Final Shailendra Project

8/8/2019 Final Shailendra Project

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A PROJECT REPORT

ON

EQUITY RESEARCH ON BANKING SECTOR

AT

INDIA INFOLINE

Pune

BY

Mr. Shailendra Chawla

IN THE PARTIAL FULFILLMENT OF THE COURSE

MASTER OF BUSINESS ADMINISTRATION

AFFILIATED TO UNIVERSITY OF PUNE

INDIRA INSTITUTE OF MANAGEMENT, PUNE.

TATHWADE, PUNE-411033

2009 2011


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ACKNOWLEDGEMENT

The completion of my report and the success of my efforts reminds of our indebtedness

towards my guide Mr. for his invaluable guidance and affectionate encouragement

throughout.

I would like to assert my heartfelt appreciation to Mr. for allowing me to work in

such a reputed organization.

I am also thankful to all the employees for helping me throughout the period.

I also thankMr.Praveen Tungare(College Internal Guide) for his valuable guidance.


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EXECUTIVE SUMMARY

Project is undertaken to understand an efficient working and strategies of different

payoffs in derivates segments of NSE, banking sectoral Analysis by analyzing Macro and

Micro-Economy on banking sector, impact of various major factors on Bank of Baroda.

It tries to explain derivates products (Forward, Futures, Options, Warrants,

Swapation) terminology for effective carrying out a various payoff strategies. Futures and

Options mix strategies for properly hedging against uncertain environments of Indian Stock

Market. Hedging is done for avoiding a future risk of underlying assets. Options strategiesthat include BULL SPREAD, BEAR SPREAD, and CALENDAR SPREAD Etc .are properly

taken into consideration for determine a range payoff in market conditions.

It evaluates various Macro-Economy parameters such as Global GDP, US Economy,

and Rupee Dollar fluctuations, Crude Oil etc & cascading effect of global cues on the Micro-

Economy view of Indian Economy are taken to understand its impact on the Indian Banking

Sector. Banks profitability and liquidity are properly gauged in given current context.

Impacts of various factor is analyzed on Bank of Baroda (3 rd Largest Public Sector

Bank). Its undergone fundamentals of the bank and studied it various impact on changing

variables. BOB delivered on core performance asquality of earnings continued to improve on

the back of robust margins, steady business expansion, and lower NPA. Bank shows steady

increase in balance sheet strength, improving metrics, and strong management. Advances

grew 30% Y-o-Y and 6% Q-o-Q to INR 1.86 tn with increased traction in both domestic

(27% Y-o-Y and 3% Q-o-Q) and overseas (38% Y-o-Y and 15% Q-o-Q) businesses. Growth

remained strong in SME and retail at 43% and 23.3%, respectively, Y-o-Y. Contribution of

housing loans to the overall retail book remained stable at 43%. Management is guiding for

~22-24% growth in advances for FY11.Five years of financial and Income expenditure are

studied in great details for determine a trend in deposits and Loans & Advances of BOB.

Factor and growth is properly is taken in consideration to obtain a future valuations of the

bank with the approximate future financial and Income statements.


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CONTENTS

Sr. Title Pg.No

B

1 Introduction

2 Industry Profile

2.1 Banking and Financing

2.2 Insurance

2.3 Capital Market

2.4 Emerging Opportunitites

3 Company Profile

3.1 Introduction

3.2 History and Milestones

3.3 Product and Services

4 Objectives of the Report

5 Theoretical Background

5.1 Review Literature

5.2 Fundamental Analysis

5.3 Introduction to Derivatives

5.4 Introduction to Forwards, Futures, and Options5.5 RBIs Key Policy Rate

6 Research Methodology

6.1 Introduction

6.2 Collection of Data

6.3 Type of Research

7 Data Analysis and Interpretation

7.1 Futures Payoff

7.2 Options Payoff

7.3 Sectoral Analysis of Banking Sector 7.4 Bank of Baroda

8 Observation and Findings

9 Suggestion and Recommodation

10 Limitations of the Study

11 Conclusion

C

References/ Bibliography


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LIST OF TABLES

Sr.No Heading Title Pg.No

1 7.1 Payoff for buyer of futures: Long futures

2 7.2 Payoff for seller of futures: Short futures

3 7.3 Payoff for buyer of call option

4 7.4 Payoff for writer of call option

5 7.5 Payoff for buyer of put option

6 7.6 Payoff for writer of put option

7 7.7 Payoff for seller of call option at various strikes

8 7.8 Payoff for buyer of put options at various strikes

9 7.9 Payoff for a bull spread created using call options

10 7.10 Bear spreads - sell a call and buy another

11 7.11 Sectoral Analysis

12 7.12 C-D Ratio

13 7.13Spread

14 7.14 Net Profit/ Working Cap & Admin Expenses/ Working Cap

15 7.15 Net Worth

16 7.16 Deposits

17 7.17 Deposits breakup

18 7.18 Loans & Advances

19 7.19 Total Assets

20 7.20 Total Income

21 7.21 Other Income + Interest Income

22 7.22 Net Profit23 8.1 Equity/ Assets

24 8.2 Operating Expense/ Assets

25 8.3 ROA

26 8.4 EPS

27 8.5 Retention Ratio

28 8.6 ROE


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LIST OF FIGURES

Sr.No Heading Title Pg.No

1 2.1 Finacial Regulator(RBI)

