1. INTRODUCTION

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

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

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

markets are marked by a very high degree of volatility. Through the use of derivative products, it is

possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk

management, these generally do not influence the fluctuations in the underlying asset prices.

However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset

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

DERIVATIVES DEFINED

Derivative is a product whose value is derived from the value of one or more basic variables,

called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying

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

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

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

wheat which is the "underlying". In the Indian context the Securities Contracts (Regulation) Act,

1956 (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 which derives its value from the prices, or index of prices, of underlying securities.

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

regulatory framework under the SC(R)A.

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NEED OF THE STUDY

Globalization has resulted in pressure on margins. The lower the margin, the greater the need

for risk management. As a result, risk management has become a key area of focus for CEO’s.

Additionally, due to failure of many banks/ financial institutions in the recent past, it has attracted

the attention of regulators also.

The challenge of a modern corporation is to ensure wealth maximization for their

shareholders that is consistent with their risk preference. On the other hand, risks have to be

managed effectively and on the other, adequate returns have to be ensured. The role played by banks

and financial institutions being what it is, they have to look at risks more carefully, since the impact

is widespread and contagious. An impact on one institution can have a fallout for the other

institutions in the market. Risk in the institutional context, therefore, needs to be understood and

dealt with appropriately.

In financial institutions, core business and risks are two sides of the same coin. Therefore,

they need to be integrated. Its absence not only risks the organization, but also financial markets and

systems. Hence, it needs to be emphasized that risk management does not imply avoidance of risk.

Taking reasonable and well understood risks is necessary in order to earn returns. For that purpose

prudent policies and procedures should be set up by the organization to identify, measure, monitor

and control the risk.

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SCOPE OF THE STUDY

My study confines to 50 listed stocks of S&P CNX Nifty only.

The report deals with the different investment decisions made by different people. It explains

the element of risk in detail while investing in Futures Contract.

It explains how derivatives hedges the risk in investment and gives optimum return, to a

given amount of risk.

The report also shows different ways of analysis of securities, different theories of

derivatives management for effective and efficient risk control.

OBJECTIVES OF THE STUDY

1) To analyze the derivatives traded in stock markets in India.

2) To analyze the operations of Futures Contracts.

3) To study the role and impact of Futures Contract w.r.t S&P CNX Nifty.

4) To study about risk management in financial markets with the help of derivatives.

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RESEARCH METHODOLOGY

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

PRIMARY DATA

Primary data has been collected through personal interaction with the employees of the

company.

SECONDARY DATA

Data collected from newspaper & magazines.

Data obtained from the internet.

Data collected from company’s financial records.

Data obtained from company journals.

SAMPLE SIZE : 50 listed stocks of S&P CNX Nifty.

PERIOD OF STUDY : 45 days (Dated 1st Jan., to 15th Feb., 2010)

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LIMITATIONS

THE MAJOR DRAWBACKS/LIMITATIONS OF THE PROJECT IS:

The data collected was basically confined to secondary sources, with very little amount of

primary data associated with the project.

There was a constraint, with regard to time allocated for the research study.

Detailed study of the topic was not possible due to the limited size of the project.

The availability of information in the form of annual reports & price fluctuations of the

companies was a big constraint to the study.

Analysis of Futures Contract is restricted to listed 50 stocks of Nifty, based on 3 months

contract.

The fulfillment of the project is limited to 45 days.

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3. INDUSTRY & COMPANY PROFILEFINANCIAL MARKETS

FINANCE IS THE PRE-REQUISITE FOR MODERN BUSINESS AND FINANCIAL INSTITUTIONS PLAY A

VITAL ROLE IN THE ECONOMIC SYSTEM. IT IS THROUGH FINANCIAL MARKETS AND INSTITUTIONS

THAT THE FINANCIAL SYSTEM OF AN ECONOMY WORKS. FINANCIAL MARKETS REFER TO THE

INSTITUTIONAL ARRANGEMENTS FOR DEALING IN FINANCIAL ASSETS AND CREDIT INSTRUMENTS

OF DIFFERENT TYPES SUCH AS CURRENCY, CHEQUES, BANK DEPOSITS, BILLS, BONDS, EQUITIES,

ETC.

FINANCIAL MARKET IS A BROAD TERM DESCRIBING ANY MARKETPLACE WHERE BUYERS AND SELLERS PARTICIPATE

IN THE TRADE OF ASSETS SUCH AS EQUITIES, BONDS, CURRENCIES AND DERIVATIVES. THEY ARE TYPICALLY

DEFINED BY HAVING TRANSPARENT PRICING, BASIC REGULATIONS ON TRADING, COSTS AND FEES AND MARKET

FORCES DETERMINING THE PRICES OF SECURITIES THAT TRADE.

GENERALLY, THERE IS NO SPECIFIC PLACE OR LOCATION TO INDICATE A FINANCIAL MARKET.

WHEREVER A FINANCIAL TRANSACTION TAKES PLACE, IT IS DEEMED TO HAVE TAKEN PLACE IN

THE FINANCIAL MARKET. HENCE FINANCIAL MARKETS ARE PERVASIVE IN NATURE SINCE

FINANCIAL TRANSACTIONS ARE THEMSELVES VERY PERVASIVE THROUGHOUT THE ECONOMIC

SYSTEM. FOR INSTANCE, ISSUE OF EQUITY SHARES, GRANTING OF LOAN BY TERM LENDING

INSTITUTIONS, DEPOSIT OF MONEY INTO A BANK, PURCHASE OF DEBENTURES, SALE OF SHARES

AND SO ON.

IN A NUTSHELL, FINANCIAL MARKETS ARE THE CREDIT MARKETS CATERING TO THE VARIOUS

NEEDS OF THE INDIVIDUALS, FIRMS AND INSTITUTIONS BY FACILITATING BUYING AND SELLING

OF FINANCIAL ASSETS, CLAIMS AND SERVICES.

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CLASSIFICATION OF FINANCIAL MARKETS

CAPITAL MARKET

THE CAPITAL MARKET IS A MARKET FOR FINANCIAL ASSETS WHICH HAVE A LONG OR

INDEFINITE MATURITY. GENERALLY, IT DEALS WITH LONG TERM SECURITIES WHICH HAVE A

FINANCIAL MARKETS

ORGANIZED MARKETS

UNORGANIZED MARKETS

CAPITAL MARKETS

MONEY MARKETS

INDUSTRIAL SECURITIES

MARKET

GOVERNMENT SECURITIES

MARKET

LONG-TERM LOAN MARKET

PRIMARY MARKET

SECONDARY MARKET

CALL MONEY MARKET

COMMERCIAL BILL MARKET

TREASURY BILL MARKET

MONEY LENDERS,

INDIGENUOS BANKERS

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PERIOD OF ABOVE ONE YEAR. IN THE WIDEST SENSE, IT CONSISTS OF A SERIES OF CHANNELS

THROUGH WHICH THE SAVINGS OF THE COMMUNITY ARE MADE AVAILABLE FOR INDUSTRIAL

AND COMMERCIAL ENTERPRISES AND PUBLIC AUTHORITIES. AS A WHOLE, CAPITAL MARKET

FACILITATES RAISING OF CAPITAL.

THE MAJOR FUNCTIONS PERFORMED BY A CAPITAL MARKET ARE:

1. MOBILIZATION OF FINANCIAL RESOURCES ON A NATION-WIDE SCALE.

2. SECURING THE FOREIGN CAPITAL AND KNOW-HOW TO FILL UP DEFICIT IN THE REQUIRED

RESOURCES FOR ECONOMIC GROWTH AT A FASTER RATE.

3. EFFECTIVE ALLOCATION OF THE MOBILIZED FINANCIAL RESOURCES, BY DIRECTING THE

SAME TO PROJECTS YIELDING HIGHEST YIELD OR TO THE PROJECTS NEEDED TO

PROMOTE BALANCED ECONOMIC DEVELOPMENT.

CAPITAL MARKET CONSISTS OF PRIMARY MARKET AND SECONDARY MARKET.

PRIMARY MARKET: PRIMARY MARKET IS A MARKET FOR NEW ISSUES OR NEW FINANCIAL

CLAIMS. HENCE IT IS ALSO CALLED AS NEW ISSUE MARKET. IT BASICALLY DEALS WITH THOSE

SECURITIES WHICH ARE ISSUED TO THE PUBLIC FOR THE FIRST TIME. THE MARKET,

THEREFORE, MAKES AVAILABLE A NEW BLOCK OF SECURITIES FOR PUBLIC SUBSCRIPTION. IN

OTHER WORDS, IT DEALS WITH RAISING OF FRESH CAPITAL BY COMPANIES EITHER FOR CASH OR

FOR CONSIDERATION OTHER THAN CASH. THE BEST EXAMPLE COULD BE INITIAL PUBLIC

OFFERING (IPO) WHERE A FIRM OFFERS SHARES TO THE PUBLIC FOR THE FIRST TIME.

SECONDARY MARKET: SECONDARY MARKET IS A MARKET WHERE EXISTING SECURITIES ARE

TRADED. IN OTHER WORDS, SECURITIES WHICH HAVE ALREADY PASSED THROUGH NEW ISSUE

MARKET ARE TRADED IN THIS MARKET. GENERALLY, SUCH SECURITIES ARE QUOTED IN THE

STOCK EXCHANGE AND IT PROVIDES A CONTINUOUS AND REGULAR MARKET FOR BUYING AND

SELLING OF SECURITIES. THIS MARKET CONSISTS OF ALL STOCK EXCHANGES RECOGNIZED BY

THE GOVERNMENT OF INDIA.

MONEY MARKET

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MONEY MARKETS ARE THE MARKETS FOR SHORT-TERM, HIGHLY LIQUID DEBT SECURITIES.

MONEY MARKET SECURITIES ARE GENERALLY VERY SAFE INVESTMENTS WHICH RETURN

RELATIVELY LOW INTEREST RATE THAT IS MOST APPROPRIATE FOR TEMPORARY CASH STORAGE

OR SHORT TERM TIME NEEDS. IT CONSISTS OF A NUMBER OF SUB-MARKETS WHICH

COLLECTIVELY CONSTITUTE THE MONEY MARKET NAMELY CALL MONEY MARKET,

COMMERCIAL BILLS MARKET, ACCEPTANCE MARKET, AND TREASURY BILL MARKET.

DERIVATIVES MARKET

THE DERIVATIVES MARKET IS THE FINANCIAL MARKET FOR DERIVATIVES, FINANCIAL

INSTRUMENTS LIKE FUTURES CONTRACTS OR OPTIONS, WHICH ARE DERIVED FROM OTHER

FORMS OF ASSETS. A DERIVATIVE IS A SECURITY WHOSE PRICE IS DEPENDENT UPON OR DERIVED

FROM ONE OR MORE UNDERLYING ASSETS. THE DERIVATIVE ITSELF IS MERELY A CONTRACT

BETWEEN TWO OR MORE PARTIES. ITS VALUE IS DETERMINED BY FLUCTUATIONS IN THE

UNDERLYING ASSET. THE MOST COMMON UNDERLYING ASSETS INCLUDE STOCKS,

BONDS, COMMODITIES, CURRENCIES, INTEREST RATES AND MARKET INDEXES. THE IMPORTANT

FINANCIAL DERIVATIVES ARE THE FOLLOWING:

FORWARDS: FORWARDS ARE THE OLDEST OF ALL THE DERIVATIVES. A FORWARD

CONTRACT REFERS TO AN AGREEMENT BETWEEN TWO PARTIES TO EXCHANGE AN

AGREED QUANTITY OF AN ASSET FOR CASH AT A CERTAIN DATE IN FUTURE AT A

PREDETERMINED PRICE SPECIFIED IN THAT AGREEMENT. THE PROMISED ASSET MAY BE

CURRENCY, COMMODITY, INSTRUMENT ETC.

FUTURES: FUTURE CONTRACT IS VERY SIMILAR TO A FORWARD CONTRACT IN ALL

RESPECTS EXCEPTING THE FACT THAT IT IS COMPLETELY A STANDARDIZED ONE. IT IS

NOTHING BUT A STANDARDIZED FORWARD CONTRACT WHICH IS LEGALLY ENFORCEABLE

AND ALWAYS TRADED ON AN ORGANIZED EXCHANGE.

OPTIONS: A FINANCIAL DERIVATIVE THAT REPRESENTS A CONTRACT SOLD BY ONE

PARTY (OPTION WRITER) TO ANOTHER PARTY (OPTION HOLDER). THE CONTRACT OFFERS

THE BUYER THE RIGHT, BUT NOT THE OBLIGATION, TO BUY (CALL) OR SELL (PUT) A

SECURITY OR OTHER FINANCIAL ASSET AT AN AGREED-UPON PRICE (THE STRIKE

PRICE) DURING A CERTAIN PERIOD OF TIME OR ON A SPECIFIC DATE (EXERCISE DATE).

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CALL OPTIONS GIVE THE OPTION TO BUY AT CERTAIN PRICE, SO THE BUYER WOULD

WANT THE STOCK TO GO UP. PUT OPTIONS GIVE THE OPTION TO SELL AT A CERTAIN

PRICE, SO THE BUYER WOULD WANT THE STOCK TO GO DOWN.

SWAPS: IT IS YET ANOTHER EXCITING TRADING INSTRUMENT. INFACT, IT IS THE

COMBINATION OF FORWARDS BY TWO COUNTERPARTIES. IT IS ARRANGED TO REAP THE

BENEFITS ARISING FROM THE FLUCTUATIONS IN THE MARKET – EITHER CURRENCY

MARKET OR INTEREST RATE MARKET OR ANY OTHER MARKET FOR THAT MATTER.

FOREIGN EXCHANGE MARKET

IT IS A MARKET IN WHICH PARTICIPANTS ARE ABLE TO BUY, SELL, EXCHANGE AND SPECULATE

ON CURRENCIES.  FOREIGN EXCHANGE MARKETS ARE MADE UP OF BANKS, COMMERCIAL

COMPANIES, CENTRAL BANKS, INVESTMENT MANAGEMENT FIRMS, HEDGE FUNDS, AND RETAIL

FOREX BROKERS AND INVESTORS. THE FOREX MARKET IS CONSIDERED TO BE THE LARGEST

FINANCIAL MARKET IN THE WORLD. IT IS A WORLDWIDE DECENTRALIZED OVER-THE-COUNTER

FINANCIAL MARKET FOR THE TRADING OF CURRENCIES. BECAUSE THE CURRENCY MARKETS

ARE LARGE AND LIQUID, THEY ARE BELIEVED TO BE THE MOST EFFICIENT FINANCIAL

MARKETS. IT IS IMPORTANT TO REALIZE THAT THE FOREIGN EXCHANGE MARKET IS NOT A

SINGLE EXCHANGE, BUT IS CONSTRUCTED OF A GLOBAL NETWORK OF COMPUTERS THAT

CONNECTS PARTICIPANTS FROM ALL PARTS OF THE WORLD.

