1. INTRODUCTION The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. DERIVATIVES DEFINED Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the 1
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1. INTRODUCTION
The emergence of the market for derivative products, most notably forwards, futures and
options, can be traced back to the willingness of risk-averse economic agents to guard themselves
against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial
markets are marked by a very high degree of volatility. Through the use of derivative products, it is
possible to partially or fully transfer price risks by locking-in asset prices. As instruments of risk
management, these generally do not influence the fluctuations in the underlying asset prices.
However, by locking in asset prices, derivative products minimize the impact of fluctuations in asset
prices on the profitability and cash flow situation of risk-averse investors.
DERIVATIVES DEFINED
Derivative is a product whose value is derived from the value of one or more basic variables,
called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying
asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to
sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a
transaction is an example of a derivative. The price of this derivative is driven by the spot price of
wheat which is the "underlying". In the Indian context the Securities Contracts (Regulation) Act,
1956 (SC(R)A) defines "derivative" to include-
1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk
instrument or contract for differences or any other form of security.
2. A contract which derives its value from the prices, or index of prices, of underlying securities.
Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the
regulatory framework under the SC(R)A.
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NEED OF THE STUDY
Globalization has resulted in pressure on margins. The lower the margin, the greater the need
for risk management. As a result, risk management has become a key area of focus for CEO’s.
Additionally, due to failure of many banks/ financial institutions in the recent past, it has attracted
the attention of regulators also.
The challenge of a modern corporation is to ensure wealth maximization for their
shareholders that is consistent with their risk preference. On the other hand, risks have to be
managed effectively and on the other, adequate returns have to be ensured. The role played by banks
and financial institutions being what it is, they have to look at risks more carefully, since the impact
is widespread and contagious. An impact on one institution can have a fallout for the other
institutions in the market. Risk in the institutional context, therefore, needs to be understood and
dealt with appropriately.
In financial institutions, core business and risks are two sides of the same coin. Therefore,
they need to be integrated. Its absence not only risks the organization, but also financial markets and
systems. Hence, it needs to be emphasized that risk management does not imply avoidance of risk.
Taking reasonable and well understood risks is necessary in order to earn returns. For that purpose
prudent policies and procedures should be set up by the organization to identify, measure, monitor
and control the risk.
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SCOPE OF THE STUDY
My study confines to 50 listed stocks of S&P CNX Nifty only.
The report deals with the different investment decisions made by different people. It explains
the element of risk in detail while investing in Futures Contract.
It explains how derivatives hedges the risk in investment and gives optimum return, to a
given amount of risk.
The report also shows different ways of analysis of securities, different theories of
derivatives management for effective and efficient risk control.
OBJECTIVES OF THE STUDY
1) To analyze the derivatives traded in stock markets in India.
2) To analyze the operations of Futures Contracts.
3) To study the role and impact of Futures Contract w.r.t S&P CNX Nifty.
4) To study about risk management in financial markets with the help of derivatives.
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RESEARCH METHODOLOGY
The data collection methods include both the primary and secondary collection methods.
PRIMARY DATA
Primary data has been collected through personal interaction with the employees of the
company.
SECONDARY DATA
Data collected from newspaper & magazines.
Data obtained from the internet.
Data collected from company’s financial records.
Data obtained from company journals.
SAMPLE SIZE : 50 listed stocks of S&P CNX Nifty.
PERIOD OF STUDY : 45 days (Dated 1st Jan., to 15th Feb., 2010)
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LIMITATIONS
THE MAJOR DRAWBACKS/LIMITATIONS OF THE PROJECT IS:
The data collected was basically confined to secondary sources, with very little amount of
primary data associated with the project.
There was a constraint, with regard to time allocated for the research study.
Detailed study of the topic was not possible due to the limited size of the project.
The availability of information in the form of annual reports & price fluctuations of the
companies was a big constraint to the study.
Analysis of Futures Contract is restricted to listed 50 stocks of Nifty, based on 3 months
contract.
The fulfillment of the project is limited to 45 days.
