financial risk management for correction - 28.03.2014

8/12/2019 Financial Risk Management for Correction - 28.03.2014

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A Study on Financial Derivative and Risk Management


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CHAPTER1

INTRODUCTION


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INTRODUCTION:

The liberalization of the Indian economy has ushered in an era of opportunities for the

Indian corporate sector. however, these opportunities are accomplished by challenges. The

corporate are now required to operate at global capacities to be able to reap the benefits of

economies of scale and be competitive. To operate at global capacities, huge investments are

called for and the main source of fund in the public at large. Therefore, the corporate now started

tapping the capital market in a big way. The response is also encouraging.

As the Indian nation integrates with world economy era, small tremors in the world

market starts affecting the Indian economy. As an example, interest rates have been south bound

in the world and the same has happened in the Indian market too. fixed income rates have fallen

drastically due to fall in the real income of people. To overcome this fall , investors have been

continuously seek to increase the yield of their of their investments. But, it is a time-tested fact

that, the yields on investment in equity shares are maximum, the accompanying risks are also

maximum. Therefore, it is absolutely essential that efforts should be made to reduce this factor.

The reduction of risk can be achieved through the process of hedging using

derivatives financial instrument.A hedge is any act that reduced the price risk of an existing

or anticipated position in the cash market. Basically, there are two type of hedging with futures

:long hedge and short hedge.

Financial derivatives are a kind of risk management instrument. A derivative's value

depends on the price changes in some more fundamental underlying assets. Many forms of

financial derivatives instruments exist in the financial markets. Among them, the three most

fundamental financial derivatives instruments are: forward contracts, futures, and options. If the

underlying assets are stocks, bonds, foreign exchange rates and commodities etc., then the

corresponding risk management instruments are: stock futures (options), bond futures (options),

currency futures (options) and commodity futures (options) etc. In risk management of the

underlying assets using financial derivatives, the basic strategy is hedging, i.e., the trader holds

two positions of equal amounts but opposite directions, one in the underlying markets, and the

other in the derivatives markets, simultaneously. This risk management strategy is based on the

following reasoning: it is believed that under normal circumstances, prices of underlying assets

and their derivatives change roughly in the same direction with basically the same magnitude;


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hence losses in the underlying assets (derivatives) markets can be offset by gains in the

derivatives (underlying assets) markets; therefore losses can be prevented or reduced by

combining the risks due to the price changes. The subject of this book is pricing of financial

derivatives and risk management by hedging.

Over the years the Indian leather has undergone drastic change from being a mere

exporter of raw materials in the early 60s and 70s to an exporter of finished, value-added

leather products.

The main reason behind this good transformation is the several policy initiatives takn by the

government of India. India proactive government initiatives have yielded quick and improved

results. Today the Indian leather industry has attained a prominent place in the Indian export and

has made the industry one of the top 7 industries that earns foreign exchange for the country.

Since 1991 as India adopted the globalization and liberalized economic policies, the leather

industry has flourished consistently in several ways and has contributed heavily to the Indian

exchequer. Investing in Indian Leather Industry is advantageous because the industry is poised to

grow further and achieve a major share in the global trading market.

The post liberalization era has opened up a great plethora of opportunities for the Indian Leather

Industry. As the global players looking for new sourcing options while in addition to China,

India stands to gain a bigger share of the global market. Leading brands from the US and Europe

have plans to source leather and leather products from India.

Indian Leather Industry currently is one among the top 8 industries for export revenue generation

in India, holding 10% of the global raw material, and 2% of the global trade. India has become

biggest livestock producer in the world, with the capacity of 1.8 billion square feet of leather

production annually. Global Footwear of 13% production comprising of 16 billion pairs are

made in India. India today produces 2065 million pairs of various categories of footwear. It

exports 115 million pairs, thus having 95% of its production to meet its own domestic demand.


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Indian leather industry has the credit of being one of the oldest manufacturing industries catering

to the global market from the 19th century. The age of the industry has linked it with social and

organizational structure, and emerges as a complex one with elements of continuity and

traditional structures. The ultimate quality of the Indian leather combined with efficient

craftsmanship has secured a sturdy place for Indian leather goods in the global market. Indian

leather industry is getting more organized, with a springing capacity for expansion.


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Indian Leather Industry has developed to a large extent and is the second largest producer next to

China. The industry is equipped mostly with a potential for employment generation, growth and

exports, with the annual exports touching 2 billion USD. The industry experienced a positive

metamorphosis from being a transporter of raw materials to an established exporter of value

added and finished leather products. Currently it is on an ever increasing phase with optimum

utilization of available raw materials and maximum returns from exports.

India has less than 3% share in the global trade in leather compared to China's 20%. Government

of India realizing the growth potential of the leather industry has been making significant efforts

to promote rapid advancement of the industry. On June 30, 2005, the Cabinet Committee on

Economic Affairs (CCEA) decided to implement an Rs 2.9 billion scheme for the integrated

development of the Indian Leather Industry. Under the scheme, existing tanneries will be

modernized and new units will be set up for footwear, components and leather products. This

scheme is expected to result in gains in terms of productivity, right-sizing of capacity, cost-

cutting, and design-development. The leather and leather products industry is one of the oldest

manufacturing industries in India. The Indian leather industry provides employment to about 2.5

million people in the country and has an annual turnover of approximately US$ 5,000,000.

Indian leather Industry occupies a prominent place in the Indian economy in view of its massive

potential for employment, growth and exports. There has been an increasing emphasis on its


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planned development, aimed at optimum utilisation of available raw materials for maximising

the returns, particularly from exports. The exports of leather and leather products gained

momentum during the past two decades. There has been a phenomenal growth in exports from

Rs.320 million in the year 1965-66 to Rs.69558 million in 1996-97. Today Indian Leather

Industry has attained well merited recognition in international markets besides occupying a

prominent place among the top seven foreign exchange earners of the country.

Market capitalization

Among all the industries the footwear industry in particular holds greater potential for

investments in India. Today India produces approx 700 million pairs of leather footwear every

year and accounts for an 18% share of the total Indian leather export.

YEAR Export from Small Sector

1993-94 25

1994-95 29

1995-96 36

1996-97 39

1997-98 44

1998-99 49


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Size of the industry

Indian Leather industry Today has capacity to produce l776 million pairs; 112 million pairs of

Shoe Uppers; Non-leather footwear - 960 million pairs of non-leather footwear's which includesshoes made of rubber, moulded PVC and other material.

Total contribution to the economy/ sales

In 2009-10 with an annual turnover of over US$ 7 billion, the export of leather and leather

products increased manifold over the past decades and touched US$ 3.40, with recording a

cumulative annual growth rate of about 5.43% (5 years).

Though India is the second largest producer of footwear and leather garments in the world, India

accounts for a share of close to 3% in the global leather import trade of US$ 137 billion (2008).

Leather Production centers for leather products are located in Tamil Nadu - Chennai, Ambur,

Ranipet, Vaniyambadi, Trichy, Dindigul ; West Bengal - Kolkata ; Uttar Pradesh - Kanpur, Agra

& Noida ; Maharashtra - Mumbai ; Punjab - Jallandhar ; Karnataka - Bangalore ; Andhra Pradesh

- Hyderabad ; Haryana - Ambala, Gurgaon, Panchkula and Karnal; Delhi


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Country 2008-09 (value in million US$)

Germany 229.48

UK 247.05

Italy 221.05

USA 163.03

France 118.9

Spain 91.86

Netherlands 76.2

Portugal 28.21

UAE 39.4

Denmark 14.78

Australia 13.34

Sweden 12.64

Canada 8.96

S. Africa 8.49

Japan 8.23

Others 252.04

Total 1533.06


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Latest developments:

The Indian federal government has earmarked a Rs 4.5 billion grant to be made availableto the industry to boost the country's leather industry over a span of five years, the fund

availability is conditional upon the sector's attracting an annual investment of Rs 2.2

trillion.

In 2002, the investments in the Indian Leather Industry stood at Rs 410 million.Footwear and their components account for about 25 %of India's total leather products

exports. These two markets also offer Indian leather industry vast scope for exports ofsaddler and harness.