COMMODITIES MARKET

IT IS A PHYSICAL OR VIRTUAL MARKETPLACE FOR BUYING, SELLING AND TRADING RAW OR

PRIMARY PRODUCTS. FOR INVESTORS' PURPOSES THERE ARE CURRENTLY ABOUT 50 MAJOR

COMMODITY MARKETS WORLDWIDE THAT FACILITATE INVESTMENT TRADE IN NEARLY 100

PRIMARY COMMODITIES. COMMODITIES ARE SPLIT INTO TWO TYPES: HARD AND SOFT

COMMODITIES. HARD COMMODITIES ARE TYPICALLY NATURAL RESOURCES THAT MUST BE

MINED OR EXTRACTED (GOLD, RUBBER, OIL, ETC.), WHEREAS SOFT COMMODITIES ARE

AGRICULTURAL PRODUCTS OR LIVESTOCK (CORN, WHEAT, COFFEE, SUGAR, SOYBEANS, PORK,

ETC.)

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INDIAN FINANCIAL MARKETS

INDIA FINANCIAL MARKET IS ONE OF THE OLDEST IN THE WORLD AND IS CONSIDERED TO BE

THE FASTEST GROWING AND BEST AMONG ALL THE MARKETS OF THE EMERGING ECONOMIES.

THE HISTORY OF INDIAN CAPITAL MARKETS DATES BACK 200 YEARS TOWARD THE END OF THE

18TH CENTURY WHEN INDIA WAS UNDER THE RULE OF THE EAST INDIA COMPANY. THE

DEVELOPMENT OF THE CAPITAL MARKET IN INDIA CONCENTRATED AROUND MUMBAI WHERE

NO LESS THAN 200 TO 250 SECURITIES BROKERS WERE ACTIVE DURING THE SECOND HALF OF

THE 19TH CENTURY.

THE FINANCIAL MARKET IN INDIA TODAY IS MORE DEVELOPED THAN MANY OTHER SECTORS

BECAUSE IT WAS ORGANIZED LONG BEFORE WITH THE SECURITIES EXCHANGES OF MUMBAI,

AHMADABAD AND KOLKATA WERE ESTABLISHED AS EARLY AS THE 19TH CENTURY.

BY THE EARLY 1960S THE TOTAL NUMBER OF SECURITIES EXCHANGES IN INDIA ROSE TO EIGHT,

INCLUDING MUMBAI, AHMADABAD AND KOLKATA APART FROM MADRAS, KANPUR, DELHI,

BANGALORE AND PUNE. TODAY THERE ARE 21 REGIONAL SECURITIES EXCHANGES IN INDIA IN

ADDITION TO THE CENTRALIZED NSE (NATIONAL STOCK EXCHANGE) AND OTCEI (OVER THE

COUNTER EXCHANGE OF INDIA).

HOWEVER THE STOCK MARKETS IN INDIA REMAINED STAGNANT DUE TO STRINGENT CONTROLS

ON THE MARKET ECONOMY THAT ALLOWED ONLY A HANDFUL OF MONOPOLIES TO DOMINATE

THEIR RESPECTIVE SECTORS. THE CORPORATE SECTOR WASN'T ALLOWED INTO MANY

INDUSTRY SEGMENTS, WHICH WERE DOMINATED BY THE STATE CONTROLLED PUBLIC SECTOR

RESULTING IN STAGNATION OF THE ECONOMY RIGHT UP TO THE EARLY 1990S. THEREAFTER

WHEN THE INDIAN ECONOMY BEGAN LIBERALIZING AND THE CONTROLS BEGAN TO BE

DISMANTLED OR EASED OUT; THE SECURITIES MARKETS WITNESSED A FLURRY OF IPO’S THAT

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WERE LAUNCHED. THIS RESULTED IN MANY NEW COMPANIES ACROSS DIFFERENT INDUSTRY

SEGMENTS TO COME UP WITH NEWER PRODUCTS AND SERVICES.

A REMARKABLE FEATURE OF THE GROWTH OF THE INDIAN ECONOMY IN RECENT YEARS HAS

BEEN THE ROLE PLAYED BY ITS SECURITIES MARKETS IN ASSISTING AND FUELLING THAT

GROWTH WITH MONEY ROSE WITHIN THE ECONOMY. THIS WAS IN MARKED CONTRAST TO THE

INITIAL PHASE OF GROWTH IN MANY OF THE FAST GROWING ECONOMIES OF EAST ASIA THAT

WITNESSED HUGE DOSES OF FDI (FOREIGN DIRECT INVESTMENT) SPURRING GROWTH IN THEIR

INITIAL DAYS OF MARKET DECONTROL. DURING THIS PHASE IN INDIA MUCH OF THE ORGANIZED

SECTOR HAS BEEN AFFECTED BY HIGH GROWTH AS THE FINANCIAL MARKETS PLAYED AN ALL-

INCLUSIVE ROLE IN SUSTAINING FINANCIAL RESOURCE MOBILIZATION. MANY PSUS (PUBLIC

SECTOR UNDERTAKINGS) THAT DECIDED TO OFFLOAD PART OF THEIR EQUITY WERE ALSO

HELPED BY THE WELL-ORGANIZED SECURITIES MARKET IN INDIA.

THE LAUNCH OF THE NSE (NATIONAL STOCK EXCHANGE) AND THE OTCEI (OVER THE

COUNTER EXCHANGE OF INDIA) DURING THE MID 1990S BY THE GOVERNMENT OF INDIA WAS

MEANT TO USHER IN AN EASIER AND MORE TRANSPARENT FORM OF TRADING IN SECURITIES.

THE NSE WAS CONCEIVED AS THE MARKET FOR TRADING IN THE SECURITIES OF COMPANIES

FROM THE LARGE-SCALE SECTOR AND THE OTCEI FOR THOSE FROM THE SMALL-SCALE

SECTOR. WHILE THE NSE HAS NOT JUST DONE WELL TO GROW AND EVOLVE INTO THE VIRTUAL

BACKBONE OF CAPITAL MARKETS IN INDIA THE OTCEI STRUGGLED AND IS YET TO SHOW ANY

SIGN OF GROWTH AND DEVELOPMENT. THE INTEGRATION OF IT INTO THE CAPITAL MARKET

INFRASTRUCTURE HAS BEEN PARTICULARLY SMOOTH IN INDIA DUE TO THE COUNTRY’S WORLD

CLASS IT INDUSTRY. THIS HAS PUSHED UP THE OPERATIONAL EFFICIENCY OF THE INDIAN

STOCK MARKET TO GLOBAL STANDARDS AND AS A RESULT THE COUNTRY HAS BEEN ABLE TO

CAPITALIZE ON ITS HIGH GROWTH AND ATTRACT FOREIGN CAPITAL LIKE NEVER BEFORE.

THE REGULATING AUTHORITY FOR CAPITAL MARKETS IN INDIA IS THE SEBI (SECURITIES AND

EXCHANGE BOARD OF INDIA). SEBI CAME INTO PROMINENCE IN THE 1990S AFTER THE CAPITAL

MARKETS EXPERIENCED SOME TURBULENCE. IT HAD TO TAKE DRASTIC MEASURES TO PLUG

MANY LOOPHOLES THAT WERE EXPLOITED BY CERTAIN MARKET FORCES TO ADVANCE THEIR

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VESTED INTERESTS. AFTER THIS INITIAL PHASE OF STRUGGLE SEBI HAS GROWN IN STRENGTH

AS THE REGULATOR OF INDIA’S CAPITAL MARKETS AND AS ONE OF THE COUNTRY’S MOST

IMPORTANT INSTITUTIONS.

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FINANCIAL MARKET REGULATIONS

REGULATIONS ARE AN ABSOLUTE NECESSITY IN THE FACE OF THE GROWING IMPORTANCE OF

CAPITAL MARKETS THROUGHOUT THE WORLD. THE DEVELOPMENT OF A MARKET ECONOMY IS

DEPENDENT ON THE DEVELOPMENT OF THE CAPITAL MARKET. THE REGULATION OF A CAPITAL

MARKET INVOLVES THE REGULATION OF SECURITIES; THESE RULES ENABLE THE CAPITAL

MARKET TO FUNCTION MORE EFFICIENTLY AND IMPARTIALLY.

A WELL REGULATED MARKET HAS THE POTENTIAL TO ENCOURAGE ADDITIONAL INVESTORS TO

PARTAKE, AND CONTRIBUTE IN, FURTHERING THE DEVELOPMENT OF THE ECONOMY. THE CHIEF

CAPITAL MARKET REGULATORY AUTHORITY IS SECURITIES AND EXCHANGE BOARD OF INDIA

(SEBI).

SEBI IS THE REGULATOR FOR THE SECURITIES MARKET IN INDIA. IT IS THE APEX BODY TO

DEVELOP AND REGULATE THE STOCK MARKET IN INDIA IT WAS FORMED OFFICIALLY BY THE

GOVERNMENT OF INDIA IN 1992 WITH SEBI ACT 1992 BEING PASSED BY THE INDIAN

PARLIAMENT. CHAIRED BY C B BHAVE, SEBI IS HEADQUARTERED IN THE POPULAR BUSINESS

DISTRICT OF BANDRA-KURLA COMPLEX IN MUMBAI, AND HAS NORTHERN, EASTERN, SOUTHERN

AND WESTERN REGIONAL OFFICES IN NEW DELHI, KOLKATA, CHENNAI AND AHMEDABAD. IN

PLACE OF GOVERNMENT CONTROL, A STATUTORY AND AUTONOMOUS REGULATORY BOARD

WITH DEFINED RESPONSIBILITIES, TO COVER BOTH DEVELOPMENT & REGULATION OF THE

MARKET, AND INDEPENDENT POWERS HAS BEEN SET UP.

THE BASIC OBJECTIVES OF THE BOARD WERE IDENTIFIED AS:

TO PROTECT THE INTERESTS OF INVESTORS IN SECURITIES;

TO PROMOTE THE DEVELOPMENT OF SECURITIES MARKET;

TO REGULATE THE SECURITIES MARKET AND

FOR MATTERS CONNECTED THEREWITH OR INCIDENTAL THERETO.

SINCE ITS INCEPTION SEBI HAS BEEN WORKING TARGETING THE SECURITIES AND IS ATTENDING

TO THE FULFILLMENT OF ITS OBJECTIVES WITH COMMENDABLE ZEAL AND DEXTERITY. THE

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IMPROVEMENTS IN THE SECURITIES MARKETS LIKE CAPITALIZATION REQUIREMENTS,

MARGINING, ESTABLISHMENT OF CLEARING CORPORATIONS ETC. REDUCED THE RISK OF CREDIT

AND ALSO REDUCED THE MARKET.

SEBI HAS INTRODUCED THE COMPREHENSIVE REGULATORY MEASURES, PRESCRIBED

REGISTRATION NORMS, THE ELIGIBILITY CRITERIA, THE CODE OF OBLIGATIONS AND THE CODE

OF CONDUCT FOR DIFFERENT INTERMEDIARIES LIKE, BANKERS TO ISSUE, MERCHANT BANKERS,

BROKERS AND SUB-BROKERS, REGISTRARS, PORTFOLIO MANAGERS, CREDIT RATING AGENCIES,

UNDERWRITERS AND OTHERS. IT HAS FRAMED BYE-LAWS, RISK IDENTIFICATION AND RISK

MANAGEMENT SYSTEMS FOR CLEARING HOUSES OF STOCK EXCHANGES, SURVEILLANCE SYSTEM

ETC. WHICH HAS MADE DEALING IN SECURITIES BOTH SAFE AND TRANSPARENT TO THE END

INVESTOR.

ANOTHER SIGNIFICANT EVENT IS THE APPROVAL OF TRADING IN STOCK INDICES (LIKE S&P

CNX NIFTY & SENSEX) IN 2000. A MARKET INDEX IS A CONVENIENT AND EFFECTIVE PRODUCT

BECAUSE OF THE FOLLOWING REASONS:

IT ACTS AS A BAROMETER FOR MARKET BEHAVIOR;

IT IS USED TO BENCHMARK PORTFOLIO PERFORMANCE;

IT IS USED IN DERIVATIVE INSTRUMENTS LIKE INDEX FUTURES AND INDEX OPTIONS;

IT CAN BE USED FOR PASSIVE FUND MANAGEMENT AS IN CASE OF INDEX FUNDS.

TWO BROAD APPROACHES OF SEBI IS TO INTEGRATE THE SECURITIES MARKET AT THE

NATIONAL LEVEL, AND ALSO TO DIVERSIFY THE TRADING PRODUCTS, SO THAT THERE IS AN

INCREASE IN NUMBER OF TRADERS INCLUDING BANKS, FINANCIAL INSTITUTIONS, INSURANCE

COMPANIES, MUTUAL FUNDS, PRIMARY DEALERS ETC. TO TRANSACT THROUGH THE

EXCHANGES. IN THIS CONTEXT THE INTRODUCTION OF DERIVATIVES TRADING THROUGH

INDIAN STOCK EXCHANGES PERMITTED BY SEBI IN 2000 AD IS A REAL LANDMARK.

SEBI HAS ENJOYED SUCCESS AS A REGULATOR BY PUSHING SYSTEMIC REFORMS AGGRESSIVELY

AND SUCCESSIVELY (E.G. THE QUICK MOVEMENT TOWARDS MAKING THE MARKETS ELECTRONIC

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AND PAPERLESS ROLLING SETTLEMENT ON T+2 BASES). SEBI HAS BEEN ACTIVE IN SETTING UP

THE REGULATIONS AS REQUIRED UNDER LAW.

STOCK EXCHANGES IN INDIA

STOCK EXCHANGES ARE AN ORGANIZED MARKETPLACE, EITHER CORPORATION OR MUTUAL

ORGANIZATION, WHERE MEMBERS OF THE ORGANIZATION GATHER TO TRADE COMPANY STOCKS

OR OTHER SECURITIES. THE MEMBERS MAY ACT EITHER AS AGENTS FOR THEIR CUSTOMERS, OR

AS PRINCIPALS FOR THEIR OWN ACCOUNTS.

AS PER THE SECURITIES CONTRACTS REGULATION ACT, 1956 A STOCK EXCHANGE IS AN

ASSOCIATION, ORGANIZATION OR BODY OF INDIVIDUALS WHETHER INCORPORATED OR NOT,

ESTABLISHED FOR THE PURPOSE OF ASSISTING, REGULATING AND CONTROLLING BUSINESS IN

BUYING, SELLING AND DEALING IN SECURITIES.

STOCK EXCHANGES FACILITATE FOR THE ISSUE AND REDEMPTION OF SECURITIES AND OTHER

FINANCIAL INSTRUMENTS INCLUDING THE PAYMENT OF INCOME AND DIVIDENDS. THE RECORD

KEEPING IS CENTRAL BUT TRADE IS LINKED TO SUCH PHYSICAL PLACE BECAUSE MODERN

MARKETS ARE COMPUTERIZED. THE TRADE ON AN EXCHANGE IS ONLY BY MEMBERS AND STOCK

BROKER DO HAVE A SEAT ON THE EXCHANGE.

