A Fundamental study on derivatives in India

1.1 Introduction
New ideas and innovations have always been the hallmark of progress made by mankind. At every stage of development, there have been two core factors that drive man to ideas and innovations. These are increasing returns and reducing risk, in all facets of life. The financial markets are not different. The endeavor has always been to maximize returns and minimize risk. A lot of innovation goes into developing financial products centered on the two factors. It has spawned a whole new area called financial engineering. Derivatives are among the forefront of the innovations in the financial markets and aim to increase return and reduce risk. They provide an outlet for investors to protect themselves from the vagaries of the financial markets. The instruments have been very popular with investors all over the world. Indian financial markets have been on the ascension and catching up with global standards in financial markets. The advent of screen based trading, dematerialization, rolling settlement has put our markets on par with international markets. As a logical step to the above progress, derivative trading was introduced in the Indian stock market in June 2000. Starting with index futures, we have made rapid strides and have four types of derivative products index futures, index option, stock future and stock option. Today there are 50 stocks on which one can have futures and options, apart from the index futures and options. The stock broking firms basically carries out online trading with respect to National Stock Exchange (hereafter as NSE), Bombay Stock Exchange (hereafter as BSE) and Futures & Options Market (hereafter as F&O Segment). The stock broking firm carries out online trading with NSE and F&O market. The investors are provided all facilities to trade in NSE cash segment and F&O segment.
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A Fundamental study on derivatives in India

1.2 Review of Literature

1. Aman Agarwal (2002) says natural and man-made catastrophes have always made man to look for awareness to hedge risk and reduce losses. The insurance sector emerged as a consequence of these needs. A derivative not only provides for what an insurance instrument does (cover), but also brings in more options to the hands of the user such as trade feasibility and mere flexibility the market for weather derivatives instrument based on temperature embedded in energy contracts. The instruments are primarily for hedging risks against floods, droughts, and rainfall and crop yields. This model and underlying value can be further utilized for hedges against the other environmental hazards, which may be monitored via water tables. 2. Deepak V Kuriakose (2004) says that, introduction of trading in Index Futures in the Indian markets will now enable operators, both individuals and institutional to hedge risks. Trading in financially engineered products such as futures, whose value is derived from the underlying asset - in this case the scripts on the index will help operators to cover their positions into the future. The risk characteristics of emerging markets differ from those of more mature markets in fundamental ways. Even standard concepts such as hedge ratios or statistical measures such as correlation and volatility must be suitably interpreted before being applied. In addition, the relationships between these risk measures can undergo abrupt and dramatic changes, similar to the phenomenon of a "phase transition" in physics. The new risk regime which involves hedging trades can turn out to have quite the opposite effect and actually increase the risk of the position if one does not comprehend the concept and the nature of the derivative instruments. 3. C. Raja Rajeshwari (2004) opins that, among their various advantages, derivatives were supposed to decrease stock market volatility by giving investors the option to hedge their positions. This, however, was not the case in Indian markets. Also says, though the bullish phase of 2003 has seen a steady uptrend, the volatility has largely been contained, because of the risk containment processes put in place by the NSE.

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A Fundamental study on derivatives in India 4. GRK Murthy (2003) opins that trading in stock market derivatives has taken roots in the country and is on the growth path. There is however certain irritant that needs to be removed at the earliest, if the market has to take deep roots quickly and smoothen the market volatility on the underlying assets. 5. Ed McCarthy (2000) says about derivatives debacles. He also says, causes for the losses varied. To mention few causes were traders working without adequate supervision, pricing model that failed to account for extreme movements and market liquidity. Even after so many debacles the corporations did not cut back on their use of these instruments. 6. Malhotra (2001) argues, There is no one event that can be considered bigger than the market itself. Market is very efficient and is able to absorb these stocks very well. Credit derivatives are here to stay. Certainly, it is not the credit derivatives that brought the downfall of Enron or Argentina, it were the bad practices in the case of Enron and fiscal mismanagement money lending in case of argent responsible for the chaotic strict regulations. Transparent accounting practices and better fiscal management from interim lenders to emerging markets will make the market more efficient. 7. William B. Joyce (2002), according to him flexibility is valuable because the future is uncertain. Flexibility in property investments can be viewed in terms of options. The ability to expand or abandon a property investment prior to its estimated physical life can enhance the propertys flexibility and profitability. 8. Fitch (2003) carries survey among 200 Bank, insurance Companies reinsure financial guarantee and broker dealers traded around the world. The survey calls for increased transparency in the credit derivative market and for need to achieve a better understanding of financial institution, total net credit derivative exposure. 9. Andrew Teufef (2000) says that placing restrictions on free markets is nearly a bad thing. Short selling provides very important market for liquidity in the market if you eliminate it, you would probably get more volatile market not less.

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A Fundamental study on derivatives in India 10. Mahendra Kumar (2003) says that the growth of options since its introductions has been phenomenal. The Indian markets have discovered the practically of hedging it in stock market exposures. He also says that circumstantial evidences show that money laundering is being done making use of thinly traded options. 11. Vaidyanathan (2001) says that in India markets options on individual stocks may become popular since large number of market participants can easily understand the nature of the product. 12. Prakash GABA (2003) says that introduction to derivatives was anticipated by the market players since long. Contribution of the derivatives is going to be defining to the development of the capital market in India when benefit and convenience continues to be the most favorable arguments in favour of the derivatives. How far these complicated products would be understood and accepted by the common investor is the question that remains. 13. Financial Economists Round Table (1994) concluded that although some major end users, mutual funds, hedge funds, securities firms, and even banks have incurred derivatives related losses, most of these losses have been due to inadequate risk-management systems and poor operations control supervision. These losses have not threatened the stability and efficiency of financial markets and, by encouraging the development of better risk management and operational controls; they have had a salutary effect. 14. Kamran Parekh (2001) comments establishment of a derivatives exchange, policymakers should begin with a feasibility analysis. Such an analysis should identify key areas of weakness, and formulate plans to address these areas. There is no point in proceeding with the design of the exchange and the products to be traded until such an analysis is conducted. 15. Kamal Seghal (2000) says although currently non-existence in India, the Credit derivatives market holds immense potential. The scenarios and factors such as opening up of the Insurance sector, relief to investors, tax benefits to corporate and proxy hedges outlined in this essay could provide the necessary impetus to the credit
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A Fundamental study on derivatives in India derivatives market to develop India, boosting yields and lowering risk for both the corporate as well as the banking sector. 16. Gerard Raynor (2002) outlines the current state of play for energy derivatives in Asia The Asian energy derivatives is still fairly underdeveloped compared to Europe and North America, but markets. 17. Ramachandran (2001) says that Indian markets are slowly maturing. The introduction of options on indexes then individual stocks is definitely a step towards that. If the risk containment measures and other systems are in place for the launch of the new products the bourses can go ahead. He says Indian market has ready for option on individual stock and on indices for more than two decades. However along with derivative market, spot markets should be developed. The insurance companys provident funds and banks must relax regulations to allow greater participation. the opening up of the regions petroleum and electricity sector should provide much needed impetus to the Asian

1.3 Scope of the Study

The study is conducted in Davanagere. The study covers functions carried out by the different companies in general and derivatives trading undertaken by the companies. Survey with 50 number of existing traders is done to know their interest and preference about derivatives.

1.4 Need for the Study

The word financial market has witnessed spectacular change in the field of derivatives market in the past one decade. Especially in the field of Options, Futures and Swaps. India had also could not became a loof from the world trend and mainly after the liberalization had set in motion introduced of different types in phased manner the derivatives market has gained momentum since its introduction in India. Derivatives has played a major role in Indian financial market. Today the derivative volume in India core in this contact the study of current scenario of Indian derivative is very contractor and important as well that is why this is subject topic of the dissertation.
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A Fundamental study on derivatives in India Similarly on the equity market manage retail investors who are uncomfortable about the equity market could enter if they were given the alternative of by insurance which control their down side risks. They would chance the action of the savings of the country. Which were routed throw the equity market more importantly derivative is one of the important tools of hedging risks.

1.5 Objectives of the Study

The present topic has been selected to know how derivatives (financial derivatives) are traded in NSE, facilitates by different stock broking firms and to know the interest among the investors about derivatives trading. To study this topic the following objectives are framed:

To study different types of Derivatives those are traded in Indian stock market. To study and analyze the growth of derivatives trading in the Indian Stock Market. To study Investors interest and preference towards derivative transactions. To make a comparative study on the Derivatives market v/s Cash market transactions in NSE. To offers suggestions on the basis of Findings.

