Deravative Marketing Karvey

DERIVATIVES market- INDIA

ABSTRACT

The research on the general study of derivatives market has been conducted to improve

the knowledge about the derivatives market and its performance in India.

However another problem was that beyond better performance many traders are not

trading derivatives. Hence the research has been conducted to study the attitude of the

investors and traders. The derivatives market is booming in India and shows better

performance year by year. The research has been conducted in Karvy Comtrade Ltd,

which works on derivatives. 10 investors have been selected for the research on their

easy availability. The results show that lack of knowledge, fear and motivation are the

main factors leading the investors and the traders to step aside of the derivatives market.

Hence there is a need of improving marketing strategies to motivate them to invest in

derivative market.

However a “Derivative” can be defined as a financial instrument whose value depends on

the values of others, more basic underlying variables. The research how to trade and

what are formalities to be accomplished to trade in the derivatives market.

The methodology adopted for the research on the basis of sampling design and selection

of respondents is clear. Hence the results are better and can be easily acceptable.

This research comes across the meaning of derivatives, the trading system and guides to

play safely in the market. It would motivate the common people to trade in the

derivatives market as it explains the risks in the market and give suggestions to overcome

those risks. This report also explains the settlement procedures, the charges involved and

process of trading. Hence it enhance the confidence level and persuade to invest or trade

in the derivative market

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Chapter 1

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INTRODUCTION

As a part of our curriculum, this project aims to study A GENERAL STUDY ON

DERIVATIVES MARKET IN INDIA. The study was conducted in Shimoga.

This study mainly helps to know the trading system of derivatives market and its

consequences. It creates awareness about the market and persuades to trade in a

safe manner. This study also come across various problems faced by the traders of

derivatives market and provides some suggestions to overcome it.

The study has been conducted under the guidance and assistance of company

guide and the staff members of Karvy the finapolis, shimoga and also under the

faculty members of our college.

The stock market took a diversified step by the way of trading through the

Derivatives. Lot of people with lack of knowledge and fear step back to trade in

Derivatives. The trading mechanism is such that a win-lose situation as one has to

incur the loss and the latter gains which is unlike the equity market. The basic

information about the market is provided in the latter part of this thesis. However

let us have a look at the research information proposed to be carried out.

RESEARCH PROPOSED TO BE CARRIED OUT

Listing the objectives of the study

The objectives are clear and the problem is recognized. The main of the study is to

improve the knowledge in the derivatives market and to assist others who wish to

trade in such market.

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Preparing the questionnaire

Open ended questionnaire are prepared for the purpose of the study as the there

is less chances to be biased. The questionnaire prepared to the staff of market and

the traders are different. However they are enclosed at the end of the report.

Collection of the secondary data

The secondary data is collected by referring books, magazines and internet. The

basic knowledge about the market has been collected through books, current news

and other information were collected through the internet.

Analysis of secondary data

Comparison of the secondary data is done. Screening of the various data collected.

The non useful data collected are screened and the data that to be collected for

primary data are planned.

Collection of Primary data

The interaction with company guide and investors helped for the collection of the

primary data. The study of secondary data helped for the collection of some useful

data here.

Evaluation of the primary data

After the collection of the primary data, comparison between the primary data

with secondary data is made to know the reliability and accuracy of the data

collected.

Suggestions from faculty guide

The suggestion from the college faculty guide is taken and it helped for the follow

ups of the research. It also helped for the clear flow of the research conducted.

Preparing the research report

Finally the report of the research has been drawn which conveys about the research.

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Objectives of the study

The following research is a part of our curriculum and it enhances the students to

improve in their special interests. So the topic was selected as am a student with

Finance as my specialization. The following are the objectives that I would

accomplish at the end of this project.

To improve my knowledge in the field of investments.

To enhance the importance and scope of Derivatives Market.

To acquire formalities to be accomplished to trade in this market.

To analyze the wideness of differentiation of this market from the other

financial markets.

To study the investor’s attitude and their speculations in this market

To know practical trading in this market.

To learn the calculations pertaining to derivatives market.

To know about the loopholes in this market.

To enhance myself to give some suggestions for the improvement for better

performance

To know the contribution of this market to National Income of India.

To equip myself for the placement in the field of Finance.

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Company Profile

KARVY- Comtrade Limited

It is a venture of the prestigious Karvy group. With well established presence in the

multifarious facets of the modern financial services industry from stock broking to

registry services, it is indeed a pleasure for them to make foray into the

commodities derivatives market which opens yet another door for them to deliver

their service to the beloved customers and the investor public at large.

With the high quality infrastructure already in place and a committed Government

providing continuous impetus, it is the responsibility of the company, the

intermediaries to deliver these benefits at the door-steps of the esteemed

customers. With the expertise in financial services, existence across the lengths

and breadths of the country and an enviable technological edge, they are all set to

bring the pleasure of investing in this burgeoning market, which they touch upon

the lives of a vast majority of the population from the farmer to the corporate

alike. They are confident that the commodity futures can be a good value addition

to customer portfolio.

The company provides investment, advisory and brokerage services in Indian

Commodities Markets. And most importantly, they offer a wide reach through

their branch network of over 225 branches located across 180 cities.

As the flagship company of the Karvy Group, Karvy Consultants Limited has always

remained at the helm of organizational affairs, pioneering business policies, work

ethic and channels of progress. Having emerged as a leader in the registry

business, the first of the businesses that they ventured into, they have now

transferred this business into a joint venture with Computershare Limited of

Australia, the world’s largest registrar. With the advent of depositories in the

Indian capital market and the relationships that they have created in the registry

business, they believe that they are best positioned to venture into this activity as

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a Depository Participant. They are one of the early entrants registered as

Depository Participant with NSDL (National Securities Depository Limited), the first

Depository in the country and then with CDSL (Central Depository Services

Limited). Today, they service over 6 lakhs customer accounts in this business

spread across over 250 cities/towns in India and are ranked amongst the largest

Depository Participants in the country. With a growing secondary market presence,

they have transferred this business to Karvy Stock Broking Limited (KSBL), they are

a associate and a member of NSE, BSE and HSE.

KARVY Stock Broking Limited

Member - National Stock Exchange (NSE), The Bombay Stock Exchange (BSE), and

The Hyderabad Stock Exchange (HSE).

Karvy Stock Broking Limited, one of the cornerstones of the Karvy 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 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.

It is an undisputed fact that the stock market is unpredictable and yet enjoys a high

success rate as a wealth management and wealth accumulation option. The

difference between unpredictability and a safety anchor in the market is provided

by in-depth knowledge of market functioning and changing trends, planning with

foresight and choosing one options with care. This is what they provide in their

Stock Broking services.

They offer services that are beyond just a medium for buying and selling stocks and

shares. Instead they provide services which are multi dimensional and multi-

focused in their scope. There are several advantages in utilizing their Stock Broking

services, which are the reasons why it is one of the best in the country.

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KARVY - the Finapolis

The paradigm shift from pure selling to knowledge based selling drives the business today. With their wide portfolio offerings, they 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 high levels of client service delivery. This has propelled them 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 they enhanced the scope of their retail brand, Karvy – the Finapolis , thereby providing planning and advisory services to the mass affluent. Here they 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 they have over competition is their portfolio of offerings and their professional expertise. The investment planning for each customer is done with an unbiased attitude so that the service is truly customized.

Their 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.

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KARVY – Investor Services Limited

Recognized as a leading merchant banker in the country, they are registered with SEBI as a Category I merchant banker. This reputation was built by capitalizing on opportunities in corporate consolidations, mergers and acquisitions and corporate restructuring, which have earned them the reputation of a merchant banker. Raising resources for corporate or Government Undertaking successfully over the past two decades have given them the confidence to renew their focus in this sector.

Their quality professional team and their work-oriented dedication have propelled them to offer value-added corporate financial services and act as a professional navigator for long term growth of their clients, who include leading corporates, State Governments, foreign institutional investors, public and private sector companies and banks, in Indian and global markets.

They have also emerged as a trailblazer in the arena of relationships, both at the customer and trade levels because of their unshakable integrity, seamless service and innovative solutions that are tuned to meet varied needs. Their team of committed industry specialists, having extensive experience in capital markets, further nurtures this relationship.

Their financial advice and assistance in restructuring, divestitures, acquisitions, de-mergers, spin-offs, joint ventures, privatization and takeover defense mechanisms have elevated their relationship with the client to one based on unshakable trust and confidence.

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KARVY Computershare Private Limited

They have traversed wide spaces to tie up with the world’s largest transfer agent,

the leading Australian company, Computershare Limited. The company that

services more than 75 million shareholders across 7000 corporate clients and

makes its presence felt in over 12 countries across 5 continents has entered into a

50-50 joint venture with them.

With their management team completely transferred to this new entity, they will

aim to enrich the financial services industry than before. The future holds new

arenas of client servicing and contemporary and relevant technologies as they are

geared to deliver better value and foster bigger investments in the business. The

worldwide network of Computershare will hold them in good stead as they expect

to adopt international standards in addition to leveraging the best of technologies

from around the world.

Excellence has to be the order of the day when two companies with such similar

ideologies of growth, vision and competence, get together.

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KARVY – Global Services Limited

The specialist Business Process Outsourcing unit of the Karvy Group. The legacy of

expertise and experience in financial services of the Karvy Group serves them well

as they enter the global arena with the confidence of being able to deliver and

deliver well.

Here they offer several delivery models on the understanding that business needs

are unique and therefore only a customized service could possibly fit the bill. Their

service matrix has permutations and combinations that create several options to

choose from.

In re-engineering and managing processes or delivering new efficiencies, their

service meets up to the most stringent of international standards. Their

outsourcing models are designed for the global customer and are backed by sound

corporate and operations philosophies, and domain expertise. Providing

productivity improvements, operational cost control, cost savings, improved

accountability and a whole gamut of other advantages.

They operate in the core market segments that have emerging requirements for

specialized services. Their wide vertical market coverage includes Banking,

Financial and Insurance Services (BFIS), Retail and Merchandising, Leisure and

Entertainment, Energy and Utility and Healthcare.

KARVY- Insurance Broking PVT. LTD

At Karvy Insurance Broking Limited., they provide both life and non-life insurance

products to retail individuals, high net-worth clients and corporates. With the

opening up of the insurance sector and with a large number of private players in

the business, they are in a position to provide tailor made policies for different

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segments of customers. In their journey to emerge as a personal finance advisor,

they will be better positioned to leverage their relationships with the product

providers and place the requirements of their customers appropriately with the

product providers. With Indian markets seeing a sea change, both in terms of

investment pattern and attitude of investors, insurance is no more seen as only a

tax saving product but also as an investment product. By setting up a separate

entity, they would be positioned to provide the best of the products available in

this business to their customers.

