1.

INTRODUCTION OF DERIVATIVES:

The first step towards introduction of financial derivatives trading in India was the
promulgation of the Securities Laws (Amendment) Ordinance, 1995. It provided for
withdrawal of prohibition on options in securities.

The last decade, beginning the year 2000, saw lifting of ban on futures trading in many
commodities. Around the same period, national electronic commodity exchanges were also
set up.

Derivatives trading commenced in India in June 2000 after SEBI granted the final
approval to this effect in May 2001 on the recommendation of L. C Gupta committee.
Securities and Exchange Board of India (SEBI) permitted the derivative segments of two
stock exchanges, NSE and BSE and their clearing house/corporation to commence trading
and settlement in approved derivatives contracts.

Initially, SEBI approved trading in index futures contracts based on various stock
market indices such The National Stock Exchange (NSE), located in Bombay is the first
screen based automated stock exchange. It was set up in 1993 to encourage stock exchange
reform through system modernization and competition. It opened for trading in mid-1994 and
today accounts for 99% market shares of derivatives trading in India.

Bombay Stock Exchange (BSE), which is Asia's Oldest Broking House, was
established in 1875 in Mumbai. It is also called as Dalal Street. The BSE Index, called the
Sensex, is calculated by Free Float Method by including scripts of top 30companies selected
on the market capitalization criterion. 21 International Research Journal of Finance and
Economics - Issue 37 (2010)as, S&P CNX, Nifty and Sensex. Subsequently, index-based
trading was permitted in options as well as individual securities.

The trading in BSE Sensex options commenced on June 4, 2001 and the trading in
options on individual securities commenced in July 2001. Futures contracts on individual
stocks were launched in November 2001. The derivatives trading on NSE commenced with
S&P CNX Nifty Index futures on June 12, 2000. The trading in index options commenced on
June 4, 2001 and trading in options on individual securities commenced on July 2, 2001.
Single stock futures were launched on November 9, 2001. The index futures and options

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contract on NSE are based on S&P CNX. In June 2003, NSE introduced Interest Rate Futures
which were subsequently banned due to pricing issue.

The emergence of the market for derivative products, most notably forwards, futures
and options, can be traced back to the willingness of risk averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very
nature, the financial markets are marked by very high degrees of volatility. Through the use
of derivative products, it is possible to partially or fully transfer price risks by locking-in asset
Prices. As instruments of risk management, these generally do not influence the Fluctuations
in the underlying asset prices. However, by locking in asset prices, Derivative products
minimize the impact of fluctuations in asset prices on the profitability and cash flow situation
or risk-averse investors.

Derivatives are risk management instruments, which derive their value from an
underlying asset. The underlying asset can be bullion, index, share, bonds, Currency, Interest,
etc., Banks, Securities firms, Companies and investors to hedge risks, to gain access to
cheaper money and to make profit, use derivatives. Derivatives are likely to grow even at a
faster rate in future.

DEFINITION OF DERIVATIVES:

Derivative is a product whose value is derived from the value of an underlying asset
in a contractual manner. The underlying asset can be Equity, Forex, Commodity or any other
asset.

Securities Contract (Regulation) Act, 1956 (SC A) defines debt instrument,

share, loan whether secured or unsecured, risk instrument or contract for
differences or any other form of security
A contract which derives its value from the prices, or index of prices, of
underlying securities.

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2. HISTORY OF DERIVATIVES MARKETS:

Early forward contracts in the US addressed merchants concerns about ensuring that
there were buyers and sellers for commodities. However Credit Risk remained a serous
problem. To deal with this problem, a group of Chicago, Businessmen formed the Chicago
Board of Trade (CBOT) in 1848. The primary intention of the CBOT was to provide a
centralized location known in advance for buyers and sellers to negotiate forward contracts.
In 1865 the CBOT went one step further and listed the first Exchange Traded derivatives
Contract in the US; these contracts were called Futures Contracts. In 1919 Chicago Butter
and Egg Board, a spin-off CBOT was reorganized to allow futures trading. Its name was
changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain the two
largest organized futures exchanges, indeed the two largest Financial exchanges of any
kind in the world today.

The first stock index futures contract was traded at Kansas City Board of Trade.
Currently the most popular stock index futures contract in the world is based on S&P 500
Index traded on Chicago Mercantile Exchange. During the Mid eighties, financial futures
became the most active derivative instruments Generating columns many times more than the
commodity futures. Index futures, futures on T-Bills and Euro-Dollar futures are the three
most popular futures contract traded today. Other popular international exchanges that trade
derivatives are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan,
MATIF in France, Eurex etc.

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3. GROWTH OF DERIVATIVES MARKET:

Over the last three decades, the derivatives markets have seen a phenomenal growth.
A large variety of derivative contracts have been launched at exchanges across the world.
Some of the factors driving the growth of financial derivatives are:

Increased volatility in asset prices in financial markets.

Increased integration of national financial markets with the international markets.
Marked improvement in communication facilities and sharp decline in their costs.
Development of more sophisticated risk management tolls, providing economic
agents a wider choice of risk management strategies, and

Innovations in the derivatives markets, which optimally combine the risks and returns
over a large number of financial assets leading to higher returns, reduced risk as well as
transactions costs as compared to individual financial assets

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4. DERIVATIVE PRODUCTS (TYPES):

The following are the various types of derivatives. They are:

Forwards:

A forward contract is a customized contract between two entities, where settlement

takes places on a specific date in the future at todays pre-agreed price.

Futures:

A futures contract is an agreement between two parties to buy or sell an asset at a

certain time in the future at a certain pri9ce. Futures contracts are special types of forward
contracts 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 the underlying asset, at a given price on or before a
given future date. Puts give the buyer the right, but not the obligation to sell a given quantity
of the underlying asset at a given price on or before a given date.

Warrants:

Options generally have lives of up to one year; the majority of options traded on
options exchanges having a maximum maturity of nine months. Longer-dated options are
called warrants and are generally traded over the counter.

Leaps:

The acronym LEAPS means Long-team Equity anticipation Securities. These are
options having a maturity of up to three years.

Baskets:

Baskets options are options on portfolio of underlying assets. The underlying asset is
usually a moving average of a basket of assets. Equity index options are a form of basket
options.

Swaps:

Swaps are private agreement between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts.

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 Forward contract:

In finance and economics, a forward contract or simply a forward is a non-

standardized contract between two parties to buy or sell an asset at a specified future
time at a price agreed today. This is in contrast to a spot contract, which is an agreement to
buy or sell an asset today. It costs nothing to enter a forward contract. The party agreeing to
buy the underlying asset in the future assumes a long position, and the party agreeing to sell
the asset in the future assumes a short position. The price agreed upon is called the delivery
price, which is equal to the forward price at the time the contract is entered into.

The price of the underlying instrument, in whatever form, is paid before control of the
instrument changes. This is one of the many forms of buy/sell orders where the time of trade
is not the time where the securities themselves are exchanged. The forward price of such a
contract is commonly contrasted with the spot price, which is the price at which the asset
changes hands on the spot date. The difference between the spot and the forward price is the
forward premium or forward discount, generally considered in the form of a profit, or loss, by
the purchasing party.

Forwards, like other derivative securities, can be used to hedge risk (typically currency
or exchange rate risk), as a means of speculation, or to allow a party to take advantage of a
quality of the underlying instrument which is time-sensitive.

A closely related contract is a futures contract; they differ in certain respects. Forward
contracts are very similar to futures contracts, except they are not exchange-traded, or defined
on standardized assets. Forwards also typically have no interim partial settlements or "true-
ups" in margin requirements like futures such that the parties do not exchange additional
property securing the party at gain and the entire unrealized gain or loss builds up while the
contract is open. However, being traded OTC; forward contracts specification can be
customized and may include mark-to-market and daily margining. Hence, a forward contract
arrangement might call for the loss party to pledge collateral or additional collateral to better
secure the party at gain.

