A Project Report Entitled
“Financial Weapon for Mass Destruction: Derivatives
with special reference to Anand Rathi Securities Ltd.”
SUBMITTED IN PARTIAL FULFILLAMENT FOR AWARD OF POST GRADUATE DIPLOMA IN BUSINESS MANAGEMENT (PGDBM)
Organization Guide: Submitted By:
Abhijeet A.
Marathe
Abhijeet Marathe -08 - 1 - Summer Internship Report
CERTIFICATE
I here by certify that this project report entitled “Financial
Weapon for Mass Destruction: Derivatives” submitted by
Abhijeet A. Marathe to International School of Business &
Media, Bangalore, is a bonafide and original research work
carried out under my guidance and supervision. It is piece of
research of sufficiently high standard to warrant its
submission to college for the award of said diploma.
No part of the thesis has been submitted any degree or
diploma or published in any other form. The assistance and
the help rendered during the course of his investigation in the
form of basic source material and information have been duly
acknowledged.
Abhijeet Marathe -08 - 2 - Summer Internship Report
DECLARATION
I hereby declare that the project report entitled “Financial Weapon
for Mass Destruction: Derivatives” is a bonafide and authentic
work done by me under the guidance of Mr.. The project is
entirely original and not been submitted to any university for the
award of any degree, diploma or any other similar title.
The sources of material & data used in this study have been duly
acknowledged.
Abhijeet Marathe -08 - 3 - Summer Internship Report
ACKNOWLEDGMENT
The completion of project on "Financial Weapon for Mass
Destruction: Derivatives" has given us immense pleasure and
knowledge. We would like to thank , who helped us in each and
every step in completion of this project.
I am greatly indebted to Mr. Nitin Goel (Asst. Manager),
sincerely acknowledge the cooperation of Mr. Vaibhav
Shrivastava (Equity Manager), Anand Rathi Financial Services
Ltd., Nagpur, Who guided us and gave us their valuable time.
We owe our heartiest thank to Mr. Ravindra Maloo (Vice
President, ARSL) who provided us such a platform and guided us
with his valuable information.
We must acknowledge our gratitude towards all the employees of
ARSL for their help and last but not the least, to all our family
members and friends for their constant help and support.
Abhijeet Marathe -08 - 4 - Summer Internship Report
OBJECTIVE OF SUMMER INTERNSHIP
The objective with which I undertook this internship is mentioned as follows:
To observe the processes, methods and system followed in the organisation
to achieve its aim.
To understand the organisational processes, organisational hierarchy,
organisational goals, communication channels in the particular organisation.
To get a hands-on experience of the corporate world.
To undertake a project and get a practical exposure of any financial sector.
To acquire thorough knowledge base on a particular subject.
To learn various pre requisite qualities expected of a manager.
Abhijeet Marathe -08 - 5 - Summer Internship Report
COMPANY PROFILE
Overview
ANAND RATHI is a premier integrated financial services provider, and ranked among
the top five in South Asia in all its business segments, services over 200 thousands
individual investors in various capacities, and provides investor services to over 300
corporate. ANAND RATHI covers the entire spectrum of financial services such as
Stock broking, Depository Participants, Distribution of financial products - mutual
funds, bonds, fixed deposit, equities, Insurance Broking, Commodities Broking,
Personal Finance Advisory Services, Merchant Banking & Corporate Finance,
placement of equity, IPOs, among others. ANAND RATHI has a professional
management team and ranks among the best in technology, operations and research
of various industrial segments.
Anand Rathi – Early DaysAnand Rathi is a leading full service securities firm providing the entire gamut of
financial services. The firm, founded in 1994 by Mr. Anand Rathi, today has a pan
India presence as well as an international presence through offices in Dubai and
Bangkok. AR provides a breadth of financial and advisory services including wealth
management, investment banking, corporate advisory, brokerage & distribution of
equities, commodities, mutual funds and insurance, structured products - all of which
are supported by powerful research teams.
The firm's philosophy is entirely client centric, with a clear focus on providing long
term value addition to clients, while maintaining the highest standards of excellence,
ethics and professionalism. The entire firm activities are divided across distinct client
groups: Individuals, Private Clients, Corporate and Institutions and was recently
Abhijeet Marathe -08 - 6 - Summer Internship Report
ranked by Asia Money 2006 poll amongst South Asia's top 5 wealth managers for the
ultra-rich.
In year 2007 Citigroup Venture Capital International joined the group as a financial partner.
Name: Abhijeet Marathe
Course: PGPBM
Year of Passing: 2009
Project Title: Financial Weapon For Mass Destruction: Derivatives
Subject: Finance
Project Type: Summers
EXECUTIVE SUMMARY
Abhijeet Marathe -08 - 7 - Summer Internship Report
I undertook my summer Internship with Anand Rathi Stock Broking Ltd. ANAND
RATHI is a premier integrated financial services provider, and ranked among the top
five in the country in all its business segments, services over 16 million individual
investors in various capacities, and provides investor services to over 300 corporate.