2 2.2 Finacial Regulator(IRDA,SEBI,PCDRA)

1 3.1 History and Milestones

2 5.1 Movement in Key Policy Rates

3 7.1 One month calls and puts trading at different strikes4 7.2 Bull spread created using call options

5 7.3 Bear spreads - sell a call and buy another

6 7.4 Macro Economy

7 7.5 Micro Economy

8 7.6 Cramped Credit

9 7.7 Bank Specific

10 7.8 Bank of Baroda

11 7.9 Balance Sheet Bank of Baroda

12 7.10 Income Statement Bank of Baroda

13 7.11 Projected Balance Sheets and Interpretation

14 7.13 Interpretation of Business Models

15 7.14 Ratios

16 8.1 Keys Growth Ratios

17 8.2 Keys Projected Ratios

18 8.3 Valuations on BOB

19 8.4 According to Capital Assets Pricing Model

20 8.5 Efficiency Ratio


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CHAPTER 1

Company Profile


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Industry Profile

Financial Sectors is greatly impacted by the recessions. The sector is looking like a lostground in economic turmoil. Many persons believe a balance sheet of financial sector does

not have right things in liabilities side and nothing is left in assets sides. It caused a greater

uncertainly in economic global environments.

The Indian Financial Services Sector

The services sector in India has been witnessing a boom in recent times. In addition to the

strong growth in IT/ ITES, the Indian financial service sector is considered to be stable and

progressive, and has been a major beneficiary of Indias growth story. Retail lending has

powered the explosive growth in the financial services sector with players focused on the

retail segment registering impressive top-line growth. Increasing prosperity coupled with

rising consumerism of Indian consumers has fueled a remarkable boom in retail credit

demand. Rapid growth by the corporate sector has generated a need for capital which has

resulted in growth of institutional finance. A large number of Non-Banking Finance

Companies (NBFCs) have been operating in the country. This has helped drive asset

penetration on account of a wider distribution reach. The growing attractiveness of the

financial services sector has triggered the entry of global majors. Aggressive plans of

incumbents coupled with the entry of new players are expected to further drive the growth of

the sector. The financial services sector analyzed comprises the following key sub-sectors:

Banking and Financing

Consumer Finance, Small and Medium Enterprise (SME) finance, Agriculture and rural

finance, Institutional Finance and Project Finance

Insurance Life and Non-life insurance

Capital Markets Asset Management, Pension, Wealth management, Investment Banking

and Securities Broking

Emerging Opportunities Private Equity,


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Attractive Investment Opportunities

The opportunities in Indian financial services have been analyzed in detail based on

parameters such as market size, growth, profitability, intensity of competition, future outlook

and government regulations governing entry. An analysis of the various sub-sectors using the

above criteria has yielded several attractive opportunities for entry in the medium term.

2.1 Banking & Financing

Banking Sector:

The banking sector is the most dominant sector in the financial system in India. Post

liberalization, the banking sector has witnessed several changes. There has been a paradigm

shift in products, technology, operations and customer service. Key reform initiatives

included banking licenses to new private sector banks, deregulation of interest rates, adoption

of Basel II norms and a roadmap for foreign banks entry unveiled by RBI in 2005. The

financial health of commercial banks has improved manifold with respect to capital

adequacy, profitability, asset quality and risk management. Further, deregulation has created

new opportunities for banks to increase revenue by diversifying into investment banking and

other sub-sectors

The Indian banking sector is growing at a fast pace as players are aggressively targeting

semi-urban and rural areas which are under penetrated. The increased focus on financial

inclusion by the government has also led to introduction of newer products, such as no-

frills banking accounts and kisan (farmer) credit cards to enhance banking access to rural

and economically weaker sections of the population. However, under the RBIs road map for

presence of foreign banks in India

Consumer Finance:

Rising consumerism and increasing focus by leading banks and NBFCs have resulted in rapid

growth of the consumer finance sector in India. Since banking penetration in rural India

remains significantly lower compared to urban India, it has become an attractive segment for

players to gain an early mover advantage.


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SME Finance:

SME financing is witnessing strong growth due to the strong performance of the buoyant

SME sector and increasing focus from banks owing to higher profitability. The burgeoning

SME sector has also led to a focus on factoring services for working capital anagement and

other advisory services.

Institutional Finance and Project Finance:

An excellent performance by corporates in India coupled with their expansion strategies

seeking inorganic growth, have resulted in a huge demand for institutional finance. Project

finance in India is also witnessing participation from leading banks and financial institutions

due to the lowered operational and execution risks.

Agri and Rural finance:

About two-thirds of Indias population resides in rural areas. There lies a huge customer base

which is under-serviced providing a significant opportunity for agri-lending and rural finance

for early movers.

