Executive Summary

History of the Stock Broking Industry

Indian Stock Markets are one of the oldest in Asia. Its history dates
back to nearly 200 years ago. In 1887, they formally established in Bombay,
the "Native Share and Stock Brokers' Association" (which is alternatively
known as "The Stock Exchange"). In 1895, the Stock Exchange acquired a
premise in the same street and it was inaugurated in 1899. Thus, the Stock
Exchange at Bombay was consolidated.
Thus in the same way, gradually
with the passage of time number of exchanges were increased and at
currently it reached to the figure of 24 stock exchanges. This was followed
by the formation of associations /exchanges in Ahmadabad (1894), Calcutta
(1908), and Madras (1937).
In order to check such aberrations and
promote a more orderly development of the stock market, the central
government introduced a legislation called the Securities Contracts
(Regulation) Act, 1956. Under this legislation, it is mandatory on the part of
stock exchanges to seek government recognition. As of January 2002 there
were 23 stock exchanges recognized by the central Government. They are
located at Ahmadabad, Bangalore, Baroda, Bhubaneswar, Calcutta, Chennai,
(the Madras stock Exchanges), Cochin, Coimbatore, Delhi, Guwahati,
Hyderabad, Indore, Jaipur, Kanpur, Ludhiana, Mangalore, Mumbai (the
National Stock Exchange or NSE), Mumbai (The Stock Exchange),
popularly called the Bombay Stock Exchange, Mumbai (OTC Exchange of
India), Mumbai (The Inter-connected Stock Exchange of India), Patna, Pune,
and Rajkot. Of course, the principle bourses are the National Stock

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Exchange and The Bombay Stock Exchange, accounting for the bulk of the
business done on the Indian stock market.
Basis of Trading
The NEAT F&O system supports an order driven market, wherein orders
match automatically. Order matching is essentially on the basis of security,
its 73 price, time and quantity. All quantity fields are in units and price in
rupees.The exchange notifies the regular lot size and tick size for each of the
contracts traded on this segment from time to time. When any order enters
the trading system, it is an active order. It tries to find a match on the other
side of the book. If it finds a match, a trade is generated. If it does not find a
match, the order becomes passive and goes and sits in the respective
outstanding order book in the system.
Corporate hierarchy
In the F&O trading software, a trading member has the facility of defining a
hierarchy amongst users of the system. This hierarchy comprises corporate
manager, branch manager and dealer.
1) Corporate manager: The term 'Corporate manager' is assigned to a user
placed at the highest level in a trading firm. Such a user can perform all the
functions such as order and trade related activities, receiving reports for all
branches of the trading member firm and also all dealers of the firm.
Additionally, a corporate manager can define exposure limits for the
branches of the firm. This facility is available only to the corporate manager.

2) Branch manager: The branch manager is a term assigned to a user who

is placed under the corporate manager. Such a user can perform and view
order and trade related activities for all deale rs under that branch.

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3) Dealer: Dealers are users at the lower most level of the hierarchy. A
Dealer can perform view order and trade related activities only for oneself
and does not have access to information on other dealers undereither the
same branch or other branches.

BSE (Bombay Stock Exchange)

The Stock Exchange, Mumbai, popularly known as" BSE" was established
in 1875 as "The Native Share and Stock Brokers Association". It is the
oldest one in Asia, even older than the Tokyo Stock Exchange, which was
established in 1878. It is the first Stock Exchange in the Country to have
obtained permanent recognition in 1956 from the Govt. of India under the
Securities Contracts (Regulation) Act, 1956.
A Governing Board having 20 directors is the apex body, which decides the
policies and regulates the affairs of the Exchange. The Governing Board
consists of 9 elected directors, who are from the broking comm. Unity (one
third of them retire ever year by rotation), three SEBI nominees, six public
representatives and an Executive Director & Chief Executive Officer and a
Chief Operating Officer.
NSE (National Stock Exchange)
NSE was incorporated in 1992 and was given recognition as a stock
exchange in April 1993. It started operations in June 1994, with trading on
the Wholesale Debt Market Segment. Subsequently it launched the Capital
Market Segment in November 1994 as a trading platform for equities and
the Futures and Options Segment in June 2000 for various derivative
instruments.

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MCX (Multy Commodity Exchange)
‘Multi Commodity Exchange’ of India limited is a new order exchange with
a mandate for setting up a nationwide, online multi- commodity market
place, offering unlimited growth opportunities to commodities market
participants. As a true neutral market, MCX has taken several initiatives for
users in a new generation commodities futures market in the process,
become the country’s premier exchange. MCX , an independent and a de-
mutualized exchange since inception, is all set up to introduce a state of the
atr, online digital exchange for commodities futures trading in the country
and has accordingly initiated several steps to translate this vision into reality.

NCDEX (National Commodities and Derivatives Exchange)

NCDEX started working on 15th December ,2003. This exchange provides
facilities to their trading members at different 130 contract. In commodity
market the main participants are speculators, hedgers and arbitrageurs.

Facilities Provided by NCDEX

 NCDEX has developed a facility for checking of commodity and
also provides awarehouse facility.
 By collaborating with industrial companies, industrial partners,
news agencies, banks and developers of kiosk network. NCDEX is
able to provide current rates and contract rates.
 To prepare guidelines related to special products of securitization
NCDEX works with bank.

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  To avail farmers from risk of fluctuation in prices of NCDEX
provides special services for agriculture.
 NCDEX is working with tax officer to make a clear different types
of sales and service tax.
 NCDEX is providingattractive products like “weather Dervatives”
Stock Market Basic
Companies are started by individuals or may be a small circle of people.
They pool their money or obtain loans, raising funds to launch the
business.
A choice is made to organize the business as a sole proprietorship
where one Person or a married couple owns everything, or as a partnership
with others who may wish to invest money. Later they may choose
to "incorporate". As a Corporation, the owners are not personally
responsible or liable for any debts of the company if the company doesn't
succeed. Corporations issue official-looking sheets of paper that represent
ownership of the company. These are called stock certificates, and
each certificate represents a set number of shares. The total
number of shares will vary from one company to another, as each
makes its own choice about how many pieces of ownership to divide
the corporation into. One corporation may have only 2,500 shares,
while another, such as IBM or the Ford Motor Company, may issue
over a billion Shares. Companies sell stock (pieces of ownership) to
raise money and provide funding for the expansion and growth of
the business. The business founders give up part of their ownership
in exchange for this needed cash. The expectation is that even
though the owners have surrendered a portion of the company to

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the Public, their remaining share of stock will become increasingly
valuable as the business grows. Corporations are not allowed to sell
shares of stock on the open Stock market without the approval of
the Securities and Exchange Commission (SEC). This transition from
a privately held corporation to a publicly traded one is called going
public, and this first sale of stock to the public is called an initial
public offering, or IPO.

Why do people invest in the stock market?

When you buy stock in a corporation, you own part of that
company. This gives you a vote at annual shareholder meetings,
and a right to a share of future profits. When a company pays out
profits to the shareholder, the money received is called a
"Dividend". The corporation's board of directors choose when to
declare a dividend and how much to pay. Most older and larger
companies pay a regular dividend; most newer and smaller
to sell. The potential of a small dividend check is of little concern.
What is usually responsible for increased interest in a company's
stock is the prospect of the company's sales and profits going up. A
company who is a leader in a hot industry will usually see its share
price rise dramatically. Investors take the risk of the price falling
because they hope to make more money in the market than they
can with safe investments such as bank CD's or government bonds.

What is a stock market index?

