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Analysis of Investment in Stock Market & Portfolio Management Using Instrument Derivatives – Futures

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INDUSTRY PROFILE

Journey of Indian stock market

Indian Stock Markets are one of the oldest in Asia. Its history dates

back to nearly 200 years ago. The earliest records of security

dealings in India are meager and obscure. The East India Company

as the dominant institution in those days and business in its loan

securities used to be transacted toards the close of the eighteenth

century.

!y "#$0%s business on corporate stocks and shares in !ank and

Cotton presses took place in !ombay. Though the trading list as

broader in "#$&' there ere only half a do(en brokers recogni(ed

by banks and merchants during "#)0 and "#*0.

The "#*0%s itnessed a rapid de+elopment of commercial

enterprise and brokerage business attracted many men into the

field and by "#,0 the number of brokers increased into ,0.

In "#,0-," the American Ci+il ar broke out and cotton supply from

/nited States of Europe as stopped thus' the %Share Mania% in

India begun. The number of brokers increased to about 200 to 2*0.

1oe+er' at the end of the American Ci+il ar' in "#,*' a disastrous

slump began for e3ample' !ank of !ombay Share hich had

touched 4s 2#*0 could only be sold at 4s. #56.

At the end of the American Ci+il ar' the brokers ho thri+ed out of

Ci+il ar in "#5)' found a place in a street no appropriately

called as 7alal Street6 here they ould con+eniently assemble

and transact business. In "##5' they formally established in

!ombay' the 89ati+e Share and Stock !rokers% Association8 hich

is alternati+ely knon as 8The Stock E3change 86. In "#&*' the

Stock E3change ac:uired a premise in the same street and it as

B.R.C.M. College of Business Administration, Surat


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inaugurated in "#&&. Thus' the Stock E3change at !ombay as

consolidated.

Grot! Pattern of t!e Indian Stock "arket

Sr#No#

$s on %&st

Decem'er &()* &(*& &(+& &(+, &(-. &(-, &((& &((,

"9o. of StockE3changes

5 5 # # & ") 20 22

29o. of;isted Cos.

""2* "20$ "*&& "**2 22,* )$)) ,22& #*&$

$

9o. ofStockIssues of;isted Cos.

"*0, 2""" 2#$# $2$0 $,&5 ,"5) #&,5 ""5#)

)

Capital of;istedCos. Cr.4s.6

250 5*$ "#"2 2,") $&5$ &52$ $20)" *&*#$

*

Market+alue of Capital of

;istedCos. Cr.4s.6

&5" "2&2 2,5* $25$ ,5*0 2*$02 ""025& )5#"2"

,

Capital per ;isted Cos.)


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/O"P$NY PROFILE

0otak Securities Limited

>otak Securities ;td.' a subsidiary of >otak Mahindra !ank ;imited'

is one of India?s largest pri+ate brokerage and distribution house'

set up in "&&)' by Mr. /day >otak it has e:uity participation from

@oldman Sachs ;. I. . 2*B6.

>otak Securities is a corporate member of both the !ombay Stock

E3change !SE6 and the 9ational Stock E3change 9SE6. Its

operations include stock broking' distribution of +arious In+estment

products including pri+ate and secondary placement of debt and

e:uity' mutual funds' fi3ed deposits and the like. Currently >otak

Securities is one of the largest broking houses in India ith offices

in more than fifteen cities. In India as ell as a presence in /S'

Europe and the Middle East through our associate companies

>otak Mahindra /.>. ;imited and >otak Mahindra International

;imited' >otak Mahindra Inc6.

Dur core strengths are our e3pertise in e:uity research and a ide

retail distribution netork. e ha+e an outstanding research

di+ision in+ol+ed in macro economic studies' industry and

company specific e:uity research' ith analyst speciali(ing in

particular economic sectors and large cap stocks.

In August 2000' >otak Securities launched >otakstreet.com' its e

broking ser+ice for retail in+estors on the net and currently has o+er

20'000 registered users.



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>otak Securities ;imited is one of the larger players in distribution of

IDs - it as ranked number Dne in 200$-0) as !ook 4unning

;ead Manager in public e:uity offerings by 4IME 7atabase. It has

also on the !est E:uity 1ouse Aard from inance Asia - April200).

The Company has a full-fledged 4esearch di+ision in+ol+ed in

macro economic studies' sectoral research and Company specific

e:uity research combined ith a strong and ell netorked sales

force hich helps deli+er current and up-to-date market information

and nes.

>otak Securities ;imited is also a depository participant ith

9ational Securities 7epository ;imited 9S7;6 and Central

7epository Ser+ices ;imited C7S;6 pro+iding dual benefit ser+ices

herein the in+estors can use the brokerage ser+ices of the

Company for e3ecuting the transactions and the depository ser+ices

for settling them.

The Company has ""$ branches ser+icing around "'00'000

customers' through our on offices and a large franchisee netork.

It?s has an Dnline presence through >otakstreet.com here e offer

Internet !roking ser+ices and also online ID and Mutual und

In+estments.

>otak Securities ;imited manages assets o+er 4s. "500 crores

through it?s ortfolio Management Ser+ices MS6 ser+icing high

net orth clients ith a large in+estible surplus through its preferred

client ser+ices in the mass affluent and ealth management

segments.



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O1JE/TI2E OF T3E STUDY

To pro+ide basic idea of different stock market in+estment

instruments to in+estor.

To pro+ide knoledge to in+estor about +arious type of

risk associated ith +arious in+estment instruments.

To pro+ide in+estor knoledge about FE' F!= and !eta

that ould help them in selection of script and creation of

portfolio.

To help in+estor in learning about deri+ati+e instrument

future for the purpose of speculation and hedging.



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"ET3ODOLOGY OF T3E PROJE/T

Researc! 4ro'5em6To identified the Stock Market In+estment A+enue and methods to

help in+estor in selection of script to create portfolio. And the

measures of hedging the portfolio ith the use of deri+ati+e

instrument future.

Researc! desi7n6

4esearch design is e3ploratory as the basic obGecti+e is to identified

the stocks and methods to create and protect portfolio.

Data co55ection6

Primary data H - rimary data are collected by my regularly

tracking the stock price of +arious script selected

Secondary data H- Secondary data are collected from +arious

Gournals ' ebsites and financial nes paper.



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LI"IT$TIONS OF T3E PROJE/T

The time duration gi+en to complete the report as

not sufficient.

The report is basically is made beteen the hori(on of

to months and the situation of market is +ery

dynamic so the conclusion or the return might not

reflect the true picture.



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Economic in;estments6:

These in+estments refer to the net addition to the capital stock of

the society. The capital stock of the society refers to the

in+estments made in plant' building' land and machinery hich are

used for the further production of the goods. This type of

in+estments are +ery important for the de+elopment of the economy

because if the in+estment are not made in the plant and machinery

the industrial production ill come don and hich ill bring don

the o+erall groth of the economy.

Financia5 In;estments6:

This type of in+estments refers to the in+estments made in the

marketable securities hich are of tradable nature. It includes the

shares' debentures' bonds and units of the mutual funds and any

other securities hich is co+ered under the ambit of the Securities

Contract 4egulations Act definition of the ord security. The

in+estments made in the capital market instruments are of +ital

important for the country economic groth as the stock market

inde3 is called as the barometer of the economy.

Genera5 In;estments6:

These in+estments refer to the in+estments made by the common

in+estor in his on small assets like the tele+ision' car' house'

motor cycle. These types of in+estments are termed as the

household in+estments. Such types of in+estment are important for

the domestic economy of the country. hen the demand in the

domestic economy boost the o+er all productions and the

manufacturing in the industrial sectors also goes up and this causes

rise in the employment acti+ity and thus boost up the @7 groth



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rate of the country. The organi(ations like the Central Statistical

Drgani(ation CSD6 regularly takes the study of the in+estments

made in the household sector hich shos that the le+el of

consumptions in the domestic markets.



