A Study on Financial Derivative and Risk Management

CHAPTER 1 INTRODUCTION

INTRODUCTION: The liberalization of the Indian economy has ushered in an era of opportunities for the Indian corporate sector. however, these opportunities are accomplished by challenges. The corporate are now required to operate at global capacities to be able to reap the benefits of economies of scale and be competitive. To operate at global capacities, huge investments are called for and the main source of fund in the public at large. Therefore, the corporate now started tapping the capital market in a big way. The response is also encouraging.

As the Indian nation integrates with world economy era, small tremors in the world market starts affecting the Indian economy. As an example, interest rates have been south bound in the world and the same has happened in the Indian market too. fixed income rates have fallen drastically due to fall in the real income of people. To overcome this fall , investors have been continuously seek to increase the yield of their of their investments. But, it is a time-tested fact that, the yields on investment in equity shares are maximum, the accompanying risks are also maximum. Therefore, it is absolutely essential that efforts should be made to reduce this factor. The reduction of risk can be achieved through the process of hedging using derivatives financial instrument. A hedge is any act that reduced the price risk of an existing or anticipated position in the cash market. Basically, there are two type of hedging with futures :long hedge and short hedge. Financial derivatives are a kind of risk management instrument. A derivative's value depends on the price changes in some more fundamental underlying assets. Many forms of financial derivatives instruments exist in the financial markets. Among them, the three most fundamental financial derivatives instruments are: forward contracts, futures, and options. If the underlying assets are stocks, bonds, foreign exchange rates and commodities etc., then the corresponding risk management instruments are: stock futures (options), bond futures (options), currency futures (options) and commodity futures (options) etc. In risk management of the underlying assets using financial derivatives, the basic strategy is hedging, i.e., the trader holds two positions of equal amounts but opposite directions, one in the underlying markets, and the other in the derivatives markets, simultaneously. This risk management strategy is based on the following reasoning: it is believed that under normal circumstances, prices of underlying assets and their derivatives change roughly in the same direction with basically the same magnitude;

hence losses in the underlying assets (derivatives) markets can be offset by gains in the derivatives (underlying assets) markets; therefore losses can be prevented or reduced by combining the risks due to the price changes. The subject of this book is pricing of financial derivatives and risk management by hedging. Over the years the Indian leather has undergone drastic change from being a mere exporter of raw materials in the early 60s and 70s to an exporter of finished, value-added leather products. The main reason behind this good transformation is the several policy initiatives takn by the government of India. India proactive government initiatives have yielded quick and improved results. Today the Indian leather industry has attained a prominent place in the Indian export and has made the industry one of the top 7 industries that earns foreign exchange for the country. Since 1991 as India adopted the globalization and liberalized economic policies, the leather industry has flourished consistently in several ways and has contributed heavily to the Indian exchequer. Investing in Indian Leather Industry is advantageous because the industry is poised to grow further and achieve a major share in the global trading market. The post liberalization era has opened up a great plethora of opportunities for the Indian Leather Industry. As the global players looking for new sourcing options while in addition to China, India stands to gain a bigger share of the global market. Leading brands from the US and Europe have plans to source leather and leather products from India. Indian Leather Industry currently is one among the top 8 industries for export revenue generation in India, holding 10% of the global raw material, and 2% of the global trade. India has become biggest livestock producer in the world, with the capacity of 1.8 billion square feet of leather production annually. Global Footwear of 13% production comprising of 16 billion pairs are made in India. India today produces 2065 million pairs of various categories of footwear. It exports 115 million pairs, thus having 95% of its production to meet its own domestic demand.

Indian leather industry has the credit of being one of the oldest manufacturing industries catering to the global market from the 19th century. The age of the industry has linked it with social and organizational structure, and emerges as a complex one with elements of continuity and traditional structures. The ultimate quality of the Indian leather combined with efficient craftsmanship has secured a sturdy place for Indian leather goods in the global market. Indian leather industry is getting more organized, with a springing capacity for expansion.

Indian Leather Industry has developed to a large extent and is the second largest producer next to China. The industry is equipped mostly with a potential for employment generation, growth and exports, with the annual exports touching 2 billion USD. The industry experienced a positive metamorphosis from being a transporter of raw materials to an established exporter of value added and finished leather products. Currently it is on an ever increasing phase with optimum utilization of available raw materials and maximum returns from exports. India has less than 3% share in the global trade in leather compared to China's 20%. Government of India realizing the growth potential of the leather industry has been making significant efforts to promote rapid advancement of the industry. On June 30, 2005, the Cabinet Committee on Economic Affairs (CCEA) decided to implement an Rs 2.9 billion scheme for the integrated development of the Indian Leather Industry. Under the scheme, existing tanneries will be modernized and new units will be set up for footwear, components and leather products. This scheme is expected to result in gains in terms of productivity, right-sizing of capacity, costcutting, and design-development. The leather and leather products industry is one of the oldest manufacturing industries in India. The Indian leather industry provides employment to about 2.5 million people in the country and has an annual turnover of approximately US$ 5,000,000. Indian leather Industry occupies a prominent place in the Indian economy in view of its massive potential for employment, growth and exports. There has been an increasing emphasis on its

planned development, aimed at optimum utilisation of available raw materials for maximising the returns, particularly from exports. The exports of leather and leather products gained momentum during the past two decades. There has been a phenomenal growth in exports from Rs.320 million in the year 1965-66 to Rs.69558 million in 1996-97. Today Indian Leather Industry has attained well merited recognition in international markets besides occupying a prominent place among the top seven foreign exchange earners of the country. Market capitalization Among all the industries the footwear industry in particular holds greater potential for investments in India. Today India produces approx 700 million pairs of leather footwear every year and accounts for an 18% share of the total Indian leather export. YEAR 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 Export from Small Sector 25 29 36 39 44 49

Size of the industry Indian Leather industry Today has capacity to produce l776 million pairs; 112 million pairs of Shoe Uppers; Non-leather footwear - 960 million pairs of non-leather footwear's which includes shoes made of rubber, moulded PVC and other material. Total contribution to the economy/ sales In 2009-10 with an annual turnover of over US$ 7 billion, the export of leather and leather products increased manifold over the past decades and touched US$ 3.40, with recording a cumulative annual growth rate of about 5.43% (5 years). Though India is the second largest producer of footwear and leather garments in the world, India accounts for a share of close to 3% in the global leather import trade of US$ 137 billion (2008). Leather Production centers for leather products are located in Tamil Nadu - Chennai, Ambur, Ranipet, Vaniyambadi, Trichy, Dindigul ; West Bengal - Kolkata ; Uttar Pradesh - Kanpur, Agra & Noida ; Maharashtra - Mumbai ; Punjab - Jallandhar ; Karnataka - Bangalore ; Andhra Pradesh - Hyderabad ; Haryana - Ambala, Gurgaon, Panchkula and Karnal; Delhi

Country Germany UK Italy USA France Spain Netherlands Portugal UAE Denmark Australia Sweden Canada S. Africa Japan Others Total

2008-09 (value in million US$) 229.48 247.05 221.05 163.03 118.9 91.86 76.2 28.21 39.4 14.78 13.34 12.64 8.96 8.49 8.23 252.04 1533.06

2008-09 (value in million US$)

Germany UK Italy USA France Spain Netherlands Portugal UAE Denmark Australia Sweden Canada S. Africa Japan

Latest developments:

The Indian federal government has earmarked a Rs 4.5 billion grant to be made available to the industry to boost the country's leather industry over a span of five years, the fund availability is conditional upon the sector's attracting an annual investment of Rs 2.2 trillion.

In 2002, the investments in the Indian Leather Industry stood at Rs 410 million. Footwear and their components account for about 25 %of India's total leather products exports. These two markets also offer Indian leather industry vast scope for exports of saddler and harness.

India is the world's second largest producer of footwear; its production estimated over 700 million pairs per annum. At about US $ 300 million per year, footwear accounts for 18 percent share of total exports of leather exports.

