24538633 Comparative Analysis of Equity and Derivative Market

8/17/2019 24538633 Comparative Analysis of Equity and Derivative Market

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CONTENTS

Chapter No. Title Page No. Declaration from student III

Certificate fromorganisation

IV

Certificate from Guide V Acknowledgement VI

List of Tables VII List of Graphs VII List of charts VII

List if abbreviations IX

Executive summary X

1 Introduction1.1 Background of the study 11.2 Company Profile

Company History 6 Top management 11

Competitive

advantage of Religare

11

1.3 Need of the tudy 131.! "#$ective of the tudy 131.% &ethodology of the tudy 131.6 'imitation of the tudy 1!

2 ata Proce!!ing "#naly!i!

(.1 E$uity 16Benefits from

e)uity16

Risk in e)uityinvestment

1*

Ho+ to overcome 1*


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from risk ,rocess of

diversification1%

election of shares 1&

-hen to #uy sellshares

1&

Types of cashmarket margin

2'

(.( eri(ati(e! 2%/actors driving thegro+th ofderivative

2&

Types ofderivatives

2&

Types of trades 0derivative

)1

Types of / "margin

)*

2.* Comparati(eanaly!i!

)+

* ,inding!,ractical situation '2

Comparativeanalysis of the

traded values in the/ " segment

+ith Cash segment

')

) Conclu!ion! ''

' -ecommendation! '

/i0liography '+


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EC #-#TION

02 &s. 'ucy Chatter$ee

here#y declare that this pro$ect report is the record of authentic +ork

carried out #y me during the period from ( * to ( 1 and has not #een

su#mitted to any other 4niversity or 0nstitute for the a+ard of any

degree diploma etc.

Name of the student5 'ucy Chatter$ee

ate5


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iii

#c no3ledgement

0t gives me an immense pleasure to present this pro$ect report2 for the partial fulfillment of the

course. This pro$ect has #een made possi#le through the direct and indirect co7operation of so

many people for +hom #y profound through appreciation the gratitude remains.

/irst of all. 0 +ould like to thanks to &rs. ,riya 8enkatraman2 enior Relationship &anagement

for her valua#le suggestions and constructive criticisms that have acted as a guiding light for me.0 also ackno+ledge the help given to me #y the people of the organi9ation +hose valua#le inputs

+ere the driving force #ehind this pro$ect. 'ast not #ut the least. 0 take this opportunity to

e:press my gratitude to ,rof. ;pte.

0 am also grateful to my guide ,rof. ,. ?rishnan +ho guided me to complete this pro$ect

successfully on time and other faculty mem#ers of &0T "B for the kno+ledge2 +hich 0 am

im#i#ed throughout the t+o years of my ,< & course.

&y deepest regards to my parents +ho have #een al+ays immense of inspiration support to

me forever. 0 +ould like to dedicate this +ork to my parents +ithout +hose co7operation this task

+ould have remained unachieved.


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vi

i!t of Ta0le

Ta0le No. Title Page No.1 ,erformance of sense:

from 1@@1*

( Client interface 1(3 istinction #et+een

futures and for+ard33

! istinction #et+eenfuture and option

!1

% Comparative analysis !66 Comparative analysis inthe / " segment +ith

cash segment

%!

i!t of 4raph

4raph No. Title Page no.1 ense: performance !( A:change traded

derivatives /or+ard31

3 ,ayoff from for+ardcontract

3(

! A:change traded inderivative "ption

3%

% ,ayoff from option 33


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vii

i!t of Chart!

Chart No. Title Page No.1 >n overvie+ of a RA' D( Religare /inancial service

group overvie+*

3 RA' vision and mission @! RA' its su#sidiaries 1


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i:

EXEC5TIVE S566#-7

The pro$ect is a#out the study of #rand a+areness of RA'0RA AC4R0RT0A '0&0TA

among investors. 0t gives the kno+ledge of market position of the company. 0 studied as to ho+

this company proves to an option for the investors2 #y studying the performance of investing in

e)uity derivative for fe+ months considering their analysis. 0 selected area of C"&,>R0T08A

>N>'F 0 "/ AG40TF AR08>T08A2 +hich attract different kinds of investors to invest in

e)uity derivative and to face high risk and get high returns. The ma$or findings of the pro$ect are

to overvie+ of the comparison of e)uity cash segment and e)uity derivative segment2 overvie+

of the e)uity and / " segment from &ay ( @ to une ( @. The methodology of the pro$ect

here is to analy9e the A)uity erivative performance #ased on N>82 A, and other things. 0n

this pro$ect 0 also included my practical situation during the pro$ect internship2 that ho+ the

market goes up and do+n and +hy it happens.

The methodology of the pro$ect here is to analy9e the investment opportunities availa#le for

those investors study the returns risk involved in various investment opportunities and also

study of investment management risk management. o for that +e have to study analy9e the

performance of A)uity erivative in the market. -e kno+ that there is a high risk2 high returnin e)uity #ut in a long time only. -hile in derivative there is a high risk2 high return in the short

term2 #ecause derivative contract is for short time for 1 ( 3 months only. o this pro$ect included

different types of returns2 margin risk involved in e)uity2 and types2 need2 use margin

involved in the derivatives market and also participants terms use in derivative market.


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I

1. INT-O 5CTION

1.1 /ac ground of the !tudy8

The oldest stock e:change in >sia ;esta#lished in 1*D%= and the first in the country to #e granted

permanent recognition under the ecurities Contract Regulation >ct2 1@%62 Bom#ay tock

A:change 'imited ;B A= has had an interesting rise to prominence over the past 133 years. > lot

has changed since 1*D% +hen 31* persons #ecame mem#ers of +hat today is called Bom#ay

tock A:change 'imited paying a princely amount of Re 1. 0n ( (2 the name JThe tock

A:change2 &um#aiJ +as changed to Bom#ay tock A:change. u#se)uently on >ugust 1@2

( %2 the e:change turned into a corporate entity from an >ssociation of ,ersons ;>o,= and

renamed as Bom#ay tock A:change 'imited.

B A2 +hich had introduced securities trading in 0ndia2 replaced its open outcry system of trading

in 1@@%2 +ith the totally automated trading through the B A "nline trading ;B"'T= system. The

B"'T net+ork +as e:panded nation+ide in 1@@D.

ince then2 the stock market in the country has passed through #oth good and #ad periods. The

$ourney in the ( th century has not #een an easy one. Till the decade of eighties2 there +as no

measure or scale that could precisely measure the various ups and do+ns in the 0ndian stock

market. Bom#ay stock A:change 'imited ;B A= in 1@*6 came out +ith a stock 0nde: that

su#se)uently #ecame the #arometer of the 0ndian tock &arket.

AN AI first compiled in 1@*6 +as calculated on a &arket Capitali9ation -eighted

methodology of 3 component stocks representing a sample of large2 +ell esta#lished and

financially sound companies. The #ase year of AN AI is 1@D*7D@. The inde: is +idely

reported in #oth domestic and international markets through prints as +ell as electronic media.

AN AI is not only scientifically designed #ut also #ased on glo#ally accepted construction and

revie+ methodology. /rom eptem#er ( 32 the AN AI is calculated on a free7float market


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capitali9ation methodology. The free float !arket Capitali"ation #eighted$ methodology is a

+idely follo+ed inde: construction methodology on +hich ma$ority of glo#al e)uity #enchmarks

are #ased.

The gro+th of e)uity markets in 0ndia has #een phenomenal in the decade gone #y Right from

early nineties the stock market +itnessed heightened activity in terms of various #ull and #ear

runs. The AN AI captured all these happenings in the most $udicial manner. "ne can identify

the #ooms and #ust of the 0ndian e)uity market through AN AI.

