Executive Summary 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 (OTC Exchange of India), Mumbai (The Inter-connected Stock Exchange of India), Patna, Pune, and Rajkot. Of course, the principle bourses are the National Stock
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Exchange and The Bombay Stock Exchange, accounting for the bulk of the business done on the Indian stock market. Basis of Trading The NEAT F&O system supports an order driven market, wherein orders match automatically. Order matching is essentially on the basis of security, its 73 price, time and quantity. All quantity fields are in units and price in rupees.The exchange notifies the regular lot size and tick size for each of the contracts traded on this segment from time to time. When any order enters the trading system, it is an active order. It tries to find a match on the other side of the book. If it finds a match, a trade is generated. If it does not find a match, the order becomes passive and goes and sits in the respective outstanding order book in the system. Corporate hierarchy In the F&O trading software, a trading member has the facility of defining a hierarchy amongst users of the system. This hierarchy comprises corporate manager, branch manager and dealer. 1) Corporate manager: The term 'Corporate manager' is assigned to a user placed at the highest level in a trading firm. Such a user can perform all the functions such as order and trade related activities, receiving reports for all branches of the trading member firm and also all dealers of the firm. Additionally, a corporate manager can define exposure limits for the branches of the firm. This facility is available only to the corporate manager. 2) Branch manager: The branch manager is a term assigned to a user who is placed under the corporate manager. Such a user can perform and view order and trade related activities for all deale rs under that branch.
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3) Dealer: Dealers are users at the lower most level of the hierarchy. A Dealer can perform view order and trade related activities only for oneself and does not have access to information on other dealers undereither the same branch or other branches. BSE (Bombay Stock Exchange) The Stock Exchange, Mumbai, popularly known as" BSE" was established in 1875 as "The Native Share and Stock Brokers Association". It is the oldest one in Asia, even older than the Tokyo Stock Exchange, which was established in 1878. It is the first Stock Exchange in the Country to have obtained permanent recognition in 1956 from the Govt. of India under the Securities Contracts (Regulation) Act, 1956. A Governing Board having 20 directors is the apex body, which decides the policies and regulates the affairs of the Exchange. The Governing Board consists of 9 elected directors, who are from the broking comm. Unity (one third of them retire ever year by rotation), three SEBI nominees, six public representatives and an Executive Director & Chief Executive Officer and a Chief Operating Officer. NSE (National Stock Exchange) NSE was incorporated in 1992 and was given recognition as a stock exchange in April 1993. It started operations in June 1994, with trading on the Wholesale Debt Market Segment. Subsequently it launched the Capital Market Segment in November 1994 as a trading platform for equities and the Futures and Options Segment in June 2000 for various derivative instruments.

MCX (Multy 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 demutualized exchange since inception, is all set up to introduce a state of the atr, online digital exchange for commodities futures trading in the country and has accordingly initiated several steps to translate this vision into reality. NCDEX (National Commodities and Derivatives Exchange) NCDEX started working on 15th December ,2003. This exchange provides facilities to their trading members at different 130 contract. In commodity market the main participants are speculators, hedgers and arbitrageurs. Facilities Provided by NCDEX NCDEX has developed a facility for checking of commodity and also provides awarehouse facility. By collaborating with industrial companies, industrial partners, news agencies, banks and developers of kiosk network. NCDEX is able to provide current rates and contract rates. To prepare guidelines related to special products of securitization NCDEX works with bank.

 To avail farmers from risk of fluctuation in prices of NCDEX provides special services for agriculture. NCDEX is working with tax officer to make a clear different types of sales and service tax. NCDEX is providingattractive products like weather Dervatives Stock Market Basic 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
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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. 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 to sell. The potential of a small dividend check is of little concern. What is usually responsible for increased interest in a company's stock is the prospect of the company's sales and profits going up. A company who is a leader in a hot industry will usually see its share price rise dramatically. Investors take the risk of the price falling because they hope to make more money in the market than they can with safe investments such as bank CD's or government bonds. What is a stock market index?

In the stock market world, you need a way to compare the movement of the market, up and down, from day to day, and from year to year. An index is just a benchmark or yardstick expressed as a number that makes it possible to do this comparison. For e.g. S&P CNX Nifty is the index of NSE and SENSEX is the index of BSE. The price per share, like the market cap, has nothing to do with how big a company is. The Securities Market consists of two segments, viz. Primary market and Secondary market. Primary market is the place where issuers create and issue equity, debt or hybrid instruments for subscription by the public; the Secondary market enables the holders of securities to trade them. Secondary market essentially comprises of stock exchanges, which provide platform for purchase and sale of securities by investors. In India, apart from the Regional StockExchanges 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
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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. 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. Secondary Market Intermediaries Stock brokers, sub-brokers, portfolio managers, custodians, share transfer agents constitute the important intermediaries in the Secondary Market. No stockbrokers or sub-brokers shall buy, sell or deal in securities unless he holds a certificate of registration granted by SEBI under the Regulations made by SEBI ion relation to them.
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The Central Government has notified SEBI (Stock Brokers & SubBrokers) Rules, 1992 in exercise of the powers conferred by section 29 of SEBI Act, 1992. These rules came into effect on 20th August, 1992.