Their wide national network, spanning the length and breadth of India, further

supports these advantages. Further, personalized service is provided here by a

dedicated team committed in giving hassle-free service to the clients

KARVY – Reality and Services (India) Limited

KARVY Realty & Services (India) Limited (KRSIL) is engaged in the business of real

estate and property services offering value added property services and offers

individuals and establishments a myriad of options across investments, financing

and advisory services in the realty sector promoted by the KARVY Group of

companies, India’s largest integrated financial services company. KARVY Realty &

Services India Limited carries forward its legacy of trust and excellence in investor

and customer services delivered with a passion for services and the highest level of

quality that align with global standards.

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Chapter 2

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LITERATURE REVIEWFor the purpose of carrying out this project I have referred the book “Options,

Futures, and Other Derivatives”, “Security Analysis” and “Financial Management”.

The book, “Options, Futures, and Other Derivatives” is written by John C. Hull. The

book is of the fifth edition which provides enormous data regarding the

derivatives. “Security Analysis” and “Financial Management” are the text books for

the students of INC which also give some important information regarding

derivatives. However I have even collected some of the PDF files relating to

derivatives from my relative Mr. Damodar Pai, who is in Udupi. Apart from these I

have collected some information through Internet which relates to Derivatives.

The details of the references that I have made are explained below.

DerivativesDerivatives are playing a major role in the stock market of all countries. At the very

first it came in the Japanese rice market. Likewise the derivatives market

transaction takes place today was followed in Osaka, Japan during 1650’s and the

organized derivatives market came into existence in 1848, when the Chicago Board

of Trade was established (the largest derivative exchange in the world).

Derivatives, the dictionary meaning stands that something “derived”, “not

original”. However in Finance, a “Derivative” can be defined as a financial

instrument whose value depends on the values of others, more basic underlying

variables. The variables underlying derivatives are the prices of a stock. The term

"Derivative" indicates that it has no independent value, i.e. its value is entirely

"derived" from the value of the underlying asset. The underlying asset can be

securities, commodities, bullion, currency, live stock or anything else. In other

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words, Derivative means a forward, future, option or any other hybrid contract of

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

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

Indian Derivative market is regulated as per the "Securities Laws (Second

Amendment) Act, 1999". Now, it is necessary to understand the meaning of the

terms used in Derivatives Market.

Derivatives are of two classifications:

One is traded through the exchange and the latter is traded through Over The

Counters (OTC). Hence they can find Exchange Traded Derivatives, OTC derivatives

and OTC Equity Derivatives.

Earlier the derivatives traders used to met at a forum of exchange and used to

shout and some hand signals were used to indicate the trades they would like to

take out. This system was known as Open outcry system.

Exchange traded Vs OTC markets

With the lot of innovations in the Information technology OTC has been providing

good and reliable service for the traders in the derivative markets. Moreover the

globalization of financial activities, modernization of commercial activities and

investment banking has led to the sharp growth of derivatives market in India. The

exchange traded has stringent structure compared to the derivatives market.

However the following are the some of features of OTC markets compared to the

exchange traded:

The management of credit risk is decentralized and located within

individual institutions

There are no formal centralized limits on individual positions, leverage, or

margining.

No formal rules for risk and burden-sharing.

No hard and fast rules for market positions and integrity

The OTC contracts are generally not regulated by a regulatory authority and

the exchange’s self-regulatory organization, although they are affected

indirectly by national legal systems, banking supervision and market surveillance

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Need for the derivatives market:

The risk, investment, trading factors signifies derivatives in a unique way. Apart

these India is among the top-5 producers of most of the commodities, in addition

to being a major consumer of bullion and energy products. Agriculture contributes

about 22% to the GDP of the Indian economy. It employees around 57% of the

labor force on a total of 163 million hectares of land. Agriculture sector is an

important factor in achieving a GDP growth of 8-10%. All this indicates that India

can be promoted as a major center for trading of commodity derivatives. Hence it

is necessary to understand the why such kind of market is needed? However the

following are some of the needs for the derivatives market:

It helps to transfer the risk of the people who are risk averse to the risk

oriented people. The risk of future loss may be transferred to the other people.

As the market signifies the future contract and the options the discovery of the

anticipated prices are made.

As the derivatives market induces many people to trade, it produces more

entrepreneurial activity.

There is increase in trade volume as there are many risk averse people who

take participation in the derivatives market.

It promotes the investment and saving in the long run.

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Participants in the Derivatives Market:

This market has noticed good success as they have attracted many different types

of traders and posses good liquidity. As such in general banks, corporate, financial

institutions, individuals and brokers are the regular participants in derivatives

market.

The participants can be broadly classified into three categories:

1. Hedgers

2. Speculators

3. Arbitrageurs

Hedgers

It is an act, whereby an investor seeks to protect a position or anticipated position

in the spot market by using the opposite position in derivatives. They use forwards,

futures and options markets to reduce or eliminate the risk associated with price of

an asset. The parties are concerned that the there will be some changes in a cash

commodity ( such as pepper, wheat, bills etc.)which they plan to buy. Hence they

want to limit the movement of such commodities as to protect themselves from

loss. In this situation, he buys or sells futures contracts of the same type and

quantity. Similar objective can posed with the options and forwards too. As they

are risk oriented, they collect much valuable information and help others in

analyzing the derivatives.

For instance let us consider that A company which is in India agrees to export on

any future date (3 months) to B company which is in Dubai on the confirmation of

receiving Rs 10 crores . A company can hedge foreign exchange risk by selling Rs 10

crores in the three months forward market in the exchange rate of 10.22. This

would have the effect of locking in the Dubai Dirham to be realized for the 102.2

crores.

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Speculators

These are the trades who trade in the futures or options with a view to make profit

from the subsequent price movements. In other words use futures and options

contracts to get extra leverage in betting on future movements in the price of an

asset. They can increase both the potential gains and potential losses by usage of

derivatives in a speculative venture. They are risk oriented people and operate at a

high level of risk in anticipation of profits.

Arbitrageurs

They make business to take advantage of a discrepancy between prices in two

different markets. They involve locking in a riskless profit by simultaneous

transaction in two or more markets. The person who does this activity is referred

as an ‘arbitrageur’. For instance a person buys stock on NSE market, if the prices

are more for the stock in BSE, he sells his stock in BSE.

However both arbitrageurs and speculators fall into same category as they perform

similar activity or function.

Over The Counter Market (OTC).

The OTC market is an important alternative for the exchanges and measured in

terms of the total volume of trading. It is a telephone and computer linked

network of dealers. The trading usually takes place between two financial

institutions or between financial institution and one of its corporate clients.

The calls are usually taped to resolve any dispute about what the traders had

agreed earlier. Advantage of the system is the terms of a contract do not have to

be those specified by an exchange. Traders are free to negotiate any mutually. The

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main disadvantage of the system is that there is Credit Risk that is the small risk

that the contract will not be honored.

Let us now consider the different types of derivatives. The following page explains

the different types of derivatives.

Types of Derivatives:

Forward contract

It is a simple derivative. A forward contract is a customized contract between two

entities, where settlement takes place on a specific date in the future at today’s

pre-agreed price. In other words, It is an agreement to buy or sell an asset at a

certain future time for a certain price. A forward contract is traded in the over the

counter market between two financial institutions or between financial institution

and one of its corporate clients.

One of the parties assumes a long position and agrees to buy the underlying asset

on a certain specified future date for a certain specified price. The other party

assumes a short position and agrees to sell the asset on the same date for the

same price. Forward contracts on foreign exchange are very popular. Besides the

Forward market in currencies has been a vibrant market in India for several

decades.

Futures:

A futures contract 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.

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Options:

Options are of two types - calls and puts. Calls give the buyer the right but not the

obligation to buy a given quantity of the underlying asset, at a given price on or

before a given future date. Puts give the buyer the right, but not the obligation to

sell a given quantity of the underlying asset at a given price on or before a given

date. The price in the contract is known as exercise or strike price. The date of the

contract is known as expiration date or maturity.

Options are traded on stocks, stock indices, foreign currencies and futures.

Warrants

Options generally have lives of up to one year; the majority of options traded on

options exchanges 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.

Baskets

Basket options are options on portfolios of underlying assets. The underlying asset

is usually a moving average or a basket of assets. Equity index options are a form of

basket options.

Swaps

Swaps are private agreements between two parties to exchange cash flows in the

future according to a prearranged formula. They can be regarded as portfolios of

forward contracts. In other words a subset of forwards and involve the exchange of

one asset (or liability) against another at a future date (or dates).

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The two commonly used swaps are:

• Interest rate swaps

These entail swapping only the interest related cash flows between the parties in

the same currency.

• 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 swaption is an option on a forward swap. Rather than

have calls and puts, the swaptions market has receiver swaptions and payer

swaptions. A receiver swaption is an option to receive fixed and pay floating. A

payer swaption is an option to pay fixed and receive floating.

The following figure generalizes the different types of derivatives and how they are

traded:

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Differences between the futures and forward contracts

Futures contract Forward contracts

These are traded in organized

location as exchanges

No particular physical location as

such

the terms of the contract are highly

standardized

Terms are structured to suit both

the contracting parties

Contracts are cleared by a separate

clearing house

No such facility exist

clearing house guarantees the

performance of the contract

No organization guarantees the

performance of the counterparty.

Depends on the worth of the

counterparty.

Traders have to deposit initial

margin irrespective of their trading

position

No compulsion to make such

deposits

Traders have to pay daily

settlement margin depending on

movement in the price of the

underlying stock

Quite difficult to do so

Future contracts can be easily

closed

Regulations are not as tight as the

latter

Futures markets are monitored

and regulated by special agencies

Regulation is not as tight as in the

latter

Marking to market is done at the

end of every trading day

No such adjustments are carried out

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Difference between Futures and Options

1. In options to honor the contract the obligation is on the writer of the option

whereas in future d both the parties are equally responsible to honor their

obligations

2. The buyer has to pay premium to the writer of the option in options, but in

futures both the parties have to deposit the initial margin with the clearing house

and also the variation margin on the basis that whether the price fluctuation is

favorable to them or not.

3. In options the buyer limits the downside risk to the extent of premium paid.

Whereas the buyer is exposed to the whole of the downside risk and had the

potential for all the upside return.