1.6 Research Methodology

This is a descriptive study that aims at studying the Derivatives systems (procedures) in India. In order to determine the essential features, the study has been designed to the opinion views and information about the derivatives system from the existing traders. The secondary data is collected from Books, Magazines, Journals and Internet. The primary data has been collected through questionnaires from 50 respondents to know their interest and preference about derivatives. The response obtained from the questionnaire is tabulated and analyzed.

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A Fundamental study on derivatives in India

Research Methodology adopted in this Project

i.

Interacted with staffs, executives and customers of different broking firms. A survey is carried out with a structured copy of questionnaire. Primary data is obtained from 50 randomly selected samples. Secondary data is obtained through published reports of National Stock Exchange (NSE) and Company. Statistical methods adopted are tabulation, use of weighted criterias and graphical representation.

ii. iii. iv.

v.

Sample Size and Technique

A sample of 50 persons is selected, using random sampling method from the existing traders in Davanagere. Who has their accounts in different stock trading firms.

Sample Description
The respondents are the existing traders in Davanagere. Who have their accounts in different stock trading firms. The respondents have knowledge about the market and they are from all walks of life.

1.7 Limitations

In-depth study couldnt be done. As the topic itself is too wide. To study in detail, it requires huge period. Study is done only for derivative contracts, which are Traded in stock exchanges, specifically with NSE.

Opinion of investors may not be sufficient and authentic because of their ignorance. Sophisticated sampling technique is not used because of cost constraint.

1.8 Chapter Scheme

Chapter-1:- Introduction
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A Fundamental study on derivatives in India Chapter first includes introduction, review of literature, scope of the study, need for the study, objectives of the study, research methodology, limitations of the study and chapter scheme.

Chapter-2:- Theoretical Background

Chapter third deals with introduction about securities market, meaning of securities and history of securities market with expanded role resource mobilizations, innovations in financial instruments.

Chapter-3:- An Overview of Derivatives Market

Chapter fourth contains introduction to derivatives, stock market derivatives, products, participants and functions, derivatives markets performs number of economic functions, type of derivatives and development in India.

Chapter-4:- Derivatives Trading at NSE

Chapter fifth includes Futures and Options trading system and trader work station.

Chapter-5:- Future and Option market Instruments at NSE

Chapter sixth deals with contacts specifications for index futures and options, contacts specifications for stock futures and options, criteria for stock eligible for option trading and charges for derivatives trading.

Chapter-6:- Settlement of Derivatives

Seventh chapter contains settlement of futures and Options contract, Regulatory and taxation aspects derivatives.

Chapter-7:- Presentation and Analysis of Data and Interpretation. Chapter-8:- Summary of Findings, Suggestions and Conclusion.

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A Fundamental study on derivatives in India

2.1 Introduction to Securities Market

The issue of securities by corporate units in India is as old as the introduction of joint stock enterprises by British government. The 18th and 19th centuries saw the emergence of cotton and jute textiles and tea plantation industries in India. Many companies were setup as joint stock with liability limited by shares. A vast number of businessmen in major cities purchased these shares and trading started in them early in the 19th century. The corporate securities came to have a market first. So far as the Government is concerned, the British India Government borrowed mostly in London by issue of sterling consoles. Only later in the 19th century did the Government Issue Treasury bills in the Government securities in rupees. This led to the emergence of government securities market also in India.

2.2 Meaning of Securities

Investment in capital market is in various financial instruments, which are all claim on money. These instruments may be of various categories with different characteristics. These are all called securities in the market parlance. In a legal sense also, the Securities Contract Act 1956 has defined securities as inclusive of shares, scripts, stocks, bonds, debentures, stock or any other marketable securities of a like nature in or of any debenture of a company or body corporate, the government and semi-government body etc., In strict sense of word, a security is an instrument of promissory note or a method of borrowing or lending or a source of contributing to the funds needed by the corporate body or non-corporate body.

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A Fundamental study on derivatives in India The securities contract (regulation) act, 1956(the SCR ACT) is the basis for the regulation of securities contract and stock Exchange in India. It was enacted in 1956 and came into force on February 20, 1957. It regulates the business of trading on stock Exchange and options trading and provides for recognition of stock exchange and related matter like listing of securities, transfer of securities, etc. the rules and by laws of the Stock exchange also govern the regulation of trading.

Securities Market
It is a broad term embracing a number of markets in which securities are bought and sold or the market in which the securities are dealt, which is called the securities market. There are number of sub-markets in the wide sense of securities market, like debt market, equity market etc. These markets help the issuers of securities, investors, intermediaries and the national economy as a whole who are all involved in the operation. Firstly the issuer will benefit as they can raise fund through this method for financing their operations. Secondly for investor the markets provide an avenue for channeling their savings and liquidity is imparted to them for their operation of investments and disinvestments. Thirdly the financial intermediaries like bankers, brokers, etc., provide a host of services, to both investor and issuers and bring them together and enable savings and investment to meet on a common ground. Lastly the nation and the economy as a whole will benefit as these markets promote savings and capital formation in the country leading to industrial growth and economic development with a multiplier effect on income, employment and output. One way in which securities market may be classified is by the types of securities bought and sold there. The broadest classification is based upon whether the securities are new issues or already outstanding and owned by investors. New issues are made available in the primary market; securities that are already outstanding and owned by investor are usually bought and sold through the secondary markets. Another classification is by maturities, securities with maturities of one year or less normally trade in the money market; those with maturities of more than one year bought and sold in the capital market needless to say classification system has many variations.

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A Fundamental study on derivatives in India

2.3 History of Securities Market

India has a well-established securities market with a long history of organized trading. The earliest capital market dealings in India where the transaction in loan stocks of the East India Companies towards the end of the 18th century. By 1830 a wide range of banks and cotton mills securities were being traded in Bombay and Calcutta. The enactment of the companys act of 1850, which introduced the concept of limited liability to India to stimulate activities in the stock market. From 1850 to 1965, the history of brokers and their rise to power in Bombay is the history of Premchand Roychand. Brokerage business attracted many people into the field and by 1860 the number of brokers had increased top 60. From 1956 to 1980, Indian stock markets grew at moderate pace. The most significant event affecting the securities market during this period was the enactment of FERA-Foreign Exchange Regulation act in the year 1973.

Capital Market in India-A transformation

The capital market was a marginal institution in the Indian financial system for almost three decades after India's independence. During this period, not many companies accessed the capital market and the quantum of funds mobilized through the capital market was emerging. Investors, in general, were not familiar or interested in corporate securities and the investor population is small, trading volumes were small and price earnings multiples modest, and equity investors, in general were under compensated for the risk borne by them. The classification of markets, are most interested in is the one, that differentiates between new and old securities- the primary and secondary market.

Primary Markets
Securities available for the first are offered through the primary securities market i.e., a market for new issues of shares, debentures and bonds here investor supply directly to the issuer for allotment and pay application money to the issuer's
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A Fundamental study on derivatives in India account. The issuer may be brand-new company or one that has been in business for many and many years. The securities offered might be a new type for the issuer or additional amounts of a security used frequently in the post. The key is that these securities absorb new funds for the offers or issuers.

Secondary Market
It is place where securities already issued are traded. It is different from the primary market where in the issuer sells securities directly to the investors. The stock exchange is an organized market place where securities are traded. The Government, Semi-government bodies, public sector undertakings and companies for borrowing funds and raising resources, issues these securities. Under the securities contract act of 1956, the central government regulates security trading and such trading can take place only in stock exchange recognized by government under this act. There are twenty one stock exchanges in India. Of these major stock exchanges, like Mumbai, Calcutta, Delhi, Chennai, Hyderabad, Bangalore, etc., are permanently recognized while a few are temporarily recognized. The above act has laid down that trading in approved contracts should be done through registered members of the exchange. As per the rules made under the above act, trading in securities permitted to be trade would be in normal trading hours (10 a.m. to 4 p.m. working days- vary from exchange to exchange) in the trading ring, as specified for trading purpose. Contracts of approved to trade are the following a. Spot delivery deals are for delivery of shares on the same day or the next day as the payment is made. b. Hand delivery deals for delivering shares, within a period of 7 to 14 days from the date of the contract. c. Delivery through a clearing for delivering shares within period of 2 months from the date of the contract d. Special delivery deals for shares for specific.
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A Fundamental study on derivatives in India Thanks to FERA dilution in the late 1970's investor interest in capital market was stimulated. The real growth and change however occurred from mid-1980 and more particularly from the early 1990's in the wake of liberalization initiative for the government. As a result of this, the capital market in India has been veritably transformed. This is reflected in the following:

2.4 Expanded Role in Resource Mobilization

Till the end of 1980s, the capital market played minor role in allocating the financial system. From 1990 onwards, the relative importance of the capital market has increased. Since then, the number of capital issues by the type of security and the type of issue has been increased.