LIST OF STOCK EXCHANGES IN INDIA

BOMBAY STOCK EXCHANGE

NATIONAL STOCK EXCHANGE

OTC EXCHANGE OF INDIA

REGIONAL STOCK EXCHANGES

1. AHMEDABAD

2. BANGALORE

3. BHUBANESWAR

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4. CALCUTTA

5. COCHIN

6. COIMBATORE

7. DELHI

8. GUWAHATI

9.

HYDERABAD

10. JAIPUR

11.

LUDHIANA

12. MADHYA PRADESH

13. MADRAS

14. MAGADH

15. MANGALORE

16. MEERUT

17. PUNE

18. SAURASHTRA KUTCH

19. UTTAR PRADESH

20.

VADODARA

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BOMBAY STOCK EXCHANGE

A VERY COMMON NAME FOR ALL TRADERS IN THE STOCK MARKET, BSE, STANDS

FOR BOMBAY STOCK EXCHANGE. IT IS THE OLDEST MARKET NOT ONLY IN THE

COUNTRY, BUT ALSO IN ASIA. IN THE EARLY DAYS, BSE WAS KNOWN AS "THE

NATIVE SHARE & STOCK BROKERS ASSOCIATION." IT WAS ESTABLISHED IN THE

YEAR 1875 AND BECAME THE FIRST STOCK EXCHANGE IN THE COUNTRY TO BE

RECOGNIZED BY THE GOVERNMENT. IN 1956, BSE OBTAINED A PERMANENT

RECOGNITION FROM THE GOVERNMENT OF INDIA UNDER THE SECURITIES

CONTRACTS (REGULATION) ACT, 1956.

IN THE PAST AND EVEN NOW, IT PLAYS A PIVOTAL ROLE IN THE DEVELOPMENT OF

THE COUNTRY'S CAPITAL MARKET. THIS IS RECOGNIZED WORLDWIDE AND ITS

INDEX, SENSEX, IS ALSO TRACKED WORLDWIDE. EARLIER IT WAS AN ASSOCIATION

OF PERSONS (AOP), BUT NOW IT IS A DEMUTUALISED AND CORPORATISED ENTITY

INCORPORATED UNDER THE PROVISIONS OF THE COMPANIES ACT, 1956, PURSUANT

TO THE BSE (CORPORATISATION AND DEMUTUALIZATION) SCHEME, 2005 NOTIFIED

BY THE SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI).

BSE VISION

THE VISION OF THE BOMBAY STOCK EXCHANGE IS TO "EMERGE AS THE PREMIER

INDIAN STOCK EXCHANGE BY ESTABLISHING GLOBAL BENCHMARKS."

BSE MANAGEMENT

BOMBAY STOCK EXCHANGE IS MANAGED PROFESSIONALLY BY BOARD OF

DIRECTORS. IT COMPRISES OF EMINENT PROFESSIONALS, REPRESENTATIVES OF

TRADING MEMBERS AND THE MANAGING DIRECTOR. THE BOARD IS AN INCLUSIVE

ONE AND IS SHAPED TO BENEFIT FROM THE MARKET INTERMEDIARIES

PARTICIPATION.

THE BOARD EXERCISES COMPLETE CONTROL AND FORMULATES LARGER POLICY

ISSUES. THE DAY-TO-DAY OPERATIONS OF BSE ARE MANAGED BY THE MANAGING

DIRECTOR AND ITS SCHOOL OF PROFESSIONAL AS A MANAGEMENT TEAM.

BSE NETWORK

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THE EXCHANGE REACHES PHYSICALLY TO 417 CITIES AND TOWNS IN THE COUNTRY.

THE FRAMEWORK OF IT HAS BEEN DESIGNED TO SAFEGUARD MARKET INTEGRITY

AND TO OPERATE WITH TRANSPARENCY. IT PROVIDES AN EFFICIENT MARKET FOR

THE TRADING IN EQUITY, DEBT INSTRUMENTS AND DERIVATIVES. ITS ONLINE

TRADING SYSTEM, POPULARLY KNOWN AS BOLT, IS A PROPRIETARY SYSTEM AND IT

IS BS 7799-2-2002 CERTIFIED. THE BOLT NETWORK WAS EXPANDED, NATIONWIDE,

IN 1997. THE SURVEILLANCE AND CLEARING & SETTLEMENT FUNCTIONS OF THE

EXCHANGE ARE ISO 9001:2000 CERTIFIED.

BSE FACTS

BSE AS A BRAND IS SYNONYMOUS WITH CAPITAL MARKETS IN INDIA. THE BSE

SENSEX IS THE BENCHMARK EQUITY INDEX THAT REFLECTS THE ROBUSTNESS OF

THE ECONOMY AND FINANCE. IT WAS THE –

FIRST IN INDIA TO INTRODUCE EQUITY DERIVATIVES

FIRST IN INDIA TO LAUNCH A FREE FLOAT INDEX

FIRST IN INDIA TO LAUNCH US$ VERSION OF BSE SENSEX

FIRST IN INDIA TO LAUNCH EXCHANGE ENABLED INTERNET TRADING

PLATFORM

FIRST IN INDIA TO OBTAIN ISO CERTIFICATION FOR SURVEILLANCE,

CLEARING & SETTLEMENT

'BSE ON-LINE TRADING SYSTEM’ (BOLT) HAS BEEN AWARDED THE

GLOBALLY

RECOGNIZED THE INFORMATION SECURITY MANAGEMENT SYSTEM

STANDARD

BS7799-2:2002.

FIRST TO HAVE AN EXCLUSIVE FACILITY FOR FINANCIAL TRAINING

MOVED FROM OPEN OUTCRY TO ELECTRONIC TRADING WITHIN JUST 50

DAYS

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BSE WITH ITS LONG HISTORY OF CAPITAL MARKET DEVELOPMENT IS FULLY

GEARED TO CONTINUE ITS CONTRIBUTIONS TO FURTHER THE GROWTH OF THE

SECURITIES MARKETS OF THE COUNTRY, THUS HELPING INDIA INCREASES ITS

SPHERE OF INFLUENCE IN INTERNATIONAL FINANCIAL MARKETS.

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NATIONAL STOCK EXCHANGE OF INDIA LIMITED

THE NATIONAL STOCK EXCHANGE OF INDIA LIMITED HAS GENESIS IN THE REPORT

OF THE HIGH POWERED STUDY GROUP ON ESTABLISHMENT OF NEW STOCK

EXCHANGES, WHICH RECOMMENDED PROMOTION OF A NATIONAL STOCK

EXCHANGE BY FINANCIAL INSTITUTIONS (FI’S) TO PROVIDE ACCESS TO INVESTORS

FROM ALL ACROSS THE COUNTRY ON AN EQUAL FOOTING. BASED ON THE

RECOMMENDATIONS, NSE WAS PROMOTED BY LEADING FINANCIAL INSTITUTIONS

AT THE BEHEST OF THE GOVERNMENT OF INDIA AND WAS INCORPORATED IN

NOVEMBER 1992 AS A TAX-PAYING COMPANY UNLIKE OTHER STOCK EXCHANGE IN

THE COUNTRY.

ON ITS RECOGNITION AS A STOCK EXCHANGE UNDER THE SECURITIES CONTRACTS

(REGULATION) ACT, 1956 IN APRIL 1993, NSE COMMENCED OPERATIONS IN THE

WHOLESALE DEBT MARKET (WDM) SEGMENT IN JUNE 1994. THE CAPITAL

MARKET (EQUITIES) SEGMENT COMMENCED OPERATIONS IN NOVEMBER 1994 AND

OPERATIONS IN DERIVATIVES SEGMENT COMMENCED.

NSE GROUP

NATIONAL SECURITIES CLEARING CORPORATION LTD. (NSCCL)

IT IS A WHOLLY OWNED SUBSIDIARY, WHICH WAS INCORPORATED IN AUGUST 1995

AND COMMENCED CLEARING OPERATIONS IN APRIL 1996. IT WAS FORMED TO BUILD

CONFIDENCE IN CLEARING AND SETTLEMENT OF SECURITIES, TO PROMOTE AND

MAINTAIN THE SHORT AND CONSISTENT SETTLEMENT CYCLES, TO PROVIDE A

COUNTER-PARTY RISK GUARANTEE AND TO OPERATE A TIGHT RISK CONTAINMENT

SYSTEM.

NSE.IT LTD.

IT IS ALSO A WHOLLY OWNED SUBSIDIARY OF NSE AND IS ITS IT ARM. THIS ARM OF

THE NSE IS UNIQUELY POSITIONED TO PROVIDE PRODUCTS, SERVICES AND

SOLUTIONS FOR THE SECURITIES INDUSTRY. NSE.IT PRIMARILY FOCUSES ON IN THE

AREA OF TRADING, BROKER FRONT-END AND BACK-OFFICE, CLEARING AND

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SETTLEMENT, WEB-BASED, INSURANCE, ETC. ALONG WITH THIS, IT ALSO PROVIDES

CONSULTANCY AND IMPLEMENTATION SERVICES IN DATA WAREHOUSING, BUSINESS

CONTINUITY PLANS, SITE MAINTENANCE AND BACKUPS, STRATUS MAINFRAME

FACILITY MANAGEMENT, REAL TIME MARKET ANALYSIS &FINANCIAL NEWS

INDIA INDEX SERVICES & PRODUCTS LTD. (IISL)

IT IS A JOINT VENTURE BETWEEN NSE AND CRISIL LTD. TO PROVIDE A VARIETY

OF INDICES AND INDEX RELATED SERVICES AND PRODUCTS FOR THE INDIAN

CAPITAL MARKETS. IT WAS SET UP IN MAY 1998. IISL HAS A CONSULTING AND

LICENSING AGREEMENT WITH THE STANDARD AND POOR'S (S&P), WORLD'S

LEADING PROVIDER OF INVESTIBLE EQUITY INDICES, FOR CO-BRANDING EQUITY

INDICES.

NATIONAL SECURITIES DEPOSITORY LTD. (NSDL)

NSE JOINED HANDS WITH IDBI AND UTI TO PROMOTE DEMATERIALIZATION OF

SECURITIES. THIS STEP WAS TAKEN TO SOLVE PROBLEMS RELATED TO TRADING IN

PHYSICAL SECURITIES. IT COMMENCED OPERATIONS IN NOVEMBER 1996.

NSE FACTS

IT USES SATELLITE COMMUNICATION TECHNOLOGY TO ENERGIZE

PARTICIPATION FROM AROUND 400 CITIES IN INDIA.

NSE CAN HANDLE UP TO 1 MILLION TRADES PER DAY.

IT IS ONE OF THE LARGEST INTERACTIVE VSAT BASED STOCK EXCHANGES

IN THE WORLD.

THE NSE- NETWORK IS THE LARGEST PRIVATE WIDE AREA NETWORK IN

INDIA AND THE FIRST EXTENDED C- BAND VSAT NETWORK IN THE WORLD.

PRESENTLY MORE THAN 9000 USERS ARE TRADING ON THE REAL TIME-

ONLINE NSE APPLICATION.

TODAY, NSE IS ONE OF THE LARGEST EXCHANGES IN THE WORLD AND STILL

FORGING AHEAD. AT NSE, WE ARE CONSTANTLY WORKING TOWARDS CREATING A

MORE TRANSPARENT, VIBRANT AND INNOVATIVE CAPITAL MARKET.

OVER THE COUNTER EXCHANGE OF INDIA

OTCEI WAS INCORPORATED IN 1990 AS A SECTION 25 COMPANY UNDER THE

COMPANIES ACT 1956 AND IS RECOGNIZED AS A STOCK EXCHANGE UNDER SECTION

4 OF THE SECURITIES CONTRACTS REGULATION ACT, 1956. THE EXCHANGE WAS

22

SET UP TO AID ENTERPRISING PROMOTES IN RAISING FINANCE FOR NEW PROJECTS

IN A COST EFFECTIVE MANNER AND TO PROVIDE INVESTORS WITH A TRANSPARENT

AND EFFICIENT MODE OF TRADING MODELED ALONG THE LINES OF THE NASDAQ

MARKET OF USA, OTCEI INTRODUCED MANY NOVEL CONCEPTS TO THE INDIAN

CAPITAL MARKETS SUCH AS SCREEN-BASED NATIONWIDE TRADING, SPONSORSHIP OF

COMPANIES, MARKET MAKING AND SCRIP LESS TRADING. AS A MEASURE OF

SUCCESS OF THESE EFFORTS, THE EXCHANGE TODAY HAS 115 LISTINGS AND HAS

ASSISTED IN PROVIDING CAPITAL FOR ENTERPRISES THAT HAVE GONE ON TO BUILD

SUCCESSFUL BRANDS FOR THEMSELVES LIKE VIP ADVANTA, SONORA TILES &

BRILLIANT MINERAL WATER, ETC.

NEED FOR OTCEI:

STUDIES BY NASSCOM, SOFTWARE TECHNOLOGY PARKS OF INDIA, THE VENTURE

CAPITALS FUNDS AND THE GOVERNMENT’S IT TASKS FORCE, AS WELL AS RISING

INTEREST IN IT, PHARMACEUTICAL, BIOTECHNOLOGY AND MEDIA SHARES HAVE

REPEATEDLY EMPHASIZED THE NEED FOR A NATIONAL STOCK MARKET FOR

INNOVATION AND HIGH GROWTH COMPANIES.

INNOVATIVE COMPANIES ARE CRITICAL TO DEVELOPING ECONOMICS LIKE INDIA,

WHICH IS UNDERGOING A MAJOR TECHNOLOGICAL REVOLUTION. WITH THEIR

ABILITIES TO GENERATE EMPLOYMENT OPPORTUNITIES AND CONTRIBUTE TO THE

ECONOMY, IT IS ESSENTIAL THAT THESE COMPANIES NOT ONLY EXPAND EXISTING

OPERATIONS BUT ALSO SET UP NEW UNITS. THE KEY ISSUE FOR THESE COMPANIES IS

RAISING TIMELY, COST EFFECTIVE AND LONG TERM CAPITAL TO SUSTAIN THEIR

OPERATIONS AND ENHANCE GROWTH. SUCH COMPANIES, PARTICULARLY THOSE

THAT HAVE BEEN IN OPERATION FOR A SHORT TIME, ARE UNABLE TO RAISE FUNDS

THROUGH THE TRADITIONAL FINANCING METHODS, BECAUSE THEY HAVE NOT YET

BEEN EVALUATED BY THE FINANCIAL WORLD.

SHAREKHAN

SHAREKHAN IS ONE OF INDIA'S LARGEST AND LEADING FINANCIAL SERVICES

COMPANIES. IT IS AN ONLINE STOCK TRADING COMPANY OF SSKI GROUP (S.S.

