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Derivatives

Summer Training Project On

“Detailed Study of Derivatives “

Submitted To

ANJUMAN I ISLAM’s ALLANA INSTITUTE OF MANAGEMENTSTUDIES

Required For Partial Fulfillment Of MMS Program

By

Kasimi Mudassar Mohd. Husain - 15

Under The Guidance Of

AHMAR BALBALE(Channel Partner)

MASS INVESTMENT

For The Academic Year

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2009 - 2010

I Mr.Kasimi Mudassar Mohd. Husain, student of MMS

(Specialization –Finance , Semester III) of Anjuman-I-

Islam’s Allana Institute of Management Studies hereby

declare that I have completed this Summer Internship project

on “detailed study of derivatives” in the academic year 2009

- 2010. The information submitted is true and original to the

best of my knowledge.

I further certify that I have no objection and grant the rights

to Anjuman-I-Islam’s Allana Institute of Management

Studies or Mumbai University to publish any chapter /

Projects if they deem fit in journals or magazines or newspapers without any permission.

Place : MumbaiDate :Name : Kasimi Mudassar Mohd. HusainClass : MMS – I Sem – IIRoll No. : 15

Signature :

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ACKNOWLEDGEMENT

If words are considered as a symbol of approval and token of appreciation

then let the words play the heralding role expressing my gratitude.

I am indebted to the reviewer of the project Mr. Kushal Bafna , my project

guide for her support and guidance. I would sincerely like to thank her for

all her efforts.

I am also grateful to Mr. Abdul Gaffar Pathan (Senior Manager – Kotak

Mahindra Old Mutual Life Insurance Ltd for helping me understand the

concept of derivatives and for providing their insights in the making of thisproject.

I would like to thank the University of Mumbai , for giving its student a

platform to stay abreast with changing business scenario, with the help of

theory as a base and practical as a solution.

Last but not least, I would like to express my sincere thanks to Dr. R. K.

Singh (Director, Mumbai Institute of Management & Research) for his

indirect help and all other staff members of Mumbai Institute of

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Management & Research for their co-operation and also my parents for

giving the best education.

PROFILE OF THE COMPANY

Kotak Mahindra Insurance Company or Om Kotak Mahindra LifeInsurance is a 74:26 joint venture between Kotak Mahindra Bank Limited India and Old Mutual PLC- a leading global financialservices provider.

Kotak Mahindra Bank Limited (KMBL) is the flagship venture of Kotak Mahindra Group. The group is a full-services financial groupproviding a wide array of services and products to institutions, banks,corporates and individuals. Kotak Mahindra has overseas offices inNew York, London and Dubai. Along with a joint venture for lifeinsurance and general insurance services with Old Mutual PLC,Kotak Mahindra also has joint ventures with leading internationalplayers Goldman Sachs for Investment Banking & Brokerage andFord Credit International for Automobile Finance.

The net result we have is Kotak Mahindra Insurance Services withvarious products customized for the insurance seekers. These include:

o Kotak Endowment Plano Kotak Money Back Plano Kotak Term Assurance Plano Kotak Term Grouplano Kotak Preferred Term Plano Kotak Credit-Term Plano Kotak Child Advantage Plano Kotak Gramin Bima Yojanao Kotak Retirement Income Plano Kotak Capital Multiplier Plano Kotak Gratuity Grouplan

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o Kotak Safe Investment Plan

Kotak Mahindra insurance policies like life insurance, company insurance,medical insurance, group insurance and other general insurance productsare some of the most popular insurance policies in the industry. Besidesthis, Kotak Mahindra brings to you other securities like bonds and mutualfunds.

The distribution network of Kotak Mahindra Insurance Co Ltd includes,retail distribution through the branches, insurance agency and individualagent’s network, and insurance brokers for claim settlements. Each KotakMahindra insurance agent and broker is trained in-house to provide the

customers a transparent transaction with the company.

On the Kotak Mahindra Old Mutual Life Insurance Ltd. website you willfind online insurance premium payment option where you can makeonline payments for your insurance premiums. Also for careers and other company info on Kotak Mahindra Old Mutual Life Insurance Ltd., OmKotak Mahindra life insurance, Kotak Finance or Kotak Mahindra Grouprefer to the site.

For other premium payment options, you also get Skypak Drop Boxes inmajor cities like Ahmedabad, Bangalore, Baroda, Bhopal, Chandigarh,

Chennai, Delhi, Guwahati, Hyderabad, Jaipur, Kanpur, Karnal, Kolkata,Lucknow, Ludhiana, Mumbai, Nagpur, Nasik, Pune, Rajkot, Surat andmore cities joining soon. ECS or Electronic Clearing Service is alsoavailable for a hassle-free payment direct from your bank account.

About Kotak Mahindra Group

Kotak Mahindra group is one of India’s leading banking and financialservices organizations, with offerings across personal financial services;commercial banking; corporate and investment banking and markets;stock broking; asset management and life insurance. The Kotak Group

employs around 20,000 people and has over 1,350 offices across 370cities and towns in India. Kotak also has offices in London, New York, SanFrancisco, Singapore, Dubai and Mauritius

About Old Mutual Plc

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Old Mutual plc is an international savings and wealth management

company based in the UK. Originating in South Africa in 1845, it is amongthe top 50 largest companies in the FTSE100. The group has a balancedportfolio of businesses offering Asset Management, Life Assurance,Banking and General Insurance Services in over 40 countries, with afocus on South Africa, Europe and the United States, and a growingpresence in Asia Pacific. Old Mutual plc employs approximately 53,000employees worldwide and is listed on the London and Johannesburgstock exchanges

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7

SR.NO TOPIC PAGE NO.

1 CHAPTER 1

INTRODUCTION TO DERIVATIVES

DEFINITION OF DERIVATIVES2 CHAPTER 2

HISTORY OF DERIVATIVES.

DERIVATIVES OF INDIA.

DEVELOPMENT OF DERIVATIVE

MARKET IN INDIA.

FACTORS CONTRIBUTING FOR

GROWTH OF DERIVATIVES.3 CHAPTER 3

TYPES OF DERIVATIVES

FUTURES vs FORWARDS

MARKETS4 CHAPTER 4

PARTICIPANTS IN DERIVATIVE

MARKET

ROLE OF DERIVATIVES5 CHAPTER 5

HOW DO BANKS USE

DERIVATIVES6 CHAPTER 6

CASE STUDIES7 BIBLIOGRAPHY



Derivatives

OBJECTIVE OF THE STUDY :

The main objectives behind the study of derivatives are:

To understand the finer points of derivatives.

