A STUDY ON

DERIVATIVES MARKETOPERATIONS AND APPLICATION OF HEDGING STRATEGIES FOR FUTUER

FROM INDIABULLS HYDERABAD A PROJECT REPORT SUBMITTED TO

HYDERABAD IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF DEGREE IN MASTER OF BUSINESS ADMINISTRATION SUBMITED PRASHANT MAHESHWARI ICBM-SBE (HYDERABAD) 2011-2013

DECLARATION

I PRASHANT MAHESHWARI student of ICBM-SBE COLLEGE have completed the project on DERIVATIVES MARKET OPERATIONS AND APPLICATION OF HEDGING STRATEGIES FOR FUTUER with reference to INDIABULLS for the Academic year 2012-2013.

The information given in this project is true to the best of my knowledge

(PRASHANT MAHESHWAWRI)

ACKNOWLEDGEMENT

I take this opportunity to express my sincere Thanks to God and everyone who directly and indirectly help me in completing my project work successfully. I would like to thank MR.ATISH GUPTA OF INDIABULLS, HYDERABAD for his kind help in completion of the project. I am thankful to my guide and HOD Mrs. Sai Rani mam for giving their support and guidance. I take this opportunity to thank other faculty members of MBA dept. for their kind Cooperation. I am also thankful to my parents and all my friends who co-operated me to complete this project.

ABSTRACT One of the most significant events in the securities markets has been the development and expansion of financial derivatives. The term derivatives is used to refer to financial instruments which derive their value from some underlying assets. The underlying assets could be equities (shares), debt (bonds, T-bills, and notes), currencies, and even indices of these various assets, such as the Nifty 50 Index. In India, derivatives markets have been functioning since the nineteenth century, with organized trading in cotton through the establishment of the Cotton Trade Association in 1875.Derivatives, as exchange traded financial instruments were introduced in India in June 2000.The National Stock Exchange (NSE) is the largest exchange in India in derivatives, trading in various derivatives contracts. The first contract to be launched on NSE was the Nifty 50 index futures contract. In a span of one and a half years after the introduction of index futures, index options, stock options and stock futures were also introduced in the derivatives segment for trading. NSEs equity derivatives segment is called the Futures & Options Segment or F&O Segment. NSE also trades in Currency and Interest Rate Futures contracts under a separate segment. The main focus of the project is to study in detail the role of futures. A futures contract is an agreement between two parties in which the buyer agrees to buy an underlying asset from the seller, at a future date at a price that is agreed upon today. A futures contract is standardized by the exchange. All the terms, other than the price, are set by the stock exchange. The conclusion of the project is to know the risk and return characteristics and derivative performance against profit and policies of the company and to know the hedgers position to reduce or eliminate the risk.

CONTENTS S.NO

PG.NO

1.

INTODUCTION OBJECTIVE
NEED SCOPE LIMITATIONS

2,

REVIEW OF LITERATURE
STOCK MARKET NATIONAL STOCK EXCHANGE BOMBAY STOCK EXCHANGE CAPITAL MARKET DERIVATIVES FUTURES HEDGERS

COMPANY PROFILE
3. 4. 5. 6.

DATA ANALYSIS AND INTERPRETATION FINDINGS AND CONCLUSIONS SUGGESTIONS AND RECOMMENDATIONS BIBLOGRAPHY

7.

Introduction 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 fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivatives 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.

DERIVATIVES

MEANING: 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 fluctuations in asset prices. By their very nature, the financial markets are marked 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. Derivatives are risk management instruments, which derive their value from an underlying asset. The underlying asset can be bullion, index, share, bonds, currency, interest etc. Annual turnover of the derivatives is increasing each year from 1986 onwards, Year 1986 1992 1998 2002 & 2003 Annual turnover 146 millions 453 millions 1329 millions it has reached to equivalent stage of cash market

Derivatives are used by banks, securities firms, companies and investors to hedge risks, to gain access to cheaper money and to make profits Derivatives are likely to grow even at a faster rate in future they are first of all cheaper to world have met the increasing volume of products tailored to the needs of particular customers, trading in derivatives has increased even in the over the counter markets. In Britain unit trusts allowed to invest in futures & options .The capital adequacy norms for banks in the European Economic Community demand less capital to hedge or speculate through derivatives than to carry underlying assets. Derivatives are weighted lightly than other assets that appear on bank balance sheets. The size of these off-balance sheet assets that include derivatives is more than seven times as large as balance sheet items at some American banks causing concern to regulators

DEFINITION:

Derivative is a product whose value is derived from the value of one or more basic variables, called bases (underlying asset, index, or reference rate), in a contractual manner. The underlying asset can be equity, forex, commodity or any other asset. In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R) A) defines derivative to include1. A security derived from a debt instrument, share, and 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 underlying securities.

FACTORS DRIVING THE GROWTH OF DERIVATIVES Over the last three decades, the derivatives market has seen a phenomenal growth. A large variety of derivative contracts have been launched at exchanges across the world. Some of the factors driving the growth of financial derivatives are: 1. Increased volatility in asset prices in financial markets, 2. Increased integration of national financial markets with the international markets, 3. Marked improvement in communication facilities and sharp decline in their costs,

4. Development of more sophisticated risk management tools, providing economic agents a wider choice of risk management strategies, and 5. Inflations in the derivatives markets, which optimally combine the risks and returns over a large number of financial assets leading to higher returns, reduced risk as well as transactions costs as compared to individual financial assets.

Emergence of financial derivatives

Derivative products initially emerged as hedging devices against fluctuations in commodity prices and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight 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-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also 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.

OBJECTIVE OF THE STUDY

1. To analyse the capital market and derivative market in India. 2. To study the risk and return characteristics and derivative performance against profit and policies of company. 3. To analyse the hedgers position to reduce or eliminate the risk. 4. To study in detail the role of futures.

NEED OF THE STUDY

Different investment avenues are available investors. Stock market also offers good investment opportunities to the investor alike all investments, they also carry certain risks. The investor should compare the risk and expected yields after adjustment off tax on various instruments while talking investment decision the investor may seek advice from expertly and consultancy include stock brokers and analysts while making investment decisions. The objective here is to make the investor aware of the functioning of the derivatives. Derivatives act as a risk hedging tool for the investors. The objective is to help the investor in selecting the appropriate derivate instrument to attain maximum risk and to construct the portfolio in such a manner to meet the investor should decide how best to reach the goals from the securities available. The development and improvement strategies in the investment policy formulated. They will help the selection of asset classes and securities in each class depending up on their risk return attributes.

SCOPE OF THE STUDY

The study is limited to Derivatives with special reference to futures in the Indian context; the study is not based on the international perspective of derivative markets. The study is limited to the analysis made for types of instruments of derivate each strategy is analyzed according to its risk and return characteristics and derivatives performance against the profit and policies of the company.

LIMITATIONS OF THE STUDY

The study is restricted only to the various future strategies available to manage the risk. The study is mainly dependent on secondary data. The subject of derivate if vast it requires extensive study and research to understand the depth of the various instrument operating in the market only a recent one. Therefore data related to last few trading months was only consider and interpreted.

RESEARCH METHODOLOGY

Research methodology is based on two types of data. 1. Primary data 2. Secondary data

Primary data: Primary data is based on the information provided by employees of India Bulls Securities Ltd .

Secondary data: Secondary data is collected through websites, annual reports of company given in magazines etc,.

Tools adopted:

For Futures

The cost-of-carry model used for pricing futures is given below.

F = Sert Where: F = Futures Price S = Spot price of the underlying r = cost of financing (using continuously compounded Interest rate) t = Time till expiration in years e = 2.71828 (or)

F=S(1+r-q)t Where: F = Futures price S = Spot price of the interest underlying r = Cost of financing (or) rate q = Expected Dividend yield t = Holding Period.