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/3$R$/TERISI/S OF IN2EST"ENT

Certain features characteri(e all in+estments. The folloing are the

main characteristics features if in+estmentsH -

Return6 -

All in+estments are characteri(ed by the e3pectation of a return. In

fact' in+estments are made ith the primary obGecti+e of deri+ing a

return. The return may be recei+ed in the form of yield plus capital

appreciation. The difference beteen the sale price the purchase

price is capital appreciation. The di+idend or interest recei+ed from

the in+estment is the yield. 7ifferent types of in+estments promise

different rates of return. The return from an in+estment depends

upon the nature of in+estment' the maturity period a host of other

factors.


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%# Safety6 :

The safety of an in+estment implies the certainty of return of capital

ithout loss of money or time. Safety is another features hich an

in+estors desire for his in+estments. E+ery in+estor e3pects to get

back his capital on maturity ithout loss ithout delay.

)# Li=uidity6 :

An in+estment' hich is easily saleable' or marketable ithout loss

of money ithout loss of time is said to possess li:uidity. Some

in+estments like company deposits' bank deposits' .D. deposits'

9SC' 9SS etc. are not marketable. Some in+estment instrument

like preference shares debentures are marketable' but there are

no buyers in many cases hence their li:uidity is negligible. E:uity

shares of companies listed on stock e3changes are easily

marketable through the stock e3changes.

An in+estor generally prefers li:uidity for his in+estment' safety of

his funds' a good return ith minimum risk or minimi(ation of risk ma3imi(ation of return.



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I"PORT$N/E

In the current situation' in+estment is becomes necessary for

e+eryone it is important useful in the folloing aysH

Retirement 45annin76 :

In+estment decision has become significant as people retire

beteen the ages of ** ,0. Also' the trend shos longer life

e3pectancy. The earning from employment should' therefore' be

calculated in such a manner that a portion should be put aay as a

sa+ings. Sa+ings by themsel+es do not increase ealth these must

be in+ested in such a ay that the principal income ill be

ade:uate for a greater number of retirement years. Increase in

orking population' proper planning for life span longe+ity ha+e

ensured the need for balanced in+estments.

ation6 :

Ta3ation is one of the crucial factors in any country' hich introduce

an element of compulsion' in a person?s sa+ing. In the form

in+estments' there are +arious forms of sa+ing outlets in our

country' hich help in bringing don the ta3 le+el by offering

deductions in personal income.

or e3amplesH -

0 /nit linked insurance plan'

" ;ife insurance'

2 9ational sa+ing certificates'

$ 7e+elopment bonds'

) ost office cumulati+e deposit schemes etc.



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%# Rates of interest6 :

It is also an important aspect for sound in+estment plan. It +aries

beteen in+estment another. This may +ary beteen risky safe

in+estment' they may also differ due different benefits schemes

offered by the in+estments. These aspects must be considered

before actually in+esting. The in+estor has to include in his portfolio

se+eral kinds of in+estments stability of interest is as important as

recei+ing high rate of interest.

)# Inf5ation6 :

Since the last decade' no a day?s inflation becomes a continuous

problem. In these years of rising prices' se+eral problems are

associated coupled ith a falling standard of li+ing. !efore funds

are in+ested' erosion of the resource ill ha+e to be carefully

considered in order to make the right choice of in+estments. The

in+estor ill try search outlets' hich gi+es him a high rate of

return in form of interest to co+er any decrease due to inflation. 1e

ill also ha+e to Gudge hether the interest or return ill becontinuous or there is a likelihood of irregularity. Coupled ith high

rate of interest' he ill ha+e to find an outlet' hich ill ensure

safety of principal. !eside high rate of interest safety of principal

an in+estor also has to alays bear in mind the ta3ation angle' the

interest earned through in+estment should not unduly increase his

ta3ation burden otherise the benefit deri+ed from interest ill be

compensated by an increase in ta3ation.



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,# Income6 :

or increasing in employment opportunities in India.' in+estment

decisions ha+e assumed importance. After independence ith the

stage of de+elopment in the country a number of organi(ation

ser+ices came into being.

For e>am45e6 -

The Indian administrati+e ser+ices'

!anking recruitment ser+ices'

E3pansion in pri+ate corporate sector'

ublic sector enterprises'Establishing of financial institutions' tourism' hotels' and education.

More a+enues for in+estment ha+e led to the ability illingness of

orking people to sa+e in+est their funds.

*# In;estment c!anne5s6 :

The groth de+elopment of country leading to greater economicacti+ity has led to the introduction of a +ast array of in+estment

outlays. Apart from putting aside sa+ing in sa+ings banks here

interest is lo' in+estor ha+e the choice of a +ariety of instruments.

The :uestion to reason out is hich is the most suitable channelJ

hich media ill gi+e a balanced groth stability of returnJ The

in+estor in his choice of in+estment ill gi+e a balanced groth

stability of returnJ The in+estor in his choice of in+estment ill ha+e

try achie+e a proper mi3 beteen high rates of return to reap the

benefits of both#

For e>am45e6 :

0 i3ed deposit in corporate sector

" /nit trust schemes.



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IN2EST"ENTS $2ENUES6:

There are +arious in+estments a+enues pro+ided by a country to its

people depending upon the de+elopment of the country itself. The

de+eloped countries like the /SA and the Kapan pro+ide +ariety of

in+estments as compared to our country. In India before the post

liberali(ation era there ere limited in+estments a+enues a+ailable

to the people in hich they could in+est. ith the opening up of the

economy the number of in+estments a+enues ha+e also increased

and the :uality of the in+estments ha+e also impro+ed due to the

use of the professional acti+ity of the players in+ol+ed in thissegment. Today in+estment is no longer a process of trial and error

and it has become a systemati(ed process' hich in+ol+es the use

of the professional in+estment solution pro+ider to play a greater

role in the in+estment process.

Earlier the in+estments ere made ithout any analysis as the

comple3ity in+ol+ed the in+estment process ere not there and also

there as no a+ailability of +ariety of instruments. !ut today as the

number of in+estment options ha+e increased and ith the +ariety

of in+estments options a+ailable the in+estor has to take decision

according to his on risk and return analysis.

$n in;estor !as a ide array of In;estment $;enue# T!ey are

as under6



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Ty4es of E=uity Instruments6

Ordinary S!ares

Drdinary shareholders are the oners of a company' and each

share entitles the holder to onership pri+ileges such as di+idends

declared by the company and +oting rights at meetings. ;osses as

ell as profits are shared by the e:uity shareholders. ithout any

guaranteed income or security' e:uity shares are a risk in+estment'

bringing ith them the potential for capital appreciation in return for the

additional risk that the in+estor undertakes in comparison to debt

instruments ith guaranteed income.

Preference S!ares

/nlike e:uity shares' preference shares entitle the holder to di+idends

at fi3ed rates subGect to a+ailability of profits after ta3. If preference

shares are cumulati+e' unpaid di+idends for years of inade:uate

profits are paid in subse:uent years. reference shares do not

entitle the holder to onership pri+ileges such as +oting rights at

meetings.

E=uity 8arrants

These are long term rights that offer holders the right to purchase

e:uity shares in a company at a fi3ed price usually higher than the

current market price6 ithin a specified period. arrants are in the

nature of options on stocks.


EQUITY SHARES: -


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/5assification in terms of "arket /a4ita5isation

"arket ca4ita5isation is e:ui+alent to the current +alue of a company

i.e. current market price per share times the number of outstanding

shares. There are ;arge Capitalisation companies' Mid-Cap

companies and Small-Cap companies. 7ifferent schemes of a fund

may define their fund obGecti+e as a preference for Lar7e or "id or

Sma55:/a4 companies% shares. ;arge Cap shares are more li:uid and

hence easily tradable. Mid or Small Cap shares may be thought of

as ha+ing greater groth potential. The stock markets generally

ha+e different indices a+ailable to track these different classes of shares.

