LOVELY PROFESSIONAL UNIVERSITY DEPARTMENT OF MANAGEMENT

Report on
DERRIVATIVES Investors Awareness regarding Risk Hedging Instruments

Submitted to Lovely Professional University

In partial fulfillment of the Requirements for the award of Degree of Master of Business Administration

SOFI OWAIS AHMAD 11112675

DEPARTMENT OF MANAGEMENT LOVELY PROFESSIONAL UNIVERSITY JALANDHAR-NEW DELHI GT ROAD PHAGWARA PUNJAB

PREFACE
This project report pertains to the making of summer training project of M.B.A. The purpose of this project is to make the students gain thorough knowledge of the topics given to them. I learned a lot about the topic after putting in much hard work in collecting the information regarding the topic allotted, which will be of a great use in future. It cannot be said with certainty that full justification has been done to the topic in the few pages presented here, but I have tried my best to cover as much as possible about Derivatives: Investors Awareness Regarding Risk Hedging Instruments in this report.

DECLARATION

I Sofi Owais Ahmad, here by declare that this is my Project Report on Derivatives: Investors Awareness Regarding Risk Hedging Instruments, which is submitted in partial fulfillment of the requirement of Master of Business Administration to Lovely Professional University. This is my original work and not submitted for the award of any other degree, diploma, fellowship or other similar titles. The assistance and help during the execution of the project has been fully acknowledged.

Date_______________

Signature_______________

Guide Certificate
This to certify that Sofi Owais Ahmad , a student of MBA, Lovely Professional University has undertaken the project on Investors Awareness Regarding Risk hedging Instruments, and has successfully completed this project under my guidance. This project was commissioned only for academic purposes, and is certified to be a bona fide work done by student.

Date:

Assistant Professor Lovely School of Business and Applied Art LPU

ACKNOWLEDGEMENT . Any research is never an individual effort. It is contributory effort of many hearts, hand and heads. First I would like to express my gratitude to LOVELY PROFESSIONAL UNIVERSITY who provided me an opportunity to do my summer training project in LSE for a span of 45 days .I am highly indebted to those who have helped me in making this summer training project a success and for providing their guidance and support in completing the project . While, I take this opportunity to thanks all of them. They are too numerous to be mentioned in this brief acknowledgement. This form of acknowledgement may not be sufficient to express the feeling of gratitude towards people, who have helped me successfully completing my training. It is my profound privilege to express my sincere thanks to Mr. Sadhu Ram, who gave me an opportunity to pursue my training in their prestigious organization. I would also like to thank Mrs. PoojaM.Kohli (executive director (offtg)) for giving her expert guidance & co-operation whenever I approached her for help in carrying out my project related to derivatives and also provided the valuable insights in understanding the basic fundamental about stock markets and regulation throughout duration of my project. I would like to express my thanks to all Faculty through which this learning was possible. Last and above all, I am extremely thankful to Miss.Jatinder kaur , Faculty Guide LOVELY PROFFESIONAL UNIVERSITY, for his timely guidance and support throughout the Final Report work. It would not have been possible with out her support and guidance. Sofi Owais Ahmad 11112675

TABLE OF CONTENTS TOPICS PAGE NO.

Acknowledgement.. Abstract.. CHAPTER:-1 (INTRODUCTION)

Introduction to Stock Exchange.... Introduction to LSE.... Operations of LSE.. CHAPTER:-2 (DERIVATIVES)

Introduction to derivatives. Types of Derivative CHAPTER:-3 (REVIEW OF LITERATURE)

Literature Review.. CHAPTER:-4 (OBJECTIVES)

Objectives CHAPTER:-5 (RESEARCH METHODOLOGY)

Research Methodology.. Limitations of the Study.. CHAPTER:-6 (ANALYSIS & CONCLUSION)

Analysis.. Research Findings.. Recommendations.. Perception held by Investors about Derivatives.. Conclusion CHAPTER:-7 (BIBLIOGRAPHY)

Bibliography. (ANEXURE) Questionnaire .

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EXECUTIVE SUMMARY From the past few years financial markets have experienced an impresssive expansion in terms of securities issued and traded on secondary markets. In addition financial markets have become more interconnected allowing almost continous trading in some precious metals and currencies and stocks traded onseveral exchanges.one of the most important boosts to the changes and development of financial market is issuance and trading of derivatives. Derivative is a prroduct whose value is derived from the value of one or more basic variables called basis (underlying assets, index or any other assets) in a contractual manner.The underlying asset can be equity ,for example commodity or any other asset .These are mostly used by investors to hedge or balance risk involved in financial transactions or trading. In this report I have tried to full fill my objective as investors awareness regarding risk hedging instruments , perception held by investors about the financial derivatives. Moreover I have focussed my study as how derivatives help to reduce the risk and how they provide hedge against risk.I have covered in this project the brief and precise introduction of stock market ,an extensive overview of financial derivatives .In order to know more about the subject matter a comprehensive literature review has been carried out. Since my objective was to know about the awareness of investors regarding risk hedging instruments , perception held by investors about derivatives for being a risk hedging instrument and moreover experience of those investorswho have dealt with derivatives , a well designed questionnaire was framed to gather the data. Keeping in view the objectives and time span sample unit and size were decided .My sampling unit was ludhiana stock exchange ,investors visiting stock exchange were taken as population.After collecting all data modern IT tools were used to cover the research methodology part like With the help of SPSS a software an analysis and interpretation was made more clear and comprehensive.Since it is not possible to cover all those things in executive summary which I have found during my analysis,however I believe that there is lack of knowledge , difficulty in understanding the risk hedging instruments like derivatives among investorswhich has keep them away from financial derivatives.The investors prefer diversification of portfolio to reduce risk than use of derivatives.Another fear of most of the investors is speculation . Thus need of the time is tocreate awareness among investors and to kill all those wrong notions associated with derivatives.
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CHAPTER:-1

INTRODUCTION

INTRODUCTION TO STOCK EXCHANGE

Stock markets refer to a market place where investors can buy and sell stocks. The price at which each buying and selling transaction takes is determined by the market forces (i.e. demand and supply for a particular stock). Inorder to have better understanding as how market forces supply and demand determine price of any stock ,what can be a best than this example. Shimar co. Ltd. enjoys high investor confidence and there is an anticipation of an upward movement in its stock price. More and more people would want to buy this stock (i.e. high demand) and very few people will want to sell this stock at current market price (i.e. less supply). Therefore, buyers will have to bid a higher price for this stock to match the ask price from the seller which will increase the stock price of Shimar co. Ltd. On the contrary, if there are more sellers than buyers (i.e. high supply and low demand) for the stock of shimar co. Ltd. in the market, its price will fall down. Gone are the days when buyers would assemble at stock exchange to make a transaction ,now with the advancement in IT , most of the operations are carried out electronically and the stock markets have become almost paper less.Now investors can trade freely from their home or office over the phone and internet. HISTORY OF THE INDIAN STOCK MARKET-THE ORIGIN

One of the oldest stock market in Asia, the Indian Stock Markets has a 200 years old history . 18th Century East India company was the dominant institution and by the end of the century, business in its loan securities gained full momentum. 1830s Business on corporate stock and shares in bank and cotton presses started in Bombay. Trading listed by the end of 1839 got broader.

1840s

Recognition from banks and merchants to about half a dozen brokers.

1850s

Rapid development of commercial enterprise saw brokerage business attracting more people in the business.

1860s 1860-61

The number of brokers increases to 60. The American civil war broke out which caused a stoppage of cotton supply of united states of America; marking the beginning of the Share Mania in India.

1862-63 1865

The number if brokers increased to 200 to 250. A disastrous slump began at the end of American civil war (as an example, bank of Bombay share which had touched Rs.2850 could only be sold at Rs.87.

Pre-Independence Scenario-Established of Different Stock Exchanges

1874

With the rapid development share trading business, brokers used to gather at a street (now well known as Dalal Street) for the purpose of tractions business.

1875

The Native Share and Stock Brokers Association (also known as The Bombay Stock Exchange) was established in Bombay.

1880s

Development of cotton mills industry and set up of many

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others. 1894 Establishment of The Ahmadabad share and Stock Brokers Association. 1880-90s Sharp increase in share prices of jute industries in 1870s was followed by a boom in tea stocks and coal. 1908 1920 The Calcutta Stock Exchange Association was formed. Madras witness was boom the business at The Madras Stock Exchange was transacted with 100 brokers. 1923 When recession was followed, number of brokers came down to 3 and the exchange was closed down. 1936 Merger of the Lahore Stock Exchange with the Punjab Stock Exchange. 1937 Re-organization and set up of Madras Stock Exchange Limited (Pvt.) led by improvement in stock market activities in South India with establishment of new textile mills and plantation companies. 1940 Uttar Pradesh Stock Exchange Limited and Nagpur Stock Exchange Limited were established. 1944 Establishment of The Hyderabad Stock Exchange was Limited. 1947 Delhi Stock and Share Brokers Association Limited and The Delhi Stocks and Shares Exchange Limited were establishment and later on merged into. The Delhi Stock Exchange Association Limited.

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POST INDEPENDENT SCENARIO

The depression witnessed after the independence led to closer of a lot of exchanges in the country. Lahore stock exchange was closed down after the partition of India, and later on merged with the Delhi stock exchange. Bangalore stock exchange limited was registered in 1957 and got recognition only by 1963. Most of the other exchanges were in a miserable state till 1957 when they applied for recognition under securities contracts (Regulations) Act, 1956.

The exchanges that were recognized under the act were: Indore Bangalore Hyderabad Delhi * Ahmadabad * Madras * Calcutta * Bombay

Many more stock exchanges were established during 1980s, names: Meerut stock Exchange Coimbatore stock exchange Vadodara stock exchange limited(at baroda,1990) Saurashtra Kutch stock exchange limited(at Rajkot,1989) Bhubaneswar stock exchange association limited(1989) Jaipur stock exchange limited(1989) Magadh stock exchange association(at patna,1986) Kanara stock exchange limited(at mangalore,1985) Gauhati stock exchange limited(1984) Ludhiana stock exchange association limited(1983) Pune stock exchange limited(1982) Uttar Pradesh stock exchange association limited(at Kanpur,1982) Cochin stock exchange(1980)

The recent to join the list was Meerut Stock Exchange and Coimbatore Stock Exchange.

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At present, There are 23 recognized stock exchanges in India, including the Over the Counter Exchange of India (OTCEI) for small and new companies and the National Stock Exchange (NSE) which was set up as a model exchange to provide nation-wide services to investors. NSE, which in the recent past has accounted for the largest trading volumes, has a fully automated screen based system that operates in the wholesale debt market segment as well as the capital market segment. Trading Pattern of the Indian Stock Market Indian Stock Exchanges allow trading of securities of only those public limited companies that are listed on the Exchange(s). They are divided into two categories:

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Types of Transactions The flowchart below describes the types of transactions that can be carried out on the Indian stock exchanges:

Indian stock exchange allows a member broker to perform following activities: 1. Act as an agent, 2. Buy and sell securities for his clients and charge commission for the same, 3. Act as a trader or dealer as a principal, Buy and sell securities on his own account and risk.

