A PROJECT REPORT ON

COMPARATIVE ANALYSIS OF EQUITY & DERIVATIVE

MARKET SUBMITTED TO MAEERs MIT SCHOOL OF BUSINESS BY LUCY CHATTERJEE Roll No. 260247

26th Batch

IN PARTIAL FULFILLMENT OF POST GRADUATE DIMPLOMA IN MANAGEMENT (PGDM)

December, 2009

MAEERs MIT SCHOOL OF BUSINESS PUNE

CONTENTS Chapter No. Title

Declaration from student Certificate from organisation Certificate from Guide Acknowledgement List of Tables List of Graphs List of charts List if abbreviations Executive summary

Page No. III IV V VI VII VII VII IX X

1 1.1 1.2

Introduction Background of the study Company Profile Company History

1 6 11 11 13 13 13 14

Top management
Competitive advantage of Religare Need of the Study Objective of the Study Methodology of the Study Limitation of the Study Data Processing & Analysis Equity Benefits from equity Risk in equity investment How to overcome from risk

1.3 1.4 1.5 1.6 2 2.1

16 16 18 18

 Process of diversification Selection of shares When to buy/sell shares Types of cash market margin

18 19 19 25 28 29 29 41 43 47

2.2

Derivatives Factors driving the growth of derivative Types of derivatives Types of trades I derivative Types of F& O margin Comparative analysis

2.3 3

Findings Practical situation Comparative analysis of the traded values in the F & O segment with Cash segment Conclusions Recommendations Bibliography

52 54

4 5 6

55 56 57

DECLARATION
I, Ms. Lucy Chatterjee

hereby declare that this project report is the record of authentic work carried out by me during the period from 2008 to 2010 and has not been submitted to any other University or Institute for the award of any degree / diploma etc.

Name of the student: Lucy Chatterjee Date:

iii

Acknowledgement

It gives me an immense pleasure to present this project report, for the partial fulfillment of the course. This project has been made possible through the direct and indirect co-operation of so many people for whom by profound through appreciation the gratitude remains.

First of all. I would like to thanks to Mrs. Priya Venkatraman, Senior Relationship Management for her valuable suggestions and constructive criticisms that have acted as a guiding light for me. I also acknowledge the help given to me by the people of the organization whose valuable inputs were the driving force behind this project. Last not but the least. I take this opportunity to express my gratitude to Prof. (Gp. Capt.) D. P. Apte.

I am also grateful to my guide Prof. P. Krishnan who guided me to complete this project successfully on time and other faculty members of MITSOB for the knowledge, which I am imbibed throughout the two years of my PGDM course.

My deepest regards to my parents who have been always immense of inspiration & support to me forever. I would like to dedicate this work to my parents without whose co-operation this task would have remained unachieved.

vi

List of Table Table No. 1

2 3 4 5 6

Title
Performance of sensex from 1991 Client interface Distinction between futures and forward Distinction between future and option Comparative analysis Comparative analysis in the F & O segment with cash segment

Page No. 3
12 33 41 46 54

List of Graph Graph No.

1 2 3 4 5

Title
Sensex performance Exchange traded derivatives Forward Payoff from forward contract Exchange traded in derivative Option Payoff from option

Page no.
4 31 32 35 33

vii

List of Charts Chart No.

1 2 3 4

Title
An overview of a REL Religare Financial service group overview REL vision and mission REL & its subsidiaries

Page No.
7 8 9 10

viii

List of Abbreviations Abbreviation

BSE CDSL DP EPS EWMA FIIs F&O IPO LN MTM NAV NSDL P/E ratio RBI SCRA SEBI SRO VaR FICCI

Full Form
Bombay stock Exchange Central depository services limited Depository Participant Earnings per share Exponentially weighted moving average Foreign institutional investors Futures & Options Initial Public Offering Natural log Mark to market Net asset value National securities depository limited Price per earnings ratio Reserve bank of India Securities contract regulation act Securities & Exchange board of India Self-regulatory organization Value at Risk Federation of Indian Chambers of Commerce and Industry

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EXECUTIVE SUMMARY
The project is about the study of brand awareness of RELIGARE SECURIRTIES LIMITED among investors. It gives the knowledge of market position of the company. I studied as to how this company proves to an option for the investors, by studying the performance of investing in equity & derivative for few months considering their analysis. I selected area of COMPARITIVE ANALYSIS OF EQUITY & DERIVATIVE, which attract different kinds of investors to invest in equity derivative and to face high risk and get high returns. The major findings of the project are to overview of the comparison of equity cash segment and equity derivative segment, overview of the equity and F & O segment from May 2009 to June 2009. The methodology of the project here is to analyze the Equity & Derivative performance based on NAV, EPS and other things. In this project I also included my practical situation during the project internship, that how the market goes up and down and why it happens. The methodology of the project here is to analyze the investment opportunities available for those investors & study the returns & risk involved in various investment opportunities and also study of investment management & risk management. So for that we have to study & analyze the performance of Equity & Derivative in the market. We know that there is a high risk, high return in equity but in a long time only. While in derivative there is a high risk, high return in the short term, because derivative contract is for short time for 1/2/3 months only. So this project included different types of returns, margin & risk involved in equity, and types, need, use & margin involved in the derivatives market and also participants & terms use in derivative market.

1. INTRODUCTION 1.1Background of the study:

The oldest stock exchange in Asia (established in 1875) and the first in the country to be granted permanent recognition under the Securities Contract Regulation Act, 1956, Bombay Stock Exchange Limited (BSE) has had an interesting rise to prominence over the past 133 years. A lot has changed since 1875 when 318 persons became members of what today is called Bombay Stock Exchange Limited paying a princely amount of Re 1. In 2002, the name "The Stock Exchange, Mumbai" was changed to Bombay Stock Exchange. Subsequently on August 19, 2005, the exchange turned into a corporate entity from an Association of Persons (AoP) and renamed as Bombay Stock Exchange Limited. BSE, which had introduced securities trading in India, replaced its open outcry system of trading in 1995, with the totally automated trading through the BSE Online trading (BOLT) system. The BOLT network was expanded nationwide in 1997. Since then, the stock market in the country has passed through both good and bad periods. The journey in the 20th century has not been an easy one. Till the decade of eighties, there was no measure or scale that could precisely measure the various ups and downs in the Indian stock market. Bombay stock Exchange Limited (BSE) in 1986 came out with a stock Index that subsequently became the barometer of the Indian Stock Market. SENSEX first compiled in 1986 was calculated on a Market Capitalization Weighted methodology of 30 component stocks representing a sample of large, well established and financially sound companies. The base year of SENSEX is 1978-79. The index is widely reported in both domestic and international markets through prints as well as electronic media. SENSEX is not only scientifically designed but also based on globally accepted construction and review methodology. From September 2003, the SENSEX is calculated on a free-float market capitalization methodology. The free-float Market Capitalization-Weighted methodology is a widely followed index construction methodology on which majority of global equity benchmarks are based.

The growth of equity markets in India has been phenomenal in the decade gone by Right from early nineties the stock market witnessed heightened activity in terms of various bull and bear runs. The SENSEX captured all these happenings in the most judicial manner. One can identify the booms and bust of the Indian equity market through SENSEX.

The Exchange also disseminates the Price-Earnings Ratio, the Price to Book Value Ratio and the Dividend Yield Percentage on day-to-day basis of all its major indices. The value of all BSE indices are every 15 seconds during the market hours and displayed through the BOLT system. BSE website and news wire agencies. All BSE-Indices are reviewed periodically by the Index Committee of the Exchange. The Committee frames the broad policy guidelines for the development and maintenance of all BSE indices. Department of BSE Indices of the exchange carries out the day to day maintenance of all indices and conducts research on development of new indices. Institutional investors, money managers and small investors all refer to the Sensex for their specific purposes The Sensex is in effect the substitute for the Indian stock markets. The country's first derivative product i.e. Index-Futures was launched on SENSEX.

