Description
The bank has subsidiaries in the United Kingdom, Russia, and Canada; branches in United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre; and representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia.
INTRODUCTION
Money markets are the important market, which gives the performance of any country’s position. Stock Exchanges play a vital role in this market. Large volumes of securities are being traded. The mail disadvantage of this market is that there is a high amount of risk and the risk is very much unsystematic. Also an individual investor/portfolio manager has many responsibilities beyond those related to specific equity selection. Some involve broader issues like the market timing portfolio asset allocation, protective hedging, efficient hedging and efficient trade execution for large transactions. At the same time many equities exhibit a high degree of liquidity in the sense, being able to buy and sell relatively large amounts quickly, with out substantial price concessions. Also in case of debt market the risks of the particular instruments have finite life and process a limited marketability due to its size. Due to the Internet limitations, mainly unsystematic risk and liquidity in the equity market they are raised a necessity of development of new financial instruments make a base for a border market rather than an individual market.
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Derivative instruments are not special types of securities but are contracts derived from some underlying asset as such these instruments will not have any independent value underlying security can be either securities, commodities bullion, currency, live stocker any thing else. In other words derivative means a forward, future, options or any other hybrid contract, which has a predetermined time for purpose of fulfillment of contract. The values of these instruments depend on value of one or more basic variables.
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OBJECTIVES
1. To study the various trends operating in derivative market. 2. To study in detail the role of futures contracts. 3. To study various rules and regulations in derivatives market. NEED FOR THE STUDY
Different investment avenues are available to investors. Stock market also offers good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including stock brokers and analyst while making investment decisions. The objective here is to make the investor aware of the functioning of the derivatives.
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Derivatives act as a risk hedging tool for the investors. The objective is to help the investors in selecting the appropriate derivative instrument to attain maximum return with minimum risk and to construct the portfolio in such a manner to meet the investor goals and objectives. The investor should decide how best to reach the goals from the securities available.
To identify investor’s objectives, constraints and preference, which will help formulate the investment policy.
To develop and implement strategies in tune with the investment policy formulated. This will help the selection of asset classes and securities in each class depending upon their risk-return attributes.
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METHODOLOGY AND DATA COLLECTION PRIMARY SOURCE: • I gathered information by interacting with employees.
SECONDARY SOURCE: • I referred to Derivatives related books • Material provided by ICICI prudential
SCOPE OF THE STUDY
The study is limited to the analysis made for types of instruments of derivatives. Each strategy is analyzed according to its risk and return characteristics and derivative performance against the profit and policies of the company.
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LIMITATION OF THE STUDY The subject of derivatives is vast it requires extensive study and research to understand the depth of the various instruments operating in the market. The study was confined to Indian derivative market only, where the use of derivative instrument is only a recent phenomenon. But, various international examples have also been added to make the study more comfortable.
There are various other factors also which define the risk and return preferences of an investor, however, the study was only confined towards the risk minimization and profit maximization objective of the investor.
The derivative market is a dynamic one, premiums, contract rates, strike price fluctuate on demand and supply basis. Therefore, data related to last few trading months was only considered and interpreted.
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ICICI PRUDENTIAL LIFE INSURANCE
ICICI prudential Life Insurance was established in the 2000 with a commitment to expand and reshape the life insurance industry in India. The company was amongst the first private sector insurance companies to begin operations after receiving approval from Insurance Regulatory Development Authority (IRDA)
NEW BASEL CAPITAL ACCORD: The new Basel capital accord is based around three complementary elements viz., (i) to reinforce minimum capital standards, (ii) to have the supervisory review process, and (iii) to promote safety and soundness in banks and financial systems. Market discipline imposes strong incentives on banks to conduct their business in a safe sound and efficient manner, including an incentive to maintain a strong capital base as a cushion against potential future losses arising from risk exposures. The Basel committee is already working on the scope of application of the accord, capital and capital adequacy, and risk exposure and assessment. The risk management has come at the central stage in the new Basel capital accord.
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Products
Insurance Solutions for Individuals ICICI Prudential Life Insurance offers a range of innovative, customercentric products that meet the needs of customers at every life stage. Its products can be enhanced with up to 4 riders, to create a customized solution for each policyholder.
Savings & Wealth Creation Solutions Cash Plus is a transparent, feature-packed savings plan that offers3 level of protection as well as liquidity options. Save'n'Protect is a traditional endowment savings plan that offers life protection along with adequate returns. Cashbook is an anticipated endowment policy ideal for meeting milestone expenses like a child's marriage, expenses for a child's higher education or purchase of an asset. It is available for terms of 15 and years. Lifetime Super & Lifetime Plus are unit-linked plans that offer customers the flexibility and control to customize the policy to meet the changing needs at different life stages. Each offers 4 fund options - Preserver, Protector, Balancer and Maxi miser.
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Lifeline Super is a single premium unit linked insurance Plan, which combines life insurance cover with the opportunity to stay, invested in the stock market. Premier Life Gold is a limited premium-paying plan specially structured for long-term wealth creation. Invest Shield Life New is a unit linked plan that provides premium guarantee on the invested premiums and ensures that the customer receives only the benefits of fund appreciation without any of the risks of depreciation. Invest Shield Cashbook is a unit linked plan that provides premium guarantee on the invested premiums along with flexible liquidity options. Protection Solutions Lifeguard is a protection plan, which offers life cover at low cost. It is available in 3 options - level term assurance, level term assurance with return of premium & single premium. Home Assure is a mortgage reducing term assurance plan designed specifically to help customers cover their home loans in simple and costeffective manner. Education insurance under the Smart Kid brand provides guaranteed educational benefits to a child along with life insurance cover for the parent
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who purchases the policy. Smart Kid plans are also available in unit-linked form - both single premium and regular premium. Retirement Solutions Forever Life is a traditional retirement product that offers guaranteed returns for the first 4 years and then declares bonuses annually. Lifetime Super Pension is a regular premium unit linked pension plan that helps one accumulate over the long term and offers an annuity option (guaranteed income for life) at the time of retirement. Life Link Super Pension is a single premium unit linked pension plan. Immediate Annuity is a single premium annuity product that guarantees income for life at the time of retirement. It offers the benefit of 5 payout options. Health Solutions Health Assure and Health Assure Plus: Health Assure is a regular premium plan which provides long term cover against 6 critical illnesses by providing policyholder with financial assistance, irrespective of the actual medical expenses. Health Assure Plus offers the added advantage of an equivalent life insurance cover.
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Cancer Care: is a regular premium plan that pays cash benefit on the diagnosis as well as at different stages in the treatment of various cancer conditions. Diabetes Care: Diabetes Care is the first ever critical illness product specially for individuals with Type 2 diabetes. Group Insurance Solutions: ICICI Prudential also offers Group Insurance Solutions for companies seeking to enhance benefits to their employees. Group Gratuity Plan: ICICI Pru's group gratuity plan helps employers fund their statutory gratuity obligation in a scientific manner. The plan can also be customized to structure schemes that can provide benefits beyond the statutory obligations. Group Superannuation Plan: ICICI Pru offers both defined contribution (DC) and defined benefit (DB) superannuation schemes to optimize returns for the members of the trust and rationalize the cost. Members have the option of choosing from various annuity options or opting for a partial commutation of the annuity at the time of retirement. Group Immediate Annuities: In addition to the annuities offered to existing superannuation customers, we offer immediate annuities to superannuation funds not managed by us.
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Group Term Plan: ICICI Pru's flexible group term solution helps provide affordable cover to members of a group. The cover could be uniform or based on designation/rank or a multiple of salary. The benefit under the policy is paid to the beneficiary nominated by the member on his/her death. Flexible Rider Options: ICICI Pru Life offers flexible riders, which can be added to the basic policy at a marginal cost, depending on the specific needs of the customer. Accident & disability benefit: If death occurs as the result of an accident during the term of the policy, the beneficiary receives an additional amount equal to the rider sum assured under the policy. If the death occurs while traveling in an authorized mass transport vehicle, the beneficiary will be entitled to twice the sum assured as additional benefit. Critical Illness Benefit: protects the insured against financial loss inthe event of 9 specified critical illnesses. Benefits are payable to the insured for medical expenses prior to death. Income Benefit: This rider pays the 10% of the sum assured to the nominee every year, till maturity, in the event of the death of the life assured. It is available on SmartKid and Cash Plus. Waiver of Premium: In case of total and permanent disability due to the future premiums continue to be paid by the company till the time of maturity.
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This rider is available with Lifetime Super, Lifetime Super Pension and Cash Plus.
Awards
India's Most Customer Responsive Insurance Company Avaya Global Connect - Economic Times Customer Responsiveness Awards Most Trusted Private Life Insurer The Economic Times - A C Nielsen Survey of Most Trusted Brands2003, 2004 and 2005
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THE Company ICICI Prudential Life Insurance Company is a joint venture between ICICI Bank, a premier financial powerhouse, and Prudential plc, a leading international financial services group headquartered in the United Kingdom.
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ICICI Prudential was amongst the first private sector insurance companies to begin operations in December 2000 after receiving approval from Insurance Regulatory Development Authority (IRDA). ICICI Prudential capital stands at Rs. 18.15 billion with ICICI Bank and Prudential plc holding 74% and 26% stake respectively. For the 10 months ended January 31, 2007, the company garnered Rs 3,240 core of weighted retail + group new business premiums and wrote over 1.3 million policies. The company has assets held to the tune of over Rs. 14,000 core. ICICI Prudential is also the only private life insurer in India to receive a National Insurer Financial Strength rating of AAA (Ind) from Fitch ratings. The AAA (Ind) rating is the highest rating, and is a clear assurance of ICICI Prudential's ability to meet its obligations to customers at the time of maturity or claims. For the past six years, ICICI Prudential has retained its position as the No. 1 private life insurer in the country, with a wide range of flexible products that meet the needs of the Indian customer at every step in life. To know more about the company, pleasevisit www.iciciprulife.com.
Distribution
ICICI Prudential has one of the largest distribution networks amongst private life insurers in India. As of January 31, 2007 the company has over 540 offices across the country and over 200,000 advisors. The company has over 20 bancassurnace partners, having tie-ups with ICICI
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Bank, Federal Bank, South Indian Bank, Bank of India, Lord Krishna Bank, Idukki District Co-operative Bank, Jalgaon Peoples Co-operative Bank, Shamrao Vithal Co-op Bank, Ernakulam Bank and 9 Bank of India sponsored Regional Rural Banks (RRBs). It has also tied up with NGOs MFIs and corporates for the distribution of rural policies. ICICI Bank (NYSE:IBN) is India's second largest bank and largest private sector bank with assets of Rs. 2958.32 billion as on December 31, 2006. ICICI Bank provides a broad spectrum of financial services to individuals and companies. This includes mortgages, car and personal loans, credit and debit cards, corporate and agricultural finance. The Bank services a growing customer base through a multi-channel access network which includes over 695 branches and extension counters, 3051 ATMs, call centers and Internet banking. Established in London in 1848, Prudential plc, through its businesses in the UK and Europe, the US and Asia, provides retail financial services products and services to more than 21 million customers, policyholder and unit holders worldwide. Today, Prudential has millions of customers worldwide and over £238 billion (as of 30 June 2006) of funds under management. In Asia, Prudential is the leading European life insurance company with a vast network of life and fund management operations in thirteen countries China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand, Vietnam and United Arab Emirates.
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The ICICI Prudential Life Insurance Company Limited Board comprises reputed people from the finance industry both from India and abroad. Mr. K.V. Kamath, Chairman Mr.BarryStowe Mrs.KalpanaMorparia Mrs.ChandaKochhar Mr.RNarayanan Mr.KekiDadiseth Ms. Shikha Sharma, ManagingDirector, Mr.N.S.Kannan,ExecutiveDirector Mr. Bhargav Dasgupta, Executive Director
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DERIVATIVES
Introduction Derivative is a security or a financial asset which derives its value from some specified underlying asset. A derivative does not have any physical existence but emerges out of a contract between two parties. It does not have any values of its own but its values, in turn depends on the value of other physical assets which are called underlying assets. These underlying assets may be shares, debentures, tangible commodities, currencies or short term or long term financial securities etc. The value of the derivative may depend upon any of these underlying assets. The parties to the contract of derivatives are the parties other than issuer or dealer in the underlying assets.
A derivative is a financial instrument whose value depends on other, more basic, underlying variables. The variables underlying could be prices of traded securities and stock, prices of gold or copper, prices of oranges to even the amount of snow that falls on a ski resort.
Derivatives have become increasingly important in the field of finance. Options and futures are traded actively on many exchanges. Forwarded contracts, swaps and different types of options are regularly traded outside exchanges by financial institutions, banks and their corporate clients in what
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are termed as over-the-counter markets – in other words, there is no single market place or an organized exchange.
Bombay Stock Exchange Share index, called Sensex, is a derivative whose value (index for a particular day) depends upon the prices of underlying 30 shares. The weighted average of the prices of the 30 shares is the Sensex. If the prices of all these shares increase, the Sensex will also increase and vice versa. So the Sensex derives its value from the market process of these shares. The Sensex fluctuates in line with the fluctuation in price of these shares.
Types of Derivatives:
1)
Commodity Derivatives and Financial Derivatives: Derivatives
contract can be entered into for different type commodities such as sugar, jute, pepper, castor seeds etc. In India futures contract in 6 commodities are available at different commodities exchanges. Financial derivatives are those which deal in currencies, gilt-edged securities, shares, share indices etc.
2)
Basic Derivatives and Complex Derivatives: The basic derivatives
are the derivatives whose value depends upon the underlying assets, such as, futures and options. Swap is one of the complex derivatives.
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Forwards: It is an agreement to buy or sell an asset at a certain future time for a certain price. The contract is usually between two financial institutions or between a financial institution and its corporate client. A forward contract is not normally traded on an exchange.
Futures: A futures contract, or simply called futures, is a contract to buy or sell a stated quantity of commodity or a financial claim at a specified price at a future specified date. The parties to the futures have to buy or sell the asset regardless of what happens to its value during the intervening period or what shall be the price on the date for which the contract is finalized.
Options: Options are contracts which provide the holder the right to sell or buy a specified quantity of underlying asset at a fixed price on or before the expiation of the option date. It may be noted that the options provided a right and not the obligation to buy or sell. The holder of the option can exercise option at his discretion or may allow the option to lapse.
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Classification of options:
1)
American options and European options: In the American option,
the option holder can exercise the right to buy or sell, at anytime before the expiration or on the expiration date. However, in the European option, the right can be exercised only on the expiry date and not before. The possibility of early exercise of right makes the American option more valuable than the European option to the option holder.
2)
Naked options and Covered options: A call option is called a
covered option if it is covered against the assets owned by the option writer. In case of exercise of the call option by the option holder, the option writer can deliver the asset or the price differential. On the other hand, if the option is not covered by the physical asset, it is known as naked option.
Swaps: A swap is a transaction in which two or more parties swap one set of predetermined payment for another. Swaps are of recent origin and two types of swaps have been evolved.
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Types of swaps
Interest rate swaps: It is an agreement between two parties to exchange interest obligations or receipts for an agreed period of time. Interest rate swaps are generally used when two parties are able to borrow at a different interest rate systems i.e., fixed rate of interest and floating rate of interest.
Currency swaps: It is an agreement between two parties to exchange payments or receipts in one currency for payment or receipts in another currency. The rationale for currency swap lays in the fact that one borrower has a comparative advantage in borrowing in one currency, while the other borrower has an advantage in borrowing in another currency.
History of derivatives
The history of derivatives is surprisingly longer than what most people think. Some tests even find the existence of the characteristics of derivative contracts in incidents of Mahabarata. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ.
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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 exchange for trading derivatives appeared to be the Royal Exchange in London, which permitted forward contracting. The celebrated Dutch Tulip bulb mania, which can be read about in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, published 1841 but still in print, was characterized by forward contracting on tulip bulbs around 1637. The first “futures” contracts are generally traced to the Yodoya rice market in Osaka, Japan around 1650. These were evidently standardized contracts, which made them much like today’s futures, although it is not known if the contracts were marked to market daily and/or had credit guarantees.
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
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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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Rationale behind the development of derivatives:
Holding portfolio of securities is associated with the risk of the possibility that the investor may realize his returns which would be much lesser than what he expected to get. There are various influences which affect the returns. 1. Price or dividend (interest). 2. Some are internal to the firm. Industrial policy Management capabilities Consumer’s preference Labor strike, etc, These forces are to a large extent controllable and are termed as nonsystematic risks. Such non- systematic risks can easily be managed by an investor by having a well diversified portfolio spread across the companies industries and groups so that a loss in one may easily be compensated with a gain in other.
