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AT
KOTAK MAHINDRA BANK
1.INTRODUCTION
The only stock exchanges operating in the 19 the century were those of Bombay set up in 1875
and Ahmadabad set up in 1894. These were organized as voluntary non-profit-making
association of brokers to regulate and protect their interests. Before the control on securities
trading became a central subject under the constitution in 1950, it was a state subject and the
Bombay securities contracts (control) Act of 1925 used to regulate trading in securities. Under
this Act, The Bombay stock exchange was recognized in 1927 and Ahmadabad in 1937.
During the war boom, a number of stock exchanges were organized even in Bombay,
Ahmadabad and other centers, but they were not recognized. Soon after it became a central
subject, central legislation was proposed and a committee headed by A.D.Gorwala went into the
bill for securities regulation. On the basis of the committee's recommendations and public
discussion, the securities contracts (regulation) Act became law in 1956.
The emergence of the market for derivatives 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 a very high degree of volatility. Through the use of
derivative products, it is possible to partially or fully transfer price risks by locking-in asset
prices.
As instruments of risk management, these generally do not influence the fluctuations in the
underlying asset prices. However, by locking-in asset prices, derivative products minimize the
impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse
investors.
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. Derivatives are
used by banks, securities firms, companies and investors to hedge risks, to gain access to cheaper
money and to make profits Derivatives are likely to grow even at a faster rate in future they are
first of all cheaper to world have met the increasing volume of products tailored to the needs of
particular customers, trading in derivatives has increased even in the over the counter markets. In
Britain unit trusts allowed to invest in futures & options .The capital adequacy norms for banks
in the European Economic Community demand less capital to hedge or speculate through
derivatives than to carry underlying assets. Derivatives are weighted lightly than other assets that
appear on bank balance sheets. The size of these off-balance sheet assets that include derivatives
is more than seven times as large as balance sheet items at some American banks causing
concern to regulators
Time constraint.
The study is not based on international perspective derivatives markets.
Non-availability of data.
The data collected is completely restricted to the M/s. KOTAK STOCK BROCKING
LTD of MAY 2012
RESEARCH METHODOLOGY:
A system of collecting data for research projects is known as research methodology. The data
may be collected for either theoretical or practical research. Research methodology is a way to
systematically solve the research problem. It may be understood as a science of studying how
research is done scientifically. In it we study the various steps that are generally adopted by a
researcher in studying his research problem along with the logic behind them.
RESEARCH DESIGN:
Task of defining the research problem is the preparation of the research project, popularly known
as the research design. Decisions regarding what, where, when, how much, by what means
concerning an inquiry or a research study constitute a research design.
A research design is the arrangement of conditions for collection and analysis of data in a manner
that aims to combine relevance to the research purpose with economy in procedure.
DATA COLLECTION:
The data used in the study was collected from primary and secondary sources:
PRIMARY DATA:
Primary data consists of financial data collected from kotak Mahindra bank.
SECONDARY DATA:
2. REVIEW OF LITERATURE
Many authors have done their research on Derivatives (futures & options) to encourage the
investors to invest on derivatives market, and many of them gave valuable suggestions &
conclusions on derivatives futures & options to minimize risk and to maximize profitability on
derivatives. Some of their findings are listed below:
Author Names:
Paper title:
Year:
FINDINGS:
Due to the increased globalization among economies of the world, corporations use derivatives
in order to minimize their exposure to the uncertainty caused by recent economic and financial
crunch.
The development of option pricing model by Black and Scholes (1973) and Merton (1973) made
possible for derivatives market to turn out to be a significant instrument in risk management.
The use of derivatives has increased dramatically over the past two decades despite of severe
loses faced by corporations. This paper emphasis on the most significant rationales over
derivative usage among corporations, i.e. why firms use derivatives, its comparison and contrast
among developed and developing economies and factors stimulating firms to use derivatives.
Author Names:
Paper title:
Year:
FINDINGS:
This article presents a different approach to modeling the return dynamics for a portfolio. The
component stocks are all assumed to be exposed to shocks from a small number of independent
factors, each of which follows a Heston-type square root diffusion process. To illustrate the
model, the authors construct a portfolio of the three biotech stocks that have the largest
weightings among the twelve stocks in the BBH ETF portfolio, assuming there are only two
independent factors. The estimated variance equations show that the more important factor,
Factor 1, has high volatility and is rapidly mean reverting, while Factor 2 reverts more slowly
and steadily toward a low value. Theoretical values for options on the three-stock portfolio
obtained by simulation should be approximately the same as traded option contracts on the BBH
index. The fitted volatility smiles under the model are similar to those observed for BBH, but
with some notable discrepancies.
