fully automated computerized mode of trading knows as Bolt and Neat. In this
system, the broker trade with each other through the computer network. Buyers
and sellers place their orders specifying the limits for quality and price. Those
that are not matched remain on the screen and is opened for future matching
during the day / settlement. After the advent of computerized trading the speed of
trading has increased multi-fold and a fuller view of the market is available to the
investors.
To start dealing with broker you have to fill a form with the broker. After fill all the
formalities the firm gives you a User Id no like a bank a/c no. through which you
can enter in the transaction with broker. Broker will gives all the which one
investor needed.
What is stock Broker?
A stock broker is one who invests other peoples money until its all
gone.
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-Woody Allen, American Film Maker
A stock broker is a person or a firm that trades on its clients behalf, you tell
them what you want to invest in and they will issue the buy or sell order. Somestock brokers also give out financial advice that you a charged for.
It wasnt too long ago and investing was very expensive because you had to go
through a full service broker which would give you advice on what to do and
would charge you a hefty fee for it.
There are three different types of stock brokers.
1. Full Service Broker - A full-service broker can provide a bunch of
services such as investment research advice, tax planning and retirement
planning.
2. Discount Broker A discount broker lets you buy and sell stocks at a low
rate but doesnt provide any investment advice.
3. Direct-Access Broker- A direct access broker lets you trade directly with
the electronic communication networks (ECNs) so you can trade faster.
Active traders such as day traders tend to use Direct Access Brokers
No. of stock broker in India9368:- Total no of share broker in the country
12687:- The no. of sub-broker.
46%:- The share of trades accounted for by NSE broker
90%: The share of On line trades clocked by segments top five companies
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Generally there are two types of trading have been done in India which is given
below:
On line Trading / E Broking / Modern Method
Trading through Brokers / Traditional method of Share trading.
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ABOUT ANAND RATHI
INTRODUCTION:-
Anand Rathi is a leading full service investment bank founded in 1994 offering a
wide range of financial services and wealth management solutions t institutions,
corporations, highnet worth individuals and families. The firm has rapidly
expanded its footprint to over 350 locations across India with international
presence in Dubai ,Hong Kong & New York. Founded by Mr. Anand Rathi and
Mr. Pradeep Gupta,the group today employs over 2,500 professionals through
out India and its international offices.
The firms philosophy is entirely client centric, with a clear focus
on providing long Term value addition to clients, while maintaining the highest
standards of excellence, Ethics and professionalism. The entire firm activities are
divided across distinct client groups: Individuals, Private Clients, Corporates and
Institutions. AnandRathi has been named The Best Domestic Private Bank in
India by Asiamoney in their Fifth Annual Private Banking Poll 2009. The firm has
emerged a winner across all key segments in Asiamoneys largest survey of highnet worth individuals in India.
The firms philosophy is entirely client centric, with a clear focus on
providing long Term value addition to clients, while maintaining the highest
standards of excellence, Ethics and professionalism. The entire firm activities are
divided across distinct client groups: Individuals, Private Clients, Corporates and
Institutions. AnandRathi has been named The Best Domestic Private Bank inIndia by Asiamoney in their Fifth Annual Private Banking Poll 2009. The firm has
emerged a winner across all key segments in Asiamoneys largest survey of
high net worth individuals in India.
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ANAND RATHI consultant
As the flagship company of the ANAND RATHI Group, ANAND RATHI Private
Limited has always remained at the helm of organizational affairs, pioneering
business policies, work ethic and channels of progress.
ANAND RATHI believe that they were best positioned to venture into that activity
as a Depository Participant. They were one of the early entrants registered asDepository Participant with NSDL (National Securities Depository Limited), the
first Depository in the country and then with CDSL (Central Depository Services
Limited). Today, It service over 1Lac customer accounts in this business spread
across over 350 cities/towns in India and are ranked amongst the largest
Depository Participants in the country. With a growing secondary market
presence.
It has transferred this business to ANAND RATHI SECURITIES LIMITED
(ARSL), their associate and a member of NSE, BSE, MCX & NCDEX.
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Business Focus:-
The focus of the business is the Customer Customer service, Customer
education, Customer support, Customer relations and last but not the least
Customer acquisition. Trade execution transparency, timely settlements, riskmonitoring and superior service shall have topmost priority, in the best interests
of all concerned.
VISION STATEMENT
TO BE A SHINING EXAMPLE AS A LEADER IN
INNOVATIONPROFESSIONALLY
MISSION STATEMENT
TO WORK TOGETHER WITH INTEGRITY & MAKE OUR
CUSTOMER FEEL VALUED
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CORE VALUE
RESPECT OUR COLLEAGUE AND THE BUSINESS ITSELF
Board of DirectorsOf
ANAND RATHI GROUP
NAME POSITION
Mr. Anand Rathi Founder & chairman
Mr. Pardeep Gupta Co- Founder & vice chairman
Mr. Amit Rathi Managing Director
Mr. P G Kakodkar Director
Dr. S A Dave Direcror
Mr. C D Arha Director
Mr. Ajit Bhushan Director
Mr. Rakesh Rawal National Head-Welth management
Mr.Sujan Hajra Chief Economist
Mr.Roy Rodrigues CEO
Mr.Puspen Karmakar Vice President
Ms. Rajni Raikar Vice President
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Principal Activities OfPrincipal Activities OfANAND RATHI GROUP
ANAND RATHI Securities Private Limited
Member : National Stock Exchange of India Limited
Member : Bombay Stock Exchange Limited
Participant : National Securities Depository Limited
Participant : Central Depository Service (India) Limited
ANAND RATHI Commodities Private Limited
Member - Multi Commodity Exchange of India Limited
Member - National Commodities and Derivatives Exchange
Ltd.
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ANAND RATHI Profile
REGISTERED OFFICE
MUZAFFARNAGAR BRANCH
24
11th Floor, Times Tower KamalaCity Senapati Bapat Marg, Lower
Parel., Mumbai - 400013, India
39-A New Mandi,Muzaffarnagar-251001PH. 0131-2605572,2600343,3291199FAX. 0131-2605571
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Organization Chart:-
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Anand Rathi
FranchiseBranch
WebDealer
SalesExecutive
SalesCoordinator
CustomerCare
Receptionist
Account Head
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ANAND RATHIs CORE SERVICES:-
ANAND RATHI is one of Indias leading broking houses providing a complete
life-cycle of investment solution.
