.

MEDICAPS INSTITUTE OF TECHNOLOGY & MANAGEMENT

MAJOR RESEARCH PROJECT

ONA study on “Investors performance in derivative market in Indore”

Submitted by

DHIRENDRA KUMAR SHUKLA

MBA(finance)Sec’Y’

Under the Guidance of

Prof. P.N.Moghe

TABLE OF CONTENT

1. Introduction

2. Literature review

3. Rationale

4. Research methodology

5. Objectives

6. Hypothesis

7. Sample plan

8. Tool of data collection

9. Analysis and data interpretation

10.Suggestion and conclusion

11. Bibliography

1. Introduction to “Derivatives”

Derivative is a product whose value is derived from the value of one or more basic variables, called underlying asset. 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. The transaction in this case would be the derivative, while the spot price of wheat would be the underlying asset

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) 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 that 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.

HISTORY

The history of derivatives goes back a very long way. In Book One of

Politics, Aristotle recounts a story about the Greek philosopher Thales who

concluded (by means of astronomical observations) that there would be a bumper

crop of olives in the coming year. Thales took out what amounted to option

contracts by placing deposits on a large number of olive presses, and when the

harvest was ready he was able to rent the presses out at a substantial profit. Some

argued that this proves that philosophers can easily make money if they choose to,

but they are actually interested in higher things. Aristotle was less than impressed.

He thought the scheme was based on cornering or monopolizing the market for

olive presses rather than any particularly brilliant insight into the prospects for the

olive harvest.

Forwards and futures are equally ancient. In medieval times sellers of goods

at European fairs signed contracts promising delivery on future dates. Commodity

futures can be traced back to rice trading in Osaka in the 1600s. Feudal lords

collected their taxes in the form of rice, which they sold in Osaka for cash.

Successful bidders were issued with vouchers that were freely transferable.

Eventually it became possible to trade standardized contracts on rice, similar to

modern futures, by putting down a deposit that was a relatively small fraction of

the value of the underlying rice. The market attracted speculators and also hedgers

seeking to manage the risks associated with fluctuations in the market value of the

rice crop. The tulip mania in sixteenth-century Holland, which saw bulbs being

bought and sold in Amsterdam at hugely inflated prices, also brought about trading

in tulip forwards and options, but the bubble finally burst spectacularly in 1637.

Derivatives on shares were being dealt on the Amsterdam Stock Exchange by the

seventeenth century. At first all deals on the exchange were made for immediate

delivery, but soon traders could deal in call and put options which provided the

right to buy or to sell shares on future dates at predetermined prices. London

superseded Amsterdam as Europe’s main financial centre, and derivative contracts

started to trade in the London market. The development was at times controversial.

In the 1820s problems arose on the London Stock Exchange over trading in call

and put options. Some members condemned the practice outright. Others argued

that dealings in options greatly increased the volume of transactions on the

exchange, and strongly resisted any attempts at interference. The committee of the

exchange tried to ban options, but was eventually forced to back down when it

became clear that some members felt so strongly about the matter that they were

prepared to subscribe funds to found a rival exchange. Meantime in the USA, stock

options were being traded as early as the 1790s, very soon after the foundation of

the New York Stock Exchange.

The Chicago Board of Trade (CBOT) was founded in 1848 by 82 Chicago

merchants. The earliest forward contract (on corn) was traded in 1851 and the

practice rapidly gained in popularity. In 1865, following a number of defaults on

forward deals, the CBOT formalized grain trading by developing standardized

agreements called ‘futures contracts’. The exchange required buyers and sellers

operating in its grain markets to deposit collateral called ‘margin’ against their

contractual obligations. Futures trading later attracted speculators as well as food

producers and food-processing companies. Trading volumes expanded in the late

nineteenth and early twentieth centuries as new exchanges were formed, including

the New York Cotton Exchange in 1870 and Chicago Mercantile Exchange (CME)

in 1919. It became possible to trade futures contracts based on a wide range of

underlying commodities and (later) metals.