KANTILAL ISHWARLAL SECURITIES LIMITED) WHICH HAS BEEN A PROVIDER OF

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INDIA-BASED INVESTMENT BANKING AND CORPORATE FINANCE SERVICE FOR OVER

80 YEARS.

SSKI CATERS TO MOST OF THE PROMINENT FINANCIAL INSTITUTIONS,

FOREIGN AND DOMESTIC, INVESTING IN INDIAN EQUITIES. IT HAS BEEN VALUED FOR

ITS STRONG RESEARCH-LED INVESTMENT IDEAS, SUPERIOR CLIENT SERVICING

TRACK RECORD AND EXCEPTIONAL EXECUTION SKILLS.

THE KEY FEATURES OF SHAREKHAN ARE AS FOLLOWS:

YOU GET FREEDOM FROM PAPERWORK.

THERE ARE INSTANT CREDIT AND MONEY TRANSFER FACILITIES.

YOU CAN TRADE FROM ANY NET ENABLED PC.

AFTER HOUR ORDERS FACILITIES.

YOU CAN GO FOR ONLINE ORDERS OVER THE PHONE.

TIMELY ADVICE AND RESEARCH REPORTS

REAL-TIME PORTFOLIO TRACKING.

INFORMATION AND PRICE ALERTS.

SHAREKHAN PROVIDES ASSISTANCE AND THE ADVICE LIKE NO ONE ELSE

COULD. IT HAS CREATED SPECIAL INFORMATION TOOLS TO HELP ANSWER ANY

QUERIES. SHAREKHAN’S FIRST STEP PROGRAM, BUILT SPECIFICALLY FOR NEW

INVESTORS, IS TESTAMENT TO OF ITS COMMITMENT TO BEING YOUR GUIDE

THROUGHOUT YOUR INVESTING LIFE CYCLE.

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SHAREKHAN SERVICES:

The tag line of Sharekhan says that it is your guide to the financial jungle. As per the

tag line there are many amazing services that Sharekhan offers like technical research,

fundamental research, share shops, portfolio management, dial-n-trade, commodities trade,

online services, depository services, equity and derivatives trading (including currency trading).

With Sharekhan’s online trading account, you can buy and sell shares at anytime and from

anywhere you like.

With a physical presence in over 300 cities of India through more than 800 "Share

Shops" with more than 3000 employees, and an online presence through Sharekhan.com,

India's premier, it reaches out to more than 8, 00,000 trading customers.

A Sharekhan outlet online destination offers the following services:

Online BSE and NSE executions (through BOLT & NEAT terminals)

Free access to investment advice from Sharekhan's Research team

Sharekhan Value Line (a monthly publication with reviews of recommendations, stocks

to watch out for etc)

Daily research reports and market review (High Noon & Eagle Eye)

Pre-market Report (Morning Cuppa)

Daily trading calls based on Technical Analysis

Cool trading products (Daring Derivatives and Market Strategy)

Personalized Advice

Live Market Information

Depository Services: Demat & Remat Transactions

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Derivatives Trading (Futures and Options)

Commodities Trading

IPOs & Mutual Funds Distribution

Internet-based Online Trading: Speed Trade

Sharekhan has one of the best state-of-art web portals providing fundamental and

statistical information across equity, mutual funds and IPOs. Surfing can be done across 5,500

companies for in-depth information, details about more than 1,500 mutual fund schemes and

IPO data. Other market related details such as board meetings, result announcements, FII

transactions, buying/selling by mutual funds and much more can also be accessed.

It provides a complete life-cycle of investment solution in Equities, Derivatives,

Commodities, IPO, Mutual Funds, Depository Services, Portfolio Management Services and

Insurance. It also offers personalized wealth management services for High Net worth

individuals.

ONLINE SERVICES

The online trading account can be chosen as per trading habits and preferences, that is

the classic account for most investors and speed trade for active day traders. Sharekhan also

provides a free software called “Trade tiger” to all its account holders.

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The Classic Account enables you to trade online for investing in Equities and

Derivatives on the NSE via sharekhan.com; it gives access to all the research content and also

comes with a free Dial-n-Trade service enabling to buy shares using the telephone.

Its features are:

Streaming quotes (using the applet based system)

Multiple watch lists

Integrated Banking, demat and digital contracts

Instant credit and transfer

Real-time portfolio tracking with price alerts and, of course, the assurance of secure

transactions

The Trade Tiger is a next-generation online trading product that brings the power of

the broker's terminal to your PC. It's the perfect trading platform for active day traders. Its

features are:

A single platform for multiple exchange BSE & NSE (Cash & F&O), MCX,

NCDEX, Mutual Funds, IPO’s

Multiple Market Watch available on Single Screen

Multiple Charts with Tick by Tick Intraday and End of Day Charting

powered with various Studies

Graph Studies include Average, Band- Bollinger, Know Sure Thing,

MACD, RSI, etc

Apply studies such as Vertical, Horizontal, Trend, Retracement & Free lines

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User can save his own defined screen as well as graph template, that is,

saving the layout for future use

User-defined alert settings on an input Stock Price trigger

Tools available to gauge market such as Tick Query, Ticker, Market

Summary, Action Watch, Option Premium Calculator, Span Calculator

Shortcut key for FAST access to order placements & reports

Online fund transfer activated with 12 Banks

Sharekhan provides you the facility to trade in Commodities through Sharekhan

Commodities Pvt. Ltd. a wholly owned subsidiary of its parent SSKI. It trades on

two major commodity exchanges of the country:

Multi Commodity Exchange of India Ltd, Mumbai (MCX) and

National Commodity and Derivative Exchange, Mumbai (NCDEX).

Commodity is to for trading in any commodity, initial margin of around 10% on any be

maintained. Sharekhan has launched its own commodity derivatives micro-site. The site is

available through the Sharekhan home page www.sharekhan.com. Along with the site

Sharekhan has launched several commodity derivatives products (both research and trading)

too. The products have been listed below:

Commodities Buzz: a daily view on precious metals and agro commodities.

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Commodities Beat: a summary of the days trading activity.

Traders Corner: Under commodity trading calls, there are two types of trading

calls:

Rapid Fire: (short-term calls for 1 day to 5 days updated daily)

Medium-term Plays: (medium-term calls for 1 month to 3 months

updated weekly or in between if needed)

Sharekhan Xclusive: the commodity research reports and analyses (periodical).

Market Scan: the daily commodity market data and statistics (end of day).

All these products are both e-mailed as newsletters and published on the commodity

derivatives site

PORTFOLIO MANAGEMENT SERVICES

The two Portfolio Management Services provided are;

1) Pro Prime

2) Pro Tech

Pro Prime PMS:

It is Ideal for investors looking at steady and superior returns with low to

medium risk appetite. This portfolio consists of a blend of quality blue chip and growth

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stocks ensuring a balanced portfolio with relatively medium risk profile. The portfolio

will mostly have large capitalization stocks based on sectors & themes that have

medium to long term growth potential.

Product Approach:

Investments are based on 3 tenets:

Consistent, steady and sustainable returns

Margin of Safety

Low Volatility

Product Characteristics:

Bottom up stock selection

In-depth, independent fundamental research

High quality companies with relatively large capitalization.

Disciplined valuation approach applying multiple valuation measures

Medium to long term vision, resulting in low portfolio turnover

Product Details:

Minimum Investment: Rs 10 lakhs

Lock in period: 6 Months

Reporting: Online access to portfolio holdings, quarterly reporting of portfolio

holdings/transactions

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Charges: 2.5% per annum AMC charged every quarter, 0.5% brokerage 20%

profit sharing after 15% hurdle is crossed-chargeable at the end of the fiscal year

Profit withdrawal in multiples of 25000 after lock in period.

Pro Tech PMS

Pro tech uses the knowledge of technical analysis and the power of derivatives

market to identify trading opportunities in the market. The Pro tech line of products is

designed around various risk/reward/volatility profiles for different kinds of investment

needs.

Pro tech is based on:

Long Short strategies

Focus on absolute returns

Timing the market

The Scheme Products are:

Nifty Thrifty: Nifty futures are bought and sold on the basis of an automated trading

system that generates calls to go long/short. The exposure never exceeds value of

portfolio i.e. there is no leveraging; but being short in Nifty allows you to earn even in

falling markets and there by generates linear

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Product Approach:

Superior performance can be achieved through sheer market timing, by picking

Stocks/Nifty before the infection points in their trading cycles

Linear returns are possible from having sell market positions in downtrends and

by using the options market to change the portfolio beta

Money management rules will be in place.

Product Characteristics:

Using swing based index -trading systems, stop and reverse, trend following and

momentum trading techniques.

Nifty based products for low impact cost and low product volatility.

Both long and short strategies to earn returns even in falling markets.

The use of options to enhance the risk reward profile of the product and

therefore offers a higher Beta.

Product Details:

Minimum Investment: Rs 5 lakhs

Lock in: 6 months

AMC fees: 0%

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Reporting: Monthly reporting of transactions, brokerage 0.05% for derivatives,

and 20% profit sharing on booked profits on quarterly basis.

Profit withdrawal in multiples of 25000 after lock in period.

ACHIEVEMENTS OF SHAREKHAN

Sharekhan.com has been voted as the “most preferred Stock Broker in India” in India’s

largest consumer study initiated by CNBI and conducted by AC Nielsen - org Marg.

2. REVIEW OF LITERATURE

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With over 25 million shareholders, India has the third largest investor base in the

world after USA and Japan. Over 7500 companies are listed on the Indian stock

exchanges (more than the number of companies listed in developed markets of Japan,

UK, Germany, France, Australia, Switzerland, Canada and Hong Kong.). The Indian

capital market is significant in terms of the degree of development, volume of trading,

transparency and its tremendous growth potential.

India’s market capitalization was the highest among the emerging markets.

Total market capitalization of The Bombay Stock Exchange (BSE), which, as on July

31, 1997, was US$ 175 billion has grown by 37.5% percent every twelve months and

was over US$ 834 billion as of January, 2007. Bombay Stock Exchanges (BSE), one of

the oldest in the world, accounts for the largest number of listed companies transacting

their shares on a nationwide online trading system. The two major exchanges namely

the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) ranked no.

3 & 5 in the world, calculated by the number of daily transactions done on the

exchanges. The Total Turnover of Indian Financial Markets crossed US$ 2256 billion in

2006

An increase of 82% from US $ 1237 billion in 2004 in a short span of 2 years

only. Turnover in the Spot and Derivatives segment both in NSE & BSE was higher by

45% into 2006 as compared to 2005. With daily average volume of US $ 9.4 billion, the

Sensex has posted excellent returns in the recent years.

Currently the market cap of the Sensex as on July 4th, 2009 was Rs 48.4 Lakh

Crore with a P/E of more than 20. Derivatives trading in the stock market have been a

subject of enthusiasm of research in the field of finance the most desired instruments

that allow market participants to manage risk in the modern securities trading are known

as derivatives. The derivatives are defined as the future contracts whose value depends

upon the underlying assets. If derivatives are introduced in the stock market, the

underlying asset may be anything as component of stock market like, stock prices or

market indices, interest rates, etc. The main logic behind derivatives trading is that

derivatives reduce the risk by providing an additional channel to invest with lower

trading cost and it facilitates the investors to extend their settlement through the future

contracts. It provides extra liquidity in the stock market.

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Derivatives are assets, which derive their values from an underlying asset.

These underlying assets are of various categories like

• Commodities including grains, coffee beans, etc.

• Precious metals like gold and silver.

• Foreign exchange rate.

•Bonds of different types, including medium to long-term negotiable debt securities

issued by governments, companies, etc.

• Short-term debt securities such as T-bills.

• Over-The-Counter (OTC) money market products such as loans or deposits.

• Equities

For example, a dollar forward is a derivative contract, which gives the buyer a

right & an obligation to buy dollars at some future date. The prices of the derivatives are

driven by the spot prices of these underlying assets. However, the most important use of

derivatives is in transferring market risk, called Hedging, which is a protection against

losses resulting from unforeseen price or volatility changes. Thus, derivatives are a very

important tool of risk management.

There are various derivative products traded.

They are: 1. Forwards 2. Futures 3. Options 4. Swaps

4.1 DERIVATIVES AS A RISK MGMT TOOL

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

futures and options, can be traced back to the willingness of risk-averse economic

agents to guard themselves against uncertainties arising out of fluctuations in asset

prices. By their very nature, the financial markets are marked by a very high degree of

35

volatility. Through the use of derivative products, it is possible to partially or fully

transfer price risks by locking-in asset prices. As instruments of risk management, these

generally do not influence the fluctuations in the underlying asset prices. However, by

locking in asset prices, derivative products minimize the impact of fluctuations in asset

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

DERIVATIVES DEFINED

Derivative is a product whose value is derived from the value of one or more

basic variables, called bases (underlying asset, index, or reference rate), in a contractual

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

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

risk of a change in prices by that date. Such a transaction is an example of a derivative.

The price of this derivative is driven by the spot price of wheat which is the

"underlying". In the Indian context the Securities Contracts (Regulation) Act, 1956

(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 which derives its value from the prices, or index of prices, of underlying

securities. Derivatives are securities under the SC(R) A and hence the trading of

derivatives is governed by the regulatory framework under the SC(R) A.

TYPES OF DERIVATIVES

Mainly derivatives classified into two types

1) Financial derivative.

2) Commodity derivatives.

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Financial derivatives are relating to treasury bills, stocks, bonds, foreign exchange

stock index etc. so, for financial derivatives underlying assets are relating to financial

securities.

Commodity derivatives relating to consuming assets or consumer goods e.g. Wheat,

rice, cotton, sugar, jute, turmeric, crude oil, natural gas, gold, etc, so for commodity

derivatives underlying assets are consumable products.

DERIVATIVE PRODUCTS

Derivative contracts have several variants. The most common variants are forwards,

futures, options and swaps. We take a brief look at various derivatives contracts that

have come to be used.

Forwards: A forward contract is a customized contract between two entities, where

settlement takes place on a specific date in the future at today's pre-agreed price.

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Futures: A futures contract is an agreement between two parties to buy or sell an asset

at a certain time in the future at a certain price. Futures contracts are special types of

forward contracts in the sense that the former are standardized exchange-traded

contracts.

Options: Options are of two types - calls and puts. Calls give the buyer the right but not

the obligation to buy a given quantity of the underlying asset, at a given price on or

before a given future date. Puts give the buyer the right, but not the obligation to sell a

given quantity of the underlying asset at a given price on or before a given date.

Warrants: Options generally have lives of upto one year, the majority of options traded

on options exchanges having a maximum maturity of nine months. Longer-dated

options are called warrants and are generally traded over-the-counter.

LEAPS: The acronym LEAPS means Long-Term Equity Anticipation Securities.

These are options having a maturity of upto three years.

Baskets: Basket options are options on portfolios of underlying assets. The underlying

asset is usually a moving average of a basket of assets. Equity index options are a form

of basket options.