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EQUITIES
DERIVATIVES
COMMODITIES
Research BasedInvestment Advice
Investment andTrading Services
Integrated DematFacility
Technology BasedInvestment Tools
Training andSeminars
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SWOT
Analysis
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Strength:-
16 years of research and broking experience
Understandings of the markets
All financial needs under one roof
Scalable and robust infrastructure
Full fledge research unit comprising of both fundamental & technical
research
Dedicated, Qualified and Loyal staff
Flexible Brokerage charges
Weakness:-
Low Brand Image in the market.
Low Professionalism
Low Advertisements
Opportunity:-
Large potential market for delivery and intra-day transactions.
Open interest of the people to enter in to stock market for investing
Attract the customers who are dissatisfied with other brokers & DPs.
Up growing markets in commodity and forex trading
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Threats:-
Decreasing rates of brokerage in the market. A Increasing competition
against other brokers & DPs.
Poor marketing activities for making the company known among the
customers. A threat of loosing clients for any kind of weakness of the
company. An Indirect threat from instable stock market, i.e., low/no profit
of ANAND RATHI's clients would lead them to go for other broker/DP.
SERVICES of ANAND RATHI
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OFFLINE
Offline A/c is the A/c for the investors who are
not familiar with the use of computer.
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ANAND RATHIs Services
Offline
Online
Other Services
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The A/C opening charges applied(One time)
.
Onlin e Account
Requirement for online trading
Linked Bank Account
Broking Account
Linked Depository Account
Benefits of online tradingFreedom from paperwork
Instant credit and transfer
Trade Anywhere
Timely Advice and access to research
Real-time portfolio tracking
After hour orders
Market Alerts
Instant quotes
Other Services:
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Dial-n-Trade
Mutual Fund
Commodity
Derivative
Depository Participants
Distribution of Financial Services
Research Based Advices
Portfolio Management System
DnT (Dial- n Trade )
Dial n Trade is the name of the phone-trading facility offered by ANAND
RATHI.
A call center wholly dedicated to order placement / confirmation.
Easy 2-step process for order placement.
Step1. Enter the phone no. of branch
Step2. And say your client code
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ANAND RATHI Securities Private Limited, one of the cornerstones of the ANAND
RATHI edifice, flows freely towards attaining diverse goals of the customer
through varied services. Creating a plethora of opportunities for the customer by
opening up investment vistas is backed by research-based advisory services.
Here, growth knows no limits and success recognizes no boundaries. Helping the
customer create waves in his portfolio and empowering the investor completely is
the ultimate goal.
Stock Broking Services
We offer trading on a vast platform; National Stock Exchange, Bombay Stock
Exchange, MCX & NCDEX. More importantly, we make trading safe to the
maximum possible extent, by accounting for several risk factors and planning
accordingly. We are assisted in this task by our in-depth research, constant
feedback and sound advisory facilities. Our highly skilled research team,
comprising of technical analysts as well as fundamental specialists, secure
result-oriented information on market trends, market analysis and market
predictions.
To empower the investor further we have made serious efforts to ensure that our
research calls are disseminated systematically to all our stock broking clients
through various delivery channels like email, chat, SMS, phone calls etc.
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MUTUAL FUNDS
Meaning:
A mutual fund is a pool of money that is invested according to a common
investment objective by an asset management company (AMC). The AMC offers
to invest the money of hundreds of investors according to a certain objective - to
keep money liquid or give a regular income or grow the money long term.
Investors buy a scheme if it fits in with their investment goals, like getting a
regular income now or letting the money accumulate over the long term.
Investors pay a small fraction of their total funds to the AMC each year as
investment management fees.
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Introduction:
Everybody talks about mutual funds, but what
exactly are they? Are they like shares in a company,
or are they like bonds and fixed deposits? Will I lose
all my money in funds or will I become an overnight
millionaire? Big questions that get answer in just five
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Commodity
Organized futures market evolved in India by the setting up of "Bombay Cotton
Trade Association Ltd." in 1875. In 1893, following widespread
discontent amongst leading cotton mill owners and
merchants over the functioning of the Bombay Cotton Trade Association,
a separate association by the name "Bombay Cotton Exchange Ltd." was
constituted. A future trading in oilseeds was organized in India for the first time
with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures
trading in groundnut, castor seed and cotton. Before the Second World War
broke out in 1939 several futures markets in oilseeds were functioning in Gujarat
and Punjab.
There were booming activities in this market and at one time as many as 110
exchanges were conducting forward trade in various commodities in the country.
The securities market was a poor cousin of this market as there were not many
papers to be traded at that time.
The era of widespread shortages in many essential commodities resulting in
inflationary pressures and the tilt towards socialist policy, in which the role of
market forces for resource allocation got diminished, saw the decline of this
market since the mid-1960s.
This coupled with the regulatory constraints in 1960s, resulted in virtual
dismantling of the commodities future markets. It is only in the last decade that
commodity future exchanges have been actively encouraged. However, the
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markets have been thin with poor liquidity and have not grown to any significant
level.
Derivative
The emergence of the market for derivative products, most notably forwards, futures
and options, can be traced back to the willingness of risk-averse economic agents to
guard themselves against uncertainties arising out of fluctuations in asset prices. By
their very nature, the financial markets are marked by a very high degree of volatility.
Through the use of derivative products, it is possible to partially or fully transfer
price risks by locking-in asset prices. As instruments of risk management,
these generally do not influence the fluctuations in the underlying asset prices.
However, by locking-in asset prices, derivative products minimize the impact of
fluctuations in asset prices on the profitability and cash flow situation of risk-averse
investors.
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Depository Participants
The onset of the technology revolution in financial services Industry saw the
emergence of ANAND RATHI as an electronic custodian registered with
National Securities Depository Ltd (NSDL) and Central Securities
Depository Ltd (CSDL). ANAND RATHI set standards enabling further
comfort to the investor by promoting paperless trading across the country and
emerged as the top 3 Depository Participants in the country in terms of
customer serviced.
Offering a wide trading platform with a dual membership at both NSDL and
CDSL, we are a powerful medium for trading and settlement of dematerialized
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Shares. We have established live DPMs, Internet access to accounts and an
easier transaction process in order to offer more convenience to individual and
Corporate investors. A team of professional and the latest technological expertise
allocated exclusively to our demat division including technological enhancements
like SPEED-e; make our response time quick and our delivery impeccable. A
wide national network makes our efficiencies accessible to all.