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OVER THE COUNTER EXCHANGE OF INDIA (OTCEI)

Traditionally, trading in Stock Exchanges in India followed a conventional style where people used to gather at the Exchange and bids and offers were made by open outcry. This age-old trading mechanism in the Indian stock markets used to create much functional inefficiency. Lack of liquidity and transparency, long settlement periods and transactions are a few examples that adversely affected investors. In order to overcome these inefficiencies, OTCEI was incorporated in 1990 under the Companies Act 1956. OTCEI is the first screen based nationwide stock exchange in India created by Unit Trust of India, Industrial Credit and Investment Corporation of India, Industrial Development Bank of India, SBI Capital Markets, Industrial Finance Corporation of India, General Insurance Corporation and its subsidiaries and Can Bank Financial Services.

Advantages of OTCEI

1. Greater liquidity and lesser risk of intermediary charges due to widely spread trading mechanism across India. 2. The screen-based script less trading ensures transparency and accuracy of prices.
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3. Faster settlement and transfer process as compared to other exchanges. 4. Shorter allotment procedure (in case of a new issue) than other exchanges.

National Stock Exchange

In order to lift the Indian stock market trading system on par with the international standards. On the basis of the recommendations of high powered M J Pherwani Committee, the National Stock Exchange was incorporated in 1992 by Industrial Development Bank of India, Industrial Credit and Investment Corporation of India, Industrial Finance Corporation of India, all Insurance Corporations, selected commercial banks and others.

NSE provides exposure to investors in two types of markets, namely: 1. Wholesale debt market 2. Capital market Wholesale Debt Market - Similar to money market operations, debt market operations institutional investors and corporate bodies entering into transactions of high value in financial instruments like treasury bills, government securities, commercial papers etc.

Trading at NSE 1. Fully automated screen-based trading mechanism. 2. Strictly follows the principle of an order-driven market. 3. Trading members are linked through a communication network. 4. This network allows them to execute trade from their offices. 5. The prices at which the buyer and seller are willing to transact will appear on the screen. 6. When the prices match the transaction will be completed. 7. A confirmation slip will be printed at the office of the trading member.

Advantages of trading at NSE 1. Integrated network for trading in stock market of India. 2. Fully automated screen based system that provides higher degree of transparency. 3. Investors can transact from any part of the country at uniform prices. Greater functional efficiency supported by totally computerized network.
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ROLE OF STOCK EXCHANGE A stock exchange fulfills a vital function in the economic development of a nation. Its main function is to liquefy capital by enabling a person who has invested money in, say a factory or railway, to convert it into cash by disposing off his shares in the enterprise to someone else. Investment in joint stock companies is attractive to public, because the value of the shares is announced day after day in the stock exchanges, and shares quoted on the exchanges are capable of almost immediate conversion into money .in modern days a company stands little chance of inducing the public to subscribe to its capital, unless its shares are quoted in an approved stock exchange. All public companies are anxious to obtain permission from reputed exchanges for securing quotations of their shares and the management of a company is anxious to inform the investing public that the shares of the company will be quoted on the stock exchange.

FUNCTIONS OF STOCK EXCHANGE

The stock exchange is really an essential pillar of the private sector corporate economy. It discharges three essential functions:

First, the stock exchange provides a market place for purchase and sale of securities viz. shares, bonds, debentures etc. it therefore ensures the free transferability of securities which is the essential basis for the joint stock enterprises system.

Secondly, the stock exchange provides the linkage between the savings in the household sector and the investment in the corporate economy. It mobilizes savings, channelizes them as securities into these enterprises which are favored by the investors on the basis of such criteria as future growth prospects, good return and appreciation of capital.

Thirdly, by providing a market quotation of the prices of shares and bonds- a short of collective judgment simultaneously reached by many buyers and sellers in the marketthe stock exchange serves the role of a barometer, not only of the state of health of individual companies, but also of the nations economy as the whole.

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LUDHIANA STOCK EXCHANGE SECURITIES LIMITED

LSE Securities Ltd. was incorporated in January, 2000 with a view to receive the capital market in the region and for taking full advantage of the emerging opportunities being provided by expansion of bigger stock exchange like NSE and BSE. The company since its inception has marched forward rapidly and has maintained consistent growth record.

LSE Securities Limited is a subsidiary of the Ludhiana Stock Exchange has presence at various locations to effectively service its large base of individual clients. The clients of the company greatly benefit from strong research capability, which encompasses fundamentals as well as technicals of LSE Securities Ltd, besides it wide reach in this part of the country.

LUDHIANA STOCK EXCHANGE PROFILE The Ludhiana Stock Exchange Limited was established in 1981, by Sh. S.P. Oswal of Vardhman Group and Sh. B.M. Lal Munjal of Hero Group, leading industrial luminaries, to fulfill a vital need of having a Stock Exchange in the region of Punjab, Himachal Pradesh, Jammu & Kashmir and Union Territory of Chandigarh. Since its inception, the Stock Exchange has grown phenomenally. The Stock Exchange has played an important role in channelizing savings into capital for the various industrial and commercial units of the State of Punjab and other parts of the country. The Exchange has facilitated the mobilization of funds by entrepreneurs from the public and thereby contributed in the overall, economic, industrial and social development of the States under its jurisdiction. Ludhiana Stock Exchange is one of the leading Regional Stock Exchange and has been in the forefront of other Stock Exchange in every spheres, whether it is formation of subsidiary for providing the platform of trading to investors, for brokers etc. in the era of Screen based trading introduced by National Stock Exchange and Bombay Stock Exchange, entering into the field of Commodities trading or imparting education to the Public at large by way of starting Certification Programs in Capital Market.

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The vision and mission of stock Exchange is: VISION Reaching small investors by providing services relating to Capital market including Trading Depository operations etc and creating Mass Awareness by way of education and training in the field of Capital market. MISSION To create educated investors and fulfilling the gap of skilled work force in the domain in Capital Market.

Further, the exchange has 295 members out of which 171 are registered with national Stock exchange as Sub- broker and 124 with Bombay Stock exchange as sub- brokers through our subsidiary.

DETAILS OF PRESIDENTS AND VICE PRESIDENTS PRESIDENT/CHAIRMEN VICE PRESIDENT/VICE CHAIRMEN

PRESIDENTS/CHAIRMEN

Sr. No. 1 2 3

Name of the person

Tenure

Sh. S.P. Oswal Sh. B.M. Lal Munjal Sh. V.N. Dhiri

16.08.1983 to 27.07.1986 28.07.1986 to 15.10.1989 16.10.1989 to 30.10.1992 30.09.1998 to 04.10.2000

4 5

Sh. G.S. Dhodi Sh. Jaspal Singh

31.10.1992 to 22.12.1993 01.10.1996 to 29.09.1998 06.10.2001 to 01.07.2002

6 7

Sh. M.S. Gandhi Sh. R.C. Singal

06.10.1995 to 30.09.1996 05.10.2000 to 05.10.2001

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8 9 10 11

Dr. B. B. Tandon, Chairman Sh. S.P. Sharma, Chairman Sh. Jagmohan Krishan Prof Padam Parkash Kansal

25.06.2007 to 10.12.2007 15.07.2007 to 23.09.2008 23.09.2008 to 29.09.2009 30.09.2009 to till date

VICE PRESIDENTS/ VICE CHIRMAN

Sr. No. 1 2 3 4 5 06 7 8 9 10

Name of the person Sh. Rajinder Verma Sh. B.K. Arora Sh. G.S. Dhodi Sh. B.S. Sidhu Sh. D.P. Gandhi Sh. M. S. Sarna Sh. T.S. Thapar Sh. Tarvinder Dhingra Dr. Rajiv Kalra Sh. D.K. Malhotra, Vice

Tenure 14.07.1984 to 08.08.1987 09.08.1987 to 15.10.1989

31.10.1992 to 22.12.1993 28.10.1991 to 30.10.1992 16.10.1989 to 27.10.1991

23.12.1993 to 05.10.1995 06.10.1995 to 26.09.1997 27.09.1997 to 29.09.1998 30.09.1998 to 04.10.2000 05.10.2000 to 05.10.2001 06.10.2001 to 01.07.2002 025.06.2007 to 10.12.2007

Chairman Sh. Jagmohan Krishan, Vice Chairman Sh. Ravinder Nath Sethi Prof Padam Parkash Kansal Sh. Joginder Kumar

11 12 13 14

15.07.2007 to 23.09.2008 23.09.2008 to 08.10.2008 09.10.2008 to 29.09.2009 30.09.2009 to till date

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GOVERNANCE AND MANAGEMENT

Ludhiana Stock Exchange has a strong governance and administration, which encompasses a right balance of industry experts with highest level educational background, practicing professional and independent experts in various filed of Financial Sector. The administration is presently headed by Sr. General Manager-cum-company Secretary (holding additional charge of Executive Director (Offtg.) and team of persons having indepth knowledge of secretarial, legal and Educational Training. The Governing Board of our Exchange comprises of twelve members, out of which three are Public Interest Directors, who are eminent persons in the fields of Finance and Accounts, Education, Law, Capital Markets and other related fields, Six are Shareholder Directors, and three are Broker Member Director and the Exchange has four Statutory Committees namely Disciplinary Committee, Arbitration Committee, Defaults Committee and Investor Services Committee. In addition, it has advisory and standing committees to assist the administration. LSE has a Code of Conduct in place that governs the elected Board Members and the Senior Management Team. The same is monitored through periodic disclosure procedures. The Exchange has an Ethics Committee, which looks into any issue of conflict of interest and has in place general code of conduct for the Senior Officials. The composition of the Governing Board is as under:-

Sr. No. 1 2 3 4

Name of Director Prof. Padam Parkash Kansal Sh. Joginder Kumar Sh. Rajinder Mohan Singla Sh. Satish Gupta

Category Chairman (Shareholder Director) Vice Chairman(Shareholder Director) Shareholder Director Shareholder Director

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5 6

Sh. Ashok Kumar Sh. Vikas Batra

Shareholder Director Shareholder Director Registrar of Companies (Public Interest Director) Public Interest Director Public Interest Director Trading member Director Trading Member Director Trading member Director

Dr. Raj Singh

8 9 10 11 12

Sh. Ashwani Kumar Sh. V.P. Gaur Sh. Jaspal Singh Sh. Sunil Gupta Sh. Sanjay Anand

STRENGHTS OF LSE GROUP 1. LSE brand is popular among masses. The brand image of LSE can be capitalized. 2. We have requisite infrastructure for the Capital Market activities which includes a multi-stored, centrally air conditioned building situated in the financial hub of the city i.e. Feroze Gandhi Mar0ket. 3. We have well experienced staff handling operations of Stock Exchange. 4. We have competent Board and professional management. 5. We have much needed networking of sub brokers in the entire region, who are having rich experience in Stock Market operations for the last 25 years. 6. We have more than 40,000 clients spread across Punjab, Himachal Pradesh, Jammu & Kashmir and adjoining areas of Haryana and Rajasthan. 7. The turnover of our subsidiary is the highest amongst all subsidiaries of Regional Stock Exchanges in India
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INFRASTRUCTURE AND ASSET BASE AT LSE

The Exchange building is situated at Feroz Gandhi Market, Ferozpur Road,

Ludhiana.