The A:change also disseminates the ,rice7Aarnings Ratio2 the ,rice to Book 8alue Ratio and the

ividend Field ,ercentage on day7to7day #asis of all its ma$or indices.

The value of all B A indices are every 1% seconds during the market hours and displayedthrough the B"'T system. B A +e#site and ne+s +ire agencies.

>ll B A70ndices are revie+ed periodically #y the 0nde: Committee of the A:change. The

Committee frames the #road policy guidelines for the development and maintenance of all B A

indices. epartment of B A 0ndices of the e:change carries out the day to day maintenance of all

indices and conducts research on development of ne+ indices.

0nstitutional investors2 money managers and small investors all refer to the ense: for their

specific purposes The ense: is in effect the su#stitute for the 0ndian stock markets. The

countryKs first derivative product i.e. 0nde:7/utures +as launched on AN AI.

PE-,O-6#NCE O, SENSEX ,-O6 1&&1


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1.2 CO6P#N7:S P-O,I E


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Company:! ;i!tory

Religare is one of the leading integrated financial services institutions od 0ndia. Religare is

promoted #y the promotion of Ran#a:y 'a#oratories 'imited. The comapn offers large and

diverse #ouuet of services ranging from e)uties2 derivatives2 commodities2 insurance

#roking2 to +ealth advisory2 portfolio managemnt services2 personal finacial services

0nvestment #anking and institutuonal #roking services. The services are #roadly clu##ed

across three key #usiness verticals7 Retail2 +ealth mangement and the institutional specturm.

Religare retail net+ork spreads across the length and the #readth of the country +ith it

presence through more than 12(1D locations across more than 3@( cities and to+ns. The

company has a represenattive office in 'ondon. Having spread itself fairly +ell across the

country and +ith the promises of not resting on its laurels2 it has also aggresively started

eyeing glo#al geographies.

#n O(er(ie3 of a -eligare Enterpri!e imited


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Healthcare

Religare Anterprise 'imited /ortis healthcare 'imited

uper Religare 'a#orataries 'imited Religare -ellness 'imited ;formerly R' Ran#a:y= ;formerly /ortis Health+orld=

Religare Technova 'imited

Religare 8oyages 'imited


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-eligare ,inancial Ser(ice! 4roup O(er(ie38<

Religare Anterprise 'imited

Their oint 8entures

'ife 0nsurance Business >sset management #usiness;>egon as a ,artner= ;>egon as a ,artner=

,rivate -ealth Business 0ndiaEs /irst AB0 approved /ilm

;&ac)uire2 >ustralian /inancial ervices &a$or /und ;8istaar as a ,artner= >s a partner=


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-E Vi!ion and 6i!!ion

To #uild Religare as a glo#ally trusted #randin the financial services domain and present itas the 0nvestment


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-E " it! !u0!idiarie!

tructurally2 all #usinesses are operated through various su#sidiaries of the holding company2Religare Anterprises 'imited.


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• Top 6anagement Team

6r. Sunil 4odh3ani< CA" &anaging irector2 Religare Anterprises 'imited. 6r. Shacindra Nath< ccounts like2 R7>lly2 R7>lly 'ite2 R7>lly ,ro etc.

• ,roviding /unding /acility.


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Client Interface8

Retail pectrum 0nstitutional pectrum -ealth pectrum

,ositioning

'everage reach and offer integrated product and service portfolio

'everage relationship+ith gro+ing &Asegment spread across0ndia

To #e a client centric +ealthmanagement advisory firmfor the high net +orthindividuals ;HN0s=

,roducts and ervices

A)uity Trading

Commodity Trading

"nline 0nvestment portal

,ersonal /inancial ervices

- In(e!tment Solution!

- In!urance

- oan! Consumer /inance

0nsurance olutions

- ife In!urance

0nstitutionalBroking

0nvestmentBanking

0nsurance>dvisory

,ortfolio&anagement

ervices

,remier Clientrts 0nitiative

0nternational>dvisory /und

&anagementervice ;>/& =


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- Non< ife In!urance

1.* NEE O, T;E ST5 7

ifferent kinds of investors to invest in e)uity derivative and to face high risk andget high returns.

Company proves to an option for the investors.

tudying the performance of investing e)uity derivative for fe+ monthsconsidering their analysis.

1.) O/>ECTIVE O, T;E ST5 7

>ny investorEs vision is a long term investment ad short term investment and gets high

returns #y #earing high risk. /or that o#$ective need to #e clim#ed successfully an so

o#$ectives of this pro$ect are2

1= To find the R0


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3= To kno+ ho+ derivatives can #e use for hedging.

!= To kno+ the outcome of A)uity and erivative.

%= Ho+ to achieve Capital appreciations.

1.'6ET;O O O47 O, T;E P-O>ECT

efining o#$ective +onEt suffice unless and until a proper methodology is to achieve the

o#$ectives.

1= >naly9ing and o#serving the investment opportunities.

(= >naly9ing the performance of A)uity and erivative market +ith the help of N>82

A, 2 , A ratio etc.

1. I6IT#TIONS O, T;E ST5 7

This pro$ect +as restricted for t+o monthsM hence e:haustive data is not availa#le upon

+hich conclusions can #e relied.

1= 0nvestment in ecurities carry risk so investment in A)uity erivative is also

carrying risk on the #asis of the market.

(= /actors affecting the &arket ,rice of 0nvestment may #e due to &arket forces2

performance of the companies is not possi#le2 and so all the data is not availa#le.


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2. #T# P-OCESSIN4 " #N# 7SIS


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2.1 E$uity

Total e)uity capital of a company is divided into e)ual units of small denominations2 each called

a share.

0t is a stock or any other security representing an o+nership interest.

0t proves the o+nership interest of stock holders in a company.

,or e=ample8<

0n a company the total e)uity capital of Rs (2 2 2 is divided into ( 2 2

units of Rs 1 each. Aach such unit of Rs 1 is called a hare. Thus2 the company then is said to

have ( 2 2 e)uity shares of Rs 1 each. The holders of such shares are mem#ers of the

company and have voting rights.

/enefit! from E$uity

The #enefits distri#uted #y the company to its shareholders can #e5 1= &onetary Benefits and (=

Non &onetary Benefits.


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1. 6onetary /enefit!8

>. i(idend8 >n e)uity shareholder has a right on the profits generated #y the

company. ,rofits are distri#uted in part or in full in the form of dividends.

ividend is an earning on the investment made in shares2 $ust like interest in case

of #onds or de#entures. > company can issue dividend in t+o forms5 a= 0nterim

ividend and #= /inal ividend. -hile final dividend is distri#uted only after

closing of financial yearM companies at times declare an interim dividend during a

financial year. Hence if I 'td. earns a profit of Rs ! crore and decides to

distri#ute Rs ( to each shareholder2 a holding of ( shares of I 'td. +ould

entitle you to Rs ! as dividend. This is a return that you shall earn as a result of

the investment made #y you #y su#scri#ing to the shares of I 'td.

B. Capital #ppreciation8 > shareholder also #enefits from capital appreciation.

imply put2 this means an increase in the value of the company usually reflected

in its share price. Companies generally do not distri#ute all their profits as

dividend. >s the companies gro+2 profits are re7invested in the #usiness. This

means an increase in net +orth2 +hich results in appreciation in the value of

shares. Hence2 if you purchase ( shares of I 'td at Rs ( per share and hold

the same for t+o years2 after +hich the value of each share is Rs 3%. This meansthat your capital has appreciated #y Rs 3 .