About ANAND RATHI:
Depository participant with both NSDL and CDSL
Over 25 thousands clients being serviced from over 135 cities.
Web enabled service to provide state of the art service delivery
Distribution of Financial Products
The paradigm shift from pure selling to knowledge based selling drives the
business today. With our wide portfolio offerings, we occupy all segments in the
retail financial services industry.
A 1600 team of highly qualified and dedicated professionals drawn from the best
of academic and professional backgrounds are committed to maintaining highlevels of client service delivery.
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This has propelled us to a position among the top distributors for equity and debt
issues with an estimated market share of 15% in terms of applications mobilized,
besides being established as the leading procurer in all public issues.
To further tap the immense growth potential in the capital markets we enhanced
the scope of our retail brand, thereby providing planning and advisory services to
the mass affluent. Here we understand the customer needs and lifestyle in the
context of present earnings and provide adequate advisory services that will
necessarily help in creating wealth. Judicious
Planning that is customized to meet the future needs of the customer deliver a
service that is exemplary. The market-savvy and the ignorant investors, both find
this service very satisfactory. The edge that we have over competition is our
portfolio of offerings and our professional expertise. The investment planning for
each customer is done with an unbiased attitude so that the service is truly
customized.
Our monthly magazine, Finapolis, provides up-dated market information on
market trends, investment options, opinions etc. Thus empowering the investor to
base every financial move on rational thought and prudent analysis and embark
on the path to wealth creation.
About ANAND RATHI :
Investments
Equity Primary and Secondary
Fixed Income Primary and Secondary
Fixed Deposits
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Mutual Funds
Insurance
Life : LIC, Amp Sanmar, HDFC Standard, ICICI Prulife, Om
Kotak, MetLife, Tata AIG, Birla Sun life
General : New India, Tata AIG, Reliance, Royal Sundaram
Portfolio Management System
The company has initiated the process of obtaining permission from SEBI for
rendering PMS Service to its clients. We are planning to start PMS Service to
High Net Worth individual and NRIs after obtaining the necessary regulatory
clearances.
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THEORETICAL ASPECT
INTRODUCTION:
According to dictionary, derivative means something which is derived
from another source. Therefore, derivative is not primary, and hence notindependent. In financial terms, derivative is a product whose value is derived
from the value of one or more basic variables. These basic variable are called
bases, which may be value of underlying asset, a reference rate etc. the
underlying asset can be equity, foreign exchange, commodity or any asset.
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For example: - the value of any asset, say share of any company, at a
future date depends upon the shares current price. Here, the share is
underlying asset, the current price of the share is the bases and the future value
of the share is the derivative. Similarly, the future rate of the foreign exchange
depends upon its spot rate of exchange. In this case, the future exchange rate is
the derivative and the spot exchange rate is the base.
Derivatives are contract for future delivery of assets at price agreed at the
time of the contract. The quantity and quality of the asset is specified in the
contract. The buyer of the asset will make the cash payment at the time of
delivery.
Meaning:
Derivatives are the financial contracts whose value/price is dependent on
the behavior of the price of one or more basic underlying assets (often simply
known as the underlying). These contracts are legally binding agreements,
made on the trading screen of stock exchanges, to buy or sell an asset in future.
The asset can be a share, index, interest rate, bond, rupee dollar exchange rate,
sugar, crude oil, soybean, cotton, coffee etc.
In the Indian Context the Security Contracts (Regulation) Act, 1956
(SC(R) A) defines derivative to include
A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or other form of security.
A contract, which derives its value from the prices, or index of prices of
underlying securities.
43
Contracts agreement
Cash Derivatives
Forward Others likeSwaps, FRAs etc
Merchandising,
customized
Futures
(Standardized
)
Options
NTSD TSD
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In financial terms derivatives is a broad term for any instrumental whose value is
derived from the value of one more underlying assets such as commodities,
forex, precious metal, bonds, loans, stocks, stock indices, etc.
Derivatives were developed primarily to manage offset, or hedge against
risk but some were developed primarily to provide potential for high returns. In
the context of equity markets, derivatives permit corporations and institutional
Investors to effectively manage their portfolios of assets and liabilitiesthrough instrument like stock index futures.
For example: - The price of Reliance Triple Option Convertible Debentures
(Reliance TOCD) used to vary with the price of Reliance shares. In addition, the
price of Telco warrants depends upon the price of Telco shares. American
Depository receipts / Global Depository receipts draw their price from the
underlying shares traded in India.
Nifty options and futures. Reliance futures and options, are the most common
and popular form of derivatives.
Although trading in agriculture and other commodities has been the
deriving force behind the development of derivatives exchanges, the demand for
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products based on financial instruments such as bond, currencies, stocks and
stock indices have now for outstripped that for the commodities contracts.
The history of the derivatives dates back to the time since the trading
came into being. The merchants entered into contracts with one another for
future delivery of specified amount of commodities at specified price. A primary
intention for contracting for future date was to keep the transaction immune to
unexpected fluctuations in price.
Therefore, derivative products initially emerged as hedging devices
against fluctuations in commodity prices. However, the concept applied to
financial trade only in the post-1970 period due to growing instability in the
financial markets. However, since their emergence, these products have
become very popular and by 1990s, they accounted for about two-third of the
total transaction in derivative products.
In recent years, the market for financial derivatives has grown tremendously
in terms of variety of instruments available, their complexity and turnover.
In the class of equity derivatives the world over, futures and options on stock
indices have gained more popularity than on individual stocks, especially among
institutional investors, who are major users of index-linked derivatives.
Even small investors find these useful due to high correlation of the
popular indexes with various portfolios and ease of use.
Early forward contracts in the US addressed merchants concerns about
ensuring that there were buyers and sellers for commodities. However credit
risk remained a serious problem.
1848
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A group of Chicago businessmen formed the Chicago Board of Trade
(CBOT). The primary intention of the CBOT was to provide a centralized location
known in advance for buyers and sellers to negotiate forward contracts.
1865
The CBOT went one-step further and listed the first exchange traded
derivatives contract in the US; these contracts were called future contracts
1919
Chicago Butter and Egg & board, a spin-off of CBOT, was reorganized to
allow futures trading. Its name was changed to Chicago Mercantile Exchange
(CME).
The CBOT and the CME remain the two largest organized futures
exchanges, indeed the two largest financial exchanges of any kind in the world
today.
The first stock index futures contract was traded at Kansas City Board of
Trade. Currently the most popular stock index futures contract in the world was
based on S&P 500 index, traded on Chicago Mercantile Exchange.