PERFORMANCE OF SENSEX FROM 1991

Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Open 1,027.38 1,957.33 2,617.78 3,436.87 3,910.16 3,114.08 3,096.65 3,658.34 3,064.95 5,209.54 3,990.65 3,262.01 3,383.85 5,872.48 6,626.49 9,422.49 13,827.77 20,325.27 9,720.55

high 1,955.29 4,546.58 3,459.07 4,643.31 3,943.66 4,131.22 4,605.41 4,322 5,150.99 6,150.69 4,462.11 3,758.27 5,920.76 6,617.15 9,442.98 14,035.30 20,498.11 21,206.77

low close 947.141 1,908.85 1,945.48 2,615.37 980.06 3,346.06 3,405.88 3,926.90 2,891.45 3,110.49 2,713.12 3,085.20 3,096.65 3,658.98 2,741.22 3,055.41 3,042.25 5,005.82 3,491.55 3,972.12 2,594.87 3,262.33 2,828.48 3,377.28 2,904.44 5,838.96 4,227.50 6,602.69 6,069.33 9,397.93 8,799.01 13,786.91 12,316.10 20,286.99 7,697.39 9,647.31 14,493.84*

*As of 30/June/2009

GRAPH SHOWING SENSEX PERFORMANCE

1.2COMPANYS PROFILE

Companys History
Religare is one of the leading integrated financial services institutions od India. Religare is promoted by the promotion of Ranbaxy Laboratories Limited. The comapn offers large and diverse bouuet of services ranging from equties, derivatives, commodities, insurance broking, to wealth advisory, portfolio managemnt services, personal finacial services Investment banking and institutuonal broking services. The services are broadly clubbed across three key business verticals- Retail, wealth mangement and the institutional specturm.

Religare retail network spreads across the length and the breadth of the country with it presence through more than 1,217 locations across more than 392 cities and towns. The company has a represenattive office in London. Having spread itself fairly well across the country and with the promises of not resting on its laurels, it has also aggresively started eyeing global geographies.

An Overview of a Religare Enterprise Limited

Religare Enterprise Limited

Fortis healthcare Limited

Super Religare Laborataries Limited (formerly SRL Ranbaxy)

Religare Wellness Limited (formerly Fortis Healthworld)

Religare Technova Limited

Religare Voyages Limited

Religare Financial Services Group Overview:Religare Enterprise Limited

Their Joint Ventures

Life Insurance Business (Aegon as a Partner)

Asset management business (Aegon as a Partner)

Private Wealth Business (Macquire, Australian Financial Services Major As a partner)

Indias First SEBI approved Film Fund (Vistaar as a Partner)

REL Vision and Mission

VISION

To build Religare as a globally trusted brand in the financial services domain and present it as the Investment Gateway of India.

MISSION

Providing financial care driven by the core values of diligence and transparency.

BRAND ESSENCE

Religare is driven by ethical and dynamic processes for wealth creation.

REL & its subsidiaries

Structurally, all businesses are operated through various subsidiaries of the holding company, Religare Enterprises Limited.

Top Management Team

Mr. Sunil Godhwani- CEO & Managing Director, Religare Enterprises Limited. Mr. Shacindra Nath- Group Chief operating Officer, Religare Enterprises Limited. Mr. Anil Saxena- Group Chief Operating Officer, Religare Enterprises Lmited.

Competitive advantage of Religare

Lowest Brokerage Online Money Transfer. Daily Confirmation Calls. Daily Contract Notes. Different Kinds of Accounts like, R-Ally, R-Ally Lite, R-Ally Pro etc. Providing Funding Facility.

Client Interface:

Retail Spectrum

Institutional Spectrum Positioning

Wealth Spectrum

Leverage reach and offer integrated product and service portfolio

Leverage relationship with growing SME segment spread across India

To be a client centric wealth management advisory firm for the high net worth individuals (HNIs)

Products and Services Equity Trading Commodity Trading Online Investment portal Personal Financial Services Investment Solutions Insurance Loans Institutional Broking Investment Banking Insurance Advisory Portfolio Management Services Premier Client Group Services Arts Initiative International Advisory Fund Management Service (AFMS)

Consumer Finance Insurance Solutions Life Insurance Non-Life Insurance

1.3NEED OF THE STUDY

Different kinds of investors to invest in equity & derivative and to face high risk and get high returns. Company proves to an option for the investors.

Studying the performance of investing equity & derivative for few months considering their analysis.

1.4 OBJECTIVE OF THE STUDY

Any investors vision is a long term investment ad short term investment and gets high returns by bearing high risk. For that objective need to be climbed successfully an so objectives of this project are, 1) To find the RIGHT SCRIPT to buy and sell at the RIGHT TIME 2) To get good return. 3) To know how derivatives can be use for hedging. 4) To know the outcome of Equity and Derivative. 5) How to achieve Capital appreciations.

1.5METHODOLOGY OF THE PROJECT

Defining objective wont suffice unless and until a proper methodology is to achieve the objectives. 1) Analyzing and observing the investment opportunities. 2) Analyzing the performance of Equity and Derivative market with the help of NAV, EPS, P/E ratio etc.

1.6LIMITATIONS OF THE STUDY

This project was restricted for two months; hence exhaustive data is not available upon which conclusions can be relied.

1) Investment in Securities carry risk so investment in Equity & Derivative is also carrying risk on the basis of the market.

2) Factors affecting the Market Price of Investment may be due to Market forces, performance of the companies is not possible, and so all the data is not available.

2. DATA PROCESSING & ANALYSIS

2.1 Equity
Total equity capital of a company is divided into equal units of small denominations, each called a share. It is a stock or any other security representing an ownership interest. It proves the ownership interest of stock holders in a company. For example:In a company the total equity capital of Rs 2, 00, 00,000 is divided into 20, 00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then is said to have 20, 00,000 equity shares of Rs 10 each. The holders of such shares are members of the company and have voting rights.

Benefits from Equity The benefits distributed by the company to its shareholders can be: 1) Monetary Benefits and 2) Non Monetary Benefits. 1. Monetary Benefits: A. Dividend: An equity shareholder has a right on the profits generated by the company. Profits are distributed in part or in full in the form of dividends. Dividend is an earning on the investment made in shares, just like interest in case of bonds or debentures. A company can issue dividend in two forms: a) Interim Dividend and b) Final Dividend. While final dividend is distributed only after closing of financial year; companies at times declare an interim dividend during a financial year. Hence if X Ltd. earns a profit of Rs 40 crore and decides to distribute Rs 2 to each shareholder, a holding of 200 shares of X Ltd. would entitle you to Rs 400 as dividend. This is a return that you shall earn as a result of the investment made by you by subscribing to the shares of X Ltd. B. Capital Appreciation: A shareholder also benefits from capital appreciation. Simply put, this means an increase in the value of the company usually reflected

in its share price. Companies generally do not distribute all their profits as dividend. As the companies grow, profits are re-invested in the business. This means an increase in net worth, which results in appreciation in the value of shares. Hence, if you purchase 200 shares of X Ltd at Rs 20 per share and hold the same for two years, after which the value of each share is Rs 35. This means that your capital has appreciated by Rs 3000. 2. Non-Monetary Benefits: Apart from dividends and capital appreciation, investments in shares also fetch some type of non-monetary benefits to a shareholder. Bonuses and rights issues are two such noticeable benefits. A. Bonus: An issue of bonus shares is the distribution free of cost to the shareholders usually made when a company capitalizes on profits made over a period of time. Rather than paying dividends, companies give additional shares in a pre-defined ratio. Prima facie, it does not affect the wealth of shareholders. However, in practice, bonuses carry certain latent advantages such as tax benefits, better future growth potential, and an increase in the floating stock of the company, etc. Hence if X Ltd decides to issue bonus shares in a ration of 1:1, every existing shareholder of X Ltd would receive one additional share free for each share held by him. Of course, taking the bonus into account, the share price would also ideally fall by 50 percent post bonus. However, depending upon market expectations, the share price may rise or fall on the bonus announcement. B. Rights Issue: A rights issue involves selling of ordinary shares to the existing shareholders of the company. A company wishing to increase its subscribed capital by allotment of further shares should first offer them to its existing shareholders. The benefit of a rights issue is that existing shareholders maintain control of the company. Also, this results in an expanded capital base, after which the company is able to perform better. This gets reflected in the appreciation of share value.

