A PROJECT REPORT

ON
EQUITY DERIVATIVES MARKET IN INDIA

25/06/2009

Submitted To: - PROF. RAJU INDUKOORI

Submitted by: -

GROUP NO. 4

MOHIT JAIN

DEEPESH BALAKRISHNAN

RAVINDRA A.M.

AMIT ASHOK UPPADHYA

NILESH KUMAR
INTRODUCTION:

Equity derivatives trading started in India in June 2000, after a regulatory process which
stretched over more than four years. In July 2001, the equity spot market moved to rolling
settlement. Thus, in 2000 and 2001, the Indian equity market reached the logical conclusion of
the reforms program which began in 1994. It is important to learn about the behavior of the
Equity market in this new regime. India’s experience with the launch of equity derivatives
market has been extremely positive, by world standards. NSE is now one of the prominent
exchanges amongst all emerging markets, in terms of equity derivatives turnover. There is an
increasing sense that the derivatives market is playing a major role in shaping price discovery.

The goal of this project is to convey a detailed sense of the functioning of the equity derivatives
market, in order to convey the ‘state of the art’. We seek to convey some insights into what is
going on with the equity derivatives market, and summaries broad empirical regularities about
pricing and liquidity.

OBJECTIVE:

1. To study the progress of equity derivative market.

2. To study the various products available in equity derivative market.
3. To study the size of the equity derivatives market.
4. To study the market structure and regulations of equity derivatives market.
5. To study Driving factors of equity derivatives market.
6. To study the significance of equity derivative market.
7. To determine the trends in equity derivative market.
8. To determine the future prospects of equity derivative market.

RESEARCH METHODOLOGY TO BE USED:

Books, White papers, Reserve Bank of India, Research papers, Industry portals, Government
Agencies, monitoring of Industry News and developments etc. Information from various sites
will be analyzed first to perform the analysis. Various online reports have been studied to and
have been combined to form a general analysis.
LIMITATIONS:

1. Time constraints
2. Financial problem
3. Inaccurate or incomplete data

REVIEW OF LITERATURE:

I. Lumina Americas Partners With Numerix to Provide Valuation and Risk for
Complex Derivatives and Structured Products.

AUTHOR NAME: Anonymous

YEAR: 2009

TITLE: Lumina Americas Partners with Numerix to Provide Valuation and Risk for Complex

Derivatives and Structured Products.

PUBLISHED IN: New York

ABSTRACT: Lumina Treasury can also act as a repository, capturing transactions either
directly in its customized trade entry screens or importing them from the different corporate
systems. Besides producing all treasury figures, Lumina Treasury performs portfolio
management and supports operational tasks.

CONCLUSION: Numerix, the leading independent provider of advanced analytics for the
derivative and structured products market, have announced a partnership which combines
Numerix cross asset analytical library for the pricing, valuation and risk management of complex
derivatives with Lumina treasury and operations, Lumina’s front to back trading system.
Lumina Treasury system has the ability to capture all the daily trading activity of a financial
institution. It provides tools for administrating the cash flows, managing the curve risk; foreign
exchange exposure, liquidity, portfolio valuation and daily, monthly and year-to-date P&L.
Lumina Treasury covers from plain vanilla products to complex structured instruments,
including all the variety of Latin America traded financial instruments. . Besides producing all
treasury figures, Lumina Treasury performs portfolio management and supports operational
tasks. Lumina Treasury has full integration with Lumina Operations, Lumina's back office
solution that provides settlement, accounting and custody among a comprehensive coverage of
back office functions.
 II. When exotic turns toxic; it doesn't have to. With the perils of playing with complex
derivatives instruments now amply visible, the lesson to be learnt is clear-cut: Keep
it simple.

AUTHOR NAME: Rachna Monga

YEAR: 2008

TITLE: When exotic turns toxic; it doesn’t have to. With the perils of playing with complex
derivatives instruments now amply visible, the lesson to be learnt is clear-cut: keep it simple.

PUBLISHED IN: New Delhi

ABSTRACT: Remember Jerome Kerviel, the 31-year-old French trader with Societe Generale,
who was at the helm of what's considered the largest fraud in banking history? Kerviel's rogue
trades in equity derivates apparently drilled a $7-billion hole in the French bank's books.
Kerviel's high-jinks are not too different from those of another rogue trader, Nick Leeson, who
brought down the British bank Barings in the mid-'90s.
CONCLUSION: Negotiate with banks to replace complex forex derivatives transactions with
simpler ones. The depreciation of the rupee has come to the rescue of some companies.
Familiarize the senior management about the risks and rewards, basic principles of hedging and
accounting principles. Put in place a risk management framework by installing systems and
processes to monitor actions of dealers in the treasury department. Banks should categorize
corporate clients according to their understanding and risk-taking capabilities. Some of them
expect marked-to-market margins from clients on a daily basis. At a time when hedge funds and
investment banks are imploding globally, courtesy their exposure to trillion dollars worth of
exotic, financially-engineered derivate products that few outside that dubious universe are able to
understand, the big question is: how much of that rot has seeped into the Indian financial system?
According to data tabled in Parliament earlier this year, Indian banks' exposure to derivatives
stood at Rs 127 lakh crore as on December 31, 2007.

III. INVESTMENT WORLD: Take note of P-Notes.

AUTHOE NAME: Anonymous

YEAR: 2008

TITLE: Investment world: Take note of P- notes.

PUBLISHED IN: Chennai

ABSTRACT: The restrictions that came as a surprise to many in October last years have now
been lifted. Yes, the bar on P-note issues by FIIs was reversed by the Securities and Exchange
Board of India (SEBI) early this month. Said to be a move to boost liquidity, it had great
significance for the markets. But what are these P-Notes? Why the ban and now the reversal?
The backdoor entrants Foreign Institutions, or FIIs as we refer to them, are overseas entities
registered with the country's stock market regulator, SEBI. On registration, these entities can
directly invest in Indian stocks, mutual funds, government securities, derivative and debt. But
there is one category of foreign investors who are not under the regulatory purview - investors
who buy stocks through Participatory Notes (P-Notes).
CONCLUSION: The objectives behind the new regulation were very clear. SEBI wanted to
track and regulate foreign investments coming into the country and stop unhealthy speculation in
the market, by unknown investors. By closing the P-Note option, the regulator wanted foreign
entities to take the FII route whereby they would have to make full disclosures. The move,
though well thought out, was not all that well received by the market. FII selling sent S&P CNX
Nifty plunging 9 per cent in the opening trade on the day following the announcement. Circuit
breakers were triggered and trading was halted on both NSE and BSE for an hour. However, on
clarifications from the Finance Ministry, the market recovered subsequently. Why was the
restriction removed? Despite the P-note ban, Indian indices continued to move northward in the
period following this move for a full four months until January 2008. But the rally didn't extend
as financial turmoil in the US escalated into a global credit and liquidity crunch, triggering a
reversal in FII flows from the Indian market. As a chain of events unfolded, big investment firms
such as Lehman Brothers and Merrill Lynch went bankrupt, even as FIIs continued selling large
chunks of their investment in the domestic market.