During the mid eighties, financial futures became the most active
derivatives instruments generating volumes many times more than the
Commodity futures. Index futures, futures on T-Bills and Euro-Dollarfutures are the three most popular future contracts traded today. Other popular
international exchanges that trade derivatives are LIFFE in England, DTB in
Germany, SGX in Singapore, TIFFE in Japan, and MATIF in France, Eurex, etc.
India has been trading derivatives contract in silver, gold, spices, coffee,
cotton, etc for decades in the gray market. Trading derivatives contracts in
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organized market was legal before Moorage Desais government banned
forward contracts.
Derivatives on stocks were traded in the form of Teji and Mandi in
unorganized on exchanges. For example, now cotton and oil futures trade in
Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee in
Bangalore, etc.
JUNE 2000
National Stock Exchange and Bombay Stock Exchange started trading in
futures on Sensex and Nifty. Options trading on Sensex and
Nifty commenced in June 2001. Very soon thereafter trading began on options
and futures in 31 prominent stocks in the month of July and November
respectively.
Option and future are the most commonly traded derivatives, but as the
understanding of financial markets and risked management continued to
improve newer derivatives were created. The family includes the host of other
product such as forward contracts. Structured notes, inverse floaters, caps &
Floors and Collar Swaps.
The largest derivatives market in the world, are on government bonds (to
help control interest rate risk) the stock index (to help control risk that is
associated with the fluctuations in the stock market) and on exchange rates (to
cope with currency risk).
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Risk Associated With Derivatives:
While derivatives can be used to help manage risks involved ininvestments, they also have risks of their own. However, the risks involved in
derivatives trading are neither new nor unique they are the same kind of
risks associated with traditional bond or equity instruments.
Market Risk
Derivatives exhibit price sensitivity to change in market condition, such as
fluctuation in interest rates or currency exchange rates. The market risk of
leveraged derivatives may be considerable, depending on the degree of
leverage and the nature of the security.
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Liquidity Risk
Most derivatives are customized instrument and could exhibit substantial
liquidity risk implying they may not be sold at a reasonable price within a
reasonable period. Liquidity may decrease or evaporate entirely during
unfavorable markets.
Credit Risk
Derivatives not traded on exchange are traded in the over-the-counter
(OTC) market. OTC instrument are subject to the risk of counter party defaults.
Hedging Risk
Several types of derivatives, including futures, options and forward are
used as hedges to reduce specific risks. If the anticipated risks do not develop,
the hedge may limit the funds total return.
FUNCTION OF DERIVATIVES MARKET:-
The derivative market performs a number of economic functions:-
Prices in an organized derivatives market reflect the perception of market
participants about the future and lead the prices of underlying to the
perceived future level. The prices of derivative converge with the prices of
the underlying at the expiration of the derivative contract. Thus,
derivatives help in discovery of future as well as current prices.
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The derivatives market helps to transfer risks from those who have them
but may not like them to those who have an appetite for them.
Derivatives, due to their inherent nature, are linked to the underlying cash
market. With the introduction of the derivatives, the underlying market
witnesses higher trading volumes because of the participation by more
players who would not otherwise participate for lack of arrangement to
transfer risk.
Speculative trades shift to a more controlled environment of derivatives
market. In the absence of an organized derivative market, speculators
trade in the underlying cash market.
An important incidental benefit that flows from derivatives trading is that it
acts as a catalyst for new entrepreneurial activity.
The derivatives have a history of attracting many bright, creative, well-
educated people with an entrepreneurial attitude. They often energize
others to create new businesses, new products and new employment
opportunities, the benefit of which are immense.
Derivatives markets help increase savings and investment in the end.
Transfer of risk enables market participants to expand their volumes of
activity.
PARTICIPANTS OF THE DERIVATIVE MARKET:-
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Market participants in the future and option markets are many and they
perform multiple roles, depending upon their respective positions. A trader acts
as a hedger when he transacts in the market for price risk management. He is a
speculator if he takes an open position in the price futures market or if he sells
naked option contracts. He acts as an arbitrageur when he enters in to
simultaneous purchase and sale of a commodity, stock or other asset to take
advantage of mispricing. He earns risk less profit in this activity. Such
opportunities do not exist for long in an efficient market. Brokers provide
services to others, while market makers create liquidity in the market.
Hedgers
Hedgers are the traders who wish to eliminate the risk (of price change) to
which they are already exposed. They may take a long position on, or short sell,
a commodity and would, therefore, stand to lose should the prices move in the
adverse direction.
Speculators
If hedgers are the people who wish to avoid the price risk, speculators are
those who are willing to take such risk. These people take position in the market
and assume risk to profit from fluctuations in prices. In fact, speculators
consume information, make forecasts about the prices and put their money in
these forecasts. In this process, they feed information into prices and thus
contribute to market efficiency. By taking position, they are betting that a price
would go up or they are betting that it would go down.
The speculators in the derivative markets may be either day trader or
position traders. The day traders speculate on the price movements during one
trading day, open and close position many times a day and do not carry any
position at the end of the day.
They monitor the prices continuously and generally attempt to make profit
from just a few ticks per trade. On the other hand, the position traders also
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attempt to gain from price fluctuations but they keep their positions for longer
durations may is for a few days, weeks or even months.
ArbitrageursArbitrageurs thrive on market imperfections. An arbitrageur profits by
trading a given commodity, or other item, that sells for different prices in different
markets. The Institute of Chartered Accountant of India, the word ARBITRAGE
has been defines as follows:-
Simultaneous purchase of securities in one market where the price there
of is low and sale thereof in another market, where the price thereof is
comparatively higher. These are done when the same securities are being
quoted at different prices in the two markets, with a view to make profit and
carried on with conceived intention to derive advantage from difference in
prices of securities prevailing in the two different markets
Thus, arbitrage involves making risk-less profits by simultaneously
entering into transactions in two or more markets.
TYPES OF DERIVATIVES:-
The most commonly used derivatives contracts are Forward, Futures and
Options. Here some derivatives contracts that have come to be used are
covered.
FORWARD:-
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A forward contract is a customized contract between two entities,
where settlement takes place on a specific date in the future at todays pre-
agreed price.
FUTURES :-
A futures contact is an agreement between two parties to buy or sell
an asset at a certain time in the future at a certain price. Futures contracts
are special types of forward contracts in the sense that the former are
standardized exchange-traded contracts.