Risks In equity investment:

Although an equity investment is the most rewarding in terms of returns generated, certain risks are essential to understand before venturing into the world of equity. Market/ Economy Risk. Industry Risk. Management Risk. Business Risk. Financial Risk Exchange Rate Risk. Inflation Risk. Interest Rate Risk.

How to overcome risks: Most risks associated with investments in shares can be reduced by using the tool of diversification. Purchasing shares of different companies and creating a diversified portfolio has proven to be one of the most reliable tools of risk reduction.

The process of Diversification: When you hold shares in a single company, you run the risk of a large magnitude. As your portfolio expands to include shares of more companies, the company specific risk reduces. The benefits of creating a well diversified portfolio can be gauged from the fact that as you add more shares to your portfolio, the weightage of each companys share gets reduced. Hence any adverse event related to any one company would not expose you to immense risk. The same logic can be extended to a sector or an industry. In fact, diversifying across sectors and industries reaps the real benefits of diversification. Sector specific risks get minimised when shares of other sectors are added to the portfolio. This is because a recession or a downtrend is not seen in all sectors together at the same time.

However all risks cannot be reduced: Though it is possible to reduce risk, the process of equity investing itself comes with certain inherent risks, which cannot be reduced by strategies such as diversification. These risks are called systematic risk as they arise from the system, such as interest rate risk and inflation risk. As these risks cannot be diversified, theoretically, investors are rewarded for taking systematic risks for equity investment.

Selection of Shares: Proper selections of shares are of two types:1. Fundamental analysis: It involves in depth study and analysis of the prospective company whose shares we want to buy, the industry it operates in and the overall market scenario. It can be done by reading and assessing the companys annual reports, research reports published by equity research houses, research analysis published by the media and discussions with the companys management or the other experienced investors.

2. Technical analysis: It involves studying the prices movement of the stock over an extended period of time in the past to judge the trend of the future price movement. It can be done by software programs, which generate stock prices charts indicating upward. Downward and sideways movements of the stock price over the stipulated time period.

When to buy & sell shares: With high volatility prevailing in the market, major price fluctuations in equities are not uncommon. Therefore, apart from ascertaining which stock to buy or sell, it becomes equally important to consider when to buy or sell. Any investor should be aware of the fact where all the investor is following i.e., Buy Low. Sell High. That means we should buy stocks at a low price and sell them at a high price.

When to buy

Three ways by which we can figure that out what it is about this stock that makes it hot.

1. Earnings per Share (EPS): How well the company is doing EPS is the total earning or profits made by company (during a given period of time) calculated on per share basis. It aims to give an exact evaluation of the returns that the company can deliver. Example: Company XYZ Ltd. Capital: Rs 100 crore (Rs 1 billion). Capital is the amount the owner has in the business. As the business grows and makes profits, it adds to its capital. This capital is subdivided into shares (or stocks). The capital is divided into 100 million shares of Rs 10 each. Net Profit in 2003-04: Rs 20 crore (Rs 200 million). EPS is the net profit divided by the total number of shares. EPS = net profit/ number of shares EPS = Rs 20 crore (Rs 200 million)/ 10 crore (100 million) shares = Rs 2 per share Lesson to be learnt 1. If a company's EPS has grown over the years, it means the company is doing well, and the price of the share will go up. If the EPS declines, that's a bad sign, and the stock price falls. 2. Companies are required to publish their quarterly results. Keep an eye out for these results; check for the trend in their EPS.

3. Price earnings ratio (PE ratio): How other investors view this share An indicator of how highly a share is valued in the market. It arrived at by dividing the closing price of a share on a particular day by EPS. The ratio tends to be high in the case of highly rated shares. The average PE ratio for companies in an industry group is often given in investment journal. Two stocks may have the same EPS. But they may have different market prices. That's because, for some reason, the market places a greater value on that stock. PE ratio is the market price of the stock divided by its EPS. PE = market price/ EPS lets take an example of two companies. Company XYZ Ltd Market price = Rs 100 EPS = Rs 2 PE ratio = 100/ 2 = 50 Company ABC Ltd Market price = Rs 200 EPS = Rs 2 PE ratio = 200/ 2 = 100 In the above cases, both companies have the same EPS. But because their market price is different, the PE ratio is different. Lesson to be learnt

In the case of EPS, it is not so much a high or low EPS that matters as the growth in the EPS. The company's PE reflects investors' expectations of future growth in the EPS. A high PE company is one where investors have hopes that earnings will rise, which is why they buy the share.

3. Forward PE: Looking ahead The stock market is not nostalgic. It is forward looking. For instance, it sometimes happens that a sick company, that has made losses for several years, gets a rehabilitation package from its bank and a new CEO. As a consequence, the company's stock shoots up. Because investors think the company will do better in the future because of the package and new leadership, and its earnings will go up. And we think it is a good time to buy the shares of the company now. Suddenly, the demand for the shares has gone up. Because stock prices are based on expectations of future earnings, analysts usually estimate the future earnings per share of a company. This is known as the forward PE. Forward PE is the current market price divided by the estimated EPS, usually for the next financial year.

Forward PE = Current market price/ estimate EPS for the next financial year. To illustrate what we have been talking about, let's take the example of Infosys Technologies. Trailing 12-month EPS = Rs 56.82 (EPS of the last four quarters) Closing price on January 6 = Rs 2043.15 PE = Price/EPS = 2043.15/ 56.82 = 35.95 Estimated EPS for 2004-05 = Rs 67 Estimated EPS for 2005-06 = Rs 90 these figures are according to brokers' consensus estimates. Forward PE = current market price/ estimated EPS for next financial year Forward PE for 2004-05 = 2043.15/ 67 = 30.49 Forward PE for 2005-06 = 2043.15/ 90 = 22.70 With an EPS growth of over 30%, a forward PE of 22.7 is not high, indicating that there is scope to be optimistic about the stock's price.

Lesson to be learnt

Sometimes, investors look out for a low PE stock, expecting that its price will rise in the future. But sometimes, low PE stocks may remain low PE stocks for ages, because the market doesn't fancy them.

Keep tab on the business news to check out the company's prospects in the future

When to sell Stock Reaches Fair Value or Target Price This is the easiest part of selling. We should sell when a stock reaches its fair value. It is the main reason why we chose to buy it on the first place. The target price can be computed by assessing the companys estimated financial performance over the next 3 to 5 years, computing its EPS and using an acceptable P/E ratio to compute the future market price. Based on this future estimated price and our required return on our investment, compute our target price. When the prices reaches Stop loss It is advisable to always consider the possibility of a loss before making our investment. We should decide how much loss we are willing to book in the stock. The lower price i.e., the price at which we are willing curtail our loss, is called Stop Loss. Need the money The generally happens due to improper planning. However, things happen. Even the most carefully planned strategy may not work. Catastrophic events may force investors to sell an investment if his household is affected by it.

The book is unclean When management left their post abruptly or when the SEBI conduct a criminal investigation on a company, it may be time to sell. Our assumption may be inaccurate as a lot of fair value calculation is based on the company's balance sheet, cash flow or other financial statement published by management.

Takeover news When one of your stock holding is getting bought by other companies, it may be time to sell. Sure, you might like the acquiring company but you still need to figure out the fair value of the common stock of the acquiring company. If the acquiring company is overvalued, then it is best to sell.