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3. INDUSTRY & COMPANY PROFILEFINANCIAL MARKETS
FINANCE IS THE PRE-REQUISITE FOR MODERN BUSINESS AND FINANCIAL INSTITUTIONS PLAY A
VITAL ROLE IN THE ECONOMIC SYSTEM. IT IS THROUGH FINANCIAL MARKETS AND INSTITUTIONS
THAT THE FINANCIAL SYSTEM OF AN ECONOMY WORKS. FINANCIAL MARKETS REFER TO THE
INSTITUTIONAL ARRANGEMENTS FOR DEALING IN FINANCIAL ASSETS AND CREDIT INSTRUMENTS
OF DIFFERENT TYPES SUCH AS CURRENCY, CHEQUES, BANK DEPOSITS, BILLS, BONDS, EQUITIES,
ETC.
FINANCIAL MARKET IS A BROAD TERM DESCRIBING ANY MARKETPLACE WHERE BUYERS AND SELLERS PARTICIPATE
IN THE TRADE OF ASSETS SUCH AS EQUITIES, BONDS, CURRENCIES AND DERIVATIVES. THEY ARE TYPICALLY
DEFINED BY HAVING TRANSPARENT PRICING, BASIC REGULATIONS ON TRADING, COSTS AND FEES AND MARKET
FORCES DETERMINING THE PRICES OF SECURITIES THAT TRADE.
GENERALLY, THERE IS NO SPECIFIC PLACE OR LOCATION TO INDICATE A FINANCIAL MARKET.
WHEREVER A FINANCIAL TRANSACTION TAKES PLACE, IT IS DEEMED TO HAVE TAKEN PLACE IN
THE FINANCIAL MARKET. HENCE FINANCIAL MARKETS ARE PERVASIVE IN NATURE SINCE
FINANCIAL TRANSACTIONS ARE THEMSELVES VERY PERVASIVE THROUGHOUT THE ECONOMIC
SYSTEM. FOR INSTANCE, ISSUE OF EQUITY SHARES, GRANTING OF LOAN BY TERM LENDING
INSTITUTIONS, DEPOSIT OF MONEY INTO A BANK, PURCHASE OF DEBENTURES, SALE OF SHARES
AND SO ON.
IN A NUTSHELL, FINANCIAL MARKETS ARE THE CREDIT MARKETS CATERING TO THE VARIOUS
NEEDS OF THE INDIVIDUALS, FIRMS AND INSTITUTIONS BY FACILITATING BUYING AND SELLING
OF FINANCIAL ASSETS, CLAIMS AND SERVICES.
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CLASSIFICATION OF FINANCIAL MARKETS
CAPITAL MARKET
THE CAPITAL MARKET IS A MARKET FOR FINANCIAL ASSETS WHICH HAVE A LONG OR
INDEFINITE MATURITY. GENERALLY, IT DEALS WITH LONG TERM SECURITIES WHICH HAVE A
FINANCIAL MARKETS
ORGANIZED MARKETS
UNORGANIZED MARKETS
CAPITAL MARKETS
MONEY MARKETS
INDUSTRIAL SECURITIES
MARKET
GOVERNMENT SECURITIES
MARKET
LONG-TERM LOAN MARKET
PRIMARY MARKET
SECONDARY MARKET
CALL MONEY MARKET
COMMERCIAL BILL MARKET
TREASURY BILL MARKET
MONEY LENDERS,
INDIGENUOS BANKERS
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PERIOD OF ABOVE ONE YEAR. IN THE WIDEST SENSE, IT CONSISTS OF A SERIES OF CHANNELS
THROUGH WHICH THE SAVINGS OF THE COMMUNITY ARE MADE AVAILABLE FOR INDUSTRIAL
AND COMMERCIAL ENTERPRISES AND PUBLIC AUTHORITIES. AS A WHOLE, CAPITAL MARKET
FACILITATES RAISING OF CAPITAL.
THE MAJOR FUNCTIONS PERFORMED BY A CAPITAL MARKET ARE:
1. MOBILIZATION OF FINANCIAL RESOURCES ON A NATION-WIDE SCALE.
2. SECURING THE FOREIGN CAPITAL AND KNOW-HOW TO FILL UP DEFICIT IN THE REQUIRED
RESOURCES FOR ECONOMIC GROWTH AT A FASTER RATE.
3. EFFECTIVE ALLOCATION OF THE MOBILIZED FINANCIAL RESOURCES, BY DIRECTING THE
SAME TO PROJECTS YIELDING HIGHEST YIELD OR TO THE PROJECTS NEEDED TO
PROMOTE BALANCED ECONOMIC DEVELOPMENT.