Products exported from India include dresses, shoes, casuals, moccasins, sports shoes, horacchis, sandals, ballerinas, and booties. Major production centres are at Chennai (Madras), Delhi, Agra, Kanpur, Mumbai (Bombay), Calcutta and Jalandhar.

The government of India for it 200-2009 Foreign Trade Policy has identified the leather sector as a focus sector in view of its immense potential for export growth and generation of employment generation prospects.

India is one of the best destinations in the world for investing in the leather industry because India is endowed with abundant raw materials required for the industry to grow. India has a huge population of cattle. India accounts for 21% of the world's cattle and buffalo and 11% of the world's goat and sheep population.

The Government is also making efforts to implement various Special Focus Initiatives under the Foreign Trade Policy for the growth of leather sector. Leather industry is aimed to augment the production, thereby to enhance export upto US$ 7.03 billion by 2013-14 which shall create additional employment opportunities for overall one million people.

Indian Industries Aluminium industry, Copper industry, Fashion Classified under RED category industry, Cement industry, Dairy industry, Fertilizer industry, Construction industry, Diamond industry, Film

industry, Granite industry, Health care industry, Jewellery industry, Mining industry, Oil industry, Paint industry, Paper industry, Power industry, Printing industry, Rubber

industry, Silk industry,Soap industry, Steel industry, Sugar industry, Textile industry, Tabacco industry, Zinc industry Classified under ORANGE category Automobile industry, Cotton industry, Hotel industry, Jute industry, Pharmaceutical industry, Tractor industry, Weaving industry

Advertising

industry, Agricultural

industry, Aviation

industry, Banking industry,Biotechnology industry, Biscuit industry, Chocolate industry, Cottage Classified under GREEN category Processing industry, Coir industry, Electronic industry, Furniture industry, IT industry, Mutual industry, Poultry estate industry, Shipping fund industry, Cosmetic industry, Food industry, Garment industry, Leather industry, Pearl industry, Railway industry, Solar

industry, Insurance industry, Music industry, Plastic industry, Real industry

Leather Industry classified under GREEN category:

Indian Leather Industry has developed to a large extent and is the second Leather Industry largest producer next to China. The industry is equipped mostly with a potential for employment generation, growth and exports, with the annual exports touching 2 billion USD. INDIAN LEATHER INDUSTRY AT A GLANCE IN 2012 2013: The leather and leather products exports touched $4.5 billion in the fiscal year 2011-12, posting growth of more than 27% as compared to last year, according to the Council for Leather Exports in India. Although, it missed the targeted $4.7 billion, the export growth has been attained in the face of slowdown during the global economy and the sliding value of the Rupee which has made the imports of raw material expensive. Last year, the exports stood at $3.5 billion. The centre has set a target of $14 billion during 201617 for the leather industry. Leather footwear accounts for almost 40% of the exports followed up with the garments that account for almost 10%. The industry has moved to the products exports from being an exporter of finished leather, which now makes up only for a small portion.

IMPORTANCE OF THE STUDY:

It helps the researcher to construct a diversified portfolio.

Provide an insight on return and risk analysis.

It helps to make a general study on derivatives.

It helps to identify and reduce by using hedging strategies and speculation

OBJECTIVE OF THE STUDY:

To find out extant to which loss can be reduced by applying hedging strategies.

To determine whether the hedger enjoys better returns from the use of hedgers.

To identify how much reduction in risk is possible.

To find out the extend of loss due to misjudgment on index movements .

SCOPE OF THE STUDY: Introduction of derivatives in the Indian capital market is the beginning of a new era , which is truly exciting. Derivatives, worldwide are recognized risk management products. These products have a long history in India, in the unorganized sector , especially in currency and commodity markets. The availability of these products on organized exchanges ha provided the market participants with broad based risk management tools.

This study mainly covers the area of hedging and speculation. The main aim of the study is to prove how risks in investing in equity shares can be reduced and how to make maximum return to the other investment.

LIMITATION OF THE STUDY:

A) While applying the strategies , transaction cost and impact cost are not taken into consideration.so,it will reflect in the profit calculation on each month of the study. B) data were collected only on the basis of NSE trading

C) Hedging strategy is applied on historical data. so the direction of each trend in the stock market is known before hand for the period selected. As a result, some bias could have been done for the application of hedging strategy.

RESEARCH METHODOLOGY: Research methodology is a way of systematically solving the research problem, research methodology deals with the research design used and methods used to present the study

Research Design: A research design is a detailed blue print used to guide a research study towards its objective. The process of designing a research study involves many interrelated decisions. The most significant decision is the choice of research approach, because it determines how the information will be obtained. The choice of the research approach depends on the nature of the research that one wants to do. The research design adopted for this study is descriptive research.

Sampling Techniques:

Identifying target persons Determining sample frame Selecting sampling procedure Determine sample size Execute sampling Obtaining information from respondents Generating information for decision making

Tools for data collection: There are several ways of collecting the appropriate data.while deciding about the method of data collection to be used for the study, the researcher should keep in mind, that there are 2 types of data

1. 2.

Primary Data Secondary Data

CHAPTERIZATION

Title

: A Study on Financial Derivative and Risk Management

Chapter 1

: First Chapter Deals with introduction of study, scope of the study, objectives of the study and limitations of the study

Chapter 2 Chapter 3 Chapter 4 Chapter 5

: Second Chapter deals with company profile and history of the company : This chapter deals with review of literature related study : Fourth chapter deals with Data Analysis and Interpretation : Fifth chapter deals with summary of findings, suggestions and Conclusions

CHAPTER 2 COMPANY PROFILE

COMPANY PROFILE:

NSIC CARE Rating is assigned under the scheme for Rating of Micro & Small Enterprises (MSEs), designed and subsidised by the National Small Industries Corporation (NSIC). A copy of the rating report is also submitted to NSIC. The rating is a one-time exercise and it will not be kept under surveillance. The validity of the rating is one year from the date of report, subject to no significant changes / events occur during this period that can materially impact the operational and financial parameters of the entity.

The rating and the report is based on the information and explanations provided to CARE and /or obtained by CARE from reliable sources. CARE does not guarantee the accuracy, completeness or adequacy of any information on which this rating and report is based. CARE is not responsible for any error / omissions for the results/opinions obtained for the use of this report. The rating is not an audit and also not any recommendation to enter into or not enter into any transaction with the entity. CARE reserves the right to disclose the rating along with the rating report to Government, Regulatory Agencies, Courts of Law, etc., if required.CARE, its directors, Rating Committee members, employees and other associated with the rating assignment do not have any financial liability whatsoever. Any reproduction of the report or part of it would require explicit written approval of CARE. Strengths: Experience of the partners in the same line of business Partners established relationship with reputed clients Modest capital structure

Risk Factors Proprietorship firm with inherent risk of capital withdrawal and limited access to external funding Long operating cycle Stagnant revenues for the past four year period ended March 2013 Client Concentration risk Thin profitability further susceptible to volatile raw material prices and foreign currency fluctuation Risk. Name Year of Establishment Constitution Registration Number Registration Date New Tech Shoe Components 2008 Partnership Firm 330031200886 28 Aug 2013

Nature of Business Type of the Unit Enterprise Category Industry Products Controlling/Registered Office: No. 14, Bajanai Koil Street, Vallancherry Village, Guduvancherry, Dist.: Kanchipuram, Chennai, Tamil Nadu-603202 Location of Plant / Servicing: No. 14, Bajanai Koil Street, Vallancherry Village, Guduvancherry, Profile:

Manufacturing Small 2 General Footwear Insole and Toe puffs for footwear industry

