equity and derivative

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EXECUTIVE SUMMARY

The project is about the study of equity and derivative market. It gives the knowledge of market

position of the company. I studied as to how this company proves to an option for the investors,by studying the performance of investing in equity & derivative for few months considering their

analysis. I selected area of COMPARITIVE ANALYSIS OF EQUITY & DERIVATIVE, which

attract different kinds of investors to invest in equity derivative and to face high risk and get high

returns. The major findings of the project are to overview of the comparison of equity cash

segment and equity derivative segment, overview of the equity and F & O segment from April

2010 to June 2010. The methodology of the project here is to analyze the Equity & Derivative

performance based on NAV, EPS and other things. In this project I also included my practical

situation during the project internship, that how the market goes up and down and why it

happens.

The methodology of the project here is to analyze the investment opportunities available for

those investors & study the returns & risk involved in various investment opportunities and also

study of investment management & risk management. So for that we have to study & analyze the

performance of Equity & Derivative in the market. We know that there is a high risk, high return

in equity but in a long time only. While in derivative there is a high risk, high return in the short

term, because derivative contract is for short time for 1/2/3 months only. So this project included

different types of returns, margin & risk involved in equity, and types, need, use & margin

involved in the derivatives market and also participants & terms use in derivative market.



CHAPTERIZATION

CHAPTER-I: INTRODUCTION

Need and importance

Objectives

Scope of the study

Methodology

Limitations

CHAPTER-II: COMPANY PROFILE

CHAPTER-III: EQUITY & DERIVATIVE PERSPECTIVES

EQUTIY PERSPECTIVES

Reasons for issuing equity

Equity Investment strategies

Characteristics of Equity

Benefits of Equity

Return on Equity

Selection of share

Risk associated with Equity Investment

Equity analysis

DERIVATIVE PERSPECTIVES

Introduction/Meaning

Factors driving growth of derivatives



Benefits of derivatives

Characteristics of derivatives

Types of derivative markets

Traders in derivative markets

Types of futures & options

Derivative analysis

CHAPTER-IV: COMPARATIVE ANALYSIS AND INTERPRETATIONS

CHAPTER-V: CONCLUSIONS AND SUGGESTIONS



INTRODUCTION

BACKGROUND OF THE STUDY:

The oldest stock exchange in Asia (established in 1875) and the first in the country to be granted

permanent recognition under the Securities Contract Regulation Act, 1956, Bombay Stock

Exchange Limited (BSE) has had an interesting rise to prominence over the past 133 years. A lot

has changed since 1875 when 318 persons became members of what today is called ³Bombay

Stock Exchange Limited´ paying a princely amount of Re 1. In 2002, the name "The Stock

Exchange, Mumbai" was changed to Bombay Stock Exchange. Subsequently on August 19,

2005, the exchange turned into a corporate entity from an Association of Persons (AoP) and

renamed as Bombay Stock Exchange Limited.

BSE, which had introduced securities trading in India, replaced its open outcry system of trading

in 1995, with the totally automated trading through the BSE Online trading (BOLT) system. The

BOLT network was expanded nationwide in 1997.

Since then, the stock market in the country has passed through both good and bad periods. The

journey in the 20th century has not been an easy one. Till the decade of eighties, there was no

measure or scale that could precisely measure the various ups and downs in the Indian stock

market. Bombay stock Exchange Limited (BSE) in 1986 came out with a stock Index that

subsequently became the barometer of the Indian Stock Market.

SENSEX first compiled in 1986 was calculated on a ³Market Capitalization Weighted´

methodology of 30 component stocks representing a sample of large, well established and

financially sound companies. The base year of SENSEX is 1978-79. The index is widelyreported in both domestic and international markets through prints as well as electronic media.

SENSEX is not only scientifically designed but also based on globally accepted construction and

review methodology. From September 2003, the SENSEX is calculated on a free-float market

capitalization methodology. The ³free-float Market Capitalization-Weighted´ methodology is a



widely followed index construction methodology on which majority of global equity benchmarks

are based.

The growth of equity markets in India has been phenomenal in the decade gone by Right from

early nineties the stock market witnessed heightened activity in terms of various bull and bear

runs. The SENSEX captured all these happenings in the most judicial manner. One can identify

the booms and bust of the Indian equity market through SENSEX.

The Exchange also disseminates the Price-Earnings Ratio, the Price to Book Value Ratio and the

Dividend Yield Percentage on day-to-day basis of all its major indices. The value of all BSE

indices are every 15 seconds during the market hours and displayed through the BOLT system.

BSE website and news wire agencies.

All BSE-Indices are reviewed periodically by the ³Index Committee´ of the Exchange. The

Committee frames the broad policy guidelines for the development and maintenance of all BSE

indices. Department of BSE Indices of the exchange carries out the day to day maintenance of all

indices and conducts research on development of new indices.

Institutional investors, money managers and small investors all refer to the Sensex for their

specific purposes The Sensex is in effect the substitute for the Indian stock markets. The

country's first derivative product i.e. Index-Futures was launched on SENSEX.

PERFORMANCE OF SENSEX FROM 1991

GRAPH SHOWING SENSEX PERFORMANCE



Financial market:-

Financial market is a mechanism that allows people to easily buy and sell (trade) financial

securities (such as stocks and bonds), commodities (such as precious metals or agricultural

goods), Financial markets have evolved significantly over several hundred years and are

undergoing constant innovation to improve liquidity.

A system that facilitates the exchange of money for financial assets. A security market such as

the National Stock Exchange is an example of a financial market.

Financial market

Equity market Derivative market



Equity market:-

A equity market is a public market for the trading of company stock at an

agreed price; these are securities listed on a stock exchange as well as those only traded

privately.

When you buy a share of a company you become a shareholder in that company. Shares

are also known as Equities. Equities have the potential to increase in value over time. It also

provides your portfolio with the growth necessary to reach your long term investment goals.

Research studies have proved that the equities have outperformed most other forms of

investments in the long term.

Equity is a share in the ownership of a company. It represents a claim on the company's

assets and earnings. As one acquire more stock, his ownership stake in the company increases.

The terms share, equity and stock means the same thing and can be used interchangeably.

Holding a company¶s stock means that you are one of the many owners (shareholders) of

a company, and, as such, you have a claim (to the extent of your holding) to everything the

company owns. As an owner, you are entitled to your share of the company's earnings as well as

any voting rights attached to the stock. Some may hold only a single share worth a few rupees,

cast only a single vote, and receive a tiny proportion of profit and dividends. Shareholders mayalso include giant pension funds and insurance companies whose investment may run to millions

of shares and hundreds of millions of rupees, and who are entitled to a correspondingly large

number of votes and proportion of profits and dividends.

Although the stockholders own the corporation, they do not manage it. Instead, they vote

to elect a board of directors. The board of directors represents the shareholders. It appoints top

management and is supposed to ensure that managers act in the shareholders¶ best interest.

This separation of ownership and management gives corporations permanence. Even if

managers quit or are dismissed and replaced, the corporation can survive, and today¶s

stockholders can sell all their shares to new investors without disrupting the operations of the

business.



In case of holding equity shares, the maximum value you can lose is the value of your

investment, which means that stockholders cannot be held personally responsible for the firm¶s

debt. Even if a company of which you are a shareholder goes bankrupt, you can never lose your

personal assets.

For example, in a company the total equity capital of Rs 2,00,00,000 is divided into

20,00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then

is said to have 20, 00,000 equity shares of Rs 10 each.

Derivative market: -

The derivatives markets are the financial markets for derivatives. The market can be

divided into two, that for exchange traded derivatives (ETD) and that for over-the-counter

derivatives(OTC).

The word ³DERIVATIVES´ is derived from the word itself derived of an underlying

asset. It is a future image or copy of an underlying asset which may be shares, stocks,

commodities, stock index, etc.

For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of

a change in prices by that date. Such a transaction is an example of a derivative. The price of this

derivative is driven by the spot price of wheat which is the "underlying".

Derivatives have become very important in the field finance. They are very important

financial instruments for risk management as they allow risks to be separated and traded.

Derivatives are used to shift risk and act as a form of insurance. This shift of risk means that each

party involved in the contract should be able to identify all the risks involved before the contract

is agreed.

It is also important to remember that derivatives are derived from an underlying asset.

This means that risks in trading derivatives may change depending on what happens to the

underlying asset. The underlying asset can be equity, forex, commodity or any other asset.



For example, if the settlement price of a derivative is based on the stock price of a stock for e.g.

Infosys, which frequently changes on a daily basis, then the derivative risks are also changing on

a daily basis. This means that derivative risks and positions must be monitored constantly.

NEED OF THE STUDY

y Different kinds of investors to invest in equity & derivative and to face high risk and get

high returns.

y Company proves to an option for the investors.

y Studying the performance of investing equity & derivative for few months considering

their analysis.

OBJECTIVE OF THE STUDY

Any investor¶s vision is a long term investment and short term investment and gets high returns

by bearing high risk. For that objective need to be climbed successfully an so objectives of this

project are,

1) To find the RIGHT SCRIPT to buy and sell at the RIGHT TIME.

2) To understand the basic of equity investment like cost of equity, risk associated and different

strategies involved in that.

3) To understand the concept of the Financial Derivatives such as Futures and Options.

4) To know how derivatives can be use for hedging.

5) To know the outcome of Equity and Derivative.



SCOPE OF THE STUDY

The study is limited to ³Equity and Derivative Market´ With reference to the Indian context and

the India Infoline has been taken as representative sample for the study.

The study cannot be said as totally perfect, any alteration may come. The study has only made

humble attempt at evaluating the comparison of Equity & Derivatives Markets only in Indian

Context. The study is not based on the International perspective of the stock markets.

METHODOLOGY OF THE STUDY

The data collection methods include both primary and secondary collection methods.

Primary method: This method includes the data collected (of the various companies) from the

personal interaction with authorized members of India Infoline limited. Also the method of

analyzing has been explained by them.

Secondary method: The secondary data collection method includes:

y The lecturers delivered by the superintendents of respective departments.

y The brochures and material provided by India Infoline limited.

y The data and the various companies balance sheet collected from the internet

y Various books related to equities, capital market, corporate finance and other related

topics.

LIMITATIONS OF THE STUDY1) This project was restricted for two months hence exhaustive data is not available upon

which conclusions can be relied.

2) Investment in Securities carry risk so investment in Equity & Derivative is also carrying

risk on the basis of the market.



3) Factors affecting the Market Price of Investment may be due to Market forces,

Performance of the companies is not possible, and so all the data is not available.



COMPANY PROFILE



THE INDIA INFOLINE LIMITED

Origin:

India infoline Ltd., was founded in 1995 by a group of professional with impeccable

educational qualifications and professional credentials. Its institutional investors include Intel

Capital (world's) leading technology company, CDC (promoted by UK government), ICICI,

TDA and Reeshanar.

India Infoline group offers the entire gamut of investment products including stock

broking, Commodities broking, Mutual Funds, Fixed Deposits, GOI Relief bonds, Post office

savings and life Insurance. India Infoline is the leading corporate agent of ICICI Prudential Life

Insurance Co. Ltd., which is India' No. 1 Private sector life insurance company.

www.indiainfoline.com has been the only India Website to have been listed by none

other than Forbes in it's 'Best of the Web' survey of global website, not just once but three times

in a row and counting... ³A must read for investors in south Asia´ is how they choose to describe

India Infoline. It has been rated as No.l the category of Business News in Asia by Alexia rat ing.

Stock and Commodities broking is offered under the trade name 5paisa. India Infoline

Commodities pvt Ltd., a wholly owned subsidiary of India Infoline Ltd., holds membership of

MCX and NCDEX

Main Objects of the Company

Main objects as contained in its Memorandum or Association are:

1. To engage or undertake software and internet based services, data processing IT enabled

services, software development services, selling advertisement space on the site, web

consulting and related services including web designing and web maintenance, softwareproduct development and marketing, software supply services, computer consultancy

services, E-Commerce of all types including electronic financial intermediation business

and E-broking, market research, business and management consultancy.



2. To undertake, conduct, study, carry on, help, promote any kind of research, probe,

investigation, survey, developmental work on economy, industries, corporate business

houses, agricultural and mineral, financial institutions, foreign financial institutions,

capital market on matters related to investment decisions primary equity market,

secondary equity market, debentures, bond, ventures, capital funding proposals,

competitive analysis, preparations of corporate / industry profile etc. and trade / invest in

researched securities

VISION STATEMENT OF THE COMPANY:

³Our vision is to be the most respected company in the financial services space In India´.

Products: the India Infoline pvt ltd offers the following products

A. E-broking.

B. Distribution

C. Insurance

D. PMS

E. Mortgages

A. E-Broking:

It refers to Electronic Broking of Equities, Derivatives and Commodities under the brand name

of 5paisa

1. Equities

2. Derivatives

3. CommoditiesB.Distribution:

1. Mutual funds

2. Govt of India bonds.

3. Fixed deposits



C.Insurance:

1. Life insurance policies

2. General Insurance

3. Health Insurance Policies.

THE CORPORATE STRUCTURE

The India Infoline group comprises the holding company, India Infoline Ltd, which has 5

wholly-owned subsidiaries, engaged in distinct yet complementary businesses which together

offer a whole bouquet of products and services to make your money grow.

The corporate structure has evolved to comply with oddities of the regulatory framework

but still beautifully help attain synergy and allow flexibility to adapt to dynamics of different

businesses.