Author Names:
Paper title:
Year:
2009
FINDINGS:
Derivatives are a tool to share risks in the economy and can thus provide a benefit to the
economy. The financial crisis has demonstrated that they can also pose significant risks to
financial stability. These are related to the exponential growth in derivatives over the last decade,
increasing leverage and interconnectedness of financial institutions. This went largely unnoticed
by markets and prudential supervisors, because derivative markets are predominantly organized
in bilateral a relationship, which makes them in transparent. The article discusses policy tools to
remedy the flaws in derivative markets, taking inspiration from a recent communication by the
European Commission.
Author Names:
Narender.L.Ahuja
Paper title:
Year:
FINDINGS:
Organized commodity derivatives in India started as early as 1875, barely about a decade after
they started in Chicago. However, many feared that derivatives fuelled unnecessary speculation
and were detrimental to the healthy functioning of the markets for the underlying commodities.
As a result, after independence, commodity options trading and cash settlement of commodity
futures were banned in 1952. A further blow came in 1960s when, following several years of
severe draughts that forced many farmers to default on forward contracts (and even caused some
suicides), forward trading was banned in many commodities considered primary or essential.
Consequently, the commodities derivative markets dismantled and remained dormant for about
four decades until the new millennium when the Government, in a complete change in policy,
started actively encouraging the commodity derivatives market.
Since 2002, the commodities futures market in India has experienced an unprecedented boom in
terms of the number of modern exchanges, number of commodities allowed for derivatives
trading as well as the value of futures trading in commodities, which might cross the $ 1 Trillion
mark in 2006.
However, there are several impediments to be overcome and issues to be decided for sustainable
development of the market.
Author Names:
Bose Suchismita
Paper title:
Year:
2006
FINDINGS:
Derivatives products provide certain important economic benefits such as risk management or
redistribution of risk away from risk-averse investors towards those more willing and able to
bear risk. Derivatives also help price discovery, i.e. the process of determining the price level for
any asset based on supply and demand.
These functions of derivatives help in efficient capital allocation in the economy; at the same
time their misuse also poses a threat to the stability of the financial sector and the overall
economy.
In the mid-1990s India started reviving the exchange traded commodity derivatives market and
introduced a variety of instruments in the foreign exchange derivatives market, while exchange
traded financial derivatives were introduced in 2001.
Given India's experience in informal derivatives trading, the exchange traded derivatives were
quick to pick up substantial volumes.
This paper presents accounts of the major developments in the Indian commodity, exchange rate
and financial derivatives markets, and outlines the regulatory provisions that have been
introduced to minimize misuse of derivatives.
Author Names:
Riddhi Kapadia
Paper title:
Year:
FINDINGS:
The derivative market has become multi-trillion dollar markets over the years. Derivatives are
financial commitments indexed or linked in some capacity to changes in the value of underlying
assets. The bulk of the derivatives trading internationally are linked to currencies and interest
rates, other derivatives are linked to equity or equity indices. A very small volume of derivatives,
compared to the total, is indexed to traditional commodities. Small by comparison to other
derivatives markets, these commodities-indexed derivatives markets are large compared to the
underlying physical commodity markets.
Author Names:
ReneM.Stulz
Paper title:
Year:
FINDINGS:
Derivatives allow firms and individuals to hedge risks and to take risks efficiently. They also can
create risk at the firm level, especially if a firm uses derivatives episodically and is inexperienced
in their use. For the economy as a whole, a collapse of a large derivatives user or dealer may
create systemic risks. On balance, Derivatives help make the economy more efficient. However,
neither users of derivatives nor regulators can be complacent. Firms have to make sure that
derivatives are used properly. So should we fear derivatives? The answer is no. We should
have a healthy respect for them. We do not fear planes because they may crash and do not refuse
to board them because of that risk. Instead, we make sure that planes are as safe as it makes
economic sense for them to be. The same applies to derivatives. Typically, the losses from
derivatives are localized, but the whole economy gains from the existence of derivatives markets.
Author Names:
Robert H.Michel
Paper title:
Year:
FINDINGS:
2004
Current research on inositols mainly focuses on myo-inositol derivatives in eukaryotic cells, and
in particular on the many roles of Ins phospholipids and polyphosphorylated Ins derivatives.
However, inositols and their derivatives are more versatile than this they have acquired diverse
functions over the course of evolution. Given the central involvement of primordial bacteria and
archaea in the emergence of eukaryotes, what is the status of inositol derivatives in these groups
of organisms, and how might inositol, inositol lipids and inositol phosphates have become
ubiquitous constituents of eukaryotes? And how, later, might the multifarious functions of
inositol derivatives have emerged during eukaryote diversification.