It is a six storey building, which is centrally air-conditioned. The building has 262 rooms, which are located on various floors ranging from second to fifth. The first floor of the building houses the administrative office and rooms from second to fifth floors have been leased out to brokers. The first floor also has canteen and banking facilities. Investor Service Centre is also located at first floor which houses a well-equipped library and view-terminals to provide live rates of NSE and BSE to investors. Investors are also provided with Cable TV for the purpose of viewing the latest happenings in the Capital Market and around. Basement of the building has airconditioning plant and Generators to provide air-conditioned environment and twenty-four hours power back up. The Exchange has also an additional plot of land measuring 2333 sq. yards in the prime location of city, to enhance its infrastructure and source of income.

STATUS OF OUR SUBSIDIARY I.E LSE SECURITIES LTD.

Due to Nation wide reach of bigger Stock Exchanges, the trading volumes at Ludhiana Stock Exchange declined and ultimately, the trading stopped in February, 2002, but the Stock Exchange converted the threat of bigger Exchanges into opportunities and acquired the corporate membership of these exchanges through its subsidiary company i.e. LSE Securities Limited. We have now been providing Trading Platforms of Bigger Stock Exchanges to the Investors of the region. The vast network of Brokers of the Exchange is servicing millions of Investors. The subsidiary company is also providing depository services in the State of Punjab and Himachal Pradesh. The turnover of subsidiary is highest amongst all the subsidiaries of Regional Stock Exchanges. The growth of subsidiary is swift and it has been providing a range of services to the public at large such as Trading, Depository, IPO bidding collection Centre. The Company in its continuous endevour to provide qualitative services to its valued clients has started e-broking trading services for its clients, thereby increasing the geographical reach of the company.

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LISTING OF SECURITIES OF A COMPANIES AT LUDHIANA STOCK EXCHANGE

At present, Ludhiana Stock Exchange has 324 listed companies, out of which 211 are regional and 113 are Non-regional. The total listed capital of aforesaid companies is Rs. 3063.56 Crores appx. The market capitalization of the said companies is more than Rs. 1890.53 crores. The Stock Exchange is covering the vast investor base through the listing of abovesaid companies, which are situated in the region comprising of Punjab, Himachal Pardesh, Jammu & Kashmir, Chandigarh. Ludhiana Stock Exchange has facilitated the capital generation for agro based industries as Punjab is a agricultural led economy. It will continue to do so, once it gets approval for a tie up with bigger Exchanges for commencing trading operations.

INVESTOR RELATED SERVICES

The Exchange has been providing a variety of services for the benefit of investing public. The services include Investor Service Centres, Investor Protection fund and Investor Educational Seminars. 1) INVESTOR SERVICE CENTRES The Exchange has set-up Investor Service Centre at LSE Building for providing information relating to Capital Market to the general public. The Centres subscribe to leading economic, financial dailies and periodicals. They also store the Annual Reports of the companies listed at the Stock Exchange.

2) INVESTOR AWARENESS SEMINARS The Exchange has been organizing Investor Awareness Seminars for the benefit of Investors of the region comprising State of Punjab, Himachal Pradesh, Jammu & Kashmir, Chandigarh and adjoining areas of Haryana and Rajasthan. This massive exercise of organizing Investor Awareness Seminars has been launched as a part of Securities Market Awareness Campaign launched by SEBI in January, 2003. The Exchange apprises the investors about Dos and Donts to be observed while dealing in Securities Market. During 2011-2012, till date, Exchange has organized more than 83 workshops in the region mentioned above.
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3) WEBSITE OF THE EXCHANGE www.lse.co.in The Exchange has its own website with the domain name www.lse.co.in. The website provides valuable information about the latest market commentary, research reports about companies, daily status of International markets, a separate module for Internet trading, information about listed companies and brokers and sub-brokers of the Exchange and its subsidiary. The website also contains many useful links on portfolio management, investor education, frequently asked questions about various topics relating to Primary and Secondary Market, information about Mutual Funds, Financials of the Company including Quarterly Results, Share Prices, Profit and Loss Accounts, Balance Sheet and Many More. The website also contains daily Technical Charts of various scrips being traded in BSE and NSE.

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CHAPTER:-2

DERIVATIVES

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INTRODUCTION TO DERIVATIVES Over the past two decades, the financial markets have experienced an impressive expansion in terms of securities issued and traded on the secondary markets. In addition, financial markets have become more and more interconnected allowing almost continuous trading in some precious metals, currencies and stock traded on several exchanges. Financial innovation that led to the issuance and trading of derivative products has been perhaps one of the most important boosts to the changes and development of financial market. In the financial market place, some securities and some instruments are regarded as fundamental, while others are regarded as derivative. In a corporation, for example the stock and bonds issued by the firm are fundamental securities. With the fundamental securities such as stock and bonds, there is entirely distinct class of financial instrument or securities whose payoffs depend on a more primitive or a fundamental good. For example a gold future contract is a derivative instrument, because the value of the future contract depends upon the value of the gold that underlies the future contract. DEFINITION OF DERIVATIVES Derivative is a product whose value is derived from the value of one or more basic variables called bases (underlying assets, index or any other assets), in a contractual manner. The underlying assets can be equity, for ex commodity or any other assets. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the underlying. Definition under SEBI Act: The terms Derivatives indicates that it has no independent value, i.e. its value is entirely derived from the value of underlying assets. The underlying assets can be securities, commodities, bullion, currency, live stock or anything else. In other words, derivative means a forward future, options or any other hybrid contract of predetermined fixed duration, linked for the purpose of contract fulfillment to the value of specified real or financial assets or to an index of securities.
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HISTORY OF DERIVATIVES The History of derivatives is surprisingly longer then what most people think. Some texts even find the existence of the characteristics of derivatives contracts even been found in incidents of Mahabharata. The traces of derivative contract even are found in incidents that date to back to the ages before Jesus Christ. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or over production. The first future contracts can be traced to rice market in Osaka, Japan around 1650. These were evidently standardized contracts, which made them much like todays future. The Chicago Board Of Trade (CBOT), the largest derivative exchange in the world, was established in 1848 where forward contracts in various commodities were standardized around 1865. From then on, futures contracts have remained more or less in the same form, as we know them today. INDIAN CONTEXT Derivatives have had a long presence in India. The commonly derivative market has been functioning in India since the 19th century with organized trading in cotton through the establishment of cotton Trade Association in 1875.Since then contracts on various other commodities have been introduced as well. Exchange trade financial derivatives were introduced in India in June 2000 at the two major stock exchanges; NSE and BSE. There are various contacts currently trade on these exchanges. DERIVATIVES MARKET IN INDIA The first step toward introduction of derivatives trading India was the promulgation of the securities Laws Ordinance, 1995, which withdrew the prohibition on option in securities the market for derivatives, however, did not take off as there was on regulatory framework to govern the trading of derivatives. SEBI set up a 24-member committee under the chairmanship of Dr. L.C gupta on November 18, 1996 to develop appropriate regulatory framework for derivatives trading in India. The committee submitted its report on March 17, 1998 prescribing necessary per-conditions for introduction of derivatives trading in India. The committee recommended that
28

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

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DERIVATIVES MARKET AT NSE The derivatives trading on the exchanged commenced with S&P CNC Nifty Index futures on June 12, 2000. The trading in index options commenced on July 2, 2001. Single stock futures were launched on November 9, 2001. The index futures and options contract on NSE are based on S&P CNX Nifty Index. Currently, the futures contracts have a maximum of 3-month expiration cycles. There contracts are available for trading. With 1 month, 2 month, 3 month expiry. A new contract is introduced on the next trading day following the expiry of the near month contract. Risk Management Tools Derivatives are powerful risk management tools. To illustrate, lets take an example of an investor who holds the stock of Infosys, which are currently trading at Rs.2, 756.30. Example: Infosys options are traded on the National Stock Exchange of India, which gives the owner the right to buy (call) shares of Infosys at Rs.2,920 each (exercise price), expiring on 30 th September,2011. Now if the share price of Infosys remains less than or equal to Rs.2,920, the contract would be worthless for the owner and he would lose the money he paid to buy the option, known as premium. However, the premium is the maximum amount that the owner of the contract can lose. Hence he has limited his loss. On the other hand, if the share prices of Infosys goes above Rs.2,920, the owner of the call option can exercise the contract, buy the share at Rs.2,920 and make profits by selling the share at the market price of Infosys. The upward gain can be unlimited. Say the share price of Infosys zooms to Rs.3, 300 by September 2011; the owner of the call option can buy the shares at Rs.2, 920, the exercise price of the option, and sell it in the market for Rs.3, 300. Making the profit of Rs.380 less the premium that has been paid. If the premium paid to buy the call option is say Rs.10, the profit would be Rs.370.

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Turnover of Derivate Market at NSE The trading volume of NSES derivatives market has seen an increase since the launch of the first derivatives contract. The average daily turnover at NSE now exceeds at 14,000cr. TYPES OF DERIVATIVES The most commonly used derivatives contracts are forwards, futures and options which shall be discuss in details in later. Here we take a brief look at various derivatives contracts that have come to be used Forwards: a forward contract is customized contract between two entities, where settlement takes place on a specific date in the future at todays pre-agreed price. Futures: a future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are special types of forward contract in the sense that the former are standardized exchange-traded contracts. 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 an underlying asset at a given price on or before a given future date. Puts gives the buyer the right, but not the obligation to sell a given price on or before a given date. Warrants: options generally have live 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 are generally traded over the counter. Leaps: Leaps means long term equity anticipation securities. The options having maturity of up to three years. Baskets: they are options on portfolio of the underlying assets. The underlying asset is usually a moving average of basket of assets. Equity index options are a form of basket options.

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Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a pre arranged formula. They can be regarded as portfolios of forward contracts. The two commonly swaps used are:

Interest Rate Swaps: these entail swapping only the interest related cash flows between the parties in the same currency.

Currency Swaps: the entail swapping both principal is interest between the parties with the cash flows in one direction being in a different currency than those in opposite direction.

PARTICIPATION OF DERIVATIVE MARKET There three board categories of participants are:

PARTICIPANTS

HEDGERS

SPECULATORS

ARBITRAGER

Hedgers: People who attempt to reduce or eliminate their risk. They are in the position where they face risk associated with the price of an asset. They use derivatives to reduce or eliminate risk. For example, a farmer may use futures or options to establish the price of his crop long before his harvest it. Various factors affect the supply and demand for that crop, causing prices to rise and fall over the growing season. The farmer can watch the prices discovered in trading at the CBOT and, when they reflect the price he wants, will sell futures contracts to assure him of a fixed price of his crop.