(. Nonpart from dividends and capital appreciation2 investments in

shares also fetch some type of non7monetary #enefits to a shareholder. Bonuses and rights

issues are t+o such noticea#le #enefits.

>. /onu!8 >n issue of #onus shares is the distri#ution free of cost to the shareholders

usually made +hen a company capitali9es on profits made over a period of time.Rather than paying dividends2 companies give additional shares in a pre7defined

ratio. ,rima facie2 it does not affect the +ealth of shareholders. Ho+ever2 in

practice2 #onuses carry certain latent advantages such as ta: #enefits2 #etter future

gro+th potential2 and an increase in the floating stock of the company2 etc. Hence


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if I 'td decides to issue #onus shares in a ration of 1512 every e:isting

shareholder of I 'td +ould receive one additional share free for each share held

#y him. "f course2 taking the #onus into account2 the share price +ould also

ideally fall #y % percent post #onus. Ho+ever2 depending upon market

e:pectations2 the share price may rise or fall on the #onus announcement.

B. -ight! I!!ue8 > rights issue involves selling of ordinary shares to the e:isting

shareholders of the company. > company +ishing to increase its su#scri#ed

capital #y allotment of further shares should first offer them to its e:isting

shareholders. The #enefit of a rights issue is that e:isting shareholders maintain

control of the company. >lso2 this results in an e:panded capital #ase2 after +hich

the company is a#le to perform #etter. This gets reflected in the appreciation ofshare value.

-i! ! In e$uity in(e!tment8

>lthough an e)uity investment is the most re+arding in terms of returns generated2 certain risksare essential to understand #efore venturing into the +orld of e)uity.

&arket Aconomy Risk.0ndustry Risk.&anagement Risk.Business Risk./inancial Risk A:change Rate Risk.

0nflation Risk.0nterest Rate Risk.

;o3 to o(ercome ri! !8


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&ost risks associated +ith investments in shares can #e reduced #y using the tool of

diversification. ,urchasing shares of different companies and creating a diversified portfolio has

proven to #e one of the most relia#le tools of risk reduction.

The proce!! of i(er!ification8

-hen you hold shares in a single company2 you run the risk of a large magnitude. >s your

portfolio e:pands to include shares of more companies2 the company specific risk reduces. The

#enefits of creating a +ell diversified portfolio can #e gauged from the fact that as you add more

shares to your portfolio2 the +eightage of each companyEs share gets reduced. Hence any adverse

event related to any one company +ould not e:pose you to immense risk. The same logic can #e

e:tended to a sector or an industry. 0n fact2 diversifying across sectors and industries reaps the

real #enefits of diversification. ector specific risks get minimised +hen shares of other sectorsare added to the portfolio. This is #ecause a recession or a do+ntrend is not seen in all sectors

together at the same time.

;o3e(er all ri! ! cannot 0e reduced8

Though it is possi#le to reduce risk2 the process of e)uity investing itself comes +ith certain

inherent risks2 +hich cannot #e reduced #y strategies such as diversification. These risks are

called systematic risk as they arise from the system2 such as interest rate risk and inflation risk.

>s these risks cannot #e diversified2 theoretically2 investors are re+arded for taking systematic

risks for e)uity investment.

Selection of Share!8

,roper selections of shares are of t+o types57

1. /undamental analysis5 0t involves in depth study and analysis of the prospective company +hose shares

+e +ant to #uy2 the industry it operates in and the overall market scenario. 0t can #e done #y reading and assessing the companyEs annual reports2 research reports pu#lished #y

e)uity research houses2 research analysis pu#lished #y the media and discussions +ith the

companyEs management or the other e:perienced investors.


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(. Technical analysis5 0t involves studying the prices movement of the stock over an e:tended period of

time in the past to $udge the trend of the future price movement. 0t can #e done #y

soft+are programs2 +hich generate stock prices charts indicating up+ard. o+n+ard and

side+ays movements of the stock price over the stipulated time period.

?hen to 0uy " !ell !hare!8

-ith high volatility prevailing in the market2 ma$or price fluctuations in e)uities

are not uncommon. Therefore2 apart from ascertaining O+hichE stock to #uy or sell2 it #ecomes

e)ually important to consider O+henE to #uy or sell. >ny investor should #e a+are of the fact

+here all the investor is follo+ing i.e.2 %uy Low& 'ell (igh .That means +e should #uy stocks at a lo+ price and sell them at a high price.

?hen to 0uy

Three +ays #y +hich +e can figure that out +hat it is a#out this stock that makes it hot.

1. Earning! per Share @EPSA8 ;o3 3ell the company i! doing

A, is the total earning or profits made #y company ;during a given period of time= calculated

on per share #asis. 0t aims to give an e:act evaluation of the returns that the company can deliver.

E=ample8

Company IFP 'td. Capital5 Rs 1 crore ;Rs 1 #illion=.

Capital is the amount the o+ner has in the #usiness. >s the #usiness gro+s and makes profits2 it

adds to its capital. This capital is su#divided into shares ;or stocks=. The capital is divided into

1 million shares of Rs 1 each.

Net ,rofit in ( 37 !5 Rs ( crore ;Rs ( million=.

A, is the net profit divided #y the total num#er of shares.


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EPS B net profit num0er of !hare!

A, Q Rs ( crore ;Rs ( million= 1 crore ;1 million= shares Q Rs ( per share

e!!on to 0e learnt

1. 0f a companyKs A, has gro+n over the years2 it means the company is doing +ell2 and the

price of the share +ill go up. 0f the A, declines2 thatKs a #ad sign2 and the stock price falls.

(. Companies are re)uired to pu#lish their )uarterly results. ?eep an eye out for these resultsM

check for the trend in their A, .

*. Price earning! ratio @PE ratioA8 ;o3 other in(e!tor! (ie3 thi! !hare

>n indicator of ho+ highly a share is valued in the market. 0t arrived at #y dividing the

closing price of a share on a particular day #y A, . The ratio tends to #e high in the case of

highly rated shares. The average ,A ratio for companies in an industry group is often givenin investment $ournal. T+o stocks may have the same A, . But they may have different

market prices. ThatKs #ecause2 for some reason2 the market places a greater value on that

stock. ,A ratio is the market price of the stock divided #y its A, .

PE B mar et price EPS

letEs take an e:ample of t+o companies.

Company IFP 'td

&arket price Q Rs 1

A, Q Rs (

,A ratio Q 1 ( Q %


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Company >BC 'td

&arket price Q Rs (

A, Q Rs (

,A ratio Q ( ( Q 1

0n the a#ove cases2 #oth companies have the same A, . But #ecause their market price is

different2 the ,A ratio is different.

e!!on to 0e learnt

• 0n the case of A, 2 it is not so much a high or lo+ A, that matters as the gro+th in the

A, . The companyKs ,A reflects investorsK e:pectations of future gro+th in the A, . >

high ,A company is one +here investors have hopes that earnings +ill rise2 +hich is +hy

they #uy the share.

*. ,or3ard PE8 oo ing ahead

The stock market is not nostalgic. 0t is for+ard looking. /or instance2 it sometimes happens that a

sick company2 that has made losses for several years2 gets a reha#ilitation package from its #ankand a ne+ CA". >s a conse)uence2 the companyKs stock shoots up. Because investors think the

company +ill do #etter in the future #ecause of the package and ne+ leadership2 and its earnings

+ill go up. >nd +e think it is a good time to #uy the shares of the company no+.

uddenly2 the demand for the shares has gone up. Because stock prices are #ased on e:pectations

of future earnings2 analysts usually estimate the future earnings per share of a company. This is

kno+n as the for+ard ,A. /or+ard ,A is the current market price divided #y the estimated A, 2

usually for the ne:t financial year.