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 How a forward contract works:

Suppose that Bob wants to buy a house a year from now. At the same time, suppose
that Andy currently owns a $100,000 house that he wishes to sell a year from now. Both
parties could enter into a forward contract with each other. Suppose that they both agree on
the sale price in one year's time of $104,000. Andy and Bob have entered into a forward
contract. Bob, because he is buying the underlying, is said to have entered a long forward
contract. Conversely, Andy will have the short forward contract.

At the end of one year, suppose that the current market valuation of Andy's house is
$110,000. Then, because Andy is obliged to sell to Bob for only $104,000, Bob will make a
profit of $6,000. To see why this is so, one need only to recognize that Bob can buy from
Andy for $104,000 and immediately sells to the market for $110,000. Bob has made the
difference in profit. In contrast, Andy has made a potential loss of $6,000, and an actual profit
of $4,000.

Currency forwards are also similar, where one party opens a forward contract to buy or
sell a currency (ex. a contract to buy Canadian dollars) to expire/settle at a future date, as they
do not wish to be exposed to exchange rate risk over a period of time. As the exchange rate
between U.S. dollars and Canadian dollars fluctuates between the trade date and the earlier of
the date at which the contract is closed or the expiration date, one party gains and the
counterparty loses as one currency strengthens against the other. Sometimes, the buy forward
is opened because the investor will actually need Canadian dollars at a future date such as to
pay a debt owed that is denominated in Canadian dollars. Other times, the party opening a
forward does so, not because they need Canadian dollars nor because they are hedging
currency risk, but because they are speculating on the currency, expecting the exchange rate
to move favourably to generate a gain on closing the contract.

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 Example of how forward prices should be agreed upon-

Continuing on the example above, suppose now that the initial price of Andy's house
is $100,000 and that Bob enters into a forward contract to buy the house one year from today.
But since Andy knows that he can immediately sell for $100,000 and place the proceeds in
the bank, he wants to be compensated for the delayed sale. Suppose that the risk free rate of
return R (the bank rate) for one year is 4%. Then the money in the bank would grow to
$104,000, risk free. So Andy would want at least $104,000 one year from now for the
contract to be worthwhile for him the opportunity cost will be covered.

Futures contract:

In finance and economics, a futures contract is a standardized contract between

two parties to exchange a specified asset of standardized quantity and quality for a price
agreed today (the futures price or the strike price) with delivery occurring at a specified
future date, the delivery date. The contracts are traded on a futures exchange.

The party agreeing to buy the underlying asset in the future i.e. the "buyer" of the
contract, is said to be "long", and the party agreeing to sell the asset in the future i.e. the
"seller" of the contract, is said to be "short". The terminology reflects the expectations of the
parties -- the buyer hopes or expects that the asset price is going to increase, while the seller
hopes or expects that it will decrease. Note that the contract itself costs nothing to enter; the
buy/sell terminology is a linguistic convenience reflecting the position each party is taking
(long or short).

In many cases, the underlying asset to a futures contract may not be traditional
commodities at all that is, for financial futures the underlying asset or item can be
currencies, securities or financial instruments and intangible assets or referenced items such
as stock indexes and interest rates.

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 While the futures contract specifies a trade taking place in the future, the purpose of
the futures exchange institution is to act as intermediary and minimize the risk of default by
either party. Thus the exchange requires both parties to put up an initial amount of cash, the
margin. Additionally, since the futures price will generally change daily, the difference in the
prior agreed-upon price and the daily futures price is settled daily also. The exchange will
draw money out of one party's margin account and put it into the other's so that each party
has the appropriate daily loss or profit. If the margin account goes below a certain value, then
a margin call is made and the account owner must replenish the margin account. This process
is known as marking to market. Thus on the delivery date, the amount exchanged is not the
specified price on the contract but the spot value (since any gain or loss has already been
previously settled by marking to market).

A closely related contract is a forward contract. A forward is like a futures contract in

that it specifies the exchange of goods for a specified price at a specified future date.
However, a forward is not traded on an exchange and thus does not have the interim partial
payments due to marking to market. Nor is the contract standardized, as on the exchange.

Unlike an option, both parties of a futures contract must fulfil the contract on the
delivery date. The seller delivers the underlying asset to the buyer, or, if it is a cash-settled
futures contract, then cash is transferred from the futures trader who sustained a loss to the
one who made a profit. To exit the commitment prior to the settlement date, the holder of a
futures position can close out its contract obligations by taking the opposite position on
another futures contract on the same asset and settlement date. The difference in futures
prices is then a profit or loss.

Futures contracts and exchanges

There are many different kinds of futures contracts, reflecting the many different kinds
of "tradable" assets about which the contract may be based such as commodities, securities
(such as single-stock futures), currencies or intangibles such as interest rates and indexes.
Futures are traded in the following markets:

Foreign exchange market, Money market, Bond market, Equity market, Soft Commodities
market.

Trading on commodities began in Japan in the 18th century with the trading of rice and
silk, and similarly in Holland with tulip bulbs. Trading in the US began in the mid 19th

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century, when central grain markets were established and a marketplace was created for
farmers to bring their commodities and sell them either for immediate delivery (also called
spot or cash market) or for forward delivery. These forward contracts were private contracts
between buyers and sellers and became the forerunner to today's exchange-traded futures
contracts. Although contract trading began with traditional commodities such as grains, meat
and livestock, exchange trading has expanded to include metals, energy, currency and
currency indexes, equities and equity indexes, government interest rates and private interest
rates.

Traders in futures

Futures traders are traditionally placed in one of two groups: hedgers, who have an
interest in the underlying asset (which could include an intangible such as an index or interest
rate) and are seeking to hedge out the risk of price changes; and speculators, who seek to
make a profit by predicting market moves and opening a derivative contract related to the
asset "on paper", while they have no practical use for or intent to actually take or make
delivery of the underlying asset. In other words, the investor is seeking exposure to the asset
in a long futures or the opposite effect via a short futures contract.

Options on futures

In many cases, options are traded on futures, sometimes called simply "futures
options". A put is the option to sell a futures contract, and a call is the option to buy a futures
contract. For both, the option strike price is the specified futures price at which the future is
traded if the option is exercised. Futures are often used since they are delta one instruments.

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Calls and options on futures may be priced similarly to those on traded assets by using an
extension of the Black-Scholes formula, namely Black's formula for futures.

Investors can either take on the role of option seller/option writer or the option buyer.
Option sellers are generally seen as taking on more risk because they are contractually
obligated to take the opposite futures position if the options buyer exercises his or her right to
the futures position specified in the option. The price of an option is determined by supply
and demand principles and consists of the option premium, or the price paid to the option
seller for offering the option and taking on risk.

Futures versus forwards

While futures and forward contracts are both contracts to deliver an asset on a future
date at a prearranged price, they are different in two main respects:

-Futures are exchange-traded, while forwards are traded over-the-counter. Thus

futures are standardized and face an exchange, while forwards are customized and
face non-exchange counterparty.

- Futures are margined, while forwards are not. Thus futures have significantly less
credit risk, and have different funding.

FUTURES FORWARDS

1. Trade on an Organized 1.OTC in nature

Exchange

2. Standardized contract terms 2.Customized Contract terms

3. Hence more liquid 3.Hence less liquid

4. Requires margin payment 4.No Margin Payment

5. Follows daily Settlement 5.Settlement happens at end of

period

FEATURES OF FUTURES
Futures are highly standardized

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 The contracting parties need not pay any down payment
Hedging of price risks
They have secondary markets to.

MARGINS:
Margins are the deposits which reduce counter party risk, arise in a futures contract.
These margins are collect in order to eliminate the counter party risk. There are three types of
margins:

Initial Margins:
Whenever a future contract is signed, both buyer and seller are required to post initial
margins. Both buyers and seller are required to make security deposits that are intended to
guarantee that they will infect be able to fulfil their obligation. These deposits are initial
margins and they are often referred as purchase price of futures contract.

Mark to market margins:

The process of adjusting the equity in an investors account in order to reflect the
change in the settlement price of futures contract is known as MTM Margin.