India is the world's second largest producer of footwear; its production estimated over700 million pairs per annum. At about US $ 300 million per year, footwear accounts for

18 percent share of total exports of leather exports.

2008-09 (value in million US$)

Germany

UK

Italy

USA

France

Spain

Netherlands

Portugal

UAE

Denmark

Australia

Sweden

Canada

S. Africa

Japan


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Products exported from India include dresses, shoes, casuals, moccasins, sports shoes,horacchis, sandals, ballerinas, and booties. Major production centres are at Chennai

(Madras), Delhi, Agra, Kanpur, Mumbai (Bombay), Calcutta and Jalandhar.

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

generation of employment generation prospects.

India is one of the best destinations in the world for investing in the leather industrybecause India is endowed with abundant raw materials required for the industry to grow.

India has a huge population of cattle. India accounts for 21% of the world's cattle and

buffalo and 11% of the world's goat and sheep population.

The Government is also making efforts to implement various Special Focus Initiativesunder the Foreign Trade Policy for the growth of leather sector. Leather industry is

aimed to augment the production, thereby to enhance export upto US$ 7.03 billion by

2013-14 which shall create additional employment opportunities for overall one million

people.

Indian Industries

Classified

under RED category

Aluminium industry,Cement industry,Construction

industry,Copper industry,Dairy industry,Diamond

industry,Fashion industry,Fertilizer industry,Film

industry,Granite industry,Health care industry,Jewellery

industry,Mining industry,Oil industry,Paint industry,Paper

industry,Power industry,Printing industry,Rubber

industry,Silk industry,Soap industry,Steel industry,Sugar

industry,Textile industry,Tabacco industry,Zinc industry

Classified

under ORANGE category

Automobile industry,Cotton industry,Hotel industry,Jute

industry,Pharmaceutical industry,Tractor industry,Weaving

industry
http://www.indianmirror.com/indian-industries/environment.html#redhttp://www.indianmirror.com/indian-industries/environment.html#redhttp://www.indianmirror.com/indian-industries/environment.html#redhttp://www.indianmirror.com/indian-industries/aluminium.htmlhttp://www.indianmirror.com/indian-industries/cement.htmlhttp://www.indianmirror.com/indian-industries/construction.htmlhttp://www.indianmirror.com/indian-industries/construction.htmlhttp://www.indianmirror.com/indian-industries/copper.htmlhttp://www.indianmirror.com/indian-industries/dairy.htmlhttp://www.indianmirror.com/indian-industries/diamond.htmlhttp://www.indianmirror.com/indian-industries/diamond.htmlhttp://www.indianmirror.com/indian-industries/fashion.htmlhttp://www.indianmirror.com/indian-industries/fertilizer.htmlhttp://www.indianmirror.com/indian-industries/film.htmlhttp://www.indianmirror.com/indian-industries/film.htmlhttp://www.indianmirror.com/indian-industries/granite.htmlhttp://www.indianmirror.com/indian-industries/health.htmlhttp://www.indianmirror.com/indian-industries/jewellery.htmlhttp://www.indianmirror.com/indian-industries/jewellery.htmlhttp://www.indianmirror.com/indian-industries/mining.htmlhttp://www.indianmirror.com/indian-industries/oil.htmlhttp://www.indianmirror.com/indian-industries/paint.htmlhttp://www.indianmirror.com/indian-industries/paper.htmlhttp://www.indianmirror.com/indian-industries/paper.htmlhttp://www.indianmirror.com/indian-industries/power.htmlhttp://www.indianmirror.com/indian-industries/printing.htmlhttp://www.indianmirror.com/indian-industries/rubber.htmlhttp://www.indianmirror.com/indian-industries/rubber.htmlhttp://www.indianmirror.com/indian-industries/silk.htmlhttp://www.indianmirror.com/indian-industries/soap.htmlhttp://www.indianmirror.com/indian-industries/steel.htmlhttp://www.indianmirror.com/indian-industries/sugar.htmlhttp://www.indianmirror.com/indian-industries/sugar.htmlhttp://www.indianmirror.com/indian-industries/textile.htmlhttp://www.indianmirror.com/indian-industries/tabacco.htmlhttp://www.indianmirror.com/indian-industries/zinc.htmlhttp://www.indianmirror.com/indian-industries/environment.html#orangehttp://www.indianmirror.com/indian-industries/environment.html#orangehttp://www.indianmirror.com/indian-industries/environment.html#orangehttp://www.indianmirror.com/indian-industries/automobile.htmlhttp://www.indianmirror.com/indian-industries/cotton.htmlhttp://www.indianmirror.com/indian-industries/hotel.htmlhttp://www.indianmirror.com/indian-industries/jute.htmlhttp://www.indianmirror.com/indian-industries/jute.htmlhttp://www.indianmirror.com/indian-industries/pharmaceutical.htmlhttp://www.indianmirror.com/indian-industries/tractor.htmlhttp://www.indianmirror.com/indian-industries/weaving.htmlhttp://www.indianmirror.com/indian-industries/weaving.htmlhttp://www.indianmirror.com/indian-industries/weaving.htmlhttp://www.indianmirror.com/indian-industries/weaving.htmlhttp://www.indianmirror.com/indian-industries/tractor.htmlhttp://www.indianmirror.com/indian-industries/pharmaceutical.htmlhttp://www.indianmirror.com/indian-industries/jute.htmlhttp://www.indianmirror.com/indian-industries/jute.htmlhttp://www.indianmirror.com/indian-industries/hotel.htmlhttp://www.indianmirror.com/indian-industries/cotton.htmlhttp://www.indianmirror.com/indian-industries/automobile.htmlhttp://www.indianmirror.com/indian-industries/environment.html#orangehttp://www.indianmirror.com/indian-industries/environment.html#orangehttp://www.indianmirror.com/indian-industries/zinc.htmlhttp://www.indianmirror.com/indian-industries/tabacco.htmlhttp://www.indianmirror.com/indian-industries/textile.htmlhttp://www.indianmirror.com/indian-industries/sugar.htmlhttp://www.indianmirror.com/indian-industries/sugar.htmlhttp://www.indianmirror.com/indian-industries/steel.htmlhttp://www.indianmirror.com/indian-industries/soap.htmlhttp://www.indianmirror.com/indian-industries/silk.htmlhttp://www.indianmirror.com/indian-industries/rubber.htmlhttp://www.indianmirror.com/indian-industries/rubber.htmlhttp://www.indianmirror.com/indian-industries/printing.htmlhttp://www.indianmirror.com/indian-industries/power.htmlhttp://www.indianmirror.com/indian-industries/paper.htmlhttp://www.indianmirror.com/indian-industries/paper.htmlhttp://www.indianmirror.com/indian-industries/paint.htmlhttp://www.indianmirror.com/indian-industries/oil.htmlhttp://www.indianmirror.com/indian-industries/mining.htmlhttp://www.indianmirror.com/indian-industries/jewellery.htmlhttp://www.indianmirror.com/indian-industries/jewellery.htmlhttp://www.indianmirror.com/indian-industries/health.htmlhttp://www.indianmirror.com/indian-industries/granite.htmlhttp://www.indianmirror.com/indian-industries/film.htmlhttp://www.indianmirror.com/indian-industries/film.htmlhttp://www.indianmirror.com/indian-industries/fertilizer.htmlhttp://www.indianmirror.com/indian-industries/fashion.htmlhttp://www.indianmirror.com/indian-industries/diamond.htmlhttp://www.indianmirror.com/indian-industries/diamond.htmlhttp://www.indianmirror.com/indian-industries/dairy.htmlhttp://www.indianmirror.com/indian-industries/copper.htmlhttp://www.indianmirror.com/indian-industries/construction.htmlhttp://www.indianmirror.com/indian-industries/construction.htmlhttp://www.indianmirror.com/indian-industries/cement.htmlhttp://www.indianmirror.com/indian-industries/aluminium.htmlhttp://www.indianmirror.com/indian-industries/environment.html#redhttp://www.indianmirror.com/indian-industries/environment.html#red


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Classified

under GREEN category

Advertising industry,Agricultural industry,Aviation

industry,Banking industry,Biotechnology industry,Biscuit

industry,Chocolate industry,Coir industry,Cosmetic

industry,Cottage industry,Electronic industry,FoodProcessing industry,Furniture industry,Garment

industry,Insurance industry,IT industry,Leather

industry,Music industry,Mutual fund industry,Pearl

industry,Plastic industry,Poultry industry,Railway

industry,Real estate industry,Shipping industry,Solar

industry

Leather Industry classified under GREEN category:

Leather

Industry

Indian Leather Industry has developed to a large extent and is the second

largest producer next to China. The industry is equipped mostly with a

potential for employment generation, growth and exports, with theannual exports touching 2 billion USD.