There are yet other types of influences which are external to the firm, cannot be controlled and affect large numbers of securities. They are termed as systematic risk. Those are
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1. Economic 2. Political 3. Sociological changes are sources of systematic risk. For instance, inflation, interest rate, etc, their effect is to cause prices of nearly all individual stocks to move together in the same manner. We therefore quite often find stock prices falling from time to time in spite of company’s earnings rising and vice -versa. Rationale behind the development of derivatives market is to manage this systematic risk, liquidity. Liquidity in the sense of being able to buy & sell relatively large amounts quickly with out substantial price concessions.
In debt market, a much larger proportion of the total risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. These factors favor for the purpose of both portfolio hedging and speculation. The introduction of a derivative security is based on some broader market rather than an individual security.
India has vibrant securities market with strong retail participation that has evolved over the years. It was until recently basically cash market with a facility to carry forward positions in actively traded ‘A’ group scrip’s from one settlement to another by paying the required margins and borrowing
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money &securities in a separate carry forward session held for this purpose. However, a need was felt to introduce financial products like in other financial markets world over which are characterized with high degree of derivatives product in India.
Derivative products allow the user to transfer this price risk by locking in the asset price there by minimizing the impact of fluctuations in the asset price on his balance sheet and have assured cash flows.
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Major players of derivatives
a) Hedgers: The objective of these kinds of traders is to reduce the risk. They are not in the derivatives market to make profits. They are in to safeguard their existing positions. Apart from equity markets, hedging is common in the foreign exchange markets where fluctuations in the exchange rate have to be taken care of in the foreign currency transactions or could be in the commodities market where spiraling oil prices have to be tamed using the security in derivatives instrument.
b) Speculators: They are traders with a view and objective of making profits. They are willing to take risk and they bet upon whether the markets would go up or come down.
c) Arbitragers: Risk less profit making is the prime goal of Arbitragers. Buying in one market and selling in another, buying two products in the same market are common. They could be making money even without putting there own money in and such opportunities often come up in the market but last for very short timeframes. This is because as soon as the situation arise arbitragers take advantage and demand-supply forces drive the markets back to normal.
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Evolution of Derivatives in India
Need for derivatives: All markets face various kinds of risks. This has induced the market participants to search for ways to manage risk. The derivatives are one of the categories of risk management tools. As this consciousness about risk management capacity of derivatives grew, the markets for derivatives developed. Derivatives markets generally are an integral part of capital markets in developed as well as in emerging market economies. These instruments assist business growth by disseminating effective price signals concerning exchange rates, indices and reference rates or other assets and thereby render both cash and derivatives markets more efficient.
These instruments also offer protection from possible adverse market movements and can be used to manage or offset exposures by hedging or shifting risks particularly during periods of volatility thereby reducing costs. By allowing for the transfer of unwanted risk, derivatives can promote more efficient allocation of capital across the economy, increasing productivity in the economy. Though the commodity features trading has been in existence since 1953 and certain OTC derivatives such as Forward Rate Agreements (FRAs) and Interest Rate Swaps (IRSs) were allowed by RBI through its
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guidelines in 1999, the trading in “securities” based derivatives on stock exchanges was permitted only in June 2000.
The legal framework for derivatives trading is a critical part of overall regulatory framework of derivatives markets. While the role of state intervention in the functioning of markets is a matter of considerable debate, it is generally agreed that regulation has a very important and critical role to ensure the efficient functioning of markets and avoidance of systemic failures.
The purpose of regulation is to promote the efficiency and competition rather than impending it. While there is a perceived similarity of regulatory objectives there is no single preferred model for regulation of derivatives markets. The major contributory factors for success or failure of derivatives market are market culture, the underlying market including its depth and liquidity and financial infrastructure including the regulatory framework. Government interventions can impair the efficiency of derivatives market. For example, Governmental price controls or trade agreements aimed at stabilizing prices are such examples of Government intervention, which do not allow derivatives market to flourish.
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Further since the market integrity and efficiency, financial safety and integrity and customer protection, which are the common regulatory objectives in all jurisdictions, are critical to the success of any financial market, anyone responsible for operating such a market would have strong incentives independent of external regulation to ensure that these conditions are present in the market place. It is also observed that the successful regulatory system can complement the incentives for self-regulation while reducing the incentive and opportunity for behavior, which threatens the success and integrity of market.
Emergence of derivatives market will normally require legislation, which addresses issues regarding legality of derivatives instruments, specifically protecting such contracts from anti-gambling laws because these involve contracts for differences to be settled by exchange of cash, prescription of appropriate regulations and powers to monitor compliance with regulation also change. Therefore, regulatory flexibility is critical to the type and scope of regulation also changes. Therefore, regulatory flexibility is critical to the long run success of both regulation and the industry it regulates. It would be interesting to observe the historical evolution of development of derivatives market and then examine what further needs to be done to develop these markets.
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The precursor to exchange based derivatives in India was a kind of “forward trading” in securities in the form of call options, put options and straddles etc. The Securities Contracts Regulation Act, 1956(SCRA) was enacted, interalias, to prevent undesirable speculation in securities.
The contracts for “clearing” commonly known as “forward trading” were banned by the Central Government through a notification issued on 27 th June 1969 in exercise of the powers conferred under Section 16 of the SCRA. As the prohibition of forward trading in securities led to a decline of traded volumes on stock markets, the Stock Exchange, Mumbai (BSE), evolved in 1972 an informal system of “forward trading”, which allowed carry forward between two settlement periods, which resulted in substantial increase in the turnover of the exchange.
However, this also created several problems and there were payments crises from time to time and frequent closure of the market. During December 1982 – January 1983 the Government reviewed the position and in exercise of its powers under Section 10 of the SCRA amended the bye-laws of stock exchanges to facilitate performance of contracts in “specified securities”. In pursuance of this policy the stock exchanges at Bombay, Calcutta and Ahmedabad introduced a system of trading in “specified shares” with carry forward facility after amending their bye-laws and regulations.
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The Joint Parliamentary Committee on Irregularities in Securities and Banking Transactions, 1992 discussed the issue of “carry forward of deals” and observed that this system was not functioning appropriately as there were lot of irregularities in the stock exchanges in the form of non enforcement of margins, non-reporting of transactions and illegal trading outside the stock outside the stock exchange.
SEBI was of the view that carry forward transactions should be disallowed and transactions conducted strictly on delivery basis and trading in futures and options should be permitted in separate markets. Consequently, SEBI issued a directive in December 1993 prohibiting the carry forward of transactions.
However,
these
were
reviewed
by
SEBI,
and
pursuant
to
the
recommendations of the G.S.Patel Committee to review the system, carry forward transactions in securities were permitted in 1995 subject to certain safeguards. These were further reviewed by the J.R.Varma Committee report in 1997 and the system was further modified subject to a number of safeguards such as segregation of carry forward transactions at the time of execution of trade, daily margin of 10%, 50% of which would be collected
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upfront, overall carry forward limit of Rs.20 Crore per broker per settlement and other prudential safeguards.
On the other hand, Repo transactions in Government securities and public sector bonds developed during 1980s. Following the discussion of JPC of 1992, which indicated that some banks were found to have entered into transactions in violation of RBI circulars, RBI banned all Repo’s except treasury bills since June 1992. The Special Court, however, declared such transactions null and void in December 1993 as being violative of the provisions of SCRA and Banking Regulation Act, 1949. The Supreme Court, however, decided in March 1997 that the ready forward contracts (Repo) were severable into two parts, viz. ready lag and the forward lag.
The ready lag of transactions has been completed, the forward lag, which alone was illegal, had to be ignored. As Repo transactions violated the Government notification of 27th June 1969 under SCRA, certain institutions such as banks, co-operative banks and other RBI registered dealers were permitted to undertake ready forward transactions in Government securities through amendment notifications from time to time during second half of 1990s. The objective was to enhance liquidity market for Government securities and to further develop it.
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There were problems with such kind of facility such as, no standard documentation, “master agreement”, non-use of clearing houses to undertake counter party risk and opacity of the regulatory validity in view of the pronouncements of the Special Court and the Supreme Court. As a result the Repo market was neither deep nor liquid.
This was an anomalous situation where there was a notification, which prohibited forward trading, while some form of forward trading was prevalent. In view of the changed circumstances particularly the need to develop derivatives market the repeal of 1969 notification was considered desirable not only to remove the existing anomaly, but also as a measure of market reforms. The issue was that the notification was to be repealed only after amendment of the SCRA so that the powers could be appropriately delegated to RBI in addition to SEBI. There were complex regulatory issues relating to repeal of the said notification and delegation of powers to RBI and SEBI.
The issue was what powers in respect of which transactions in which securities should be delegated to RBI, since SEBI was already exercising delegated powers under SCRA, irrespective of type of transactions/securities. The Securities Laws (Amendment) Bill, 1999 was passed by the Parliament permitting a legal framework for derivatives trading in India in December
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1999. Consequently, the Central Government lifted a three decade old prohibition on forward trading in securities on 1st March 2000.
Simultaneously, in order to promote an orderly development of the market, the Government issued another notification on 1st March 2000 delineating the area of responsibility between RBI and SEBI. In terms of this notification, the contracts for sale and purchase of Government securities, gold related securities, money market securities and securities derived from these securities and ready forward contracts in debt securities were to be regulated by RBI. Such contracts if executed on stock exchanges would be regulated by SEBI in a manner that this consistent with the guidelines issued by RBI. On the same date, both RBI and SEBI issued notifications specifying the regulatory framework in their respective areas. The RBI’s notification while retaining the general prohibition on forward trading, permitted ready forward contracts by the specified entities subject to certain conditions, such as, maintenance of subsidiary ledger account and a current account and such other conditions, as may be prescribed. SEBI also retained the general prohibition on forward trading but permitted derivatives contracts, as permissible under the securities law. An important step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which
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lifted the prohibition on “options in securities” (NSEIL, 2000). SEBI set up a committee in November 1996 under the chairmanship of Dr. L.C.Gupta to develop appropriate regulatory framework for derivatives trading. The committee suggested that if derivatives could be declared as “securities” under SCRA, the appropriate regulatory framework of “securities” could also govern trading of derivatives. SEBI also set up a group under the chairmanship of Prof. J.R.Varma in 1998 to recommend risk containment measures for derivatives trading. The Government decided that a legislative amendment in the securities laws was necessary to provide a legal framework for derivatives trading in India.
Consequently, the Securities Contracts (Regulation) Amendment Bill 1998 was introduced in the LOK Sabha on 4th July 1998 and was referred to the Parliamentary Standing Committee on Finance for examination and report thereon. The Bill suggested that derivatives may be included in the definition of “securities” in the SCRA whereby trading in derivatives may be possible within the framework of that Act. The said Committee submitted the report on 17th March 1999. The Proposed Bill, which incorporated the recommendations of the said Parliamentary Committee, was finally enacted in December 1999.
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J.R.Varma committee report:
The committee observed that Dr.L.C.Gupta Committee appointed by SEBI had drawn out detailed guidelines pertaining to the regulatory framework on derivatives prescribing necessary preconditions which should be adopted before the introduction of derivatives. The committee, therefore,
recommended that these should be adhered to fully.
i.
The Committee felt that there was an urgent need to educate the Indian investors by creating investment awareness among them by conducting intensive educational programs, so that they are able to understand their risk profiles in a better way.
ii.
Measures should be taken to strengthen the cash market so that they become strong and efficient.
iii. The committee felt that it is imperative that the regulatory authorities ensure a strong surveillance/vigilance and enforcement machinery.
iv. The committee was of the view that since derivatives trading require a critical mass of sophisticated investors supported by credit and stock analysts,
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SEBI should, in consultation with the stock exchanges, endeavor to conduct certification program on derivatives trading with a view to educating the investors and market intermediaries.
v. Keeping in view the swift movement of funds and the technical complexities involved in derivatives transactions, the committee felt that there was a need to protect particularly the small investors by preventing them from venturing in to options and futures market, who may be lured by the sheer speculative gains. The Committee, therefore, recommended that the threshold limit of the transactions should be pegged not below Rs. 2 Lakhs. l vi. The Committee was of the view that there is an urgent need to prescribe pronounced accounting standards in the case of investors/dealers and also back office standards for intermediaries with a view to reducing the possibility of concealing loss and perpetrating the frauds by
companies/intermediaries.
vii. The committee also asked the government to consider exempting derivatives transactions from the imposition of stamp duty. It is important to note that the suggestions and recommendations of the said Committee were implemented by the statutory regulators.
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Thus the enactment of Securities of Laws (Amendment) Act.1999 and repeal of 1969 notification provided a legal framework for securities based derivatives trading on stock exchanges in India , which is co-terminus with framework of trading of other “securities” allowed under the SCRA. The trading of stock index futures started in June 2000 and later on, other products, such as, stock index options and stock options and single stock futures were also allowed.
Categories of Derivatives Traded in India
1.
Commodities futures for coffee, Oil seeds, Oil, Pepper, Cotton, jute
and jute goods are traded in the commodities futures. Forward markets commission regulates the trading of commodities futures.
2.
Index futures based on sensex and nifty index are also traded under
the supervision of SEBI.
3.
RBI has permitted banks, FIIs and PDs to enter into forward rate
agreement, interest rate swaps in order to facilitate hedging of interest rate risks and ensuring orderly development of the derivatives market.
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4.
NSE became the first exchange to launch trading in options on
individual securities. Trading in options on individual securities commenced from July 2, 2001. Option contracts are American style and cash settled and are available on 41 securities stipulated by the Securities & Exchange Board of India (SEBI).
5.
NSE commenced trading in futures on individual securities on
November 9, 2001. The future contracts are available on 41 securities stipulated by the SEBI. BSE also has started trading in individual stock option & futures (both Index & Stocks) around the same time as NSE.
FORWARD CONTRACT
A forward contract is a simple derivative. It is an agreement to buy or sell an asset at a certain future time for a certain price. The contract is usually between two financial instruments or between a financial institution and its corporate client.
One of the parties in a forward contract assumes a long poison i.e. agrees to buy the underlying asset on a specified future date at a specified future price. The other party assumes a short position i.e. agrees to sell the asset on the
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same price. This specified price is referred to as the delivery price. This delivery price is chosen so that the value of the forward contract is equal to zero for both transaction parties. In other words, it costs nothing to the either party to hold the long or the short position.
A forward contract is settled at maturity. The holder of the short position delivers the asset to the holder of the long position in return for cash at the agreed upon rate. Therefore, a key determinant of the value of the contract is the market price of the underlying asset. A forward contract can therefore, assume a positive or negative value depending on the movements of the price of the asset. For example, if the price of the asset rises sharply after the two parties has entered into the contract, the party holding the long position stands to benefits, i.e. the value of the contract is position for her. Conversely, the value of the contract becomes negative for the party holding the short position.
The concept of forward price is also important. The forward price for a certain contract is defined as that delivery price which would make the value of the contract zero. To explain further, the forward price and the delivery price are equal on the day that the contract is entered into. Over the duration of the contract, the forward price is liable to change while the delivery price remains the same.
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FUTURES CONTRACT Introduction A futures contract is an exchange traded forward contract to buy or sell a predetermined quantity of an asset on a pre-determined future date at a predetermined price. Here the buyer and the seller will be requested to make a security deposit at the time when the contract is signed.
A futures contract is an agreement between two parties to buy sell an asset at a certain specified time in future for certain specified price. In this, it is similar to a forward contract. However, there are a number of differences between forwards and futures. These relate to the contractual features, the way the markets are organized, profiles of gains and losses, kinds of participants in the markets and the ways in which they use the two instruments.
Futures contracts in physical commodities such as wheat, cotton, corn, gold, silver, cattle, etc. have existed for a long time. Futures in financial assets, currencies, interest bearing instruments like T-bills and bonds and other innovations like futures contracts in stock indexes are a relatively new development dating back mostly to early seventies in the United States and subsequently in other markets around the world.
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An index is a number used to represent the changes in a set of values between a base time period and the current time. A stock index represents change in the value of a set of stocks which constitute the index over a base year.
An index future is a derivative whose value is dependant on the value of the underlying asset (e.g. BSE Sensex, S&P CNX NIFTY). While trading on index futures, an investor is basically buying and selling the basket of securities comprising an index in their relative weights.
Unlike commodity and other futures contracts, Index Future contracts are settled in cash. The fair futures price is based upon arbitrage. In case of stock index futures, this would be cash and carry arbitrage.
The futures price should be such that there is no arbitrage profit from buying stock and simultaneously selling futures. The excess of the financing cost of holding the stock over the dividend receipts constitutes the net cost of carry. The selling price guaranteed by the futures should match the initial cost of the stock plus the net cost of carry.
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In other words, the futures price should provide a guaranteed capital gain that exactly compensates the excess of interest payments over the dividend receipts. The fair value of the future contract is calculated in a way that there is o arbitrage available in the trade. This can be explained as follows:
Futures price=Spot price + Holding costs F=S+C Holding cost = Cost of financing minus Dividend returns.