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 In the stock market world, you need a way to compare the
movement of the market, up and down, from day to day, and from
year to year. An index is just a benchmark or yardstick expressed as
a number that makes it possible to do this comparison. For e.g. S&P
CNX Nifty is the index of NSE and SENSEX is the index of BSE. The
price per share, like the market cap, has nothing to do with how big
a company is.
The Securities Market consists of two segments, viz. Primary
market and Secondary market. Primary market is the place where
issuers create and issue equity, debt or hybrid instruments for
subscription by the public; the Secondary market enables the
holders of securities to trade them. Secondary market essentially
comprises of stock exchanges, which provide platform for purchase
and sale of securities by investors. In India, apart from the Regional
StockExchanges established in different centers, there are exchanges like the
National Stock Exchange (NSE) and the Over the Counter Exchange of
India (OTCEI), who provide nation wide trading facilities with terminals all
over the country. The trading platform of stock exchanges is accessible only
through brokers and trading of securities is confined only to stock
exchanges.
Corporate Securities:
The no of stock exchanges increased from 11 in 1990 to 23 now. All the
exchanges are fully computerized and offer 100% on- line trading. 9644
companies were available for trading on stock exchanges at the end of
March 2002. The trading platform of the stock exchanges was accessible to
9687 members from over 400 cities on the same date

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Derivatives Market:
Derivatives trading commenced in India in June 2000. The total
exchange traded derivatives witnessed a volume of Rs. 442,343 crore during
2002-03 as against Rs. 4018 crore during the preceding year. While NSE
accounted for about 99.5% of total turnover, BSE accounted for about 0.5%
in 2002-03. The market witnessed higher volumes from June 2001 with
introduction of index options, and still higher volumes with introduction of
stock options in July 2001. There was a spurt in volumes in November 2001
when stock futures were introduced. It is believed that India is the largest
market in the world for stock futures.
Supply and Demand
A stock's price movement up and down until the end of the
trading day is strictly a result of supply and demand. The supply is
the number of shares offered for sale at anyone one moment. The
DEMAND is the number of shares investors wish to buy at exactly
that same time. What a share of a company is worth on anyone day
or at any one minute, is determined by all investors voting with their
money. If investors want a stock and are willing to pay more, the
price will go up. If investors are selling a stock and there aren't
enough buyers, the price will go down Period.
Secondary Market Intermediaries
Stock brokers, sub-brokers, portfolio managers, custodians,
share transfer agents constitute the important intermediaries in the
Secondary Market. No stockbrokers or sub-brokers shall buy, sell or
deal in securities unless he holds a certificate of registration granted
by SEBI under the Regulations made by SEBI ion relation to them.

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The Central Government has notified SEBI (Stock Brokers & Sub-
Brokers) Rules, 1992 in exercise of the powers conferred by section
29 of SEBI Act, 1992. These rules came into effect on 20th August,
1992.

Trading Through Brokers / Traditional Method of Share

Trading:-
Trading in the stock exchange can be conducted only through
member broker in securities that are listed on the respective
exchange. Investor intending to buy/sell securities in the exchange
has to do so only through a SEBI registered broker/sub-broker. This
is very popular concept in India for Share Trading before the
facilities like on line trading introduce. Both the exchange have
switched over from the open outcry trading system to fully
automated computerized mode of trading knows as Bolt and Neat.
In this system, the broker trade with each other through the
computer network. Buyers and sellers place their orders specifying
the limits for quality and price. Those that are not matched remain
on the screen and is opened for future matching during the day /
settlement. After the advent of computerized trading the speed of
trading has increased multi-fold and a fuller view of the market is
available to the investors. To start dealing with broker you have to
fill a form with the broker. After fill all the formalities the firm gives

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you a User Id no like a bank a/c no. through which you can enter in
the transaction with broker. Broker will gives all the which one
investor needed.

What is stock Broker?

“A stock broker is one who invests other people’s money
until it’s all gone.”
-Woody Allen, American Film Maker
A stock broker is a person or a firm that trades on its clients behalf, you tell
them what you want to invest in and they will issue the buy or sell order.
Some stock brokers also give out financial advice that you a charged for.
It wasn’t too long ago and investing was very expensive because
you had to go through a full service broker which would give youadvice on
what to do and would charge you a hefty fee for it. There
are three different types of stock brokers.
1. Full Service Broker - A full-service broker can provide a bunch of
services such as investment research advice, tax planning and retirement
planning.
2. Discount Broker – A discount broker let’s you buy and sell stocks at a
low rate but doesn’t provide any investment advice.

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3. Direct-Access Broker- A direct access broker lets you trade directly with
the electronic communication networks (ECN’s) so you can trade faster.
Active traders such as day traders tend to use Direct Access Brokers.
No. of stock broker in India
9368 :- Total no of share broker in the country
12687 :- The no. of sub-broker.
46% :- The share of trades accounted for by NSE broker
90%: The share of on line trades clocked by segment’s top five companies
Generally there are two types of trading have been done in India which is
given below:
• On line Trading / E – Broking / Modern Method
• Trading through Brokers / Traditional method of Share trading.

About MSB e_trade securities

MSB E-TRADE SECURITIES LTD. (MSB e-Trade) was incorporated in
the year of 1993, The company reached their strength in financial market by
the great effort of the Director of the company MR. MUNISH BAJAJ. MSB
e-Trade looks forward to tougher challenges and newer milestone to conquer
for get nothing less than the best. MSB e-Trade group providing the trading
platform Equities, Derivatives, Currency, IPOs, Mutual Fund, Depository
Services of NSDL(Launching Shortly) and Commodities (By its group
company) to raising the graph of your savings.

Our Team
MSB e-Trade group managed by a team of young professionals of Chartered
Accountant, Cost Accountants, Company Secretaries, MBAs, Technicals

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and the other senior executives in Stock Broking, Future & Options
Trading, Currency Trading, Depository Services (Launching Shortly), IPOs,
Mutual Funds Services and Commodities Trading (by its group company).

Membership
MSBe_tradeSecurities is Member of National Stock Exchange (NSE) for
Capital Market, Future & Option, Currency Derivative Segment Member of
MCX Stock Exchange (MCX-SX) for Currency Derivative
Segment.Awaiting for the Members of UnitedStockExchange of India Ltd.
(USEIL) for Currency Derivative Segment Member of Association of
Mutual Fund In India (AMFI) Company is also planning for Depository
Participant with NSDL at the earliest.

Membership of Group Company

Kalyani Commodities Pvt. Ltd. (The Group company of MSB e-Trade)
Member of Multi Commodities Exchange (MCX)
Member of National Commodity & Derivative Exchange (NCDEX)
Member of National Multi Commodity Exchange (NMCE) &
Member of Indian Commodity Exchange (ICEX)

Business Associates
Kalyani Commodities Pvt Ltd. (Member of MCX. NCDEX, NMCE &
ICEX)

Swot Analysis

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Strength
1) Understandings of the markets
2) All financial needs under one roof
3) Scalable and robust infrastructure
4) Full fledge research unit comprising of both fundamental &

technical research
5) Dedicated, Qualified and Loyal staff

6) Flexible Brokerage charges

Weakness:-
1) Low Brand Image in the market.
2) Low Professionalism
3) Low Advertisements
Opportunity:-
1) Large potential market for delivery and intra-day transactions.

2) Open interest of the people to enter in to stock market for investing

3) Attract the customers who are dissatisfied with other brokers & DPs.
4) Up growing markets in commodity and forex trading

Threats:-
1) Decreasing rates of brokerage in the market. A Increasing competition
against other brokers & DPs.
2) Poor marketing activities for making the company known among the
customers. A threat of loosing clients for any kind of weakness of the
company. An Indirect threat from instable stock market, i.e., low/no
profitof MSB e_trade's clients would lead them to go for other
broker/DP

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Services Provided by MSB e_trade securities
Equity and Derivative
MSB e-Trade provides online & offline trading facilities in Equities,
Equities Derivatives & currency Derivatives to the investors on the basis of
live environment who are looking for the ease and convenience of trading
experience. We also provides the trading applications that would approved
by exchange. You can now trade & access from any destination at your
convenience. Investors may trade through our network or telephonically by
the designated representatives in the branch where you are registered as a
client.

Offline & Online Trading Features

1) Live trading in a fraction of a second.

2) Support by the executive.
3) Quick order punching.
4) Quick trade confirmation.
5) Live streaming quoted. Price watch on any number of scrips.
6) Online trading.
7) Online access of accounts and DP.
8) Set any number of price alerts on any number of scrips.
9) Flexibility to customize screen layout and setting.
10) Facility to customize any number of portfolios & watchlists.
11) Facility to cancel all pending orders at one click.
12) Facility to square off all transactions at one click.
13) Top Gainers, Top losers, Most Active, updated live.

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 14) Index information; index chart, index stock information live.
15) Market depth, i.e. Best 5 bids and offers, updated live for all scrips
16) Facility to place orders on the phone in all major cities.
17) Historical charts and technical analysis tools.

Commodities
Kalyani Commodities Pvt. Ltd. (the group company of MSB e-Trade) is a
member Multi Commodity Exchange (MCX), National Commodity and
Derivative Exchange (NCDEX), National Multi Commodity Exchange
(NMCE) & Indian Commodity Exchange (ICEX). We are providing the
trading platform in commodities derivative.

Online Trading
MSB e-Trade providing the online trading facilities to the investors through
the platform approved by the exchange on free of cost

Mutual Fund and IPO

Distribution of Mutual fund & IPO MSB e-Trade registered with
Association of Mutual Fund in India (AMFI) for providing the Mutual Fund
services in India. We are also providing the online mutual fund activities
through National Stock Exchange (NSE). We also providing the IPOs
services through leading distributors of IPOs.
Depository
We are launching shortly the Depository Services to the investor.
Back Office

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MSB e-Trade Providing the Bank office facility to the client registered with
us. Client can check the financial & securities details held in their name.
You can access or print the financial statement, Holding statement etc. by
the login id and password issue by the authority to the client at the time
opening of their trading account.