ANAND RATHI covers the entire spectrum of financial services such as Stock
broking, Depository Participants, Distribution of financial products - mutual funds,
bonds, fixed deposit, equities, Insurance Broking, Commodities Broking, Personal
Finance Advisory Services, Merchant Banking & Corporate Finance, placement of
equity, IPOs, among others.
I got an opportunity to work on project titled “Financial Weapon for Mass Destruction:
Derivative”.
ANAND RATHI GROUP COMPANIES
Abhijeet Marathe -08 - 8 - Summer Internship Report
Anand Rathi is a leading full service securities firm providing the entire gamut of
financial services. The firm, founded in 1994 by Mr. Anand Rathi, today has a pan
India presence as well as an international presence through offices in Dubai and
Bangkok. AR provides a breadth of financial and advisory services including wealth
management, investment banking, corporate advisory, brokerage & distribution of
equities, commodities, mutual funds and insurance, structured products - all of which
are supported by powerful research teams.
The firm's philosophy is entirely client centric, with a clear focus on providing long
term value addition to clients, while maintaining the highest standards of excellence,
ethics and professionalism. The entire firm activities are divided across distinct client
groups: Individuals, Private Clients, Corporate and Institutions and was recently
ranked by Asia Money 2006 poll amongst South Asia's top 5 wealth managers for the
ultra-rich.
In year 2007 Citigroup Venture Capital International joined the group as a financial
partner.
Milestones:
1994: Started activities in consulting and Institutional equity sales with staff of 15
1995: Set up a research desk and empanelled with major institutional investors
1997: Introduced investment banking businessesRetail brokerage services launched
1999:
Lead managed first IPO and executed first M & A deal
2001: Initiated Wealth Management Services
2002: Retail business expansion recommences with ownership model
Abhijeet Marathe -08 - 9 - Summer Internship Report
2003:
Wealth Management assets cross Rs1500 crores
Insurance broking launched
Launch of Wealth Management services in Dubai
Retail Branch network exceeds 50
2004:
Commodities brokerage and real estate services introduced
Wealth Management assets cross Rs3000crores
Institutional equities business re launched and senior research team put in
place
Retail Branch network expands across 100 locations within India
2005:
Real Estate Private Equity Fund Launched
Retail Branch network expands across 200 locations within India
2006:
AR Middle East, WOS acquires membership of Dubai Gold & Commodity
Exchange (DGCX)
Ranked amongst South Asia's top 5 wealth managers for the ultra-rich by
Asia Money 2006 poll
Ranked 6th in FY2006 for All India Broker Performance in equity distribution
in the High Net worth Individuals (HNI) Category
Ranked 9th in the Retail Category having more than 5% market share
Completes its presence in all States across the country with offices at 300+
locations within India
2007:
Citigroup Venture Capital International picks up 19.9% equity stake
Retail customer base crosses 200 thousand
Establishes presence in over 450 locations
Abhijeet Marathe -08 - 10 - Summer Internship Report
SWOT Analysis (Strength, weakness, opportunities & threats)
Anand Rathi Core strengths:
Breadth of Services
In line with its client-centric philosophy, the firm offers to its clients the entire spectrum of financial services ranging from brokerage services in equities and commodities, distribution of mutual funds, IPOs and insurance products, real estate, investment banking, merger and acquisitions, corporate finance and corporate advisory.
Clients deal with a relationship manager who leverages and brings together the product specialists from across the firm to create an optimum solution to the client needs.
Management Team
AR brings together a highly professional core management team that comprises of individuals with extensive business as well as industry experience.
In-Depth Research
Our research expertise is at the core of the value proposition that we offer to our clients. Research teams across the firm continuously track various markets and products. The aim is however common - to go far deeper than others, to deliver incisive insights and ideas and be accountable for results.
Weakness:
1) Motivational Forces
The motivational factors to the greater extent were missing in the organization. There
was not much of motivation provided to most of the employee base. The method that
was followed to encourage the employees to improve there performance was more
Abhijeet Marathe -08 - 11 - Summer Internship Report
inclined towards the fear of not missing on there targets particularly in context of sales
and marketing people.
2) Knowledge
There were handful of people who had high level of knowledge about Derivatives.
Anand Rathi group should arrange training sessions for their employees.
Opportunities:1) Huge Client Base
There are great opportunities for the Anand Rathi employees to generate the
targeted business because they have large cliental in central India.
2) Awareness in Retail Segment
Continuously rising awareness about the market and derivatives in retail segment is
beneficial for the firm as they don’t have to educate clients about the business.