STOCK MARKET: A stock market or equity market is a public entity for the trading of company stock (shares) and derivatives at an agreed price; these are securities listed on a stock exchange as well as those only traded privately. The size of the world stock market was estimated at about $36.6 trillion at the start of October 2008. The total world derivatives market has been estimated at about $791 trillion face or nominal value, 11 times the size of the entire world economy. The value of the derivatives market, because it is stated in terms of notional values, cannot be directly compared to a stock or a fixed income security, which traditionally refers to an actual value. Moreover, the vast majority of derivatives 'cancel' each other out (i.e., a derivative 'bet' on an event occurring is offset by a comparable derivative 'bet' on the event not occurring). Many such relatively illiquid securities are valued as marked to model, rather than an actual market price. The stocks are listed and traded on stock exchanges which are entities of a corporation or mutual organization specialized in the business of bringing buyers and sellers of the organizations to a listing of stocks and securities together. The largest stock market in the United States, by market cap, is the New York Stock Exchange, NYSE. In Canada, the largest stock market is the Toronto Stock Exchange. Major European examples of stock exchanges include the London Stock Exchange, Paris Bourse, and the Deutsche Brse (Frankfurt Stock Exchange). Asian examples include the Tokyo Stock Exchange, the Hong Kong Stock Exchange, the Shanghai Stock Exchange, and the Bombay Stock Exchange. In Latin America, there are such exchanges as the BM&F Bo Vespa and the BMV.

REGULATION OF STOCK EXCHANGES: The securities contracts (regulation) act is the basis for operations of the stock exchanges in India. No exchange can operate legally without the government permission or recognition. Stock exchanges are given monopoly in certain areas under section 19 of the above Act to ensure that the control and regulation are facilitated. Recognition can be granted to a stock exchange provided certain conditions are satisfied and the necessary information is supplied to the government. Recognition can also be withdrawn, if necessary. Where there are no stock exchanges, the government can license some of the brokers to perform the functions of a stock exchange in its absence.

SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI): SEBI was set up as an autonomous regulatory authority by the Government of India in 1988 " to protect the interests of investors in securities and to promote the development of, and to regulate the securities market and for matters connected therewith or incidental thereto." It is empowered by two acts namely the SEBI Act, 1992 and the securities contract (regulation) Act, 1956 to perform the function of protecting investor's rights and regulating the capital markets.

NATIONAL STOCK EXCHANGE: The derivatives trading on the NSE commenced with S&P CNX Nifty Index Futures on June 12, 2000. The trading in index options commenced on June 4, 2001 and trading in options on individual securities commenced on July 2, 2001. Single stock futures were launched on november 9, 2001. Today, both in terms of volume and turnover, NSE is the largest derivatives exchange in India. Currently, the derivatives contracts have a maximum of 3-month expiration cycles. Three contracts are available for trading, with 1 month, 2 months and 3 months expiry. A new contract is introduced on the next trading day following the expiry of the near month contract.

PARTICIPANTS AND FUNCTIONS NSE admits members on its derivatives segment in accordance with the rules and regulations of the exchange and the norms specified by SEBI. NSE follows 2-tier membership structure stipulated by SEBI to enable wider participation. Those interested in taking membership on F&O segment are required to take membership of CM and F&O segment or CM, WDM and F&O segment. Trading and clearing members are admitted separately. Essentially, a clearing member (CM) does clearing for all his trading members (TMs), undertakes risk management and performs actual settlement. There are three types of CMs: Self Clearing Member: A SCM clears and settles trades executed by him only either on his own account or on account of his clients. Trading Member Clearing Member: TM-CM is a CM who is also a TM. TM-CM may clear and settle his own proprietary trades and client's trades as well as clear and settle for other TMs.

 Professional Clearing Member PCM is a CM who is not a TM. Typically, banks or custodians could become a PCM and clear and settle for TMs. The TM-CM and the PCM are required to bring in additional security deposit in respect of every TM whose trades they undertake to clear and settle. Besides this, trading members are required to have qualified users and sales persons, who have passed a certification programme approved by SEBI. At present, there are 24 stock exchanges recognized under the securities contract (regulation) Act, 1956. They are List of Stock Exchanges recognized under the securities contract (regulation) Act, 1956

NAME OF THE STOCK EXCHANGE Bombay stock exchange, Ahmedabad share and stock brokers association Calcutta stock exchange association Ltd, Delhi stock exchange association Ltd, Madras stock exchange association Ltd, Indoor stock brokers association, Bangalore stock exchange, Hyderabad stock exchange, Cochin stock exchange, Pune stock exchange Ltd, U.P stock exchange association Ltd, Ludhiana stock exchange association Ltd, Jaipur stock exchange Ltd, Gauhathi stock exchange Ltd, Mangalore stock exchange Ltd, Maghad stock exchange Ltd, Patna, Bhubaneswar stock exchange association Ltd, Over the counter exchange of India, Bombay, Saurasthra Kutch stock exchange Ltd,

YEAR

1875 1957 1957 1957 1957 1958 1963 1943 1978 1982 1982 1983 1983-84 1984 1985 1986 1989 1989

Vadodara stock exchange Ltd, Coimbatore stock exchange Ltd, The Meerut stock exchange Ltd, 1National stock exchange Ltd, Integrated stock exchange,

1990 1991 1991 1991 1991,1999

BOMBAY STOCK EXCHANGE: This stock exchange, Mumbai, popularly known as "BSE" was established in 1875 as " The Native share and stock brokers association", as a voluntary non-profit making association. It has an evolved over the years into its present status as the premiere stock exchange in the country. It may be noted that the stock exchanges the oldest one in Asia, even older than the Tokyo Stock exchange which was founded in 1878.The exchange, while providing an efficient and transparent market for trading in securities, upholds the interests of the investors and ensures redressed of their grievances, whether against the companies or its own member brokers. It also strives to educate and enlighten the investors by making available necessary informative inputs and conducting investor education programs. A governing board comprising of 9 elected directors, 2 SEBI nominees, 7 public representatives and an executive director is the apex body, which decides the policies and regulates the affairs of the exchange. The Executive director as the chief executive officer is responsible for the day today administration of the exchange. The average daily turnover of the exchange during the year 2000-01(April-March) was Rs 3984.19 crs and average number of daily trades 5.69 laces. during the year 2001-02 has However the average daily turnover of the exchange

declined to Rs. 1244.10 crs and number of average daily trades

during the period to 5.17laces. The average daily turnover of the exchange during the year 200203 has declined and number of average daily trades during the period is also decreased. The Ban on all deferral products like BLESS AND ALBM in the Indian capital markets by SEBI i.e. July 2, 2001, abolition of account Period settlements, introduction of compulsory rolling settlements in all scrips traded on the exchanges i.e. APR 31, 2001, etc., have adversely impacted the liquidity and consequently there is a considerable decline in the daily turnover at the exchange. The average daily turnover of the exchange present scenario is 110363 (Laces) and number of average daily trades 1057(Laces)

BSE INDICES: In order to enable the market participants, analysts etc., to track the various ups and downs in the Indian stock market, the Exchange has introduced in 1986 an equity stock index called BSESENSEX that subsequently became the barometer of the moments of the share prices in the Indian stock market. It is a "Market capitalization-weighted" index of 30 component stocks representing a sample of large, well-established and leading companies. The base year of Sensex is 1978-79. The Sensex is widely reported in both domestic and international markets through print as well as electronic media. Sensex is calculated using a market capitalization weighted method. As per this methodology, the level of the index reflects the total market value of all 30-component stocks from different industries related to particular base period. The total market value of a company is determined by multiplying the price of its stock by the number of shares outstanding. Statisticians call an index of a set of combined variables (such as price and number of shares) a composite Index. An Indexed number is used to represent the results of this calculation in order to make the value easier to work with and track over a time. It is much easier to graph a chart based on Indexed values than one based on actual values world over majority of the well-known Indices are constructed using Market capitalization weighted method ".