Capital Markets

With India witnessing an economic boom, capital flows into the country via the FII route

have been on the rise, positively impacting the Indian equity markets. The performance of

Indian equity markets has been impressive, not only because of FII inflows but also due to

increased confidence levels among retail investors in the country. The key sub-sectors that

have benefited from this strong growth include asset management, wealth management,

investment banking and securities broking services. The Indian asset management industry

has witnessed a massive increase in AUM, post the entry of large domestic and foreign

players. However, there exists a huge opportunity on account of low penetration levels in

comparison with other countries. Wealth management services are likely to witness

heightened activity owing to increasing prosperity and awareness of financial planning.

Increasing participation from retail investors due to a strong equity market performance has

led to a robust demand for securities broking. The increasing appetite of Indian corporates for

capital as well, as an acquisition-led inorganic growth strategy, has also resulted in a strong

demand for investment banking and advisory services. The changing Indian demographic mix


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and low pension coverage has sparked reforms in the pension sector which is set to

dramatically change the pension landscape in India in the medium to long term.

2.2Insurance

The Indian insurance industry witnessed a landmark event with the enactment of the

Insurance Regulatory and Development Authority Act in 1999 to regulate, promote and

ensure orderly growth of the insurance industry. Under the new dispensation, private and

foreign insurance companies have been permitted to operate in India with some restrictions

on FDI limits.Given that the Indian insurance market is largely under penetrated especially in

the non-life segment, there exists a huge potential for investment due to the burgeoning

middle-class that can afford to buy life, health, disability and pension products. The recent

detariffication of key non-life insurance categories is also expected to give a fillip to motor,

fire and engineering insurance, while increasing focus of all players towards health insurance.

Life Insurance

The Indian life insurance industry has experienced tremendous activity since the opening up

of the insurance market in 2000 to private and foreign investments. Though the industry is

still dominated by the public sector behemoth, the Life Insurance Corporation of India private

players are catching up rapidly. The new entrants have been able to garner market share by

aggressively building the distribution network (in the form of agents) and reaching rural and

semi-urban areas, to take on the market leader. Besides, the private players are focusing on

unit-linked policies, which have contributed to their increasing market share vis--vis LIC in

value terms. The growth in the life insurance sector has been catalyzed by increased

awareness of the need for life insurance and introduction of unit linked policies and products

which are more acceptable to the Indian masses. The insurance industry in India has

tremendous growth potential, due to a large population, fast and rapid growing economy and

constant improvement in the standard of living. Besides, life insurance penetration in India is

low, in comparison to other developed nations. Life insurance penetration in India is slated to

grow rapidly due to the increasing reach of players in Tier II and Tier III cities. Micro-

insurance is expected to significantly increase the size of the target population as it increases

the affordability of the product. The anticipated increase in Foreign Direct Investment (FDI)

limit from the current 26 percent is expected to spur the entry of global players into this

sector. The market size for FY 2007 was USD 18.9 billion, and is projected to grow to USD41.1 billion by FY 2010.


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Non-life Insurance

The Indian Non-life insurance sector witnessed the entry of several global majors after the

sector was opened up to private sector players in the year 2000. The entry of private sector

insurers marked a paradigm shift in this industry and has triggered several changes in product

features and service levels. However, the growth potential was not fully realized due to fixed

tariffs and relatively low scope for customization. India has an extremely low insurance

penetration with tremendous scope for improvement to reach levels comparable with other

emerging markets. In fact, non-life insurance density is very low in comparison to other

nations, indicating the tremendous opportunity. The entry of new players and introduction of

new products coupled with increasing distribution reach is helping increase awareness among

customers. The changing demographic profile with rising incomes and a young population is

also leading to increased per capita expenditure on insurance products. With saturated

markets in most developed nations, global insurers are increasingly interested in India for

sustaining growth. The anticipated increase in the FDI limit for foreign companies and recent

de-tariffication is expected to significantly increase global interest in this sector. The non-life

insurance industry is currently worth around USD 6.1 bn and is projected to grow at a CAGR

of 13 percent in the foreseeable future.

2.3 Capital Markets

The Indian capital market is one of the oldest capital markets in Asia (the Mumbai stock

exchange was established in 1875). Post introduction of reforms in 1992, when the Securities

and Exchange Board of India (SEBI) was elevated to a fullfledged capital market regulator,

capital markets in India have increasingly progressed towards becoming more stable and

mature. An important policy initiative in 1993 was the opening of capital markets to Foreign

Institutional Investors (FIIs). To inject an international standard to the Indian stock market,

the National Stock Exchange was started in 1992 which has increased transparency. Further,

share dematerialization systems were also introduced to enhance the efficiency of the

transaction cycle.

Investment Banking

In the last few years, the number of investment banks operational in India has increased

significantly, because of the rise in the number of global merger and acquisition (M&A) deals

involving Indian companies. High-value deals such as the Tata-Corus deal and the


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Hutchison-Essar stake sale is creating further interest amongst global players, with respect to

the Indian investment banking space. M&A Advisory has been the most significant

contributor to Investment Banking revenues. With an increasing number of Indian companies

looking at overseas acquisitions, this activity is likely to increase in prominence. The strong

regulatory mechanism and capital market environment has attracted the interest of leading

Wall Street investment banks, who are focusing on their India operations. Deregulation has

also opened opportunities to offer more services like risk management, distressed debt,

proprietary investing and leveraged finance, apart from other conventional offerings.