Assume that current value of Nifty is 910 and the annualized dividend yield of Nifty index is 2%. The cost of capital is 15% and your investment days are 60.
So the fair value of future is, F = S + C = 928.47 F = S*exp (1n (1+r-q))*T i.e. 910*exp (1n (1.15-.02)*60/365 = Rs. 928.45 C= There is no storage or holding cost of financial instrument
Hedging is a method of reducing the risk of loss caused by price fluctuation. It consists of the purchase or sale of equal quantities of the same or very similar commodities, approximately simultaneously, in two different markets
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with the expectation that a future change in price in one market will be offset by an opposite change in the other market.
Features of Futures Contracts
Organized Exchanges: Unlike forward contracts which are traded in an over-the-counter market, futures are traded on organized exchanges with a designated physical location where trading takes place. This provides a ready, liquid market in which futures can be bought and sold at any time like in a stock market.
Standardization: In the case of forward currency contracts, the amount of commodity to be delivered and the maturity date are negotiated between the buyer and seller and can be tailor-made to buyer’s requirements. In a futures contract both these are standardized by the exchange on which the contract is traded. Thus, for instance, one futures contract in pound sterling on the international Monetary Market (IMM), a financial futures exchange in the US, calls for delivery of 62,500 British Pounds and contracts are always traded in whole numbers i.e. you cannot buy or sell fractional contracts. The exchange also specified the minimum size of price movement (called the “tick”) and, in
46
some cases, may also impose a ceiling on the maximum price change within a day. In the case of commodity futures, the commodity in question is also standardized for quality in addition to quantity in a single contact. Clearing House: The exchange acts as a clearinghouse to all contracts struck on the trading floor. For instance, a contract is struck between A and B. Upon entering into the records of the exchange, this is immediately replaced by two contracts, one between A and the clearing house and another between B and the clearing house. In other words, the exchange interposes itself in every contract and deal, where it is a buyer toe very seller and a seller to every buyer. The advantage of this is that A and B do not have to undertake any exercise to investigate each other’s creditworthiness. It also guarantees the financial integrity of the market. The exchange enforces delivery for contracts held until maturity and protects itself from default risk by imposing margin requirements on traders and enforcing this through a system called “marking to market”.
Margins: Like all exchanges, only members are allowed to trade in futures contracts on the exchange. Others can use the services of the members as brokers to use this instrument. Thus, an exchange member can trade on his own account as well as on behalf of a client. A subset of the members is the “clearing
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members” or members of the clearinghouse and non-clearing members must clear all their transaction through a clearing member. The exchange requires that a margin must be deposited with the clearinghouse by a member who enters into a futures contract. The amount of the margin is generally between 2.5% to 10% of the value of the contract but can vary. A member acting on behalf of a client, in turn, requires a margin from the client. The margin can be in the from of cash or securities like treasury bills or bank letters of credit.
Marketing to Market: The exchange uses a system called marketing to market where, at the end of each trading session, all outstanding contracts are repriced at the settlement price of that trading session. This would mean that some participants would make a loss while others would stand to gain. The exchange adjusts this by debiting the margin accounts of those members who made a loss and crediting the accounts of those members who have gained. This feature of futures trading creates an important difference between forward contracts and futures. In a forward contract, gains or losses arise only on maturity. There are no intermediate cash flows. Whereas, in a futures contract, even though the gains and losses are the same, the time profile of the accruals is different. In other words, the total gains or loss over the entire period is broken up into a daily series of gains and losses, which clearly has a different present value.
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Actual delivery is rare: In most forward contract, the commodity is actually delivered by the seller and is accepted by the buyer. Forward contracts are entered into for acquiring or disposing off a commodity in the future for a gain at a price known today. In contrast to this, in most futures markets, actual delivery takes place in less than one percent of the contracts traded. Futures are used as a device to hedge against price risk and as a way of betting against price movements rather than a means of physical acquisition of the underlying asset. To achieve this, most of the contracts entered into are nullified by a matching contract in the opposite direction before maturity of the first.
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Types of futures
Trading in futures is equivalent to betting on the price movements in futures prices. If such betting is used to protect a position either long or short in the underlying asset, it is termed as hedging. On the other hand, if the activity is undertaken only with the objective of generating profits from absolute or relative price movements, it is termed as speculation. It must be noted that speculators provide liquidity to the markets by their willingness to enter open positions.
Currency futures: We shall look at both hedging and speculation in currency futures. Corporations, banks and others use currency futures for hedging purposes. The underlying principle is as follows:
Assume that a corporation has an asset e.g. a receivable in a currency A, that it would like to hedge, it should take a futures position such that futures generate a positive cash whenever the asset declines in value. In this case, since the firm in long, in the underlying asset, it should go short in futures i.e. it should sell futures contracts in A. obviously, the firm cannot gain from an appreciation of A since the gain on the receivable will be eaten away by the
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loss on the futures. The hedger is willing to sacrifice this potential profit to reduce or eliminate the uncertainty.
In hedging too, the corporation has the option of a direct hedge and a cross hedge. A British firm with a dollar payable can hedge by selling sterling futures (same effect as buy dollar futures) on the IMM or LIFFE. This is an example of a direct hedge. If the dollar appreciates, it will lose on the payable but gain on the futures, as the dollar price of futures will decline.
A Belgian firm with a dollar payable cannot hedge by selling Belgian franc futures because they are not traded. However, since the Belgian franc is closely tied to the Deutschemark in the European Monetary System (EMS). It can sell DM futures. An important point to note is that, in a cross hedge, a firm must choose a futures contract on an underlying currency that is highly positively correlated with the currency exposure being hedged.
The reasons for low use of cross hedge are that futures contract is for standardized amounts as this is designed by the exchange. Evidently, this will only rarely match the exposure involved. The second reason involves the concept of basis risk. The difference between the spot price at initiation of the contract and the futures price agreed upon is called the basis. Over the term of the contract, the spot price changes, as does the futures price. But the
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change is not always perfectly correlated – in other words, the basis is not constant. This gives rise to the basis risk. Basis risk is dealt with through the hedge ratio and a strategy called delta hedging.
A speculator trades in futures to profit from price movements. They hold views about the future price movements – if these differ from those of the general market, they will trade to profit from this discrepancy. The flip side is that they are willing to take the risk of a loss if the prices move against their views of opinions.
Speculation using futures can be in the either open position trading or spread trading. In the former, the speculator is betting on movements in the price of a particular futures contract. In the latter, he is betting on the price differential between two futures contracts.
Interest rate futures:
Interest rate futures are one of the most successful financial innovations in recent years. The underlying asset is a debt instrument such as a Treasury bill a bond or time deposit in a bank. The International Monetary Market (IMM) – a part of the Chicago Mercantile Exchange, has futures contracts on US Government treasury bonds, three – month Euro dollar time deposits and
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medium term US treasury notes among others. The LIFFE has contracts on euro-dollar deposit, sterling time deposits and UK Government bonds. The Chicago Board of Trade offers contracts on long term US treasury bonds.
Interest rate futures are used by corporations, banks and financial institutions to hedge interest rate risk. A corporation planning to issue commercial paper can use T-bill futures to protect itself against an increase in interest rate. A treasurer who is expecting some surplus cash in the near future to be invested in some short term investment may use the same as insurance against a fall in interest rates. Speculators bet on interest rate movement or changes in the term structure in the hope of generating profits.
A complete analysis of interest rate futures would be a complex exercise as it involves thorough understanding and familiarity with concept such as mathematics of bond
discount yield ,yield-to-maturity and elementary valuation and pricing .
Stock Index Futures:
A stock index futures contract is an obligation to deliver on the settlement date an amount of cash equivalent to the value of 500 times the difference
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between the stock index value at the close of the last trading day of the contract and the price at which the futures contract was originally struck.
It must be noted that no physical delivery of stock is made. Therefore, in order to ensure that sufficient funds are available for settlement, both parties have to maintain the requisite deposit and meet the variation margin calls as and when required.
Futures Pricing:
The price of futures refers to the rate at which the futures contract will be entered into. The basic determinants of futures price are spot rate and other carrying cost. In order to find out the futures prices, the cost of carrying are added or deducted to the spot rate. The cost of carrying depends upon
-Time involved -Rate of Interest -Other factors
On the settlement date, the futures price would be the spot rate itself. However before the settlement day, the futures price may be more or less the prevailing spot rate. In case the demand for futures is high, the buyers of
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futures will be required to pay a price higher than the spot rate and the additional charges paid is known is as contango charges. However, if the
sellers are more, the futures price may be lower than the spot rate and the difference is known as backwardation.
With reference to the stock index futures, the pricing would be such that the investors are indifferent between owning the shares and owning the futures contract. The price of stock index futures should equate the price of buying and carrying such shares from the share settlement date to the contract maturity date. The financing cost of buying the shares would generally be more than the dividend yield. This means that there is a cost of carrying the shares purchased. So, the price of futures contract will be higher than the price of the shares. The carrying cost of the stock index futures is calculated as.
Index value * (financing cost – Dividend Yield) * t
Where, ‘t’ is the time period from share settlement date to the maturity date of the futures contract.
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The first futures market
The Chicago Board of trade (CBOT) was established in 1848 to standardize the size, quality and delivery date of these commodity agreements that were forwards contracts into a contract that could be traded on an exchange.
Once established, the standardization of the terms of the contract enable contracts to be readily traded as what we call today ‘futures contracts’.
Another important result of the creation of the CBOT was the ability to discover the price of a commodity. As buyers and sellers joined together on the floor of the exchange to trade and quoted prices to each other, the ‘real’ price for , say, soybeans was established. Price discovery helps to create stability in price because anyone, buyer or seller, can immediately see by looking at the futures price what price the supply and demand for the underlying is generating.
In essence, today’s markets do the same job as the original concept back in 1848 but in hundreds of different products. The CBOT, for instant, trades a wide range of contracts on commodities, like soybeans and silver as well as financials like Treasury Bonds and Notes.
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In 1874, following in CBOT’s footsteps, the Chicago Produce Exchange provided the market the market for perishable agricultural products like butter and eggs. After some upheaval in 1898, certain traders broke away and formed what is now known as the Chicago Mercantile Exchange, (CME). In 1919 the CME was recognized to allow futures trading. Futures on a variety of commodities have since come to the exchange, including pork bellies, hogs and cattle as well as financials like currencies and index products.
The emergence of financial futures and options markets In 1972 the CME established a division known as the International Monetary Market (IMM). Its purpose was to enable trading in futures contracts based on foreign currencies. In 1982 the CME started trading futures contracts on the S & p 500 Stock Index and now trades many different index products.
In the United States, prior to 1975, nearly all contracts traded were agricultural. Volume in these contracts was less than 10 million per year. However, by 1994 the figure had risen to almost 700 million contracts and by the end of 2003 to a staggering 8.1 billion contracts.
From the end of Second World War until early 1970s there was a very stable economic environment in the United States helped by the Breton Woods Agreement, which kept interest rates in a narrow range. However, when the
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US dollar was devalued, partly as a consequence of the funding of the Vietnam War and a heavy domestic spending programmed, uncertainly and fluctuation in interest rates replaced the economic stability. Europe and Japan had also recovered in economic terms from the re-building effects of Second World War and, with their economies growing, the Dollar came under severe pressure. The need to be able to hedge (or to protect) against the risk associated with volatile currencies and interest rates became critical for financial contracts, which became the cornerstone of the futures and options industry, as we know it today.
It was in 1975 that the CBOT launched the first futures contract on a financial instrument, the Ginnie Mae Mortgage Bond future, followed by the CME, which listed a Eurodollar contract. Shortly, the CBOT listed what was to become one of the world’s most heavily traded futures contract, the Treasury bond future.
Since then, the growth in volume of futures and options contracts in the United States and the rest of the world has been quite phenomenal, as more and more exchanges have opened and a plethora of financial products were developed and listed to meet the demand for risk-hedging mechanisms.
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This process continues today as new markets open in the developing countries. However, the emergence of futures and options markets outside the United States has seen a change in the make-up of the overall volume of business traded.
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About satyam ltd
SCSL is one of the large software exporters form India. It offers it services to clients through a mix of off-shore, on-site facilities.
SCSL originally provided a wide range of offshore software services at the lower end it was into reengineering of legacy application, porting mainframes applications to client server and converting code written in out dated languages to current ones. At the higher end it focused on applications on telecom, networking technologies and engineering services executing projects in 2D drafting and 3D solid modeling. The company had also set up subsidiaries to tap key business segments like enterprise solutions, consulting products and internet services.
SCSL has had one of the fastest growth rates within the large six companies with a CAGR of over 100% for past 8 years. It also has strong base of more than 10,000 highly skilled employees. It also has a very impressive client list with a total of about 300 global customers of which 40 are Fortune 500 companies. The company has its presence in 35 countries and has clients consisting of like GE, Caterpillar, Northern Telecom, Cable and wireless etc.
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Its internet subsidiary is India’s first private ISP and is the only listed company of Indian internet sector.
SCSL has a very wide technology portfolio and has been building alliances with best of breed global venders to offer end-to-end IT solutions across a range of technologies and platforms. It has partnerships with enterprise technology vendors like Microsoft, Oracle, SAP, Siebel, i2 technologies, Arriba, vitria, IBM lotus enterprise, Hummingbird, Docunmentum, Epicentric, MatrixOne, Vignette, CommerceOne and others are the these partnerships have allowed the company to win new projects and increase market share at existing accounts.
The company has entered into various Joint Ventures during FY 2001. It entered into a joint venture with TRW Inc. to float a company called Satyam Mfg. Technology. It also entered into a joint venture with US – based Idea EDGE and it has also partnered with CCMB for global foray into Bioinformatics.
The company was listed on the NYSE under the symbol SAY on May 15, 2001 with an issue of 16675 mn ADS. Each ADS represents two equity shares of satyam. It also achieved a unique distinction of being of the first company in the world to obtain ISO 9001:2000 certifications from BVQI. It
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has also achieved SEI CMM levels for quality in FY99. the company also went for a stock split in August 2000 when it divided a rs 10 share into five shares of two each.
It has also taken various new initiatives during the year that includes setting up of Asia-Pacific headquarters in Singapore and inauguration of Middle East Solutions Center. It also unveiled .NET Solutions Frame Work for AsiaPacific customers. However the company’s subsidiaries have not been doing well and have incurred net losses to the tune of Rs. 2980 mn during FY2001.
During the year 2000 – 2001, company received various award that includes the National HRD award and Data Quest IT man of the year 2000 conferred upon chairman of company Mr. Ramalingu Raju.
Objectives:
The objective of this analysis is to evaluate the profit/loss position of futures contracts. This analysis is done based on the sample data. The sample is taken as satyam comp scripts of March ’06. The lot size is 600. As the scripts of satyam comp are volatile, they are chosen as the sample. The data is collected from various News papers and websites.
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Limitations:
• The sample size chosen as satyam Comp scripts for the month of March. • The study is confined to March month only. Stock index futures
Stock Index futures are the most popular financial futures which have been used to hedge or manage the systematic risk by the investors of Stock Market. They are called hedgers who own portfolio of securities and are exposed to the systematic risk Stock Index is the apt hedging asset since th4 rise or fall due to syst4matic risk is accurately shown in the Stock Index. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock index traded on a regulated futures exchange for a specified price for settlement at a specified time future.
Stock Index futures will require lower capital adequacy and margin requirements as compared to margins on carry forward of individual scripts. The brokerage costs and index futures will be much lower.
Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. The impact cost will be much lower in case of
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stock index futures as opposed to dealing in individual scripts. The market is conditioned to think in terms of the index and therefore would prefer to trade in stock index futures. Further, the chances of manipulation are much lesser. The Stock index futures are expected to be extremely liquid given the speculative nature of out markets and the overwhelming retail participation expected to be fairly high. In the near future, stock index futures will
definitely see incredible volumes in India. It will be a block buster product and is pitched to become the most liquid contract in the world in terms of number of contracts traded if not in terms of notional value. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more de4pth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base any conclusions on the volume or to form any firm trend.
The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract. Illustration: If the BSE stock index is at 3000 and each point in the index equals to Rs. 50, a contract struck at this level could be worth Rs. 150000(3000*50). If at the
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expiration of the contract, the BSE stock index is at 3020, a cash settlement of Rs.100 is required ((3020-3000)*50). No physical delivery of stocks is made in order to ensure that sufficient funds are available for settlement. Stock futures If the current price of the satyam share is Rs.170 per share. We believe that in one month it will touch Rs. 200. and we buy satyam shares. If price really increase to Rs. 200, we made of profit of Rs.30 i.e. a return of 18%.
If we buy satyam futures instead, we get the same position as satyam in the cash market, but we have to pay the margin not the entire amount. In the above example if the margin is 20%, we would pay only Rs. 34. If satyam goes up Rs.200, we will still earn Rs. 30 as profit. Now that translates into a fabulous return of 89% in one month.