To understand the concept of derivatives in a more

appropriate way.

To understand the scope and growth of derivatives in

India.

To understand how the derivatives are used in banks.

To understand how derivatives can be used to hedge

risk.

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CHAPTER – 1

INTRODUCTION TO

DERIVATIVES

DEFINITION OF DERIVATIVES

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CHAPTER 1

INTRODUCTION:

Derivatives are one of the most complex instruments. The

word derivative comes from the word ‘to derive’. It indicates that it has no

independent value. A derivative is a contract whose value is derived from

the value of another asset, known as the underlying asset, which could be

a share, a stock market index, an interest rate, a commodity, or a

currency. The underlying is the identification tag for a derivative contract.

When the price of the underlying changes, the value of the derivative alsochanges. Without an underlying asset, derivatives do not have any

meaning. For example, the value of a gold futures contract derives from

the value of the underlying asset i.e., gold. The prices in the derivatives

market are driven by the spot or cash market price of the underlying

asset, which is gold in this example.

Derivatives are very similar to insurance. Insurance protectsagainst specific risks, such as fire, floods, theft and so on. Derivatives on

the other hand, take care of market risks - volatility in interest rates,

currency rates, commodity prices, and share prices. Derivatives offer a

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sound mechanism for insuring against various kinds of risks arising in the

world of finance. They offer a range of mechanisms to improveredistribution of risk, which can be extended to every product existing,

from coffee to cotton and live cattle to debt instruments.

In this era of globalisation, the world is a riskier place and

exposure to risk is growing. Risk cannot be avoided or ignored. Man,

however is risk averse. The risk averse characteristic of human beings

has brought about growth in derivatives. Derivatives help the risk averseindividuals by offering a mechanism for hedging risks.

Derivative products, several centuries ago, emerged as

hedging devices against fluctuations in commodity prices. Commodity

futures and options have had a lively existence for several centuries.

Financial derivatives came into the limelight in the post-1970 period; today

they account for 75 percent of the financial market activity in Europe,

North America, and East Asia. The basic difference between commodity

and financial derivatives lies in the nature of the underlying instrument. In

commodity derivatives, the underlying asset is a commodity; it may be

wheat, cotton, pepper, turmeric, corn, orange, oats, Soya beans, rice,

crude oil, natural gas, gold, silver, and so on. In financial derivatives, the

underlying includes treasuries, bonds, stocks, stock index, foreign

exchange, and Euro dollar deposits. The market for financial derivatives

has grown tremendously both in terms of variety of instruments andturnover.

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Presently, most major institutional borrowers and investors

use derivatives. Similarly, many act as intermediaries dealing in derivativetransactions. Derivatives are responsible for not only increasing the range

of financial products available but also fostering more precise ways of

understanding, quantifying and managing financial risk.

Derivatives contracts are used to counter the price risks

involved in assets and liabilities. Derivatives do not eliminate risks. They

divert risks from investors who are risk averse to those who are riskneutral. The use of derivatives instruments is the part of the growing trend

among financial intermediaries like banks to substitute off-balance sheet

activity for traditional lines of business. The exposure to derivatives by

banks has implications not only from the point of capital adequacy, but

also from the point of view of establishing trading norms, business rules

and settlement process. Trading in derivatives differ from that in equities

as most of the derivatives are market to the market.

DEFINITION OF DERIVATIVES :

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.

According to Securities Contracts (Regulation) Act, 1956

{SC(R)A} , derivatives is

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A security derived from a debt instrument, share, loan, whether

secured or unsecured, risk instrument or contract for differences or

any other form of security.

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

prices, of underlying securities.

Derivatives are securities under the Securities Contract(Regulation) Act and hence the trading of derivatives is governed by the

regulatory framework under the Securities Contract (Regulation) Act.

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CHAPTER 2

HISTORY OF DERIVATIVES :

The history of derivatives is quite colourful and surprisingly a

lot longer than most people think. Forward delivery contracts, stating what

is to be delivered for a fixed price at a specified place on a specified date,

existed in ancient Greece and Rome. Roman emperors entered forward

contracts to provide the masses with their supply of Egyptian grain. These

contracts were also undertaken between farmers and merchants to

eliminate risk arising out of uncertain future prices of grains. Thus, forwardcontracts have existed for centuries for hedging price risk.

The first organized commodity exchange came into

existence in the early 1700’s in Japan. The first formal commodities

exchange, the Chicago Board of Trade (CBOT) , was formed in 1848 in

the US to deal with the problem of ‘credit risk’ and to provide centralised

location to negotiate forward contracts. From ‘forward’ trading incommodities emerged the commodity ‘futures’. The first type of futures

contract was called ‘to arrive at’. Trading in futures began on the CBOT in

the 1860’s. In 1865, CBOT listed the first ‘exchange traded’ derivatives

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contract, known as the futures contracts. Futures trading grew out of the

need for hedging the price risk involved in many commercial operations.The Chicago Mercantile Exchange (CME) , a spin-off of CBOT, was

formed in 1919, though it did exist before in 1874 under the names of

‘Chicago Produce Exchange’ (CPE) and ‘Chicago Egg and Butter

Board’ (CEBB) . The first financial futures to emerge were the currency in

1972 in the US. The first foreign currency futures were traded on May 16,

1972, on International Monetary Market (IMM), a division of CME. The

currency futures traded on the IMM are the British Pound, the CanadianDollar, the Japanese Yen, the Swiss Franc, the German Mark, the

Australian Dollar, and the Euro dollar. Currency futures were followed

soon by interest rate futures. Interest rate futures contracts were traded

for the first time on the CBOT on October 20, 1975. Stock index futures

and options emerged in 1982. The first stock index futures contracts were

traded on Kansas City Board of Trade on February 24, 1982.

The first of the several networks, which offered a trading link

between two exchanges, was formed between the Singapore

International Monetary Exchange (SIMEX) and the CME on September

7, 1984.

Options are as old as futures. Their history also dates back

to ancient Greece and Rome. Options are very popular with speculators in

the tulip craze of seventeenth century Holland. Tulips, the brightlycoloured flowers, were a symbol of affluence; owing to a high demand,

tulip bulb prices shot up. Dutch growers and dealers traded in tulip bulb

options. There was so much speculation that people even mortgaged their

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homes and businesses. These speculators were wiped out when the tulip

craze collapsed in 1637 as there was no mechanism to guarantee theperformance of the option terms.