CAPITAL MARKET CONSISTS OF PRIMARY MARKET AND SECONDARY MARKET.
PRIMARY MARKET: PRIMARY MARKET IS A MARKET FOR NEW ISSUES OR NEW FINANCIAL
CLAIMS. HENCE IT IS ALSO CALLED AS NEW ISSUE MARKET. IT BASICALLY DEALS WITH THOSE
SECURITIES WHICH ARE ISSUED TO THE PUBLIC FOR THE FIRST TIME. THE MARKET,
THEREFORE, MAKES AVAILABLE A NEW BLOCK OF SECURITIES FOR PUBLIC SUBSCRIPTION. IN
OTHER WORDS, IT DEALS WITH RAISING OF FRESH CAPITAL BY COMPANIES EITHER FOR CASH OR
FOR CONSIDERATION OTHER THAN CASH. THE BEST EXAMPLE COULD BE INITIAL PUBLIC
OFFERING (IPO) WHERE A FIRM OFFERS SHARES TO THE PUBLIC FOR THE FIRST TIME.
SECONDARY MARKET: SECONDARY MARKET IS A MARKET WHERE EXISTING SECURITIES ARE
TRADED. IN OTHER WORDS, SECURITIES WHICH HAVE ALREADY PASSED THROUGH NEW ISSUE
MARKET ARE TRADED IN THIS MARKET. GENERALLY, SUCH SECURITIES ARE QUOTED IN THE
STOCK EXCHANGE AND IT PROVIDES A CONTINUOUS AND REGULAR MARKET FOR BUYING AND
SELLING OF SECURITIES. THIS MARKET CONSISTS OF ALL STOCK EXCHANGES RECOGNIZED BY
THE GOVERNMENT OF INDIA.
MONEY MARKET
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MONEY MARKETS ARE THE MARKETS FOR SHORT-TERM, HIGHLY LIQUID DEBT SECURITIES.
MONEY MARKET SECURITIES ARE GENERALLY VERY SAFE INVESTMENTS WHICH RETURN
RELATIVELY LOW INTEREST RATE THAT IS MOST APPROPRIATE FOR TEMPORARY CASH STORAGE
OR SHORT TERM TIME NEEDS. IT CONSISTS OF A NUMBER OF SUB-MARKETS WHICH
COLLECTIVELY CONSTITUTE THE MONEY MARKET NAMELY CALL MONEY MARKET,
COMMERCIAL BILLS MARKET, ACCEPTANCE MARKET, AND TREASURY BILL MARKET.
DERIVATIVES MARKET
THE DERIVATIVES MARKET IS THE FINANCIAL MARKET FOR DERIVATIVES, FINANCIAL
INSTRUMENTS LIKE FUTURES CONTRACTS OR OPTIONS, WHICH ARE DERIVED FROM OTHER
FORMS OF ASSETS. A DERIVATIVE IS A SECURITY WHOSE PRICE IS DEPENDENT UPON OR DERIVED
FROM ONE OR MORE UNDERLYING ASSETS. THE DERIVATIVE ITSELF IS MERELY A CONTRACT
BETWEEN TWO OR MORE PARTIES. ITS VALUE IS DETERMINED BY FLUCTUATIONS IN THE
UNDERLYING ASSET. THE MOST COMMON UNDERLYING ASSETS INCLUDE STOCKS,
BONDS, COMMODITIES, CURRENCIES, INTEREST RATES AND MARKET INDEXES. THE IMPORTANT
FINANCIAL DERIVATIVES ARE THE FOLLOWING:
FORWARDS: FORWARDS ARE THE OLDEST OF ALL THE DERIVATIVES. A FORWARD
CONTRACT REFERS TO AN AGREEMENT BETWEEN TWO PARTIES TO EXCHANGE AN
AGREED QUANTITY OF AN ASSET FOR CASH AT A CERTAIN DATE IN FUTURE AT A
PREDETERMINED PRICE SPECIFIED IN THAT AGREEMENT. THE PROMISED ASSET MAY BE
CURRENCY, COMMODITY, INSTRUMENT ETC.