Swaps: Swaps are private agreements between two parties to exchange cash flows

in the future according to a prearranged formula. They can be regarded as portfolios of

forward contracts. The two commonly used swaps are:

Interest rate swaps: These entail swapping only the interest related cash flows

between the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between the

parties, with the cash flows in one direction being in a different currency than those in

the opposite direction.

Swaptions: Swaptions are options to buy or sell a swap that will become operative at

the expiry of the options. Thus a swaption is an option on a forward swap. Rather than

38

have calls and puts, the swaptions market has receiver swaptions and payer swaptions.

A receiver swaption is an option to receive fixed and pay floating. A payer swaption is

an option to pay fixed and receive floating.

PARTICIPANTS IN THE DERIVATIVES MARKETS

The following three broad categories of participants - hedgers, speculators, and

arbitrageurs trade in the derivatives market. Hedgers face risk associated with the price

of an asset. They use futures or options markets to reduce or eliminate this risk.

Speculators wish to bet on future movements in the price of an asset. Futures and

options contracts can give them an extra leverage; that is, they can increase both the

potential gains and potential losses in a speculative venture. Arbitrageurs are in business

to take advantage of a discrepancy between prices in two different markets. If, for

example, they see the futures price of an asset getting out of line with the cash price,

they will take offsetting positions in the two markets to lock in a profit.

ECONOMIC FUNCTION OF THE DERIVATIVEMARKET

Inspite of the fear and criticism with which the derivative markets are commonly

looked at, these markets perform a number of economic functions.

1. Prices in an organized derivatives market reflect the perception of market participants

about the future and lead the prices of underlying to the perceived future level. The

prices of derivatives converge with the prices of the underlying at the expiration of the

39

derivative contract. Thus derivatives help in discovery of future as well as current

prices.

2. The derivatives market helps to transfer risks from those who have them but may not

like them to those who have an appetite for them.

3. Derivatives, due to their inherent nature, are linked to the underlying cash markets.

With the introduction of derivatives, the underlying market witnesses higher trading

volumes because of participation by more players who would not otherwise participate

for lack of an arrangement to transfer risk.

4. Speculative trades shift to a more controlled environment of derivatives market. In

the absence of an organized derivatives market, speculators trade in the underlying cash

markets. Margining, monitoring and surveillance of the activities of various participants

become extremely difficult in these kind of mixed markets.

5. An important incidental benefit that flows from derivatives trading is that it acts as a

catalyst for new entrepreneurial activity. The derivatives have a history of attracting

many bright, creative, well-educated people with an entrepreneurial attitude. They often

energize others to create new businesses, new products and new employment

opportunities, the benefit of which are immense. In a nut shell, derivatives markets help

increase savings and investment in the long run. Transfer of risk enables market

participants to expand their volume of activity.

EXCHANGE-TRADED vs. OTC DERIVATIVESMARKETS

Derivatives have probably been around for as long as people have been trading

with one another. Forward contracting dates back at least to the 12th century, and may

well have been around before then. Merchants entered into contracts with one another

for future delivery of specified amount of commodities at specified price. A primary

motivation for pre-arranging a buyer or seller for a stock of commodities in early

forward contracts was to lessen the possibility that large swings would inhibit marketing

40

the commodity after a harvest. As the word suggests, derivatives that trade on an

exchange are called exchange traded derivatives, whereas privately negotiated

derivative contracts are called OTC contracts.

The OTC derivatives markets have witnessed rather sharp growth over the last

few years, which has accompanied the modernization of commercial and investment

banking and globalisation of financial activities. The recent developments in

information technology have contributed to a great extent to these developments. While

both exchange-traded and OTC derivative contracts offer many benefits, the former

have rigid structures compared to the latter. It has been widely discussed that the highly

leveraged institutions and their OTC derivative positions were the main cause of

turbulence in financial markets in 1998. These episodes of turbulence revealed the risks

posed to market stability originating in features of OTC derivative instruments and

markets.

The OTC derivatives markets have the following features compared to exchange

traded derivatives:

1. The management of counter-party (credit) risk is decentralized and located within

individual institutions.

2. There are no formal centralized limits on individual positions, leverage, or margining.41

3. THERE ARE NO FORMAL RULES FOR RISK AND BURDEN-SHARING.

4. There are no formal rules or mechanisms for ensuring market stability and integrity,

and for safeguarding the collective interests of market participants, and

5. The OTC contracts are generally not regulated by a regulatory authority and the

exchange's self-regulatory organization, although they are affected indirectly by national

legal systems, banking supervision and market surveillance.

NSE's DERIVATIVES MARKET

The derivatives trading on the NSE commenced with S&P CNX Nifty Index

futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and

trading in options on individual securities commenced on July 2, 2001. Single stock

futures were launched on November 9, 2001. Today, both in terms of volume and

turnover, NSE is the largest derivatives exchange in India. Currently, the derivatives

contracts have a maximum of 3-month expiration cycles. Three contracts are available

for trading, with 1 month, 2 months and 3 months expiry. A new contract is introduced

on the next trading day following the expiry of the near month contract.

Participants and functions

NSE admits members on its derivatives segment in accordance with the rules

and regulations of the exchange and the norms specified by SEBI. NSE follows 2-tier

membership structure stipulated by SEBI to enable wider participation. Those interested

in taking membership on F&O segment are required to take membership of CM and

F&O segment or CM, WDM and F&O segment. Trading and clearing members are

admitted separately. Essentially, a clearing member (CM) does clearing for all his

42

trading members (TMs), undertakes risk management and performs actual settlement.

There are three types of CMs:

• Self Clearing Member: A SCM clears and settles trades executed by him only either

on his own account or on account of his clients.

• Trading Member Clearing Member: TM-CM is a CM who is also a TM. TM-CM

may clear and settle his own proprietary trades and client's trades as well as clear and

settle for other TMs.

• Professional Clearing Member: PCM is a CM who is not a TM. Typically, banks or

custodians could become a PCM and clear and settle for TMs.

Trading mechanism

The futures and options trading system of NSE, called NEAT-F&O trading

system, provides a fully automated screen-based trading for Index futures & options and

Stock futures & options on a nationwide basis and an online monitoring and

surveillance mechanism. It supports an anonymous order driven market which provides

complete transparency of trading operations and operates on strict price-time priority. It 43

is similar to that of trading of equities in the Cash Market (CM) segment. The NEAT-

F&O trading system is accessed by two types of users. The Trading Members (TM)

have access to functions such as order entry, order matching, order and trade

management. It provides tremendous flexibility to users in terms of kinds of orders that

can be placed on the system. Various conditions like Immediate or Cancel,

Limit/Market price, Stop loss, etc. can be built into an order. The Clearing Members

(CM) use the trader workstation for the purpose of monitoring the trading member(s)

for whom they clear the trades. Additionally, they can enter and set limits to positions,

which a trading member can take.

Turnover

The trading volumes on NSE's derivatives market has seen a steady increase

since the launch of the first derivatives contract, i.e. index futures in June 2000. Table

1.1 gives the value of contracts traded on the NSE. The average daily turnover at NSE

now exceeds Rs. 35,000 crore. A total of 216,883,573 contracts with a total turnover of

Rs.7,356,271 crore were traded during 2006-2007.

4.2: MARKET INDEX

To understand the use and functioning of the index derivatives markets, it is

necessary to understand the underlying index. In the following section, we take a look at

index related issues. Traditionally, indexes have been used as information sources. By

looking at an index, we know how the market is faring. In recent years, indexes have

come to the forefront owing to direct applications in finance in the form of index funds

and index derivatives. Index derivatives allow people to cheaply alter their risk

44

exposure to an index (hedging) and to implement forecasts about index movements

(speculation). Hedging using index derivatives has become a central part of risk

management in the modern economy.

UNDERSTANDING THE INDEX NUMBER

An index is a number which measures the change in a set of values over a period

of time. A stock index represents the change in value of a set of stocks which

constitute the index. More specifically, a stock index number is the current relative

value of a weighted average of the prices of a pre-defined group of equities. It is a

relative value because it is expressed relative to the weighted average of prices at some

arbitrarily chosen starting date or base period. The starting value or base of the index is

usually set to a number such as 100 or 1000. For example, the base value of the Nifty

was set to 1000 on the start date of November 3, 1995. A good stock market index is

one which captures the behavior of the overall equity market. It should represent the

market, it should be well diversified and yet highly liquid. Movements of the index

should represent the returns obtained by "typical" portfolios in the country.

A market index is very important for its use

1. AS A BAROMETER FOR MARKET BEHAVIOR,

2. AS A BENCHMARK PORTFOLIO PERFORMANCE,

3. AS AN UNDERLYING IN DERIVATIVE INSTRUMENTS LIKE INDEX FUTURES, AND

4. In passive fund management by index funds

ECONOMIC SIGNIFICANCE OF INDEX MOVEMENTS

How do we interpret index movements? What do these movements mean? They

reflect the changing expectations of the stock market about future dividends of the

corporate sector. The index goes up if the stock market thinks that the prospective

dividends in the future will be better than previously thought. When the prospects of

45

dividends in the future becomes pessimistic, the index drops. The ideal index gives us

instant readings about how the stock market perceives the future of corporate sector.

Every stock price moves for two possible reasons:

1. NEWS ABOUT THE COMPANY (E.G. A PRODUCT LAUNCH, OR THE CLOSURE OF A

FACTORY)

2. News about the country (e.g. budget announcements)

The job of an index is to purely capture the second part, the movements of the

stock market as a whole (i.e. news about the country). This is achieved by averaging.

Each stock contains a mixture of two elements - stock news and index news. When we

take an average of returns on many stocks, the individual stock news tends to cancel out

and the only thing left is news that is common to all stocks. The news that is common to

all stocks is news about the economy. That is what a good index captures. The correct

method of averaging is that of taking a weighted average, giving each stock a weight

proportional to its market capitalization.

Example: Suppose an index contains two stocks, A and B. A has a market

capitalization of Rs.1000 crore and B has a market capitalization of Rs.3000 crore.

Then we attach a weight of 1/4 to movements in A and 3/4 to movements in B.

INDEX CONSTRUCTION ISSUES

A good index is a trade-off between diversification and liquidity. A well

diversified index is more representative of the market/economy. However there are

46

diminishing returns to diversification. Going from 10 stocks to 20 stocks gives a sharp

reduction in risk. Going from 50 stocks to 100 stocks gives very little reduction in risk.

Going beyond 100 stocks gives almost zero reduction in risk. Hence, there is little to

gain by diversifying beyond a point. The more serious problem lies in the stocks that we

take into an index when it is broadened. If the stock is illiquid, the observed prices yield

contaminated information and actually worsen an index.

TYPES OF INDEXES

Most of the commonly followed stock market indexes are of the following two

types: Market capitalization weighted index or price weighted index. In a market

capitalization weighted index, each stock in the index affects the index value in

proportion to the market value of all shares outstanding. A price weighted index is one

that gives a weight to each stock that is proportional to its stock price. Indexes can also

be equally weighted. Recently, major indices in the world like the S&P 500 and the

FTSE-100 have shifted to a new method of index calculation called the "Free float"

method. We take a look at a few methods of index calculation.

In the example below we can see that each stock affects the index value in proportion to

the market value of all the outstanding shares. In the present example, the base index =

1000 and the index value works out to be 1002.60

Company Current Mkt capitalization Base Mkt capitalization (Rs.Lakh) (Rs.Lakh)

Grasim Inds 1,668,791.10 1,654,247.50

47

Telco 872,686.30 860,018.25

SBI 1,452,587.65 1,465,218.80

Wipro 2,675,613.30 2,669,339.55

Bajaj 660,887.85 662,559.30

Total 7,330,566.20 7,311,383.40

1. Price weighted index: In a price weighted index each stock is given a

weight proportional to its stock price.

2. Market capitalization weighted index: In this type of index, the equity price is

weighted by the market capitalization of the company (share price * number of

outstanding shares). Hence each constituent stock in the index affects the index value in

proportion to the market value of all the outstanding shares. This index forms the

underlying for a lot of index based products like index funds and index futures. Table

below gives an example of how market capitalization weighted index is calculated.

In the market capitalization weighted method,

where:

Current market capitalization = Sum of (current market price * outstanding shares)

of all securities in the index.

Base market capitalization = Sum of (market price * issue size) of all securities as

on base date.

CONSTITUENTS, MAJOR INDICES

S&P CNX NIFTY

CNX NIFTY JUNIOR

CNX 100

48

S&P CNX 500

CNX MIDCAP *

NIFTY MIDCAP 50

S&P CNX DEFTY

CNX MIDCAP 200 **

S&P CNX Nifty

S&P CNX Nifty is a well diversified 50 stock index accounting for 24 sectors of

the economy. It is used for a variety of purposes such as benchmarking fund

portfolios, index based derivatives and index funds.

S&P CNX Nifty is owned and managed by INDIA INDEX SERVICES AND

PRODUCTS LTD. (IISL), which is a joint venture between NSE and CRISIL.

IISL is India's first specialised company focussed upon the index as a core

product. IISL have a consulting and licensing agreement with Standard & Poor's

(S&P), who are world leaders in index services.

The average total traded value for the last six months of all Nifty stocks is

approximately 58% of the traded value of all stocks on the NSE.

Nifty stocks represent about 60% of the total market capitalisation as on on

March 31, 2005.

Impact cost of the S&P CNX Nifty for a portfolio size of Rs.5 million is 0.07%.

S&P CNX Nifty is professionally maintained and is ideal for derivatives trading.

CNX Nifty Junior

The next rung of liquid securities after S&P CNX NIFTY is the CNX Nifty Junior. It

may be useful to think of the S&P CNX Nifty and the CNX Nifty Junior as making

up the 100 most liquid stocks in India.

As with the S&P CNX Nifty, stocks in the CNX Nifty Junior are filtered for

* CNX Midcap - Introduced from July 18, 2005

** CNX Midcap 200 - Discontinued from July 18, 2005

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liquidity, so they are the most liquid of the stocks excluded from the S&P CNX

Nifty. The maintenance of the S&P CNX Nifty and the CNX Nifty Junior are

synchronized so that the two indexes will always be disjoint sets; i.e. a stock will

never appear in both indexes at the same time. Hence it is always meaningful to pool

the S&P CNX Nifty and the CNX Nifty Junior into a composite 100 stock index or

portfolio.

CNX Nifty Junior represents about 10% of the total market capitalization as on

March 31, 2005.

The average traded value for the last six months of all Junior Nifty stocks is

approximately 9% of the traded value of all stocks on the NSE.

Impact cost for CNX Nifty Junior for a portfolio size of Rs.2.50 million is

0.15%.

CNX 100

CNX 100 is a diversified 100 stock index accounting for 35 sector of the economy.

CNX 100 is owned and managed by India Index Services & Products Ltd. (IISL).

Which is a joint venture between CRISIL & NSE. IISL is India's first specialized

company focused upon the index as a core products. IISL has a licensing &

marketing agreement with Standard & Poor's (S&P), who are leader's in index

services.