4. The expiration period for the options is nine months, while for the future it is

twelve months

5. Options are employed by both the hedgers and speculators, while trading in

futures is by and large by speculators.

A brief history of Derivatives Market in India:

Derivatives market were existed long back in India, but in the area of commodities,

the Bombay cotton trade association started futures trading in 1875 and was the

world’s largest future trader by early’ s of 1990. Due to the ban of cash settlement

and option trading by the government in 1952, the derivatives took informal

forward trading. By 2000’s National electronic commodity exchanges were

created. The system of ‘Badla’ was banned due to some undesirable practices and

the SEBI banned it for goods in 2001. A series of reforms of the stock market

between 1993 and 1996 paved the way for the development of exchange-traded

equity derivatives markets in India.

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The report of L C Gupta committee recommended for the self regulation by the

exchanges and the report of J C Varma committee recommended for the margining

systems. In 1999, the Securities Contracts (Regulation) Act of 1956, or SC(R) A, was

amended so that derivatives could be declared “securities”. This allowed for the

extension of regulatory framework of trading securities to derivatives.

The economic liberalization of the early nineties facilitated the introduction of

derivatives based on interest rates and foreign exchange. A system of market-

determined exchange rates was adopted by India in March 1993. In August 1994,

the rupee was made fully convertible on current account. These reforms allowed

increased integration between domestic and international markets, and created a

need to manage currency risk.

Factors leading for the Growth of Derivatives

Increased volatility in asset prices in financial markets

Increased integration of national financial markets with the international

markets

Marked improvement in communication facilities and sharp decline in their

costs

Development of more sophisticated risk management tools, providing

economic agents a wider choice of risk management strategies

Innovations in the derivatives markets, which optimally combine the risks and

returns over a large number of financial assets, leading to higher returns,

reduced risk as well as trans-actions costs as compared to individual financial

assets

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Derivatives Instruments Traded in India

Derivatives in equity products have succeeded in India. Index future, Index options,

options and futures on individual securities were introduced in June 2000, June

2001, July 2001 and November 2001 respectively. In 2005, NSE trades 118

individual stocks and 3 stock indices in futures and options. All these stock are

settled by cash payment and there was no physical movement of underlying

products.

In June 2003, NSE launched Interest Rate Futures, but the problem with these was

faulty contract specifications, resulting in the underlying interest rate deviating

erratically from the reference rate used by market participants.

Later the institutional investors preferred the trade in OTC markets where interest

rate swaps and forward rate agreements were flourishing as the interest rate were

falling during 2005, companies swapped their fixed rate borrowings into floating

rates to reduce funding costs. OTC instruments in currency forwards and swaps are

the most popular. Importers, exporters and banks use the rupee forward market to

hedge their foreign currency exposure. But currently for the currency trading there

is a separate market called Currency Market.

Derivatives Users in India

As usual the derivatives in India are traded by the financial and non financial

institutions. Financial institutions use derivatives on interest rates, currencies and

derivatives to manage credit risk as they have the assets and liabilities of different

maturities and transactions through different currencies. Apart from these they are

exposed to different risk of default from their borrowers. However Non-financial

institutions are regulated differently from financial institutions and this affects

their incentives to use derivatives.

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The exchange-traded markets, domestic financial institutions and mutual funds

have shown great interest in OTC fixed income instruments. But the transactions of

the banks dominate the derivatives of interest rate while the proportion of state

owned banks are small. Moreover Corporations show great interest in Currency

forwards and Swap markets.

The institutions have not been participating to the fullest capabilities as some

institutions such as banks and mutual funds are not allowed to hedge their existing

positions in the spot market or to rebalance their existing positions. Moreover the

banks are little exposure to equity market due to the banking regulations they have

little incentives in equity derivatives.

Foreign institutions must register as FII’s (Foreign Institutional Investors) to trade in

exchange traded derivatives and are posed to certain limits assigned by SEBI.

However they can incorporate as local Broker Dealers (some foreign investors also

invest in Indian markets by issuing Participatory Notes to an off-shore investor).

The FII’s have little incentive to trade in interest rate derivatives as they have little

investment in domestic bond markets.

Retail investors (including small brokerages trading for themselves) are the major

participants in equity derivatives, accounting for about 60% of turnover in October

2005, according to NSE. The success of single stock futures in India is unique, as

this instrument has generally failed in most other countries. One reason for this

success may be retail investors’ prior familiarity with “Badla” trades which shared

some features of derivatives trading.

Another reason may be the small size of the futures contracts, compared to similar

contracts in other countries. Retail investors also dominate the markets for

commodity derivatives, due in part to their long-standing expertise in trading in

the “Havala” or forwards markets.

27 | P a g e


Modern Commodity Exchanges

The regulations, stringent government policies over the derivatives market acted

as hurdles for the growth and development. Hence FMC (Forward Market

Commission) and Government encouraged the setting up of more commodity

exchanges with the implications of modern systems and policies followed world

wide. Some of the main regulatory measures imposed by the FMC include daily

mark to market system of margins, creation of trade guarantee fund, back-office

computerization for the existing single commodity Exchanges, online trading for

the new Exchanges, demutualization for the new Exchanges, and one-third

representation of independent Directors on the Boards of existing Exchanges etc.

There were several changes in the trading system due to the globalization in India

and hence responding to the changes the several Nation wide Multi Commodity

Exchange [NMCE] was set up in the year 2002 by the usage of modern practices

such as electronic trading and clearing.

The two most commodity exchanges in India are Multi-Commodity Exchange of

India Limited (MCX), and National Multi-Commodity & Derivatives Exchange of

India Limited (NCDEX), where for the purpose of facilitating online trading and

clearing and settlement operations for commodity futures market across the

country, the Government of India has given a permanent recognition for MCX as an

independent and de-mutulised multi commodity exchange. Key shareholders of

MCX are Financial Technologies (India) Ltd., State Bank of India, NABARD, NSE,

HDFC Bank, State Bank of Indore, State Bank of Hyderabad, State Bank of

Saurashtra, SBI Life Insurance Co. Ltd., Union Bank of India, Bank Of India, Bank Of

Baroda, Canara Bank, Corporation Bank. The Headquarter is in Mumbai, and is led

by an expert management team with deep domain knowledge of the commodity

futures markets.

28 | P a g e


However the National Commodity & Derivatives Exchange Limited (NCDEX) is a

professionally managed online multi commodity exchange promoted by ICICI Bank

Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for

Agriculture and Rural Development (NABARD) and National Stock Exchange of

India Limited (NSE). Punjab National Bank (PNB), CRISIL Limited (formerly the

Credit Rating Information Services of India Limited), Indian Farmers Fertilizer

Cooperative Limited (IFFCO) and Canara Bank by subscribing to the equity shares

have joined the initial promoters as shareholders of the Exchange. NCDEX is the

only commodity exchange in the country promoted by National level institutions.

Commodity Derivatives

Futures contracts in pepper, turmeric, gur (jaggery), hessian (jute fabric), jute sacking,

castor seed, potato, coffee, cotton, and soybean and its derivatives are traded in 18

commodity exchanges located in various parts of the country. Futures trading in other

edible oils, oilseeds and oil cakes have been permitted. Trading in futures in the new

commodities, especially in edible oils, is expected to commence in the near future. The

sugar industry is exploring the merits of trading sugar futures contracts. The policy

initiatives and the modernization program include extensive training, structuring a reliable

clearinghouse, establishment of a system of warehouse receipts, and the thrust towards

the establishment of a national commodity exchange. The Government of India has

constituted a committee to explore and evaluate issues pertinent to the establishment and

funding of the proposed national commodity exchange for the nationwide trading of

commodity futures contracts, and the other institutions and institutional processes such as

warehousing and clearinghouses. With commodity futures, delivery is best effected using

warehouse receipts (which are like dematerialized securities). Warehousing functions have

enabled viable exchanges to augment their strengths in contract design and trading. The

viability of the national commodity exchange is predicated on the reliability of the

warehousing functions. The programme for establishing a system of warehouse receipts is

in progress. The Coffee Futures Exchange India (COFEI) has operated a system of

warehouse receipts since 1998.

29 | P a g e


Top 10 Commodities.

Due to non availability of the recent top list, the top ten commodities futures of

the year 2005 during 15-9-09 to 30-9-09 are as follows: (INR 43.84 per USD)

Commodity Turnover in $ Millions

Guar seed 4,432.71

Gold 4,082.15

Silver 3,869.36

Crude oil 3,380.13

Chana (chick peas) 2,100.15

Urad (Black Legume) 624.71

Soy oil 478.28

Gur (Jaggery: cane sugar) 369.72

Guar Gum 345.08

Tur (Lentils) 329.35

The figure depicts that the growth for the commodities has high certainty and

indicate that the commodities derivative market has a bright future. The volume

and value of trade in commodity derivatives could in fact take a quantum jump as

bullion, crude oil and other high value commodities being added with each passing

day get more actively traded in the coming months. It is also being speculated by

market operators that finally the commodity derivatives market would out-pace

and overtake the market for stock derivatives.

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Fixed Income Derivatives in India

The fixed income derivative market is a relatively new market in India, with the

first interest rate swaps in India being traded in July 1999. These derivatives

have seen exponential growth in volumes, an increase in liquidity as evidenced

by narrowing in bid−offer spreads, and expansion of the universe of market

participants.

Salient features

Banks can offer these derivatives to corporate for hedging underlying genuine

exposures

Benchmark can be any rate from the domestic money or debt market, or any rate

implied in the forward foreign exchange markets, provided that the methodology

of calculating the rate is objective, transparent and mutually acceptable

There are no restrictions on size or tenor for interest rate swaps, though there

are some limits on currency swaps

Banks are allowed to deal without underlying exposure for market making

activity (within prudential internal limits).

Usage of fixed Income derivatives

The primary purpose of using the fixed income derivatives is for hedging. However

there are variety of purposed to which the derivatives are used. They are as

follows:

Separation of interest rate risk from the liquidity risk

By the usage of this derivatives the corporate can raise money in whichever market

where it is easily available (liquidity risk) and and they can manage the interest rate

by swapping all or a portion of it.

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Debt Portfolio Management

By simply dealing in the swap market rather than in the underlying cash markets,

Indian corporate and banks are now able to manage various features of their debt

portfolio like the fixed−floating mix, currency mix and portfolio duration. For

example, an Indian company can raise all of it’s debt in fixed rate rupees, and then

swap a quarter of it into floating dollar debt.

Investment Portfolio Management

The flip side of debt portfolio management is investment portfolio management.

For e.g., the duration of the investment portfolio of a financial institution can be

changed by entering into interest rate swaps.