The parent company, India Infoline Ltd owns and managers the web properties

www.Indiainfoline.com and www.5paisa.com. It also undertakes research Customized and off-

the-shelf.

Indian Infoline Securities Pvt. Ltd. is a member of BSE, NSE and DP with NSDL. Its

business encompasses securities broking Portfolio Management services.

India Infoline.com Distribution Co. Ltd., Mobilizes Mutual Funds and other personal

investment products such as bonds, fixed deposits, etc.

India Infoline Insurance Services Ltd. Is the corporate agent of ICICI Prudential Life Insurance,

engaged in selling Life Insurance, General Insurance and Health Insurance products.

India Infoline Commodities Pvt. Ltd. is a registered commodities broker MCX and offers

futures trading in commodities.



India Infoline Investment Services Pvt Ltd., is proving margin funding and NBFC services to the

customers of India Infoline Ltd.,

Pictorial Representation of India Infoline Ltd



Management of India Infoline Ltd.,

India Infoline is a professionally managed Company. The promoters who run the

company/s day-to-day affairs as executive directors have impeccable academic professional track

records.

Nirmal Jain, chairman and Managing Director, is a Chartered Accountant, (All India

Rank 2); Cost Account, (All India Rank l) and has a post-graduate management degree from IIM

Ahmedabad. He had a successful career with Hindustan Lever, where he inter alia handled

Commodities trading and export business. Later he was CEO of an equity research organization.

R. Venkataraman, Director, is armed with a post- graduate management degree from IIM

Bangalore, and an Electronics Engineering degree from IIT, Kharagpur. He spent eight fruitful

years in equity research sales and private equity with the cream of financial houses such as ICICI

group, Barclays de Zoette and G.E. Capital

The non-executive directors on the board bring a wealth of experience and expertise.

Satpal khattar -Reeshanar investments, SingaporeThe key management team comprises seasoned

and qualified professionals.

Mukesh Sing- Director, India Infoline Securities Pvt Ltd.

Seshadri Bharathan- Director, India Infoline. Com Distribution Co Ltd

S Sriram- Vice President, Technology

Sandeepa Vig Arora- Vice President, Portfolio Management Services

Dharmesh Pandya- Vice President, Alternate Channel

Toral Munshi- Vice President, Research

Anil Mascarenhas- Chief Editor

Pinkesh Soni Financial controller

Harshad Apte Chief Marketing Officer



Fiancials of India Infoline Ltd.,

As per the latest results India Infoline limited's Net Sales for the 3 months period ending 31-

Dec-2009 is Rs.2317.53 Mn and its PAT is Rs 647.17 Mn.

Financials

All

figures in

Mn QoQ YoY



Component

Current

Quarter Previous Quarter Last Year's Quarter

Quarter ending

(months)

31-Dec-

2009 (3)

30-Sep-

2009 (3) Difference(%)

31-Dec-

06 Difference(%)

Net sales 2317.53 1191.12 94.57 2317.53 0

Other income 81.13 118.83 -31.73 81.13 0

Total income 2398.66 1309.95 83.11 2398.66 0

Total expenses 0 543.41 -100 0 N.A

Gross profit(OPBDIT) 2398.66 766.53 212.92 2398.66 0

Depreciation 23.96 51.16 -53.16 23.96 0

Operating profit(OPBIT) 2374.7 715.38 231.95 2374.7 0

Interest 0 32.71 -100 0 N.A

OPBT 2374.7 682.66 247.86 2374.7 0

Extraordinaryincome / exp 0 0 N.A 0 N.A

Prior period

adjustments 0 0 N.A 0 N.A

PBT 2374.7 682.66 247.86 2374.7 0

Tax provision 329.13 227.28 44.81 329.13 0

Net profit (PAT) 2045.57 455.38 349.2 2045.57 0

Adjusted PAT 2045.57 455.38 349.2 2045.57 0

Average tax rate 0.14 0.33 -58.37 0.14 0

GPM (%) 103.5 64.35 60.83 103.5 0

OPM (%) 102.47 60.06 70.61 102.47 0

NPM (%) 102.47 57.31 78.78 102.47 0

Equity Capital 533.88 533.55 0.06 533.88 0



Its growth figures for last 5 quarters

Growth Margins -

Quarterly (Difference between successive quarters) In %

Quarter

ending

(months

) 31-Dec-2009 (3)

30-Sep-2009

(3)

30-Jun-2009

(3)

31-Mar-2009

(3)

31-Dec-2006

(3)

Compo

nent Value

Differe

nce

(%)

Valu

e

Differ

ence

(%) Value

Differ

ence

(%) Value

Differ

ence

(%)

Valu

e

Differe

nce (%)

GPM 103.5 60.83

64.3

5 71.04 37.63 71.04 0 71.04 0 71.04

OPM 102.47 70.61

60.0

6 90.59 31.51 90.59 0 90.59 0 90.59

NPM 102.47 78.7857.31

-303.05 -28.23

-303.05 0

-303.05 0 -303.05

View the line graphs below for the Sales & Pat growth pattern over last 5 quarters:



Sales & PAT

Peer Group Comparison

Figured in Mn

Company name Sales Rank PAT Rank Market Cap Rank

India Infoline Limited 2697.80 1 521.22 2 68283.17 3

Indiabulls Financial Services Limited 2611.70 2 1531.03 1 179464.07 1

Edelweiss Capital Limited 576.38 3 261.97 3 75670.97 2

Motilal Oswal Financial Services Limited 107.48 4 14.88 5 41271.01 4

Religare Enterprises Limited 25.91 5 119.72 4 40454.70 5



CHAPTER III

EQUITY AND DERIVATIVE

PERSPECTIVES



Equity

Total equity capital of a company is divided into equal units of small denominations, each called

a share.

y It is a stock or any other security representing an ownership interest.

y It proves the ownership interest of stock holders in a company.

For example:-

In a company the total equity capital of Rs 2, 00, 00,000 is divided into 20, 00,000 units of Rs 10

each. Each such unit of Rs 10 is called a Share. Thus, the company then is said to have 20,

00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and

have voting rights.

Reasons for issuing equity

To expand the business, a company, at some point, needs to raise money. To do this, it caneither borrow by taking a loan or raise funds by offering prospective investors a stake in the

company. which is known as issuing stock. However it can also buy back those shares, if

required. A company usually borrows from banks and/or financial institutions. This is called

µdebt financing¶.

On the other hand, issuing stock is called µequity financing¶. Loans raised are used for

temporary cash requirements (such as borrowing to fund a project), issuing stock is used to raise

funds of a permanent nature.

After taking the financing decision now the company has to decide the investment

decision. Investment and financing decisions are typically separated. When an investment

opportunity or ³project´ is identified, the project manager first asks whether the project is worth



more than the capital required to undertake it. If the answer is yes, he or she then considers how

the project should be financed.

EQUITY INVESTMENT STRATEGIES

Equity investment strategies include:

Buy-and-hold strategy Vs a market-timing strategy and

Value-oriented strategy Vs a growth-oriented strategy

Buy-and-hold Vs a market- timing strategy

A buy-and-hold strategy is like selecting and holding those stocks which has strong earning

potential and appreciation over the long term. Generally, the stocks are maintained as long as it

has the power to generate profit (or at least according to expectations), even though there may be

price swings. When they are no longer able to generate the adequate return/ profit then they are

sold away.

A market-timing strategy is more short term than a buy-and-hold strategy. Market timing

is used to capture short-term swings. This strategy seeks to optimize stock returns over simplybuying and holding stocks.

Value-oriented Vs growth oriented strategy

Value investing means identifying and investing in companies that are believed to be

currently undervalued but whose worth will be recognized by the market eventually. These

companies¶ intrinsic or fundamental values are higher than their current market values. This

strategy implies investing in such companies before the markets recognize their true values and

push up their share prices accordingly.



Growth investing means investing in those companies that show steady growth over a

certain time period, whose turnover and profits are expected to grow significantly, which will

result in appreciation in their share prices. Companies, whose potential for growth in sales and

earnings are excellent, are growing faster than other companies in the market are or other stocks

in the same industry are called the Growth Stocks. These companies usually pay little or no

dividends and instead prefer to reinvest their profits in their business for further expansions.

CHARACTERISTICS OF EQUITY

Profit Sharing: Investors can enjoy unlimited participation in the earnings of the firm.

Generally, there is no limit for a particular firm to earn profit and if it wants, it candistribute a part of that among the shareholders as dividends, because the dividend payment

is not compulsory. Dividend is a percentage of the face value of a share that a company

returns to its shareholders from its annual profits. Of course there is always a risk of non-

functioning or less profitability of the firm, which mainly the equity shareholders have to

bear.

Voting Rights: Equity stocks come with certain rights including the voting rights to which

the investors are entitled.

Limited Liability: Another important feature of equity is its limited liability, which means

that stockholders cannot be held personally responsible for the firm¶s debt, unlike

partnerships and sole proprietorships. In case of bankruptcies no one can demand the

shareholders to put up more money to cover the companies¶ debts. Stockholders can lose

their entire investment, but no more.

Highly liquid: Equity stocks are generally highly liquid instruments, which can be bought

and sold easily in the equity markets. Ownership stake in the company changes with every

buy and sell. An investor can acquire ownership and sell off his ownership quite easily

whenever he wishes to do so.



Benefits from Equity

The benefits distributed by the company to its shareholders can be:

1) Monetary Benefits

2) Non Monetary Benefits.

1. Monetary Benefits:

A. Dividend: An equity shareholder has a right on the profits generated by the Company. Profits

are distributed in part or in full in the form of dividends. Dividend is an earning on the

investment made in shares, just like interest in case Of bonds or debentures. A company can

issue dividend in two forms:a) Interim Dividend

b) Final Dividend.

While final dividend is distributed only after closing of financial year; companies at times

declare an interim dividend during a financial year. Hence if X Ltd. earns a profit of Rs 40 crore

and decides to distribute Rs 2 to each shareholder, a holding of 200 shares of X Ltd. Would

entitle you to Rs 400 as dividend. This is a return that you shall earn as a result of the investment

made by you by subscribing to the shares of X Ltd.

B. Capital Appreciation: A shareholder also benefits from capital appreciation. Simply put, this

means an increase in the value of the company usually reflected in its share price. Companies

generally do not distribute all their profits as dividend. As the companies grow, profits are re-

invested in the business. This means an increase in net worth, which results in appreciation in the

value of shares. Hence, if you purchase 200 shares of X Ltd at Rs 20 per share and hold the

same for two years, after which the value of each share is Rs 35. This means that your capital has

appreciated by Rs 3000.

2. Non-Monetary Benefits:



Apart from dividends and capital appreciation, investments in shares also fetch some type of

non-monetary benefits to a shareholder. Bonuses and rights issues are two such noticeable

benefits.

A. Bonus: An issue of bonus shares is the distribution free of cost to the shareholders usually

made when a company capitalizes on profits made over a period of time. Rather than paying

dividends, companies give additional shares in a pre-defined ratio. Prima facie, it does not affect

the wealth of shareholders. However, in practice, bonuses carry certain latent advantages such as

tax benefits, better future growth potential, and an increase in the floating stock of the company,

etc. Hence if X Ltd decides to issue bonus shares in a ration of 1:1, every existing Shareholder of

X Ltd would receive one additional share free for each share held by him. Of course, taking the

bonus into account, the share price would also ideally fall by 50 percent post bonus. However,

depending upon market expectations, the share price may rise or fall on the bonus

announcement.

B. Rights Issue: A rights issue involves selling of ordinary shares to the existing shareholders of

the company. A company wishing to increase its subscribed capital by allotment of further shares

should first offer them to its existing shareholders. The benefit of a rights issue is that existing

shareholders maintain control of the company. Also, this results in an expanded capital base,

after which the company is able to perform better. This gets reflected in the appreciation of share

value.

Risks In equity investment:

Although an equity investment is the most rewarding in terms of returns generated, certain risks

are essential to understand before venturing into the world of equity.

y Market/ Economy Risk.

y Industry Risk.

y Management Risk.

y Business Risk.



y Financial Risk

y Exchange Rate Risk.

y Inflation Risk.

y Interest Rate Risk.

How to overcome risks:

Most risks associated with investments in shares can be reduced by using the tool of

diversification. Purchasing shares of different companies and creating a diversified portfolio has

proven to be one of the most reliable tools of risk reduction.

The process of Diversification:

When you hold shares in a single company, you run the risk of a large magnitude. As your

portfolio expands to include shares of more companies, the company specific risk reduces. The

benefits of creating a well diversified portfolio can be gauged from the fact that as you add more

shares to your portfolio, the weightage of each company¶s share gets reduced. Hence any adverse

event related to any one company would not expose you to immense risk. The same logic can be

extended to a sector or an industry. In fact, diversifying across sectors and industries reaps the

real benefits of diversification. Sector specific risks get minimised when shares of other sectors

are added to the portfolio. This is because a recession or a downtrend is not seen in all sectors

together at the same time.

However all risks cannot be reduced:

Though it is possible to reduce risk, the process of equity investing itself comes with certain

inherent risks, which cannot be reduced by strategies such as diversification. These risks arecalled systematic risk as they arise from the system, such as interest rate risk and inflation risk.

As these risks cannot be diversified, theoretically, investors are rewarded for taking systematic

risks for equity investment.