Other Investment Opportunity Let us consider we bought stock A and it has risen to 10% below its fair value. Meanwhile, we noticed that stock B fallen to below 50% of our calculated fair value. This is an easy decision. We will sell our stock A and buy stock B. Our goal as an investor is to maximize our investment return. Sacrificing a 10% of return in order to earn a 50% return is a sensible way to do that.

Inaccurate Fair Value Calculation As investors, we sometimes made errors in our fair value calculation. There are factors that we might not take into accounts when researching a particular company. For example, satyam scandal.

New Competitors with Better Products When new competitors sprung up, the company that you hold might have to spend more money in order to fend off competition. Recent example includes the emergence of pay-per click advertising by Google. Any advertising business such as newspapers or cable network, this new product by Google might hurt profit margins and eventually the fair value of the stock.

Not having a valid reason to Buy When we don't know why we bought a particular stock, we won't know how much our potential return is or when we should sell it. This is the easiest way of losing money. When we have no valid reason to buy, we should sell immediately.

Types of Cash market margin

1. Value at Risk (VaR) margin. 2. Extreme loss margin 3. Mark to market Margin

1. Value at Risk (VaR) margin : VaR Margin is at the heart of margining system for the cash market segment. VaR is a technique used to estimate the probability of loss of value of an asset or group of assets (for example a share or a portfolio of a few shares), based on the statistical analysis of historical price trends and volatilities. A VaR statistic has three components: a time period, a confidence level and a loss amount (or loss percentage). Keep these three parts in mind as we give some examples of variations of the question that VaR answers: With 99% confidence, what is the maximum value that an asset or portfolio may lose over the next day?

Example:Suppose shares of a company bought by an investor. Its market value today is Rs.50 lakhs but its market value tomorrow is obviously not known. An investor holding these shares may, based on VaR methodology, say that 1-day VaR is Rs.4 lakhs at 99% confidence level. This implies that under normal trading conditions the investor can, with 99% confidence, say that the value of the shares would not go down by more than Rs.4 lakhs within next 1-day.

In the stock exchange scenario, a VaR Margin is a margin intended to cover the largest loss (in %) that may be faced by an investor for his / her shares (both purchases and sales) on a single day with a 99% confidence level. The VaR margin is collected on an upfront basis (at the time of trade).

How is VaR margin calculated? VaR is computed using exponentially weighted moving average (EWMA) methodology. Based on statistical analysis, 94% weight is given to volatility on T-1 day and 6% weight is given to T day returns. To compute, volatility for January 1, 2008, first we need to compute days return for Jan 1, 2009 by using LN (close price on Jan 1, 2009 / close price on Dec 31, 2008). Take volatility computed as on December 31, 2008. Use the following formula to calculate volatility for January 1, 2009: Square root of [0.94*(Dec 31, 2008 volatility)*(Dec 31, 2008 volatility)+ 0.06*(January 1, 2009 LN return)*(January 1, 2009 LN return)]

Example: Share of ABC Ltd Volatility on December 31, 2008 = 0.0314 Closing price on December 31, 2008 = Rs. 360 Closing price on January 1, 2009 = Rs. 330 January 1, 2009 volatility = Square root of [(0.94*(0.0314)*(0.0314) + 0.06 (0.08701)* (0.08701)] = 0.037 or 3.7%

How is the Extreme Loss Margin computed?

The extreme loss margin aims at covering the losses that could occur outside the coverage of VaR margins.

The Extreme loss margin for any stock is higher of 1.5 times the standard deviation of daily LN returns of the stock price in the last six months or 5% of the value of the position. This margin rate is fixed at the beginning of every month, by taking the price data on a rolling basis for the past six months.

Example: In the Example given at question 10, the VaR margin rate for shares of ABC Ltd. was 13%. Suppose the 1.5 times standard deviation of daily LN returns is 3.1%. Then 5% (which is higher than 3.1%) will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme Loss Margin). As such, total margin payable (VaR margin + extreme loss margin) on a trade of Rs.10 lakhs would be 1, 80,000/-

How is Mark-to-Market (MTM) margin computed?

MTM is calculated at the end of the day on all open positions by comparing transaction price with the closing price of the share for the day.

Example: A buyer purchased 1000 shares @ Rs.100/- at 11 am on January 1, 2008. If close price of the shares on that day happens to be Rs.75/-, then the buyer faces a notional loss of Rs.25, 000/ - on his buy position. In technical terms this loss is called as MTM loss and is payable by January 2, 2008 (that is next day of the trade) before the trading begins.

In case price of the share falls further by the end of January 2, 2008 to Rs. 70/-, then buy position would show a further loss of Rs.5,000/-. This MTM loss is payable.

In case, on a given day, buy and sell quantity in a share are equal, that is net quantity position is zero, but there could still be a notional loss / gain (due to difference between the buy and sell values), such notional loss also is considered for calculating the MTM payable.

MTM Profit/Loss = [(Total Buy Qty X Close price)] - Total Buy Value] - [Total Sale Value (Total Sale Qty X Close price)]

2.2

Derivatives
Derivative is a product whose value is derived from the value of one or more

basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices by that date. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of wheat which is the "underlying".

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SCRA) defines "derivative" to include1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument or contract for differences or any other form of security. 2. A contract which derives its value from the prices, or index of prices, of underlying securities. Derivatives are securities under the SC(R)A and hence the trading of derivatives is governed by the regulatory framework under the SC(R)A.

Factors driving the growth of derivatives Over the last three decades, the derivatives market has seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are:

1. Increased volatility in asset prices in financial markets, 2. Increased integration of national financial markets with the international markets, 3. Marked improvement in communication facilities and sharp decline in their costs, 4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and 5. Innovations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

Types of derivatives:
1. Forward Contract: A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying asset on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are: They are bilateral contracts and hence exposed to counter-party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the party wishes to reverse the contract, it has to compulsorily go to the same counter-party, which often results in high prices being charged.

Limitations of Forward Contract

Forward markets world-wide are afflicted by several problems: Lack of centralization of trading, Illiquidity, and Counterparty risk In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a real estate market in that any two consenting adults can form contracts against each other. This often makes them design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable.

Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers. Even when forward markets trade standardized contracts, and hence avoid the problem of illiquidity, still the counterparty risk remains a very serious issue.

Exchange Traded Derivative" Forward"

7000 amount in billion of $ 6000 5000 4000 3000 2000 1000 0 interest rate futures stock index futures Types currency futures

2. Future Contracts:

Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way.

The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement

The payoff from a long position in a forward contract is P = S - X, where S is a spot price of the security at time of contract maturity, X is the delivery price. Similarly, the payoff from a short position is P = X - S. For example, let's say the current price of the stock is $80.00 and we entered in forward contract to buy this stock in 3 months time for $81.00 (that means we hope that price will not fall lower than $81.00). If after three months price is more than $81.00, let's say $83.00, than we can buy the same stock for $81.00 (as stated by forward contract) and after reselling it on the market our payoff will be P = $83.00 - $81.00 = $2.00 If at forward maturity the stock price falls to $78.00, than our loss will be P = $81.00 - $78.00 = $3.00

The graphs above illustrate the forward contract payoff patterns for long and short positions.

Distinction between futures and forwards

Futures Trade on an organized exchange Standardized contract terms hence more liquid Follows daily settlement

Forwards OTC in nature Customised contract terms hence less liquid Settlement happens at end of period

Future terminology
Spot price: The price at which an asset trades in the spot market.

Futures price: The price at which the futures contract trades in the futures market.

Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one- month, two-month and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three- month expiry is introduced for trading.

Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist.

Contract size: The amount of asset that has to be delivered less than one contract. Also called as lot size.

Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices.

Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin.

Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market.

Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

3. Option Contracts
Options are fundamentally different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contract, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirements) to enter into a futures contract, the purchase of an option requires an up-front payment.