Improve Funding Costs

There are a number of Indian companies who have managed to rise cheaper

funding by arbitraging between differentials in credit spreads in the bond markets

and swap markets. For instance many companies who wish to raise dollar funding

can raise in cheap rupee fund and swap it into dollar in the derivatives market.

Products and Benchmarks

Till now swaps are the only type of derivatives where a Indian Rupee can be traded

in India. However the following are the three main categories of products, which in

turn have different benchmarks on which these are transacted:

Plain Vanilla Interest Rate Swaps

These are the most basic and actively traded instruments in the market. The

underlying benchmark in these swaps is linked to funding costs for banks or

corporate. The principal benchmarks are:

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Overnight Index Swaps (OIS)

This is the most popular and liquid benchmark. This was the first benchmark that

was actively used by banks, since it fulfilled a long felt need for them to be able to

extend the duration and manage the volatility of their overnight borrowings. As

the name implies, the underlying benchmark is the overnight call money rate. The

floating benchmark is known as MIBOR, which is a daily fixing done by the National

Stock Exchange (NSE) against which the swap is settled.

MITOR Swaps

These are similar to OIS swaps, with the difference being that the underlying

overnight floating rupee rate is derived from the USD Fed Funds Rate, rather than

being directly derived from the actual call rate in the Indian market. This

benchmark is not as popular as the preceding OIS benchmark.

MIFOR

Large number of Indian Corporate now regularly use this benchmark to actively

manage the interest rate risk on their debt portfolios, and access funding at better

rates. Since India does not have a fully developed term money market, it is derived

from USD Libor and the USD/INR Forward Premia, both of which are extremely

deep and liquid markets. The perception is that MIFOR might be subject to sudden

swings on account of the fact that it is derived from the forex forwards market.

This is a misplaced fear, as it is simply the Indian equivalent of USD Libor and the

USD Interest Rate Swaps market, and behaves like an interest rate benchmark, not

a forex benchmark.

Currency Swaps

These are interest rate derivatives whereby Rupee debt held by banks or corporate

can be swapped into debt in another currency or vice versa. As expected, the most

popular currency for swapping debt is the US Dollar. It is especially useful for

companies having raised forex debt who wish to hedge all or part of the foreign

33 | P a g e


exchange risk and interest rate risk by swapping into Rupees and companies

holding rupee debt who wish to either lower funding costs or diversify the

currency mix of their debt portfolios often choose to swap from rupee debt into

forex debt. There are also many variants of currency swaps, like coupon swaps and

Principal Only swaps (POS) which are popular amongst Indian corporate.

G−Sec Linked Swaps

This category of benchmarks is linked to the Government of India’s borrowing cost

that is yields on Government Securities (G−Sec). These swaps are important as they

allow banks and corporate to take views on the relative movements of GOI yields

and corporate spreads, without necessarily actually taking positions in the

securities themselves.

Till now we come across the usage of derivatives. But as usual they also do not

stand aside from the various risk. We have read in news papers or magazines that

the companies undergoing huge amount of losses in derivatives market. The fact is

that when the risk is gone through thoroughly the amount of loss can minimized.

Hence it necessary to know about the risk that follows while is trading in

derivatives market.

Associated risks while trading in derivatives

Strategic risk

It is the risk to earnings or capital arising from adverse business decisions or

improper implementation of those decisions. This risk is a function of the

compatibility between an organization’s strategic goals, the business strategies

developed to achieve those goals, the resources deployed in pursuit of these goals,

and the quality of implementation.

The management of strategic risk involves more than development of the strategic

plan. It also focuses on how plans, systems, and implementation affect the value of

34 | P a g e


the institution. It includes analyses of external factors affecting the bank’s strategic

direction and analyses of the success of past business strategies.

Reputation Risk

Reputation risk is the risk to earnings or capital arising from negative public

opinion. This affects the institution’s ability to establish new relationships or

services, or continue servicing existing relationships. This risk can expose the

institution to litigation, financial loss, or damage to its reputation. Reputation risk

is present throughout the organization and includes the responsibility to exercise

an abundance of caution in dealing with its customers and community. This risk is

present in such activities as asset management and agency transactions.

Management of reputation risk begins with fostering a know-your-customer

culture within the institution. Senior management should adopt a code of conduct

that addresses such areas as conflicts of interest, customer confidentiality, sales

practices, appropriateness, illegal and improper payments, and insider trading.

Management should encourage compliance with policies through employee

affirmations, standardized disclosures, and appropriate testing processes. The

administration of prompt and consistent disciplinary action against infractions will

also help to foster a strong compliance culture. Senior management should

continually assess the compatibility of bank activities and employee compensation

programs with the code of conduct.

Price Risk

Price risk is the risk to earnings or capital arising from changes in the value of

portfolios of financial instruments. This risk arises from market-making, dealing,

and position-taking activities for interest rate, foreign exchange, equity and

commodity markets.

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Interest Rate Risk

Interest rate risk applies to Banks and Dealers, those who use derivatives as active

position-takers or limited end-users. Interest rate risk is the risk to earnings or

capital arising from movements in interest rates. Interest rate risk is the risk to

earnings or capital arising from movements in interest rates, from changing

relationships among different yield curves affecting bank activities, from changing

rate relationships across the spectrum of maturities and from interest-related

options embedded in bank products.

Liquidity risk

Liquidity risk is the risk to earnings or capital from a bank’s inability to meet its

obligations when they come due, without incurring unacceptable losses. Liquidity

risk includes the inability to manage unplanned decreases or changes in funding

sources. Liquidity risk also arises from the failure to recognize or address changes

in market conditions that affect the ability to liquidate assets quickly and with

minimal loss in value.

Foreign exchange risk

Foreign exchange risk is the risk to earnings or capital arising from movement of

foreign exchange rates. This risk is applicable to cross-border investing and

operating activities. Market-making and position-taking in foreign currencies

should be captured under price risk. Foreign exchange risk is also known as

translation risk. Foreign exchange translation risk arises from holding accrual

accounts denominated in foreign currency, including loans, bonds, and deposits.

36 | P a g e


Credit risk

Credit risk is the risk to earnings or capital of an obligor's failure to meet the terms

of any contract with the bank or otherwise to perform as agreed. Credit risk arises

from all activities in which success depends on counterparty, issuer, or borrower

performance. It arises any time bank funds are extended, committed, invested, or

otherwise exposed through actual or implied contractual agreements, whether

reflected on or off the balance sheet.

Transaction Risk

Transaction risk is the risk to earnings or capital arising from problems with service

or product delivery. This risk is a function of internal controls, information systems,

employee integrity, and operating processes. Transaction risk exists in all products

and services. Derivative activities can pose challenging operational risks because of

their complexity and continual evolution. The operations function, which is

discussed in a later section, refers to the product support systems and related

processes.

Compliance Risk

Compliance risk is the risk to earnings or capital arising from violations, or

nonconformance with, laws, rules, regulations, prescribed practices, or ethical

standards. The risk also arises when the laws or rules governing certain bank

products or activities of the bank’s clients may be ambiguous or untested.

Compliance risk exposes the institution to fines, civil money penalties, payment of

damages, and the voiding of contracts. Compliance risk can lead to a diminished

reputation, reduced franchise value, limited business opportunities, lessened

expansion potential, and an inability to enforce contracts.

Despite the various derivatives still a success story in the Indian Market. When

there is profit, it will be certainly backed by risk. However it is important to know

the contribution of the derivatives in India.

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Derivatives – a booming business

The exchanges have made quick business and profits when the national level

commodity derivatives exchange was started since 2002. There was a good come

back of the commodities future trading in India both in the number of quantity and

value of commodities. In the year only 8 commodities were traded, and it rose to

80 commodities by 2004 and today we trade around 180 commodities in the

derivatives market. The value of trading in local currency saw a quantum jump

from about INR 350 billion in 2001-02 to INR 1.3 Trillion in 2003-04.

A comparative data presented below give some facts which states the

performance of derivatives market. It is a comparative trading data for three

fortnightly periods in March, June and September 2005. (Due to the non

availability of recent progress, a bit older has been given).

Multi-Commodity Exchange of India Limited, Mumbai recorded $m 3,503.69 during

16th march to 30th march, $m 4974. 76 (16 Jun 05 to 30 Jun 05), $m 11,042.25 (16

Sep 05 to 30 Sep 05).

National Multi-Commodity Exchange of India Limited, Ahmedabad, recorded

$m135.64 (16 Mar 05to 31 Mar 05), $m 113.13 (16 Jun 05 to 30 Jun 05), $m106.85

(16 Sep 05 to 30 Sep 05). National Commodity & Derivatives Exchange Limited,

Mumbai recorded $m5, 360.45, $m 7,950.49 and $m 10,694.29 during 16 Mar

05to 31 Mar 05, 16 Jun 05 to 30 Jun 05 and 16 Sep 05 to 30 Sep 05 respectively.

The above data shows that the market for the commodity derivatives were more

than a double over a six-month period between second half of March 2005 and the

second half of September 2005. It also shows that the total commodity futures

turnover for the three national level exchanges added up to $21.84 billion for a

fortnight in September 2005 or $546 billion for a year.

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Chapter 3

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RESEARCH DESIGN/METHODOLOGY

Sampling design:

The sample selected for the purpose of research is the investors who trade frequently and

staff of the Karvy comtrade. The karvy comtrade posses nearly 2000 to 3000 investors,

among nearly 800 trade in derivatives. The intra day transactions are carried by nearly 20

people and only 10 people are considered as active customers.

Type of sampling

Convenience sampling which is a type of non probability sampling is carried while

selection of samples. The selection of investors from the population based on their

easy availability and accessibility to the researcher has been taken.

Criteria for selection of samples

Degree of accuracy

As the samples selected on the basis of the convenience (samples are selected on

their availability) the information collected carries a good wieghtage. The samples

are informed that they are under research and they came forward as respondents.

Time

The time taken for the research is a long time. Under various circumstances the

same questions were asked and the responses were not changed. Hence there was

no time constraint or the influence of time upon the investors.

Prior knowledge

The investors were not new to the market. They have seen the ups and down since

many years. Hence the prior knowledge of respondents was good.

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Research design

Nature of research design

Experience survey

The research can be categorized under the experience survey as it conducted to

gain additional knowledge on derivatives market as a lot of important information

is not freely available. The handful of secondary data is available on the subject but

it is not sufficient to trade in the derivatives market.

