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PROJECT REPORT ON ANALYSIS OF investors perception towards DERIVATIVES AS AN INVESTMENT STRATEGY

Submitted in partial fulfillment of the requirement of the degree course of Master of Business Administration (2011-2013) from Desh Bhagat Institute Of Management affiliated to Punjabi University Patiala
PROJECT GUIDE :Mr. DAKSH BANSAL SUBMITTED BY:HARDEV SINGH

AWARDED AS THE BEST BROKERAGE FIRM IN INDIA FOR 2012

ACKNOWLEDGEMENT
A project report is never the sole product of the person whose name appears on the cover. There are always some people who guidance proves to be an immense help in giving its final shape so; it become my first duty to express my gratitude towards all of them. I am thankful to MR.DAKSH BANSAL (Manager Online) for giving me his kind permission to carry out SUMMER TRANING in the organization. I feel especially privileged to work under their kind supervision. He guided me at every step to make my project a real masterpiece. My heartfelt gratitude to my respected faculty without their continuous help the project would not have been materialised in the present form. Their valuable suggestions helped me at every step. I am also grateful to our institute DESH BHAGAT for providing me a platform and opportunity to do work in the field of management.

PREFACE
Practical training constitutes an integral part of the management studies. Training gives opportunities to the students to expose themselves to the industrial environment, which is quite different from the classroom teaching. One can not rely merely upon theoretical knowledge. It has to be coupled with practical for it to be fruitful. Classroom lecture make the fundamentals concept of management clear but not their application in actual practice. Positive and corrective results of classroom learning need realities of practical situation. The training also enables the management students to themselves see the working condition under which they have to work in future. It thus enables the students to undergo those experiences, which will help them later when they join the organisation. It is in this sense that practical training in the company has a significant role to play in the subject of management for developing managerial and administrative skills in the future managers and to enhance their analytical skills. I received my training in KOTAK SECURITIES at Chandigarh. It was my fortune to get training in a very healthy atmosphere. I learnt a lot of new things which I could never been learnt from theory classes.

CERTIFICATION OF COMPLITION
This is to certify that Mr. Hardev Singh, a student of Master of Business Administration, Desh Bhagat Institute of Management, Mandi Gobindgarh affiliated to Punjabi University; Patiala has worked under my Supervision to complete his Project Report. Analysis of Investors Perception Towards Derivatives As Strategy An Investment

The work done is original and out come of his sincere efforts. I am satisfied with the work done by him and recommend the same to be forward for evaluation.

Declaration
I hereby declare that the final Project Report Analysis of Investors Perception towards Derivatives as an Investment Strategy submitted in partial fulfillment of the award for the degree of Master of Business Administration (MBA) to Desh bhagat Institute Of Management, Mandi Gobindgarh (Approved by A.I.C.T.E New Delhi, Affiliated to Punjabi University, Patiala), is one of my original work and not submitted to any other Degree/Diploma, fellowship or other similar title. Name:- Hardev Singh

CONTENTS
Serial No. Contents Page No 1 Introduction To Kotak Group 7 11 2 Introduction To Kotak 12 29 3 4 5 6 7 8 9 10 11 12 13 Securities Introduction To Derivatives Objectives Of Study Rationale Of Study & Research Methodology Survey Of Literature Analysis Of Study Findings Recommendations Limitations Conclusion Bibliography Questionnaire 30 51 52 53 54 55 64 65 88 89 90 91 92 93 94 95 96

INTRODUCTION
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TO KOTAK GROUP

Kotak Mahindra is one of Indias leading banking and financial services institutions, offering a wide range of financial services that encompass every sphere of life. From commercial banking, to stock broking, to mutual funds, to life insurance, to investment banking, the group caters to the diverse financial needs of individuals and corporate sector. The group has a net worth of over Rs. 100.6 billion and has a distribution network of branches, frenchisees, representative offices and satellite offices across cities and towns in India, and offices in New York, San Fransisco, London, Dubai, Mauritius and Singapore servicing around 8 million customer accounts. Kotak Group products and services: . Bank . Life Insurance . Mutual Fund . Car Finance 7

. Securities . Institutional Equities . Investment Banking . Kotak Mahindra International . Kotak Private Equity . Kotak Reality Fund

KOTAK MAHINDRA BANK Kotak Mahindra Bank Ltd is a one stop shop for all banking needs. The bank offers personal finance solutions of every kind from savings accounts to credit cards, distribution of mutual funds to life insurance products. Kotak Mahindra Bank offers transaction banking, operates lending verticals, manages IPOs and provides working capital loans. Kotak has one of the largest and most respected Wealth Management teams in India, providing the widest range of solutions to high net worth individuals, entrepreneurs, business families and employed professionals.

KOTAK SECURITIES Kotak Securities is one of the largest broking houses in India with a wide geographical reach. Kotak Securities operations include stock broking and distribution of various financial products including private and secondary placement of debt, equity and mutual funds. Kotak Securities operates in five main areas of business: Stock Broking Depository Services Portfolio Management Services Distribution of Mutual Funds Distribution of Kotak Mahindra Old Mutual Life Insurance Ltd Products.

KOTAK MAHINDRA CAPITAL COMPANY Kotak Investment Banking (KMCC) is a full-service investment bank in India offering a wide suite of capital market and advisory solutions to leading domestic and multinational corporations, banks, financial institutions and government companies. Our services encompass Equity & Debt Capital Markets, M&A Advisory, Private Equity Advisory, Restructuring and Recapitalization services, Structured Finance services and Infrastructure Advisory and Fund Mobilization.

KOTAK MAHINDRA ASSET MANAGEMENT COMPANY Kotak Mahindra Asset Management Company offers a complete bouquet of asset management products and services that are designed to suit the diverse risk return profiles of each and every type of investor. KMAMC and Kotak Mahindra Bank are the sponsors of Kotak Mahindra Pension Fund Ltd, which has been appointed as one of six fund managers to manage pension funds under the new pension scheme.

KOTAK MAHINDRA PRIME LTD Kotak Mahindra Prime Ltd is among India's largest dedicated passenger vehicle finance companies. KMPL offers loans for the entire range of passenger cars, multiutility vehicles and pre-owned cars. Also on offer are inventory funding and infrastructure funding to car dealers.

KOTAK PRIVATE EQUITY GROUP Kotak Private Equity Group helps nurture emerging businesses and mid-size enterprises to evolve into tomorrow's industry leaders. With a proven track record of helping build companies, KPEG also offers expertise with a combination of equity capital, strategic support and value added services. What differentiates KPEG is not

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merely funding companies, but also having a close involvement in their growth as board members, advisors, strategists and fund raisers.

KOTAK INTERNATIONAL BUSINESS Kotak International Business specialises in providing a range of services to overseas customers seeking to invest in India. For institutions and high net worth individuals outside India, Kotak International Business offers asset management through a range of offshore funds with specific advisory and discretionary investment management services.

KOTAK REALITY FUND Kotak Realty Fund deals with equity investments covering sectors such as hotels, IT parks, residential townships, shopping centres, industrial real estate, health care, retail, education and property management. The investment focus here is on development projects and enterprise level investments, both in real estate intensive businesses.

KOTAK GROUP TEAM LEADERS

Mr. Uday S. kotak

Executive Vice Chairman and Managing Director

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Mr. C Jayaram
Joint Managing Director

Mr. Deepak Gupta

Joint Managing Director

KOTAK SECURITIES

Originally established in 1994, Kotak Securities is a subsidary of Kotak Mahindra Bank, which services more than 7.4 lakh customers. The firm has a wide network of more than 1400 branches, frenchisees, representatives offices, and satellite offices across 448 cities in India and offices in New York, London, San Fransisco, Dubai, Maritius and Singapore.

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We process more than 400000 trades a day which is much higher than some of the other renowned international brokers. The company is a corporate member of both The Bombay Stock Exchange (BSE) and The National stock Exchange (NSE) of India. Our operations include stock broking services for trading in stock markets through branches and internet and distribution of various financial products including investments in IPOs, Mutual Funds and Currency Derivatives. Currently, Kotak Securities is one of the largest broking houses in India with substential geographical reach to Asia Pecific, Europe, Middle East and America. Kotak Securities Limited has Rs. 1202 crores of Assets Under Management (AUM) as of 31st Dec 2011.

INNOVATORS
We have been the pioneers in providing many products and services which have now become industry standards for stock broking in India. Some of them include: Mobile stock trading application to keep track of your investments even on the go. Facility of Margin Finance to the customers for online stock trading. Investing in IPOs and Mutual Funds on phone. SMS alerts before execution of depository transactions. Auto Invest- A systematic investing plan in equities and Mutual Funds. Provision of margin against securities automatically against shares in your Demat account.

RESEARCH EXPERTISE:
We specialize in Fundamental and Technical analysis backed by a team of highly trained and qualified individuals.

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Our full fledged research division is involved in Macro Economic studies, Sectorial Research and Company Specific Equity Research which publishes in- depth stock market analysis. This is combined with a strong and well networked sales force which helps deliver current and upto date market information and news. We are also a depository participant with National Securities Depositary Limited (NSDL) and Central Depository Services Limited (CDSL). By being a stock broker and depository participant, we provide dual benefit in our services wherein the investors can avail our stock broking services for executing the transactions and the depository services for settling them. Our Portfolio Management Service comes as an answer to those who would like to grow exponentially on the crest of the stock market, with the backing of an expert.

AWARDS:

Best broker in India by FinanceAsia for 2010 & 2009. UTIMF- CNBC TV 18 Financial Advisor Awards- Best Performing Equity Broker (National) for the year 2009. Best brokerage firm in India by Asiamoney in 2010, 2009, 2008, 2007 & 2006. Best Performing Equity Broker in India- CNBC Financial Advisor awards 2008. Avaya Customer Responsiveness Award (2008, 2007 & 2006) in Financial Services Sector. The Leading Equity House in India in Thomson Extel Surveys Awards for year 2007. Euromoney Award (2007 & 2006) Best provider of Portfolio Management Equities. Euromoney Award (2005) Best Equity House in India. Finance Asia Award (2005) Best Broker in India. Finance Asia Award (2004) Indias Best Equity House.

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Most Recent Award

Kotak Securities is awarded as the Best Brokerage Firm of year 2012 by FinanceAsia

Products And Services Offered By Kotak

Account types

Account type package various products and tools based on service levels and customer segments Account types distinguished between Self Reliant and Managed Accounts Service level differentiation which involves structuring and customising offering products and tools as per customer/market segments

Benefits of being a kotak customer

Enjoy convenience and ease while investing in IPO's - through Easy IPO. Trinity Account Open Trading, Demat and Bank account through Kotak Securities Consistent Award Winner

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Our Research Reports on the economy, select industries and companies help you make informed investment decisions while dealing in Equity. Buy and sell stocks on phone using Call & Trade. Access to 16+ mutual fund houses and over 650+ mutual fund schemes through Easy Mutual Fund.