INDIAN LEATHER INDUSTRY AT A GLANCE IN 20122013:

The leather and leather products exports touched $4.5 billion in the fiscal year 2011-12, posting

growth of more than 27% as compared to last year, according to the Council for Leather Exports

in India. Although, it missed the targeted $4.7 billion, the export growth has been attained in the

face of slowdown during the global economy and the sliding value of the Rupee which has made

the imports of raw material expensive.

Last year, the exports stood at $3.5 billion. The centre has set a target of $14 billion during 2016-

17 for the leather industry. Leather footwear accounts for almost 40% of the exports followed up

with the garments that account for almost 10%. The industry has moved to the products exports

from being an exporter of finished leather, which now makes up only for a small portion.
http://www.indianmirror.com/indian-industries/environment.html#greenhttp://www.indianmirror.com/indian-industries/environment.html#greenhttp://www.indianmirror.com/indian-industries/environment.html#greenhttp://www.indianmirror.com/indian-industries/advertising.htmlhttp://www.indianmirror.com/indian-industries/agricultural.htmlhttp://www.indianmirror.com/indian-industries/aviation.htmlhttp://www.indianmirror.com/indian-industries/aviation.htmlhttp://www.indianmirror.com/indian-industries/banking.htmlhttp://www.indianmirror.com/indian-industries/biotechnology.htmlhttp://www.indianmirror.com/indian-industries/biscuit.htmlhttp://www.indianmirror.com/indian-industries/biscuit.htmlhttp://www.indianmirror.com/indian-industries/chocolate.htmlhttp://www.indianmirror.com/indian-industries/coir.htmlhttp://www.indianmirror.com/indian-industries/cosmetics.htmlhttp://www.indianmirror.com/indian-industries/cosmetics.htmlhttp://www.indianmirror.com/indian-industries/cottage.htmlhttp://www.indianmirror.com/indian-industries/electronics.htmlhttp://www.indianmirror.com/indian-industries/food.htmlhttp://www.indianmirror.com/indian-industries/food.htmlhttp://www.indianmirror.com/indian-industries/furniture.htmlhttp://www.indianmirror.com/indian-industries/garment.htmlhttp://www.indianmirror.com/indian-industries/garment.htmlhttp://www.indianmirror.com/indian-industries/insurance.htmlhttp://www.indianmirror.com/indian-industries/information-technology.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/music.htmlhttp://www.indianmirror.com/indian-industries/mutual-fund.htmlhttp://www.indianmirror.com/indian-industries/pearl.htmlhttp://www.indianmirror.com/indian-industries/pearl.htmlhttp://www.indianmirror.com/indian-industries/plastic.htmlhttp://www.indianmirror.com/indian-industries/poultry.htmlhttp://www.indianmirror.com/indian-industries/railway.htmlhttp://www.indianmirror.com/indian-industries/railway.htmlhttp://www.indianmirror.com/indian-industries/real-estate.htmlhttp://www.indianmirror.com/indian-industries/shipping.htmlhttp://www.indianmirror.com/indian-industries/solar.htmlhttp://www.indianmirror.com/indian-industries/solar.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/solar.htmlhttp://www.indianmirror.com/indian-industries/solar.htmlhttp://www.indianmirror.com/indian-industries/shipping.htmlhttp://www.indianmirror.com/indian-industries/real-estate.htmlhttp://www.indianmirror.com/indian-industries/railway.htmlhttp://www.indianmirror.com/indian-industries/railway.htmlhttp://www.indianmirror.com/indian-industries/poultry.htmlhttp://www.indianmirror.com/indian-industries/plastic.htmlhttp://www.indianmirror.com/indian-industries/pearl.htmlhttp://www.indianmirror.com/indian-industries/pearl.htmlhttp://www.indianmirror.com/indian-industries/mutual-fund.htmlhttp://www.indianmirror.com/indian-industries/music.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/leather.htmlhttp://www.indianmirror.com/indian-industries/information-technology.htmlhttp://www.indianmirror.com/indian-industries/insurance.htmlhttp://www.indianmirror.com/indian-industries/garment.htmlhttp://www.indianmirror.com/indian-industries/garment.htmlhttp://www.indianmirror.com/indian-industries/furniture.htmlhttp://www.indianmirror.com/indian-industries/food.htmlhttp://www.indianmirror.com/indian-industries/food.htmlhttp://www.indianmirror.com/indian-industries/electronics.htmlhttp://www.indianmirror.com/indian-industries/cottage.htmlhttp://www.indianmirror.com/indian-industries/cosmetics.htmlhttp://www.indianmirror.com/indian-industries/cosmetics.htmlhttp://www.indianmirror.com/indian-industries/coir.htmlhttp://www.indianmirror.com/indian-industries/chocolate.htmlhttp://www.indianmirror.com/indian-industries/biscuit.htmlhttp://www.indianmirror.com/indian-industries/biscuit.htmlhttp://www.indianmirror.com/indian-industries/biotechnology.htmlhttp://www.indianmirror.com/indian-industries/banking.htmlhttp://www.indianmirror.com/indian-industries/aviation.htmlhttp://www.indianmirror.com/indian-industries/aviation.htmlhttp://www.indianmirror.com/indian-industries/agricultural.htmlhttp://www.indianmirror.com/indian-industries/advertising.htmlhttp://www.indianmirror.com/indian-industries/environment.html#greenhttp://www.indianmirror.com/indian-industries/environment.html#green


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IMPORTANCE OF THE STUDY:

It helps the researcher to construct a diversified portfolio. Provide an insight on return and risk analysis.

It helps to make a general study on derivatives.

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

OBJECTIVE OF THE STUDY:

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

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

To identify how much reduction in risk is possible.

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

SCOPE OF THE STUDY:

Introduction of derivatives in the Indian capital market is the beginning of a new era ,

which is truly exciting. Derivatives, worldwide are recognized risk management products. These

products have a long history in India, in the unorganized sector , especially in currency and

commodity markets. The availability of these products on organized exchanges ha provided the

market participants with broad based risk management tools.

This study mainly covers the area of hedging and speculation. The main aim of the

study is to prove how risks in investing in equity shares can be reduced and how to make

maximum return to the other investment.


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LIMITATION OF THE STUDY:

A) While applying the strategies , transaction cost and impact cost are not taken intoconsideration.so,it will reflect in the profit calculation on each month of the study.

B) data were collected only on the basis of NSE trading

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

been done for the application of hedging strategy.

RESEARCH METHODOLOGY:

Research methodology is a way of systematically solving the research problem, research

methodology deals with the research design used and methods used to present the study

Research Design:

A research design is a detailed blue print used to guide a research study towards its objective.

The process of designing a research study involves many interrelated decisions. The most

significant decision is the choice of research approach, because it determines how theinformation will be obtained. The choice of the research approach depends on the nature of the

research that one wants to do. The research design adopted for this study is descriptive research.

Sampling Techniques:

Identifying target persons

Determining sample frame

Selecting sampling procedure

Determine sample size

Execute sampling

Obtaining information from respondents

Generating information for decision making


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Tools for data collection:

There are several ways of collecting the appropriate data.while deciding about the method of

data collection to be used for the study, the researcher should keep in mind, that there are 2 types

of data

1. Primary Data2. Secondary Data

CHAPTERIZATION

Title : A Study on Financial Derivative and Risk Management

Chapter 1 : First Chapter Deals with introduction of study, scope of the study, objectives of

the study and limitations of the study

Chapter 2 : Second Chapter deals with company profile and history of the company

Chapter 3 : This chapter deals with review of literature related study

Chapter 4 : Fourth chapter deals with Data Analysis and Interpretation

Chapter 5 : Fifth chapter deals with summary of findings, suggestions and Conclusions


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CHAPTER2

COMPANY PROFILE

COMPANY PROFILE:

NSIC CARE Rating is assigned under the scheme for Rating of Micro & Small

Enterprises (MSEs), designed and subsidised by the National Small Industries Corporation

(NSIC). A copy of the rating report is also submitted to NSIC. The rating is a one-time exercise

and it will not be kept under surveillance. The validity of the rating is one year from the date of

report, subject to no significant changes / events occur during this period that can materially

impact the operational and financial parameters of the entity.