Trading Through Brokers / Traditional Method of Share Trading:Trading in the stock exchange can be conducted only through member broker in securities that are listed on the respective exchange. Investor intending to buy/sell securities in the exchange has to do so only through a SEBI registered broker/sub-broker. This is very popular concept in India for Share Trading before the facilities like on line trading introduce. Both the exchange have switched over from the open outcry trading system to fully automated computerized mode of trading knows as Bolt and Neat. In this system, the broker trade with each other through the computer network. Buyers and sellers place their orders specifying the limits for quality and price. Those that are not matched remain on the screen and is opened for future matching during the day / settlement. After the advent of computerized trading the speed of trading has increased multi-fold and a fuller view of the market is available to the investors. To start dealing with broker you have to fill a form with the broker. After fill all the formalities the firm gives
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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. -Woody Allen, American Film Maker A stock broker is a person or a firm that trades on its clients behalf, you tell them what you want to invest in and they will issue the buy or sell order. Some stock brokers also give out financial advice that you a charged for. It wasnt too long ago and investing was very expensive because you had to go through a full service broker which would give youadvice 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.

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

About MSB e_trade securities MSB E-TRADE SECURITIES LTD. (MSB e-Trade) was incorporated in the year of 1993, The company reached their strength in financial market by the great effort of the Director of the company MR. MUNISH BAJAJ. MSB e-Trade looks forward to tougher challenges and newer milestone to conquer for get nothing less than the best. MSB e-Trade group providing the trading platform Equities, Derivatives, Currency, IPOs, Mutual Fund, Depository Services of NSDL(Launching Shortly) and Commodities (By its group company) to raising the graph of your savings. Our Team MSB e-Trade group managed by a team of young professionals of Chartered Accountant, Cost Accountants, Company Secretaries, MBAs, Technicals

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and the other senior executives in Stock Broking, Future & Options Trading, Currency Trading, Depository Services (Launching Shortly), IPOs, Mutual Funds Services and Commodities Trading (by its group company). Membership MSBe_tradeSecurities is Member of National Stock Exchange (NSE) for Capital Market, Future & Option, Currency Derivative Segment Member of MCX Stock Exchange (MCX-SX) for Currency Derivative Segment.Awaiting for the Members of UnitedStockExchange of India Ltd. (USEIL) for Currency Derivative Segment Member of Association of Mutual Fund In India (AMFI) Company is also planning for Depository Participant with NSDL at the earliest. Membership of Group Company Kalyani Commodities Pvt. Ltd. (The Group company of MSB e-Trade) Member of Multi Commodities Exchange (MCX) Member of National Commodity & Derivative Exchange (NCDEX) Member of National Multi Commodity Exchange (NMCE) & Member of Indian Commodity Exchange (ICEX)

Business Associates Kalyani Commodities Pvt Ltd. (Member of MCX. NCDEX, NMCE & ICEX) Swot Analysis

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Strength 1) Understandings of the markets 2) All financial needs under one roof 3) Scalable and robust infrastructure
4) Full fledge research unit comprising of both fundamental &

technical

research

5) Dedicated, Qualified and Loyal staff 6) Flexible Brokerage charges

Weakness:1) Low Brand Image in the market. 2) Low Professionalism 3) Low Advertisements Opportunity:1) Large potential market for delivery and intra-day transactions. 2) Open interest of the people to enter in to stock market for investing

3) Attract the customers who are dissatisfied with other brokers & DPs.
4) Up growing markets in commodity and forex trading

Threats:1) Decreasing rates of brokerage in the market. A Increasing competition against other brokers & DPs. 2) 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 profitof MSB e_trade's clients would lead them to go for other broker/DP

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Services Provided by MSB e_trade securities Equity and Derivative MSB e-Trade provides online & offline trading facilities in Equities, Equities Derivatives & currency Derivatives to the investors on the basis of live environment who are looking for the ease and convenience of trading experience. We also provides the trading applications that would approved by exchange. You can now trade & access from any destination at your convenience. Investors may trade through our network or telephonically by the designated representatives in the branch where you are registered as a client. Offline & Online Trading Features
1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13)

Live trading in a fraction of a second. Support by the executive. Quick order punching. Quick trade confirmation. Live streaming quoted. Price watch on any number of scrips. Online trading. Online access of accounts and DP. Set any number of price alerts on any number of scrips. Flexibility to customize screen layout and setting. Facility to customize any number of portfolios & watchlists. Facility to cancel all pending orders at one click. Facility to square off all transactions at one click. Top Gainers, Top losers, Most Active, updated live.

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14) 15) 16) 17)

Index information; index chart, index stock information live. Market depth, i.e. Best 5 bids and offers, updated live for all scrips Facility to place orders on the phone in all major cities. Historical charts and technical analysis tools.

Commodities Kalyani Commodities Pvt. Ltd. (the group company of MSB e-Trade) is a member Multi Commodity Exchange (MCX), National Commodity and Derivative Exchange (NCDEX), National Multi Commodity Exchange (NMCE) & Indian Commodity Exchange (ICEX). We are providing the trading platform in commodities derivative.