3) Strong Growing Economy
Because of the strong growing economy, Indian market became fundamentally strong
and Foreign institutional investors also find it beneficial to invest in Indian Market.
Threats: 1) Cut throat Competition:
There is a cut throat competition amongst the broking houses for the acquisition of
clients. This has increased the client switchovers from one broking house to another
because of the additional services from other broking houses.
2) Decreasing Brokerages:
Broking houses mainly work for generating brokerage through equity markets.
Nowadays it is not as easy as it was because each broking house is decreasing its
brokerage levels to acquire more clients. Because of this employees have to work
more to generate the same amount of brokerage.
Abhijeet Marathe -08 - 12 - Summer Internship Report
COPS Analysis (culture ,organization ,people ,system)
During the six months internship, I got many opportunities to interact with the
employees as well as other interns from different institutions, who had joined the
organization with me, which gave a lot of opportunity to understand more about the
various organizational processes in the Company. The overall environment in the
office was very friendly.
During the period of my internship I observed the various
organizational processes taking place at the work place.
Some of these were based on my own experiences and
others were the observations as an independent observer.
The various organizational processes observed in the
company were as follows:
As I observed that stock trading involves the sentiments and emotions of the people.
The traders were very focused on their job and hardly had the time to gauge on
other’s emotions. The trading section required just to give the requisite services to the
client but the PR department needed to chase the clients and had the targets to be
achieved on a regular basis. So the trading section people were more or less involved
in providing services in their responsibility areas. Whereas in the PR department was
more concerned to chasing the targets.
At the time of my internship, there were some students perusing their internship in the
PR department on the same project and under some other guide. The first step in the
project was collecting the data. I was supposed to collect at least database of 15
people in a day without fail. In case of any default the students were required to get
the pending databases the next day. This attitude towards the interns encouraged
Abhijeet Marathe -08 - 13 - Summer Internship Report
them to avoid the reporting heads to the extend possible. Many of them switched over
their profiles and guides.
On the other hand at the trading section did not required too much of reviewing and
also the clients had little grievances from them, so the employees in this section were
more relaxed and satisfied with their work and work environment.
Thankfully no such thing happened with me. My guide Mr. was a very cooperative
man. He always encouraged me to ask any doubts and suggested me to do self
study. He never demotivated me. He understood that I was keen on learning many
things about the market and the companies, so he always focused on discussing all
the issues which otherwise not dealt properly with would have discouraged me from
thinking of going ahead with finance. I even observed that when markets soared
high, he would encourage and cheer the trading staff for their job. Many times the
juniors came with their problems and he handled them with utmost detail and
concern.
Communication Process
The communication process happening in the organization was very direct and
informal. The seniors and subordinates communicated directly to each other. The
bosses and other staff members were very approachable even to the interns. I
was accompanied by six of my class mates in the same project, so we were
pretty comfortable with ourselves as a team. We were initially introduced to all
the employees of the trading department as the interns for the coming two
months and all were requested to provide all support that was needed.
The trading hours of the Stock markets are till 3.30 in the afternoon, so
employees are usually free in the evening hours, which gave me a huge
opportunity to have long discussion with my boss and other member of the staff,
which definitely added to my learning during the internship.
Abhijeet Marathe -08 - 14 - Summer Internship Report
Apart from this also most of the communication like reporting, problems etc
happened directly. Nobody could even get a clue about the designation of the
people based on the communication pattern followed in the company. When
market was in a better condition, there would be lot of cheerfulness in the
environment, where everybody would be discussing about the profit their clients
have made. Just the reverse situation happens when there is a down trend in
market. The environment would be tensed. Senior employees shouting at the
traders or the juniors for not taking due care about it. A lot of analysis as well as
instruction is given through word of mouth.
Even most of the clients used to order directly to the personal relations
department either through telephone or meeting in person.
Interaction Influence Process
The intra departmental interaction was pretty smooth in terms of conveying the
ideas to the administrative heads of the one department. My most of the time
went away in the Trading Section and so every discussion regarding the internal
problems, decision etc happened only after the market hours i.e. 3.30 pm. The
jobs in this particular department were so divided that everyone was given a
different responsibility, which did not required much of interference by others.
One of the phenomenon's that I observed in the company was that if there was a
minor problem in the working in any section then all the employees will assemble
and discuss the issue may be accompanied by the branch coordinator or
technical support manager. So, every one was willing to support and help in the
issues which may not be pertaining to their function directly. As far as influencing
the decisions of the top management is concerned the employees were given
enough autonomy to work in their own way, so I did not came across any such
incidence where the middle level were forced into something.
Abhijeet Marathe -08 - 15 - Summer Internship Report
Decision Making Process:
The decision-making process was carried out in a top down hierarchy. The
company head office is situated in Bangalore and all the decisions are taken there
and later on communicated to the branch offices. For example if the stock market
crashed severely in a span of very short duration, which will cause a default for
margin for various brokerage houses. To access the position of its clients, the HO
will decide to call off the trading across all offices in the country on open market
day.