,or3ard PE B Current mar et price e!timate EPS for the ne=t financial year.

To illustrate +hat +e have #een talking a#out2 letKs take the e:ample of 0nfosys Technologies.


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Trailing 1(7month A, Q Rs %6.*( ;A, of the last four )uarters=

Closing price on anuary 6 Q Rs ( !3.1%

,A Q ,rice A, Q ( !3.1% %6.*( Q 3%.@%

Astimated A, for ( !7 % Q Rs 6D

Astimated A, for ( %7 6 Q Rs @

these figures are according to #rokersK consensus estimates.

/or+ard ,A Q current market price estimated A, for ne:t financial year

/or+ard ,A for ( !7 % Q ( !3.1% 6D Q 3 .!@

/or+ard ,A for ( %7 6 Q ( !3.1% @ Q ((.D

-ith an A, gro+th of over 3 2 a for+ard ,A of ((.D is not high2 indicating that there is scopeto #e optimistic a#out the stockKs price.

e!!on to 0e learnt

• ometimes2 investors look out for a lo+ ,A stock2 e:pecting that its price +ill rise in the

future. But sometimes2 lo+ ,A stocks may remain lo+ ,A stocks for ages2 #ecause themarket doesnKt fancy them.

• ?eep ta# on the #usiness ne+s to check out the companyKs prospects in the future

?hen to !ell

Stoc -eache! ,air Value or Target Price

This is the easiest part of selling. -e should sell +hen a stock reaches its fair value. 0t is the main

reason +hy +e chose to #uy it on the first place.

The target price can #e computed #y assessing the companyEs estimated financial performance

over the ne:t 3 to % years2 computing its A, and using an accepta#le , A ratio to compute the


31/64

future market price. Based on this future estimated price and our re)uired return on our

investment2 compute our target price.

?hen the price! reache! Stop lo!!

0t is advisa#le to al+ays consider the possi#ility of a loss #efore making our investment. -e

should decide ho+ much loss +e are +illing to #ook in the stock. The lo+er price i.e.2 the price

at +hich +e are +illing curtail our loss2 is called O top 'ossE.

Need the money

The generally happens due to improper planning. Ho+ever2 things happen. Aven the most

carefully planned strategy may not +ork. Catastrophic events may force investors to sell an

investment if his household is affected #y it.

The 0oo i! unclean

#hen management left their post a#ruptly or +hen the AB0 conduct a criminal investigation on

a company2 it may #e time to sell. "ur assumption may #e inaccurate as a lot of fair value

calculation is #ased on the companyKs #alance sheet2 cash flo+ or other financial statement pu#lished #y management.

Ta eo(er ne3!

#hen one of your stock holding is getting #ought #y other companies2 it may #e time to sell.

ure2 you might like the ac)uiring company #ut you still need to figure out the fair value of the

common stock of the ac)uiring company. 0f the ac)uiring company is overvalued2 then it is #est

to sell.

Other In(e!tment Opportunity

Let us consider we bought stock > and it has risen to 1 #elo+ its fair value. &ean+hile2 +e

noticed that stock B fallen to #elo+ % of our calculated fair value. This is an easy decision.


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-e +ill sell our stock > and #uy stock B. "ur goal as an investor is to ma:imi9e our investment

return. acrificing a 1 of return in order to earn a % return is a sensi#le +ay to do that.

Inaccurate ,air Value Calculation

>s investors2 +e sometimes made errors in our fair value calculation. There are factors that +e

might not take into accounts +hen researching a particular company. /or e:ample2 satyam

scandal.

Ne3 Competitor! 3ith /etter Product!

#hen ne+ competitors sprung up2 the company that you hold might have to spend more money

in order to fend off competition. Recent e:ample includes the emergence of pay7per click

advertising #y ny advertising #usiness such as ne+spapers or ca#le net+ork2 this ne+

product #y 8aR statistic has three components5 a time period2 a confidence level and a loss amount


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;or loss percentage=. ?eep these three parts in mind as +e give some e:amples of

variations of the )uestion that 8aR ans+ers5

-ith @@ confidence2 +hat is the ma:imum value that an asset or portfolio

may lose over the ne:t dayS

E=ample8<

uppose shares of a company #ought #y an investor. 0ts market value today is Rs.% lakhs #ut its

market value tomorro+ is o#viously not kno+n. >n investor holding these shares may2 #ased on

8aR methodology2 say that 17day 8aR is Rs.! lakhs at @@ confidence level. This implies that

under normal trading conditions the investor can2 +ith @@ confidence2 say that the value of the

shares +ould not go do+n #y more than Rs.! lakhs +ithin ne:t 17day.

0n the stock e:change scenario2 a 8aR &argin is a margin intended to cover the largest loss ;in

= that may #e faced #y an investor for his her shares ;#oth purchases and sales= on a single

day +ith a @@ confidence level. The 8aR margin is collected on an upfront #asis ;at the time of

trade=.

;o3 i! Va- margin calculatedD

8aR is computed using e:ponentially +eighted moving average ;A-&>= methodology. Based

on statistical analysis2 @! +eight is given to volatility on OT71E day and 6 +eight is given to

OTE day returns.

To compute2 volatility for anuary 12 ( *2 first +e need to compute dayEs return for an 12 ( @

#y using 'N ;close price on an 12 ( @ close price on ec 312 ( *=.Take volatility computed as on ecem#er 312 ( *.

4se the follo+ing formula to calculate volatility for anuary 12 ( @5

)uare root of .@!L; ec 312 ( * volatility=L; ec 312 ( * volatility=U . 6L; anuary 12 ( @

'N return=L; anuary 12 ( @ 'N return=V


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E=ample8

hare of >BC 'td

8olatility on ecem#er 312 ( * Q . 31!

Closing price on ecem#er 312 ( * Q Rs. 36 Closing price on anuary 12 ( @ Q Rs. 33

anuary 12 ( @ volatility Q

)uare root of ; .@!L; . 31!=L; . 31!= U . 6 ; . *D 1=L ; . *D 1=V Q . 3D or 3.D

;o3 i! the E=treme o!! 6argin computedD

The e:treme loss margin aims at covering the losses that could occur outside the coverage of 8aR margins.

The A:treme loss margin for any stock is higher of 1.% times the standard deviation of daily 'N

returns of the stock price in the last si: months or % of the value of the position.

This margin rate is fi:ed at the #eginning of every month2 #y taking the price data on a rolling

#asis for the past si: months.

E=ample8

0n the A:ample given at )uestion 1 2 the 8aR margin rate for shares of >BC 'td. +as 13 .

uppose the 1.% times standard deviation of daily 'N returns is 3.1 . Then % ;+hich is higher

than 3.1 = +ill #e taken as the A:treme 'oss margin rate.

Therefore2 the total margin on the security +ould #e 1* ;13 8aR &argin U % A:treme 'oss

&argin=. >s such2 total margin paya#le ;8aR margin U e:treme loss margin= on a trade of Rs.1

lakhs +ould #e 12 * 2 7

;o3 i! 6ar


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&T& is calculated at the end of the day on all open positions #y comparing transaction price

+ith the closing price of the share for the day.

E=ample8

> #uyer purchased 1 shares W Rs.1 7 at 11 am on anuary 12 ( *. 0f close price of the

shares on that day happens to #e Rs.D% 72 then the #uyer faces a notional loss of Rs.(%2 7 on

his #uy position. 0n technical terms this loss is called as &T& loss and is paya#le #y anuary (2

( * ;that is ne:t day of the trade= #efore the trading #egins.

0n case price of the share falls further #y the end of anuary (2 ( * to Rs. D 72 then #uy position

+ould sho+ a further loss of Rs.%2 7. This &T& loss is paya#le.