Investment banking is a people-driven business and requires human resources with

experience in the industry, track record of success, ability to win and execute deals, strong

negotiation skills and excellent relationship management skills. Going forward, players need

to focus on skilled professionals having domain expertise, given that increased activity in the

investment banking space has resulted in a talent crunch.

Securities Broking

The Indian stock broking industry is witnessing increased global attention with increase in

number of mergers and acquisitions and rising trading volumes. The continued Foreign

Institutional Investor (FII) interest in the Indian capital markets and robust stock market

performance is fueling retail investor interest in equity products. The immense potential

offered by leveraging the latent demand in semiurban and rural markets is driving aggressive

expansion plans of leading Indian broking houses. The Indian broking industry currently

includes a number of players with a regional or sectoral focus. Large brokerage houses are

growing and scaling up through geographical expansion. This process is expected to continue

with the entry of global majors into the industry. However, increasing competition is

expected to reduce margins in the industry thereby impacting profitability. The entry of

aggressive players such as Reliance Capital through its portal Reliance Money is expected

to significantly increase the reach and penetration of securities broking services in India.

Several large global players are also mulling an entry into the Indian market in the near

future. This sector is therefore set to witness increasing action with intensifying levels of

competition among existing players and new entrants leading to the emergence of large

players with a pan-India presence and a significant share in the total market volumes. Players

are also positioning themselves as retail financial services brands to improve share of wallet

and enhance customer retention.


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Wealth Management

The booming Indian economy, rising stock prices and increase in salaries has turned the

spotlight on the Wealth Management sector. Key products and services include investment

advisory - in debt, equity, mutual funds and derivatives; besides tax advisory; estate planning;

and insurance advisory. The wealth management space was hitherto considered the preserve

of some foreign banks, which offered exclusive services to select high networth customers.

Today, several private banks offer these services, while there is virtually no participation

from the large nationalized banks. Further, international players are increasingly offering

dedicated wealth propositions with more evolved products than their Indian counterparts.

The growing number of affluent Indians coupled with increasing awareness of financial

planning has resulted in expanding the base of potential wealth management customers.

Private Equity

In the past few years, India has become one of the top five PE destinations in the Asia Pacific

region with PE funds constituting over 25 percent of FDI inflows into India. Liberal foreign

investment policy encouraging foreign participation and availability of targets at attractive

valuations relative to other emerging markets have resulted in a rapid growth of private

equity investments in the country.

Pensions

The current demographic dividend that India enjoys may not last indefinitely. As a result of

declining birth rates and longer life expectancy, the elderly will constitute a large proportion

of the total population. Even today, while the population of the elderly is proportionately

lower, in absolute terms, it is till a very significant number. The changing demographic

dynamics calls for a critical look at the pension support system in India. Less than 10 percent

of the estimated working population in India is covered under formal old-age income security

schemes. The penetration by way of the Public Provident Fund (PPF) account is less than 1

percent of the entire working population. In the past few years, there have been numerous

discussions on permitting participation from the private sector and foreign players in the

Indian pensions industry, powered by the proposed introduction of favorable regulatory

initiatives. The regulations planned for the pension and provident fund industries require

structural and procedural modifications. The formation of the interim Pension Fund

Regulatory and Development Authority (PFRDA) kicked-off the reform process. The pension


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reforms in the country then acquired momentum with the announcement from Reserve Bank

of India (RBI) regarding norms for management of pension funds by banks. Implementation

of pension sector reforms is expected to have a salutary impact on the Indian pension and

provident fund sector. PFRDA has already laid down the eligibility criteria for pension funds.

Though the RBI norms intend to eventually permit private and foreign banks to enter the

business of pension funds management, the definition of the roadmap for future growth is

still awaited.

2.4 Emerging opportunities

The vibrant Indian economy and robust financial services sector have led to the emergence of

several emerging opportunities which are expected to gain prominence in the long term based

on regulatory and market developments. The Indian structured finance sector is dominated by

asset backed securitization. Increasing regulatory clarity and initiatives to enhance liquidity is

expected to increase the breadth and depth in the sector. The Indian distressed assets sector is

also witnessing increasing attention due to the rapid economic growth and higher asset values

with the real estate boom. India has charted an ambitious infrastructure development program

in the next five to seven years, wherein public-private partnerships are emerging as the

preferred investment vehicle. Non recourse lending is emerging as the preferred lending route

owing to reduced leverage, thereby obviating the need for security. Real estate funds are

witnessing intense activity with significant participation from domestic (specifically High

Networth Individuals) and foreign investors; estimates suggest that funds exceeding USD 12-

15 billion are awaiting deployment in the Indian real estate sector. The booming Indian

economy and the robust corporate and SME performance has led to a massive inflow in

Private Equity capital into India. The acquisition-led inorganic growth strategy of Indian

corporates is also expanding the leveraged finance market in India.