2.5 Innovation in Financial Instruments

Till 1992, corporate had limited freedom in designing and pricing financial instruments with the enunciation of new guidelines on capital issues by SEBI in 1992, corporate, were given considerable latitude in the design of financial instrument. Thanks to this freedom, a number of new instruments like deep discount bonds, potable-cum-callable bonds, floating rate bonds, and index bonds have been introduced.

Emergence of Numerous Capital Market Intermediaries

Many new capital market intermediaries have emerged; while there was only one mutual fund (UTI) in existence till 1986, a number of new mutual funds have came into being since then.

Establishment of new Stock Exchange and Growth in Trading

Stock exchanges are the pivot of the capital market. They serve as the channels through which primary issues are offered to the investing public and they provide the mechanism through which outstanding securities are traded. While there was only 9 recognized stock exchanges in 1980,the number has gone up to 22 by the end of 1997. The most important event, of course, those been establishment of NSE in
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A Fundamental study on derivatives in India November 1994. Within a short period, it has emerged as the principal stock exchange in the country. At present the number of stock exchange has been increased to twenty three.

Adoption of Screen - Based Trading

NSE and OTC exchange India were setup, abinitio, as computerized exchanges other exchanges to have switched or are in the process of switching from traditional open outcry system of trading to screen-based system of trading. This has been a major development in the secondary market in India. A major innovation in Indian capital market is introduction of screen based trading in place of open-outcry trading system where traders shot and resort to signal and trading of floor of exchange is replaced by screen-based trading. It is a system, where distant participation can trade with each other through computer network. The traditional system of trading i.e., buying and selling of share is taken place through share brokers of the stock exchange in the auction market. In the auction market, the market marker and an auction system based on a current high bid low offer. Those not meeting either of these prices may not participate in the auction. The auction system allows the buyer and seller to find a mutually agreeable price with no intervention of the stockbroker. This auction system is also called out-cry system. The buy and sell orders are automatically matched with specialist filling in the gap when an imbalance occurs. The specialist system emerged precisely because in a continuous auction market where broker trade with each other there is no guarantee of a simultaneous coincidence of buyer and seller. This system of trading having lots of drawbacks t overcome this new system of trading was introduced namely screen based system or online trading.

Emerging Derivatives market structure in India

Apart from traditional financial markets, two more markets are emerging, namely the derivatives market has came into being recently and the bank assurance market, which is likely to emerge in an important way once banks start undertaking insurance business derivatives in the Indian Financial markets are of recent origin,
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A Fundamental study on derivatives in India barring trade related forward contracts in the forex Exchange. Exchange trade derivatives tend to be more standardized and offer greater liquidity than OTC contracts, which are negotiated between counter parties and tailored to meet the needs of the parties to the contract. Exchange traded derivatives also offer-centralized limits on individual positions and has formal rules for risk and burden sharing. While one exchange traded derivative viz., Stock Index Futures was introduced by the two largest stock exchanges in June 2000. The most notable development concerning the secondary segment of the Indian capital market is the introduction of derivatives trading in June 2000. SBI approved derivatives trading based on Futures contracts at both BSE and NSE in accordance with the rules / bylaws and regulations of the stock exchanges. BSE and NSE have made a beginning with equity derivatives with the introduction of stock index futures.

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A Fundamental study on derivatives in India

3.1 Introduction
In the present state of the economy, there is an imperative need for the corporate clients to protect their operating profits by shifting some of the uncontrollable financial risks to those who are able to bear and manage them. Thus, risk management becomes must for survival since there is a high volatility in the present financial markets. In the present state of the economy, there is an important place as a risk reducing machinery. Derivatives are useful to reduce many of the risks discussed above. In fact, the financial service companies can play a very dynamic role in dealing with such risks. They can ensure that the above risks are hedged by using derivatives like forwards, futures, options, swaps etc. Derivatives, thus, enable the clients to transfer their financial risks to the financial service companies. This really protects the clients from unforeseen risks and helps them to get their due operating profits or to keep the project well within the budgeted costs. To hedge the various risks that one faces in the financial market today, derivatives are absolutely essential.

3.2 Stock Market Derivatives

Despite of many institutional setups, financial securities are always exposed to price risk for, they are written on future cash flows that are embedded with uncertainty. It is this eagerness of the risk adverse investors to protect themselves against such price risk that has led to the development of the derivative market. A derivative, such as future or option is an instrument whose value is derived from the value of one or more underlying assets, which can be a commodity currency, stocks, stock indices etc. These are basically hedging tools that facilitate an investor who is long on stock to protect from its down side, if any, by taking an offsetting position in the derivatives market.

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A Fundamental study on derivatives in India

What are derivatives?

In a broad sense, many commonly used instruments can we called derivatives since they derive their value from an underlying asset. For instance, equity share itself is a derivative, since; it derives its value from the firms underlying assets. Similarly, one takes an insurance against his/her house covering all risks. This insurance is also a derivative instrument on the house. In a strict sense, derivatives are based upon all those major financial instruments, which are explicitly traded like equities, debt instruments, forex instruments and commodity based contracts. Thus, when we talk about derivatives, we usually mean only financial derivatives, namely, forwards, futures, options, swaps etc. the peculiar features of these instruments are that: 1. They can be designed in such a way so as to cater to the varied requirements of the users either by simply using any one of the instruments or by using a combination of two or more such instruments. 2. They can be designed and traded on the basis of the expectations regarding the future price movements of underlying assets. 3. They are all off-balance sheet instruments and 4. They are used as a device for reducing the risks of fluctuations in asset values. A derivative is a financial instrument that derives its value from an underlying asset. This underlying asset can be stocks, bonds, currency, commodities, metals and even intangible, pseudo assets like stock indices. In other words, 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.
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A Fundamental study on derivatives in India

What exactly is meant by Derives its value from an asset?

What the phrase means is that the derivative on its own does not have any value. It is considered important because of the importance of the underlying asset. When we say an Infosys future or an Infosys option, these carry a value only because of the value of Infosys. In the Indian context the Securities Contracts (Regulation) Act, 1956 SCRA defines derivative to include:1. A security derived from a debt instrument, share, and loan whether secured or unsecured, risk instrument or contract for differences or any other form or security. 2. A contract, which derives its value from the prices, or index of price, of underlying securities. Derivatives are securities under the SCRA and hence the trading of derivatives is governed by the regulatory framework under the SCR. A Derivative can be of different types like futures, options, swaps, caps, floor, collars etc. The most popular derivative instruments are futures and options. Equity derivative markets in India were launched in April 2000. Within the span of one and a half years thereafter, the entire range of exchange traded equity derivatives products, from index futures, index options, stock options and single stock futures contracts have been successfully launched. The equity derivative markets in India have been structured after studying practices in equity derivative markets globally, and keeping in mind the unique culture and ethos of the Indian market. The processes of trading and settlement of equity derivatives contracts are consistent with the international standards prescribed by BIS-IOSCO and EACH (European Association of Central Counter Party Clearing Houses).

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A Fundamental study on derivatives in India

3.3 Products, Participants and Functions

Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps. The following three broad categories of participants Hedgers, Speculators, and arbitrageurs trade in the derivatives market. Hedgers are the brokers who buy or sell to minimize their losses. For

example, an importer has to pay US $ to buy goods and rupee is expected to fall to Rs. 50/$ from Rs. 48/$, then the importer can minimize his losses by buying a currency future at 49/$. Speculators are the brokers who buy or sell in the market to make profits. For example, if you will the stock price of Reliance is expected to go up to Rs 450 in 1 month, one can buy a one month future of Reliance at Rs. 400 and make profits. Arbitrageurs are the brokers who buy or sell to make money on price differentials in different market. For example, a futures price is simply the current price plus the interest cost. If there is any change in the interest, it presents an arbitrage opportunity.

3.4 The Derivatives Market performs a number of Economic Functions

First, prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying asset to the perceived future level. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices. Second, the derivatives market helps to transfer risks from those who wish to reduce risk to those who wish to take risk. Third, derivatives, due to their inherent nature, are linked to the underlying cash market, with the introduction of derivatives, the underlying market witnesses

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A Fundamental study on derivatives in India higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. Fourth, 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. Fifth, 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. This often energizes others to create new business, new products and new employment opportunities, the benefits of which are immense. Finally, derivative market helps increase savings and investment in the long run. Transfer of risk enables market participants to expand their volume of activity.