The decisions like recruitment, training, business development etc. were delegated at
the branch level. The head of the respective department would take a call on such
issues. The decision pertaining to the limits offered to the clients were taken by the
senior staff and some of the decisions were further delegated to the junior staff. At the
time of my internship, all the interns were give a basic training seven days; this
training was managed and guided by the most junior staff of the company. They
decided the schedule of training based on the availability of the trainer etc.
Goal Setting Process:
There was hardly any goal activity happening in company. The organization is
quite bureaucratic in nature. In fact I did not found any instance where the
employees were ever reminded of the company objectives or goals leave apart
the setting of the goals. The work atmosphere was too casual. The employees
use to just dispose off their responsibilities, doing only what is required with no
connection to the goals or objectives of the company at large. I could not see any
intensity in the work done by the employees there.
This is in particular to the trading section that there was no incentive for
performance and no punishment for underperformance. And at the Personal
Relations department, the Sales and Marketing executives had their own targets,
which were decided by the management, and most of them followed a similar
style of working. This also suggested that the employees had lackadaisical
Abhijeet Marathe -08 - 16 - Summer Internship Report
attitude towards the work, though they had performance incentives for their better
performance. The sales people used to compete against each other, which lead
to hiding of information from each other. I don’t know whether it was positive or
negative for the company.
Control Process
No importance was given to any control process in the marketing department.
The things used to be ignored till the time they became a problem. The decisions
were taken on ad-hoc basis and no proper planning was one on these fronts. In
the initial phase of internship, the interns were given training but it was carried out
in a completely haphazard manner. On the other hand in the in the trading section
most of the control was exercised through the technological systems. For all the
important parameters the systems were in place. For example the computer
software would generate the limits available in each client’s account on a day to
day basis. In case the limit fell below a certain limit the system gave alert for the
same. In case of purchase of shares in the account of client who had inadequate
balance in his account, the delivery was his shares were always given only after
the payment was collected.
Performance characteristics
The performance characteristics that were classifiable were mostly result
oriented. There were some concrete parameters defined for each profile. The
employees had to perform well along these parameters to get a positive
performance rating. For the sales people it was there monthly, half yearly and
yearly targets. For dealers it was about getting business of five times their own
salary. So, these parameters ensured the productive of the employees.
The quality of work done could be rated as above average because the
performance parameters were pre-determined so every employee had too
achieve this bare minimum level of standards and these standards were pretty
realistic and achievable.
Abhijeet Marathe -08 - 17 - Summer Internship Report
The absenteeism was quite low as the work was not too hectic or rigorous.
Expect for the markets most of the staff could move in and out of the office. No
strict control over the office in and out time was exercised. The trading section
staff would reach office before the markets open without fail and worked till late
evening without fail. The marketing and sales staff would usually come bit late in
the morning but the kind of there job did not allowed them to have a fixed off time
from the job.
As stated earlier the work environment was such that no one valued time and
punctuality. I never observed that anybody cared about any sort of deadlines, in
fact most of the time there were no deadlines either. So, definitely there was a lot
of wastage of time. Apart from the time factor, other resources were utilized with
minimal wastage.
PROBLEMS FACED DURING THE INTERNSHIP
The initial problem faced by me was my complete ignorance about the stock market.
Moreover when I was given this project on Derivatives, I was not able to understand
even a bit of it. I used to go through a lot of books. Most of the book’s language was
not properly understood by me. I felt that I was getting nowhere. The theories and
what in practicality I was asked to do in derivatives was completely different. Later on
I found that the theories are for supporting the assumptions taken. Everything has
logic to it. My guide helped me to look at these issues from a very rational point of
view.
Another problem faced was that there were a lot of mathematical calculations and
statistical tools to be used in the derivatives or even the mutual funds comparison.
Every term had different computations given in different books or from different net
based tutorials. It really confused many times till they were discussed before my guide
and other team mates.
Abhijeet Marathe -08 - 18 - Summer Internship Report
.
LEARNING AND EXPERIENCE
I was able to learn and experience a lot of things during the period of my internship at
ANAND RATHI. These learning were not only restricted to the responsibilities that I
handled but also in terms of the interaction patterns that happen within the
organization.
Knowledge about the Financial Markets
Prior to my summer training, I had zilch knowledge on financial markets. But by
undergoing this training I got to know many things in greater clarity and detail about
how the markets operate, how derivatives are used with calculated risk, what are the
jobs of the equity managers, what all tools and techniques backed by theories exist.