Online Trading MSB e-Trade providing the online trading facilities to the investors through the platform approved by the exchange on free of cost Mutual Fund and IPO Distribution of Mutual fund & IPO MSB e-Trade registered with Association of Mutual Fund in India (AMFI) for providing the Mutual Fund services in India. We are also providing the online mutual fund activities through National Stock Exchange (NSE). We also providing the IPOs services through leading distributors of IPOs. Depository We are launching shortly the Depository Services to the investor. Back Office
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MSB e-Trade Providing the Bank office facility to the client registered with us. Client can check the financial & securities details held in their name. You can access or print the financial statement, Holding statement etc. by the login id and password issue by the authority to the client at the time opening of their trading account. Products
1) Equities & Derivative 2) Currency Derivative 3) Commodities Derivative 4) Mutual Fund 5) IPO

Offline
1) Offline A/C is the A/C for the investors who are not familiar with the

use of computer.
2) The A/C opening Charges applied (One time). 3) For 1st Year Demat A/c is free , On 2nd year AMC charge is

applicable.

Online Account Requirements for online trading

1) Linked Bank account 2) Broking Account

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3) Linked Depository Account

Benefits Of online trading

1) Freedom from paperwork 2) Instant credit and transfer 3) Trade Anywhere 4) Timely Advice and access to research 5) Real-time portfolio tracking 6) After hour orders 7) Market Alerts 8) Instant Quotes

Other services
1) Dial-n-trade 2) Mutual fund 3) Commodity 4) Derivative 5) Depository Participants 6) Distribution of Financial Services 7) Research Based Advices 8) Portfolio Management System 9) Portofolia management System

DnT (Dial-n-Trade)

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Dial n Trade is the name of the phone-trading facility offered by MSB e_trade securities. A call center wholly dedicated to order placement / confirmation Easy 2-step process for order placement. Step1. Step2. Enter Enter your your Phone Client ID Code

On successful dial, call gets transferred to call center executives. MSB e_trade Securities Private Limited, one of the cornerstones of the MSB 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

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clients through various delivery channels like email, chat, SMS, phone calls etc. Mutual Funds Introduction: Everybody talks about mutual funds, but what exactly are they? Are they like shares in a company, or are they like bonds and fixed deposits? Will I lose all my money in funds or will I become an overnight millionaire? Big questions that get answer in just five minutes. Meaning: A mutual fund is a pool of money that is invested according to a common investment objective by an asset management company (AMC). The AMC offers to invest the money of hundreds of investors according to a certain objective to keep money liquid or give a regular income or grow the money long term. Investors buy a scheme if it fits in with their investment goals, like getting a regular income now or letting the money accumulate over the long term. Investors pay a small fraction of their total funds to the AMC each year as investment management fees.

Commodity Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association 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
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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 nflationary 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 mid1960s. This coupled with the regulatory constraints in 1960s, resulted in virtual dismantling of the commodities future markets. It is only in the last decade that commodity future exchanges have been actively encouraged. However, the markets have been thin with poor liquidity and have not grown to any significant level.

Conceptual Description 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
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fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking- in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. Depository Participants The onset of the technology revolution in financial services Industry saw the emergence of MSB as an electronic custodian registered with National Securities Depository Ltd (NSDL) and Central Securities Depository Ltd (CSDL). M S B 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, settlement we of are a powerful Shares. medium We for have trading established and live dematerialized

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.

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Portfolio Management System The company has initiated the process of obtaining permission from SEBI for rendering PMS Service to its clients. We are planning to start PMS Service to High Net Worth individual and NRIs after obtaining the necessary regulatory clearances Theoretical Aspect Introduction: According to dictionary, derivative means something which is derived from another source. Therefore, derivative is not primary, and hence not independent. In financial terms, derivative is a product whose value is derived from the value of one or more basic variables. These basic variable are called bases, which may be value of underlying asset, a reference rate etc. the underlying asset can be equity, foreign exchange, commodity or any asset. For example: - the value of any asset, say share of any company, at a future date depends upon the 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:
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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. In financial terms derivatives is a broad term for any instrumental whose value is derived from the value of one more underlying assets such as commodities, forex, precious metal, bonds, loans, stocks, stock indices, etc. Derivatives were developed primarily to manage offset, or hedge against risk but some were developed primarily to provide potential for high returns. In the context of equity markets, derivatives permit corporations and institutional Investors to effectively manage their portfolios of assets and liabilities through instrument like stock index futures. For example: The price of Reliance Triple Option Convertible

Debentures (Reliance TOCD) used to vary with the price of Reliance shares. In addition, the price of Telco warrants depends upon the price of Telco shares. American Depository receipts / Global Depository receipts draw

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their price from the underlying shares traded in India. Nifty options and futures. Reliance futures and options, are the most common and popular form of derivatives. Although trading in agriculture and other commodities has been the deriving force behind the development of derivatives exchanges, the demand for products based on financial instruments such as bond, currencies, stocks and stock indices have now for outstripped that for the commodities contracts. The history of the derivatives dates back to the time since the trading came into being. The merchants entered into contracts with one another for future delivery of specified amount of commodities at specified price. A primary 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.

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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 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-Dollar futures are the three most popular future contracts traded today. Other popular international exchanges that trade derivatives are LIFFE in England, DTB in Germany,
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SGX in Singapore, TIFFE in Japan, and MATIF in France, Eurex, etc. India has been trading derivatives contract in silver gold, spices, coffee, cotton, etc for decades in the gray market. Trading derivatives contracts in organized market was legal before Moorage Desais government banned forward conracts. 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 in investments, 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. 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

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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.