The risks are that losses will be get leveraged or multiplied in the as profit do. For example, if satyam drops from Rs.170 to Rs.150, you would make a loss of Rs.20. The Rs.20 loss would translate to a 12% loss in the cash market and a 58% loss in the futures market.
It is very easy to reduce / minimize such losses if we keep a sharp eye on the market. Suppose, we are bullish and we hence buy satyam futures. But satyam futures start moving down after we have bought.
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Apart from leverage, a great advantage of futures (at the moment) is that they are not linked to ‘delivery’. This means, we can sell Futures (short sell) of Satyam even if we do not have any shares of Satyam. Thus, we can benefit from a downturn as well as from an upturn. If we predict an upturn, we should buy Futures and if we predict a downturn, we can always sell Futures – thus we can make money in a falling market as well as in a rising one.
Illustration: If Satyam is quoting at Rs.250 in the cash market and one month Satyam futures are quoting at Rs. 253 in the futures market, we can earn is 3 as difference. We will then buy Satyam in the cash market and at the same time, sell Satyam one month futures. On or around the expiry day (last Thursday of each month), we will square up both the positions, i.e. we will sell Satyam in the cash market and buy futures. The two prices will be the same (or very nearly the same) As cash and futures prices will converge on expiry. It does not matter to us what the price is. We will make our profit of Rs 3 any way. For example, if the price is Rs 270, we will make a profit of Rs 20 on selling our Cash market Satyam and a loss of Rs. 17 on buying back Satyam futures. The net profit is Rs 3. On the other hand, if the price is Rs 225, we make a loss of Rs 25 on selling Cash market Satyam and a profit of Rs 28 on Satyam futures.
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The net profit remains Rs 3. Our investment in this transaction will be
Rs
250 on cash market Satyam plus a margin of say 20% on Satyam futures (say Rs 50 approx). thus an investment of Rs 300 has generated a return of Rs 3 i.e. 1% per month or 12% per annum. Now take a situation where only 15 days are left for expiry and we spot the same opportunity as above. We will still generate Rs 3 which will translate into a return of 2% per month or 24% per annum. In this manner, we will generate returns whenever the futures prices are above cash market prices. Suppose we have 1,200 shares of Satyam which is currently quoting at Rs. 170 per share-a total value of Rs 2.04 lakhs. We need cash, but protect the upside profits. All we need to do is – one – sell our shares in the cash market and get paid the Rs 2.04 lakhs and –two – buy Satyam (one month ) futures in the derivatives market (say at Rs 172 per share ). The futures position will keep our profits intact, if the share price moves up. The futures will expire on the last Thursday of the month. On the last Thursday (or before that at any convenient time), we should reverse the transaction i.e. we will sell out Satyam futures and buy back Satyam shares.
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Script price of Satyam Computers March ‘07
DATE 1-03-07 20-03-07 5-03-07 6-03-07 7-03-07 8-03-07 9-03-07 12-03-07 13-03-07 14-03-07 16-03-07 19-03-07 20-03-06 21-03-06 22-03-06 23-03-06 26-03-06 27-03-06 28-03-06 29-03-06
PRICE 409.05 421.25 422.75 418.05 421.9 422.85 411.75 400.8 410.3 406.7 383.5 384.1 367.55 370.05 396.15 404.9 424.05 416.45 409.9 419.3
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Satyam computers
440 420 400 380 360 340 320
1M ar -0 6 8M ar -0 6 15 -M ar -0 6 22 -M ar -0 6 29 -M ar -0 6
share price
PRICE
date
FUTURES CONTRACTS – NIFTY
DATE 2-03-07 3-03-07 4-03-07 7-03-06 8-03-07 9-03-07 10-03-07 11-03-07 14-03-06 15-03-07 17-03-07 18-03-07 21-Mar-07 22-Mar-07 23-03-07 24-03-07 2503-07 28-03-07 29-03-07 30-03-07 31-03-07
OPENINGHIGH 3061.05 3108 3113 3149.8 3140 3144.9 3144.7 3189 3179.9 3179.9 3156 3158.8 3080 3123.7 3131 3171.7 3177 3198 3128 3212.8 3176.4 3210 3221.9 3235 3224.5 3256 3254.9 3278.9 3240 3257.9 3237.5 3261 3231 3284 3286.35 3329 3343 3345.95 3331.35 3373 3385 3424.95
LOW 3055.6 3105 3120.5 3148 3157.25 3075 3040.4 3125.65 3175.05 3128 3175.4 3206.5 3223.55 3231 3207.5 3209 3231 3286.35 3311.15 3326.3 3374.3
CLOSING 3101.75 3134.5 3137.6 3185.45 3167.35 3082.65 3113.85 3166.45 3180.85 3171.9 3205 3213.95 3251.7 3241.95 3227.5 3239.25 3279.9 3326.45 3332.4 3364.9 3412.75
INT. '000CONTRACT 26595 180933 27602 216589 28852 191388 29399 172417 32221 224130 33242 446952 33091 414564 32524 232650 33078 199344 33113 324141 33419 234096 32487 213460 32792 164860 32982 241089 32338 310538 31404 328642 29902 231608 25254 194088 21391 226314 16481 203831 12967 190997
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NIFTY
3500 3400 3300 3200 3100 3000 2900 2800
6 20 06 20 06 3/ 16 /2 00 20 06 3/ 23 / 3/ 30 / 3/ 2/ 3/ 9/ 20 06
OPENING HIGH LOW CLOSING
DATES
BANK NIFTY
DATE 2-3-07 3-03-07 4-03-07 7-03-07 8-03-07 9-03-07 10-03-07 11-03-07 14-03-07 15-03-07 17-03-07 18-03-07 21-03-07 22-03-07 23-03-07 24-03-07 25-03-07 28-03-07
OPENING 4558.6 4594.85 4634.95 4642 4645 4663.65 4530 4614 4668 4601 4699.9 4686 4710 4685 4683.95 4620.2 4659.85 4686
HIGH 4594.4 4644 4684 4669 4666 4665 4594 4667 4628.8 4772.8 4724.5 4734.5 4716 4745 4790 4674.9 4684 4724.9
LOW 4515 4550 4620 4641 4573 4534 4467 4590.15 4640.25 4601 4687 4675 4685 4650 4576.2 4601.1 4638 4680
CLOSING 4560.85 4615.8 4640.6 4646.25 4651.55 4545.9 4585.95 4636.4 4656.1 4687.7 4697.8 4692.45 4702.95 4661.45 4602.25 4637.465 4676.6 4704.95
INT.000 196 183 186 184 179 184 181 158 164 162 148 149 150 151 143 141 136 133
CONTRACTS 1093 2243 2240 630 1870 1208 1138 1234 842 2027 644 559 361 679 744 807 452 362 70
29-03-07 4711 30-03-07 4641 31-03 -07 4685
4715 4677 4694
4668 4641 4620
4673.55 4671.4 4630.95
125 127 114
309 310 619
BANK NIFTY 4900 4800 4700 4600 4500 4400 4300
6 6 20 06 20 06 /2 00 /2 00 3/ 9/ 3/ 2/ /2 00 6
OPENING HIGH LOW CLOSING
3/ 16
DATES
CNX IT
3/ 30
3/ 23
INT. DATE 2-03-07 OPENING HIGH 3930.05 4079 LOW 3930.05 CLOSING 4067.55 '000 35
CONTR ACTS 552
3-03-07
4080
4098
4042
4052.85
35
354
4-03-07
4068
4068
4008
4023.65
38
178
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7-03-07 8-03-07 9-03-07 10-03-07 11-03-07 14-03-07 15-03-07 17-03-07 18-03-07 21-03-07 22-03-07 23-03-07 24-03-07 25-03-07 28-03-07 29-03-07 30-03-07 31-03-07
4020 4015.05 4015.05 3960 4021.05 4140 4158 4115 4164.95 4152.35 4260 4205 4198 4160 4248.95 4205.05 4244 4400
4081.6 4048 4050 4009 4099 4237.45 4165 4158 4181 4249 4261 4228 4208.5 4223.8 4248.95 4268 4316 4400
4020 4009 3950 3936 4021.95 4109 4114 4110 4132 4152.35 4200 4160 4154 4155 4190 4183 4236.2 4325
4069.9 4029.7 3958.35 3998.3 4094.15 4153.9 4123.95 4144.2 4139.65 4241.1 4213 4185.8 4166.1 4216.65 4203 4243.55 4313.15 4371.5
37 36 41 41 43 61 63 59 47 48 42 41 39 37 34 33 31 21
241 128 407 150 368 673 220 128 195 438 351 257 137 128 94 129 257 258
CNX IT
4600 4400 4200 4000 3800 3600
6 6 -0 6 -0 6 ar -0 ar -0 -M ar -M ar -M ar -0 6
OPENING HIGH LOW CLOSING
2M
9M
16
23
DATES
30
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OPTIONS Introduction A option agreement is a contract in which the writer of the option grants the buyer of the option the right purchase from or sell to the writer a designated instrument for a specified price within a specified period of time. The writer grants this right to the buyer for a certain sum of money called the option premium. An option that grants the buyer the right to buy some instrument is called a call option. An option that grants the buyer the right to sell an instrument is called a put option. The price at which the buyer an exercise his option is called the exercise price, strike price or the striking price.
Options are available on a large variety of underlying assets like common stock, currencies, debt instruments and commodities. Also traded are options on stock indices and futures contracts – where the underlying is a futures contract and futures style options.
Options have proved to be a versatile and flexible tool for risk management by themselves as well as in combination with other instruments. Options also provide a way for individual investors with limited capital to speculate on the
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movements of stock prices, exchange rates, commodity prices etc. The biggest advantage in this context is the limited loss feature of options.
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Differences between futures & options
FUTURES
OPTIONS
1) Both the parties are obligated to perform 2) With futures premium is paid by either party. 3) The parties to futures contracts must perform at the settlement date only. They are not obligated to perform before that date. 4) The holder of the contract is exposed to the entire spectrum of the down side risk and hadthe potential for all the upside return.
1) Only the seller (writer) is obligated to perform. 2) With option, the buyer pays the seller a premium. 3) The buyer of an options contract can exercise any time prior to expiration date.
4) The buyer limits the down side risk to the option premium buy retain the upside potential.
5) In futures margin to be paid. They are approximate 15-20% on the current stock price.
5) In options premiums to be paid. But they are very less as compared to the margins.
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REGULATORY FRAME WORK
While from the purely regulatory angle, a separate exchange for trading would be a better arrangement. Considering the constraints in infrastructure facilities, the existing stock (cash) exchanges may also be permitted to trade derivatives subject to the following conditions.
? Trading should take place through an on-line screen based trading system ? The clearing of the derivative market should be done by an independent clearing corporation. ? The exchange must have an online surveillance capability which monitors positions, price and volumes in real time so as to deter market manipulation price and position limits should be used for improving market quality ? Information about trades quantities, and quotes should be disseminated by the exchange in the real time over at least two information vending networks which are accessible to investors in the country. ? The exchange should have at least 50 members to start derivatives trading ? The derivatives trading should be done in a separate segment with separate membership, that is, all members of the cash market would not automatically become members of the derivatives market.
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? The derivatives market should have a separate governing council which should not have representation of trading by clearing members beyond whatever percentage SEBI may prescribe after reviewing the working the working of the present governance system of exchanges. ? The chairman of the governing council of the derivative division / exchange should be a member of the governing council. If the chairman is broker / dealer, then he should not carry on any broking or dealing on any exchange during his tenure. ? No trading / clearing member should be allowed simultaneously to be on the governing council both derivatives market and cash market.
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UNDERLYING INDEX
NIFTY BANK NIFTY CNX IT Lot sizes of different companies 100 100 100
CODE ACC
LOT SIZE 35
COMPANY NAME ASSOCIATED CEMENT COMPANIES LTD. BHARAT ELECTRICAL LTD. BHARA PETROL CORPORATION LTD. CIPLA LTD. DIVISLAB DR. REDDY’S LABORATARIES LTD. GRASM INDUSTRIES LTD. GUJARAT AMBUJA CEMENTS LTD. HINDUSTAN CORPORATION LTD TECHNO. HOUSING DEVELOPMENT FINANCE CORP. HEROHONDA MOTORS LTD. HINDUSTAN LEVE LTD. HINDUSTAN PETROLIUM CORPORATION LTD
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BHARAT ELEC.BHEL 275 BPCL CIPLA DIVISLAB DR. REDDY’S LAB GRASIM GUJAMBCEM HCL TECH HDFC HEROHONDA HINDLEVER HINDPETRO 150 1100 1250 250 400 175 2060 325 150 400 1060
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ICICI BANK INFOSYSTCH IPCL ITC LICHSGFIN M&M MARUTI MTNL NATIONAL NDTV ONGC POLARIS RANBAXY LABS RELIANCE SATYAM COMP SBI SCI STERLITE OPT TATA POWER TATA TEA TATAMOTORS TATASTEEL VSNL
1300 350 100 1100 1125 1700 625 1600 1150 225 1400 800 150 600 250 1600 350 400 27 412 675 525 600
ICICI BANKING CORPORATION LTD. INFOSYS TECHNOLOGIES LTD. INDIAN PETROLIUM CHEMICALS CORP.LTD. INDIAN TOBACCO COMPANY LTD. LIC HOUSING FINANCE LTD. MAHENDRA & MAHENDRA LTD. MARUTI UDYOG LTD. MAHANAGAR TELECOM NIGAM LTD. NATIONAL ALUMINIUM COMPANY NDTV OIL & NATURAL GAS CORPORATION. POLARIS SOFTWARE COMPANY LTD. RANBAXY LABORATARIES LTD. RELIANCE INDUSTRIES LTD. SATYAM COMPUTERS SERVICES LTD. STATE BANK OF INDIA. SHIPPING CORPORATION OF INDIA. STERLITE OPTICALS LTD. TATA POWER COMPANY LTD. TATA TEA LTD. TATA ENG.&LOCOMOTIVE COMPANY TATA IRON & STEEL COMPANY LTD. VIDESH SANCHAR NIGAM LTD.
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Results:
Futures and options markets are global and traded contracts on a wide range of products encompassing currencies, commodities, interest rates, shares, indices, insurance; in fact you can find derivatives on just about anything.
The derivatives industry continues to be innovative and to grow. New products, new exchanges, growing use of OTC products all of this is creating
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a massive challenge to the firms and infrastructure that supports the industry, and the growth is not confined to the United States and European markets.
Study about the NIFTY futures reveals that the futures contracts are in a positive direction. The investors have a positive attitude towards the use of risk hedging tools. The futures NIFTY reached 3400 points gaining almost 300 points in a month. The increase in points suggests that the shares which are underlying assets for NIFTY futures are performing well in stock market. The good performance of stock market can be attributed to fund inflow from FII and mutual funds.
IT sector and Banking sector are also moving into positive direction which indicates growth of the economy in these sectors. The underlying Banking shares have shown good results thereby leading to movement of future prices. The anticipation of good yearly results by the companies also can be considered as a factor for positive direction.
Indian economy is growing at a faster rate and contribution from all sectors has to be there for betterment of country. Inflation rate is under control and the rate of interest prevailing in the market is also a major contributor for growth of banking sector.
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• Derivative trading provides a lot of opportunities in the market but the investor should have a deep insight of derivatives and use of different combinations.
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• In cash market the profit/loss of the investor is depends on the current market price, i.e. the investor may get unlimited profits & at the same time he may get unlimited losses. But in derivatives market the investor can enjoy unlimited profits by bearing limited losses.
• In cash market the investor has to pay the total money. But in derivatives the investor has to pay premiums or margins which are some percentage of total money.
• Derivatives are mostly used for hedging purpose.
• Short positions should be handled carefully because of unlimited loss liability with limited profits.
• Investor should try to hedge his/her positions to minimize losses rather anticipating huge profits.
• Avoid taking positions in contract where liquidity is low.
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BIBLIOGRAPHY Multinational financial management by Alan C. Shapiro Financial management by R. P. Rustogi Multinational financial by Bukley Financial services and market by Dr. S. Gurusamy International financial management by P. G. Apte
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Clearing and settlement of derivatives by David Loader NCFM module on derivatives A journal on derivatives market by ICFAI www.moneypore.com www.nseindia.com www.finpipe.com www.indianderivatives.com www.wikipedia.com www.futuressource.com www.freecharts.com www.bseindia.com www.sharekhan.com www.indiainfoline.com www.commodityindia.com
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doc_952450213.doc
The bank has subsidiaries in the United Kingdom, Russia, and Canada; branches in United States, Singapore, Bahrain, Hong Kong, Sri Lanka, Qatar and Dubai International Finance Centre; and representative offices in United Arab Emirates, China, South Africa, Bangladesh, Thailand, Malaysia and Indonesia.