In practice, the daily calculation of SENSEX is done by dividing the aggregate market value of the 30 companies in the Index by a number called the Index Divisor. The Divisor is the only link to the original base period value of the SENSEX. The Divisor keeps the Index comparable over a period of time and if the reference point for the entire Index maintenance adjustments. SENSEX is widely used to describe the mood in the Indian Stock markets. Base year average is changed as per the formula New base year average = Old base year average*(New market Value/old market value)

CAPITAL MARKET

Markets in the United States provide the lifeblood of capitalism. Companies turn to them to raise funds needed to finance the building of factories, office buildings, airplanes, trains, ships, telephone lines, and other assets; to conduct research and development; and to support a host of other essential corporate activities. Much of the money comes from such major institutions as pension funds, insurance companies, banks , foundations, and colleges and universities. Increasingly, it comes from individuals as well. Very few investors would be willing to buy shares in a company unless they knew they could sell them later if they needed the funds for some other purpose. The market and other capital markets allow investors to buy and sell stocks continuously.

The markets play several other roles in the American economy as well. They are a source of income for investors. When stocks or other financial assets rise in value, investors become wealthier; often they spend some of this additional wealth, bolstering sales and promoting economic growth. Moreover, because investors buy and sell shares daily on the basis of their expectations for how profitable companies will be in the future, stock prices provide instant feedback to corporate executives about how investors judge their performance. Stock values reflect investor reactions to government policy as well. If the government adopts policies that investors believe will hurt the economy and company profits, the market APRlines; if investors believe policies will help the economy, the market rises. Critics have sometimes suggested that American investors focus too much on short-term profits; often, these analysts say, companies or policy-makers are discouraged from taking steps that will prove beneficial in the long run because they may require short-term adjustments that will depress stock prices. Because the market reflects the sum of millions of APRisions by millions of investors, there is no good way to test this theory. In any event, Americans pride themselves on the efficiency of their stock market and other capital markets, which enable vast numbers of sellers and buyers to engage in millions of transactions each day. These markets owe their success in part to computers, but they also depend on tradition and trust -- the trust of one broker for another and the trust of both in the good faith of the customers they represent to deliver securities after a sale or to pay for purchases. Occasionally, this trust is abused. But during the last half century, the federal government has played an increasingly important role in ensuring honest and equitable dealing. As a result, markets have thrived as continuing sources of investment funds that keep the economy growing and as devices for letting many Americans share in the nation's wealth.

To work effectively, markets require the free flow of information. Without it, investors cannot keep abreast of developments or gauge, to the best of their ability, the true value of stocks. Numerous sources of information enable investors to follow the fortunes of the market daily, hourly, or even minute-by-minute. Companies are required by law to issue quarterly earnings reports, more elaborate annual reports, and proxy statements to tell stockholders how they are doing. In addition, investors can read the market pages of daily newspapers to find out the price at which particular stocks were traded during the previous trading session. They can review a variety of indexes that measure the overall pace of market activity; the most notable of these is the Dow Jones Industrial Average (DJIA), which tracks 30 prominent stocks. Investors also can turn to magazines and newsletters devoted to analyzing particular stocks and markets. Certain cable television programs provide a constant flow of news about movements in stock prices. And now, investors can use the Internet to get up-to-the-minute information about individual stocks and even to arrange stock transactions.

TYPES OF DERIVATIVES

Derivative contracts have several variants. The most common variants are forwards, futures, options and swaps. We take a brief look at various derivatives contracts that have come to be used. Forwards: 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 contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts. Options: Options are of two types - calls and puts. Calls give 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. Puts give 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.

Warrants: Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. Leaps: The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of up to three years. Baskets: Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options. Swaps: Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. The two commonly used swaps are: Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency. 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 receives floating.

PARTICIPANTS IN THE DERIVATIVES MARKET The following three broad categories of participants who trade in the derivatives market: 1. Hedgers 2. Speculators and 3. Arbitrageurs

Hedgers:

Hedgers face risk associated with the price of an asset. They use futures or options markets to reduce or eliminate this risk.

Speculators: Speculators wish to bet on future movements in the price of an asset. Futures and Options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture.

Arbitrageurs: Arbitrageurs are in business to take advantage of a discrepancy between prices in two different markets. For example, they see the futures price of an asset getting out of line with the cash price; they will take offsetting positions in the two markets to lock in a profit.

FUNCTIONS OF THE DERIVATIVES MARKET: The derivatives market performs a number of economic functions. They are: 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. 2. Derivatives, due to their inherent nature, are linked to the underlying cash markets. With the introduction of derivatives, the underlying market witnesses higher trading volumes because of participation by more players who would not otherwise participate for lack of an arrangement to transfer risk. 3. Speculative trades shift to a more controlled environment of derivatives market. In the absence of an organized derivatives market, speculators trade in the underlying cash markets. 4. An important incidental benefit that flows from derivatives trading is that it acts as a catalyst for new entrepreneurial activity.

5. Derivatives markets help increase savings and investment in the long run. Transfer of risk
enables market participants to expand their volume of activity.

FUTURES:
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered and a standard timing of such settlement. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transactions are offset this way. The standardized items in a futures contract are: Quantity of the underlying Quality of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement The basic flow of a transaction between three parties, namely Buyer, Seller and Clearing Corporation is depicted in the diagram below:

STOCK INDEX FUTURES Stock Index futures are the most popular financial futures, which have been used to hedge or manage the systematic risk by the investors of Stock Market. They are called hedgers who own portfolio of securities and are exposed to the systematic risk. Stock Index is the apt hedging asset since the rise or fall due to systematic risk is accurately shown in the Stock Index. Stock index futures contract is an agreement to buy or sell a specified amount of an underlying stock index traded on a regulated futures exchange for a specified price for settlement at a specified time future. Stock index futures will require lower capital adequacy and margin requirements as compared to margins on carry forward of individual scrip. The brokerage costs on index futures will be much lower. Savings in cost is possible through reduced bid-ask spreads where stocks are traded in packaged forms. The impact cost will be much lower in case of stock index futures as opposed to dealing in individual scrip. The market is conditioned to think in terms of the index and therefore would prefer to trade in stock index futures. Further, the chances of manipulation are much lesser.

The Stock index futures are expected to be extremely liquid given the speculative nature of our markets and the overwhelming retail participation expected to be fairly high. In the near future, stock index futures will definitely see incredible volumes in India. It will be a blockbuster product and is pitched to become the most liquid contract in the world in terms of number of contracts traded if not in terms of notional value. The advantage to the equity or cash market is in the fact that they would become less volatile as most of the speculative activity would shift to stock index futures. The stock index futures market should ideally have more depth, volumes and act as a stabilizing factor for the cash market. However, it is too early to base any conclusions on the volume or to form any firm trend. The difference between stock index futures and most other financial futures contracts is that settlement is made at the value of the index at maturity of the contract.

FUTURES TERMINOLOGY Spot price: The price at which an asset trades in the spot market. Futures price: The price at which the futures contract trades in the futures market. Contract cycle: The period over which a contract trades. The index futures contracts on the NSE have one- month, two-month and three months expiry cycles which expire on the last Thursday of the month. Thus a January expiration contract expires on the last Thursday of January and a February expiration contract ceases trading on the last Thursday of February. On the Friday following the last Thursday, a new contract having a three- month expiry is introduced for trading. Expiry date: It is the date specified in the futures contract. This is the last day on which the contract will be traded, at the end of which it will cease to exist. Contract size: The amount of asset that has to be delivered less than one contract also called as lot size. Basis: In the context of financial futures, basis can be defined as the futures price minus the spot price. There will be a different basis for each delivery month for each contract. In a normal market, basis will be positive. This reflects that futures prices normally exceed spot prices. Cost of carry: The relationship between futures prices and spot prices can be summarized in terms of what is known as the cost of carry. This measures the storage cost plus the interest that is paid to finance the asset less the income earned on the asset.