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Speculators: They wish to bet on future movement in price of an asset. Future and option contracts can give them an extra leverage; that is they can increase both the potential gains and potential losses in a speculative venture.

Arbitragers: People who aim at profits by taking advantage of difference in prices in same products among different markets .for example, they see the future price of an asset getting out of line with the cash price, they will take offsetting in the two markets to lock in a profit.

FUNCTIONS OF DERIVATIVE MARKET The derivatives market performs a number of economic functions. They are: Price is an organized derivatives market reflects the perception of market participants about the future and leads the prices of underlying to the perceived future level. The prices of the derivatives converge with the prices of the underlying expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices. The derivatives market help to transfer risks from those who have them but may not like them to those who have an appetite for them. Derivatives, due to their inherent nature are linked to the underlying cash markets. With the introduction of derivative the underlying market witness higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. The derivative has a history of attracting many bright people with an entrepreneurial attitude. Derivatives market helps increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity.

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TYPES OTC and Exchange-Traded Broadly speaking there are two distinct groups of derivative contracts, which are distinguished by the way that they are traded in the market: Over The Counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, product rate agreements. Exchange-traded derivatives are those derivatives products that are traded via specialized derivatives exchanged or other exchanges. Derivative exchanges acts as an intermediary to all related transactions, and take initial margin from both sides of the trade to act as a guarantee. There are number of financial instruments that are categorized as derivatives, but futures, forwards, options and swaps are by far the most common.

DERIVATIVES

OVER THE COUNTER DERIVATIVES (FORWARD)

EXCHANGE TRADED DERIVATIVES (FUTURES & OPTIONS)

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A) Forward contracts A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Thus, the trade date and delivery date are separated. One party agrees to buy, the other sell, from a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collaterised exchange of margin will take place according to a pre-agreed rule. Otherwise no asset of any kind actually changes hands, until the maturity of contract. A forward contract is one to one bi-partite contract, to be performed in the future, at the terms decided today. (E.g. forward currency market in India). Forward contracts offer tremendous flexibility to the parties to design the contracts in terms of the price, quantity, quality (in case of commodities), delivery time and place. Forward contracts suffer from poor liquidity and default risk.

Example of how forward contract work Suppose that B wants to buy a house in one years time. At the same time, suppose that A currently owns a house that he wishes to sell in one years time. Both parties could enter into a forward contract with each other. Suppose that they agree on the sale price in one years time of Rs.1, 04,000. A and B have entered into a forward contract . B, because he is buying the underlying, is said to have entered a long forward contract. Conversely, A will have the short forward contract. At the end of one year, suppose that the current market valuation of A house is Rs.1, 10,000. Then, because A is obliged to sell to B for only Rs.1, 04,000, B will make a profit of Rs.6, 000. To see why this is so, one need only to recognize that B can buy from A for Rs.104, 000 and immediately sells to the market for Rs, 110,000. B has made the difference in profit. In contrast, A has made a loss of Rs.6, 000. To see why this is so, one needs only recognize that A could have sold to the open market Rs.110, 000 rather than B for Rs.104, 000. Unfortunately for A, he is legally obliged to sell to B at the lower price.

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B) Future Contracts Future market was designed to solve the problem that exists in forward markets. 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. But unlike forward contracts, the future contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard feature of the contract. It is a standardized contract with the standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used in reference purpose for settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. Future contracts are organized / standardized contracts, which are traded on the exchanges These contracts, being standardized and traded on the exchanges are very liquid in nature. In futures market, clearing corporation/house provides the settlement guarantee Every futures contract is a forward contract. They: Are entered into through exchange, traded on exchange and clearing corporation/ house provides the settlement guarantee for trades. Are of standard quantity: standard quality (in case of commodities). Have standard delivery time and place. Futures terminology Spot price: The price at which an asset trades in the spot market or price which is prevailed in cash market. Futures price: The prices at which the futures contract trades in the futures market or price of contract in future.

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 Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one-month, three-month expiry cycles which expire on the last Thursday of the month. Contract size: the amount of asset that has to be delivered under one contract and which is fixed by SEBI. Basis: It can be defined as the future price minus the spot price. There will be a different basis for each basis for each delivery month for each contract. Cost of carry: This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset. Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

(Different Products of derivatives in India) INDEX FUTURE Index futures are futures contract where the underlying asset is the index. The index futures provide a hedge against price fluctuations of the securities and hedgers are using it as an insurance tool. A stock index future contract is an obligation to deliver at settlement an amount of cash equal to the difference between the stock index value at the close of the last trading day of the contact and price at which the futures contract was originally struck. For instance, if the SENSEX index is at 3000 and a lot size of contract is equal to 50, a contract struck at this level could be worth Rs.1,50,000(3000*50). If at the expiration of the contract, the SENSEX stock index is at 3100, a cash settlement of Rs.5000 is required {(3100-3000)*50}. In stock index futures, no physical delivery of stock is made. In India, the BSE was the first stock exchange to introduce index futures on 9 June, 2000 on SENSEX. In NSE, the trading of index futures commenced on 12June, 2000 on the S&P CNX NIFTY. The stock index futures are traded on the F&O segment of the both exchanges.

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Both buyers and sellers are required to deposit margin at the time of contract. The margin amount is based volatility if market index. In India the initial margin is expected to be around 810%. The margin is kept in a way that it covers prices movement more than 99% of the time. Usually key sigma (standard deviation) is used for this measurement. This technique is also called value at risk (VAR). In futures market at the end of the each trading day, the margin account is adjusted to reflect the investors gain or loss depending upon the futures closing prices and variation may be required or released. This is known as mark to market (MAM).

STOCK FUTURE Stock futures are the contract where the underlying asset is the individual securities or stock. Stock Future contract is an agreement to buy or sell a specified quantity of underlying equity share for a future date at a price agreed upon between the buyer and seller. The contracts have standardized specifications like market lot, expiry day, and unit of price quotation, tick size and method of settlement. In stock futures, the investor also require to deposit initial margin is decided by the exchange (on the basis of four time change in security prices in a day) on the volatility of individual stock. Beside this exposure margin is also required by the stock exchange, it can be 5 % (6% or 7% at specific securities) of all 41 individual securities. In India settlement of future on individual stock is settled in cash only. Contract Specification Underlying Index Exchange of Trading S&P CNX NIFTY NSE

Security Descriptor

N FUSTK

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Contract size

100 or multiple thereof (minimum value of Rs.2 lakh)

Trading Cycle

The future contract will have maximum of the three month trading cycle. The near month (one), the next month (two), and the far month (three). New contract will be introduced on the next trading day

following the expiry of the near month contract. Expiry Day The last Thursday of the expiry month of the previous trading day if the last Thursday is the trading holiday Settlement Basis Mark to market & final settlement will be cash settled on T+1 basis

Forward / Futures Contracts Features Forward contract Future contract

Operational Mechanism Contract Specification Counterparty Risk

Not

traded

on

exchange

or Traded on exchange

traded between two parties Differ from trade to trade. Contracts are standardized contract Exist Exists, but assumed by

clearing corporation/house

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Liquidation Profile

Poor Liquidity as contract are Very high liquidity as contract tailor maid contract are standardized contracts.

Price Discovery

Not Efficient.

Highly Efficient

C) Options Options: Is it just Another Derivative Option on stock was first traded on an organized stock exchange in 1973. Since then there has been extensive work on these instruments and manifold growth in the field has taken the world market by storm. This financial innovation is present in case of stock, stock indices, foreign currencies, depth instruments, commodities, and futures contracts. An option gives the holder of the option the right to do something. The holder does not has to exercise this right. In contrast, in forward or futures contract, the two parties have committed themselves to do something. Whereas it cost nothing (except margin requirements) to enter into a futures contract, the purchase of an option require an up-front payment. Options are instruments whereby the right is given by the option seller to the option buyer to buy or sell a specific asset at a specific price on or before a specific date. Option Terminology Index options: These options have the index as underlying. Some option are European while other are American. Like index futures contracts, index option contracts are also cash settled. Stock options: Stock option are option on individual stocks Buyer of an option: the buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer.

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 Writer of an option: the writer of a option is the one who receives the one who receives the option premium and is thereby obliged to see/buy the asset if the buyer exercise on him Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. Put option: Holder has the right to sell and not the obligation. Option prices: it is the price which the option buyer pays to the option seller. It is also referred to as option premium. Expiration date: The date specified in the option contract is known as expiration date. Strike price: The price specified in the option contact is known as the strike price or the exercise price. American options: they are option can be exercised at any time up to the expiration date European options: They are option that can be exercised only on the expiration date. In-the-money option: It is an option that would lead to a positive cash flow to the holder if it were exercised immediately. At-the-money option: it is an option that would lead to zero cash flow if it were exercised immediately. INDEX OPTION Index option are the contract between two parties that give the right, but not the obligation to buy or sell underlying at a stated date & a stated price to buyer of the contract. In index option, the underlying is share price index and all contracts are based upon it. In index option, the buyer requires to pay a sum for the buying the contract that is called premium. The premium is decided by the market force and not by the stock exchange. All index option are cash settled and physical delivery is not applicable.

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Beside the premium the seller of the contract is required to pay 3% margin on contract value to the exchange to eliminate the risk that is called exposure margin. In India the option on index started by the BSE & NSE on their SENSEX and S&P CNX NIFITY respectively. Trading on S&P CNX NIFTY commenced at NSE on 2 June, 2001. In index option the investor can hedge their risk and make profits. In index option the loss is limited to premium paid and profit is unlimited of the buyer, On the other hand the profit to premium received of the writer is limited and loss is unlimited. Contact Specification Underlying Index Exchange of Trading Security Descriptor Contract size S&P CNX NIFTY NSE N OPTIDX NIFTY Permitted lot size shall 200 & multiple thereof (minimum value of Rs.2lakh) Trading Cycle The future contract will have maximum of the three month trading cycle. The near month (one), the next month (two), and the far month (three). New contract will be introduced on the next trading day following the expiry of the near month contract.

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Expiry Day

The last Thursday of the expiry month of the previous trading day if the last Thursday is the trading holiday.