The derivative market performs a number of economic functions:1) 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.
2) 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.
3) 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.
4) 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.
5) An important incidental benefit that flows from derivatives trading is

that it acts as a catalyst for new entrepreneurial activity.

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6) 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.
7)

Derivatives markets help increase savings and investment in volumes of activity.

the

end. Transfer of risk enables market participants to expand their Participants of Derivative Market:Market participants in the future and option markets are many and they perform multiple roles, depending upon their respective positions. A trader acts as a hedger when he transacts in the market for price risk management. He is a speculator if he takes an open position in the price futures market or if he sells naked option contracts. He acts as an arbitrageur when he enters in to simultaneous purchase and sale of a commodity, stock or other asset to take advantage of mispricing. He earns risk less profit in this activity. Such opportunities do not exist for long in an efficient market. Brokers provide services to others, while market makers create liquidity in the market. Hedgers Hedgers are the traders who wish to eliminate the risk (of price change) to which they are already exposed. They may take a long position on, or short sell, a commodity and would, therefore, stand to lose should the prices move in the adverse direction. Speculators

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If hedgers are the people who wish to avoid the price risk, speculators are those who are willing to take such risk. These people take position in the market and assume risk to profit from fluctuations in prices. In fact, speculators consume information, make forecasts about the prices and put their money in these forecasts. In this process, they feed information into prices and thus contribute to market efficiency. By taking position, they are betting that a price would go up or they are betting that it would go down. The speculators in the derivative markets may be either day trader or position traders. The day traders speculate on the price movements during one trading day, open and close position many times a day and do not carry any position at the end of the day. They monitor the prices continuously and generally attempt to make profit from just a few ticks per trade. On the other hand, the position traders also attempt to gain from price fluctuations but they keep their positions for longer durations may is for a few days, weeks or even months. Arbitrageurs Arbitrageurs thrive on market imperfections. An arbitrageur profits by trading a given commodity, or other item, that sells for different prices in different markets. The Institute of Chartered Accountant of India, the word ARBITRAGE has been defines as follows:Simultaneous purchase of securities in one market where the price there of is low and sale thereof in another market, where the price thereof is comparatively higher. These are done when the same securities are being quoted at different prices in the two markets, with a view to make profit and carried on with conceived intention to derive advantage from difference in
30

prices of securities prevailing in the two different markets Thus, arbitrage involves making risk- less profits by simultaneously entering into transactions in two or more markets.

Types of derivatives:The most commonly used derivatives contracts are Forward, Futures and Options. Here some derivatives contracts that have come to be used are covered. Forward:A forward contract is a customized contract between two entities, where settlement takes place on a specific date in the future at 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 1st 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

31

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 1st Aug. buys an option to buy 600 shares of Reliance Ind. Ltd. @ 450 Rs 450 on or before 1st Sep. In this case, A has the right to buy the shares on or before the specified date, but he is not bound to buy the shares. 2. Puts:Put gives the buyer the right, but not the obligation, to sell a given quantity of the underlying asset, at a given price, on or before a given date. For example :- A, on 1st Aug. buys an option to sell 600 shares of Reliance Ind. Ltd. @ Rs 450 on or before 1st Sep. In this case, A has the right to sell the shares on or before the specified date, but he is not bound to sell the shares. In both the types of the options, the seller of the option has an obligation but not a right to buy or sell an asset. His buying or selling of an asset depends upon the action of buyer of the option. His position in both the type of option is exactly the reverse of that of a buyer. Warrants :Options generally have lives of up to one year, the majority of options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. Leaps :-

32

The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years. Basket :Basket options are options on portfolios of underlying assets are usually a moving average of a basket of assets. Equity index options are a form of basket options. Swaps :Swaps are private agreement between two parties to exchange cash flows in the future according to a pre arranged formula. They can be regarded as portfolios of forward contract. The two commonly used swaps are as follows : 1.) Interest rate swaps:These entail swapping only the interest related cash flows between the parties in the same currency. 2.) Currency Swaps:These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction. 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.
33

Emergence of Derivative Trading in India Approval For Derivatives Trading The first step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which withdrew the prohibition on options in securities. The market for derivatives, however, did not take off, as there was no regulatory framework 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 preconditions 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

34

1998 under the chairmanship of Prof. J.R.Verma, to recommend measures for risk containment in derivative market in India. The repot, which was submitted in October 1998, worked out the operational details of margining system, methodology for charging initial margins, broker net worth, deposit requirement and real - time monitoring requirements. The SCRA was amended in December 1999 to include derivatives within the ambit of securities and the regulatory framework were developed for governing derivatives trading. The act also made it clear that derivatives shall be legal and valid only if such contracts are traded on a recognized stock exchange, thus precluding OTC derivatives. The government also rescinded in March 2000, the three decade old notification, which prohibited forward trading in securities. Derivatives trading commenced in India in June 2000 after SEBI granted the final approval to this effect in May 2000. SEBI permitted the derivative segment of two stock exchanges, NSE and BSE, and their clearing house/corporation to commence trading and settlement in approved derivatives contract. To begin with, SEBI approved trading in index future contracts based on S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval for trading in options based on these two indices and options on individual securities. The trading in index options commenced in June 2001. Futures contracts on individual stocks were launched in November 2001. Trading and settlement in derivatives contracts are done in accordance with the rules, bye laws, and regulations of the respective exchanges and their

35

clearing house/corporation duly approved by SEBI and notified in the official gazette.