0n case2 on a given day2 #uy and sell )uantity in a share are e)ual2 that is net )uantity position is

9ero2 #ut there could still #e a notional loss gain ;due to difference #et+een the #uy and sell

values=2 such notional loss also is considered for calculating the &T& paya#le.

&T& ,rofit 'oss Q ;Total Buy Gty I Close price=V 7 Total Buy 8alueV 7 Total ale 8alue 7

;Total ale Gty I Close price=V

2.2 eri(ati(e!

erivative is a product +hose value is derived from the value of one or more

#asic varia#les2 called #ases ;underlying asset2 inde:2 or reference rate=2 in a contractual manner.

The underlying asset can #e e)uity2 fore:2 commodity or any other asset. /or e:ample2 +heatfarmers may +ish to sell their harvest at a future date to eliminate the risk of a change in prices

#y that date. uch a transaction is an e:ample of a derivative. The price of this derivative is

driven #y the spot price of +heat +hich is the JunderlyingJ.


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0n the 0ndian conte:t the ecurities Contracts ;Regulation= >ct2 1@%6 ; CR>= defines

JderivativeJ to include7

1. > security derived from a de#t instrument2 share2 loan +hether secured or unsecured2 risk

instrument or contract for differences or any other form of security.

(. > contract +hich derives its value from the prices2 or inde: of prices2 of underlying securities.

erivatives are securities under the C;R=> and hence the trading of derivatives is governed #y

the regulatory frame+ork under the C;R=>.

,actor! dri(ing the gro3th of deri(ati(e!

"ver the last three decades2 the derivatives market has seen a phenomenal gro+th. > large

variety of derivative contracts have #een launched at e:changes across the +orld. ome of the

factors driving the gro+th of financial derivatives are5

1. 0ncreased volatility in asset prices in financial markets2

(. 0ncreased integration of national financial markets +ith the international markets2

3. &arked improvement in communication facilities and sharp decline in their costs2

!. evelopment of more sophisticated risk management tools2 providing economic agents a

+ider choice of risk management strategies2 and

%. 0nnovations in the derivatives markets2 +hich optimally com#ine the risks and returns over alarge num#er of financial assets leading to higher returns2 reduced risk as +ell as transactions

costs as compared to individual financial assets.

Type! of deri(ati(e!8

1. ,or3ard Contract8

> for+ard contract is an agreement to #uy or sell an asset on a specified date for a specified

price. "ne of the parties to the contract assumes a long position and agrees to #uy the underlying

asset on a certain specified future date for a certain specified price. The other party assumes a

short position and agrees to sell the asset on the same date for the same price. "ther contract

details like delivery date2 price and )uantity are negotiated #ilaterally #y the parties to the

contract. The for+ard contracts are normally traded outside the e:changes.


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The salient features of for+ard contracts are5

X They are #ilateral contracts and hence e:posed to counter7party risk.

X Aach contract is custom designed2 and hence is uni)ue in terms of contract si9e2 e:piration date

and the asset type and )uality.

X The contract price is generally not availa#le in pu#lic domain.

X "n the e:piration date2 the contract has to #e settled #y delivery of the asset.

X 0f the party +ishes to reverse the contract2 it has to compulsorily go to the same counter7party2

+hich often results in high prices #eing charged.

imitation! of ,or3ard Contract

/or+ard markets +orld7+ide are afflicted #y several pro#lems5

'ack of centrali9ation of trading20lli)uidity2 andCounterparty risk

0n the first t+o of these2 the #asic pro#lem is that of too much fle:i#ility and generality. The

for+ard market is like a real estate market in that any t+o consenting adults can form contracts

against each other. This often makes them design terms of the deal +hich are very convenient in

that specific situation2 #ut makes the contracts non7trada#le.

Counterparty risk arises from the possi#ility of default #y any one party to the transaction. -hen

one of the t+o sides to the transaction declares #ankruptcy2 the other suffers. Aven +hen for+ard

markets trade standardi9ed contracts2 and hence avoid the pro#lem of illi)uidity2 still thecounterparty risk remains a very serious issue.


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01000200030004000500060007000

E=change Traded eri(ati(e ,or3ard

Type!

amount in 0illion of F

2. ,uture Contract!8

/utures markets +ere designed to solve the pro#lems that e:ist in for+ard markets. > futures

contract is an agreement #et+een t+o parties to #uy or sell an asset at a certain time in the future

at a certain price. But unlike for+ard contracts2 the futures contracts are standardi9ed and

e:change traded. To facilitate li)uidity in the futures contracts2 the e:change specifies certain

standard features of the contract. 0t is a standardi9ed contract +ith standard underlying

instrument2 a standard )uantity and )uality of the underlying instrument that can #e delivered2 ;or

+hich can #e used for reference purposes in settlement= and a standard timing of such settlement.

> futures contract may #e offset prior to maturity #y entering into an e)ual and opposite

transaction. &ore than @@ of futures transactions are offset this +ay.

The standardi9ed items in a futures contract are5

Guantity of the underlyingGuality of the underlyingThe date and the month of deliveryThe units of price )uotation and minimum price change


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'ocation of settlement

The payoff from a long position in a for+ard contract is

, Q 7 I2

+here is a spot price of the security at time of contract maturity2 I is the delivery price.

imilarly2 the payoff from a short position is

, Q I 7 .

/or e:ample2 letKs say the current price of the stock is Y* . and +e entered in for+ard contract

to #uy this stock in 3 months time for Y*1. ;that means +e hope that price +ill not fall lo+er

than Y*1. =. 0f after three months price is more than Y*1. 2 letKs say Y*3. 2 than +e can #uy

the same stock for Y*1. ;as stated #y for+ard contract= and after reselling it on the market our

payoff +ill #e

, Q Y*3. 7 Y*1. Q Y(.

0f at for+ard maturity the stock price falls to YD*. 2 than our loss +ill #e


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, Q Y*1. 7 YD*. Q Y3.

The graphs a#ove illustrate the for+ard contract payoff patterns for long and short positions.

i!tinction 0et3een future! and for3ard!

,uture! ,or3ard!Trade on an organi9ed e:change "TC in nature

tandardi9ed contract terms Customised contract termshence more li)uid hence less li)uid/ollo+s daily settlement ettlement happens at end of period

,uture terminology

Spot price: The price at +hich an asset trades in the spot market.

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

Contract cycle: The period over +hich a contract trades. The inde: futures contracts on the N A

have one7 month2 t+o7month and three months e:piry cycles +hich e:pire on the last Thursday

of the month. Thus a anuary e:piration contract e:pires on the last Thursday of anuary and a

/e#ruary e:piration contract ceases trading on the last Thursday of /e#ruary. "n the /riday

follo+ing the last Thursday2 a ne+ contract having a three7 month e:piry is introduced for

trading.

Expiry date: 0t is the date specified in the futures contract. This is the last day on +hich the

contract +ill #e traded2 at the end of +hich it +ill cease to e:ist.


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Contract size ) The amount of asset that has to #e delivered less than one contract. #l!o called a!

lot !iGe.

Basis: 0n the conte:t of financial futures2 #asis can #e defined as the futures price minus the spot

price. There +ill #e a different #asis for each delivery month for each contract. 0n a normal

market2 #asis +ill #e positive. This reflects that futures prices normally e:ceed spot prices.

Cost of carry: The relationship #et+een futures prices and spot prices can #e summari9ed in

terms of +hat is kno+n as the cost of carry. This measures the storage cost plus the interest that

is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must #e deposited in the margin account at the time a futurescontract is first entered into is kno+n as initial margin.