Maintenance margin:
The investor must keep the futures account equity equal to or grater than certain
percentage of the amount deposited as initial margin. If the equity goes less than that
percentage of initial margin, then the investor receives a call for an additional deposit of cash
known as maintenance margin to bring the equity up to the initial margin.

Options:

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 The right, but not the obligation, to buy (for a call option) or sell (for a put
option) a specific amount of a given stock, commodity, currency, index, or debt, at a
specified price (the strike price) during a specified period of time is called an option.

For stock options, the amount is usually 100 shares. Each option contract has a buyer,
called the holder, and a seller, known as the writer. If the option contract is exercised, the
writer is responsible for fulfilling the terms of the contract by delivering the shares to the
appropriate party. In the case of a security that cannot be delivered such as an index, the
contract is settled in cash.

For the holder, the potential loss is limited to the price paid to acquire the option and
the possible gain is unlimited. When an option is not exercised, it expires. No shares change
hands and the money spent to purchase the option is lost. Option contracts, like stocks, are
therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is
unlimited unless the contract is covered, meaning that the writer already owns the security
underlying the option.

Option contracts are most frequently as either leverage or protection. As leverage,

options allow the holder to control equity in a limited capacity for a fraction of what the
shares would cost. The difference can be invested elsewhere until the option is exercised. As
protection, options can guard against price fluctuations in the near term because they provide
the right acquire the underlying stock at a fixed price for a limited time. Risk is limited to the
option premium (except when writing options for a security that is not already owned).
However, the costs of trading options (including both commissions and the bid/ask spread) is
higher on a percentage basis than trading the underlying stock. In addition, options are very
complex and require a great deal of observation and maintenance.

Application of option contract in unilateral contracts

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 The option contract provides an important role in unilateral contracts. In unilateral
contracts, the promisor seeks acceptance by performance from the promisee. In this scenario,
the classical contract view was that a contract is not formed until the performance that the
promisor seeks is completely performed. This is because the consideration for the contract
was the performance of the promisee. Once the promisee performed completely, the condition
is satisfied and a contract is formed and only the promisor is bound to his promise.

A problem arises with unilateral contracts because of the late formation of the contract.
With classical unilateral contracts, a promisor can revoke his offer for the contract at any
point prior to the promises complete performance. So, if a promisee provides 99% of the
performance sought, the promisor could then revoke without any remedy for the promisee.
The promisor has maximum protection and the promisee has maximum risk in this scenario.

An option contract can provide some security to the promisee in the above scenario.
Essentially, once a promisee begins performance, an option contract is implicitly created
between the promisor and the promisee. The promisor impliedly promises not to revoke the
offer and the promisee impliedly promises to furnish complete performance, but as the name
suggests, the promisee still retains the "option" of not completing performance. Basically, the
consideration is provided by the promises beginning of performance.

Case law differs from jurisdiction to jurisdiction, but an option contract can either be
implicitly created instantaneously at the beginning of performance (the Restatement view) or
after some "substantial performance."

It has been hypothesized that option contracts could help allow free market roads to be
constructed without resorting to eminent domain, as the road company could make option
contracts with many landowners, and eventually consummate the purchase of parcels
comprising the contiguous route needed to build the road.

HISTORY OF OPTIONS:
Although options have existed for a long time, they wee traded OTC, without much
knowledge of valuation. The first trading in options began in Europe and the US as early as
the seventeenth century. It was only in the early 1900s that a group of firms set up what was
known as the put and call Brokers and Dealers Association with the aim of providing a
mechanism for bringing buyers and sellers together. If someone wanted to buy an option, he

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or she would contact one of the member firms. If no seller could be found, the firm would
undertake to write the option itself in return for a price.
This market however suffered from two deficiencies. First, there was no secondary
market and second, there was no mechanism to guarantee that the writer of the option would
honor the contract. In 1973, Black, Merton and Scholes invented the famed Black-Scholes
formula. In April 1973, CBOE was set up specifically for the purpose of trading options. The
market for option developed so rapidly that by early 80s, the number of shares underlying
the option contract sold each day exceeded the daily volume of shares traded on the NYSE.
Since then, there has been no looking back.
Option made their first major mark in financial history during the tulip-bulb mania
in seventeenth-century Holland. It was one of the most spectacular get rich quick binges in
history. The first tulip was brought Into Holland by a botany professor from Vienna. Over a
decade, the tulip became the most popular and expensive item in Dutch gardens. The more
popular they became, the more Tulip bulb prices began rising. That was when options came
into the picture. They were initially used for hedging. By purchasing a call option on tulip
bulbs, a dealer who was committed to a sales contract could be assured of obtaining a fixed
number of bulbs for a set price. Similarly, tulip-bulb growers could assure themselves of
selling their bulbs at a set price by purchasing put options. Later, however, options were
increasingly used by speculators who found that call options were an effective vehicle for
obtaining maximum possible gains on investment. As long as tulip prices continued to
skyrocket, a call buyer would realize returns far in excess of those that could be obtained by
purchasing tulip bulbs themselves. The writers of the put options also prospered as bulb
prices spiraled since writers were able to keep the premiums and the options were never
exercised. The tulip-bulb market collapsed in 1636 and a lot of speculators lost huge sums of
money. Hardest hit were put writers who were unable to meet heir commitments to purchase
Tulip bulbs
PROPERTIES OF OPTION
Options have several unique properties that set them apart from other securities.
The following are the properties of option:
Limited Loss
High leverages potential
Limited Life
PARTIES IN AN OPTION CONTRACT:
There are two participants in Option Contract.

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 Buyer/Holder/Owner of an Option:
The Buyer of an Option is the one who by paying the option premium buys the right but not
the obligation o exercise his option on the seller/writer.
Seller/writer of an Option:
The writer of a call/put option is the one who receives the option premium and is thereby
obliged to sell/buy the asset if the buyer exercises on him.

TYPES OF OPTIONS
The Options are classified into various types on the basis of various variables. The
following are the various types of options.
On the basis of the underlying asset:
On the basis of the underlying asset the option are divided into two types:
Index options:
These options have the index as the underlying. Some options are European while
others are American. Like index futures contracts, index options contracts are also
cash settled.
Stock options:
Stock Options are options on individual stocks. Options currently trade on over 500
stocks in the United States. A contract gives the holder the right to buy or sell shares
at the specified price.
On the basis of the market movements:
On the basis of the market movements the option are divided into two types. They are:
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. It is brought by an investor when he seems that the
stock price moves upwards.
Put Option:
A put option gives the holder the right but not the obligation to sell an asset by a
certain date for a certain price. It is brought by an investor when he seems that the
stock price moves downwards.
3. On the basis of exercise of option:
On the basis of the exercise of the Option, the options are classified into two
Categories.

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 American Option:
American options are options that can be exercised at any time up to the expiration
date. Most exchange-traded options are American
European Option:
European options are options that can be exercised only on the expiration date itself.
European options are easier to analyze than American options, and properties of an
American option are frequently deduced from those of its European counterpart.

FACTORS AFFECTING THE PRICE OF AN OPTION:

The following are the various factors that affect the price of an option they are:
Stock Price:
The pay-off from a call option is an amount by which the stock price exceeds the
strike price. Call options therefore become more valuable as the stock price increases and
vice versa. The pay-off from a put option is the amount; by which the strike price exceeds the
stock price. Put options therefore become more valuable as the stock price increases and vice
versa.

Strike price:
In case of a call, as a strike price increase, the stock price has to make a larger upward
move for the option to go in-the-money. Therefore, for a call, as the strike price increases
option becomes less valuable and as strike price decreases, option become more valuable.

Time to expiration:
Both put and call American options become more valuable as a time to expiration
increase.

Volatility:
The volatility of a stock price is measured of uncertain about future stock price
movements. As volatility increases, the chance that the stock will do very well or very poor
increases. The value of both calls and puts therefore increases as volatility increase.

Risk-free interest rate:

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 The put option prices decline as the risk-free rate increases where as the price of call
always increases as the risk free interest rate increases.

OPTIONS TERMINOLOGY
Option price/premium:
Option price is the price which the option buyer pays to the option seller. It is also
referred to as the option premium.