CNX 100 represents about 66.61 % of the total market capitalization as on April

10, 2007

The average traded value for the last six months of all CNX100 stocks is

approximately 56.02 % of the traded value of all stocks on the NSE

Impact cost for CNX 100 for a portfolio size of Rs. 8 million is 0.11%

S&P CNX 500

The S&P CNX 500 is India’s first broad-based benchmark of the Indian capital

market for comparing portfolio returns vis-a-vis market returns. The S&P CNX 500

represents about 96% of total market capitalisation and about 93% of the total

turnover on the NSE.

50

The S&P CNX 500 companies are disaggregated into 72 industry indexes viz. S&P

CNX Industry Indexes. Industry weightages in the index reflect the industry

weightages in the market. For e.g. if the banking sector has a 5% weightage in the

universe of stocks traded on NSE, banking stocks in the index would also have an

approx. representation of 5% in the index.

CNX Midcap *

The medium capitalized segment of the stock market is being increasingly perceived

as an attractive investment segment with high growth potential. The primary

objective of the CNX Midcap Index is to capture the movement and be a benchmark

of the midcap segment of the market.

METHOD OF COMPUTATION

CNX Midcap is computed using market capitalization weighted method, wherein

the level of the index reflects the total market value of all the stocks in the index

relative to a particular base period. The method also takes into account constituent

changes in the index and importantly corporate actions such as stock splits, rights,

etc without affecting the index value.

BASE DATE AND VALUE

The CNX Midcap Index has a base date of Jan 1, 2003 and a base value of 1000.

CRITERIA FOR SELECTION OF CONSTITUENT STOCKS

The constituents and the criteria for the selection judge the effectiveness of the

index. Selection of the index set is based on the following criteria :

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All the stocks, which constitute more than 5% market capitalization of the

universe (after sorting the securities in descending order of market

capitalization), shall be excluded in order to reduce the skewness in the

weightages of the stocks in the universe.

After step (a), the weightages of the remaining stocks in the universe is

determined again.

After step (b), the cumulative weightage is calculated.

After step (c) companies which form part of the cumulative percentage in

ascending order unto first 75 percent (i.e. upto to 74.99 percent) of the revised

universe shall be ignored.

After, step (d), all the constituents of S&P CNX Nifty shall be ignored.

From the universe of companies remaining after step (e) i.e. 75th percent and

above, first 100 companies in terms of highest market capitalization, shall

constitute the CNX Midcap Index subject to fulfillment of the criteria mentioned

below.

TRADING INTEREST

All constituents of the CNX Midcap Index must have a minimum listing record of 6

months. In addition, all candidates for the Index are also evaluated for trading

interest, in terms of volumes and trading frequency.

FINANCIAL PERFORMANCE

All companies in the CNX Midcap Index have a minimum track record of three

years of operations with a positive net worth.

OTHERS

A company which comes out with a IPO will be eligible for inclusion in the index, if

52

it fulfills the normal eligibility criteria for the index for a 3 month period instead of a

6 month period.

*CNX Midcap - Introduced from July 18, 2005

Nifty Midcap 50

The medium capitalized segment of the stock market is being increasingly perceived as an attractive investment segment with high growth potential. The primary objective of the Nifty Midcap 50 Index is to capture the movement of the midcap segment of the market. It can also be used for index-based derivatives trading.

METHOD OF COMPUTATION

Nifty Midcap 50 is computed using market capitalisation weighted method, wherein

the level of the index reflects the total market value of all the stocks in the index

relative to a particular base period. The method also takes into account constituent

changes in the index and importantly corporate actions such as stock splits, rights,

etc without affecting the index value.

BASE DATE AND VALUE

The Nifty Midcap 50 Index has a base date of Jan 1, 2004 and a base value of 1000.

CRITERIA FOR SELECTION OF CONSTITUENT STOCKS

The constituents and the criteria for the selection judge the effectiveness of the

index. Selection of the index set is, inter alia, based on the following criteria:

Stocks with average market capitalization ranging from Rs.1000 Crore to

Rs.5000 Crore at the time of selection.

Stocks which are not part of the derivatives segment are excluded.

Stocks which are forming part of the S&P CNX NIFTY index are excluded.

OTHER STATISTICS:

A company which comes out with a IPO will be eligible for inclusion in the index, if

it fulfills the normal eligibility criteria for the index for a 3 month period instead of a

6 month period.

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Nifty Midcap 50 stocks represent about 4.89 % of the total market capitalization

as on August 31, 2007.

The average traded volume for the last six months of all Nifty Midcap 50 stocks

is approximately 15.21 % of the traded volume of all stocks on the NSE.

S&P CNX Defty

Almost every institutional investor and off-shore fund enterprise with an equity

exposure in India would like to have an instrument for measuring returns on their

equity investment in dollar terms. To facilitate this, a new index the S&P CNX

Defty-Dollar Denominated S&P CNX Nifty has been developed.

S&P CNX Defty is S&P CNX Nifty, measured in dollars. The S&P CNX Defty is

calculated real-time. When there is currency volatility, the S&P CNX Defty is an

ideal device for a foreign investor to know where he stands, even intraday

Salient Features:

Performance indicator to foreign institutional investors, off shore funds, etc.

Provides an effective tool for hedging Indian equity exposure.

Impact cost of the S&P CNX Nifty for a portfolio size of Rs.5 million is 0.20%

Provides fund managers an instrument for measuring returns on their equity

investment in dollar terms.

Calculation of S&P CNX Defty:

Computations are done using the S&P CNX NIFTY index calculated on the NEAT

trading system of NSE and end of previous day Exchange Rate(US $-Re).

S&P CNX Defty = S&P CNX Nifty at time t x Exchange rate as on base date.

54

= Exchange rate at time t

Specifications of S&P CNX Defty:

Base date: 03 November 1995

Base S&P CNX Defty Index Value: 1000

S&P CNX Nifty Value as on Base date: 1000

Exchange rate as on base date: 34.65

Adjustment factor as on Base date:1.00

CNX Midcap 200 **

The medium capitalised segment of the stock market is being increasingly

perceived as an attractive investment segment with high growth potential. The

primary objective of the CNX MidCap 200 Index is to capture the movement

and be a benchmark of the midcap segment of the market.

CNX Midcap 200 represents about 72% of the total market capitalization of

the Mid-Cap Universe and about 70% of the total traded value of the Mid-

Cap Universe. (Mid-Cap Universe is defined as stocks having average six

months market capitalization between Rs.75 crores and Rs.750 crores).

Industry weightages in the index dynamically reflect industry weightages in

the market

Provide investors a broad based benchmark for comparing portfolio returns

vis-à-vis market returns in the midcap segment.

** CNX Midcap 200 - Discontinued from July 18, 2005.

Graph showing 1 year S&P CNX Nifty movements

55

Graph showing 10 year S&P CNX Nifty movements

THE S&P CNX NIFTY

56

What makes a good stock market index for use in an index futures and index

Options market? Several issues play a role in terms of the choice of index. We will

discuss how the S&P CNX Nifty addresses some of these issues.

Diversification: As mentioned earlier, a stock market index should be well diversified,

thus ensuring that hedgers or speculators are not vulnerable to individual-company or

industry risk.

Liquidity of the index: The index should be easy to trade on the cash market. This is

partly related to the choice of stocks in the index. High liquidity of index components

implies that the information in the index is less noisy.

Operational issues: The index should be professionally maintained, with a steady

evolution of securities in the index to keep pace with changes in the economy. The

calculations involved in the index should be accurate and reliable. Market impact cost is

a measure of the liquidity of costs faced when actually trading an index. For a stock to

qualify for possible inclusion into the Nifty, it has to have market impact cost of below

0.75% when doing Nifty trades of half a crore rupees. The market impact cost on a trade

of Rs.3 million of the full Nifty works out to be about 0.05%. This means that if Nifty is

at 2000, a buy order goes through at 2001, i.e.2000+(2000*0.0005) and a sell order gets

1999, i.e. 2000-(2000*0.0005).

CONSTITUENTS LIST OF S&P CNX NIFTY

COMPANY NAME INDUSTRY SYMBOL

ABB LTD. ELECTRICAL EQUIPMENT ABB

57

ACC LTD. CEMENT AND CEMENT PRODUCTS ACCAMBUJA CEMENTS LTD. CEMENT AND CEMENT PRODUCTS AMBUJACEMAXIS BANK LTD. BANKS AXISBANKBHARAT HEAVY ELECTRICALS LTD. ELECTRICAL EQUIPMENT BHELBHARAT PETROLEUM CORPORATION LTD. REFINERIES BPCLBHARTI AIRTEL LTD. TELECOMMUNICATION - SERVICES BHARTIARTLCAIRN INDIA LTD. OIL EXPLORATION/PRODUCTION CAIRNCIPLA LTD. PHARMACEUTICALS CIPLADLF LTD. CONSTRUCTION DLFGAIL (INDIA) LTD. GAS GAILGRASIM INDUSTRIES LTD. CEMENT AND CEMENT PRODUCTS GRASIMHCL TECHNOLOGIES LTD. COMPUTERS - SOFTWARE HCLTECHHDFC BANK LTD. BANKS HDFCBANK

HERO HONDA MOTORS LTD.AUTOMOBILES - 2 AND 3 WHEELERS HEROHONDA

HINDALCO INDUSTRIES LTD. ALUMINIUM HINDALCOHINDUSTAN UNILEVER LTD. DIVERSIFIED HINDUNILVRHOUSING DEVELOPMENT FINANCE CORPORATION LTD. FINANCE - HOUSING HDFCI T C LTD. CIGARETTES ITCICICI BANK LTD. BANKS ICICIBANKIDEA CELLULAR LTD. TELECOMMUNICATION - SERVICES IDEAINFOSYS TECHNOLOGIES LTD. COMPUTERS - SOFTWARE INFOSYSTCHINFRASTRUCTURE DEVELOPMENT FINANCE CO. LTD. FINANCIAL INSTITUTION IDFCJAIPRAKASH ASSOCIATES LTD. DIVERSIFIED JPASSOCIATJINDAL STEEL & POWER LTD. STEEL AND STEEL PRODUCTS JINDALSTELLARSEN & TOUBRO LTD. ENGINEERING LTMAHINDRA & MAHINDRA LTD. AUTOMOBILES - 4 WHEELERS M&MMARUTI SUZUKI INDIA LTD. AUTOMOBILES - 4 WHEELERS MARUTINTPC LTD. POWER NTPCOIL & NATURAL GAS CORPORATION LTD. OIL EXPLORATION/PRODUCTION ONGCPOWER GRID CORPORATION OF INDIA LTD. POWER POWERGRIDPUNJAB NATIONAL BANK BANKS PNBRANBAXY LABORATORIES LTD. PHARMACEUTICALS RANBAXYRELIANCE CAPITAL LTD. FINANCE RELCAPITALRELIANCE COMMUNICATIONS LTD. TELECOMMUNICATION - SERVICES RCOMRELIANCE INDUSTRIES LTD. REFINERIES RELIANCERELIANCE INFRASTRUCTURE LTD. POWER RELINFRARELIANCE POWER LTD. POWER RPOWERSIEMENS LTD. ELECTRICAL EQUIPMENT SIEMENSSTATE BANK OF INDIA BANKS SBINSTEEL AUTHORITY OF INDIA LTD. STEEL AND STEEL PRODUCTS SAILSTERLITE INDUSTRIES (INDIA) LTD. METALS STERSUN PHARMACEUTICAL INDUSTRIES LTD. PHARMACEUTICALS SUNPHARMASUZLON ENERGY LTD. ELECTRICAL EQUIPMENT SUZLONTATA CONSULTANCY SERVICES LTD. COMPUTERS - SOFTWARE TCSTATA MOTORS LTD. AUTOMOBILES - 4 WHEELERS TATAMOTORSTATA POWER CO. LTD. POWER TATAPOWERTATA STEEL LTD. STEEL AND STEEL PRODUCTS TATASTEELUNITECH LTD. CONSTRUCTION UNITECHWIPRO LTD. COMPUTERS - SOFTWARE WIPRO

58

Hedging effectiveness

Hedging effectiveness is a measure of the extent to which an index correlates

With a portfolio, whatever the portfolio may be. Nifty correlates better with all kinds of

portfolios in India as compared to other indexes. This holds good for all kinds of

portfolios, not just those that contain index stocks. Similarly, the CNX IT and BANK

Nifty contracts which NSE trades in, correlate well with information technology and

banking sector portfolios.

NIFTY, CNX IT, BANK NIFTY, CNX NIFTY JUNIOR, CNX 100, NIFTY MIDCAP 50

and Mini Nifty 50 indices are owned, computed and maintained by India Index

Services & Products Limited (IISL), a company setup by NSE and CRISIL with

technical assistance from Standard & Poor's

Index derivatives

Index derivatives are derivative contracts which have the index as the

underlying. The most popular index derivatives contracts the world over are index

futures and index options. NSE's market index, the S&P CNX Nifty was scientifically

designed to enable the launch of index-based products like index derivatives and index

funds. The first derivative contract to be traded on NSE's market was the index futures

contract with the Nifty as the underlying.

This was followed by Nifty options, derivative contracts on sectoral indexes like

CNX IT and BANK Nifty contracts. Trading on index derivatives were further

introduced on CNX Nifty Junior, CNX 100, Nifty Midcap 50 and Mini Nifty 50.

4.3 DERIVATIVES INSTRUMENTS

59

In recent years, derivatives have become increasingly important in the field of

finance. While futures and options are now actively traded on many exchanges, forward

contracts are popular on the OTC market. In this chapter we shall study in detail these

three derivative contracts.

FORWARD CONTRACTS

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

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

buy the underlying asset on a certain specified future date for a certain specified price.

The other party assumes a short position and agrees to sell the asset on the same date for

the same price. Other contract details like delivery date, price and quantity are

negotiated bilaterally by the parties to the contract. The forward contracts are normally

traded outside the exchanges.

The salient features of forward contracts are:

• THEY ARE BILATERAL CONTRACTS AND HENCE EXPOSED TO COUNTER-PARTY RISK.• Each contract is custom designed, and hence is unique in terms of contract size,

expiration date and the asset type and quality.

• THE CONTRACT PRICE IS GENERALLY NOT AVAILABLE IN PUBLIC DOMAIN.• On the expiration date, the contract has to be settled by delivery of the asset.

• If the party wishes to reverse the contract, it has to compulsorily go to the same

counter-party, which often results in high prices being charged.

However forward contracts in certain markets have become very standardized, as in the

case of foreign exchange, thereby reducing transaction costs and increasing transactions

volume. This process of standardization reaches its limit in the organized futures

market.