New Tech Shoe Components (NTSC) is a Chennai based partnership firm engaged in the business of manufacturing in-soles, toe puffs and other shoe components for footwear industry. NTSC was established in April 2008 by Mr. A Mahendran, as a partnership firm, the other partner, being his wife Mrs. M. Lakshmi. Mr. Mahendran is the managing partner of the firm. The firm procures leather sheets & paper boards from countries such as Italy, Germany and China, processes the same and manufactures in-soles of various design and other specifications. The same is supplied to footwear manufacturers. The shoes in turn produced by shoe

manufacturers are sold primarily in the export market. However, NTSCs sales are predominantly in the domestic market itself. The firm has an installed capacity to manufacture 5000 pairs of insoles per day and its manufacturing facilities are situated in Chennai, Tamil Nadu. The day-today operations of the firm are managed by Mr. A. Mahendran. ORGANISTION & MANAGEMENT: PROFILE OF THE PROMOTERS: Name Position Qualification Age Work Experience Mr. A Mahendran Partner Under Graduate 46 years 27 years Ms. M. Lakshmi Partner Under Graduate 43 years 7 years

Responsibilities Handled Overall management Mr. A. Mahendran, the managing partner of the firm has more than two decades of experience in the footwear industry. He was earlier employed in a shoe manufacturing company before the establishment of NSTC in 2008. The partners long experience in the footwear industry has helped the firm to forger good relationship with leading chennai based footwear manufacturers. ORGANISATION &MANAGEMENT:MANAGEMENT & OWNERSHIP STRUCTURE:

Promoters stake: Promoters & Relatives (P & R) A Mahendran M. Lakshmi Total Employee Profile : Type of employees Skilled Employees Semi-Skilled Employees Total Nos. 25 8 33 Share in Business 50 50 100 %

Comment: The level of professionalization seems to be Moderate. The key decisions are family centric. BUSINESS PROFILE: OPERATIONS OVERVIEW:

OPERATIONS OVERVIEW Nature of Activity Industry Segment In-sole for Shoes No. 14, Bajanai Koil Street, Vallancherry Village, Guduvancherry, District: Kanchipuram, Chennai, Tamil Nadu-603202 Products Plant Location Manufacturing 6,500 Sq. Feet Owned No

PRODUCT & CAPACITIES: Class of Goods Units Installed Capacity Actual Production Shoe Components Pair 15,00,000 7,80,000

BUSINESS ACTIVITY DETAILS: Electricity Consumption Key Raw Materials Level of Raw Material Price Fluctuation Risk MSME Status Quality Certifications Level of Value Addition CUSTOMER & SUPPLIER ANALYSIS: CUSTOMER PROFILE: Name of the Customer Good Leather Shoes Private Limited Approx. 6500 units/month Imported leather sheets and paper boards Moderate Small - 2 No Moderate

Country Contribution to Sales

India 60.00

NTSC has been associated with it since inception for the supply of insoles. However, the partner has been associated with it for more than a decade through his earlier employment. Name of the Customer Country Contribution to Sales Tata International Limited India 30.00%

NTSC has been associated with it since inception for the supply of insoles. Name of the Customer Country Contribution to Sales Sara Leathers Private Limited India 10.00%

NTSC has been associated with it since 2010 for the supply of insoles. CONTRIBUTION BY TOP THREE CUSTOMERS (100% of total operating income in FY13): Overall Customer Profile Export Proportion Foreign Exchange Fluctuation Risk exports) The firms revenues are concentrated with these top three clients who contributed 100% of its total operating income in FY13 (100% in FY12). The shoe manufacturers avail a credit period of about 60 to 90 days from NTSC. Known & Less diversified Nil High (Due to significant proportion of imports and nil

INDUSTRY ANALYSIS: Name of the Industry Product Portfolio Overall Industry Risk INDUSTRY WRITE-UP: The Leather industry holds a prominent place in the Indian economy. This sector is known for its consistency in high export earnings and it is among the top ten foreign exchange earners for the country. With an annual turnover of over US$ 7.5 billion, the export of leather and leather products increased manifold over the past decades and touched US$ 4.86 billion in 2012, recording a cumulative annual growth rate of about 8.22% (5 years). The leather industry is bestowed with an affluence of raw materials as India is endowed with 21% of world cattle & buffalo and 11% of world goat & sheep population. Added to this are the strengths of skilled manpower, innovative technology, increasing industry compliance to international environmental standards, and the dedicated support of the allied industries. The major markets for Indian leather & leather Products are Germany with a share of 15.01%, UK 11.15%, Italy 10.85%, USA 9.02%, Hong Kong 7.38%, France 6.25%, Spain 6.08%,Netherlands 4.07%, Belgium 2.32%, China 2.54%, U.A.E.2.24%, Australia 1.39%, These 12 countries together accounts for nearly 78.30% of Indias total leather& leather products export. The Government of India had identified the Leather Sector as a focus sector in its Foreign Trade Policy in view of its immense potential for export growth prospects and employment generation. Accordingly, the Government is also implementing various special focus initiatives under the Foreign Trade Policy for the growth of leather sector. With the implementation of various industrial developmental programs as well as Footwear Manufacture of leather insoles for Footwear industry Moderate

export promotional activities, the Indian leather industry aims to augment the production, thereby enhance export, and resultantly create additional employment opportunities for over one million people. The industry is essentially dominated by small scale firms with a few medium and large sized firms. The industry is concentrated in several leather clusters in 4-5 distinct locations in the country. Though government policies towards the industry have been supportive both for smallscale sector development as well export promotion, the industry is caught up with socio political issues relating to slaughtering of animals. SITE VISIT REPORT: Location of Plant No. 14, Bajanai Koil Street, Vallancherry Guduvancherry, District: Chennai, Tamil Nadu-603202 Information of Operational Facilities: Sites visited No. 14, Bajanai Koil Street, Vallancherry Village, Guduvancherry, District: chennai, Tamil Nadu-603202 Presence in a cluster Area of the unit No. of employees at site Ownership of premises Electricity consumption (units) No 6500 Sq. Feet 33 Owned Approx. 6,500 units/month

Other facilities Adequacy of Facilities:

Yes

Availability of land for future expansion Site layout Adequacy of insurance coverage Source of power Adequacy of power Source of water

Yes Structured Fully Covered Tamil Nadu State Electricity Board Adequate Chennai Metropolitan Water Supply and Sewerage Board

Type of fuel used Presence of labour union Industrial relations Level of work safety Adequacy of storage facilities Operational status of plants

Not Applicable No Good Adequate Adequate Operational

FINANCIAL PERFORMANCE - PROFITABILITY STATEMENT:

The total operating income has remained in the range of Rs. 105 lakhs in the past four year period FY10-13. In FY12, the total operating income declined by nearly 12% primarily on account of higher job work carried out by the firm wherein the customer provided the raw material (leather sheets & paper boards) and the company processed the same, to manufacture insoles for footwear. However, in FY13, the total operating income registered a growth of 13.41% primarily on account of increased volumes from the existing customers.

FINANCIAL PERFORMANCE - COST STRUCTURE:

MC = Material Costs; EC = Employee Costs; Dep = Depreciation; P&F = Power and Fuel; I&F =Interest and Finance Charges; OC = Other Cost Material Costs constituted the highest pie in the cost structure for FY13. For the previous year also, itwas the major cost contributor to the total costs. While employee costs increased from Rs. 32.63 lakh toRs.37.65 lakh in FY13, the power & fuel costs increased from Rs. 0.79 lakh to Rs.0.90 lakh. Fixedcapital charges (depreciation and finance costs) covered 5.14 portion of total costs for FY13.

FINANCIAL PERFORMANCE - BALANCE SHEET:ASSETS:

FINANCIAL PERFORMANCE - PROFITABILITY & RETURNS:

Although, the PBILDT margin has continuously increased in the past four years from 3.40% in FY10 to 5.47% in FY13, it continues to remain thin on account of fragmented nature of industry with intense competition, putting pressure on margins. The PAT margins continue to remain thin at 0.56% in FY13 in line with low PBILDT margins. Furthermore, the thin profit margins are also exposed to price volatility associated with the imported raw materials. The firm procures its key raw materials from Italy, Germany and China based on usance letter of credit.