IV. INVESTMENT WORLD: What the P-Note relaxation could mean

AUTHOR NAME: Anonymous

YEAR: 2008

TITLE: Investment world: what the P- note relaxation could mean.

PUBLISHED IN: Chennai

ABSTRACT: Policy backdrop it was exactly a year ago that SEBI, amidst a furor, had imposed
restrictions on the issue of these instruments in order to stem the copious inflow from overseas
into the capital market. But as the SEBI chairman, Mr. C. B. Bhave, put it this week: "The
context has changed completely since then," and hence the move to revert to the pre-October
2007 state.
CONCLUSION: These are unprecedented times and market regulators across the globe have
been up in arms fighting the tumbling stock prices. The Reserve Bank of India and Securities and
Exchanges Board of India (SEBI) has been pro-actively managing the situation at home with a
series of policy changes. One such measure, taken last Monday, was SEBI's decision to reverse
its stance on offshore derivative instruments (ODIs). While this move could stem the outflow of
money from the stock market to some extent, there are a few pitfalls as well. Policy backdrop it
was exactly a year ago that SEBI, amidst a furor, had imposed restrictions on the issue of these
instruments in order to stem the copious inflow from overseas into the capital market. But as the
SEBI chairman, Mr. C. B. Bhave, put it this week: "The context has changed completely since
then," and hence the move to revert to the pre-October 2007 state. ODIs are investment vehicles
through which overseas investors not registered with the Indian regulators can take an exposure
to Indian equities. Participatory notes, or p-notes, are one form of ODI. Participatory notes were
held to be the principal route through which $9 billion of foreign institutional investor (FII)
money flowed into the stock market in September and October 2007. Both RBI and SEBI were
then worried about the entities that were gaining a back-door entry into the stock market through
this route and causing a frenzied rise in stock prices and spurring the rupee to appreciate sharply
to almost 39 against the dollar. The most significant change brought about last October was
banning further issue of p-notes with derivatives as underlying and stopping sub-accounts from
issuing p-notes. The existing p-notes on derivatives and those issued by sub-accounts were given
18 months from October 25 to unwind. The share of p-notes in the assets under custody (AUC)
of FIIs was then restricted to 40 per cent. These moves met with great success. The froth in the
derivatives segment on the National Stock Exchange dissipated, with turnover in this sector
dropping almost 40 per cent by November 2007.

V. MARKET WATCH: Arbitrage funds fare better than peers since January.
AUTHOR NAME: Anonymous
YEAR: 2008
TITLE: Market Watch: Arbitrage funds fare better than peers since January.
PUBLISHED IN: Chennai
ABSTRACT: The gainers Among them are UTI Spread, which has given a return of 7.08 per
cent, HDFC Arbitrage Wholesale gave returns of 6.67 per cent, HDFC Arbitrage Retail gave
returns of 6.48 per cent, Lotus India Arbitrage Fund gave 6.44 per cent, JM Arbitrage Fund
earned 6.43 per cent, ICICI Prudential Blended Plan gave returns of 6.15 per cent and Kotak
Equity Arbitrage earned 5.96 per cent, according to data provided by Value Research. (The
returns are as on September 29, 2008).
Arbitrage funds seek to capitalize on the arbitrage opportunity arising out of the pricing
mismatch of stocks in the equity and derivatives segments. They are market-neutral funds.
Whichever way the market moves they can take the opportunity to earn returns, said Mr. Rajiv
Anand, Head-Investments, IDFC Mutual Fund.
CONCLUSION: A fairly new category of funds has managed to outperform most other
categories of mutual fund schemes since January. Arbitrage funds have given a return of six per
cent over the nine months of the current calendar year. Equity diversified funds have given
negative returns of 43.49 per cent and the hybrid-debt category gave negative returns of 8.62 per
cent over the same period. Arbitrage funds have come up only recently, but are not much favored
as they are a comparatively new category, said Ms Mallika Baheti, Mutual Fund Analyst, and
Share khan Ltd. According to analysts, these funds seem to have outperformed most other fund
categories mainly due to the fact that the market conditions since January have been quite
unusual. Otherwise, these funds give returns similar to that of fixed deposits or other fixed
income schemes and are preferred by risk- averse investors, an analyst added. Currently, there
are 14 funds in this category, and all of them have given positive returns since January.

VI. MARKET WATCH: Eligibility norms for exchange traded currency futures.

AUTHOR NAME: Anonymous

YEAR: 2008

TITLE: Market Watch: Eligibility norms for exchange traded currency futures.
 PUBLISHED IN: Chennai

ABSTRACT: The definition of balance sheet net worth would be the same as that in the equity
derivatives market. The clearing member would also be subject to a liquid net worth requirement
of Rs 50 lakh. "The minimum liquid net worth shall be treated as a capital cushion for days of
unforeseen market volatility," the report said.

CONCLUSION: The technical committee, set up jointly by the Reserve Bank of India and
SEBI, today issued a report listing the eligibility criteria for the exchanges wishing to trade in
currency futures, members and clearing and settlement operations. According to the report, the
membership of the currency futures segment would be separate from the membership of the
equity derivative segment or the cash segment of a recognized stock exchange. Liquid net worth
the trading member will be subject to a balance sheet net worth requirement of Rs 1 crore, while
the clearing member would be subject to a balance sheet net worth requirement of Rs 10 crore.
The definition of balance sheet net worth would be the same as that in the equity derivatives
market. The clearing member would also be subject to a liquid net worth requirement of Rs 50
lakh. "The minimum liquid net worth shall be treated as a capital cushion for days of unforeseen
market volatility," the report said. The trading members and sales persons in the currency futures
market must clear a certification programme, which is considered adequate by SEBI.

STUDY AND ANALYSIS:

INTRODUCTION:

Equity derivatives trading started in India in June 2000, after a regulatory process which
trenched over more than four years. In July 2001, the equity spot market moved to rolling
settlement. Thus, in 2000 and 2001, the Indian equity market reached the logical conclusion of
the reforms program which began in 1994. It is important to learn about the behavior of the
equity market in this new regime.
India’s experience with the launch of equity derivatives market has been extremely positive, by
world standards. NSE is now one of the prominent exchanges amongst all emerging markets, in
terms of equity derivatives turnover. There is an increasing sense that the derivatives market is
playing a major role in shaping price discovery.
The goal of this project is to convey a detailed sense of the functioning of the equity derivatives
market, in order to convey the ‘state of the art’. We seek to convey some insights into what is
going on with the equity derivatives market, and summaries broad empirical regularities about
pricing and liquidity.