The first call and put options were invented by an American

financier, Russell Sage, in 1872. These options were traded over the

counter. Agricultural commodities options were traded in the nineteenth

century in England and the US. Options on shares were available in the

US on the over the counter (OTC) market only until 1973 without muchknowledge of valuation. A group of firms known as Put and Call brokers

and Dealer’s Association was set up in early 1900’s to provide a

mechanism for bringing buyers and sellers together.

On April 26, 1973, the Chicago Board options Exchange

(CBOE) was set up at CBOT for the purpose of trading stock options. It

was in 1973 again that black, Merton, and Scholes invented the famous

Black-Scholes Option Formula . This model helped in assessing the fair

price of an option which led to an increased interest in trading of options.

With the options markets becoming increasingly popular, the American

Stock Exchange (AMEX) and the Philadelphia Stock Exchange (PHLX)

began trading in options in 1975.

The market for futures and options grew at a rapid pace in

the eighties and nineties. The collapse of the Bretton Woods regime of fixed parties and the introduction of floating rates for currencies in the

international financial markets paved the way for development of a

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number of financial derivatives which served as effective risk

management tools to cope with market uncertainties.

The CBOT and the CME are two largest financial exchanges

in the world on which futures contracts are traded. The CBOT now offers

48 futures and option contracts (with the annual volume at more than 211

million in 2001).The CBOE is the largest exchange for trading stock

options. The CBOE trades options on the S&P 100 and the S&P 500

stock indices. The Philadelphia Stock Exchange is the premier exchangefor trading foreign options.

The most traded stock indices include S&P 500, the Dow

Jones Industrial Average, the NASDAQ 100, and the Nikkei 225. The US

indices and the Nikkei 225 trade almost round the clock. The N225 is also

traded on the Chicago Mercantile Exchange.

DERIVATIVES IN INDIA:

India has started the innovations in financial markets very

late. Some of the recent developments initiated by the regulatory

authorities are very important in this respect. Futures trading have been

permitted in certain commodity exchanges. Mumbai Stock Exchange has

started futures trading in cottonseed and cotton under the BOOE andunder the East India Cotton Association. Necessary infrastructure has

been created by the National Stock Exchange (NSE) and the Bombay

Stock Exchange (BSE) for trading in stock index futures and the

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commencement of operations in selected scripts. Liberalised exchange

rate management system has been introduced in the year 1992 for regulating the flow of foreign exchange. A committee headed by

S.S.Tarapore was constituted to go into the merits of full convertibility on

capital accounts. RBI has initiated measures for freeing the interest rate

structure. It has also envisioned Mumbai Inter Bank Offer Rate (MIBOR)

on the line of London Inter Bank Offer Rate (LIBOR) as a step towards

introducing Futures trading in Interest Rates and Forex. Badla

transactions have been banned in all 23 stock exchanges from July 2001.NSE has started trading in index options based on the NIFTY and certain

Stocks.

A.} EQUITY DERIVATIVES IN INDIA –

In the decade of 1990’s revolutionary changes took place in

the institutional infrastructure in India’s equity market. It has led to wholly

new ideas in market design that has come to dominate the market. These

new institutional arrangements, coupled with the widespread knowledge

and orientation towards equity investment and speculation, have

combined to provide an environment where the equity spot market is now

India’s most sophisticated financial market. One aspect of the

sophistication of the equity market is seen in the levels of market liquidity

that are now visible. The market impact cost of doing program trades of

Rs.5 million at the NIFTY index is around 0.2%. This state of liquidity onthe equity spot market does well for the market efficiency, which will be

observed if the index futures market when trading commences. India’s

equity spot market is dominated by a new practice called ‘Futures – Style

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settlement’ or account period settlement. In its present scene, trades on

the largest stock exchange (NSE) are netted from Wednesday morning tillTuesday evening, and only the net open position as of Tuesday evening is

settled. The future style settlement has proved to be an ideal launching

pad for the skills that are required for futures trading.

Stock trading is widely prevalent in India, hence it seems

easy to think that derivatives based on individual securities could be very

important. The index is the counter piece of portfolio analysis in modernfinancial economies. Index fluctuations affect all portfolios. The index is

much harder to manipulate. This is particularly important given the

weaknesses of Law Enforcement in India, which have made numerous

manipulative episodes possible. The market capitalisation of the NSE-50

index is Rs.2.6 trillion. This is six times larger than the market

capitalisation of the largest stock and 500 times larger than stocks such

as Sterlite, BPL and Videocon. If market manipulation is used to artificially

obtain 10% move in the price of a stock with a 10% weight in the NIFTY,

this yields a 1% in the NIFTY. Cash settlements, which is universally used

with index derivatives, also helps in terms of reducing the vulnerability to

market manipulation, in so far as the ‘short-squeeze’ is not a problem.

Thus, index derivatives are inherently less vulnerable to market

manipulation.

A good index is a sound trade of between diversification andliquidity. In India the traditional index- the BSE – sensitive index was

created by a committee of stockbrokers in 1986. It predates a modern

understanding of issues in index construction and recognition of the

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pivotal role of the market index in modern finance. The flows of this index

and the importance of the market index in modern finance motivated thedevelopment of the NSE-50 index in late 1995. Many mutual funds have

now adopted the NIFTY as the benchmark for their performance

evaluation efforts. If the stock derivatives have to come about, it should be

restricted to the most liquid stocks. Membership in the NSE-50 index

appeared to be a fair test of liquidity. The 50 stocks in the NIFTY are

assuredly the most liquid stocks in India.

The choice of Futures vs. Options is often debated. The

difference between these instruments is smaller than, commonly

imagined, for a futures position is identical to an appropriately chosen long

call and short put position. Hence, futures position can always be created

once options exist. Individuals or firms can choose to employ positions

where their downside and exposure is capped by using options. Risk

management of the futures clearing is more complex when options are in

the picture. When portfolios contain options, the calculation of initial price

requires greater skill and more powerful computers. The skills required for

pricing options are greater than those required in pricing futures.

B.} COMMODITY DERIVATIVES TRADING IN INDIA –

In India, the futures market for commodities evolved by the

setting up of the “Bombay Cotton Trade Association Ltd.”, in 1875. Aseparate association by the name "Bombay Cotton Exchange Ltd” was

established following widespread discontent amongst leading cotton mill

owners and merchants over the functioning of the Bombay Cotton Trade

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Association. With the setting up of the ‘Gujarati Vyapari Mandali” in 1900,

the futures trading in oilseed began. Commodities like groundnut, castor seed and cotton etc began to be exchanged.