Products

1) Equities & Derivative

2) Currency Derivative

3) Commodities Derivative

4) Mutual Fund

5) IPO

Offline

1) Offline A/C is the A/C for the investors who are not familiar with the

use of computer.
2) The A/C opening Charges applied (One time).

3) For 1st Year Demat A/c is free , On 2nd year AMC charge is

applicable.

Online Account Requirements for online trading

1) Linked Bank account

2) Broking Account

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 3) Linked Depository Account

Benefits Of online trading

1) Freedom from paperwork

2) Instant credit and transfer

3) Trade Anywhere

4) Timely Advice and access to research

5) Real-time portfolio tracking

6) After hour orders

7) Market Alerts

8) Instant Quotes

Other services

1) Dial-n-trade

2) Mutual fund

3) Commodity

4) Derivative

5) Depository Participants

6) Distribution of Financial Services

7) Research Based Advices

8) Portfolio Management System

9) Portofolia management System

DnT (Dial-n-Trade)

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Dial n Trade is the name of the phone-trading facility offered by MSB
e_trade securities.
A call center wholly dedicated to order placement / confirmation
Easy 2-step process for order placement.
Step1. Enter your Phone ID
Step2. Enter your Client Code
On successful dial, call gets transferred to call center executives. MSB
e_trade Securities Private Limited, one of the cornerstones of the MSB
edifice, flows freely towards attaining diverse goals of the customer through
varied services. Creating a plethora of opportunities for the customer by
opening up investment vistas is backed by research-based advisory services.
Here, growth knows no limits and success recognizes no boundaries.
Helping the customer create waves in his portfolio and empowering the
investor completely is the ultimate goal.
Stock Broking Services
We offer trading on a vast platform; National Stock Exchange, Bombay
Stock Exchange, MCX & NCDEX. More importantly, we make trading safe
to the maximum possible extent, by accounting for several risk factors and
planning accordingly. We are assisted in this task by our in-depth research,
constant feedback and sound advisory facilities. Our highly skilled research
team, comprising of technical analysts as well as fundamental specialists,
secure result- oriented information on market trends, market analysis and
market predictions.
To empower the investor further we have made serious efforts to ensure that
our research calls are disseminated systematically to all our stock broking

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clients through various delivery channels like email, chat, SMS, phone calls
etc.

Mutual Funds
Introduction:
Everybody talks about mutual funds, but what exactly are they? Are they
like shares in a company, or are they like bonds and fixed deposits? Will I
lose all my money in funds or will I become an overnight millionaire? Big
questions that get answer in just five minutes.
Meaning:
A mutual fund is a pool of money that is invested according to a common
investment objective by an asset management company (AMC). The AMC
offers to invest the money of hundreds of investors according to a certain
objective – to keep money liquid or give a regular income or grow the
money long term. Investors buy a scheme if it fits in with their investment
goals, like getting a regular income now or letting the money accumulate
over the long term. Investors pay a small fraction of their total funds to the
AMC each year as investment management fees.

Commodity
Organized futures market evolved in India by the setting up of "Bombay
Cotton Trade Association Ltd." in 1875. In 1893, following widespread
discontent amongst leading cotton mill owners and merchants over the
functioning of the Bombay Cotton Trade Association, a separate association
by the name "Bombay Cotton Exchange Ltd." Was constituted. A future

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trading in oilseeds was organized in India for the first time with the setting
up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in
groundnut, castor seed and cotton. Before the Second World War broke out
in 1939 several futures markets in oilseeds were functioning in Gujarat and
Punjab. There were booming activities in this market and at one time as
many
as 110 exchanges were conducting forward trade in various
commodities in the country.
The securities market was a poor cousin of this market as there were not
many papers to be traded at that time. The era of widespread shortages in
many essential commodities resulting in nflationary pressures and the tilt
towards socialist policy, in which the role of market forces for resource
allocation got diminished, saw the decline of this market since the mid-
1960s.
This coupled with the regulatory constraints in 1960s, resulted in virtual
dismantling of the commodities future markets. It is only in the last decade
that commodity future exchanges have been actively encouraged. However,
the markets have been thin with poor liquidity and have not grown to any
significant level.

Conceptual Description
Derivative
The emergence of the market for derivative products, most notably forwards,
futures and options, can be traced back to the willingness of risk-averse
economic agents to guard themselves against uncertainties arising out of

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fluctuations in asset prices. By their very nature, the financial markets are
marked by a very high degree of volatility. Through the use of derivative
products, it is possible to partially or fully transfer price risks by locking-in
asset prices. As instruments of risk management, these generally do not
influence the fluctuations in the underlying asset prices. However, by
locking- in asset prices, derivative products minimize the impact of
fluctuations in asset prices on the profitability and cash flow situation of
risk-averse investors.

Depository Participants
The onset of the technology revolution in financial services Industry saw the
emergence of MSB as an electronic custodian registered with National
Securities Depository Ltd (NSDL) and Central Securities Depository Ltd
(CSDL). M S B set standards enabling further comfort to the investor
by promoting paperless trading across the country and emerged as the top 3
Depository Participants in the country in terms of customer serviced.
Offering a wide trading platform with a dual membership at both NSDL and
CDSL, we are a powerful medium for trading and
settlement of dematerialized Shares. We have established live
DPMs, Internet access to accounts and an easier transaction process in order
to offer more convenience to individual and corporate investors. A team of
professional and the latest technological expertise allocated exclusively to
our demat division including technological enhancements like SPEED-e;
make our response time quick and our delivery impeccable. A wide national
network makes our efficiencies accessible to all.

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Portfolio Management System
The company has initiated the process of obtaining permission from SEBI
for rendering PMS Service to its clients. We are planning to start PMS
Service to High Net Worth individual and NRIs after obtaining the necessary
regulatory clearances

Theoretical Aspect
Introduction:
According to dictionary, derivative means ‘something which is derived from
another source’. Therefore, derivative is not primary, and hence not
independent. In financial terms, derivative is a product whose value is
derived from the value of one or more basic variables. These basic variable
are called bases, which may be value of underlying asset, a reference rate
etc. the underlying asset can be equity, foreign exchange, commodity or any
asset.
For example: - the value of any asset, say share of any company, at a future
date depends upon the share’s current price. Here, the share is underlying
asset, the current price of the share is the bases and the future value of the
share is the derivative. Similarly, the future rate of the foreign exchange
depends upon its spot rate of exchange. In this case, the future exchange rate
is the derivative and the spot exchange rate is the base.
Derivatives are contract for future delivery of assets at price agreed at the
time of the contract. The quantity and quality of the asset is specified in the
contract. The buyer of the asset will make the cash payment at the time of
delivery.
Meaning:

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Derivatives are the financial contracts whose value/price is dependent on the
behavior of the price of one or more basic underlying assets (often simply
known as the underlying). These contracts are legally binding agreements,
made on the trading screen of stock exchanges, to buy or sell an asset in
future.
The asset can be a share, index, interest rate, bond, rupee dollar exchange
rate, sugar, crude oil, soybean, cotton, coffee etc. In the Indian Context the
Security Contracts (Regulation) Act, 1956 (SC(R) A) defines “derivative” to
include – A security derived from a debt instrument, share, loan whether
secured or unsecured, risk instrument or contract for differences or other
form of security.

In financial terms derivatives is a broad term for any instrumental

whose value is derived from the value of one more underlying
assets such as commodities, forex, precious metal, bonds, loans,
stocks, stock indices, etc. Derivatives were developed primarily to manage
offset, or hedge against risk but some were developed primarily to provide
potential for high returns. In the context of equity markets, derivatives
permit corporations and institutional Investors to effectively manage their
portfolios of assets and liabilities through instrument like stock index
futures.