THE NEED FOR A DERIVATIVES MARKET:

The derivatives market performs a number of economic functions:

1. They help in transferring risks from risk averse people to risk oriented people.
 2. They help in the discovery of future as well as current prices.
3. They catalyze entrepreneurial activity.
4. They increase the volume traded in markets because of participation of risk averse people
in greater numbers.
5. They increase savings and investment in the long run.

FACTORS DRIVING THE GROWTH OF FINANCIAL DERIVATIVES:

1. Increased volatility in asset prices in financial markets.

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

DERIVATIVE MARKETS TODAY:

• The prohibition on options in SCRA was removed in 1995. Foreign currency options in
currency pairs other than Rupee were the first options permitted by RBI.
• The Reserve Bank of India has permitted options, interest rate swaps, currency swaps and
other risk reductions OTC derivative products.
• Besides the Forward market in currencies has been a vibrant market in India for several
decades.
• In addition the Forward Markets Commission has allowed the setting up of commodities
futures exchanges. Today we have 18 commodities exchanges most of which trade
futures.
E.g. the Indian Pepper and Spice Traders Association (IPSTA) and the Coffee Owners
Futures Exchange of India (COFEI).
• In 2000 an amendment to the SCRA expanded the definition of securities to included
Derivatives thereby enabling stock exchanges to trade derivative products.
• The year 2000 will herald the introduction of exchange traded equity derivatives in India
for the first time.

EQUITY DERIVATIVES EXCHANGES IN INDIA:

• In the equity markets both the National Stock Exchange of India Ltd. (NSE) and The
Stock Exchange, Mumbai (BSE) has applied to SEBI for setting up their derivatives
segments.
• The exchanges are expected to start trading in Stock Index futures by mid-May 2000.
BSE'S AND NSE’S PLANS:
• Both the exchanges have set-up an in-house segment instead of setting up a separate
exchange for derivatives.
 • BSE’s Derivatives Segment will start with Sensex futures as its first product.
• NSE’s Futures & Options Segment will be launched with Nifty futures as the first
product.

BENEFITS OF DERIVATIVES:

Derivatives provide a low-cost, effective method for end users of hedge and manage their
exposures to interest rates, commodity prices, or exchange rates. Interest rate futures and swaps,
for example, help banks of all sizes better manage the repricing mismatches in funding long term
assets, such as mortgages, with short term liabilities, such as certificates of deposits. Around
1980 the first swap contracts were developed. A swap is another forward based derivative that
obligates two counter parties Finance o exchange a series of cash flows at specified settlement
dates in the future. Swaps are entered into through private negotiations to meet each firm's
specific risk management objectives. There are two principal types of swaps: Interest rate swaps
and currency swaps. Today interest rate swaps account for the majority of banks swap activity,
and the fixed for floating rate swap is the most common interest rate swap. In such a swap, one
party agrees to make fixed rate interest payments in return for floating rate interest payments
from the counter party.

• Financial derivatives, by reducing uncertainties, make it possible for corporations to

initiate productive activities that might not otherwise be pursued. For example, an U.S.
Company may want to build a manufacturing facility in India but is concerned about the
projects overall cost because of exchange rate volatility between the rupee and the dollar.
To ensure that the company will have the necessary cash available when it is needed for
investment, the U.S. manufacturer should devise a prudent risk-management strategy that
is in harmony with its broader corporate objective of building a manufacturing facility in
India. As part of that strategy, the U.S. firm should use financial derivatives to hedge
against foreign exchange risk. Derivatives used as a hedge can improve the management
of cash flows at the individual firm level.
• Corporations, governmental entities, and financial institutions also benefit from
derivatives through lower funding costs and more diversified funding sources. Currency
and interest rate derivatives provide the ability to borrower in the cheapest capital
market, domestic or foreign, without regard to the currency in which the debt is
denominated or the form in which interest is paid. Derivatives can covert the foreign
borrowing into a synthetic domestic currency financing with either fixed or floating rate
interest.
• Derivatives allow corporations and institutional investors to more effectively manage
their portfolio of assets and liabilities. An equity funds, for example, can reduce its
exposure to the stock market quickly and at the relatively low cost without selling off
part of its equity assets by using stock index futures or index options. Corporate
borrowers and governmental entities can effectively manage their liability structure the
ratio of fixed to floating rate debt and the currency composition of that debt -using
interest rate and currency futures and swaps.
• Extensive academic literature addresses the question of whether the dynamic hedging of
options positions increases market volatility. These studies examine the effects of option
listing on the volatility of the under lying stock price and are particularly relevant
because dynamic hedging of option positions by market makers is an important factor
linking the markets for the option and the underlying stock. The findings are uniform.
Majority of the study concludes that volatility is reduced with the introduction of options
trading. These studies are quite powerful because they span numerous time periods and
literally hundreds of option listings. The range of commodities examined is extensive.
The majority of studies find that the introduction of future trading in stock indices does
not result in increased volatility of the underlying stocks. Where an increase is found,
moreover, it is usually for short term volatility. Studies examining other commodities
find that the introduction of derivatives trading tends to either decrease volatility or result
in no change. The FIIs would be pleased, with the trading systems moving closer to
international methods such as derivatives. The FIIs inflows in the stock markets have
increased since banning of badla and introduction of derivatives. Over the next few
years, there will be fundamental change in the market structure. By March 2002, the
classification of script intro different categories such as A, B1 and B2 will come to an
end. The A group stocks hitherto enjoying an edge over other categories due to high
liquidity has come to an end with the introduction of rolling settlement prevented the
practice of switching of position from one exchange to another due to different
exchanges having different settlement cycles. This leads to an upward re-rating of a large
number of fundamentally good scripts which are currently neglected just because they
belong to B1 and B2 categories.
• One important aspect is the pricing of the options. With regard to, whether the premium
is fair and what factors should be considered while deciding such a price.
Mathematically, the price can be calculated by using either the Black- Scholes model
(For European style options) or Binomial model (for American Options). Without going
into complex mathematical formulas, which can be worked out in electronic
spreadsheets, one must understand the relation and impact of factors, which are
considered to determine that price. Some of these factors include the relationship
between the strike price and the value of the underlying expected volatility of the
underlying assets, time to expiration, interest rates and dividend yield of the underlying
over the life of the option.
• A great deal of speculation is about the broad market movement. The most common
topic of discussion among equity investors is always where you see the market three
months down the line, etc. Speculation on an individual stock is a fairly difficult
proposition in view of insiders knowing more than others about the affairs of the
company. In contrast, information Finance about the index is fairly symmetric i.e. CNX
NIFTY 50 and BSE30 SENSEX. Everyone roughly knows the same facts about how the
economy is faring, political uncertainties, etc. Hence speculation on the index is a fair
game. Interestingly, the survey findings (L.C.Gupta Committee) showed that stock index
futures ranked as the most popular and preferred type of equity derivative, the second
 being stock index options and the third being options on individual stocks. Considerable
interest exists in all the three types of equity derivatives mentioned above. The fourth
type, viz. Individual stock futures, was favored much less. It is pertinent to note that as of
now SEBI does not permit individual stock futures.
• Banks are permitted to invest up to five percent of their total outstanding credit as at end
of previous year in capital market. This is huge money, but Ibanks are traditionally not
active players in the stock market. Derivatives help them to effectively manage the equity
portfolio.
• For banking supervisors around the world including Indian sub-continent, probably the
most important question is what could go wrong go engender systemic risk – the danger
that a failure at a single bank could cause a domino effect, precipitating a banking crisis.
As financial derivatives allow different risk components to be isolated and passed around
the financial system, clearly reduces the overall cost of risk bearing and enhance
economic efficiency. Those who are willing and able to bear each risk component at the
least cost will become the risk holders.
• It is expected that arbitrage transactions between the index futures market and the cash
market for equities is likely to have a beneficial effect on the functioning of the cash
market in terms of price discovery, broadening of liquidity and overall efficiency.
• Derivatives help mutual funds and other financial institutions in their investment
strategy for strategic purposes of controlling risk or restructuring portfolios. Suppose that
a mutual fund scheme decides to reduce its equity exposure, presently, this can be
achieved only by actual selling of equity holdings and selling is likely to depress equity
prices to the disadvantage of the Scheme and the whole market. Besides, it is a time
consuming process and increases transaction costs due to brokerage. By selling index
futures immediately, the actual sale of equity holdings may be done gradually depending
on market conditions in order to realize the best possible prices. The index futures
transaction may be unwound by an opposite transaction to the same extent as unloading
of holdings progresses. Likewise, securities may not be immediately available in
sufficient quantity at reasonable prices when a new scheme is floated as per the broad
objectives of the scheme. In purely cash market, rushing to invest the whole money is
likely to drive up prices to the disadvantage of the scheme. The availability of stock
index futures can take care of this entire problem. Repurchase may sometimes necessitate
liquidation of a part of the portfolio in the case of an open ended scheme. Selling each
holding in proportion of its weight in the portfolio is often impracticable and rushing to
the cash market to liquidate would drive down prices. Hence, the price used in
computation of NAV may not match with the actual realization. Stock Index Futures can
help to overcome these problems to the advantage of unit holders
• For participants in the derivatives market, there are various permutations and
combinations of call and put options, with a fuller understanding, an investor will
appreciate that alternatives available to him are plenty.
• If an investor has no information about individuals stocks, then he diversifies and holds
the market; if he has information about a specific industry but neither on individual firms
 within the industry nor on the market, then he diversifies across the industry and hedges
the market, and soon.