Raw jute and jute goods began to be traded in Calcutta with

the establishment of the “Calcutta Hessian Exchange Ltd.” in 1919. The

most notable centres for existence of futures market for wheat were the

Chamber of Commerce at Hapur, which was established in 1913. Other

markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Fazilka,Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar, Chandausi,

Meerut, Saharanpur, Hathras, Gaziabad, Sikenderabad and Barielly in

U.P. The Bullion Futures market began in Bombay in 1990. After the

economic reforms in 1991 and the trade liberalization, the Govt. of India

appointed in June 1993 one more committee on Forward Markets under

Chairmanship of Prof. K.N. Kabra. The Committee recommended that

futures trading be introduced in basmati rice, cotton, raw jute and jute

goods, groundnut, rapeseed/mustard seed, cottonseed, sesame seed,

sunflower seed, safflower seed, copra and soybean, and oils and oilcakes

of all of them, rice bran oil, castor oil and its oilcake, linseed, silver and

onions. All over the world commodity trade forms the major backbone of

the economy. In India, trading volumes in the commodity market have

also seen a steady rise - to Rs 5,71,000 crore in FY05 from Rs 1,29,000

crore in FY04. In the current fiscal year, trading volumes in the commodity

market have already crossed Rs 3,50,000 crore in the first four months of trading. Some of the commodities traded in India include Agricultural

Commodities like Rice Wheat, Soya, Groundnut, Tea, Coffee, Jute,

Rubber, Spices, Cotton, Precious Metals like Gold & Silver, Base Metals

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like Iron Ore, Aluminium, Nickel, Lead, Zinc and Energy Commodities like

crude oil, coal. Commodities form around 50% of the Indian GDP. Thoughthere are no institutions or banks in commodity exchanges, as yet, the

market for commodities is bigger than the market for securities.

Commodities market is estimated to be around Rs 44,00,000 Crores in

future. Assuming a future trading multiple is about 4 times the physical

market, in many countries it is much higher at around 10 times.

DEVELOPMENT OF DERIVATIVES MARKET IN INDIA:

The first step towards introduction of derivatives trading in

India was the promulgation of the Securities Laws (Amendment)

Ordinance, 1995, which withdrew the prohibition on options in securities.

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

November 18, 1996 to develop appropriate regulatory framework for

derivatives trading in India. The committee submitted its report on March

17, 1998 prescribing necessary pre–conditions for introduction of

derivatives trading in India. The committee recommended that derivatives

should be declared as ‘securities’ so that regulatory framework applicable

to trading of ‘securities’ could also govern trading of securities. SEBI also

set up a group in June 1998 under the Chairmanship of Prof.J.R.Varma,to recommend measures for risk containment in derivatives market in

India. The report, which was submitted in October 1998, worked out the

operational details of margining system, methodology for charging initial

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margins, broker net worth, deposit requirement and real–time monitoring

requirements. The Securities Contract Regulation Act ( SCRA ) wasamended in December 1999 to include derivatives within the ambit of

‘securities’ and the regulatory framework was developed for governing

derivatives trading. The act also made it clear that derivatives shall be

legal and valid only if such contracts are traded on a recognized stock

exchange, thus precluding OTC derivatives. The government also

rescinded in March 2000, the three decade old notification, which

prohibited forward trading in securities. Derivatives trading commenced inIndia in June 2000 after SEBI granted the final approval to this effect in

May 2001. SEBI permitted the derivative segments of two stock

exchanges, NSE and BSE, and their clearing house/corporation to

commence trading and settlement in approved derivatives contracts. To

begin with, SEBI approved trading in index futures contracts based on

S&P CNX Nifty and BSE–30 (Sense) index. This was followed by approval

for trading in options based on these two indexes and options on

individual securities.

The trading in BSE Sensex options commenced on June 4,

2001 and the trading in options on individual securities commenced in

July 2001. Futures contracts on individual stocks were launched in

November 2001. The derivatives trading on NSE commenced with S&P

CNX Nifty Index futures on June 12, 2000. The trading in index options

commenced on June 4, 2001 and trading in options on individualsecurities commenced on July 2, 2001. Single stock futures were

launched on November 9, 2001. The index futures and options contract

on NSE are based on S&P CNX Trading and settlement in derivative

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contracts is done in accordance with the rules, byelaws, and regulations

of the respective exchanges and their clearing house/corporation dulyapproved by SEBI and notified in the official gazette. Foreign Institutional

Investors (FIIs) are permitted to trade in all Exchange traded derivative

products.

The following are some observations based on the trading

statistics provided in the NSE report on the futures and options (F&O):

• Single-stock futures continue to account for a sizable proportion of

the F&O segment. It constituted 70 per cent of the total turnover

during June 2002. A primary reason attributed to this phenomenon

is that traders are comfortable with single-stock futures than equity

options, as the former closely resembles the erstwhile badla

system.

• On relative terms, volumes in the index options segment continues

to remain poor. This may be due to the low volatility of the spot

index. Typically, options are considered more valuable when the

volatility of the underlying (in this case, the index) is high. A related

issue is that brokers do not earn high commissions by

recommending index options to their clients, because low volatility

leads to higher waiting time for round-trips.

• Put volumes in the index options and equity options segment have

increased since January 2002. The call-put volumes in index

options have decreased from 2.86 in January 2002 to 1.32 in June.

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The fall in call-put volumes ratio suggests that the traders are

increasingly becoming pessimistic on the market.

• Farther month futures contracts are still not actively traded. Trading

in equity options on most stocks for even the next month was non-

existent.

• Daily option price variations suggest that traders use the F&O

segment as a less risky alternative (read substitute) to generateprofits from the stock price movements. The fact that the option

premiums tail intra-day stock prices is evidence to this. If calls and

puts are not looked as just substitutes for spot trading, the intra-day

stock price variations should not have a one-to-one impact on the

option premiums.

FACTORS CONTRIBUTING TO THE GROWTH OF

DERIVATIVES :

Factors contributing to the explosive growth of derivatives

are price volatility, globalisation of the markets, technological

developments and advances in the financial theories.