Expiration date:
The date specified in the options contract is known as the expiration date, the exercise
date, the strike date or the maturity.

Strike price:
The price specified in the option contract is known as the strike price or the exercise
price.

DISTINCTION BETWEEN FUTURES AND OPTIONS

FUTURES OPTIONS
1. Exchange traded, with Innovation 1. Same as futures
2. Exchange defines the product 2. Same as futures
3. Price is zero, strike price moves 3. Strike price is fixed, price moves
4. Price is Zero 4. Price is always positive
5. Linear payoff 5. Nonlinear payoff
6. Both long and short at risk 6. Only short at risk

Swap:

A swap is nothing but a barter or exchange but it plays a very important role in
international finance. A swap is the exchange of one set of cash flows for another. A swap is

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a contract between two parties in which the first party promises to make a payment to
the second and the second party promises to make a payment to the first. Both payments
take place on specified dates. Different formulas are used to determine what the two sets of
payments will be.

Classification of swaps is done on the basis of what the payments are based on. The
different types of swaps are as follows.

Interest rate swaps:

The interest rate swap is the most frequently used swap. An interest rate swap
generally involves one set of payments determined by the Eurodollar (LIBOR) rate, although,
it can be pegged to other rates. The other set is fixed at an agreed-upon rate. This other agreed
upon rate usually corresponds to the yield on a Treasury Note with a comparable maturity,
although, this can also be variable.

Additionally, there will be a spread of a pre-determined amount of basis points. This is

just one type of interest rate swap. Sometimes payments tied to floating rates are used for
interest rate swaps. The notional principal is the exchange of interest payments based on face
value. The notional principal itself is not exchanged. On the day of each payment, the party
who owes more to the other makes a net payment i.e. the party making a loss pays the loss
amount to the party making a profit. Here the loss amount will be equal to the profit amount.
Only one party makes a payment.

Currency swaps:

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 A currency swap is an agreement between two parties in which one party promises to
make payments in one currency and the other promises to make payments in another
currency. Currency swaps are similar yet notably different from interest rate swaps and are
often combined with interest rate swaps.

Currency swaps help eliminate the differences between international capital markets.
Interest rates swaps help eliminate barriers caused by regulatory structures. While currency
swaps result in exchange of one currency with another, interest rate swaps help exchange a
fixed rate of interest with a variable rate. The needs of the parties in a swap transaction are
diametrically different. Swaps are not traded or listed on exchange but they do have an
informal market and are traded among dealers.

A swap is a contract, which can be effectively combined with other type of derivative
instruments. An option on a swap gives the party the right, but not the obligation to enter into
a swap at a later date.

Commodity swaps:

In commodity swaps, the cash flows to be exchanged are linked to commodity prices.
Commodities are physical assets such as metals, energy stores and food including cattle. E.g.
in a commodity swap, a party may agree to exchange cash flows linked to prices of oil for a
fixed cash flow.

Commodity swaps are used for hedging against

o Fluctuations in commodity prices or

o Fluctuations in spreads between final product and raw material prices (E.g.
Cracking spread which indicates the spread between crude prices and refined
product prices significantly affect the margins of oil refineries)

A Company that uses commodities as input may find its profits becoming very volatile
if the commodity prices become volatile. This is particularly so when the output prices may
not change as frequently as the commodity prices change. In such cases, the company would
enter into a swap whereby it receives payment linked to commodity prices and pays a fixed
rate in exchange. A producer of a commodity may want to reduce the variability of his
revenues by being a receiver of a fixed rate in exchange for a rate linked to the commodity
prices.

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Gold- popular commodity swap Oil popular commodity swap

Equity swaps:

Under an equity swap, the shareholder effectively sells his holdings to a bank,
promising to buy it back at market price at a future date. However, he retains a voting right
on the shares.

Credit default swaps:

A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes
a series of payments to the seller and, in exchange, receives a payoff if an instrument -
typically a bond or loan - goes into default (fails to pay). Less commonly, the credit event that
triggers the payoff can be a company undergoing restructuring, bankruptcy or even just
having its credit rating downgraded. CDS contracts have been compared with insurance,
because the buyer pays a premium and in return, receives a sum of money if one of the events
specified in the contract occur. Unlike an actual insurance contract the buyer is allowed to
profit from the contract and may also cover an asset to which the buyer has no direct
exposure.

Other variations:

There are myriad different variations on the vanilla swap structure, which are limited
only by the imagination of financial engineers and the desire of corporate treasurers and fund
managers for exotic structures.

A total return swap is a swap in which party A pays the total return of an asset, and
party B makes periodic interest payments. The total return is the capital gain or loss, plus
any interest or dividend payments. Note that if the total return is negative, then party A
receives this amount from party B. The parties have exposure to the return of the underlying

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stock or index, without having to hold the underlying assets. The profit or loss of party B is
the same for him as actually owning the underlying asset.

An option on a swap is called a swaption. These provide one party with the right but
not the obligation at a future time to enter into a swap.

A variance swap is an over-the-counter instrument that allows one to speculate on or

hedge risks associated with the magnitude of movement, a CMS, is a swap that allows the
purchaser to fix the duration of received flows on a swap.

An Amortising swap is usually an interest rate swap in which the notional principal for
the interest payments declines during the life of the swap, perhaps at a rate tied to the
prepayment of a mortgage or to an interest rate benchmark such as the LIBOR. It is suitable
to those customers of banks who want to manage the interest rate risk involved in predicted
funding requirement, or investment programs.

A Zero coupon swap is of use to those entities which have their liabilities denominated
in floating rates but at the same time would like to conserve cash for operational purposes.

A Deferred rate swap is particularly attractive to those users of funds that need funds
immediately but do not consider the current rates of interest very attractive and feel that the
rates may fall in future.

An Accreting swap is used by banks which have agreed to lend increasing sums over
time to its customers so that they may fund projects.

A Forward swap is an agreement created through the synthesis of two swaps differing in
duration for the purpose of fulfilling the specific time-frame needs of an investor.-also
referred to as a forward start swap, delayed start swap, and a deferred start swap.

Components of swap price

There are four major components of a swap price:

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 Benchmark price:
Swap rates are based on a series of benchmark instruments. They may be quoted as a
spread over the yield on these benchmark instruments or on an absolute interest rate basis.
In the Indian markets the common benchmarks are MIBOR, 14, 91, 182 & 364 day T-
bills, CP rates and PLR rates.

Liquidity:
Liquidity, which is function of supply and demand, plays an important role in swaps
pricing. This is also affected by the swap duration. It may be difficult to have
counterparties for long duration swaps, especially so in India.

Transaction Costs:
Transaction costs include the cost of hedging a swap. Say in case of a bank, which
has a floating obligation of 91 days T. Bill. Now in order to hedge the bank would go long
on a 91 day T. Bill. For doing so the bank must obtain funds. The transaction cost would
thus involve such a difference.

Yield on 91 day T. Bill - 9.5%

Cost of fund (e.g.- Repo rate) 10%

The transaction cost in this case would involve 0.5%

Credit Risk:
Credit risk must also be built into the swap pricing. Based upon the credit rating of
the counterparty a spread would have to be incorporated. Say for e.g. it would be 0.5% for
an AAA ratin

5. PARTICIPANT IN DERIVATIVES MARKET:

Hedgers:

Hedgers are individuals and firms that make purchases and sales in the futures market
solely for the purpose of establishing a known price level--weeks or months in advance--for
something they later intend to buy or sell in the cash market (such as at a grain elevator or in
the bond market). In this way they attempt to protect themselves against the risk of an
unfavourable price change in the interim. Or hedgers may use futures to lock in an acceptable

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margin between their purchase cost and their selling price. The details of hedging can be
somewhat complex but the principle is simple.

Consider this example: A jewellery manufacturer will need to buy additional gold
from his supplier in six months. Between now and then, however, he fears the price of gold
may increase. That could be a problem because he has already published his catalogue for a
year ahead.

To lock in the price level at which gold is presently being quoted for delivery in six
months, he buys a futures contract at a price of, say, $350 an ounce.