FUTURES: FUTURE CONTRACT IS VERY SIMILAR TO A FORWARD CONTRACT IN ALL
RESPECTS EXCEPTING THE FACT THAT IT IS COMPLETELY A STANDARDIZED ONE. IT IS
NOTHING BUT A STANDARDIZED FORWARD CONTRACT WHICH IS LEGALLY ENFORCEABLE
AND ALWAYS TRADED ON AN ORGANIZED EXCHANGE.
OPTIONS: A FINANCIAL DERIVATIVE THAT REPRESENTS A CONTRACT SOLD BY ONE
PARTY (OPTION WRITER) TO ANOTHER PARTY (OPTION HOLDER). THE CONTRACT OFFERS
THE BUYER THE RIGHT, BUT NOT THE OBLIGATION, TO BUY (CALL) OR SELL (PUT) A
SECURITY OR OTHER FINANCIAL ASSET AT AN AGREED-UPON PRICE (THE STRIKE
PRICE) DURING A CERTAIN PERIOD OF TIME OR ON A SPECIFIC DATE (EXERCISE DATE).
liquidity, so they are the most liquid of the stocks excluded from the S&P CNX
Nifty. The maintenance of the S&P CNX Nifty and the CNX Nifty Junior are
synchronized so that the two indexes will always be disjoint sets; i.e. a stock will
never appear in both indexes at the same time. Hence it is always meaningful to pool
the S&P CNX Nifty and the CNX Nifty Junior into a composite 100 stock index or
portfolio.
CNX Nifty Junior represents about 10% of the total market capitalization as on
March 31, 2005.
The average traded value for the last six months of all Junior Nifty stocks is
approximately 9% of the traded value of all stocks on the NSE.
Impact cost for CNX Nifty Junior for a portfolio size of Rs.2.50 million is
0.15%.
CNX 100
CNX 100 is a diversified 100 stock index accounting for 35 sector of the economy.
CNX 100 is owned and managed by India Index Services & Products Ltd. (IISL).
Which is a joint venture between CRISIL & NSE. IISL is India's first specialized
company focused upon the index as a core products. IISL has a licensing &
marketing agreement with Standard & Poor's (S&P), who are leader's in index
services.
CNX 100 represents about 66.61 % of the total market capitalization as on April
10, 2007
The average traded value for the last six months of all CNX100 stocks is
approximately 56.02 % of the traded value of all stocks on the NSE
Impact cost for CNX 100 for a portfolio size of Rs. 8 million is 0.11%
S&P CNX 500
The S&P CNX 500 is India’s first broad-based benchmark of the Indian capital
market for comparing portfolio returns vis-a-vis market returns. The S&P CNX 500
represents about 96% of total market capitalisation and about 93% of the total
turnover on the NSE.
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The S&P CNX 500 companies are disaggregated into 72 industry indexes viz. S&P
CNX Industry Indexes. Industry weightages in the index reflect the industry
weightages in the market. For e.g. if the banking sector has a 5% weightage in the
universe of stocks traded on NSE, banking stocks in the index would also have an
approx. representation of 5% in the index.
CNX Midcap *
The medium capitalized segment of the stock market is being increasingly perceived
as an attractive investment segment with high growth potential. The primary
objective of the CNX Midcap Index is to capture the movement and be a benchmark
of the midcap segment of the market.
METHOD OF COMPUTATION
CNX Midcap is computed using market capitalization weighted method, wherein
the level of the index reflects the total market value of all the stocks in the index
relative to a particular base period. The method also takes into account constituent
changes in the index and importantly corporate actions such as stock splits, rights,
etc without affecting the index value.
BASE DATE AND VALUE
The CNX Midcap Index has a base date of Jan 1, 2003 and a base value of 1000.
CRITERIA FOR SELECTION OF CONSTITUENT STOCKS
The constituents and the criteria for the selection judge the effectiveness of the
index. Selection of the index set is based on the following criteria :
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All the stocks, which constitute more than 5% market capitalization of the
universe (after sorting the securities in descending order of market
capitalization), shall be excluded in order to reduce the skewness in the
weightages of the stocks in the universe.
After step (a), the weightages of the remaining stocks in the universe is
determined again.
After step (b), the cumulative weightage is calculated.
After step (c) companies which form part of the cumulative percentage in
ascending order unto first 75 percent (i.e. upto to 74.99 percent) of the revised
universe shall be ignored.