60

LIMITATIONS OF FORWARD MARKETS

Forward markets world-wide are afflicted by several problems:

• LACK OF CENTRALIZATION OF TRADING,

• ILLIQUIDITY, AND

• Counterparty risk

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

generality. The forward market is like a real estate market in that any two consenting

adults can form contracts against each other. This often makes them design terms of the

deal which are very convenient in that specific situation, but makes the contracts non-

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

transaction. When one of the two sides to the transaction declares bankruptcy, the other

suffers. Even when forward markets trade standardized contracts, and hence

avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.

INTRODUCTION TO FUTURES

Futures markets were designed to solve the problems that exist in forward

61

markets. A futures contract is an agreement between two parties to buy or sell an asset

at a certain time in the future at a certain price. But unlike forward contracts, the futures

contracts are standardized and exchange traded. To facilitate liquidity in the futures

contracts, the exchange specifies certain standard features of the contract. It is a

standardized contract with standard underlying instrument, a standard quantity and

quality of the underlying instrument that can be delivered, (or which can be used for

reference purposes in settlement) and a standard timing of such settlement. A futures

contract may be offset prior to maturity by entering into an equal and opposite

transaction. More than 99% of futures transactions are offset this way.

The standardized items in a futures contract are:

QUANTITY OF THE UNDERLYING

QUALITY OF THE UNDERLYING

THE DATE AND THE MONTH OF DELIVERY

THE UNITS OF PRICE QUOTATION AND MINIMUM PRICE CHANGE

Location of settlement

Distinction between futures and forwardsFutures ForwardsTrade on an organized exchange OTC in nature

Standardized contract terms Customised contract terms

hence more liquid hence less liquid

Requires margin payments No margin payment

Follows daily settlement Settlement happens at end of period

FUTURES TERMINOLOGY

Spot price: THE PRICE AT WHICH AN ASSET TRADES IN THE SPOT MARKET.

62

Futures price: The price at which the futures contract trades in the futures market.

Contract cycle: The period over which a contract trades. The index futures contracts

on the NSE have one-month, two-month and three months expiry cycles which expire

on the last Thursday of the month. Thus a January expiration contract expires on the last

Thursday of January and a February expiration contract ceases trading on the last

Thursday of February. On the Friday following the last Thursday, a new contract having

a three-month expiry is initiated.

Basis: In the context of financial futures, basis can be defined as the futures price

minus the spot price. There will be a different basis for each delivery month for each

contract. In a normal market, basis will be positive. This reflects that futures prices

normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be

summarized in terms of what is known as the cost of carry. This measures the storage

cost plus the interest that is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the time a

futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day, the margin

account is adjusted to reflect the investor's gain or loss depending upon the futures

closing price. This is called marking-to-market.

Maintenance margin: This is somewhat lower than the initial margin. This is set to

ensure that the balance in the margin account never becomes negative. If the balance in

the margin account falls below the maintenance margin, the investor receives a margin

call and is expected to top up the margin account to the initial margin level before

trading commences on the next day.

INDEX DERIVATIVES

Index derivatives are derivative contracts which derive their value from an

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Underlying Index. The two most popular index derivatives are index futures and index

options. Index derivatives have become very popular worldwide. Index derivatives offer

various advantages and hence have become very popular.

Institutional and large equity-holders need portfolio-hedging facility. Index-

derivatives are more suited to them and more cost-effective than derivatives based on

individual stocks. Pension funds in the US are known to use stock index futures for risk

hedging purposes.

Index derivatives offer ease of use for hedging any portfolio irrespective of its

composition.

Stock index is difficult to manipulate as compared to individual stock prices, more so

in India, and the possibility of cornering is reduced. This is partly because an individual

stock has a limited supply, which can be cornered.

Stock index, being an average, is much less volatile than individual stock prices. This

implies much lower capital adequacy and margin requirements.

Index derivatives are cash settled, and hence do not suffer from settlement delays and

problems related to bad delivery, forged/fake certificates.

APPLICATIONS OF FUTURES TRADING UNDERLYING VERSUS TRADING SINGLE STOCK FUTURES

The single stock futures market in India has been a great success story across the

world. NSE ranks first in the world in terms of number of contracts traded in single

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stock future s. One of the reasons for the success could be the ease of trading and

settling these contracts.

To trade securities, a customer must open a security trading account with a

Securities broker and a Demat account with a securities depository. Buying security

involves putting up all the money upfront. With the purchase of shares of a company,

the holder becomes a part owner of the company. The shareholder typically receives the

rights and privileges associated with the security, which may include the receipt of

dividends, invitation to the annual shareholders meeting and the power to vote.

To trade futures, a customer must open a futures trading account with a

derivatives broker. Buying futures simply involves putting in the margin money. They

enable the futures traders to take a position in the underlying security without having to

open an account with a securities broker. With the purchase of futures on a security, the

holder essentially makes a legally binding promise or obligation to buy the underlying

security at some point in the future (the expiration date of the contract). Security futures

do not represent ownership in a corporation and the holder is therefore not regarded as a

shareholder.

FUTURES PAYOFFS

Futures contracts have linear payoffs. In simple words, it means that the losses

as well as profits for the buyer and the seller of a futures contract are unlimited. These

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linear payoffs are fascinating as they can be combined with options and the underlying

to generate various complex payoffs.

The payoff for a person who buys a futures contract is similar to the payoff for a

person who holds an asset. He has a potentially unlimited upside as well as a potentially

unlimited downside. Take the case of a speculator who buys a two-month Nifty index

futures contract when the Nifty stands at 2220. The underlying asset in this case is the

Nifty portfolio. When the index moves up, the long futures position starts making

profits, and when the index moves down it starts making losses.

Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for

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a person who shorts an asset. He has a potentially unlimited upside as well as a

potentially unlimited downside. Take the case of a speculator who sells a two-month

Nifty index futures contract when the Nifty stands at 2220. The underlying asset in this

case is the Nifty portfolio. When the index moves down, the short futures position starts

making profits, and when the index moves up, it starts making losses.

PRICING FUTURES

Pricing of futures contract is very simple. Using the cost-of-carry logic, we calculate the

fair value of a futures contract. Everytime the observed price deviates from the fair

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value, arbitragers would enter into trades to capture the arbitrage profit. This in turn

would push the futures price back to its fair value.

The cost of carry model used for pricing futures is given below:

where:

r = Cost of financing (using continuously compounded interest rate)

T = Time till expiration in years.

e = 2.71828

Example: Security XYZ Ltd trades in the spot market at Rs. 1150. Money can be

invested at 11% p.a. The fair value of a one-month futures contract on XYZ is

calculated as follows:

PRICING STOCK FUTURES

A futures contract on a stock gives its owner the right and obligation to buy or

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sell the stocks. Like index futures, stock futures are also cash settled; there is no

delivery of the underlying stocks. Just as in the case of index futures, the main

differences between commodity and stock futures are that:

THERE ARE NO COSTS OF STORAGE INVOLVED IN HOLDING STOCK. Stocks come with a dividend stream, which is a negative cost if you

are long the stock and a positive cost if you are short the stock.

Therefore, Cost of carry = Financing cost - Dividends.

Thus, a crucial aspect of dealing with stock futures as opposed to commodity futures is

an accurate forecasting of dividends. The better the forecast of dividend offered by a

security, the better is the estimate of the futures price.

Example

XYZ futures trade on NSE as one, two and three- month contracts. Money can be

borrowed at 10% per annum. What will be the price of a unit of new two-month futures

contract on SBI if no dividends are expected during the two-month period?

1. ASSUME THAT THE SPOT PRICE OF XYZ IS RS.228. I.E. 0.10× (60/365)

2. THUS, FUTURES PRICE F = 228e

= Rs.231.90

FUTURES AND OPTIONS TRADING SYSTEM

The futures & options trading system of NSE, called NEAT-F&O trading

system, provides a fully automated screen-based trading for Index futures & options and

Stock futures & options on a nationwide basis as well as an online monitoring and

surveillance mechanism. It supports an order driven market and provides complete

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transparency of trading operations. It is similar to that of trading of equities in the cash

market segment.

Entities in the trading system

There are four entities in the trading system. Trading members, clearing

members, professional clearing members and participants.

1) Trading members: Trading members are members of NSE. They can trade either on

their own account or on behalf of their clients including participants. The exchange

assigns a trading member ID to each trading member. Each trading member can have

more than one user. The number of users allowed for each trading member is notified by

the exchange from time to time. Each user of a trading member must be registered with

the exchange and is assigned an unique user ID. The unique trading member ID

functions as a reference for all orders/trades of different users. This ID is common for

all users of a particular trading member. It is the responsibility of the trading member to

maintain adequate control over persons having access to the firm’s User IDs.

2) Clearing members: Clearing members are members of NSCCL. They carry out risk

management activities and confirmation/inquiry of trades through the trading system.

3) Professional clearing members: A professional clearing members is a clearing

member who is not a trading member. Typically, banks and custodians become

professional clearing members and clear and settle for their trading members.

4) Participants: A participant is a client of trading members like financial institutions.

These clients may trade through multiple trading members but settle through a single

clearing member.

4.4 BASIS OF TRADING

The NEAT F&O system supports an order driven market, wherein orders match

automatically. Order matching is essentially on the basis of security, its price, time and

quantity. All quantity fields are in units and price in rupees. The exchange notifies the

regular lot size and tick size for each of the contracts traded on this segment from time

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to time. When any order enters the trading system, it is an active order. It tries to find a

match on the other side of the book. If it finds a match, a trade is generated. If it does

not find a match, the order becomes passive and goes and sits in the respective

outstanding order book in the system.

Client Broker Relationship in Derivative Segment

A trading member must ensure compliance particularly with relation to the

following while dealing with clients:

1. Filling of 'Know Your Client' form

2. Execution of Client Broker agreement

3. Bring risk factors to the knowledge of client by getting acknowledgement of

client on risk disclosure document

4. Timely execution of orders as per the instruction of clients in respective client

codes.

5. Collection of adequate margins from the client

6. Maintaining separate client bank account for the segregation of client money.

7. Timely issue of contract notes as per the prescribed format to the client

8. Ensuring timely pay-in and pay-out of funds to and from the clients

9. Resolving complaint of clients if any at the earliest.

10. Avoiding receipt and payment of cash and deal only through account payee

cheques

11. Sending the periodical statement of accounts to clients

12. Not charging excess brokerage

13. Maintaining unique client code as per the regulations.

Order types and conditions

The system allows the trading members to enter orders with various conditions

attached to them as per their requirements. These conditions are broadly divided into the

following categories:

TIME CONDITIONS

PRICE CONDITIONS

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Other conditions

Several combinations of the above are allowed thereby providing enormous flexibility

to the users. The order types and conditions are summarized below.

• Time conditions- Day order: A day order, as the name suggests is an order, which is valid for the day on

which it is entered. If the order is not executed during the day, the system cancels the

order automatically at the end of the day.

- Immediate or Cancel (IOC): An IOC order allows the user to buy or sell a contract as

soon as the order is released into the system, failing which the order is cancelled from

the system. Partial match is possible for the order, and the unmatched portion of the

order is cancelled immediately.

• Price condition- Stop-loss: This facility allows the user to release an order into the system, after the

market price of the security reaches or crosses a threshold price e.g. if for stop-loss buy

order, the trigger is 1027.00, the limit price is 1030.00 and the market (last traded) price

is 1023.00, then this order is released into the system once the market price reaches or

exceeds 1027.00. This order is added to the regular lot book with time of triggering as

the time stamp, as a limit order of 1030.00. For the stop-loss sell order, the trigger price

has to be greater than the limit price.

• Other conditions

- Market price: Market orders are orders for which no price is specified at the time the

order is entered (i.e. price is market price). For such orders, the system determines the

price.

- Trigger price: Price at which an order gets triggered from the stop-loss book.

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- Limit price: Price of the orders after triggering from stop-loss book.

- Pro: Pro means that the orders are entered on the trading member's own account.

- Cli: Cli means that the trading member enters the orders on behalf of a client.

CONTRACT SPECIFICATIONS FOR INDEX FUTURES

NSE trades Nifty, CNX IT, BANK Nifty, CNX Nifty Junior, CNX 100, Nifty

Midcap 50 and Mini Nifty 50 futures contracts having one-month, two-month and three-

month expiry cycles. All contracts expire on the last Thursday of every month. Thus a

January expiration contract would expire on the last Thursday of January and a

February expiry contract would cease trading on the last Thursday of February. On the

Friday following the last Thursday, a new contract having a three-month expiry would

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be introduced for trading. Thus, as shown in Figure, at any point in time, three contracts

would be available for trading with the first contract expiring on the last Thursday of

that month. Depending on the time period for which you want to take an exposure in

index futures contracts, you can place buy and sell orders in the respective contracts.

The Instrument type refers to "Futures contract on index" and Contract symbol - NIFTY

denotes a "Futures contract on Nifty index" and the Expiry date represents the last date

on which the contract will be available for trading. Each futures contract has a separate

limit order book. All passive orders are stacked in the system in terms of price-time

priority and trades take place at the passive order price (similar to the existing capital

market trading system). The best buy order for a given futures contract will be the order

to buy the index at the highest index level whereas the best sell order will be the order to

sell the index at the lowest index level.

Example: If trading is for a minimum lot size of 100 units. If the index level is around

2000, then the appropriate value of a single index futures contract would be Rs.200,000.

The minimum tick size for an index future contract is 0.05 units. Thus a single move in

the index value would imply a resultant gain or loss of Rs.5.00 (i.e. 0.05*100 units) on

an open position of 100 units.

Contract cycle

The figure shows the contract cycle for futures contracts on NSE's derivatives

market. As can be seen, at any given point of time, three contracts are available for

trading - a near-month, a middle-month and a far-month. As the January contract

expires on the last Thursday of the month, a new three-month contract starts trading

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from the following day, once more making available three index futures contracts for

trading.

CHARGES

Trades affected in the contracts admitted to dealing on the F&O segment of

NSE is fixed at 2.5% of the contract value in case of index futures and stock futures. In

case of index options and stock options it is 2.5% of notional value of the contract

[(Strike Price + Premium) * Quantity)], exclusive of statutory levies. The transaction

charges payable to the exchange by the trading member for the trades executed by him

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on the F&O segment are fixed at the rate of Rs. 2 per lakh of turnover (0.002%) subject

to a minimum of Rs. 1,00,000 per year. However for the transactions in the options sub-

segment the transaction charges are levied on the premium value at the rate of 0.05%

(each side) instead of on the strike price as levied earlier. Further to this, trading

members have been advised to charge brokerage from their clients on the Premium

price (traded price) rather than Strike price. The trading members contribute to Investor

Protection Fund of F&O segment at the rate of Re. 1/- per Rs. 100 crores of the traded

value (each side).

CLEARING AND SETTLEMENT

National Securities Clearing Corporation Limited (NSCCL) undertakes clearing

and settlement of all trades executed on the futures and options (F&O) segment of the

NSE. It also acts as legal counterparty to all trades on the F&O segment and guarantees

their financial settlement.