Initial margin: The amount that must be deposited in the margin account at the time a futures contract is first entered into is known as initial margin. Marking-to-market: In the futures market, at the end of each trading day, the margin account is adjusted to reflect the investor's gain or loss depending upon the futures closing price. This is called marking-to-market. Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the balance in the margin account never becomes negative. If the balance in the margin account falls below the maintenance margin, the investor receives a margin call and is expected to top up the margin account to the initial margin level before trading commences on the next day.

TRADING FUTURES To understand futures trading and profit/loss that can occur while trading, knowledge of pay-off diagrams is necessary. Pay-off refers to profit or loss in a trade. A pay-off is positive if the investor makes a profit and negative if he makes a loss. A pay-off diagram represents profit/loss in the form of a graph which has the stock price on the X axis and the profit/ loss on the Y axis. Thus, from the graph an investor can calculate the profit or loss that his position can make for different stock price values. Forwards and futures have same pay-offs. In other words, their profit/loss values behave in a similar fashion for different values of stock price.

PAY-OFF OF FUTURES The Pay-off of a futures contract on maturity depends on the spot price of the underlying asset at the time of maturity and the price at which the contract was initially traded. There are two positions that could be taken in a futures contract: a. Long position: one who buys the asset at the futures price (F) takes the long position and b. Short position: one who sells the asset at the futures price (F) takes the short position

In general, the pay-off for a long position in a futures contract on one unit of an asset is: Long Pay-off = S T F Where F is the traded futures price and ST is the spot price of the asset at expiry of the contract (that is, closing price on the expiry date). This is because the holder of the contract is obligated to buy the asset worth ST for F. Similarly, the pay-off from a short position in a futures contract on one unit of asset is: Short Pay-off = F ST Pay-off diagram for a long futures position Below depicts the payoff diagram for an investor who is long on a futures contract. The investor has gone long in the futures contract at a price F.

Long Futures

Payoff for Long Futures

The long investor makes profits if the spot price (ST) at expiry exceeds the futures contract price F, and makes losses if the opposite happens. In the above diagram, the slanted line is a 45 degree line, implying that for every one rupee change in the price of the underlying, the profit/ loss will change by one rupee. As can be seen from the diagram, if ST is less than F, the investor makes a loss and the higher the ST, the lower the loss. Similarly, if S T is greater than F, the investor makes a profit and higher the S T, the higher is the profit. Pay-off diagram for a short position Below is the pay-off diagram for someone who has taken a short position on a futures Contract on the stock at a price F. Short Futures

Payoff for Short Futures Here, the investor makes profits if the spot price (ST) at expiry is below the futures contract price F, and makes losses if the opposite happens. Here, if ST is less than F, the investor makes a profit and the higher the ST, the lower the profit. Similarly, if ST is greater than F, the investor makes a loss and the higher the S T, the lower is the profit. As can be seen from the pay-off diagrams for futures contracts, the pay-off is depicted by a straight line (both buy and sell). Such pay-off diagrams are known as linear pay-offs.

A THEORETICAL MODEL FOR FUTURE PRICING

While futures prices in reality are determined by demand and supply, one can obtain a theoretical

Futures price, using the following model: Where: F = Futures price S = Spot price of the underlying asset r = Cost of financing (using continuously compounded interest rate) T = Time till expiration in years e = 2.71828 Example: Security XYZ Ltd trades in the spot market at Rs. 1150. Money can be invested at 11% per annum. The fair value of a one-month futures contract on XYZ is calculated as follows:

This model is also called the cost of carry model of pricing futures. It calculates the Fair Value of futures contract (Rs. 1160) based on the current spot price of the underlying asset (Rs. 1150), interest rate and time to maturity. Every time the market price for futures (which is determined by demand and supply) deviates from the fair value determined by using the above formula, arbitragers enter into trades to capture the arbitrage profit. For example, if the market price of the Future is higher than the fair value, the arbitrageur would sell in the futures market and buy in the spot market simultaneously and hold both trades till expiry and book riskless profit. As more and more people do this, the Future price will come down to its fair value level.

CONTRACT SPECIFICATIONS FOR INDEX BASED FUTURES

Index futures are futures contracts on an index, like the Nifty. The underlying asset in case of index futures is the index itself. For example, Nifty futures traded in NSE track spot Nifty returns. If the Nifty index rises, so does the payoff of the long position in Nifty futures. Apart from Nifty, CNX IT, Bank Nifty, CNX Nifty Junior, CNX 100, Nifty Midcap 50 and Mini Nifty 50 futures contracts are also traded on the NSE. They have one-month, two-month, and threemonth expiry cycle: a one-month Nifty futures contract would expire in the current month, a two-month contract the next month, and a three-month contract the month after. All contracts expire on the last Thursday of every month, or the previous trading day if the last Thursday is a trading holiday. Thus, a September 2009 contract would expire on the last Thursday of September 2009, which would be the final settlement date of the contract. Table summarizes contract specifications for S&P Nifty Index Futures. Contract Specification for S&P Nifty Index Futures

UNDERLYING INDEX S&P CNX NIFTY Exchange of trading National Stock Exchange of India Limited Security Descriptor FUTIDX NIFTY Contract Size Permitted lot size is 50(minimum value Rs 2 lakh) Trading Cycle the future contracts have a maximum of three month trading cycle - the near month (one), the next month (two), and the far month (three). New contracts are introduced on the next trading day following the expiry of the near month contract. Expiry Day The last Thursday of the expiry month or the previous trading day if the last Thursday is a trading holiday Settlement Basis Mark-to-market and final settlement are cash settled on T+1 basis Settlement Price Daily Settlement price is the closing price of the futures contracts for the trading day and the final settlement price is the value of the underlying index on the last trading day

DIFFERENCE BETWEEN FUTURES & OPTIONS:

FUTURES 1) Both the parties are obligated to perform. 2) With futures premium is paid by either party.

OPTIONS 1) Only the seller (writer) is obligated to perform. 2) With options, the buyer pays the seller a

3) The parties to futures contracts must perform premium. at the settlement date only. They are not obligated 3) The buyer of an options contract can exercise to perform before that date. any time prior to expiration date.

4) The holder of the contract is exposed to the 4) The buyer limits the downside risk to the option entire spectrum of downside risk and had the premium but retain the upside potential. potential for all upside return. 5) In options premiums to be paid. But they are

5) In futures margins to be paid. They are very less as compared to the margins. approximate 15-20% on the current stock price.

RISK MANAGEMENT WITH FUTURES

Liquidity risk and basis risk are important considerations when one is com- paring futures and forwards for risk management. In contrast, futures clearing houses and the mark-to-market process essentially eliminate credit risk when futures are used. Using futures to manage price risk also introduces the following risks: 1. Because futures contracts are standardized, the underlying asset, the delivery location, the

quantity, and the delivery date may all differ from the asset that is being hedged. This risk is called basis risk.

2.

If the underlying asset of the futures contract is sufficiently different from the asset being

hedged, it is important to determine the degree to which price changes of the two assets are correlated.

3.

If the date of the hedging horizon lies beyond the date of the most nearby futures

contract, then the choice the correct delivery date must be made. Frequently, hedges must be rolled forward by offsetting the position of nearby contracts and entering into a position in contracts with more distant delivery dates.

4.

Because futures are marked to market daily, futures hedges must be tailed.

Futures contracts enable market participants to alter risks they face that are caused by adverse, unexpected price changes. One of the main reasons cited for the existence of futures markets is that they are a low cost, effective way to transfer price risk. It is no accident that interest rate futures markets did not evolve until the 1970s. Before then, unhedged long or short positions in debt instruments were considerably less risky because their prices rarely changed. When interest rates became volatile in the late 1960s and 1970s, the demand for ways to hedge against this volatility increased, and the interest rate futures market came into existence. The increase in interest rate risk that began in the late 1960s is further illustrated, which graphs the volatility (rolling 60-month standard deviation of monthly interest rates; of Treasury bills and AAA-rated corporates since APRember 1954. Before the late 1960s, the standard deviation of monthly rates was never above l% Volatility did not return to those levels until the late l990s.