After, step (d), all the constituents of S&P CNX Nifty shall be ignored.
From the universe of companies remaining after step (e) i.e. 75th percent and
above, first 100 companies in terms of highest market capitalization, shall
constitute the CNX Midcap Index subject to fulfillment of the criteria mentioned
below.
TRADING INTEREST
All constituents of the CNX Midcap Index must have a minimum listing record of 6
months. In addition, all candidates for the Index are also evaluated for trading
interest, in terms of volumes and trading frequency.
FINANCIAL PERFORMANCE
All companies in the CNX Midcap Index have a minimum track record of three
years of operations with a positive net worth.
OTHERS
A company which comes out with a IPO will be eligible for inclusion in the index, if
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it fulfills the normal eligibility criteria for the index for a 3 month period instead of a
6 month period.
*CNX Midcap - Introduced from July 18, 2005
Nifty Midcap 50
The medium capitalized segment of the stock market is being increasingly perceived as an attractive investment segment with high growth potential. The primary objective of the Nifty Midcap 50 Index is to capture the movement of the midcap segment of the market. It can also be used for index-based derivatives trading.
METHOD OF COMPUTATION
Nifty Midcap 50 is computed using market capitalisation weighted method, wherein
the level of the index reflects the total market value of all the stocks in the index
relative to a particular base period. The method also takes into account constituent
changes in the index and importantly corporate actions such as stock splits, rights,
etc without affecting the index value.
BASE DATE AND VALUE
The Nifty Midcap 50 Index has a base date of Jan 1, 2004 and a base value of 1000.
CRITERIA FOR SELECTION OF CONSTITUENT STOCKS
The constituents and the criteria for the selection judge the effectiveness of the
index. Selection of the index set is, inter alia, based on the following criteria:
Stocks with average market capitalization ranging from Rs.1000 Crore to
Rs.5000 Crore at the time of selection.
Stocks which are not part of the derivatives segment are excluded.
Stocks which are forming part of the S&P CNX NIFTY index are excluded.
OTHER STATISTICS:
A company which comes out with a IPO will be eligible for inclusion in the index, if
it fulfills the normal eligibility criteria for the index for a 3 month period instead of a
6 month period.
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Nifty Midcap 50 stocks represent about 4.89 % of the total market capitalization
as on August 31, 2007.
The average traded volume for the last six months of all Nifty Midcap 50 stocks
is approximately 15.21 % of the traded volume of all stocks on the NSE.
S&P CNX Defty
Almost every institutional investor and off-shore fund enterprise with an equity
exposure in India would like to have an instrument for measuring returns on their
equity investment in dollar terms. To facilitate this, a new index the S&P CNX
Defty-Dollar Denominated S&P CNX Nifty has been developed.
S&P CNX Defty is S&P CNX Nifty, measured in dollars. The S&P CNX Defty is
calculated real-time. When there is currency volatility, the S&P CNX Defty is an
ideal device for a foreign investor to know where he stands, even intraday
Salient Features:
Performance indicator to foreign institutional investors, off shore funds, etc.
Provides an effective tool for hedging Indian equity exposure.
Impact cost of the S&P CNX Nifty for a portfolio size of Rs.5 million is 0.20%
Provides fund managers an instrument for measuring returns on their equity
investment in dollar terms.
Calculation of S&P CNX Defty:
Computations are done using the S&P CNX NIFTY index calculated on the NEAT
trading system of NSE and end of previous day Exchange Rate(US $-Re).
S&P CNX Defty = S&P CNX Nifty at time t x Exchange rate as on base date.
and Mini Nifty 50 indices are owned, computed and maintained by India Index
Services & Products Limited (IISL), a company setup by NSE and CRISIL with
technical assistance from Standard & Poor's
Index derivatives
Index derivatives are derivative contracts which have the index as the
underlying. The most popular index derivatives contracts the world over are index
futures and index options. NSE's market index, the S&P CNX Nifty was scientifically
designed to enable the launch of index-based products like index derivatives and index
funds. The first derivative contract to be traded on NSE's market was the index futures
contract with the Nifty as the underlying.