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The rating and the report is based on the information and explanations provided to CARE

and /or obtained by CARE from reliable sources. CARE does not guarantee the accuracy,

completeness or adequacy of any information on which this rating and report is based. CARE is

not responsible for any error / omissions for the results/opinions obtained for the use of this

report. The rating is not an audit and also not any recommendation to enter into or not enter into

any transaction with the entity. CARE reserves the right to disclose the rating along with the

rating report to Government, Regulatory Agencies, Courts of Law, etc., if required.CARE, its

directors, Rating Committee members, employees and other associated with the rating

assignment do not have any financial liability whatsoever. Any reproduction of the report or part

of it would require explicit written approval of CARE.

Strengths:

Experience of the partners in the same line of business Partners established relationship with reputed clients Modest capital structure

Risk Factors

Proprietorship firm with inherent risk of capital withdrawal and limited access to externalfunding

Long operating cycle Stagnant revenues for the past four year period ended March 2013 Client Concentration risk Thin profitability further susceptible to volatile raw material prices and foreign currency

fluctuation Risk.

Name New Tech Shoe Components

Year of Establishment 2008

Constitution Partnership Firm

Registration Number 330031200886

Registration Date 28 Aug 2013


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Nature of Business Manufacturing

Type of the Unit Small2

Enterprise Category General

Industry Footwear

Products Insole and Toe puffs for footwear industry

Controlling/Registered Office:

No. 14, Bajanai Koil Street,

Vallancherry Village,

Guduvancherry,

Dist.: Kanchipuram,

Chennai,

Tamil Nadu-603202

Location of Plant / Servicing:

No. 14, Bajanai Koil Street,


Guduvancherry,

Profile:

New Tech Shoe Components (NTSC) is a Chennai based partnership firm engaged in the

business of manufacturing in-soles, toe puffs and other shoe components for footwear industry.

NTSC was established in April 2008 by Mr. A Mahendran, as a partnership firm, the other

partner, being his wife Mrs. M. Lakshmi. Mr. Mahendran is the managing partner of the firm.

The firm procures leather sheets & paper boards from countries such as Italy, Germany and

China, processes the same and manufactures in-soles of various design and other specifications.

The same is supplied to footwear manufacturers. The shoes in turn produced by shoe


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manufacturers are sold primarily in the export market. However, NTSCs sales are predominantly

in the domestic market itself. The firm has an installed capacity to manufacture 5000 pairs of

insoles per day and its manufacturing facilities are situated in Chennai, Tamil Nadu. The day-to-

day operations of the firm are managed by Mr. A. Mahendran.

ORGANISTION & MANAGEMENT: PROFILE OF THE PROMOTERS:

Name Mr. A Mahendran Ms. M. Lakshmi

Position Partner Partner

Qualification Under Graduate Under Graduate

Age 46 years 43 years

Work Experience 27 years 7 years

Responsibilities Handled Overall management

Mr. A. Mahendran, the managing partner of the firm has more than two decades of

experience in the footwear industry. He was earlier employed in a shoe manufacturing company

before the establishment of NSTC in 2008. The partners long experience in the footwear

industry has helped the firm to forger good relationship with leading chennai based footwear

manufacturers.

ORGANISATION &MANAGEMENT:MANAGEMENT & OWNERSHIP STRUCTURE:


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OPERATIONS OVERVIEW

Nature of Activity In-sole for Shoes

Industry Segment No. 14, Bajanai Koil Street, Vallancherry Village, Guduvancherry,

District: Kanchipuram, Chennai, Tamil Nadu-603202

Products 6,500 Sq. Feet

Plant Location Owned

Manufacturing No

PRODUCT & CAPACITIES:

Class of Goods Shoe Components

Units Pair

Installed Capacity 15,00,000

Actual Production 7,80,000

BUSINESS ACTIVITY DETAILS:

Electricity Consumption Approx. 6500 units/month

Key Raw Materials Imported leather sheets and paper boards

Level of Raw Material Price Fluctuation Risk Moderate

MSME Status Small - 2

Quality Certifications No

Level of Value Addition Moderate

CUSTOMER & SUPPLIER ANALYSIS:

CUSTOMER PROFILE:

Name of the Customer Good Leather Shoes Private Limited


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Country India

Contribution to Sales 60.00

NTSC has been associated with it since inception for the supply of insoles. However, the

partner has been associated with it for more than a decade through his earlier employment.

Name of the Customer Tata International Limited

Country India

Contribution to Sales 30.00%

NTSC has been associated with it since inception for the supply of insoles.

Name of the Customer Sara Leathers Private Limited

Country India

Contribution to Sales 10.00%

NTSC has been associated with it since 2010 for the supply of insoles.

CONTRIBUTION BY TOP THREE CUSTOMERS (100% of total operating income in

FY13):

Overall Customer Profile Known & Less diversified

Export Proportion Nil

Foreign Exchange Fluctuation Risk High (Due to significant proportion of imports and nil

exports)

The firms revenues are concentrated with these top three clients who contributed 100%

of its total operating income in FY13 (100% in FY12). The shoe manufacturers avail a credit

period of about 60 to 90 days from NTSC.


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INDUSTRY ANALYSIS:

Name of the Industry Footwear

Product Portfolio Manufacture of leather insoles for Footwear industry

Overall Industry Risk Moderate

INDUSTRY WRITE-UP:

The Leather industry holds a prominent place in the Indian economy. This sector is

known for its consistency in high export earnings and it is among the top ten foreign exchange

earners for the country. With an annual turnover of over US$ 7.5 billion, the export of leather

and leather products increased manifold over the past decades and touched US$ 4.86 billion in

2012, recording a cumulative annual growth rate of about 8.22% (5 years). The leather industry

is bestowed with an affluence of raw materials as India is endowed with 21% of world cattle &

buffalo and 11% of world goat & sheep population. Added to this are the strengths of skilled

manpower, innovative technology, increasing industry compliance to international environmental

standards, and the dedicated support of the allied industries. The major markets for Indian leather

& leather Products are Germany with a share of 15.01%, UK 11.15%, Italy 10.85%, USA 9.02%,

Hong Kong 7.38%, France 6.25%, Spain 6.08%,Netherlands 4.07%, Belgium 2.32%, China2.54%, U.A.E.2.24%, Australia 1.39%, These 12 countries together accounts for nearly 78.30%

of Indias total leather& leather products export. The Government of India had identified the

Leather Sector as a focus sector in its Foreign Trade Policy in view of its immense potential for

export growth prospects and employment generation. Accordingly, the Government is also

implementing various special focus initiatives under the Foreign Trade Policy for the growth of

leather sector. With the implementation of various industrial developmental programs as well as


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export promotional activities, the Indian leather industry aims to augment the production, thereby

enhance export, and resultantly create additional employment opportunities for over one million

people.

The industry is essentially dominated by small scale firms with a few medium and large

sized firms. The industry is concentrated in several leather clusters in 4-5 distinct locations in the

country. Though government policies towards the industry have been supportive both for small-

scale sector development as well export promotion, the industry is caught up with socio political

issues relating to slaughtering of animals.