Introduction to forward Contracts:Forward Contracts A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. The parties to the contract negotiate other contracts details like delivery date, price, and

36

quantity

bilaterally.

The

forward

contracts

are

normally

traded

outside the exchanges. Salient features of forward contracts are as follows:1) They are bilateral contracts and hence exposed to counter party

risk.
2) Each contract is custom designed, and hence is unique in

terms of contract size, expiration date and the asset type and quality.
3) The contract price is generally not available in public domain 4) On the expiration date, the contract has to be settled by

delivery of the asset.

5) 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:1) Lack of centralization. 2) Illiquidity. 3) 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

37

them design terms of the deal, which are very convenient in that specific situation, but makes the contract non-tradable. Counter party risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade standardized contracts, and hence avoid the problem illiquidity, the counter party risk remains a very serious. Introduction to Futures:Future contract is specie of forward contract. Futures are exchange- traded contracts to sell or buy standardized financial instruments or physical commodities for delivery on a specified date at an agreed price. Futures 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: 1) Quantity of the underlying. 2) Quality of the underlying. 3) The date and month of delivery. 4) The units of price quotation and minimum price change. 5) 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.
38

It enables the consumer get an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and cover his purchases by making forward contracts. The future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market. Other benefits of futures trading are: Price stabilization in time of violent price fluctuations- this 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 other trade functionaries. FEATURE OPERATIONAL MECHANISM FORWARD CONTRACT Traded between (not two traded FUTURE CONTRACT Directly Traded parties exchanges on the on the farmers and mechanism dampens the peaks and lifts up the valleys i.e. the amplitude of price

exchanges)
39

CONTRACT

Differ from trade to Contracts

are

SPECIFICATIONS trade. COUNTER PARTY Exists RISK

standardised contracts Exists. However by the clearing Corp., which becomes the counter party to all trades or uncontionally guarantees their

LIQUIDATION PROFILE

settlement. Low, as contracts are High, as contracts are tailor made contracts standardised the parties. Not efficient, markets are scattered. exchange catering to the needs of traded contracts.

PRICE DISCOVERY

as Efficient as markets are centralized and all buyers and sellers come to a common platform to discover the price.

Margins The margining system is based on the J R Verma committee recommendations. The actual margining happens on a daily basis while online position monitoring is done on an intra day basis. Daily margining is of two types: 1.Initial margins.

40

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-tomarket settlement is done in cash. Settlement of Future Contract:Futures contract has two types of settlement, the MTM settlement, which happens on a continuous basis at the end of each day, and the final settlement, which happens on the last trading day of the futures contract. 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.

41

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 settlement for futures On the expiry of the future contracts, after the close of trading hours, NSCCL marks all positions of CM to the final settlement price and the resulting profits/losses is settled in cash. Final settlement loss/profits amount is debited/credit to the relevant CMs clearing bank account on the day following expiry day of the contract Settlement price 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
42

of NSE, on the last trading day of the contract. The closing price of the underlying Index/security is currently its last half an hour weighted average value in the capital market segment of NSE. Introduction to options-: Options give the holder or buyer of the option the right to do something. If the option is a call option, the buyer or holder has the right to buy the number of shares mentioned in the contract at the agreed strike price. If the option is a put option, the buyer of the option has a right to sell the number of shares mentioned in the contract at the agreed strike price. The holder of the buyer does not have to exercise this right. Thus on the expiry of the day of the contract the option may or may not be exercised by the buyer. In contrast, in a futures contract, the two parties to the contract have committed themselves to doing something at a future date. To have this privilege of doing the transaction at a future only if it is a profitable, the buyer of the option has to pay a premium to the seller of options. Types of options:An option is a contract between two parties giving the taker/buyer) the right, but not obligation, to buy or sell a parcel of shares at a predetermined price possibly on, or before a predetermined rate. To acquire this right the taker pays a premium to the writer (seller) of the contract. There are two types of options: 1. Call Options
43

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 OptionsLong & Short Positions When you expect prices to rise, then you take a long position by buying calls. You are bullish. When you expect prices to fall, then you take a short position by selling calls. You are bearish. Put Options: A Put Option gives the holder of the right to sell a specific number of an agreed security at a fixed price for a period. Put Options- Long & Short Positions When you expect prices to rise, then you take a long position by buying Puts. You are bearish. When you expect prices to fall, then you take a short position by selling Puts. You are bullish. Particulars Call Options Put Options If you expect a fall in price [Bearish] Short Long If you expect a rise in price [Bullish] Long Short TABLE SHOWING THE DEALING OF CALL & PUT OPTION Call option Holder (buyer) 1) Pays premium 2) Right to exercise and buy shares 3) Profit from rising prices 4) Limited losses, potentially Call option Writer (seller) 1) Receives Premium 2) Obligations of sell shares if exercised 3) Profits from falling prices or remaining neutral

44

unlimited gains. Put option Holder (buyer) 1) Pays premium 2) Right to exercise and buy shares 3) Profit from rising prices 4) Limited losses , potentially unlimited gains.