/5assification in terms of $ntici4ated Earnin7s

In terms of the antici4ated earnin7s of the companies' shares are

generally classified on the basis of their market price in relation to

one of the folloing measuresH

? Price@Earnin7s Ratio is the price of a share di+ided by the

earnings per share' and indicates hat the in+estors are illing

to pay for the company%s earning potential. Loung and


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!ased on companies% anticipated earnings and in the light of the

in+estment management e3perience the orld o+er' stocks are

classified in the folloing groupsH

• /yc5ica5 Stocks are shares of companies hose earnings are

correlated ith the state of the economy. Their earnings and

therefore' their share prices6 tend to go up during upard

economic cycles and +ice +ersa. Cement or Aluminium

producers fall into this category' Gust as an e3ample. These

companies may command relati+ely loer


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Many instruments gi+e regular income. 7ebt instruments may be

secured by the assets of the borroers as generally in case of

Corporate 7ebentures' or be unsecured as is the case ith Indian

inancial Institution !onds.

A debt security is issued by a borroer and is often knon by the

issuer category' thus gi+ing us @o+ernment Securities and Corporate

Securities or I bonds. 7ebt instruments are also distinguished by their

maturity profile. Thus' instruments issued ith short-term maturities'

typically under one year' are classified as Money Market Securities.

Instruments carrying longer than one-year maturities are generally

called 7ebt Securities.

Most debt securities are interest-bearing. 1oe+er' there aresecurities that are discounted securities or (ero-coupon bonds that

do not pay regular interest at inter+als but are bought at a discount

to their face +alue. A large part of the interest-bearing securities are

generally i3ed Income-paying' hile there are also securities that

pay interest on a loating 4ate basis.

$ Re;ie of t!e Indian De't "arket

The holesale 7ebt Market segment deals in fi3ed income

securities and is fast gaining ground in an en+ironment that has

largely focused on e:uities.

The holesale 7ebt Market 7M6 segment of the E3change

commenced operations on Kune $0' "&&). This pro+ided the first

formal screen-based trading facility for the debt market in the

country.


FIBED IN/O"E SE/URITIES


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This segment pro+ides trading facilities for a +ariety of debt

instruments including @o+ernment Securities' Treasury !ills and

!onds issued by ublic Sector /ndertakings< Corporates< !ankslike loating 4ate !onds' ero Coupon !onds' Commercial apers'

Certificate of 7eposits' Corporate 7ebentures' State @o+ernment

loans' S;4 and 9on-S;4 !onds issued by inancial Institutions'

/nits of Mutual unds and Securiti(ed debt by banks' financial

institutions' corporate bodies' trusts and others.

;arge in+estors and a high a+erage trade +alue characteri(e this

segment. Till recently' the market as purely an informal market

ith most of the trades directly negotiated and struck beteen

+arious participants. The commencement of this segment by 9SE

has brought about transparency and efficiency to the debt market'

along ith effecti+e monitoring and sur+eillance to the market.



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1usiness Grot! in 8D" Se7ment

Year

"arket

/a4ita5isationCRs#crores

Num'er

of Trades

Net Traded

2a5ueCRs#crores

$;era7e

Dai5y 2a5ueCRs#crores

$;era7e

Trade SieCRs#crores

200*-200,

"'**$'))# ,0'"*& )*#')$).&) "'#$$.5) 5.,2

200)-200*

"'),"'5$) "2)'$0# ##5'2&$.,, $'02#.$" 5.")

200$-200)

"'2"*'#,) "#&'*"# "'$",'0&,.2) )')5,.*2 ,.&)

2002-

200$

#,)')#" ",5'55# "'0,#'50".*) $'*.$2 ,.$5

200"-2002

5*,'5&) "))'#*" &)5'"&".22 $'255.)# ,.*)

2000-200"

*#0'#$* ,)')50 )2#'*#".*" "')#2. ,.,*

"&&&-2000

)&)'0$$ ),' $0)'2",.2) "'0$).5* ,.)5

"&-"&&&

)""')50 ",'0&2 "0*'),&."$ $,).&* ,.**

"&&5-"&

$)$'"&" ",'#2" """'2,$.2# $55.", ,.,"

"&&,-"&&5

2&2'552 5'#0) )2'255.*& ")*.2# *.)2

"&&*-"&&,

205'5#$ 2'&&" ""'#,5.,# )0.5# $.&5

"&&)-"&&*

"*#'"#" "'02" ,'5#"."* $0.)" ,.,)

Instruments in t!e Indian De't "arket

/ertificate of De4osit


http://www.nseindia.com/content/debt/debt_busgrow2005-06.htmhttp://www.nseindia.com/content/debt/debt_busgrow2005-06.htmhttp://www.nseindia.com/content/debt/debt_busgrow2004-05.htmhttp://www.nseindia.com/content/debt/debt_busgrow2004-05.htmhttp://www.nseindia.com/content/debt/debt_busgrow2003-04.htmhttp://www.nseindia.com/content/debt/debt_busgrow2003-04.htmhttp://www.nseindia.com/content/debt/debt_busgrow2002-03.htmhttp://www.nseindia.com/content/debt/debt_busgrow2002-03.htmhttp://www.nseindia.com/content/debt/debt_busgrow2001-02.htmhttp://www.nseindia.com/content/debt/debt_busgrow2001-02.htmhttp://www.nseindia.com/content/debt/debt_busgrow2000-01.htmhttp://www.nseindia.com/content/debt/debt_busgrow2000-01.htmhttp://www.nseindia.com/content/debt/debt_busgrow1999-00.htmhttp://www.nseindia.com/content/debt/debt_busgrow1999-00.htmhttp://www.nseindia.com/content/debt/debt_busgrow1998-99.htmhttp://www.nseindia.com/content/debt/debt_busgrow1998-99.htmhttp://www.nseindia.com/content/debt/debt_busgrow1997-98.htmhttp://www.nseindia.com/content/debt/debt_busgrow1997-98.htmhttp://www.nseindia.com/content/debt/debt_busgrow1996-97.htmhttp://www.nseindia.com/content/debt/debt_busgrow1996-97.htmhttp://www.nseindia.com/content/debt/debt_busgrow1995-96.htmhttp://www.nseindia.com/content/debt/debt_busgrow1995-96.htmhttp://www.nseindia.com/content/debt/debt_busgrow1994-95.htmhttp://www.nseindia.com/content/debt/debt_busgrow1994-95.htmhttp://www.nseindia.com/content/debt/debt_busgrow2005-06.htmhttp://www.nseindia.com/content/debt/debt_busgrow2005-06.htmhttp://www.nseindia.com/content/debt/debt_busgrow2004-05.htmhttp://www.nseindia.com/content/debt/debt_busgrow2004-05.htmhttp://www.nseindia.com/content/debt/debt_busgrow2003-04.htmhttp://www.nseindia.com/content/debt/debt_busgrow2003-04.htmhttp://www.nseindia.com/content/debt/debt_busgrow2002-03.htmhttp://www.nseindia.com/content/debt/debt_busgrow2002-03.htmhttp://www.nseindia.com/content/debt/debt_busgrow2001-02.htmhttp://www.nseindia.com/content/debt/debt_busgrow2001-02.htmhttp://www.nseindia.com/content/debt/debt_busgrow2000-01.htmhttp://www.nseindia.com/content/debt/debt_busgrow2000-01.htmhttp://www.nseindia.com/content/debt/debt_busgrow1999-00.htmhttp://www.nseindia.com/content/debt/debt_busgrow1999-00.htmhttp://www.nseindia.com/content/debt/debt_busgrow1998-99.htmhttp://www.nseindia.com/content/debt/debt_busgrow1998-99.htmhttp://www.nseindia.com/content/debt/debt_busgrow1997-98.htmhttp://www.nseindia.com/content/debt/debt_busgrow1997-98.htmhttp://www.nseindia.com/content/debt/debt_busgrow1996-97.htmhttp://www.nseindia.com/content/debt/debt_busgrow1996-97.htmhttp://www.nseindia.com/content/debt/debt_busgrow1995-96.htmhttp://www.nseindia.com/content/debt/debt_busgrow1995-96.htmhttp://www.nseindia.com/content/debt/debt_busgrow1994-95.htmhttp://www.nseindia.com/content/debt/debt_busgrow1994-95.htm


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Certificates of 7eposit C76 are issued by scheduled commercial

banks e3cluding regional rural banks. These are unsecured

negotiable promissory notes. !ank C7s ha+e a maturity period of &"

days to one year' hile those issued by Is ha+e maturitiesbeteen one and three years.