WHAT DO WE MEAN BY DERIVATIVES?

The term derivative instrument is generally accepted to mean a financial instrument with a
payoff structure determined by the value of an underlying security, commodity, interest rate, or
index. According to some notable surveys, over 80% of private sector corporations consider
Derivatives to be important in implementing their financial policies. Derivatives have also
gained wide acceptance among national and local governments, government – sponsored entities,
such as the Student Loan Marketing Association and the Federal Home Loan Mortgage
Corporation,
And supranational, such as the World Bank.

Derivatives are used to lower funding costs by borrowers, to efficiently alter the proportions of
fixed to floating rate debt, to enhance the yield on assets, to quickly modify the assets payoff
structure to correspond to the firm's market view, to avoid taxes and skirt regulations, and
perhaps most importantly, to transfer market risk (hedge) - where the term market risk is used to
connote the possibility of losses sustained due to an unforeseen price or volatility change. A firm
may execute a derivative transaction to alter its market risk profile by transferring to the trade's
counter party a particular type of risk. The price that the firm must pay for this risk transfer is the
Acceptance of another type of risk and/ or a cash payment to the counter party.

The term "derivative" indicates that it has no independent value, i.e. its value is entirely
“derived" from the value of the cash asset. A derivative contract or product, or simply
"derivative", is to be sharply distinguished from the underlying cash asset, i.e. the asset brought /
sold in the cash market on normal delivery terms. A general definition of "derivative" may be
suggested here as follows: "Derivative" means forward, future or option contract of pre-
determined fixed duration, linked for the purpose of contract fulfillment to the value of specified
Real or financial asset or to index of securities. Derivatives offer organizations the opportunity to
break financial risks into smaller components and then to buy and sell those components to best
meet specific risk management objectives.

As both forward contracts and futures contracts are used for hedging, it is important to
understand the distinction between the two and their relative merits. Forward contracts are
private bilateral contracts and have well established commercial usage. They are exposed to
default risk by counter-party. Each forward contract is unique in term of contract size, expiration
date and the asset type/ quality. The contract price is not transparent, as it is not publicly
disclosed. Since the forward contract is not typically tradable, it has to be settled by delivery of
the asset on the expiration date. In contrast, futures contracts are standardized tradable contracts.
They are standardized in terms of size, expiration date and all other features. They are traded on
Specially designed exchanges in a highly sophisticated environment of stringent financial
safeguards. They are liquid and transparent. Their market prices and trading volumes are
regularly reported. The futures trading system has effective safeguards against defaults in the
form of Clearing Corporation guarantees for trades and the daily cash adjustment (mark to
market) to the accounts of trading members based on daily price change. Futures are far more
cost-efficient than forward contracts for hedging.

WHAT DOES EQUITY DERIVATIVE MEAN?

A derivative instrument with underlying assets based on equity securities. An equity derivative's
value will fluctuate with changes in its underlying asset's equity, which is usually measured by
share price.

Investors can use equity derivatives to hedge the risk associated with taking a position in stock
by setting limits to the losses incurred by either a short or long position in a company's shares.
The investor receives this insurance by paying the cost of the derivative contract, which is
referred to as a premium. If an investor purchases a stock, he or she can protect against a loss in
share value by purchasing a put option. On the other hand, if the investor has shorted shares, he
or she can hedge against a gain in share price by purchasing a call option.

Options are the most common equity derivatives because they directly grant the holder the right
to buy or sell equity at a predetermined value. More complex equity derivatives include equity
index swaps, convertible bonds or stock index futures.