If, six months later, the cash market price of gold has risen to $370, he will have to
pay his supplier that amount to acquire gold. However, the extra $20 an ounce cost will be
offset by a $20 an ounce profit when the futures contract bought at $350 is sold for $370. In
effect, the hedge provided insurance against an increase in the price of gold. It locked in a net
cost of $350, regardless of what happened to the cash market price of gold. Had the price of
gold declined instead of risen, he would have incurred a loss on his futures position but this
would have been offset by the lower cost of acquiring gold in the cash market.

The number and variety of hedging possibilities is practically limitless. A cattle

feeder can hedge against a decline in livestock prices and a meat packer or supermarket chain
can hedge against an increase in livestock prices. Borrowers can hedge against higher interest
rates, and lenders against lower interest rates. Investors can hedge against an overall decline
in stock prices, and those who anticipate having money to invest can hedge against an
increase in the over-all level of stock prices. And the list goes on.

Whatever the hedging strategy, the common denominator is that hedgers willingly
give up the opportunity to benefit from favourable price changes in order to achieve
protection against unfavourable price changes. Past performance is not necessarily indicative
of future results. The risk of loss exists in futures and options trading.

Speculators:

Speculators are somewhat like a middle man. They are never interested in actual owing
the commodity. They will just buy from one end and sell it to the other in anticipation of
future price movements. They actually bet on the future movement in the price of an asset.
They are the second major group of futures players. These participants include independent

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floor traders and investors. They handle trades for their personal clients or brokerage firms.

Buying a futures contract in anticipation of price increases is known as going long.

Selling a futures contract in anticipation of a price decrease is known as going short.

Speculators have certain advantages over other investors they are as follows:
1. If the traders judgement is good, he can make more money in the futures market faster
because prices tend, on average, to change more quickly than real estate or stock prices.

2. Futures are highly leveraged investments. The trader puts up a small fraction of the value
of the underlying contract as margin, yet he can ride on the full value of the contract as it
moves up and down. The money he puts up is not a down payment on the underlying
contract, but a performance bond. The actual value of the contract is only exchanged on those
rare occasions when delivery takes place.

Arbitrageurs:

A type of investor who attempts to profit from price differences in the market by
making simultaneous trades that offset each other and capturing risk-free profits. An
arbitrageur would, for example, seek out price discrepancies between stocks listed on more
than one exchange, and buy the undervalued shares on one exchange while short selling the
same number of overvalued shares on another exchange, thus capturing risk-free profits as
the prices on the two exchanges converge.

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 Suppose that the exchange rates (after taking out the fees for making the exchange) in
London are 5 = $10 = 1000 and the exchange rates in Tokyo are 1000 = $12 = 6.
Converting 1000 to $12 in Tokyo and converting that $12 into 1200 in London, for a profit
of 200, would be arbitrage. In reality, this "triangle arbitrage" is so simple that it almost
never occurs. But more complicated foreign exchange arbitrages, such as the spot-forward
arbitrage are much more common.

6. ADVANTAGE OF THE DERIVATIVE MARKET:

Today's sophisticated international markets have helped foster the rapid growth in
derivative instruments. In the hands of knowledgeable investors, derivatives can derive profit
from:

-Changes in interest rates and equity markets around the world

-Currency exchange rate shifts

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 -Changes in global supply and demand for commodities such as agricultural products,

precious and industrial metals, and energy products such as oil and natural gas

Adding some of the wide variety of derivative instruments available to a traditional

portfolio of investments can provide global diversification in financial instruments and
currencies, help hedge against inflation and deflation, and generate returns that are not
correlated with more traditional investments. The two most widely recognized benefits
attributed to derivative instruments are price discovery and risk management.

Price Discovery:

Futures market prices depend on a continuous flow of information from around the
world and require a high degree of transparency. A broad range of factors (climatic
conditions, political situations, debt default, refugee displacement, land reclamation and
environmental health, for example) impact supply and demand of assets (commodities in
particular) - and thus the current and future prices of the underlying asset on which the
derivative contract is based. This kind of information and the way people absorb it constantly
changes the price of a commodity. This process is known as price discovery.

With some futures markets, the underlying assets can be geographically dispersed,
having many spot (or current) prices in existence. The price of the contract with the shortest
time to expiration often serves as a proxy for the underlying asset.

Options also aid in price discovery, not in absolute price terms, but in the way the
market participants view the volatility of the markets. This is because options are a different
form of hedging in that they protect investors against losses while allowing them to
participate in the asset's gains.

Risk Management:

This could be the most important purpose of the derivatives market. Risk management
is the process of identifying the desired level of risk, identifying the actual level of risk and
altering the latter to equal the former. This process can fall into the categories of hedging and
speculation.

Hedging has traditionally been defined as a strategy for reducing the risk in holding a
market position while speculation referred to taking a position in the way the markets will

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move. Today, hedging and speculation strategies, along with derivatives, are useful tools or
techniques that enable companies to more effectively manage risk.

Improve Market Efficiency for the Underlying Asset:

For example, investors who want exposure to the S&P 500 can buy an S&P 500 stock
index fund or replicate the fund by buying S&P 500 futures and investing in risk-free bonds.
Either of these methods will give them exposure to the index without the expense of
purchasing all the underlying assets in the S&P 500.

If the cost of implementing these two strategies is the same, investors will be neutral as
to which they choose. If there is a discrepancy between the prices, investors will sell the
richer asset and buy the cheaper one until prices reach equilibrium. In this context,
derivatives create market efficiency.

Help Reduce Market Transaction Costs

Because derivatives are a form of insurance or risk management, the cost of trading in
them has to be low or investors will not find it economically sound to purchase such
"insurance" for their positions

7. FEATURE OF THE DERIVATIVES MARKET:

The derivatives market has grown rapidly since its inception. Today derivatives
account for nearly 75% of market transactions in the USA, Europe and Japan. Derivatives are
fast catching up in the developing countries as well. In India also derivatives have registered
a substantial growth.

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 Although commodity derivatives existed since centuries ago, the market for
financial derivatives has now grown tremendously both in terms of variety of instruments and
turnover.

The value of underlying assets of derivatives is more than US $16 trillion which is
almost 3 times the value of stocks traded at the NYSE and twice the size of the US GDP.

This insurgent growth is expected to continue at this pace or faster as markets

continue to get more advanced and developed. As derivatives are excellent hedging devices, a
trader has very little to lose and a lot to gain. It is this feature of the derivative which will
ensure it grows and takes over 90% of market transactions in the near future. One can only
keep guessing and making arbitrary assumptions about the value of underlying assets that
will be traded in the future.

8. FUNCTIONS OF THE DERIVATIVES MARKET:

In spite of the fear and criticism with which the derivative markets are commonly
looked at, these markets perform a number of economic functions.

Price in an organized derivative markets reflect the perception of market participants

about the future and lead the prices of underlying to the perceived future level. The prices

29 | P a g e
 of derivatives converge with the prices of the underlying at the expiration of the
derivative contract. Thus derivatives help in discovery of future as well as current prices.

The derivative markets helps to transfer risks from those who have them but may not like
them to those who have an appetite for them.

Derivative due to their inherent nature, are linked to the underlying cash markets. With
the introduction of derivatives, 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.

Speculative trades shift to a more controlled environment of derivatives market. In the

absence of an organized derivatives market, speculators trade in the underlying cash
markets. Margining, Monitoring and Surveillance of the activities of various participants
become extremely difficult in these kinds of mixed markets.

An important incidental benefit that flows from derivatives trading is that is acts as a
catalyst for new entrepreneurial activity. The derivatives have a history of attracting many
bright, creative, Well-educated people with an entrepreneurial attitude.

9. NATURE OF THE PROBLEM:

The turnover of the stock exchange has been tremendously increasing from last 10
Years. The number of trades and the number of investors, who are participating, have
increased. The investors are willing to reduce their risk, so they are seeking for the risk
management tools.

Prior to SEBI abolishing the BADLA system, the investors had this system as a
source of reducing the risk, as it has many problems like no strong margining system, unclear
expiration date and generating counter party risk. In view of this problem SEBI abolished the
BADLA system.