For example: - The price of Reliance Triple Option Convertible

Debentures (Reliance TOCD) used to vary with the price of Reliance shares.
In addition, the price of Telco warrants depends upon the price of Telco
shares. American Depository receipts / Global Depository receipts draw

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their price from the underlying shares traded in India. Nifty options and
futures. Reliance futures and options, are the most common and popular
form of derivatives. Although trading in agriculture and other commodities
has been the deriving force behind the development of derivatives
exchanges, the demand for products based on financial instruments such as
bond, currencies, stocks and stock indices have now for outstripped that for
the commodities contracts. The history of the derivatives dates back to the
time since the trading came into being. The merchants entered into contracts
with one another for future delivery of specified amount of commodities at
specified price. A primary intention for contracting for future date was to
keep the transaction immune to unexpected fluctuations in price. Therefore,
derivative products initially emerged as hedging devices against fluctuations
in commodity prices. However, the concept applied to financial trade only in
the post-1970 period due to growing instability in the financial markets.
However, since their emergence, these products have become very popular
and by 1990s, they accounted for about two-third of the total transaction in
derivative products.
In recent years, the market for financial derivatives has grown tremendously
in terms of variety of instruments available, their complexity and turnover.
In the class of equity derivatives the world over, futures and options on stock
indices have gained more popularity than on individual stocks, especially
among institutional investors, who are major users of index-linked
derivatives. Even small investors find these useful due to high correlation of
the popular indexes with various portfolios and ease of use.

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Early forward contracts in the US addressed merchants concerns about
ensuring that there were buyers and sellers for commodities. However
“credit risk” remained a serious problem.
1848
A group of Chicago businessmen formed the Chicago Board of Trade
(CBOT). The primary intention of the CBOT was to provide a centralized
location known in advance for buyers and sellers to negotiate forward
contracts.
1865
The CBOT went one-step further and listed the first “exchange traded”
derivatives contract in the US; these contracts were called “future contracts”
1919
Chicago Butter and Egg & board, a spin-off of CBOT, was reorganized to
allow futures trading. Its name was changed to Chicago Mercantile
Exchange (CME).
The CBOT and the CME remain the two largest organized futures
exchanges, indeed the two largest “financial” exchanges of any kind in the
world today.
The first stock index futures contract was traded at Kansas City Board of
Trade. Currently the most popular stock index futures contract in the world
was based on S&P 500 index, traded on Chicago Mercantile Exchange.
During the mid eighties, financial futures became the most active derivatives
instruments generating volumes many times more than the Commodity
futures. Index futures, futures on T-Bills and Euro-Dollar futures are the
three most popular future contracts traded today. Other popular international
exchanges that trade derivatives are LIFFE in England, DTB in Germany,

25
SGX in Singapore, TIFFE in Japan, and MATIF in France, Eurex, etc. India
has been trading derivatives contract in silver gold, spices, coffee, cotton, etc
for decades in the gray market. Trading derivatives contracts in organized
market was legal before Moorage Desai’s government banned forward
conracts. Derivatives on stocks were traded in the form of Teji and Mandi in
unorganized on exchanges. For example, now cotton and oil futures trade in
Mumbai, soybean futures trade in Bhopal, pepper futures in Kochi, coffee in
Bangalore, etc.

June 2000
National Stock Exchange and Bombay Stock Exchange started trading in
futures on Sensex and Nifty. Options trading on Sensex and Nifty
commenced in June 2001. Very soon thereafter trading began on options and
futures in 31 prominent stocks in the month of July and November
respectively.
Option and future are the most commonly traded derivatives, but as the
understanding of financial markets and risked management
continued to improve newer derivatives were created. The family includes
the host of other product such as forward contracts. Structured notes, inverse
floaters, caps & Floors and Collar Swaps. The largest derivatives market in
the world, are on government bonds (to help control interest rate risk) the
stock index (to help control risk that is associated with the fluctuations in the
stock market) and on exchange rates (to cope with currency risk).

26
Risk Associated With Derivatives:
While derivatives can be used to help manage risks involved in investments,
they also have risks of their own. However, the risks involved in derivatives
trading are neither new nor unique – they are the same kind of risks
associated with traditional bond or equity instruments.
Market Risk
Derivatives exhibit price sensitivity to change in market condition, such as
fluctuation in interest rates or currency exchange rates. The market risk of
leveraged derivatives may be considerable, depending on the degree of
leverage and the nature of the security.
Liquidity Risk
Most derivatives are customized instrument and could exhibit
substantial liquidity risk implying they may not be sold at a reasonable price
within a reasonable period. Liquidity may decrease
or evaporate entirely during unfavorable markets.

Credit Risk
Derivatives not traded on exchange are traded in the over-the- counter
(OTC) market. OTC instrument are subject to the risk of counter party
defaults.
Hedging Risk

27
Several types of derivatives, including futures, options and forward are used
as hedges to reduce specific risks. If the anticipated risks do not develop, the
hedge may limit the fund’s total return.

The derivative market performs a number of economic functions:-

1) Prices in an organized derivatives market reflect the perception of
market participants about the future and lead the prices of underlying
to the perceived future level. The prices of derivative converge with
the prices of the underlying at the expiration of the derivative contract.
Thus, derivatives help in discovery of future as well as current prices.
2) The derivatives market helps to transfer risks from those who have
them but may not like them to those who have an appetite for them.
3) Derivatives, due to their inherent nature, are linked to the

underlying cash market. With the introduction of the derivatives, the

underlying market witnesses higher trading volumes because of the
participation by more players who would not otherwise participate for
lack of arrangement to transfer risk.
4) Speculative trades shift to a more controlled environment of

derivatives market. In the absence of an organized derivative market,

speculators trade in the underlying cash market.
5) An important incidental benefit that flows from derivatives trading is

that it acts as a catalyst for new entrepreneurial activity.

28
 6) The derivatives have a history of attracting many bright, creative,
well educated people with an entrepreneurial attitude. They often
energize others to create new businesses, new products and new
employment opportunities, the benefit of which are immense.
7) Derivatives markets help increase savings and investment in the
end. Transfer of risk enables market participants to expand their
volumes of activity.
Participants of Derivative Market:-
Market participants in the future and option markets are many and they
perform multiple roles, depending upon their respective positions. A trader
acts as a hedger when he transacts in the market for price risk management.
He is a speculator if he takes an open position in the price futures market or
if he sells naked option contracts. He acts as an arbitrageur when he enters in
to simultaneous purchase and sale of a commodity, stock or other asset to
take advantage of mispricing. He earns risk less profit in this activity. Such
opportunities do not exist for long in an efficient market. Brokers provide
services to others, while market makers create liquidity in the market.

Hedgers
Hedgers are the traders who wish to eliminate the risk (of price change) to
which they are already exposed. They may take a long position on, or short
sell, a commodity and would, therefore, stand to lose should the prices move
in the adverse direction.

Speculators

29
If hedgers are the people who wish to avoid the price risk, speculators are
those who are willing to take such risk. These people take position in the
market and assume risk to profit from fluctuations in prices. In fact,
speculators consume information, make forecasts about the prices and put
their money in these forecasts. In this process, they feed information into
prices and thus contribute to market efficiency. By taking position, they are
betting that a price would go up or they are betting that it would go down.
The speculators in the derivative markets may be either day trader
or position traders. The day traders speculate on the price movements during
one trading day, open and close position many
times a day and do not carry any position at the end of the day.
They monitor the prices continuously and generally attempt to make profit
from just a few ticks per trade. On the other hand, the position traders also
attempt to gain from price fluctuations but they keep their positions for
longer durations may is for a few days, weeks or even months.

Arbitrageurs
Arbitrageurs thrive on market imperfections. An arbitrageur profits by
trading a given commodity, or other item, that sells for different prices in
different markets. The Institute of Chartered Accountant of India, the word
“ARBITRAGE” has been defines as follows:-
“Simultaneous purchase of securities in one market where the price there of
is low and sale thereof in another market, where the price thereof is
comparatively higher. These are done when the same securities are being
quoted at different prices in the two markets, with a view to make profit and
carried on with conceived intention to derive advantage from difference in

30
prices of securities prevailing in the two different markets” Thus, arbitrage
involves making risk- less profits by simultaneously entering into
transactions in two or more markets.