Marking-to-market: 0n the futures market2 at the end of each trading day2 the margin account is

ad$usted to reflect the investorKs gain or loss depending upon the futures closing price. This is

called marking7to7market.

Maintenance margin: This is some+hat lo+er than the initial margin. This is set to ensure that

the #alance in the margin account never #ecomes negative. 0f the #alance in the margin account

falls #elo+ the maintenance margin2 the investor receives a margin call and is e:pected to top up

the margin account to the initial margin level #efore trading commences on the ne:t day.


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*. Option Contract!

"ptions are fundamentally different from for+ard and futures contracts. >n option gives the

holder of the option the right to do something. The holder does not have to e:ercise this right. 0n

contrast2 in a for+ard or futures contract2 the t+o parties have committed themselves to doing

something. -hereas it costs nothing ;e:cept margin re)uirements= to enter into a futures

contract2 the purchase of an option re)uires an up7front payment.

0500

100015002000250030003500

E=change Traded eri(ati(e! option!

In 0illion! of F

type!


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Option Terminology

Index options ) These options have the inde: as the underlying. ome options are Auropean+hile others are >merican. 'ike inde: futures contracts2 inde: options contracts are also cash

settled.

Stock options: tock options are options on individual stoc ks. "ptions currently trade on over

% stocks in the 4nited tates. > contract gives the holder the right to #uy or sell shares at the

specified price.

Z Buyer of an option: The #uyer of an option is the one +ho #y paying the option premium #uys

the right #ut not the o#ligation to e:ercise his option on the seller +riter.

ZWriter of an option: The +riter of a call put option is the one +ho receives the option premium

and is there#y o#liged to sell #uy the asset if the #uyer e:ercises on him.

ption price!premium: "ption price is the price +hich the option #uyer pays to the option seller.

0t is also referred to as the option premium.

Expiration date: The date specified in the options contract is kno+n as the e:piration date2 thee:ercise date2 the strike date or the maturity.

Strike price: The price specified in the options contract is kno+n as the strike price or the

e:ercise price.

"merican options: >merican options are options that can #e e:ercised at any time upto the

e:piration date. &ost e:change7traded options are >merican.

European options: Auropean options are options that can #e e:ercised only on the e:piration

date itself. Auropean options are easier to analy9e than >merican options2 and properties of an

>merican option are fre)uently deduced from those of its Auropean counterpart.


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In-t#e-money option: >n in7the7money ;0T&= option is an option that +ould lead to a positive

cash flo+ to the holder if it +ere e:ercised immediately. > call option on the inde: is said to #e

in7the7money +hen the current inde: stands at a level higher than the strike price ;i.e. spot price

[strike price=. 0f the inde: is much higher than the strike price2 the call is said to #e deep 0T&. 0n

the case of a put2 the put is 0T& if the inde: is #elo+ the strike price.

"t-t#e-money option: >n at7the7money ;>T&= option is an option that +ould lead to 9ero cash

flo+ if it +ere e:ercised immediately. >n option on the inde: is at7the7money +hen the current

inde: e)uals the strike price ;i.e. spot price Q strike price=.

ut-of-t#e-money option: >n out7of7the7money ;"T&= option is an option that +ould lead to a

negative cash flo+ if it +ere e:ercised immediately. > call option on the inde: is out7of7themoney +hen the current inde: stands at a level +hich is less than the strike price ;i.e. spot price

\ strike price=. 0f the inde: is much lo+er than the strike price2 the call is said to #e deep "T&.

0n the case of a put2 the put is "T& if the inde: is a#ove the strike price.

Intrinsic $alue of an option: The option premium can #e #roken do+n into t+o components 7

intrinsic value and time value. The intrinsic value of a call is the amount the option is 0T&2 if it

is 0T&. 0f the call is "T&2 its intrinsic value is 9ero. ,utting it another +ay2 the intrinsic value of

a call is !ax*+, -'t . /01 +hich means the intrinsic value of a call is the greater of or -'t .

/0& imilarly2 the intrinsic value of a put is !ax*+, / ] t V2i.e. the greater of or -/ . 't0& ? is

the strike price and 't is the spot price.

%ime $alue of an option: The time value of an option is the difference #et+een its premium and

its intrinsic value. Both calls and puts have time value. >n option that is "T& or >T& has only

time value. 4sually2 the ma:imum time value e:ists +hen the option is >T&. The longer the time

to e:piration2 the greater is an optionKs time value2 all else e)ual. >t e:piration2 an option should

have no time value.


45/64


46/64

2et profit3 ;gross= ,ayoff7 cost of #uying options or other securitiesU premium

received for selling options or other securities.

0f is a final price of the option underlying security2 I is a strike price and ", is an option price2

than the profit is


47/64

'ong Call5 , Q 7 I 7 ",

hort Call5 , Q I 7 U ",

'ong ,ut5 , Q I 7 7 ",

hort ,ut5 , Q 7 I U ",

/or e:ample2 letKs say the stock price is Y% . 2 +e #ought Auropean call option +ith strike

Y%3. and paid Y(. for this option. 0f option price is less than Y%3. 2 +e +ill not e:ercise the

option to #uy the stock2 #ecause it doesnKt make sense to #uy security for higher price than it

costs on the market. 0n this case +e lose all initial investment e)ual to the option price Y(. . 0f

stock price is more than Y%3. 2 +e +ill e:ercise the option. /or e:ample if the stock price is

Y%6. 2 after e:ercising the option and immediately reselling the ac)uired stock our profit +ill

#e5

, Q Y%6. 7 Y%3. 7 Y(. Q Y1.

if the stock price is Y%!. 2 than the profit is5

, Q Y%!. 7 Y%3. 7 Y(. Q 7 Y1.

>s +e see in latter case +e lose money. The reason is that increase of stock price $ust #y Y1.

a#ove the strike ;Y%3. = doesnKt cover our initial investment of Y(. 2 although +e still e:ercise

the option to recover at least Y1. of initial investment. 0f the stock price at e:ercise time isY%%. than +e e:ercise the option to cover our initial e:penses;e)ual to option price=5

, Q Y%%. 7 Y%3. 7 Y(. Q Y .

This latter case corresponds to option graph intersection point +ith hori9ontal a:is on the

dra+ing a#ove.

i!tinction 0et3een future! and option!


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,uture! Option!A:change traded2 +ith novation ame as futures.A:change defines the product ame as futures.

,rice is 9ero2 strike price moves trike price is fi:ed2 price moves.,rice is 9ero ,rice is al+ays positive.'inear payoff Nonlinear payoff.Both long and short at risk "nly short at risk.

Type! of trader! in deri(ati(e mar et

1. ;edger!8< Hedgers are those +ho protect themselves from the risk associated +ith the

price of an asset #y using derivatives. > person keeps a close +atch upon the prices

discovered in trading and +hen the comforta#le price is reflected according to his +ants2

he sells futures contracts. 0n this +ay he gets an assured fi:ed price of his produce.

0n general2 hedgers use futures for protection against adverse future price movements in

the underlying cash commodity. Hedgers are often #usinesses2 or individuals2 +ho at one

point or another deal in the underlying cash commodity.

Take an e:ample5 > Hedger pay more to the farmer or dealer of a produce if its prices go

up. /or protection against higher prices of the produce2 he hedges the risk e:posure #y

#uying enough future contracts of the produce to cover the amount of produce he e:pects

to #uy. ince cash and futures prices do tend to move in tandem2 the futures position +ill

profit if the price of the produce raise enough to offset cash loss on the produce.2. Speculator!8

peculators are some+hat like a middle man. They are never interested in actual o+ing

the commodity. They +ill $ust #uy from one end and sell it to the other in anticipation of

future price movements. They actually #et on the future movement in the price of an

asset.