3.5 Types of Derivatives

The following are the popular and important derivatives. (i) (ii) (iii) (iv) Forwards Futures Options and Swaps

1. Forwards

A forward contract is one to one bi-partite contract, to be performed in the future, at the terms decided today. (E.g. forward currency market in India). Forward contracts offer tremendous flexibility to the parties to design the contract in terms of the price, quantity, quality (in case of commodities), delivery time and place.

Forward contracts suffer from poor liquidity and default risk. 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
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A Fundamental study on derivatives in India a certain date in future at a predetermined price in that agreement. The promised asset may be currency, commodity, instrument etc. In a forward contract, a user (holder) who promises to buy the specified asset at an agreed price at a fixed future date is said to be in the Long position. On the other hand, the user (holder) who promises to sell at an agreed price at a future date is said to be in Short position. Thus, Long position and Short position take the form of buy and sell in a forward contract.

Features of forward contracts

Traded in Over the Counter (OTC) markets. No down payment required. Settlement is done on the date of maturity. Linearity: symmetrical gains or losses due to price fluctuation of the underlying asset. No secondary market is available. Necessity of third party is required.

2. Futures
A future contract is very similar to a forward contract in all respects excepting the fact that it is completely a standardized one. Hence, it is rightly said that a futures contract is nothing but a standardized forward contract. It is legally enforceable and it is always traded on an organized exchange. A future is a contract to buy or sell an asset at a specified future date at a specified price. These contracts are traded on the stock exchanges and it can change many hands before final settlement is made.

Features of future contracts

Highly standardized in nature. No down payment is required at the time of agreement.

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A Fundamental study on derivatives in India Settlement: futures instruments are marked to the market and the exchange records profit and loss on them on daily basis though held till maturity. Hedging of price risk is most common in futures. Non-linearity. Non-delivery of asset: In future contracts generally parties simply exchange the difference between the future and spot prices. The advantage of a future is that it eliminates counterparty risk. Since there is an exchange involved in between, and the exchange guarantees each trace, the buyer or seller does not get affected with the opposite party defaulting.

Futures v/s Forwards Futures

Futures are traded on a stock exchange. instruments. Futures are contracts having standard Forwards are contracts customized by the terms and conditions. buyer and seller. No default risk as the exchange provides High risk of default by either party. a counter guarantee. Exit route is provided because of high No exit route for these contracts. liquidity on the stock exchange. Highly regulated with strong margining No such systems are present in a forward and surveillance systems. market.

Forwards
Forwards are non-tradable, negotiated

Commodity futures
A commodity future is a futures contract in commodities like agriculture products, metals and minerals etc. In organized commodity future markets, contracts are standardized with standard quantities. Of course, this standard varies from commodity to commodity. They also fixed delivery dates in each month or a few months in a year. In India commodity futures in agricultural products are popular.

Financial futures
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A Fundamental study on derivatives in India Financial futures refer to a futures contract in foreign exchange or financial instruments like Treasury bill, commercial paper, and stock market index or interest rate. It is an area where financial service companies can play a very dynamic role. Financial futures are very popular in Western countries as hedging instruments to protect against exchange rate/interest rate fluctuations and for ensuring future interest rates on loans. The Stock Index Futures contract is a futures contract on major stock market indices. This type of contract is very much useful for speculators, investors and especially portfolio managers. They can hedge against future decline or increase in prices of portfolios depending upon the situation. Generally the asset will not be delivered on the maturity of the contract. The parties simply exchange the difference between the future and spot prices on the date of maturity. But, these kinds of financial futures are relatively new in India.

3. Options
In the volatile environment, risk of heavy fluctuations in the prices of assets is very heavy. Option is yet another tool to manage such risks. Options are one better than futures. In option, as the name indicates, gives one party the option to take or make delivery. But this option is given to only one party in the transaction while the other party has an obligation to take or make delivery. The asset can be a stock, bond, index, currency or a commodity. But since the other party has an obligation and a risk associated with making good the obligation, he receives a payment for that, this payment is called as premium. The party that had the option or the right to buy/sell enjoys low risk. The cost or this low risk is the premium amount that is paid to the other party. The buyer of the right is called the option holder. The seller of the right (and buyer of the obligation) is called the option writer. The cost of this transaction is the premium.

Writer
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A Fundamental study on derivatives in India In an options contract, the seller is usually referred to as a writer since he is said to write the contract. It is similar to the seller who is said to be in Short position in a forward contract. However, in a put option, the writer is in a different position. He is obliged to buy shares. In an option contract, the buyer has to pay a certain amount at the time of writing the contract for enjoying the right to buy or sell.

American Option Vs European Option

In an option contract, if the option can be exercised at any time between the writing of the contract and its expiration, it is called as an American option. On other hand, if it can be exercised only the time of maturity, it is termed as European option.

Types of options
Options may fall under any one of the following main categories: i) ii) iii) Call Option Put Option Double Option

I.

Call Option
A call option is one which gives the option holder the right to buy a

underlying asset (commodities, foreign exchange, stocks, shares etc.) at a predetermined price called exercise price or strike price on or before a specified date in future. In such a case, the writer of a call option is under an obligation to sell the asset at the specified price, in case the buyer exercises his option to buy. Thus, the obligation to sell arises only when the option is exercised.

II.

Put Option
A put option is one, which gives the option holder the right to sell an

underlying asset at a predetermined price on or before a specified date in future. It means that the writer of a put option is under an obligation to buy the asset at the exercise price provided the option holder exercises his option to sell.

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III.

Double Option
A double option is one, which gives the option holder both the rights either to

buy or to sell an underlying asset at a predetermined price on or before a specified date in future.

Option Premium
In an option contract, the option writer agrees to buy or sell an underlying asset at a future date for an agreed price from/to the option buyer/seller at his option. This contract, like any other contract must be supported by consideration. The consideration for this contract is a sum of money called premium. The premium is nothing but the price, which is required to be paid for the purchase of right to buy or sell. The premium, one pays is the maximum amount to which he is exposed in the market, since, in any case he cannot lose more than that amount. Thus, his risk is limited to that extent only. However, his gain potential is unlimited. In the case of a double option, this premium money is also double.

Options Market
Options market refers to the market where option contracts are brought and sold. Once an option contract is written, it can be bought or sold on the options market. The first option market namely the Chicago Board of Options Exchange was set up in 1973. Thereafter, several options markets have been established.

Features of Option Market

i) ii) iii) Highly Flexible. Down Payment. Settlement.

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A Fundamental study on derivatives in India iv) v) Non-Linearity. No Obligation to Buy or Sell.

4. Swap
Swap is yet another exciting trading instrument. Infact, it is a combination of forward 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.

Features
Basically a forward. Double coincidence of wants. Necessity of an intermediary. Settlement. Long term agreement.

Kinds of Swap
A swap can be arranged for the exchange of currencies, interest rates etc. A swap in which two currencies are exchanged is called cross-currency swap. A swap in which a fixed rate of interest is exchanged for a floating rate is called interest rate swap. This interest rate swap can also be arranged in multi-currencies. A swap in which one stream of floating interest rate is exchanged for another stream of floating interest is called Basis swap. Thus, swap can be arranged according to the requirements of the parties concerned and may innovative swap instruments can be evolved like this.

Advantages
1. Borrowing at Lower Cost. 2. Access to New Financial Markets.
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A Fundamental study on derivatives in India 3. Hedging of Risk. 4. Tool to correct Asset-Liability Mismatch. 5. Additional Income.