Types of derivatives:-
The most commonly used derivatives contracts are Forward, Futures and
Options. Here some derivatives contracts that have come to be used are
covered.
Forward:-
A forward contract is a customized contract between two entities, where
settlement takes place on a specific date in the future at today’s pre agreed
price.
Futures :-
A futures contact 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 For example: - A, on
1 Aug. agrees to sell 600 shares of Reliance Ind.Ltd. @ Rs. 450 to B on 1st
sep. A, on 1st Aug. agrees to buy 600 shares of Reliance Ind. Ltd. @ Rs. 450
to B on 1st Sep.
Options:-
Options are a right available to the buyer of the same, to purchase or sell an
asset, without any obligation. It means that the buyer of the option can

31
exercise his option but is not bound to do so. Options are of 2 types: calls
and puts.
1. Calls:-
Call gives the buyer the right, but not the obligation, to buy a given
quantity of the underlying asset, at a given price, on or before a given future
date.
For example :- A, on 1st Aug. buys an option to buy 600 shares of Reliance
Ind. Ltd. @ 450 Rs 450 on or before 1st Sep. In this case, A has the right to
buy the shares on or before the specified date, but he is not bound to buy the
shares.
2. Puts:-
Put gives the buyer the right, but not the obligation, to sell a given
quantity of the underlying asset, at a given price, on or before a given date.
For example :- A, on 1st Aug. buys an option to sell 600 shares of Reliance
Ind. Ltd. @ Rs 450 on or before 1st Sep. In this case, A has the right to sell
the shares on or before the specified date, but he is not bound to sell the
shares. In both the types of the options, the seller of the option has an
obligation but not a right to buy or sell an asset. His buying or selling of an
asset depends upon the action of buyer of the option. His position in both the
type of option is exactly the reverse of that of a buyer.
Warrants :-
Options generally have lives of up to one year, the majority of options
exchanges having a maximum maturity of nine months. Longer-dated
options are called warrants and are generally traded over-the-counter.
Leaps :-

32
The acronym LEAPS means Long-Term Equity Anticipation Securities.
These are options having a maturity of up to three years.

Basket :-
Basket options are options on portfolios of underlying assets are usually a
moving average of a basket of assets. Equity index options are a form of
basket options.
Swaps :-
Swaps are private agreement between two parties to exchange cash flows in
the future according to a pre arranged formula. They can be regarded as
portfolios of forward contract. The two commonly used swaps are as follows
:
1.) Interest rate swaps:-
These entail swapping only the interest related cash flows between the
parties in the same currency.
2.) Currency Swaps:-
These entail swapping both principal and interest between the parties, with
the cash flows in one direction being in a different currency than those in the
opposite direction.
SWAPTIONS :-
Swaptions are options to buy or sell a swap that will become operative at the
expiry of the options. Thus, a swaptions is an option on a forward swap.
Rather than have calls and puts, the swaptions market has receiver swaptions
and payer swaptions. A receiver swaptions is an option to receive fixed and
pay floating. A payer swaptions is an option to pay fixed and receive
floating Out of the above-mentioned types of derivatives forward.

33
Emergence of Derivative Trading in India
Approval For Derivatives Trading
The first step towards introduction of derivatives trading in India was the
promulgation of the Securities Laws (Amendment) Ordinance, 1995, which
withdrew the prohibition on options in securities. The market for derivatives,
however, did not take off, as there was no regulatory framework to govern
trading of derivatives. SEBI set up a 24 – member committee under the
chairmanship of Dr. L.C.Gupta on November 18, 1996 to develop
appropriate regulatory framework for derivatives trading in India. The
committee submitted its report on March 17, 1998 prescribing necessary pre-
conditions for introduction of derivatives trading in India.
The committee recommended that derivatives should be declared as
‘securities’ so that regulatory framework applicable to trading of ‘securities’
could also govern trading of securities. SEBI also set up a group in June

34
1998 under the chairmanship of Prof. J.R.Verma, to recommend measures
for risk containment in derivative market in India.
The repot, which was submitted in October 1998, worked out the operational
details of margining system, methodology for charging initial margins,
broker net worth, deposit requirement and real - time monitoring
requirements.
The SCRA was amended in December 1999 to include derivatives within the
ambit of ‘securities’ and the regulatory framework were developed for
governing derivatives trading. The act also made it clear that derivatives
shall be legal and valid only if such contracts are traded on a recognized
stock exchange, thus precluding OTC derivatives. The government also
rescinded in March 2000, the three – decade old notification, which
prohibited forward trading in securities.
Derivatives trading commenced in India in June 2000 after SEBI granted the
final approval to this effect in May 2000. SEBI permitted the derivative
segment of two stock exchanges, NSE and BSE, and their clearing
house/corporation to commence trading and settlement in approved
derivatives contract.
To begin with, SEBI approved trading in index future contracts based on
S&P CNX Nifty and BSE-30 (Sensex) index. This was followed by approval
for trading in options based on these two indices and options on individual
securities. The trading in index options commenced in June 2001. Futures
contracts on individual stocks were launched in November 2001. Trading
and settlement in derivatives contracts are done in accordance with the
rules, bye laws, and regulations of the respective exchanges and their

35
clearing house/corporation duly approved by SEBI and notified in the
official gazette.

Introduction to forward Contracts:-

Forward Contracts
A forward contract is an agreement to buy or sell an asset on a
specified date for a specified price. One of the parties to the
contract assumes a long position and agrees to buy 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. The parties to the contract
negotiate other contracts details like delivery date, price, and

36
quantity bilaterally. The forward contracts are normally traded
outside the exchanges.
Salient features of forward contracts are as follows:-
1) They are bilateral contracts and hence exposed to counter party

risk.
2) Each contract is custom designed, and hence is unique in

terms of contract size, expiration date and the asset type and
quality.
3) The contract price is generally not available in public domain

4) On the expiration date, the contract has to be settled by

delivery of the asset.

5) If the party wishes to reverse the contract, it has to

compulsorily go to the same counter party, which often results

in high prices being charged.

Limitation of forward market

Forward market worldwide is affected by several problems:-
1) Lack of centralization.
2) Illiquidity.
3) Counter party risk
In the first two of these, the basic problem is that of too much flexibility and
generality. The forward market is like a real estate market in that any two
consenting adults can form contracts against each other. This often makes

37
them design terms of the deal, which are very convenient in that specific
situation, but makes the contract non-tradable.
Counter party risk arises from the possibility of default by any one party to
the transaction. When one of the two sides to the transaction declares
bankruptcy, the other suffers. Even when forward markets trade standardized
contracts, and hence avoid the problem illiquidity, the counter party risk
remains a very serious.

Introduction to Futures:-
Future contract is specie of forward contract. Futures are exchange- traded
contracts to sell or buy standardized financial instruments or physical
commodities for delivery on a specified date at an agreed price. Futures
contracts are used generally for protecting against rich of adverse price
fluctuations (hedging). As the terms of contracts are standardized, these are
generally not used for merchandizing purpose.
The standardized items in a futures contract are:
1) Quantity of the underlying.
2) Quality of the underlying.
3) The date and month of delivery.
4) The units of price quotation and minimum price change.
5) Location of settlement.
Futures contract performs two important functions of price discovery and
price risk management with reference to the given commodity. It is useful to
all segment of economy. It is useful to the producer because investor can get
an idea of the price likely to prevail at a future point of time and therefore
can decide between various competing commodities, the best that suits him.

38
It enables the consumer get an idea of the price at which the commodity
would be available at a future point of time. He can do proper costing and
cover his purchases by making forward contracts. The future trading is very
useful to the exporters as it provides an advance indication of the price likely
to prevail and thereby help the exporter in quoting a realistic price and
thereby secure export contract in a competitive market. Having entered into
an export contract, it enables him to hedge his risk by operating in futures
market.

Other benefits of futures trading are:

 Price stabilization in time of violent price fluctuations- this mechanism
dampens the peaks and lifts up the valleys i.e. the amplitude of price
variation is reduced.
 Leads to integrated price structure throughout the country.
 Facilitates lengthy and complex, production and manufacturing
activities.
 Helps balance in supply and demand position throughout the year.
 Encourages competition and acts as a price barometer to farmers and
other trade functionaries.

FEATURE FORWARD FUTURE CONTRACT

CONTRACT
OPERATIONAL Traded Directly Traded on the
MECHANISM between two parties exchanges
(not traded on the
exchanges)

39
CONTRACT Differ from trade to Contracts are
SPECIFICATIONS trade. standardised contracts
COUNTER PARTY Exists Exists. However by the
RISK clearing Corp., which
becomes the counter
party to all trades or
uncontionally
guarantees their
settlement.
LIQUIDATION Low, as contracts are High, as contracts are
PROFILE tailor made contracts standardised exchange
catering to the needs of traded contracts.
the parties.
PRICE DISCOVERY Not efficient, as Efficient as markets are
markets are scattered. centralized and all
buyers and sellers come
to a common platform
to discover the price.

Margins
The margining system is based on the J R Verma committee
recommendations. The actual margining happens on a daily basis
while online position monitoring is done on an intra day basis. Daily
margining is of two types:
1.Initial margins.