The company does not hedge its foreign currency exposure and has to absorb adverse fluctuations in exchange rates that might occur from the time of material procurement to the time of settlement of usance letter of credit. The promoter has indicated that the firm is renegotiating the prices with its customers to pass on the increase in input prices on account of rupee depreciation. However, the firms thin profitability is exposed to foreign currency fluctuation risk, which is likely to impact the already thin margins adversely. FINANCIAL PERFORMANCE - LIQUIDITY ANALYSIS:

Liquidity Ratio: Particulars Working Capital Turnover Ratio Average Raw Material Inventory Period Average Inventory Period (days) Average Collection Period (days) Average Creditors Period (days) Working Capital Cycle (days) 31 Mar 2012 2.73 73 41 85 59 67 31 Mar 2013 2.46 106 60 71 55 75

The average raw material inventory days remains high at 106 days as of March 31, 2013. This is primarily on account of firms procurement policy wherein it imports its key raw material namely leather sheets and paper boards to meet its six months production in order to achieve better pricing and economies of scale. However, the total inventory period is at 60 days as it is computed on cost of sales (which includes employee cost and other overheads) whereas the average raw material inventory period is computed on material cost. The firm provides to 3 months credit period to its customers whereas it imports based on usance letter of credit for a period of 90 days. The firm relies upon bank funding in the form of overdraft facility to meet its working capital requirement. The banker has indicated that the average overdraft utilization levels remained at nearly 90% for the past 12- month period ended July 2013. FINANCIAL PERFORMANCE - BALANCE SHEET: LIABILITIES: Period Ends on: Result Type: SUMARY: LIABILITIES Partners Capital TANGIBLE NET WORTH Other Long Term Loans TOTAL LONG TERM DEBT Working capital Bank Borrowings Loans & Advances from partners and family Other Short Term Loans & Advances TOTAL SHORT TERM DEBT Creditors for goods Other Current Liabilities: related to ops. TOTAL OTHER LIABILITIES 25.13 25.13 2.51 2.51 15.00 5.00 20 10.89 3.18 14.08 29.81 29.81 1.71 1.71 25.31 7.00 5.00 37.31 18.17 0.78 18.95 31.15 31.15 0.80 0.80 29.39 29.39 12.72 0.76 13.48 31 Mar 2011 Actual 31 Mar 2012 31 Mar 2013 Actual Actual

Total Current Liabilities and Provisions ; related to operations TOTAL OUTSIDE LIABILITIES TOTAL LIABILITIES

14.08

18.95

13.48

22.51 61.71

39.02 87.78

30.20 74.84

FINANCIAL PERFORMANCE - FINANCIAL FLEXIBILITY:

Capital Structure Ratio: Particulars Debt Equity Ratio Overall Gearing Ratio Average Cost of Borrowings Total Outside Liabilities to Networth 31 Mar 2012 0.06 1.31 1.03 1.31 31 Mar 2013 0.03 0.97 5.79 0.97

The firm does not have any term debt borrowings except vehicle loan of Rs. 0.8 lakhs as of March 31, 2013 primarily on account of absence of debt funded asset additions in the past. The firm relies on overdraft facility from bank to fund its working capital requirements. The overall gearing remained moderate at 0.97 times as of March 31, 2013 (1.31 times as of March 31, 2012).

FINANCIAL PERFORMANCE - DEBT PROTECTION INDICATORS:

`The firms capital structure is marked by an overall gearing of 0.97 times and the Total debt to GCA of 7.50 times as on March 31, 2013. The interest coverage ratio remained moderate at 2.90 times in FY13.The Total debt/ GCA remained high primarily on account of thin profitability and low cash accruals.

COMMON SIZE STATEMENT - P & L ACCOUNT:

COMMON SIZE STATEMENT ASSETS:

DETAILS OF BANK FACILITIES:

Details of Bank Facilities: NTSC has been sanctioned overdraft facility of Rs.30 lakhs from Corporation Bank. The account is regular with Corporation Bank. The banker has expressed satisfaction over the conduct of the account. Disclaimer: CAREs MSE rating is an independent opinion on performance capability and financial strength. The rating is a one-time exercise and it will not be kept under surveillance. The validity of the rating is one year from the date of provisional communication of rating, subject to no significant changes / events occur during this period that can materially impact the operational and financial parameters of the entity. The rating is not an audit and also not a recommendation for entering into any transaction with the entity. CARE has based its ratings on information obtained from sources believed by it to be accurate and reliable. CARE does not, however, guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information.

CHAPTER 3 REVIEW OF LITERATURE

REVIEW OF LITERATURE:

FACTORS AFFECTING OPTION PREMIUM

THE PRICE OF THE UNDERLYING ASSET: (S) Changes in the underlying asset price can increase or decrease the premium of an option. These price changes have opposite effects on calls and puts. For instance, as the price of the underlying asset rises, the premium of a call will increase and the premium of a put will decrease. A decrease in the price of the underlying assets value will generally have the opposite effect THE SRIKE PRICE: (K) The strike price determines whether or not an option has any intrinsic value. An options premium generally increases as the option gets further in the money, and decreases as the option becomes more deeply out of the money. Time until expiration: (t) An expiration approaches, the level of an options time value, for puts and calls, decreases. Volatility: Volatility is simply a measure of risk (uncertainty), or variability of an options underlying. Higher volatility estimates reflect greater expected fluctuations (in either direction) in underlying price levels. This expectation generally results in higher option premiums for puts and calls alike, and is most noticeable with at- the- money options. Interest rate: (R1) This effect reflects the COST OF CARRY the interest that might be paid for margin, in case of an option seller or received from alternative investments in the case of an option buyer for the premium paid.Higher the interest rate, higher is the premium of the option as the cost of carry increases. It is a interesting tool for small retail investors. An option is a contract, which gives the buyer (holder) the right, but not the obligation, to buy or sell specified quantity of the underlying assets, at a specific (strike) price on or before a specified time (expiration date). The underlying may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like equity stocks/ stock index/ bonds etc.

MONTHLY OPTIONS : The exchange trade option with one month maturity and the contract usually expires on last Thursday of every month.

PROBLEMS WITH MONTHLY OPTIONS: Investors often face a problem when hedging using the three-monthly cycle options as the premium paid for hedging is very high. Also the trader has to pay more money to take a long or short position which results into illiquidity in the market. Thus to overcome the problem the BSE introduced WEEKLY OPTIONS. WEEKLY OPTIONS: The exchange trade option with one or weak maturity and the contract expires on last Friday of every week ADVANTAGES Weekly Options are advantageous to many to investors, hedgers and traders. The premium paid for buying options is also much lower as they have shorter time to maturity. The trader will also have to pay lesser money to take a long or short position. the trader can take a larger position in the market with limited loss. On account of low cost, the liquidity will improve, as more participants would come in. Weekly Options would lead to better price discovery and improvement in market depth, resulting in better price discovery and improvement in market efficiency TYPES OF OPTION: CALL OPTION A call option gives the holder (buyer/ one who is long call), the right to buy specified quantity of the underlying asset at the strike price on or before expiration date. The seller (one who is short call) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy. To acquire this right the buyer pays a premium to the writer (seller) of the contract.

Example:Suppose in this option there are two parties one is Mahesh (call buyer) who is bullish in the market and other is Rakesh (call seller) who is bearish in the market.

The current market price of RELIANCE COMPANY is Rs.600 and premium is Rs.25

1. CALL BUYER

Here the Mahesh has purchase the call option with a strike price of Rs.600.The option will be excerised once the price went above 600. The premium paid by the buyer is Rs.25.The buyer will earn profit once the share price crossed to Rs.625(strike price + premium). Suppose the stock has crossed Rs.660 the option will be exercised the buyer will purchase the RELIANCE scrip from the seller at Rs.600 and sell in the market at Rs.660.

Profit

30 20 10 0 590 600 610 620 630 640 -10 -20 -30 Loss

Unlimited profit for the buyer = Rs.35{(spot price strike price) premium} Limited loss for the buyer up to the premium paid.