3.6 Derivatives: Development in India

I. Development Prior to 1998-99
In the last few years there have been substantial improvements in the functioning of the securities market. Requirements of adequate capitalization, margining and establishment of clearing corporations have reduced market and credit risks. System improvements have been effected through introduction of screen based trading system and electronic transfer and maintenance of ownership records of securities. However, there are inadequate advanced risk management tools. In order to provide such tools and to deepen and strengthen cash market, a need was felt for trading of derivatives like futures and options. But it was not possible in view of prohibitions in the SCRA. Its preamble stated that the Act is to prevent undesirable transactions in securities by prohibiting options and by providing for certain other matters connected therewith. Section 20 of the Act explicitly prohibited all options in securities. The Act empowered central Government to prohibit by notification any type of transaction in any security. In exercise of this power, Government by its notification in 1969 prohibited all forward trading in securities. As the need for derivatives was felt, it was thought that if these prohibitions were withdrawn, trading in derivatives could commence. The securities laws (amendment) ordinance, 1995, promulgated on 25th January 1995, lifted the ban by repealing section 20 of the SCRA and amending its preamble. The market for derivatives, however, did not take off, as there was no regulatory framework to govern trading of derivatives. SEBI set up a 24 member committee under the Chairmanship of Dr. L.C.Gupta on 18th November 1996 to develop appropriate regulatory framework for derivatives trading in India. The Committee submitted its report on March 17, 1998.
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A Fundamental study on derivatives in India Market went ahead with preparation. It was soon realized that there was no law under which the regulations could be framed for derivatives. It was felt that if derivatives could be treated as securities under the SCRA, trading in derivatives would be possible within the framework of that Act. According to section 2(h) of the SCRA, securities includes shares, scrips, stocks bonds, debentures, debentures stock, or other marketable securities of a like nature in or of any incorporated company or other body corporate, government securities, such other instruments as may be declared by the Central Government to be securities, and rights and interest in securities. SEBI felt that the definition of Securities under SCRA could be expanded by declaring derivative contracts based on index of prices of securities and other derivative contracts as securities. It was thought that Government could declare derivatives to be securities under its delegated powers. Government, however did not declare derivatives as securities, probably because its power was circumscribed by the words such other. Only those instruments, which resemble the ones listed in the Act could be declared.

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4.1 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 Nifty 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 transparency of trading operations. It is similar to that of trading of equities in the cash market segment.

Entities in the Trading System

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.

Clearing Members: Clearing members are members of NSCCL. They

carry out risk management activities and confirmation/ inquiry of trades through the trading system.

Professional Clearing Members: A professional clearing member 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.

Participants: A participant is a client of trading members like

financial institutions. These clients may trade through multiple trading members but settle through single clearing member.
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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 lot size on the futures market is for 200 Nifties the exchange notifies the regular lot size and tick size for each of the contracts traded on this segment from time to time.

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 Time conditions, Price conditions and other conditions.

4.2 The Trader Work Station

The Markets Watch Window and Inquiry Window
The best way to familiarize oneself with the screen and its various segments is to actually spend some time studying a live screen. The market watch window is always visible to the user and the purpose of market watch is to allow continuous monitoring of contracts or securities that are of specific interest to the user. It displays trading information for contracts selected by the user. The user also gets a broadcast of all the cash market securities on the screen. The inquiry window enables the user to view information such as Market by Order (MBO), Market by Price (MBP), Previous Trades (PT), Out standing Orders (OO), Activity Log (AL), Snap Quote (SQ), Order Status (OS), Market Moment (MM), Market Inquiry (MI), Net Position (NP), Online backup, Multiple index inquiry, Most active security and so on. Relevant information for selected contract/security can be viewed through windows.
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Placing Orders on the Trading System

For both the futures and the options market, while entering to identify the orders as being proprietary or client orders. Proprietary orders should be identified as Pro and those of clients should be identified as Cli. Apart from this, in the case of Cli trades, the client account number should also be provided.

Market Spread/Combination Order Entry

The NEAT F&O trading system also enables to enter spread /combination screen. This enables the user to input two or three orders simultaneously into the market. These orders will have the condition attached to it that unless and until the whole batch of orders finds a countermarch they shall not be traded.

Basket Trading
In order to provide a facility for easy arbitrage between futures and cash markets, NSE introduced basket-trading facility. This enables the generation of portfolio offline order files in the derivatives trading system and its execution in the cash segment. A trading member can buy or sell a portfolio through a single door, once he determines its size.

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5.1 Futures and options market instruments at NSE

The F&O segment of NSE provides trading facilities for the following derivative instruments: a. Index based futures b. Index based options c. Individual stock options

d. Individual stock futures 5.2 Contract Specifications for Index Futures

NSE trades Nifty futures contracts having one-month, two-month and threemonth 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 be introducing for trading. Trading is for a minimum lot size of 200 units. Thus if the index level is around 1000, then the appropriate value of a single index futures contract would be Rs.200000. 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.10.00 (i.e.0.05*200 units) on an open position of 200 units.

Contract specification: S&P CNX Nifty Futures

Underlying index Exchange of trading : S&P CNX Nifty : National Stock Exchange of India Limited

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A Fundamental study on derivatives in India Security descriptor Contract size : N FUTIDX NIFTY : Permitted lot size shall be 200 and multiple thereof (Minimum value Rs.2 lakh). Price steps Price bands Trading cycle : Re.0.05 : Not applicable : The futures contracts will have a maximum of three month trading cycle-the near month (one), the next month (two) and the far month (three). New contract will be introduced on the next trading day following the expiry of near month Contract. Expiry day : The last Thursday of the expiry month or the Previous trading day if the last Thursday is a Trading holiday. Settlement basis : Mark to market and final settlement will be cash Settled on T+1 basis. Settlement price : Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be the closing value of the underlying index on the last trading day.

5.3 Contract Specification for Index Options

On NSEs index options market, contracts at different strikes, having onemonth, two-month and three-month expiry cycles are available for trading. There are typically one-month, two-month and three month options, each with five different strikes available for trading. Hence at a given point in time there are minimum 3*5*2
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A Fundamental study on derivatives in India or 30 options products. Option contracts are specified as follows: DATE-EXPIRY MONTH-YEAR-CALL/ PUT-AMERICAN/EUROPEAN-STRIKE.

Contract specification: S&P CNX Nifty Options

Underlying index Exchange of trading Security descriptor Contract size : S&P CNX Nifty : National Stock Exchange of India Limited : N OPTIDX NIFTY : Permitted lot size shall be 200 and multiple thereof (Minimum value Rs.2 lakh) Price steps Price bands Trading cycle : Re.0.05 : Not applicable : The Options contracts will have a maximum of Three month trading cycle-the near month (one), the next month (two) and the far month (three). New contract will be introduced on the next Trading day following the expiry of near month Contract. Expiry day : The last Thursday of the expiry month or the previous trading day if the last Thursday is a Trading holiday. Settlement basis Style of option Strike price level Daily settlement price Final settlement price : Cash settled on T+1 basis. : European : Rs.20 : Premium value (net) : Closing value of the index on the last trading day.

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5.4 Contract Specifications for Stock Futures

Trading in stock futures commenced on the NSE from November 2001. These contracts are cash settled on a T+1 basis. The expiration cycle for stock futures is the same as for index futures, index options and stock futures and stock options. A new contract is introduced on the trading day following the expiry of the near month contract.

Contract specification: Stock Futures

Underlying Exchange of trading Security descriptor Contract size Price steps Price bands Trading cycle : Individual securities : National Stock Exchange of India Limited : N FUTSTK--------: 100 or multiples there of (minimum value Rs.2 lakh) : Re.0.05 : Not applicable : The futures contracts will have a maximum of three month trading cycle-the near month (one), the next month (two) and the far month (three). New contract will be introduced on the next trading day following the expiry of near month contract. Expiry day : The last Thursday of the expiry month or the previous trading day if the last Thursday is a Trading holiday. Settlement basis : Mark to market and final settlement will be cash settled on T+1 basis.
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A Fundamental study on derivatives in India Settlement price : Daily settlement price will be the closing price of the futures contracts for the trading day and the final settlement price shall be the closing value of the underlying security on the last trading day.

5.5 Contract Specifications for Stock Options

Trading in stock options commenced on the NSE from July 2001. These contracts are American style and are settled in cash. The expiration cycle for stock options is the same as for index futures and index options. A new contract is introduce on the trading day following the expiry of the near month contract.

Contract specification: Stock Options

Underlying : Individual securities available for trading in Cash market Exchange of trading Security descriptor Style of option Strike price level : National Stock Exchange of India Limited : N OPTSTK--------: American : Between Rs.2.5 and Rs.100 depending on the Price of the underlying Contract size Price steps Price bands Trading cycle : 100 or multiples there of (minimum value Rs.2 lakh) : Re.0.05 : Not applicable : The options contracts will have a maximum of Three month trading cycle-the near month (one),
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the

next

A Fundamental study on derivatives in India month (two) and the far month (three). New contract will be introduced on the next trading day following the expiry of near month contract. Expiry day : The last Thursday of the expiry month or the Previous trading day if the last Thursday is a trading holiday. Settlement basis : Daily settled on T+1 basis and final option exercise settlement on T+3 basis. Daily settlement price Final settlement price : Premium value (net) : Closing price of underlying on exercise day or Expiry day. Settlement day : Last trading day

5.6 Criteria for Stocks Eligible for Options Trading

The following criteria will have to be met before a stock can be considered eligible for options trading. The stock should be amongst the top 200 Scrips; on the basis of average market capitalization during the last 6 months and the average free float market capitalization should not be less than Rs.750 crore. The free float market capitalization means the non-promoter holding in the stock. The non-promoter holding in the company should be at least 30% The stock should be amongst the top 200 Scripps on the basis of average daily volume (in value terms), during the last six months. Further, the average daily volume should not be less than Rs.5 crore in the underlying cash market. The stock should be traded on at lest 90% of the trading days in the last Six months. The ratio of the daily volatility of the stock vis--vis the daily volatility of the index should not be more than 4, at any time during the previous six months.
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5.7 Charges for Derivatives Trading

The maximum brokerage chargeable by a TM in relation to trades effected in the contracts admitted to dealing on the F&O segment of NSE is fixed at 2.5% of national value of the contract [(Strike price + Premium) x Quantity] in case of index options, exclusive of statutory levies. The transaction charges payable by a TM for the trades executed by him on the F&O segment are fixed at Rs.2 per lakh of turnover (0.002)(each side) or Rs.1 lakh annually, whichever is higher. The TMs contribute to Investor Protection Fund of F&O segment at the rate of Rs.10 per crore of turnover (0.0001%) each side.