Author Names:
Paper title:
Year:
1999
FINDINGS:
Derivatives, ranging from relatively simple forward contracts to complicated options products,
are an increasingly important feature of financial markets worldwide. They are already being
used in many emerging markets, and as the financial sector becomes deeper and more stable,
their use is certain to grow. This Handbook provides a basic guide to the different types of
derivatives traded, including the pricing and valuation of the products, and accounting and
statistical treatment. Also, it aims to highlight the main areas in which derivatives matter to
central banks, notably those of monetary policy and banking supervision. It is not intended as a
manual for traders, nor to describe in depth the current state of world markets, where changes
can happen so rapidly that any description must soon become outdated. But we do hope to
provide a clear enough description of derivatives and their relevance to central banks for central
bankers to be confident in tackling the issues that arise. Most derivatives traded are, in fact, fairly
simple, and well within the grasp of our intended readership. This handbook is also available in
Spanish.
3.INDUSTRY PROFILE.
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) & London International financial Futures Exchange
(LIFFE) (for currency & Interest rate futures)
Philadelphia Stock Exchange (PSE), London stock Exchange (LSE) & Chicago Board options
exchange (CBOE) (for currency options)
New York Stock Exchange (NYSE) and London Stock Exchange (LSE) (for equity derivatives)
Chicago Mercantile Exchange (CME) and London Metal Exchange (LME) for commodities.
These exchanges account for a large portion of the trading volume in the respective derivatives
segment.
SEBI was set up as an autonomous regulatory authority by the Government of India in 1988 " to
protect the interests of investors in securities and to promote the development of, and to regulate
the securities market and for matters connected therewith or incidental thereto." It is empowered
by two acts namely the SEBI Act, 1992 and the securities contract (regulation) Act, 1956 to
perform the function of protecting investor's rights and regulating the capital markets.
BSE INDICES:
In order to enable the market participants, analysts etc., to track the various ups and downs in the Indian stock
market, the Exchange has introduced in 1986 an equity stock index called BSE-SENSEX that subsequently became
the barometer of the moments of the share prices in the Indian stock market. It is a "Market capitalizationweighted" index of 30 component stocks representing a sample of large, well-established and leading companies.
The base year of Sensex is 1978-79. The Sensex is widely reported in both domestic and international markets
through print as well as electronic media.
Sensex is calculated using a market capitalization weighted method. As per this methodology, the level of the index
reflects the total market value of all 30-component stocks from different industries related to particular base
period. The total market value of a company is determined by multiplying the price of its stock by the number of
shares outstanding.
Statisticians call an index of a set of combined variables (such as price and number of shares) a composite
Index. An Indexed number is used to represent the results of this calculation in order to make the value easier to
work with and track over a time. It is much easier to graph a chart based on Indexed values than one based on actual
values world over majority of the well-known Indices are constructed using Market capitalization weighted method
".
In practice, the daily calculation of SENSEX is done by dividing the aggregate market value of the 30 companies in
the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the
SENSEX. The Divisor keeps the Index comparable over a period of time and if the reference point for the entire
Index maintenance adjustments. SENSEX is widely used to describe the mood in the Indian Stock markets. Base
year average is changed as per the formula
New base year average = Old base year average*(New market Value/old market value)
REGULATORY FRAMEWORK:
The trading of derivatives is governed by the provisions contained in the SC (R) Act, the SEBI
Act, and the regulations framed there under the rules and byelaws of stock exchanges. In this
chapter we look at the broad regulatory frame work for derivatives trading and the requirement
to become a member and authorized dealers of the F&O segment and the position limits as they
apply to various participants.
The amendment of the SCR Act to include DERIVATIVES within the ambit of securities in the
SCR Act made trading in Derivatives possible within the framework of the Act.
Any exchange fulfilling the eligibility criteria as prescribed in the L.C.Gupta committee report
may apply to SEBI for grant of recognition under section 4 of the SCR Act, 1956 to start
Derivatives Trading.
The exchange shall have minimum 50 members.
The members of an existing segment of the exchange will not automatically become the members
of the derivatives segment. The members of the derivatives segment need to fulfill the eligibility
conditions as lay down by the L. C. Gupta committee.
The clearing and settlement of derivatives trades shall be through a SEBI approved clearing
corporation/clearing house. Clearing Corporation/Clearing House complying with the eligibility
conditions as lay down by the committee have to apply to SEBI for grant of approval.
Derivatives broker/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 lakh.
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 advance
Prepaid expenses
Intangible Assets
30% marketable securities
The Minimum contract value shall not be less than Rs.2 Lakhs. Exchange should also submit
details of the futures contract they purpose to introduce.
The trading members are required to have qualified approved user and sales persons who have
passed a certification programmed approved by SEBI.
The L.C.Gupta committee report requires strict enforcement of Know your customer rule and
requires that every client shall be registered with the derivates broker.
The members of the derivatives segment are also required to make their clients aware of the risks
involved in derivatives trading by issuing to the client the Risk Disclosure and obtain a copy of
the same duly signed by the clients.