Futures contracts are used to manage risk by taking a futures position that is the opposite of the existing or anticipated cash position. In other words, a hedger sells futures against a long position in the cash asset or buys futures against a short position in the cash asset.

Rolling volatility (standard deviation) of three-month discount rates on bills (upper curve) and Treasury AAA-rated corporate bond yields (lower curve), APRember 1959-March 2001.

Futures hedges are often characterized as either long hedges or short hedges. In a long hedge, one buys futures contracts. The hedger either is current short the cash good or has a future commitment to buy the good at the spot rice that will exist at a later date (the price is a random variable) in either case, the long hedge the risk that prices will raise. Because the long hedger has long future position and a short cash position, any subsequent price rise should lead to a profit in the futures market and a loss in the cash market. The hedger should also be aware that prices may fall' in which case a profit will be earned on the spot position, while a loss will be sustained in the futures market. Note their the success of this depends on the linkage between price changes in the two markets; that is, the hedger must be reasonably sure that the changes in the value of his cash position and changes in the future, price will be correlated.

A long hedge might be used by a mutual fund or pension fund money manager who is anticipating the receipt of a large sum of money to invest. The manager expects asset prices to rise between today and the day that the cash will be received. Thus, he should buy future contracts calling for delivery of an asset (e.g. a stock index or Treasury bond) that is similar to the asset he intends to buy upon receiving the cash. If prices rise, more will have to be paid for the cash assets (a loss in the spot market), but a profit will have been earned on the futures contracts. Long hedges such as this are called anticipatory hedges, because they are done in anticipation of a subsequent long position.

In a short hedge, futures contracts are sold. Here, the hedger fears that prices will fall, because if they do, losses will be sustained on the spot position. Typically, the short hedger either is currently long the cash good or has a commitment to sell it in the future at an unknown price, with the hedge in place, if prices do indeed APRline, losses will occur on the cash position, but profits should be earned on the short futures position.

A firm that is planning on issuing new debt securities (corporate bonds, or commercial paper) in the near future might use a short hedge. It fears that between today and the issuance day, security prices will APRline (interest rates will rise). Thus, the firm should sell futures. The asset underlying the futures contracts should be debt instruments that will have price changes correlated with price changes of the securities the firm plans on issuing. Then if security prices do indeed APRline, the new securities will have to be sold at a lower price (a loss in the spot market), but the hedger will also realize gains on the short futures position. The primary motivation of hedging is risk reduction. Because the gains in the futures market offset losses in the cash market, and vice versa, the variability of returns to the hedger is lower than when an unhedged position is held.

Most hedges are cross hedges. A cross hedge is one in which the cash asset and the asset underlying the futures contract are not identical. This situation arises when the hedger uses a futures contract with an underlying asset different from the one he is currently long or short. For example, consider a hedger who uses S&P 500 futures contracts to hedge against a APRline in the value of his portfolio, which is different from the 500 component stocks in the S&P 500. Or con- sider an oil refiner who anticipates the purchase of crude oil in the near future. The firm can hedge against possible price increases by going long crude oil futures. This will be a cross hedge if the quality of crude oil the refiner will likely purchase is not the same as the quality of crude oil under- lying the futures contract. It will also be considered a cross hedge if the location of the refinery differs from the location at which the crude oil futures contract is being priced; since the price of oil will be different at the two locations. When the price or value of the asset being hedged differs from the price or value of the asset underlying the futures contract, we say that basis risk exists.

An investor who uses T-bill futures contracts to hedge against undesired price changes in any debt instrument other than a 90-day T-bill also has a cross hedge. In fact, the only hedging situation that is not a cross hedge with T-bill futures contracts arises when one is anticipating the purchase or sale of 90-day T-bills on the contract's delivery date. If you are currently long $ I million in T:-bills that have 90 days to maturity today and hedge with the T-bill futures contract, you are cross hedging, because the futures contract prices 90 day T-bills it on the delivery date, not today.

Your T-bills may have 90 days to maturity today, but they will have 89 days to maturity tomorrow 88 days to maturity on the day after that and still fewer days to maturity on the T-bill futures contract's delivery date. In general, differences in coupon, maturity, or type of debt instrument will create cross hedges when interest rate futures contracts are used.

Because of basis risk, the correlation between the price movements of the futures contract and the cash asset being hedged becomes important. The hedger must be confident that price changes of the spot asset and the futures contract will move together. Basis refers to the difference between the price of a cash asset and the futures price: Basis = cash price-futures price The relevant cash price differs for different individuals. For a hedger, what is important is the difference between the price of the cash asset that he is long or short (as opposed to the deliverable asset) and the futures price. For example, if a New Jersey refinery is planning to purchase Mexican oil and pay the New Jersey crude oil price, then the basis risk of concern is third difference between the New Jersey crude price and the NYMEX futures price. But theunderlying asset of NYMEX crude oil futures contracts is West Texas Intermediate crude oil, priced in Cushing, Oklahoma. For this hedger, the cash asset, defined in terms of the oil's quality and its physical location, differs in quality and location from the crude oil that determines the futures price.

In contrast, when speculators and arbitrageurs discuss basis, they use the price of the deliverable asset underlying the contract. To illustrate, consider the case of the S&P 500 futures contract: & hedger would be concerned with the difference in the value of the stock portfolio being hedged the futures price of the S&P 500 futures contract. In contrast; an arbitrageur would be con with how the futures price deviates from the' value-weighted portfolio of 500 stocks that the spot S&P 500 index.

Finally, for interest rate futures, basis is sometimes. Defined as the difference between the for price and the futures price, or between the forward yield implicit in the today's term structure the futures yield. The determination of forward interest rates implicates in the spot prices of debt movements. Recall that buying a debt security of one maturity in the market and simultaneously selling a debt security of another maturity in the spot market creates a synthetic forward instrument and determines a forward price (and a forward interest rate).

A hedger exchanges price risk for basis risk. To understand this statement, consider an individually who is currently long or short one unit of a cash asset. The current spot price of that asset is so. The risk is that the price of the cash asset will change to In other words, the risk faced by an unheeded investor is The hedger should use a futures contract on one unit of an underlying asset that will move in m with the cash asset being hedged. Then the risk equals the change in the price of the cash minus the change in the futures price:

The minus sign used between the two terms in parentheses accounts for the fact that the hedger a position in the futures market that is the opposite of the one that exists in the spot market. The basis at time l, basis, is generally a random variable. That is as of time 0, the basis that will exist at time 1 is usually unknown.

An unhedged individual faces price risk: the risk that the price of the cash asset will change. A hedged investor faces basis risk: the risk that the basis will change. Upon combining the definition of basis, S-F and the theoretical cost-of-carry model, carry model, F=S+CC CRew conclude that basis should theoretically equal carry returns minus carry costs. This is also frequently called the net of carry:

Because of convergence, some of the change in basis is predictable. That is, the basis is known to be zero on the delivery date if the cash asset exactly matches the underlying asset of the futures contract. If the basis is guaranteed to remain unchanged, or if it is perfectly predictable at the end of the hedging horizon, the investor can create a perfect hedge. Since, however, the basis on the day the hedge is lifted is rarely known with certainty, perfect futures hedges are rare in practice. To minimize basis risk, price changes of the cash asset and the futures price must be highly correlate higher the correlation between the price changes of the cash asset and futures contract, the I the level of basis risk. As the asset underlying the futures contract becomes more like the asset, the correlation between the two approaches, and basis risk is reduced. Some aggressive hedgers will "speculate on the basis." A hedger must APRide on the of futures contract to trade with a view to reducing the overall risk exposure as much as If, however, a hedger believes that the basis will change in some predictable way, this hedge try to profit by trading fewer contracts than would normally be the case, or additional than normal.