2. CALL SELLER:

In another scenario, if at the tie of product price falls below Rs. 600 say suppose the stock price fall to Rs.550 the buyer will choose not to exercise the option.

Profit 30 20 10 0 590 -10 -20 -30 Loss 600 610 620 630 640

Profit for the Seller limited to the premium received = Rs.25

Loss unlimited for the seller if price touches above 600 say 630 then the loss of Rs.30

Finally the stock price goes to Rs.610 the buyer will not exercise the option because he has the lost the premium of Rs.25.So he will buy the share from the seller at Rs.610.

Thus from the above example it shows that option contracts are formed so to avoid the unlimited losses and have limited losses to the certain extent Thus call option indicates two positions as follows:

LONG POSITION If the investor expects price to rise i.e. bullish in the market he takes a long position by buying call option. SHORT POSITION If the investor expects price to fall i.e. bearish in the market he takes a short position by selling call option. FACTORS AFFECTING DELTA OPTION: Strike price Risk free interest rate Volatility Underlying price Time to maturity

Example:-

The investor has buys the call option in the future contract for the strike price of Rs.19. The premium charged for the strike price of 19 at 0.80 The delta for this option is 0.5.Here if the price of the option rises to 20.A rise of 1. then the premium will increase by 0.5 x 1.00 = 0.50. The new option premium will be 0.80 + 0.50 = Rs 1.30.

Here in the money call option will increase the delta by 1.which will make the value more and expensive while at the money option have the delta to 0.5 and finally out the money call option will have the delta very close to 0 as the change in underlying price is not likely to make them valuable or cheap and reverse for the put option Delta varies from 0 to 1 for call options and from 1 to 0 for put options. Some people refer to delta as 0 to 100 numbers. ADVANTAGE The delta is advantageous for the option buyer because it can tell him much of an option and accordingly buyer can expect his short term movements by the underlying stock. This can help the option of an buyer which call/put option should be bought.

A measure of change in the delta that may occur corresponding to the rise or fall in the price of the underlying asset.

Gamma = change in option delta

__________________

change in underlying price

The gamma of an option tells you how much the delta of an option would increase or decrease for a unit change in the price of the underlying. For example, assume the gamma of an option is 0.04 and its delta is 0.5. For a unit change in the price of the underlying, the delta of the option would change to 0.5 + 0.04 = 0.54. The new delta of the option at changed underlying price is 0.54; so the rate of change in the premium has increased. suppose the delta changed to 0.5-0.04 = 0.46 thus the rate of premium will decreased . In simple terms if delta is velocity, then gamma is acceleration. Delta tells you how much the premium would change; gamma changes delta and tells you how much the next premium change would be for a unit price change in the price of the underlying. Gamma is positive for long positions (long call and long put) and negative for short positions (short call and short put). Gamma does not matter much for options with long maturity. However for options with short maturity, gamma is high and the value of the options changes very fast with swings in the underlying prices THETA: A measure of change in the value of an option corresponding to its time to maturity. It is a measure of time decay (or time shrunk). Theta is generally used to gain an idea of how time decay is affecting your portfolio.

Change in an option premium Theta = -------------------------------------Change in time to expiry

Theta is usually negative for an option as with a decrease in time, the option value decreases. This is due to the fact that the uncertainty element in the price decreases.

Example:-

Suppose the theta of Infosys 30-day call option with a strike price of Rs3,900 is 4.5 when Infosys is quoting at Rs3,900, volatility is 50% and the risk-free interest rate is 8%. This means that if the price of Infosys and the other parameters like volatility remain the same and one day passes, the value of this option would reduce by Rs.4.5. ADVANTAGE: Theta is always positive for the seller of an option, as the value of the position of the seller increases as the value of the option goes down with time. DISADVANTAGE: Theta is always negative for the buyer of an option, as the value of the option goes down each day if his view is not realized. In simple words theta tells how much value the option would lose after one day, with all the other parameters remaining the same. VEGA The extent of extent of change that may occur in the option premium, given a change in the volatility of the underlying instrument.

Change in an option premium

Vega = ----------------------------------------Change in volatility

Example:Suppose the Vega of an option is 0.6 and its premium is Rs15 when volatility of the underlying is 35%. As the volatility increases to 36%, the premium of the option would change upward to Rs15.6. Vega is positive for a long position (long call and long put) and negative for a short position (short call and short put). ADVANTAGE Simply put, for the buyer it is advantageous if the volatility increases after he has bought the option.

DISADVANTAGE For the seller any increase in volatility is dangerous as the probability of his option getting in the money increases with any rise in volatility.In simple words Vega indicates how much the option premium would change for a unit change in annual volatility of the underlying.

TYPES OF MARGIN: INITIAL MARGIN: It is a amount that a trader must deposit before trading any futures. The initial margin approximately equals the maximum daily price fluctuation permitted for the contract being traded. Upon proper completion of all obligations associated with a traders futures position, the initial margin is returned to the trader. OBJECTIVE The basic aim of Initial margin is to cover the largest potential loss in one day. Both buyer and seller have to deposit margins. The initial margin is deposited before the opening of the position in the Futures transaction. MAINTENANCE MARGIN: It is the minimum margin required to hold a position. Normally the maintenance is lower than initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call to top up the margin account to the initial level before trading commencing on the next level. EXAMPLE:On MAY 15th two traders, one buyer and seller take a position on June NSE S and P CNX nifty futures at 1300 by depositing the initial margin of Rs.50,000with a maintenance margin of 12%. The lot size of nifty futures =200.suppose on MAY 16th . The price of futures settled at Rs.1950. As the buyer is bullish and the seller is bearish in the market. The profit for the buyer will be 10,000 [(1350-1300)*200]

Loss for the seller will be 10,000[(1300-1350)]

Net Balance of Buyer = 60,000(50,000 is the margin +10,000 profit for the buyer)

Net Balance of Seller = 40,000(50,000 is the margin -10,000 loss for the seller) Suppose on may 17th nifty futures settled at 1400.

Profit of buyer will be 10,000[(1450-1350)*200]

Loss of seller will be 10,000[(1350-1400)*200]

Net balance of Buyer =70,000(50, 000 is the margin +20,000 profit for the buyer)

Net Balance of Seller = 30,000(50,000 is the margin -20,000 loss for the seller)

As the sellers balance dropped below the maintenance margin i.e. 12% of 1400*200=33600 While the initial margin was 50,000.Thus the seller must deposit Rs.20,000 as a margin call. Now the nifty futures settled at Rs.1390.

Loss for Buyer will be 2,000 [(1390-1400)*200]

Profit for Seller will be 2,000 [(1390-1400)*200]

Net balance of Buyer =68,000(70,000 is the margin -2000 loss for the buyer) Net Balance of Seller = 52,000(50,000 is the margin +2000 profit for the seller)

Therefore in this way each account each account is credited or debited according to the settlement price on a daily basis. Deficiencies in margin requirements are called for the broker, through margin calls. Till now the concept of maintenance margin is not used in India.

ADDITIONAL MARGIN:

In case of sudden higher than expected volatility, additional margin may be called for by the exchange. This is generally imposed when the exchange fears that the markets have become too volatile and may result in some crisis, like payments crisis, etc. This is a preemptive move by exchange to prevent breakdown.

CROSS MARGINING: This is a method of calculating margin after taking into account combined positions in Futures, options, cash market etc. Hence, the total margin requirement reduces due to crossHedges. MARK-TO-MARKET MARGIN: It is a one day market which fluctuates on daily basis and on every scrip proper evaluation is done. E.g. Investor has purchase the Wipro FUTURES. and pays the Initial margin. Suddenly script of Wipro falls then the investor is required to pay the mark-to-market margin also called as variation margin for trading in the future contract.