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6.1 Settlement of Futures Contracts

Mark to market settlement
There is a daily settlement for Mark to Market. The profits/losses are computed as the difference between the trade price or the previous days settlement price, as the case may be, and the current days settlement price. The party who have suffered a loss are required to pay the mark to market loss amount to exchange which is in turn passed on to the party who has made a profit. This is known as daily markto-market settlement. Theoretical daily settlement price for unexpired futures contracts, which are not traded during the last half an hour on a day, is currently the price computed as per the formula detailed below: F = S * e rt Where: F = Theoretical futures price S = Value of the underlying index/stock r = Rate of interest (MIBOR-Mumbai Inter Bank Offer Rate) t = Time to expiration. Clearing bank account on T + 1 (T = Expiry day). This is then passed on the client from the broker. Opened positions in futures contracts cease to exist after their expiration day.
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6.2 Settlement of Option Contracts

Daily premium settlement
Premium settlement is cash settled style is premium style. The premium payable position and premium receivable positions are netted across all option contracts for each broker at the client level to determine the net premium payable or receivable amount, at the end of each day. The brokers who have a premium payable position are required to pay the premium amount to exchange which is in turn passed on to the members who have a premium receivable position. This is known as daily premium settlement. The brokers in turn would take this from their clients. The pay-in and pay-out of the premium settlement is on T + 1 days directly debited or credited to the broker, from where it is passed on to the client. (T =

Trade day). The premium payable amount and premium receivable amount are

Interim Exercise Settlement for Option on Individual Securities

Interim exercise settlement for Option contracts on Individual Securities is affected for valid exercised option positions at in-the-money strike prices, at the close of the trading hours, on the day of exercise. Valid exercised option contracts are assigned to short positions in option contracts with the same series, on a random basis. The interim exercise settlement value is the difference between the strike price and the settlement price of the relevant option contract. Exercise settlement value is debited /credited to the relevant broker account on T + 3 day (T = exercise date). From there it is passed on to the clients.

Final Exercise Settlement

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A Fundamental study on derivatives in India Final Exercise settlement is effected for option positions at in-the-money strike prices existing at the close of trading hours, on the expiration day of an option contract. Long positions at in-the money strike prices are automatically assigned to short positions in option contracts with the same series, on a random basis. For index options contracts, exercise style is European style, while for options contracts on individual securities exercise style is American style. Final Exercise is Automatic on expiry of the option.

6.3 Regulatory and Taxation Aspects of Derivatives

Since derivative are a highly risk market, as experience world over has shown, there are tight regulatory controls in this market. The same is true of India. In India, a committee was set up under Dr.L.C.Gupta to study the introduction of the derivatives market in India. This committee formulated the guidelines and framework for the derivatives market and paved the way for the derivatives market in India. There other committee that has far reaching implications in the derivatives market is the J.R.Verma Committee. This committee has recommended norms for trading in the exchange. A lot of emphasis has been laid on margining and surveillance so as to provide a strong backbone in systems and processes and ensure stringent controls in risky market. As for the taxation aspect, the CBDT is treated gains from derivative transactions as profit from speculation losses for tax purpose.

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7.1 Analysis of Primary data

Primary data is chosen for the purpose of study in Davanagere city. I have conducted survey with an intention to bring out the opinion of the investors who has invested in Derivatives market. The survey is conducted through direct interview and questionnaires method for 50 respondents, the survey is interpreted in the following table:

7.2 Investors Interest and Preference towards Derivatives

Preference of Respondents for investing in Equity Market Table No. 7.1 Table showing the weighted of Preference of Respondents for investing in Equity Market

Weight Sl.No 1 2 3 4 5 Reasons\ Ranks Gambling Long Term Returns Short Term Returns Excess Money Others Total

5 R1 13 10 21 6 0 50

4 R2 15 17 8 9 1 50

3 R3 15 8 14 9 4 50

Actual Percent Score 183 171 193 140 63 Weight 73.2 68.4 77.2 56 25 Rank 2 3 1 4 5

R4 R5 6 1 14 1 7 0 21 5 2 43 50 50

Source: Field Survey From the above table it is noted that as per the preference given by the investors through ranking in order of preference for given choices which is presented in R1 to R5 in columns for given choices Sl.No. 1 to 5.
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A Fundamental study on derivatives in India For given response actual score is calculated in 5 weighted criteria and the expected score comes 50 X 5 = 250 (No. of respondents multiplied with 5 criteria). The reason short term scored highest of 193, succeeded by savings with an actual score of 183 and followed by long term return, excess money and other reason with actual score of 171, 140 and 63 respectively. By employing formula: Actual score / Expected score x 100 The percent of weights are calculated, and the reason short term returns is preferred as rank 1 with 77.2 percent succeeded by gambling with 73.2 percent and followed by long term returns, excess money and Others with 68.4, 56, and 25 percent respectively. Graph No. 7.1 Graph showing the weighted Preference of Respondents for investing in Equity Market

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A Fundamental study on derivatives in India Percentage of Investment that the Respondents Invest in Equity Market Table No. 7.2 Table showing total Percentage of Investment that the Respondents Invest in Equity Market Percentage of respondents 60 24 10 6 100

Sl.No. 1 2 3 4

Investment portion for equity market (%) 0 20 20 40 40 60 60 100 Total

Responde nts 30 12 5 3 50

Source: Field Survey From the above table it is noted that out of all 50 respondents investment portion for equity market, 30 (60%) come under the range of 0-20, succeeded by 12 (24%) come under 20-40, followed by 5 (10%) and 3 (6%) come under the range of 40-60 and 60-100 respectively invests in equity market. Graph No. 7.2 Graph showing total Percentage of Investment that the Respondents Invest in Equity Market

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A Fundamental study on derivatives in India Trading the Securities with Stock broking firm Table No. 7.3 Table showing the Respondents Trading the Securities with Stock broking firm Sl.No 1 2 3 4 5 Firms Indiabulls Securities Kotak karvi Small Stock Holdings firms Other Total Source: Field Survey From the above table and graph it is noted that out of all 50 respondents who are existing clients of different stock broking firms 14 (28%) of them has Trading account with Indiabulls, 10 (20%) of respondents has trading account with Kotak, and followed by 1 (2%) with stock broking firm and rest 5 (10%) has accounts in different firms. Graph No. 7.3 Graph showing the Respondents Trading the Securities with Stock broking firm Respondents 14 10 20 1 5 50 Percentage 28 20 40 2 10 100

Trading Pattern by the Respondents

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A Fundamental study on derivatives in India Table No. 7.4 Table showing the regularity of Trading Pattern by the Respondents Sl.No. 1 2 Trading Regularly Occasionally Respondents 42 8 50 Percentage 84 16 100

Total
Source: Field Survey

Analysis
The above table shows the regularity of the trading pattern practiced by the respondents. 42 respondents (84%) on regular basis and 8 respondents (16%) trade occasionally But to find out the Range of Proportion of regularity in trading by the respondents, the following P-test has made. p = 42/50 *100 = 0.84, q = 8/50 * 100 =0.16 Where, p = Proportion of respondents regularly trading q = Proportion of respondents occasionally trading. Sample Error (S.E) = pq/n S.E = (0.84) (0.16)/50 S.E = 0.00268 Employing: P = p 3(S.E)
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A Fundamental study on derivatives in India Upper Limit: P = 0.84 + 3(0.00268) = 0.84804 0.84 Lower Limit: P = 0.84 3(0.00268) = 0.83

Interpretation
From the above test it is noted that, the proportion of regularity in trading operation by the investors varies between 83 percent and 84 percent. This shows regular traders are dominating in trading activity of equity market. Graph No. 7.4 Graph showing the regularity of Trading Pattern by the Respondents