For example :- A, on 1 Aug. agrees to sell 600 shares of Reliance Ind.
Ltd. @ Rs. 450 to B on 1 st sep.
A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd. @ Rs. 450 to B on
1st Sep.
OPTIONS:-
Options are a right available to the buyer of the same, to purchase or
sell an asset, without any obligation. It means that the buyer of the option can
exercise his option but is not bound to do so. Options are of 2 types: calls
and puts.
1. CALLS :-
Call gives the buyer the right, but not the obligation, to buy a given
quantity of the underlying asset, at a given price, on or before a given future
date.
For example :- A, on 1 st Aug. buys an option to buy 600 shares of Reliance Ind.
Ltd. @ 450 Rs 450 on or before 1 st Sep. In this case, A has the right to buy the
shares on or before the specified date, but he is not bound to buy the shares.
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2. PUTS :-
Put gives the buyer the right, but not the obligation, to sell a given
quantity of the underlying asset, at a given price, on or before a given date.
For example :- A, on 1st Aug. buys an option to sell 600 shares of
Reliance Ind. Ltd. @ Rs 450 on or before 1 st Sep. In this case, A has the right
to sell the shares on or before the specified date, but he is not bound to sell
the shares.
In both the types of the options, the seller of the option has an
obligation but not a right to buy or sell an asset. His buying or selling of an
asset depends upon the action of buyer of the option. His position in both the
type of option is exactly the reverse of that of a buyer.
WARRANTS :-
Options generally have lives of up to one year, the majority of optionsexchanges having a maximum maturity of nine months. Longer-dated options
are called warrants and are generally traded over-the-counter.
LEAPS :-
The acronym LEAPS means Long-Term Equity Anticipation Securities.
These are options having a maturity of up to three years.
BASKET :-
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Basket options are options on portfolios of underlying assets are
usually a moving average of a basket of assets. Equity index options are a
form of basket options.
SWAPS :-
Swaps are private agreement between two parties to exchange cash
flows in the future according to a pre arranged formula. They can be
regarded as portfolios of forward contract. The two commonly used swaps
are as followas:
1.)INTEREST RATE SWAPS:-
These entail swapping only the interest related cash flows between
the parties in the same currency.
2.)CURRENCY SWAPS:-
These entail swapping both principal and interest between the parties,
with the cash flows in one direction being in a different currency than those inthe opposite direction.
SWAPTIONS :-
Swaptions are options to buy or sell a swap that will become operative
at the expiry of the options. Thus, a swaptions is an option on a forward
swap. Rather than have calls and puts, the swaptions market has receiver
swaptions and payer swaptions. A receiver swaptions is an option to receive
fixed and pay floating. A payer swaptions is an option to pay fixed and
receive floating Out of the above-mentioned types of derivatives forward.
EMERGENCE OF THE DERIVATIVE TRADING IN INDIA
Approval For Derivatives Trading
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The first step towards introduction of derivatives trading in India was
the promulgation of the Securities Laws (Amendment) Ordinance, 1995,
which withdrew the prohibition on options in securities. The market for
derivatives, however, did not take off, as there was no regulatory framework
to govern trading of derivatives. SEBI set up a 24 member committee under
the chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India.
The committee submitted its report on March 17, 1998 prescribing
necessary pre-conditions for introduction of derivatives trading in India.
The committee recommended that derivatives should be declared as
securities so that regulatory framework applicable to trading of securities
could also govern trading of securities. SEBI also set up a group in June
1998 under the chairmanship of Prof. J.R.Verma, to recommend measures
for risk containment in derivative market in India.
The repot, which was submitted in October 1998, worked out the
operational details of margining system, methodology for charging initial
margins, broker net worth, deposit requirement and real - time monitoring
requirements.
The SCRA was amended in December 1999 to include derivatives
within the ambit of securities and the regulatory framework were developed
for governing derivatives trading. The act also made it clear that derivatives
shall be legal and valid only if such contracts are traded on
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a recognized stock exchange, thus precluding OTC derivatives. The
government also rescinded in March 2000, the three decade old
notification, which prohibited forward trading in securities.
Derivatives trading commenced in India in June 2000 after SEBI
granted the final approval to this effect in May 2000. SEBI permitted the
derivative segment of two stock exchanges, NSE and BSE, and their clearing
house/corporation to commence trading and settlement in approved
derivatives contract.
To begin with, SEBI approved trading in index future contracts based
on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by
approval for trading in options based on these two indices and options on
individual securities. The trading in index options commenced in June 2001.
Futures contracts on individual stocks were launched in November
2001. Trading and settlement in derivatives contracts is done in accordance
with the rules, byelaws, and regulations of the respective exchanges and
their clearing house/corporation duly approved by SEBI and notified in the
official gazette.
INTRODUCTION TO FORWARDS;-
Forward Contracts
A forward contract is an agreement to buy or sell an asset on a
specified date for a specified price. One of the parties to the contract
assumes a long position and agrees to buy underlying asset on a certain
specified future date for a certain specified price. The other party
assumes a short position and agrees to sell the asset on the same date
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for the same price. The parties to the contract negotiate other contracts
details like delivery date, price, and quantity bilaterally. The forward
contracts are normally traded outside the exchanges.
Salient features of forward contracts are as follows:-
They are bilateral contracts and hence exposed to counter party risk.
Each contract is custom designed, and hence is unique in terms of contract
size, expiration date and the asset type and quality.
The contract price is generally not available in public domain.
On the expiration date, the contract has to be settled by delivery of the asset.
If the party wishes to reverse the contract, it has to compulsorily go to the
same counter party, which often results in high prices being charged.
Limitation of forward market
Forward market worldwide is affected by several problems:-
Lack of centralization.
Illiquidity.
Counter party risk.
In the first two of these, the basic problem is that of too much flexibility
and generality. The forward market is like a real estate market in that any two
consenting adults can form contracts against each other. This often makes
them design terms of the deal, which are very convenient in that specific
situation, but makes the contract non-tradable.
Counter party risk arises from the possibility of default by any oneparty to the transaction. When one of the two sides to the transaction
declares bankruptcy, the other suffers. Even when forward markets trade
standardized contracts, and hence avoid the problem illiquidity, the counter
party risk remains a very serious.
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INTRODUCTION TO FUTURES:-
Future contract is specie of forward contract. Futures are exchange-traded
contracts to sell or buy standardized financial instruments or physical
commodities for delivery on a specified date at an agreed price. Futures
contracts are used generally for protecting against rich of adverse price
fluctuations (hedging). As the terms of contracts are standardized, these are
generally not used for merchandizing purpose.