This was followed by Nifty options, derivative contracts on sectoral indexes like
CNX IT and BANK Nifty contracts. Trading on index derivatives were further
introduced on CNX Nifty Junior, CNX 100, Nifty Midcap 50 and Mini Nifty 50.
4.3 DERIVATIVES INSTRUMENTS
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In recent years, derivatives have become increasingly important in the field of
finance. While futures and options are now actively traded on many exchanges, forward
contracts are popular on the OTC market. In this chapter we shall study in detail these
three derivative contracts.
FORWARD CONTRACTS
A forward contract is an agreement to buy or sell an asset on a specified date for a
specified price. One of the parties to the contract assumes a long position and agrees to
buy the underlying asset on a certain specified future date for a certain specified price.
The other party assumes a short position and agrees to sell the asset on the same date for
the same price. Other contract details like delivery date, price and quantity are
negotiated bilaterally by the parties to the contract. The forward contracts are normally
traded outside the exchanges.
The salient features of forward contracts are:
• THEY ARE BILATERAL CONTRACTS AND HENCE EXPOSED TO COUNTER-PARTY RISK.• Each contract is custom designed, and hence is unique in terms of contract size,
expiration date and the asset type and quality.
• THE CONTRACT PRICE IS GENERALLY NOT AVAILABLE IN PUBLIC DOMAIN.• On the expiration date, the contract has to be settled by delivery of the asset.
• If the party wishes to reverse the contract, it has to compulsorily go to the same
counter-party, which often results in high prices being charged.
However forward contracts in certain markets have become very standardized, as in the
case of foreign exchange, thereby reducing transaction costs and increasing transactions
volume. This process of standardization reaches its limit in the organized futures
market.
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LIMITATIONS OF FORWARD MARKETS
Forward markets world-wide are afflicted by several problems:
• LACK OF CENTRALIZATION OF TRADING,
• ILLIQUIDITY, AND
• Counterparty risk
In the first two of these, the basic problem is that of too much flexibility and
generality. The forward market is like a real estate market in that any two consenting
adults can form contracts against each other. This often makes them design terms of the
deal which are very convenient in that specific situation, but makes the contracts non-
tradable. Counterparty risk arises from the possibility of default by any one party to the
transaction. When one of the two sides to the transaction declares bankruptcy, the other
suffers. Even when forward markets trade standardized contracts, and hence
avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.
INTRODUCTION TO FUTURES
Futures markets were designed to solve the problems that exist in forward
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markets. A futures contract is an agreement between two parties to buy or sell an asset
at a certain time in the future at a certain price. But unlike forward contracts, the futures
contracts are standardized and exchange traded. To facilitate liquidity in the futures
contracts, the exchange specifies certain standard features of the contract. It is a
standardized contract with standard underlying instrument, a standard quantity and
quality of the underlying instrument that can be delivered, (or which can be used for
reference purposes in settlement) and a standard timing of such settlement. A futures
contract may be offset prior to maturity by entering into an equal and opposite
transaction. More than 99% of futures transactions are offset this way.
The standardized items in a futures contract are:
QUANTITY OF THE UNDERLYING
QUALITY OF THE UNDERLYING
THE DATE AND THE MONTH OF DELIVERY
THE UNITS OF PRICE QUOTATION AND MINIMUM PRICE CHANGE
Location of settlement
Distinction between futures and forwardsFutures ForwardsTrade on an organized exchange OTC in nature
Midcap 50 and Mini Nifty 50 futures contracts having one-month, two-month and three-
month expiry cycles. All contracts expire on the last Thursday of every month. Thus a
January expiration contract would expire on the last Thursday of January and a
February expiry contract would cease trading on the last Thursday of February. On the
Friday following the last Thursday, a new contract having a three-month expiry would
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be introduced for trading. Thus, as shown in Figure, at any point in time, three contracts
would be available for trading with the first contract expiring on the last Thursday of
that month. Depending on the time period for which you want to take an exposure in
index futures contracts, you can place buy and sell orders in the respective contracts.
The Instrument type refers to "Futures contract on index" and Contract symbol - NIFTY
denotes a "Futures contract on Nifty index" and the Expiry date represents the last date
on which the contract will be available for trading. Each futures contract has a separate
limit order book. All passive orders are stacked in the system in terms of price-time
priority and trades take place at the passive order price (similar to the existing capital
market trading system). The best buy order for a given futures contract will be the order
to buy the index at the highest index level whereas the best sell order will be the order to
sell the index at the lowest index level.