A.} PRICE VOLATILITY –

A price is what one pays to acquire or use something of

value. The objects having value maybe commodities, local currency or

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foreign currencies. The concept of price is clear to almost everybody

when we discuss commodities. There is a price to be paid for thepurchase of food grain, oil, petrol, metal, etc. the price one pays for use of

a unit of another persons money is called interest rate. And the price one

pays in one’s own currency for a unit of another currency is called as an

exchange rate.

Prices are generally determined by market forces. In a

market, consumers have ‘demand’ and producers or suppliers have‘supply’, and the collective interaction of demand and supply in the market

determines the price. These factors are constantly interacting in the

market causing changes in the price over a short period of time. Such

changes in the price is known as ‘price volatility’. This has three factors :

the speed of price changes, the frequency of price changes and the

magnitude of price changes.

The changes in demand and supply influencing factors

culminate in market adjustments through price changes. These price

changes expose individuals, producing firms and governments to

significant risks. The break down of the BRETTON WOODS agreement

brought and end to the stabilising role of fixed exchange rates and the

gold convertibility of the dollars. The globalisation of the markets and rapid

industrialisation of many underdeveloped countries brought a new scale

and dimension to the markets. Nations that were poor suddenly became amajor source of supply of goods. The Mexican crisis in the south east-

Asian currency crisis of 1990’s have also brought the price volatility factor

on the surface. The advent of telecommunication and data processing

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against future losses. This factor alone has contributed to the growth of

derivatives to a significant extent.

C.} TECHNOLOGICAL ADVANCES –

A significant growth of derivative instruments has been

driven by technological break through. Advances in this area include the

development of high speed processors, network systems and enhanced

method of data entry. Closely related to advances in computer technologyare advances in telecommunications. Improvement in communications

allow for instantaneous world wide conferencing, Data transmission by

satellite. At the same time there were significant advances in software

programmes without which computer and telecommunication advances

would be meaningless. These facilitated the more rapid movement of

information and consequently its instantaneous impact on market price.

Although price sensitivity to market forces is beneficial to the

economy as a whole resources are rapidly relocated to more productive

use and better rationed overtime the greater price volatility exposes

producers and consumers to greater price risk. The effect of this risk can

easily destroy a business which is otherwise well managed. Derivatives

can help a firm manage the price risk inherent in a market economy. To

the extent the technological developments increase volatility, derivatives

and risk management products become that much more important.

D.} ADVANCES IN FINANCIAL THEORIES –

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Advances in financial theories gave birth to derivatives.

Initially forward contracts in its traditional form, was the only hedging toolavailable. Option pricing models developed by Black and Scholes in

1973 were used to determine prices of call and put options. In late 1970’s,

work of Lewis Edeington extended the early work of Johnson and started

the hedging of financial price risks with financial futures. The work of

economic theorists gave rise to new products for risk management which

led to the growth of derivatives in financial markets.

The above factors in combination of lot many factors led to

growth of derivatives instruments.

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Derivatives

CHAPTER – 3

TYPES OF DERIVATIVES

FUTURES VS. FORWARD MARKETS

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Derivatives

CHAPTER 3

TYPES OF DERIVATIVES:

There are mainly four types of derivatives i.e. Forwards,

Futures, Options and swaps.

Derivatives

Forwards Futures Options Swaps

1. FORWARDS -

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Derivatives

A contract that obligates one counter party to buy and theother to sell a specific underlying asset at a specific price, amount and

date in the future is known as a forward contract. Forward contracts are

the important type of forward-based derivatives. They are the simplest

derivatives. There is a separate forward market for multitude of

underlyings, including the traditional agricultural or physical commodities,

as well as currencies and interest rates. The change in the value of a

forward contract is roughly proportional to the change in the value of itsunderlying asset. These contracts create credit exposures. As the value of

the contract is conveyed only at the maturity, the parties are exposed to

the risk of default during the life of the contract. Forward contracts are

customised with the terms and conditions tailored to fit the particular

business, financial or risk management objectives of the counter parties.

Negotiations often take place with respect to contract size, delivery grade,

delivery locations, delivery dates and credit terms.

2. FUTURES -

A future contract is an agreement between two parties to

buy or sell an asset at a certain time the future at the certain price.

Futures contracts are the special types of forward contracts in the sense

that are standardized exchange-traded contracts.

Equities, bonds, hybrid securities and currencies are the

commodities of the investment business. They are traded on organised

exchanges in which a clearing house interposes itself between buyer and

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Derivatives

seller and guarantees all transactions, so that the identity of the buyer or

the seller is a matter of indifference to the opposite party. Futures contractprotect those who use these commodities in their business.

Futures trading are to enter into contracts to buy or sell

financial instruments, dealing in commodities or other financial

instruments for forward delivery or settlement on standardised terms. The

futures market facilitates stock holding and shifting of risk. They act as a

mechanism for collection and distribution of information and then performa forward pricing function. The futures trading can be performed when

there is variation in the price of the actual commodity and there exists

economic agents with commitments in the actual market. There must be a

possibility to specify a standard grade of the commodity and to measure

deviations from this grade. A futures market is established specifically to

meet purely speculative demands is possible but is not known. Conditions

which are thought of necessary for the establishment of futures trading

are the presence of speculative capital and financial facilities for payment

of margins and contract settlement. In addition, a strong infrastructure is

required, including financial, legal and communication systems.

3. OPTIONS -

A derivative transaction that gives the option holder the right

but not the obligation to buy or sell the underlying asset at a price, calledthe strike price, during a period or on a specific date in exchange for

payment of a premium is known as ‘option’ . Underlying asset refers to

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Derivatives

any asset that is traded. The price at which the underlying is traded is

called the ‘strike price’ .

There are two types of options i.e., CALL OPTION AND

PUT OPTION .

a. CALL OPTION :

A contract that gives its owner the right but not theobligation to buy an underlying asset-stock or any financial

asset, at a specified price on or before a specified date is

known as a ‘Call option’ . The owner makes a profit provided he

sells at a higher current price and buys at a lower future price.

b. PUT OPTION :

A contract that gives its owner the right but not the

obligation to sell an underlying asset-stock or any financial

asset, at a specified price on or before a specified date is

known as a ‘ Put option’ . The owner makes a profit provided he

buys at a lower current price and sells at a higher future price.

Hence, no option will be exercised if the future price does not

increase.

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Derivatives

Put and calls are almost always written on equities, although

occasionally preference shares, bonds and warrants become the subjectof options.