Settlement Basis Style of option Strike price Daily settlement price Final settlement price

Cash settled on T+1 basis European Rs.20 Premium value (net) Closing value of the index on the trading day

Call Option The following example would clarify the basics on Call Option Illustration1: An investor buys one European Call option on one share of Reliance Petroleum at a premium of Rs.2 per share on 31 July. The strike prices Rs.60 and the contract matures on 30 September. The payoffs for the investor on the basis of fluctuating spot prices at any time are shown by the payoff table (Table 1). It may be clear from the graph that even in the worst case scenario; the investor would only lose a maximum of Rs.2 per share which he/she had paid for the premium. The upside to it has an unlimited profits opportunity. On the other hand the seller of the call option has a payoff chart completely reverse of the call option buyer. The maximum loss that he can have is unlimited though a profit of Rs.2 per share would be made on the premium payment by the buyer

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Payoff from Call Buying/long (Rs.) S 57 58 59 60 61 62 63 64 65 66 Xt 60 60 60 60 60 60 60 60 60 60 C 2 2 2 2 2 2 2 2 2 2 Payoff 0 0 0 0 1 2 3 4 5 6 Net Profit -2 -2 -2 -2 -1 0 1 2 3 4

A European call option gives the following payoff to the investor: max (S Xt, 0). The seller gets a payoff: max (S Xt, 0) or min (Xt s, 0). Notes: S Stock price Xt exercise Price at timet C European Call Option Premium Payoff Max(S Xt, 0)

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Net profit- Payoff minus c Exercising the Call Option and what are its implication for the Buyer and the Seller The Call option gives the buyer a right to buy the requisite shares on a specific date price. This put the seller under the obligation to sell the shares on that specific date and specific price. The Call buyer exercises his option only when he/she feels it is profitable. This process is called Exercising the option. This leads us to the fact that if the spot prices is lower than the strike price then it might be profitable for the investor to buy the share in the open market and the premium paid. The implication for a buyer is that it is his/her decision whether to exercise the option or not. In case the investor expect price to rise far above the strike price in the future then he/she would surely be interested in buying call options. On the other hand, if the seller feel that his are not given the desire return and they are not going to perform any better in the future, a premium can be charged or return from selling the call option can be used to make up.

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For the desired returns. At the end of the options contract there is an exchange of the underlying asset. In the real world, most of the deals are closed with another counter or reverse deal. There is no requirement to exchange the underlying assets then as the investigator gets out of the contract just before its expiry. Put Options The European Put Option is the reverse of the call option deal. Heres, there is a contract to sell a particular number of underlying assets on a particular date at a specific price. Illustration 2: An investor buys one European Put Option on one share of Reliance Petroleum at a premium of Rs. 2 per on 31 July. The strike price is Rs. 60 and the contract matures on 30 September. The payoff table shows the fluctuations of net profit with a change in the spot price. Payoff from Put Buying/Long (Rs.) S 55 56 57 58 59 60 61 62 63 Xt 60 60 60 60 60 60 60 60 60 P 2 2 2 2 2 2 2 2 2 Payoff 5 4 3 2 1 0 0 0 0 Net Profit 3 2 1 0 -1 -2 -2 -2 -2

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The payoff for the put buyer is max (Xt S, 0) The payoff for a put writer is max (Xt S, 0) or min S Xt, 0) Graph Payoff from Put buying / long

These are the two basic options that form the whole gamut of transactions in the Options trading. These in combination with other derivatives create a whole world of instruments to choose form depending on the kind of requirement and the kind of market expectations. Exotic Options are often mistaken to be another kind of option. They are nothing But non-standard derivatives and are not a third type of option.

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STOCK OPTION Stock options are the contract on the individual scripts means where underlying are Individual scripts. A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy (call) or sell (put) a stock at an agreed-upon price within a certain period or on a specific date. The buyer is requires to pay some money at the time of the purchases of the contract to seller of the contract that is called 'premium'. And seller requires paying exposure Margin to exchange that is 5% (6% and 7% on specific securities) on the contract value. At present in India 41 individual scripts are approved by the SEBI for stock option. The trading on the stock commenced at NSE on 2 July, 2001. These contracts are Available at BSE & NSE on highly liquid and price band free 41 scripts. Contract Specification Underlying Index Exchange of Trading Security Descriptor Individual Securities NSE N OPTSTK

Contract size

100 or multiple thereof (minimum value of Rs.2lakh)

Trading Cycle

The future contract will have maximum of the three months trading cycle. The near month (one), the next month(two), and the far month (three). New contracts will be introduced on the next trading day

following the expiry of the near month contract. Expiry Day The last Thursday of the expiry month of the previous trading day if the last Thursday is the trading holiday

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Settlement Basis

Daily settlement on T+1 basis & final option exercise settlement on T+2 basis.

Style of option

American

Strike price interval

Between Rs. 2.5 & Rs. 100 depending on the price of underlying

Daily settlement price Final settlement price

Premium value (net) Closing value of the index on the trading day

Buying options can be compared to buying insurance. For example to cover the risk of burglary, fire etc. you by insurance and pay premium in the event of any untoward happening, the insurance cover expires after the specific period of time.

What is minimum contract size? The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract ( Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2,00,000 . Based on this recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 200,000 at the time of introducing the contract in the market.

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What is the lot size of a contract? Lot size refers to number of underlying securities in one contract. Additionally, for stock specific derivative contracts SEBI has specified that the lot size of the underlying individual security should be in multiples of 100 and fractions, if any, should be rounded off to next higher multiple of 100. This requirement of SEBI coupled with the requirement of minimum contract size forms the basis of arriving at the lot size of a contract. For example, if shares of XYZ Ltd are quoted at Rs. 1000 each and the minimum contract size is Rs. 200,000, then the lot size for that particular scrip stands to be 200000/ 1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares.

OPTIONS PRICING Prices of options are commonly depending upon five factors. Unlike futures which derives there prices primarily from prices of the undertaking. Option's prices are far more complex. The table below helps understands the affect of each of these factors and gives a broad picture of option pricing keeping all other factors constant IN- THE-MONEY, AT-THE-MONEY, OUT-OF-THE-MONEY All equity option may be classified as being in-the-money, at-the-money, or out-of-the-money. These terms refer to a particular options exercise price in relation to its current underlying stock price. A call is considered: In-the-money when its exercise (or strike) price is less than the current underlying stock price. At-the-money when its exercise (or strike) price is the same as the current underlying stock price. Out-of-the-money when the strike price (or strike) is a greater than the current underlying stock
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A put is considered: In-the-money when its exercise (or strike) price is greater than the current underlying stock price. At-the-money when its exercise (or strike) price is the same as the current underlying stock price. Out-of-the-money when the strike price(or strike) is less than the current underlying stock price

Lets discuss the above terms in detail a) In-The-Money Call Option A call is considered in-the-money when its exercise (or strike) price is less than the current underlying stock price. Example Consider an XYZ September 60 call option, with XYZ stock currently at Rs.65. Again, its owner has the right to purchase 100 shares of XYZ stock at Rs.60 per share. Since the actual par value of XYZ stock is Rs.65, it would be cheaper to exercise the call and purchase shares at Rs.60 than to purchase shares outright at Rs.65 on a stock exchange. Under this condition, this call option is in-the-money by Rs.5 (Rs.65 current share price Rs.60 exercise price) b) At-The-Money Call Option A call is considered at-the-money when its exercise (or strike) price is the same as the current underlying stock price. Example With a current XYZ stock price of 65.00,all calls and puts with an exercise price if 65 are exactly at-the-money. While by definition such an options exercise price and underlying market should be the same, you might see or hear reference to option whose exercise prices are close to the
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price of the underlying stock as being at-the-money. For instant: At-the-money options trade more than in-the-money or out-of-the-money option. In this context, the observer is nothing that contracts that are approximately at-the-money give or take a few dollars might have more trading volume than those that are considerably in-the-money or out-of-the-money. c) Out-Of-The-Money Call Option A call is considered out-of-the-money when the strike price(or strike) is greater than the current underlying stock price. Results in negative cash flow I.e. Current Price < Strike Price Example Consider an XYZ September 70 call option, with XYZ stock currently at Rs.65. Again, its owner has the right to purchase 100 share of XYZ stock at Rs.70 per share. Since the actual market value of XYZ stock is Rs.65, it would not make sense to exercise the call and purchase XYZ shares at Rs.70 when the same shares could be purchase outright a Rs.65 on a stock exchange. Under these conditions, this call option is out-of-the-money by Rs.5 (Rs.70 exercise price-Rs.65 current share price). d) In-The-Money Put Option A put considered in-the-money when exercise (or strike) price is greater than the current underlying stock price Example Consider an XYZ September 70 put, with XYZ stock currently at Rs.65. Again, its owner has the right to sell 100 shares of XYZ stock at Rs.70 per share. Since the actual market value of XYZ stock is Rs.65, it would be more profitable to exercise the put and sell shares at Rs.70 than to sell shares outright at Rs.65 on a stock exchange. Under these conditions, this put option is in-themoney by Rs.5 (Rs.70 exercise price Rs.65 current share price).

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e) At-The-Money Put Option: A put is consider at-the-money when its exercise (or stock) price is the same as the current underlying stock price Example With a current XYZ stock price of Rs.65.00 (as above), all calls and puts with an exercise price if 65 are exactly at-the-money. While by definition such as options exercise price and underlying market should be the same, you might see or hear reference to options whose exercise prices are close to the price of the underlying stock as being at-the-money. For instant: At-themoney option trade more in-the-money or out-of-the-money options. In this context, the observer is nothing that contract that are approximately at-the-money give or takes a few dollars might have more trading volume than those that are considerably in-the-money or out-of-themoney. f) At-The-Money Put option A put is considered out-of-the-money when the strike price (or strike) is less than the current underlying stock price. Example With a current XYZ stock price of 65.00(as above), all calls and puts with an exercise price if 65 are exactly at-the-money. While by definition such an options exercise price and underlying market should be the same, you might see or hear reference to options whose exercise prices are close to the price of the underlying stock as being at-the-money. For instance: At-the-money options trade more than in-the-money or out-of-the-money options. In this context, the observer is nothing that contract that are approximately at-the-money give or take a few dollars might have more trading volume than that are considerably in-the-money or out-of-the-money.

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CHAPTER:-3

REVIEW OF LITERATURE

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LITERATURE REVIEW

From the past many years derivatives have emerged as an interesting subject to researchers across the world. Here are few reviews of research papers . Asani sarkar (2006) Rise of derivatives in India., The research paper focuses on the
rise of derivatives after the bretton wood system of fixed exchange rate was dismantled in year 1971.The paper further describes the evolution of Indian derivative markets, the popular derivative instruments and the main users of derivatives in India. According to researcher In terms of the growth of derivatives markets, and the variety of derivatives users, the Indian market has equaled or exceeded many other regional markets.13 While the growth is being spearheaded mainly by retail investors, private sector institutions and large corporations, smaller companies and state-owned institutions are gradually getting into the act. Foreign brokers such as JP Morgan Chase are boosting their presence in India in reaction to the growth in derivatives. The variety of derivatives instruments available for trading is also expanding.