Exchange Traded Derivatives "options"

3500 3000 2500 2000 1500 1000 500 0 individal stock options stock index options currency options interset rate options

types

In billions of $

Option Terminology
Index options: These options have the index as the underlying. Some options are European while others are American. Like index futures contracts, index options contracts are also cash settled.

Stock options: Stock options are options on individual stoc ks. Options currently trade on over 500 stocks in the United States. A contract gives the holder the right to buy or sell shares at the specified price. Buyer of an option: The buyer of an option is the one who by paying the option premium buys the right but not the obligation to exercise his option on the seller/writer. Writer of an option: The writer of a call/put option is the one who receives the option premium and is thereby obliged to sell/buy the asset if the buyer exercises on him.

Option price/premium: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

Expiration date: The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity.

Strike price: The price specified in the options contract is known as the strike price or the exercise price.

American options: American options are options that can be exercised at any time upto the expiration date. Most exchange-traded options are American.

European options: European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart.

In-the-money option: An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price >strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price).

Out-of-the-money option: An out-of-the-money (OTM) option is an option that would lead to a negative cash flow if it were exercised immediately. A call option on the index is out-of-the money when the current index stands at a level which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price.

Intrinsic value of an option: The option premium can be broken down into two components intrinsic value and time value. The intrinsic value of a call is the amount the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it another way, the intrinsic value of a call is Max[0, (St K)] which means the intrinsic value of a call is the greater of 0 or (St K). Similarly, the intrinsic value of a put is Max[0, K St],i.e. the greater of 0 or (K St). K is the strike price and St is the spot price.

Time value of an option: The time value of an option is the difference between its premium and its intrinsic value. Both calls and puts have time value. An option that is OTM or ATM has only time value. Usually, the maximum time value exists when the option is ATM. The longer the time to expiration, the greater is an option's time value, all else equal. At expiration, an option should have no time value.

There are two basic types of options, call options and put options.

Call option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price. i) Long a call:- person buys the right (a contract) to buy an asset at a certain price. We feel that the price in the future will exceed the strike price. This is a bullish position. ii) Short a call:- person sells the right ( a contract) to someone that allows them to buy to buy an asset at a certain price. The writer feels that asset will devaluate over the time period of the contract. This person is bearish on that asset.

Put option: A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price. i) Long a put:- Buy the right to sell an asset at a pre-determined price. We feel that the asset will devalue over the time of the contract. Therefore we can sell the asset at a higher price than is the current market value. This is a bearish position. ii) Short a put:- sell the right to someone else. This will allow them to sell the asset at a specific price. We feel the price will go down and we do not. This is a bullish position.

Profit / payoff in Option

The payoff to a derivative portfolio is the market value of the portfolio at expiration. (Also gross payoff). The profit on a derivative portfolio is the payoff less the cost of acquisition or assembling the portfolio. (Net profit). We will be looking at a number of option strategies and combinations. The (gross) payoff is the value (positive or negative) of the option or portfolio at maturity.

 The payoff does not include the initial cost (or the initial cash inflow) at the time the portfolio was set up. Net profit= (gross) Payoff- cost of buying options or other securities+ premium received for selling options or other securities.

If S is a final price of the option underlying security, X is a strike price and OP is an option price, than the profit is Long Call: P = S - X - OP Short Call: P = X - S + OP Long Put: P = X - S - OP Short Put: P = S - X + OP For example, let's say the stock price is $50.00, we bought European call option with strike $53.00 and paid $2.00 for this option. If option price is less than $53.00, we will not exercise the option to buy the stock, because it doesn't make sense to buy security for higher price than it costs on the market. In this case we lose all initial investment equal to the option price $2.00. If stock price is more than $53.00, we will exercise the option. For example if the stock price is $56.00, after exercising the option and immediately reselling the acquired stock our profit will be: P = $56.00 - $53.00 - $2.00 = $1.00 if the stock price is $54.00, than the profit is: P = $54.00 - $53.00 - $2.00 = - $1.00 As we see in latter case we lose money. The reason is that increase of stock price just by $1.00 above the strike ($53.00) doesn't cover our initial investment of $2.00, although we still exercise the option to recover at least $1.00 of initial investment. If the stock price at exercise time is $55.00 than we exercise the option to cover our initial expenses(equal to option price): P = $55.00 - $53.00 - $2.00 = $0.00 This latter case corresponds to option graph intersection point with horizontal axis on the drawing above.

Distinction between futures and options

Futures Exchange traded, with novation Exchange defines the product Price is zero, strike price moves Price is zero Linear payoff Both long and short at risk Options Same as futures. Same as futures. Strike price is fixed, price moves. Price is always positive. Nonlinear payoff. Only short at risk.

Types of traders in derivative market

1. Hedgers:- Hedgers are those who protect themselves from the risk associated with the price of an asset by using derivatives. A person keeps a close watch upon the prices discovered in trading and when the comfortable price is reflected according to his wants, he sells futures contracts. In this way he gets an assured fixed price of his produce.

In general, hedgers use futures for protection against adverse future price movements in the underlying cash commodity. Hedgers are often businesses, or individuals, who at one point or another deal in the underlying cash commodity.

Take an example: A Hedger pay more to the farmer or dealer of a produce if its prices go up. For protection against higher prices of the produce, he hedges the risk exposure by buying enough future contracts of the produce to cover the amount of produce he expects to buy. Since cash and futures prices do tend to move in tandem, the futures position will profit if the price of the produce raise enough to offset cash loss on the produce.

2. Speculators:

Speculators are somewhat like a middle man. They are never interested in actual owing the commodity. They will just buy from one end and sell it to the other in anticipation of future price movements. They actually bet on the future movement in the price of an asset.

They are the second major group of futures players. These participants include independent floor traders and investors. They handle trades for their personal clients or brokerage firms . Buying a futures contract in anticipation of price increases is known as going long. Selling a futures contract in anticipation of a price decrease is known as going short. Speculative participation in futures trading has increased with the availability of alternative methods of participation.

Speculators have certain advantages over other investments they are as follows: If the traders judgment is good, he can make more money in the futures market faster because prices tend, on average, to change more quickly than real estate or stock prices. Futures are highly leveraged investments. The trader puts up a small fraction of the value of the underlying contract as margin, yet he can ride on the full value of the contract as it moves up and down. The money he puts up is not a down payment on the underlying contract, but a performance bond. The actual value of the contract is only exchanged on those rare occasions when delivery takes place.

3. Arbitrators:

According to dictionary definition, a person who has been officially chosen to make a decision between two people or groups who do not agree is known as Arbitrator. In commodity market Arbitrators are the person who takes the advantage of a discrepancy between prices in two different markets. If he finds future prices of a commodity edging out with the cash price, he will take offsetting positions in both the markets to lock in a profit. Moreover the commodity future investor is not charged interest on the difference between margin and the full contract value.

Types of Futures and Options Margins

Margins on Futures and Options segment comprise of the following: 1) Initial Margin 2) Exposure margin In addition to these margins, in respect of options contracts the following additional margins are collected 1) Premium Margin 2) Assignment Margin

How is Initial Margin Computed? Initial margin for F&O segment is calculated on the basis of a portfolio (a collection of futures and option positions) based approach. The margin calculation is carried out using software called - SPAN (Standard Portfolio Analysis of Risk). It is a product developed by Chicago Mercantile Exchange (CME) and is extensively used by leading stock exchanges of the world. SPAN uses scenario based approach to arrive at margins. It generates a range of scenarios and highest loss scenario is used to calculate the initial margin. The margin is monitored and collected at the time of placing the buy / sell order.

The SPAN margins are revised 6 times in a day - once at the beginning of the day, 4 times during market hours and finally at the end of the day. Obviously, higher the volatility, higher the margins.

How is exposure margin computed? In addition to initial / SPAN margin, exposure margin is also collected. Exposure margins in respect of index futures and index option sell positions have been currently specified as 3% of the notional value. For futures on individual securities and sell positions in options on individual securities, the exposure margin is higher of 5% or 1.5 standard deviation of the LN returns of the security (in the underlying cash market) over the last 6 months period and is applied on the notional value of position.