SITE VISIT REPORT:

Location of Plant No. 14, Bajanai Koil Street,

Vallancherry

Guduvancherry,

District: Chennai,

Tamil Nadu-603202

Information of Operational Facilities:

Sites visited No. 14, Bajanai Koil Street,


Guduvancherry,

District: chennai, Tamil Nadu-603202

Presence in a cluster No

Area of the unit 6500 Sq. Feet

No. of employees at site 33

Ownership of premises Owned

Electricity consumption (units) Approx. 6,500 units/month


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Other facilities Yes

Adequacy of Facilities:

Availability of land for future expansion Yes

Site layout Structured

Adequacy of insurance coverage Fully Covered

Source of power Tamil Nadu State Electricity Board

Adequacy of power Adequate

Source of water Chennai Metropolitan Water Supply

and Sewerage Board

Type of fuel used Not Applicable

Presence of labour union No

Industrial relations Good

Level of work safety Adequate

Adequacy of storage facilities Adequate

Operational status of plants Operational

FINANCIAL PERFORMANCE - PROFITABILITY STATEMENT:


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The total operating income has remained in the range of Rs. 105 lakhs in the past four

year period FY10-13. In FY12, the total operating income declined by nearly 12% primarily on

account of higher job work carried out by the firm wherein the customer provided the raw

material (leather sheets & paper boards) and the company processed the same, to manufacture

insoles for footwear. However, in FY13, the total operating income registered a growth of

13.41% primarily on account of increased volumes from the existing customers.

FINANCIAL PERFORMANCE - COST STRUCTURE:


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MC = Material Costs; EC = Employee Costs; Dep = Depreciation; P&F = Power and Fuel; I&F

=Interest and Finance Charges; OC = Other Cost

Material Costs constituted the highest pie in the cost structure for FY13. For the previous year

also, itwas the major cost contributor to the total costs. While employee costs increased from Rs.

32.63 lakh toRs.37.65 lakh in FY13, the power & fuel costs increased from Rs. 0.79 lakh to

Rs.0.90 lakh. Fixedcapital charges (depreciation and finance costs) covered 5.14 portion of totalcosts for FY13.


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FINANCIAL PERFORMANCE - BALANCE SHEET:ASSETS:

FINANCIAL PERFORMANCE - PROFITABILITY & RETURNS:

Although, the PBILDT margin has continuously increased in the past four years from

3.40% in FY10 to 5.47% in FY13, it continues to remain thin on account of fragmented nature of

industry with intense competition, putting pressure on margins. The PAT margins continue to

remain thin at 0.56% in FY13 in line with low PBILDT margins. Furthermore, the thin profit

margins are also exposed to price volatility associated with the imported raw materials. The firm

procures its key raw materials from Italy, Germany and China based on usance letter of credit.


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The company does not hedge its foreign currency exposure and has to absorb adverse

fluctuations in exchange rates that might occur from the time of material procurement to the time

of settlement of usance letter of credit. The promoter has indicated that the firm is renegotiating

the prices with its customers to pass on the increase in input prices on account of rupee

depreciation. However, the firms thin profitability is exposed to foreign currency fluctuation

risk, which is likely to impact the already thin margins adversely.

FINANCIAL PERFORMANCE - LIQUIDITY ANALYSIS:

Liquidity Ratio:

Particulars 31 Mar 2012 31 Mar 2013

Working Capital Turnover Ratio 2.73 2.46

Average Raw Material Inventory Period 73 106

Average Inventory Period (days) 41 60

Average Collection Period (days) 85 71

Average Creditors Period (days) 59 55

Working Capital Cycle (days) 67 75


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The average raw material inventory days remains high at 106 days as of March 31, 2013.

This is primarily on account of firms procurement policy wherein it imports its key raw material

namely leather sheets and paper boards to meet its six months production in order to achieve

better pricing and economies of scale. However, the total inventory period is at 60 days as it is

computed on cost of sales (which includes employee cost and other overheads) whereas the

average raw material inventory period is computed on material cost. The firm provides to 3

months credit period to its customers whereas it imports based on usance letter of credit for a

period of 90 days. The firm relies upon bank funding in the form of overdraft facility to meet its

working capital requirement. The banker has indicated that the average overdraft utilization

levels remained at nearly 90% for the past 12- month period ended July 2013.

FINANCIAL PERFORMANCE - BALANCE SHEET: LIABILITIES:

Period Ends on: 31 Mar 2011 31 Mar 2012 31 Mar 2013

Result Type: Actual Actual Actual

SUMARY: LIABILITIES

Partners Capital 25.13 29.81 31.15

TANGIBLE NET WORTH 25.13 29.81 31.15

Other Long Term Loans 2.51 1.71 0.80

TOTAL LONG TERM DEBT 2.51 1.71 0.80

Working capital Bank Borrowings - 25.31 29.39

Loans & Advances from partners and family 15.00 7.00 -

Other Short Term Loans & Advances 5.00 5.00 -

TOTAL SHORT TERM DEBT 20 37.31 29.39

Creditors for goods 10.89 18.17 12.72

Other Current Liabilities: related to ops. 3.18 0.78 0.76

TOTAL OTHER LIABILITIES 14.08 18.95 13.48


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Total Current Liabilities and Provisions ; 14.08 18.95 13.48

related to operations

TOTAL OUTSIDE LIABILITIES 22.51 39.02 30.20

TOTAL LIABILITIES 61.71 87.78 74.84

FINANCIAL PERFORMANCE - FINANCIAL FLEXIBILITY:

Capital Structure Ratio:

Particulars 31 Mar 2012 31 Mar 2013

Debt Equity Ratio 0.06 0.03

Overall Gearing Ratio 1.31 0.97

Average Cost of Borrowings 1.03 5.79

Total Outside Liabilities to Networth 1.31 0.97


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The firm does not have any term debt borrowings except vehicle loan of Rs. 0.8 lakhs as of

March 31, 2013 primarily on account of absence of debt funded asset additions in the past. The

firm relies on overdraft facility from bank to fund its working capital requirements. The overall

gearing remained moderate at 0.97 times as of March 31, 2013 (1.31 times as of March 31,

2012).

FINANCIAL PERFORMANCE - DEBT PROTECTION INDICATORS:

`The firms capital structure is marked by an overall gearing of 0.97 times and the Total

debt to GCA of 7.50 times as on March 31, 2013. The interest coverage ratio remained moderate

at 2.90 times in FY13.The Total debt/ GCA remained high primarily on account of thin

profitability and low cash accruals.


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COMMON SIZE STATEMENT - P & L ACCOUNT:

COMMON SIZE STATEMENTASSETS:


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DETAILS OF BANK FACILITIES:

Details of Bank Facilities:

NTSC has been sanctioned overdraft facility of Rs.30 lakhs from Corporation Bank. The

account is regular with Corporation Bank. The banker has expressed satisfaction over the

conduct of the account.

Disclaimer:

CAREs MSE rating is an independent opinion on performance capability and financial strength.

The rating is a one-time exercise and it will not be kept under surveillance. The validity of the

rating is one year from the date of provisional communication of rating, subject to no significant

changes / events occur during this period that can materially impact the operational and financial

parameters of the entity. The rating is not an audit and also not a recommendation for entering

into any transaction with the entity. CARE has based its ratings on information obtained from

sources believed by it to be accurate and reliable. CARE does not, however, guarantee the

accuracy, adequacy or completeness of any information and is not responsible for any errors or

omissions or for the results obtained from the use of such information.


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REVIEW OF LITERATURE:

FACTORS AFFECTING OPTION PREMIUM

THE PRICE OF THE UNDERLYING ASSET: (S)

Changes in the underlying asset price can increase or decrease the premium of an option.

These price changes have opposite effects on calls and puts. For instance, as the price of the

underlying asset rises, the premium of a call will increase and the premium of a put will

decrease. A decrease in the price of the underlying assets value will generally have the opposite

effect

THE SRIKE PRICE: (K)

The strike price determines whether or not an option has any intrinsic value. An options

premium generally increases as the option gets further in the money, and decreases as the option

becomes more deeply out of the money.

Time until expiration: (t)

An expiration approaches, the level of an options time value, for puts and calls, decreases.

Volatility:

Volatility is simply a measure of risk (uncertainty), or variability of an options underlying.

Higher volatility estimates reflect greater expected fluctuations (in either direction) in underlying

price levels. This expectation generally results in higher option premiums for puts and calls alike,

and is most noticeable with at- the- money options.

Interest rate: (R1)

This effect reflects the COST OF CARRY the interest that might be paid for margin, in

case of an option seller or received from alternative investments in the case of an option buyer

for the premium paid.Higher the interest rate, higher is the premium of the option as the cost of

carry increases.