Online account types Gateway AutoInvest Advance Fee Schemes Kotak Privileged Circle Kotak Trader - Saxo Capital Markets Singapore is our business Associate for this Product

Gateway If Customer Needs a Simple Online Trading account Product Offering Online Trading in Equities, derivatives Invest in IPO, Mutual Funds and Debt securities Research Reports , Trading Strategies, customer Service Etc. Sebi Margin Finance

Product Positioning Main/Staple Product Offering of Kotak Securities Self Reliant Service

Gateway Pricing Gateway Pricing has two variants:

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Normal Gateway Turnover Based brokerage Rate From 0.59% to 0.18% for delivery

Gateway Flat Note

Gateway Flat - Flat rate of 0.49% for Delivery irrespective of T/O

Both variants come under the Gateway Umbrella Brand Services offered are the same Account opening Fee of Rs 750/Call n Trade First 20 calls free, Rs 20 from the 21st call onwards

Auto invest If Customer Needs a I need assistance for my investments on Regular basis Product Offering Regular portfolio construction and rebalancing Hence the term Autoinvest Asset classes recommended extend to mutual funds and Gold (ETFs) Tele Sales Individual would advise and churn the customer portfolio based on a model portfolio Model Portfolio suggested post Customer Risk profiling

Product Positioning Assisted/Managed Account service Systematic investing

Product Target Group Salaried class who regularly invest in stock markets Mutual Fund SIP customers Assistance in trading and advisory

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Risk averse investors that seek diversification to Gold Buy and Hold clients

Product Pricing 2% for every Trade Account opening Fee of Rs 750

Note Trades are not placed automatically - Customer consent is required for every execution

Advance fee schemes If Customer Needs a Simple Online Trading account + lower brokerage fee than existing account Types What are Advance Fee Schemes? Customer pays an advance amount upfront Lower brokerage rate is assigned to the customer based on his Chosen period and brokerage rate Brokerage generated during the validity period is reversible up to a maximum of the advance fee

Suppose under Plan A acustomers generates a brokerage of Rs 800 during the validity period, then Rs 800 would be reversed to your account. If the brokerage generated is Rs 4000, then only Rs 1000 is reversible as the Maximum amount reversible is the advance fee. If no brokerage is generated during the validity period the advance fee will not be reversed.

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Positioning Product Genesis Business Advantages Advance fee is collected upfront acts as an assurance of income from the customer

Why Advance Fee Plans? - Sales Pitch Points No Account opening Fee Identify customer Trading potential i.e. existing turnover , brokerage rate and cash outflow capacity Suggest Product based on customers Existing Turnover

Ex Rs 2500 product is ideal for a customer with a T/O of at least Rs 8.33 lacs during the validity period

Advance fee variants

Important : Advance fee variants can be customized based on potential revenue

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Advance Fee variants are automatically renewed at the end of the Validity period Offline and Online have different start date billing cycles. Please read Form for more details %age Incentive is paid to RM on the advance fee collected. So larger the advance fee, the better is the incentive!

Kotak privileged circle If Customer Needs a Pampered Service plus is the customer brings in a Margin of Rs 10,00,000 Product Positioning Premium service offering

Product Offering Same as Gateway except KEAT PRO free Unlimited call and Trade Brokerage Rate starts from 0.18% and then moves as per Gateway Slab

Kotak trader If Customer Needs a I want to trade in International Markets Product Offering Trade in 24 stock exchanges across the world Advance Trading platform

Product Positioning Niche service offering Diversification benefit

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Product Pricing Brokerage rate 0.75% for every Trade each side .However there is a minimum brokerage which differs from exchange to exchange. Hence on any given trade the brokerage would be either the minimum brokerage rate or .75 which ever is higher. Account opening Fee of Rs 750 Minimum Margin to open an Account is $10,000USD Maximum of remittance of $ 200,000 per annum as per RBI guidelines

Account opening process The client can fill in his details on Kotak Securities website, by which he will be contacted by the local RM who will deliver the account opening form to him. The forms will then be sent to account opening team who will carry out the due diligence and then scan the documents to Saxo Singapore. Saxo will then conduct the due diligence and will give the final approval. Saxo contacts the client directly once the account is opened and ready to be funded The account opening team will send the approved original document in batches once every fortnight to Saxo.

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Product Matrix- online

NRI Account

You can do online delivery based trading through our NRI-Trinity Account. This account links your Banking, Demat and Trading account, thus providing you a seamless platform to trade efficiently and conveniently. Avail top class research from our dedicated Research Team that gives you valid, fact based and reliable research inputs on industry trends, sector news, which company scrips to buy, sell or hold and more. You also get detailed reports on Daily Morning Briefs, Stock Ideas, special Reports and access to Kotak Securities News Channel. You can now avail 80% margin against your executed & unbilled delivery marked trades. You also have the facility to trade on both- NSE and BSE. MF and IPO is currently unavailable for NRI's Equip yourself with useful information through the Kotak Securities News Channel. Get detailed news on the Indian stock markets, the Indian

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Charges

Eligibility All Non Resident Indians - NRI / PIO (except minors) residing in Gulf Co-operation Council (GCC) countries of United Arab Emirates, Saudi Arabia, Bahrain, Kuwait, Oman and Qatar can avail of our NRI account services.

CURRENCY DERIVATIVES

Exchange Traded Currency Derivatives In India Exchange Traded Currency Derivatives were Launched in August 2009 after consultation with SEBI and RBI. Exchange allows retail participation in the new segment and hence provides first time access to retail investor in the new asset class. There is no need for underlying exposure to participate in the market. Also there is much higher accessibility, price transparency and liquidity compared to OTC market. In exchange traded Currency Derivatives, standard agreements and processes makes investment hassle free and simple. In Exchange Traded currency Derivatives, higher participation provides better liquidity to the clients

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Why Currency Derivatives ?

Directional Views Positioning for INR appreciation or depreciation Hedging current exposure Importers and exporters can hedge future payables & receivables Borrowers can hedge FCY loans for interest or principal payments Hedge for offshore investment for Resident Indians FIIs and NRIs hedge their investments in India Trade & Capital Flows Remittances for trade or services and capital transactions Arbitrage Arbitrage opportunity for entities who can access onshore and non deliverable forward markets

What are Exchange Traded Currency Derivatives ?

Underlying of contract is rate of exchange between the currency and INR 12 near calendar month contracts available on the market Order driven market similar to equity derivative segment Fixed expiry on the last business day of any month Minimum price fluctuation of 0.25 paise or INR 0.0025 Cash settlement in INR at relevant RBI reference rate of exchange between the currency and INR

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Market timing from 0900 hours to 1700 hours Contract fixing two days prior to Contract Expiration date and settlement on contract expiry date Currencies Available USD INR (Contract size USD 1000) EUR INR (Contract size EUR 1000) GBP INR (Contract size GBP 1000) JPY INR (Contract size JPY 100,000)

Why Exchange Traded Currency Derivatives ? Access to a new asset class which was earlier not allowed for trading to all Indian residents Higher participation in market increases higher liquidity for structured contracts Permitting NRIs and FIIs at a future date may shift a substantial portion of NDF business to exchanges Potential arbitrage opportunity in OTC vs. Futures market could increase volumes in both the markets

How to Get Started ?

New Clients Account opening form with currency derivative segment agreements Required KYC proofs Existing Clients Additional Currency derivative application form including model currency derivative agreement, model currency derivative RDD & additional annexure Mandatory KYC proofs required by exchanges 24

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SUPER TOOLS

KEAT and KEAT Premium are two trading tools that enable you to view unlimited scrips, Intraday and Historical charts for scrips, use most of the charting tools, view the graphs type you want to, see Derivative chains, see online order and trade confirmations, view dynamic net positions, dynamic profit and loss, select indices/sectors or business groups and lots more. KEAT Premium runs faster than KEAT Pro as it runs on a separate server and has Scrip Alerts Charges for KEAT Premium are Rs 500

Super Multiple In Cash Management Kotaksecurities.com has launched Super Multiple, a service that offers you up to 12 times exposure against your margin, on specified scrips. For e.g., if you have a margin of Rs. 1,00,000/-, you will get up to 12 times exposure on your Super Multiple orders, i.e. Rs. 12,00,000/-.

Super Multiple In Futures Segment Kotaksecurities.com has launched Super Multiple, a service that offers you up to 12 times exposure against your margin, on specified scrips. For e.g., if you have a margin of Rs. 1,00,000/-, you will get up to 12 times exposure on your Super Multiple orders, i.e. Rs. 12,00,000/-.

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COMPETITORS OF KOTAK SECURITIES

India Bulls Share Khan/SSKI Motilal Oswal Angel Stock Broking KR Choksey Anand Rathi ICICI Direct.com (Online) R - Trade (New entrant) Prabhudas Liladhar India Infoline Karvy Magnum Securities SBI Capital L K P Shares & Securities Geojit Financial Man Financial Religare Securities IL & FS Emkay Share & Stock Broking Enam Financial HDFC Securities Edelwise Capital UTI Securities Ambit Capital Ventura Capital

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OFFLINE ACCOUNT

Normal Account Normal Account It is a simple trading account The clients DP ( Depository Participant ) or Demat Account can be with Kotak or with any other DP Delivery Based Trading is done under Normal account Shares are bought, sold and transferred electronically The client can buy / sell shares, he can transfer his shares from one DP account to another A unique code is generated for each clientAfter completing all the formalities of opening the normal account, the account will open in 3 working days The client will receive a Welcome letter and Trading code

Security Margin Account Security Margin Account The Client will compulsorily will have to have the DP with Kotak. The Client will sign the POA Power of Attorney, where by Kotak has the right to sell off clients shares if the settlement is not done by Friday or on T + 2 days i.e. Trading + 2 days. Either the client will have to square off or pay to retain the shares in his DP account. The clients who would like Kotak to handle their DP. Big Traders are major clients for this kind of account. Stock holding in the DP is used as margin. Limit To purchase The Limit for delivery will be 4 times of the DP amount The Limit for Intra Day will be 7 times of the DP amount

Advantages No Need to sign the transaction slip for buy or sell of shares Hassle free trading Position can be known at any moment Special features like phone / sms facility which enables the clients to do trading from any corner of the world.

Disadvantage The shares cannot be transferred from one DP to another. The broker has the right to sell the shares if not settled on time.

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SEBI Margin Funding SEBI margin funding The Client will have to compulsorily open a DP and sign a POA to Kotak Securities Margin Funding is upto 50% in specific Scripts around 600 scripts approved by SEBI Clients Positional Traders and People who need some Leverage.

Advantages

The interest will be charged to client only on upto 50% funding taken by the client from Kotak Securities. Eg: if the client buys shares of Rs.1 lac under SEBI margin account, he will have to pay interest only on 50% amount paid by Kotak Sec on his behalf. If the Position is +ve The client can sell the shares and books his profits after paying the brokerage and the interest or can hold for longer period. If the position is ve Say the share value is dropped rs.10000, then the client is asked to pay the Top-Up / Mark to Margin ( M to M ) of the above said amount.

Disadvantages When the stocks are down, the client has to immediately pay the difference. In SEBI Funding Margins, stock volumes are not considered and is strictly operated in cash. After 2 lac the stock category comes into picture, A category stocks are normally funded upto 50%, B, C and D category stocks will be funded upto 50% but will be according to the Haircut.

Eg: If a B category stock is of Rs.100 and has a hair cut of 10% then the funding will happen as below Rs.100 10% = Rs.90

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So here Kotak sec will fund 50% on Rs.90 and not on Rs.100. So the ratio will be Kotak sec : Rs.45 and Client will Pay Rs.55. The client cannot watch the before-said division in his ledger. The client cannot get the Position on day to day basis Only chosen scripts are funded.