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 After the abolition of the BADLA system, the investors are seeking for a Hedging
system, which could reduce their portfolio risk, SEBI thought the Introduction of the
derivatives trading, as a first step it has set up a 24 Member committee under the
chairmanship of Dr. L.C. Gupta to develop the appropriate Framework for derivatives trading
in India, SEBI accepted the recommendation of the committee on May 11, 1998 and
approved the phase introduction of the Derivatives trading beginning with stock index
futures.

There are many investors who are willing to trade in the derivatives segment, because
of its advantages like limited loss unlimited profit by paying the small premiums.

10.DEVLOPMENT OF DERIVATIVES MARKET:

Holding portfolios of Securities is associate with the risk of the possibility that the
investor may realize his returns, which would be much lesser than what he expected to get.
There are various factors, which affect the returns:

Price or dividend (interest)

Some are internal to the firm like-
Industrial Policy
Management Capabilities
Consumers preference
Labour strike, etc.

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 These forces are to a large extent controllable and are termed as non systematic risks.
An investor can easily manage such non-systematic by having a Well-diversified portfolio
spread across the companies, industries and groups so that a loss in one may easily be
compensated with a gain in other.

There are yet other of influence which are external to the firm, cannot be controlled and
affect large number of securities. They are termed as systematic risk. They are:

Economic
Political
Sociological changes are sources of systematic risk.

For instance, inflation, interest rate, etc. their effect is to cause prices if nearly All
individual stocks to move together in the same manner. We therefore quite often find stock
prices falling from time to time in spite of companys earnings rising and vice versa.

Rational Behind the development of derivatives market is to manage this systematic

risk, liquidity in the sense of being able to buy and sell relatively large amounts quickly
without substantial price concession.

In debt market, a large position of the total risk of securities is systematic. Debt
instruments are also finite life securities with limited marketability due to their small size
relative to many common sticks. Those factors favour for the purpose of both portfolio
hedging and speculation, the introduction of a derivatives securities that is on some broader
market rather than an individual security.

11.GLOBAL DERIVATIVES MARKET:

The global financial centers such as Chicago, New York, Tokyo and London dominate
the trading in derivatives. Some of the worlds leading exchanges for the exchange traded
derivatives are:

Chicago Mercantile exchange (CME) and London International Financial

Futures Exchange (LIFE) (for currency & Interest Futures).
Philadelphia Stock Exchange (PSE), London Stock Exchange (LSE) &
Chicago Board Options Exchange (CBOE) (for currency & Interest Futures).
New York Stock Exchange (NYSE) and London Stock Exchange (LSE) (for
equity derivatives).
Chicago Mercantile Exchange (CME) and London Metal Exchange (LME)
(for Commodities)

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 These exchanges account for a large portion of the trading volume in the respective
derivatives segment.

HISTORY OF DERIVATIVES GLOBALLY:

To start we need to go back to the Bible. In Genesis Chapter 29, believed to be about
the year 1700 B.C., Jacob purchased an option costing him seven years of labour that granted
him the right to marry Laban's daughter Rachel. His prospective father-in-law, however,
reneged, perhaps making this not only the first derivative but the first default on a derivative.
Laban required Jacob to marry his older daughter Leah. Jacob married Leah, but because he
preferred Rachel, he purchased another option, requiring seven more years of labour, and
finally married Rachel, bigamy being allowed in those days. Jacob ended up with two wives,
twelve sons, who became the patriarchs of the twelve tribes of Israel. Some argue that Jacob
really had forward contracts, which obligated him to the marriages but that does not matter.
Jacob did derivatives, one way or the other. Around 580 B.C., Thales the Milesian purchased
options on olive presses and made a fortune off of a bumper crop in olives. So derivatives
were around before the time of Christ.

The first known instance of derivatives trading dates to 2000 B.C. when merchants, in
what is now called Bahrain Island in the Arab Gulf, made consignment transactions for goods
to be sold in India. Derivatives trading in the same era also occurred in Mesopotamia. A more
literary reference comes some 2,350 years ago from Aristotle who discussed a case of market
manipulation through the use of derivatives on olive oil press capacity in Chapter 9 of his
Politics.

Derivatives trading in an exchange environment and with trading rules can be traced
back to Venice in the 12th Century. Forward and options contracts were traded on
commodities, shipments and securities in Amsterdam after 1595. The Japanese traded futures-
like contracts on warehouse receipts or rice in the 1700s.Dojima Rice Exchange was
established in 1710 in Osaka, Japan.

The United States followed in the early 1800s. Forward contracts were standard at the
time .In 1848, the Chicago Board of Trade (CBOT) was formed. Trading was originally in
forward contracts, the first contract (on corn) was written on March 13, 1851. In 1865,
standardized futures contracts were introduced. In 1972, the International Monetary Market

33 | P a g e
(IMM), division of the Chicago Mercantile Exchange, was formed to
offer futures contracts in foreign currencies: British pound, Canadian dollar, German mark,
Japanese yen, Mexican peso, and Swiss franc. In 1881, a regional market was founded in
continuously since then; today the Minneapolis Grain Exchange (MGEX) is the only
exchange for hard red spring wheat futures and options. The 1970s saw the development of
the financial futures contracts, which allowed trading in the future value of interest rates.
Today, the futures market shave far outgrown their agricultural origins.

12. NSES DERIVATIVES MARKET:

The derivatives trading on the NSE commenced with S & P CNX Nifty index Futures
on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in
options on individual securities commence on July 2, 2001 Single stock futures were
launched on November 9, 2001. Today, both in terms of volume and turnover, NSE is the
largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of
3-Months expiration cycles. Three contracts are available for trading, with 1 month, 2 month
and 3 month expiry. A new contact is introduced on the next trading day following of the near
month contract.

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13.REGULATORY FRAMEWORK:

The trading of derivatives is governed by the provisions contained in the SC (R) A,

the SEBI Act., the rules and regulations framed there under and the rules and bye-laws of
stock exchanges.

In this chapter we look at the broad regulatory framework for derivatives trading and
the requirement to become a member and an authorized dealer of the F & O segment and the
position limits as they apply to various participants.

Regulation for derivatives trading:

SEBI set up a 24-members committee under the Chairmanship of Dr. L.C GUPTA to
develop the appropriate regulatory framework for derivatives trading in India. On May 11,
1998 SEBI accepted the recommendations of the committee and approved the phased
introduction of derivatives trading in India beginning with stock index futures.
35 | P a g e
 The provision in the SC(R) A and the regulatory framework developed there under
govern trading in securities. The am

Endment of the SC (R) A to include derivatives within the ambit of securities in the SC (R)
a made trading in derivatives possible within the framework of that Act.

Any Exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta

Committee report can apply to SEBI for grant of recognition under Section 4 of the
SC (R) A, 1956 to start trading derivatives. The derivatives

Exchange / segment should have a separate governing council and representation of

trading / clearing members shall be limited to maximum of 40% of the total members
of the governing council. The exchange would have to regulate the sales practices of
its members and would have to obtain prior approval of SEBI before start of trading
in any derivative contract.
The exchange should have minimum 50 Members.
The members of an existing segment of the exchange would not automatically
become the members of derivative segment. The members of the derivative segment
would need to fulfil the eligibility conditions as laid down by the L.C. Gupta
committee.
The clearing and settlement of derivatives trades would be through a SEBI approved
clearing corporation / house. Clearing corporations/ houses complying with the
eligibility as laid down by the committee have to apply to SEBI for grant of approval.
Derivatives brokers / dealers and clearing members are required to seek registration
from SEBI. This is in addition to their registration as brokers of existing stock
exchanges. The minimum net worth for clearing members of the derivatives clearing
corporation / house shall be Rs.300 Lakhs. The net worth of the member shall be
computed as follows.
Capital + Free Reserves
Less non-allowable assets viz.,
Fixed assets
Pledged securities
Members card
Non allowable securities (Unlisted securities)
Bad deliveries
Doubtful debts and advances
Prepaid expenses
Intangible assets

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 The minimum contact value shall not be less than Rs.2 Lakhs. Exchanges have to
submit details of the futures contract they propose to introduce.
The initial margin requirement, exposure limits linked to capital adequacy and margin
demands related to the risk of loss on the position will be prescribed by SEBI /
Exchanged from time to time.
The L.C. Gupta committee report requires strict enforcement of Know your
customer rule and requires that every client shall be registered with the derivatives
broker. The members of the derivatives segment are also required to make their clients
aware of the risks involved in derivatives trading by issuing to the clients the Risk
Disclosure and obtain a copy of the same duly signed by the clients.
The trading members are required to have qualified approved user and sales person
who have passed a certification programmed approved by SEBI.
14. ELIGIBILITY OF ANY STOCK TO ENTER IN DERIVATIVES
MARKET:
Non Promoter holding (Free float capitalization) not less than Rs. 750 Crores from
last 6 Months.
Daily Average Trading value not less than 5 Crores in last 6 Months
At least 90% of Trading days in last 6 Months
Non Promoter Holding at least 30%
BETA not more than 4 (previous last 6 Months)

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15. COMPANY PROFILE

INDIA INFOLINE LTD.