SOME SPECIAL CONSIDERATIONS IN HEDGING WITH FUTURES The most important decision when one is hedging-whether to go long or short futures-requires proper identification of the direction of risk exposure. Determining the proper number of con to trade is also very important and will be discussed, the decision hedge with futures requires both the choice of the proper underlying asset as well as the delivery month. Choosing the correct underlying asset or assets can be difficult. Because are standardized, a contract that precisely matches the underlying asset being hedged may trade on any exchange. For example, Treasury bill, Eurodollar, and/or Treasury note might be used to hedge a portfolio of money market instruments and short-term debt securities have an average time to maturity of one year.

Selecting the delivery month can also require analysis. For example, suppose you are explaining a cash flow on July 20, and futures contracts with delivery dates only in June and September, exist. You can (a) use June futures and bear price risk between the delivery date and July 20' use June futures today, offset the June contract just before delivery, and then (in June) September futures to hedge, or (c) use September futures today and bear the basis risk that when you offset the September futures position on July 20.

Sometimes there are several hedging horizon dates. For example, a jeweler might anticipate he purchase of gold every three months over the next year or two. These situations require the risk a strip hedge requires the use of contracts with different delivery dates. A stacking hedge requires using contracts with only one delivery date, usually the nearest one. As that delivery date is bears, the hedger rolls out of the expiring contracts (They are offset) and moves into contracts with more distant delivery dates. deciding to use a strip hedge or a rolling hedge will depend on several factors. First the hedger must consider the liquidity of the nearby contract relative to the liquidity of contracts more distant delivery dates. Sometimes the hedging horizon lies beyond the latest date of any futures contract, in which case the hedge must be rolled over at least once. They nearby contract will usually be more liquid than contracts with distant delivery dates, and therefore will have a narrower bid-asked spread. Thus, when liquidity is a factor, a rolling hedge is usually appropriate, all else equal.

On the other hand, transactions costs will usually be lower when one is employing a strip hedge. The rolling hedge requires trading two times as many futures contracts (30) as the strip hedge. Another factor in deciding between the two methods is relative mispricing. Is the contract with the more distant delivery more or less overpriced than the nearby contract? Finally, be basis risk for a rolling hedge is usually greater than the basis risk existing in a strip hedge.

It is important to understand the difference between micro hedging and. A hedge is one that protects an individual transaction. The concept of micro hedging requires of the firm examine its overall exposure to risk factors. In other words, one division of a company may be exposed to the risk that the exchange rate will raise, while another division may be a declining rate. Overall, the firm might be hedged, and there is clearly no need for cross hedging. Firms should definitely examine their overall risk exposure before deciding hedging is needed.

In addition to these decisions, the hedger must determine the optimal number of futures contacts to trade. Two different ways of determining the proper number of futures contracts to buy or sell when one is hedge, Note that the process of selecting which futures contract and the number of futures contract to trade is frequently described as an art There is no substitute for gathering as much information as possible and carefully analyzing the date to establish a predicted relationship between the price of the cash good being hedged and a futures price. Native use of any one approach without careful thought can lead to costly errors. In both approaches we discus, the hedge ratio is defined to be the ratio between the number of futures contracts each on one unit of an underlying asset) required to hedge on unit of a cash asset that must be hedged.

For example, if it is determined that 1.2 Treasury note futures contracts are needed to hedge each Treasury note, then the hedge ratio is 1.2. If 0.95 crude oil futures contracts (each on one barrel of crude oil) must be sold to hedge the future production of one barrel of crude, then the hedge ratio is 0.95.

MANAGING THE FUTURE HEDGE

Hedgers recognize the price risk they face, and they hedge that risk by purchasing or selling the proper number of futures contracts with the appropriate underlying commodity. The hedger first estimates using either the regression approach or the dollar equivalency approach. This hedge ratio H* should then be multiplied by the number of units of the spot position being hedged relative to the number of units underlying one futures contract. A tail should be applied if necessary. The final task is to monitor, adjust, and evaluate the hedge.

Sometimes another futures contract becomes more favorably priced for the hedger. In this case' the initial contract used to hedge should be offset, and the better priced futures employed instead' additionally; the hedger should always be aware. Of upcoming delivery dates that will force the hedge to be rolled over. Thus, the hedger should always be aware of upcoming delivery dates that will force the hedge to be rolled over. Thus, the hedger should monitor the relative pricing of the nearby and adjacent contract. With the right information, the rollover trade can be entered as a calendar spread order, thereby reducing commission changes and allowing the hedger to trade when the spread is believed to be favorable.

HEDGERS

These investors have a position in the underlying market but are worried about a potential loss arising out of a change in the asset price in the future. Hedgers participate in the derivatives market to lock the prices at which they will be able to transact in the future. Thus, they try to avoid price risk through holding a position in the derivatives market. Different hedgers take different positions in the derivatives market based on their exposure in the underlying market. A hedger normally takes an opposite position in the derivatives market to what he has in the underlying market. Hedging in futures market can be done through two positions, viz. short hedge and long hedge. Short Hedge A short hedge involves taking a short position in the futures market. Short hedge position is taken by someone who already owns the underlying asset or is expecting a future receipt of the underlying asset.

For example, an investor holding Reliance shares may be worried about adverse future price movements and may want to hedge the price risk. He can do so by holding a short position in the derivatives market. The investor can go short in Reliance futures at the NSE. This protects him from price movements in Reliance stock. In case the price of Reliance shares falls, the investor will lose money in the shares but will make up for this loss by the gain made in Reliance Futures. Note that a short position holder in a futures contract makes a profit if the price of the underlying asset falls in the future. In this way, futures contract allows an investor to manage his price risk. Similarly, a sugar manufacturing company could hedge against any probable loss in the future due to a fall in the prices of sugar by holding a short position in the futures/ forwards market. If the prices of sugar fall, the company may lose on the sugar sale but the loss will be offset by profit made in the futures contract. Long Hedge A long hedge involves holding a long position in the futures market. A Long position holder agrees to buy the underlying asset at the expiry date by paying the agreed futures/ forward price. This strategy is used by those who will need to acquire the underlying asset in the future. For example, a chocolate manufacturer who needs to acquire sugar in the future will be worried about any loss that may arise if the price of sugar increases in the future. To hedge against this risk, the chocolate manufacturer can hold a long position in the sugar futures. If the price of sugar rises, the chocolate manufacture may have to pay more to acquire sugar in the normal market, but he will be compensated against this loss through a profit that will arise in the futures market. Note that a long position holder in a futures contract makes a profit if the price of the underlying asset increases in the future. Long hedge strategy can also be used by those investors who desire to purchase the underlying asset at a future date but wants to lock the prevailing price in the market. This may be because he thinks that the prevailing price is very low.

Clearing members A Clearing member (CM) is the member of the clearing corporation i.e., NSCCL. These are the members who have the authority to clear the trades executed in the F&O segment in the exchange. There are three types of clearing members with different set of functions: 1) Self-clearing Members: Members who clear and settle trades executed by them only on their own accounts or on account of their clients.

2) Trading cum Clearing Members: They clear and settle their own trades as well as trades of other trading members (TM). 3) Professional Clearing Members (PCM): They only clear and settle trades of others but do not trade themselves. PCMs are typically Financial Institutions or Banks who are admitted by the Clearing Corporation as members.

Clearing banks Some commercial banks have been designated by the NSCCL as Clearing Banks. Financial settlement can take place only through Clearing Banks. All the clearing members are required to open a separate bank account with an NSCCL designated clearing bank for the F&O segment. The clearing members keep a margin amount in these bank accounts.

Settlement of Futures When two parties trade a futures contract, both have to deposit margin money which is called the initial margin. Futures contracts have two types of settlement: (i) the mark-to-market (MTM) settlement which happens on a continuous basis at the end of each day, and (ii) the final settlement which happens on the last trading day of the futures contract i.e., the last Thursday of the expiry month.