Duration of trading operation Table No. 7.5

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A Fundamental study on derivatives in India Table showing the duration of trading operation (in months) from which the respondent trading in Equity Market till May 2008 Sl. No. 1 2 3 4

Period (months) 16 6 12 12 18 18 and above Total

Respondents 19 26 5 0 50

Percentage 38 52 10 0 100

Source: Field Survey From the above table it is noted that out of 50 respondents 19 (38%) trading their securities from 1 6 months range, 26 (52%) from 6 12 months and 5 (10%) from 12 18 months and none of them are trading from above 18 months. Graph No. 7.5 Graph showing the duration of trading operation (in months) from which the respondent trading in Equity Market till May 2008

Type trading Table No. 7.6 Table showing the Type trading preferred by the Respondents
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A Fundamental study on derivatives in India Sl.No. 1 2 3 Type of Trading Intra-day trading Delivery trading Both type Total Respondents 4 26 20 50 Percentage 8 52 40 100

Source: Field Survey From the above table it is noted that out of 50 respondents, 4 (8%) prefers to trade their securities on Intra-day basis, 26 (52%) prefers Delivery based trading and 20 (40%) prefers both Intra-day as well as Delivery based trading. Graph No. 7.6 Graph showing the Type trading preferred by the Respondents

Trade on Intra-day Table No. 7.6.1 Table showing the purpose to trade on Intra-day (which also includes Respondents ranked under both type category) basis
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A Fundamental study on derivatives in India

Sl.No. 1 2 3 4

Reason Profit Booking Loss Averaging Avoiding Payment Referred by others Total

R1 23 0 1 0 24

R2 0 4 17 3 24

R3 1 12 5 6 24

R4 0 8 1 15 24

Total 24 24 24 24

Source: Field Survey Table No. 7.6.1(A) Table showing the weighted rank calculated from Table-7.6.1 for given purposes Sl.No. 1 2 3 4 Reasons Profit booking Loss averaging Avoiding payment Referred by others Actual Score 94 44 49 36 Percent Weight 98 45.8 51.04 37.5 Rank 1 3 2 4

Source: Field Survey

Expected Score = No. of respondents x 5 criteria. Percent of weight = Actual score / Expected score multiplied by 100. In this case the Expected scores comes 24 respondents x 4 criteria = 96. From the above tables 7.6.1 it is noted that out of 24 respondents who are trading on intra-day basis have ranked the given choices mentioned in table as per their preference. From table 7.6.1(A) it is noted that, as per the weighted preference the purpose of Profit Booking takes the first preference in 98 percent cases, succeeded by purpose of Avoiding Payment and followed by Loss Averaging and Referred by Others takes third and fourth rank respectively. This shows that, the traders intention of Intra-day trading is to book the profit.

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A Fundamental study on derivatives in India Graph No. 7.6.1(A) Graph showing the weighted rank calculated from Table-7.6.1 for given purposes

Trading on Delivery type Table No. 7.6.2 Table showing the purpose of trading on Delivery type of (which includes respondents ranked under both type categories) trading by the respondents Sl.No. 1 2 3 Reason Long term holding Minimum risk Strengthening portfolio R1 15 29 2 R2 11 14 20 R3 17 3 20 R4 3 0 4 Total 46 46 46

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A Fundamental study on derivatives in India 4 Referred by others 0 46 0 46 6 46 40 46 46

Total
Source: Field Survey

Table No. 7.6.2(A) Table showing the weighted rank calculated from Table 7.6.2 for given purposes Sl.No. 1 2 3 4 Reason Long term holding Minimum risk Strengthening portfolio Referred by others Actual score 130 164 49 36 Percent Weight 70.65 89.13 26.63 19.56 Rank 2 1 3 4

Source: Field Survey Expected Score = No. of respondents x 5 criteria. Percent of weight = Actual score / Expected score multiplied by 100. In this case the Expected score comes 46 respondents x 4 criteria = 184. From the above tables it is noted out of 46 respondents who are trading on Delivery basis have ranked the given choices as per their preference. From table 5.6.2(A) it is noted that, the purpose of Minimum Risk involved takes the first rank, succeeded by purpose of Long-term holding second rank and followed by Strengthening portfolio and Referenced by others takes third and fourth rank respectively. It shows most of the traders trades on delivery basis to avoid the risk involved in the market and wants to make money safely. Graph No. 7.6.2(A) Graph showing the weighted rank calculated from Table 7.6.2 for given purposes
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A Fundamental study on derivatives in India

Knowledge of derivatives Table No. 7.7 Table showing the knowledge of derivatives among the respondents Sl.No. 1 2 3 Knowledge Known Somewhat known Not known Total Respondents 8 14 28 50 Percentage 16 28 56 100

Source: Field Survey From the above table it is noted that, out of 50 respondents 8 (16%) wholly aware of derivatives, 14 (28%) somewhat aware about derivatives and 28 (56%) not aware of derivatives traded on stock market.
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A Fundamental study on derivatives in India Graph No. 7.7 Graph showing the knowledge of derivatives among the respondents

Interest among the respondents to trade in Derivatives Market Table No. 7.8 Table showing the interest among the respondents to trade in Derivatives Market Sl.No. 1 2 3 Interested Yes No Sometimes Total Respondents 20 18 12 50 Percentage 40 36 24 100

Source: Field Survey It is noted that from above table, out of 50 respondents 20 (40%) shown their whole interest to trade in derivative segment, 12 (24%) shown little interest to trade in derivatives segment and 18 (36%) not shown any interest to trade in derivatives.
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A Fundamental study on derivatives in India Graph No. 7.8 Graph showing the interest among the respondents to trade in Derivatives Market

Respondents expecting guidance for trading in derivatives market Table No. 7.9 Table showing the number of respondents expecting guidance for trading in derivatives market Sl.No. 1 2 Expecting guidance Yes No Total Respondents 46 4 50 Percentage 92 8 100

Source: Field Survey From the above table it is noted that, out of 50 respondents 46 (92%) respondents expecting guidance for trading in derivatives and 4 (8%) are not expecting any guidance. Graph No. 7.9

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A Fundamental study on derivatives in India Graph showing the number of respondents expecting guidance for trading in derivatives market

Opinion of respondents about Derivatives Table No. 7.10 Table showing opinion of respondents about Derivatives Sl.No. 1 2 3 4 5 Opinion of Respondents Good for minimizing risk involved in the market Helps in diversification of funds Opportunities for making money safely Minimizes the cost of trading Yet to know about Derivatives Respondents 18 2 4 2 24 50 Percentage 36 4 8 4 48 100

Total
Source: Field Survey

It is noted that from the above table, out of 50 respondents as per their awareness level, 18 (36%) had pursues that derivatives are good for minimizing risk involved in the market, 2 (4%) pursues derivatives helps in diversifying funds, 4 (8%) pursues opportunities for making money safely and 2 (4%) pursues minimizes
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A Fundamental study on derivatives in India cost of trading where as remaining 24 (48%) respondents pursues yet to know about derivatives. Graph No. 7.10 Graph showing opinion of respondents about Derivatives

Derivatives Market segments in addition to Cash market segment Table No. 7.11 Table showing the respondents already trading in Derivatives Market segments in addition to Cash market segment Sl.No. 1 2 3 Response Only cash market Only derivatives market Both Segments Total Respondents 35 0 15 50 Percentage 70 0 30 100

Source: Field Survey From the above table it is noted that out of all 50 respondents 35 (70%) are trading only in cash market segment, 15 (30%) are trading in both cash and well as derivatives segment and none of trading only in derivatives segment. Graph No. 7.11

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A Fundamental study on derivatives in India Graph showing the respondents already trading in Derivatives Market segments in addition to Cash market segment

Trading style Table No. 7.12 Table showing the form of trading style adopted by the respondents who are trading in Derivatives (Number of respondents trading in derivatives are 15) Sl.No. 1 2 3 4 Form of trading Hedging Speculating Arbitraging All of above Respondents 0 12 0 2 15 Percentage 0 80 0 20 100

Total
Source: Field Survey

From the above table it is noted that among 15 derivatives traders 12 (80%) invests in derivatives in the form of speculator, 2 (20%) in the form of Hedging, Speculating as well as Arbitraging. None of respondents invest either in the form of Hedger or Arbitrageur.