However at first the objectives of the study was listed and then the secondary data

was collected and then it was analyzed, prepared the questionnaire, interaction

with company guide, investors which was the primary data collected. After the

collection of the primary data, compared the primary data with secondary data

and the evaluation of the primary data is carried out to know the reliability and

accuracy of the data collected. However the suggestions from faculty guide has

been taken and prepared the research report

Questionnaire design

(The questionnaire is enclosed under the section Annexure)

Probing was made when felt necessary.

The following are decision taken to collect the information required

Required information:

The research objectives were clear before conducting the research. While framing

questionnaire it was ensured that the questions are designed to draw information

that will fulfill research objectives.

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Target respondents

Before conducting research it was decided that the target respondents to be the

frequent investor’s or speculators as they possess more knowledge about trading.

This was a crucial step because target respondents becomes important as the task

of developing a questionnaire that will be suitable to all cross sectional groups of a

diversified investors.

Data that was gathered

In short, the common information collected from the investors who stands of the

opinion that the require of investment is more in currency market and commodity

market. The loss incurred or the profit earned is huge amount. A small changes in

the value of gold or currencies subject huge loss. Hence the risk is more in options

of derivatives market under gold or currency. Many investors show less interest to

trade in futures and even on commodities as such.

Sources from which the data was collected

Both the primary data and secondary data are the sources of data collection.

Through the primary data information regarding investor’s attitude towards the

investment in derivatives market is studied and through the secondary data the details

of derivatives market is collected.

Data collection

Time of data collection

The time for the collection of secondary information around 15 days and for the

primary data 45 days

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Field condition during the data collection

The market was showing a positive response and the investors were showing keen

interest in investment. The affect of recession was not in light as many companies

showed better profits. Moreover there was hike in the prices of commodities as

well.

Human resource in the research

One person to conduct the research under the guidance of the company guide and

faculty guide

Training

We were well trained during our SIP as it was just like a research. The faculty guide

and company guide are trained as per the institution and company norms

respectively.

Data analysis

Data handling

The secondary data collected are screened and then the primary data has been

collected. It was important to acquire knowledge on the derivatives at first and

then follow the primary research. The data collected are not mismanaged and are

true information as they are collected from the popular sources. The investors are

of speculative in nature who posses good knowledge about the market.

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Ground work

A clear ground work has been done to pursue the research as the objectives were

clear. On the basis of the objectives the secondary data were collected. Contacting

the company guide and investors was a major ground work in the research. The

permission to conduct the research was taken from the college and company.

Limitations

Various sites have been referred to collect the secondary data. But some sites

provided wrong data, the genuine of the data was not good.

The books referred failed to provide complete details and hence it made to refer

more books and web sites.

The investors have good knowledge about trading but they lack the theoretical

knowledge. They were speculative in nature and they had good knowledge on

the time of changes in the prices.

It is assumed that as the market was positive and hence they were showing keen

interest in trading. But the same sort of attitude may not be hoped when the

market performance is not up to the mark.

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Chapter 4

45 | P a g e


RESULTS AND ANALYSIS

The very big myth in common people is that they perceive the derivative market is small. But the derivative market in India are about Rs. 11 trillion worth per annum.

The future market is 5 – 20 times that of the spot market. The following table depicts the following:

Market Annual Physical Trade (Rs . Cr)

3 times multiple (Rs in Cr)

5 times multiple(Rs in Cr)

Bullion 40000 120000 200000

Metals 60000 180000 300000

Agriculture 500000 1500000 2500000

Energy 500000 1500000 2500000

Total 1100000 3300000 5500000

Per day 4400 13200 22000

Bullio

nMeta

ls

Agricu

lture

Energ

yTo

tal

Per day

0

1000000

2000000

3000000

4000000

5000000

6000000

Annual Physical Trade (Rs . Cr)3 times multiple (Rs in Cr)5 times multiple (Rs in Cr)

46 | P a g e


Information collected through research

Steps to Trading

The investor who likes to trade in derivatives market has to open an account with the broker. The Karvy comtrade ltd, charges Rs 2000 to open an I zone account from which the investor can trade in both equity market and derivatives market.

After opening the account by submitting his documents, it will be forwarded to the Head Quarters of Karvy comtrade ltd, which is located in Hyderabad. It analysis the document and his account. The initial margin is fixed which is 5% to 10% of the contract value.

Code will be given on the account for the accessability of trading for the investor. The investor has to trade on this code, where the commission charges apply on code basis. The code will be forwarded to regional office.

The investor can trade after the completion of the above process. When a contract takes place he has give 0.05% commission to Karvy comtrade ltd.

47 | P a g e

Open an account with the brokerDeposit the initial margin

Step 1


Safety measures

Trade only through registered Members.

In the interest of our own safety, it is important to trade only through registered

members since the commodity exchanges have jurisdiction over them in terms of their

own rules, bye laws, etc and can therefore, play a role in resolving investor grievances

or even take action against the members if necessary. The exchange has no jurisdiction

over entities who are not their members.

Be familiar with FMC guidelines and rules, regulations, byelaws, circulars, etc. of MCX.

Be familiar with FMC guidelines and rules, bye laws, etc. of the exchange to have an

adequate understanding of the legal framework under which the commodity futures

are traded. This would be useful in terms of giving you a better understanding of the

procedures relating to trading, clearing and settlement, your rights as investor, etc.

Take an informed decision

Be sure while taking an informed decision. Read the product note available on the

exchange website to understand the commodity specifications. Keep track of

Government policy announcements such as the Minimum Support Price,

Export/Import policy, etc, which have a significant impact on the prices of

commodities. Also keep track of exchange announcements made through circulars

regarding the methodology of computation of due date rates, launch of new contracts,

etc. Understand the commodity thoroughly. Study historical and seasonal price

movements of the commodity.

Understand the Delivery and Settlement Procedure.

Thoroughly understand the delivery and settlement procedure which differs from

commodity to commodity in terms of quality implications, place of delivery, options,

penalties, margins, etc. This information is given in the product note available on the

website. Understanding of delivery would help in avoiding rejection of your delivery.

Understand and Comply with Taxation and other relevant laws.

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Before initiating a trade, ascertain whether the price of the commodity is inclusive or

exclusive of various taxes applicable at the delivery centre at the given point of time.

Be aware of implications of various taxes such as Sales tax, Service tax, VAT, etc. Make

sure that you understand and comply with accounting standards for derivatives.

Pay all applicable margins. Collect / pay mark-to-market margins on a daily basis.

Pay all the applicable margins on your futures position to the member. Also, collect or

pay (as the case may be) mark-to-market margins from/to the member which are

required to be settled on a daily basis.

Insist on documentation with the member such as Member Client agreement, and

Know Your Client.

Enter into an agreement with the member since that would ensure that you have

recourse to all the investor protection mechanisms of the exchange. Co-operate with

the member in filling up the 'Know Your Client form. This form has been devised to

ensure that a member knows all his clients properly, and you are thus protected from

the risk which may arise out of a member having unsuitable clients. Only clients with

pan numbers are allowed to trade on commodity exchanges.

Read and understand the Risk Disclosure Document.

The Risk Disclosure Document provides valuable insight into the risk associated with

futures trading. It is therefore, in your interest to carefully read and understand this

document.

Insist on signed Contract Notes containing all relevant information such as Member

Registration Number, Order Details, Trade Rate, Quantity, etc.

Insist on signed contract notes with all the relevant information for all your trades. The

contract note is a proof of the transaction between you and the member and is

absolutely essential for you to be able to approach the exchange for redressal of your

complaints, availing arbitration mechanisms, etc.

Obtain receipt for collateral deposited with the Members.

Take a receipt from your members for collateral deposited with them.

Insist on a periodical statement of your ledger account.

Monitor your account with the member properly by insisting on a periodical statement

of your ledger account.

Close the de-mat account in case of a long absence.

49 | P a g e


Structure of Commodity Market

Trading system

The best five buy and sell orders for every contract available for trading are visible to

the market and orders are matched based on price time priority logic. Orders can be

placed with time conditions and/ or price conditions

50 | P a g e

Ministry of Consumer Affairs

FMC

Commodity Exchange

National Exchange

NCDEX

MCX NMCE

Regional Exchange

NBOTOther

Regional Exchanges


Time related Conditions

DAY order- A Day order is valid for the day on which it is entered. If the order is not

matched during the day, the order gets cancelled automatically at the end of the

trading day.

GTC - A Good Till Cancelled (GTC) order is an order that remains in the system until the

expiry of the respective contract in which it is entered or until when the same is

cancelled by the member.

GTD - A Good Till Date (GTD) order is valid till the date specified by the member. After

the specified date the unexecuted orders get automatically cancelled by the system.

IOC - An Immediate or Cancel (IOC) order allows a member to execute the orders as

soon as the same is placed in the market, failing which the order will get cancelled

immediately

Price Conditions

Limit Order – The order wherein the price is to be specified while placing the same.

Market Order – The order at the best available price at the time of placing the same.

Trade timings

Monday to Saturday: 9:45 a.m. to 9:59 a.m.

Special Session (order cancellation session) is held to cancel the pending orders prior

to opening of market

Normal Session:

Monday through Friday: 10:00 a.m. to 11:30 p.m.

(up to 11:55 p.m. on account of day light savings typically between every November

and March of the following year)

Saturdays: 10:00 a.m. to 2:00 p.m.

Agri-commodities are available for futures trading up to 5:00 p.m. whereas non agri-

commodities (bullions, metals, energy products) are available up to 11:30 pm /

11.55pm.

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Trading Holidays

1 Mahashivratri

2 Id-E-Milad

3 Good Friday / Holi (1 st Day)

4 Ambedkar Jayanti

5 Mahavir Jayanti

6 Maharashtra Day

7 Buddha Purnima

8 Independence Day

9 Ganesh Chathurthi

10 Ramzan Id / Gandhi Jayanti

11 Dasera

12 Diwali (Laxmi Pujan)

13 Diwali ( Bhaubeez)

14 Gurunanak Jayanti

15 Bakri-Id

16 Christmas

The Exchange may alter / change any of the above Holidays, for which a separate

circular will be issued in advance.

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Trading related documents

Application for New User ID creation

Application for Change of User Name

User Id cancellation

Application for User ID/ Member ID mapping

Increase/ Decrease in Maximum Order Size of trade

Increase/ Decrease in Turnover limit

Enablement of Pro facility

Reset of Member Admin/ User Id password

Application for Cancellation of orders

Application for Square-off of trades

Trading rules

The Derivatives Trading at BSE takes place through a fully automated screen-based

trading platform called DTSS (Derivatives Trading and Settlement System).The DTSS

is designed to allow trading on a real-time basis. In addition to generating trades by

matching opposite orders, the DTSS also generates various reports for the member

participants.