COMMERCIALS Trading Account Opening Rs. 750 Only Demat Account Rs. 500 Brokerage Delivery 0.5% (Max 2.5%) Intra-day & Derivatives 0.10% (On Options Premium Only) Service Tax 10.30% of brokerage STT Delivery buy 0.125% Delivery sale 0.125% Cash market sq up 0.025% (seller) Derivatives 0.017% (seller) Stamp Duty Cash Market 0.01% Derivatives 0.002%

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INTRODUCTION TO DERIVATIVES

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Derivatives are financial instruments whose value is derived from the value of something else. They generally take the form of contracts under which the parties agree to payments between them based upon the value of an underlying asset or other data at a particular point in time. The main types of derivatives are futures, forwards, options, and swaps. The main use of derivatives is to reduce risk for one party while offering the potential for a high return (at increased risk) to another. The diverse range of potential underlying assets and payoff alternatives leads to a huge range of derivatives contracts available to be traded in the market. Derivatives can be based on different types of assets such as commodities, equities (stocks), bonds, interest rates, exchange rates, or indexes (such as a stock market index, consumer price index (CPI) see inflation derivatives or even an index of weather conditions, or other derivatives). Their performance can determine both the amount and the timing of the payoffs. The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived" from the value of the underlying asset. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities. With Securities Laws (Second Amendment) Act, 1999, Derivatives has been included in the definition of Securities. The term Derivative has been defined in Securities Contracts (Regulations) Act, as:-

A Derivative includes: a. 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;

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b. A contract which derives its value from the prices, or index of prices, of underlying securities. 1.1.2History of derivatives The history of derivatives is surprisingly longer than what most people think. Some texts even find the existence of the characteristics of derivative contracts in incidents of Mahabharata. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or overproduction. The first 'futures' contracts can be traced to the Yodoya rice market in Osaka, Japan around 1650. These were evidently standardized contracts, which made them much like today's futures. The Chicago Board of Trade (CBOT), the largest derivative exchange in the world, was established in 1848 where forward contracts on various commodities were standardized around 1865. From then on, futures contracts have remained more or less in the same form, as we know them today. Derivatives have had a long presence in India. The commodity derivative market has been functioning in India since the nineteenth century with organized trading in cotton through the establishment of Cotton Trade Association in 1875. Since then contracts on various other commodities have been introduced as well. Exchange traded financial derivatives were introduced in India in June 2000 at the two major stock exchanges, NSE and BSE. There are various contracts currently traded on these exchanges. National Commodity & Derivatives Exchange Limited (NCDEX) started its operations in December 2003, to provide a platform for commodities trading. The derivatives market in India has grown exponentially, especially at NSE. Stock Futures are the most highly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE, as on April 13, 2005.

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1.1.3Types of Derivatives

Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, and exotic options are almost always traded in this way. The OTC derivatives market is huge. According to the Bank for International Settlements, the total outstanding notional amount is USD 516 trillion (as of June 2007).

Exchange-traded derivatives (ETD) are those derivatives products that are traded via specialized Derivatives exchanges or other exchanges. A derivatives exchange acts as an intermediary to all related transactions, and takes Initial margin from both sides of the trade to act as a guarantee. The world's largest derivatives exchanges (by number of transactions) are the Korea Exchange (which lists KOSPI Index Futures & Options), Eurex (which lists a wide range of European products such as interest rate & index products), and CME Group (made up of the 2007 merger of the Chicago Mercantile Exchange and the Chicago Board of Trade). According to BIS, the combined turnover in the world's derivatives exchanges totaled USD 344 trillion during Q4 2005. Some types of derivative instruments also may trade on traditional exchanges. For instance, hybrid instruments such as convertible bonds and/or convertible preferred may be listed on stock or bond exchanges. Also, warrants (or "rights") may be listed on equity exchanges. Performance Rights, Cash xPRTs(tm) and various other instruments that essentially consist of a complex set of options bundled into a simple package are routinely listed on equity exchanges. Like other derivatives, these publicly traded derivatives provide investors access to risk/reward and volatility characteristics that, while related to an underlying commodity, nonetheless are distinctive.

1.1.4 Types of Derivative contracts 1. Forward Contract: A forward contract is an agreement between two parties to buy or sell an asset (which can be of any kind) at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and

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hedge risk, for example currency exposure risk (e.g., forward contracts on USD or EUR) or commodity prices (e.g., forward contracts on oil). One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In a forward transaction, no actual cash changes hands. If the transaction is collateralized, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no asset of any kind actually changes hands, until the maturity of the contract. The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the asset changes hands (on the spot date, usually two business days). The difference between the spot and the forward price is the forward premium or forward discount. A standardized forward contract that is traded on an exchange is called a futures contract. 2. Futures Contract : A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date. The pre-set price is called the futures price. The price of the underlying asset on the delivery date is called the settlement price. A futures contract gives the holder the obligation to buy or sell, which differs from an options contract, which gives the holder the right, but not the obligation. In other words, the owner of an options contract may exercise the contract, but both parties of a "futures contract" must fulfill the contract on the settlement date. The seller delivers the commodity to the buyer, or, if it is a cash-settled future, then cash is transferred from the futures trader who sustained a loss to the one who made a profit. To exit the commitment prior to the settlement date, the holder of a futures position has to offset their position by either selling a long position or buying back a short position, effectively closing out the futures position and its contract obligations. Futures contracts, or simply futures, are exchange traded derivatives. The exchange's clearinghouse acts as counterparty on all contracts, sets margin requirements, etc. Futures Contract means a legally binding agreement to buy or sell the underlying security on a future date. Future contracts are the organized/standardized contracts in terms of quantity, quality (in case of commodities), delivery time and place for settlement on any date in future. The contract expires on a pre-specified date which is called the expiry date of the contract. On expiry, futures can be settled by delivery

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of the underlying asset or cash. Cash settlement enables the settlement of obligations arising out of the future/option contract in cash. 3. Option contract: The right, but not the obligation, to buy (for a call option) or sell (for a put option) a specific amount of a given stock, commodity, currency, index, or debt, at a specified price (the strike price) during a specified period of time. For stock options, the amount is usually 100 shares. Each option contract has a buyer, called the holder, and a seller, known as the writer. If the option contract is exercised, the writer is responsible for fulfilling the terms of the contract by delivering the shares to the appropriate party. In the case of a security that cannot be delivered such as an index, the contract is settled in cash. For the holder, the potential loss is limited to the price paid to acquire the option. When an option is not exercised, it expires. No shares change hands and the money spent to purchase the option is lost. For the buyer, the upside is unlimited. Option contracts, like stocks, are therefore said to have an asymmetrical payoff pattern. For the writer, the potential loss is unlimited unless the contract is covered, meaning that the writer already owns the security underlying the option. Option contracts are most frequently as either leverage or protection. As leverage, options allow the holder to control equity in a limited capacity for a fraction of what the shares would cost. The difference can be invested elsewhere until the option is exercised. As protection, options can guard against price fluctuations in the near term because they provide the right acquire the underlying stock at a fixed price for a limited time. risk is limited to the option premium (except when writing options for a security that is not already owned). However, the costs of trading options (including both commissions and the bid/ask spread) is higher on a percentage basis than trading the underlying stock. In addition, options are very complex and require a great deal of observation and maintenance. 4. Warrants & convertible: Warrants & convertible are other important categories of financial derivatives, which are frequently traded in the market. Warrants are just like an option contract where the holder has the right to buy shares of a specified company at a certain price during the given time period. In the other words the holder of a warrant has the right to purchase a specific number of shares at a fixed price in a fixed period from a issuing company. Convertible are hybrid securities

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which combine the basic attributes of fixed interest and variable return securities. These are mostly convertible bonds, convertible debentures, and convertible preference shares. These are also called equity derivative securities. They can be fully or partially converted in to equity shares of the issuing company at the predetermined specified terms with regards to conversion ratio and conversion price. 5. Swap Contracts: These are agreements between two parties to exchange cash flows in the future under the swap agreement various terms like the dates. When the cash flows are to be paid, the currency in which to be paid & the mode of payment are finalized by the parties. The most popular type of swap contracts is given below: a) Interest rate swaps contracts: A contract entered into by an issuer or obligor with a swap provider to exchange periodic interest payments. Typically, one party agrees to make payments to the other based upon a fixed rate of interest in exchange for payments based upon a variable rate. Interest rate swap contracts typically are used as hedges against interest rate risk or to provide fixed debt service payments to an issuer or conduit borrower dependent on a specified revenue stream for payment of such debt. For example, an issuer may issue variable rate debt and simultaneously enter into an interest rate swap contract. The swap contract may provide that the issuer will pay to the swap counter-party a fixed rate of interest in exchange for the counter-party making variable payments equal to the amount payable on the variable rate debt. b) Currency swaps: A currency swaps (or cross currency swap) is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped. Currency swaps can be negotiated for a variety of maturities up to 30 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by United States accounting laws and thus it is not reflected on a company's balance sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an obligation to close the swap (far leg) being a forward contract. Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe

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where companies "shop" for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency. Commodity Derivatives: Futures contracts in pepper, turmeric, gur (jaggery), Hessian (jute fabric), jute sacking, castor seed, potato, coffee, cotton, and soybean and its derivatives are traded in 18 commodity exchanges located in various parts of the country. Futures trading in other edible oils, oilseeds and oil cakes have been permitted. Trading in futures in the new commodities, especially in edible oils, is expected to commence in the near future. The sugar industry is exploring the merits of trading sugar futures contracts. The policy initiatives and the modernization programme include extensive training, structuring a reliable clearinghouse, establishment of a system of warehouse receipts, and the thrust towards the establishment of a national commodity exchange. The Government of India has constituted a committee to explore and evaluate issues pertinent to the establishment and funding of the proposed national commodity exchange for the nationwide trading of commodity futures contracts, and the other institutions and institutional processes such as warehousing and clearinghouses. With commodity futures, delivery is best affected using warehouse receipts (which are like dematerialized securities). Warehousing functions have enabled viable exchanges to augment their strengths in contract design and trading. The viability of the national commodity exchange is predicated on the reliability of the warehousing functions. The programme for establishing a system of warehouse receipts is in progress. The Coffee Futures Exchange India (COFEI) has operated a system of warehouse receipts since 1998. 1.1.5 Uses of derivatives: Derivatives are supposed to provide the following services: 1. One of the most important services provided by the derivatives is to control, avoid, shift and manage efficiently different types of risks through various strategies like hedging, arbitraging, spreading, etc. derivatives assist the holders to shift or modify suitably the risk characteristics of their portfolios. These are

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specifically useful in highly volatile market conditions like erratic trading, highly flexible interest rates, and volatile exchange rates. 2. Derivatives serve as barometers of the future trends in prices which in the discovery of new prices both on the spot and futures markets. Further they help in disseminating different information regarding the futures markets trading of various commodities and securities to the society which discover or form suitable or correct true equilibrium prices in the markets. 3. As we see that in derivatives trading no immediate full amount of the transaction is required since most of them are based on the margin trading. As a result, large number of traders, speculators arbitrageurs operates in such markets. So, derivatives trading enhance liquidity and reduce transactions costs in the markets for underlying assets. 4. The derivatives assist the investors, traders and managers of large pools of funds to devise such strategies so that they may make proper asset allocation increase their yields and achieve other investment goals. 5. It has been observed from the derivatives trading in the market that in the market that the derivatives have smoothen out price fluctuations, squeeze the price spread, integrate price structure different points of time and remove shortages in the market. 6. The derivatives trading encourage the competitive trading in the markets, different risk taking preference of the market operators like speculators, hedgers, traders, arbitrageurs, etc. resulting in increase in trading volume in the country. They also attract young investors, professionals and other experts who will act as catalysts to growth of financial markets. 1.1.6 Demerits of Derivatives: 1. Speculative and gambling motives: one of the most important arguments against the derivatives is that they promote speculative activities in the market. It is witnessed from the financial markets throughout the world that the trading volumes in derivatives have increased in multiples of the value of the underlying assets. As such speculation has become the primary purpose