The standardized items in a futures contract are:
Quantity of the underlying.
Quality of the underlying.
The date and month of delivery.
The units of price quotation and minimum price change.
Location of settlement.
Futures contract performs two important functions of price discovery
and price risk management with reference to the given commodity. It is useful
to all segment of economy. It is useful to the producer because investor can
get an idea of the price likely to prevail at a future point of time and therefore
can decide between various competing commodities, the best that suits him.
It enables the consumer get an idea of the price at which the commodity
would be available at a future point of time.
He can do proper costing and cover his purchases by making forward
contracts. The future trading is very useful to the exporters as it provides an
advance indication of the price likely to prevail and thereby help the exporter
in quoting a realistic price and thereby secure export contract in a
competitive market.Having entered into an export contract, it enables him to hedge his risk
by operating in futures market .
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Other benefits of futures trading are:
Price stabilization in time of violent price fluctuations- this mechanism
dampens the peaks and lifts up the valleys i.e. the amplitude of price
variation is reduced.
Leads to integrated price structure throughout the country.
Facilitates lengthy and complex, production and manufacturing activities.
Helps balance in supply and demand position throughout the year.
Encourages competition and acts as a price barometer to farmers and
other trade functionaries.
FEATURE FORWARD CONTRACT FUTURE CONTRACT
OperationalMechanism
Traded directly between twoparties (not traded on theexchanges).
Traded on theexchanges.
ContractSpecifications
Differ from trade to trade. Contracts arestandardized contracts.
Counter-partyrisk Exists. Exists. However,assumed by theclearing corp., whichbecomes the counterparty to all the tradesor unconditionallyguarantees their settlement.
LiquidationProfile
Low, as contracts are tailormade contracts catering tothe needs of the needs of the
parties.
High, as contracts arestandardized exchangetraded contracts.
Price discovery Not efficient, as markets arescattered.
Efficient, as marketsare centralized and allbuyers and sellerscome to a commonplatform to discover theprice.
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Margins
The margining system is based on the J R Verma committee
recommendations. The actual margining happens on a daily basis while onlineposition monitoring is done on an intra day basis. Daily margining is of two
types:
1. Initial margins.
2. Mark-to market profit/loss.
The computation of initial margin on the futures market is done using the
concept of Value-at-risk (VaR). The initial margin amount is large enough to
cover a one-day loss that can be encountered on 99% of the days.
VaR methodology seeks to measure the amount of value that a portfolio
may stand to lose within certain horizon period (one day for the clearing
corporation) due to potential changes in the underlying asset market price.
Initial margin amount computed using VaR is collected up-front. The daily
settlement process called mark-to-market provides for collection of losses that
have already occurred (historic losses) whereas initial margin seeks to
safeguard against potential losses on outstanding positions. The mark-to-market
settlement is done in cash.
Settlement of Future Contract:-
Futures contract has two types of settlement, the MTM settlement, which
happens on a continuous basis at the end of each day, and the final settlement,which happens on the last trading day of the futures contract.
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i. MTM Settlement
All futures contact for each member is marked-to-market (MTM) to the
daily settlement price of the relevant futures contract at the end of each day. The
profits/losses are computes as a difference between:
1. The trade price and the days settlement price for contracts executed during
the day but not squared up.
2. The previous days settlement price and the current days settlement price for
brought forward contracts.
The buy price and the sell price for the contracts executed during the day
and squared up. The clearing members (CMs) who have a loss are required to
pay the mark-to-market (MTM) loss amount in cash which is in, turn passed on
to the CMs who have made a MTM profit. This is known as daily mark-to-market
settlement. CMs are responsible to collect and settle the daily MTM
profits/losses incurred by the Trading members (TMs) and their clients clearing
and settling through them. Similarly, TMs are responsible to
collect/pay/losses/profits from/to their clients by the next day. The pay-in and
payout of the mark-to-market settlement are affected on the day following the
trade day. After completion of daily settlement computation, all the open
positions are reset to the daily settlement price. Such position becomes the
opening positions for the next day.
ii. FINAL SETTLEMENTS FOR FUTURES
On the expiry of the future contracts, after the close of trading hours,
NSCCL marks all positions of CM to the final settlement price and the resulting
profits/losses is settled in cash. Final settlement loss/profits amount is
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debited/credit to the relevant CMs clearing bank account on the day following
expiry day of the contract
SETTLEMENT PRICES FOR FUTURES:-
Daily settlement price on a trading day is the closing price of the
respective future contracts on such day. The closing price for the future
contracts is currently calculated as the last half an hour weighted average price
of a contract in the F&O segment of NSE. Final settlement price is the closing
price of the relevant underlying index/security in the capital market segment of
NSE, on the last trading day of the contract. The closing price of the underlying
Index/security is currently its last half an hour weighted average value in the
capital market segment of NSE.
INTRODUCTION TO OPTIONS:-
Options give the holder or buyer of the option the right to do something. If
the option is a call option, the buyer or holder has the right to buy the number of
shares mentioned in the contract at the agreed strike price. If the option is a put
option, the buyer of the option has a right to sell the number of shares
mentioned in the contract at the agreed strike price. The holder of the buyer
does not have to exercise this right.
Thus on the expiry of the day of the contract the option may or may not be
exercised by the buyer. In contrast, in a futures contract, the two parties to the
contract have committed themselves to doing something at a future date. To
have this privilege of doing the transaction at a future only if it is a profitable, the
buyer of the option has to pay a premium to the seller of options.
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TYPES OF OPTIONS:-
An option is a contract between two parties giving the taker/buyer) the
right, but not obligation, to buy or sell a parcel of shares at a predetermined price
possibly on, or before a predetermined rate. To acquire this right the taker pays
a premium to the writer (seller) of the contract.
There are two types of options:
1. Call Options
2. Put Options
Call Options:
Call options give the taker the right, but not the obligation, to buy the
underlying shares at a predetermined price, on or before a predetermined date.
Call Options- Long & Short Positions
When you expect prices to rise, then you take a long position by buying
calls. You are bullish.
When you expect prices to fall, then you take a short position by selling
calls. You are bearish.
Put Options:
A Put Option gives the holder of the right to sell a specific number of an
agreed security at a fixed price for a period.Put Options- Long & Short Positions
When you expect prices to rise, then you take a long position by buying
Puts. You are bearish.