Futures on financial assets are more recent in origin. CME launched futures

contracts on seven foreign currencies in 1972, which were the world’s first

contracts not to be based on a physical commodity. In 1975 the CBOT launched

futures on US Treasury bonds, and in 1982 it created exchange-traded options on

bond futures. In 1981 CME introduced a Eurodollar futures contract based on

short-term US dollar interest rates, a key hedging tool for banks and traders. It is

settled in cash rather than through the physical delivery of a financial asset. In

1973 the Chicago Board Options Exchange (CBOE) started up, founded by

members of the CBOT. It revolutionized stock option trading by creating

standardized contracts listed on a regulated exchange. Before that, stock options in

the USA were traded in informal over-the-counter markets. The CBOE first

introduced calls on 16 underlying shares and later in 1977 launched put option

contracts. Within a few years option trading had become so popular that other

exchanges began to create their own contracts. In 1983 the CBOE introduced

options on stock market indices, including the S&P 500. By extreme good fortune,

just as the CBOE was starting up, the industry-standard option pricing model

developed by Fischer Black, Myron Scholes and Robert Merton was published. For

the first time it was possible to value options on a common and consistent basis.

Meanwhile in Europe in 1982 the London International Financial Futures and

Options Exchange (LIFFE) was set up as a marketplace for trading financial

futures and options. After the 1996 merger with the London Commodity Exchange

it also began to offer a range of commodity futures contracts. The purchase of

LIFFE by Euronext was completed in 2002. Euronext. liffe is now an international

business comprising the Amsterdam, Brussels, Lisbon and Paris derivatives

markets in addition to LIFFE. LIFFE’s great rival in Europe is Eurex, which was

created in 1998 through the merger of DTB (Deutsche Terminb¨orse) and SOFFEX

(Swiss Options and Financial Futures

Exchange). Eurex is the world’s leading futures and options market for euro-

denominated derivative instruments. It is also now the largest exchange in the

world, measured by trading volume – over 1 billion contracts were traded in 2003,

with the highest turnover achieved by contracts on German government bonds. In

that year 640.2 million contracts were traded on CME with an underlying value of

$333.7 trillion. Eurex has global ambitions and launched a fully electronic futures

and options exchange in the USA in February 2004. As the exchanges have

continued to expand their activities, over-the-counter trading in forwards, swaps

and options has experienced an explosion of growth in the past twenty years or so.

The first proper interest rate swap was agreed as late as 1982. The statistics in the

next section show just how rapidly the market has grown from small beginnings. It

is now possible to trade futures contracts on swaps on a number of exchanges, and

to arrange a third-party guarantee against the possible risk of default on swap

contracts. In the OTC market dealers offer an array of more complex derivatives,

including later-generation option products with exotic-sounding names such as

barriers, cliquets, choosers and digitals.

At many times in its long history the derivatives business has unfortunately

been associated in the public mind with financial disasters and scandals. The

collapse of Barings Bank in 1995 as a result of speculative trading on (among other

things) futures contracts on the Japanese stock market by Nick Leeson is very well

documented. But there are other examples, some involving still larger sums of

money. In September 1998 the US Federal Reserve was forced to organize a

$3.625 billion bail-out for the Long-Term Capital Management hedge fund

because of trading losses, including those on complex derivatives deals. In 2002

the US division of Allied Irish Banks lost around $700 million from currency-

based deals made by John Rusnack. The counter-argument is that many such

stories concern poor risk-control and bad management practices rather than

anything that is specifically about derivatives. After all, over the years financial

institutions have lost billions of dollars on activities as mundane as lending money

to governments and trading bonds. The real strength of derivative products is that

they permit the efficient management and transference of risk. A farmer who is

exposed to changes in the market price of a crop can hedge by entering into an

appropriate derivative contract. The risk can then be assumed by a trader or

speculator who is prepared to live with uncertainty in return for the prospect of

achieving an attractive return. A bank with a book of corporate loans can use

derivatives to protect itself against default on those loans. The risk is taken on by

another party in return for suitable compensation. Many such applications of

derivatives are used every day of the week in the modern world.