COMPANY PROFILE:
The Kotak Mahindra Group was born in 1985 as Kotak Capital Management Finance
Limited. Uday Kotak, Sidney A.A.Pinto and Kotak & Company promoted this
company. Industrialists Harish Mahindra and Anand Mahindra took a stake in 1986, and thats
when the company changes its name to Kotak Mahindra Finance Limited.
Since then its been a steady and confident journey to growth and success.
Table : 3.1
1986
1987
Kotak Mahindra Finance Limited enters the lease and hire purchase market.
1990
1991
1992
1995
1996
The Auto Finance Business is hired off into a separate company Kotak
Securities investment Banking Division Incorporated into a separate
company Kotak Mahindra Capital Company.
1998
Enters the Mutual Fund Marker with the launch of Kotak Mahindra asset
Management Company.
2000
Kotak Mahindra ties up with old Mutual PIC for the life insurance business.
Kotak Securities launches its on-line broking site
( www.kotaksecurities.com )
2001
2003
2004
2005
Kotak group religions Joint Ventures in ford credit; Buys Kotak Mahindra
prime and sells ford credit Kotak Mahindra Launches a Real-estate Fund.
2005
2006
2008
2009
2010
2011
of the worlds largest bank and brokerage firm) ford credit (one of the worlds largest dedicated
automobile financiers) and old mutual (a large insurance, banking and asset management
conglomerate). Kotak Mahindra bank is the flagship company of the group. The company was
incorporated in 1985 and over the years has spread its business into the entire spectrum of
financial services either directly or through subsidiaries. In February 2003, the company reached
a new milestone when it was given license to carry on banking business by the Reserve Bank of
India. It was the first company in India to convert to a bank. The company has been in retail
leading since mid 1990s. With the conversion into bank retail liabilities, treasury and corporate
banking segments have been added.
CORPORATE HIERARCHY:
Corporate Manager
Branch Manager
Dealer (user)
Figure : 3.1
CORPORATE MANAGER:
He has the right to see all branches and dealers out standing orders, previous traders, net
positions & end of day reports to set branch order limits.
BRANCH MANAGER:
He has the right to see all branches and dealers out standing orders, previous traders, net
positions & end of day reports to set branch order limits.
DEALERS (USER):
He has the right to perform orders & trading activities.
GROUP MANAGEMENT:
Mr.KM GHERDA - group chairman
Mr. Uday Kotak Executive Vice Chairman & Managing Director.
Mr. Sivaji Dam
Mr. C. Jayaram
Mr. Dipak Gupta
Kotak Mahindra is one of Indias leading financial institutions offering complete financial
solutions that encompass every sphere of life. From commercial banking, to stock broking, to
mutual funds, to life insurance to investment banking, the group caters to the financial needs of
individuals and corporate. The group has a net worth of around Rs.2000 crore and the AUM
across the group is around 120 billion and employs over 6000 employees in its various
businesses. With a presence in 216 cities in India and offices in New York, London, Dubai and
Mauritius, it services a customer base of over 10.00,000. The group specializes in offering top
class financial services catering to every segment of the industry. The various group companies
include.
Kotak Securities Limited, Manages assets over 2500 crores of Assets under Management
(AUM). The Portfolio Management Services provide top class service, catering to the high end
of the market.
Portfolio Management from Kotak Securities comes as an answer to those who would like to
grow exponentially on the crest of the stock market, with the backing of an expert.
ICAI Award
Excellence in Financial Reporting under Category 1 - Banking Sector for the year ending 31st
March, 2010
Asia money
Best Local Cash Management Bank 2010
IDG India
Kotak won the CIO 100 'The Agile 100' award 2010
IDRBT
Banking Technology Excellence Awards Best bank award in framework and governance among
other banks 2009 Banking technology award for IT governance and value delivery, 2008.
IR Global Rankings
Best Corporate Governance Practices - Ranked among the top 5 companies in Asia Pacific, 2009
Asia
Best Private Bank in India, for Wealth Management business, 2009
Kotak Royal Signature Credit Card
Was chosen "Product of the Year" in a survey conducted by Nielsen in 2009
IBA Banking Technology Awards
Best Customer relationship Achievement winner 2008 & 2009.
Best overall winner, 2007.
Best IT Team of the year, 4 years in a row from 2006 to 2009.
Best IT Security Policies & practices, 2007
Euro Money
Best Private Banking Services (overall), 2009
Emerson Uptime Champion Awards
Technology Senate Emerson Uptime Championship Award in the BFSI category, 2008
INSURANCE:
Outlook Money
Kotak Platinum Advantage Plan - Ranked 1st in Type II ULIP category, 2008
Kotak Long Life Wealth Plus Plans - Ranked 4th in the Type I ULIPs category
SECURITIES:
Finance Asia
Best Broker in India 2010
CNBC Financial Advisor Awards
Best Performing Equity Broker, 2008 & 2009
Asia money Brokers poll
Best local brokerage 2006, 2007, 2008, & 2009
Best Analyst in India Sanjeev Prasad, 2005, 2006, 2007, 2008, & 2009.