We were originally incorporated on October 18, 1995 as Probilty Research and
Services private limited at Mumbai under the Companies Act, 1956 with Registration No. 11
93797. We commenced our operations as an independent provider of information, analysis
and research covering Indian business, financial markets and economy, to institutional
Customers. We became a public limited company on April 28, 2000 and the name of the
Company was changed to Probity Research and Services Limited. The name of the company
was changed to India infoline.com Limited on May 23, 2000 and later to India Infoline
Limited on March23, 2001.
In 1999, we identified the potential of the Internet to cater to a mass retail segment and
transformed our business model from providing information services to institutional
customers to retail customers. Hence we launched our Internet portal, www.indianfoline.com
in May 1999 and started providing news and market information, independent research,
interviews with business leaders and other specialized features.
In May 2000, the name of our Company was changed to India Infoline.com Limited to
reflect the transformation of our business. Over a period of time, we have emerged as one of
the leading business and financial information services provider in India.
In the year 2000, we leveraged our position as a provider of Financial information and
analysis by diversifying into transactional services, primarily for online trading in shares and
securities and online as well as offline distribution of personal financial products, like Mutual
funds and RBI Bonds. These activities were carried on by our wholly owned subsidiaries.

38 | P a g e
Our broking services was launched under the brand name of 5paisa.com through our
subsidiary, India Infoline Securities Private Limited and www.5paisa.com, the e-broking
portal, was launched for online trading in July 2000. It combined competitive brokerage rates
and research, supported by Internet technology Besides investment advice from an
experienced team of research analysts, we also offer real time stock quotes, market news and
price chars with multiple tools for technical analysis.

Acquisition of Agri Marketing Services limited (Agri)

In March 2000, we acquired 100% of the equity shares of Agri Marketing services
Limited, from their owners in exchange for the issuance of 508,482 of our equity shares. Agri
was a direct selling agent of personal financial products including mutual funds, fixed
deposits, corporate bonds and post-office instruments. At the time of our acquisition, Agri
operated 32 branches in South and West India.
Serving more than 30,000 customers with a staff of, approximately 180 employees.
After the acquisition, we changed the company name to India Infoline.com Distribution
Company Limited.

Facilities:
Out main offices are located in approximately 4,000 square feet of office space
located in Mumbai, India. Our India Infoline Branches collectively occupy an additional
10,000 square feet of office space located throughout India, as on March 31, 2005 we have 73
brnaches across 36 locations in India.

Reason for Change:

Requirement of more floor space:
The instances when the name of the Company was changed are cited below:
Previous name New Name
Probity Research and Probity Research and
Services Private-Limited Services Limited
Probity Research and India Infoline.com Limited
Services Limited
India Infoline.com Limited India Infoline Limited
Date of Change Reason for change

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April 28, 2000 Conversion from Private Limited to
Public Limited Company
May 23, 2000 to focus on the retail financial intermediary business
through an online set-up

Milestones:
1995-
-Incorporated as an equity research and consulting firm with a client base that
included leading FIIs, banks, consulting firms and
Corporate.
1999-
-Restructured the business model to embrace the internet; launched
archives.indianfoline.com mobilized capital from reputed private equity investors.

2000-
-Commenced the distribution of personal financial products; launched online equity
trading; entered life insurance distribution as a corporate agent. Acknowledged by
Forbes as Best of the Web and must read for investors.
2004
-Acquired commodities broking license; launched Portfolio Management service.
2005
-Listed on the Indian stock markets
-India Infoline fixes a price band between Rs 70 and Rs 80 for its forthcoming public
issue. The company is coming out with public issue of 1.18 crore shares with a face
value of Rs 10 through the book building route. The issue is slated to open on April 21
and close on April 27. Enam Financial Consultants Private Ltd would be the sole book
running lead manager to the issue while Intimate Spectrum Registry Ltd is the
registrar to the issue.
-India Infoline public issue gets 6.6 times oversubscription.
-IIL appoints R Mohan as VP
-India Infoline Ltd has informed that the Company has entered into a advertising
agreement with Times Group where in the Company and other group companies

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 would spend about Rupees Thirty Crores over the next 5 years in print as well as non
print media of The Times Group.
-India Infoline to buy 75-pc stake in Money tree
2006
-India Infoline launches exclusive SMS Value Added Service
-India infoline enters into strategic agreement with Saraswat Bank
-India Infoline to launch stock trading on cell phones
-India Infoline to roll out MCX, NCDEX, DGCX software
-Acquired membership of DGCX; launched investment banking services

2007
-Launched a proprietary trading platform; inducted and institutional equites team;
formed a Singapore subsidiary; raised over USD 300mn in the group; launched
consumer finance business under the Money line brand.
2008
-Launched wealth management services under the IIFL Wealth brand; set up Indian
Infoline Private Equity fund; received the Insurance broking license from IRDA;
received the venture capital license; received in principle approval to sponsor a
mutual fund; received Best broker-India award from Finance Asia; Most Improved
Brokerage-India award from Asia money.
-India Infoline Ltd has informed that the Board of Directors of the Company have
vide circular resolution passed on March 10, 2008 approved the appointment of Mr.
A.K. Purwar, ex-Chairman of the State Bank of India, as an independent director on
the Board of the Company.
-India Infoline Ltd has informed that pursuant to the resignation of Mr. Nimish
Mehata, Company Secretary and Compliance Officer of the Company. Ms. Falguni
Sanghvi has been appointed as the Company Secretary with effect from October 07,
2008
-The Company has splits its face value from Rs 10/- to Rs 2/-
2009
-Received registration for a housing finance company from the National Housing
Bank; received Fastest growing Equity Broking house.

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16.HIGHEST INVESTOR POPULATION IN DERIVATIVES:

State Total No. Investors % of Investors in India

Maharashtra 9.11 Lakhs 28.50

Gujarat 5.36 Lakhs 16.75

Delhi 3.25 Lakhs 10.10

Chennai 2.30 Lakhs 7.205

West Bengal 2.14 Lakhs 6.75

Andhra Pradesh 1.94 Lakhs 6.05

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17.LOT SIZES OF SELECTED COMPANIES FOR ANALYSIS:

CODE LOT SIZE COMPANY NAME

ACC 750 Associates Cement Companies

Ltd
ARVIND MILLS 2150 Arvind Mills Ltd.
BHEL 300 Bharat Heavy Electrical Ltd.

The following tables explain about the table that took place in futures and options

between 25/02/2010 to 29/02/2010. The table has various columns, which explains various

factors involved in derivative trading.

Date - The day on which the trading took place

Closing premium - Premium for that day.

Open interest - No.of options that did not get exercised

Traded Quantity - No.of futures and options traded on that day.

N.O.C - No.of contracts traded on that day.

Closing price - The price of the futures at the end of the trading day

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18. CALCULATION OF RATE OF RETURN:

ANALYSIS AND INTERPRETATION:

FUTURES:

Futures are legally binding agreement to buy or sell an asset at a certain time in the

future at a certain price.