When you expect prices to fall, then you take a short position by selling
Puts. You are bullish.
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Particulars Call Options Put Options
If you expect a fall in price [Bearish] Short Long
If you expect a rise in price [Bullish] Long Short
TABLE SHOWING THE DEALING OF CALL & PUT OPTION
IMPORTANT CONCEPTS:-
In -the- money option:
It is an option with intrinsic value. A call option is in the memory if the
underlying price is above the strike price. A put option is in the memory if the
underlying price is below the strike price.
Out- of- the- money:
Call Option Holder (Buyer) Call Option Writer (Seller)
Pays Premium
Right to exercise & buy theshares
Profit from rising prices
Limited losses, potentiallyunlimited gains
Receives premium
Obligation to sell shares ifexercised
Profits from falling prices orremaining neutral
Potentially unlimited losses,limited gains
Put Option Holder (Buyer) Put Option Holder (Seller)
Pays Premium
Right to exercise & buy theshares
Profit from rising prices
Limited losses, potentiallyunlimited gains
Receives premium
Obligation to buy shares ifexercised
Profits from rising prices orremaining neutral
Potentially limited losses,unlimited gains
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It is an option that has no intrinsic value, i.e. all of its value consists of
time value. A call option is out of the money if the stock price is below its strike
price.
At- the- money:
A term that describes an option with a strike price that is equal to the
current market price of the underlying stock. But of the money if the stock price
is above its strike price.
Market Scenario Call Option Put OptionMarket price > strike price In- the- money Out- of- the- money
Market price < strike price Out- of- the- money In- the- money
Market price = strike price At- the- money At the- money
Market price ~ strike price Near- the- money Near- the- money
Intrinsic Value
In a call option, if the value of the underlying asset is higher than the
strike price, the option premium has an intrinsic value and is an in- the- money
option. If the value of the underlying asset is lower than the strike price, the
option has no intrinsic value and is an out- of- the- money option. If the value of
the underlying asset is equivalent to the strike price, the call option is at- the-
money and has no intrinsic value or zero intrinsic value.
In a put option, if the value of the underlying asset is lower than the strike
price, the option has an intrinsic value and is an in- the- money option. If the
value of the underlying asset is higher than the strike price, the option has no
intrinsic value and is out- of- money option.
If the value of the underlying asset is equivalent to the strike price, the put
option is at the- money
Time Value
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Time value is the amount an investor is willing to pay for an option, in the
hope that at some time prior to expiration its value will increase because of a
favorable change in the price of the underlying asset. Time value reduces as the
expiration draws near and on expiration day; the time value of the option is zero.
Option Price
An option cost or price is called premium. The potential loss for the
buyer of an option is limited to the amount of premium paid for the contract. The
writer of the option, on the other hand, undertakes the risk of unlimited potential
loss, for premium received. Thus,
Option Price = Premium Price
A premium is the net amount the buyer of an option pays to the seller of
the option. It does not refer to an amount above the base price, as the term
premium commonly used. The of an option has two important
constituents, intrinsic value and time value.
Premium = Intrinsic value + Time
PRICING WITH REGARD TO OPTIONS:-
The Black and Scholes Model:
The Black and Scholes Option Pricing Model didn't appear overnight, in
fact, Fisher Black started out working to create a valuation model for stock
warrants. This work involved calculating a derivative to measure how the
discount rate of a warrant varies with time and stock price. The result of this
calculation held a striking resemblance to a well-known heat transfer equation.
Soon after this discovery, Myron Scholes joined Black and the result of their work
is a startlingly accurate option pricing model.
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Black and Scholes can't take all credit for their work; in fact their model is
actually an improved version of a previous model developed by A. James Boness
in his Ph.D. dissertation at the University of Chicago. Black and Scholes'
improvements on the Boness model come in the form of a proof that the risk-free
interest rate is the correct discount factor, and with the absence of assumptions
regarding investor's risk preferences.
Black and Scholes Model:
In order to understand the model itself, we divide it into two parts. The first
part, SN [d1), derives the expected benefit from acquiring a stock outright. This is
found by multiplying stock price [S] by the change in the call premium with
respect to a change in the underlying stock price [N (d1)]. The second part of the
model, Ke [-rt) N (d2), gives the present value of paying the exercise price on the
expiration day. The fair market value of the call option is then calculated
by taking the difference between these two parts.
Assumptions of the Black and Scholes Model:-
1) The stock pays no dividends during the option's life
Most companies pay dividends to their share holders, so this might seem
a serious limitation to the model considering the observation that higher dividend
yields elicit lower call premiums. A common way of adjusting the model for thissituation is to subtract the discounted value of a future dividend from the stock
price.
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2) European exercise terms are used
European exercise terms dictate that the option can only be exercised on
the expiration date. American exercise term allow the option to be exercised at
any time during the life of the option, making American options more valuable
due to their greater flexibility. This limitation is not a major concern because very
few calls are ever exercised before the last few days of their life. This is true
because when you exercise a call early, you forfeit the remaining time value on
the call and collect the intrinsic value. Towards the end of the life of a call, the
remaining time value is very small, but the intrinsic value is the same.
3) Markets are efficient
This assumption suggests that people cannot consistently predict the
direction of the market or an individual stock. The market operates continuously
with share prices following a continuous into process. To understand what a
continuous into process is, you must first know that a Markov process is "one
where the observation in time period t depends only on the preceding
observation." An into process is simply a Markov process in continuous
time. If you were to draw a continuous process you would do so without picking
the pen up from the piece of paper.
4) No commissions are charged
Usually market participants do have to pay a commission to buy or sell
options. Even floor traders pay some kind of fee, but it is usually very small. The
fees that Individual investor's pay is more substantial and can often distort the
output of the model.
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5) Interest rates remain constant and known
The Black and Scholes model uses the risk-free rate to represent this
constant and known rate. In reality there is no such thing as the risk-free rate, but
the discount rate on U.S. Government Treasury Bills with 30 days left until
maturity is usually used to represent it. During periods of rapidly changing
interest rates, these 30-day rates are often subject to change, thereby violating
one of the assumptions of the model.
6) Returns are log normally distributed
This assumption suggests, returns on the underlying stock are normally
distributed, which is reasonable for most assets that offer options.
Advantages & Limitations:-
Advantage:
The main advantage of the Black-Scholes model is speed -- it lets you
calculate a very large number of option prices in a very short time.