Selection of Shares:

Proper selections of shares are of two types:-

1. Fundamental analysis:

It involves in ±depth study and analysis of the prospective company whose shares we want to

buy, the industry it operates in and the overall market scenario. It can be done by reading and

assessing the company¶s annual reports, research reports published by equity research houses,

research analysis published by the media and discussions with the company¶s management or the

other experienced investors.

2. Technical analysis :

It involves studying the prices movement of the stock over an extended period of

time in the past to judge the trend of the future price movement. It can be done by

software programs, which generate stock prices charts indicating upward. Downward and

sideways movements of the stock price over the stipulated time period.

When to buy & sell shares:

With high volatility prevailing in the market, major price fluctuations in equities

are not uncommon. Therefore, apart from ascertaining µwhich¶ stock to buy or sell, it becomes

equally important to consider µwhen¶ to buy or sell. Any investor should be aware of the fact

where all the investor is following i.e., Buy Low. Sell High.

That means we should buy stocks at a low price and sell them at a high price.

When to buy

Three ways by which we can figure that out what it is about this stock that makes it

hot.

1. Earnings per Share (EPS): How well the company is doing:

EPS is the total earning or profits made by company (during a given period of time) calculated

on per share basis. It aims to give an exact evaluation of the returns that the company can deliver.



Example:

Company XYZ Ltd. Capital: Rs 100 crore (Rs 1 billion).

Capital is the amount the owner has in the business. As the business grows and makes profits, it

adds to its capital. This capital is subdivided into shares (or stocks). The capital is divided into

100 million shares of Rs 10 each.

Net Profit in 2003-04: Rs 20 crore (Rs 200 million).

EPS is the net profit divided by the total number of shares.

EPS = net profit/ number of shares

EPS = Rs 20 crore (Rs 200 million)/ 10 crore (100 million) shares = Rs 2 per share

Lesson to be learnt

y If a company's EPS has grown over the years, it means the company is doing well, and

the price of the share will go up. If the EPS declines, that's a bad sign, and the stock price

falls.

y Companies are required to publish their quarterly results. Keep an eye out for these

results; check for the trend in their EPS.

2 Price earnings ratio (PE ratio): How other investors view this share



An indicator of how highly a share is valued in the market. It arrived at by dividing the closing

price of a share on a particular day by EPS. The ratio tends to be high in the case of highly rated

shares. The average PE ratio for companies in an industry group is often given in investment

journal. Two stocks may have the same EPS. But they may have different market prices. That's

because, for some reason, the market places a greater value on that stock. PE ratio is the market

price of the stock divided by its EPS.

PE = market price/ EPS

let¶s take an example of two companies.

Company XYZ Ltd

Market price = Rs 100

EPS = Rs 2

PE ratio = 100/ 2 = 50

Company ABC Ltd

Market price = Rs 200

EPS = Rs 2

PE ratio = 200/ 2 = 100

In the above cases, both companies have the same EPS. But because their market price is

different, the PE ratio is different.

Lesson to be learnt

y In the case of EPS, it is not so much a high or low EPS that matters as the growth in

the EPS. The company's PE reflects investors' expectations of future growth in the

EPS. A high PE company is one where investors have hopes that earnings will rise,

which is why they buy the share.



3. Forward PE: Looking ahead

The stock market is not nostalgic. It is forward looking. For instance, it sometimes happens that a

sick company, that has made losses for several years, gets a rehabilitation package from its bank

and a new CEO. As a consequence, the company's stock shoots up. Because investors think the

company will do better in the future because of the package and new leadership, and its earnings

will go up. And we think it is a good time to buy the shares of the company now. Suddenly, the

demand for the shares has gone up. Because stock prices are based on expectations of future

earnings, analysts usually estimate the future earnings per share of a company. This is known as

the forward PE. Forward PE is the current market price divided by the estimated EPS, usually for

the next financial year.

Forward PE = Current market price/ estimate EPS for the next financial year.

To illustrate what we have been talking about, let's take the example of Infosys Technologies.

Trailing 12-month EPS = Rs 56.82 (EPS of the last four quarters)

Closing price on January 6 = Rs 2043.15

PE = Price/EPS = 2043.15/ 56.82 = 35.95

Estimated EPS for 2004-05 = Rs 67

Estimated EPS for 2005-06 = Rs 90

these figures are according to brokers' consensus estimates.

Forward PE = current market price/ estimated EPS for next financial year

Forward PE for 2004-05 = 2043.15/ 67 = 30.49

Forward PE for 2005-06 = 2043.15/ 90 = 22.70

With an EPS growth of over 30%, a forward PE of 22.7 is not high, indicating that there is scope

to be optimistic about the stock's price.

Lesson to be learnt



y Sometimes, investors look out for a low PE stock, expecting that its price will rise in

the future. But sometimes, low PE stocks may remain low PE stocks for ages,

because the market doesn't fancy them.

y Keep tab on the business news to check out the company's prospects in the future

When to sell

Stock Reaches Fair Value or Target Price:

This is the easiest part of selling. We should sell when a stock reaches its fair value. It is the

main reason why we chose to buy it on the first place.

The target price can be computed by assessing the company¶s estimated financial performance

over the next 3 to 5 years, computing its EPS and using an acceptable P/E ratio to compute the

future market price. Based on this future estimated price and our required return on our

investment, compute our target price.

When the prices reaches Stop loss:It is advisable to always consider the possibility of a loss before making our investment. We

should decide how much loss we are willing to book in the stock. The lower price i.e., the price

at which we are willing curtail our loss, is called µStop Loss¶.

Need the money:

T he generally happens due to improper planning. However, things happen. Even the most

carefully planned strategy may not work. Catastrophic events may force investors to sell an

investment if his household is affected by it.

The book is unclean:

When management left their post abruptly or when the SEBI conduct a criminal investigation on

a company, it may be time to sell. Our assumption may be inaccurate as a lot of fair value



calculation is based on the company's balance sheet, cash flow or other financial statement

published by management.

Takeover news:

When one of your stock holding is getting bought by other companies, it may be time to sell.

Sure, you might like the acquiring company but you still need to figure out the fair value of the

common stock of the acquiring company. If the acquiring company is overvalued, then it is best

to sell.

Other Investment Opportunity:

Let us consider we bought stock A and it has risen to 10% below its fair value. Meanwhile, we

noticed that stock B fallen to below 50% of our calculated fair value. This is an easy decision.

We will sell our stock A and buy stock B. Our goal as an investor is to maximize our investment

return. Sacrificing a 10% of return in order to earn a 50% return is a sensible way to do that.

Inaccurate Fair Value Calculation:

There are factors that we might not take into accounts when researching a

particular company. For example, satyam scandal. As investors, we sometimes

made errors in our fair value calculation.

New Competitors with Better Products:

When new competitors sprung up, the company that you hold might have to spend more money

in order to fend off competition. Recent example includes the emergence of pay-per click

advertising by Google. Any advertising business such as newspapers or cable network, this new

product by Google might hurt profit margins and eventually the fair value of the stock.

Not having a valid reason to Buy:

When we don't know why we bought a particular stock, we won't know how much our potential

return is or when we should sell it. This is the easiest way of losing money. When we have no

valid reason to buy, we should sell immediately.



Types of Cash market margin

1. Value at Risk (VaR) margin.

2. Extreme loss margin

3. Mark to market Margin

1. Value at Risk ( VaR ) margin :

VaR Margin is at the heart of margining system for the cash market segment.

VaR is a technique used to estimate the probability of loss of value of an asset or group of assets

(for example a share or a portfolio of a few shares), based on the statistical analysis of historical

price trends and volatilities.

A VaR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage). Keep these three parts in mind as we give some examples of variations of the

question that VaR answers:

y With 99% confidence, what is the maximum value that an asset or portfolio may lose

over the next day?

Example:-

Suppose shares of a company bought by an investor. Its market value today is Rs.50 lakhs but its

market value tomorrow is obviously not known. An investor holding these shares may, based on

VaR methodology, say that 1-day VaR is Rs.4 lakhs at 99% confidence level. This implies that

under normal trading conditions the investor can, with 99% confidence, say that the value of the

shares would not go down by more than Rs.4 lakhs within next 1-day.

In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest

loss (in%) that may be faced by an investor for his / her shares (both purchases and sales) on a

single day with a 99% confidence level. The VaR margin is collected on an upfront basis (at the

time of trade).

How is VaR margin calculated?



VaR is computed using exponentially weighted moving average (EWMA) methodology. Based

on statistical analysis, 94% weight is given to volatility on µT-1¶ day and 6% weight is given to

µT¶ day returns.

To compute, volatility for January 1, 2008, first we need to compute day¶s return for Jan 1, 2009

by using LN (close price on Jan 1, 2009 / close price on Dec 31, 2008).

Take volatility computed as on December 31, 2008.

Use the following formula to calculate volatility for January 1, 2009:

Square root of [0.94*(Dec 31, 2008 volatility)*(Dec 31, 2008 volatility)+ 0.06*(January 1, 2009

LN return)*(January 1, 2009 LN return)]

Example:

Share of ABC Ltd

Volatility on December 31, 2008 = 0.0314

Closing price on December 31, 2008 = Rs. 360 Closing price on January 1, 2009 = Rs. 330

January 1, 2009 volatility =

Square root of [(0.94*(0.0314)*(0.0314) + 0.06 (0.08701)* (0.08701)] = 0.037 or 3.7%

How is the Extreme Loss Margin computed?

The extreme loss margin aims at covering the losses that could occur outside the coverage of

VaR margins.

The Extreme loss margin for any stock is higher of 1.5 times the standard deviation of

daily LN returns of the stock price in the last six months or 5% of the value of the position. This

margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis

for the past six months.

Example:

In the Example given at question 10, the VaR margin rate for shares of ABC Ltd. was 13%.

Suppose the 1.5 times standard deviation of daily LN returns is 3.1%. Then 5% (which is higher

than 3.1%) will be taken as the Extreme Loss margin rate.

Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme Loss



Margin). As such, total margin payable (VaR margin + extreme loss margin) on a trade of Rs.10

lakhs would be 1, 80,000/-

How is Mark-to-Market (MTM) margin computed?

MTM is calculated at the end of the day on all open positions by comparing transaction price

with the closing price of the share for the day.

Example:

A buyer purchased 1000 shares @ Rs.100/- at 11 am on January 1, 2008. If close price of the

shares on that day happens to be Rs.75/-, then the buyer faces a notional loss of Rs.25, 000/ - on

his buy position. In technical terms this loss is called as MTM loss and is payable by January 2,

2008 (that is next day of the trade) before the trading begins.

In case price of the share falls further by the end of January 2, 2008 to Rs. 70/-, then buy

position would show a further loss of Rs.5,000/-. This MTM loss is payable.

In case, on a given day, buy and sell quantity in a share are equal, that is net quantity

position is zero, but there could still be a notional loss / gain (due to difference between the buy

and sell values), such notional loss also is considered for calculating the MTM payable.

MTM Profit/Loss = [(Total Buy Qty X Close price)] - Total Buy Value] - [Total Sale Value -

(Total Sale Qty X Close price)]

STOCK SELECTION GUIDELINES

Choose a company:

Select companies in businesses that you already have an idea of and find interesting. One of the

businesses that could be of interest to you would be the one, which you are affiliated to because

of your employment or so on. For instance, if you are working in a manufacturing company, you

may understand this business well.



Analyze company¶s growth:

Just try to understand and analyze companies past performance and based on that determine the

future growth of the company. Ratio analysis is widely used to assess a company¶s past

performance.

Evaluate company¶s management:

The promoters and the management team of a company are the key people who drive

its business. Their integrity dictates whether the business benefits or they benefit

personally. Also, their experience and business competence is crucial for business

growth. Evaluate the company¶s promoters and management on the basis of four Cs:

Competence, Credibility, Corporate governance and Concern for shareholders.

Forecast the future prospects of the company

Although a company may have performed really well in the past, it is not necessary that it will

continue performing well in the future. All companies go through business cycles of ups and

downs. It is important that you form a view on the future trends of the business of the company

you have chosen. This can be done by reading views of experts in that business/industry and

forming your own view by reading and understanding economic trends and the impact of these

trends on the company¶s business.

Determine 5 year potential:

As mentioned earlier, the share price of all companies continuously fluctuate on the stock

markets with investors buying and selling the shares. The price at which an investor is willing to

buy or sell a share of a company is the perceived value of the share of the company taking into

consideration the company¶s present business and future business growth. In addition to this,

investor sentiment plays a large role in pricing of stocks. It is important that before you buy a

company¶s share, you assess whether the price of the share at which it is available for purchase,

is adequately valued i.e. it is not over-priced. Similarly, when you sell, you need to make sure



that you are not selling too cheap. To help you assess this, you could use a popular stock market

ratio called the Price/Earning ratio (P/E ratio).

The P/E ratio is based on the following formula:

P/E ratio = Market price of the share

Earning per share (EPS)*

*EPS = Profit After Tax (PAT)

Total number of shares issued by the company

Let¶s understand how the P/E ratio is used with an example:

Company ABC Ltd. has issued a total of 10 lakh equity shares and has earned a net profit of Rs

10 lakh. The EPS of the company is Re 1. The current market price of the company is Rs 15 per

share. The P/E ratio of Company ABC Ltd will be 15 (Rs 15 / Re 1).

The P/E ratio helps judge by how many times the company¶s share is traded based on its

earnings. In this case, the company¶s stock is available at a multiple of 15 times its earnings. The

higher the P/E ratio, the higher is the stock¶s valuation. Usually market prices of well-established

companies with a good past track record and reputed promoters command a high P/E ratio.