Investment Principle
I got my first practical knowledge on finance and that too on investments. I learnt that
it is risk and reward that any investor will take into consideration before parting away
with his money. Before designing or planning anything for the client one needs to
gauge upon the client’s risk taking ability and risk tolerance. Therefore in Anand Rathi
whenever a new client is approached they first try to canalize the client and
Abhijeet Marathe -08 - 19 - Summer Internship Report
understand his need and expectation form his investments. Only them they decide
what better avenues are open for the client.
Teamwork
The importance of forming self managed teams and getting the work done through a
proper channel was one of my most important learning.
Your work matters at the end of the day.
When my guide knew about my suffering owing to my ignorance on this subject and
being badly handled by my teammates, he came to my rescue. He gave lot of god
advices. He said that at the end of the day what matters is your work and contribution
towards the objective. He said that management in its real sense is getting one’s work
done either by hook or crook. Though he cleared that crook doesn’t mean unethical
practices all the way. One needs to focus on the objective rather than get disturbed by
the obstacles in the way. He encouraged me to quench my inquisitiveness, even
though that might be trivial for all others.
I learned to be patient, tactful and perseverance
All through this project, I learnt the basic aspects that were missing on my part. Earlier
I used to be impatient when my efforts were not given due recognition. But when I
worked here, I learnt that patience is very important in this field. At one point of time
you may be gaining by the increased prices of your shares or assets and at another
time you may be losing all the money you have. So, one needs to strike a balance
between sudden gain and loss. My interactions with my teammates made me more
tactful in delivering what I am supposed to convey and what I am not supposed to
convey in the corporate world where we have to first perceive the thin line of
competition and collaboration. And perseverance is something that every one of us
has to develop in order to strive in volatile tempered industry like Anand Rathi or so to
say any stock broking firm.
Abhijeet Marathe -08 - 20 - Summer Internship Report
Abhijeet Marathe -08 - 21 - Summer Internship Report
INTRODUCTION OF DERIVATIVES
Derivative is a product whose value is derived from the value of one
or more basic variables, called underlying. The underlying asset can be
equity, index, foreign exchange (forex), commodity or any other asset.
Derivative products initially emerged as hedging devices against fluctuations
in commodity prices and commodity-linked derivatives remained the sole
form of such products for almost three hundred years. The financial
derivatives came into spotlight in post-1970 period due to growing instability
in the financial markets. However, since their emergence, these products have
become very popular and by 1990s, they accounted for about two thirds of
total transactions in derivative products.
Definition:
In the Indian context the Securities Contracts (Regulation) Act, 1956
(SC(R) A) defines “derivative” as:
"A contract, which derives its value from the prices or index of prices,
of underlying securities."
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”.
Abhijeet Marathe -08 - 22 - Summer Internship Report
Derivatives are securities under the SC(R) A and hence the regulatory
framework under the SC(R) A governs the trading of derivatives.
Emergence of Derivatives Market
Starting from a controlled economy, India has moved towards a world where
prices fluctuate every day.
The introduction of risk management instruments in India gained momentum
in the last few years due to liberalization process and Reserve Bank of India's
(RBI) efforts in creating currency forward market.
Derivatives are an integral part of liberalization process to manage risk.
NSE gauging the market requirements initiated the process of setting up
In July 1999, derivatives trading commenced in India.
1991 Liberalization process initiated
14-Dec-95NSE asked SEBI for permission to trade index
futures.
18-Nov-96SEBI setup L.C.Gupta Committee to draft a
policy framework for index futures.
11-May-98 L.C.Gupta Committee submitted report.
07-Jul-99RBI gave permission for OTC forward rate
agreements (FRAs) and interest rate swaps.
24-May-00SIMEX chose Nifty for trading futures and
options on an Indian index.
Abhijeet Marathe -08 - 23 - Summer Internship Report
25-May-00SEBI gave permission to NSE and BSE to do
index futures trading.
09-Jun-00Trading of BSE Sensex futures commenced at
BSE.
12-Jun-00 Trading of Nifty futures commenced at NSE.
25-Sep-00 Nifty futures trading commenced at SGX.
02-Jun-01 Individual Stock Options & Derivatives
Milestones
Emergences of Derivatives
Derivative Markets in India
Trading takes place either on a separate and independent Derivative
Exchange or on a separate segment of an existing Stock Exchange.
Derivative Exchange or segment operates as a self regulatory
Securities and Exchange Board of India (SEBI) acts as the guardian.
Clearing & settlement of all derivative trades made on a Derivative
Exchange or Segment are done through a Clearing Corporation - an
independent body set to act as a regulatory.
Types of Derivatives
Abhijeet Marathe -08 - 24 - Summer Internship Report
Forwards: A forward contract is a customized contract between two
entities, where settlement takes place on a specific date in the future at
today’s pre-agreed price.