/ommercia5 Pa4er

Commercial paper C6 is a short term' unsecured instrument

issued by corporate bodies public pri+ate6 to meet short-term

orking capital re:uirements. Maturity +aries beteen $ months and

" year. This instrument can be issued to indi+iduals' banks'

companies and other corporate bodies registered or incorporated in

India. Cs can be issued to 94Is on non-repatriable and non-

transferable basis.

/or4orate De'entures

The debentures are usually issued by manufacturing companies ith

physical assets' as secured instruments' in the form of certificates

They are assigned a credit rating by rating agencies. Trading in

debentures is generally based on the current yield and market +alues

are based on yield-to-maturity. All publicly issued debentures are

listed on e3changes.



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F5oatin7 Rate 1onds CFR1

These are short to medium term interest bearing instruments

issued by financial intermediaries and corporates. The typical

maturity of these bonds is $ to * years. 4!s issued by financial

institutions are generally unsecured hile those from pri+ate

corporates are secured. The 4!s are pegged to different reference

rates such as T-bills or bank deposit rates. The 4!s issued by the

@o+ernment of India are in the form of Stock Certificates or issued

by credit to S@; accounts maintained by the 4!I.

Go;ernment Securities

These are medium to long term interest-bearing obligations issued

through the 4!I by the @o+ernment of India and state go+ernments.

The 4!I decides the cut-off coupon on the basis of bids recei+ed

during auctions. There are issues here the rate is pre-specified and

the in+estor only bids for the :uantity. In most cases the coupon is

paid semi-annually ith bullet redemption features.

Treasury 1i55s

T-bills are short-term obligations issued through the 4!I by the

@o+ernment of India at a discount. The 4!I issues T-bills for different

tenuresH no &" -days and $,)-days. These treasury bills are issued

through an auction procedure. The yield is determined on the

basis of bids tendered and accepted.

1ank@FI 1onds

Most of the institutional bonds are in the form of promissory notes

transferable by endorsement and deli+ery. These are negotiable

certificates' issued by the inancial Institutions such as the

I7!I


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been issued both as regular income bonds and as discounted long-

term instruments deep discount bonds6.

Pu'5ic Sector Undertakin7s CPSU 1onds

S/ !onds are medium and long term obligations issued by public

sector companies in hich the go+ernment share holding is

generally greater than *"B. Some S/ bonds carry ta3

e3emptions. The minimum maturity is * years for ta3able bonds and

5 years for ta3-free bonds. S/ bonds are generally not guaranteed

by the go+ernment and are in the form of promissory notes

transferable by endorsement and deli+ery. S/ bonds in electronicform demat6 are eligible for repo transactions.

An in+estor can participant in +arious schemes floated by mutual

fund instead of buying e:uity shares. In mutual funds in+est in

e:uity shares fi3ed income securities. There are three broad

types of mutual fund schemes.

@roth schemes

Income schemes

!alanced schemes


"UTU$L FUND S/3E"ES


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It is Gust like fi3ed income securities earn a fi3ed return. 1oe+er'

unlike fi3ed income securities' deposits are negotiable or

transferable. The important types of deposits in India areH

!ank deposits

Company deposits

ostal deposits.

It pro+ides benefits to those ho participate in them. The most

important ta3 sheltered sa+ing schemes in India isH

Employee pro+ident fund scheme

ublic pro+ident fund schemes

9ational sa+ing certificate

In a broad sense' life insurance may be +ieed as an in+estment.

Insurance premiums represent the sacrifice the assured sum the

benefit. In India' the important types of insurance polices areH

Endoment assurance policy

Money back policy

hole life policy

remium back term assurance policy


DEPOSITS

T$B:S3ELTERED S$2ING S/3E"EST$B:S3ELTERED S$2ING S/3E"ES

LIFE INSUR$N/E


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or the bilk of the in+estors the most important asset in their

portfolio is a residential house. In addition to a residential house'

the more affluent in+estors are likely to be interested in the folloing

types of real estateH

Agricultural land

Semi-urban land

PRE/IOUS O1JE/TS6 :

It is highly +aluable in monetary terms but generally they are small

in si(e. The important precious obGects areH

@old sil+er

recious stones

Art obGects

FIN$N/I$L DERI2$TI2ES6 :

A financial deri+ati+e is an instrument hose +alue is deri+ed from

the +alue of underlying asset. It may be +ieed as a side bet on the

asset. The most import financial deri+ati+es from the point of +ie of

in+estors areH

Dptions

utures.


RE$L EST$TE

PRE/IOUS O1JE/TS

FIN$N/I$L DERI2$TI2ES


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RIS0 RETURN OF 2$RIOUS IN2EST"ENT

$2ENUES

E+ery in+estment is characteri(ed by return risk. In+estors

intuiti+ely understand the concept of risk. A person making an

in+estment e3pects to get some return from the in+estment in the

future. !ut' as future is uncertain' so is the future e3pected return. It

is this uncertainty associated ith the returns from an in+estment

that introduces risk into an in+estment. 4isk arises here there is a

possibility of +ariation beteen e3pectation and reali(ation ith

regard to an in+estment.

"eanin7 of Risk

Risk uncertainty are an inte7rate 4art of an in;estment

decision# Tec!nica55y Hrisk can 'e define as situation !ere t!e

4ossi'5e conse=uences of t!e decision t!at is to 'e taken are

knon# HUncertainty is 7enera55y defined to a445y to situations

!ere t!e 4ro'a'i5ities cannot 'e estimated# 3oe;er risk

uncertainty are used interc!an7ea'5y#



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Ty4es of risks

Systematic risk6 :

Systematic risk is non di+ersifiable is associated ith the

securities market as ell as the economic' sociological' political'

legal considerations of prices of all securities in the economy. The

affect of these factors is to put pressure on all securities in such a

ay that the prices of all stocks ill more in the same direction.

E>am45e6 :

7uring a boom period prices of all securities ill rise indicate that

the economy is mo+ing toards prosperity. Market risk' interest rate

risk purchasing poer risk are grouped under systematic risk.

4IS>S

SYSTAMATIC UNSYSTAMATIC

Market Risk Business Risk

Interest Rate Risk Financial Risk

Purchasing p!er Risk



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Systematic Risk

C$ "arket risk

Market risk is referred to as stock +ariability due to changes in

in+estor?s attitudes e3pectations. The in+estor reaction toards

tangible and intangible e+ents is the chief cause affecting Nmarket

risk?.

C1 Interest rate risk

There are four types of mo+ements in prices of stocks in the

markets. These may termed as "6 long term' 26 cyclical bull and

bear markets6' $6 intermediate or ithin the cycle' and )6 short

term. The prices of all securities rise or fall depending on the

change in interest rates. The longer the maturity period of a security

the higher the yield on an in+estment loer the fluctuations in

prices.

" / Purc!asin7 Poer risk

urchasing poer risk is also knon as inflation risk. This risk

arises out of change in the prices of goods ser+ices and

technically it co+ers both inflation and deflation periods. 7uring the

last to decades it has been seen that inflationary pressures ha+e

been continuously affecting the Indian economy. Therefore' in India

purchasing poer risk is associated ith inflation and rising prices

in the economy.



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#$ Unsystematic Risk6 :

The importance of unsystematic risk arises out of the uncertainty

surrounding of particular firm or industry due to factors like labour strike' consumer preferences and management policies. These

uncertainties directly affect the financing and operating en+iourment

of the firm. /nsystematic risks can oing to these considerations be

said to complement the systematic risk forces.

C$ 1usiness risk

E+ery corporate organi(ation has its on obGecti+es and goals and

aims at a particular gross profit operating income also accepts

to pro+ide a certain le+el of di+idend income to its shareholders. It

also hopes to plough back some profits. Dnce it identifies its

operating le+el of earnings' the degree of +ariation from this

operating le+el ould measure business risk.