4. SWAPS -

Swaps are transactions which obligates the two parties to

the contract to exchange a series of cash flows at specified intervals

known as payment or settlement dates. They can be regarded asportfolios of forward's contracts. A contract whereby two parties agree to

exchange (swap) payments, based on some notional principle amount is

called as a ‘SWAP’ . In case of swap, only the payment flows are

exchanged and not the principle amount. The two commonly used swaps

are:

a. INTEREST RATE SWAPS :

Interest rate swaps is an arrangement by which one

party agrees to exchange his series of fixed rate interest

payments to a party in exchange for his variable rate interest

payments. The fixed rate payer takes a short position in the

forward contract whereas, the floating rate payer takes a long

position in the forward contract.

b. CURRENCY SWAPS :

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Derivatives

Currency swaps is an arrangement in which both

the principle amount and the interest on loan in one currencyare swapped for the principle and the interest payments on loan

in another currency. The parties to the swap contract of

currency generally hail from two different countries. This

arrangement allows the counter parties to borrow easily and

cheaply in their home currencies. Under a currency swap, cash

flows to be exchanged are determined at the spot rate at a time

when swap is done. Such cash flows are supposed to remainunaffected by subsequent changes in the exchange rates.

c. FINANCIAL SWAP:

Financial swaps constitute a funding technique

which permit a borrower to access one market and then

exchange the liability for another type of liability. It also allows

the investors to exchange one type of asset for another type of

asset with a preferred income stream.

The other kind of derivatives, which are not, much

popular are as follows:

5. BASKETS -

Baskets options are option on portfolio of underlying asset.

Equity Index Options are most popular form of baskets.

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Derivatives

6. LEAPS -

Normally option contracts are for a period of 1 to 12 months.

However, exchange may introduce option contracts with a maturity period

of 2-3 years. These long-term option contracts are popularly known as

Leaps or Long term Equity Anticipation Securities.

7. WARRANTS -

Options generally have lives of up to one year, the majority

of options traded on options exchanges having a maximum maturity of

nine months. Longer-dated options are called warrants and are generally

traded over-the-counter.

8. SWAPTIONS -

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

operative at the expiry of the options. Thus a swaption is an option on a

forward swap. Rather than have calls and puts, the swaptions market has

receiver swaptions and payer swaptions. A receiver swaption is an option

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

fixed and receive floating.

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Derivatives

Settlements are made daily through

the exchange clearing house. Gains

on open positions may be

withdrawn and losses are collected

daily.

Settlement occurs on date agreed

upon between the parties to each

transaction.

Long and short positions are usually

liquidated easily.

Forward positions are not as easily

offset or transferred to the other

participants.Settlements are normally made in

cash, with only a small percentage

of all contracts resulting actual

delivery.

Most transactions result in delivery.

A single, round trip (in and out of

the market) commission is charged.

It is negotiated between broker and

customer and is relatively small in

relation to the value of the contract.

No commission is typically charged if

the transaction is made directly with

another dealer. A commission is

charged to born buyer and seller,

however, if transacted through a

broker.Trading is regulated. Trading is mostly unregulated.The delivery price is the spot price. The delivery price is the forward

price.

39

F u t u r e s M a r k e t F o r w a r d M a r k e t

Margin deposits are to be required

of all participants.

Typically, no money changes hands

until delivery, although a small

margin deposit might be required of

non-dealer customers on certain

occasions.Contract terms are standardised

with all buyers and sellers

negotiating only with respect to

price.

All contract terms are negotiated

privately by the parties.

Non-member participants deal

through brokers (exchange

members who represent them on

the exchange floor)

Participants deal typically on a

principal-to-principal basis.

Participants include banks,

corporations, financial institutions,

individual investors, and

speculators.

Participants are primarily institutions

dealing with one other and other

interested parties dealing through

one or more dealers.The clearing house of the exchange

becomes the opposite side to each

cleared transactions; therefore, the

credit risk for a futures market

participant is always the same and

there is no need to analyse the

credit of other market participants.

A participant must examine the

credit risk and establish credit limits

for each opposite party.



Derivatives

CHAPTER – 4

PARTICIPANTS IN DERIVATIVES MARKET

ROLE OF DERIVATIVES

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Derivatives

CHAPTER 4

PARTICIPANTS IN THE DERIVATIVES MARKET:

The participants in the derivatives market are as follows:

A.} TRADING PARTICIPANTS:

1.] HEDGERS –

The process of managing the risk or risk management is

called as hedging. Hedgers are those individuals or firms who managetheir risk with the help of derivative products. Hedging does not mean

maximising of return. The main purpose for hedging is to reduce the

volatility of a portfolio by reducing the risk.

2.] SPECULATORS –

Speculators do not have any position on which they enter into futures and options Market i.e., they take the positions in the futures

market without having position in the underlying cash market. They only

have a particular view about future price of a commodity, shares, stock

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Derivatives

index, interest rates or currency. They consider various factors like

demand and supply, market positions, open interests, economicfundamentals, international events, etc. to make predictions. They take

risk in turn from high returns. Speculators are essential in all markets –

commodities, equity, interest rates and currency. They help in providing

the market the much desired volume and liquidity.

3.] ARBITRAGEURS –

Arbitrage is the simultaneous purchase and sale of the same

underlying in two different markets in an attempt to make profit from price

discrepancies between the two markets. Arbitrage involves activity on

several different instruments or assets simultaneously to take advantage

of price distortions judged to be only temporary.

Arbitrage occupies a prominent position in the futures world.

It is the mechanism that keeps prices of futures contracts aligned properly

with prices of underlying assets. The objective is simply to make profits

without risk, but the complexity of arbitrage activity is such that it is

reserved to particularly well-informed and experienced professional

traders, equipped with powerful calculating and data processing tools.

Arbitrage may not be as easy and costless as presumed.

B.} INTERMEDIARY PARTICIPANTS:

4.] BROKERS –

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Derivatives

For any purchase and sale, brokers perform an important

function of bringing buyers and sellers together. As a member in anyfutures exchanges, may be any commodity or finance, one need not be a

speculator, arbitrageur or hedger. By virtue of a member of a commodity

or financial futures exchange one get a right to transact with other

members of the same exchange. This transaction can be in the pit of the

trading hall or on online computer terminal. All persons hedging their

transaction exposures or speculating on price movement need not be and

for that matter cannot be members of futures or options exchange. A non-member has to deal in futures exchange through member only. This

provides a member the role of a broker. His existence as a broker takes

the benefits of the futures and options exchange to the entire economy all

transactions are done in the name of the member who is also responsible

for final settlement and delivery. This activity of a member is price risk free

because he is not taking any position in his account, but his other risk is

clients default risk. He cannot default in his obligation to the clearing

house, even if client defaults. So, this risk premium is also inbuilt in

brokerage recharges. More and more involvement of non-members in

hedging and speculation in futures and options market will increase

brokerage business for member and more volume in turn reduces the

brokerage. Thus more and more participation of traders other than

members gives liquidity and depth to the futures and options market.