How is Premium and Assignment margins computed? In addition to Initial Margin, a Premium Margin is charged to trading members trading in Option contracts. The premium margin is paid by the buyers of the Options contracts and is equal to the value of the options premium multiplied by the quantity of Options purchased. For example, if 1000 call options on ABC Ltd are purchased at Rs. 20/-, and the investor has no other positions, then the premium margin is Rs. 20,000. The margin is to be paid at the time trade. Assignment Margin is collected on assignment from the sellers of the contracts.

How Marked to Market Margins are computed?

1. Future contracts:- The open positions (gross against clients and net of proprietary/ self trading) in the futures contracts for each member are marked to market to the daily settlement price at the end of each day is the weighted average price of the last half an hour of the futures contract. The profits/losses arising from the different between the trading price and the settlement price are collected/ given to all clearing members.

2. Option contracts:- the marked o market for option contracts is computed and collected as part of the Initial Margin in the form of Net Option Values. The Initial Margin is collected on an online real time basis based on the data feeds given to the system at discrete time intervals.

How Client Margins are computed? Client Members and Trading Member are required to collect initial margins from all their clients. The collection of margins at client level in the derivatives markets is essential as derivatives are leveraged products and non-collection of margins at the client level would provide zero cost leverage. In the derivative markets all money paid by the client towards margins is kept in trust with the Clearing House/ Clearing Corporation and in the event of default of the Trading or Clearing Member the amounts paid by the client towards margins are segregated and not utilized towards the dues of the defaulting member.

Therefore, Clearing members are required to report on a daily basis details in respect of such margin amounts due and collected from their Trading members/ clients clearing and settling through them. Trading members are also required to report on a daily basis details of the amount due and collected from their clients. The reporting of the collection of the margins by the clients is done electronically through the system at the end of each trading day. The reporting of collection of client level margins plays a crucial role not only in ensuring that members collect margin from clients but it also provides the clearing corporation with a record of the quantum of funds it has to keep in trust for the clients.

2.3

Comparative Analysis

Basis Return

Equity Capital appreciation Dividend Income

Derivative Capital gain Price Fluctuation Market risk Credit risk Liquidity risk Settlement risk Initial margin Exposure margin Premium margin Short term (Max. 3 months) Speculations Arbitragers Hedgers

Risk

Company Specified Sector specified Global risk General Market Risk

Types of margin

VaR Extreme Loss Mark to market

Duration

Generally Long term (more than 1 yr)

Participants

Long term Investors Hedgers Safe Investors

Expiry Date of contract

No such things

Last Thursday of any month

Comparative analysis is easy to understand when we are analysis with the example of the real market situation.

Now I would like to quote a real life example during my internship where I understood the actual comparison of equity and derivative market.

Example:There was an investor Mr. Jaichand. He has Rs. 1, 00,000/- and he wants to invest it in share market. Now he has two options either to invest in equity cash market or equity derivative market (F&O). Now suppose if he invest in equity cash market and buy shares of Rs. 1, 00, 000/- and diversified risk so he buys different scrips. So he purchases 10 RIL shares of Rs. 2350/- each. 10 L&T shares of Rs 800/- each, 15 Religare Enterprises Shares of Rs. 370/- each, 20 ICICI bank shares of Rs. 800/- each, 10 Tata power shares of Rs. 1250 each and 10 BHEL shares of Rs. 1595/each. So for investing Rs. 1, 00,000/- in equity cash market he has to pay Rs. 1,00,000/- and gets the delivery of the shares. Now suppose if he invest in equity derivative market then he will able to purchase the shares worth Rs. 5,00,000/- though he has capital of Rs. 1,00,00/- only, because of the margin payment. But he has to purchase the share in a lot size. So he is able to purchase the 1 lot (100 shares) of RIL at Rs. 2350/-, 1 lot (50 shares) of L&T at 2650/-, 2 lots (100 shares each) of Religare Enterprises at Rs. 370/- and 1 lot (70 shares) of ICICI bank at Rs. 800/-. Here Mr. Jaichand has to pay Rs. 1,00,000/- as a margin money and he is able to purchase a shares worth Rs. 5,00,000/But he has to pay the full amount of money at T+3 basis. So he has to pay the remaining amount on the 3rd day of the trading if he wants the delivery.

I.

Returns

Mr. Jaichand gets return on equity by two ways. One is when the share price of the holding shares will increases in futures, called as capital appreciation. Second is by getting a dividend income from the holding shares.

Mr. Jaichand gets return on equity derivative when the future prices of the shares are increase in short term called as capital gain through price fluctuation or through options premium.

II.

Risk: There are four types of risk involved in equity cash market. 1. Company Specified risk:- If company is not performing well than process of the shares will declining and vice versa. 2. Sector specified risks:- If the sector is not performing well i.e. power sector, metal sector, oil & gas sector, banking sector then prices of the shares will go down and vice versa. 3. Global risk:- If global cues are positive then prices will increases but if global cues are not good than prices of shares will go down. 4. General market risk:- General market risk is also affect the equity cash market like inflation, banks interest rates etc.

So Mr. Jaichand has to consider all these risk factors while dealing in the equity cash market. There are four types of risk involved in equity derivative market.

1. Market risk:- In derivative market we have to calculate the market risk or mark to market risk involved in the stocks or securities, that is the exposure to potential loss from fluctuations in market prices (as opposed to changes in credit status). It is calculated on the tradable assets i.e., stocks, currencies etc. 2. Credit risk: It may possible in derivative contract that the counterparty may be fail to perform the contract or say defaulted then it is a risk for us. It is calculated on nontradable assets i.e., loans. So generally it is for long term purpose. 3. Liquidity Risk:- If Mr. Jaichand will not able to find a price( or a price within a reasonable tolerance in terms of the deviation from prevailing or expected prices) for one or more of its financial contracts in the secondary market. Consider the case of a counterparty who buys a complex option on European interest rates. He is exposed to

liquidity risk because of the possibility that he cannot find anyone to make him a price in the secondary market and because of the possibility that the price he obtains is very much against him and the theoretical price for the product. 4. Settlement Risk:- The risk of non-payment of an obligation by a counterparty to a transaction, exacerbated by mismatches in payment timings. So, Mr. Jaichand has to consider all these factors while dealing in the equity derivative market.

III.

Margins:

Now Mr. Jaichand has also seen the margin paid in the equity cash segment.

1. Var Margin: - Now Mr. jaichand bought shares of a company. Its market value today is Rs. 1, 00,000/- Obviously, we do not know what would be the market value of these shares next day. Now Mr. Jaichand holding these shares may, based on VaR methodology, say that 1-day Var is Rs. 1, 00,000/- at the 99% confidence level. This implies that under normal trading conditions the investors can with 99% confidence, say that the value of shares would not go down by more than Rs. 1,00,000/- within next 1-day. 2. Extreme loss margin: - In the above situation, the VaR margin rate for shares of RIL was 13%. Suppose that SD would be 1.5 x 3.1= 4.65. Then 5% (which is higher than 4.65%) will be taken as the Extreme Loss margin rate. Therefore, the total margin on the security would be 18% (13% VaR Margin + 5% Extreme Loss margin). As such, total margin payable( VaR margin + extreme loss margin) on a trade of Rs. 23, 500/- woud be 4, 230/-

3. Mark to Market Margin:-

Now Mr. Jaichand purchased 10 shares of RIL @

Rs. 2350/-, at 11 am on May 12, 2009. If close price of the shares on that happened to be Rs. 2350, then the buyer faces a notional loss of Rs. 500/- on his buy position. In technical term this loss is called as MTM loss and is payable by May 13, 2009 (that is next day of the trade) before the trading begins.