E>am45e6:

If operating income is e3pected to be "*B in a year' business risk

ill be lo if the operating income +aries beteen ")B and ",B. If

the operating income ere as lo as "0B or as high as "#B it

ould be said that the business risk is high.

C1 Financia5 Risk6 :

inancial risk in a company is associated ith the method through

hich it plans its financial structure. If the capital structure of a

company tends to make earning unstable' the company may fail

financially. 1o a company raises funds to finance its needs and

groth ill ha+e an impact on its future earnings and conse:uently

on the stability of earnings. 7ebt financing pro+ides a lo cost

source of funds to a company' at the same time pro+iding financial



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le+erage for the common stock holders. As long as the earnings of

the company are higher than the cost of borroed funds' the

earning per share of common stock is increased. /nfortunately' a

large amount of debt financing also increases the +ariability of thereturns of the common stock holder thus increases their risk. It is

found that +ariation in returns for shareholders in le+ered firms

borroed funds company6 is higher than in unle+ered firms. The

+ariance in returns is the financial risk.



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Risk Return Of 2arious In;estment $5ternati;es

Managem

ent

7ecision

4e:uired

In+estmentMarket4isk

!usiness

4isk

Interest

4isk

urchasingoer

4isk

1 @roth stock 1 1 ; ;

1Speculati+e

common stock1 1 ; ;

M !lue chips M M ; ;

M

Con+ertible

referred stock M M ; ;

;Con+ertible

debenturesM M ; ;

;Corporate

bonds; ; 1 1

;@o+ernment

bonds; ; 1 1

;Short-term

bonds

; ; ; 1

;Money market

funds; ; ; 1

D ;ife insurance ; ; ; 1

DCommercial

banks; ; ; 1

D /nit trusts ; ; ; M-1

D Sa+ing a


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Portfo5io

A combination of securities ith different risk return

characteristics ill constitute the portfolio of the in+estor. Thus' a

portfolio is the combination of +arious assets and


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that he has to bear. The return reali(ed from the portfolio has to be

measured and the performance of the portfolio has to be e+aluated.

It is e+ident that rational in+estment acti+ity in+ol+es creation of anin+estment portfolio. ortfolio management comprises all the

processes in+ol+ed in the creation and maintenance of an

in+estment portfolio. It deals specifically ith the security analysis'

portfolio analysis' portfolio selection' portfolio re+ision and portfolio

e+aluation. ortfolio management makes use of analytical

techni:ues of analysis and conceptual theories regarding rational

allocation of funds. ortfolio management is a comple3 process

hich tries to make in+estment acti+ity more rearding and less

risky.



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!efore designing a portfolio one ill ha+e to kno the intention of the in+estor or the returns that the in+estor is e3pecting from his

in+estment. This ill help in adGusting the amount of risk. This

becomes an important point from the point of +ie of the portfolio

designer because if the in+estor ill be ready to take more risk at

the same time he ill also get more returns. This can be more

appropriately understood from the figure dran belo.

R 1

E>4ected ReturnsE>4ected Returns

R 2

Risk less

Investment

M1 M2 Risk

rom the abo+e figure e can see that hen the in+estor is ready

to take risk of M"' he is likely to get e3pected return of 4 "' and if

the in+estor is taking the risk of M2' he ill be getting more returns

i.e. 42. So e can conclude that risk and returns are directly

related ith each other. As one increases the other ill also

increase in same of different proportion and same if one

decreases the other ill also decrease.


PORTFOLIO DESIGN


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rom the abo+e discussion e can conclude that the in+estors

can be of the folloing three typesH

". In+estors illing to take minimum risk and at the same time

are also e3pecting minimum returns.

2. In+estors illing to take moderate risk and at the same time

are also e3pecting moderate returns.

$. In+estors illing to take ma3imum risk and at the same time

are also e3pecting ma3imum returns.



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Lour age ill help you determine hat a good mi3 is < portfolio is

$7e Portfo5io

belo $0 #0B in stocks or mutual funds"0B in cash"0B in fi3ed income

$0 t0 )0 50B in stocks or mutual funds

"0B in cash20B in fi3ed income

)0 to *0 ,0B in stocks or mutual funds"0B in cash$0B in fi3ed income

*0 to ,0 *0B in stocks or mutual funds"0B in cash)0B in fi3ed income

abo+e ,0 )0B in stocks or mutual funds"0B in cash*0B in fi3ed income

These aren%t hard and fast allocations' Gust guidelines to get you

thinking about ho your portfolio should look. Lour risk profile ill

gi+e you more e:uities or more fi3ed income depending on your

aggressi+e or conser+ati+e bias. 1oe+er' it%s important to alays

ha+e some e:uities in your portfolio or e:uity funds6 no matter

hat your age. If inflation roars back' this ill be the portion of your

in+estments that protects you from the damage' not your fi3ed

income.

Also' the fi3ed income of your portfolio should be di+ersified. If you

buy bonds and debentures directly or if you in+est in 7s' then

make sure you ha+e at least fi+e different maturities to spread out

the interest rate risk.


PORTFOLIO $GE REL$TIONS3IP


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7i+ersifying in e:uities and bonds means more than buying a

number of positions. Each position needs to be scrutini(ed as to

ho it fits into the stocks or bonds that already are in your portfolio'

and ho they might be affected by the same e+ent such as higher interest rates' loer fuel prices' etc. ut your portfolio together like

a pu((le' adding a piece at a time' each one a little different from

the other but achie+ing a uniform hole once the portfolio is

complete.

Ty4es of 4ortfo5io for study6

In portfolio 7esign' e are considering only to types of portfolio.

They are as folloH

". 4andom ortfolio

2. Sector ortfolio

Random 4ortfo5io

4andom portfolio consists of the scripts that are randomly selected

by the in+estor by its on knoledge and preference of the stocks.

1ere there is no analysis is done of the script' they are selected on

the tips and buts recei+ed by the in+estors from the e3ternal

sources.

Features of random 4ortfo5io

• There is no method used for selection of the script in the

portfolio.

• Selection is based on the indi+idual criteria for the scripts.

• The in+estment is made for higher return in short term.



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• @enerally in India most of the portfolio are selected

according to this random methods as no in+estor himself in

that much analysis of the script.

$d;anta7es of random 4ortfo5io

• Easier to keep a track on the market as not much time

asted in the analysis.

• This portfolio seems to ha+e perform better in short term as

script are generally hich are performing better at that time.

• Tips are a+ailable e+ery here for the in+estor to pouch.

• It is the e3perience of the indi+idual that can fetch him good

return.

Disad;anta7es of random 4ortfo5io

• There is e+ery chance that you may select a script that has a

+ery bad background in the market.

• 9ot e+ery time the tips pay off for you. Lou need to ha+e

strong reason to select that script.

• Such portfolios are not able to sustain hen there is a crisis

in the market.

• There is a +ery high risk and return in+ol+e in such portfolio.



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Disad;anta7es of sector 4ortfo5io

• It is a highly risky portfolio as risk associated ith the sector

directly affects the performance of the portfolio.

• These types of portfolios are not suited for long-term in+estor

as risk taken for the return can be too high.

There is alays the possibly many scripts in the sector may not be

gi+ing that much good attracti+e return as others. They may eat the

profits from other scripts.



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T!e P@E ratio as a 7uide to in;estment decisions

Earnings per share alone mean absolutely nothing. In order to get a

sense of ho e3pensi+e or cheap a stock is' you ha+e to look at

earnings relati+e to the stock price and hence employ the


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R$NDO" PORTFOLIO

4andom portfolio consists of the scripts that are randomly selected

by the in+estor by its on knoledge and preference of the stocks.

1ere there is no analysis is done of the script' they are selected on

the tips and buts recei+ed by the in+estors from the e3ternal

sources.

e are considering 1ET$ factor to design our Random Portfo5io.