Private Equity Market Size

Private equity capital is being preferred over traditional sources of funds to leverage their

brand equity, sector knowledge and relationships. PE investment in India was earlier limited

to the IT and ITES industry with a focus on early stage ventures. However, in recent times,

PE investment has extended to a large number of sectors besides IT and ITES. PE players are

increasingly focusing on attractive opportunities in real estate, media and entertainment,

telecom, financial services and manufacturing and auto industry. With investments of over


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USD 20-2517 billion needed by India in the infrastructure sector alone, the current high

growth trajectory in the private equity sector is expected to continue in the medium term.

Financial Services and Regulator are as follows:

(Figures 2.1 Finacial RBI a regulator)

Investment Considerations

The Indian financial services sector will continue to tread the high growth path in the medium

term on the back of favorable structural drivers, which will continue to drive GDP growth.

This provides South African firms an opportunity to enter an expanding market with high

growth potential. The Indian regulatory framework for entry into the Indian financial services

sector has been defined by various regulators with respect to the entry vehicle (FDI or FII),

mode of operations/ presence (branch, representative office or subsidiary) which have a

significant bearing on the tax and reporting requirements. To develop a coherent strategy for

entry into the Indian market, South African firms should consider the regulatory implications

as well. An India strategy is increasingly becoming a key imperative for any truly global

corporation, and interested South African players need to weigh their options and choose the


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optimal strategy to leverage the India opportunity in the financial services sector. India is the

world's largest democracy and ranks second in the list of fastest growing economies globally.

The past decade has witnessed fundamental changes in the Indian economy with respect to

government policy, business outlook and more importantly, the Indian mindset. Some

contributors to the dynamic growth of the Indian economy include, a new industrial

resurgence, increased business and investor confidence, increased investment, relatively

modest inflation in spite of spiraling global crude prices, laying of some institutional

foundations for faster development of physical infrastructure and progress in fiscal

consolidation.

Services-led Growth

Traditionally, developing countries have transitioned from being primary agriculture-based

to secondary manufacturing-based and subsequently to tertiary services-based economies.

India has leap-frogged a stage through its direct transformation from a primary focused into a

tertiary services based economy.

(Figure 2.2 Finacial Regulator(IRDA,SEBI,PFRDA))


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Favorable Demographics: The Engine of Growth

A key factor driving Indias growth is its large and young population. With a median age of

around 24 years and over 500 million Indians below the age of 21 years, a large percentage of

Indias population is expected to be in the working age even in 2025, when the median age

shall be 31 years. This large class of consumers is expected to drive Indias impressive

growth, making it the worlds fifth largest consumer market by 2025,4 surpassing Germany.

According to a study by the McKinsey Global Institute, Indias growth is expected to create a

vast middle class (Income of USD 5,000 USD 25,0005), bigger than that of U.S. and

Europe combined. This middle class, numbering around 600 million by 2025, is expected to

account for over 60 percent of the total spending in the country. India has fast become a

preferred investment destination for global investors and

companies propelled by:

Existence of a stable democracy and political system;

Globalization of the Indian economy;

Favorable regulatory reforms and institutional framework leading to

integration with the global economy;

Emergence as a global hub for manufacturing, software and BPO services;

Robust earnings growth of the corporate sector and a booming capital market;

Favorable demographics with a growing consuming and investing class; and

Increased savings in the economy, channelized into the creation of productive

assets


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COMPANY PROFILE

1.1 INTRODUCTION:

INDIA INFOLINE LTD

Head Office: India Infoline Ltd., 75, Nirlon Complex, Off. Western Express Highway,

Goregaon (East), Mumbai 400063.

Web Address: www.indiainfoline.com

BSE: 532636 | NSE: INDIAINFO | ISIN: INE530B01024

Market Cap: [`Cr.] 2,887 | Face Value: [

`] 2

Industry: Finance & Investments

The IIFL (India Infoline) group, comprising the holding company, India Infoline Ltd

(NSE: INDIAINFO, BSE: 532636) and its subsidiaries, is one of the leading players in the

Indian financial services space. IIFL offers advice and execution platform for the entire range

of financial services covering products ranging from Equities and derivatives, Commodities,

Wealth management, Asset management, Insurance, Fixed deposits, Loans, InvestmentBanking, GoI bonds and other small savings instruments. IIFL recently received an in-

principle approval for Securities Trading and Clearing memberships from Singapore

Exchange (SGX) paving the way for IIFL to become the first Indian brokerage to get a

membership of the SGX. IIFL also received membership of the Colombo Stock Exchange

becoming the first foreign broker to enter Sri Lanka

A network of over 2,500 business locations spread over more than 500 cities and

towns across India facilitates the smooth acquisition and servicing of a large customer base.
http://www.indiainfoline.com/http://www.indiainfoline.com/