To use the P/E ratio correctly, keep the following aspects in perspective:

Compare the P/E ratio of a company with that of other companies in the same business.

Compare it with P/E ratios of the benchmark indices such as the P/E ratio of the BSE

Sensex, the NSE Nifty, etc.

Compare the P/E ratio with the growth potential of the company and the industry it is a

part of. There could be a situation that even if the P/E ratio of a company is high, it would be

worthwhile to buy the stock if the growth potential is significant.



It is said that the higher the P/E the more the market is willing to pay for the company¶s earnings.

But it doesn¶t holds true always as a high P/E ratio can be an indicator of lesser return and a low

P/E ratio can also indicate a higher return which we can understand with the help of an example:

Stock A Stock B *

Price Rs10.00 Rs20.00

Earnings per share Rs2.00 Rs2.00

P/E Ratio 5 10

* Stock B is more expensive than Stock A in terms of earnings. For Stock B, you must pay

Rs20.00 to earn Rs2.00, but for Stock A, you pay only Rs10.00 to earn Rs 2.00.

To conclude, just because a company¶s P/E ratio is high, it does not mean that it is over-priced.

Consider this ratio along with other factors such as past performance, business potential,

promoters, the company¶s order book position, etc.

Apart from analyzing the P/E ratio of certain companies, there are other fundamental methods

that will help to determine the actual worth of the company. Some of them are:

INTRINSIC VALUE

Intrinsic value means the real worth/ value of the investment, apart from its market price or book

value. The intrinsic value includes other variables such as brand name, trademarks, and

copyrights that are often difficult to calculate and sometimes not accurately reflected in the

market price.

MARGIN OF SAFETY

It is the difference between the companies¶ intrinsic value and the stock price. It mainly helps an

investor to take decision regarding his investment. It is basically a principle of investing in



which an investor only purchases shares when the market price is significantly below its intrinsic

value. This difference allows an investor to avoid making inaccurate decision and also minimize

the downside risk of his investment.

For example, you find that the intrinsic value for stock BIOCON is $70 and are currently

traded at $48. After applying 20 per cent discount, the fair value is $56 (20 per cent discount

from $70). So, current price at $48 is still lower than the discounted intrinsic value. In this

case, it is safe to buy the stock today.

EQUITY ANALYSIS

The fundamental analyst believes that securities are priced in a rational manner based on

macroeconomic information, industry news, and the firm's financial statements.

Technical analysis is the technique to forecast the future price of the stock by studying

the past trend such as past price, volume and market data. It only deals with the price movements

in the market with the help of various charts. It generally study the supply and demand of the

market and on the basis of that determine the trend that will continue in the future.

There are two classic market types used to characterize the general direction of the market.

Bull Market

Bear Market

Bull markets are movements in the stock market in which prices are rising and the

consensus is that prices will continue moving upward. During this time, economic production is

high, jobs are plentiful and inflation is low.

Bear markets are the opposite--stock prices are falling, and the view is that they willcontinue falling. The economy will slow down, coupled with a rise in unemployment and

inflation.

The field of technical analysis is based on three assumptions:

The market discounts everything



A major drawback of technical analysis is that it only considers price movement, ignoring the

fundamental factors of the company. However, technical analysis assumes that, at any given

time, a stock's price reflects everything that has or could affect the company- including

fundamental factors. Technical analysts believe that the company's fundamentals, along with

broader economic factors and market psychology, are all priced into the stock, removing the

need to actually consider these factors separately.

Price moves in trends:

In technical analysis, price movements are believed to follow trends. This means

that after a trend has been established, the future price movement is more likely to be in the

same direction as the trend than to be against it. Most technical trading strategies are based

on this assumption. Moving Averages and Elliott wave principle are said to be the most

common trend indicators.

History tends to repeat itself:

Another important idea in technical analysis is that history tends to repeat itself,

mainly in terms of price movement. The repetitive nature of price movements is attributed to

market psychology; in other words, market participants tend to provide a consistent reaction

to similar market stimuli over time. Technical analysis uses chart patterns to analyze market

movements and understand trends. Although many of these charts have been used for more

than 100 years, they are still believed to be relevant because they illustrate patterns in price

movements that often repeat themselves.

The equity analysis has been done on the following companies.

1) BATA INDIA

2) HDFC

3) ASIAN PAINTS

4) DABUR INDIA LTD



5) MRF TYRES

BATA INDIA:

Bata India manufactures different types of footwear including rubber/canvas footwear,

leather footwear and plastic footwear. The company offers various selection of footwear, Bata

also markets apparel under the brand names of ³North Star´, ³Power´ and ³Ambassador´. The

company sells its products through its retail outlets, as well as through wholesalers.

Present situation:

Net profit of Bata India declined 6.35% to Rs 10.33 crore in the quarter ended March

2009 as against Rs 11.03 crore during the previous quarter ended March 2008. Sales rose 6.80%

to Rs 233.03 crore in the quarter ended March 2009 as against Rs 218.20 crore during the

previous quarter ended March 2008.

The board of Bata India has recommended dividend at the rate of 25%.This was

recommended at the board meeting held on 27 February 2009.

Net profit of Bata India rose 0.05% to Rs 21.11 crore in the quarter ended December

2008 as against Rs 21.10 crore during the previous quarter ended December 2007. Sales rose

9.44% to Rs 255.23 crore in the quarter ended December 2008 as against Rs 233.22 crore during

the previous quarter ended December 2007.

For the full year, net profit rose 28.04% to Rs 60.74 crore in the year ended December 2008 as

against Rs 47.44 crore during the previous year ended December 2007. Sales rose 13.65% to Rs

983.60 crore in the year ended December 2008 as against Rs 865.45 crore during the previous

year ended December 2007.



Half yearly market report from Sep 2008- 28 Feb, 2009

In this case the BLUE bar indicates that stock has closed above than its open price and

RED bar indicates that the stock has closed lower its open price and other than that we should

also analyze the trend that this company follows:

Analyzing with the help of candlestick method:

With the help of candlesticks representation we can analyze that the market of BATA India has

shown a major decline from 150 (and above) to 79.5 in this six months. On the day before the

last day the company has shown a double decline to Rs 76.5. The stock previously moved up

from similar levels in Nov 2008. As per the last day, the company has shown a slight

improvement of Rs.3.5 on the day with an opening at Rs.81- Rs 82 and closing at Rs 84.5. Stop

loss is at Rs.79.5 while upside targets was at Rs.85.5.

The company has shown similar level in the mid of November and then the stock price

moved up to certain level. Once again it came to that level. So Rs 76.5 is said to be the Support

level i.e. from this level the company shows an upward movement and Rs 114- Rs 120 is

considered to be the Level of Resistance. As per the trend goes, it is suggested to buy the stock



with a 1-2 days perspective, as the stock price is expected to move higher. Let¶s see whether this

assumption really hold true or not by analyzing the price of next two months i.e. of March- April.

LINE CHART

The Line chart is the simplest type of chart. As shown in the chart the single line represents the

stock¶s closing price on each day of the entire year. Dates are displayed along the bottom of the

chart and prices are displayed on the side. Line charts are typically displayed using stocks

closing prices.

BATA INDIA:

Analyzing the stock movement from March 2009- April 2009:

By seeing the further movement of the stock price from Feb 2009, it is clear that the assumption

holds true. As it is a well saying that price movements are believed to follow trends and in case

of this company it holds true also.

As seen in the previous chart that the stock price of the company has shown a decline in

the 28 Feb 2009. But its condition has become somewhat better from March 2009 onwards. On

28 Feb it closes with the price of Rs79.5 and on April it has reached almost Rs 120. And by the

end of the month it has reached to Rs 130.90, thus succeeded to break the resistance level. A



break above the resistance level indicate that buyers have increased their expectations and are

willing to buy at even higher prices.

COMPARITIVE ANALYSIS WITH BSE

One-year comparative graph with BSE

BATA BSE

With the help of this graph we can say that Rs. 100 invested in the BATA in May 2008 has a

worth of Rs.70 in April 2009, it has almost shown a fall of Rs.30 (approx). During this period,

the benchmark BSE Sensex too recorded a fall with Rs 100 invested in May 2008 declining to

Rs.70 in April 2009. During the time of bearish market both BATA and BSE has shown almost

equal decline in the previous year. But now the share price has started moving in the upward

direction. And as per the technical analysis it is suggested to buy the share of the company.



Now with the help of the fundamental analysis let us analyze whether investing in

this company will be riskier or beneficial.

CALCULATION OF THE INTRINSIC VALUE

Current price = 130 Rs

EPS = 9.1

P/E ratio = 14.4%

Market capitalization= Rs.8408

Dividend payout ratio=32.6%

Expected ROI= 10%

EPSGR (earning per share growth rate) = 33.60%

STEP 1- Forecast share price for the next 5 years.

Forecast share price in 2013=EPS after 5th

year * P/E ratio

= 9.1*(1.34)* 14.4

= 566

STEP 2- Forecast Total Future Value.



Year Projected EPS

2008 9.1*1=9.1

2009 9.1*1.34=12.19

2010 9.1*(1.34)²=16.33

2011 9.1*(1.34)³=21.90

2012 9.1*(1.34)=29.34

2013 9.1*(1.34)=39.3

Total EPS =128.16

Total Dividend = Total EPS*Dividend Payout Ratio

= 128.16*32.6% =41.78

Total Future Value=Forecasted stock price in 2013+Total Dividend

= 566+41.78 =607.78

STEP 3: Calculate Intrinsic Value which is equal to

NET PRESENT VALUE=FUTURE VALUE

(EXPECTED ROI)NO OF YEARS



NPV=608 = 377.64

(1.10)

STEP 4: Compare with current stock price

Since the intrinsic value (377.64) is more than the current stock price (130), the

value of the stock is undervalued

MARGIN OF SAFETY

This is simply discounting the calculated intrinsic value. You can use

any discount rate. In this case, the intrinsic value of BATA is 377.64. Using a

discount rate of 20%, the fair value is 302.11. The current price is Rs130. It is

still lesser than its intrinsic value.

CONCLUSION:

Investing in the company is proving to be beneficial on the basis of both

technical and fundamental analyses. And it is also suggested to invest in those

companies which holds profitable on the basis of both technical and



fundamental analysis, which means in those companies where both the technical

and fundamental analyses go hand in hand. In case of this company it can also

be concluded that the company has the potential to grow further. So, it is

advisable to buy the stock.

HDFC Bank

HDFC Bank is the second largest private sector bank in the country (afterICICI Bank) in terms of asset size. At the end of March 2007, it had a franchise of

over 1,600 ATMs and 680 branches. The bank is focusing on loan origination in

the retail, SME (small and medium enterprises) and agriculture segments and on

non-fund based products and services. Its group companies, HDFC Standard Life

(insurance), HDFC AMC (mutual funds) and HDFC Securities (equities) adds

scalability to the bank's offerings.

HDFC Bank Ltd has informed BSE that the Investor Grievance (Share)

Committee of the Bank at its meeting held on May 08, 2009, have approved

allotment of 70,421 equity shares to the employees of the Bank under the

Employees Stock Option Scheme (ESOS).



Price representation by OHLC/ Bar chart

Analyzing the stock movement from May 2008- April 2009:



The stock price of HDFC seems to be highly unstable. The prices are rising

and falling very soon, not giving the time to the investors to decide whether to

stick with their stocks or simply sell them. In May 2008 it has entered with the

price of Rs 1475. And by the end of the same month the price has fallen to Rs.

1050, a fall of approx 28.8%. Again in the month of Sep it has managed to reach

near to Rs 1350. Again within 2 months i.e. in the first week of November itself

the stock price has drastically fall to Rs 825 approx. In April 2009 somehow the

stock price has managed to reach Rs 1075- Rs 1100 and now its current price is

Rs.1379. By analyzing the trend it is suggested not to buy the shares of the

company as previous year the stock price has fallen from this particular level so

there is a chance for the price to follow the same trend again.





HDFC Bank BSE

With the help of this graph we can say that Rs. 100 invested in the HDFC Bank

in May 2008 has a worth of Rs.94 in April 2009, it has just shown a fall of Rs.6

(approx). During this period, the benchmark BSE Sensex has recorded a fall with

Rs 100 invested in May 2008 declining to Rs.70 in April 2009. During the time of

bearish market HDFC Bank has somehow managed the fall of its stock price

compared to the benchmark BSE. As it is said that equity market is a high risk-

high return market and it holds true as we can see in the case of HDFC Bank. The

investors of the bank havent faced much loss as compared to the investors of the

some other companies, as by the end of the year it has managed to reach the

price level of its starting point. The investors of the company are still standing in

the same point where they were standing in the previous year. And as there were

high fluctuations in the price level, so it is suggested not to hurry in investing in

the company.

Now, let us analyze whether the fundamental analysis supports our

assumption or not.




Current price = Rs1379

EPS = 53.0

P/E ratio = 26.0%



Expected ROI= 10%




year * P/E ratio

= 53*(1.06)* 26.0

= 1846.52


Year Projected EPS



2008 53*1=53

2009 53*1.06= 56.18

2010 53*(1.06)²=59.55

2011 53*(1.06)³=63.12

2012 53*(1.06)=66.90

2013 53*(1.06)=71.02

Total EPS =369.77


= 369.77*18.9% =69.88


= 1846.52+69.88 =1916.4




NPV=1916.4 = 1190.3

(1.10)




Since the intrinsic value (1190.3) is less than the current stock price (1379),

the value of the stock is overvalued

MARGIN OF SAFETY


any discount rate. In this case, the intrinsic value of HDFC Bank is Rs 1190.3,

which is already less than the stock price. Discounting the intrinsic value will

make the value of the company lesser than its stock price. Using a discount rate

of 20%, the fair value is 952.24. The current price is Rs1379. In this case the

stock price is more than the actual worth of the company. So it is advisable, not

to buy the stock.