Mark to market settlement

To cover for the risk of default by the counterparty for the clearing corporation, the futures contracts are marked-to-market on a daily basis by the exchange. Mark to market settlement is the process of adjusting the margin balance in a futures account each day for the change in the value of the contract from the previous day, based on the daily settlement price of the futures contracts. This process helps the clearing corporation in managing the counterparty risk of the future contracts by requiring the party incurring a loss due to adverse price movements to part with the loss amount on a daily basis. Simply put, the party in the loss position pays the clearing corporation the margin money to cover for the shortfall in cash. In extraordinary times, the Exchange can require a mark to market more frequently (than daily). To ensure a fair mark-to-market process, the clearing corporation computes and APRlares the official price for determining daily gains and losses. This price is called the settlement price and represents the closing price of the futures contract. The closing price for any contract of any given day is the weighted average trading price of the contract in the last half hour of trading.

For example, suppose the current spot price of Wipro Ltd. is Rs. 250 per stock. An investor is expecting to have Rs. 250 at the end of the month. The investor feels that Wipro Ltd. is at a very attractive level and he may miss the opportunity to buy the stock if he waits till the end of the month. In such a case, he can buy Wipro Ltd. in the futures market. By doing so, he can lock in the price of the stock. Assuming that he buys Wipro Ltd. in the futures market at Rs.250 (this becomes his locked-in price), there can be three probable scenarios: Scenario I: Price of Wipro Ltd. in the cash market on expiry date is Rs. 300. As futures price is equal to the spot price on the expiry day, the futures price of Wipro would be at Rs. 300 on expiry day. The investor can sell Wipro Ltd in the futures market at Rs. 300. By doing this, he has made a profit of 300 250 = Rs. 50 in the futures trade. He can now buy Wipro Ltd in the spot market at Rs. 300. Therefore, his total investment cost for buying one share of Wipro Ltd equals Rs.300 (price in spot market) 50 (profit in futures market) = Rs.250. This is the amount of money he was expecting to have at the end of the month. If the investor had not bought Wipro Ltd futures, he would have had only Rs. 250 and would have been unable to buy Wipro Ltd shares in the cash market. The futures contract helped him to lock in a price for the shares at Rs. 250.

Scenario II: Price of Wipro Ltd in the cash market on expiry day is Rs. 250. As futures price tracks spot price, futures price would also be at Rs. 250 on expiry day. The investor will sell Wipro Ltd in the futures market at Rs. 250. By doing this, he has made Rs. 0 in the futures trade. He can buy Wipro Ltd in the spot market at Rs. 250. His total investment cost for buying one share of Wipro will be = Rs. 250 (price in spot market) + 0 (loss in futures market) = Rs. 250. Scenario III: Price of Wipro Ltd in the cash market on expiry day is Rs. 200. As futures price tracks spot price, futures price would also be at Rs. 200 on expiry day. The investor will sell Wipro Ltd in the futures market at Rs. 200. By doing this, he has made a loss of 200 250 = Rs. 50 in the futures trade. He can buy Wipro in the spot market at Rs. 200.Therefore, his total investment cost for buying one share of Wipro Ltd will be = 200 (price in spot market) + 50 (loss in futures market) = Rs. 250. Thus, in all the three scenarios, he has to pay only Rs. 250. This is an example of a Long Hedge.

Final settlement for futures After the close of trading hours on the expiry day of the futures contracts, NSCCL marks all positions of clearing members to the final settlement price and the resulting profit/loss is settled in cash. Final settlement loss is debited and final settlement profit is credited to the relevant clearing bank accounts on the day following the expiry date of the contract. Suppose the above contract closes on day 6 (that is, it expires) at a price of Rs. 1040, then on the day of expiry, Rs. 100 would be debited from the seller (short position holder) and would be transferred to the buyer (long position holder).

India bulls Group is one of Indias top business houses with business spread over Real Estate, Infrastructure, Financial Services, Securities, Retail,n Multiplex and Power Sectors. The group companies are listed on important Indian and Overseas markets. India bulls has been conferred the status of a Business Superbrand by the Brand Council, Superbrands India. Vision: To be the largest and most profitable financial services organization in Indian Retail Market and become one stop shop for all non banking financial products and services for the retail customers. Mission: Rapidly increase the number of client relationships by providing a broad array of product offering to emerge as a clear market leader.

Board of Directors:

Mr. Sameer Gelhau (Chairman Indiabulls Group)

Mr. Saurabh K Mittal (Director India bulls Group)

Mr. Rajiv Rattan (Co-Founder & Vice Chairman)

The company headquarters are co-located in Mumbai and Delhi, allowing it to access the two most important regions for Indian financial markets. The marketing and sales efforts are headquartered out of Mumbai, with a regional headquarter in Delhi. Back office, risk management, internal finances etc. are headquartered out of Delhi/NCR allowing the company to scale these processes efficiently for the nation wide network. Market Capitalization: Over 7 Billion US$ Tota Net Worth: Over 2.5 Billion US$

Company is listed on:

National Stock Exchange The National Stock Exchange of India Limited is a Mumabi based stock exchange. It is the largest stock exchange in India in terms of daily turMARer and number of trades, for both equities and derivatives trading. NSE has a market capitalization of around Rs. 4701923

crore (7 October 2009) and is expected to become the biggest stock exchange in India in terms of market capitalization by the end 2009. The NSEs key Index is the S&P CNX Nifty, known as the Nifty, an index of fifty major stocks weighted by market capitalization. NSE is mutually owned by a set of leading financial institutions, banks, insurance companies and othe financial intermediareis in India but its ownership and management operate as separate entities. Bombay Stock Exchange (BSE): The Bombay Stock Exchange Limited is the oldest stock exchsnge in Asia and

has third largest number of listed companies in the world, with 4700 listed as of August 2007. It is located at Dalal Street Mumbai, India. On 31 APRember 2007, the equity market capitalization of the companies listed on the BSE was UD$ 1.79 trillion, making it the largest stock exchange in South Asia and the 12th largest in the world. With over 4700 Indian companies listed & over 7700 scriptson the stock exchange. It has a significant trading volume. The BSE SENSEX also called as BSE 30 is a widely used market index in India and Asia. Though many other exchanges exist, BSE and the National Stock Exchange on India account for most of the teading in shares in India. Luxemburg Stock Exchange: The Luxemburg Stock Exchange is a stock exchange based in Luxemburg city, in Southern Luxemburg. The Exchange is locateg an avenue de la Porte-Neuve. The Chairman of the board is Raymond Kirsch and President of the Executive Committee and Chief executive Officer is Michel Maquil. A law established a stock exchange in Luxemburg was passed on 30th January 1927. The company was incorporated as the Societe Anonyme de la Bourse de Luxemburg on 5th April 1028, with an initial issue of 7000 shares, each valued at 1000 francs. In MARember 2000, it entered into an agreement with Euronext.

Strategic Updates:

India bulls Financial Services Limited (IBFSL) completed the de-merger of its real estate business into a separate publicly traded company, (IBREL) unlocked over Rs. 10000 crore of shareholder wealth.

De-Merger: A situation in which a company sells one or more of its subsidiaries. Shareholders in the original company are usually given the same proportion of shares in the newly independent company.

So De-Merger of India bulls Securities Limited from India bulls financial services Limited. Each shareholder of India bulls Financial Services Limited received a share of India bulls Securities Limited. SARFAESI Act Notification: India bulls Housing Finance Limited, a wholly owned subsidiary of India bulls Financial Services Limited has been notified as a Financial Institution for the purpose of SARFAESI Act, 2002. This notification is being effectively used by the company to yield positive results in speedy recoveries of delinquent mortgage loans.

New Business Venture Updates:

Life Insurance Venture:

India bulls Financial Services Limited (IBFSL) has entered into an MOU with Sogecap, the insurance arm of Society General (SocGen) for its upcoming life insurance joint venture. Sogecap will invest Rs 150 crore to subscribe to 26% of the paid up capital in the joint venture.

Commodities Exchange (ICEX):

A screen based on-line derivatives exchange for commodities and has established a reliable, time tested, and a transparent trading platform. It is also in the process of putting in

place robust assaying and warehousing facilities in order to facilitate deliveries. ICEX is promoted by India bulls Financial Services and MMTC.