CLEARING ENTITIES

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Clearing and settlement activities in the F&O segment are undertaken by

NSCCL with the help of the following entities:

Clearing members

In the F&O segment, some members, called self clearing members, clear and

settle their trades executed by them only either on their own account or on account of

their clients. Some others, called trading member-cum-clearing member, clear and settle

their own trades as well as trades of other trading members (TMs). Besides, there is a

special category of members, called professional clearing members (PCM) who clear

and settle trades executed by TMs. The members clearing their own trades and trades of

others, and the PCMs are required to bring in additional security deposits in respect of

every TM whose trades they undertake to clear and settle.

Clearing banksFunds settlement takes place through clearing banks. For the purpose of

settlement all clearing members are required to open a separate bank account

with NSCCL designated clearing bank for F&O segment. The Clearing and

Settlement process comprises of the following three main activities:

1) Clearing

2) Settlement

3) Risk Management

CLEARING MECHANISM

The clearing mechanism essentially involves working out open positions and

Obligations of clearing (self-clearing/trading-cum-clearing/professional clearing)

members. This position is considered for exposure and daily margin purposes. The open

positions of CMs are arrived at by aggregating the open positions of all the TMs and all

custodial participants clearing through him, in contracts in which they have traded. A

TM's open position is arrived at as the summation of his proprietary open position and

clients' open positions, in the contracts in which he has traded. While entering orders on

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the trading system, TMs are required to identify the orders, whether proprietary (if they

are their own trades) or client (if entered on behalf of clients) through 'Pro/ Cli' indicator

provided in the order entry screen. Proprietary positions are calculated on net basis (buy

- sell) for each contract. Clients' positions are arrived at by summing together net (buy -

sell) positions of each individual client. A TM's open position is the sum of proprietary

open position, client open long position and client open short position.

SETTLEMENT MECHANISM

All futures and options contracts are cash settled, i.e. through exchange of cash.

The underlying for index futures/options of the Nifty index cannot be delivered. These

contracts, therefore, have to be settled in cash. Futures and options on individual

securities can be delivered as in the spot market. However, it has been currently

mandated that stock options and futures would also be cash settled. The settlement

amount for a CM is netted across all their TMs/clients, with respect to their obligations

on MTM, premium and exercise settlement.

REGULATORY FRAMEWORK

The trading of derivatives is governed by the provisions contained in the

SC(R)A, the SEBI Act, the rules and regulations framed thereunder and the rules and

bye–laws of stock exchanges.

SECURITIES CONTRACTS (REGULATION) ACT, 1956

SC(R)A aims at preventing undesirable transactions in securities by regulating

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the business of dealing therein and by providing for certain other matters connected

therewith. This is the principal Act, which governs the trading of securities in India. The

term “securities” has been defined in the SC(R)A. As per Section 2(h), the ‘Securities’

include:

1. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable

securities of a like nature in or of any incorporated company or other body corporate.

2. Derivative.

3. Units or any other instrument issued by any collective investment scheme to the

investors in such schemes.

4. Government securities.

5. Such other instruments as may be declared by the Central Government to be

securities.

6. Rights or interests in securities.

SECURITIES AND EXCHANGE BOARD OF INDIAACT, 1992

SEBI Act, 1992 provides for establishment of Securities and Exchange Board of

India (SEBI) with statutory powers for (a) protecting the interests of investors in

securities (b) promoting the development of the securities market and (c) regulating the

securities market. Its regulatory jurisdiction extends over corporates in the issuance of

capital and transfer of securities, in addition to all intermediaries and persons associated

with securities market. SEBI has been obligated to perform the aforesaid functions by

such measures as it thinks fit. In particular, it has powers for:

Regulating the business in stock exchanges and any other securities markets.

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Registering and regulating the working of stockbrokers, sub–brokers etc.

PROMOTING AND REGULATING SELF-REGULATORY ORGANIZATIONS.PROHIBITING FRAUDULENT AND UNFAIR TRADE PRACTICES.

Calling for information from, undertaking inspection, conducting inquiries and audits

of the stock exchanges, mutual funds and other persons associated with the securities

market and intermediaries and self–regulatory organizations in the securities market.

performing such functions and exercising according to Securities Contracts

(Regulation) Act, 1956, as may be delegated to it by the Central Government.

Requirements to become F&O segment member

The eligibility criteria for membership on the F&O segment is as given in Table

7.1. Table 7.2 gives the requirements for professional clearing membership. Anybody

interested in taking membership of F&O segment is required to take membership of

“CM and F&O segment” or “CM, WDM and F&O segment”. An existing member of

CM segment can also take membership of F&O segment. A trading member can also be

a clearing member by meeting additional requirements. There can also be only clearing

members.

Eligibility criteria for membership on F&O segment

Particulars(all values in Rs. Lakh) CM and F&O segment CM, WDM and F&O segmentNet worth 1 100 200Interest free security deposit(IFSD) 2 125 275Collateral security deposit(CSD) 3 25 25Annual subscription 1 2

1: No additional networth is required for self clearing members. However, a networth of

Rs. 300 Lakh is required for TM-CM and PCM.

2 & 3: Additional Rs. 25 Lakh is required for clearing memberships (SCM, TM-CM). In

addition, the clearing member is required to bring in IFSD of Rs. 2 Lakh and CSD of

Rs. 8 Lakh per trading member he undertakes to clear and settle.

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Requirements for professional clearing membership

Particulars F&O Segment CM & F&O Segment

Note: The PCM is required to bring in IFSD of Rs. 2 Lakh and CSD of Rs. 8 Lakh per trading member whose trades he undertakes to clear and settle in the F&O segment.

Requirements to become authorized / approved user

Trading members and participants are entitled to appoint, with the approval of

the F&O segment of the exchange authorized persons and approved users to operate the

trading workstation(s). These authorized users can be individuals, registered partnership

firms or corporate bodies. Authorized persons cannot collect any commission or any

amount directly from the clients he introduces to the trading member who appointed

him. However he can receive a commission or any such amount from the trading

member who appointed him as provided under regulation. Approved users on the F&O

segment have to pass a certification program which has been approved by SEBI. Each

approved user is given a unique identification number through which he will have

access to the NEAT system. The approved user can access the NEAT system through a

password and can change such password from time to time.

Eligibility Trading members of NSE/SEBI registered custodian/recg bank

Trading members of NSE/SEBI registered custodian/recg bank

Networth 300 300Interest free securitydeposit (IFSD) 25 34Collateral security deposit 25 50Annual subscription NIL 2.5

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TAXATION OF DERIVATIVE TRANSACTION IN SECURITIESTaxation of Profit/Loss on derivative transaction in securities

Prior to Financial Year 2005–06, transaction in derivatives were considered as

speculative transactions for the purpose of determination of tax liability under the

Income -tax Act. This is in view of section 43(5) of the Income -tax Act which defined

speculative transaction as a transaction in which a contract for purchase or sale of any

commodity, including stocks and shares, is periodically or ultimately settled otherwise

than by the actual delivery or transfer of the commodity or scripts. However, such

transactions entered into by hedgers and stock exchange members in course of jobbing

or arbitrage activity were specifically excluded from the purview of definition of

speculative transaction.

In view of the above provisions, most of the transactions entered into in

derivatives by investors and speculators were considered as speculative transactions.

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The tax provisions provided for differential treatment with respect to set off and carry

forward of loss on such transactions. Loss on derivative transactions could be set off

only against other speculative income and the same could not be set off against any

other income. This resulted in payment of higher taxes by an assessee.

Finance Act, 2005 has amended section 43(5) so as to exclude transactions in

derivatives carried out in a “recognized stock exchange” for this purpose. This implies

that income or loss on derivative transactions which are carried out in a “recognized

stock exchange” is not taxed as speculative income or loss.

Thus, loss on derivative transactions can be set off against any other income during the

year. In case the same cannot be set off, it can be carried forward to subsequent

assessment year and set off against any other income of the subsequent year. Such

losses can be carried forward for a period of 8 assessment years. It may also be noted

that securities transaction tax paid on such transactions is eligible as deduction under

Income-tax Act, 1961

Securities transaction tax on derivatives transactions

As per Chapter VII of the Finance (No. 2) Act, 2004, Securities Transaction

Tax (STT) is levied on all transactions of sale and/or purchase of equity shares and units

of equity oriented fund and sale of derivatives entered into in a recognized stock

exchange.

As per Finance Act 2008, the following STT rates are applicable w.e.f. 1st t June,

2008 in relation to sale of a derivative, where the transaction of such sale in entered into

in a recognized stock exchange.

Sr. No. Taxable securities transaction Rate Payable by(a) Sale of an option in securities 0.017% Seller

(b) Sale of an option in securities, where

option is exercised 0.125% Purchaser

(c) Sale of a futures in securities 0.017% Seller

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Consider an example. Mr. A. sells a futures contract of M/s. XYZ Ltd. (Lot Size: 1000)

expiring on 29-Sep-2005 for Rs. 300. The spot price of the share is Rs. 290.

The securities transaction tax thereon would be calculated as follows:

1. Total futures contract value = 1000 x 300 = Rs. 3,00,000

2. Securities transaction tax payable thereon 0.017% = 3,00,000 x 0.017% = Rs. 51

Note: No tax on such a transaction is payable by the buyer of the futures contract.

4.5 ANALYZING S&P CNX NIFTYS’ FUTURES

CONTRACT

(DATED 29TH DECEMBER, 2009 TO 25TH MARCH, 2010)

Explanation of terms in the table:

Date – Date as on which contract is traded.

Expiry – Expiry date of the Contract.

Open – Day open price of the contract.

High – Day high price of the contract.

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Low – Day low price of the contract.

Close – Closing price of the contract.

LTP – Last Traded Price.

Settlement price – The price at which MTM is calculated.

No. of contracts – Contracts traded during the day.

Turnover in Lakhs – Traded value for the trade.

Open Interest – Unclosed contracts or open positions.

Change in Open Interest – Variation of contracts from the previous

trade OI

Underlying value – Underlying asset or Spot value.

DATA FOR FUTIDX-NIFTY FROM 30-12-2011 TO 26-03-2012

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INTERPRETATION:

From the above table we can understand that, at any point of time, Near

month, Next month and Far month contracts are available i.e. near month

is DEC., next month is JAN., & Far month is FEB. contracts.

Expiry of the contract is informed in the contract itself i.e. 31st Dec., 2009

resembles that it is the contract expiry date. So after this date, the contract

will not be in existence. So on 31st Dec., this contract expires and new

contract emerges i.e. March contract; as existing next month contract

becomes near month contract and far month becomes next month and new

contract is the far month contract.

Every Month’s last Thursday is the contract expiry date. If holiday comes

on Thursday, the previous trading day is expiry date. After the expiry of

the contract, new contract comes into existence.

Generally Near month contracts are having the huge liquidity and the

buyer & seller price spread is minimum, because of huge participation

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from all market participants. We can understand from the above graph the

OI (Open Interest) contracts are very high.

Open Interest is the ‘Unclosed Contracts’ or the people who have taken

position, but not squared off or closed.

In Derivatives market Open interest plays a very crucial role. If Open

interest is increasing day by day with the increase in price , it resemble

peoples anticipation is very high and expecting a further rise in the price.

So that we can understand that Long Positions are increasing in the market.

Change in the OI will be +ve. ( positive )

If Open Interest comes down with the price, resemble market participants

booked profit or exiting positions from the market .This bring the change

in the Open Interest to –ve. ( negative ) No. of contracts reduced from the

previous day close.

If Open interest increase with the price fall, it shows that short positions

are building in the market and they are expecting further fall.

Generally Futures contracts price reflects with premium or discount which

show the market participants’ interest. Premium means quoting higher

price with the underlying spot i.e. if Nifty is 5300. Futures price quoting

with 5310. Resembling 10 points premium.

Discount means quoting lower price with the underlying spot i.e. if Nifty is

5300. Futures price quoting with 5290 Resembling 10 points discount.

When demand for the underlying asset is more it shows with premium,

when lack of demand and expecting fall it shows in terms of discount.

In derivative markets Rollovers will happen every month i.e. Market

participants rollover their contracts to the next month, by closing the near

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month contract, when the expiry is near by. This is just like renewal of the

existing contract.

Conclusions:

1. Derivatives market is an innovation to cash market.

2. In cash market, the settlement process is by way of delivery. In Futures Market,

the settlement process will be in cash, in some segments & in commodities,

delivery is possible.

3. In cash market the investor has to pay the total money, but in derivatives the

investor has to pay premiums or margins, which are some percentage of total

money.

4. Derivatives are the financial instruments designed for hedging purpose to reduce

the risk.

5. Derivatives are the best option in minimizing the risk when proper hedging is

done with proper calculations.

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6. Index futures having huge liquidity as the participation from all segments such

as FIIs (Foreign Institutional Investors), DIIs (Domestic Institutional Investors), HNIs

(High Net worth Individuals) and retail sector while comparing with individual

stock futures.

7. Derivatives allow risk about the price of the underlying asset to be transferred

from one party to another.

8. Derivatives facilitate the buying and selling of risk and many people consider

this to have a positive impact on the ECONOMIC SYSTEM.

9. Although someone loses money, while someone else gains with a derivative.

Under normal circumstances, trading in derivatives should not adversely affect

the economic system because it is ZERO SUM in UTILITY.

Recommendations & Suggestions:

Derivatives are the financial instruments created for minimizing risk by way of

hedging, but due to speculation investors are loosing money heavily by not

following the Risk Management.

Investors trading in derivative segment need to analyze the risk and return

relationship and need to follow the stop loss rules strictly.

Due to the standardization of lot sizes, small investors cannot afford this much

of huge premiums.

Derivatives market should be developed in order to keep it at par with other

derivative markets in the world.

Risk awareness to be developed among the investors, about the derivative

instruments.

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Derivative instruments are to be designed in such a way where every one can

understand and utilize in minimizing their risk.

SEBI and Exchanges should conduct seminars regarding the use of derivatives

to educate investors.

After study it is clear that Derivative markets influence on our Indian Economy

is increasing to a significant level and impacting the whole market with its high

OPEN INTEREST (Unclosed or Open contracts). So, SEBI should take

necessary steps for regularizing and controlling the operators of Derivative

Market.

Derivatives instruments can be used efficiently in minimizing the risk by using

various strategies.

BIBLIOGRAPHY

BOOKS REFERRED

Gordan & Natarajan (2007), Financial Markets & Services (4th edition),

Himalaya Publishing House.

Prasanna Chandra (2007), Financial Management (7th Edition),

Tata McGraw-Hill Publishing Co., New Delhi.

NEWS PAPERS :-

ECONOMIC TIMES

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TIMES OF INDIA

BUSINESS STANDARD

MAGAZINES :-

BUSINESS TODAY

BUSINESS WORLD

BUSINESS INDIA

WEBSITES :-

WWW.DERIVATIVESINDIA.COM

WWW.INDIAINFOLINE.COM

WWW.NSEINDIA.COM

WWW.BSEINDIA.COM

WWW.SEBI.GOV.IN

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