FORMULA:

Fo = So (1 + r-d) T

So = closing price of a market on that day.

r = Rate of return

d = Dividend

T = Time period

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 FUTURES OF ACC CEMENTS:

Table I

High Low Close Open Int Trd Qty N.O.C

Date FO
Rs. Rs. Rs ('000) ('000) .
23.05.1
818.34 768.00 810.65 7146 986 2781 88582.21
1
24.05.1
812.45 712.60 755.95 7322 1012 3482 89881.32
1
25.05.1
698.30 589.80 591.40 1800 1943 2591 89858.54
1
26.05.1
691.00 598.50 616.85 8168 891 2270 90154.82
1
27.05.1
827.00 790.50 806.20 1785 1465 1953 90132.04
1
The above table has been given in the following graph.

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Source

FUTURES PRICE OF ACC

90500
23.05.11
90000
89500 24.05.11
89000 25.05.11
88500 26.05.11
88000
87500
FO

The data has been collected BUSINESS STANDARED (Paper) and Online Trading of

INDIA INFOLIONE LTD

INTERPRETATION:

It is observed from the above mentioned table that the future price (FO) has increased

tremendously due to increase in closing price, decrease in open interest and reduction in

value and volume of futures.

FUTURES OF ARVIND MILLS:

Table 2

Date High Rs. Low Rs. Close Rs Open Trd Qty N.O.C. FO
Int ('000)

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 ('000)

23.05.11 100.40 97.40 98.00 13360 5334 2481 1515.3

24.05.11 95.10 92.25 94.90 10636 3053 1420 1467.4
25.05.11 96.65 94.85 96.25 9129 4444 2067 1488.3
26.05.11 96.70 95.10 95.95 5609 3990 1856 1483.6
27.05.11 96.70 94.50 95.45 3038 5771 2684 1475.9
The above table has been given in the following graph.

Picture 2

FUTURES PRICE OF ARVIND MILLS

1520 23.05.11
24.05.11
1500
25.05.11
1480 26.05.11
1460 27.05.11

1440
FO

Source:

The data has been collected BUSINESS STANDARDS (paper) and Online Trading of

INDIA INFOLINE LTD.

INTERPRETATION:

The above graph shows that the future price (FO) has been decrease due to decrease

in closing price and decrease in open interest and it is observed that increase in volume and

value.

FUTURES OF BHEL:

Table 3

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 Open
Trd Qty
Date High Rs. Low Rs. Close Rs Int N.O.C. FO
('000)
('000)
23.05.11 2010.00 1978.00 2006.40 2192 988 3293 218768
24.05.11 2057.00 1995.00 2024.75 1586 1405 4682 212665
25.05.11 2260.00 2038.00 2221.60 1257 1508 5025 218096
26.05.11 2335.00 2210.00 2223.10 871 934 6147 222906
27.05.11 2405.00 2300.00 2350.00 462 1400 4667 219881
The above table has been given in the following graph.

Picture 3

FUTURES PRICE OF BHEL

225000 23.05.11
24.05.11
220000
25.05.11
215000 26.05.11
210000 27.05.11

205000
FO

Source:

The data has been collected BUSINESS STANDARDS (paper) and Online Trading of

INDIA INFOLINE LTD.

INTERPRETATION:

From the above mentioned table it is observed that the future price (FO) has shown

fluctuation due to fluctuation in closing price and volume, value is increase and it is observed

that open interest is decrease.

19. OPTIONS DERIVATIVES:

Options are two types. They are CALL OPTION and PUT OPTION:

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 CALL OPTION:

A Call option is bought by an investor when he seems that the stock price moves

upwards. A call option gives the holder of the option the right but not the obligation to buy an

asset by an certain date for a certain price.

PUT OPTION:

A put option is bought by an investor when he seems that the stock price moves

downwards. A put option gives the holder of the option the right but not the obligation to sell

asset by an certain date for a certain price.

20. SUMMARY:

Project deals with five chapters

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Chapter I- deals with introduction, need, objectives, methodology and limitations of the
project.

The emergence of the market for derivative products, most notably forwards, futures
and options, can be traced back to the willingness of risk averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices.

Chapter II- deals with the company profile and industry profile.

We were originally incorporated on October 18, 1995 as Probilty Research and

Services private limited at Mumbai under the Companies Act, 1956 with Registration No. 11
93797. We commenced our operations as an independent provider of information, analysis
and research covering Indian business, financial markets and economy, to institutional
Customers. We became a public limited company on April 28, 2000 and the name of the
Company was changed to Probity Research and Services Limited. The name of the company
was changed to India infoline.com Limited on May 23, 2000 and later to India Infoline
Limited on March23, 2001.
The Indian broking industry is one of the oldest trading industries that have been
around even before the establishment of the BSE in 1875. Despite passing through number of
changes in the post liberalization period, the industry has found its way onwards sustainable
growth.

Chapter III deals with the review of literature for derivative (future & options)

Derivative is a product whose value is derived from the value of an underlying asset
in a contractual manner. The underlying asset can be Equity, Forex, Commodity or any other
asset.

Futures:

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 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 pri9ce. Futures contracts are special types of forward

contracts 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 the underlying asset, at a given price on or before a

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

of the underlying asset at a given price on or before a given dateChapter VI- deals with the data

analysis and interpretation.

Chapter V- deals with the summary, findings, suggestions and conclusion.

21 FINDINGS:

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 The above analysis of futures and options of ACC, ARVINDMILLS AND BHEL had

shown a positive market in the week.

The major factors that influence the futures and options market are the cash market,

foreign institutional investor involvement, News related to the underlying asset, national

and international markets, Researchers view etc.

In cash market the profit / loss is limited but where in future and option an investor can

enjoy unlimited profit / loss.

It is recommended that SEBI should take measures in improving awareness about the

future and option market as it is launched vary recently.

At present scenario the derivatives market is increased to a great position. Its daily

turnover reaches to the equal stage of cash market. The average daily turnover of the NSE

in derivative is four lacks volume.

The derivatives are mainly used for hedging purpose.
In cash market the investor has to pay the total money, but in derivatives has to pay the

premiums or margins, which are some percentage of the total money.

Application of future, forward and option.
Different tools of Hedging, Speculation and Arbitrage.

22. SUGGESTIONS:
In a bearish market it is suggested to an investor to opt for put option in order to

minimize profits.
In a bullish market it is suggested to an investor to apt for call option in order to

maximize profits.

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 It is suggested to an investor to keep in mind the time or expiry duration of futures and

options contract before trading. The lengthy time, the risk is low and profit making. The

fewer time may be high risk and chances of loss making.

At present futures and options are traded on NSE. It is recommended to SEBI to take

actions in trading of futures and options in other regional exchanges.

SEBI has to take further steps in the risk management mechanism.
Contract sixe should be minimized because small investors cannot afford this much of

huge premiums.
SEBI should conduct seminars regarding the use of derivatives to educate individual

investors.

23.CONCLUSION:

Derivatives are mostly used for hedging purpose. In derivative segment the profit/loss

of the option writer is purely depend on the fluctuations of the underlying asset.

During the study of the option and future trading in India we found that the trading of

the option and future (stock and index) rapidly growing till 2008 and then decline for the one

year and then increase. The decline year was basically the 2008-09 because of the slow down

53 | P a g e
in this year and then increase by the speed. This trend is basically very popular in India

during these year so many persons trading by option and future in Indian market.

24. BIBLIOGRAPHY:

WEBSITES

1. WWW.derivativesindia.com
2. WWW.kotiksecurities.com
3. WWW.nseindian.com
4. WWW.bseindia.com
5. www.eurojournals.com
6. www.investopedia.com
7. www.Wikipedia.com

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8. www.unitedfutures.com
9. www.scribd.com

Books:

FINANCIAL MANAGEMENT Prasanna Chandra

DERIVATES CORE MODULE NCFM MATERIAL
SAPM - Prasanna Chandra

JOURNALS:

FINANCIAL EXPRESS

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