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All our offices are connected with the corporate office in Mumbai with cutting edge

networking technology. The group caters to a customer base of about a million customers,

over a variety of mediums viz. online, over the phone and at our branches

1.2 History and Milestones

Ye ar M ile s tone s

1 9 9 5 C o mme nced op erations as a n Equity R ese arch firm

1 9 9 7Launchedresearchproductso flead ingInd ianco mp anies,k eyse c to rsan

ec ono my C lient included lea ding F IIs, ba nks and co mp anie1 9 9 9 La unched w w w .indiainfo line.co m

2 0 0 0 La unched w w w .5 p aisa .co m S tarted d istrib utio n of life insur

2 0 0 3 La unched p rop rietary trad ing platfo rm Tra d er T erm inal fo r

2 0 0 4 Acquired commodities broking license

La unched P ortfo lio M anageme nt S ervice

2 0 0 5 M aiden IP O and lis ted o n N S E, BS E2 0 0 6 Acquired membership of DGCX

C o mme nced the lending business

2 0 0 7 C o mme nced institutio nal eq uities b usiness unde r IIF L

F o rmed S ingap o re subsid iary, IIFL (As ia) P te Ltd

2 0 0 8 Launched IIF L W ealth

Transitioned to insurance broking model2 0 0 9 A cq uired registratio n fo r H o using F inance

S EB I in- p rincip le a p p ro val fo r M utual F und

O b tained V enture C ap ital lice nse

2 0 1 0

R ec eivedin- p rincip leap p ro valfo r me mb ers hipo f the S ingap o reS

Exchange

Rece ived membershi o f the C o lombo S tock Exchan e(Table 1.1: History and Milestones)


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1.3 PRODUCT AND SERVICES:

We are a one-stop financial services shop, most respected for quality of its advice,

personalized service and cutting-edge technology.

Equities Broking:

India Infoline provided the prospect of researched investing to its clients, which was

hitherto restricted only to the institutions. Research for the retail investor did not exist

prior to India Infoline. India Infoline leveraged technology to bring the convenience of

trading to the investors location of preference (residence or office) through computerized

access. India Infoline made it possible for clients to view transaction costs and ledger

updates in real time

Commodities

IIFL offers commodities trading to its customers vide its membership of the MCX and the

NCDEX. Our domain knowledge and data based on in depth research of complex

paradigms of commodity kinetics, offers our customers a unique insight into behavioral

patterns of these markets. Our customers are ideally positioned to make informed

investment decisions with a high probability of success.

Credit and finance

IIFL offers a wide array of secured loan products. Currently, secured loans (mortgage

loans, margin funding, and loans against shares) comprise 94% of the loan book. The

Company has discontinued its unsecured products. It has robust credit processes and

collections mechanism resulting in overall NPAs of less than 1%. The Company has

deployed proprietary loan-processing software to enable stringent credit checks while

ensuring fast application processing. Recently the company has also launched Loans

against Gold.


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Insurance

IIFL entered the insurance distribution business in 2000 as ICICI Prudential Life

Insurance Co. Ltds corporate agent. Later, it became an Insurance broker in October

2008 in line with its strategy to have an open architecture model. The Company now

distributes products of major insurance companies through its subsidiary India Infoline

Insurance Brokers Ltd. Customers can choose from a wide bouquet of products from

several insurance companies including Max New York Life Insurance, MetLife, Reliance

Life Insurance, Bajaj Allianz Life, Birla Sunlife, Life Insurance Corporation, Kotak Life

Insurance and others.

Wealth Management Service

IIFL offers private wealth advisory services to high-net-worth individuals (HNI) and

corporate clients under the IIFL Private Wealth brand. IIFL Private Wealth is managed

by a qualified team of MBAs from IIMs and premier institutes with relevant industry

experience. The team advises clients across asset classes like sovereign and quasi-

sovereign debt, corporate and collateralised debt, direct equity, ETFs and mutual funds,

third party PMS, derivative strategies, real estate and private equity. It has developedinnovative products structured on the fixed income side. It also has tied up with

Interactive Brokers LLC to strengthen its execution platform and provide investors with a

global investment platform

Research:

Sound investment decisions depend upon reliable fundamental data and stock selection

techniques. Equity investment professionals routinely use our research and models as

integral tools in their work. They choose Ford Equity Research when they can clear yourdoubts.

Invest In Mutual Fund

India Infoline offers you a host of mutual fund choices under one roof, backed by in-

depth research and advice from research house and tools configured as investor friendly.


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Investment Banking

IIFLs investment banking division was launched in 2006. The business leverages upon its

strength of research and placement capabilities of the institutional and retail sales teams.

Our experienced investment banking team possesses the skill-set to manage all kinds of

investment banking transactions. Our close interaction with investors as well as corporate

helps us understand and offer tailor-made solutions to fulfil requirements

The Company possesses strong placement capabilities across institutional, HNI and retail

investors. This makes it possible for the team to place large issues with marquee investors

In FY10, the team advised and managed more than 10 transactions including four IPOs

and four Qualified Institutions Placements

Portfolio Management Services:

Our Portfolio Management Service is a product wherein an equity investment portfolio is

created to suit the investment objectives of a client. We at India infoline invest your

resources into stocks from different sectors, depending on your risk-return profile. This

service is particularly advisable for investors who cannot afford to give time or don't have

that expertise for day-to-day management of their equity portfolio.