CONCLUSION

Investing in the company is not that beneficial on the basis of both technical and

fundamental analyses. In case of technical analysis it has been found that the

share price of the company is highly unstable and fundamental analysis showed

that the price is more than the actual worth of the company. From which it can be



concluded that investing in the company includes high risk. So, it is not advisable

to buy the stock.

ASIAN PAINTS

Asian Paints has a market share of around 49% in the decorative paint segment.

The company, through a 50:50 joint venture with PPG Industries US, also has

presence in the automotive paints segment. The company is well focus on its core

business of paints and has posted a Company Annual Growth Rate (CAGR) of 28%

over the last five years in top line. The other competitors are Berger paint,

Nerolac etc.



The company manufactures and markets paints. The group also

manufactures phthalic anhydride and pentaerythritol. The group operates in

Australia, Fiji, Solomon Islands, Tonga, Vanuatu, Myanmar, China, Thailand,

Malaysia, Singapore, Bangladesh, Nepal, Sri Lanka, Bahrain, the UAE, Oman,

Barbados, Jamaica, Trinidad, Tobago, Egypt, Mauritius and Malta.

Asian Paints Limited has informed the Exchange regarding the

announcement made by Berger International Limited (BIL), Singapore which is

listed on the Singapore Stock Exchange Limited. BIL is a subsidiary of Asian Paints

Limited. Berger International Limited, Singapore has no operations in India





By analyzing the chart one can easily say that the company has shown a

steady decline over a certain period of time. On May 2008 the stock price of the

company was nearly around Rs1220-Rs 1230. It has even touched the price level

of Rs 1300 once in the mid of the month and then declined to Rs 1175 by the end

of the same month, which means a decline of 9.6% approx within a month itself.

Then again the stock price slightly increased to a level of Rs 1275, in the month of

August but after that it is showing a continuous fall in the price. The major fall in

the price level can be seen in the last week of September, when the share price

has declined from Rs 1180 to Rs 980, a straight Rs 200/ 16.9% fall within a week.

When the price touched the level of Rs 1000/- in the month of October, the



investors believed that there will be an increase in the price level after that and Rs

1000 will act as a support level but all these assumptions proved wrong and there

was further decrease in the price level. Another decline of Rs 145/ 15.7% can be

notice in the end of Dec. Within a year i.e. in April 2009 it has came down to Rs

925 approx, i.e. a decline of 25% approx. and the current market price is Rs 955.



ASIAN Paints BSE

With the help of this graph we can say that Rs. 100 invested in the ASIAN

Paints in May 2008 has a worth of Rs.80 in April 2009, it has almost shown a fall of

Rs.20 (approx). During this period, the benchmark BSE Sensex too recorded a fall



with Rs 100 invested in May 2008 declining to Rs.70 in April 2009. During the time

of bearish market both ASIAN Paints and BSE has shown decline in the previous

year. Although the company has shown a decline but by analyzing the graph one

can say that while the overall market has been bearish, Asian Paints has managed

to stand better than BSE.

By the technical analysis it has been observed that investing in the company

wont be a good idea, but then let us analyze with the help of the intrinsic value

calculation whether investing in this company will be really beneficial or not.


Current price = Rs955

EPS = 44.8

P/E ratio = 21.3%



Expected ROI= 10%






year * P/E ratio

= 44.8*(1.37)* 21.3

= 4608.90


Year Projected EPS

2008 44.8*1=44.8

2009 44.8*1.37= 61.38

2010 44.8*(1.37)²=84.09

2011 44.8*(1.37)³=115.20

2012 44.8*(1.37)=157.8

2013 44.8*(1.37)=216.23

Total EPS =679.5


= 679.5*39.8% =270.44




= 4608.90+270.44 =4879.34




NPV=4879.34 = 3030.6

(1.10)


Since the intrinsic value (3030.6) is more than the current stock price (955),

the value of the stock is under valued

MARGIN OF SAFETY


any discount rate. In this case, the intrinsic value of ASIAN Paints is Rs 3030.6,



which is more than the current stock price. Using a discount rate of 20%, the fair

value is 2424.48. The current price is Rs 955. In this case the stock price is less

than the actual worth of the company. So it is advisable to buy the stock.

CONCLUSION

By analyzing this company through both the technical and fundamental ways it

is seen that as the company is worth more than its price but at the same time the

price level do not show a good growth in the short run. Investing in the company

is beneficial for the long term investors. An investment in the company for at

least 5-6 years will prove to be beneficial.

DABUR

Dabur is India's fourth largest FMCG Company. It has a wide variety of

health care, personal care and food products. The company's name is generic to

'ayurvedic' products in India and it has big brands like Vatika (hair oils),

Chyawanprash, Hajmola, Amla oil and Lal Dant Manjan in its stable. The ayurvedic

products and certain brands like Laltail and Lal Dant Manjan are particularly

strong in the rural markets where Dabur has a strong distribution network. Dabur

has hived off its other food products (Real fruit juice & Homemade culinary

pastes), into a 100 per cent subsidiary Dabur Foods Ltd.

Present situation:

Dabur India's net profit rose 16.40% to Rs 91.71 crore on 16.20% rise in

net sales to Rs 620.23 crore in Q4 March 2009 over Q8 March 2008. Early this

month, the company had announced that Ratna Commercial Enterprises, a



promoter group company, revoked 4.50 lakh shares representing 0.05% of the

equity capital of the company out of 1.45 crore shares representing 1.68% of the

equity capital of the company Ratna Commercial Enterprises held 9.44% stake in

the company as on 31 March 2009.

The company had in February 2009 announced that promoters pledged

more than 7.95 crore shares representing 9.20% of the equity capital of the

company. The total promoter shareholding in the company stood at 70.73% as on

31 March 2009.

The committee of Dabur India has granted 2,04,144 fresh stock options

under Dabur Employees Stock Option Scheme 2000 to the eligible employees of

the company. The above options have vesting period of 1 year. These options

were granted at the committee meeting held on 29 April 2009.





By simply analyzing the graph one can say that stock price has not shown a

good movement in case of this company. It entered with a price of Rs 98 in May

2008 and after a certain highs and lows, it was back to Rs 98 in April 2009. After

reaching this level the investors thought that the price level will further show a

decline, as it has shown in the previous year but the share price has not followed

the previous trend and it has shown some further growth after that. We can

analyze that investing in this company wont be harmful as there can be seen a

stability in the price level of the company. The current stock price of the company

is Rs.115.9. Now we are going to further compare the company with BSE in order

to identify the actual scenario.





DABUR BSE

Now analyzing this graph gives an entire different picture. With the help

of this graph we can say that Rs. 100 invested in the DABUR in May 2008 has a

worth of Rs.100- Rs 110 in April 2009. During this period, the benchmark BSE

Sensex has recorded a fall with Rs 100 invested in May 2008 declining to Rs.70 in

April 2009. During the time of bearish market both where BSE has shown decline

in the previous year, DABUR has managed to hold its position. One can say that

during this period of not- so- good market condition also the company has

managed to outperformed the market.



With the help of the intrinsic value calculation let us analyze whether

investing in this company will be really beneficial or not.


Current price = Rs115.9

EPS = 3.9

P/E ratio = 30.0%


Expected ROI= 10%




year * P/E ratio

= 3.9*(1.24)* 30.0

= 343




Year Projected EPS

2008 3.9*1=3.9

2009 3.9*1.24= 4.84

2010 3.9*(1.24)²=5.99

2011 3.9*(1.24)³=7.43

2012 3.9*(1.24)=9.21

2013 3.9*(1.24)=11.4

Total EPS =42.77


= 42.77*38.8% =16.60


= 343+16.60 =359.6






NPV=359.6 = 223.35

(1.10)


Since the intrinsic value (223.35) is more than the current stock price (115.9),


MARGIN OF SAFETY


any discount rate. In this case, the intrinsic value of DABUR is Rs 223.35,

which is more than the current stock price. Now let¶s observe after using the

discount rate. Using a discount rate of 20%, the fair value is 178.68. The current



price is Rs 115.9. In this case the stock price is less than the actual worth of the

company. So it is advisable to buy the stock.

CONCLUSION

The company has proved to maintain stability and even its worth more

than its price. The company has the potential of further growth. So investing in

the company seems to be a good investment decision. In the case of this company

also our technical assumption holds equal to the fundamental calculation. So,

investing in the company is advisable.

MRF TYRES



MRF is India`s largest tyre manufacturer, having a 22% market share.

The company derives over 95% of its revenues from its core business i.e. tyres,

the rest comes from its presence in toys and paints. This focus on tyres has

enabled it to constantly increase capacities, and maintain market leadership and

profitability in most segments. MRF exports its products to over 75 countries

worldwide.

MRF reported a net loss of Rs 38.30 crore in Q1 December 2008 as

compared to net profit of Rs 51.75 crore in Q1 December 2007. Net sales rose

17% to Rs 1351.97 crore in Q1 December 2008 over Q1 December 2007.





Being remaining at the top position also couldn¶t escape the company

from the current market scenario. While entering, the share price of the company

was somewhere around Rs 4400. With small ups and downs the company has

shown a steady decline after the month of Sep, last year. It has faced a major

decline in the month of March, this year, when the share price has almost fallen

to Rs 1550. After that the price has bounced back. Showing a steady increase .In

the month of April 2009 the share price of the company was somewhere around

Rs 2250- Rs 2300. The current share price is Rs 2500.





MRF Tyres BSE

The graph says that Rs. 100 invested in MRF in May 2008 has a worth of

Rs.53- Rs54 in April 2009, it has shown almost a fall of Rs.47 (approx). And till the

month of May 2009, it has come up to a price level of Rs 56- Rs 57. During this

period, the benchmark BSE Sensex too recorded a fall with Rs 100 invested in May

2008 declining to Rs.70 in April 2009. During the time of bearish market both MRF

and BSE has shown decline in the previous year. It is also noticeable that the in

the starting of the period the company managed to run along with BSE. And from

the mid of October 2008 the price of the company has fallen below BSE and after

that its share price is moving in proportion with the price of BSE, which means a

small fall of BSE makes the company also fall to some extent and with the rise in

BSE, the company also rises. One can say that while the overall market has been

bearish, MRF has underperformed the market, as it has fallen much below the



benchmark. So it is suggested not to invest in the stock in the present scenario, till

it gains somewhat better position.

As its market price fall in the previous year, from that time onwards it has

not shown any kind of improvement. Once it has fallen, it further continues to fall.

So, it is advisable not to purchase the stock of the company. Further let us analyze

with the help of intrinsic value calculation and see that whether our assumptions

hold true or not.


Current price = Rs 2500

EPS = 332.1

P/E ratio = 7.5%



Expected ROI= 10%



Forecast share price in 2013=EPS after 5th year * P/E ratio



= 332.1*(1.16)* 7.5

= 5230


Year Projected EPS

2008 332.1*1=332.1

2009 332.1*1.16= 385.2

2010 332.1*(1.16)²=446.8

2011 332.1*(1.16)³=518.4

2012 332.1*(1.16)=601.3

2013 332.1*(1.16)=697.5

Total EPS =2981.3


= 2981.3*5.9% =175.90


= 5230+175.90=5405.9






NPV=5405.9 = 3358

(1.10)


Since the intrinsic value (3358) is more than the current stock price (2500),


MARGIN OF SAFETY




any discount rate. In this case, the intrinsic value of MRF is Rs 3358, which is

more than the current stock price. Using a discount rate of 20%, the fair value is

2686. The current price is Rs 2500. In this case the stock price is less than the

actual worth of the company but not much. So it is advisable to buy the stock.

CONCLUSION

By analyzing the company it can be concluded that the price of the shares of the

company has shown a continuous decline in the previous year and also the worth

of the company doesn¶t differ much than its current price. So it is advisable to

think twice before buying the stock.



Derivatives

The emergence of the market for derivative products, most notably forwards, futures and options,

can be traced back to the willingness of risk-averse economic agents to guard themselves against

uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets

are marked by a very high degree of volatility. Through of derivatives of 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 underlying prices. However, by

locking ±in asset prices, derivatives products minimize the impact of fluctuations in asset prices

on the profitability and cash flow situation of risk±averse investors.

DEFINITION:

Understanding the word itself, Derivatives is a key to mastery of the topic. The word originates

in mathematics and refers to a variable, which has been derived from another variable. For

example, a measure of weight in pound could be derived from a measure of weight in kilograms

by multiplying by two.

In financial sense, these are contracts that derive their value from some

underlying asset. Without the underlying product and market it would have no independent

existence. Underlying asset can a Stock, Bond, Currency, Index or a Commodity. Some one maytake an interest in the derivative products. Without having an interest in the underlying product

market, but the two are always related and may therefore interact with each other.

The term Derivative has been defined in Securities Contracts (Regulation) Act 1956, as:

A. A security derived from a debt instrument, share, loan whether secure or

unsecured, risk instrument or contract for differences or any other form of

security.

B. A contract, which derives its value from the prices, or index of prices, of

underlying securities.