Finance Asia Country for Achievement
Best Broker in India, 2006, 2009 & 2010
Thomson Extel Surveys Awards
India's Leading Equity House, 2007
Super Brands Council of India
Business Super brand India, 2008.
INVESTMENT BANKING:
Finance Asia
Best Investment Bank in India, 2010.
Best Equity House in India, 2010.
Best Broker in India, 2010.
Asia Money
Best Domestic Equity House, 2010
Best Local Brokerage in the Asia money Brokers Poll 2010
Global Finance
Best Investment Bank in India, 2010
Euro Money Real Estate poll
Best Bank for Equity Finance in India, 2010
Asset Asian Awards
Best Domestic Investment Bank, 2010
Finance Asia Country Awards for Achievement
Best Investment Bank in India, 2006, 2007, 2008, 2009 & 2010
Best Equity House in India, 2008 & 2010.
Asia money Best Domestic bank Awards
Best Domestic Equity House, 2008, 2009 & 2010
IFR Asia
India Equity House of the Year, 2008
Global Finance
Best Investment Bank in India, 2008, 2009 & 2010
Asset Asian Awards
Best Domestic Investment Bank, 2006, 2007, 2008 & 2009
ASSET MANAGEMENT:
MISCELLANEOUS:
Indian Business Leader of the Year, 2008 awarded to Uday Kotak, Executive Vice Chairman &
Managing Director
WEALTH MANAGEMENT:
Finance Asia
Best Private Bank India Finance Asia 2010
ADEQUATE CAPITAL:
Mr. Kotak said that the bank, with a capital adequacy ratio of over 20 per cent, has a significant ability to
invest, lend and grow without being short of capital. The bank's tier-I capital is about 18 per cent. Capital
is not an issue for the bank, and making good use of capital is our focus, he added.
In order to have a wider reach, the bank is also focusing on smaller customers, and has significantly
increased its portfolio in car finance, commercial vehicles, tractors and other such areas that serve small
customers, pointed out Mr. Kotak.
The Bank at present has a network of over 300 branches and 540 ATMs across 150 locations in the
country. Technology would also help them in the process, he said, pointing out that in future the banking
industry has a big opportunity to be transformed by technology.
The way to deepen to be much more driven by technology, he added. There are also plans to recruit
200-300 people a month for branch banking and support network.
4. CONCEPTUAL FRAMEWORK
DERIVATIVES INSTRUMENTS IN INDIA:
The first derivative product to be introduced in the Indian securities market is going to be
"INDEX FUTURES". In the world, first index futures were traded in U.S. on Kansas City Board
of Trade (KCBT) on Value Line Arithmetic Index (VLAI) in 1982. Organized exchanges began
trading options on equities in 1973, whereas exchange traded debt options did not appear until
1982, on the other hand fixed income futures began trading in 1975, but equity related futures
did not begin until 1982.
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 Contracts (Regulation) Act, 1956 (SCR Act) 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.
GROWTH OF DERIVATIVES:
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:
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
indexes,traded on Chicago Mercantile Exchange.
During the Mid eighties, financial futures became the most active derivative instruments
generating volumes many times more than the commodity futures.
Index futures, futures on T-bills and Euro-Dollar futures are the three most popular futures
contracts traded today.
Other popular international exchanges that trade derivates are LIFFE in England,
DTB in Germany, SGX in Singapore, TIFFE in Japan MATIF in France, Eurex etc.
Industrial policy
Management capabilities
Consumers preference
Labour strike, etc.
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:
1. Economic
2. Political
3. Sociological changes are sources of systematic risk.
For instance, inflation, interest rate, etc. their effect is to cause prices of 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 stocks. Those factors favor 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.
Prices in an organized derivatives market reflect the perception of market participants about the
future and lead the price of underlying to the perceived future level. The prices 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.
Derivatives market 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 it 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. They often energize others to create new
businesses, new products and new employment opportunities, the benefit of which are immense.
regulation and control of trading and settlement of derivatives contracts. The provisions in the
SC(R) A and the regulatory framework developed there under govern trading in securities. The
amendment of the SC(R) A to include derivatives within the ambit of securities in the SC(R) A
made trading in derivatives possible within the framework of the Act.
1. Any exchange fulfilling the eligibility criteria as prescribed in the L C Gupta committee report
may 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 shall regulate the sales practices of its
members and will obtain approval of SEBI before start of trading in any derivative contract.
2. The exchange shall have minimum 50 members.
3. The members of an existing segment of the exchange will not automatically become the
members of derivative segment. The members of the derivative segment need to fulfill the
eligibility conditions as laid down by the L C Gupta committee.