2. Review of literature

By: - Mahima Sharda SNR Securities & Finance, Indore

Abstract:- Financial system is the mirror reflection of an economy. The performance of any economy to a large extent is dependent on the performance of the Financial Institution. Financial system plays an important role by mobilizing saving and allocating them to the most profitable activities, and enables society to make more productive use of its scarce resources.The Financial system consist of many institution,Instruments and markets. Financial Institution range from moneylender to banks, pension funds, insurance companies brokerage house, investment trust and stock exchange.Financial markets are, by nature, extremely volatile and hence the risk factor is an important concern for financial agents. To reduce this risk, the concept of derivatives comes into the picture. Derivative securities provide them a valuable set of tools for managing this risk. Derivative securities have penetrated the Indian stock market and it emerged that investors are using these securities for different purposes, namely, risk management, profit enhancement, speculation and arbitrage This project describes the evolution of Indian derivatives markets, the popular derivatives instruments, and the main users of derivatives in India. I conclude by assessing the outlook for Indian derivatives markets in the near and medium term.

By :- Anil KumarDecember 2007DEVELOPMENT OF CREDIT DERIVATIVE MARKETS: IMPLICATIONS ONMONETARY POLICY AND FINANCIAL STABILITY OF DEVELOPING ECONOMIES LIKE INDIAAbstractIn recent times the issue of credit risk management has been attracting a great deal of attention globally. Despite various structural developments risk-management

practitioners and regulators are still overtly concerned about risk exposure and the issues related to credit default. The issue of the effects of distribution of credit in the economy and how it affects the role of the central banks as the lender of the last resort is addressed. Similarly, the use of credit derivatives may reduce the transparency within the financial system regarding allocation of risks and at the same time reduce the effect of money policy transmission. The problem of designing an appropriate regulatory structure are becoming more difficult with derivatives and off-balance sheet items, and are more difficult for developing countries, both because they are likely to face a shortage of good regulators andbecause they face greater risks Furman and Stiglz (1998). ). In India, for instance, the Central Bank, has issued draft guidelines for banks and dealers to begin trading credit default swaps in the country to mitigate risks emerging due to such trading means. In the light of theses development, it is imperative to understand the impact of such credit derivatives instruments on monetary policy and the resultant financial stability, mostly for a developing economy like India. Against this backdrop, the present paper aims to analyze the development of credit derivative instruments as well as the aggregate effects of credit derivatives from a macro economic perspective. Significantly international experiences are used to study the implications for monetary policy operations and financial stability for a developing country like India.

By:- BUILDING BRAZILIAN CREDIT DERIVATIVES MARKET.Journal of International Finance & Economics, December 20, 2008 by Herbert Kimura, Roberto Borges Kerr, Luiz Carlos Jacob Perera, Sérgio Ishikawa

abstract:

This paper discusses the Credit Derivatives Market perspectives in Brazil based on an empirical research aimed to evaluate the ability of financial market agents to deal with these instruments. The difficulties found by regulators and banking institutions to promote operations with Credit Derivatives in the domestic market are investigated through the use of a questionnaire with Likert scale to collect data which was analyzed using qualitative By :- Anil KumarDecember 2007DEVELOPMENT OF CREDIT DERIVATIVE MARKETS: IMPLICATIONS ONMONETARY POLICY AND FINANCIAL STABILITY OF DEVELOPING ECONOMIES LIKE INDIAAbstract