CHAPTER 4

DATA ANALYSIS AND INTERPRRETATION

DATA ANALYSIS AND INTERPRRETATION: Derivatives is a financial product (shares, bonds) any act which is concerned with lending and borrowing (bank) does not have its value borrow the value from underlying asset/ basic variables. Derivatives is derived from the following products:

A. Shares

B. Debuntures

C. Mutual funds

D. Gold

E. Steel

F. Interest rate

G. Currencies.

Derivatives is a type of market where two parties are entered into a contract one is bullish and other is bearish in the market having opposite views regarding the market. There cannot be a derivatives having same views about the market. In short it is like a INSURANCE market where investors cover their risk for a particular position. Derivatives are financial contracts of pre-determined fixed duration, whose values are derived from the value of an underlying primary financial instrument, commodity or index, such as: interest rates, exchange rates, commodities, and equities. Derivatives are risk shifting instruments. Initially, they were used to reduce exposure to changes in foreign exchange rates, interest rates, or stock indexes or commonly known as risk hedging. Hedging is the most important aspect of derivatives and also its basic economic purpose. There has to be counter party to hedgers and they are speculators. Speculators dont look at derivatives as means of reducing risk but its a business for them. Rather he accepts risks

from the hedgers in pursuit of profits. Thus for a sound derivatives market, both hedgers and speculators are essential. Derivatives trading has been a new introduction to the Indian markets. It is, in a sense promotion and acceptance of market economy, that has really contributed towards the growing awareness of risk and hence the gradual introduction of derivatives to hedge such risks. Initially derivatives was launched in America called Chicago. Then in 1999, RBI introduced derivatives in the local currency Interest Rate markets, which have not really developed, but with the gradual acceptance of the ALM guidelines by banks, there should be an instrumental product in hedging their balance sheet liabilities.The first product which was launched by BSE and NSE in the derivatives market was index futures

INTRODUCTION TO FUTURE MARKET: Futures markets were designed to solve the problems that exit in forward markets. A futures con tract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. There is a multilateral contract between the buyer and seller for a underlying asset which may be financial instrument or physical commodities. But unlike forward contracts the future contracts are standardized and exchange traded. PURPOSE: The primary purpose of futures market is to provide an efficient and effective mechanism for management of inherent risks, without counter-party risk. It is a derivative instrument and a type of forward contract The future contracts are affected mainly by the prices of the underlying asset. As it is a future contract the buyer and seller has to pay the margin to trade in the futures market. It is essential that both the parties compulsorily discharge their respective obligations on the settlement day only, even though the payoffs are on a daily marking to market basis to avoid default risk. Hence, the gains or losses are netted off on a daily basis and each morning start with a fresh opening value. Here both the parties face an equal amount of risk and are also required to pay upfront margins to the exchange irrespective of whether they are buyers or sellers. Index based financial futures are settled in cash unlike futures on individual stocks which are very rare and yet to be launched even in the US. Most of the financial futures worldwide are index based and hence the buyer never comes to know who the seller is, both due to the presence of the clearing corporation of the stock exchange in between and also due to secrecy reasons

MARGIN Margin is money deposited by the buyer and the seller to ensure the integrity of the contract. Normally the margin requirement has been designed on the concept of VAR at 99% levels. Based on the value at risk of the stock/index margins are calculated. In general margin ranges between 10-50% of the contract value. PURPOSE: The purpose of margin is to provide a financial safeguard to ensure that traders will perform on their contract obligations. HEDGERS : Hedgers are the traders who wish to eliminate the risk of price change to which they are already exposed.It is a mechanism by which the participants in the physical/ cash markets can cover their price risk. Hedgers are those persons who dont want to take the risk therefore they hedge their risk while taking position in the contract. In short it is a way of reducing risks when the investor has the underlying security.

PURPOSE: TO REDUCE THE VOLATILITY OF A PORTFOLIO, BY REDUCING THE RISK

Figure 1.1

Hedgers

Existing

SYSTEM

New

Approach 1) Difficult to offload holding during adverse

Peril &Prize 1) No Leverage available risk reward dependant

Approach 1)Fix price today to buy latter by paying premium.

Peril &Prize 1) Additional cost is only

2)For Long, buy ATM Put premium. Option. If market goes up, long position benefit else exercise the option. 3)Sell deep OTM call option with underlying shares, earn premium + profit with increase prcie Advantages Availability of Leverage

market conditions on market prices as circuit filters limit to curtail losses.

STRATEGY:

The basic hedging strategy is to take an equal and opposite position in the futures market to the spot market. If the investor buys the scrip in the spot market but suddenly the market drops then the investor hedge their risk by taking the short position in the Index futures.

HEDGING AND DIVERSIFICATION:

Hedging is one of the principal ways to manage risk, the other being diversification. Diversification and hedging do not have have cost in cash but have opportunity cost. Hedging is implemented by adding a negatively and perfectly correlated asset to an existing asset. Hedging eliminates both sides of risk: the potential profit and the potential loss. Diversification minimizes risk for a given amount of return (or, alternatively, maximizes return for a given amount of risk). Diversification is affected by choosing a group of assets instead of a single asset (technically, by adding positively and imperfectly correlated assets). Example:Ram enters into a contract with Shyam that he sells 50 pens to Shyam for Rs.1000. The cost of manufacturing the pen for Ram is only Rs. 400 and he will make a profit of Rs 600 if the sale is completed.

COST 400

SELLING PRICE 1000

PROFIT 600

However, Ram fears that Shyam may not honour his contract. So he inserts a new clause in the contract that if Shyam fails to honour the contract he will have to pay a penalty of Rs.400. And if Shyam honours the contract Ram will offer a discount of Rs 100 as incentive.

Shyam defaults 400 (Initial Investment) 400 (penalty from Shyam - (No gain/loss)

Shyam honors 600 (Initial profit) (-100) discount given to Shyam 500 (Net gain)

Finally if Shyam defaults Ram will get a penalty of Rs 400 but Ram will recover his initial investment. If Shyam honors the bill the ram will get a profit of 600 deducting the discount of Rs.100 and net profit for ram is Rs.500. Thus Ram has hedged his risk against default and protected his initial investment.

Now lets see how investor hedge their risk in the market Example:

Say you have bought 1000 shares of XYZ Company but in the short term you expect that the market would go down due to some news. Then, to minimize your downside risk you could hedge your position by buying a Put Option. This will hedge your downside risk in the market and your loss of value in XYZ will be set off by the purchase of the Put Option. Therefore hedging does not remove losses .The best that can be achieved using hedging is the removal of unwanted exposure, i.e.unnessary risk. The hedging position will make less profits than the un-hedged position, half the time. One should not enter into a hedging strategy hoping to make excess profits for sure; all that can come out of hedging is reduce risk.

HEDGING WITH OPTIONS: Options can be used to hedge the position of the underlying asset. Here the options buyers are not subject to margins as in hedging through futures. Options buyers are however required to pay premium which are sometimes so high that makes options unattractive.

Example:With a market price of ACC Rs.600 the investor buys the 50 shares of ACC.Now the investor excepts that price will fall by 100.So he decided to buy the put Option b y paying the premium of Rs.25. Thus the investor has hedge their risk by purchasing the put Option. Finally stock falls by 100 the loss of investor is restricted t the premium paid of Rs.2500 as investor recovered Rs.75 a share by buying ACC put.

HEDGING STRATEGIES: LONG SECURITY, SELL NIFTY FUTURES: Under this investor takes a long position on the security and sell some amount of Nifty Futures. This offsets the hidden Nifty exposure that is inside every long- security position. Thus the position LONG SECURITY, SELL NIFTY is a pure play on the performance of the security, without any extra risk from fluctuations of the market index. Finally the investor has HEDGED AWAY his index exposure.

LONG SECURITY, SELL FUTURES: Here stock futures can be used as an effective risk management tool. In this case the investor buys the shares of the company but suddenly the rally goes down. Thus to maximize the risk the Hedger enters into a future contract and takes a short position. However the losses suffers in the security will be offset by the profits he makes on his short future position.