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of the birth, existence and growth of derivatives. Sometimes these speculative buying and selling by professionals have adversely affect the genuine producers and distributors. 2. Increase in risk: The derivatives are supposed to be efficient tool of risk management in the market. In fact this is also one sided argument. It has been observed that the derivatives market-especially OTC markets, as particularly customized, privately managed and negotiated and thus they are highly risky. Empirical studies in this respect have shown that derivatives used by the banks have not resulted in the reduction in risk, and rather these have raised new types of risks. 3. Instability of financial system: it is argued that derivatives have increased the risk not only for their users but also for the whole financial system. The fears of micro and macro financial crisis have caused to unchecked growth of derivatives which have turned many market players into big losers. The malpractices, desperate behavior and fraud by users of derivatives have threatened the stability of the financial markets and the financial system. 4. Price instability: Some experts argue in favor of the derivatives that their major contribution is forward contribution is toward price stability and price discovery in the market whereas some others have doubt about this. Rather they argue that derivatives have caused wild fluctuations in asset prices and moreover they widened the range of such fluctuations in the prices. The derivatives may be helpful in the price stabilization only if there exist a properly organized, competitive and well regulated market. Further the traders behave and function in professional manner and follow standard code of conduct. Unfortunately all these are not so frequently practiced in the market and hence the derivatives sometimes cause to price instability rather than stability. 5. Displacement effect: There is another doubt about the growth of the derivatives that they will reduce the volume of the business in the primary or new issue market specifically for new and small corporate units. it is apprehension that most of investors will divert to derivatives markets, raisings fresh capital by such units will be difficult and hence this will create displacement effect in the financial market. However it is not so strong

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argument because there is no such rigid segmentation of investors and investors behave rationally in market. 1.1.7 Users of Derivatives: The participants in the derivatives markets can be classified into three broad categories. These are the arbitrageurs, the speculators and the hedgers. Arbitrageurs: These are an important category as the principles underlying the valuation of derivatives are based on the assumption that capital markets are efficient and opportunities for arbitrage are inexistent. Arbitrage can be defined as the ability to make a risk-less profit from market anomalies. Speculators: Speculators are traders who aim to make profits from favorable market movements. In other words speculators are investors that are after capital gains. Traders using derivatives take leveraged positions and hence the market risk of the underlying assets is amplified. Hedgers: Before discussing how derivatives can be used in mitigating risk, it is essential to understand risk and the implications of hedging. Hedging does not imply avoiding losses but reducing uncertainty i.e. risk. Higher risks could result in higher returns and therefore hedging against risks entails reducing the likelihood of excessive gains as well as excessive losses. For example, the appreciation of the euro against the US$ during 2003 shaved US$ 1.25 billion from Volkswagen operating income for that year. Hedging would have reduced this loss but if the euro weakened instead of strengthening, Volkswagen would have forfeited the opportunity to make an exceptional gain. The decision on whether to hedge or not depends primarily on the extent to which a business can pass on adverse market movements to consumers. If one refers to the local market, competition has intensified and it is very difficult for local businesses to pass on adverse movements in say interest rates, exchange rates and commodity prices to consumers. A counter argument to this is that if hedging is

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not the norm then all market suppliers are in the same position and therefore at the end of the day adverse market fluctuations are borne by consumers. Nonetheless, not all market suppliers are equally sensitive to market fluctuations so such argument may not hold in practice. 1.1.8 Derivatives Markets: Derivatives are either traded over-the-counter or on specialized exchanges. Overthe-counter (OTC) derivatives are entered into between two parties directly. One party would normally be a bank or an investment bank, while the counterparty is likely to be a corporate or an institutional investor. On the other hand exchange traded derivatives are traded, to a certain extent, similarly to listed equities and bonds. The main difference is that while OTC derivatives are specifically engineered according to the needs of the parties involved, exchange traded derivatives are standardized contracts. Normally, OTC derivatives are offered by banks and each bank will have an agreement which governs the relationship between the bank and counterparty vis--vis the derivative contract. This agreement would be based on the International Swaps Dealers Association (ISDA) master agreement but can be slightly modified particularly for exotic contracts. Needless to say, it is important that financial controllers that are considering the use of OTC derivatives, with the assistance of their companys lawyers, understand the contents of these agreements. Exchange traded derivatives are standardized and the terms and conditions of each contract are set out by the exchange where they are traded. The fact that these are traded on an exchange and due to their standardized nature makes these contracts highly liquid. However, their liquidity declines with the duration of the contract, i.e. generally the longer the duration of the contract, the lower the volume of transactions in that contract. Liquidity also depends on the popularity of the contract in terms of willing buyers and sellers. Standardization helps to keep the transaction costs involved in trading these instruments low. The exchange guarantees that the contract will be honoured and to ensure fulfillment every exchange uses what is termed as a margining system. When a contract is bought or sold, the buyer/seller is bound to make a deposit with the clearing house of the exchange. This deposit would be a percentage of the contracted amount. This deposit is referred to as the initial margin. Derivative trading in India takes can place either on a separate and

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independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organization (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment. 1.1.9 The regulatory framework of Derivatives markets in India With the amendment in the definition of 'securities' under SC(R)A (to include derivative contracts in the definition of securities), derivatives trading takes place under the provisions of the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992. Dr. L.C Gupta Committee constituted by SEBI had laid down the regulatory framework for derivative trading in India. SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws. SEBI has also laid the eligibility conditions for Derivative Exchange/Segment and its Clearing Corporation/House. The eligibility conditions have been framed to ensure that Derivative Exchange/Segment & Clearing Corporation/House provide a transparent trading environment, safety & integrity and provide facilities for redressal of investor grievances. Some of the important eligibility conditions areo

Derivative trading to take place through an on-line screen based Trading System. The Derivatives Exchange/Segment shall have on-line surveillance capability to monitor positions, prices, and volumes on a real time basis so as to deter market manipulation. The Derivatives Exchange/ Segment should have arrangements for dissemination of information about trades, quantities and quotes on a real time basis through at least two information vending networks, which are easily accessible to investors across the country.

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o

The Derivatives Exchange/Segment should have arbitration and investor grievances redressal mechanism operative from all the four areas / regions of the country. The Derivatives Exchange/Segment should have satisfactory system of monitoring investor complaints and preventing irregularities in trading. The Derivative Segment of the Exchange would have a separate Investor Protection Fund. The Clearing Corporation/House shall perform full novation, i.e., the Clearing Corporation/House shall interpose itself between both legs of every trade, becoming the legal counterparty to both or alternatively should provide an unconditional guarantee for settlement of all trades. The Clearing Corporation/House shall have the capacity to monitor the overall position of Members across both derivatives market and the underlying securities market for those Members who are participating in both. The level of initial margin on Index Futures Contracts shall be related to the risk of loss on the position. The concept of value-at-risk shall be used in calculating required level of initial margins. The initial margins should be large enough to cover the one-day loss that can be encountered on the position on 99% of the days. The Clearing Corporation/House shall establish facilities for electronic funds transfer (EFT) for swift movement of margin payments. In the event of a Member defaulting in meeting its liabilities, the Clearing Corporation/House shall transfer client positions and assets to another solvent Member or close-out all open positions. The Clearing Corporation/House should have capabilities to segregate initial margins deposited by Clearing Members for trades on their own account and on account of his client. The Clearing Corporation/House shall hold the clients margin money in trust for

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the client purposes only and should not allow its diversion for any other purpose.
o

The Clearing Corporation/House shall have a separate Trade Guarantee Fund for the trades executed on Derivative Exchange / Segment. Presently, SEBI has permitted Derivative Trading on the Derivative Segment of BSE and the F&O Segment of NSE.

1.1.10 Eligibility criteria for stocks on which derivatives trading is permitted: A stock on which stock option and single stock future contracts are proposed to be introduced is required to fulfill the following broad eligibility criteria:o

The stock shall be chosen from amongst the top 500 stock in terms of average daily market capitalization and average daily traded value in the previous six month on a rolling basis. The stocks median quarter-sigma order size over the last six months shall be not less than Rs.1 Lakh. A stocks quarter-sigma order size is the mean order size (in value terms) required to cause a change in the stock price equal to one-quarter of a standard deviation. The market wide position limit in the stock shall not be less than Rs.50 crores. A stock can be included for derivatives trading as soon as it becomes eligible. However, if the stock does not fulfill the eligibility criteria for 3 consecutive months after being admitted to derivatives trading, then derivative contracts on such a stock would be discontinued.

1.1.11 Minimum contract size: The Standing Committee on Finance, a Parliamentary Committee, at the time of recommending amendment to Securities Contract (Regulation) Act, 1956 had recommended that the minimum contract size of derivative contracts traded in the Indian Markets should be pegged not below Rs. 2 Lakhs. Based on this 44

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recommendation SEBI has specified that the value of a derivative contract should not be less than Rs. 2 Lakh at the time of introducing the contract in the market. In February 2004, the Exchanges were advised to re-align the contracts sizes of existing derivative contracts to Rs. 2 Lakhs. Subsequently, the Exchanges were authorized to align the contracts sizes as and when required in line with the methodology prescribed by SEBI. 1.1.2 Lot size of a contract: Lot size refers to number of underlying securities in one contract. The lot size is determined keeping in mind the minimum contract size requirement at the time of introduction of derivative contracts on a particular underlying. For example, if shares of XYZ Ltd are quoted at Rs.1000 each and the minimum contract size is Rs.2 lacs, then the lot size for that particular scrips stands to be 200000/1000 = 200 shares i.e. one contract in XYZ Ltd. covers 200 shares. 1.1.13 Derivatives and Risk: Derivatives help to manage risk in new ways--an important economic function. Yet the risks involved in derivatives activities are neither new nor unique. They are the same kinds of risks found in traditional financial products: market, credit, legal, and operational risks. Because over-the-counter derivatives are customized transactions, they often assemble risks in complex ways. This can make the measurement and control of these risks more difficult and create the possibility of unexpected loss. Banking supervisors have conducted several studies into the implications of derivatives for the financial system. None of these studies concluded that derivatives significantly increase systemic risk, but neither did they find cause for complacency. For derivatives activity to grow and prosper, those who take part in it--whether as dealers, end-users, or both--should continue laying a strong foundation of good management practice. They also should provide the public with information that will allay unjustified fears by demystifying this activity. And participants should discuss

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openly with legislators, supervisors, and regulators, ways to further strengthen the current institutional framework. These steps are both appropriate and sufficient to address the systemic and other concerns about derivatives activity. Without minimizing the significance of these concerns, this Study does not conclude that any fundamental changes in the current regulatory framework, such as separate regulation of this activity, are needed. Separate regulation of global derivatives would be at cross-purposes with the existing framework of supervision, with its focus on the common risks contained in derivatives and traditional instruments. There is also a danger in imposing regulatory formulas that inhibit new product innovation or discourage firms from developing the individualized, robust risk management systems on which they should rely. The Various types of risks in derivatives are given below: Credit Risk: It is also called default risk. The risk that a counter party will default on its obligations is called credit risk. Most of the derivatives transactions are executed through over the counter and recognized exchanges. An exchange traded futures contracts is likely to have significantly less counter party risk in comparison to OTC driver contracts. The major factors influencing the credit risk are such as rating system, scope for credit enhancements, sophistication of users, measurement approach, need for diversified client bases, product characteristics, valuation data, barriers to entry, etc. The credit analysis includes the techniques which are used to measure the ongoing credit risk that the firm is bearing. The major technique include: using risk adjusted return calculations applying options theory to credit default analysis; using efficient portfolio and aggregating risks into a single measurement by the statistical correlation between individual credit risks. After analyzing the credit risk of counter party next step is to control credit risk. Various methods have been suggested like collateral agreements, netting agreements, credit guarantees, credit triggers, mutual termination options, etc. Market Risk: This risk relates to adverse changes in the market price of a derivative. In other words, market risk exposes a firm to uncertainty due to changes in various market factors like foreign exchange rates, commodity prices, equity prices, volatility related to options positions, market interest rates etc. in fact market