Members can attract involvement of other by providing efficient services at

a reasonable cost. In the absence of well functioning broking houses, thefutures exchange can only function as a club.

5.] MARKET MAKERS AND JOBBERS –

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Derivatives

Even in organised futures exchange, every deal cannot getthe counter party immediately. It is here the jobber or market maker plays

his role. They are the members of the exchange who takes the purchase

or sale by other members in their books and then square off on the same

day or the next day. They quote their bid-ask rate regularly. The difference

between bid and ask is known as bid-ask spread. When volatility in price

is more, the spread increases since jobbers price risk increases. In less

volatile market, it is less. Generally, jobbers carry limited risk. Even byincurring loss, they square off their position as early as possible. Since

they decide the market price considering the demand and supply of the

commodity or asset, they are also known as market makers. Their role is

more important in the exchange where outcry system of trading is present.

A buyer or seller of a particular futures or option contract can approach

that particular jobbing counter and quotes for executing deals. In

automated screen based trading best buy and sell rates are displayed on

screen, so the role of jobber to some extent. In any case, jobbers provide

liquidity and volume to any futures and option market.

C.} INSTITUTIONAL FRAMEWORK :

6.] EXCHANGE –

Exchange provides buyers and sellers of futures and optioncontract necessary infrastructure to trade. In outcry system, exchange has

trading pit where members and their representatives assemble during a

fixed trading period and execute transactions. In online trading system,

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Derivatives

would be there in stock futures or options, commodity futures and options

and interest rates futures. In the absence of proper custodian or warehouse mechanism, delivery of financial assets and commodities will

be a cumbersome task and futures prices will not reflect the equilibrium

price for convergence of cash price and futures price on maturity,

custodian and warehouse are very relevant.

9.] BANK FOR FUND MOVEMENTS –

Futures and options contracts are daily settled for which

large fund movement from members to clearing house and back is

necessary. This can be smoothly handled if a bank works in association

with a clearing house. Bank can make daily accounting entries in the

accounts of members and facilitate daily settlement a routine affair. This

also reduces a possibility of any fraud or misappropriation of fund by any

market intermediary.

10.] REGULATORY FRAMEWORK –

A regulator creates confidence in the market besides

providing Level playing field to all concerned, for foreign exchange and

money market, RBI is the regulatory authority so it can take initiative in

starting futures and options trade in currency and interest rates. For

capital market, SEBI is playing a lead role, along with physical market instocks, it will also regulate the stock index futures to be started very soon

in India. The approach and outlook of regulator directly affects the

strength and volume in the market. For commodities, Forward Market

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Derivatives

Commission is working for settling up national National Commodity

Exchange.

ROLE OF DERIVATIVES :

Derivative markets help investors in many different ways:

1.] RISK MANAGEMENT –

Futures and options contract can be used for altering the risk

of investing in spot market. For instance, consider an investor who owns

an asset. He will always be worried that the price may fall before he can

sell the asset. He can protect himself by selling a futures contract, or by

buying a Put option. If the spot price falls, the short hedgers will gain in

the futures market, as you will see later. This will help offset their losses in

the spot market. Similarly, if the spot price falls below the exercise price,the put option can always be exercised.

Derivatives markets help to reallocate risk among investors.

A person who wants to reduce risk, can transfer some of that risk to a

person who wants to take more risk. Consider a risk-averse individual. He

can obviously reduce risk by hedging. When he does so, the opposite

position in the market may be taken by a speculator who wishes to take

more risk. Since people can alter their risk exposure using futures and

options, derivatives markets help in the raising of capital. As an investor,

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Derivatives

The availability of derivatives makes markets more efficient;spot, futures and options markets are inextricably linked. Since it is easier

and cheaper to trade in derivatives, it is possible to exploit arbitrage

opportunities quickly and to keep prices in alignment. Hence these

markets help to ensure that prices reflect true values.

5.] EASE OF SPECULATION –

Derivative markets provide speculators with a cheaper

alternative to engaging in spot transactions. Also, the amount of capital

required to take a comparable position is less in this case. This is

important because facilitation of speculation is critical for ensuring free

and fair markets. Speculators always take calculated risks. A speculator

will accept a level of risk only if he is convinced that the associated

expected return, is commensurate with the risk that he is taking.

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Derivatives

CHAPTER – 5

HOW BANKS USE DERIVATIVES

• ASSET LIABILITY MANAGEMENT

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Derivatives

CHAPTER 5

HOW BANKS USE DERIVATIVES:

ASSET LIABILITY MANAGEMENT -

Banks have traditionally taken deposits from their customers and

put those deposits to work as loans. Because the deposits and the loans

are dominated in the same currency, this activity has no associated

foreign exchange risk. But it does limit banks to lending to customers

which need to borrow in the currencies which the banks have available on

deposits.

If a bank is asked to lend to a customer in a currency other than

one of those it has on deposits it creates a currency exposure for the

bank. Suppose a customer wants to borrow EUROS from a US Bank for 5

years and that the US bank has no natural source of EUROS. It ispossible for the banks to cover this exposure in the forward market by

selling EUROS forwards and buying US dollars. The transaction costs

associated with this, in particular the bid / offer spread in the medium term

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Derivatives

foreign exchange forward market, would make the resultant cost of the

loan prohibitively expensive for the borrower.

Currency swaps provide an economic alternative to this problem for

banks. In order to cover the exposure created by a loan to a customer in

EUROS funded by a bank’s deposit in US dollar, a bank could receive

fixed rate US dollars in a currency swap and pay fixed rate EUROS.

One of the consequences of the development of the currency swapmarket is that banks now often make much more competitive medium

term forward foreign exchange prices than they used to. Most banks

quote forward foreign exchange and currency swap prices from the same

desk and increases liquidity in the latter has improved liquidity in the

former. Banks therefore, need no longer restrict their lending activities to

the currencies in which they have natural deposits. They are free to fund

themselves in the most competitively priced currency and to lend to their

customers in the currency of the customer’s preference, using a currency

swap as an asset and liability matching tool

The “Normal yield curve”, reflects that it is much easier for banks to

borrow at the short end of the curve than the long end. This means that

banks can fund themselves much more effectively in the inter bank market

in maturities such as the overnight, tom / next (overnight from tomorrow,

or tomorrow to the next day), spot / next, one week, one month, threemonths and six months than they can in maturities such as five years or

20 years.