4. The clearing and settlement of derivatives trades shall be through a SEBI approved clearing
corporation / house. Clearing corporation / houses complying with the eligibility conditions as
laid down by the committee have to apply to SEBI for grant of approval.
5. Derivative brokers/dealers and clearing members are required to seek registration from SEBI.
6. The minimum contract value shall not be less than Rs. 2 Lakh. Exchanges should also submit
details of the futures contract they propose to introduce.
7. The trading members are required to have qualified approved user and sales person who have
passed a certification programme approved by SEBI.
While from the purely regulatory angle, a separate exchange for trading would be a better
arrangement. Considering the constraints in infrastructure facilities, the existing stock (cash)
exchanges may also be permitted to trade derivatives subject to the following conditions.
1.Trading should take place through an on-line screen based trading system.
2.An independent clearing corporation should do the clearing of the derivative market.
3.The exchange must have an online surveillance capability, which monitors positions, price and
volumes in real time so as to deter market manipulation price and position limits should be used
for improving market quality.
4.Information about trades quantities, and quotes should be disseminated by the exchange in the
real time over at least two information-vending networks, which are accessible to investors in the
country.
5.The exchange should have at least 50 members to start derivatives trading.
6.The derivatives trading should be done in a separate segment with separate membership; That is,
all members of the cash market would not automatically become members of the derivatives
market.
7.The derivatives market should have a separate governing council which should not have
representation of trading by clearing members beyond whatever percentage SEBI may prescribe
after reviewing the working of the present governance system of exchanges.
8.The chairman of the governing council of the derivative division / exchange should be a member
of the governing council. If the chairman is broker / dealer, then he should not carry on any
broking or dealing on any exchange during his tenure.
9.No trading/clearing member should be allowed simultaneously to be on the governing council
both derivatives market and cash market.
TYPES OF DERIVATIVES:
1. Equity Derivatives (security Derivatives):
Index Future & Option
Stock Future & Option
2. Financial Derivatives:
Equity Derivatives
Forex currency future
Interest rate future
3. Underlying Asset or Derivatives:
Financial Derivatives
Commodities
Any other asset
TYPES OF DERIVATIVES:
The following are the various types of derivatives, explained below:
FORWARDS:
A forward contract is a customized contract between two entities, where settlement takes place
on a specific date in the future at todays pre-agreed price.
FUTURES:
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in
the future at a certain price. Futures contracts are special types of forward contracts in the sense
that the former are standardized exchange traded contracts.
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 give 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-term Equity Anticipation securities. These are options having a
maturity of up to three years.
BASKETS:
Basket options are options on portfolios of underlying assets. The underlying asset is usually a
moving average of a basket of assets. Equity index options are a form of basket options.
SWAPS:
Swaps are private agreements between two parties to exchange cash flows in the future
according to a prearranged formula. They can be regarded as portfolios of forward contracts. The
two commonly used Swaps are:
HEDGERS:
Hedgers face risk associated with the price of an asset. They use futures or options markets to
reduce or eliminate this risk.
SPECULATORS:
Speculators wish to bet on future movements in the price of an asset. Futures and options
contracts can give them an extra leverage; that is, they can increase both the potential gains and
potential losses in a speculative venture.
ARBITRAGERS:
Arbitrageurs are in business to take of a discrepancy between prices in two different markets, if,
for, example, they see the futures price of an asset getting out of line with the cash price, they
will take offsetting position in the two markets to lock in a profit.
INTRODUCTION OF FUTURES:
Futures markets were designed to solve the problems that exist in forward markets. A futures
contract is an agreement between two parties to buy or sell an asset as a certain time in the future
at a certain price. But unlike forward contract, the futures contracts are standardized and
exchange traded.
To facilitate liquidity in the futures contract, the exchange specifies certain standard underlying
instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or
which can be used for reference purpose in settlement) and a standard timing of such settlement.
A futures contract may be offset prior to maturity by entering into an equal and opposite
transaction. More than 90% of futures transactions are offset this way. The standardized items in
a futures contract are:
DEFINITION:
A future contract is an agreement between two parties to buy or sell an asset at a certain time in
the future at a certain price. Futures contracts are special types of forward contracts in the sense
that the former are standardized exchange-traded contracts.
FEATURES OF FUTURES:
TYPES OF FUTURES:
On the basis of the underlying asset they derive, the futures are divided into two types:
Stock futures
Index futures
OTC in nature
Customized
Less Liquidity
No Margin Payment
Settlement happens at end of Period
Table : 4.1
FUTURES TERMINOLOGY:
SPOT PRICE: The price at which an asset trades in the spot market.