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risk arises due to market factors, which is beyond the control of counter party. Such risk is to be estimated and then steps are taken to mange the same. There are three important aspects relating to market risk: tools necessary to carry out timely and accurate measurement, technique of risk analysis and monitoring and strong and effective lines of communication to senior management. In order to develop a sound market risk approach, an organization and culture, executives skill, theoretical underpinnings, systems architecture, procedure and control, portfolio characteristics, management information etc. Liquidity Risk: Liquidity risk refers to the fluctuation of derivative instruments prices for not quickly sold or purchased in the market. Sometimes due to various factors, a particular derivative may not be easily sold at a fair price. It is observed that usually liquidity risk is higher at OTC market in of a comparison to exchange traded derivatives. Two elements of liquidity risk arise due to relative ability of an organization to transfer its assets into, and second the mismatch between the banks cash inflows and outflows arising out of derivative activity. The transfer ability of a derivative to be converted in to cash at fair value depends largely on the existence of the secondary market. This depends upon three factors: a) transaction costs incurred on liquidation determined largely by bid ask spread. b) cost of exposure of the position maintained and c) the cost of hedging the exposure, where possible. Trade off between the three components would determine the rate of liquidation. Sometimes, large derivatives portfolios can be subject to sudden cash demands and thus creating mismatch between a banks cash inflows and outflows. This position may make liquidity management for off balance sheets products crucial. Sudden liquidity changes can arise out cash flow risk, which the bank should monitor considering the potential price and volatility changes in derivative instrument. Legal Risk: Legal risk is the likelihood that the counterparty is not legally bound to fulfill his obligations under the derivative contract or that the derivative contract does not cover certain situations. This situation is similar to that where a person takes insurance cover and later on he finds out that certain risks are not covered or that the insurance contract is null and void. An example of legal risk involving derivatives is that of the London borough of Fulham and Hammersmith. Between 1983 and 1989, this borough entered into derivative contracts with various banks.

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The derivative contracts were losing money and the borough defaulted from its commitments. In 1991, the House of Lords declared that the borough did not have the contractual capacity to enter into such contracts and therefore the contracts were null and void. It is estimated that a number of banks, which were the counterparties of the borough in question, made 400 million losses plus incurring 15 million in legal fees. Operational risk: This risk relates to that errors or frauds which may occur in carrying out operations, placing orders, making payments, taking derivatives, accounting for derivatives transactions. The main reason for this is that operational risk is every where within an organization. Since derivative transaction decisions are taken by senior management in the organization and implemented by the executory functionaries through business line technologies; various sophisticated instruments are used for placing the orders and then for cleaning them. Thus potential exposures commonly associated with operations are diverse. These may relate to technology choices: batch vs. real time processing, intra day settlement exposure, cross border payment issue, reliance or manual controls, multilateral vs. bilateral payment systems, timing of payment and delivery. Many of these issues even go beyond the organization level. Operational risk is relevant to the entire value chain of an organization technology and people. Manual and automated controls throughout the organization all have a part to play in creating a secure operational environment. Thus operational risk can be mitigated internally through proper controls and procedures and a detailed understanding of all stages of the operational process. The other types of risks linked to derivative products are: Leverage: When an investor trades derivative products it must provide a deposit and/or exchange (pay or receive) a premium. The amount provided as the deposit or exchanged as a premium represents only a fraction of the derivative product's value. Transactions in derivative products involve significant leverage as a relatively small fluctuation in the price of the underlying instrument can have a proportionately greater impact on the cash or on the value of any other guarantee deposited by the investor. This can work for and against the client. If the market moves in an unfavorable direction, the investor may not only lose more than the full amount of the initial margin deposit, but also pay an additional margin and meet margin calls. 48

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To maintain the investor's position, new margin payments can be requested on very short notice, occasionally during a market session. If the investor does not meet margin calls within the required time limit, its position may be liquidated and the investor will be liable for any debit balance on its account. Losses may therefore be far greater than the margin initially deposited with the clearing house or than the premium exchanged. Liquidity and price fluctuations: Derivatives markets can be illiquid. If the market is not sufficiently liquid, the investor may be unable to liquidate or even partially close out a futures position at the desired time. In addition, the difference between the bid price and the offer price of a given contract may be significant. Prices on derivatives markets can fluctuate considerably, depending on a number of factors that are difficult to forecast. The price and liquidity of any investment depends upon the availability and value of the underlying asset, which can be affected by a number of extrinsic factors including, but not limited to, political, environmental and technical. Such factors can also affect the ability to settle or perform on time or at all. The impact of these events on the liquidity and prices increases as the maturity date is near. Orders aimed at limiting a loss (stop-limit, stop-loss): Trading conditions on futures markets allow investors to place orders with a stop-limit price and orders with a trigger threshold, which are also referred to as stop orders. These orders were designed to limit losses that could occur as a result of market fluctuations. The use of such orders does not provide a guarantee that losses will be limited to the intended amounts. Placing contingent orders, such as "stop-loss" or "stop-limit" orders, will not necessarily limit its losses to the intended amounts, since market conditions on the exchange where the order is placed may make it difficult or impossible to execute such orders. Commission, fees and taxes: All charges relating to a futures transaction reduce the investor's profit or increase its loss. Commission, agreed upon between the broker and investor, is paid in addition to the fees due to the markets and clearing houses. Before concluding a transaction, investors must be informed of all fees and costs to be paid. Any payments made or received in relation to any investment may be subject to tax and the Client should seek professional advice in this respect. Seller and buyer obligations: Transactions in derivative products involve the obligation to make, or to take, delivery of the underlying asset of the contract at a 49

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future date, or in some cases to settle the position with cash, in accordance with the applicable market conditions. (a) Obligation to deliver: Unless it is able to offset its position before the delivery date and thereby free itself from its obligation, the seller of a futures contract or a call option may be required to deliver a predetermined quantity of the underlying instrument, in accordance with the relevant market and clearing house rules. The terms and conditions of trading require the seller to deliver the underlying asset in accordance with the characteristics of the contract. If the seller does not comply with this obligation, it may risk incurring additional costs and penalties. (b) Obligation to take delivery: Unless it is able to offset its position before the delivery date and thereby free itself from its obligation, the buyer of a futures contract or the seller of put option must accept delivery of and pay for the underlying instrument, in accordance with the relevant market and clearing house rules. It may have to pay an amount higher than the margin deposited with the clearing house. For commodities, it may be required to agree to the necessary storage, to organize transport and to take responsibility for any subsequent related costs. If the buyer is not the end buyer of the commodity or a trader in commodities of this type, it may encounter difficulties relating to storage or sales, due to the fact that it cannot use the commodity in question. Furthermore, there is a risk of loss if it decides to sell the commodity on the spot market. The margin deposited by the buyer of a futures contract serves solely as a guarantee and is not valid for the partial execution of its obligations. Non-fungibility of contracts: As such, the orders we execute on behalf of our clients are carried out on regulated markets and in some cases on over-the-counter markets. Cases in which the same instrument can be traded on different markets, and where two instruments are fungible, are exceptional. Before placing an order relating to a product and prior to selecting a market, the client must assess the market and its historical performance in order to take into account, in particular, its liquidity. Where the Client is unable to transfer a particular instrument which it holds, to exit its commitment under that instrument, the Client may have to offset its position by either buying back a short position or selling a long position. Such an offsetting transaction may have to be over the counter and the terms of such a 50

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contract may not match entirely those of the initial instrument. For example, the price of such a contract may be more or less than the Client received or paid for the sale or purchase of the initial instrument. Foreign markets and emerging markets: Foreign markets will involve different risks from the French markets. In some cases the risks will be greater. On request, Calyon Financial will provide an explanation of the relevant risks and protections (if any) which will operate in any foreign markets, including the extent to which it will accept liability for any default of a foreign firm through whom it deals. The potential for profit or loss from transactions on foreign markets or in foreign denominated contracts will be affected by fluctuations in foreign exchange rates. Such transactions may also be affected by exchange controls that could prevent or delay performance Risk of default or insolvency: insolvency or default, or that of any other brokers involved with the Clients transaction, may lead to positions being liquidated or closed out without the Clients consent. In certain circumstances, the Client may not get back the actual assets which it lodged as collateral and the Client may have to accept any available payments in cash.

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Section-2
1.2.1 Objectives of study: In the present current scenario when derivatives are playing an important role it is essential to study and analyze the perception of investors who actually deals in them and also what they feels about these innovative financial instruments. The objectives of the study are: 1. To study the customer perception regarding the derivatives with reference to future and options. 2. To study the customer preference between the future and options. 3. To study the risk factors affecting derivatives. 1.2.2 Null Hypothesis: 1. H0 = Preference of derivatives is independent to types of contracts 2. H0= Risk factor is not related to the return as factor of decision. 3. H0= Risk factor is not related to the safety as a factor of decision. 4. H0= Risk factor is not related to the liquidity as a factor of decision. 5. H0= Risk factor is not related to the tax saving as a factor of decision. 6. H0= Risk is not related to the speculation as a factor of decision. 7. H0= All the risks are not dependent on one another.

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1.2.3 Rationale of study:

In present current scenario when derivatives have taken the markets by sweep, it is essential to study and analyze what the investor, who actually deals in them, feels about these innovative financial instruments. The study intends to have an insight into the expectations, apprehensions and interpretations of these individual investors about this a new kind of the financial markets. The study is also conducted to know the various risks involved in the derivatives.

1.2.4 Research Methodology:

1.2.4.1 Research Design: The research design carried out here is descriptive research design. 1.2.4.2 Scope of Study: The scope of study is limited to the area of Chandigarh city. 1.2.4.3 Sample Size: Sample size of my study is 100 respondents or the investors of Chandigarh. 1.2.4.4 Population: The sample size is 100 respondents or investors who invest in the derivatives with respect to the future and options. 1.2.4.5 Sampling Technique: Convenience sampling is used as a technique of sampling. 1.2.4.6 Data Collection Methods: The following methods are used for the purpose of collection. Primary Method: The primary data is collected with the help of the questionnaires in which both open ended and closed ended questionnaires are asked from the investors related to derivatives with special reference to future and options. Secondary Method: The secondary data is collected with the help of various books related to the derivatives and from the various internet sites. 1.2.4.7 Tools of Data Analysis: Chi square and correlation are used as the tools of data analysis and the data is classified with the help of bar diagrams and pie charts.