Futures: A futures contract is an agreement between two parties to buy or
sell an asset at a certain time in the future at a certain price. Futures contracts
are special types of forward contracts in the sense that the former are
standardized exchange-traded contracts, such as futures of the Nifty index.
Options: An Option is a contract, which gives the right, but not an
obligation, to buy or sell the underlying at a stated date and at a stated price.
While a buyer of an option pays the premium and buys the right to exercise
his option, the writer of an option is the one who receives the option premium
and therefore obliged to sell/buy the asset if the buyer exercises it on him.
Options are of two types - Calls and Puts options:
‘Calls’ give the buyer the right, but not the obligation to
buy a given quantity of the underlying asset at a given price
on or before a given future date.
‘Puts’ give the buyer the right, but not the obligation to sell
a given quantity of underlying asset at a given price on or
before a given future date.
Warrants: Options generally have lives of up to one year. The majority of
options traded on exchanges have maximum maturity of nine months. Longer
dated options are called Warrants and are generally traded over-the counter.
Abhijeet Marathe -08 - 25 - Summer Internship Report
Baskets: Basket options are options on portfolios of underlying assets. The
underlying asset is usually a moving average of a basket of assets. Equity
index options are a form of basket options.
Swaps: Swaps are private agreements between two parties to exchange cash
flows in the future according to a prearranged formula. They can be regarded
as portfolios of forward contracts. The two commonly used swaps are:
Interest rate swaps: These entail swapping only the interest
related cash flows between the parties in the same currency.
Currency swaps: These entail swapping both principal and
interest between the parties, with the cash flows in one direction
being in a different currency than those in the opposite direction.
(London interbank offered rate)
Participants
Three broad categories of participants - hedgers, speculators, and
arbitrageurs - trade in the derivatives market.
Hedgers face risk associated with the price of an asset. They use futures or
options markets to reduce or eliminate this risk.
Speculators wish to bet on future movements in the price of an asset.
Futures and options contracts can give them an extra leverage; that is, they
can increase both the potential gains and potential losses in a speculative
venture.
Abhijeet Marathe -08 - 26 - Summer Internship Report
Arbitrageurs are in business to take advantage of a discrepancy between
prices in two different markets. If, for example, they see the futures price of
an asset getting out of line with the cash price, they will take offsetting
positions in the two markets to lock in a profit.
Commodity derivatives market
Commodity derivatives market trade contracts for which the underlying asset
is commodity. It can be an agricultural commodity like wheat, soybeans,
cotton, etc or precious metals like gold, silver, etc.
Difference between Commodity and Financial
derivatives
The basic concept of a derivative contract remains the same whether the
underlying happens to be a commodity or a financial asset. However there are
some features, which are very peculiar to commodity derivative markets.
In the case of financial derivatives, most of these contracts are cash
settled. Even in the case of physical settlement, financial assets are
not bulky and do not need special facility for storage.
Due to the bulky nature of the underlying assets, physical settlement
in commodity derivatives creates the need for warehousing.
The concept of varying quality of asset does not really exist as far as
financial underlings are concerned.
Abhijeet Marathe -08 - 27 - Summer Internship Report
However in the case of commodities, the quality of the asset
underlying a contract can vary at times.
Exchange-traded vs. OTC derivatives markets
Derivatives that trade on an exchange are called exchange-traded
derivatives, whereas privately negotiated derivative contracts are called OTC
(Over the Counter) contracts. The OTC derivatives markets have witnessed
rather sharp growth over the last few years, which have accompanied the
modernization of commercial and investment banking and globalization of
financial activities. The recent developments in information technology have
contributed to a great extent to these developments. While both exchange-
traded and OTC derivative contracts offer many benefits, the former have
rigid structures compared to the latter.
The OTC derivatives markets have the following features compared to
exchange-traded derivatives:
1. The management of counter-party (credit) risk is decentralized and
located within individual institutions,
2. There are no formal centralized limits on individual positions,
leverage, or margining,
3. There are no formal rules for risk and burden sharing,
4. There are no formal rules or mechanisms for ensuring market stability
and integrity, and for safeguarding the collective interests of market
participants.
Abhijeet Marathe -08 - 28 - Summer Internship Report
5. A regulatory authority and the exchange’s self-regulatory
organization do not regulate the OTC contracts, although they are
affected indirectly by national legal systems, banking supervision and
market surveillance.
Exchange traded Vs. OTC Market.
Abhijeet Marathe -08 - 29 - Summer Internship Report
NSE’s derivatives market
The derivatives trading on the NSE commenced with S&P CNX Nifty Index
futures on June 12, 2000. The trading in index options commenced on June 4,
2001 and trading in options on individual securities commenced on July 2,
2001. Single stock futures were launched on November 9, 2001.
Today, both in terms of volume and turnover, NSE is the largest derivatives
exchange in India. Currently, the derivatives contracts have a maximum of 3-
month expiration cycles. Three contracts are available for trading, with 1
month, 2 months and 3 months expiry.