It is a interesting tool for small retail investors. An option is a contract, which gives the buyer

(holder) the right, but not the obligation, to buy or sell specified quantity of the underlying

assets, at a specific (strike) price on or before a specified time (expiration date). The underlying

may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like

equity stocks/ stock index/ bonds etc.


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MONTHLY OPTIONS :

The exchange trade option with one month maturity and the contract usually expires on

last Thursday of every month.

PROBLEMS WITH MONTHLY OPTIONS:

Investors often face a problem when hedging using the three-monthly cycle options as the

premium paid for hedging is very high. Also the trader has to pay more money to take a long or

short position which results into illiquidity in the market. Thus to overcome the problem the BSE

introduced WEEKLY OPTIONS.

WEEKLY OPTIONS:

The exchange trade option with one or weak maturity and the contract expires on last

Friday of every week

ADVANTAGES

Weekly Options are advantageous to many to investors, hedgers and traders. The premium paid for buying options is also much lower as they have shorter time to

maturity.

The trader will also have to pay lesser money to take a long or short position. the trader can

take a larger position in the market with limited loss. On account of low cost, the liquidity will

improve, as more participants would come in. Weekly Options would lead to better pricediscovery and improvement in market depth, resulting in better price discovery and improvement

in market efficiency

TYPES OF OPTION:

CALL OPTION

A call option gives the holder (buyer/ one who is long call), the right to buy specified

quantity of the underlying asset at the strike price on or before expiration date. The seller (one

who is short call) however, has the obligation to sell the underlying asset if the buyer of the call

option decides to exercise his option to buy. To acquire this right the buyer pays a premium to

the writer (seller) of the contract.

Example:-

Suppose in this option there are two parties one is Mahesh (call buyer) who is bullish in

the market and other is Rakesh (call seller) who is bearish in the market.


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2. CALL SELLER:

In another scenario, if at the tie of product price falls below Rs. 600 say suppose the stock price

fall to Rs.550 the buyer will choose not to exercise the option.

Profit

30

20

10

0

590 600 610 620 630 640

-10

-20

-30

Loss

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

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

Finally the stock price goes to Rs.610 the buyer will not exercise the option because he has the

lost the premium of Rs.25.So he will buy the share from the seller at Rs.610.

Thus from the above example it shows that option contracts are formed so to avoid the unlimited

losses and have limited losses to the certain extent

Thus call option indicates two positions as follows:


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

the underlying asset.

Gamma = change in option delta

__________________

change in underlying price

The gamma of an option tells you how much the delta of an option would increase or

decrease for a unit change in the price of the underlying. For example, assume the gamma of an

option is 0.04 and its delta is 0.5. For a unit change in the price of the underlying, the delta of the

option would change to 0.5 + 0.04 = 0.54. The new delta of the option at changed underlying

price is 0.54; so the rate of change in the premium has increased. suppose the delta changed to

0.5-0.04 = 0.46 thus the rate of premium will decreased .

In simple terms if delta is velocity, then gamma is acceleration. Delta tells you how much

the premium would change; gamma changes delta and tells you how much the next premium

change would be for a unit price change in the price of the underlying.

Gamma is positive for long positions (long call and long put) and negative for shortpositions (short call and short put). Gamma does not matter much for options with long maturity.

However for options with short maturity, gamma is high and the value of the options changes

very fast with swings in the underlying prices

THETA:

A measure of change in the value of an option corresponding to its time to maturity. It is

a measure of time decay (or time shrunk). Theta is generally used to gain an idea of how time

decay is affecting your portfolio.

Change in an option premium

Theta = --------------------------------------

Change in time to expiry

Theta is usually negative for an option as with a decrease in time, the option value decreases.

This is due to the fact that the uncertainty element in the price decreases.


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Example:-

Suppose the theta of Infosys 30-day call option with a strike price of Rs3,900 is 4.5 when Infosys

is quoting at Rs3,900, volatility is 50% and the risk-free interest rate is 8%. This means that if

the price of Infosys and the other parameters like volatility remain the same and one day passes,

the value of this option would reduce by Rs.4.5.

ADVANTAGE:

Theta is always positive for the seller of an option, as the value of the position of the

seller increases as the value of the option goes down with time.

DISADVANTAGE:

Theta is always negative for the buyer of an option, as the value of the option

goes down each day if his view is not realized. In simple words theta tells how much

value the option would lose after one day, with all the other parameters remaining the

same.

VEGA

The extent of extent of change that may occur in the option premium, given a change in

the volatility of the underlying instrument.

Change in an option premium

Vega = -----------------------------------------

Change in volatility

Example:-

Suppose the Vega of an option is 0.6 and its premium is Rs15 when volatility of the

underlying is 35%. As the volatility increases to 36%, the premium of the option would change

upward to Rs15.6. Vega is positive for a long position (long call and long put) and negative for a

short position (short call and short put).

ADVANTAGE

Simply put, for the buyer it is advantageous if the volatility increases

after he has bought the option.


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CROSS MARGINING:

This is a method of calculating margin after taking into account combined positions in

Futures, options, cash market etc. Hence, the total margin requirement reduces due to cross-

Hedges.

MARK-TO-MARKET MARGIN:

It is a one day market which fluctuates on daily basis and on every scrip proper

evaluation is done. E.g. Investor has purchase the Wipro FUTURES. and pays the Initial margin.

Suddenly script of Wipro falls then the investor is required to pay the mark-to-market margin

also called as variation margin for trading in the future contract.


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CHAPTER4

DATA ANALYSIS AND INTERPRRETATION


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DATA ANALYSIS AND INTERPRRETATION:

Derivatives is a financial product (shares, bonds) any act which is concerned with lending

and borrowing (bank) does not have its value borrow the value from underlying asset/ basic

variables.

Derivatives is derived from the following products:

A. Shares

B. Debuntures

C. Mutual funds

D. Gold

E. Steel

F. Interest rate

G. Currencies.Derivatives is a type of market where two parties are entered into a contract one is bullish

and other is bearish in the market having opposite views regarding the market. There cannot be a

derivatives having same views about the market. In short it is like a INSURANCE market where

investors cover their risk for a particular position.

Derivatives are financial contracts of pre-determined fixed duration, whose values are

derived from the value of an underlying primary financial instrument, commodity or index, such

as: interest rates, exchange rates, commodities, and equities.

Derivatives are risk shifting instruments. Initially, they were used to reduce exposure to

changes in foreign exchange rates, interest rates, or stock indexes or commonly known as risk

hedging. Hedging is the most important aspect of derivatives and also its basic economic

purpose. There has to be counter party to hedgers and they are speculators. Speculators dont

look at derivatives as means of reducing risk but its a business for them. Rather he accepts risks


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from the hedgers in pursuit of profits. Thus for a sound derivatives market, both hedgers and

speculators are essential.

Derivatives trading has been a new introduction to the Indian markets. It is, in a sense

promotion and acceptance of market economy, that has really contributed towards the growing

awareness of risk and hence the gradual introduction of derivatives to hedge such risks.

Initially derivatives was launched in America called Chicago. Then in 1999, RBI introduced

derivatives in the local currency Interest Rate markets, which have not really developed, but with

the gradual acceptance of the ALM guidelines by banks, there should be an instrumental product

in hedging their balance sheet liabilities.The first product which was launched by BSE and NSE

in the derivatives market was index futures

INTRODUCTION TO FUTURE MARKET:

Futures markets were designed to solve the problems that exit in forward markets. A

futures con tract is an agreement between two parties to buy or sell an asset at a certain time in

the future at a certain price. There is a multilateral contract between the buyer and seller for a

underlying asset which may be financial instrument or physical commodities. But unlike forward

contracts the future contracts are standardized and exchange traded.