Spot Price of ACC = 390 Market action Loss Strategy = 350 = 40 = BUY SECURITY, SELL FUTURES

Two month Futures= 390 Premium Short position Future profit = 12 = 390 = 40(390-350)

As the fall in the price of the security will result in a fall in the price of Futures. Now the Futures will trade at a price lower then the price at which the hedger entered into a short position. Finally the loss of Rs.40 incurred on the security hedger holds, will be made up the profits made on his short futures position.

HAVE STOCK, BUY PUTS: This is one of the simplest ways to take on hedge. Here the investor buys 100 shares of HLL.The spot price of HLL is 232 suddenly the investor worries about the fall of price. Therefore the solution is buy put options on HLL.The investor buys put option with a strike of Rs.240. The premium charged is Rs.10.Here the investor has two possible scenarios three months later.

1) IF PRICE RISES

Market action: 215 Loss Strike price : 17(232-15) : 240

Premium Profit

: 08 : 17(240-215-8)

Thus loss he suffers on the stock will be offset by the profit the investor earns on the put option bought.

2) IF PRICE RISES:

Market share : 250 Loss : 10

Short position : 250(spot market)

Thus the investor has a limited loss(determined by the strike price investor chooses) and an unlimited profit.

HAVE PORTFOLIO, SHORT NIFTY FUTURES: Here the investor are holding the portfolio of stocks and selling nifty futures. In the case of portfolios, most of the portfolio risk is accounted for by index fluctuations. Hence a position LONG PORTFOLIO+ SHORT NIFTY can often become one-tenth as risky as the LONG PORTFOLIO position. Let us assume that an investor is holding a portfolio of following scrips as given below on 1st May, 2001.

Company Infosys Global Tele Satyam Comp HFCL Total Value of Portfolio 1.55 2.06 1.95 1.9

Beta

Amount of Holding ( in Rs) 400,000.00 200,000.00 175,000.00 125,000.00 1,000,000.00

Trading Strategy to be followed: The investor feels that the market will go down in the next two months and wants to protect him from any adverse movement. To achieve this the investor has to go short on 2 months NIFTY futures i.e he has to sell June Nifty. This strategy is called Short Hedge.

Formula to calculate the number of futures for hedging purposes is

Beta adjusted Value of Portfolio / Nifty Index level

Beta of the above portfolio

=(1.55*400,000)+(2.06*200,000)+(1.95*175,000)+(1.9*125, 000)/1,000,000

=1.61075 (round to 1.61)

Applying the formula to calculate the number of futures contracts Assume NIFTY futures to be 1150 on 1st May 2001

= (1,000,000.00 * 1.61) / 1150

= 1400 Units

Since one Nifty contract is 200 units, the investor has to sell 7 Nifty contracts. Short Hedge

Stock Market 1st May

Futures Market

Holds Rs 1,000,000.00 in stock portfolio

Sell 7 NIFTY futures contract at 1150.

25th June

Stock portfolio fall by 6% to Rs 940,000.00

NIFTY futures falls by 4.5% to 1098.25

Profit / Loss

Loss: -Rs 60,000.00

Profit: 72,450.00

Net Profit: + Rs 15,450.00

SPECULATORS:

If hedgers are the people who wish to avoid price risk, speculators are those who are willing to take such risk. speculators are those who do not have any position and simply play with the others money. They only have a particular view on the market, stock, commodity etc. In short, speculators put their money at risk in the hope of profiting from an anticipated price change. Here if speculators view is correct he earns profit. In the event of speculator not being covered, he will loose the position. They consider various factors such as demand supply, market positions, open interests, economic fundamentals and other data to take their positions.

SPECULATION IN THE FUTURES MARKET Speculation is all about taking position in the futures market without having the underlying. Speculators operate in the market with motive to make money. They take: Naked positions - Position in any future contract. Spread positions - Opposite positions in two future contracts. This is a conservative speculative strategy. Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate

the price discovery in the market.

Figure 1.2

Speculators

Existing

SYSTEM

New

Approach 1) Deliver based Trading, margin trading& carry forward transactions. 2) Buy Index Futures hold till expiry.

Peril

&Prize

Approach 1)Buy &Sell stocks on delivery basis 2) Buy Call &Put by paying premium

Peril &Prize 1)Maximum loss possible to premium paid

1) Both profit & loss to extent of price change.

Advantages *Greater Leverage as to pay only the premium.

*Greater variety of strike price options at a given time. EXAMPLE:Here the Speculator believes that stock market will going to appreciate.

Current market price of PATNI COMPUTERS = 1500

Strategy: Buy February PATNI futures contract at 1500

Lot size = 100 shares

Contract value = 1,50,000 (1500*100)

Margin = 15000 (10% of 150000)

Market action = rise to 1550

Future Gain:Rs. 5000 [(1550-1500)*100]

Market action = fall to 1400

Future loss: Rs.-10000 [(1400-1500)*100]

Thus the Speculator has a view on the market and accept the risk in anticipating of profiting from the view. He study the market and play the game with the stock market TYPES: POSITION TRADERS: These traders have a view on the market an hold positions over a period of as days until their target is met. DAY TRADERS: Day traders square off the position during the curse of the trading day and book the profits. SCALPERS: Scalpers in anticipation of making small profits trade a number of times throughout the day.

SPECULATING WITH OPTIONS:

A speculator has a definite outlook about future price, therefore he can buy put or call option depending upon his perception about future price. If speculator has a bullish outlook, he will buy calls or sell (write) put. In case of bearish perception, the speculator will put r write calls. If speculators view is correct he earns profit. In the event of speculator not being covered, he will loose the position. A Speculator will buy call or put if his price outlook in a particular direction is very strong but if is either neutral or not so strong. He would prefer writing call or put to earn premium in the event of price situations.

Example:-

Here if speculator excepts that ZEE TELEFILMS stock price will rise from present level of Rs.1050 then he buys call by paying premium. If prices have gone up then he earns profit otherwise he losses call premium which he pays to buy the call. if speculator sells that ZEE TELEFILMS stock will come down then he will buy put on the stale price until he can write either call or put.

Finally Speculators provide depth an liquidity to the futures market an in their absence; the price protection sought the hedger would be very costly.

STRATEGIES:

BULLISH SECURITY,SELL FUTURES:

Here the Speculator has a view on the market. The Speculator is bullish in the market. Speculator buys the shares of the company an makes the profit. At the same time the Speculator enters into the future contract i.e. buys futures and makes profit.

Spot Price of RELIANCE = 1000

Value Market action Profit Initial margin Market action Profit

= = = = = =

1000*100shares = 1,00,000 1010 1000 20,000 1010 400(investment of Rs.20,000)

This shows that with a investment of Rs.1,00,000 for a period of 2 months the speculator makes a profit of 1000 and got a annual return of 6% in the spot market but in the case of futures the Speculator makes a profit of Rs.400 on the investment of Rs.20,000 and got return of 12%. Thus because of leverage provided security futures form an attractive option for speculator.

BULLISH STOCK, BUY CALLS OR BUY PUTS:

Under this strategy the speculator is bullish in the market. He could do any of the following:

BUY STOCK

ACC spot price No of shares Price Market action Profit Return

: 150 : 200 : 150*200 = 30,000 : 160 : 2,000 : 6.6% returns over 2months

BUY CALL OPTION:

Strike price Premium Lot size Market action Profit Return

: 150 :8 : 200 shares :160 : (160-150-8)*200 = 400 : 25% returns over 2months

This shows that investor can earn more in the call option because it gives 25% returns over a investment of 2months as compared to 6.6% returns over a investment in stocks

BEARISH SECURITY,SELL FUTURES:

In this case the stock futures is overvalued and is likely to see a fall in price. Here simple arbitrage ensures that futures on an individual securities more correspondingly with the underlying security as long as there is sufficient liquidity in the market for the security. If the security price rises the future price will also rise and vice-versa.