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A Fundamental study on derivatives in India Graph No. 7.12 Graph showing the form of trading style adopted by the respondents who are trading in Derivatives (Number of respondents trading in derivatives are 15)

Trade in Derivatives segment in addition to Cash market segment Table No. 7.13 Table showing why the respondents trading prefer to trade in Derivatives segment in addition to Cash market segment Sl.No. 1 2 3 4 5 Reasons Minimizing risk Diversifying funds Good returns Reduces trading cost Dont know R1 10 0 5 0 0 15 R2 1 3 6 5 0 15 R3 4 5 1 5 0 15 R4 0 7 3 5 0 15 R5 0 0 0 0 15 15

Total
15 15 15 15 15

Total
Source: Field Survey

From the above table it is noted that among all 15 derivatives traders 10 (67%) respondents given first rank to Minimizing risk, and 5 (33%) given first preference to Good returns. The overall weighted ranks for all choices are shown in table 7.13.1.
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A Fundamental study on derivatives in India Table No. 7.13.1 Table shows the weighted preference given by respondents for preferring to invest in derivatives in addition to cash market Sl.No. 1 2 3 4 5 Reasons Minimizing risk Diversifying funds Good returns Reduces trading cost Dont know Actual score 66 41 58 50 15 Percent of weight 88.00 54.66 77.33 66.66 20.00 Rank 1 4 2 3 5

Source: Field Survey Expected Score = No. of respondents x 5 criteria Percent of weight = Actual score / Expected score multiplied by 100. In this case the Expected score comes 15 derivative traders x 5 criteria = 75. From the above tables it is noted that among all 15 derivative traders ranked the given choices as per their preference. Among all factors Minimum risk factor takes first rank with a weightage of 88 percent, succeeded by Good returns takes weight of 77.33 percent and followed by Reduces trading costs, Diversifying funds and Dont know factors as third, fourth and fifth respectively. This proves that, there is a minimum risk involved in derivatives market as compared to cash market segment. Graph No. 7.13.1 Graph showing the weighted preference given by respondents for preferring to invest in derivatives in addition to cash market

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A Fundamental study on derivatives in India

Derivative traders segment Table No. 7.14 Table showing the opinion of derivative traders segment they feel better among both derivatives and cash market segment Sl.No. 1 2 3 Feels better Cash market segment Derivatives segment Both Segments Total Respondents 9 2 4 15 Percentage 60 13 27 100

Source: Field Survey From the above table it is noted that among all 15 derivative segment respondents 9 (60%) pursues cash market segment is better, 2 (13%) pursues derivatives segment is better and 4 (27%) pursues both segment are equally better. Graph No. 7.14

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A Fundamental study on derivatives in India Graph showing the opinion of derivative traders segment they feel better among both derivatives and cash market segment

Expectation of further services Table No. 7.15 Table showing the expectation of further services that the derivative traders expecting in derivatives segment Sl.No. 1 2 Response Expecting Not Expecting Total Respondents 13 2 15 Percentage 87 13 100

Source: Field Survey From the above table it is noted that among all derivative segment respondents 13 (87%) still expects further services in derivative segment and remaining 2 (13%) not expecting any further services in derivatives segment. This indicates the service providing in derivatives segment is insufficient, so the service level should be improved. Graph No. 7.15
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A Fundamental study on derivatives in India Graph showing the expectation of further services that the derivative traders expecting in derivatives segment

Perception about services Table No. 7.16 Table showing the respondents perception about services providing by the stock broking firms in Cash Market Segment Perception about services Excellent Good Better Poor

Sl.No. 1 2 3 4

Respondents 5 30 8 7 50

Percentage 10 60 16 14 100

Total
Source: Field Survey

From the above table it is noted that, among 50 respondents 5 (10%) pursued about services providing by stock broking firms is Excellent, 30 (60%) as Good, 8 (16%) as Better and remaining 7 (14%) pursues as Poor. This indicates that most of the respondents have good opinion about service providing under cash segment. So service is acceptable by investors.

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A Fundamental study on derivatives in India Graph No. 7.16 Graph showing the respondents perception about services providing by the stock broking firms in Cash Market Segment

Satisfaction level of respondents with existing services Table No. 7.17 Table showing the satisfaction level of respondents with existing services provided by stock broking firms Sl.No. 1 2 3 Response Satisfied Little Satisfied Not Satisfied Total Respondents 29 19 2 50 Percentage 58 38 4 100

Source: Field Survey From the above table it is noted that, out of all 50 respondents 29 (58%) respondents satisfied with existing service level provided by, 19 (38%) are little bit satisfied and 2 (4%) are not satisfied. This indicates only average numbers of investors are fully satisfied with service level but there is another group also there with little satisfaction level which should be taken care of. Graph No. 7.17
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A Fundamental study on derivatives in India Graph showing the satisfaction level of respondents with existing services provided by stock broking firms

8.1 Findings
1.

In the BANGALORE the companies provides online trading facilities

for shares in cash market and also derivatives in F&O segment of NSE. The other services providing are IPOs, Depository services, Margin funding, Equity research etc. 2. Derivative contracts have several variants. The most common variants are forwards, futures, options and swap. But only futures and options index futures, index options, stock futures and stock options are traded in stock exchanges under separate segment of NSE called F & O segment. 3. It is found that, the derivative market was able to beat the cash market The in terms of monthly turnover for the first time in February 2003.

derivative segment of the equity market clocked a total monthly turnover of Rs. 49,395 crores compared with the total cash markets Rs. 48,289 crores which give the sign of popularity about derivatives even new to the market compared to cash market products. 4. It is found that, Stock Futures are much more popular as compared to Index Futures. Starting off with a measly turnover of Rs. 2811 crore in November 2001, the same jumped to Rs.14, 000 crore by March 2002, Rs.32752 crore in May 2003 and Rs.70515 crores in July 2003.
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A Fundamental study on derivatives in India Similarly Index Futures started its turnover journey with Rs.35 crore in June 2000, jumped to Rs.524 crore in March 2001, Rs.1309 crores in June 2001, Rs.2747 crores in February 2002, Rs.3500 crore in November 2002 and Rs.14743 crores in July 2003. 5. All most all prescriptions given by the various committees LCGC

and JRVG have implemented in NSE which includes trading of derivatives in separate segment called F&O, Separate Clearing and Settlements, Risk contained related issues, Margining system etc. 6. The survey had with 50 respondents to know about the interest and preference among investors about derivatives trading reveals the following Among all respondents who are trading in cash market segment as well as derivative segment o Very few respondents are wholly aware of derivatives and major percent of respondents (56%) completely not aware of derivatives.
o

Overall major percent (76) of respondents are interested to trade in derivatives market. Therefore there is scope for derivatives market in Bangalore has seen.

o All respondents are having good opinion about Derivatives, but average number of respondents required more guidance about derivatives. o 30 percent of respondents i.e. 15 respondents out of 50 are already trading in derivatives segment and most of Derivatives traders (i.e.80 %) prefer to invest in Derivatives as speculators. o Most of Investors are bringing up to 20 percent of their investment portfolio to equity market. Here out of 50 respondents 60 percent comes under 0-20 percent range. o Most of the respondents trade their securities on regular basis i.e. between 83 to 84 percent; this denotes most of investors prefer shortterm gain and liquidity from their financial assets.

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A Fundamental study on derivatives in India o All most all intra-day traders prefers to book the profit in short term, here out of 24 intra-day traders, 23 have given the first preference to profit booking. o Most of the traders trading on delivery basis trades in this category due minimum risk involved as compared to intra-day trading, out of 46 respondents, 29 (63%) opinion came in fever of minimum risk.
o

More than average number of respondents felt about the service provided by STOCK BROKING FIRMS is good. Which denotes the service is acceptable. Average numbers of respondents are satisfied with existing service level of Indiabulls Securities, Karvi, Kotak, and other stocking firms. But at the same time the group of little satisfied and not satisfied also found.

o It was found that many of the respondents required frequent market information and improved services in cash market segment

8.2 Suggestions
Since there is a good scope for derivatives market in Bangalore, the Stock broking firms can have separate department for Derivatives Stock broking firms should try to have at least separate cell to guide Stock broking firms should improve its service level in both Cash

Stock broking firms may try to expand the activities in derivatives segment. segment, which could carry out research in derivatives. the investors about derivatives trading. market and Derivative segment

8.3 Conclusion
It was a great experience for researcher to study about Financial Market and derivatives trading. In the present scenario derivatives have became the risk reducing tools in the todays volatile market conditions. However it was observed that there is a need for awareness about the derivatives among its small investors to safeguard them from risk. Finally, it can be
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A Fundamental study on derivatives in India concluded that, derivatives are very sophisticated instruments to hedge against the market fluctuations. Financial derivatives have a great scope in the Indian Market.

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