In recent times the issue of credit risk management has been attracting a great deal of attention globally. Despite various structural developments risk-management practitioners and regulators are still overtly concerned about risk exposure and the issues related to credit default. The issue of the effects of distribution of credit in the economy and how it affects the role of the central banks as the lender of the last resort is addressed. Similarly, the use of credit derivatives may reduce the transparency within the financial system regarding allocation of risks and at the same time reduce the effect of money policy transmission. The problem of designing an appropriate regulatory structure are becoming more difficult with derivatives and off-balance sheet items, and are more difficult for developing countries, both because they are likely to face a shortage of good regulators andbecause they face greater risks Furman and Stiglz (1998). ). In India, for instance, the Central Bank, has issued draft guidelines for banks and dealers to begin trading credit default swaps in the country to mitigate risks emerging due to such trading means. In the light of theses development, it is imperative to understand the impact of such credit derivatives instruments on monetary policy and the resultant financial stability, mostly for a developing economy like India. Against this backdrop, the present paper aims to analyze the development of credit derivative instruments as well as the aggregate effects of credit derivatives from a macro economic perspective. Significantly international experiences are used to study the implications for monetary policy operations and financial stability for a developing country like India.-quantitative methodology.ABSTRACT FROM AUTHORCopyright of Journal of International Finance & Economics is the property of International Academy of Business & Economics (IABE) and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. This abstract may be abridged. No warranty is given about the accuracy of the copy. Users should refer to the original published version of the material for the full abstract.

3. Rationale

There are several risks inherent in financial transactions and asset liability positions. Derivatives are risk shifting devices, they shift risk from those ‘who have it but may not want it’ to ‘those who have the appetite and are willing to take it.

The three broad types of price risks are as follows Market risk: market risk arises when security prices go up due to reasons

affecting the sentiments of the whole market. Market risk is also referred to as ‘systematic risk’ since it can not be diversified away because the stock market as a whole may go up or down from time to time.

Interest rate risk: this risk arises in the case of fixed income securities such as treasury bills, government securities, and bonds, whose market price could fluctuate heavily if interest rates change. For example the market price of fixed income securities could fall if the interest rate shot up.

Exchange rate risk: in case of imports, exports, foreign loans or investments, foreign currency is involved which gives rise to exchange rate risk.

To hedge these risks, equity derivatives, interest rate derivatives, and currency derivatives have emerged. This study is conducted for the investors so that they get to understand the risk associated with the derivative market, which then influence their investment decisions.

4. Research Method

This study is based on the primary and secondary data analysis and the previous

research findings. In this study we would use the descriptive and empirical type of

strategy and then we would analyze the data and trying to find out the conclusion

and relate it to practical aspect of capital market. We would use various research

finding that has been done earlier.

5. OBJECTIVE OF STUDY

The study is being conducted for the following objectives:

1. To study the functioning of Indian derivative market.

2. To study the investment patterns of investors in Derivative market and

physical market.

3. To analyze the factors affecting the decisions of investors in derivative

market.

4. To find new vistas for research.

6. Hypothesis

1) Ho1:- There is no significant difference in the derivative and physical market.

2) Ho2:- Technology and services that are being used are same in physical and derivative market.

3) Ho3:- the scope of both financial structures is same.

4) H04 :- There is no difference in the preference of investors for investing in either market.

7. Sampling

The sample size will consist of 150 investors and 10 broking firm that would be

better to analyses the result.

8. Tool of data collection

Primary source: self designed questioner will be used for collecting the data.

Secondary sources: E-books ,E-Journal, and newspaper will be used to collect the

relevant data to find the accurate result.

9. Analysis and data Interpretation:-

The collected data will be analyzed in the following manner:1. Correlation will be applied on the collected data.2. T -test will be conducted on the data collected.3. Mean and standard deviation will also be conducted.

10. Suggestion and conclusion:-

This study will help to analyze the investor preferences towards the Indian derivatives and physical market of India.

11. REFERENCES

BOOKS1. Derivative Market by NSE India Ltd.2. Options Futures, and other Derivatives by John C Hull3. Derivatives FAQ by Ajay Shah4. NSE’s Certification in Financial Markets: - Derivatives Core module5. Investment Monitor Magazine July 2001

REPORTS1. Regulatory framework for financial derivatives in India by Dr. L.C.Gupta2. Risk containment in the derivatives markets by Prof.J.R.Verma

WEBSITES1. www.derivativesindia.com2. www.nse-india.com3. www.sebi.gov.in4. www.appliederivatives.com5. www.moneycontrol.com6. www.myiris.com7. www.valuenotes.com8. www.wikipedia.org9. www.rediff/money/derivatives.htm10.www.standardcharteredwealthmanagers.com