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References: Gupta. S.L (2006), financial derivatives, 5th addition, prentice hall of India. Websites: http://en.wikipedia.org/wiki/Derivative_(finance) http://www.edinformatics.com/investor_education/derivatives.html http://www.reliancemoney.com/KB/Story.aspx?ArticleID=6ac0bbee-e465-4e97b882-59a1485bbdcc http://www.investorbuddy.com.au/learning-centre/common-types-of-derivatives http://finance.indiamart.com/markets/commodity/derivatives.html http://www.sjsu.edu/faculty/watkins/deriv.html

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2.1 Survey of Literature

Brangers N, Schlag, C & Schneider E (2007) make a general equilibrium analysis in a complete markets economy when the dividend is declared. The key output of their analysis is the structure of the investors optimal portfolios and the volume and direction of trading between them. It was found that trading in derivatives is economically significant, with a value of traded contracts of up to twenty percent of total market capitalization. In line with intuition, the less risk-averse investor holds more pure stock price risk than the more risk-averse one. Volatility derivatives, on the other hand, are special in the sense that the direction of trading depends on the exact values for the levels of risk aversion of the individual investors, not just on who is more and who is less risk-averse. Handa (2006) summarized that in present current scenario when derivatives have taken the markets by sweep, it is essential to study and analyze what the investor, who actually deals in them, feels about these innovative financial instruments. The study intends to have an insight into the expectations, apprehensions and interpretations of these individual investors about this a new kind of the financial markets. To effectuate the objectives a representative sample of 70 investors was chosen, their responses recorded and analyzed using various statistical techniques. The paper also traces the growth of the derivatives markets since their inception on the Indian bourses. At the same time, it also draws the attention towards the impediments on this seemingly smoothes road which can make the journey ahead rather bumpy. Sharma and Gupta (2006) abstracted the impact of derivatives on the Indian capital market. It is necessary to understand and measure the impact of various factors on derivatives is necessary since it stirred the micro structures of Indian capital market in general stock exchanges in particular. Derivatives derive their values from the underlying instruments. An attempt is therefore, made to study and analyze the impact of underlying instruments on the price of futures on the selected companies of NSE on which future trading is permitted. Changes in the price of equity stock and index value are expected to

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cause changes in the price of equity stock futures and nifty index futures respectively. The study confirms this belief on the basis of regression analysis of the selected companies. Arnoldi (2006) the article is concerned with problems of 'framing' in electronic derivatives markets. Traders in any given trading environment 'frame' or interpret information about the market by drawing on a range of other information, knowledge and heuristics. Such framing reduces uncertainty. In an open outcry market environment, framing information would be flowing in the social networks of that market environment. In electronic markets, traders do not interact with their counterparts and are generally disembedded from the social networks of the open outcry environment. Other ways of framing therefore have to be found. The article examines various ways in which this happens. The article also suggests, however, that framing in an electronic market environment remains difficult and that electronic trading therefore creates incentives to do other forms of trading as well, such as block trading, where there is more personal interaction, and where frames can therefore be re-established more easily. Acharya (2005) summarized that insider trading in the credit derivatives market has become a significant concern for regulators and participants. This paper attempts to quantify the problem. Using news reflected in the stock market as a benchmark for public information, we report evidence of significant incremental information revelation in the credit default swap (CDS) market under circumstances consistent with the use of non-public information by informed banks. Specifically, the information revelation occurs only for negative credit news and for entities that subsequently experience adverse shocks. Moreover the degree of advance information revelation increases with the number of banks that have lending/monitoring relations with a given firm, and this effect is robust to controls for non-informational trade. We find no evidence, however, that the degree of asymmetric information adversely affects prices or liquidity in either the equity or credit markets. If anything, with regard to liquidity, the reverse appears to be true. Nasakkala (2004) concluded the derivative markets from a view point of an electricity producer. The traditionally used asset pricing methods, based on the no arbitrage principle, are extended to take into account electricity specific 56

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features: the non storability of electricity and the variability in the load process. The sources of uncertainty include electricity forward curve, prices of resources used to generate electricity, and the size of the future production. Also the effects of competitors' actions are considered. The thesis illustrates how the information in the derivative prices can be used in investment and production planning. In addition, the use of derivatives as a tool to stabilize electricity dependent cash flows is considered. The results indicate that the information about future electricity prices and their uncertainty, obtained from derivative markets, is important in investment analysis and production planning. Gupta (2004) discusses the introduction and growth of the derivatives market in India. It describes in detail the reasons that led to the introduction of derivatives trading in India and why it faced opposition by a section of industry analysts and media. The case then describes the issues that still remain to be addressed by the regulatory authorities to accelerate the long-term growth of the derivatives market. Finally, the case mentions a few steps taken by the concerned authorities in early 2004. Main objectives and reasons for the introduction of derivatives trading in India; and the factors that can accelerate/suppress the growth of the derivatives market in a country. Garcia, P., Leuthold, R. M. (2003) summarized the development of intertemporal price relationships; hedging and basis relationships; price behavior; and institutional issues related to futures markets. In each case the recent contributions are recognized. Using this base of information as background, future research directions are discussed with respect to the following topics: risk management and marketing strategies; price and volatility behavior; electronic trading, price discovery and trading funds; and exchange behavior. Tehran and Kaur (2003) viewed as the negative image of crisis created by derivatives overwhelms any positive publicity on the use of derivatives. It is not cleared whether derivatives enable us to mange risk or just magnify it. This paper is an attempt to explore the scope of derivatives transactions in emerging markets, the policy developments regarding risk containment

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measures for stock options and for stock futures, the need and regulations for risk management and the relevance of derivatives in India. Streltchenko (2003) abstracted in derivative research that why investors trade in the derivatives at a specified price. Here a model is developed that explicitly incorporates a motivation to trade into the mathematical model describing the investment problem. This motivation lies in investors' pre-existing liabilities. By showing the equivalence, via a duality argument, of portfolio optimization and derivatives pricing operator (measure) calibration, we are also able to explore (using the same model) derivative valuation by investors in light of their individual portfolio properties. It is conducted a simulation of a market populated with investors whose decision support was based on this microeconomic model, and observed various trading patterns depending on investors' individual properties. Mahajan(2003) abstracted that in this dynamic environment financial innovation is the word of the day as the tool of risk management. It is crucial to introduce innovative risk reducing and risk transferring instruments to maintain the market efficiency i.e. risk return trade off while increasing the liquidity at mass level and to protect the operating profits of market participants from volatility and uncontrollable risk at class level. The integration of financial markets and free mobility of capital has multiplied risk due to complex nature of financial structuring and multiple currency transactions. The information technology has contributed by eliminating the geographical and time disparities and increased market efficiency. This dynamic global financial environment creates the need for a shift from financial innovation to financial engineering. Financial derivatives are the latest and modern type of financial engll1eenng derivatives. They have been very successful risk management tool in the world capital market. This paper discusses about the history of derivatives which goes back to more than 100 yrs. It also discusses about various types of derivatives with special reference to futures and options it also throws some light on the working of the derivatives market. It also highlights the current scenario and future of the derivative market. Liang T. (2001) said that transactions are notoriously subject to a variety of risks such as credit or counterparty risk, market risk, settlement risk, operational risk

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(remember Nick Lesson), liquidity risk, systemic risk and legal risk. There are a variety of legal risks (which is beyond the scope of this article) and not least of all, documentation risk. It is hoped that the above discussion will have given some indication how such documentation risk in relation to derivatives can arise. Bichler M. (2000) examined that Derivative instruments have become increasingly important to financial institutions, institutional investors, traders and private individuals throughout the world, both as risk-management tools and as a source of revenue. The volume of over-the-counter (OTC) traded derivatives has increased enormously over the past decade, because institutional investors have often had a need for special derivative products which are not traded on organized exchanges. An important feature of OTC trading is the bargaining on multiple attributes of a contract such as price, strike price and contract maturity. Negotiation on multiple attributes of a deal is currently not supported by electronic trading floors. In this paper we describe an approach of how to automate the multi-attribute multilateral negotiations using a Web-based trading system. First, we will give an overview of various approaches to supporting or automating negotiations on multiple attributes. Then we will introduce multi-attribute auctions, an extension of single-sided auction theory and analyze preliminary game-theoretic results. Finally, we will show a Webbased electronic trading system for OTC derivatives, based on multi-attribute auctions. Fatemi A. & Glaum M. (2000) Identifies some gaps in corporate risk management research and presents a study of risk management practices in large, non-financial German firms. Compares the perceived relevance of different types of risk with the intensity of their management and reports that no respondents admitted major difficulty in developing a risk management system. Finds that firm survival is rated as the top goal of risk management, that respondents are closer to risk-neutral than risk-averse for financial risks, that around half centralize treasury management and 88 per cent use derivatives. Ranks the types of derivatives used and the importance of associated problems; shows how foreign exchange risk, US $ exposure and interest rate risk are managed; and assesses attitudes towards foreign exchange and interest rate risk management. Considers consistency with other research and calls for more.

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Dixon R & Bhandari K. (1997) summarized that an extraordinary increase in the use of financial derivatives in the capital markets. Consequently derivative instruments can have a significant impact on financial institutions, individual investors and even national economies. This relatively recent change in the status of derivatives has led to calls for regulation. Fears that using derivatives to hedge against risk carries in itself a new risk was brought sharply into focus by the collapse of Barings Bank in 1995. The principal concerns of regulators about how legislation may meet those concerns are the subject of current debate between the finance industry and the regulators. Recommendations have been made and reviewed by some of the key players in the capital markets at national and global levels. There is a clear call for international harmonization and its recognition by both traders and regulators. There are calls also for a new international body to be set up to ensure that derivatives, while remaining an effective tool of risk management, carry a minimum risk to investors, institutions and national/global economies. Having reviewed derivatives and how they work, proceeds to examine regulation. Finds that calls for regulation through increased legislation are not universally welcome, whereas the regulators main concern is that the stability of international markets could be severely undermined without greater regulation. Considers the expanding role of banks and securities houses in the light of their sharp reactions to increases in interest rates and the effect their presence in the derivatives market may have on market volatility. Includes the reaction of some 30 dealers and users to the recommendations of the G-30 report and looks at some key factors in overcoming potential market volatility. Figlewski (1997) reviewed that derivative instruments have been traded for a long time, the enormous growth in the volume and variety of futures, options, swaps, and more exotic types of contracts in recent years has been without precedent. Concern about the risks of trading in these instruments is also not new, but it too has grown along with the markets. In the last couple of years, a series of widely publicized losses related to derivatives activities has focused public attention (once again) on derivatives risks. Through derivatives, major classes of risk that in the past were mostly borne by specialized financial institutions, with limited risk bearing capacity,

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can now be shared more broadly. For example, derivatives based on mortgages allow home buyers to acquire funds from the bond market rather than having to rely on the ability of savings and loans and similar financial institutions to attract deposits. Recent innovations in derivatives based on catastrophic risks like hurricanes and earthquakes are beginning to make it possible for insurance companies to share risk exposure more broadly with outside investors. Derivatives with option features allow investors to restructure risk exposures to provide preferred patterns. For the public, this often means allowing an investor to control the risk of a loss from an adverse price change without eliminating the possibility of profiting from a favorable market move. Okamoto (1996) found a system and method for creating a limited risk derivative based on a realized variance of an underlying equity is disclosed. In one implementation, a limited risk derivative product includes a capped value for a statistical property reflecting a variance of the underlying equity is calculated based on a pari-mutuel action. The capped value comprises a dynamic value and a cap. The dynamic value reflects an average volatility of prices returns of the underlying equity over a predefined period of time and the cap reflects a maximum value of the dynamic value. The limited risk derivative product additionally includes an average of a summation of each squared daily return of the underlying equity included in the value for the statistical property reflecting the variance of the underlying equity. Porterfield, Laura J. (1994) summarized growing size and complexity of the derivatives market has prompted calls for improved reporting of information about derivative activities. Derivatives, such as swaps, forwards, futures, calls, floors, collars and puts, are financial instruments that derive their values from an underlying asset, reference rate or index. They are often used by government entities, corporations, financial institutions, institutional investors and nonprofit organizations to manage exposures stemming from their asset and liability mix in response to rising public concern about these very complex products, the FASB has embarked on a limited-scope project on derivative activity disclosures. As part of this project, the Board has issued the exposure draft, 'Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,' to enhance such disclosures and make technical improvements to the disclosures in time for 1994

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year-end reporting. Derivative financial instruments, puts, calls, futures, et al, are in the news and people are concerned. The FASB has issued an exposure draft that proposes additional disclosures for these financial instruments in financial statements for this year end. Swaps, forwards, futures, puts, calls, swaptions, caps, floors, collars, captions--the rapid growth of these useful but complex and poorly understood financial instruments, known collectively as derivatives, has propelled them into the spotlight as one of today's hottest financial topics. Accountants-prepares, auditors, and standard-setters--are struggling to keep pace with this innovative and increasingly important market.