Limitation:
The Black-Scholes model has one major limitation: it cannot be used to
accurately price options with an American-style exercise as it only calculates
the option price at one point in time -- at expiration. It does not consider the
steps along the way where there could be the possibility of early exercise of
an American option.
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As all exchange traded equity options have American-style exercise (i.e. they
can be exercised at any time as opposed to European options which can
only be exercised at expiration) this is a significant limitation.
The exception to this is an American call on a non-dividend paying asset. In
this case the call is always worth the same as its European equivalent as
there is never any advantage in exercising early.
Various adjustments are sometimes made to the Black-Scholes price to
enable it to approximate American option prices but these only works well
within certain limits and they don't really work well for puts.
Difference between derivative and equity
DERIVATIVE EQUITY
Warehousing No warehousing isrequired
No warehousing isrequired
Quality of underlyingassets
Derivatives contractdont have attribute ofquality
Equity contract dont haveattribute of quality
Contract life Comparatively having Having long and short
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long contract life contract life
Maturity date Standardized Standardized
Return High Medium
Risk Very High Less
Liquidity Less Very high
InvestmentAmount
Very high Low
Lot size Fixed by SEBI Not fixed by SEBI
Time of trading 9a.m to 3.30p.m 9a.m to 3.30p.m
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RESEARCH METHODOLOGY:-
Problem Statement:
The topic, which is selected for the study, is DERIVATIVE MARKET in
the firm so the problem statement for this study will be, AWARENESS ABOUT
THE DERIVATIVE AND ITS COMPARISION WITH EQUITY.
Objective of the Study:
1. To know the awareness of the Derivative Market in Surat City.
2. To know which one is beneficial for the investor.
3. To find what proportion of the population are investing in such derivatives
along with their investment pattern and product preferences.
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Research Design:
The research design specifies the methods and procedures for
conducting a particular study. The type of research design applied here are
DESCRIPTIVE as the objective is to check the position of the Derivative
Market in Surat city. The objectives of the study have restricted the choice of
research design up to descriptive research design. This survey will help the firm
to know how the investors invest in the derivative segment & which factors affect
their investing behavior.
Scope of the Study:
The scope of the study will include the analysis of the survey, which is
being conducted to know the awareness of the Derivative Market in the city &
also doing comparison of derivatives with equity.
Research Source of Data:-There are two types of sources of data which is being used for the studies:-
Primary Source of Data:
Preparing a Questionnaire is collecting the primary source of data & it
was collected by interviewing the investors.
Secondary Source of Data:For having the detailed study about this topic, it is necessary to have
some of the secondary information, which is collected from the following:-Books.
Magazines & Journals.
Websites.
Newspapers, etc.
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Methods of Data Collection:-
The study to be conducted is about the awareness of the Derivative
Market in the
Surat City so
the method of
data collection
used id SURVEY METHOD.
DATA ANALYSIS AND INTERPRETATION:
Q.1 Are you trading in derivative market?
Objective: To know that whether the investors are trading in derivative market
or not.
Frequency
Graph:
Frequencies PercentageYes 74 37.0
No 126 63.0
Total 200 100.0
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Trading
74
126
37
63
0
20
40
60
80
100
120
140
Yes No
Trading
percent/freq
uency
Frequencies
Percentage
Inference: from the above graph out of 200 investors, only 37% investors means
74 respondent are trading in derivative market and 63% means 126 respondents
are not trading in derivative market.
Q.2 Reasons for not investing in derivative market. {Give the rank}
Objective: To know the reason why investors are not trading in trading in
derivative market
Frequency
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Graph:
Inference: From the above graphical representation you can see that 49.2%
investors think that the derivatives are high risky whereas 1.6% investors dont
have specify their reasons for not trading in derivative market.
Q.3 what is the objective of trading in derivative market?
Objective: To know that why they are trading in derivative market.
Frequency
Frequency Percent
Reasons Frequency Percent
Lack of knowledge 26 20.6
Lack of awareness 19 15.1
High risky 62 49.2
Huge amount of
investment
17 13.5
Other 2 1.6
Total 126 100.0
77
Reason
0
2619
62
17
20
20.615.1
49.2
13.5
1.6
0
10
20
30
40
50
60
70
Reasons Lack of
knowledge
Lack of
awareness
High risky Huge
amount of
investment
Other
reasons
percent/frequency
Series1
Series2
Series3
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Dont trade 126 63.0
Not at all preferred 2 1.0
Neutral 2 1.0
Some how preferred 5 2.5
Most preferred 65 32.5
Total 200 100
Graph:
High Return
126
2 2 5
6563
1 1 2.5
32.5
0
20
40
60
80
100
120
140
Dont trade Not at all
preferred
Neutral Some how
preferred
Most preferred
preferred
p
ercent/frequency
Frequency
Percent
Inference: From the above graph we can see that 32.5% investors are most
preferred the objective of high return and 1% investors are neutral while they are
trading in derivative market.
Q .4what are the criteria do you taken in the consideration while investing
in derivative market?
Objective: To know that which criteria are consider by the investors while they
are investing in derivative market. Which criteria are most important for them
whether derivatives are ease in transaction, less costly, or available of different
contract or for the margin money.
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Frequency
Frequency Percent
Dont trade 126 63.0
Not at all preferred 2 1.0
Some how not
preferred4 2.0
Neutral 16 8.0
Some how preferred 23 11.5
Most preferred 29 14.5
Total 200 100.0
Graph:
Ease in transaction
126
2 416 23
29
63
1 2 811.5 14.5
0
20
40
60
80
100
120
140
Dont
trade
Not at all
preferred
Some
how notpreferred
Neutral Some
howpreferred
Most
preferred
preferred
percentage/frequency
Frequency
Percent
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Inference: from the above graph we can conclude that out of the 200 investors
14.5% investors are most preferred and 1% investors are not at all preferred the
ease in transaction contract.
Q-5 Give your preference of trading in derivative instrument.
Objective: To know the preference of the investors while they are trading in
derivative market.
Frequency
Frequency Percent
Dont trade 126 63.0 Not at all preferred 1 .5 Some how not preferred 1 .5 Neutral 15 7.5 Some how preferred 14 7.0 Most preferred 43 21.5
Total 200 100.0
Graph:
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Index future
126
1 115 14
43
63
0.5 0.5 7.5 7
21.5
020
406080
100120
140
Dont trade Not at all
preferred
Some how
not
preferred
Neutral Some how
pr