IMPORTANCE OF DERIVATIVES

Derivatives are becoming increasingly important in world markets as a tool for risk management.

Derivatives instruments can be used to minimize risk. Derivatives are used to separate risks and

transfer them to parties willing to bear these risks. The kind of hedging that can be obtained by

using derivatives is cheaper and more convenient than what could be obtained by using cash

instruments. It is so because, when we use derivatives for hedging, actual delivery of the

underlying asset is not at all essential for settlement purposes.

More over, derivatives would not create any risk. They simply manipulate the risks and transfer

to those who are willing to bear these risks. For example, Mr. A owns a bike. If does not take

insurance, he runs a big risk. Suppose he buys insurance [a derivative instrument on the bike] he

reduces his risk. Thus, having an insurance policy reduces the risk of owing a bike. Similarly,

hedging through derivatives reduces the risk of owing a specified asset, which may be a share,

currency, etc.

Derivative is a product whose value is derived from the value of one or more basic variables,called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying

asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish

to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a

transaction is an example of a derivative. The price of this derivative is driven by the spot price

of wheat which is the "underlying".

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SCRA) defines

"derivative" to include-

1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk

instrument or contract for differences or any other form of security.



2. A contract which derives its value from the prices, or index of prices, of underlying securities.

Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by

the regulatory framework under the SC(R)A.

Factors driving the growth of derivatives

Over the last three decades, the derivatives market has 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:

1. Increased volatility in asset prices in financial markets,

2. Increased integration of national financial markets with the international markets,

3. Marked improvement in communication facilities and sharp decline in their costs,

4. Development of more sophisticated risk management tools, providing economic agents a

wider choice of risk management strategies, and

5. Innovations in the derivatives markets, which optimally combine the risks and returns over a

large number of financial assets leading to higher returns, reduced risk as well as transactions

costs as compared to individual financial assets.

Purpose and benefits of derivative market;-

1. Today's sophisticated international markets have helped foster the rapid growth in

derivative instruments. In the hands of knowledgeable investors, derivatives can derive

profit from:

y Changes in interest rates and equity markets around the world.

y Changes in price of assets.

2. Help of hedge against inflation and deflation, and generate returns that are not correlated

with more traditional investments. The two most widely recognized benefits attributed to

derivative instruments are price discovery and risk management and others.



3. Price discovery: -

The kind of information and the way people absorb it constantly changes

the price of a commodity. This process is known as price discovery. the price of all future

contracts serve as prices that can be accepted by those who trade the contracts in lieu of

facing the risk of uncertain future prices.

4. Risk management: -

This could be the most important purpose of the derivatives market.

Risk management is the process of identifying the desired level of risk, identifying the

actual level of risk and altering the latter to equal the former. This process can fall into

the categories of hedging and speculation.

5. Derivatives help in transferring risks from risk-averse people to risk-oriented people.

6. By allowing transfer of unwanted risks, derivatives can promote more efficient allocation

of capital across the economy and thus, increasing productivity in the economy.

7. Derivatives increase the volume traded in markets because of participation of risk-averse

people in greater numbers.

RATIONALE BEHIND THE DEVELOPMENT OF DERIVATIVES

Holding portfolio of securities is associated with the risk of the possibility that the investor may

realize his returns, which would be much lesser than what he expected to get. There are various

influences, which affect the returns.

1. Price or dividend (interest).

2. Sum are internal to the firm bike:

Industry policy

Management capabilities



Consumer¶s preference

Labour strike, etc.

These forces are to a large extent controllable and are termed as ³Non-systematic Risks´. An

investor can easily manage such non- systematic risks 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 other types of influences, which are external to the firm, cannot be controlled, and they

are termed as ³systematic risks´. Those are

1. Econonmic

2. Political

3. Sociological changes are sources of Systematic Risk.

For instance inflation interest rate etc. Their effect is to cause the 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 company¶s earnings rising and vice ±versa.

Rational behind the development of derivatives market is to manage this systematic risk,

liquidity. Liquidity means, being able to buy & sell relatively large amounts quickly without

substantial price concessions.

In debt market, a much larger portion 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. These factors favor for the purpose of both portfolio hedging

and speculation.

India has vibrant securities market with strong retail participation that has evolved over the

years. It was until recently a cash market with facility to carry forward positions in actively

traded ³A´ group scripts from one settlement to another by paying the required margins and

barrowing money and securities in a separate carry forward sessions held for this purpose.



However, a need was felt to introduce financial products like other financial markets in the

world.

CHARACTERISTICS OF DERIVATIVES

1. Their value is derived from an underlying instrument such as stock index, currency, etc.

2. They are vehicles for transferring risk.

3. They are leveraged instruments.

Types of derivatives:

1. Forward Contract:

A forward contract is an agreement to buy or sell an asset on a specified date for a specified

price. One of the parties to the contract assumes a long position and agrees to buy the underlying

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

short position and agrees to sell the asset on the same date for the same price. Other contract

details like delivery date, price and quantity are negotiated bilaterally by the parties to the

contract. The forward contracts are normally traded outside the exchanges

The salient features of forward contracts are:

� They are bilateral contracts and hence exposed to counter-party risk.

� Each contract is custom designed, and hence is unique in terms of contract size, expiration

date and the asset type and quality.

� The contract price is generally not available in public domain.

� On the expiration date, the contract has to be settled by delivery of the asset.

� If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party,

which often results in high prices being charged.



Limitations of Forward Contract

Forward markets world-wide are afflicted by several problems:

y Lack of centralization of trading,

y Illiquidity, and

y Counterparty risk

In the first two of these, the basic problem is that of too much flexibility and generality. The

forward market is like a real estate market in that any two consenting adults can form contracts

against each other. This often makes them design terms of the deal which are very convenient in

that specific situation, but makes the contracts non-tradable.

Counterparty risk arises from the possibility of default by any one party to the transaction.

Whenone of the two sides to the transaction declares bankruptcy, the other suffers. Even when

forward markets trade standardized contracts, and hence avoid the problem of illiquidity, still the

counterparty risk remains a very serious issue.

2 . Future Contracts:

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 at a certain time in the future

at a certain price. But unlike forward contracts, the futures contracts are standardized and

exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain

standard features of the contract. It is a standardized contract with standard underlying

instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or

which can be used for reference purposes 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 99% of futures transactions are offset this way.

The standardized items in a futures contract are:



y Quantity of the underlying

y Quality of the underlying

y The date and the month of delivery

y The units of price quotation and minimum price change

y Location of settlement

The payoff from a long position in a forward contract is

P = S - X,

where S is a spot price of the security at time of contract maturity, X is the delivery price.

Similarly, the payoff from a short position is

P = X - S.

For example, let's say the current price of the stock is $80.00 and we entered in forward contract

to buy this stock in 3 months time for $81.00 (that means we hope that price will not fall lower

than $81.00). If after three months price is more than $81.00, let's say $83.00, than we can buy



the same stock for $81.00 (as stated by forward contract) and after reselling it on the market our

payoff will be

P = $83.00 - $81.00 = $2.00

If at forward maturity the stock price falls to $78.00, than our loss will be

P = $81.00 - $78.00 = $3.00

The graphs above illustrate the forward contract payoff patterns for long and short positions.

Distinction between futures and forwards

Futures Forwards

Trade on an organized exchange OTC in nature

Standardized contract terms Customised contract terms

hence more liquid Hence less liquid

Follows daily settlement Settlement happens at end of period

Future 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.

Contract cycle: The period over which a contract trades. The index futures contracts on the NSE

have one- month, two-month and three months expiry cycles 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.



Ex piry date: It is the date specified 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 less than one contract. Also called as

lot size.

Basis: In the context of financial futures, basis can be defined as the futures price minus the spot

price. There 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 of 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 investor's 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.

3. Option Contracts

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 requirements) to enter into a futures

contract, the purchase of an option requires an up-front payment.

Option Terminology

Index options: These options have the index as the underlying. Some options are European

while others are American. Like index futures contracts, index options contracts are also

cashsettled.

Stock options: Stock options are options on individual stocks. Options currently trade on over

500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the

specified price.

Buyer of an option: The buyer of an option is the one who buy paying the option premium buys

the right but not the obligation to exercise his option on the seller/writer.

Writer of an option: The writer of a call/put option is the one who receives the option premium

and is thereby obliged to sell/buy the asset if the buyer exercises on him.

Option price/premium: Option price is the price which the option buyer pays to the option seller.

It is also referred to as the option premium.

Ex piration date: The date specified in the options contract is known as the expiration date, the

exercise date, the strike date or the maturity.

Strike price: The price specified in the options contract is known as the strike price or the

exercise price.



American options: American options are options that can be exercised at any time upto the

expiration date. Most exchange-traded options are American.

E uropean options: 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.

In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive

cash flow to the holder if it were exercised immediately. A call option on the index is said to be

in-the-money when the current index stands at a level higher than the strike price (i.e. spot price

>strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In

the case of a put, the put is ITM if the index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash

flow if it were exercised immediately. An option on the index is at-the-money when the current

index equals the strike price (i.e. spot price = strike price).

Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a

negative cash flow if it were exercised immediately. A call option on the index is out-of-the

money when the current index stands at a level which is less than the strike price (i.e. spot price

< strike price). If the index is much lower than the strike price, the call is said to be deep OTM.

In the case of a put, the put is OTM if the index is above the strike price.

Intrinsic value of an option: The option premium can be broken down into two components -

intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it

is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of

a call is Max[0, (St ² K)] which means the intrinsic value of a call is the greater of 0 or (St ²

K). Similarly, the intrinsic value of a put is Max[0, K ² St ],i.e. the greater of 0 or (K ² St). K is

the strike price and St is the spot price.



T ime value of an option: The time value of an option is the difference between its premium and

its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only

time value. Usually, the maximum time value exists when the option is ATM. The longer the

time to expiration, the greater is an option's time value, all else equal. At expiration, an option

should have no time value.

There are two basic types of options, call options and put options:

Call option: A call option gives the holder the right but not the obligation to buy an asset by a

certain date for a certain price.

i) Long a call :- person buys the right (a contract) to buy an asset at a certain price. We feel that

the price in the future will exceed the strike price. This is a bullish position.

ii) Short a call :- person sells the right ( a contract) to someone that allows them to buy to buy an

asset at a certain price. The writer feels that asset will devaluate over the time period of the

contract. This person is bearish on that asset.

Put option: A put option gives the holder the right but not the obligation to sell an asset by a

certain date for a certain price.

i) Long a put :- Buy the right to sell an asset at a pre-determined price. We feel that the asset will

devalue over the time of the contract. Therefore we can sell the asset at a higher price than is the

current market value. This is a bearish position.

ii) Short a put :- sell the right to someone else. This will allow them to sell the asset at a specific

price. We feel the price will go down and we do not. This is a bullish

position.



Profit / payoff in Option

The payoff to a derivative portfolio is the market value of the portfolio at expiration. (Also

gross payoff).

The profit on a derivative portfolio is the payoff less the cost of acquisition or

assembling the portfolio. (Net profit).

We will be looking at a number of option strategies and combinations.

The (gross) payoff is the value (positive or negative) of the option or portfolio at

maturity.

The payoff does not include the initial cost (or the initial cash inflow) at the time the

portfolio was set up.

N et profit= (gross) Payoff- cost of buying options or other securities+ premium

received for selling options or other securities



If S is a final price of the option underlying security, X is a strike price and OP is an option price,

than the profit is

Long Call: P = S - X - OP

Short Call: P = X - S + OP

Long Put: P = X - S - OP

Short Put: P = S - X + OP



For example, let's say the stock price is $50.00, we bought European call option with strike

$53.00 and paid $2.00 for this option. If option price is less than $53.00, we will not exercise the

option to buy the stock, because it doesn't make sense to buy security for higher price than it

costs on the market. In this case we lose all initial investment equal to the option price $2.00. If

stock price is more than $53.00, we will exercise the option. For example if the stock price is

$56.00, after exercising the option and immediately reselling the acquired stock our profit will

be:

P = $56.00 - $53.00 - $2.00 = $1.00

if the stock price is $54.00, than the profit is:

P = $54.00 - $53.00 - $2.00 = - $1.00

As we see in latter case we lose money. The reason is that increase of stock price just by $1.00

above the strike ($53.00) doesn't cover our initial investment of $2.00, although we still exercise

the option to recover at least $1.00 of initial investment. If the stock price at exercise time is

$55.00 than we exercise the option to cover our initial expenses(equal to option price):

P = $55.00 - $53.00 - $2.00 = $0.00

This latter case corresponds to option graph intersection point with horizontal axis on the

drawing above.

Distinction between futures and options

Futures Options

Exchange traded, with novation Same as futures.

Exchange defines the product Same as futures.

Price is zero, strike price moves Strike price is fixed, price moves.



Price is zero Price is always positive.

Linear payoff Nonlinear payoff.

Both long and short at risk Only short at risk

Types of traders in derivative market

1.Hedgers :-

Hedgers are those who protect themselves from the risk associated with the price of an asset by

using derivatives. A person keeps a close watch upon the prices discovered in trading and when

the comfortable price is reflected according to his wants, he sells futures contracts. In this way he

gets an assured fixed price of his produce.

In general, hedgers use futures for protection against adverse future price movements in the

underlying cash commodity. Hedgers are often businesses, or individuals, who at one point or

another deal in the underlying cash commodity.

Take an example: A Hedger pay more to the farmer or dealer of a produce if its prices go up.