40
2. Mark-to market profit/loss.
The computation of initial margin on the futures market is done using the
concept of Value-at-risk (VaR). The initial margin amount is large enough to
cover a one-day loss that can be encountered on 99% of the days. VaR
methodology seeks to measure the amount of value that a portfolio may
stand to lose within certain horizon period (one day for the clearing
corporation) due to potential changes in the underlying asset market price.
Initial margin amount computed using VaR is collected up-front. The daily
settlement process called “mark-to-market” provides for collection of losses
that have already occurred (historic losses) whereas initial margin seeks to
safeguard against potential losses on outstanding positions. The mark-to-
market settlement is done in cash.
Settlement of Future Contract:-
Futures contract has two types of settlement, the MTM settlement, which
happens on a continuous basis at the end of each day, and the final
settlement, which happens on the last trading day of the futures contract.
i. MTM Settlement
All futures contact for each member is marked-to-market (MTM) to the
daily settlement price of the relevant futures contract at the end of each day.
The profits/losses are computes as a difference between:

1. The trade price and the day’s settlement price for contracts
executed during the day but not squared up.
2. The previous day’s settlement price and the current day’s settlement price
for brought forward contracts.

41
The buy price and the sell price for the contracts executed during the day
and squared up. The clearing members (CMs) who have a loss are required
to pay the mark-to-market (MTM) loss amount in cash which is in, turn
passed on to the CMs who have made a MTM profit. This is known as daily
mark-to-market settlement. CMs are responsible to collect and settle the
daily MTM profits/losses incurred by the Trading members (TMs) and their
clients clearing and settling through them. Similarly, TMs are responsible to
collect/pay/losses/profits from/to their clients by the next day. The pay-in
and payout of the mark-to-market settlement are affected on the day
following the trade day. After completion of daily settlement computation,
all the open positions are reset to the daily settlement price. Such position
becomes the opening positions for the next day.

ii. Final settlement for futures

On the expiry of the future contracts, after the close of trading hours,
NSCCL marks all positions of CM to the final settlement price and the
resulting profits/losses is settled in cash. Final settlement loss/profits amount
is debited/credit to the relevant CM’s clearing bank account on the day
following expiry day of the contract

Settlement price for futures:-

Daily settlement price on a trading day is the closing price of the respective
future contracts on such day. The closing price for the future contracts is
currently calculated as the last half an hour weighted average price of a
contract in the F&O segment of NSE. Final settlement price is the closing
price of the relevant underlying index/security in the capital market segment

42
of NSE, on the last trading day of the contract. The closing price of the
underlying Index/security is currently its last half an hour weighted average
value in the capital market segment of NSE.

Introduction to options-:
Options give the holder or buyer of the option the right to do
something. If the option is a call option, the buyer or holder has the right to
buy the number of shares mentioned in the contract at the agreed strike
price. If the option is a put option, the buyer of the option has a right to sell
the number of shares mentioned in the contract at the agreed strike price.
The holder of the buyer does not have to exercise this right.
Thus on the expiry of the day of the contract the option may or may not be
exercised by the buyer. In contrast, in a futures contract, the two parties to
the contract have committed themselves to doing something at a future date.
To have this privilege of doing the transaction at a future only if it is a
profitable, the buyer of the option has to pay a premium to the seller of
options.

Types of options:-
An option is a contract between two parties giving the taker/buyer)
the right, but not obligation, to buy or sell a parcel of shares at a
predetermined price possibly on, or before a predetermined rate. To
acquire this right the taker pays a premium to the writer (seller) of
the contract.
There are two types of options:
1. Call Options

43
2. Put Options
Call Options:
Call options give the taker the right, but not the obligation, to buy
the underlying shares at a predetermined price, on or before a
predetermined date. Call Options- Long & Short Positions
When you expect prices to rise, then you take a long position by
buying calls. You are bullish. When you expect prices to fall, then
you take a short position by selling calls. You are bearish.
Put Options:
A Put Option gives the holder of the right to sell a specific number of an
agreed security at a fixed price for a period. Put Options- Long & Short
Positions When you expect prices to rise, then you take a long position by
buying Puts. You are bearish.

When you expect prices to fall, then you take a short position by selling
Puts. You are bullish.
Particulars Call Options Put Options
If you expect a fall in price [Bearish] Short Long
If you expect a rise in price [Bullish] Long Short
TABLE SHOWING THE DEALING OF CALL & PUT OPTION
Call option Holder (buyer) Call option Writer (seller)
1) Pays premium 1) Receives Premium
2) Right to exercise and buy 2) Obligations of sell shares if
shares exercised
3) Profit from rising prices 3) Profits from falling prices or
4) Limited losses, potentially remaining neutral

44
 unlimited gains. 4) Potentially unlimited losses ,
limited gains
Put option Holder (buyer) Put option Writer ( seller)
1) Pays premium 1) Receives Premium
2) Right to exercise and buy 2) Obligations of sell shares if
shares exercised
3) Profit from rising prices 3) Profits from rising prices or
4) Limited losses , potentially remaining neutral
unlimited gains. 4) Potentially limited losses ,
limited gains

Impotant Concepts:-
In -the- money option:
It is an option with intrinsic value. A call option is in the memory if the
underlying price is above the strike price. A put option is in the memory if
the underlying price is below the strike price.

Out- of- the- money:

It is an option that has no intrinsic value, i.e. all of its value consists of time
value. A call option is out of the money if the stock price is below its strike
price.

At- the- money:

A term that describes an option with a strike price that is equal to the current
market price of the underlying stock. But of the money if the stock price is
above its strike price.

45
Market Scenario Call Option Put Option
Market price > strike In- the- money Out- of- the- money
price

Market price < strike Out- of- the- money In- the- money
price

Market price = strike At- the- money At the- money

price

Market price ~ strike Near- the- money Near- the- money

price

Intrinsic Value
In a call option, if the value of the underlying asset is higher than
the strike price, the option premium has an intrinsic value and is an
“in- the- money” option. If the value of the underlying asset is lower
than the strike price, the option has no intrinsic value and is an “out-
of- the- money” option. If the value of the underlying asset is
equivalent to the strike price, the call option is “at- themoney” and
has no intrinsic value or zero intrinsic value.In a put option, if the value of
the underlying asset is lower than the strike price, the option has an intrinsic
value and is an “in- the- money” option. If the value of the underlying asset
is higher than the strike price, the option has no intrinsic value and is “out-

46
of- money” option. If the value of the underlying asset is equivalent to the
strike price, the put option is at the- money”

Time Value
Time value is the amount an investor is willing to pay for an option, in the
hope that at some time prior to expiration its value will increase because of a
favorable change in the price of the underlying asset. Time value reduces as
the expiration draws near and on expiration day; the time value of the option
is zero.
Option Price
An option cost or price is called“premium”. The potential loss for the buyer
of an option is limited to the amount of premium paid for the contract. The
writer of the option, on the other hand, undertakes the risk of unlimited
potential loss, for premium received. Thus,
Option Price = Premium Price
A premium is the net amount the buyer of an option pays to the seller of the
option. It does not refer to an amount above the base price, as the term
“premium” commonly used. The of an option has two important
constituents, intrinsic value and time value.
Premium = Intrinsic value + Time

Pricing with regard to Options:-

The Black and Scholes Model:
The Black and Scholes Option Pricing Model didn't appear overnight, in
fact, Fisher Black started out working to create a valuation model for stock
warrants. This work involved calculating a derivative to measure how the

47
discount rate of a warrant varies with time and stock price. The result of this
calculation held a striking resemblance to a well-known heat transfer
equation.
Soon after this discovery, Myron Scholes joined Black and the result of their
work is a startlingly accurate option pricing model. Black and Scholes can't
take all credit for their work; in fact their model is actually an improved
version of a previous model developed by A. James Boness in his Ph.D.
dissertation at the University of Chicago. Black and Scholes' improvements
on the Boness
model come in the form of a proof that the risk-free interest rate is the
correct discount factor, and with the absence of assumptions regarding
investor's risk preferences.
Black and Scholes Model:
In order to understand the model itself, we divide it into two parts. The first
part, SN [d1), derives the expected benefit from acquiring a stock outright.
This is found by multiplying stock price [S] by the change in the call
premium with respect to a change in the underlying stock price [N (d1)]. The
second part of the model, Ke [-rt) N (d2), gives the present value of paying
the exercise price on the expiration day. The fair market value of the call
option is then calculated by taking the difference between these two parts.
Assumptions of the Black and Scholes Model:-
1) The stock pays no dividends during the option's life
Most companies pay dividends to their share holders, so this might seem a
serious limitation to the model considering the observation that higher
dividend yields elicit lower call premiums. A common way of adjusting the

48
model for this situation is to subtract the discounted value of a future
dividend from the stock price.