INTRODUCTION
Money markets are the important market, which gives the performance of any country’s position. Stock Exchanges play a vital role in this market. Large volumes of securities are being traded. The mail disadvantage of this market is that there is a high amount of risk and the risk is very much unsystematic. Also an individual investor/portfolio manager has many responsibilities beyond those related to specific equity selection. Some involve broader issues like the market timing portfolio asset allocation, protective hedging, efficient hedging and efficient trade execution for large transactions. At the same time many equities exhibit a high degree of liquidity in the sense, being able to buy and sell relatively large amounts quickly, with out substantial price concessions. Also in case of debt market the risks of the particular instruments have finite life and process a limited marketability due to its size. Due to the Internet limitations, mainly unsystematic risk and liquidity in the equity market they are raised a necessity of development of new financial instruments make a base for a border market rather than an individual market.
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Derivative instruments are not special types of securities but are contracts derived from some underlying asset as such these instruments will not have any independent value underlying security can be either securities, commodities bullion, currency, live stocker any thing else. In other words derivative means a forward, future, options or any other hybrid contract, which has a predetermined time for purpose of fulfillment of contract. The values of these instruments depend on value of one or more basic variables.
2
OBJECTIVES
1. To study the various trends operating in derivative market. 2. To study in detail the role of futures contracts. 3. To study various rules and regulations in derivatives market. NEED FOR THE STUDY
Different investment avenues are available to investors. Stock market also offers good investment opportunities to the investors. Like all investments, they also carry certain risks. The investors should compare the risks and expected yields after adjustment of tax on various instruments while taking investment decisions. The investors may seek advice from experts and consultants including stock brokers and analyst while making investment decisions. The objective here is to make the investor aware of the functioning of the derivatives.
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Derivatives act as a risk hedging tool for the investors. The objective is to help the investors in selecting the appropriate derivative instrument to attain maximum return with minimum risk and to construct the portfolio in such a manner to meet the investor goals and objectives. The investor should decide how best to reach the goals from the securities available.
To identify investor’s objectives, constraints and preference, which will help formulate the investment policy.
To develop and implement strategies in tune with the investment policy formulated. This will help the selection of asset classes and securities in each class depending upon their risk-return attributes.
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METHODOLOGY AND DATA COLLECTION PRIMARY SOURCE: • I gathered information by interacting with employees.
SECONDARY SOURCE: • I referred to Derivatives related books • Material provided by ICICI prudential
SCOPE OF THE STUDY
The study is limited to the analysis made for types of instruments of derivatives. Each strategy is analyzed according to its risk and return characteristics and derivative performance against the profit and policies of the company.
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LIMITATION OF THE STUDY The subject of derivatives is vast it requires extensive study and research to understand the depth of the various instruments operating in the market. The study was confined to Indian derivative market only, where the use of derivative instrument is only a recent phenomenon. But, various international examples have also been added to make the study more comfortable.
There are various other factors also which define the risk and return preferences of an investor, however, the study was only confined towards the risk minimization and profit maximization objective of the investor.
The derivative market is a dynamic one, premiums, contract rates, strike price fluctuate on demand and supply basis. Therefore, data related to last few trading months was only considered and interpreted.
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ICICI PRUDENTIAL LIFE INSURANCE
ICICI prudential Life Insurance was established in the 2000 with a commitment to expand and reshape the life insurance industry in India. The company was amongst the first private sector insurance companies to begin operations after receiving approval from Insurance Regulatory Development Authority (IRDA)
NEW BASEL CAPITAL ACCORD: The new Basel capital accord is based around three complementary elements viz., (i) to reinforce minimum capital standards, (ii) to have the supervisory review process, and (iii) to promote safety and soundness in banks and financial systems. Market discipline imposes strong incentives on banks to conduct their business in a safe sound and efficient manner, including an incentive to maintain a strong capital base as a cushion against potential future losses arising from risk exposures. The Basel committee is already working on the scope of application of the accord, capital and capital adequacy, and risk exposure and assessment. The risk management has come at the central stage in the new Basel capital accord.
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Products
Insurance Solutions for Individuals ICICI Prudential Life Insurance offers a range of innovative, customercentric products that meet the needs of customers at every life stage. Its products can be enhanced with up to 4 riders, to create a customized solution for each policyholder.
Savings & Wealth Creation Solutions Cash Plus is a transparent, feature-packed savings plan that offers3 level of protection as well as liquidity options. Save'n'Protect is a traditional endowment savings plan that offers life protection along with adequate returns. Cashbook is an anticipated endowment policy ideal for meeting milestone expenses like a child's marriage, expenses for a child's higher education or purchase of an asset. It is available for terms of 15 and years. Lifetime Super & Lifetime Plus are unit-linked plans that offer customers the flexibility and control to customize the policy to meet the changing needs at different life stages. Each offers 4 fund options - Preserver, Protector, Balancer and Maxi miser.
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Lifeline Super is a single premium unit linked insurance Plan, which combines life insurance cover with the opportunity to stay, invested in the stock market. Premier Life Gold is a limited premium-paying plan specially structured for long-term wealth creation. Invest Shield Life New is a unit linked plan that provides premium guarantee on the invested premiums and ensures that the customer receives only the benefits of fund appreciation without any of the risks of depreciation. Invest Shield Cashbook is a unit linked plan that provides premium guarantee on the invested premiums along with flexible liquidity options. Protection Solutions Lifeguard is a protection plan, which offers life cover at low cost. It is available in 3 options - level term assurance, level term assurance with return of premium & single premium. Home Assure is a mortgage reducing term assurance plan designed specifically to help customers cover their home loans in simple and costeffective manner. Education insurance under the Smart Kid brand provides guaranteed educational benefits to a child along with life insurance cover for the parent
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who purchases the policy. Smart Kid plans are also available in unit-linked form - both single premium and regular premium. Retirement Solutions Forever Life is a traditional retirement product that offers guaranteed returns for the first 4 years and then declares bonuses annually. Lifetime Super Pension is a regular premium unit linked pension plan that helps one accumulate over the long term and offers an annuity option (guaranteed income for life) at the time of retirement. Life Link Super Pension is a single premium unit linked pension plan. Immediate Annuity is a single premium annuity product that guarantees income for life at the time of retirement. It offers the benefit of 5 payout options. Health Solutions Health Assure and Health Assure Plus: Health Assure is a regular premium plan which provides long term cover against 6 critical illnesses by providing policyholder with financial assistance, irrespective of the actual medical expenses. Health Assure Plus offers the added advantage of an equivalent life insurance cover.
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Cancer Care: is a regular premium plan that pays cash benefit on the diagnosis as well as at different stages in the treatment of various cancer conditions. Diabetes Care: Diabetes Care is the first ever critical illness product specially for individuals with Type 2 diabetes. Group Insurance Solutions: ICICI Prudential also offers Group Insurance Solutions for companies seeking to enhance benefits to their employees. Group Gratuity Plan: ICICI Pru's group gratuity plan helps employers fund their statutory gratuity obligation in a scientific manner. The plan can also be customized to structure schemes that can provide benefits beyond the statutory obligations. Group Superannuation Plan: ICICI Pru offers both defined contribution (DC) and defined benefit (DB) superannuation schemes to optimize returns for the members of the trust and rationalize the cost. Members have the option of choosing from various annuity options or opting for a partial commutation of the annuity at the time of retirement. Group Immediate Annuities: In addition to the annuities offered to existing superannuation customers, we offer immediate annuities to superannuation funds not managed by us.
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Group Term Plan: ICICI Pru's flexible group term solution helps provide affordable cover to members of a group. The cover could be uniform or based on designation/rank or a multiple of salary. The benefit under the policy is paid to the beneficiary nominated by the member on his/her death. Flexible Rider Options: ICICI Pru Life offers flexible riders, which can be added to the basic policy at a marginal cost, depending on the specific needs of the customer. Accident & disability benefit: If death occurs as the result of an accident during the term of the policy, the beneficiary receives an additional amount equal to the rider sum assured under the policy. If the death occurs while traveling in an authorized mass transport vehicle, the beneficiary will be entitled to twice the sum assured as additional benefit. Critical Illness Benefit: protects the insured against financial loss inthe event of 9 specified critical illnesses. Benefits are payable to the insured for medical expenses prior to death. Income Benefit: This rider pays the 10% of the sum assured to the nominee every year, till maturity, in the event of the death of the life assured. It is available on SmartKid and Cash Plus. Waiver of Premium: In case of total and permanent disability due to the future premiums continue to be paid by the company till the time of maturity.
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This rider is available with Lifetime Super, Lifetime Super Pension and Cash Plus.
Awards
India's Most Customer Responsive Insurance Company Avaya Global Connect - Economic Times Customer Responsiveness Awards Most Trusted Private Life Insurer The Economic Times - A C Nielsen Survey of Most Trusted Brands2003, 2004 and 2005
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THE Company ICICI Prudential Life Insurance Company is a joint venture between ICICI Bank, a premier financial powerhouse, and Prudential plc, a leading international financial services group headquartered in the United Kingdom.
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ICICI Prudential was amongst the first private sector insurance companies to begin operations in December 2000 after receiving approval from Insurance Regulatory Development Authority (IRDA). ICICI Prudential capital stands at Rs. 18.15 billion with ICICI Bank and Prudential plc holding 74% and 26% stake respectively. For the 10 months ended January 31, 2007, the company garnered Rs 3,240 core of weighted retail + group new business premiums and wrote over 1.3 million policies. The company has assets held to the tune of over Rs. 14,000 core. ICICI Prudential is also the only private life insurer in India to receive a National Insurer Financial Strength rating of AAA (Ind) from Fitch ratings. The AAA (Ind) rating is the highest rating, and is a clear assurance of ICICI Prudential's ability to meet its obligations to customers at the time of maturity or claims. For the past six years, ICICI Prudential has retained its position as the No. 1 private life insurer in the country, with a wide range of flexible products that meet the needs of the Indian customer at every step in life. To know more about the company, pleasevisit www.iciciprulife.com.
Distribution
ICICI Prudential has one of the largest distribution networks amongst private life insurers in India. As of January 31, 2007 the company has over 540 offices across the country and over 200,000 advisors. The company has over 20 bancassurnace partners, having tie-ups with ICICI
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Bank, Federal Bank, South Indian Bank, Bank of India, Lord Krishna Bank, Idukki District Co-operative Bank, Jalgaon Peoples Co-operative Bank, Shamrao Vithal Co-op Bank, Ernakulam Bank and 9 Bank of India sponsored Regional Rural Banks (RRBs). It has also tied up with NGOs MFIs and corporates for the distribution of rural policies. ICICI Bank (NYSE:IBN) is India's second largest bank and largest private sector bank with assets of Rs. 2958.32 billion as on December 31, 2006. ICICI Bank provides a broad spectrum of financial services to individuals and companies. This includes mortgages, car and personal loans, credit and debit cards, corporate and agricultural finance. The Bank services a growing customer base through a multi-channel access network which includes over 695 branches and extension counters, 3051 ATMs, call centers and Internet banking. Established in London in 1848, Prudential plc, through its businesses in the UK and Europe, the US and Asia, provides retail financial services products and services to more than 21 million customers, policyholder and unit holders worldwide. Today, Prudential has millions of customers worldwide and over £238 billion (as of 30 June 2006) of funds under management. In Asia, Prudential is the leading European life insurance company with a vast network of life and fund management operations in thirteen countries China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand, Vietnam and United Arab Emirates.
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The ICICI Prudential Life Insurance Company Limited Board comprises reputed people from the finance industry both from India and abroad. Mr. K.V. Kamath, Chairman Mr.BarryStowe Mrs.KalpanaMorparia Mrs.ChandaKochhar Mr.RNarayanan Mr.KekiDadiseth Ms. Shikha Sharma, ManagingDirector, Mr.N.S.Kannan,ExecutiveDirector Mr. Bhargav Dasgupta, Executive Director
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DERIVATIVES
Introduction Derivative is a security or a financial asset which derives its value from some specified underlying asset. A derivative does not have any physical existence but emerges out of a contract between two parties. It does not have any values of its own but its values, in turn depends on the value of other physical assets which are called underlying assets. These underlying assets may be shares, debentures, tangible commodities, currencies or short term or long term financial securities etc. The value of the derivative may depend upon any of these underlying assets. The parties to the contract of derivatives are the parties other than issuer or dealer in the underlying assets.
A derivative is a financial instrument whose value depends on other, more basic, underlying variables. The variables underlying could be prices of traded securities and stock, prices of gold or copper, prices of oranges to even the amount of snow that falls on a ski resort.
Derivatives have become increasingly important in the field of finance. Options and futures are traded actively on many exchanges. Forwarded contracts, swaps and different types of options are regularly traded outside exchanges by financial institutions, banks and their corporate clients in what
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are termed as over-the-counter markets – in other words, there is no single market place or an organized exchange.
Bombay Stock Exchange Share index, called Sensex, is a derivative whose value (index for a particular day) depends upon the prices of underlying 30 shares. The weighted average of the prices of the 30 shares is the Sensex. If the prices of all these shares increase, the Sensex will also increase and vice versa. So the Sensex derives its value from the market process of these shares. The Sensex fluctuates in line with the fluctuation in price of these shares.
Types of Derivatives:
1)
Commodity Derivatives and Financial Derivatives: Derivatives
contract can be entered into for different type commodities such as sugar, jute, pepper, castor seeds etc. In India futures contract in 6 commodities are available at different commodities exchanges. Financial derivatives are those which deal in currencies, gilt-edged securities, shares, share indices etc.
2)
Basic Derivatives and Complex Derivatives: The basic derivatives
are the derivatives whose value depends upon the underlying assets, such as, futures and options. Swap is one of the complex derivatives.
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Forwards: It is an agreement to buy or sell an asset at a certain future time for a certain price. The contract is usually between two financial institutions or between a financial institution and its corporate client. A forward contract is not normally traded on an exchange.
Futures: A futures contract, or simply called futures, is a contract to buy or sell a stated quantity of commodity or a financial claim at a specified price at a future specified date. The parties to the futures have to buy or sell the asset regardless of what happens to its value during the intervening period or what shall be the price on the date for which the contract is finalized.
Options: Options are contracts which provide the holder the right to sell or buy a specified quantity of underlying asset at a fixed price on or before the expiation of the option date. It may be noted that the options provided a right and not the obligation to buy or sell. The holder of the option can exercise option at his discretion or may allow the option to lapse.
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Classification of options:
1)
American options and European options: In the American option,
the option holder can exercise the right to buy or sell, at anytime before the expiration or on the expiration date. However, in the European option, the right can be exercised only on the expiry date and not before. The possibility of early exercise of right makes the American option more valuable than the European option to the option holder.
2)
Naked options and Covered options: A call option is called a
covered option if it is covered against the assets owned by the option writer. In case of exercise of the call option by the option holder, the option writer can deliver the asset or the price differential. On the other hand, if the option is not covered by the physical asset, it is known as naked option.
Swaps: A swap is a transaction in which two or more parties swap one set of predetermined payment for another. Swaps are of recent origin and two types of swaps have been evolved.
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Types of swaps
Interest rate swaps: It is an agreement between two parties to exchange interest obligations or receipts for an agreed period of time. Interest rate swaps are generally used when two parties are able to borrow at a different interest rate systems i.e., fixed rate of interest and floating rate of interest.
Currency swaps: It is an agreement between two parties to exchange payments or receipts in one currency for payment or receipts in another currency. The rationale for currency swap lays in the fact that one borrower has a comparative advantage in borrowing in one currency, while the other borrower has an advantage in borrowing in another currency.
History of derivatives
The history of derivatives is surprisingly longer than what most people think. Some tests even find the existence of the characteristics of derivative contracts in incidents of Mahabarata. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ.
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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 exchange for trading derivatives appeared to be the Royal Exchange in London, which permitted forward contracting. The celebrated Dutch Tulip bulb mania, which can be read about in Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay, published 1841 but still in print, was characterized by forward contracting on tulip bulbs around 1637. The first “futures” contracts are generally traced to the Yodoya rice market in Osaka, Japan around 1650. These were evidently standardized contracts, which made them much like today’s futures, although it is not known if the contracts were marked to market daily and/or had credit guarantees.
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
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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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Rationale behind the development of derivatives:
Holding portfolio of securities is associated with the risk of the possibility that the investor may realize his returns which would be much lesser than what he expected to get. There are various influences which affect the returns. 1. Price or dividend (interest). 2. Some are internal to the firm. Industrial policy Management capabilities Consumer’s preference Labor strike, etc, These forces are to a large extent controllable and are termed as nonsystematic risks. Such non- systematic risks can easily be managed by an investor by having a well diversified portfolio spread across the companies industries and groups so that a loss in one may easily be compensated with a gain in other.