Ö Order Matching Rules

Ö Order Conditions

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Order Matching Rules

Order Matching takes place after order acceptance wherein the system searches

for an opposite matching order. If a match is found, a trade is generated. The order

against which the trade has been generated is removed from the system. In case

the order is not exhausted further matching orders are searched for and trades

generated till the order gets exhausted or no more match-able orders are found. If

the order is not entirely exhausted, the system retains the order in the pending

order book. Matching of the orders is in the priority of price and timestamp. A

unique trade-id is generated for each trade and the entire information of the trade

is sent to the relevant Members.

Order Conditions

The derivatives market is order driven i.e. the traders can place only orders in the

system. Following are the order types allowed for the derivative products. These

order types have characteristics similar to the ones in the cash market.

Limit Order

An order for buying or selling at a limit price or better, if possible. Any unexecuted

portion of the order remains as a pending order till it is matched or its duration

expires. An order that becomes a limit order only when the market trades at a

specified price.

Market Order

An order for buying or selling at the best price prevailing in the market at the time

of submission of the order.

There are two types of Market Orders

Partial Fill Rest Kill (PF): execute the available quantity and kill any unexecuted

portion.

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Partial Fill Rest Convert (PC): execute the available quantity and convert any

unexecuted portion into a limit order at the traded price.

All orders have the following attributes

Order Type (Limit / Market PF/Market PC/ Stop Loss)

Asset Code, Product Type, Maturity, Call/Put and Strike Price

Buy/Sell Indicator

Order Quantity

Price

Client Type (Propritory / Institutional / Normal)

Client Code

Order Retention Type (GFD / GTD / GTC)

Good For Day (GFD) - The lifetime of the order is that trading session

Good Till Date (GTD) - The life of the order is till the number of days as specified by

the Order Retention Period.

Good Till Cancelled (GTC) - The order if not traded will remain in the system till it is

cancelled or the series expires, whichever is earlier.

Order Retention Period (in calendar days) : This field is enabled only if the value of

the previous attribute is GTD. It specifies the number of days the order is to be

retained.

Protection Points Protection Points : This is a field relevant in Market Orders and

Stop Loss orders. The value enterable will be in absolute underlying points and

specifies the band from the touchline price or the trigger price within which the

market order or the stop loss order respectively can be traded.

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Risk Reducing Orders (Y/N)

When a Member's collateral falls below 50 lacs, he will be allowed to put only risk

reducing orders and will not be allowed to take any fresh positions. It is not

essentially a type of order but a mode into which the Member is put into when he

violates his collateral limit. A Member who has entered the risk-reducing mode will

be allowed to put only one risk reducing order at a time

National Commodity Exchanges and Regional Commodity Exchanges

Demutualization has gathered pace around the world and Indian commodity

exchanges are also looking into it. Existing single and regional commodity

exchanges have realized the possible threat that the national level exchange may

pose on their future.

Given the experience of the regional stock exchanges in India, commodity

exchanges are becoming proactive to counter such a threat. Commodity exchanges

may not face the threat of extinction because of the following reasons.

(1) Commodity exchanges are trading in futures contracts on those commodities,

which have some regional relevance. It is not going to be as easy as a share of a

company to get listed in a different exchange.

(2) Delivery of commodity is a physical activity; delivery of shares is an electronic

activity (3) Commodity exchange members are stakeholders in those commodities

where in stock exchange members were never the owners of the stock to control

where the stock should get traded.

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(4) Importance of commodity exchanges are linked to the stakeholders of that

particular commodity wherein success of a stock exchange is more on

transparency and low transaction cost.

Above reasons are possibilities; national level exchanges could encourage the

existing commodity exchanges and their members to the national stream. Such

exchanges and members are of relevance to the Indian economy as a whole and

for the success of commodity futures in particular.

Member of derivative segment in BSE

Steps to become a member of derivative segment in BSE

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Fill the derivatives

membership form

available at BSE India website

Contact Relationship

Managers (BDM

Department)

Choose the type of

Membership

The applications forms duly filled along

with the required

documents should be submitted

to the Membership Services & Developmen

t

Application will be placed

before the BSE

Committee of

Executives

BSE Committee

of Executives

may call you for a

personal interview

Applications approved by

BSE Committee

of Executives will be sent to SEBI for approval

and registration

SEBI's approval

After receipt of SEBI

registration, applicants

account will be debited

by Rs. 50,000.00 in

case of Clearing

Membership

For Commence

ment of Business in

the Derivatives Segment,

please contact

Relationship Managers

(BDM Department

)

START TRADING IN

DERIVATIVES


Types of Memberships in the BSE Derivatives Segment

Trading Member

A Trading Member should be an existing Member of BSE cash segment. A Trading

Member has only trading rights but no clearing rights. He has to associate with a

Clearing Member to clear his trades.

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Types of membership

TRADING MEMBER (TM)

TRADING-CUM-CLEARING

MEMBER(TCM)

PROFESSIONAL CLEARING MEMBER (PCM) /CUSTODIAL

CLEARING MEMBER (CU)

LIMITED TRADING MEMBER(LTM)

SELF CLEARING MEMBER(SCM)


Trading-Cum-Clearing Member

A Trading-cum-Clearing Member should be an existing Member of BSE cash

segment. A TCM can trade and clear his trades. In addition, he can also clear the

trades of his associate Trading Members.

Professional Clearing Member / Custodial Clearing Member:

A Professional Clearing Member need not be a Member of BSE cash segment. A

PCM has no trading rights and has only clearing rights i.e. he just clears the trades

of his associate Trading Members & institutional clients.

Limited Trading Member

A Limited Trading Member need not be a Member of BSE cash segment. A LTM has

only trading rights and no clearing rights. He has to associate with a Clearing

Member has to clear his trades.

Self Clearing Member

A Self Clearing Member should be an existing Member of the BSE cash segment. An

SCM can clear and settle trades on his own account or on account of his client only

and not for any other Trading Member.

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FINANCIAL REQUIREMENT AND FEE CHART FOR MEMBERS OF BSE DERIVATIVES SEGMENT

Sl

No

Particulars PCM / CCM /

TCM / SCM

TM LTM

Members of other Stock Exchanges whose Clearing member is a subsidiary Company of a Regional Exchange

Others

1 Net Worth 300(PCM / TCM)

100 (SCM)

25 10 25

2 Security Deposit

Interest Free Cash - 2.5 2.5 2.5

Cash/Cash Equivalents

(#)

2.5 2.5 2.5 2.5

Approved Securities 2.5 2.5 2.5 2.5

Total 50 7.5 7.5 7.5

3 Processing Fees _ _ _ _

4 Annual Charges (*) 0.50 0.25 0.25 0.25

5 One Time Charges

Exchange Fee

(Refundable Deposit)

5 _ _ _

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Regulators of Derivatives Market in India

Just as SEBI regulates the stock exchanges, the derivatives market are regulated by

the FMC (Forward Market Commission). The FCM works under the purview of the

Ministry of Food, Agriculture and Public Distribution

The commodities on which futures trading takes place

Almost all commodities known to us are traded in the derivatives market. However

there are 180 commodities are traded in this market. They have categorized as

follows, only some important commodities traded are taken into consideration.

Bullion Gold and Silver

Oil and oil

seeds

Castor seeds, soya beans, castor oil, refined soya oil, soyameal,

RBD palmolein, crude palm oil, ground nut oil, mustard seed oil,

cotton seed oil, cotton seed oilcake, cotton seed, menthe oil.

Spices Pepper, red chilly, jeera, turmeric, cardamom, coriander

Metals Steel long, steel flat, copper, nickel, tin, steel ingots, zinc,

aluminium

Fibre Kapas, long staple cotton, medium staple cotton

Pulses Chana, urad, yellow peas, tur, masur

Cereals Rice, basmati rice, wheat, maize, sarbati rice.

Energy Crude oil, furnace oil, natural gas, heating oil

Others Rubber, guar seed, guargum, cashew, cashew kernel, sugar, gur,

coffee, silk

Interpretation of futures price quotations

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Open High Low Settle Change Life time Open

interestHigh low

Dec 250 255 248 252 2 265 245 11000

Mar 230 233 223 232 2 243 220 23000

May 220 224 217 223 3 233 215 12330

July 240 243 236 243 3 249 230 3600

Sep 230 234 229 225 -5 240 225 1245

Dec 260 265 254 255 -3 270 250 5688

The first column gives the maturity of the contract that is the month in which the

contract will expire.

The second column, OPEN denotes the price for the first trade on that particular

trading day.

The third and the fourth column HIGH and LOW denotes the highest and lowes

price at which a particular contract traded on that day.

The fifth column SETTLE stands for the settlement price. It is determined by the

settlement committee by using a formula which considers the prices at which

trading took place during the last few minutes of the closing time.

The sixth column CHANGE represents the difference between today’s settlement

price and yesterday’s settlement price. It can be positive or negative.

The HIGH and the LOW in the seventh column denotes the highest and the lowest

ever price at which the contract was traded till date.

The last column OPEN INTEREST denotes the cumulative number of contracts that

are due to delivery. In other words it is the number of futures contract that has to

be settled on or before expiry date.

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Turnover in financial market and commodity market

Market segments 2002-03 (Rs in crores)

2003-04(Rs in crores)

2004-05 (Rs in crores)

Government Securities Market 1,544,376 2,518,322 2,827,872

Forex Market 658,035 2,318,531 3,867,936

Total Stock Market Turnover (I+ II) 1,374,405 3,745,507 4,160,702

National Stock Exchange (a+b) 1,057,854 3,230,002 3,641,672

a)Cash 617,989 1,099,534 1,147,027

b)Derivatives 439,865 2,130,468 2,494,645

Bombay Stock Exchange (a+b) 316,551 515,505 519,030

a)Cash 314,073 503,053 499,503

b)Derivatives 2,478 12,452 19,527

Commodities Market NA 130,215 500,000

Source : Ankur Rajoria, Student (Batch-2006-SEM-III), ICFAI Business School, ICFAI

House, Nr. GNFC Tower, S.G. Highway, Bodakdev, Ahmedabad-380 054

E-mail: [email protected] / [email protected]

Leading commodity exchange of the world

Some of the leading exchanges of the world are

New York Mercantile Exchange (NYMEX),

London Metal Exchange (LME)

Chicago Board of Trade (CBOT).