1eta Factor P!etaQ indicates the proportion of the yield of a

portfolio to the yield of the entire market as indicated by some

inde36. If there is an increase in the yield of the market' the yield of

the indi+idual portfolio may also go up. If the inde3 goes up by ".*B

and the yield of your portfolio goes up by 0.&B' the beta is 0.&


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beta of " or de+elop a portfolio that has stocks ith betas greater

than " and less than " so that they ha+e the hole portfolio ith an

a+erage beta of ".

A beta for a stock is deri+ed from historical data. This means it has

no predicti+e +alue for the future' but it does sho that if the stock

continues to ha+e the same price patterns relati+e to the market in

general as it has in the past' you%+e got a ay of knoing ho your

portfolio ill perform in relation to the market. And ith a portfolio

ith an a+erage beta of "' you can create your on inde3 fund

since you%ll mo+e more or less in tandem ith the market.



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Inter4retation of 1etaInter4retation of 1eta

henhen 1 K &1 K & means that the scrip has same +olatility as comparedmeans that the scrip has same +olatility as compared

to Inde3. Suitable for moderate in+estor.to Inde3. Suitable for moderate in+estor.

henhen 1&1& means that scrip is more +olatile as compared to marketmeans that scrip is more +olatile as compared to market

suitable for aggressi+e in+estors.suitable for aggressi+e in+estors.

henhen 1M&1M& then scrip is less +olatile as compared to market andthen scrip is less +olatile as compared to market and

suitable for defensi+e in+estors.suitable for defensi+e in+estors.

!eta of scrips plays +ital role in scrip selection in ortfolio!eta of scrips plays +ital role in scrip selection in ortfolio

management. ortfolio can be created in many ays as sector management. ortfolio can be created in many ays as sector

ise' di+ersified in +arious sector' beta ise scrip portfolio.ise' di+ersified in +arious sector' beta ise scrip portfolio.

SD !ASE7 D9 T1IS !ETA 9D E I;; 4EA4E T14EE

D4TD;ID TD MATC1 T1E 4IS> TA>I9@ CAACITL D A9

I9=ESTD4

THAT IS

AGGRESSIVE MODERATE DEFENSIVE


PORTFOLIO


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DEFENSI2E PORTFOLIO

SRNO# S/RIPT 1ET$ PRI/E ON 0.5, 5"$.)* "0.22

, ITC 0.#" ")0."0 "0.#&

5 4A9!/OL 0.,& ))).$* &.25

# 1E4D 1D97A 0.# #),."0 "0.5*

& 17C 0.#2 ""&".$ "".02

"0 @;AOD 0.," """"., #.20

Total Portfolio Beta = Wi BETA

!"#$% &'#('&"#)*&%#%"&%#%"

&'#'+&"#)*&'#"*&$#*)&,#**

! %)#$- . %,


Total Portfolio Invest/ent = 10,00,000 Rs#


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RETURN ON INDI2IDU$L S/RIPTS

&ST "ONT3

SR NO# S/RIPT 1ET$ 0.5, 5"$.)* 5,2.)* ,.#5

, ITC 0.#" ")0."0 "*).#0 "0.)&

5 4A9!/OL 0.,& ))).$* $&&.)0 -"0."2

# 1E4D 1D97A 0.#0 #),."0 #*5.20 ".$"

& 17C 0.#2 ""&".$0 "$$&.50 "2.),

"0 @;AOD 0.," """".,0 "2#2.#0 "*.)0


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- 52 -

RETURN IN DEFENSI2E PORT FOLIO

TOT$L PORTFOLIO IN2EST"ENT K &......

2$LUE OF PORTFOLIO $S ON


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"ODR$TE PORTFOLIO

SR NO# S/RIPT 1ET$ PRI/E ON


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- 54 -


&ST "ONT3

SR NO# S/RIPT 1ET$


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RET1RN IN MODRATE PORT FOLIO

TOT$L PORTFOLIO IN2EST"ENT K &......@: Rs##



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$GGRESSI2E PORTFOLIO

SR NO# S/RIPT 1ET$ PRI/E ON


57/115


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- 57 -


&ST "ONT3

SR NO# S/RIPT 1ET$ ;T7 ".0& *&5.00 ,"*.2* $.0,2 I9DSLS ".05 2&5&.$* 2#2#.&* -*.0*

$ D9@C ".02 ""&".,* ""$,.)0 -).,)

) 4E;IA9CE ".0* ))".0* *00.** "$.)&

* SATLAM ".2$ 5$".** 5,&.,* *.2"

, S!I9 ".0& &0).&0 #55.*0 -$.0$

5 TATA DE4 "."" )$).20 *"".20 "5.5$

# TATA MDTE4 "."& ,$&.** #",.20 25.,2

& TATA STEE; "."$ $5&.00 )$".00 "$.52

"0 I4D ".$$ ),".50 *20.)* "2.52



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RETURN IN $GGRESSI2E PORT FOLIO

TOT$L PORTFOLIO IN2EST"ENT K &......@: Rs#



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Inter4retation of Random Portfo5io

• As in the theoretical ay e ha+e scene that the !eta shos

the mo+ement or change in the price of script +is--+is inde3.

And a !eta " is more riskier and hence should gi+e more

return as compared to the script ha+ing !eta U ". as the

person is taking more risk then he should get more return.

!ut in our case e ha+e scene that Moderate portfolio

ha+ing !eta U " has gi+en more return as compared to

Aggressi+e ortfolio.

• So e can easily say that the in+estment in e:uity market is

subGect to market risk and any one ha+ing long-term

in+estment hori(on should only enter into e:uity market. This

analysis that has been carried out as only for a period of

to month there are chances that in the long run aggressi+e

portfolio ould outperform the other portfolio



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DERI2$TI2ES

7eri+ati+es is a product hose +alue is deri+ed from the +alue of

one or more basic +ariables' called bases underlying asset' inde3'

or reference rate6' in a contractual manner. The underlying asset

can be e:uity' fore3 or commodity or any other asset. or e3ample'

heat farmer may ish to sell their har+est at a future date to

eliminate the risk of a change in prices by the date. Such a

transaction is an e3ample of a deri+ati+e. The price of this deri+ati+e

is dri+en by the spot price of heat hich is the NunderlyingQ.

In the Indian conte3t the Securities Contracts 4egulation6 Act. "&*,

SC46A6 defines Pderi+ati+eQ to include

". A security deri+ed from a debts instrument' share' loan

hether secured or unsecured' risk instrument or contract for

differences or any other form of security.

2. A contract' hich deri+es its +alue from the prices' or inde3

of price' of underlying securities.

The deri+ati+es are securities under the SC46A6 and hence the

trading of deri+ati+es is go+erned by the regulatory frameork

under the SC46A6.



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TYPES OF DERI2$TI2ES

The most commonly used types of deri+ati+es are as follosH

o Forards6 A forard contract is a customi(ed contract

beteen to entities' here settlement takes place on a

specific date in the future at today?s pre-agreed price.

o Futures6 A future contract is an agreement beteen to

parties to buy or sell an asset at a certain time in the

future at a certain price. uture contracts are special

types of forard contract in the sense that the former are

standardi(ed e3change-traded contracts.

o O4tions6 Dptions are of to types call and put. Calls

gi+e the buyer the right but not the obligation to buy a

gi+es :uantity of the underlying asset' at a gi+en price on

or before a gi+en future date. lus gi+e the buyer theright' but not the obligation to sell a gi+en :uantity of the

underlying asset at a gi+en price on or before a gi+en

date.



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INTRODU/TION TO FUTURE

uture markets ere designed to sol+e the problems that e3ist in

forard markets. A future contract is an agreement beteen to

parties to buy or sell an asset at a certain time in the future at a

certain price. !ut unlike forard contracts' the future contracts are

standardi(ed and e3change traded. To facilitate li:uidity in the

future contracts' the e3change specifies certain standard features of

the contract. It is a standardi(ed contract ith standard underlying

instrument' a standard :uantity and :uality of the underlying

instrument that can be deli+ered' or hich can be used for

reference purpose in settlement6 and a standard time of such

settlement. A future contract may be offset prior to maturity by

entering into an e:ual and opposite transaction. More than &&B of

future transactions ate offset this ay.