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Derivatives

With the development of the swaps market it is possible for banks

to satisfy their customers demands for fixed rate funding while ensuringthat the banks assets and liabilities are matched. Suppose a bank has a

customer who needs 5 years fixed rate funds. Let us say that the bank

finances in this loan in the interbank market at 3 month LIBOR. The bank

now has a 3 month liability and a 5 year asset (Figure 1).

The bank is short floating rate interest at 3 month LIBOR and long

fixed rate interest at the rate at which it lends to its customer. This is

called the asset liability mismatch. So in order to hedge its position the

banks needs to match its exposure to 3 month LIBOR by receiving on a

floating rate basis in an interest rate swap, and match its exposure on a

fixed rate basis by paying a fixed rate in a interest rate swap. This is ahedge which is ideally suited to an interest rate swap which the bank

receives a floating rare of interest and pays a fixed rare (Figure 2).

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Derivatives

This structure has the benefit for the bank that it eliminates the

bank’s exposure to interest rate risk. The bank can no longer profit from afall in interest rates but it cannot lose money on its asset and liability

mismatch as a result of an increase in rates. The bank will make or lose

money based on its pricing of the credit risk in the transaction and its

overall loan exposure rather than on its ability to forecast interest rates.

Hence the interest rate swaps provide banks with an opportunity to

change their risks from interest rate to credit.

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Derivatives

CHAPTER – 6

CASE STUDIES

• hedging interest rate risk

• Hedging foreign exchange risk

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Derivatives

CHAPTER 6

CASE STUDIES :

CASE STUDY 1

Hedging interest rate risk

Scenario

A major aircraft manufacturer has decided to replace his mainframe

computer. The cost after trade in is $ 10 million, payable on delivery.

Delivery

Mid December, 2006.

Funding

A projected cash flow short fall will create a $ 10 million borrowing

requirement.

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Derivatives

Borrowing Rate

LIBOR + 50 Basis points

Outlook

The treasurer is worried that the central bank’s future policy directions will

lead to an increase in short term rates.

Market Conditions

Current LIBOR - 8.38 %

Euro-Dollar Options On Futures :

December 91.25 (implied rate of 8.75%) Put, Premium of .25

December 91.00 (implied rate of 9.00%) Put, Premium of .15

Strategy

The treasurer buys the December Put Option with a strike price of 91.25

(implied rate of 8.75%), which allows the manufacturer to enter into a Euro

– Dollar futures contract for a premium price of .25. the notional principal,

that is the size of the contract is $ 1 million, so ten contracts are taken to

cover the full short-term borrowing cost. The put will make money only if

the underlying future falls below the strike price less the price paid for theoption. Remember, the Euro-Dollar future is quoted as an index on a base

of 100, a lower price means a higher rate of interest

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Derivatives

Results

In Mid-December, depending upon how the LIBOR rate has changed, the

treasurer will use or not use the put option on the future which was

purchased. If the cost of short-term borrowing has remained the same or

declined, the put option will expire worthless. The money expended upon

the premium, of 0.25 % per $ 1 million contract, will have been lost. If,

however, interest rates were to rise, the put option contract on the Euro-

Dollar future will be exercised. If, for example, Euro – Dollar Rates rise to10.76% (89.10 on the index) which would have given the treasurer a

borrowing cost of 11.26% (LIBOR + 50 bases points), the Put would be

utilised, exercising the right to sell the option on the future at the strike

price of 91.25, for an intrinsic value of 2.1 (Or 2% in interest terms).

The gain in value on the Put options contract compensates for the

increased cost of borrowing on the LIBOR Rate. The risk of funding the

new mainframe computer has been managed.

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Exchange Rate

The present rate is STG/ USD = 1.50, which is satisfactory with respect to

commercial objectives, but a weakening of more than 5% will result in

diminished margins or a non competitive position.

Outlook

The manufacturer is worried that because of declining rates of interests

and the current account deficits, the US dollar may waken against the

Pound Sterling, from its current rate of 1.50.

Market Conditions

Current spot rate - STG/USD = 1.50

June calls @ strike price of STG/USD = $1.51, premium of 2.50% per

contract, that is 4 US cents.

June calls @ Strike price of STG/USD = $1.52, premium of 2.00% per

contract, that is 3 US cents.

Strategy

The manufacturer buys one call option contract with a Strike or Exercise

price of 1.51. If the US dollar weakens the call contract will be used to buy

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Derivatives

the Pounds – Sterling at the set price. If, the US dollar stays the same or

strengthens, the contract will expire worthless and the premium paid for the option will have been lost.

Results

In June 2005, the Us dollar does weaken and the new spot exchange rate

is STG/USD = 1.60. Hence, the call option at 1.51 has intrinsic value of 9

US cents. Instead of the 1 million Pound Sterling required by the

manufacturer costing 1.6 million US dollars, the exercise of the call

contract will net $ 90000 US ( $ 1.6 million – $ 1.51 million).

After subtracting the price of the premium of 2.5%, the net gain will be $

50000 US ( $ 1.6 million – $ 1.55 million), which partially off-sets the

depreciation in the US Dollar exchange Rate, and is within the

manufacturer’s target range of 5% to remain competitive on pricing.

Through this hedging technique the underlying commercial objective will

be ensured. If the US Dollar exchange rate had not weakened, the

expenditure on the premium would still have kept his net cost of the

imports within the self imposed 5% competitive range.

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Derivatives

RECOMMENDATIONS

RBI should play a greater role in supporting derivatives.

Derivatives market should be developed in order to keep it at

par with other derivative markets in the world.

Speculation should be discouraged.

There must be more derivative instruments aimed at individual

investors.

SEBI should conduct seminars regarding the use of

derivatives to educate individual investors.

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Derivatives

BIBLIOGRAPHY :

BOOKS

Futures markets – Sunil. K. Parameswaran

Understanding futures market – Robert. W. Klob

Derivatives Market in India – Susan Thomas

Financial Derivatives – V. K. Bhalla

INTERNET

www.cxotoday.com

www.indiainfoline.com

www.indiamart.com

www.google.com

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