FUTURES PRICE: The price at which the futures contract trades in the futures market.3
CONTRACT CYCLE: The period over which contract trades. The index futures contracts on
the NSE have one-month, twomonth and three-month expiry cycle which expire on the last
Thursday of the month. Thus a January expiration contract expires on the last Thursday of
January and a February expiration contract ceases trading on the last Thursday of February. On
the Friday following the last Thursday, a new contract having a three-month expiry is introduced
for trading.
EXPIRY DATE: It is the date specifies in the futures contract. This is the last day on which the
contract will be traded, at the end of which it will cease to exist.
CONTRACT SIZE: The amount of asset that has to be delivered under one contract. For
instance, the contract size on NSEs futures market is 50 Nifties.
BASIS: In the context of financial futures, basis can be defined as the futures price minus the
spot price. These will be a different basis for each delivery month for each contract. In a normal
market, basis will be positive. This reflects that futures prices normally exceed spot prices.
COST CARRY: The relationship between futures prices and spot prices can be summarized in
terms of what is known as the cost of carry. This measures the storage cost plus the interest that
is paid to finance the asset less the income earned on the asset.
INITIAL MARGIN: The amount that must be deposited in the margin account at the time a
futures contract is first entered into is known as initial margin.
MARKING-TO-MARKET: In the futures market, at the end of each trading day, the margin
account is adjusted to reflect the investors gain or loss depending upon the futures closing price.
This is called marking-to-market.
MAINTENANCE MARGIN: This is somewhat lower than the 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 and is
expected to top up the margin account to the initial margin level before trading commences on
the next day.
INTRODUCTION OF OPTIONS:
In this section, we look at the next derivative product to be traded on the NSE, namely options.
Options are fundamentally different from forward and futures contracts. An option gives the
holder of the option the right to do something. The holder does not have to exercise this right. In
contrast, in a forward or futures contract, the two parties have committed themselves to doing
something.
Whereas it costs nothing (except margin requirement) to enter into a futures contracts, the
purchase of an option requires as up-front payment.
DEFINITION:
Option is a type of contract between two persons where one grants the other the right to buy a
specific asset at a specific price within a specific time period. Alternatively the contract may
grant the other person the right to sell a specific asset at a specific price within a specific time
period. In order to have this right. The option buyer has to pay the seller of the option premium.
The assets on which option can be derived are stocks, commodities, indexes etc. If the
underlying asset is the financial asset, then the option are financial option like stock options,
currency options, index options etc, and if options like commodity option.
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
SELLER/WRITER OF AN OPTION:
The writer of the call /put options is the one who receives the option premium and is there by
obligated 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.
I.
INDEX OPTIONS:
These options have the index as the underlying. Some options are European while others are
American. Like index futures contract, index options contracts are also cash settled.
STOCK OPTIONS:
Stock options are options on the 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
II.
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 a 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 right but not the obligation to sell an asset by a certain
date for a certain price.
III.
On the basis of the exercised of the option, the options are classified into two
categories.
AMERICAN OPTION:
American options are options that can be exercised at any time up to the expiration
date, most exchange-traded option are American.
EUOROPEAN 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.
The following are the various factors that affect the price of an option they are:
Stock price: The payoff from a call option is a 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 increases, 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 increases.
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 increase as volatility increase.
Risk-free interest rate: The put options prices decline as the risk-free rate increases where as
the prices of call always increase as the risk-free interest rate increases.
Dividends: Dividends have the effect of reducing the stock price on the x-dividend rate. This
has a negative effect on the value of call options and a positive effect on the value of put options.
OPTIONS
1.Same in nature
2.Same in nature
3.Strike price is fixed, price moves
4.Price is always positive
5.Nonlinear payoff
6.only short at risk
Table : 4.2
SPOT
(2)
FUTURE
742.00
742.80
738.85
740.20
780.00
785.00
815.55
848.00
845.00
776.55
770.05
822.95
823.15
855.70
848.75
774.55
767.70
700.00
685.00
690.00
711.00
722.00
712.30
685.40
692.50
696.85
716.65
724.45
707.05
704.05
740
(3)
800
840
PUT OPTION
740
48.45
25.35
14.00 47.50
65.15
30.35
17.00 30.15
TRADING HOLIDAY
55.25
32.25
16.30 30.95
94.00
51.80
31.90 4.80
108.20 55.15
32.80 13.00
0
75.80
48.50 7.65
123.00 71.35
42.25 8.90
0
32.60
19.05 26.3
TRADING HOLIDAY
38.55
16.95
8.60
60.00
24.15
11.55
8.00
73.00
24.70
9.80
8.40
0
21.55
9.05
0
0
23.80
8.80
0
0
22.75
8.00
0
0
TRADING HOLIDAY
15.95
6.70
0
0
(4)
800
840
0
0
0
0
64.95
30.55
31.55
20.10
20.25
53.75
0
0
0
44.65
36.55
72.75
101.0
130.0
0
0
0
0
0
0
0
0
0
0
May/tue/29
May/wed/30
May/thu/31
Jun/fri/01
Jun/sat/02
Jun/sun/03
Jun/mon/04
695.00
697.00
660.00
640.10
645.00
682.90
660.65
634.80
637.10
673.25
681.35
661.45
31.00
77.00
13.00 0
3.50
1.05
0
105.5
0.90
0.75
1.05
0
0.55
0.20
0
0
1.20
0.20
0
0
TRADING HOLIDAY
0.05
0.05
0.05
0
0
0
0
0
0
0
0
0
0
0
TABLE DETAILS:
Second Column (a) explains the SPOT MARKET PRICE in cash segment on that date of
Opening Balance of Equity Amount.