PURPOSE:

The primary purpose of futures market is to provide an efficient and effective mechanism

for management of inherent risks, without counter-party risk. It is a derivative instrument and a

type of forward contract The future contracts are affected mainly by the prices of the underlying

asset. As it is a future contract the buyer and seller has to pay the margin to trade in the futures

market. It is essential that both the parties compulsorily discharge their respective obligations on

the settlement day only, even though the payoffs are on a daily marking to market basis to avoid

default risk. Hence, the gains or losses are netted off on a daily basis and each morning start with

a fresh opening value. Here both the parties face an equal amount of risk and are also required to

pay upfront margins to the exchange irrespective of whether they are buyers or sellers. Index

based financial futures are settled in cash unlike futures on individual stocks which are very rare

and yet to be launched even in the US. Most of the financial futures worldwide are index based

and hence the buyer never comes to know who the seller is, both due to the presence of the

clearing corporation of the stock exchange in between and also due to secrecy reasons


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MARGIN

Margin is money deposited by the buyer and the seller to ensure the integrity of the

contract. Normally the margin requirement has been designed on the concept of VAR at 99%

levels. Based on the value at risk of the stock/index margins are calculated. In general margin

ranges between 10-50% of the contract value.

PURPOSE:

The purpose of margin is to provide a financial safeguard to ensure that traders will

perform on their contract obligations.

HEDGERS :

Hedgers are the traders who wish to eliminate the risk of price change to which they are

already exposed.It is a mechanism by which the participants in the physical/ cash markets can

cover their price risk. Hedgers are those persons who dont want to take the risk therefore they

hedge their risk while taking position in the contract. In short it is a way of reducing risks when

the investor has the underlying security.


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PURPOSE:

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

Figure 1.1

Hedgers

SYSTEMExisting New

Approach Peril &Prize Approach Peril &Prize

1) Difficult to 1) No Leverage 1)Fix price today to buy 1) Additional

offload holding available risk latter by paying premium. cost is only

during adverse reward dependant 2)For Long, buy ATM Put premium.

market conditions on market prices Option. If market goes up,

as circuit filters long position benefit else

limit to curtail losses. exercise the option.

3)Sell deep OTM call option

with underlying shares, earn

premium + profit with increase prcie

Advantages

Availability of Leverage

STRATEGY:

The basic hedging strategy is to take an equal and opposite position in the futures market to the

spot market. If the investor buys the scrip in the spot market but suddenly the market drops then

the investor hedge their risk by taking the short position in the Index futures.


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HEDGING AND DIVERSIFICATION:

Hedging is one of the principal ways to manage risk, the other being diversification.

Diversification and hedging do not have have cost in cash but have opportunity cost. Hedging is

implemented by adding a negatively and perfectly correlated asset to an existing asset. Hedging

eliminates both sides of risk: the potential profit and the potential loss. Diversification minimizes

risk for a given amount of return (or, alternatively, maximizes return for a given amount of risk).

Diversification is affected by choosing a group of assets instead of a single asset (technically, by

adding positively and imperfectly correlated assets).

Example:-

Ram enters into a contract with Shyam that he sells 50 pens to Shyam for Rs.1000. The

cost of manufacturing the pen for Ram is only Rs. 400 and he will make a profit of Rs 600 if

the sale is completed.

COST SELLING PRICE PROFIT

400 1000 600

However, Ram fears that Shyam may not honour his contract. So he inserts a new clause

in the contract that if Shyam fails to honour the contract he will have to pay a penalty of Rs.400.And if Shyam honours the contract Ram will offer a discount of Rs 100 as incentive.

Shyam defaults Shyam honors

400(Initial Investment) 600(Initial profit)

400(penalty from Shyam (-100) discount given to Shyam

- (No gain/loss) 500(Net gain)

Finally if Shyam defaults Ram will get a penalty of Rs 400 but Ram will recover his

initial investment. If Shyam honors the bill the ram will get a profit of 600 deducting the

discount of Rs.100 and net profit for ram is Rs.500. Thus Ram has hedged his risk against default

and protected his initial investment.


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LONG SECURITY, SELL FUTURES:

Here stock futures can be used as an effective risk management tool. In this case the

investor buys the shares of the company but suddenly the rally goes down. Thus to maximize the

risk the Hedger enters into a future contract and takes a short position. However the losses

suffers in the security will be offset by the profits he makes on his short future position.

Spot Price of ACC = 390

Market action = 350

Loss = 40

Strategy = BUY SECURITY, SELL FUTURES

Two month Futures= 390

Premium = 12

Short position = 390

Future profit = 40(390-350)

As the fall in the price of the security will result in a fall in the price of Futures. Now the Futures

will trade at a price lower then the price at which the hedger entered into a short position.

Finally the loss of Rs.40 incurred on the security hedger holds, will be made up the profits made

on his short futures position.

HAVE STOCK, BUY PUTS:

This is one of the simplest ways to take on hedge. Here the investor buys 100 shares of

HLL.The spot price of HLL is 232 suddenly the investor worries about the fall of price.

Therefore the solution is buy put options on HLL.The investor buys put option with a strike of

Rs.240. The premium charged is Rs.10.Here the investor has two possible scenarios three

months later.

1) IF PRICE RISES

Market action: 215

Loss : 17(232-15)

Strike price : 240


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Premium : 08

Profit : 17(240-215-8)

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

option bought.

2) IF PRICE RISES:

Market share : 250

Loss : 10

Short position : 250(spot market)

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

unlimited profit.

HAVE PORTFOLIO, SHORT NIFTY FUTURES:

Here the investor are holding the portfolio of stocks and selling nifty futures. In the case of

portfolios, most of the portfolio risk is accounted for by index fluctuations. Hence a position

LONG PORTFOLIO+ SHORT NIFTY can often become one-tenth as risky as the LONGPORTFOLIO position.

Let us assume that an investor is holding a portfolio of following scrips as given below on

1stMay, 2001.

Company Beta Amount of Holding ( in Rs)

Infosys 1.55 400,000.00

Global Tele 2.06 200,000.00

Satyam Comp 1.95 175,000.00

HFCL 1.9 125,000.00

Total Value of Portfolio 1,000,000.00


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Trading Strategy to be followed:

The investor feels that the market will go down in the next two months and wants to

protect him from any adverse movement. To achieve this the investor has to go short on 2

months NIFTY futures i.e he has to sell June Nifty. This strategy is called Short Hedge.

Formula to calculate the number of futures for hedging purposes is

Beta adjusted Value of Portfolio / Nifty Index level

Beta of the above portfolio

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

=1.61075 (round to 1.61)

Applying the formula to calculate the number of futures contracts

Assume NIFTY futures to be 1150 on 1stMay 2001

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

=1400 Units

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

Short Hedge


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Stock Market Futures Market

1

st

May Holds Rs 1,000,000.00 in Sell 7 NIFTY futuresstock portfolio contract at 1150.

25t June Stock portfolio fall by 6% NIFTY futures falls by 4.5%

to Rs 940,000.00 to 1098.25

Profit / Loss Loss: -Rs 60,000.00 Profit: 72,450.00

Net Profit: + Rs 15,450.00

SPECULATORS:

If hedgers are the people who wish to avoid price risk, speculators are those who are willing to

take such risk. speculators are those who do not have any position and simply play with the

others money. They only have a particular view on the market, stock, commodity etc. In short,

speculators put their money at risk in the hope of profiting from an anticipated price change.

Here if speculators view is correct he earns profit. In the event of speculator not being covered,

he will loose the position. They consider various factors such as demand supply, market

positions, open interests, economic fundamentals and other data to take their positions.

SPECULATION IN THE FUTURES MARKET

Speculation is all about taking position in the futures market without having the underlying.

Speculators operate in the market with motive to make money. They take:

Naked positions - Position in any future contract. Spread positions - Opposite positions in two future contracts. This is a conservative

speculative strategy.

Speculators bring liquidity to the system, provide insurance to the hedgers and facilitate


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the price discovery in the market.

Figure 1.2

Speculators

SYSTEMExisting New


1) Deliver based 1) Both profit & 1)Buy &Sell stocks 1)Maximum

Trading, margin loss to extent of on delivery basis loss possible

trading& carry price change. 2) Buy Call &Put to premium

forward transactions. by paying paid

2) Buy Index Futures premium

hold till expiry.

Advantages

*Greater Leverage as to pay only the premium.

*Greater variety of strike price options at a given time.

EXAMPLE:-

Here the Speculator believes that stock market will going to appreciate.