There remain major areas of concern for Indian derivatives users. Large gaps exist in the rangeof derivatives products that are traded actively. In equity derivatives, NSE figures show that almost 90% of activity is due to stock futures or index futures, whereas trading in options is limited to a few stocks, partly because they are settled in cash and not the underlying stocks. Exchangetraded derivatives based on interest rates and currencies are virtually absent. According to researcher Liquidity and transparency are important properties of any developed market. Liquid markets require market makers who are willing to buy and sell, and be patient while doing so. In India, market making is primarily the province of Indian private and foreign Banks, with public sector banks lagging in this area (FitchRatings, 2004). A lack of market liquidity may be responsible for inadequate trading in some markets. Transparency is achieved partly through financial disclosure. Financial statements.

Sasidharan, k. and Mathews, Alex k, (Nov 11, 2005) A study on Indian derivative market opportunities and challenges. This paper evaluates the growth of Indian stock
derivatives market and examines the opportunities and challenges ahead. The paper consists of
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six parts covering Market and products, Turnover, Arbitrage opportunities, Challenges, Participation, Conclusions. The researcher has used many statistical techniques to find out the frequency and level of return while arbitraging between index future with spot index, and to find out the efficiency of index future market by finding out degree of arbitrage opportunities available in Indian market .According to researcher one of the major factors to be considered when doing cash and carry arbitrage (when futures are at premium)is the number of days to expiry. When the days to expiry is high, the cost of carry of the borrowed funds (needed to buy spot) is high and the net returns from arbitrage drops significantly even though there is a considerable difference in prices .The paper further reads that the key reasons for the high return in this segment is lack of institutional participation, high investment cost, poor IT infrastructure to exploit the arbitrage opportunities and lack of knowledge about arbitrage by the retail investors. The study brings certain interesting facts, which are of highly useful to investors and derivative traders. The futures market provides excellent arbitrage opportunity. The magnitude of the arbitrage profits nullifies the impact of the losses. The investors can identify the best opportunities available for arbitrage between the futures and spot in the stock market and enhance their returns. The scope for high returns will create more arbitrage and can attract more players to the market. As a result the depth of the market will increase providing better opportunities for expanded trading activities. The current trend indicates that the Indian equity derivatives market is poised for a big leap in the days to come.

Varma,Jayant, Rama,(Feb 2009) Risk management lessons from the Global financial crisis for derivative exchanges. The research paper is a comprehensive
analysis of derivative exchanges with special reference to after math of global financial crisis of 2007 and 2008. The research paper reads that during the global financial crisis of 2007 and 2008 no major derivative clearing house encountered distress while many banks pushed to brink and beyond.An important reason for this is that derivative exchanges have avoided using value at risk, normal distributions and linear correlations. The global financial crisis has also taught us that in risk management, robustness is more important than sophistication and that it is dangerous to use models that are over calibrated to short time series of market prices. The paper applies these lessons to the important exchange traded derivatives in India and recommends
56

major changes the current margining systems to improve their robustness. It also discusses directions in which global best practices in exchange risk management could be improved to take advantage of recent advances in computing power and finance theory. The paper argues that risk management should evolve towards explicit models based on coherent risk measures (like expected shortfall), fat tailed distributions and non linear dependence structures. According to researcher Derivative exchanges have fared much better banks during the global financial crisis as their models were more robust even if they appeared crude in comparison to the internal models of the large banks. This is an important lesson and risk managers must continue to emphasize robustness in their models. Sophistication and market calibration should neverbe pursued at the cost of robustness. However, it would be a mistake for exchanges to become complacent about their margining systems. Risk management is a rapidly evolving field with new methods being developed constantly. Growing computational power is also making previously infeasible approaches increasingly practicable. Risk managers must be continually striving to adopt the best models that are both robust and computationally tractable .Derivative exchanges in India need to look carefully at their margining methodology and eliminate certain elements that could contribute to the fragility of the risk management system. Specific recommendations have been given in the paper about stock index futures and currency futures. Similar analyses have to be performed about other derivative products as well.

Narain,(Aug 2011)After effects of global financial crisis on Indian derivative market. This paper tries to analyse the impact of global financial crisis on the financial
derivatives market in India. It is found that the global financial crisis of 2008 has structurally altered the composition of equity derivatives market in India. The predominance of single stock futures as a derivative product has now been replaced by the predominance of Index option as a favourite derivative product in India. The speculative nature of single stock futures had been the prime reason for the dominance of this derivative product in the precrisis period. However, the cautious risk-aversion on the part of the investor has now been the reason for the dominance of Index options in the revised scenario. Such over domination of particular derivative products is not a healthy sign for the derivatives market in India.

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The global financial crisis has proved to be a structural break in the financial derivative segment of Indian stock market. As has been reflected by the analysis, the turnover structure of National Stock Exchange of India, the exchange with dominating position in India, has shown that the derivatives trading has been a substantial & significant component of Indian stock market. Within this segment, the investors have been spotted with their obsession with Single Stock Futures contracts in the pre global financial crisis period. This obsession has now been altered in the post-crisis period. However, the obsession is now with the Index Option contracts. However, with such preference for Index based derivative products, studies focusing on the interaction of derivatives trading with spot market on aspects of lead-lag relationship, impact on liquidity, transfer of trading, etc. can now be justified to come up with robust conclusions. Such studies have been inconclusive so far in Indian contexts. Nevertheless, such a skewed preference is not desirable situation for an emerging economy like India. A reasonable mix of the derivative products should provide a better alternative to the investors by supplementing the avenues for investment and risk management with the growing maturity of Indias derivatives market. Ahmad, Tabrez, Jaffrey, Reshma Sheerin, Sahoo, Sheetal and Chatterjee,

Aman(September 11, 2009) Trading Risks: Contracts and Regulatory Issues of Derivative Transactions in India. The paper analyses market risk and counterparty credit risk and almost exclusively focuses on risk as potential loss. The methods for measuring, in a specified context, the potential loss of economic value of a portfolio of financial contracts are also described. The context that needs to be specified includes the time frame over which the losses might occur, the confidence level at which the potential losses are measured and the types of loss that would be attributed to the risk being measured .This wider distribution of credit risks within the global financial system should in principle limit risk concentrations and reduce the risk of a systemic shock. Banks have fewer incentives to effectively screen and monitor borrowers. A systematic deterioration in lending and collateral standards would of course entail losses greater than historical experience of default and loss-given-default rates would indicate, and it is not clear that current risk management practices make enough allowance for this. Further the gap between the original borrower and the ultimate investors widened with a number of vehicles in between. Secondly, events may force banks to re-assume risks they had assumed transferred to other parties - either to preserve a banks reputation or to honour contingency liquidity/credit lines.
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The derivatives market in India has been expanding rapidly and will continue to grow. The participation of private and public sector banks and corporates are dependent on development of skills, adapting technology and developing sound risk management practices. While derivatives are very useful for hedging and risk transfer, and hence improve market efficiency, it is necessary to keep in view the risks of excessive leverage, lack of transparency particularly in complex products, difficulties in valuation, tail risk exposures, counterparty exposure and hidden systemic risk. Clearly there is need for greater transparency to capture the market, credit as well as liquidity risks in off-balance sheet positions and providing capital therefore. From the corporate point of view, understanding the product and inherent risks over the life of the product is extremely important. Further development of the market will also hinge on adoption of international accounting standards and disclosure practices by all market participants, including corporates. The recent episode of financial turbulence has provoked debate about the measurement, pricing and allocation of risk by way of derivatives, which can have important lessonsfor India.

Varghese, John, (February 1, 2011) , Regulation of Financial Derivatives: Some Policy Consideration. This paper tries to examine the various models of regulation
of financial derivatives from a purposive perspective. According to researcher Regulation of Financial Derivatives has a chequered history. There were periods in history when the trading in these instruments was banned. However like any prohibition, the prohibition of openly trading in financial derivatives only led to evolution of a clandestine market for these instruments, and innovative players in these markets created new types of instruments to bypass regulatory restraints .The paper further provides an extensive over view of regulation of derivatives, role of RBI,MCX , SEBI in the regulation of derivatives. In India derivatives trading is regulated by a mixture of command control, franchising, contractual and self regulatory mechanism. The

researcher has provided certain suggestions to ameliorate the regulation of derivatives like there is a need for a stricter regulatory regime for derivatives, in other words re-regulation and more government involvement in the economy . There are also suggestions to have a central counter party (CCP) for OTC derivatives especially for Credit Default Swaps (CDS) applicable to all jurisdictions, which will help to ensure greater transparency and better reporting. It is also
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imperative that there should be some international standard setting process for both product design as well as approach towards risk of all forms so far as derivative products are concerned, since in the current globalised economy, strict regulatory regime in some countries and lax standards in others would lead only to regulatory arbitrage. There is a need for creation of a net work amongst regulators in various countries, as well as the different regulators in the same jurisdiction, to ensure better regulatory cooperation, common regulatory standards and denial of regulatory arbitrage opportunities to unscrupulous players in market. An international

regulatory framework arrangement, much like the BASEL guidelines for banks, should be brought in place for derivative instruments and trading in derivatives market. Such a framework should lay down standards of risk taking in derivative instruments and guidelines to derivative product design and tighter control over structure of underlying securities, which will then help to have a uniform standard across the world for such instruments. There should also be a proper control mechanism to identify sufficiently early, mitigate and to cover up the various types of risks involved in similar type of instruments. Such an approach would enable to retain the derivatives products as good risk hedging tools for all investors, rather than an instrument to satisfy the greed of a few investment bankers.

Shobna, solanki, abishek,dilip kumar and dash, mihir,(jan 20 2012).A study on commodity market behaviour ,price discovery and its factors . This paper
provides an overview of the commodity market in India and its participants,and analyses twelve commodities that are traded in MCX (Multi Commodity Exchange), in terms of price discovery of the spot and futures markets using GARCH model. It also analyses the impact of trading volume, inflation and other macroeconomic factors on spot and futures price movements. After studying the paper we came to know about the dynamic character of commodity market thus offering the opportunity of forward contracting and hedging, and witnessing activity almost eighteen times higher in volume as compared to the spot market. . However, awareness of the commodity market is less when compared to the stock market. This is mainly due to the huge investment that is required in order to hedge and trade, even though only a small margin amount is required. Three multi-commodity exchanges have been set up in India to facilitate commodity trading for the retail investors. They are the Multi60