There are yet other types of influences which are external to the firm, cannot be controlled and affect large numbers of securities. They are termed as systematic risk. Those are
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1. Economic 2. Political 3. Sociological changes are sources of systematic risk. For instance, inflation, interest rate, etc, their effect is to cause prices of nearly all individual stocks to move together in the same manner. We therefore quite often find stock prices falling from time to time in spite of company’s earnings rising and vice -versa. Rationale behind the development of derivatives market is to manage this systematic risk, liquidity. Liquidity in the sense of being able to buy & sell relatively large amounts quickly with out substantial price concessions.
In debt market, a much larger proportion of the total risk of securities is systematic. Debt instruments are also finite life securities with limited marketability due to their small size relative to many common stocks. These factors favor for the purpose of both portfolio hedging and speculation. The introduction of a derivative security is based on some broader market rather than an individual security.
India has vibrant securities market with strong retail participation that has evolved over the years. It was until recently basically cash market with a facility to carry forward positions in actively traded ‘A’ group scrip’s from one settlement to another by paying the required margins and borrowing
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money &securities in a separate carry forward session held for this purpose. However, a need was felt to introduce financial products like in other financial markets world over which are characterized with high degree of derivatives product in India.
Derivative products allow the user to transfer this price risk by locking in the asset price there by minimizing the impact of fluctuations in the asset price on his balance sheet and have assured cash flows.
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Major players of derivatives
a) Hedgers: The objective of these kinds of traders is to reduce the risk. They are not in the derivatives market to make profits. They are in to safeguard their existing positions. Apart from equity markets, hedging is common in the foreign exchange markets where fluctuations in the exchange rate have to be taken care of in the foreign currency transactions or could be in the commodities market where spiraling oil prices have to be tamed using the security in derivatives instrument.
b) Speculators: They are traders with a view and objective of making profits. They are willing to take risk and they bet upon whether the markets would go up or come down.
c) Arbitragers: Risk less profit making is the prime goal of Arbitragers. Buying in one market and selling in another, buying two products in the same market are common. They could be making money even without putting there own money in and such opportunities often come up in the market but last for very short timeframes. This is because as soon as the situation arise arbitragers take advantage and demand-supply forces drive the markets back to normal.
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Evolution of Derivatives in India
Need for derivatives: All markets face various kinds of risks. This has induced the market participants to search for ways to manage risk. The derivatives are one of the categories of risk management tools. As this consciousness about risk management capacity of derivatives grew, the markets for derivatives developed. Derivatives markets generally are an integral part of capital markets in developed as well as in emerging market economies. These instruments assist business growth by disseminating effective price signals concerning exchange rates, indices and reference rates or other assets and thereby render both cash and derivatives markets more efficient.
These instruments also offer protection from possible adverse market movements and can be used to manage or offset exposures by hedging or shifting risks particularly during periods of volatility thereby reducing costs. By allowing for the transfer of unwanted risk, derivatives can promote more efficient allocation of capital across the economy, increasing productivity in the economy. Though the commodity features trading has been in existence since 1953 and certain OTC derivatives such as Forward Rate Agreements (FRAs) and Interest Rate Swaps (IRSs) were allowed by RBI through its
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guidelines in 1999, the trading in “securities” based derivatives on stock exchanges was permitted only in June 2000.
The legal framework for derivatives trading is a critical part of overall regulatory framework of derivatives markets. While the role of state intervention in the functioning of markets is a matter of considerable debate, it is generally agreed that regulation has a very important and critical role to ensure the efficient functioning of markets and avoidance of systemic failures.
The purpose of regulation is to promote the efficiency and competition rather than impending it. While there is a perceived similarity of regulatory objectives there is no single preferred model for regulation of derivatives markets. The major contributory factors for success or failure of derivatives market are market culture, the underlying market including its depth and liquidity and financial infrastructure including the regulatory framework. Government interventions can impair the efficiency of derivatives market. For example, Governmental price controls or trade agreements aimed at stabilizing prices are such examples of Government intervention, which do not allow derivatives market to flourish.
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Further since the market integrity and efficiency, financial safety and integrity and customer protection, which are the common regulatory objectives in all jurisdictions, are critical to the success of any financial market, anyone responsible for operating such a market would have strong incentives independent of external regulation to ensure that these conditions are present in the market place. It is also observed that the successful regulatory system can complement the incentives for self-regulation while reducing the incentive and opportunity for behavior, which threatens the success and integrity of market.
Emergence of derivatives market will normally require legislation, which addresses issues regarding legality of derivatives instruments, specifically protecting such contracts from anti-gambling laws because these involve contracts for differences to be settled by exchange of cash, prescription of appropriate regulations and powers to monitor compliance with regulation also change. Therefore, regulatory flexibility is critical to the type and scope of regulation also changes. Therefore, regulatory flexibility is critical to the long run success of both regulation and the industry it regulates. It would be interesting to observe the historical evolution of development of derivatives market and then examine what further needs to be done to develop these markets.
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The precursor to exchange based derivatives in India was a kind of “forward trading” in securities in the form of call options, put options and straddles etc. The Securities Contracts Regulation Act, 1956(SCRA) was enacted, interalias, to prevent undesirable speculation in securities.
The contracts for “clearing” commonly known as “forward trading” were banned by the Central Government through a notification issued on 27 th June 1969 in exercise of the powers conferred under Section 16 of the SCRA. As the prohibition of forward trading in securities led to a decline of traded volumes on stock markets, the Stock Exchange, Mumbai (BSE), evolved in 1972 an informal system of “forward trading”, which allowed carry forward between two settlement periods, which resulted in substantial increase in the turnover of the exchange.
However, this also created several problems and there were payments crises from time to time and frequent closure of the market. During December 1982 – January 1983 the Government reviewed the position and in exercise of its powers under Section 10 of the SCRA amended the bye-laws of stock exchanges to facilitate performance of contracts in “specified securities”. In pursuance of this policy the stock exchanges at Bombay, Calcutta and Ahmedabad introduced a system of trading in “specified shares” with carry forward facility after amending their bye-laws and regulations.
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The Joint Parliamentary Committee on Irregularities in Securities and Banking Transactions, 1992 discussed the issue of “carry forward of deals” and observed that this system was not functioning appropriately as there were lot of irregularities in the stock exchanges in the form of non enforcement of margins, non-reporting of transactions and illegal trading outside the stock outside the stock exchange.
SEBI was of the view that carry forward transactions should be disallowed and transactions conducted strictly on delivery basis and trading in futures and options should be permitted in separate markets. Consequently, SEBI issued a directive in December 1993 prohibiting the carry forward of transactions.
However,
these
were
reviewed
by
SEBI,
and
pursuant
to
the
recommendations of the G.S.Patel Committee to review the system, carry forward transactions in securities were permitted in 1995 subject to certain safeguards. These were further reviewed by the J.R.Varma Committee report in 1997 and the system was further modified subject to a number of safeguards such as segregation of carry forward transactions at the time of execution of trade, daily margin of 10%, 50% of which would be collected
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upfront, overall carry forward limit of Rs.20 Crore per broker per settlement and other prudential safeguards.
On the other hand, Repo transactions in Government securities and public sector bonds developed during 1980s. Following the discussion of JPC of 1992, which indicated that some banks were found to have entered into transactions in violation of RBI circulars, RBI banned all Repo’s except treasury bills since June 1992. The Special Court, however, declared such transactions null and void in December 1993 as being violative of the provisions of SCRA and Banking Regulation Act, 1949. The Supreme Court, however, decided in March 1997 that the ready forward contracts (Repo) were severable into two parts, viz. ready lag and the forward lag.
The ready lag of transactions has been completed, the forward lag, which alone was illegal, had to be ignored. As Repo transactions violated the Government notification of 27th June 1969 under SCRA, certain institutions such as banks, co-operative banks and other RBI registered dealers were permitted to undertake ready forward transactions in Government securities through amendment notifications from time to time during second half of 1990s. The objective was to enhance liquidity market for Government securities and to further develop it.
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There were problems with such kind of facility such as, no standard documentation, “master agreement”, non-use of clearing houses to undertake counter party risk and opacity of the regulatory validity in view of the pronouncements of the Special Court and the Supreme Court. As a result the Repo market was neither deep nor liquid.
This was an anomalous situation where there was a notification, which prohibited forward trading, while some form of forward trading was prevalent. In view of the changed circumstances particularly the need to develop derivatives market the repeal of 1969 notification was considered desirable not only to remove the existing anomaly, but also as a measure of market reforms. The issue was that the notification was to be repealed only after amendment of the SCRA so that the powers could be appropriately delegated to RBI in addition to SEBI. There were complex regulatory issues relating to repeal of the said notification and delegation of powers to RBI and SEBI.
The issue was what powers in respect of which transactions in which securities should be delegated to RBI, since SEBI was already exercising delegated powers under SCRA, irrespective of type of transactions/securities. The Securities Laws (Amendment) Bill, 1999 was passed by the Parliament permitting a legal framework for derivatives trading in India in December
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1999. Consequently, the Central Government lifted a three decade old prohibition on forward trading in securities on 1st March 2000.
Simultaneously, in order to promote an orderly development of the market, the Government issued another notification on 1st March 2000 delineating the area of responsibility between RBI and SEBI. In terms of this notification, the contracts for sale and purchase of Government securities, gold related securities, money market securities and securities derived from these securities and ready forward contracts in debt securities were to be regulated by RBI. Such contracts if executed on stock exchanges would be regulated by SEBI in a manner that this consistent with the guidelines issued by RBI. On the same date, both RBI and SEBI issued notifications specifying the regulatory framework in their respective areas. The RBI’s notification while retaining the general prohibition on forward trading, permitted ready forward contracts by the specified entities subject to certain conditions, such as, maintenance of subsidiary ledger account and a current account and such other conditions, as may be prescribed. SEBI also retained the general prohibition on forward trading but permitted derivatives contracts, as permissible under the securities law. An important step towards introduction of derivatives trading in India was the promulgation of the Securities Laws (Amendment) Ordinance, 1995, which
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lifted the prohibition on “options in securities” (NSEIL, 2000). SEBI set up a committee in November 1996 under the chairmanship of Dr. L.C.Gupta to develop appropriate regulatory framework for derivatives trading. The committee suggested that if derivatives could be declared as “securities” under SCRA, the appropriate regulatory framework of “securities” could also govern trading of derivatives. SEBI also set up a group under the chairmanship of Prof. J.R.Varma in 1998 to recommend risk containment measures for derivatives trading. The Government decided that a legislative amendment in the securities laws was necessary to provide a legal framework for derivatives trading in India.
Consequently, the Securities Contracts (Regulation) Amendment Bill 1998 was introduced in the LOK Sabha on 4th July 1998 and was referred to the Parliamentary Standing Committee on Finance for examination and report thereon. The Bill suggested that derivatives may be included in the definition of “securities” in the SCRA whereby trading in derivatives may be possible within the framework of that Act. The said Committee submitted the report on 17th March 1999. The Proposed Bill, which incorporated the recommendations of the said Parliamentary Committee, was finally enacted in December 1999.
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J.R.Varma committee report:
The committee observed that Dr.L.C.Gupta Committee appointed by SEBI had drawn out detailed guidelines pertaining to the regulatory framework on derivatives prescribing necessary preconditions which should be adopted before the introduction of derivatives. The committee, therefore,
recommended that these should be adhered to fully.
i.
The Committee felt that there was an urgent need to educate the Indian investors by creating investment awareness among them by conducting intensive educational programs, so that they are able to understand their risk profiles in a better way.
ii.
Measures should be taken to strengthen the cash market so that they become strong and efficient.
iii. The committee felt that it is imperative that the regulatory authorities ensure a strong surveillance/vigilance and enforcement machinery.
iv. The committee was of the view that since derivatives trading require a critical mass of sophisticated investors supported by credit and stock analysts,
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SEBI should, in consultation with the stock exchanges, endeavor to conduct certification program on derivatives trading with a view to educating the investors and market intermediaries.
v. Keeping in view the swift movement of funds and the technical complexities involved in derivatives transactions, the committee felt that there was a need to protect particularly the small investors by preventing them from venturing in to options and futures market, who may be lured by the sheer speculative gains. The Committee, therefore, recommended that the threshold limit of the transactions should be pegged not below Rs. 2 Lakhs. l vi. The Committee was of the view that there is an urgent need to prescribe pronounced accounting standards in the case of investors/dealers and also back office standards for intermediaries with a view to reducing the possibility of concealing loss and perpetrating the frauds by
companies/intermediaries.
vii. The committee also asked the government to consider exempting derivatives transactions from the imposition of stamp duty. It is important to note that the suggestions and recommendations of the said Committee were implemented by the statutory regulators.
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Thus the enactment of Securities of Laws (Amendment) Act.1999 and repeal of 1969 notification provided a legal framework for securities based derivatives trading on stock exchanges in India , which is co-terminus with framework of trading of other “securities” allowed under the SCRA. The trading of stock index futures started in June 2000 and later on, other products, such as, stock index options and stock options and single stock futures were also allowed.
Categories of Derivatives Traded in India
1.
Commodities futures for coffee, Oil seeds, Oil, Pepper, Cotton, jute
and jute goods are traded in the commodities futures. Forward markets commission regulates the trading of commodities futures.
2.
Index futures based on sensex and nifty index are also traded under
the supervision of SEBI.
3.
RBI has permitted banks, FIIs and PDs to enter into forward rate
agreement, interest rate swaps in order to facilitate hedging of interest rate risks and ensuring orderly development of the derivatives market.
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4.
NSE became the first exchange to launch trading in options on
individual securities. Trading in options on individual securities commenced from July 2, 2001. Option contracts are American style and cash settled and are available on 41 securities stipulated by the Securities & Exchange Board of India (SEBI).
5.
NSE commenced trading in futures on individual securities on
November 9, 2001. The future contracts are available on 41 securities stipulated by the SEBI. BSE also has started trading in individual stock option & futures (both Index & Stocks) around the same time as NSE.
FORWARD CONTRACT
A forward contract is a simple derivative. It is an agreement to buy or sell an asset at a certain future time for a certain price. The contract is usually between two financial instruments or between a financial institution and its corporate client.
One of the parties in a forward contract assumes a long poison i.e. agrees to buy the underlying asset on a specified future date at a specified future price. The other party assumes a short position i.e. agrees to sell the asset on the
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same price. This specified price is referred to as the delivery price. This delivery price is chosen so that the value of the forward contract is equal to zero for both transaction parties. In other words, it costs nothing to the either party to hold the long or the short position.
A forward contract is settled at maturity. The holder of the short position delivers the asset to the holder of the long position in return for cash at the agreed upon rate. Therefore, a key determinant of the value of the contract is the market price of the underlying asset. A forward contract can therefore, assume a positive or negative value depending on the movements of the price of the asset. For example, if the price of the asset rises sharply after the two parties has entered into the contract, the party holding the long position stands to benefits, i.e. the value of the contract is position for her. Conversely, the value of the contract becomes negative for the party holding the short position.
The concept of forward price is also important. The forward price for a certain contract is defined as that delivery price which would make the value of the contract zero. To explain further, the forward price and the delivery price are equal on the day that the contract is entered into. Over the duration of the contract, the forward price is liable to change while the delivery price remains the same.
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FUTURES CONTRACT Introduction A futures contract is an exchange traded forward contract to buy or sell a predetermined quantity of an asset on a pre-determined future date at a predetermined price. Here the buyer and the seller will be requested to make a security deposit at the time when the contract is signed.
A futures contract is an agreement between two parties to buy sell an asset at a certain specified time in future for certain specified price. In this, it is similar to a forward contract. However, there are a number of differences between forwards and futures. These relate to the contractual features, the way the markets are organized, profiles of gains and losses, kinds of participants in the markets and the ways in which they use the two instruments.
Futures contracts in physical commodities such as wheat, cotton, corn, gold, silver, cattle, etc. have existed for a long time. Futures in financial assets, currencies, interest bearing instruments like T-bills and bonds and other innovations like futures contracts in stock indexes are a relatively new development dating back mostly to early seventies in the United States and subsequently in other markets around the world.
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An index is a number used to represent the changes in a set of values between a base time period and the current time. A stock index represents change in the value of a set of stocks which constitute the index over a base year.
An index future is a derivative whose value is dependant on the value of the underlying asset (e.g. BSE Sensex, S&P CNX NIFTY). While trading on index futures, an investor is basically buying and selling the basket of securities comprising an index in their relative weights.
Unlike commodity and other futures contracts, Index Future contracts are settled in cash. The fair futures price is based upon arbitrage. In case of stock index futures, this would be cash and carry arbitrage.
The futures price should be such that there is no arbitrage profit from buying stock and simultaneously selling futures. The excess of the financing cost of holding the stock over the dividend receipts constitutes the net cost of carry. The selling price guaranteed by the futures should match the initial cost of the stock plus the net cost of carry.