T!e standardied items in a future contract are6

• Vuantity of the underlying.

• Vuality of the underlying.

• The date and the month of deli+ery.

• The units of price :uotation and minimum price change.

• ;ocation of settlement.

FE$TURES OF $ FUTURE /ONTR$/T

•• uture contracts are organi(ed < standardi(ed contracts'

hich are traded on the e3changes.

•• These contracts' being standardi(ed and traded on the

e3changes are +ery li:uid in nature.

•• In futures market' clearing corporation< house pro+ides

the settlement guarantee.



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DISTIN/TION 1ET8EEN FUTURE $ND FOR8$RDDISTIN/TION 1ET8EEN FUTURE $ND FOR8$RD

/ONTR$/TS6/ONTR$/TS6

uture contracts are often confused ith future contracts. The

confusion is primarily because both ser+e essentially the same

economic functions of allocating risk in the presence of future price

uncertainty. 1oe+er futures are a significant impro+ement o+er the

forard contracts as they eliminate counterparty risk and offer more

li:uidity.

Features Forard /ontract Future Contract

Dperational

Mechanism

9ot traded on

e3change

Traded on e3change

Contract

Specifications

7iffers from trade totrade.

Contracts arestandardi(ed

contracts.

Counterparty 4iskE3ists E3ists' but assumed

by Clearing

Corporation< house.

;i:uidation rofile

oor ;i:uidity as

contracts are tailor

maid contracts.

=ery high ;i:uidity as

contracts are

standardi(ed

contracts.

rice 7isco+eryoor as markets are

fragmented.

!etter as fragmented

markets are brought to

the common platform.

FUTURE TER"INOLOGYFUTURE TER"INOLOGY



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• S4ot Price6 The price at hich an asset trades in the spot

market.

• Future Price6 The price at hich the future contracts trades

in the market.

• /ontract /yc5e6 The period o+er hich a contract trades.

The inde3 futures contracts on the 9SE ha+e one-month'

to-months and three-months e3piry cycle' hich e3pire on

the last Thursday of the month. Thus a Kanuary e3piration

contract ould e3pire on the last Thursday of Kanuary and a

ebruary e3piration contract ould cease trading on the last

Thursday of ebruary. Dn the riday folloing the last

Thursday' a ne contract ha+ing a three-month e3piry ould

be introduced for trading.

• E>4iry Date6 It is the date specified in the future contract.

This is the last day on hich the contract ill be traded' at

the end of hich it ill cease to e3ist.

• /ontract Sie6 The amount of asset that has to be deli+ered

under one contract. or instance' the contract si(e on 9SE?s

futures market is 200 9ifties.

• 1asis6 !asis is usually defined as the spot price minus the

future price. There ill be a different basis for each deli+ery

month for each contract. In a normal market' basis ill be

negati+e. This reflects that futures prices normally e3ceed

spot prices.

• /ost of /arry6 The relationship beteen futures prices and

spot prices can be summari(ed in terms of hat is knon as



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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.

• Initia5 "ar7in6 The amount that must be deposited in the

margin account at the time a futures contract is first entered

into is knon as initial margin.

• "arkin7:to:"arket6 In the future market' at the end of each

trading day' the margin account is adGusted to reflect the

in+estor?s gain or loss depending upon the futures closingprice. This is called marking-to-market.

• "aintenance "ar7inH This is somehat loer than the initial

margin. This is set to ensure that the balance in the margin

account ne+er becomes negati+e. If the balance in the

margin account falls belo the maintenance margin' in+estor

recei+es a margin call and is e3pected to top up the margin

account to the initial le+el before trading commences on the

ne3t day.



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DIFFEREN/E 1ET8EEN FUTURES $ND OPTIONSDIFFEREN/E 1ET8EEN FUTURES $ND OPTIONS

At a practical le+el' the option buyer faces an interesting situation.

1e pays for the option in full at the time it is purchased. After this'

he only has an upside. There is no possibility of the options position

generating any further losses to him other than the funds already

paid for option6. This is different from futures' hich is free to enter

into' but can generate +ery large losses. This characteristic makes

options attracti+e to many occasional market participants' ho

cannot put in the time to closely monitor their future options.

!uying put option means that you are buying insurance. To buy a

put option on 9ifty is to buy insurance hich reimburses the full

e3tent to hich 9ifty drops belo the strike price of the put option.

This is attracti+e to many people' and to mutual funds creating

Pguaranteed return productsQ. The 9ifty inde3 fund industry ill find

it +ery useful to make a bundle of a 9ifty inde3 fund and a 9ifty put

option to create a ne kind of a 9ifty inde3 fund' hich gi+es thein+estor protection against e3treme drops in 9ifty.

Selling put option is selling insurance' so anyone ho feels like

earning re+enues by selling insurance can set himself up to do so

on the inde3 option market.

More generally' option offer Pnonlinear payoffsQ hereas futuresonly ha+e Plinear payoffsQ. !y combining futures and options' a ide

+ariety of inno+ati+e and useful payoff structures can be created.



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P$YOFF FOR DERI2$TI2ES /ONTR$/T

ayoff is likely profit


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• Payoff for se55er of futures6 S!ort futures

The payoff for a person ho sells a futures contracts is similar tothe payoff for a person ho shorts an asset. 1e has a potentially

unlimited upside as ell as a potentially unlimited donside.

Take the case of a speculator ho sells a to-month 9ifty inde3

futures contract hen the 9ifty stands at "220. The underlying

asset in this case is the 9ifty portfolio. hen the inde3 mo+es

don' the short future position starts making profits' and hen

the inde3 mo+es up' it starts making losses.

Profit

1220

0

ift!

"oss



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USING INDEB FUTURES

There is alays risk in+ol+ed hen e trade in a stock market. The

risk cannot be eradicated fully but can be minimi(ed up to some

e3tent. olloing are the types of risks that can be minimi(ed

through futuresH

• !asic obGecti+e of introduction of futures is to manage the

price risk.

• Inde3 futures are used to manage the systemic risk' +ested

in the in+estment in securities.

!asically there are eight basic modes of trading on the inde3 futures

market

3ed7in7

3& ;ong stock' short 9ifty futures

3< Short stock' long nifty futures3% 1a+e portfolio' short 9ifty futures

3) 1a+e funds' long 9ifty futures

3ed7e Termino5o7y6

;ong hedge- hen you hedge by going long in futures market.

• S!ort !ed7e - hen you hedge by going short in futures

market.

• /ross !ed7e - hen a futures contract is not a+ailable on

an asset' you hedge your position in cash market on this

asset by going long or short on the futures for another asset

hose prices are closely associated ith that of your

underlying.



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• 3ed7e /ontract "ont!- Maturity month of the contract

through hich hedge is accomplished.

• 3ed7e Ratio - 9umber of future contracts re:uired to hedge

the position.

S4ecu5ation

Speculation is all about taking position in the futures market

ithout ha+ing the underlying. Speculators operate in the market

ith moti+e to make money. They takeH

9aked positions - osition in any future contract.

Spread positions - Dpposite positions in to future

contracts. This is a conser+ati+e speculati+e strategy.

Speculators bring li:uidity to the system' pro+ide insurance to the

hedgers and facilitate the price disco+ery in the market.

S& !ullish inde3' long 9ifty futures

S< !earish inde3' short 9ifty futures



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3EDGING

3&6 5on7 stock s!ort Nifty futures

A person ho feels that the stocks ill be intrinsically under

e+aluated or the profits and the :uality of the company ill make it

more orth as compared to the market ill alays like to take a

long position on the cash market. hile doing so he ill ha+e to

face the folloing kinds of risksH

". 1is understanding can be rong' and the company is really

not orth more than the market prices.

2. The entire market mo+es against him and generate losses

e+en though the underlying idea as correct.

The second outcome happens all time. A person may buy 4eliance

at 4s."&0 thinking hat it ould announce good results and the stock

price ould rise. A fe days later' 9ifty drops' so he makes losses'

e+en if his understanding of 4eliance as correct.