THE PARTICIPANTS IN EQUITY DERIVATIVES MARKET:

• Hedgers use futures or options markets to reduce or eliminate the risk associated with
price of an asset.
• Speculators use futures and options contracts to get extra leverage in betting on future
movements in the price of an asset. They can increase both the potential gains and
potential losses by usage of derivatives in a speculative venture.
• Arbitrageurs are in business to take advantage of a discrepancy between prices in two
different markets. If, for example, they see the futures price of an asset getting out of line
with the cash price, they will take offsetting positions in the two markets to lock in a
profit.

TYPES OF EQUITY DERIVATIVES:

• Futures: A futures contract is an agreement between two parties to buy or sell an asset at
a certain time in the future at a certain price. Futures contracts are special types of
forward contracts in the sense that the former are standardized exchange-traded contracts
A "Futures Contract" is a highly standardized contract with certain distinct features. Some of
the important features are as under:
a. A future trading is necessarily organized under the auspices of a market association so
that such trading is confined to or conducted through members of the association in
accordance with the procedure laid down in the Rules & Bye-laws of the association.
b. It is invariably entered into for a standard variety known as the "basis variety" with
permission to deliver other identified varieties known as "tenderable varieties".
 c. The units of price quotation and trading are fixed in these contracts, parties to the
contracts not being capable of altering these units.
d. The delivery periods are specified.
e. The seller in a futures market has the choice to decide whether to deliver goods against
outstanding sale contracts. In case he decides to deliver goods, he can do so not only at
the location of the Association through which trading is organized but also at a number of
other pre-specified delivery centers.
f. In futures market actual delivery of goods takes place only in a very few cases.
Transactions are mostly squared up before the due date of the contract and contracts are
settled by payment of differences without any physical delivery of goods taking place.
Why Futures are popular

No delivery

There is no delivery. When you buy in the cash segment (where investors buy and sell any
number of shares and hold them in demat accounts), the shares are delivered to you and sent to
your demat account. Over here, there is no delivery so you do not need a demat account.

Lower brokerage

The brokerage in Futures is much lower. It will be around 0.03% to 0.05% of the transaction.
These are the rates given to regular investors. An occasional investor may end up paying up to
0.1% as brokerage. In the cash segment, the brokerage will be around 0.25% to 0.75%.

Margin payment

When you buy shares in the cash segment, you have to make the entire payment to your broker.
Within two days, you will have to make the full payment to your broker. In Futures, you just pay
the margin, not the entire amount.

Can effectively short sell

When you sell shares without owning them, it is known as short selling. You would do so if you
believe that the price of the stock is going to drop. This way, you sell it at a higher rate and buy it
at a lower rate later.

With Futures, you do not have to square your transaction at the end of the day. You can square
the transaction whenever you want or wait till it expires on the last Thursday of the month. But,
in the cash segment, you have to square your transaction by the end of the day, so you can short
sell just for a day.

Future contracts are of two types:

• Index future
• Stock future
 • Options:

What are options?

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell
an underlying asset at a specific price on or before a certain date. An option, just like a stock or
bond, is a security. It is also a binding contract with strictly defined terms and properties.

Calls and Puts:

The two types of options are calls and puts:

A call gives the holder the right to buy an asset at a certain price within a specific period of time.
Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will
increase substantially before the option expires.

A put gives the holder the right to sell an asset at a certain price within a specific period of time.
Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of
the stock will fall before the option expires.

Participants in the Options Market:

There are four types of participants in options markets depending on the position they take:

1. Buyers of calls.
2. Sellers of calls.
3. Buyers of puts.
4. Sellers of puts.

People who buy options are called holders and those who sell options are called writers;
furthermore, buyers are said to have long positions, and sellers are said to have short positions.

Here is the important distinction between buyers and sellers:

-Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to
exercise their rights if they choose.
-Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a
seller may be required to make good on a promise to buy or sell.
Types:

There are two main types of options:

• American options can be exercised at any time between the date of purchase and the
expiration date. The example about Cory's Tequila Co. is an example of the use of an
American option. Most exchange-traded options are of this type.
• European options are different from American options in that they can only be exercised
at the end of their lives.

The Lingo:

To trade options, you'll have to know the terminology associated with the options market.
The price at which an underlying stock can be purchased or sold is called the strike price. This is
the price a stock price must go above (for calls) or go below (for puts) before a position can
be exercised for a profit. All of this must occur before the expiration date.

An option that is traded on a national options exchange such as the Chicago Board Options
Exchange (CBOE) is known as a listed option. These have fixed strike prices and expiration
dates. Each listed option represents 100 shares of company stock (known as a contract).

For call options, the option is said to be in-the-money if the share price is above the strike price.
A put option is in-the-money when the share price is below the strike price. The amount by
which an option is in-the-money is referred to as intrinsic.

The total cost (the price) of an option is called the premium. This price is determined by factors
including the stock price, strike price, time remaining until expiration (time value) and volatility.
Because of all these factors, determining the premium of an option is complicated.

There are two main reasons why an investor would use options: to speculate and to hedge.

INSTRUMENTS AVAILABLE IN INDIA:

The National stock Exchange (NSE) has the following derivative products:

Products Index Futures Index Options Futures on Options on

Individual Individual
Securities Securities
Underlying S&P CNX Nifty S&P CNX Nifty 30 securities 30 securities
Instrument stipulated by stipulated by
SEBI SEBI
Type European American
 Trading Cycle maximum of 3- Same as index Same as index Same as index
Month trading cycle. Futures futures futures
At any point in time,
there will be 3
contracts available :
1) near month,
2) mid month &
3) far month duration
Expiry Day Last Thursday of the Same as index Same as index Same as index
expiry month Futures futures futures
Contract Size Permitted lot size is Same as index As stipulated by As stipulated by
200 & multiples Futures NSE (not less NSE (not less
thereof than Rs.2 lacs) than Rs.2 lacs)
Price Steps Re.0.05 Re.0.05
Base Price- previous day closing Theoretical value previous day Same as Index
First day of Nifty value of the options closing value of options
trading contract arrived at underlying
based on Black- security
Scholes model
Base Price- Daily settlement daily close price Daily settlement Same as Index
Subsequent price price options
Price Bands Operating ranges are Operating ranges Operating Operating
kept at + 10 % for are kept at ranges are kept ranges for are
99% of the base at + 20 % kept at 99% of
price the base price
Quantity Freeze 20,000 units or 20,000 units or Lower of 1% of Same as
greater Greater marketwise individual
position limit futures
stipulated for
open positions
or Rs.5 cores

TRADING OF EQUITY DERIVATIVES:

Derivatives markets broadly can be classified into two categories, those that are traded on the
exchange and the traded one to one or ‘over the counter’.
• Exchange Traded Derivatives: An exchange-traded contract, such as a futures contract,
has a standardized format that specifies the underlying asset to be delivered, the size of
the contract, and the logistics of delivery. They trade on organized exchanges with prices
determined by the interaction of many buyers and sellers. In India, two exchanges offer
derivatives trading: the Bombay Stock Exchange (BSE) and the National Stock Exchange
(NSE). However, NSE now accounts for virtually all exchange-traded derivatives in
India, accounting for more than 99% of volume in 2003-2004. Contract performance is
guaranteed by a clearinghouse, which is a wholly owned subsidiary of the NSE. Margin
requirements and daily marking-to-market of futures positions substantially reduce the
credit risk of exchange-traded contracts, relative to OTC contracts.
 • OTC Derivatives (Over the Counter): OTC (over-the-counter) contracts, such as forwards
and swaps, are bilaterally negotiated between two parties. The terms of an OTC contract
are flexible, and are often customized to fit the specific requirements of the user. OTC
contracts have substantial credit risk, which is the risk that the counterparty that owes
money defaults on the payment. In India, OTC derivatives are generally prohibited with
some exceptions: those that are specifically allowed by the Reserve Bank of India (RBI)
or, in the case of commodities (which are regulated by the Forward Markets
Commission), those that trade informally in “havala” or forwards markets.

PROGRESS OF DERIVATIVE MARKET IN INDIA

American billionaire Warren Buffet harrumphed against derivatives as the "financial weapons of
mass destruction" in his annual letter to shareholders. This stemmed from his failure to stomach
long-term derivatives losses in one of his subsidiaries. Fortunately Indian investors have not
taken a serious note of the Sage of Omaha.
Derivative products made a debut in the Indian market during June 2000 and it won't be an
aberration to say that the overall progress of derivatives market in India has indeed been
impressive. Index futures were initially introduced in the market. From contracts valued at Rs 35
crore in index futures in June 2000, we have the derivatives segment recording a turnover of Rs
109,850 crore in July 2003.
According to Indian Securities Market report the total exchange traded derivatives witnessed a
volume of Rs 1,03,848 crore during the financial year ended on March 2002 and Rs 3,918 crore
during the year 2001. So the total volume in July 2003 is more than the total yearly volume of
2002.
Currently, derivatives contracts in India are cash settled and not physically settled as Sebi feels
that physical settlement of these contracts needs to have very good stock lending system in place,
along with the facility of electronic fund transfer (EFT). But it is expected that as systems come
in place and the market become more matured, contracts would be physically settled.
The Indian equity derivatives market has registered an "explosive growth" and is expected to
continue its dream run in the years to come with the various pieces that are crucial for the
market's growth slowly falling in place.
Reasons to have propelled the growth of derivatives market are as:
• The settlement of contentious issues relating to taxation of transactions in equity
derivatives.
• Most of the foreign institutional investors are getting into the game.
• The familiarity of the badla traders with the individual stock futures has made stock
futures the most popular product in the Indian equity derivatives market. India is the only
country in which individual stock futures are the most popular equity derivatives product.
• In December 2002 for expansion of the derivatives market, the Securities and Exchange
Board of India (Sebi) released risk containment measures and the broad eligibility criteria
of stocks on which stock options and single stock futures could be introduced. The capital
market regulator has put the ball in the court of stock exchanges (SEs) to expand the list
 of individual stock futures from the current 30 to maximum of 500 based on the average
daily market capitalization and average daily traded value.
• In January 2003, the Securities and Exchange Board of India cleared the way for mutual
funds to trade in derivatives. Now they can offset potential losses from cash-market
positions by trading in derivatives products by hedging and portfolio balancing.
• In February 2003 - the Securities and Exchange Board of India decided that exposure of
foreign institutional investors (FIIs) in both the cash and futures markets will be treated
separately. It said that the limit on individual foreign funds investments in local
companies will not be included in their holdings in derivatives instruments such as
options and futures. Sebi has allowed an FII to hold up to ten per cent of a company's
equity and their sub-accounts can hold up to five per cent. However Sebi said this rule
will hold only as long as derivatives contracts continue to be settled in cash.
Though the Futures & Options segment provides a nation-wide market, Mumbai leads the city-
wise distribution of contracts traded at 49.08 per cent followed by Delhi (including Ghaziabad)
at 24.28 per cent, Kolkata (including Howrah) at 12 per cent, and others accounted for balance
share of trading. The others include cities such as Kochi, Ernakulam, Parur, Kalamasserry,
Always at 2.44 per cent each, Ahmedabad (2.25 per cent), Chennai (2.01 per cent), Hyderabad,
Secunderabad and Kukatpally at 1.54 per cent and others at 5.80 per cent.
If there is a winner of the current Bull Run on the bourses, it is undoubtedly the infantile
derivatives segment. In the battle for turnover, the derivatives segment has overshadowed the
long-established cash market.
Today, in less than three years, the derivative segment has not only overtaken the traditional cash
market, but has also emerged as an ideal hedging mechanism in the equities market. The
derivatives market was able to beat the cash market in terms of monthly turnover for the first
time in February 2003. Then the derivatives segment of the equity market clocked a total
monthly turnover of Rs 49,395 crore compared with the total cash market's Rs 48,289 crore
In the just completed July 2003, the derivatives segment has recorded a turnover of Rs 109,850
crore, while the cash market segment has been pushed behind with a turnover of Rs 78,878 crore.
The average daily turnover in the derivatives market has touched Rs 4,776 crore against the cash
market turnover of Rs 3,429 crore. For the past six months (except in the month of May 2003),
the monthly volume in the derivatives segment has been higher than in the cash market.
The bourses are thriving on derivatives volumes. The growing volume turnover indicates a
healthy sign. The derivatives segment has brought in a lot of liquidity and depth to the market,
and the mind-boggling turnover statistics of the derivatives segment speak for themselves.
But why are derivatives such a big hit in Indian market?
• The derivatives products - index futures, index options, stock futures and stock options
provide a carry forward facility for investors to take a position (bullish or bearish) on an
index or a particular stock for a period ranging from one to three months.
• They provide a substitute for the infamous badla system.
• The current daily settlement in the cash market has left no room for speculation. The cash
market has turned into a day market, leading to increasing attention to derivatives.
• Unlike the cash market of full payment or delivery, you don't need many funds to buy
derivatives products. By paying a small margin, one can take a position in stocks or
market index.
 • The derivatives volume is also picking up in anticipation of reduction of contract size
from the current Rs. 200,000 to Rs. 100,000.
Everything works in a rising market. Unquestionably, there is also a lot of trading interest in the
derivatives market.
Futures are more popular in the Indian market as compared to options.
Market observer says that futures product like index futures and stock futures are easy to
understand as compared to options product. Options' being a more complicated product is not
very much popular in the market.
If we compare futures, stock futures are much more popular as compared to index futures.
Starting off with a measly turnover of Rs 2,811 crore in November 2001, the stock futures
turnover jumped to Rs 14,000 crore by March 2002, Rs 32,752 crore in May 2003 and Rs 70,515
crore in July 2003.
Similarly, index futures started its turnover journey with Rs 35 crore-figure way back in June
2000. The trading interest picked up steadily and jumped to Rs 524 crore in March 2001, Rs
1,309 crore in June 2001, Rs 2,747 crore in February 2002, Rs 3,500 crore in November 2002
and Rs 14,743 crore in July 2003.
Stock futures were a hit right from their launch. It is important to note that the Securities &
Exchange Board of India introduced stock futures in November 2001 after it launched all the
other derivative products and now it accounts for nearly 65% of total volumes. In the month of
July alone, stock futures considered to be the riskiest of the lot recorded a turnover of Rs 70,515
crore followed by stock options, index futures and index options.
The popularity of stock futures can be traced to their similarity to the earlier badla system of
carrying forward of trades. Stock futures encourage speculation in the capital market and with
speculation being an integral part of the market; the popularity of the product is not a surprise.
Also stock futures have the advantage of giving higher exposure by paying a small margin.
Stock futures are currently available in 41 most active stocks like Reliance, SBI, HDFC, Infosys,
L&T, Wipro, HPCL and ICICI.
While the rising popularity of derivatives is a good sign, market pundits opine that the
sophisticated derivatives are out of reach for the small investors.
However I would assume it to be a myth. It's a myth that the retail investors do not understand
derivatives. In fact, retail investors are the ones driving the volumes in the derivatives segment;
otherwise it would have taken years to achieve such impressive numbers.
RISKS OF DERIVATIVES:

So, far, we have examined some of the economic benefits associated with derivative products.
The appreciation of these products' effective benefits would however be partial and incomplete
without an analysis of some of the risks inherently linked. The major preoccupation of regulatory
bodies, banks and other market participants would essentially gravitate around the identification
and qualitative appreciation of these risks. The kinds of risks associated with derivatives are no
different from those associated with traditional financial instruments, although they can be far
more complex i.e., credit, market, operational, and legal risk.
 • Credit risk is the risk that a loss will be incurred because counterparty fails to make
payments as due. In the event of the default, the loss on a derivatives contract is the cost
of replacing the contract with a new counterparty. Concern has been expressed that
financial institutions (especially dealers) may have used derivatives to take on an
excessive level of credit risk that is poorly managed.
• Market risk is the risk that the value of a position in a contract, financial instrument,
asset, or portfolio will decline when market conditions change. Concern has been
expressed that derivatives expose firms to new market risks, while increasing the overall
level of exposures.
• A risk that arises in all businesses is operational risk the risk that losses will be incurred
as a result of inadequate systems and control, inadequate disaster or contingency
planning, human error, or management failure.
• Legal risk is the risk of loss because a contract cannot be enforced or because the
contract terms fail to achieve her intended goals of the contracting parties.

This risk, of Finance course, is as old as contracting itself. Because of the relative newness of
derivatives transactions, however, their treatment under existing laws and regulations is often
ambiguous. This legal uncertainty can result in significant unexpected losses. The credit risk
from derivatives activities can be controlled by the traditional credit risk management
function of dealers. This can be supplemented by the more precise identification and
measurement made possible by derivatives technology. The technology can evaluate the
creditworthiness if counterparts, set risk limit to avoid excessive concentrations, regularly
measuring exposures and monitoring them against risk limits. Derivatives generally have not
exposed institutions to fundamentally new sources of market risk and have long been
exposed to these same market risks.

• Interest rate exposure is inherent in the mismatch of assets and liabilities.

• Currency exposure is inherent in foreign exchange trading and in foreign currency
denominated borrowing or lending.
• Equity exposure is inherent in margin loans.

The market risks of any financial activity, including derivatives activity, must be evaluated on
the basis of its effect on the net exposure of an overall portfolio.

• Market risk can be effectively managed through frequent

➢ marking to market of portfolios,
➢ coupled with the identification and measurement of market risk,
➢ the setting of risk limits, and monitoring of positions against limits.

These same sound principles and practices can be, and are, applied to other activities. While no
aspect of operational risk is unique to derivatives, however, it is important for institutions
actively engaged in derivatives activities to have adequate oversight of well trained and
knowledgeable staff by informed and involved senior management. Users of derivatives, like
other firms, should attempt to manage and minimize legal risks.
• Derivatives related disasters, particularly the collapse of Barings, have led to questions
about the ability of individual derivatives participants to internally manage the trading
operations. In addition, concern has surfaced about regulator ability to detect and control
potential derivatives losses. But regulatory and legislative restrictions on derivatives
activities are not the answer, primarily because simple, standardized rules most likely
would only impair banks' ability to manage risk effectively. A better answer lies in
greater reliance on market forces to control derivatives related risk taking, together with
more emphasis on government supervision, as opposed to regulation.
• Banking regulators should emphasize more disclosure of derivatives positions in financial
statements and be certain that Finance institutions trading huge derivatives portfolios
have adequate capital. In additions, because derivatives could have implications for the
stability of the financial system, it is important that users maintain sound risk
management practices. It is the responsibility of a bank's senior management to ensure
that risks are effectively controlled and limited to levels that do not pose a serious threat
to its capital position. Regulation is an ineffective substitute for sound risk management
at the individual firm level.
• It is important that derivatives players fully understand the complexity of financial
derivatives contracts and the accompanying risks. Users should be certain that the proper
safeguards are built into trading practices.
• The following are some of the essential market monitoring tools and policies that should
prevent financial disruptions, by keeping the various risk exposures in the financial
market under control.
• Enhancing confidence and knowledge among all market participants is a necessary
condition in order to guarantee the stability of the derivatives markets.
• Enhance information standardization and disclosure at all levels of the derivatives trading
industry. Also, the market value concept should always be preferred in order to serve as a
benchmark for the marking to market or collateralization of the various risk exposures. L
Increase and harmonize the frequency of market, accounting and credit assessment data
disclosure in order to allow for daily risk monitoring. Market participants should be able
to effectively monitor and limit their market, credit and liquidity risk exposures to the
extent of remaining exposed to a "sustainable" price, volume or credit variation at most.
• An efficient risk management system for the derivatives industry has to be "dynamic" and
explicitly consider and monitor the evolution of market, credit and liquidity risk
exposures. In this respect, the credit risk of derivatives positions should be analyzed
across maturities as well as across counterparties.
• In order to enforce the risk management and monitoring at all responsibility levels, the
performance measurement and financial compensation schemes of the firm employees
have to be incentive compatible. In order to guarantee efficient self regulation in the
derivative market, the managers, traders and other derivative dealers must receive the
proper incentive when hedging, trading or speculating with those instruments. Thus, their
performance objective (in term of risk targets) has to be clearly specified and their
fulfillment enforced through explicit penalties. Finally, the horizon over which a given
 performance is assessed should be compatible with the long run objectives of the
institution and prevent traders from engaging in short term horizon performance
enhancing strategies that lead them to adopt exaggerate risk exposures or turnover
activities.
• Whenever possible, the reputation of the market participant in the derivative business
should be used as a monitoring device to prevent them from adopting excessively risky
positions or from engaging in irregular transactions. In an industry where the competition
for market shares is intense and involves a few major players, where the products are
highly substitutable and where the technology for financial innovation and transaction
costs reduction is not anymore the property at privileged elite, reputation is a very
effective market monitoring instrument.
• Derivatives participants should adopts more transparent and standardized accounting and
disclosure rules, putting more emphasis on the education of their personal and developing
an expertise in their back office management and settlement procedures.
• The ultimate and perhaps most delicate topic are related to the monitoring of derivatives,
namely the justification of external regulation. Regulation is clearly not the only
monitoring device that can be used to enforce market participants risk exposures.
External regulation should be considered as the ultimate enforcement mechanism
whenever self regulation of the market participants fails to achieve the monitoring goals.
Thus, one could view the role of regulation as that of a player of last resort who
guarantees that the economic benefits associated to the derivative trading activity remain
on the efficient "risk/return" frontier.