2) European exercise terms are used

European exercise terms dictate that the option can only be exercised on the
expiration date. American exercise term allow the option to be exercised at
any time during the life of the option, making American options more
valuable due to their greater flexibility. This limitation is not a major
concern because very few calls are ever exercised before the last few days of
their life. This is true because when you exercise a call early, you forfeit the
remaining time value on the call and collect the intrinsic value. Towards the
end of the life of a call, the remaining time value is very small, but the
intrinsic value is the same.

3) Markets are efficient

This assumption suggests that people cannot consistently predict the
direction of the market or an individual stock. The market operates
continuously with share prices following a continuous into process. To
understand what a continuous into process is, you must first know that a
Markov process is "one where the observation in time period t depends only
on the preceding observation." An into process is simply a Markov process
in continuous time. If you were to draw a continuous process you would do
so without picking the pen up from the piece of paper.

4) No commissions are charged

49
Usually market participants do have to pay a commission to buy or sell
options. Even floor traders pay some kind of fee, but it is usually very small.
The fees that Individual investor's pay is more substantial and can often
distort the output of the model.

5) Interest rates remain constant and known

The Black and Scholes model uses the risk-free rate to represent this
constant and known rate. In reality there is no such thing as the risk-free
rate, but the discount rate on U.S. Government Treasury Bills with 30 days
left until maturity is usually used to represent it. During periods of rapidly
changing interest rates, these 30-day rates are often subject to change,
thereby violating one of the assumptions of the model.

6) Returns are log normally distributed

This assumption suggests, returns on the underlying stock are
normally distributed, which is reasonable for most assets that offer options.
Advantages & Limitations:-
Advantage:
1) The main advantage of the Black-Scholes model is speed -- it lets
you calculate a very large number of option prices in a very short
time.
Limitation:
1) The Black-Scholes model has one major limitation: it cannot be usedto
accurately price options with an American-style exercise as it only calculates
the option price at one point in time -- at expiration. It does not consider the

50
steps along the way where there could be the possibility of early exercise of
an American option.
2) As all exchange traded equity options have American-style exercise (i.e.
they can be exercised at any time as opposed to European options which can
only be exercised at expiration) this is a significant limitation.
3) The exception to this is an American call on a non-dividend paying asset.
In this case the call is always worth the same as its European equivalent as
there is never any advantage in exercising early.
4)Various adjustments are sometimes made to the Black-Scholes price to
enable it to approximate American option prices but these only works well
within certain limits and they don't really work well for puts.

Difference between derivative and equity

Warehousing No warehousing is No warehousing is
required required

Quality of Derivatives contract Equity contract don’t

underlying don’t have attribute have
assets of quality attribute of quality
Contract life Comparatively having Having long and short
long contract life contract life

Maturity date Standardized Standardized

Return High Medium
Risk Very High Less
Liquidity Less Very high
Lot size Fixed by SEBI Not fixed by SEBI
Time of trading 9a.m to 3.30p.m 9a.m to 3.30p.m

51
Investment Very high Low
Amount

Regulatory Framework
The trading of derivatives is governed by the provisions contained in
theSC(R)A, the SEBI Act, the rules and regulations framed there under and
the rules and bye–laws of stock exchanges.

Securities Contract (Regulation) Act, 1956

SC(R)A aims at preventing undesirable transactions in securities by
regulating the business of dealing therein and by providing for certain other
matters connected therewith. This is the principal Act, which governs the
trading of securities in India. The term “securities” has been defined in the
SC(R)A. As per Section 2(h), the ‘Securities’ include:
1. Shares, scripts, stocks, bonds, debentures, debenture stock or other
marketable securities of a like nature in or of any incorporated company or
other body corporate.
2. Derivative
3. Units or any other instrument issued by any collective investment scheme
to the investors in such schemes.
4. Government securities
5. Such other instruments as may be declared by the Central Government to
be securities.
6. Rights or interests in securities.

52
“Derivative” is defined to include:
1) A security derived from a debt instrument, share, loan whether

secured or unsecured, risk instrument or contract for differences or

any other form of security.
2) A contract which derives its value from the prices, or index of prices,
of
3) underlying securities.
4) Section 18A provides that notwithstanding anything contained in any

other law for the time being in force, contracts in derivative shall be
legal and valid if such contracts are:
5) Traded on a recognized stock exchange
6) Settled on the clearing house of the recognized stock exchange, in

accordance with the rules and bye–laws of such stock exchanges.

Securities and Exchange Board of India Act, 1992

SEBI Act, 1992 provides for establishment of Securities and Exchange
Board of India(SEBI) with statutory powers for (a) protecting the interests of
investors in securities (b) promoting the development of the securities
market and (c) regulating the securities market. Its regulatory jurisdiction
extends over corporates in the issuance of capital and transfer of securities,
in addition to all intermediaries and persons associated with securities
market. SEBI has been obligated to perform the aforesaid functions by such
measures as it thinks fit. In particular, it has powers for:
 r egulating the business in stock exchanges and any other securities
markets.

53
 1) registering and regulating the working of stock brokers, sub–brokers

etc.
2) promoting and regulating self-regulatory organizations.
3) prohibiting fraudulent and unfair trade practices.
4) calling for information from, undertaking inspection, conducting

inquiries and audits of the stock exchanges, mutual funds and other
persons associated with the securities market and intermediaries and
self–regulatory organizations in the securities market.
5) performing such functions and exercising according to Securities

Contracts (Regulation) Act, 1956, as may be delegated to it by the

Central Government.

Regulations for derivatives Trading

SEBI set up a 24- member committee under the Chairmanship of Dr. L. C.
Gupta to develop the appropriate regulatory framework for derivatives
trading in India. On May 11, 1998 SEBI accepted the recommendations of
the committee and approved the phased introduction of derivatives trading in
India beginning with stock index futures. The provisions in the SC(R)A and
the regulatory framework developed thereunder govern trading in securities.
The amendment of the SC(R)A to include derivatives within the ambit of
‘securities’ in the SC(R)A made trading in derivatives possible within the
framework of that Act.
1. Any Exchange fulfilling the eligibility criteria as prescribed in the L. C.
Gupta committee report can apply to SEBI for grant of recognition under
Section 4 of the SC(R)A, 1956 to start trading derivatives. The derivatives

54
exchange/segment should have a separate governing council and
representation of trading/clearing members shall be limited to maximum of
40% of the total members of the governing council. The exchange would
have to regulate the sales practices of its members and would have to obtain
prior approval of SEBI before start of trading in any derivative contract.

2. The Exchange should have minimum 50 members.

3. The members of an existing segment of the exchange would not

automatically become the members of derivative segment. The members of
the derivative segment would need to fulfill the eligibility conditions as laid
down by the L. C. Gupta committee.

4. The clearing and settlement of derivatives trades would be through a SEBI

approved clearing corporation/house. Clearing corporations/houses
complying with the eligibility conditions as laid down by the committee
have to apply to SEBI for grant of approval.

5. Derivative brokers/dealers and clearing members are required to seek

registration from SEBI. This is in addition to their registration as brokers of
existing stock exchanges. The minimum networth for clearing members of
the derivatives clearing corporation/house shall be Rs.300 Lakh. The
networth of the member shall be computed as follows:
Capital + Free reserves
Less non-allowable assets viz.,
(a) Fixed assets

55
(b) Pledged securities
(c) Member’s card
(d) Non-allowable securities(unlisted securities)
(e) Bad deliveries
(f) Doubtful debts and advances
(g) Prepaid expenses
(h) Intangible assets
(i) 30% marketable securities
6. The minimum contract value shall not be less than Rs.2 Lakh. Exchanges
have to submit details of the futures contract they propose to introduce.

7. The initial margin requirement, exposure limits linked to capital adequacy

and margin demands related to the risk of loss on the position will be
prescribed by SEBI/Exchange from time to time.

8. The L. C. Gupta committee report requires strict enforcement of “Know

your customer” rule and requires that every client shall be registered with
the derivatives broker. The members of the derivatives segment are also
required to make their clients aware of the risks involved in derivatives
trading by issuing to the client the Risk Disclosure Document and obtain a
copy of the same duly signed by the client.