49/64

They are the second ma$or group of futures players. These participants include

independent floor traders and investors. They handle trades for their personal clients or

#rokerage firms

.

Buying a futures contract in anticipation of price increases is kno+n as Ogoing longE. elling a

futures contract in anticipation of a price decrease is kno+n as Ogoing shortE. peculative

participation in futures trading has increased +ith the availa#ility of alternative methods of

participation.

'peculators have certain advantages over other investments they are as follows)

0f the traderEs $udgment is good2 he can make more money in the futures market

faster #ecause prices tend2 on average2 to change more )uickly than real estate or

stock prices.

/utures are highly leveraged investments. The trader puts up a small fraction of the

value of the underlying contract as margin2 yet he can ride on the full value of the

contract as it moves up and do+n. The money he puts up is not a do+n payment on

the underlying contract2 #ut a performance #ond. The actual value of the contract is

only e:changed on those rare occasions +hen delivery takes place.

*. #r0itrator!8

>ccording to dictionary definition2 a person +ho has #een officially chosen to make a


50/64

decision #et+een t+o people or groups +ho do not agree is kno+n as >r#itrator. 0n

commodity market >r#itrators are the person +ho takes the advantage of a discrepancy

#et+een prices in t+o different markets. 0f he finds future prices of a commodity edging

out +ith the cash price2 he +ill take offsetting positions in #oth the markets to lock in a

profit. &oreover the commodity future investor is not charged interest on the difference

#et+een margin and the full contract value.

Type! of ,uture! and Option! 6argin!

&argins on /utures and "ptions segment comprise of the follo+ing5

1= 0nitial &argin

(= A:posure margin

0n addition to these margins2 in respect of options contracts the follo+ing additional margins are

collected

1= ,remium &argin

(= >ssignment &argin

;o3 i! Initial 6argin ComputedD

0nitial margin for / " segment is calculated on the #asis of a portfolio ;a collection of futures

and option positions= #ased approach. The margin calculation is carried out using soft+are called

7 ,>N^ ; tandard ,ortfolio >nalysis of Risk=. 0t is a product developed #y Chicago &ercantile

A:change ;C&A= and is e:tensively used #y leading stock e:changes of the +orld.

,>N^ uses scenario #ased approach to arrive at margins. 0t generates a range of scenarios and

highest loss scenario is used to calculate the initial margin. The margin is monitored andcollected at the time of placing the #uy sell order.

The ,>N^ margins are revised 6 times in a day 7 once at the #eginning of the day2 ! times

during market hours and finally at the end of the day.

"#viously2 higher the volatility2 higher the margins.


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;o3 i! e=po!ure margin computedD

0n addition to initial ,>N^ margin2 e:posure margin is also collected.A:posure margins in respect of inde: futures and inde: option sell positions have #een currently

specified as 3 of the notional value.

/or futures on individual securities and sell positions in options on individual securities2 the

e:posure margin is higher of % or 1.% standard deviation of the 'N returns of the security ;in

the underlying cash market= over the last 6 months period and is applied on the notional value of

position.

;o3 i! Premium and #!!ignment margin! computedD

0n addition to 0nitial &argin2 a ,remium &argin is charged to trading mem#ers trading in "ption

contracts.

The premium margin is paid #y the #uyers of the "ptions contracts and is e)ual to the value of

the options premium multiplied #y the )uantity of "ptions purchased.

/or e:ample2 if 1 call options on >BC 'td are purchased at Rs. ( 72 and the investor has no

other positions2 then the premium margin is Rs. ( 2 .

The margin is to #e paid at the time trade.

>ssignment &argin is collected on assignment from the sellers of the contracts.

;o3 6ar ed to 6ar et 6argin! are computedD


52/64

1. ,uture contract!8< The open positions ;gross against clients and net of proprietary self

trading= in the futures contracts for each mem#er are marked to market to the daily

settlement price at the end of each day is the +eighted average price of the last half an

hour of the futures contract. The profits losses arising from the different #et+een the

trading price and the settlement price are collected given to all clearing mem#ers.

2. Option contract!8< the marked o market for option contracts is computed and collected

as part of the 0nitial &argin in the form of Net "ption 8alues. The 0nitial &argin is

collected on an online real time #asis #ased on the data feeds given to the system at

discrete time intervals.

;o3 Client 6argin! are computedD

Client &em#ers and Trading &em#er are re)uired to collect initial margins from all their

clients. The collection of margins at client level in the derivatives markets is essential as

derivatives are leveraged products and non7collection of margins at the client level +ould

provide 9ero cost leverage. 0n the derivative markets all money paid #y the client to+ards

margins is kept in trust +ith the Clearing House Clearing Corporation and in the event of default

of the Trading or Clearing &em#er the amounts paid #y the client to+ards margins are

segregated and not utili9ed to+ards the dues of the defaulting mem#er.

Therefore2 Clearing mem#ers are re)uired to report on a daily #asis details in respect of such

margin amounts due and collected from their Trading mem#ers clients clearing and settling

through them. Trading mem#ers are also re)uired to report on a daily #asis details of the amount

due and collected from their clients. The reporting of the collection of the margins #y the clients

is done electronically through the system at the end of each trading day. The reporting of

collection of client level margins plays a crucial role not only in ensuring that mem#ers collectmargin from clients #ut it also provides the clearing corporation +ith a record of the )uantum of

funds it has to keep in trust for the clients.

2.* Comparati(e #naly!i!


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/a!i! E$uity eri(ati(e-eturn Capital appreciation

ividend 0ncome

Capital gain

,rice /luctuation-i! Company pecified

ector specified

r#itragers

Hedgers

E=piry ate of contract No such things 'ast Thursday of any month

Comparative analysis is easy to understand +hen +e are analysis +ith the e:ample of the real

market situation.

No+ 0 +ould like to )uote a real life e:ample during my internship +here 0 understood the actual

comparison of e)uity and derivative market.

E=ample8


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There +as an investor &r. aichand. He has Rs. 12 2 7 and he +ants to invest it in share

market. No+ he has t+o options either to invest in e)uity cash market or e)uity derivative

market ;/ "=.

No+ suppose if he invest in e)uity cash market and #uy shares of Rs. 12 2 7 and diversified

risk so he #uys different scrips. o he purchases 1 R0' shares of Rs. (3% 7 each. 1 ' T

shares of Rs * 7 each2 1% Religare Anterprises hares of Rs. 3D 7 each2 ( 0C0C0 #ank shares

of Rs. * 7 each2 1 Tata po+er shares of Rs. 1(% each and 1 BHA' shares of Rs. 1%@% 7

each. o for investing Rs. 12 2 7 in e)uity cash market he has to pay Rs. 12 2 7 and gets

the delivery of the shares.

No+ suppose if he invest in e)uity derivative market then he +ill a#le to purchase the shares

+orth Rs. %2 2 7 though he has capital of Rs. 12 2 7 only2 #ecause of the margin payment.

But he has to purchase the share in a lot si9e. o he is a#le to purchase the 1 lot ;1 shares= of R0' at Rs. (3% 72 1 lot ;% shares= of ' T at (6% 72 ( lots ;1 shares each= of Religare

Anterprises at Rs. 3D 7 and 1 lot ;D shares= of 0C0C0 #ank at Rs. * 7. Here &r. aichand has

to pay Rs. 12 2 7 as a margin money and he is a#le to purchase a shares +orth Rs. %2 2 7

But he has to pay the full amount of money at TU3 #asis. o he has to pay the remaining amount

on the 3 rd day of the trading if he +ants the delivery.