Example: If trading is for a minimum lot size of 100 units. If the index level is around
2000, then the appropriate value of a single index futures contract would be Rs.200,000.
The minimum tick size for an index future contract is 0.05 units. Thus a single move in
the index value would imply a resultant gain or loss of Rs.5.00 (i.e. 0.05*100 units) on
an open position of 100 units.
Contract cycle
The figure shows the contract cycle for futures contracts on NSE's derivatives
market. As can be seen, at any given point of time, three contracts are available for
trading - a near-month, a middle-month and a far-month. As the January contract
expires on the last Thursday of the month, a new three-month contract starts trading
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from the following day, once more making available three index futures contracts for
trading.
CHARGES
Trades affected in the contracts admitted to dealing on the F&O segment of
NSE is fixed at 2.5% of the contract value in case of index futures and stock futures. In
case of index options and stock options it is 2.5% of notional value of the contract
[(Strike Price + Premium) * Quantity)], exclusive of statutory levies. The transaction
charges payable to the exchange by the trading member for the trades executed by him
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on the F&O segment are fixed at the rate of Rs. 2 per lakh of turnover (0.002%) subject
to a minimum of Rs. 1,00,000 per year. However for the transactions in the options sub-
segment the transaction charges are levied on the premium value at the rate of 0.05%
(each side) instead of on the strike price as levied earlier. Further to this, trading
members have been advised to charge brokerage from their clients on the Premium
price (traded price) rather than Strike price. The trading members contribute to Investor
Protection Fund of F&O segment at the rate of Re. 1/- per Rs. 100 crores of the traded
value (each side).
CLEARING AND SETTLEMENT
National Securities Clearing Corporation Limited (NSCCL) undertakes clearing
and settlement of all trades executed on the futures and options (F&O) segment of the
NSE. It also acts as legal counterparty to all trades on the F&O segment and guarantees
their financial settlement.
CLEARING ENTITIES
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Clearing and settlement activities in the F&O segment are undertaken by
NSCCL with the help of the following entities:
Clearing members
In the F&O segment, some members, called self clearing members, clear and
settle their trades executed by them only either on their own account or on account of
their clients. Some others, called trading member-cum-clearing member, clear and settle
their own trades as well as trades of other trading members (TMs). Besides, there is a
special category of members, called professional clearing members (PCM) who clear
and settle trades executed by TMs. The members clearing their own trades and trades of
others, and the PCMs are required to bring in additional security deposits in respect of
every TM whose trades they undertake to clear and settle.
Clearing banksFunds settlement takes place through clearing banks. For the purpose of
settlement all clearing members are required to open a separate bank account
with NSCCL designated clearing bank for F&O segment. The Clearing and
Settlement process comprises of the following three main activities:
1) Clearing
2) Settlement
3) Risk Management
CLEARING MECHANISM
The clearing mechanism essentially involves working out open positions and
Obligations of clearing (self-clearing/trading-cum-clearing/professional clearing)
members. This position is considered for exposure and daily margin purposes. The open
positions of CMs are arrived at by aggregating the open positions of all the TMs and all
custodial participants clearing through him, in contracts in which they have traded. A
TM's open position is arrived at as the summation of his proprietary open position and
clients' open positions, in the contracts in which he has traded. While entering orders on
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the trading system, TMs are required to identify the orders, whether proprietary (if they
are their own trades) or client (if entered on behalf of clients) through 'Pro/ Cli' indicator
provided in the order entry screen. Proprietary positions are calculated on net basis (buy
- sell) for each contract. Clients' positions are arrived at by summing together net (buy -
sell) positions of each individual client. A TM's open position is the sum of proprietary
open position, client open long position and client open short position.
SETTLEMENT MECHANISM
All futures and options contracts are cash settled, i.e. through exchange of cash.
The underlying for index futures/options of the Nifty index cannot be delivered. These
contracts, therefore, have to be settled in cash. Futures and options on individual
securities can be delivered as in the spot market. However, it has been currently
mandated that stock options and futures would also be cash settled. The settlement
amount for a CM is netted across all their TMs/clients, with respect to their obligations
on MTM, premium and exercise settlement.