Abhijeet Marathe -08 - 30 - Summer Internship Report
F&O Trade Volume index options European options, stck opt-
American opt. euro opt can not be exercised. And American
opt can be.
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, the parties to the contract negotiate price
Abhijeet Marathe -08 - 31 - Summer Internship Report
and quantity bilaterally. 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.
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 counterparty, 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.
Forward contracts are very useful in hedging and speculation. The classic
hedging application would be that of an exporter who expects to receive
payment in dollars three months later. He is exposed to the risk of exchange
rate fluctuations. By using the currency forward market to sell dollars
forward, he can lock on to a rate today and reduce his uncertainty. Similarly
an importer who is required to make a payment in dollars two months hence
can reduce his exposure to exchange rate fluctuations by buying dollars
forward. If a speculator has information or analysis, which forecasts an
upturn in a price, then he can go long on the forward market instead of the
cash market. The speculator would go long on the forward, wait for the price
to raise, and then take a reversing transaction to book profits.
Limitations of forward markets
Abhijeet Marathe -08 - 32 - Summer Internship Report
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.
Futures
Futures markets were designed to solve the problems that exist in
forward 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
Abhijeet Marathe -08 - 33 - Summer Internship Report
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 forwards
Futures vs. Forwards
Sr. No. Futures Forwards
Abhijeet Marathe -08 - 34 - Summer Internship Report
1. Trade on an organized
exchange
OTC in nature
2. Standardized contract terms Customized contract
3. Terms more liquid Less liquid
4. Requires margin payments No margin payment
5. Follows daily settlement Settlement happens at
end of period
Futures terminology
Spot price: The price at which an asset trades in the spot market.
Futures price: The price at which the futures contract trades in the
futures market.
Abhijeet Marathe -08 - 35 - Summer Internship Report
Contract cycle: The period over which a contract trades. The
index futures contracts on the NSE have one-month, two-months and
three-month expiry cycles, which expire on the last Thursday of the
month.
Expiry date: It is the date specified in the futures contract. This is
the last day on which the contract will be traded, at the end of which it
will cease to exist.
Contract size: The amount of asset that has to be delivered less
than one contract. For instance, the contract size on NSE’s futures
market is 50 Nifties.
Basis: In the context of financial futures, basis can be defined as the
futures price minus the spot price. There will be a different basis for
each delivery month for each contract. In a normal market, basis will
be positive. This reflects that futures prices normally exceed spot
prices.
Cost of carry: The relationship between futures prices and spot
prices can be summarized in terms of what is known as the cost of
carry. This measures the storage cost plus the interest that is paid to
finance the asset less the income earned on the asset.
Initial margin: The amount that must be deposited in the margin
account at the time a futures contract is first entered into is known as
initial margin.
Abhijeet Marathe -08 - 36 - Summer Internship Report
Marking-to-market: In the futures market, at the end of each
trading day, the margin account is adjusted to reflect the investor’s
gain or loss depending upon the futures closing price. This is called
marking–to–market.
Maintenance margin: This is somewhat lower than the initial
margin. This is set to ensure that the balance in the margin account
never becomes negative. If the balance in the margin account falls
below the maintenance margin, the investor receives a margin call and
is expected to top up the margin account to the initial margin level
before trading commences on the next day.
Options
Options are fundamentally different from forward and futures
contracts. An option gives the holder of the option the right to do something.
The holder does not have to exercise this right.
In contrast, in a forward or futures contract, the two parties have committed
themselves to doing something. Whereas it costs nothing (except margin
Abhijeet Marathe -08 - 37 - Summer Internship Report
requirements) to enter into a futures contract, the purchase of an option
requires an up–front payment.
Option terminology
Index options: These options have the index as the underlying. Some
options are European while others are American. Like, index futures
contracts, index options contracts are also cash settled.
Stock options: Stock options are options on individual stocks. Options
currently trade on over 500 stocks in the United States. A contract gives the
holder the right to buy or sell shares at the specified price.
Buyer of an option: The buyer of an option is the one who by paying the
option premium buys the right but not the obligation to exercise his option on
the seller/writer.
Writer of an option: The writer of a call/put option is the one who
receives the option premium and is thereby obliged to sell/buy the asset if the
buyer exercises on him.
Call option: A call option gives the holder the right but not the obligation
to buy an asset by a certain date for a certain price.
Put option: A put option gives the holder the right but not the obligation to
sell an asset by a certain date for a certain price.
Abhijeet Marathe -08 - 38 - Summer Internship Report
Option price/premium: Option price is the price, which the option
buyer pays to the option seller. It is also referred to as the option premium.