4) Potentially unlimited losses , limited gains Put option Writer ( seller) 1) Receives Premium 2) Obligations of sell shares if exercised 3) Profits from rising prices or remaining neutral 4) Potentially limited losses , limited gains

Impotant 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: 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.
45

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

Call Option In- the- money

Put Option Out- of- the- money

Out- of- the- money

In- the- money

At- the- money

At the- money

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 outof- the- money option. If the value of the underlying asset is equivalent to the strike price, the call option is at- themoney and has no intrinsic value or zero intrinsic value.In a put option, if the value of the underlying asset is lower than the strike price, the option has an intrinsic value and is an in- the- money option. If the value of the underlying asset is higher than the strike price, the option has no intrinsic value and is out-

46

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 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 calledpremium. 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
47

discount rate of a warrant varies with time and stock price. The result of this calculation held a striking resemblance to a well-known heat transfer equation. Soon after this discovery, Myron Scholes joined Black and the result of their work is a startlingly accurate option pricing model. Black and Scholes can't take all credit for their work; in fact their model is actually an improved version of a previous model developed by A. James Boness in his Ph.D. dissertation at the University of Chicago. Black and Scholes' improvements on the Boness model come in the form of a proof that the risk-free interest rate is the correct discount factor, and with the absence of assumptions regarding investor's risk preferences. 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

48

model for this situation is to subtract the discounted value of a future dividend from the stock price. 2) European exercise terms are used European exercise terms dictate that the option can only be exercised on the expiration date. American exercise term allow the option to be exercised at any time during the life of the option, making American options more valuable due to their greater flexibility. This limitation is not a major concern because very 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

49

Usually market participants do have to pay a commission to buy or sell options. Even floor traders pay some kind of fee, but it is usually very small. The fees that Individual investor's pay is more substantial and can often distort the output of the model. 5) Interest rates remain constant and known The Black and Scholes model uses the risk-free rate to represent this constant and known rate. In reality there is no such thing as the risk-free rate, but the discount rate on U.S. Government Treasury Bills with 30 days left until maturity is usually used to represent it. During periods of rapidly changing interest rates, these 30-day rates are often subject to change, thereby violating one of the assumptions of the model. 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:
1) 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: 1) The Black-Scholes model has one major limitation: it cannot be usedto 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

50

steps along the way where there could be the possibility of early exercise of an American option. 2) 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. 3) 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. 4)Various adjustments are sometimes made to the Black-Scholes within certain limits and they don't really work well for puts. Difference between derivative and equity Warehousing No warehousing is required Quality underlying assets Contract life of Derivatives dont have No warehousing is required contract Equity contract dont attribute have attribute of quality Having long and short contract life Standardized Medium Less Very high Not fixed by SEBI 9a.m to 3.30p.m price to enable it to approximate American option prices but these only works well

of quality Comparatively having long contract life

Maturity date Return Risk Liquidity Lot size Time of trading

Standardized High Very High Less Fixed by SEBI 9a.m to 3.30p.m

51

Investment Amount

Very high

Low

Regulatory Framework The trading of derivatives is governed by the provisions contained in theSC(R)A, the SEBI Act, the rules and regulations framed there under and the rules and byelaws of stock exchanges. Securities Contract (Regulation) Act, 1956 SC(R)A aims at preventing undesirable transactions in securities by regulating the business of dealing therein and by providing for certain other matters connected therewith. This is the principal Act, which governs the trading of securities in India. The term securities has been defined in the SC(R)A. As per Section 2(h), the Securities include: 1. Shares, scripts, stocks, bonds, debentures, debenture stock or other marketable securities of a like nature in or of any incorporated company or other body corporate. 2. Derivative 3. Units or any other instrument issued by any collective investment scheme to the investors in such schemes. 4. Government securities 5. Such other instruments as may be declared by the Central Government to be securities. 6. Rights or interests in securities.

52

Derivative is defined to include:

1) A security derived from a debt instrument, share, loan whether

secured or unsecured, risk instrument or contract for differences or any other form of security. 2) A contract which derives its value from the prices, or index of prices, of 3) underlying securities.
4) Section 18A provides that notwithstanding anything contained in any

other law for the time being in force, contracts in derivative shall be legal and valid if such contracts are: 5) Traded on a recognized stock exchange
6) Settled on the clearing house of the recognized stock exchange, in

accordance with the rules and byelaws of such stock exchanges. Securities and Exchange Board of India 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 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: egulating the business in stock exchanges and any other securities r markets.
53

1) registering and regulating the working of stock brokers, subbrokers

etc. 2) promoting and regulating self-regulatory organizations. 3) prohibiting fraudulent and unfair trade practices.
4) calling for information from, undertaking inspection, conducting

inquiries and audits of the stock exchanges, mutual funds and other persons associated with the securities market and intermediaries and selfregulatory organizations in the securities market.
5) performing such functions and exercising according to Securities

Contracts (Regulation) Act, 1956, as may be delegated to it by the Central Government.