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References: Acharya V. Viral, (2005) The Journal of Financial Economics, Vol. 84, No.pp.110141 http://www.defaultrisk.com/pp_crdrv_58.html Fatemi Ali & Glaum, Risk management practices of German firms from the Journal of Managerial Finance, 2000 Volume: 26, Issue: 3 Page:1 17,DOI:10.1108/03074350010766549,Barmarick Publications Bichler M. (2000) Springer Publisher Volume 1, Number 4, April 2000, pp. 401414(14)http://www.ingentaconnect.com/content/klu/isfi/2000/00000001/00000004/0 0258707 Brangers N, Schlag, C & Schneider E (2007) available in the article of Derivatives Trading in a General Equilibrium Model, http://www.wiwi.unifrankfurt.de/schwerpunkte/finance/wp/1537.pdf Dixon R & Bhandari K. (1997), Journal: International Journal of Bank Marketing, Volume: 15 Issue: 3 Page: 91 98, DOI: 10.1108/02652329710166000, http://www.emeraldinsight.com/10.1108/02652329710166000 Figlewski (1997) Article: Derivative risks old and new, http://fic.wharton.upenn.edu/fic/papers/97/b4.html Garcia, P., Leuthold, R. M. (2003) http://www.urotoday.com/browse_category/bph_male_luts/luts_treatment_future_tr eatment_options_abstracts.html Gupta Vivek Gautam, (2004), ECCH Case Collection, published by ICFAI Center for Management Research (ICMR), http://www.asiacase.com/ecatalog/NO_FILTERS/page-EC_INDUS-648548.html

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Okamoto Karl Shumpei (1996) http://www.freshpatents.com/Method-and-systemfor-creating-and-trading-derivative-investment-products-based-on-a-statisticalproperty-reflecting-the-variance-of-an-underlying-assetdt20070510ptan20070106583.php Porterfield, Laura J. (1994) Article: Derivative financial instruments: time for better disclosure, http://www.nysscpa.org/cpajournal/old/15611641.htm Streltchenko Olga (2003) http://ebiquity.umbc.edu/paper/html/id/198/ExploringTrading-Dynamics-in-a-Derivative-Securities-Market-of-Heterogeneous-Agents

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3.1 Sample Break-up Sex: Table 3.1 Sex Male Female Total No. of Respondents 67 33 100

No. of Respondents

33% Male Female 67%

Figure 3.1

From the sample selected of 100 investors, 67 were of the male and 33 were of the female. Thus we can say that most of the males invest in the derivatives.

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Age: Table 3.2 Age Under 30 Between 30 to 40 Between 40 to 50 More than 50 Total Frequency 29 35 31 5 100

No. of respondents

5% 29% 31% Under 30 Between 30 to 40 Between 40 to 50 More than 50 35%

Figure: 3.2

Out of the sample of 100 investors 29investors were of less than 30 years of age, 35 were from 30 years to 40 years, 31 were from 40 years to the 50 years and remaining 5 investors were of more than 50 years of age. So we can say that most of the investors invest from the age of 30 to 40 years.

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Income: Table 3.3 Income level Under RS 50000 Between RS 50000 to RS 100000 Between RS 100000 to Rs 200000 More than RS 200000 Total No. of respondents 3 11 32 54 100

60 50 40 30 20 10 0 Income level No. of respondents

Figure: 3.3 There are 3 respondents who are having the income of less than Rs. 50000, 11 respondents are from income of Rs. 50000 to Rs. 100000, 32 respondents fall in the income level of between Rs. 100000 to Rs. 200000 and 54 fall in the income of more than Rs. 200000. So we can say that most of the investors fall in the income group of more than Rs. 200000.

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3.2 Which category do you belong to? Table 3.4

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Category Studies Business Service Others Total

No. of respondents 14 35 25 26 100

No. of respondents

Others 26%

Studies 14%

Studies Business Service Business 35% Service 25% Others

Figure 3.4 From the sample selected 14 respondents belong to the student category, 35 respondents to the business, 25 respondents to the service and 26 respondents to

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the other categories such as housewives, farmers, agents, brokers etc. so from the above data collected it can be said that most of the business category invest in the derivatives. 3.3 What kind if derivatives preferred by you? Table 3.5 Types of derivatives Over the counter derivatives Exchange traded derivatives Total No. of respondents 27 73 100

No. of respondents

Over the counter derivatives 27% Over the counter derivatives Exchange traded derivatives Exchange traded derivatives 73%

Figure: 3.5 From the sample selected of 100 investors, the type of derivative contracts they preferred was asked. 27 respondents prefer to deal in over the counter derivatives

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and 73 respondents deal with exchange traded derivatives. So here it can be interpreted that most of the investors prefer to deal with exchange traded derivatives.

3.4 Which type of contracts under derivatives is preferred by you? Table 3.6 Type of contracts Futures Options Both a & b Total No. of respondents 25 29 46 100

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No. of respondents
50 45 40 35 30 25 20 15 10 5 0 No. of respondents 25 29 Futures Options Both a & b 46

Figure: 3.6 It was interpreted that from the sample selected of 100 respondents, 25 of the respondents deal in the futures, 29 deals with the options and remaining 46 respondents deal in both future and options. So it can be said that most of the people deal in the both i.e. futures and options.

Hypothesis: Ho = Preference of derivatives is independent to types of contracts Ha = Preference of derivatives is dependent to types of contracts The value of Chi square is 0.022989. The tabulated value of chi square is 0 Here the calculated value of chi square is more than the tabulated value. So the difference between the observed and expected frequencies is insignificant so the hypothesis is rejected. 3.5 How much money do you invest in the future and options? Table 3.7

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Amount invested Less than Rs. 25000 Between Rs. 25000 to Rs. 50000 Between Rs. 50000 to Rs 100000 More than Rs. 100000 Total

No. of respondents 42 37 14 7 100

No. of Respondents
45 40 35 30 25 20 15 10 5 0 No. of respondents 14 Less than Rs. 25000 Between Rs. 25000 to Rs. 50000 Between Rs. 50000 to Rs 100000 More than Rs. 100000 7 42 37

Figure 3.7

The respondents were asked about the average money invested in future and options. 42 of the investors replied that they invest less than Rs. 25000, 37 of the

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respondents replied that they invest between RS. 25000 to Rs. 50000, 13 investors invest between Rs. 50000 to Rs. 100000 and 7 investors invest more than RS. 100000 in the futures and options. So we can say that average investment falls in the category of less than Rs. 25000. 3.6 What is your average investment period? Table 3.8 Period Less than 3 months 3 months to 9 months 9 months to 12 months More than 12 months Total No. of respondents 23 20 32 25 100

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No. of respondents

More than 12 months 25%

Less than 3 months 23% Less than 3 months 3 months to 9 months 9 months to 12 months 3 months to 9 months 20% More than 12 months

9 months to 12 months 32%

Figure 3.8 The respondents were asked about the average investment period in future and options. 23 of the investors replied that they invest for less than 3 months, 20 of the respondents replied that they invest between 3 months to 9 months, 32 investors invest between 9 months to 12 months and 25 investors invest for more than 12 months in the future and options. So we can say that average investment period is between 9 months to 12 months.

3.7 Who influences your investment decision? Table 3.9

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Influence on investment decision Broker Family/friends Media Any other Total

No. of Respondents
40 35 30 25 20 15 10 5 0 No. of respondents 8 30 25 37

No. of respondents 37 30 25 8 100

Broker Family/friends Media Any other

Figure: 3.9 The influence of the investment decision was asked from the investors. 37 respondents decision is being influenced by the brokers, 30 are influenced by family or friends, 25 are influenced by media and 8 are influenced by any other persons decision and it basically includes self decision. so it can be interpreted that the buying decision is mostly influenced by the brokers opinion. 3.8 How much is your decision influenced by the above selected option? Table 3.10

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Extent of influence To great extent To some extent Very little Total

No. of respondents 48 50 2 100

No. of respondents

Very little 2%

To some extent 50%

To great extent 48%

To great extent To some extent Very little

Figure 3.10 Here the extent of influence was asked 48 people are greatly influenced by the selected people and 50 peoples decision influence is to some extent and 2 people have a very little effect. So it can be interpreted that sometimes decision is more influential and sometimes it is less influential.

3.9 Why do you invest in the Future and Options? a) Return

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Table 3.11 Ranks for Return 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank Total No. of respondents 59 25 7 7 2 0 100

70 60 50 40 30 20 10 0 No. of respondents 7 7 2 0 25 59 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank

Figure 3.11 From the above diagram it is interpreted that out of the sample selected 59 of the investors give their first preference to the return, 25 investors gave second preference to return, 7 investors gave third preference to the return, 7 investors gave return as fourth preference and 2 investors gave return as fifth preference. Hypothesis: H0= Risk factor is not related to the return as factor of decision. Ha= Risk factor is related return as factor of decision. Here the correlation between return and risk factor is -0.58844877. As we know that the value of r lies between -1 to 1 so here the value of r = -0.5. In this there is a negative correlation. So the hypothesis is accepted. So our hypothesis is accepted. b) Safety 78

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Table 3.12 Ranks for Safety 1st rank 2nd rank 3rd rank 4th rank 5th rank 6 rank Total
th

No of respondents 20 20 25 6 19 10 100

30 25 20 15 10 6 5 0 No of respondents 10 20 20 25 19 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank

Figure: 3.12 From the above diagram it is interpreted that out of the sample selected 20 of the investors give their first preference to the safety, 20 investors gave second preference to safety, 25 investors gave third preference to the safety, 6 investors gave safety as fourth preference, 19 investors gave safety as fifth preference and 10 investors gave safety as the sixth preference. Hypothesis: H0= Risk factor is not related to the safety as a factor of decision. Ha= Risk factor is related to the safety as a factor of decision.

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Here the correlation between return and risk factor is -0.54399373. As we know that the value of r lies between -1 to 1 so here the value of r = -0.54. In this there is a negative correlation. In this there is a negative correlation. So the hypothesis is accepted. c) Liquidity Table 3.13 Preference for Liquidity 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank Total No. of respondents 3 21 21 26 15 14 100

30 25 21 20 15 10 5 0 3 21

26 1st rank 2nd rank 15 14 3rd rank 4th rank 5th rank 6th rank

No. of respondents

Figure 3.13 From the above diagram it is interpreted that out of the sample selected of 100 investors, 3 of the investors give their first preference to the liquidity, 21 investors gave second preference to liquidity, 21 investors gave third preference to the liquidity, 26 investors gave liquidity as fourth preference, 15 investors gave liquidity as fifth preference and 14 investors gave liquidity as the sixth preference.

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Hypothesis: H0= Risk factor is not related to the liquidity as a factor of decision. Ha= Risk factor is related to the liquidity as a factor of decision. Here the correlation between liquidity and risk factor is -0.08179367. As we know that the value of r lies between -1 to 1 so here the value of r = -0.08. In this there is a negative correlation. In this there is a negative correlation. So the hypothesis is accepted.

d) Tax saving Table 3.14 Preference for Tax savings 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank Total No. of Respondents 16 27 29 21 6 1 100

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35 30 25 20 15 10 5 0 No. of Respondents 6 1 16 27 29 1st rank 21 2nd rank 3rd rank 4th rank 5th rank 6th rank

Figure 3.14 From the above diagram it is interpreted that out of the sample selected of 100 investors, 16 of the investors give their first preference to the tax savings, 27 investors gave second preference to tax savings, 29 investors gave third preference to the tax savings, 21 investors gave tax savings as fourth preference, 6 investors gave tax savings as fifth preference and 1 investor gave tax savings as the sixth preference.