Two month Futures on SBI = 240

Lot size Margin Market action Future profit

= = = =

100shares 24 220 20(240-220)

Finally on the day of expiration the spot and future price converges the investor makes a profit because the speculator is bearish in the market and all the future stocks need to sell in the market.

BULLISH INDEX, LONG NIFTY FUTURES: Here the investor is bullish in the index. Using index futures, an investor can BUY OR SELL the entire index trading on one single security. Once a person is LONG NIFTY using the futures market, the investor gains if the index rises and loss if the index falls. 1st July = Index will rise

Buy nifty July contract = 960

Lot =200 14th July nifty risen= 967.35

Nifty July contract= 980

Short position Profit

=980 = 4000(200*20)

ARBITRAGEURS:

Arbitrage is the concept of simultaneous buying of securities in one market where the price is low and selling in another market where the price is higher.

Arbitrageurs thrive on market imperfections. Arbitrageur is intelligent and knowledgeable person and ready to take the risk He is basically risk averse. He enters into those contracts were he can earn risk less profits. When markets are imperfect, buying in one market and simultaneously selling in other market gives risk less profit. Arbitrageurs are always in the look out for such imperfections. In the futures market one can take advantages of arbitrage opportunities by buying from lower priced market and selling at the higher priced market.

JM Morgan introduced EQUITY DERIVATIVES FUND called as ARBITRAGE FUND where the investor buys the shares in the cash market and sell the shares in the future market.

ARBITRAGEURS IN FUTURES MARKET

Arbitrageurs facilitate the alignment of prices among different markets through operating in them simultaneously.

Figure 1.3

Arbitrageurs

Existing

SYSTEM

New

Approach 1) Buying Stocks in one and selling in another exchange. forward transactions. 2) If Future Contract more or less than Fair price

Peril

&Prize

Approach 1) B Group more promising as still

Peril &Prize 1) Risk free game.

1) Make money whichever way the Market moves.

in weekly settlement 2) Cash &Carry arbitrage continues

Fair Price = Cash Price + Cost of Carry. Example:

Current market price of ONGC in BSE= 500

Current market price of ONGC in NSE= 510

Lot size = 100 shares

Thus the Arbitrageur earns the profit of Rs.1000(10*100)

STRATEGIES: BUY SPOT, SELL FUTURES: In this the investor observing that futures have been overpriced, how can the investor cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One month ACC futures = 1025. This shows that futures have been overpriced and therefore as an Arbitrageur, investor can make risk less profits entering into the following set f transactions.

On day one, borrow funds, buy security on the spot market at 1000

Simultansely, sell the futures on the security at1025

Take delivery of the security purchased and hold the security for a month

on the futures expiration date, the spot and futures converge . Now unwind the position

Sa y the security closes at Rs.1015. Sell the security

Futures position expires with the profit f Rs.10

The result is a risk less profit of Rs.15 on the spot position and Rs.10 on the futures position

Return the Borrow funds.

Finally if the cost of borrowing funds to buy the security is less than the arbitrage profit possible, it makes sense for the investor to enter into the arbitrage. This is termed as cash and-carry arbitrage.

BUY FUTURES, SELL SPOT:

In this the investor observing that futures have been under priced, how can the investor cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One month ACC futures = 965.

This shows that futures have been under priced and therefore as an Arbitrageur, investor can make risk less profits entering into the following set f transactions.

On day one, sell the security on the spot market at 1000

Mae delivery of the security

Simultansely, buy the futures on the security at 965

On the futures expiration date, the spot and futures converge . Now unwind the position

Sa y the security closes at Rs.975. Sell the security

Futures position expires with the profit f Rs.10

The result is a risk less profit of Rs.25 the spot position and Rs.10 on the futures position

Finally if the returns get investing in risk less instruments is less than the return from the arbitrage it makes sense for the investor to enter into the arbitrage. This is termed as reverse cash and- carry arbitrage.

ARBITRAGE WITH NIFTY FUTURES: Arbitrage is the opportunity of taking advantage of the price difference between two markets. An arbitrageur will buy at the cheaper market and sell at the costlier market. It is possible to arbitraged between NIFTY in the futures market and the cash market. If the futures price is any of the prices given below other than the equilibrium price then the strategy to be followed is

CASE-1

Spot Price of INFOSEYS = 1650

Future Price Of INFOSEYS = 1675

In this case the arbitrageur will buy INFOSEYS in the cash market at Rs.1650 and sell in the futures at Rs.1675 and finally earn risk free profit Of Rs.25.

CASE-2

Future Price Of ACC = 675

Spot Price of ACC = 700

In this case the arbitrageur will buy ACC in the Future market at Rs.675 and sell in the Spot at Rs.700 and finally earn risk free profit Of Rs.25.

A Graphical representation of month wise product wise turn over in new tech shoe for the period of January 2008 to june 2013

CHAPTER 5 SUMMARY FINDINGS SUGGESTION AND CONCLUSION

FINDINGS

The study reveals the effectiveness of risk reduction using hedging strategies. It has found out that risk cannot be avoided. But can only be minimized.

Through the study. it has found out that, the hedging provides a safe position on an underlying security. The loss gets shifted to a counter party. Thus the hedging covers the loss and risk. Sometimes, the market performs against the expectation. This will trigger losses. so the hedger should be a strategic and positive thinker.

The anticipation of the hedger regarding the trend of the movement in the prices of the underlying security plays a key role in the result of the strategy applied.

It has been found that, all the strategies applied on historical data of the period of the study were able to reduce the loss that rose from price risk substantially.

If the trader is not sure about the direction of the movement of the profits of the current position, he can counter position in the future contract and reduces the level of risks.

The trader can effectively use the strategy for return enhancement provided he has the correct market anticipation.

In general, the anticipation of the strategies purely for return enhancement is a risky affair, because, if the anticipation about the performance of the market and the underlying goes wrong, the position taker would end up in higher losses.

SUGGESTIONS If an organisation wants to hedge with portfolios, it must consist of scrips from different industries, since they are convenient and represent true nature of the securities market as a whole.

The hedging tool to reduce the losses that may arise from the market risk. Its primary objective is loss minimization, not profit maximization .The profit from futures or shares will be offset from the losses from futures or shares, as the case may be. as a result, a hedger will earn a lower return compared to that of an unhedger. But the unhedger faces a high risk than a hedger.

The hedger will have to be a strategic thinker and also one who think positively. He should be able to comprehend market trends and fluctuations. Otherwise, the strategies adopted by him earn him earn losses.

The hedging tool is suitable in the short term period. They can be specifically adopted by the investor, who are facing high risks and has sufficient liquid cash with them. Long term investor should beware from the market, because of the volatile nature of the market.

A lot more awareness needed about the stock market and investment pattern, both in spot and future market. The working of BSE Training Institute and NSE Institutes are apprehensible in this regard.

CONCLUSION

Derivative use for hedging is only to increase due to the increased global linkages and volatile exchange rates. Firms need to look at instituting a sound risk management system and also need to formulate their hedging strategy that suits their specific firm

characteristics and exposures.

In India, regulation has been steadily eased and turnover and liquidity in the foreign currency derivative markets has increased, although the use is mainly in shorter maturity contracts of one year or less. Forward and option contracts are the more popular instruments. Regulators had initially only allowed certain banks to deal in this market however now corporates can also write option contracts. There are many variants of these derivatives which investment banks across the world specialize in,and as the awareness and demand for these variants increases.

BIBLIOGRAPHY: BOOKS SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT PUNITHAVATHY PANDYAN SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT KEVIN DERIVATIVES AND FINANCIAL INNOVATION THE BOMBAY STOCK EXCHAHGE PUBLICATION

FUTURES AND OPTIONS- N.D. VOHRA AND B. R. BAGRI POTFOLIO MANAGEMENT HAND BOOK ROBORT.A.STRONG SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

JEFFERY.V.BAILERY

Websites

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www.capitaline.com

www.geojit.com

www.derivativeindia.com

www.capitalmarket.com

www.indiabulls.com