It is a well known fact that risk management is not about the elimination of risk; it is about
the management of risk; selectively choosing those risks an organization is comfortable with
the minimizing those that it does not want. Financial derivatives serve a useful purpose in
fulfilling risk management objectives. Through derivatives, risk from Finance traditional
instruments can be efficiently unbundled and managed independently.

REGULATORY OBJECTIVES:

(a) Investor Protection: Attention needs to be given to the following four aspects:

(i) Fairness and Transparency: The trading rules should ensure that trading is conducted in a
fair and transparent manner. Experience in other countries shows that in many cases, derivatives
brokers/dealers failed to disclose potential risk to the clients. In this context, sales practices
adopted by dealers for derivatives would require specific regulation. In some of the most widely
reported mishaps in the derivatives market elsewhere, the underlying reason was inadequate
internal control system at the user-firm itself so that overall exposure was not controlled and the
use of derivatives was for speculation rather than for risk hedging. These experiences provide
useful lessons for us for designing regulations.
(ii) Safeguard for clients’ moneys: Moneys and securities deposited by clients with the trading
members should not only be kept in a separate clients’ account but should also not be attachable
for meeting the broker’s own debts. It should be ensured that trading by dealers on own account
is totally segregated from that for clients.

(iii) Competent and honest service: The eligibility criteria for trading members should be
designed to encourage competent and qualified personnel so that investors/clients are served
well. This makes it necessary to prescribe qualification for derivatives brokers/dealers and the
sales persons appointed by them in terms of a knowledge base.

(iv) Market integrity: The trading system should ensure that the market’s integrity is
safeguarded by minimizing the possibility of defaults. This requires framing appropriate rules
about capital adequacy, margins, clearing corporation, etc.

(b) Quality of markets: The concept of “Quality of Markets” goes well beyond
market integrity and aims at enhancing important market qualities, such as cost-
efficiency, price-continuity, and price-discovery. This is a much broader objective
than market integrity.

(c) Innovation: While curbing any undesirable tendencies, the regulatory framework
should not stifle innovation which is the source of all economic progress, more so
because financial derivatives represent a new rapidly developing area, aided by
advancements in information technology.”

CONCLUSION:

In this project, we have tried to learn about India’s equity derivatives market, in a variety of
aspects. India is one of the most successful developing countries in terms of a vibrant market
For exchange-traded derivatives. This episode reiterates the strengths of the modern development
Of India’s securities markets, which are based on nationwide market access, anonymous
electronic trading, and a predominantly retail market. Internationally, banks and mutual funds are
major players on the equity derivatives market.

Among exchange-traded derivative markets in Asia, India was ranked second behind S. Korea
for the first quarter of 2005. The variety of derivatives instruments available for trading is also
expanding. In equity derivatives, NSE figures show that almost 90% of activity is due to stock
futures or index futures, whereas trading in options is limited to a few stocks, partly because they
are settled in cash and not the underlying stocks. Exchange-traded derivatives based on interest
rates and currencies are virtually absent.

As Indian derivatives markets grow more sophisticated, greater investor awareness will become
essential. NSE has programmes to inform and educate brokers, dealers, traders, and market
personnel. In addition, institutions will need to devote more resources to develop the business
processes and technology necessary for derivatives trading.
REFERENCES:
• Chitale, Rajendra P., 2003, Use of Derivatives by India’s Institutional Investors: Issues
and Impediments, in Susan Thomas (ed.), Derivatives Markets in India, Tata McGraw-
Hill Publishing Company Limited, New Delhi, India.
• J.N. Dhankar, "Capital Market Reforms", paper presented in the conference of 2nd
Generation Reforms, pp 1- 2, 2001.
• Ranjan Mukherjee "Derivatives – what it is?" the Management Accountant, May 1998,
pp 335-37.
• Sanjive Aggarwal, "Indian Capital Market" 2nd edition. 4. Fred. D. Arditti, Derivatives:
A comprehensive Resource for options, futures, Interest Rate Swaps and Mortgage
securities, Harward Business School Press.
• K. Bhalla, Financial Derivatives (Risk management 2001, S. Chand & Company Ltd.
Publication.
• A. S. Harish "Potential of Derivatives Market in India", The ICFAI Journal of Applied
Finance, Vol. 7, No.5, Nov. 2001, pp 1-24.
• Andrew Kasapi, Mastering credit derivatives, Financial Times prentice Hall, pp 1-3.
• Report of the L. C. Gupta Committee on Derivatives and Verma Committee Report on
Risk Containment in the Derivatives Market.
• John C Hull, Options, futures and Other Derivatives, Prentice Hall of India Private
Limited, 1997.
• Websites: Securities and Exchange Board of India (www.sebi.com), National Stock
Exchange of India (www.nseindia.com) and Stock Exchange, Mumbai
(www.bseindia.org)