9. The trading members are required to have qualified approved user and
sales person who have passed a certification programme approved by SEBI

56
Research Methodology:-
Problem Statement:
The topic, which is selected for the study, is “Derivative Market” in the firm
so the problem statement for this study will be, “Study of Dervatives and its
comparison with equity”

Objective of the Study:

1. To know the awareness of the Derivative Market in Delhi City.
2. To know which one is beneficial for the investor.
3. To find what proportion of the population are investing in such
derivatives along with their investment pattern and product preferences.
Research Design:
The research design specifies the methods and procedures for conducting a
particular study. The type of research design applied here are “Descriptive”
as the objective is to check the position of the Derivative Market in Delhi
city. The objectives of the study have restricted the choice of research design
up to descriptive research design. This survey will help the firm to know
how the investors invest in the derivative segment & which factors affect
their investing behavior.
Scope of the Study:

57
The scope of the study will include the analysis of the survey, which is being
conducted to know the awareness of the Derivative Market in the city & also
doing comparison of derivatives with equity.
Research Source of Data:-
There are two types of sources of data which is being used for the
studies:-
Primary Source of Data:
Preparing a Questionnaire is collecting the primary source of data & it was
collected by interviewing the investors.
Secondary Source of Data:
For having the detailed study about this topic, it is necessary to have some of
the secondary information, which is collected from the following:-Books.
Magazines & Journals. Websites. Newspapers, etc.

Methods of Data Collection:-

The study to be conducted is about the awareness of the Derivative Market
in the Delhi City so the method of data collection used is “Survey Method”.

58
Data Analysis and Interpretation:

Q.1 Are you trading in derivative market?

Frequencies Percentage
Yes 74 37.0
No 126 63.0
Total 200 100.0
Objective: To know that whether the investors are trading in derivative
market or not.

Q.2 Reasons for not investing in derivative market.

Objective : To know the reason why investors are not trading in
trading in derivative market.
Reasons Frequency Percent
Lack of knowledge 26 20.6
Lack of awareness 19 15.1
High risky 62 49.2
Huge amount of 17 13.5
investment

Other 2 1.6

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Total 126 100

Q.3 what is the objective of trading in derivative market?

Objective: To know that why they are trading in derivative market.
Frequency Percent
Don’t trade 126 63.0
Not at all preferred 2 1.0
Neutral 2 1.0
Some how preferred 5 2.5
Most preferred 65 32.5
Total 200 100

Q.4 What are the criteria do you taken in the consideration while investing
in derivative market?
Objective : To know that which criteria are consider by the investors while
they are investing in derivative market. Which criteria are most important
for them whether derivatives are ease in transaction, less costly, or available
of different contract or for the margin money.
Frequency Percent
Don’t trade 126 63.0
Not at all preferred 2 1.0
Some how not 4 2.0
preferred

Neutral 16 8.0
Some how preferred 23 11.5
Most preferred 29 14.5
Total 200 100

Q-5 Give your preference of trading in derivative instrument.

Objective: To know the preference of the investors while they are

60
trading in derivative market.
Frequency Percent
Don’t trade 126 63.0
Not at all preferred 1 .5
Some how not 1 .5
preferred
Neutral 15 7.5
Some how preferred 14 7.0
Most preferred 43 21.5
Total 200 100

Q-6 Give your preference in term of trading in derivative

market?
Objective : To know the preference of the investors in term of
trading in derivative market.
Frequency Percent
Don’t trade 126 63.0
Not at all preferred 4 2.0
Some how not 1 .5
preferred
Neutral 5 2.5
Some how preferred 10 5
Most preferred 54 27
Total 200 100

Q-7 How much percentage of your income you trade in

derivative market?
Objective: To know investors are how much percentage of their
income trade in derivative market.
Frequency Percent

61
Don’t trade 126 63.0
Less than 5% 8 4.0
5%-10% 25 12.5
11%-15% 25 12.5
16%-20% 13 6.5
More than 20% 3 1.5
Total 200 100

Q-8 what is the rate of return expected by you from derivative market?
Objective: To know the investors expectation towards their
investment in derivative market.
Frequency Percent
Do not trade 126 63.0
5%-9% 21 10.5
10%-13. % 22 11.0
14%-17. % 23 11.5
18%-23% 8 4.0
Total 200 100

Q-9. You are satisfied with the current performance of the derivative market.
Objective: To know that investors are satisfied with the performance of the
derivative market or not.

Frequency Percent
Do not trade 126 63.0
Strongly disagree 8 4.0
Disagree 14 7.0
Neutral 18 9.0
Agree 25 12.5

62
strongly agree 9 4.5
Total 200 100

Gender:
Frequency Percent
Male 157 78.5
Female 43 21.5
Total 200 100

AGE:
Frequency Percent
Below 20 years 3 1.5
20-25 years 61 30.5
26-30 years 51 25.5
31-35 years 43 21.5
above 35 years 42 21.0
Total 200 100

Occupation:
Frequency Percent
Student 35 17.5
Employeed 82 41.0
Business 32 16.0
Professional 22 11.0
Housewife 13 6.5
Others 16 8.0
total 200 100

63
Findings
1. Here we found that out of 200 investors 74 means 37% investors are
trading in derivative market whereas 126 means 63% are not trading in
derivative market.
2. Reasons for not investing in derivative market Is derivative is because
lack of awareness and knowledge, high risky, need huge amount of
investment.
3. The main objective I of trading in derivative market of the investors is
getting high return.
4. Criteria for trading is considered by investors are derivatives in derivative
they get margin money and derivatives are more liquid.
5. Their attractive preference is index future and index options
6. Most of the investors are trading intraday.
7. Out of 200 investors 12.5% investors are investing 11% to 15% of their
income trading in derivative market.
8.12.5% are satisfied with derivative market
9.157male investors and 43 female investors out of 200 investors.

64
10.-most of the businessman and employed are trading in derivative
market.

Conclusion
1. The awareness regarding Derivative among investor is 78 percent.
2. In terms of investment in Derivative and Equity investors have Capability
of taking risk.
3. Investors also prefer Safety and Time Factor as the important parameter
for investing.
4. The important factor that affecting the investor decision is based
on In Consult With Their Broke .

65
Recommendations
1. Only 74 investors are trading whereas 126 are not trading .so attract them
for trading.
2.19 are lack of awareness so make them aware with the derivative so
increase the customer.
3. Out of 126, 26 don’t have knowledge for derivative so provide them
knowledge for trading in derivative market.
4. Those who are not satisfied with the derivative by knowing their behavior
of investment make them satisfied. Because negative word mouth of the
customers fall down the business. And good word of mouth builds the
business.

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Questionnaire

1. Are you investing in Derivative Market?

Yes
No
2. Reason for not investing in Derivative Market.
{Give the rank}
1) Lack of Knowledge

2) Lack of awareness

3) High risky

4) Huge amount of investment

5) other

3.What are the objectives of the investing in derivatives Market ?

Scale 5 4 3 2 1

67
Instrument Most Somewhat Neutral Somewhat Not at all
prefered prefered not Prefered
prefered
High
Return
Hedge The
Risk
More
reliable
Safe to
invest in
derivative
market
More
Liquid

4. What are the criteria do you taken in the consideration while investing in
derivative market?
Scale 5 4 3 2 1
Instrument Most Somewhat Neutral Somewhat Not at all
prefered prefered not prefered
prefered
Flexibilty
Ease in
transaction
Less costly

68
Availabilt
y ogf
different
Contract
Margin
money

5. Give your preference of investment in derivative instrument.

Scale 5 4 3 2 1
Instrument Most Somewhat Neutral Somewhat Not all
prefered prefered not Prefered
prefered
Index
future
Stock
Future
Index
Option
Stock
Option

6. Give your preference in terms of investment in derivative market.

Scale 5 4 3 2 1
Instrument Most Somewhat Neutral Somewhat Not all
prefered prefered not Prefered

69
 prefered
Short term
Medium
term
Long term

7. How much Percentage of your income you invest in derivative market?

(a)Less than 5%
(b) 5% TO 10%
(c)11% TO 15%
(d) 16% TO 20%
(e) MORE THAN 20%

8. What is the rate of return expected by you from derivative market ?

(a)5 % TO 9.5%
(b)10% TO 13.5%
(c)14 % TO 17%
(d)18% TO 23%
(e)ABOVE 23%

9. You are satisfied with the current performance of the derivative in terms
of expected return.
(a)STRONGLY AGREE
(b)AGREE

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(c)NUTRAL DISAGREE
(d)STRONGLY DISAGREE.

Demographic profile
Name:………………………
Contact No............................
Email id:……………………
Age-:
a) Below 20 yrs.
b) 20 – 30 yrs.
c) 30-40 yrs.
d) 40-50 yrs
e) Above 50 yrs.

Gender-
a) Male
b) Female

Income (yearly)-:
a) Less than 100000
b) 100000-200000
c) 200000-300000
d) 300000-400000
e) Above 400000

71
Bibliography
Newspapers and Journals-:
1. Economic Times
2. Times of India

Websites referred –:
1. nseindia.com
2. bseindia.com
3. msbetrade.com
4. mcx.com
5. ncdex.com
6. moneycontrol.com

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