Commodity Exchange (MCX), the National Commodity and Derivatives Exchange (NCDEX), and the National Multi-Commodity Exchange (NMCE).The researcher has done comprehensive analysis of long term volatility of each commodity ,to compare volatility between different commodity groups, to examine the effect of inflation and volume on the prices of the commodities, and to understand the fundamental and technical factors affecting the price of each commodity. The study explores commodity prices from several different angles. First, there is

the possibility of lead-lag relationships between commodity spot and futures prices, as seen from the similarity of their trend patterns. Another area explored in the study is the impact of trading volume and inflation on commodity price volatility for selected commodities. While trading volume was found to have significant impact on volatility, inflation was found to have significant impact on crude oil price volatility only. Lodha, Kalpit Rajkumar,(feb 2008) Derivatives in Indian Financial Market - 'Structure & Financial Concerns' an Indian Perspective .The research paper focuses on various types of risks associated with financial instruments or other trade practices ,and how to hedge the risks .As the concept of derivatives came into frame to reduce the price related risks .The paper further examines the Indian derivative market .A complete history of introduction of derivatives in Indian market after the liberalisation process has been given. Until the advent of NSE, the Indian capital market had no access to the latest trading methods and was using traditional out-dated methods of trading. There was a huge gap between the investors aspirations of the markets and the available means of trading.8 The opening of Indian economy has precipitated the process of integration of Indias financial markets with the international financial markets. Introduction of risk management instruments in India has gained momentum in last few years thanks to Reserve Bank of Indias efforts in allowing forward contracts, cross currency options etc. which have developed into a very large market. The author has termed derivatives as a boon to Indian financial markets.Since the constant risks have forced the investors to manage it through various risk management tools.The author terms derivatives as an integral part of capital market of developed as well as emerging market economies. Many benefits of derivative products have been enumerated in paper viz it helps in transferring the risk from risk averse people to risk oriented people. Derivatives assist business growth by disseminating effective price signals concerning exchange rates, indices and reference rates or other assets and thereby, render both cash and derivatives markets more efficient. Derivatives catalyze entrepreneurial activities.
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By allowing transfer of unwanted risks, derivatives can promote more efficient allocation of capital across the economy and thus, increasing productivity in the economy. List is unending. In reply to a popular notion that derivatives are weapons of mass destruction, the author says that derivatives if judiciously used , with the sole intention of mitigating underlying exposures can act as a boon , but if used for speculative purposes can have a disastrous results.. Agarwal, Ravi Kumar, Amaresan, Shiva Kumar, Mukhtar, Wasif and Abar, Hemanth January 16, 2009), Impact of Derivatives on Stock Market . The research paper throws light on the impact of derivatives on Indian stock market, the author has done a comprehensive analysis of impact of derivatives on stock market.The paper reads that many empirical and theoretical studies have been carried out to assess the impact of derivatives on Indian stock market. Two main bodies of theory about the impact of derivatives trading on the spot market are prevailing in the literature and both are contradicting each other. One school of thought argues that the introduction of futures trading increases the spot market volatility and thereby, destabilizes the market. They are the proponents of Destabilizing forces hypothesis. (Lockwood and Linn, 1990)) They explain that derivatives market provides an additional channel by which information can be transmitted to the cash markets. Frequent arrival and rapid processing of information might lead to increased volatility in the underlying spot market. They also attribute increased volatility to highly speculative alevered participants. Others argue that the introduction of futures actually reduces the spot market and volatility and thereby, stabilises the market. They are the proponents of Market completion hypothesis. (Satya Swaroop Debasish, 2007). Kumar et al (1995) argued that derivatives trading helps in price discovery, improve the overall market depth, enhance market efficiency, augment market liquidity, reduce asymmetric information and thereby reduce volatility of the cash market. The impact that the derivatives market has on the underlying spot market remains an issue debated again and again with arguments both in favour and against them. This study seeks to examine the volatility of the spot market due to the derivatives market. Whether the volatility of the spot market has increased, decreased or remained the same. If increased then, what extent it is due to futures market.

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Yong chen,(Aug 2011) Derivatives Use and Risk Taking: Evidence from the Hedge Fund Industry. This paper examines the use of derivatives and its relation with risk
taking in the hedgefund industry. In a large sample of hedge funds, 71% of the funds trade derivatives. Af-ter controlling for fund strategies and characteristics, derivatives users on average exhibitlower fund risks (e.g., market risk, downside risk, and event risk), such risk reduction isespecially pronounced for directional-style funds. Further, derivatives users engage lessin risk shifting and are less likely to liquidate in a poor market state. However, the flow-performance relation suggests that investors do not differentiate derivatives users whenmaking investing decisions. This paper assesses the link between derivatives use and risk taking by exam-ining 3 essential aspects of hedge fund risk profiles. First, I compare several riskmeasures between derivatives users and nonusers. Risk-management-motivateduse of derivatives should be associated with lower risk. But if derivatives aremainly traded by funds with better information, they can enhance fund perfor-mance through leverage and transaction-cost savings. In the sample, derivativesuse in hedge funds is on average associated with a lower level of fund risks (e.g.return volatility, market risk, downside risk, and extreme event risk). The neg-ative relation between derivatives use and fund risks is both economically andstatistically significant for most of the risk measures. For example, from a regres-sion model that controls various fund characteristics and investment strategiesthe derivatives-use dummy variable is associated with a reduction of market betaby 0.053, indicating that derivatives users on average have market risk about 27% lower than an average hedge fund whose market beta is 0.20. More strik-\ingly, derivatives users on average bear downside and event risks over 80% lower than nonusers. Such evidence is robust to correcting data biases (e.g., survivor-ship bias and backfilling bias), to controlling fund characteristics, to using bothnet-of-fee and pre-fee fund returns, to examining a subperiod, and to applying2-stage least squares (2SLS) regressions with fund managers prior expertise inderivatives trading as an instrumental variable .

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CHAPTER:-4

OBJECTIVES

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Need of the study

Stock markets have experienced a comprehensive change from the last few years , with the invent of new financial instruments their issuance and trade it has become worthy to study . Moreover the wrong notion and the perception held by investors about derivatives, their being a risk hedging instrument has further opened the ways to study it more. Since the risk creates staganacy ,economic instability thus arises a need to study what can be the safe investment for investors.Below are mentioned some points with regard to need of study. 1) To know about different kinds of derivatives and the derivative market in india. 2) To know about the occurrence of risk of various investments of investors in stock market. 3) To provide knowledge to investors regarding various kinds of derivatives and to construct a portfolio in such a manner which could balance the risk.

Objectives of study
A successful completion of any project is based on certain objectives, following are the objectives of my project. 1.) To study the awareness of investors about risk hedging instruments. 2) To know about the perception held by investors about the financial derivatives. 3) To study the perception of investors towards diversification 4) To know experience of investors with derivatives till date.

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CHAPTER:-5

RESEARCH METHODOLOGY

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METHODOLOGY

Source of data
The primary data is collected with the help of questionnaire to study the individual investors perception regarding the risk hedging instruments. And secondary data collected from journals, internet, articles and other publications.

Research design
Sampling: primary data is collected to study investors awareness through a well designed questionnaire.

Sample design
Sampling unit: Ludhiana stock exchange investors Type of sampling: convenient Sample size: 50

LIMITATIONS OF THE STUDY

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1) Small Sample Size: In order to complete any study one should have a diversified sample, since my time and resources did not allow me to increase my sample size ,so research can be biased also. 2) Time Constraints: Period of 45 days was not enough to collect all the data . 3) Area Restriction: The survey carried out was confined to one unit i,e ludhiana stock exchange ,so there are very high chances of variation from one unit to another unit. 4) Method of sampling: Method of sampling is convenient so biasness cannot be ruled out. 5) Secondary Data: The secondary data taken from a source might be wrong or twisted to serve the purpose of a person or organization concerned. 6) Human Errors: to err is human, as Questionnaires have been filled by human beings, so they are prone to error knowingly or unknowingly.

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CHAPTER:- 6 ANALYSIS & CONCLUSION

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Analysis Q.NO.1

As is evident from the above chart majority of the people who were surveyed fall in the age group of 35-45 i.e. 36.73%. 16.33% fall within the age group below 25. In the age group of 25-35 are 30.61% .While as 16.33% are above 45.

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Q.NO.2

Majority of the investors who were surveyed are retired i.e 46% as compared to those who are either self employed or in service. 30% of respondents are self employed, 22% in service and only 2% fall within the category of students.

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Q.NO.3

As is evident from the above bar chart majority of the investors investing in stock market are day traders that is 40%. While short term investors precede them with 34%. Long term investors are found to be 26%.

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Q.NO .4

The above graph shows that majority of the investors are aware about the risk hedging instruments i.e., 48%. 26% respondents are not aware about risk hedging instruments.,and 26% are neutral.

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Q.NO .5

As is evident from the above graph that 44% strongly agree that derivatives can be termed as risk hedging instruments. 48% of people surveyed are neutral ,6% disagree and only 2% strongly disagree.

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Q.NO .7

As is evident from the above bar chart majority of the buy and sell risk hedging instruments with a sole purpose to take a position in stocks and derivative segment to minimize the loses., which is 50%. 32% of people surveyed have purpose to earn profit. Only 18% of the people surveyed consider to purchase and sell the regular income bonds , government securities.

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Q.NO .8

The above mentioned graph shows that 52% repondents hold the choice that best option as risk hedging instruments is entering into future contract. 48% of the investors hold the choice that entering into option contract as best choice.

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Q.NO .9

The above bar chart shows that 32% people consider futures as most important , 12% people surveyed consider it important, mean while 34% respondents consider it least important. Only 10% consider it not important.

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Q.NO .9

As is evident from the above graph that majority of people surveyed prefer options as risk hedging instruments i.e,44% . 26% respondents consider it important , 10% neutral and 20% not important.

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Q.NO .10

Majority of people surveyed have been trading in derivatives from less than one year i.e,48%. 28% people surveyed are trading from one year . people who are trading from more than one year are 24% .

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Q.NO .11

The above graph shows that majority i.e, 50% of the investors have found their experience with derivatives as profitable. Respondents who consider it not profitable are 32% and those who consider equities better than derivatives are 18% .

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Q.NO .12

The above graph shows that majority of the people surveyed are of the opinion that it is lack of knowledge and difficulty in understanding the derivatives that keeps it away from using derivatives i.e, 48% .34% of people surveyed consider increasing speculation as reason that keeps away people from derivatives. Respondents who consider it very risky and highly leveraged instrument are 8% .while as 10% consider counter party risk as reason.

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Q.NO .13

The above graph shows that 32% people surveyed strongly agree that diversification of portfolio is more effective than buying and selling risk hedging instruments. 34% agree, 16% are neutral . Only 8% disagree and 10% strongly disagree.

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Q.NO .14

As is evident from the above graph that 40% of the respondents consider diversification of portfolio as highly effective in managing risk, 18% effective. 10% respondents are neutral while 16% consider it ineffective.

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Q.NO .15

The above bar chart shows that 60% of the people surveyed prefer brokerage houses to take advice before investing in derivative market. 18% Consider research analysis, 14% prefer website and only 8% prefer media.

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Q.NO .16

40% will prefer index future, 26% stock future and 14% of the respondents cant say however 18% will prefer both.

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Q.NO .17

As is evident from the bar chart that 22% of the respondents say frequently entering into derivative agreements have lead you in speculative mode rather than that of hedger as absolutely while 64% say some times and 14% say never.