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In other words, the futures price should provide a guaranteed capital gain that exactly compensates the excess of interest payments over the dividend receipts. The fair value of the future contract is calculated in a way that there is o arbitrage available in the trade. This can be explained as follows:
Futures price=Spot price + Holding costs F=S+C Holding cost = Cost of financing minus Dividend returns.
Assume that current value of Nifty is 910 and the annualized dividend yield of Nifty index is 2%. The cost of capital is 15% and your investment days are 60.
So the fair value of future is, F = S + C = 928.47 F = S*exp (1n (1+r-q))*T i.e. 910*exp (1n (1.15-.02)*60/365 = Rs. 928.45 C= There is no storage or holding cost of financial instrument
Hedging is a method of reducing the risk of loss caused by price fluctuation. It consists of the purchase or sale of equal quantities of the same or very similar commodities, approximately simultaneously, in two different markets
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with the expectation that a future change in price in one market will be offset by an opposite change in the other market.
Features of Futures Contracts
Organized Exchanges: Unlike forward contracts which are traded in an over-the-counter market, futures are traded on organized exchanges with a designated physical location where trading takes place. This provides a ready, liquid market in which futures can be bought and sold at any time like in a stock market.
Standardization: In the case of forward currency contracts, the amount of commodity to be delivered and the maturity date are negotiated between the buyer and seller and can be tailor-made to buyer’s requirements. In a futures contract both these are standardized by the exchange on which the contract is traded. Thus, for instance, one futures contract in pound sterling on the international Monetary Market (IMM), a financial futures exchange in the US, calls for delivery of 62,500 British Pounds and contracts are always traded in whole numbers i.e. you cannot buy or sell fractional contracts. The exchange also specified the minimum size of price movement (called the “tick”) and, in
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some cases, may also impose a ceiling on the maximum price change within a day. In the case of commodity futures, the commodity in question is also standardized for quality in addition to quantity in a single contact. Clearing House: The exchange acts as a clearinghouse to all contracts struck on the trading floor. For instance, a contract is struck between A and B. Upon entering into the records of the exchange, this is immediately replaced by two contracts, one between A and the clearing house and another between B and the clearing house. In other words, the exchange interposes itself in every contract and deal, where it is a buyer toe very seller and a seller to every buyer. The advantage of this is that A and B do not have to undertake any exercise to investigate each other’s creditworthiness. It also guarantees the financial integrity of the market. The exchange enforces delivery for contracts held until maturity and protects itself from default risk by imposing margin requirements on traders and enforcing this through a system called “marking to market”.
Margins: Like all exchanges, only members are allowed to trade in futures contracts on the exchange. Others can use the services of the members as brokers to use this instrument. Thus, an exchange member can trade on his own account as well as on behalf of a client. A subset of the members is the “clearing
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members” or members of the clearinghouse and non-clearing members must clear all their transaction through a clearing member. The exchange requires that a margin must be deposited with the clearinghouse by a member who enters into a futures contract. The amount of the margin is generally between 2.5% to 10% of the value of the contract but can vary. A member acting on behalf of a client, in turn, requires a margin from the client. The margin can be in the from of cash or securities like treasury bills or bank letters of credit.
Marketing to Market: The exchange uses a system called marketing to market where, at the end of each trading session, all outstanding contracts are repriced at the settlement price of that trading session. This would mean that some participants would make a loss while others would stand to gain. The exchange adjusts this by debiting the margin accounts of those members who made a loss and crediting the accounts of those members who have gained. This feature of futures trading creates an important difference between forward contracts and futures. In a forward contract, gains or losses arise only on maturity. There are no intermediate cash flows. Whereas, in a futures contract, even though the gains and losses are the same, the time profile of the accruals is different. In other words, the total gains or loss over the entire period is broken up into a daily series of gains and losses, which clearly has a different present value.
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Actual delivery is rare: In most forward contract, the commodity is actually delivered by the seller and is accepted by the buyer. Forward contracts are entered into for acquiring or disposing off a commodity in the future for a gain at a price known today. In contrast to this, in most futures markets, actual delivery takes place in less than one percent of the contracts traded. Futures are used as a device to hedge against price risk and as a way of betting against price movements rather than a means of physical acquisition of the underlying asset. To achieve this, most of the contracts entered into are nullified by a matching contract in the opposite direction before maturity of the first.
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Types of futures
Trading in futures is equivalent to betting on the price movements in futures prices. If such betting is used to protect a position either long or short in the underlying asset, it is termed as hedging. On the other hand, if the activity is undertaken only with the objective of generating profits from absolute or relative price movements, it is termed as speculation. It must be noted that speculators provide liquidity to the markets by their willingness to enter open positions.
Currency futures: We shall look at both hedging and speculation in currency futures. Corporations, banks and others use currency futures for hedging purposes. The underlying principle is as follows:
Assume that a corporation has an asset e.g. a receivable in a currency A, that it would like to hedge, it should take a futures position such that futures generate a positive cash whenever the asset declines in value. In this case, since the firm in long, in the underlying asset, it should go short in futures i.e. it should sell futures contracts in A. obviously, the firm cannot gain from an appreciation of A since the gain on the receivable will be eaten away by the
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loss on the futures. The hedger is willing to sacrifice this potential profit to reduce or eliminate the uncertainty.
In hedging too, the corporation has the option of a direct hedge and a cross hedge. A British firm with a dollar payable can hedge by selling sterling futures (same effect as buy dollar futures) on the IMM or LIFFE. This is an example of a direct hedge. If the dollar appreciates, it will lose on the payable but gain on the futures, as the dollar price of futures will decline.
A Belgian firm with a dollar payable cannot hedge by selling Belgian franc futures because they are not traded. However, since the Belgian franc is closely tied to the Deutschemark in the European Monetary System (EMS). It can sell DM futures. An important point to note is that, in a cross hedge, a firm must choose a futures contract on an underlying currency that is highly positively correlated with the currency exposure being hedged.
The reasons for low use of cross hedge are that futures contract is for standardized amounts as this is designed by the exchange. Evidently, this will only rarely match the exposure involved. The second reason involves the concept of basis risk. The difference between the spot price at initiation of the contract and the futures price agreed upon is called the basis. Over the term of the contract, the spot price changes, as does the futures price. But the
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change is not always perfectly correlated – in other words, the basis is not constant. This gives rise to the basis risk. Basis risk is dealt with through the hedge ratio and a strategy called delta hedging.
A speculator trades in futures to profit from price movements. They hold views about the future price movements – if these differ from those of the general market, they will trade to profit from this discrepancy. The flip side is that they are willing to take the risk of a loss if the prices move against their views of opinions.
Speculation using futures can be in the either open position trading or spread trading. In the former, the speculator is betting on movements in the price of a particular futures contract. In the latter, he is betting on the price differential between two futures contracts.
Interest rate futures:
Interest rate futures are one of the most successful financial innovations in recent years. The underlying asset is a debt instrument such as a Treasury bill a bond or time deposit in a bank. The International Monetary Market (IMM) – a part of the Chicago Mercantile Exchange, has futures contracts on US Government treasury bonds, three – month Euro dollar time deposits and
52
medium term US treasury notes among others. The LIFFE has contracts on euro-dollar deposit, sterling time deposits and UK Government bonds. The Chicago Board of Trade offers contracts on long term US treasury bonds.
Interest rate futures are used by corporations, banks and financial institutions to hedge interest rate risk. A corporation planning to issue commercial paper can use T-bill futures to protect itself against an increase in interest rate. A treasurer who is expecting some surplus cash in the near future to be invested in some short term investment may use the same as insurance against a fall in interest rates. Speculators bet on interest rate movement or changes in the term structure in the hope of generating profits.
A complete analysis of interest rate futures would be a complex exercise as it involves thorough understanding and familiarity with concept such as mathematics of bond
discount yield ,yield-to-maturity and elementary valuation and pricing .
Stock Index Futures:
A stock index futures contract is an obligation to deliver on the settlement date an amount of cash equivalent to the value of 500 times the difference
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between the stock index value at the close of the last trading day of the contract and the price at which the futures contract was originally struck.
It must be noted that no physical delivery of stock is made. Therefore, in order to ensure that sufficient funds are available for settlement, both parties have to maintain the requisite deposit and meet the variation margin calls as and when required.
Futures Pricing:
The price of futures refers to the rate at which the futures contract will be entered into. The basic determinants of futures price are spot rate and other carrying cost. In order to find out the futures prices, the cost of carrying are added or deducted to the spot rate. The cost of carrying depends upon
-Time involved -Rate of Interest -Other factors
On the settlement date, the futures price would be the spot rate itself. However before the settlement day, the futures price may be more or less the prevailing spot rate. In case the demand for futures is high, the buyers of
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futures will be required to pay a price higher than the spot rate and the additional charges paid is known is as contango charges. However, if the
sellers are more, the futures price may be lower than the spot rate and the difference is known as backwardation.
With reference to the stock index futures, the pricing would be such that the investors are indifferent between owning the shares and owning the futures contract. The price of stock index futures should equate the price of buying and carrying such shares from the share settlement date to the contract maturity date. The financing cost of buying the shares would generally be more than the dividend yield. This means that there is a cost of carrying the shares purchased. So, the price of futures contract will be higher than the price of the shares. The carrying cost of the stock index futures is calculated as.
Index value * (financing cost – Dividend Yield) * t
Where, ‘t’ is the time period from share settlement date to the maturity date of the futures contract.
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The first futures market
The Chicago Board of trade (CBOT) was established in 1848 to standardize the size, quality and delivery date of these commodity agreements that were forwards contracts into a contract that could be traded on an exchange.
Once established, the standardization of the terms of the contract enable contracts to be readily traded as what we call today ‘futures contracts’.
Another important result of the creation of the CBOT was the ability to discover the price of a commodity. As buyers and sellers joined together on the floor of the exchange to trade and quoted prices to each other, the ‘real’ price for , say, soybeans was established. Price discovery helps to create stability in price because anyone, buyer or seller, can immediately see by looking at the futures price what price the supply and demand for the underlying is generating.
In essence, today’s markets do the same job as the original concept back in 1848 but in hundreds of different products. The CBOT, for instant, trades a wide range of contracts on commodities, like soybeans and silver as well as financials like Treasury Bonds and Notes.
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In 1874, following in CBOT’s footsteps, the Chicago Produce Exchange provided the market the market for perishable agricultural products like butter and eggs. After some upheaval in 1898, certain traders broke away and formed what is now known as the Chicago Mercantile Exchange, (CME). In 1919 the CME was recognized to allow futures trading. Futures on a variety of commodities have since come to the exchange, including pork bellies, hogs and cattle as well as financials like currencies and index products.
The emergence of financial futures and options markets In 1972 the CME established a division known as the International Monetary Market (IMM). Its purpose was to enable trading in futures contracts based on foreign currencies. In 1982 the CME started trading futures contracts on the S & p 500 Stock Index and now trades many different index products.
In the United States, prior to 1975, nearly all contracts traded were agricultural. Volume in these contracts was less than 10 million per year. However, by 1994 the figure had risen to almost 700 million contracts and by the end of 2003 to a staggering 8.1 billion contracts.
From the end of Second World War until early 1970s there was a very stable economic environment in the United States helped by the Breton Woods Agreement, which kept interest rates in a narrow range. However, when the
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US dollar was devalued, partly as a consequence of the funding of the Vietnam War and a heavy domestic spending programmed, uncertainly and fluctuation in interest rates replaced the economic stability. Europe and Japan had also recovered in economic terms from the re-building effects of Second World War and, with their economies growing, the Dollar came under severe pressure. The need to be able to hedge (or to protect) against the risk associated with volatile currencies and interest rates became critical for financial contracts, which became the cornerstone of the futures and options industry, as we know it today.
It was in 1975 that the CBOT launched the first futures contract on a financial instrument, the Ginnie Mae Mortgage Bond future, followed by the CME, which listed a Eurodollar contract. Shortly, the CBOT listed what was to become one of the world’s most heavily traded futures contract, the Treasury bond future.
Since then, the growth in volume of futures and options contracts in the United States and the rest of the world has been quite phenomenal, as more and more exchanges have opened and a plethora of financial products were developed and listed to meet the demand for risk-hedging mechanisms.
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This process continues today as new markets open in the developing countries. However, the emergence of futures and options markets outside the United States has seen a change in the make-up of the overall volume of business traded.
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About satyam ltd
SCSL is one of the large software exporters form India. It offers it services to clients through a mix of off-shore, on-site facilities.
SCSL originally provided a wide range of offshore software services at the lower end it was into reengineering of legacy application, porting mainframes applications to client server and converting code written in out dated languages to current ones. At the higher end it focused on applications on telecom, networking technologies and engineering services executing projects in 2D drafting and 3D solid modeling. The company had also set up subsidiaries to tap key business segments like enterprise solutions, consulting products and internet services.
SCSL has had one of the fastest growth rates within the large six companies with a CAGR of over 100% for past 8 years. It also has strong base of more than 10,000 highly skilled employees. It also has a very impressive client list with a total of about 300 global customers of which 40 are Fortune 500 companies. The company has its presence in 35 countries and has clients consisting of like GE, Caterpillar, Northern Telecom, Cable and wireless etc.
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Its internet subsidiary is India’s first private ISP and is the only listed company of Indian internet sector.
SCSL has a very wide technology portfolio and has been building alliances with best of breed global venders to offer end-to-end IT solutions across a range of technologies and platforms. It has partnerships with enterprise technology vendors like Microsoft, Oracle, SAP, Siebel, i2 technologies, Arriba, vitria, IBM lotus enterprise, Hummingbird, Docunmentum, Epicentric, MatrixOne, Vignette, CommerceOne and others are the these partnerships have allowed the company to win new projects and increase market share at existing accounts.
The company has entered into various Joint Ventures during FY 2001. It entered into a joint venture with TRW Inc. to float a company called Satyam Mfg. Technology. It also entered into a joint venture with US – based Idea EDGE and it has also partnered with CCMB for global foray into Bioinformatics.
The company was listed on the NYSE under the symbol SAY on May 15, 2001 with an issue of 16675 mn ADS. Each ADS represents two equity shares of satyam. It also achieved a unique distinction of being of the first company in the world to obtain ISO 9001:2000 certifications from BVQI. It
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has also achieved SEI CMM levels for quality in FY99. the company also went for a stock split in August 2000 when it divided a rs 10 share into five shares of two each.
It has also taken various new initiatives during the year that includes setting up of Asia-Pacific headquarters in Singapore and inauguration of Middle East Solutions Center. It also unveiled .NET Solutions Frame Work for AsiaPacific customers. However the company’s subsidiaries have not been doing well and have incurred net losses to the tune of Rs. 2980 mn during FY2001.
During the year 2000 – 2001, company received various award that includes the National HRD award and Data Quest IT man of the year 2000 conferred upon chairman of company Mr. Ramalingu Raju.
Objectives:
The objective of this analysis is to evaluate the profit/loss position of futures contracts. This analysis is done based on the sample data. The sample is taken as satyam comp scripts of March ’06. The lot size is 600. As the scripts of satyam comp are volatile, they are chosen as the sample. The data is collected from various News papers and websites.
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Limitations:
• The sample size chosen as satyam Comp scripts for the month of March. • The study is confined to March month only. Stock index futures
Stock Index futures are the most popular financial futures which have been used to hedge or manage the systematic risk by the investors of Stock Market. They are called hedgers who own portfolio of securities and are exposed to the systematic risk Stock Index is the apt hedging asset since th4 rise or fall due to syst4matic risk is accurately shown in the Stock Index. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock index traded on a regulated futures exchange for a specified price for settlement at a specified time future.
Stock Index futures will require lower capital adequacy and margin requirements as compared to margins on carry forward of individual scripts. The brokerage costs and index futures will be much lower.
Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. The impact cost will be much lower in case of
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stock index futures as opposed to dealing in individual scripts. The market is conditioned to think in terms of the index and therefore would prefer to trade in stock index futures. Further, the chances of manipulation are much lesser. The Stock index futures are expected to be extremely liquid given the speculative nature of out markets and the overwhelming retail participation expected to be fairly high. In the near future, stock index futures will
definitely see incredible volumes in India. It will be a block buster product and is pitched to become the most liquid contract in the world in terms of number of contracts traded if not in terms of notional value. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more de4pth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base any conclusions on the volume or to form any firm trend.
The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract. Illustration: If the BSE stock index is at 3000 and each point in the index equals to Rs. 50, a contract struck at this level could be worth Rs. 150000(3000*50). If at the
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expiration of the contract, the BSE stock index is at 3020, a cash settlement of Rs.100 is required ((3020-3000)*50). No physical delivery of stocks is made in order to ensure that sufficient funds are available for settlement. Stock futures If the current price of the satyam share is Rs.170 per share. We believe that in one month it will touch Rs. 200. and we buy satyam shares. If price really increase to Rs. 200, we made of profit of Rs.30 i.e. a return of 18%.