Regulations for derivatives Trading SEBI set up a 24- member committee under the Chairmanship of Dr. L. C. Gupta to develop the appropriate regulatory framework for derivatives trading in India. On May 11, 1998 SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index futures. The provisions in the SC(R)A and the regulatory framework developed thereunder govern trading in securities. The amendment of the SC(R)A to include derivatives within the ambit of securities in the SC(R)A made trading in derivatives possible within the framework of that Act. 1. Any Exchange fulfilling the eligibility criteria as prescribed in the L. C. Gupta committee report can apply to SEBI for grant of recognition under Section 4 of the SC(R)A, 1956 to start trading derivatives. The derivatives
54

exchange/segment should have a separate governing council and representation of trading/clearing members shall be limited to maximum of 40% of the total members of the governing council. The exchange would have to regulate the sales practices of its members and would have to obtain prior approval of SEBI before start of trading in any derivative contract. 2. The Exchange should have minimum 50 members. 3. The members of an existing segment of the exchange would not automatically become the members of derivative segment. The members of the derivative segment would need to fulfill the eligibility conditions as laid down by the L. C. Gupta committee. 4. The clearing and settlement of derivatives trades would be through a SEBI approved clearing corporation/house. Clearing corporations/houses complying with the eligibility conditions as laid down by the committee have to apply to SEBI for grant of approval. 5. Derivative brokers/dealers and clearing members are required to seek registration from SEBI. This is in addition to their registration as brokers of existing stock exchanges. The minimum networth for clearing members of the derivatives clearing corporation/house shall be Rs.300 Lakh. The networth of the member shall be computed as follows: Capital + Free reserves Less non-allowable assets viz., (a) Fixed assets
55

(b) Pledged securities (c) Members card (d) Non-allowable securities(unlisted securities) (e) Bad deliveries (f) Doubtful debts and advances (g) Prepaid expenses (h) Intangible assets (i) 30% marketable securities 6. The minimum contract value shall not be less than Rs.2 Lakh. Exchanges have to submit details of the futures contract they propose to introduce. 7. The initial margin requirement, exposure limits linked to capital adequacy and margin demands related to the risk of loss on the position will be prescribed by SEBI/Exchange from time to time. 8. The L. C. Gupta committee report requires strict enforcement of Know your customer rule and requires that every client shall be registered with the derivatives broker. The members of the derivatives segment are also required to make their clients aware of the risks involved in derivatives trading by issuing to the client the Risk Disclosure Document and obtain a copy of the same duly signed by the client. 9. The trading members are required to have qualified approved user and sales person who have passed a certification programme approved by SEBI

56

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, Study of Dervatives and its comparison with equity Objective of the Study: 1. To know the awareness of the Derivative Market in Delhi City. 2. To know which one is beneficial for the investor. 3. To find what proportion of the population are investing in such derivatives along with their investment pattern and product preferences. Research Design: The research design specifies the methods and procedures for conducting a particular study. The type of research design applied here are Descriptive as the objective is to check the position of the Derivative Market in Delhi 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:

57

The scope of the study will include the analysis of the survey, which is being conducted to know the awareness of the Derivative Market in the city & also doing comparison of derivatives with equity. Research Source of Data:There are two types of sources of data which is being used for the studies:Primary Source of Data: Preparing a Questionnaire is collecting the primary source of data & it was collected by interviewing the investors. Secondary Source of Data: For having the detailed study about this topic, it is necessary to have some of the secondary information, which is collected from the following:-Books. Magazines & Journals. Websites. Newspapers, etc. Methods of Data Collection:The study to be conducted is about the awareness of the Derivative Market in the Delhi City so the method of data collection used is Survey Method.

58

Data Analysis and Interpretation:

Q.1 Are you trading in derivative market? Frequencies Percentage Yes 74 37.0 No 126 63.0 Total 200 100.0 Objective: To know that whether the investors are trading in derivative market or not. Q.2 Reasons for not investing in derivative market. Objective : To know the reason why investors are not trading in trading in derivative market. Reasons Lack of knowledge Lack of awareness High risky Huge amount of investment Other 2
59

Frequency 26 19 62 17

Percent 20.6 15.1 49.2 13.5

1.6

Total

126

100

Q.3 what is the objective of trading in derivative market? Objective: To know that why they are trading in derivative market. Dont trade Not at all preferred Neutral Some how preferred Most preferred Total Frequency 126 2 2 5 65 200 Percent 63.0 1.0 1.0 2.5 32.5 100

Q.4 What 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. Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total 16 23 29 200 8.0 11.5 14.5 100 Frequency 126 2 4 Percent 63.0 1.0 2.0

Q-5 Give your preference of trading in derivative instrument. Objective: To know the preference of the investors while they are
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trading in derivative market. Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total Frequency 126 1 1 15 14 43 200 Percent 63.0 .5 .5 7.5 7.0 21.5 100

Q-6 Give your preference in term of trading in derivative market? Objective : To know the preference of the investors in term of trading in derivative market. Dont trade Not at all preferred Some how not preferred Neutral Some how preferred Most preferred Total Frequency 126 4 1 5 10 54 200 Percent 63.0 2.0 .5 2.5 5 27 100

Q-7 How much percentage of your income you trade in derivative market? Objective: To know investors are how much percentage of their income trade in derivative market. Frequency
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Percent

Dont trade Less than 5% 5%-10% 11%-15% 16%-20% More than 20% Total

126 8 25 25 13 3 200

63.0 4.0 12.5 12.5 6.5 1.5 100

Q-8 what is the rate of return expected by you from derivative market? Objective: To know the investors expectation towards their investment in derivative market. Do not trade 5%-9% 10%-13. % 14%-17. % 18%-23% Total Frequency 126 21 22 23 8 200 Percent 63.0 10.5 11.0 11.5 4.0 100

Q-9. You are satisfied with the current performance of the derivative market. Objective: To know that investors are satisfied with the performance of the derivative market or not.