Leading commodity markets of India

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mailto:[email protected]


The government has now allowed national commodity exchanges, similar to the BSE & NSE,

to come up and let them deal in commodity derivatives in an electronic trading

environment. These exchanges are expected to offer a nation-wide anonymous, order

driven, screen based trading system for trading. The Forward Markets Commission (FMC)

will regulate these exchanges.

Consequently four commodity exchanges have been approved to commence business in this regard. They are:

Multi Commodity Exchange (MCX) located at Mumbai.

National Commodity and Derivatives Exchange Ltd (NCDEX) located at Mumbai.

National Board of Trade (NBOT) located at Indore.

National Multi Commodity Exchange (NMCE) located at Ahmedabad.

Derivatives - Governing / Clearing Council

GOVERNING COUNCIL Non-Executive Chairman - Public Representative - Mr. Jagdish Kapoor

Managing Director & Chief Executive Officer - Mr. Madhu Kannan

Chief Operating Officer - Mr. M. L. Soneji

CLEARING COUNCIL

Non-Executive Chairman - Public Representative - Mr. Jagdish Kapoor

Managing Director & Chief Executive Officer - Mr. Madhu Kannan

Chief Operating Officer - Mr. M. L. Soneji

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Chapter 5

DISCUSSION OF IMPLICATIONS

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It is important to note that GOLD is traded more in the derivatives market. Some

details about it is provided.

Gold is a unique asset based on few basic characteristics. First, it is primarily a

monetary asset, and partly a commodity. The distinction between gold and

commodities is important. Gold has maintained its value in after-inflation terms

over the long run, while commodities have declined.

Role of gold in derivatives market

Timeless and Very Timely Investment

For thousands of years, gold has been prized for its rarity, its beauty, and above all,

for its unique characteristics as a store of value. Nations may rise and fall,

currencies come and go, but gold endures. In today’s uncertain climate, many

investors turn to gold because it is an important and secure asset that can be

tapped at any time, under virtually any circumstances. But there is another side to

gold that is equally important, and that is its day-to-day performance as a

stabilizing influence for investment portfolios. These advantages are currently

attracting considerable attention from financial professionals and sophisticated

investors worldwide.

Gold is an effective diversifier

Diversification helps protect your portfolio against fluctuations in the value of any

one-asset class. Gold is an ideal diversifier, because the economic forces that

determine the price of gold are different from, and in many cases opposed to, the

forces that influence most financial assets.

Gold is the ideal gift

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In many cultures, gold serves as a family treasure or a wealth transfer vehicle that

is passed on from generation to generation. Gold bullion coins make excellent gifts

for birthdays, graduations, weddings, holidays and other occasions. They are

appreciated as much for their intrinsic value as for their mystical appeal and

beauty. And because gold is available in a wide range of sizes and denominations,

you don’t need to be wealthy to give the gift of gold.

Gold is highly liquid

Gold can be readily bought or sold 24 hours a day, in large denominations and at

narrow spreads. This cannot be said of most other investments, including stocks of

the world’s largest corporations. Gold is also more liquid than many alternative

assets such as venture capital, real estate, and timberland. Gold proved to be the

most effective means of raising cash during the 1987 stock market crash, and again

during the 1997/98 Asian debt crisis. So holding a portion of your portfolio in gold

can be invaluable in moments when cash is essential, whether for margin calls or

other needs.

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Top Gold Demanding Nations

COUNTRIE

S

1996 1997 1998 1999 2000

India 506.98 736.84 814.9 838.86 855.34

USA 331.56 362.04 428.3 459.71 387.55

China 374.48 406.83 314.5 343.38 329.38

SE Asia 329.69 204.04 51.63 265.62 267.18

Saudi 184.75 199.06 208.4 199.37 221.14

Turkey 153.03 201.86 172 139.03 207.15

COUNTRIES51%

India13%

USA9%

China10%

SE Asia9%

Saudi5%

Turkey4%

Gold Demand in Key Markets Worldwide

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Recent Developments in India

World Gold Council (WGC) has estimated that the annual Indian demand for the

precious metal in recent years has been in excess of 800 tons. Most of it appears to

be meant for jewellery fabrication, and the rest, estimated at 10 to 15 percent, is

possibly meant to meet demand on account of investment and industrial

processes. A major step in the development of gold markets in India was the

authorization in July 1997 by the RBI to commercial banks to import gold for sale or

loan to jewellers and exporters. Initially, 7 banks were selected for this purpose on

the basis of certain specified criteria like minimum capital adequacy, profitability,

risk management expertise, previous experience in this area, etc. The number of

banks later went upto 18. On a review, since five banks had not evinced adequate

interest in this business in terms of activity, the RBI did not find it appropriate to

renew their licences for this purpose. At present, 13 banks are active in the import

of gold. The quantum of gold imported through these banks has been in the range

of 500 tons per year.

Import of gold by banks authorized by the RBI has succeeded to a large extent in

curbing illegal operations in gold and in foreign exchange markets. It has also

resulted in reducing the disparity between international and domestic prices of

gold from 57 per cent during 1986 to 1991 to 8.5 percent in 2001. The import duty

on gold, which was Rs.220 per ten grams up to January 1999, was increased

toRs.400 per ten grams, and with effect from April 2001 has been reduced to

Rs.250 per ten grams. The estimates of duty realized from gold imports indicate an

annual amount varying from about Rs. 1,000 to Rs. 2,000 crore per annum since

1997.

Even though the country consumes more than 800 tons of the metal every year,

the system of assaying and hallmarking has not gained the desired importance. The

low quality of gold jewels being sold in the country and the resultant losses being

incurred by the consumers are being recognized now. Recent surveys conducted

69 | P a g e


by the Bureau of Indian Standards (BIS) jointly with Central Consumer Protection

Council in 5 major cities reveal that more than 80 per cent of the jewels being sold

in the market were of lower purity than claimed and charged for. In some cases,

the gold articles sold were 38.6 per cent short in purity in monetary terms. The low

purity results in a loss of around 16 per cent to gold jewels.

In the recent past, RBI has been actively pursuing the issue of upgrading the quality

of trade and products through a system of assaying and hallmarking with

Government of India and BIS. The major objectives of introducing a proper

assaying and hallmarking system in the country are enabling consumer protection,

developing export competitiveness of the gold jewels industry, introducing gold

based financial products, which will help in mopping up the vast dormant gold

resources with the domestic sector and developing India into a leading gold market

centre in the world.

The Government of India announced the Gold Deposit Scheme in 1999 and RBI

issued guidelines to the banks intending to launch the scheme in October 1999.

Five banks have launched their schemes under the guidelines and the quantum of

gold mobilized so far has been about 7 tonnes. Unfortunately, the scheme has not

evoked the expected response. A number of reasons can be cited for the low

response, prominent among them being depositors’ losing the making charges

spent on jewels (as the banks would convert them into primary form before

accepting as deposits), the low carat of jewels, low rate of return on deposit (as

seen by the depositors) and the absence of any amnesty.

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However numerous data were covered on the study was covered under the study

of the derivatives market in India. Howver the clearing and settlement of the

futures and options have to seen. They are as follows;

Clearing and settlement of Futures

Clearing mechanism in NSE

The open position of CM is calculated by averaging of the open position of all the

Trading Members clearing through them.

A TM’s open position is calculated by adding up his proprietary open positions and

client’s open positions.

The proprietary open position is calculated on net basis and client positions will be

calculated on gross basis.

Settlement Mechanism

The Nifty Index Futures and options contracts are cash settled. The CM are

required to open bank account specified by NSCCL. The open positions in the index

futures contracts are marked to market at the settlement priceof the contract at

the end of each trading day. The members who have a loss position should pay the

loss amount to NSCCL which is then transferred to the members who have made

profits. This is known as daily market to market settlement. The closing price of

index futures contract which is computed by taking the weighted average of the

prices of the daily settlement price.

On the expiry of the futures contract, NSCCL marks the open position of CM to the

final settlement price and the resulting profit or loss is settled in cash

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Settlement of Options Contracts

Settlement of Index Options Contract

In the index option contract the premium has to be paid or received is calculated

for each CM after netting the positions at the end of each day. The CM who has to

pay the premium has to pay to NSCCL and this is adjusted with those who have to

receive the premium. This is known as daily premium settlement. On the expiry

day of the options contract, NSCCL will determine the outstanding in the money

contracts based on the final settlement price and resulting profit or loss will be

settled in cash. The final settlement price is the closing value of the underlying

index price on the expiration day of the contract. The final settlement profit or loss

will be the difference between the stock price and the final settlement price of the

relevant index option contract. Final settlement profit or loss amount is credited or

debited to the relevant CM’s clearing bank account on the day next the expiry day.

Settlement of Options Contract on Individual Securities

The premium to be paid or received is netted across all option contracts on

individual securities at the client level to determine the net premium payable or

receivable at the end of each day. The settlement procedure is similar to that of

the index option contracts. Interim exercise settlement price is the clearing price of

the underlying security on the exercise day. The settlement value is the difference

between the strike price and the exercise settlement price of the option contract.

The exercise settlement value is debited or credited to the CM’s clearing bank

account on the third day of the exercise day.

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However besides the second largest populated country India is not seen in top list

of commodity exchange. The main reason is that lack of knowledge and many

people are risk averse. The commodities are traded world wide but the farmers are

not interested to trade in the derivatives market. There is lack of motivation for

our farmers to trade in derivatives. Apart from these the investors tend to invest in

equities rather than derivatives. Hence Indian Derivatives market is not performing

up to the mark.

Apart from it is should be noted that the brokers receive message from the market

very fastly. So they can guide the investors to earn better profits. The online

traders do not get such information and may end up by huge losses.

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Chapter 6

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FINDINGS

The research has helped to gain knowledge over various aspects in the derivatives market.

Various changes has been seen in the derivatives market. The Indian market is performing

well in these days.

The stock exchange Mumbai created history by launching the first exchange traded financial

derivatives product in India, the Sensex Futures. The trading was inaugurated by Prof. J R

Varma, member of SEBI and chairman of committee responsible for formulation of risk

containment measures for the derivatives market. The first historical trade of 5 contracts of

June series was done on June 9, 2000 at 9.55.03 am between M/s Kaji & Maulik Securities

Pvt. Ltd and M/s Emkay Share & Stock Brokers Ltd., @ 4755

However the following are the findings of the research

ð Commodity futures help us to procure or sell the commodities at a price

decided month before the actual transaction, so risk on any fluctuation in

prices may be a minimized.

ð By taking positions in the futures one can effectively lock in the price at

which he wish to sell his produce.

ð One can store the underlying commodities in exchange approved warehouse

and sell in the futures to realize the future value of the commodity.