REGULATORY FRAMEWORK
The trading of derivatives is governed by the provisions contained in the
SC(R)A, the SEBI Act, the rules and regulations framed thereunder and the rules and
bye–laws of stock exchanges.
SECURITIES CONTRACTS (REGULATION) ACT, 1956
SC(R)A aims at preventing undesirable transactions in securities by regulating
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the business of dealing therein and by providing for certain other matters connected
therewith. This is the principal Act, which governs the trading of securities in India. The
term “securities” has been defined in the SC(R)A. As per Section 2(h), the ‘Securities’
include:
1. Shares, scrips, stocks, bonds, debentures, debenture stock or other marketable
securities of a like nature in or of any incorporated company or other body corporate.
2. Derivative.
3. Units or any other instrument issued by any collective investment scheme to the
investors in such schemes.
4. Government securities.
5. Such other instruments as may be declared by the Central Government to be
securities.
6. Rights or interests in securities.
SECURITIES AND EXCHANGE BOARD OF INDIAACT, 1992
SEBI Act, 1992 provides for establishment of Securities and Exchange Board of
India (SEBI) with statutory powers for (a) protecting the interests of investors in
securities (b) promoting the development of the securities market and (c) regulating the
securities market. Its regulatory jurisdiction extends over corporates in the issuance of
capital and transfer of securities, in addition to all intermediaries and persons associated
with securities market. SEBI has been obligated to perform the aforesaid functions by
such measures as it thinks fit. In particular, it has powers for:
Regulating the business in stock exchanges and any other securities markets.
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Registering and regulating the working of stockbrokers, sub–brokers etc.
PROMOTING AND REGULATING SELF-REGULATORY ORGANIZATIONS.PROHIBITING FRAUDULENT AND UNFAIR TRADE PRACTICES.
Calling for information from, undertaking inspection, conducting inquiries and audits
of the stock exchanges, mutual funds and other persons associated with the securities
market and intermediaries and self–regulatory organizations in the securities market.
performing such functions and exercising according to Securities Contracts
(Regulation) Act, 1956, as may be delegated to it by the Central Government.
Requirements to become F&O segment member
The eligibility criteria for membership on the F&O segment is as given in Table
7.1. Table 7.2 gives the requirements for professional clearing membership. Anybody
interested in taking membership of F&O segment is required to take membership of
“CM and F&O segment” or “CM, WDM and F&O segment”. An existing member of
CM segment can also take membership of F&O segment. A trading member can also be
a clearing member by meeting additional requirements. There can also be only clearing
members.
Eligibility criteria for membership on F&O segment
Particulars(all values in Rs. Lakh) CM and F&O segment CM, WDM and F&O segmentNet worth 1 100 200Interest free security deposit(IFSD) 2 125 275Collateral security deposit(CSD) 3 25 25Annual subscription 1 2
1: No additional networth is required for self clearing members. However, a networth of
Rs. 300 Lakh is required for TM-CM and PCM.
2 & 3: Additional Rs. 25 Lakh is required for clearing memberships (SCM, TM-CM). In
addition, the clearing member is required to bring in IFSD of Rs. 2 Lakh and CSD of
Rs. 8 Lakh per trading member he undertakes to clear and settle.
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Requirements for professional clearing membership
Particulars F&O Segment CM & F&O Segment
Note: The PCM is required to bring in IFSD of Rs. 2 Lakh and CSD of Rs. 8 Lakh per trading member whose trades he undertakes to clear and settle in the F&O segment.
Requirements to become authorized / approved user
Trading members and participants are entitled to appoint, with the approval of
the F&O segment of the exchange authorized persons and approved users to operate the
trading workstation(s). These authorized users can be individuals, registered partnership
firms or corporate bodies. Authorized persons cannot collect any commission or any
amount directly from the clients he introduces to the trading member who appointed
him. However he can receive a commission or any such amount from the trading
member who appointed him as provided under regulation. Approved users on the F&O
segment have to pass a certification program which has been approved by SEBI. Each
approved user is given a unique identification number through which he will have
access to the NEAT system. The approved user can access the NEAT system through a
password and can change such password from time to time.
Eligibility Trading members of NSE/SEBI registered custodian/recg bank
Trading members of NSE/SEBI registered custodian/recg bank