Mortgages:

During the year under review, Indiainfoline acquired a 75% stake in Moneytree

Consultancy Services to mark its foray into the business of mortgages and other loan

products distribution. The business is still in the investing phase and at the time of the

acquisition was present only in the cities of Mumbai and Pune. The Company brings on

board expertise in the loans business coupled with existing relationships across a number

of principals in the mortgage and personal loans businesses. Indiainfoline now has plans

to roll the business out across its pan-Indian network to provide it with a truly national

scale in operations.


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CHAPTER 2

Objectives of the Report


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OBJECTIVES OF THE PROJECT

TO STUDY DERIVATES SEGMENTS OF NSE (FUTURES & OPTIONS)

WITH EFFECTIVE PAYOFF STRATEGIES.

TO ANALYZE IMPACTS OF VARIOUS MACRO-ECONOMY & MICRO-

ECONOMY FACTORS ON INDIAN BANKING SECTOR

TO EVALUATE VALUATIONS ON BANK OF BARODA IN INDIAN STOCK

MARKET WITH RESPECT TO ITS FINANCIAL PERFORMANCE AND

FUTURE EARNINGS CAPACITY.


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CHAPTER 3

Theoretical Background


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THEORETICAL BACKGROUND

3.1 FUNDAMENTAL ANALYSIS

Fundamental analysis is a technique that attempts to determine a securitys value by

focusing on underlying factors that affect a company's actual business and its future

prospects.

Fundamental analysis serves to answer questions, such as:

Is the companys top-line is growing?

Is it actually making an increase in bottom line of company?

Is it able to repay its debts?

Is management effective focusing on utilization of resources and able to grow in near

future?

In general, the investor should try to get greater insights on the following aspects of the

company:

Business Model

Competitive Advantage

Management

Corporate Governance

Financial and Information Transparency

Stakeholder Rights

Structure of the Board of Directors Customers

Market Share

Industry Growth

Competition

Regulation, if any


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Financial statements are the medium by which a company discloses information

concerning its financial performance, which include profit and loss account, balance sheet

and other financial statements published by the company from time to time.

3.2 INTRODUCTION TO DERIVATIVES

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 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 Defined

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. The price of this

derivative is driven by the spot price of "underlying".

In the Indian context the Securities Contracts (Regulation) Act, 1956 (SC(R)A) defines

"derivative" to include-

1. A security derived from a debt instrument, share, loan whether secured or unsecured, risk

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

2. A contract which derives its value from the prices, or script of prices, of underlying

securities.

Derivatives are securities under the SC(R) A and hence the trading of derivatives is governed

by the regulatory framework under the SC(R) A.


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Derivatives Product

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 upto 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.

Swaps & Swaptions: 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:

o Interest rate swaps: These entail swapping only the interest related cash

flows between the parties in the same currency.

o 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.

o Swaptions: Swaptions are options to buy or sell a swap that will become

operative at the expiry of the options. Thus a swaption is an option on a

forward swap. Rather than have calls and puts, the swaptions market has

receiver swaptions and payer swaptions. A receiver swaption is an option to

receive fixed and pay floating. A payer swaption is an option to pay fixed and

receive floating.


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3.3 INTRODUCTION TO FORWARD, FUTURES AND OPTIONS

Forward Contract:

A forward contract is an agreement to buy or sell an asset on a specified date for a

specified price. One of the parties to the contract assumes a long position and agrees to buy

the underlying asset on a certain specified future date for a certain specified price. The other

party assumes a short position and agrees to sell the asset on the same date for the same price.

Other contract details like delivery date, price and quantity are negotiated bilaterally by the

parties to the contract. The forward contracts are normally traded outside the exchanges.

The salient features of forward contracts are:

They are bilateral contracts and hence exposed to counter party risk.

Each contract is custom designed, and hence is unique in terms of contract size, expiration

date and the asset type and quality.

The contract price is generally not available in public domain.

On the expiration date, the contract has to be settled by delivery of the asset.

If the party wishes to reverse the contract, it has to compulsorily go to the same counter-

party, which often results in high prices being charged.

Forward contracts are very useful in hedging.

For E.g. Classic hedging application would be that of an exporter who expects to receive

payment in dollars three months later. He is exposed to the risk of exchange rate fluctuations.

By using the currency forward market to sell dollars forward, he can lock on to a rate today

and reduce his uncertainty. Similarly an importer who is required to make a payment in

dollars two months hence can reduce his exposure to exchange rate fluctuations by buying

dollars forward.

Limitations of Forward Market

Forward markets world-wide are afflicted by several problems:

Lack of centralization of trading,


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Illiquidity, and

Counterparty risk

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.

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

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.


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Contract cycle: The period over which a contract trades. The index futures contracts

on the NSE have one- month, two-months 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 under 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.

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.