In case, price of the shares falls further by the end of May 13 2009 to Rs. 2200/-, then buy postion would show a further loss of Rs. 1, 000/-. This MTM loss is payable by next day. Now we will consider the margin payable under the equity derivatives segment. i) Initial Margin: The initial margin required to be paid by the investor would be equal to the highest loss the portfolio would suffer in any of the scenarios considered. The margin is monitored and collected at the time of placing the buy/ sell order. As higher the volatility, higher the initial margin. ii) Exposure Margin:- Exposure margins in respect of index futures and index option sell position are 3% of the notional value. iii) Premium margin:- If 1000 call option on RIL are purchased at Rs. 20/and Mr. Jaichand has no other positions, then the premium margin Rs. 20,000. iv) Assignment Margin:- Assignment Margin is collected on assignment from the sellers of the contract.

IV.

Duration: Generally equity market is a long term market and people invested in it for more than one year and then only they get good return on equity. Generally any safe investors can invest in it because here risk is comparatively low then derivative market. While in derivative market investors are investing for less than one yea, generally for 2 months or 3 months. Here they get high returns on it because they are bringing high risk.

V.

Participants: Generally any long term investors can invest in equity or hedgers are investing in the equity, who wants to reduce their risk. Any person who wants to be safe investors and wanted to earn a good amount of returns after a period of more than one year is also invested in equity.

In derivative market mostly speculators and arbitragers are invested because they wanted quick money in short time period and hedgers are also invested in derivative market to reduce their risk.

VI.

Expiry date: Its a last Thursday of any month in case of a derivative market but no such things in case of an equity market.

3. FINDINGS
Start of 2012 turns out to be favorable for Indian stock markets as nifty rose 1000 points in two mnths. The 2012 budget was flat with hike of 2% in service tax and excise duty etc, the stock mkt reacted negatively with fall of around 200 points in nifty in the previous two sessions after the budget. However, the market corrected soon after the announcement of budget due to absence of major policy announcements. The market picked momentum from mid of the month. This was helped by better-than-expected corporate earnings, huge overseas inflows and encouraging global cues. Global stocks rallied over the month on encouraging economic data and earnings reports. February saw a continuation of the rally in global risk assets that begain in December last year. Further unconventional monetary policy from the European cental bank (ECB),the bank of England(BOE) and the bank of japan(BOJ), together with continuing positive economic data from the US, Supported global equity and high yield fixed income markets. The MSCI World Index ended February up 9.3% year to date, the Msci emerging market index up 12.3%, While the jp morgan global bond index has risen just 0.8% , global large cap stocks performed broadly in line with small cap, while growth performed a little better than value. Sector Performance The Union Budget sometimes come with good surprises and sometimes disappoints us with negative ones. On the Budget day, all sectors move up and down as the Budget announcements related to a specific sector are made. Sector Performance since Previous Union Budget
Index Name BSE FMCG Sector BSE Auto BSE Cons Durable BSE Healthcare BSE Tech BSE Bankex BSE IT Sector BSE Realty Index BSE PSU BSE Oil Date Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Feb 29, 2012 Close Price Date Close Price 3432.42 8252.92 5631.61 5717.96 3572.85 11840.34 6106.81 1981.65 8380.61 9459.45 % Change 21.40 21.10 16.51 10.82 1.38 1.13 0.89 -1.31 -7.36 -7.90 4166.85 Feb 28, 2011 9994.61 Feb 28, 2011 6561.17 Feb 28, 2011 6336.41 Feb 28, 2011 3622.04 Feb 28, 2011 11974.16 Feb 28, 2011 6161.06 Feb 28, 2011 1955.60 Feb 28, 2011 7764.04 Feb 28, 2011 8711.71 Feb 28, 2011

BSE Power BSE Cap Goods BSE Metal

Feb 29, 2012 Feb 29, 2012 Feb 29, 2012

2280.39 Feb 28, 2011 10426.37 Feb 28, 2011 12052.39 Feb 28, 2011

2523.29 12399.76 15348.81

-9.63 -15.91 -21.48

Institutional Activities FII Investment Activity in February 2012 FII Activity is a date wise list of Gross Buy ( in Crores) and Sell ( in Crores) investments done by Foreign Institutional Investors, their Net Investment Positions for those dates and Cummulative Investments as on that date in Million $ with a break up of Investments made in Equity and Debt instruments.
Date
29-Feb-12 28-Feb-12 27-Feb-12 24-Feb-12 23-Feb-12 22-Feb-12 21-Feb-12 17-Feb-12 15-Feb-12 14-Feb-12 13-Feb-12 10-Feb-12 09-Feb-12 08-Feb-12 07-Feb-12 06-Feb-12 03-Feb-12 02-Feb-12 01-Feb-12

Gross Purchase(Cr)
3,679.30 2,955.40 3,079.30 9,675.90 4,080.60 4,024.00 4,093.70 4,095.00 7,863.80 2,971.70 2,591.60 2,666.40 3,988.60 4,405.40 2,893.40 3,509.80 3,192.30 5,124.80 5,227.20

Gross Sale(Cr)
3,028.80 2,099.00 3,621.70 2,077.80 3,703.80 3,057.00 2,599.20 3,500.40 5,678.50 1,825.00 1,944.00 2,323.10 2,538.20 3,954.90 2,201.10 2,405.50 2,218.40 2,989.90 3,134.50

Net Cummulative Investment(Cr) Investment($Mn)

650.50 856.50 -542.50 7,598.10 376.90 966.90 1,494.60 594.60 2,185.30 1,146.70 647.60 343.30 1,450.40 450.50 692.30 1,104.30 974.00 2,134.90 2,092.70 132.91 174.29 -110.60 1,548.59 76.53 196.35 304.50 120.82 444.05 232.44 131.31 69.15 294.27 91.80 141.53 226.85 198.92 434.55 422.49

Major Corporate Events Infosys beat market forecasts with a 33 per cent rise in quarterly profit as a weak rupee boosted margins, but it cut its full-year revenue outlook because of the debt crisis in Europe, its secondbiggest market. Infosys, which is also listed in New York, said consolidated net profit rose to Rs 23.72 billion ($457 million) in the third quarter ended Dec. 31 from Rs 17.8 billion a year earlier, helped by an 8 per cent fall in the rupee.

Steel Authority of India has lined up capital expenditure (capex) of Rs 145 billion for next financial year 2012-13, the company is looking to add 5 million tonnes annual production capacity, to raise the total capacity to 19 million tonnes per annum (MTPA) by the end of next fiscal. Punj Lloyd Group has been awarded a contract for mechanical works for a value of $30,795,888 amounting Rs 153 crore approximately from SK Engineering & Construction, Singapore. The company has reported consolidated net profit to Rs 74.6 crore for the third quarter ended December 31, on higher sales. The company had clocked a net loss of Rs 59.9 crore in the October-December quarter of the last fiscal. The income from operations during the quarter went up by 28.71% to Rs 2,694 crore from over Rs 2,093 crore in the same period a year ago. Key Macro Developments There are a few key macro-economic developments and themes to watch for in 2012, which will impact investors across the globe. For starters, the euro zone crisis is not over and will continue to impact investor sentiment negatively, till its resolved. If the recession in Europe is fiercer than what most expect, it would be accompanied by an international credit crunch, dragging both developed and developing economies into renewed global recession. Over the year, nearly a dozen countries will go into elections, representing nearly 50 per cent of world GDP. While the US and France will see presidential elections, China will see a one-in-10year leadership change. German federal elections are due in February 2013. This would also bring some semblance of stability in the financial markets. In volatile times, emerging market assets remain highly volatile. However, as inflation comes down in economies like India and China, central banks in both countries would get more room to ease rates. This would result in

inflows into both emerging market equities and bonds. India stands to gain even within the region, as yields on bonds are higher compared to peers. Gold, which emerged as the best asset class in 2011, is likely to lose some sheen as the world recovers from the current crisis. In 2011, most central banks were net buyers of gold, with net purchases adding upto 192 tonnes. There is evidence now that some of the troubled European sovereigns are selling gold stock piles for austerity and liquidity measures. Going by these trends, gold may correct to $1,250 in 2015, due to a broader economic recovery and macrofinancial stabilisation, says Citi.