For protection against higher prices of the produce, he hedges the risk exposure by buying

enough future contracts of the produce to cover the amount of produce he expects to buy. Since

cash and futures prices do tend to move in tandem, the futures position will profit if the price of

the produce raise enough to offset cash loss on the produce.

2. Speculators:

Speculators are somewhat like a middle man. They are never interested in actual owing the

commodity. They will just buy from one end and sell it to the other in anticipation of future price

movements. They actually bet on the future movement in the price of an asset.

They are the second major group of futures players. These participants include

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

brokerage firms

.



Buying a futures contract in anticipation of price increases is known as µgoing long¶. Selling a

futures contract in anticipation of a price decrease is known as µgoing short¶. Speculative

participation in futures trading has increased with the availability of alternative methods of

participation.

Speculators have certain advantages over other investments they are as follows:

If the trader¶s judgment is good, he can make more money in the futures market

faster because prices tend, on average, to change more quickly than real estate or

stock prices.

Futures are highly leveraged investments. The trader puts up a small fraction of the value of

the underlying contract as margin, yet he can ride on the full value of the contract as it moves up

and down. The money he puts up is not a down payment on the underlying contract, but a

performance bond. The actual value of the contract is only exchanged on those rare occasions

when delivery takes place.

3. Arbitrators:

According to dictionary definition, a person who has been officially chosen to make a decision

between two people or groups who do not agree is known as Arbitrator. In commodity market

Arbitrators are the person who takes the advantage of a discrepancy between prices in two

different markets. If he finds future prices of a commodity edging out with the cash price, he will

take offsetting positions in both the markets to lock in a profit. Moreover the commodity future

investor is not charged interest on the difference between margin and the full contract value.

Types of Futures and Options Margins

Margins on Futures and Options segment comprise of the following:

1) Initial Margin

2) Exposure margin

In addition to these margins, in respect of options contracts the following additional margins are

collected



1) Premium Margin

2) Assignment Margin

How is Initial Margin Computed?

Initial margin for F&O segment is calculated on the basis of a portfolio (a collection of futures

and option positions) based approach. The margin calculation is carried out using software called

- SPAN® (Standard Portfolio Analysis of Risk). It is a product developed by Chicago Mercantile

Exchange (CME) and is extensively used by leading stock exchanges of the world.

SPAN® uses scenario based approach to arrive at margins. It generates a range of scenarios and

highest loss scenario is used to calculate the initial margin. The margin is monitored and

collected at the time of placing the buy / sell order.

The SPAN® margins are revised 6 times in a day - once at the beginning of the day, 4 times

during market hours and finally at the end of the day. Obviously, higher the volatility, higher the

margins.

How is exposure margin computed?

In addition to initial / SPAN® margin, exposure margin is also collected.

Exposure margins in respect of index futures and index option sell positions have been currently

specified as 3% of the notional value.

For futures on individual securities and sell positions in options on individual securities, the

exposure margin is higher of 5% or 1.5 standard deviation of the LN returns of the security (in

the underlying cash market) over the last 6 months period and is applied on the notional value of

position.

How is Premium and Assignment margins computed?

In addition to Initial Margin, a Premium Margin is charged to trading members trading in Option

contracts. The premium margin is paid by the buyers of the Options contracts and is equal to the

value of the options premium multiplied by the quantity of Options purchased.



For example, if 1000 call options on ABC Ltd are purchased at Rs. 20/-, and the investor has no

other positions, then the premium margin is Rs. 20,000. The margin is to be paid at the time

trade.

Assignment Margin is collected on assignment from the sellers of the contracts.

How Marked to Market Margins are computed?

1. Future contracts :- The open positions (gross against clients and net of proprietary/ self

trading) in the futures contracts for each member are marked to market to the daily settlement

price at the end of each day is the weighted average price of the last half an hour of the futures

contract. The profits/losses arising from the different between the trading price and the

settlement price are collected/ given to all clearing members.

2. Option contracts :- the marked o market for option contracts is computed and collected as

part of the Initial Margin in the form of Net Option Values. The Initial Margin is collected on an

online real time basis based on the data feeds given to the system at discrete time intervals.

How Client Margins are computed?

Client Members and Trading Member are required to collect initial margins from all their clients.

The collection of margins at client level in the derivatives markets is essential as derivatives are

leveraged products and non-collection of margins at the client level would provide zero cost

leverage. In the derivative markets all money paid by the client towards margins is kept in trust

with the Clearing House/ Clearing Corporation and in the event of default of the Trading or

Clearing Member the amounts paid by the client towards margins are segregated and not utilized

towards the dues of the defaulting member.

Therefore, Clearing members are required to report on a daily basis details in respect of such

margin amounts due and collected from their Trading members/ clients clearing and settling

through them. Trading members are also required to report on a daily basis details of the amount

due and collected from their clients. The reporting of the collection of the margins by the clients



is done electronically through the system at the end of each trading day. The reporting of

collection of client level margins plays a crucial role not only in ensuring that members collect

margin from clients but it also provides the clearing corporation with a record of the quantum of

funds it has to keep in trust for the clients.



DERIVATIVE ANALYSIS

FUTURES

Profit/Loss for a Future contract holder

Example:

On 7th Jan 2008 REL is trading at 2100 and REL January 2009 Contract is trading @ 2120. We

expect the share price to rise significantly and want to make a profit from the increase.

Lot size of REL is 550

Span Margin for REL Future is 42.93% on the contract value

If an Investor bought 1 REL Future @ 2120 on 7th January 2008 and the closing price of REL

Future on 16th Jan 2008 is 2600. To make profit from this transaction the buyer of the contract

can sell the Future and book profit.

Span Margin Payable for buying REL Contract = 2120x550x42.93%=500563

Capital Invested on this contract is Rs.500563/-

On 16th Jan 2008 REL January Contract is trading @2600, If the investor sold the contract then

he would have gained profit of Rs.264000/-

Profit = (2600-2120) x 550 = Rs.264000/-

On 23rd Jan 2008 REL Jan Future closed @ 1600; if the investor holds the future till date. His

Mark to Market loss is as fallows

Mark to Market Loss = (1600-2120) x 550 = Rs.286000/-



Investor has to pay/receive the margin with respect to the yesterday¶s closing price and to the

today¶s closing price.

Mark to Market margin payable/receivable = (Today¶s Closing price ± Yesterdays Closing Price)

x Lot Size

BASIC OPTION STRATEGIES

Buyer of the Call Option

Market View Bullish

Action Buy a calloption

Profit Potential Unlimited

Loss Potential Limited

To make a profit from an expected increase in the price of an underlying share during option¶s

life:

Case 1: On 30th Nov 2009, IOC is quoting at Rs.538. and the December Rs.560 (strike price)

Call costs Rs.32 (premium). We expect the share price to rise significantly and want to make a

profit from the increase.

Lot Size of IOC is 600

(i) IOC Dec 2009 CA 560 is trading @ 32 (Buying Out of Money Call Option):

Buy 1 IOC call at Rs.32, Market lot for IOC is 600. So, Net outlay is Rs.19200 (32x600). If IOC

shares go up, we can close the position either by selling the option back to the market or

exercising the right to buy the underlying shares at the exercise price.

On Expiry (27th Dec 2009) Market Price of IOC is Rs. 713/-



DATE Share price

(Cash

market)

Strike

Price

Call

Premium

CALL OPTION VALUE

30t Nov Rs.538 560 32 Buy 1 Dec 560 Call @ Rs.32

Cost = 19200

27th Dec Rs. 713 560 153 1. Sell 1 Dec contract (expiry)

Net gain Rs.153 (713--

560)*600 = Rs.91800

Analysis Rises by

Rs.175.

Return

32.5%

560 Gain: Option sale = Rs.91800

Premium Paid = Rs.19200.

Net Profit = Rs.72600.

Possible Outcome of IOC If the Spot price is not @ 713 on Expiry:

Share price Rs.713 Option worth Rs.91800. Closing the

position now will produce a net profit of

Rs.72600

Spot price < 560 Option expires worthless. The loss is

Rs.19200 (premium paid)

Share price >= 592 Net profit = Intrinsic value of (Break

even = 560+32) option i.e. by whatever

amount the share price exceeds Rs.592.



To establish a maximum cost at which to purchase shares at a lesser date if funds are not

available immediately:

(ii) IOC Dec 2009 CA 520 is trading @ 47 (Buying In the Money Call Option):

Buy 1 Dec 2009 IOC 520 call option at Rs.47 for total outlay of Rs.28200 on 30th Nov.

On Expiry 27th Dec 2009 Price of IOC is 713

DATE Share price

(Cash

market)

Strike

Price

Call

Premium

CALL OPTION VALUE

30th

Nov

Rs.538 520 47 Buy 1 Dec 520 Call @ Rs.47

Cost = 28200

27th

Dec

Rs. 713 520 193 1. Sell 1 Dec contract (expiry)

Net gain Rs.193 (713-520)*600

= Rs.115800

Analysi

s

Rises by

Rs.175.

Return 32.5%

520 Gain: Option sale = Rs.115800

Premium Paid = Rs.28200.

Net Profit = Rs.87600.

Possible outcome at Expiry



Share price Rs.713 Option worth Rs.115800. Closing the

position now will produce a net profit of

Rs.87600

Spot price < 520 Option expires worthless. The loss is

Rs.28200 (premium paid)

Share price >= 567 Net profit = Intrinsic value of (Break

even = 520+47) option i.e. by whatever

amount the share price exceeds Rs.567.

Writing a Call Option :

To earn additional income from a static shareholding, over and above any dividend earnings, in

terms of premium received on writing the option (Covered short call).

Market View Bearish/Neutral

Action: Sell call against an existing shareholding

Profit Potential Limited


Situation: On 30th Nov GMRINFRA share is trading at Rs.245. An investor holds 5000 shares

of GMRINFRA. He does not expect its price to move very much in the next few months. So, he

decides to write a call option against this shareholding.



Action: The Dec 260 call is trading at Rs.15 and investor sells 5 contracts (one contract = 1000

shares). He received an option premium of Rs.75000 and takes on the obligation to deliver 5000

shares at Rs.260 each if the holder exercises the option

Date Share price

(Cash market) Option market

30t Nov Rs.245 Sell 5 Dec 260 calls @

Rs.15

Income = Rs.75000

(15x5000).

27t Dec Rs.248 Option expires worthless

Analysis No change in shareholding Profit = Rs.75000

(Option Premium

received)



Possible Outcome at Expiry

Share > Rs.260 The holder will exercise his option.

The investor as a writer will sell shares

originally purchased for Rs.245 at Rs.275

(260+15).

Share price < 260 The option expires worthless.

Share Price = 260 Option won¶t be exercised as there is no

price difference.

Buyer of a Put Option

Market View Bearish

Action Buy a Put option

Profit Potential Unlimited


To make profit, from a fall in value of share price:

Situation: Current price of NTPC is @ Rs.280 on 14

th

Nov 2009. An investor thinks that NTPCis overvalued and may fall substantially. He therefore decides to buy Put option to gain exposure

to its anticipated fall.

Action: Buy 1 NTPC NOV Rs.270 Put at Rs.10 for a total consideration of Rs.16250.



Share price

(Cash market) Option market

14t Nov Rs.280 Buy 1 NTPC NOV put at

Rs.10.

Total outlay = Rs.16250.

29th Nov Rs.235 Sell 1 July contract.

Net gain = Rs.56875

[Rs.35(270-235)x1625]

Analysis Fall of share price Rs.45. Option purchase =

Rs.16250

Option sale = Rs.56875.

Net profit = Rs.40625.

Possible Outcome at Expiry If NPTC at diff. prices:

Share price = Rs.235 The put will be trading at Rs.35, which

gives a profit of Rs.25 (35-10)*1625, if

the position is closed out.

Share price is 260 Recover intrinsic value premium.

Share Price is between 260 to 270 Loss of Premium Varies from 1625 to

16250/-

Share Price is > 270 Loss of Premium Paid



Writing a PUT Option:

Market View Bullish/neutral

Action Sell put option

Profit Potential Limited

Loss Potential Unlimited

To generate earnings on portfolio of shares:

Situation: An investor owns 5500 shares of REL and also has cash holding of around

Rs.10000000. In early April he feels that the share price of REL will either remain constant or

slightly rise.

Action: The investor decides to generate some additional income on his portfolio writes 10 REL

Rs.1800 puts at Rs. Thus he received a premium of Rs.220000 (40x5500 shares).

Possible Outcome at Expiry

Share price > (or) = Rs.1800 The investor¶s expectation is correct and

the put will expire unexercised.

Profit = Rs.220000 (premium received).

Share price < Rs.1800 The put option will be exercised and the

stock will have to be purchased for

Rs.7700000 (9900000-220000).



CHAPTER IV

ANALYSIS &INTERPRETATIONS



Comparative Analysis

Basis Equity Derivative

Return Capital appreciation

Dividend Income

Capital gain

PriceFluctuation

Risk Company Specified

Sector specified

Global risk

General Market Risk

market risk

Credit risk

Liquidity risk

Settlement risk

Types of margin VaR

Extreme Loss

Mark to market

Initial margin

Premium margin

Exposure margin

Duration Generally Long term

(more than 1 yr)

Short term

(Max. 3 months)

Participants Long term Investors

Hedgers

Safe Investors

Speculations

Arbitragers

Hedgers

Expiry Date of

contract

No such things Last Thursday of any month

Comparative analysis is easy to understand when we are analysis with the example of the real

market situation.