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RESEARCH FINDINGS:
Indian derivative market is experiencing a comprehensive change, issuance of new hedging instruments has opened a new ways to trade in stock exchange .It is growing and attracting new investors to exploit the price movements in commodities in stock market. Below are mentioned the findings of research. It has been found that majority of the people investing in derivatives fall in the age group of 35-45, 36.73% of the respondents among the investors surveyed are dealing in risk hedging instruments. Among the people surveyed majority of them are retired, 46% of the respondents are retired. Since retired people are more apprehensive about future and have a lot of savings so they invest it in stock market. Majority of the investors surveyed are day traders, it was found that 40% of the respondents are day traders while as 34% are short term investors and 26% are long term investors. Since investors investing in stock market want profits within a short span of time so day trading provides them a good opportunity. As we know that how prices of shares and stocks vary after every minute, so they can easily exploit the price changes to make profit. Among the people surveyed majority of the respondents are aware about risk hedging instruments i.e 48% . Thus we can say that awareness regarding risk hedging instruments is growing among the investors. Majority of the respondents remained neutral when they were asked can derivatives be termed as risk hedging instruments ?.This shows that ignorance among investors about derivatives is still in its inception. 48% were neutral and only 44% strongly agree. It has been found that majority of the investors buy and sell risk hedging instruments to take a position in stocks and derivative segment to minimise the loses . The research shows 52% of the investors prefer entering into future contracts as compared to entering into option contract .Since futures are most popular derivative instruments and provide a better hedge in minimising the risks. Although it cannot be ruled out that investors use options also to hedge their risks. Most of the investors have found their experience with derivatives as profitable .
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 However many investors hold the opinion that diversification of portfolio is better than buying and selling risk hedging instruments and is considered more effective in managing the risk. Investors mostly prefer brokerage houses operating in our country for taking advice prior to investment . Index futures are emerging as popular risk hedging instruments among the investors. Sometimes frequently investing in derivative agreements have lead them to speculators instead of hedgers.

SUGGESTIONS
More and more short term and long term investors should be wooed to use derivatives as risk hedging instruments apart from day traders. There is a dire need to make investors aware about the risk hedging instruments viza viz derivatives. Since lot of wrong notions are associated with derivatives, the ambiguity should be killed and investors need to be made understand the benefits of using derivatives. Investors should enter into option contract also apart from futures, as options provide an opportunity to sell or buy the underlying assets at a given price on or before certain time. Thus an investor can exploit the price fluctuations and make profits. As customers are new and young in the derivative market and they dont have adequate knowledge about derivatives and found this market be risky but at the same time they feel this market provide good returns so a broking firm must provide support and time to time guidance to their customer while trading in the market so that they are able to sustain for long time in the market so that customer is also able to know about where their money is being invested and how safe it is. Investors should choose risk hedging instruments in accordance with their aim which can be either profit maximization or risk minimization. Before using any risk hedging instrument an investor should consult his broker or any other expert to know whether it will b feasible for him or not.
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 Moreover an ardent investor should keep himself updated about the progress in derivative segment through electronic and print media. Apart from using the old tool of port folio diversification to reduce the risk , hedging instruments should be also included to make safe investment

Perception held by customers on derivative

Myth Number 1: Derivatives Are New, Complex, High-tech Financial Product Fact: Financial derivative are not new: they have been around for years.

Myth Number 2: Derivatives Are Purely Speculative, Highly Leveraged Instruments Fact: The explosive use of financial derivative products in recent years was brought about due to the more volatile markets, deregulation, and new technologies. From the simple forward agreements, financial future contract were developed. Future are similar to forwards, except that future are standardized by exchange clearinghouses, which facilitates anonymous trading in a more competitive and liquid market .in addition, futures contract are marked to market daily, which greatly decreases counterparty risk-the risk the other party to the transaction will be unable to meet its obligations on the maturity date

Myth Number 3: Financial Derivatives Are Simply The Latest Risk-Management Tool Fact: Financial derivative are not the latest risk-management fad; they are important tools for helping organization to better manage their risk exposures. Financial derivative are important tools that can help organizations to meet their specific riskmanagement objectives. As is the case with all tools, it is important that the user understand the tools intended function and that the necessary safety precautions be taken before the tool is put to use When used wisely, financial derivatives can increase shareholder value by providing a means to better control a firms risk exposures and cash flows

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Myth Number 4: Derivative Take Money Out Of Productive Processes and Never Put Anything Back Fact: Financial derivative by reducing uncertainties, make it possible for corporations to initiate productive activities that might not otherwise be pursued. Derivative used as a hedge can improve the management of cash flows at the individual firm level

Myth Number 5: Only Risk-Seeking Organization Should Use Derivative Fact: financial derivative can be used in two way; to hedge against unwanted risks or to speculate by taking a position in anticipation of a market movement. Organizations today can use financial derivative to actively seek out specific risk and speculate on the direction of interest-rate or exchange-rate movements, or they can use derivatives to hedge against unwanted risks. Hence, it is not true that only risk-seeking institution use derivatives Indeed, organization should use derivatives as part of their overall risk-management strategy for keeping those risks that are comfortable managing and selling those that they do not want to other who are more willing to accept them. Even conservatively managed institution can use derivatives to improve their cash-flow management to ensure that the necessary fund are available to meet broader corporate objectives. Myth Number 6: The Risk Associated With Financial Derivative Are New And Unknown Fact: The kinds of risk associated with derivative are no different from those associated with traditional financial instruments, although they can far more complex. There are credit risks, operating risks, market risks, and so on. Risk from derivatives originates with the customer. With few exceptions, the risks are manmade, that is, they do not readily appear in nature.

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CONCLUSION

After the comprehensive study of the project I have concluded that indian stock markets are growing and are showing new path ways to trade in various financial instruments. Investors are using risk hedging instruments to hedge their risks . Most of the investors are day traders and it will be a profitable deal for them if they make use of derivatives , as they can exploit the price fluctuations .Although investors use these hedging instruments to minimise risk but many investors held an opinion that they have earned profit also from the use of these risk hedging instruments. Index futures are emerging as popular risk hedging instruments which investors will prefer in future. Currently investors enter into future contracts to reduce risks and minimise loses. Lack of knowledge and awareness regarding risk hedging instruments is a reason that keeps most of the investors away from derivatives. Moreover increasing speculation also prevents them to deal in derivatives. Since most of the investors prefer brokerage houses to take advice prior to any investment so they need to provide them true and valuable guidance .Many investors believe that increased use of derivatives lead them to be speculators.

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CHAPTER:-7

BIBLIOGRAPHY

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BIBLIOGRAPHY
https://docs.google.com/viewer?a=v&q=cache:TPON5f9CAgJ:www.newyorkfed.org/research/economists/sarkar/derivatives_in_india.pdf+d erivatives+market&hl=en&gl=in&pid=bl&srcid=ADGEESj2EzeG5PGuIsta2Bp9oLS_kc hDgPPLVnf_YR3W4oX7CuiGzrirbmhDRhCLGtt8uTCKzMfY0FOA5HOyssIvmL3sFn 4oyJbNxwGYVEESA-dmcj3h4RqpJ7ktXafrVfUNmF7jvem&sig=AHIEtbTPULhCAJBc4zJ2av_hvE-Kpjq9XQ Varma, Jayanth Rama, Risk Management Lessons from the Global Financial Crisis for Derivative Exchanges (February 2009) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1376276 Narain, After Effects of Global Financial Crisis on Indian Derivatives Market (August 1, 2011). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1904136 Sasidharan, K. and Mathews, Alex K., A Study on Indian Derivative MarketOpportunities and Challenges (November 11, 2005) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1795750 Mishra, Dr. Sisira Kanti, Trends and Prospects of Derivative Markets in India (March 16, 2011) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1788024 Shobana, Solanki, Abhishek Dilipkumar and Dash, Mihir, A Study on Commodity Market Behaviour, Price Discovery and Its Factors (January 20, 2012). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1988812

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 Varghese, John, Regulation of Financial Derivatives: Some Policy Considerations (February 1, 2011). http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1753116 http://www.jvi.org/uploads/tx_abaeasydownloads/DERIV_INDA_2006_Indian%20Com modity%20Derivatives%20Markets.pdf. http://web.ebscohost.com/ehost/detail?vid=3&hid=108&sid=4199a03e-2b9c-4c00-981bbba4487f9aaf%40sessionmgr115&bdata=JnNpdGU9ZWhvc3QtbGl2ZQ%3d%3d#db=bt h&AN=65456695 Ahmad, Tabrez, Jaffrey, Reshma Sheerin, Sahoo, Sheetal and Chatterjee, Aman, Trading Risks: Contracts and Regulatory Issues of Derivative Transactions in India (September 11, 2009) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=14798

INTERNET SITES www.google.co.in www.lse.co.in www.SSRN.COM

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ANNEXURE

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QUESTIONNAIRE I Sofi owais Ahmad student of lovely professional university phagwara Punjab is conducting a study on Derivatives: Investors awareness regarding risk hedging instruments. The response will be used solely for academic purpose and your personal information will not be disclosed. So kindly fill the questionnaire. Personal Information: Name: 1) Age Below 25 2) Occupation: Self employed Service retired Student 25-35 35-45 Above 45

3) Do you invest in stock market? a) Yes b) No

4) what type of investor you are in a market? a) Day trader b) Short term investor c) Long term investor 5) Are you aware about risk hedging instruments? a) Yes b) No

6) Can derivatives be termed as risk hedging instruments? a) strongly agree b) Agree c) Neutral d) Disagree e) Strongly disagree

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7) The purpose of buying and selling risk hedging instruments on regular basis a) To earn profit b) To take a position in stocks and derivative segment to minimise the loses c) To purchase and sell the regular income bonds/government securities d) Other 8) As per your choice what is the best option as risk hedging instruments ? a)Entering into forward contract b) Entering into future contracts c) Entering into option contracts 9) Which of the following products do you prefer for hedging risk? Please give weight age as per your preference (1-5) Futures ( ) Options ( ) Forwards ( ) SWAPs ( )

10) How long you have been trading in derivatives? a) Less than one year b) one year c) More than one year. 11) How will you describe your experience with derivatives till date? a) I find this Quite Profitable. b) I dont find Derivative can give profits. c) I feel that Equities are better than Derivatives. d) Any other..

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12) What keeps people away from dealing in derivatives? a) Lack of knowledge and difficulty in understanding. b) Increasing Speculation c) Very Risky and Highly Leveraged instrument. d) Counter party Risk. 13) Diversification of portfolio is more effective rather than opting for buying and selling of risk hedging instruments a) Strongly agree d) Disagree b) agree c) neutral

e) strongly disagree

14) Diversification of portfolio is really effective in managing risk a)Highly effective e) Highly ineffective 15) Whom you prefer to take advice before investing in derivative market.? a) Brokerage houses b) Research analysis c) Website d) Media e) Others specify 16) In future what will you prefer? a) Index future b) stock future c) cant say d) both b) Effective c)neutral d) ineffective

17) Do you agree that frequently entering into Derivative agreements have lead you into speculative mode instead that of a Hedger? a) Absolutely b) Sometimes c) Never

Thank you..

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