ð Selling commodity in futures contract can give assured demand at the time

of harvest.

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ð One can fix the rate of commodities to purchase in future before itself. For

instance if an industrialist want to purchase raw materials and there is a

scenario of increase in prices for it, he can fix a price for the raw materials

now itself.

ð One can avoid risk of short supply of raw materials by buying a commodity

futures contract by which he is assured of supply of a fixed quantity of

materials at a pre decided price at the appointed time.

ð In the derivatives market, the commodity prices are less volatile than the

stock prices and hence it is relatively safer.

ð As many of the commodities are prices on International standards there is

ample scope for manipulation.

ð There will be a doubt on the physical deliveries of the commodities traded

through the exchange among many common people. Of course the

exchanges in order to maintain the futures prices in line with spot market,

have made provisions of settlement of contracts by physical deliveries.

ð There is no need of paying the sales tax if the trade is squared off, however

the sales tax is applicable only in case of trade which result into delivery.

ð Options in goods are prohibited under section 19 of the Forward Contracts

(Regulation) Act, 1952.

ð India is a signatory of WTO, as such the producers and traders have

opportunities to explore the global market.

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ð FCI – Food Corporation of India is working with storage of commodities

where many farmers and traders have considered it as a failure. Futures

market will produce their own kind of smoothing between the present and

the future. If the future price is high and the present price is low, an

arbitrager will buy today and sell in the future, if the future price is low the

arbitrageur will buy in the futures market. These activities produce their

own "optimal" buffer stocks, smooth prices. They also work very effectively

when there is trade in agricultural commodities, arbitrageurs on the futures

market will use imports and exports to smooth Indian prices using foreign

spot markets.

ð In case of any dispute with a Member regarding the trades, a client holding a

valid contract note has the right to obtain redressal as per the byelaws of

the Exchange, including arbitration.

ð The risk of loss in case of options is high. A small drop of prices could

account of large amount of loss to the investors.

ð Many respondents wish to trade in futures as it is of less risk. But the

respondents who can considered as speculators wish to trade in options.

ð The minimum price needed to trade in commodity market is Rs 15000/-. The

investors need to deposit initial margin which is between 5% to 10% of the

contract and also pay the broker while opening an account which is around

Rs.2000/-. It seems to be burden on the prospective investors who wish to

trade in derivatives and hence they step aside.

ð The experienced investors would like to trade privately that is on line trading

and other open the account with brokers and trade.

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ð The returns from derivatives market are free from the direct influence of the

equity and debt market which means that they are capable of being used as

effective hedging instruments providing better diversification

ð The margins in the commodity futures market are less than the F&O section

of the equity market.

SUGGESTIONS

The derivatives helps to transfer the risk of the people, the discovery of the

anticipated prices are made. Derivatives promote the investment and saving in the

long run. Retail investors (including small brokerages trading for themselves) are

the major participants in equity derivatives, accounting for about 60% of turnover

in October 2005, according to NSE. There were several changes in the trading

system due to the globalization in India and hence responding to the changes the

several Nation wide Multi Commodity Exchange [NMCE] was set up in the year

2002 by the usage of modern practices such as electronic trading and clearing. The

Government of India has constituted a committee to explore and evaluate issues

pertinent to the establishment and funding of the proposed national commodity

exchange for the nationwide trading of commodity futures contracts, and the

other institutions and institutional processes such as warehousing and clearing

houses.

Ω The charges implied has to be lowered down

Ω Market information and market knowledge has to be provided to the common

man

Ω Motivate the farmers to trade in futures to sell their commodities

Ω Enlighten the general traders about the market

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Ω Motivate the general traders to trade in derivatives market

Ω The restriction on traders and the brokers have to minimized

Ω Tax reduction or exemption is to be provided.

Ω Financial assistance may be given to farmers to trade in futures.

Ω Government should interfere if in case any manipulations takes place while

trading international.

Ω Timely research should be conducted to see the performance of the derivatives

market. This enables to overcome the hurdles and assure better performance.

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Chapter 7

80 | P a g e


CONCLUSION

In India Derivative Market plays a major role in the development of the Nation.

Recently SEBI has started CURRENCY MARKET which can be considered as a

milestone achieved. It is said that a lot of risk is associated in the currency market.

The research objectives are fulfilled except the placement in the finance sector

which is hoped on the positive side. Learning and improving my knowledge in the

field of derivatives was the main aim of the study. By pursuing the research it was

known about the scope of Derivatives Market, formalities to be accomplished to

trade in this market, the wideness of differentiation of this market from the other

financial markets, the investor’s attitude and their speculations, practical trading in

this market, the calculations pertaining to derivatives market, the loopholes in this

market, the contribution of this market to National Income of India and was to give

some suggestions for the improvement of the derivatives market.

By referring the books, internet, magazine I came to know what exactly the

derivatives market mean, need for the derivatives market, participants in the

Derivatives Market, types of Derivatives, differences between the futures and

forward contracts, difference between Futures and Options, history of Derivatives

Market in India, factors leading for the Growth of Derivatives, Derivatives Users,

Derivatives Instruments Traded in India, Associated risks while trading in

derivatives and much more theoretical aspects.

The methodology adopted was right as the investors were of speculative in nature

and some were inactive traders. The sampling design, Convenience sampling,

Criteria for selection of samples was good. The survey can which can be considered

as an experience survey would provide better information for the readers of the

report. The Questionnaire design which was drafted on the basis of Required

information, Target respondents can be recognized by the company. The data was

81 | P a g e


collected both from the primary source and secondary source. The limitations of

the methodology is also discussed which enhance my professionalism.

In the results and analysis I have given details on the Steps to Trading, Safety

measures Structure of Commodity Market, Trading system, Trade timings, Trading

related documents, Trading rules, National Commodity Exchanges and Regional

Commodity Exchanges, Steps to become a member of derivative segment in BSE,

Types of Memberships in the BSE Derivatives Segment, FINANCIAL REQUIREMENT

AND FEE CHART FOR MEMBERS OF BSE DERIVATIVES SEGMENT, Trading Holidays,

Regulators of derivatives market in India, Interpretation of futures price quotations

has been discussed. On seeing the results and analysis it can be understood that

the derivatives market is booming and showing better performances year by year.

Hence it can said that this report furnishes important information about the

derivatives market and will be helpful for the readers, company. The students who

wish to improve their knowledge can follow this report. The survey was conducted

for a long period comprising of 3 months. The time the survey was conducted the

market was positive and hence the attitude of the customers is not a very reliable

factor. However the details regarding the derivatives market, the company profile,

the members, trading tactics possess better weightage.

I would like to conclude the report saying that the derivates market is booming in

India and hence it is better to invest or trade in derivatives.

Before ending up I would like to thank my Parents, college staff and company staff

for providing support throughout the project

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REFERENCES

Introduction to Security Analysis (ICFAI press)

Financial Management (ICFAI press)

Options, futures and Other derivatives. (Fifth edition, author John C Hull).

www.nseindia.com

Rediff.com news

http://www.eurojournals.com/finance.htm

Commodity Derivatives Market in India: Development, Regulation and Future

Prospects. Author - Narender L. Ahuja. Pdf file.

INDIAN DERIVATIVES MARKETS 1. Author - Asani Sarkar file Pdf.

Fixed Income Derivatives. Author unknown, file Pdf.

www.mcxindia.com

www.bseindia.com

www.indianmba.com

Ankur Rajoria, Student (Batch-2006),ICFAI Business School, Ahmedabad-380

054E-mail: [email protected] / [email protected]

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http://www.indianmba.com/

http://www.bseindia.com/

http://www.mcxindia.com/

http://www.eurojournals.com/finance.htm

http://www.nseindia.com/


APPENDICES

Specific Research Questions and why these have been selected and pursued

Questions to investors:

How would you define a derivative market?

How does this market differ from the equity market?

What are the formalities you come across to trade in this market?

Are you an active trader in the market? (Probing: if yes, how frequently you trade, if

no the reason is asked)

What are the risk associated while trading in the market?

What is the good time to trade in the derivatives market?

Do derivatives yield better? (Probing: if yes, how much percentage in an average you

earn in it)

Do you think derivatives market needs more development or marketing?

What are the tactics you follow to be on a safer side?

Your suggestions

FORMULAE

Basis

Current cash price – Futures price

Naked put writing

A (out of money)

1st method

Option Premium * Number of Shares + .20 (Market Value)( Number of Shares) – Number

of Shares (Stock Price – Exercise Price)

2nd method

Number of Shares * Option Premium + .10 [(Stock Price)( Number of Shares)]

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B (In the money option)

Option Premium * Number of Shares + .20 (Stock Price) (Number of Shares)

GLOSSARY

Arbitrageurs

They make business to take advantage of a discrepancy between prices in two different markets.

Baskets

Basket options are options on portfolios of underlying assets.

Compliance Risk

Compliance risk is the risk to earnings or capital arising from violations, or nonconformance with, laws, rules, regulations, prescribed practices, or ethical standards.

Credit risk

Credit risk is the risk to earnings or capital of an obligor's failure to meet the terms of any contract with the bank or otherwise to perform as agreed.

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.

Forward contract

It is a simple derivative. A forward contract is a customized contract between two entities,

where settlement takes place on a specific date in the future at today’s pre-agreed price.

Futures:

A futures contract is an agreement between two parties to buy or sell an asset at a certain

time in the future at a certain price.

Hedgers

It is an act, whereby an investor seeks to protect a position or anticipated position in the spot market by using the opposite position in derivatives.

Interest rate swaps

These entail swapping only the interest related cash flows between the parties in the same

currency.

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Leaps

The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options

having a maturity of up to three years.

Liquidity risk

Liquidity risk is the risk to earnings or capital from a bank’s inability to meet its obligations when they come due, without incurring unacceptable losses.

Options:

Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity

Over The Counter Market (OTC). It is a telephone and computer linked network of dealers.

The trading usually takes place between two financial institutions or between financial

institution and one of its corporate clients.

Price Risk

Price risk is the risk to earnings or capital arising from changes in the value of portfolios of financial instruments.

Reputation Risk

Reputation risk is the risk to earnings or capital arising from negative public opinion.

Speculators

These are the trades who trade in the futures or options with a view to make profit from the subsequent price movements.

Strategic risk

It is the risk to earnings or capital arising from adverse business decisions or improper implementation of those decisions.

Swaps

Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula.

Swaptions

Swaptions are options to buy or sell a swap that will become operative at the expiry of the options.

Warrants

Longer dated options are called warrants and are generally traded over the counter.

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