Hypothesis: H0= Risk factor is not related to the tax saving as a factor of decision. Ha= Risk factor is related to the tax saving as a factor of decision. Here the correlation between tax savings and risk factor is -0.88180567. As we know that the value of r lies between -1 to 1 so here the value of r = -0.88. In this there is a negative correlation. In this there is a negative correlation. So the hypothesis is accepted. e) Speculation Table 3.15 Preference for Speculation 1st rank No. of respondents 2

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2nd rank 3rd rank 4th rank 5th rank 6 rank Total
th

7 17 27 29 18 100

35 30 25 20 15 10 5 0 No. of respondents 2 7 17 18 27 29 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank

Figure 3.15 From the above diagram it is interpreted that out of the sample selected of 100 investors, 2 of the investors give their first preference to the speculation, 7 investors gave second preference to speculation, 17 investors gave third preference to the speculation, 27 investors gave speculation as fourth preference, 29 investors gave speculation as fifth preference and 18 investors gave speculation as the sixth preference. Hypothesis: H0= Risk is not related to the speculation as a factor of decision. Ha= Risk is related to the speculation as a factor of decision. Here the correlation between tax savings and risk factor is 0.467725073. As we know that the value of r lies between -1 to 1 so here the value of r = 0.46. In this there is a positive correlation. In this there is a negative correlation. So the hypothesis is accepted. f) Risk factors 83

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Table 3.16 Preference for Risk factors 1st rank 2nd rank 3rd rank 4th rank 5th rank 6th rank Total No. of respondents 0 0 1 13 29 57 100

60 50

57

1st rank 40 30 20 10 0 0 0 1 No. of respondents 13 29 2nd rank 3rd rank 4th rank 5th rank 6th rank

Figure3.16 From the above diagram it is interpreted that out of the sample selected of 100 investors, 1 investor gave third preference to the risk factors, 13 investors gave risk factors as fourth preference, 29 investors gave risk factors as fifth preference and 57 investors gave risk factors as the sixth preference. 3.10 Rate the following risks related to derivatives? a) Credit Risk

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Table3.17 Ratings for credit risk Very high High Moderate Low Very low No. of Respondents 23 54 16 7 0
No. of Respondents

7% 0% 23% 16% Very high High Moderate Low Very low 54%

Figure 3.17 From the above data collected it is interpreted that 23 investors are in favor that the credit risk in the derivatives is very high, 54 considers that credit risk is high, 16 considers that credit risk is moderate in the derivatives, 7 considers that credit risk is low. Hypothesis: H0= All the risks are not dependent on one another. Ha= All the risks are dependent on one another. The calculated value of Chi square is 1.46. The tabulated value of the chi square is 28.3.

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The calculated value of chi square is less than the tabulated value so the hypothesis is accepted here because the difference between observed and expected is insignificant.

b) Market risk Table 3.18 Ratings for market risk Very High High Moderate Low Very low No. of Respondents 30 52 17 1 0

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No. of Respondents

17%

1% 0% 30% Very High High Moderate Low Very low

52%

Figure 3.18 From the above data collected it is interpreted that 1investor is in favor that the market risk in the derivatives is very high, 30 considers that market risk is high, 52 considers that market risk is moderate in the derivatives, 17 considers that market risk is low and 1 investor is in the favor that market risk is very low in the derivatives

c) Legal risk:

Table 3.19

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Ratings for legal risk Very high High Moderate Very low Low Total

No. of Respondents 12 30 42 8 8 100

No. of Respondents

6% 15% Very high High 50% 21% 4% 4% Moderate Very low Low Total

Figure 3.19 From the above data collected it is interpreted that 12 investors are in favor that the legal risk in the derivatives is very high, 30 considers that legal risk is high, 42 considers that legal risk is moderate in the derivatives, 8 considers that legal risk is low and 8 investors are in the favor that legal risk is very low in the derivatives

d) Liquidity risk: Table 3.20

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Ratings for Liquidity risk Very high High Moderate Low Very low Total

No. of respondents 10 33 36 17 4 100

No. of respondents

4% 17%

10% Very high High 33% Moderate Low Very low

36%

Figure 3.20 From the above data collected it is interpreted that 10 investors are in favor that the liquidity risk in the derivatives is very high, 33 considers that liquidity risk is high, 36 considers that liquidity risk is moderate in the derivatives, 17 considers that liquidity risk is low and 4 investors are in the favor that liquidity risk is very low in the derivatives.

3.11 Which is the most prominent factor related to derivatives? Table3.21

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Most prominent factor Reduction in the capital/amount invested No return Foreign exchange risk Total

Frequency 46 18 36 100

No. of Respondents

36% 46%

Reduction in the capital/amount invested No return

Foreign exchange risk 18%

Figure 3.21

The investors were asked about the most prominent factors related to derivatives. 46 respondents were in favor of reduction in the capital or the amount invested, 18 were in favor that they will not get any return on their investment and 36 replied that there is a lot of foreign risk in the derivatives. So it can be interpreted that most of the people consider that the most prominent risk factor is the reduction in the basic amount invested.

3.12 Are you satisfied with your investment in derivatives? Table 3.22

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Satisfaction Yes No Total

No. of respondents 68 32 100

No. of respondents

32% Yes No 68%

Figure 3.22 The investors were also asked about their satisfaction with their investment. Out of the sample selected of 100 respondents, 68 investors were fully satisfied with their investment and 32 were not at all satisfied with their investment so it can be interpreted that most of the people are satisfied.

4.1Findings: The findings of my study are given below:

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1. Most of the respondents of my study are the business class people who invest in the derivatives with respect to future and options. 2. There are two types of the contracts. One is the over the counter derivatives and other is the exchange traded derivatives. From the study it is found that most of the respondents of my sample size invest in the exchange traded derivatives. 3. Most of the respondents of my sample prefer to deal with the both futures and options contracts basically. And if we see preference from futures and options then the preference is for the options contracts. 4. Most of the respondents of my sample selected prefer to invest less than Rs. 25000 in the futures and options contracts. 5. The average investment period preferred by the investors is the period ranging from the 9 months to the 12 months. It means that investors prefer to deal in the long term contracts. 6. The investment decision of the investor is being influenced by the broker as compared to the other persons. 7. The extent of the influence of the brokers decision is to some extent even though it is the broker whose decision is more influenced the investors investment decision. 8. It is found that most of the people invest their money due to the return purpose. 9. It is found that investors consider that in the derivatives credit risk and the market risk are high. Both the legal risk and the liquidity risk are moderate. 10. It is found that the most prominent factor related to the derivatives is the reduction in the basic amount or the capital invested by the investors. 11. Most of the investors are satisfied with their investment in the derivatives even there are some investors who are not satisfied with their investment. 12. Out of the investors most of the respondents are male. It shows that male invest more in the derivatives rather than the females. 13. Most of the people who fall in the age group of 30 to 40 invest in the derivatives. 14. The people who fall in the income level of more than Rs. 200000 invest their money in the derivatives contracts.

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15. It has also been analyzed that the preference of derivatives is dependant to the type of contract. 16. It has also been analyzed that risk factor is not related to the return as a factor of decision. 17. It has also been analyzed that risk factor is not related to the safety as a factor of decision. 18. It has also been analyzed that risk factor is not related to the Liquidity as a factor of decision. 19. It has also been analyzed that risk factor is not related to the tax saving as a factor of decision. 20. It has also been analyzed that risk factor is not related to the speculation as a factor of decision. 21. It is found that all the risks are not dependant on one another.

4.2 Recommendations: Most of the investors decision is influenced by the broker so that broker should present the true and fair figure to the investor.

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Broker should not misguide or cheat the investors because he is the middleman between the shareholder and the company. There should be seminars, group discussions on the derivative trading which can be conducted by the various stock exchanges to provide the knowledge to the general public while investing they can take their self decisions.

Insider trading should be banned so that It can not be misused by the directors of the company SEBI should also take some steps to control the market. As we know that there is lot of fluctuations in the market these days so it should be controlled that will definitely increase in more satisfaction of the investor.

There is a need to bring more stability in foreign exchange market also. Because as we know that the domestic market is influenced by the foreign market.

Awareness programmes should be launched or introduced by SEBI for providing the knowledge to the investors.

4.3 Limitations The data which is collected with the help of questionnaire may be biased.

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The sample size of 100 respondents is small as it does not represent the whole figure. Due to time and resource constraints the study was limited to the area of Chandigarh. The scope of study was very limited to the Chandigarh only.

4.4 Conclusion:

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At the end it can be concluded that derivatives are now a days playing an important role. Investors preferred to deal in the both futures and options contracts. They also prefer the long term contracts rather than the short term contracts. As it is found that the decision of the investor is being influenced by the brokers. Most of the investors are satisfied still there are some investors who are not satisfied so efforts should be made to satisfy all the investors. There is a need to provide the knowledge to the investors about the derivatives so it can be done with the help of the various seminars and group discussion programmes which can be conducted by the stock exchanges and SEBI either singly or jointly.

5 BIBLIOGRAPHY 5.1 Books: 96

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Singh harpreetresearch methodology,Kalyani publisher,printed in 2006.Singh Singh Inderpal, singh Jaswinder, Kaur Raminder, Kalyani Publisher, reprinted in 2006 5.2 Websites http://en.wikipedia.org/wiki/derivative_(finance) http://www.sebi.gov.in/faq/derivativesfaq.html http://www.futuresoptions.com http://www.urotoday.com/browse_category/bph_male_luts/luts_treatment_future_tr eatment_options_abstracts.html http://www.cababstractsplus.org/google/abstract.asp?AcNo=20053017970 http://www.amazon.ca/Introduction-futures-options-markets-John/dp/0138891486 http://www.conceptvisionindia.com/derivatives/basics.asp

QUESTIONAIRE

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I am Hardev Singh doing MBA from Desh Bhagat Institute of Management (Affiliated to Punjabi University, Patiala). I am conducting a project on Investors perception towards Derivatives as an investment strategy.I would request you to fill the below mentioned questionnaire: 1Q: Which category do you belong to? a) Student b) Business c) Service d) Others 2Q: What kind of derivatives is preferred by you? a) Over the counter derivatives. b) Exchange traded derivatives. 3Q: Which type of contracts under derivatives is preferred by you? a) Future b) Options c) Both a & b 4Q: How much money do you invest in the futures and options? a) Less than Rs. 25000 b) Between Rs. 25000 to Rs. 50000 c) Between Rs. 50000 to Rs. 100000 d) More than Rs. 100000 5Q: Who influence your investment decision? a) Broker b) Family members/Friends c) Media d) Any other (Pls.specify.) 6Q: How much your decision is influenced by the above selected option? a) To great extent b) To some extent c) Very little 7Q: Why do you invest in future and options? (Give preferences) a) Return ( ) b) Safety ( ) c) Capital appreciation ( ) d) Liquidity ( ) e) Tax Saving ( ) f) Speculation ( ) g) Any other (pls. Specify) ( ) 8Q: why do you invest in future and options? (Give preferences) 5 (Very High) 4 3 2 1(very Low) Risk factors Credit Risk Market Risk Legal Risk Liquidity Risk

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9Q: Which is the most prominent factor related to derivatives? a) Reduction in the capital or amount invested b) No return c) Foreign Exchange Risk 10: Are you satisfied with your investment in derivatives? a) Yes b) No 11 Q: What are the suggestions for the futures and options? Ans: . Personal Profile Name: . Phone No. Sex: a) Male b) Female b) Between 30 to 40 d) More than 50 b) Between Rs.50000 to Rs.100000 d) More than Rs.200000

Age: a) Under 30 c) Between 40 to 50

Income (per annum): a) Under Rs. 50000 c) Between Rs.100000 to Rs.200000

(Thanks)

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