Asset Management Business:

India bulls Financial Services Limited proposes to set up an asset management company to manage mutual funds and has applied to SEBI for its approval and the same is awaited.

India bulls Financial Services Limited:

Indiabulls Financial Services is one of Indias leading and fastest growing private sector financial services companies. Indiabulls Financial Services is an integrated financial services

powerhouse providing Consumer Finance, Housing Finance, Commercial Loans, Life Insurance, Asset Management and Advisory services. The company is focused on providing multiple financial services through an extensive network of consumer touch-points covering Tier 1, Tier 2 & Tier 3 cities. Indiabulls serves more than 500,000 customers across different financial products through its branch network, call centers & the internet. It also ranks among the top private sector financial services and banking groups in terms of net worth. India bulls Financial Services Limited was incorporated on January 10, 2000 as M/s Orbis Infotech Private Limited at New Delhi under the Companies Act, 1956. The name of the company was changed to M/s. India bulls Financial services Private Limited on March 16, 2001. In the year 2004, India bulls came up with its own public issue & became a public limited company on February 27, 2004. The company was promoted by three engineers from IIT Delhi, and has attracted more than Rs. 700 million as investments from venture capital, private equity and institutional investors and has developed significant relationships with large commercial banks sucas citibank, HDFC Bank, Union Bank, ICICI Bank, ABN Amro Bank, Standard Chartered Bank.

India bulls Real Estate Limited

India bulls stepped into the real estate market as India bulls Real Estate Limited (IREL) in 2005. A joint venture between India bulls and a US based investment major Farallon Capital Management LLC resulted in bringing FDI (Foreign Direct Investment) for the first time in the Indian real estate market. Another joint venture amongst India bulls and DLF, Kenneth Builders and Developers (KBD), has brought up projects for development of residential apartments. India bulls Real Estate Limited with projects covering a total land area in excess of 10000 acres is one of the largest listed real estate companies in India and a leading national player across multiple realty and infrastructure sectors. IBREL projects include High-end Office and

Commercial Spaces, Premium Residential Developments, Integrated Townships, Luxury Resorts and Special Economic Zones. IBREL is partners with internationally-renowned consultants and construction companies for its developments at various stages of execution.

Our Projects: India bulls are currently evaluating many large-scale projects with the worth of hundred million dollar:

1. One India bulls Centre 2. India bulls Central Park 3. Central Park Madurai 4. Central Park Hyderabad 5. Castlewood 6. India bulls Finance Center 7. High Street Vadodara 8. Central Park Vadodara 9. India bulls Greens 10. Centrum Park 11. India bulls Riverside 12. Gurgoan Housing 13. Sonepat Township 14. Chennai Township 15. India bulls Greens Panvel 16. Mumbai Township 17. Nasik SEZ 18. Raigarh SEZ 19. Goa Luxury Resort

India bulls Power Limited:

India bulls Power Limited was established in 2007 to capitalize on emerging opportunities in the Indian power sector. It develops and intends to operate and maintain power projects in India. India bulls are currently developing five thermal power projects with an aggregate capacity of approximately 6600 MW. These projects include: Amravati Phase-I (1320 MW), Amravati Phase-II (1320 MW), Nasik (1335 MW) in Maharashtra, Bhaiyathan Thermal Power Project (1320 MW), Chhattisgarh Power Project (1320 MW). In addition to the above India bulls is also developing four medium size Hydro Power Projects in Arunachal Pradesh aggregating to 167 MW. The Company is a subsidiary of IBREL, a part of the Indiabulls Group and listed on the BSE and the NSE. IBREL focuses on construction and development of properties, project management, investment advisory and construction services, with operations spanning all aspects of real estate development, from the identification and acquisition of land, to the planning, execution, construction and marketing of its projects (including architecture, design management and interior design), through to the maintenance and management of its completed developments, as well as providing consultancy services on engineering, industrial and technical matters to various industries including companies engaged in construction-development of real estate and infrastructure projects.

India bulls Securites Limited:

India bulls Securities Limited is Indias leading capital markets company with All-India presence and an extensive client base. India bulls Securities is the first and only brokerage house in India to be assigned the highest rating BQ 1 by CRISIL. India bulls Securities Limited is listed on NSE, BSE & Luxemburg stock exchange. India bulls also provide commodity brokerage services under India bulls Commodities Limited (ICL). It deals in research work and formation of reports on agricultural commodities and metals. ICL has one of the largest retail branch networks in the country. Milestones Achieved

Developed one of the first internet trading platforms in India Amongst the first to develop in-house real-time CTCL (computer to computer link) with NSE

Introduction of integrated accounts with automatic gateways to client bank accounts Development of products such as Power India bulls for high volume traders India bulls Signature Account for self-directed investors India bulls Group Professional Network for information and trading service

Group Structure
India bulls Group structure has five separately listed five companies with susdiaries which contributed in enhancing the scope and profile of the business.

INDUSTRY PROFILE
INVESTMENT IN INDIAN MARKET India is believed to be a good investment despite political uncertainty, bureaucratic hassles, and shortages of power and infrastructure deficiencies. India presents a vast potential for overseas investment and is actively encouraging the entrance of foreign players into the market. No companies, of any size, aspiring to be a global player can, for long ignore this country, which is expected to become one of the top three emerging economies. Success in India Success in India will depend on the correct estimation of the country's potential; underestimation of its complexity or overestimation of its possibilities can lead to failure. While calculating, due consideration should be given to the factor of the inherent difficulties and uncertainties of functioning in the Indian system. Entering India's marketplace requires a welldesigned plan backed by serious thought and careful research. For those who take the time and look to India as an opportunity for long-term growth, not short-term profit- the trip will be well worth the effort. Market potential India is the fifth largest economy in the world (ranking above France, Italy, the United Kingdom, and Russia) and has the third largest GDP in the entire continent of Asia. It is also the second largest among emerging nations. (These indicators are based on purchasing power parity). India is also one of the few markets in the world, which offers high prospects for growth and earning potential in practically all areas of business. Despite the practically unlimited

possibilities in India for overseas businesses, the world's most populous democracy has, until fairly recently, failed to get the kind of enthusiastic attention generated by other emerging economies such as China. Lack of enthusiasm among investors The reason being, after independence from Britain 50 years ago, India developed a highly protected, semi-socialist autarkic economy. Structural and bureaucratic impediments were vigorously fostered, along with a distrust of foreign business. Even as today the climate in India has seen a sea change, smashing barriers and actively seeking foreign investment, many companies still see it as a difficult market. India is rightfully quoted to be an incomparable country and is both frustrating and challenging at the same time. Foreign investors should be prepared to take India as it is with all of its difficulties, contradictions and challenges. Developing a basic understanding or potential of the Indian market Envisaging and developing a Market Entry Strategy and implementing these strategies when actually entering the market are three basic steps to make a successful entry into India. The Indian middle class is large and growing; wages are low; many workers are well educated and speak English; investors are optimistic and local stocks are up; despite political turmoil, the country presses on with economic reforms. But there is still cause for worries- Infrastructure hassles. The rapid economic growth of the last few years has put heavy stress on India's infrastructure facilities. The projections of further expansion in key areas could snap the already strained lines of transportation unless massive programs of expansion and modernization are put in place. Problems include power demand shortfall, port traffic capacity mismatch, poor road conditions (only half of the country's roads are surfaced) and low telephone penetration. Indian Bureaucracy Although the Indian government is well aware of the need for reform and is pushing ahead in this area, business still has to deal with an inefficient and sometimes still slow-moving bureaucracy.

Diverse Market The Indian market is widely diverse. The country has 17 official languages, 6 major religions, and ethnic diversity as wide as all of Europe. Thus, tastes and preferences differ greatly among sections of consumers. Therefore, it is advisable to develop a good understanding of the Indian market and overall economy before taking the plunge.