Current market price of PATNI COMPUTERS = 1500

Strategy: Buy February PATNI futures contract at 1500

Lot size = 100 shares

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


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Margin = 15000 (10% of 150000)

Market action = rise to 1550

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

Market action = fall to 1400

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

Thus the Speculator has a view on the market and accept the risk in anticipating of profiting from

the view. He study the market and play the game with the stock market

TYPES:

POSITION TRADERS:

These traders have a view on the market an hold positions over a period of as days until their

target is met.

DAY TRADERS:

Day traders square off the position during the curse of the trading day and book theprofits.

SCALPERS:

Scalpers in anticipation of making small profits trade a number of times throughout the

day.

SPECULATING WITH OPTIONS:

A speculator has a definite outlook about future price, therefore he can buy put or call option

depending upon his perception about future price. If speculator has a bullish outlook, he will buy

calls or sell (write) put. In case of bearish perception, the speculator will put r write calls. If

speculators view is correct he earns profit. In the event of speculator not being covered, he will

loose the position. A Speculator will buy call or put if his price outlook in a particular direction

is very strong but if is either neutral or not so strong. He would prefer writing call or put to earn

premium in the event of price situations.


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BULLISH STOCK, BUY CALLS OR BUY PUTS:

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

BUY STOCK

ACC spot price : 150

No of shares : 200

Price : 150*200 = 30,000

Market action : 160

Profit : 2,000

Return : 6.6% returns over 2months

BUY CALL OPTION:

Strike price : 150

Premium : 8

Lot size : 200 sharesMarket action :160

Profit : (160-150-8)*200 = 400

Return : 25% returns over 2months

This shows that investor can earn more in the call option because it gives 25% returns over a

investment of 2months as compared to 6.6% returns over a investment in stocks

BEARISH SECURITY,SELL FUTURES:

In this case the stock futures is overvalued and is likely to see a fall in price. Here simple

arbitrage ensures that futures on an individual securities more correspondingly with the

underlying security as long as there is sufficient liquidity in the market for the security. If the

security price rises the future price will also rise and vice-versa.


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Two month Futures on SBI = 240

Lot size = 100shares

Margin = 24

Market action = 220

Future profit = 20(240-220)

Finally on the day of expiration the spot and future price converges the investor makes a profit

because the speculator is bearish in the market and all the future stocks need to sell in the market.

BULLISH INDEX, LONG NIFTY FUTURES:

Here the investor is bullish in the index. Using index futures, an invest or can BUY OR SELL

the entire index trading on one single security. Once a person is LONG NIFTY using the futures

market, the investor gains if the index rises and loss if the index falls.

1stJuly = Index will rise

Buy nifty July contract = 960

Lot =200

14thJuly nifty risen= 967.35

Nifty July contract= 980

Short position =980

Profit = 4000(200*20)


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ARBITRAGEURS:

Arbitrage is the concept of simultaneous buying of securities in one market where the price is

low and selling in another market where the price is higher.

Arbitrageurs thrive on market imperfections. Arbitrageur is intelligent and knowledgeable person

and ready to take the risk He is basically risk averse. He enters into those contracts were he can

earn risk less profits. When markets are imperfect, buying in one market and simultaneously

selling in other market gives risk less profit. Arbitrageurs are always in the look out for such

imperfections.

In the futures market one can take advantages of arbitrage opportunities by buying from lower

priced market and selling at the higher priced market.

JM Morgan introduced EQUITY DERIVATIVES FUND called as ARBITRAGE FUND where

the investor buys the shares in the cash market and sell the shares in the future market.

ARBITRAGEURS IN FUTURES MARKET

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


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Figure 1.3

Arbitrageurs

SYSTEMExisting New


1) Buying Stocks in 1) Make money 1) B Group more 1) Risk free

one and selling in whichever way the promising as still game.

another exchange. Market moves. in weekly settlement

forward transactions. 2) Cash &Carry

2) If Future Contract arbitrage continues

more or less than Fair price

Fair Price = Cash Price + Cost of Carry.

Example:

Current market price of ONGC in BSE= 500

Current market price of ONGC in NSE= 510

Lot size = 100 shares

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


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STRATEGIES:

BUY SPOT, SELL FUTURES:

In this the investor observing that futures have been overpriced, how can the investor

cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One month

ACC futures = 1025.

This shows that futures have been overpriced and therefore as an Arbitrageur, investor can

make risk less profits entering into the following set f transactions.

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

Simultansely, sell the futures on the security at1025

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

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

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

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

position

Return the Borrow funds.Finally if the cost of borrowing funds to buy the security is less than the arbitrage profit possible,

it makes sense for the investor to enter into the arbitrage. This is termed as cash and-carry

arbitrage.


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BUY FUTURES, SELL SPOT:

In this the investor observing that futures have been under priced, how can the

investor cash in this opportunity to earn risk less profits. Say for instance ACC = 1000 and One

month ACC futures = 965.

This shows that futures have been under priced and therefore as an Arbitrageur, investor can

make risk less profits entering into the following set f transactions.

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

Mae delivery of the security

Simultansely, buy the futures on the security at 965

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

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

Futures position expires with the profit f Rs.10

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

Finally if the returns get investing in risk less instruments is less than the return from the

arbitrage it makes sense for the investor to enter into the arbitrage. This is termed as reverse

cashand- carry arbitrage.

ARBITRAGE WITH NIFTY FUTURES:

Arbitrage is the opportunity of taking advantage of the price difference between two

markets. An arbitrageur will buy at the cheaper market and sell at the costlier market. It is

possible to arbitraged between NIFTY in the futures market and the cash market. If the futures

price is any of the prices given below other than the equilibrium price then the strategy to be

followed is


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CASE-1

Spot Price of INFOSEYS = 1650

Future Price Of INFOSEYS = 1675

In this case the arbitrageur will buy INFOSEYS in the cash market at Rs.1650 and sell in the

futures at Rs.1675 and finally earn risk free profit Of Rs.25.

CASE-2

Future Price Of ACC = 675

Spot Price of ACC = 700

In this case the arbitrageur will buy ACC in the Future market at Rs.675 and sell in the Spot at

Rs.700 and finally earn risk free profit Of Rs.25.

A Graphical representation of month wise product wise turn over in new tech shoe for the period

of January 2008 to june 2013


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CHAPTER5

SUMMARY FINDINGS SUGGESTION AND CONCLUSION


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FINDINGS

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

Through the study. it has found out that, the hedging provides a safe position on an underlying security. The loss gets shifted to a counter party. Thus the hedging covers the

loss and risk. Sometimes, the market performs against the expectation. This will trigger

losses. so the hedger should be a strategic and positive thinker.

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

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

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

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

In general, the anticipation of the strategies purely for return enhancement is a riskyaffair, because, if the anticipation about the performance of the market and the underlying

goes wrong, the position taker would end up in higher losses.


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SUGGESTIONS

If an organisation wants to hedge with portfolios, it must consist of scrips fromdifferent industries, since they are convenient and represent true nature of the securities

market as a whole.

The hedging tool to reduce the losses that may arise from the market risk. Its primaryobjective is loss minimization, not profit maximization .The profit from futures or shares

will be offset from the losses from futures or shares, as the case may be. as a result, a

hedger will earn a lower return compared to that of an unhedger. But the unhedger faces a

high risk than a hedger.

The hedger will have to be a strategic thinker and also one who think positively. Heshould be able to comprehend market trends and fluctuations. Otherwise, the strategies

adopted by him earn him earn losses.

The hedging tool is suitable in the short term period. They can be specifically adopted bythe investor, who are facing high risks and has sufficient liquid cash with them. Long

term investor should beware from the market, because of the volatile nature of themarket.

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

apprehensible in this regard.


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CONCLUSION

Derivative use for hedging is only to increase due to the increased global linkages and

volatile exchange rates. Firms need to look at instituting a sound risk management system and

also need to formulate their hedging strategy that suits their specific firm

characteristics and exposures.

In India, regulation has been steadily eased and turnover and liquidity in the foreign

currency derivative markets has increased, although the use is mainly in shorter maturity

contracts of one year or less. Forward and option contracts are the more popular instruments.

Regulators had initially only allowed certain banks to deal in this market however now

corporates can also write option contracts. There are many variants of these derivatives which

investment banks across the world specialize in,and as the awareness and demand for these

variants increases.


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