Risk Management & Derivatives Unit 1

8/11/2019 Risk Management & Derivatives Unit 1

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TYPES OF RISK


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TYPES OF RISK


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RISK AND RETURNTRADEOFF

The risk/return tradeoff is the balance between the desire for the lowestpossible risk and the highest possible return.


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UNDERSTANDING INTERESTRATE

money paid regularly a

particular rate for the u

money lent, or for dela

repayment of a debt.


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NOMINAL INTEREST RATE

The nominal interest rate is conceptually the simplest

type of interest rate. It is quite simply the stated interes

rate of a given bond or loan.


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THE REAL INTEREST

The real interest rate is so named because it states the

real rate that the lender or investor receives after

inflation is factored in; that is, the interest rate that

exceeds the inflation rate.

Nominal interest rate Inflation = Real int

rate


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EFFECTIVE INTEREST RATE

One other type of interest rate that investors an

borrowers should know is called the effective rate, whic

takes the power of compounding into account.


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BASE OF STOCK MARKETINDICES

Price Weighted Indexes

Market value Weighted Indexes

Un Weighted Indexes


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Index Weightings Sample

Dow Jones Industrial Average Price-Weighted 30 of the largest and mheld firms in the U.S.

NASDAQ Composite Maraket-Cap Weighted All domestic and interncommon stocks listed oNASDAQ.

NASDAQ-100 Market-Cap Weighted100 of the largest domeinternational non-financcompanies listed on the

BSE SENSEXMarket-Cap Weighted

30 MAJOR INDIAN C

NSE-50(NIFTY) Market-Cap Weighted 50 MAJOR INDIAN COM

Economic Times Index of ordinaryshare Un Weighted Index All companies equal weigh


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ECONOMIC SIGNIFICANCEOF INDEX MOVEMENTS

To recognizedbroad trends in the

economy.

To guide investorwhere to invest?

To helpful forfuture contracts


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INDEX CONSTRUCTION


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INDEX CONSTRUCTIONISSUES

The compositionof the stocks

The Weights

Base year


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DESIRABLE ATTRIBUTES OF AN INDEX

IndustryRepresentati

on

MarketCapitalization Liquidity

The MarketDepth


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APPLICATION OF INDICES

To Recognized Broad Trends in the Market

For Creation of Benchmark for evaluating the investor portfolio

To know the economic health of nation

To earn better return with low risk

To study future performance of market on the bases of past data

CONSTRUCTION AND COMPOSITION


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CONSTRUCTION AND COMPOSITIONSENSEX AND NIFTY

S&P BSE SENSEX, first compiled in 1986, was

calculated on a "Market Capitalization-

Weighted" methodology of 30 component

stocks representing large, well-established and

financially sound companies across key

sectors. The base year of S&P BSE SENSEX

was taken as 1978-79. S&P BSE SENSEX today

is widely reported in both domestic and

international markets through print as well as

CONSTRUCTION AND COMPOSITION


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CONSTRUCTION AND COMPOSITIONSENSEX AND NIFTY


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METHODOLOGY S&P BSE SENSEX is calculated using the 'Free-float Market Capitalization' methodology, where

level of index at any point of time reflects the free-float market value of 30 component stocks rel

to a base period.

The market capitalization of a company is determined by multiplying the price of its stock by the

number of shares issued by the company.

This market capitalization is further multiplied by the free-float factor to determine the free-float

capitalization.

The base period of S&P BSE SENSEX is 1978-79 and the base value is 100 index points. This is

often indicated by the notation 1978-79=100.

Scrip Scrip


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Sr.No.ScripCode

Company

1 500010 HDFC

2 532540 TCS

3 500875 ITC

4 500112 SBIN

5 50 03 25 R ELIAN CE

6 500696 HINDUNILVR

7 500312 ONGC

8 500570 TATAMOTORS

9 500103 BHEL

10 500209 INFY

11 53 25 00 MAR UTI

12 524715 SUNPHARMA

13 532215 AXISBANK

14 50 01 80 H DFC BAN K

15 500520 M&M

Sr.No.ScripCode

16 532454 BHA

17 532174 ICIC

18 500510 LT

19 500124 DRR

20 500087 CIPL

21 507685 WIPR

22 533278 COA

23 532555 NTPC

24 500182 HER

25 500400 TATA

26 532977 BAJA

27 532155 GAIL

28 500 440 H IND

29 500470 TATA

30 500295 SSLT

CNX NIFTY 50


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CNX NIFTY 50

The CNX Nifty, also called the Nifty 50 or simply the Nifty, is National Stock

Exchange of India's benchmark index for Indian equity market.