The option premium can be broken down into two components:-
Intrinsic value: - The option premium can be broken down into
two components – intrinsic value and time value. The intrinsic value
of a call is the amount the option is ITM, if it is ITM. If the call is
OTM, its intrinsic value is zero.
Time value: - The time value of an option is the difference
between its premium and its intrinsic value
Expiration date: The date specified in the options contract is known as
the expiration date, the exercise date, the strike date or the maturity.
Strike price: The price specified in the options contract is known as the
strike price or the exercise price.
American options: American options are options that can be exercised at
any time up to the expiration date. Most exchange-traded options are
American.
European options: European options are options that can be exercised
only on the expiration date itself. European options are easier to analyze than
American options, and properties of an American option are frequently
deduced from those of its European counterpart.
In-the-money option: An in-the-money (ITM) option is an option that
would lead to a positive cash flow to the holder if it were exercised
Abhijeet Marathe -08 - 39 - Summer Internship Report
immediately. A call option on the index is said to be in-the-money when the
current index stands at a level higher than the strike price (i.e. spot price >
strike price).
At-the-money option: An at-the-money (ATM) option is an option that
would lead to zero cash flow if it were exercised immediately. An option on
the index is at-the-money when the current index equals the strike price (i.e.
spot price = strike price).
Out-of-the-money option: An out-of-the-money (OTM) option is an
option that would lead to a negative cash flow, it were exercised
immediately. A call option on the index is out-of-the-money when the current
index stands at a level, which is less than the strike price (i.e. spot price <
strike price).
Futures and options
An interesting question to ask at this stage is - when would one
use options instead of futures?
Options are different from futures in several interesting senses. At a practical
level, the option buyer faces an interesting situation. He pays for the option in
Abhijeet Marathe -08 - 40 - Summer Internship Report
full at the time it is purchased. After this, he only has an upside. There is no
possibility of the options position generating any further losses to him (other
than the funds already paid for the option). This is different from futures,
which is free to enter into, but can generate very large losses. This
characteristic makes options attractive to many occasional market
participants, who cannot put in the time to closely monitor their futures
positions. Buying put options is buying insurance. To buy a put option on
Nifty is to buy insurance, which reimburses the full extent to which Nifty
drops below the strike price of the put option. This is attractive to many
people, and to mutual funds creating “guaranteed return products”.
Distinction between futures and options
Futures vs. Options
Abhijeet Marathe -08 - 41 - Summer Internship Report
Sr. No. Futures Options
1. Exchange traded, with
novation
Same as futures
2. Exchange defines the product Same as futures
3. Price is zero, strike price
moves
Strike price is fixed,
price moves
4. Price is zero No margin payment
5. Both long and short at risk Only short at risk.
RESEARCH
The term research can be defined as “A Scientific and systematic search for
pertinent information on a specific topic.” A research is a careful
investigation or inquiry especially through search for new fact in branch of
knowledge. It is an increase in the existing stock of knowledge making for
advancement.
We decided to do the project in two parts. The first part of the project is
comprised of the brief detail of stock exchange i.e. BSE and NSE and their
Abhijeet Marathe -08 - 42 - Summer Internship Report
indices and the second part deals with the study of Derivative market and its
instruments.
The first part of the project i.e. stock exchange gives a very short detail about
the role of exchange, Bombay Stock exchange and National Stock Exchange.
There is also a short description of Sensex and about Nifty 50. It also has the
list of companies, which has a major impact over these indices.
The second part of the project is about Derivatives. Indian stock market has
undergone tremendous changes over the years. The derivative market has its
own dynamics. So we tried to cover the introductory part of Derivatives. It
covers the definition, types and the other basic details about it.
SOURCE OF DATA COLLECTION
Primary Data: - is the first hand information collected directly from the
employees of ARSL. They explained us the basics of Derivative market and
also shared their experience with their F&O clients.
Secondary Data: - is collected through Internet and Books
Abhijeet Marathe -08 - 43 - Summer Internship Report
SUGGESTIONS
The study done was a tool to study the Derivative market's setup and to know
WORKING OF A Brokerage firm. The study proved fruitful and many facts
came into light. Following are some of the recommendations for ARSL:
ARSL should provide recreation facility to their employees.
Abhijeet Marathe -08 - 44 - Summer Internship Report
ARSL should organize some promotional campaigns for making
people aware about Derivatives.
They can also arrange some training and educational programs for
their employees.
BIBLIOGRAPHY
BOOKS:
Financial Management: I M Pandey.
NCFM's Derivatives Market Module: NSE
Abhijeet Marathe -08 - 45 - Summer Internship Report
WEBSITES:
www.rathi.com
www.derivativesIndia.com
www.bseindia.com
www.nseindia.com
www.moneycontrol.com
www.valueresearchonline.com
Abhijeet Marathe -08 - 46 - Summer Internship Report