Outlook

The global economic outlook for 2012 isn't pretty

Recession in Europe, anaemic growth at best in the United States, and a sharp slowdown in China and in most emerging-market economies. Asian economies are exposed to China. Latin America is exposed to lower commodity prices (as both China and the advanced economies slow). Central and Eastern Europe are exposed to the eurozone. And turmoil in the Middle East is causing serious economic risks both there and elsewhere as geopolitical risk remains high and thus high oil prices will constrain global growth. At this point, a eurozone recession is certain. While its depth and length cannot be predicted, a continued credit crunch, sovereign-debt problems, lack of competitiveness, and fiscal austerity imply a serious downturn. The US growing at a snail's pace since 2010 faces considerable downside risks from the eurozone crisis. It must also contend with significant fiscal drag, ongoing deleveraging in the household sector (amid weak job creation, stagnant incomes, and persistent downward pressure on real estate and financial wealth), rising inequality, and political gridlock. Elsewhere among the major advanced economies, the United Kingdom is double dipping, as front-loaded fiscal consolidation and eurozone exposure undermine growth. In Japan, the postearthquake recovery will fizzle out as weak governments fail to implement structural reforms. Meanwhile, flaws in China's growth model are becoming obvious. Falling property prices are starting a chain reaction that will have a negative effect on developers, investment, and government revenue. The construction boom is starting to stall, just as net exports have become a drag on growth, owing to weakening US and especially eurozone demand. Having sought to cool the property market by reining in runaway prices, Chinese leaders will be hard put to restart growth.

They are not alone. On the policy side, the US, Europe, and Japan, too, have been postponing the serious economic, fiscal, and financial reforms that are needed to restore sustainable and balanced growth. Private- and public-sector deleveraging in the advanced economies has barely begun, with balance sheets of households, banks and financial institutions, and local and central governments still strained. Only the high-grade corporate sector has improved. But, with so many persistent tail risks and global uncertainties weighing on final demand, and with excess capacity remaining high, owing to past over-investment in real estate in many countries and China's surge in manufacturing investment in recent years, these companies' capital spending and hiring have remained muted. Rising inequality owing partly to job-slashing corporate restructuring is reducing aggregate demand further, because households, poorer individuals, and labour-income earners have a higher marginal propensity to spend than corporations, richer households, and capital-income earners. Moreover, as inequality fuels popular protest around the world, social and political instability could pose an additional risk to economic performance. At the same time, key current-account imbalances between the US and China (and other emerging-market economies), and within the eurozone between the core and the periphery remain large. Orderly adjustment requires lower domestic demand in over-spending countries with large current-account deficits and lower trade surpluses in over-saving countries via nominal and real currency appreciation. To maintain growth, over-spending countries need nominal and real depreciation to improve trade balances, while surplus countries need to boost domestic demand, especially consumption. Finally, policymakers are running out of options. Currency devaluation is a zero-sum game, because not all countries can depreciate and improve net exports at the same time. Monetary policy will be eased as inflation becomes a non-issue in advanced economies (and a lesser issue in emerging markets). But monetary policy is increasingly ineffective in advanced economies, where the problems stem from insolvency and thus creditworthiness rather than liquidity. Meanwhile, fiscal policy is constrained by the rise of deficits and debts, bond vigilantes, and new fiscal rules in Europe. Backstopping and bailing out financial institutions is politically unpopular, while near-insolvent governments don't have the money to do so. As a result, dealing with stock imbalances the large debts of households, financial institutions, and governments by papering over solvency problems with financing and liquidity may eventually give way to painful and possibly disorderly restructurings. Likewise, addressing weak competitiveness and currentaccount imbalances requires currency adjustments that may eventually lead some members to exit the eurozone. Restoring robust growth is difficult enough without the ever-present spectre of deleveraging and a severe shortage of policy ammunition. But that is the challenge that a fragile and unbalanced global economy faces in 2012. To paraphrase Bette Davis in All About Eve, "Fasten your seatbelts, it's going to be a bumpy year.

Comparative analysis of the traded value in the F & O Segment with the cash segment
F& O( turnover in crores) Cash Segment( turnover in crores) Jan 2009 Feb 2009 March 2009 April 2009 May 2009 June 2009 12, 00, 000 12,00, 000 14,00,000 16, 00, 000 19,00,000 18,00,000 2, 00, 000 1,00, 000 5, 00, 000 4, 50, 000 6 00, 000 6, 50, 000

From this table we can see that in practical life though equity cash segment is better than the derivatives because it involves lesser risk more numbers of investors are trading in derivatives (F& O) segment. It is a major finding of the projects shows that by 60% to 70% investors are bear more risk and traded in derivatives market because they want to earn more profits by trading in derivatives.

4. CONCLUSIONS
This project has covered several areas. Its main conclusions are: Derivatives market growth continues almost irrespective of equity cash market turnover growth. Since 2000. Cash equity turnover has fallen in the developed markets, but derivatives turnover continued to rise steeply and steadily. Equity derivatives businesses like interest derivatives are highly concentrated. Using notional value as the measure, the 2 main US markets and the 2 cross-border European markets accounted for about 75% of the total. This was most apparent in index derivatives, which make 99% of the notional value of equity derivatives. In single stock derivatives, other markets have established niches and the dominance of the gig four is less evident. Equity market volume and derivative market notional value are strongly correlated- with a ratio significant differences between individual markets. A number of cash equity markets- particularly in developing Asia- do not have equity derivatives markets. Comparison of their cash market volumes with those that do have derivative exchanges shows that the markets without derivatives are of similar size. I Am not convinced that market or infrastructure differences explain this, but suspects that regularity barriers have effectively prevented the development, markets in several developing Asian countries.

People should learned first and then investor should consult their financial advisor before investing. If people have adequate knowledge then they can earn good return in stock market.

Intraday trading should not be traded by normal man as they lose money due to volatility in the market. People should invest in stock market as a long term investor rather than short term because in short term risk is many and profit are less. F&O do cover risk of future so my advice is those have adequate knowledge should invest in F&O segment and others should start first with cash market with long term perspective.

5. RECOMMENDATIONS
RBI should play a greater role in supporting Derivatives. Because nowadays derivatives market are increasing rapidly and it plays a major role in the whole securities market. Derivatives market should be developed in order to keep it at par with other derivative market in the world. Nowadays more number of investors are shows their interest in derivatives market because it includes high return by bearing high risk. Speculation should be discouraged because it affects the market conditions badly and new investors are reducing their interest in the market. There must be more derivatives instruments aimed at individual investors. SEBI should conduct seminars regarding the use of derivatives to educate individual investors

 There is a need to have a smaller contract size in F & O Market. We can review the size of the contract from Rs. Two lacs to On Lacs. People have very little knowledge about option market which is less risky compare to future market and I think sebi should conduct seminars in this regard. There are few business channels on equity market but they should also cover futures market a bit more as more interest lies on the future than the present and the past. People feel that on future prices current price moves if future share price of particular company is up and then current share price should also be up, likewise it shows how people gamble and loose money in stock market this should be stopped and proper training programmes should be conducted by both exchanges so that investor are educated Margin limit by brokers should be reduced and more and more people fall in this trap they buy more shares and if share prices fall loose their hard money. Apart from hindi business news channel should be started in other language like gujarati, urdu etc.

6. BIBLIORAPHY
Books: Securities Laws and Regulations of Financial Markets National Securities Depository Limited Fundamentals of Futures & Options Markets- John C. Hull Financial Derivatives- S. L. Gupta

Websites: www.world-exchange.org www.nseindia.com www.bseindia.com www.religaresecurities.com www.moneycontrol.com www.indiamart.com www.finpipe.com