Second column (b) explains the FUTURE MARKET PRICE in cash segment on that date of
Closing Balance on Future Market Amount.
The Third column explains call Option premiums amounting 740, 800, 840.
The Fourth column explains Put Option premiums amounting 740, 800, 840.
It is in the money for the buyer, so it is in out of the money for seller; hence his profit is also
increase.
Strike price
740.00
Spot price
681.35
Amount
+58.65
Premium Received
48.45
Net profit
10.20 x 100 = +1020
Seller Profit = Rs.1020 (Net Amount)
Because it is positive it is out of the money, hence seller will get more profit, incase spot price
increase in below strike price, seller get loss in premium level
740.00
681.35
58.65 x 100 = 5865
681.35
740.00
-58.65 x100 =-5865
738.85
740.20
770.05
822.95
823.15
855.70
848.75
774.55
712.30
685.40
692.50
696.85
716.65
724.45
704.05
682.90
660.65
634.80
637.10
673.25
661.45
Figure : 5.1
FUTURE MARKET:
B
UYER
11/05/2012(Buying)
738.85
04/06/2012(Cl., period)
SELLER
738.85
681.35
Loss
681.35
57.00
Profit
57.00
Because buyer future price will decrease so, he can get loss. Seller future price also decrease so,
profit also increase, In case seller future will increase, and he can get loss.
The closing price of Mahindra Satyam formerly Satyam Computer services, at the end
of the contract period is 681.35 and this is considered as settlement price.
Table : 5.3
SPOT PRICE
FUTURE PRICE
742.00
742.80
780.00
785.00
815.55
848.00
845.00
776.55
767.70
700.00
685.00
690.00
711.00
722.00
707.05
695.00
697.00
660.00
640.10
645.00
681.35
Figure : 5.2
738.85
740.20
770.05
822.95
823.15
855.70
848.75
774.55
712.30
685.40
692.50
696.85
716.65
724.45
704.05
682.90
660.65
634.80
637.10
673.25
661.45
6.CONCLUSIONS
OBSERVATIONS AND FINDINGS:
The future price of M/S KOTAK STOCK moving along with the market price.
If the buy price of the future is less than the settlement price, than the buyer gets profit on
futures.
If the selling price of the future is less than the settlement price, than the seller incur losses.
SUGGESTIONS:
In bullish market the call option writer incurs more losses so the investor is suggested to go for a
call option to hold, where as the put option holder suffers in a bullish market, so he is suggested
to write a put option.
In bearish market the call option holder will incur more losses so the investor is suggested to go
for a call option to write, where as the put option writer will get more losses, so he is suggested
to hold a put option.
In the above analysis the market price of M/S.KOTAK is having low volatility, so the call
option writers enjoy more profits to holders.
The derivative market is newly started in India and it is not known by every investor, so SEBI
has to take steps to create awareness among the investors about the derivative segment.
In order to increase the derivatives market in India, SEBI should revise some of their regulations
like contract size, participation of FII in the derivatives market.
Contract size should be minimized because small investors cannot afford this much of huge
premiums.
SEBI has to take measures to use effectively the derivatives segment as a tool of hedging.
CONCLUSIONS:
Derivatives market is an innovation to cash market. Approximately its daily turnover reaches to
the equal stage of cash market. The average daily turnover of the NSE derivative segments
In cash market the profit/loss of the investor depends on the market price of the underlying
asset. The investor may incur huge profits or he may incur huge loss. But in derivatives segment
the investor enjoys huge profits with limited downside.
In cash market the investor has to pay the total money, but in derivatives the investor has to pay
premiums or margins, which are some percentage of total money.
In derivative segment the profit/loss of the option writer is purely depend on the fluctuations of
the underlying asset.
BIBLIOGRAPHY:
BOOKS:
JOURNALS:
NEWS PAPERS:
Economic times
The Hindu
Business Standard
MAGAZINES:
Business Today
Business World
Business India
WEBSITES:
www.derivativesindia.com
www.indianinfoline.com
www.nseindia.com
www.bseindia.com
www.sebi.gov.in
www.google.com
Source : http://oumbanotes.blogspot.in/2012/12/mba-project-on-derivativesfuture.html