Now I would like to quote a real life example during my internship where I understood the actualcomparison of equity and derivative market

Example:-



There was an investor Mr. Jaichand. He has Rs. 1, 00,000/- and he wants to invest it in

sharemarket. Now he has two options either to invest in equity cash market or equity derivative

market (F&O).

Now suppose if he invest in equity cash market and buy shares of Rs. 1, 00, 000/- and diversified

risk so he buys different scrips. So he purchases 10 RIL shares of Rs. 2350/- each. 10 L&T

shares of Rs 800/- each, 15 Religare Enterprises Shares of Rs. 370/- each, 20 ICICI bank shares

of Rs. 800/- each, 10 Tata power shares of Rs. 1250 each and 10 BHEL shares of Rs. 1595/-

each. So for investing Rs.1,00,000/- in equity cash market he has to pay Rs. 1,00,000/-

and gets the delivery of the shares

Now suppose if he invest in equity derivative market then he will able to purchase the shares

worth Rs. 5,00,000/- though he has capital of Rs. 1,00,00/- only, because of the margin payment.

But he has to purchase the share in a lot size. So he is able to purchase the 1 lot (100 shares) of

RIL at Rs. 2350/-, 1 lot (50 shares) of L&T at 2650/-, 2 lots (100 shares each) of Religare

Enterprises at Rs. 370/- and 1 lot (70 shares) of ICICI bank at Rs. 800/-. Here Mr. Jaichand has

to pay Rs. 1,00,000/- as a margin money and he is able to purchase a shares worth Rs. 5,00,000/-

But he has to pay the full amount of money at T+3 basis. So he has to pay the remaining amount

on the 3rd day of the trading if he wants the delivery.

I. Returns

Mr. Jaichand gets return on equity by two ways. One is when the share price of the

holding shares will increases in futures, called as capital appreciation. Second is by

getting a dividend income from the holding shares.

Mr. Jaichand gets return on equity derivative when the future prices of the shares are

increase in short term called as capital gain through price fluctuation or through options

premium.

II. Risk:

There are four types of risk involved in equity cash market.



1. Company Specified risk :- If company is not performing well than process of the shares will

declining and vice versa.

2. Sector specified risks : - If the sector is not performing well i.e. power sector,

metal sector, oil & gas sector, banking sector then prices of the shares will go

down and vice versa.

3. Global risk :- If global cues are positive then prices will increases but if global

cues are not good than prices of shares will go down.

4. General market risk :- General market risk is also affect the equity cash market

like inflation, banks interest rates etc.

So Mr. Jaichand has to consider all these risk factors while dealing in the equity

cash market.

There are four types of risk involved in equity derivative market

1. Market risk:- In derivative market we have to calculate the market risk or mark to market risk

involved in the stocks or securities, that is the exposure to potential loss from fluctuations in

market prices (as opposed to changes in credit status). It is calculated on the tradable assets i.e.,

stocks, currencies etc.

2. Credit risk: It may possible in derivative contract that the counterparty may be fail to perform

the contract or say defaulted then it is a risk for us. It is calculated on nontradable assets i.e.,

loans. So generally it is for long term purpose.

3. Liquidity Risk : - If Mr. Jaichand will not able to find a price( or a price within a reasonable

tolerance in terms of the deviation from prevailing or expected prices) for one or more of its

financial contracts in the secondary market. Consider the case of a counterparty who buys a

complex option on European interest rates. He is exposed to liquidity risk because of the

possibility that he cannot find anyone to make him a price in the secondary market and because

of the possibility that the price he obtains is very much against him and the theoretical price for

the product.



4. Settlement Risk : - The risk of non-payment of an obligation by a counterparty to a

transaction, exacerbated by mismatches in payment timings.

So, Mr. Jaichand has to consider all these factors while dealing in the equity derivative market.

Margins:

Now Mr. Jaichand has also seen the margin paid in the equity cash segment.

1. Var Margin: - Now Mr. jaichand bought shares of a company. Its market value today is Rs. 1,

00,000/- Obviously, we do not know what would be the market value of these shares next day.

Now Mr. Jaichand holding these shares may, based on VaR methodology, say that 1-day Var is

Rs. 1, 00,000/- at the 99% confidence level. This implies that under normal trading conditions

the investors can with 99% confidence, say that the value of shares would not go down by more

than Rs. 1,00,000/- within next 1-day.

2. Extreme loss margin: - In the above situation, the VaR margin rate for shares of RIL was

13%. Suppose that SD would be 1.5 x 3.1= 4.65. Then 5% (which is higher than 4.65%) will be

taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18%

(13% VaR Margin + 5% Extreme Loss margin). As such, total margin payable( VaR margin +

extreme loss margin) on a trade of Rs. 23, 500/- woud be 4, 230/-

3. Mark to Market Margin :- Now Mr. Jaichand purchased 10 shares of RIL @ Rs. 2350/-, at

11 am on May 12, 2009. If close price of the shares on that happened to be Rs. 2350, then the

buyer faces a notional loss of Rs. 500/- on his buy position. In technical term this loss is called as

MTM loss and is payable by May 13, 2009 (that is next day of the trade) before the trading

begins. In case, price of the shares falls further by the end of May 13 2009 to Rs. 2200/-, then

buy postion would show a further loss of Rs. 1, 000/-. This MTM loss is payable by next day.



Now we will consider the margin payable under the equity derivatives segment.

i) Initial Margin: The initial margin required to be paid by the investor would be equal to

the highest loss the portfolio would suffer in any of the scenarios considered. The margin

is monitored and collected at the time of placing the buy/ sell order. As higher the

volatility, higher the initial margin.

ii) Exposure Margin : - Exposure margins in respect of index futures and index option sell

position are 3% of the notional value.

iii) Premium margin : - If 1000 call option on RIL are purchased at Rs. 20/- and Mr. Jaichand

has no other positions, then the premium margin Rs. 20,000.

iv) Assignment Margin : - Assignment Margin is collected on assignment from the sellers of

the contract.

I. Duration:

Generally equity market is a long term market and people invested in it for more than one year

and then only they get good return on equity. Generally any safe investors can invest in it

because here risk is comparatively low then derivative market. While in derivative market

investors are investing for less than one yea, generally for 2 months or 3 months. Here they get

high returns on it because they are bringing high risk.

II. Participants:

Generally any long term investors can invest in equity or hedgers are investing in the equity, who

wants to reduce their risk. Any person who wants to be safe investors and wanted to earn a good

amount of returns after a period of more than one year is also invested in equity.



In derivative market mostly speculators and arbitragers are invested because they wanted

quick money in short time period and hedgers are also invested in derivative market to reduce

their risk.

III. Expiry date:

It¶s a last Thursday of any month in case of a derivative market but no such things in case of an

equity market.

These are comparisions between the equity and derivative market.



CHAPTER V

CONCLUSIONS AND

RECOMMENDATIONS



FINDINGS

Practical situation

During my training internship I had experience of real practical situation in the stock Market andin an Organization.

End of June 2010 turned out to be favorable for Indian stock markets. The first few sessions saw

optimism in the market on the hope that the government will make policy announcements in the

budget. However, the market corrected soon after the announcement of budget due to absence of

major policy announcements. The sentiments remained negative during following few sessions.

However, the market picked momentum from mid of the month. This was helped by better-than

expected corporate earnings, huge overseas inflows and encouraging global cues. The buoyancy

in the market continued in the second half helping the BSE Sensex to touch highest in more than

a year towards the month end. On the whole, the market closed on a strong note. Global stocks

rallied over the month on encouraging economic data and earnings reports. The MSCI AC World

Index gained 8.70%, where as the MSCI Emerging Markets Index climbed 10.86% during the

month. The performance of Indian markets was in line with the global

counterparts. The Sensex settled the month with a gain of 8.12%, while the Nifty registered a rise

of 8.05%. The BSE Mid and Small caps performance was in line with their larger counterparts,

gaining 9.74% and 8.11% respectively over the month.

Sector Performance

All the BSE Sectoral indices wrapped the month with gains except Capital Goods. Intense

buying spree was seen in Auto, Realty, FMCG and IT indices, which posted gains of over 20%.

Metal, Teck, Health Care and Consumer Durable indices were among other top gainers whereas

Oil & Gas index posted a marginal rise over the month



Institutional Activities

The FIIs flow remained positive in equities with net inflows of Rs 11,625 crores (USD 2.40 bn)

during the month. The domestic MFs were also net buyers with inflows of Rs 1,825.50 crores

(USD 381 mn) during the month.

Major Corporate Events

Infosys Technologies announced a 17.28% y-o-y rise in � consolidated net profit for the quarter

ended June 2009 to Rs 1,527 crores (USD 318.59 mn). Income from operations for the quarter

climbed 12.73% y-o-y to Rs 5,472 crores (USD 1.14 bn).

Reliance Industries reported a drop of 11.53% y-o-y in � net profit for the quarter ended June

2009 to Rs 3,636 crores (USD 758.60 mn). Total income for the quarter slipped 21.64% y-o-y to

Rs 32,757 crores (USD 6.83 bn).

Steel Authority of India earmarked Rs 59,800 crores (USD � 12.48 bn) capex plan. It includes

ongoing modernization and expansion, value addition, technology up-gradation and sustenance.

Of the total capex plan, Rs 10,000 crores (USD 2.10 bn) will be spent during 2009-10.

Punj Lloyd along with its group companies bagged orders � worth Rs 10,250 crores (USD 2.14

bn) during the month. It reported a 27% y-o-y rise in consolidated profit after tax for the quarter

ended June 2009 to Rs 125 crores (USD 26.1 mn). Consolidated revenues for the quarter climbed

12% y-o-y to Rs 2,658 crores (USD 554.56 mn).

Key Macro Developments:

Industrial production continued to remain positive in May 2009, with a growth of 2.7%. Core

sectors registered a growth of 6.5% for June 2009. Exports growth continued to drop for a ninth

consecutive month. In dollar terms, exports plunged 27.70% to USD 12.81 billion, however, in

rupee terms, it dropped 17.40% to Rs 61,217 crores during June 2009. Meanwhile, oil prices

slipped marginally 0.63% over the month to USD 69.45 a barrel.



Outlook:

On the international front, the markets will track developments and key economic data from US,

China and Japan. The exit strategy of the central banks will also have bearing on the global

markets. On the other hand, the Indian markets will be driven by the progress of monsoon, policy

announcements from the government and key economic data. Overall quarterly corporate

earnings performance was better than the market expectations. The market is now hoping for

better earnings growth prospects for FY2010. The manufacturing growth has also started

showing signs of improvement.

Now, with signs of economic recovery in developed countries and improvement in risk appetite

globally, the funds will flow in the emerging markets like India in search of higher growth. This

coupled with encouraging earnings outlook for FY2010, provides good opportunity for investors

to take active participation in the market and increase the equity allocation from long term

perspective.

Comparative analysis of the traded value in the F & O Segment with the cash segment

From this table we can see that in practical life though equity cash segment is better than the

derivatives because it involves lesser risk more numbers of investors are trading in derivatives

(F& O) segment. It is a major finding of the projects shows that by 60% to 70% investors are



bear more risk and traded in derivatives market because they want to earn more profits by trading

in derivatives.

CONCLUSIONS

This project has covered several areas. Its main conclusions are:

y Derivatives market growth continues almost irrespective of equity cash market turnover

growth. Since 2000. Cash equity turnover has fallen in the developed markets, but

derivatives turnover continued to rise steeply and steadily.

y Equity derivatives businesses like interest derivatives are highly concentrated. Using

notional value as the measure, the 2 main US markets and the 2 cross-border European

markets accounted for about 75% of the total. This was most apparent in index

derivatives, which make 99% of the notional value of equity derivatives. In single stock

derivatives, other markets have established niches and the dominance of the gig four is

less evident.

y Equity market volume and derivative market notional value are strongly correlated- witha ratio significant differences between individual markets.

y A number of cash equity markets- particularly in developing Asia- do not have equity

derivatives markets. Comparison of their cash market volumes with those that do have

derivative exchanges shows that the markets without derivatives are of similar size. I Am

not convinced that market or infrastructure differences explain this, but suspects that

regularity barriers have effectively prevented the development, markets in several

developing Asian countries.



RECOMMENDATIONS

y RBI should play a greater role in supporting Derivatives. Because nowadays

Derivatives market are increasing rapidly and it plays a major role in the whole

Securities market.

y Derivatives market should be developed in order to keep it at par with other

derivative market in the world. Nowadays more number of investors are shows

their interest in derivatives market because it includes high return by bearing high

risk.

y Speculation should be discouraged because it affects the market conditions badly andnew investors are reducing their interest in the market.

y There must be more derivatives instruments aimed at individual investors.

y SEBI should conduct seminars regarding the use of derivatives to educate

individual investors

y There is a need to have a smaller contract size in F & O Market. We can review

the size of the contract from Rs. Two lacs to One lacs. In the FICCI survey, 73%

of the respondents also held the same view.

BIBLIORAPHY

Books:-

Securities Laws and Regulations of Financial Markets

National Securities Depository Limited

Fundamentals of Futures & Options Markets- John C. Hull



Financial Derivatives- S. L. Gupta

Websites:-

www.world-exchange.org

www.nseindia.com

www.bseindia.com

www.religaresecurities.com

www.moneycontrol.com

www.indiamart.com

www.finpipe.com

Documents

equity and derivative