I. -eturn!

&r. aichand gets return on e)uity #y t+o +ays. "ne is +hen the share price of the

holding shares +ill increases in futures2 called as capital appreciation. econd is #y

getting a dividend income from the holding shares.

&r. aichand gets return on e)uity derivative +hen the future prices of the shares are

increase in short term called as capital gain through price fluctuation or through

options premium.

II. -i! 8

There are four types of risk involved in e)uity cash market.


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1. Company Specified ri! 8< 0f company is not performing +ell than process of the

shares +ill declining and vice versa.

2. Sector !pecified ri! !8< 0f the sector is not performing +ell i.e. po+er sector2

metal sector2 oil gas sector2 #anking sector then prices of the shares +ill go

do+n and vice versa.

*. 4lo0al ri! 8< 0f glo#al cues are positive then prices +ill increases #ut if glo#al

cues are not good than prices of shares +ill go do+n.

). 4eneral mar et ri! 8<


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o2 &r. aichand has to consider all these factors +hile dealing in the e)uity derivative

market.

III. 6argin!8

No+ &r. aichand has also seen the margin paid in the e)uity cash segment.

1. Var 6argin8 < No+ &r. $aichand #ought shares of a company. 0ts market value

today is Rs. 12 2 7 "#viously2 +e do not kno+ +hat +ould #e the market

value of these shares ne:t day. No+ &r. aichand holding these shares may2 #ased

on 8aR methodology2 say that 17day 8ar is Rs. 12 2 7 at the @@ confidence

level. This implies that under normal trading conditions the investors can +ith@@ confidence2 say that the value of shares +ould not go do+n #y more than Rs.

12 2 7 +ithin ne:t 17day.

2. E=treme lo!! margin8 7 0n the a#ove situation2 the 8aR margin rate for shares of

R0' +as 13 . uppose that +ould #e 1.% : 3.1Q !.6%. Then % ;+hich is

higher than !.6% = +ill #e taken as the A:treme 'oss margin rate.

Therefore2 the total margin on the security +ould #e 1* ;13 8aR &argin U %

A:treme 'oss margin=. >s such2 total margin paya#le; 8aR margin U e:treme loss

margin= on a trade of Rs. (32 % 7 +oud #e !2 (3 7

*. 6ar to 6ar et 6argin8< No+ &r. aichand purchased 1 shares of R0' W

Rs. (3% 72 at 11 am on &ay 1(2 ( @. 0f close price of the shares on that

happened to #e Rs. (3% 2 then the #uyer faces a notional loss of Rs. % 7 on his

#uy position. 0n technical term this loss is called as &T& loss and is paya#le #y

&ay 132 ( @ ;that is ne:t day of the trade= #efore the trading #egins.

0n case2 price of the shares falls further #y the end of &ay 13 ( @ to Rs. (( 72

then #uy postion +ould sho+ a further loss of Rs. 12 7. This &T& loss is

paya#le #y ne:t day.

No+ +e +ill consider the margin paya#le under the e)uity derivatives segment.


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iA Initial 6argin8 The initial margin re)uired to #e paid #y the investor

+ould #e e)ual to the highest loss the portfolio +ould suffer in any of the

scenarios considered. The margin is monitored and collected at the time of

placing the #uy sell order. >s higher the volatility2 higher the initial

margin.

iiA E=po!ure 6argin8 7 A:posure margins in respect of inde: futures and

inde: option sell position are 3 of the notional value.

iiiA Premium margin8 7 0f 1 call option on R0' are purchased at Rs. ( 7

and &r. aichand has no other positions2 then the premium margin Rs.

( 2 .

i(A #!!ignment 6argin8 7 >ssignment &argin is collected on assignment

from the sellers of the contract.

IV. uration8


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VI. E=piry date8

0tEs a last Thursday of any month in case of a derivative market #ut no such things in

case of an e)uity market.

*. ,IN IN4S

Practical !ituation


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earnings performance +as #etter than the market e:pectations. The market is no+ hoping for

#etter earnings gro+th prospects for /F( 1 . The manufacturing gro+th has also started

sho+ing signs of improvement.

No+2 +ith signs of economic recovery in developed countries and improvement in risk appetite

glo#ally2 the funds +ill flo+ in the emerging markets like 0ndia in search of higher gro+th. This

coupled +ith encouraging earnings outlook for /F( 1 2 provides good opportunity for investors

to take active participation in the market and increase the e)uity allocation from long term

perspective.

Comparati(e analy!i! of the traded (alue in the , " O Segment 3ith

the ca!h !egment

," O@ turno(er in crore!A Ca!h Segment@ turno(er in

crore!A>an 299& 1(2 2 (2 2

,e0 299& 12,00, 000 12 2 6arch 299& 14,00,000 %2 2 #pril 299& 16, 00, 000 !2 % 2 6ay 299& 19,00,000 6 2 >une 299& 18,00,000 62 % 2

/rom this ta#le +e can see that in practical life though e)uity cash segment is #etter than the

derivatives #ecause it involves lesser risk more num#ers of investors are trading in derivatives

;/ "= segment. 0t is a ma$or finding of the pro$ects sho+s that #y 6 to D investors are

#ear more risk and traded in derivatives market #ecause they +ant to earn more profits #y trading

in derivatives.

). CONC 5SIONS


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This pro$ect has covered several areas. 0ts main conclusions are5

erivatives market gro+th continues almost irrespective of e)uity cash market turnover

gro+th. ince ( . Cash e)uity turnover has fallen in the developed markets2 #ut

derivatives turnover continued to rise steeply and steadily.

A)uity derivatives #usinesses like interest derivatives are highly concentrated. 4sing

notional value as the measure2 the ( main 4 markets and the ( cross7#order Auropean

markets accounted for a#out D% of the total. This +as most apparent in inde:

derivatives2 +hich make @@ of the notional value of e)uity derivatives. 0n single stock

derivatives2 other markets have esta#lished niches and the dominance of the gig four is

less evident.

A)uity market volume and derivative market notional value are strongly correlated7 +ith

a ratio significant differences #et+een individual markets.

> num#er of cash e)uity markets7 particularly in developing >sia7 do not have e)uity

derivatives markets. Comparison of their cash market volumes +ith those that do have

derivative e:changes sho+s that the markets +ithout derivatives are of similar si9e. 0

>m not convinced that market or infrastructure differences e:plain this2 #ut suspects thatregularity #arriers have effectively prevented the development2 markets in several

developing >sian countries.

'. -ECO66EN #TIONS


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RB0 should play a greater role in supporting erivatives. Because no+adays

derivatives market are increasing rapidly and it plays a ma$or role in the +hole

securities market.

erivatives market should #e developed in order to keep it at par +ith other

derivative market in the +orld. No+adays more num#er of investors are sho+s

their interest in derivatives market #ecause it includes high return #y #earing high

risk.

peculation should #e discouraged #ecause it affects the market conditions #adly

and ne+ investors are reducing their interest in the market.

There must #e more derivatives instruments aimed at individual investors.

AB0 should conduct seminars regarding the use of derivatives to educate

individual investors

There is a need to have a smaller contract si9e in / " &arket. -e can revie+

the si9e of the contract from Rs. T+o lacs to "n 'acs. 0n the /0CC0 survey2 D3

of the respondents also held the same vie+.

. /I/ IO-#P;7


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/oo !8<

ecurities 'a+s and Regulations of /inancial &arkets

National ecurities epository 'imited

/undamentals of /utures "ptions &arkets7 ohn C. Hull

/inancial erivatives7 . '.

24538633 Comparative Analysis of Equity and Derivative Market

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Transcript of 24538633 Comparative Analysis of Equity and Derivative Market