If we buy satyam futures instead, we get the same position as satyam in the cash market, but we have to pay the margin not the entire amount. In the above example if the margin is 20%, we would pay only Rs. 34. If satyam goes up Rs.200, we will still earn Rs. 30 as profit. Now that translates into a fabulous return of 89% in one month.
The risks are that losses will be get leveraged or multiplied in the as profit do. For example, if satyam drops from Rs.170 to Rs.150, you would make a loss of Rs.20. The Rs.20 loss would translate to a 12% loss in the cash market and a 58% loss in the futures market.
It is very easy to reduce / minimize such losses if we keep a sharp eye on the market. Suppose, we are bullish and we hence buy satyam futures. But satyam futures start moving down after we have bought.
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Apart from leverage, a great advantage of futures (at the moment) is that they are not linked to ‘delivery’. This means, we can sell Futures (short sell) of Satyam even if we do not have any shares of Satyam. Thus, we can benefit from a downturn as well as from an upturn. If we predict an upturn, we should buy Futures and if we predict a downturn, we can always sell Futures – thus we can make money in a falling market as well as in a rising one.
Illustration: If Satyam is quoting at Rs.250 in the cash market and one month Satyam futures are quoting at Rs. 253 in the futures market, we can earn is 3 as difference. We will then buy Satyam in the cash market and at the same time, sell Satyam one month futures. On or around the expiry day (last Thursday of each month), we will square up both the positions, i.e. we will sell Satyam in the cash market and buy futures. The two prices will be the same (or very nearly the same) As cash and futures prices will converge on expiry. It does not matter to us what the price is. We will make our profit of Rs 3 any way. For example, if the price is Rs 270, we will make a profit of Rs 20 on selling our Cash market Satyam and a loss of Rs. 17 on buying back Satyam futures. The net profit is Rs 3. On the other hand, if the price is Rs 225, we make a loss of Rs 25 on selling Cash market Satyam and a profit of Rs 28 on Satyam futures.
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The net profit remains Rs 3. Our investment in this transaction will be
Rs
250 on cash market Satyam plus a margin of say 20% on Satyam futures (say Rs 50 approx). thus an investment of Rs 300 has generated a return of Rs 3 i.e. 1% per month or 12% per annum. Now take a situation where only 15 days are left for expiry and we spot the same opportunity as above. We will still generate Rs 3 which will translate into a return of 2% per month or 24% per annum. In this manner, we will generate returns whenever the futures prices are above cash market prices. Suppose we have 1,200 shares of Satyam which is currently quoting at Rs. 170 per share-a total value of Rs 2.04 lakhs. We need cash, but protect the upside profits. All we need to do is – one – sell our shares in the cash market and get paid the Rs 2.04 lakhs and –two – buy Satyam (one month ) futures in the derivatives market (say at Rs 172 per share ). The futures position will keep our profits intact, if the share price moves up. The futures will expire on the last Thursday of the month. On the last Thursday (or before that at any convenient time), we should reverse the transaction i.e. we will sell out Satyam futures and buy back Satyam shares.
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Script price of Satyam Computers March ‘07
DATE 1-03-07 20-03-07 5-03-07 6-03-07 7-03-07 8-03-07 9-03-07 12-03-07 13-03-07 14-03-07 16-03-07 19-03-07 20-03-06 21-03-06 22-03-06 23-03-06 26-03-06 27-03-06 28-03-06 29-03-06
PRICE 409.05 421.25 422.75 418.05 421.9 422.85 411.75 400.8 410.3 406.7 383.5 384.1 367.55 370.05 396.15 404.9 424.05 416.45 409.9 419.3
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Satyam computers
440 420 400 380 360 340 320
1M ar -0 6 8M ar -0 6 15 -M ar -0 6 22 -M ar -0 6 29 -M ar -0 6
share price
PRICE
date
FUTURES CONTRACTS – NIFTY
DATE 2-03-07 3-03-07 4-03-07 7-03-06 8-03-07 9-03-07 10-03-07 11-03-07 14-03-06 15-03-07 17-03-07 18-03-07 21-Mar-07 22-Mar-07 23-03-07 24-03-07 2503-07 28-03-07 29-03-07 30-03-07 31-03-07
OPENINGHIGH 3061.05 3108 3113 3149.8 3140 3144.9 3144.7 3189 3179.9 3179.9 3156 3158.8 3080 3123.7 3131 3171.7 3177 3198 3128 3212.8 3176.4 3210 3221.9 3235 3224.5 3256 3254.9 3278.9 3240 3257.9 3237.5 3261 3231 3284 3286.35 3329 3343 3345.95 3331.35 3373 3385 3424.95
LOW 3055.6 3105 3120.5 3148 3157.25 3075 3040.4 3125.65 3175.05 3128 3175.4 3206.5 3223.55 3231 3207.5 3209 3231 3286.35 3311.15 3326.3 3374.3
CLOSING 3101.75 3134.5 3137.6 3185.45 3167.35 3082.65 3113.85 3166.45 3180.85 3171.9 3205 3213.95 3251.7 3241.95 3227.5 3239.25 3279.9 3326.45 3332.4 3364.9 3412.75
INT. '000CONTRACT 26595 180933 27602 216589 28852 191388 29399 172417 32221 224130 33242 446952 33091 414564 32524 232650 33078 199344 33113 324141 33419 234096 32487 213460 32792 164860 32982 241089 32338 310538 31404 328642 29902 231608 25254 194088 21391 226314 16481 203831 12967 190997
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NIFTY
3500 3400 3300 3200 3100 3000 2900 2800
6 20 06 20 06 3/ 16 /2 00 20 06 3/ 23 / 3/ 30 / 3/ 2/ 3/ 9/ 20 06
OPENING HIGH LOW CLOSING
DATES
BANK NIFTY
DATE 2-3-07 3-03-07 4-03-07 7-03-07 8-03-07 9-03-07 10-03-07 11-03-07 14-03-07 15-03-07 17-03-07 18-03-07 21-03-07 22-03-07 23-03-07 24-03-07 25-03-07 28-03-07
OPENING 4558.6 4594.85 4634.95 4642 4645 4663.65 4530 4614 4668 4601 4699.9 4686 4710 4685 4683.95 4620.2 4659.85 4686
HIGH 4594.4 4644 4684 4669 4666 4665 4594 4667 4628.8 4772.8 4724.5 4734.5 4716 4745 4790 4674.9 4684 4724.9
LOW 4515 4550 4620 4641 4573 4534 4467 4590.15 4640.25 4601 4687 4675 4685 4650 4576.2 4601.1 4638 4680
CLOSING 4560.85 4615.8 4640.6 4646.25 4651.55 4545.9 4585.95 4636.4 4656.1 4687.7 4697.8 4692.45 4702.95 4661.45 4602.25 4637.465 4676.6 4704.95
INT.000 196 183 186 184 179 184 181 158 164 162 148 149 150 151 143 141 136 133
CONTRACTS 1093 2243 2240 630 1870 1208 1138 1234 842 2027 644 559 361 679 744 807 452 362 70
29-03-07 4711 30-03-07 4641 31-03 -07 4685
4715 4677 4694
4668 4641 4620
4673.55 4671.4 4630.95
125 127 114
309 310 619
BANK NIFTY 4900 4800 4700 4600 4500 4400 4300
6 6 20 06 20 06 /2 00 /2 00 3/ 9/ 3/ 2/ /2 00 6
OPENING HIGH LOW CLOSING
3/ 16
DATES
CNX IT
3/ 30
3/ 23
INT. DATE 2-03-07 OPENING HIGH 3930.05 4079 LOW 3930.05 CLOSING 4067.55 '000 35
CONTR ACTS 552
3-03-07
4080
4098
4042
4052.85
35
354
4-03-07
4068
4068
4008
4023.65
38
178
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7-03-07 8-03-07 9-03-07 10-03-07 11-03-07 14-03-07 15-03-07 17-03-07 18-03-07 21-03-07 22-03-07 23-03-07 24-03-07 25-03-07 28-03-07 29-03-07 30-03-07 31-03-07
4020 4015.05 4015.05 3960 4021.05 4140 4158 4115 4164.95 4152.35 4260 4205 4198 4160 4248.95 4205.05 4244 4400
4081.6 4048 4050 4009 4099 4237.45 4165 4158 4181 4249 4261 4228 4208.5 4223.8 4248.95 4268 4316 4400
4020 4009 3950 3936 4021.95 4109 4114 4110 4132 4152.35 4200 4160 4154 4155 4190 4183 4236.2 4325
4069.9 4029.7 3958.35 3998.3 4094.15 4153.9 4123.95 4144.2 4139.65 4241.1 4213 4185.8 4166.1 4216.65 4203 4243.55 4313.15 4371.5
37 36 41 41 43 61 63 59 47 48 42 41 39 37 34 33 31 21
241 128 407 150 368 673 220 128 195 438 351 257 137 128 94 129 257 258
CNX IT
4600 4400 4200 4000 3800 3600
6 6 -0 6 -0 6 ar -0 ar -0 -M ar -M ar -M ar -0 6
OPENING HIGH LOW CLOSING
2M
9M
16
23
DATES
30
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OPTIONS Introduction A option agreement is a contract in which the writer of the option grants the buyer of the option the right purchase from or sell to the writer a designated instrument for a specified price within a specified period of time. The writer grants this right to the buyer for a certain sum of money called the option premium. An option that grants the buyer the right to buy some instrument is called a call option. An option that grants the buyer the right to sell an instrument is called a put option. The price at which the buyer an exercise his option is called the exercise price, strike price or the striking price.
Options are available on a large variety of underlying assets like common stock, currencies, debt instruments and commodities. Also traded are options on stock indices and futures contracts – where the underlying is a futures contract and futures style options.
Options have proved to be a versatile and flexible tool for risk management by themselves as well as in combination with other instruments. Options also provide a way for individual investors with limited capital to speculate on the
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movements of stock prices, exchange rates, commodity prices etc. The biggest advantage in this context is the limited loss feature of options.
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Differences between futures & options
FUTURES
OPTIONS
1) Both the parties are obligated to perform 2) With futures premium is paid by either party. 3) The parties to futures contracts must perform at the settlement date only. They are not obligated to perform before that date. 4) The holder of the contract is exposed to the entire spectrum of the down side risk and hadthe potential for all the upside return.
1) Only the seller (writer) is obligated to perform. 2) With option, the buyer pays the seller a premium. 3) The buyer of an options contract can exercise any time prior to expiration date.
4) The buyer limits the down side risk to the option premium buy retain the upside potential.
5) In futures margin to be paid. They are approximate 15-20% on the current stock price.
5) In options premiums to be paid. But they are very less as compared to the margins.
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REGULATORY FRAME WORK
While from the purely regulatory angle, a separate exchange for trading would be a better arrangement. Considering the constraints in infrastructure facilities, the existing stock (cash) exchanges may also be permitted to trade derivatives subject to the following conditions.
? Trading should take place through an on-line screen based trading system ? The clearing of the derivative market should be done by an independent clearing corporation. ? The exchange must have an online surveillance capability which monitors positions, price and volumes in real time so as to deter market manipulation price and position limits should be used for improving market quality ? Information about trades quantities, and quotes should be disseminated by the exchange in the real time over at least two information vending networks which are accessible to investors in the country. ? The exchange should have at least 50 members to start derivatives trading ? The derivatives trading should be done in a separate segment with separate membership, that is, all members of the cash market would not automatically become members of the derivatives market.
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? The derivatives market should have a separate governing council which should not have representation of trading by clearing members beyond whatever percentage SEBI may prescribe after reviewing the working the working of the present governance system of exchanges. ? The chairman of the governing council of the derivative division / exchange should be a member of the governing council. If the chairman is broker / dealer, then he should not carry on any broking or dealing on any exchange during his tenure. ? No trading / clearing member should be allowed simultaneously to be on the governing council both derivatives market and cash market.
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UNDERLYING INDEX
NIFTY BANK NIFTY CNX IT Lot sizes of different companies 100 100 100
CODE ACC
LOT SIZE 35
COMPANY NAME ASSOCIATED CEMENT COMPANIES LTD. BHARAT ELECTRICAL LTD. BHARA PETROL CORPORATION LTD. CIPLA LTD. DIVISLAB DR. REDDY’S LABORATARIES LTD. GRASM INDUSTRIES LTD. GUJARAT AMBUJA CEMENTS LTD. HINDUSTAN CORPORATION LTD TECHNO. HOUSING DEVELOPMENT FINANCE CORP. HEROHONDA MOTORS LTD. HINDUSTAN LEVE LTD. HINDUSTAN PETROLIUM CORPORATION LTD
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BHARAT ELEC.BHEL 275 BPCL CIPLA DIVISLAB DR. REDDY’S LAB GRASIM GUJAMBCEM HCL TECH HDFC HEROHONDA HINDLEVER HINDPETRO 150 1100 1250 250 400 175 2060 325 150 400 1060
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ICICI BANK INFOSYSTCH IPCL ITC LICHSGFIN M&M MARUTI MTNL NATIONAL NDTV ONGC POLARIS RANBAXY LABS RELIANCE SATYAM COMP SBI SCI STERLITE OPT TATA POWER TATA TEA TATAMOTORS TATASTEEL VSNL
1300 350 100 1100 1125 1700 625 1600 1150 225 1400 800 150 600 250 1600 350 400 27 412 675 525 600
ICICI BANKING CORPORATION LTD. INFOSYS TECHNOLOGIES LTD. INDIAN PETROLIUM CHEMICALS CORP.LTD. INDIAN TOBACCO COMPANY LTD. LIC HOUSING FINANCE LTD. MAHENDRA & MAHENDRA LTD. MARUTI UDYOG LTD. MAHANAGAR TELECOM NIGAM LTD. NATIONAL ALUMINIUM COMPANY NDTV OIL & NATURAL GAS CORPORATION. POLARIS SOFTWARE COMPANY LTD. RANBAXY LABORATARIES LTD. RELIANCE INDUSTRIES LTD. SATYAM COMPUTERS SERVICES LTD. STATE BANK OF INDIA. SHIPPING CORPORATION OF INDIA. STERLITE OPTICALS LTD. TATA POWER COMPANY LTD. TATA TEA LTD. TATA ENG.&LOCOMOTIVE COMPANY TATA IRON & STEEL COMPANY LTD. VIDESH SANCHAR NIGAM LTD.
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Results:
Futures and options markets are global and traded contracts on a wide range of products encompassing currencies, commodities, interest rates, shares, indices, insurance; in fact you can find derivatives on just about anything.
The derivatives industry continues to be innovative and to grow. New products, new exchanges, growing use of OTC products all of this is creating
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a massive challenge to the firms and infrastructure that supports the industry, and the growth is not confined to the United States and European markets.
Study about the NIFTY futures reveals that the futures contracts are in a positive direction. The investors have a positive attitude towards the use of risk hedging tools. The futures NIFTY reached 3400 points gaining almost 300 points in a month. The increase in points suggests that the shares which are underlying assets for NIFTY futures are performing well in stock market. The good performance of stock market can be attributed to fund inflow from FII and mutual funds.
IT sector and Banking sector are also moving into positive direction which indicates growth of the economy in these sectors. The underlying Banking shares have shown good results thereby leading to movement of future prices. The anticipation of good yearly results by the companies also can be considered as a factor for positive direction.
Indian economy is growing at a faster rate and contribution from all sectors has to be there for betterment of country. Inflation rate is under control and the rate of interest prevailing in the market is also a major contributor for growth of banking sector.
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• Derivative trading provides a lot of opportunities in the market but the investor should have a deep insight of derivatives and use of different combinations.
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• In cash market the profit/loss of the investor is depends on the current market price, i.e. the investor may get unlimited profits & at the same time he may get unlimited losses. But in derivatives market the investor can enjoy unlimited profits by bearing limited losses.
• In cash market the investor has to pay the total money. But in derivatives the investor has to pay premiums or margins which are some percentage of total money.
• Derivatives are mostly used for hedging purpose.
• Short positions should be handled carefully because of unlimited loss liability with limited profits.
• Investor should try to hedge his/her positions to minimize losses rather anticipating huge profits.
• Avoid taking positions in contract where liquidity is low.
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BIBLIOGRAPHY Multinational financial management by Alan C. Shapiro Financial management by R. P. Rustogi Multinational financial by Bukley Financial services and market by Dr. S. Gurusamy International financial management by P. G. Apte
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Clearing and settlement of derivatives by David Loader NCFM module on derivatives A journal on derivatives market by ICFAI www.moneypore.com www.nseindia.com www.finpipe.com www.indianderivatives.com www.wikipedia.com www.futuressource.com www.freecharts.com www.bseindia.com www.sharekhan.com www.indiainfoline.com www.commodityindia.com
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doc_952450213.doc