Do not trade Strongly disagree Disagree Neutral Agree

Frequency 126 8 14 18 25
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Percent 63.0 4.0 7.0 9.0 12.5

strongly agree Total

9 200

4.5 100

Gender: Male Female Total AGE: Below 20 years 20-25 years 26-30 years 31-35 years above 35 years Total Frequency 3 61 51 43 42 200 Percent 1.5 30.5 25.5 21.5 21.0 100 Frequency 157 43 200 Percent 78.5 21.5 100

Occupation: Student Employeed Business Professional Housewife Others total Frequency 35 82 32 22 13 16 200 Percent 17.5 41.0 16.0 11.0 6.5 8.0 100

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Findings
1. Here we found that out of 200 investors 74 means 37% investors are trading in derivative market whereas 126 means 63% are not trading in derivative market. 2. Reasons for not investing in derivative market Is derivative is because lack of awareness and knowledge, high risky, need huge amount of investment. 3. The main objective I of trading in derivative market of the investors is getting high return. 4. Criteria for trading is considered by investors are derivatives in derivative they 6. get Most margin of money the and derivatives are are more liquid. intraday. market. market 5. Their attractive preference is index future and index options investors in satisfied with trading 7. Out of 200 investors 12.5% investors are investing 11% to 15% of their income 8.12.5% trading are derivative derivative

9.157male investors and 43 female investors out of 200 investors.

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10.-most of the businessman and employed are trading in derivative market.

Conclusion
1. The awareness regarding Derivative among investor is 78 percent. 2. In terms of investment in Derivative and Equity investors have Capability of for investing. 4. The important factor that affecting the investor decision is based on In Consult With Their Broke . taking risk. 3. Investors also prefer Safety and Time Factor as the important parameter

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Recommendations
1. Only 74 investors are trading whereas 126 are not trading .so attract them for trading. 2.19 are lack of awareness so make them aware with the derivative so increase the customer. 3. Out of 126, 26 dont have knowledge for derivative so provide them knowledge for trading in derivative market. 4. Those who are not satisfied with the derivative by knowing their behavior of investment make them satisfied. Because negative word mouth of the customers fall down the business. And good word of mouth builds the business.

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Questionnaire 1. Are you investing in Derivative Market? Yes No 2. Reason for not investing in Derivative Market. {Give the rank}
1) Lack of Knowledge 2) Lack of awareness 3) High risky 4) Huge amount of investment

5) other 3.What are the objectives of the investing in derivatives Market ? Scale 5 4 3
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Instrument Most prefered High Return Hedge The Risk More reliable Safe to invest market More Liquid in derivative

Somewhat prefered

Neutral

Somewhat not prefered

Not at all Prefered

4. What are the criteria do you taken in the consideration while investing in derivative market? Scale 5 Instrument Most prefered Flexibilty Ease in transaction Less costly
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4 Somewhat prefered

3 Neutral

2 Somewhat not prefered

1 Not at all prefered

Availabilt y ogf different Contract Margin money

5. Give your preference of investment in derivative instrument. Scale 5 Instrument Most prefered Index future Stock Future Index Option Stock Option 4 Somewhat prefered 3 Neutral 2 Somewhat not prefered 1 Not Prefered

all

6. Give your preference in terms of investment in derivative market. Scale 5 Instrument Most prefered 4 Somewhat prefered
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3 Neutral

2 Somewhat not

1 Not Prefered

all

prefered Short term Medium term Long term

7. How much Percentage of your income you invest in derivative market? (a)Less than 5% (b) 5% TO 10% (c)11% TO 15% (d) 16% TO 20% (e) MORE THAN 20%

8. What is the rate of return expected by you from derivative market ? (a)5 % TO 9.5% (b)10% TO 13.5% (c)14 % TO 17% (d)18% TO 23% (e)ABOVE 23%

9. You are satisfied with the current performance of the derivative in terms of expected return. (a)STRONGLY AGREE (b)AGREE

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(c)NUTRAL DISAGREE (d)STRONGLY DISAGREE.

Demographic profile Name: Contact No............................ Email id: Age-: a) Below 20 yrs. b) 20 30 yrs. c) 30-40 yrs. d) 40-50 yrs e) Above 50 yrs. Gendera) Male b) Female Income (yearly)-: a) Less than 100000 b) 100000-200000 c) 200000-300000 d) 300000-400000 e) Above 400000
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Bibliography Newspapers and Journals-: 1. Economic Times 2. Times of India Websites referred : 1. nseindia.com 2. bseindia.com 3. msbetrade.com 4. mcx.com 5. ncdex.com 6. moneycontrol.com

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