Nifty is owned and managed by India Index Services and Products Ltd. (IISL),

which is a wholly owned subsidiary of the NSE Strategic Investment Corporatio

Limited. IISL is India's first specialized company focused upon the index as a

core product.

'CNX' in its name stands for 'CRISIL NSE Index'.

The CNX Nifty is a well diversified 50 stock index accounting for 22 sectors of

the economy. It is used for a variety of purposes such as benchmarking fund


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METHODOLOGY

CNX Nifty is computed using market capitalization weighted method, wherein t

level of the index reflects the total market value of all the stocks in the ind

relative to a particular base period. The method also takes into accouconstituent changes in the index and importantly corporate actions such as stock

splits, rights, etc without affecting the index value


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assume that the free-float market capitalisation is Rs 10,00,000Crore. At that point, the Sensex is at 12500. What would be the valueof Sensex if the free-float market capitalization is Rs 11,50,000 Crore?


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UNIT-II: INTRODUCTIONTO DERIVATIVES

TRADING AND

SETTLEMENT

By:- Prof.Ru


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Derivatives are financial instruments whose value

is derived from the value of an underlying asset

(such as gold, wheat or other commodities) or

other financial instruments including bonds, or

market benchmarks such as interest rates.

Meaning of Derivative Contracts

TYPE F DERIVATIVE


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TYPE F DERIVATIVEMARKET


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In the Exchange Traded Derivatives Market or Future Market, exchange acts as the main party and by tradi

of derivatives actually risk is traded between two parties.

One party who purchases future contract is said to go long and the person who sells the futurecontract is said to go short.


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THE MAIN PARTICIPANTS OFOTC MARKET

Investment Banks, Commercial Banks, Govt. Sponsored

Enterprises and Hedge Funds. The investment banks markets

the derivatives through traders to the clients like hedge funds

and the rest.

BASIC FINANCIAL


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BASIC FINANCIAL

DERIVATIVES:-

FORWARD CONTRACTforward contract is an agreement between the counter parties to buy or sell a

specified quantity of an asset at a specified price, with delivery at a specifie

time (future) and place.


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FUTURES CONTRACTSLike a forward contract, a futures contract is an agreement between two parties to buy o

a specified quantity of an asset at a specified price and at a specified time and place. Futcontracts are normally traded on an exchange which sets the certain standardized norm

trading in the futures contracts.

Standardization

Clearing House

Settlement PriceDaily Settlement andMarginTick Size

Cash Settlement

Delivery


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OPTIONS CONTRACTS

Options are the most important group of derivative securities. Option may be defined as

a contract, between two parties whereby one party obtains the right, but not the

obligation, to buy or sell a particular asset, at a specified price, on or before a specified

date.

The person who acquires the right is known as the option buyer or option holder.

Other person (who confers the right) is known as option seller or option writer.

option premium.


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OPTIONS CONTRACTS

Calloptio

n

exercise price or the strike price

expiration date or the exercise date or the maturitydate


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SWAP CONTRACTS

Swaps have become popular derivative instruments in recent years all over t

world.

A swap is an agreement between two counter parties to exchange cash flow

in the future.


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PARTICIPANTS IN THEDERIVATIVES WORLD

Hedging

Speculation

Arbitrage


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HEDGING

If someone bears an economic risk and uses the futures market toreduce that risk, the person is a hedger

Hedging is a prudent business practice and a prudent manager has alegal duty to understand and use the futures market hedgingmechanism


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ARBITRAGE

Arbi t rage is the existence of a riskless profit

Arbitrage opportunities are quickly exploited and eliminated


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ARBITRAGE (CONTD)

Persons actively engaged in seeking out minor pricing discrepanciesare called arbi t rageurs

Arbitrageurs keep prices in the marketplace efficientAn efficient market is one in which securities are priced in accordance with theirperceived level of risk and their potential return


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USES OF DERIVATIVES

Risk management

Income generation

Financial engineering


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Risk Management & Derivatives Unit 1

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