There is a peculiar problem here. E+ery buy position on a stock is

simultaneously a buy position on 9ifty. This is because a' ;D9@

4E;IA9CE position generally gains if 9ifty rises and generally

losses if 9ifty drops. In this sense' a ;D9@ 4E;IA9CE position isnot a focused play on the +aluation of 4eliance. It carries a ;D9@

9ITL position along ith it' as incidental baggage. The stock

picker may be thinking that he ants to be ;D9@ 4E;IA9CE but a

long position on 4eliance effecti+ely forces him to be ;D9@

4E;IA9CE W ;D9@ 9ITL.



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If e think that I4D is under e+aluated' the position ;D9@

I4D is not purely about I4D it is also partly about 9ifty.

E+ery trader ho has a ;D9@ I4D position is forced to be an

inde3 speculator' e+en though he may not ha+e no interest in theinde3.

Those ho are bullish about the inde3 should Gust buy

9ifty futures the need not trade indi+idual stocks.

Those ho are bullish about I4D do rong by

carrying along a long position on 9ifty as ell.

There is a simple ay out. E+ery time e adopt a long position on a

stock' e should sell some amount of 9ifty futures. This ill help in

offsetting the hidden 9ifty e3posure that is e+ery long-stock

position. Dnce this is done' e ill ha+e a position hich ill be

purely about the performance of the stock. The position ;D9@

I4D W S1D4T 9ITL is a pure play on the +alue of I4D'

ithout any risk from fluctuation of the market inde3. hen this ill

be done the stockpicker has Phedged aayQ his inde3 e3posure.

The basic point of this hedging strategy is that the stockpicker

proceeds ith his core skill' i.e. picking stocks' at the cost of loer

risk.

NOTE6 hedging does not remo+e losses. The best that can be

achie+ed by using hedging is the remo+al of unanted e3posure'

i.e. unnecessary risk. The hedged position ill make less profit than

the un-hedged position' half the time. Dne should not enter into a

hedging strategy hoping profit for sure all that can come out of

hedging is reduced risk.



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E+en if e think that I4D is o+er+alued' the position S1D4T

I4D is not purely about I4D it is also about the 9ifty. E+ery

trader ho has a S1D4T I4D position is forced to be an inde3

speculator' e+en though he may not ha+e any interest in the inde3.

Those ho are bearish about the inde3 should Gust sell

9ifty futures the need not trade indi+idual stocks.

Those ho are bearish about I4D do rong by

carrying along a short position on 9ifty as ell.

There is a simple ay out. E+ery time e adopt a short position ona stock' e should buy some amount of 9ifty futures. This ill help

in offsetting the hidden 9ifty e3posure that is e+ery short-stock

position. Dnce this is done' e ill ha+e a position' hich ill be

purely about the performance of the stock. The position S1D4T

I4D W ;D9@ 9ITL is a pure play on the +alue of I4D'

ithout any risk from fluctuation of the market inde3. hen this ill

be done the stockpicker has Phedged aayQ his inde3 e3posure.

The basic point of this hedging strategy is that the stockpicker

proceeds ith his core skill' i.e. picking stocks' at the cost of loer

risk.



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3%6 3a;e Portfo5io s!ort Nifty futures

Some of us might ha+e e3perienced the feeling of oing an e:uity

portfolio' and then one day' e become uncomfortable about the

o+erall stock market. Sometimes e ha+e a +ie that the stock

prices ill fall in the near future. At other times' e may see that the

market is in for a fe days or eeks of massi+e +olatility' and e do

not ha+e an appetite for this kind of +olatility. The best e3ample of

this +olatility is the union budget. Market positions become +olatile

for one eek before and to eeks after the budget. Many

in+estors ant to eradicate this three eeks +olatility.

This becomes a peculiar problem if e are thinking of selling the

shares in the near future' for e3ample' in order to finance a

purchase a house. This planning can go rong if by the time e sell

shares' 9ifty has dropped sharply.

There are to main alternati+es' hen one faces this type of

problemH

". Sell shares immediately. This sentiment generates Ppanic

sellingQ hich is rarely optimal for the in+estor.

2. 7o nothing' i.e. suffer the pain of +olatility. This leads to

political pressure for go+ernment to Pdo somethingQ hen

stock prices fall.

1ere in this case' ith the inde3 futures market' a third and a

remarkable alternati+e becomes a+ailableH

$. 4emo+e your e3posure to inde3 fluctuations temporarily

using inde3 futures. This ill allo rapid response to market

conditions' ithout Ppanic sellingQ of shares. It ill allo an

in+estor to be in control of his risk' instead of doing nothing

and suffering the risk.



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The idea here is that e+ery portfolio contains a hidden inde3

e3posure. This statement is true for all portfolios' hether a portfolio

is composed of inde3 stock or not. In the case of portfolios' most of the portfolio risk is accounted for by inde3 fluctuations. 1ence a

position ;D9@ D4TD;ID W S1D4T 9ITL can often become

one-tenth as risky as the ;D9@ D4TD;ID position.

Is suppose e ha+e a portfolio of 4s." billion' hich is ha+ing a

beta of ".2*. Then a complete hedge is obtained by selling 4s.".2*

million of 9ifty futures.



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3)6 3a;e funds 'uy Nifty futures

A person may be in a situation here he is ha+ing funds' hich

needed to be in+ested in e:uity' or he may be e3pecting to get

funds in future to be in+ested in e:uity. The folloing can be the

occurrences in the abo+e conditionsH

A closed-end fund' hich Gust finished its initial public

offering' has cash' hich is not yet in+ested.

If a person is planning to sell some of his shares. The

land deal is slo and ill take time to complete. It takes

se+eral eeks from the date that it becomes sure that the

funds ill come to the date that the funds are actually are

in hands.

An open-ended fund has Gust sold fresh units and has

recei+ed funds.

To get oneself in+ested in e:uity sounds :uite easy but it in+ol+es

the folloing problemsH

". A person may need time to research stocks' and carefully

pick stocks that are e3pected to do ell. This process of

research takes time. or that time the in+estor is partly

in+ested in cash and partly in+ested in stocks. 7uring this

time' he is e3posed to the risk of missing out if the o+erall

market inde3 goes up.

2. A person may ha+e made up his mind on hat portfolio he

seeks to buy' but going to the market and placing the market

order ould generate large Nimpact cost?. The e3ecution

ould be impro+ed substantially if he could instead place a

limit orders and gradually accumulate the portfolio at



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fa+orable prices. This takes time' and during this time' he is

e3posed to the risk of missing out if the 9ifty goes up.

$. In some cases' such as land sale abo+e' the person may not

simply ha+e cash to immediately buy the shares' hence he isforces to ait e+en if he feels that 9ifty is unusually cheap.

1e is e3posed to the risk of missing out if 9ifty rises.

T!e t!ree a5ternati;es t!at are a;ai5a'5e it! an in;estor are as

fo55os6

The in+estor ould obtain the desired e:uity e3posure by

buying inde3 futures' immediately. A person ho e3pects

to obtain 4s.* million by selling land ould immediately

enter into a position ;D9@ 9ITL orth 4s.* million.

Similarly a close-end fund' hich has Gust finished its

initial public offering and has cash' hich is not yet

in+ested' can immediately enter into a ;D9@ 9ITL to

the e3tent it ants to be in+ested into e:uity. The inde3

futures market is likely to be more li:uid than indi+idual

stocks so it is possible to take e3tremely large position at

a lo impact cost.

;ater' the in+estor < close-end fund can gradually ac:uire

stocks. As and hen shares are obtained' one ould

scale don the ;D9@ 9ITL position correspondingly.

9o matter ho sloly the stocks are purchased' this

strategy ould fully capture a rise in 9ifty' so there is no

risk of missing out on a broad rise in the stock market

hile this process is taking place. 1ence' this strategy

allos the in+estor to take more care and spend more

time in choosing stocks and placing aggressi+e limit

orders.


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