Introduction to Options

Options are fundamentally different from forward and futures contracts. An option

gives the holder of the option the right to do something. The holder does not have to exercise

this right. In contrast, in a forward or futures contract, the two parties have committed


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themselves to doing something. Whereas it costs nothing (except margin requirements) to

enter into a futures contract, the purchase of an option requires an up-front payment.

Option Terminology

Index options: These options have the index as the underlying. Some options are

European while others are American. Like index futures contracts, index options

contracts are also cash settled.

Stock options: Stock options are options on individual stocks. Options currently

trade on over 500 stocks in the United States. A contract gives the holder the right to

buy or sell shares at the specified price.

Buyer of an option: The buyer of an option is the one who by paying the option

premium buys the right but not the obligation to exercise his option on the

seller/writer.

Writer of an option: The writer of a call/put option is the one who receives the

option premium and is thereby obliged to sell/buy the asset if the buyer exercises on

him.

There are two basic types of options, call options and put options.

Call option: A call option gives the holder the right but not the obligation to buy an

asset by a certain date for a certain price.

Put option:A put option gives the holder the right but not the obligation to sell an

asset by a certain date for a certain price.

Option price/premium: Option price is the price which the option buyer pays to the

option seller. It is also referred to as the option premium.

Expiration date: The date specified in the options contract is known as the

expiration date, the exercise date, the strike date or the maturity.

Strike price: The price specified in the options contract is known as the strike price

or the exercise price.

American options: American options are options that can be exercised at any time up

to the expiration date. Most exchange-traded options are American.

European options: European options are options that can be exercised only on the

expiration date itself. European options are easier to analyze than American options,


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and properties of an American option are frequently deduced from those of its

European counterpart.

In-the-money option:An in-the-money (ITM) option is an option that would lead to

a positive cash flow to the holder if it were exercised immediately. A call option on

the index is said to be in-the-money when the current index stands at a level higher

than the strike price (i.e. spot price > strike price). If the index is much higher than the

strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the

index is below the strike price.

At-the-money option: An at-the-money (ATM) option is an option that would lead to

zero cash flow if it were exercised immediately. An option on the index is at-the-

money when the current index equals the strike price (i.e. spot price = strike price).

Out-of-the-money option: An out-of-the-money (OTM) option is an option that

would lead to a negative cash flow if it were exercised immediately. A call option on

the index is out-of-the-money when the current index stands at a level which is less

than the strike price (i.e. spot price < strike price). If the index is much lower than the

strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the

index is above the strike price.

Intrinsic value of an option: The option premium can be broken down into two

components - intrinsic value and time value. The intrinsic value of a call is the amount

the option is ITM, if it is ITM. If the call is OTM, its intrinsic value is zero. Putting it

another way, the intrinsic value of a call is Max[0, (St K)] which means the

intrinsic value of a call is the greater of 0 or(St K). Similarly, the intrinsic value of

a put is Max[0, K St],i.e. the greater of 0 or(K St). K is the strike price and Stis

the spot price.

Time value of an option:The time value of an option is the difference between its

premium and its intrinsic value. Both calls and puts have time value. An option that is

OTM or ATM has only time value. Usually, the maximum time value exists when the

option is ATM. The longer the time to expiration, the greater is an option's time value,

all else equal. At expiration, an option should have no time value.

The following factors affect the value of an option:

1. Underlying market price

2. Strike price


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3. Volatility (variability) of underlying instrument

4. Time to expiration

5. Interest rate

As these factors change, the value of options maintained within a portfolio also changes.

3.4 RBIS KEY POLICY RATE:

The key policy rate include the bank rate, the repo rate, the reverse repo rate, the cash reserve

ratio (CRR) and the statutory liquidity ratio (SLR). RBI increases its key policy rates when

there is greater volume of the money in the economy. Conversely, when there is a liquidity

crunch or recession, RBI would lower its key policy rates to inject more money into the

economic system.


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Repo rate:

Repo rate or repurchase rate is the rate at which RBI lends to banks for short periods. This is

done by RBI buying government bonds from banks with an agreement to sell them back at

fixed rate. If central bank wants to make more expensive for banks to borrow money, it

increases the repo rate. Similarly, if it wants to make it cheaper for banks to borrow money, it

reduces the repo rate. The current repo rate is 5.50%

Reverse Repo rate:

Reverse repo rate is the rate of interest at which the central bank borrows funds from other

banks in the short term. Like the repo, this is done by selling government bonds to banks with

the commitment to buy them back at future date. The banks use the reverse repo facility to

deposits their short term excess funds with central bank to earn interest on it.RBI can reduce

liquidity in the banking system by increasing the rate at which it borrow from banks. Hiking

the repo and reverse repo rate ends up reducing the liquidity and pushes up interest rates.

Statutory Liquidity Ratio (SLR)

Apart from keeping a portion of deposits with RBI as cash, banks are also required to

maintain a minimum percentage of deposits with them at the end of every business day, in theform of gold, cash, government bonds or other approved securities. This minimum

percentage is called Statutory Liquidity Ratio. The current SLR is 25%.In times of high

growth, an increase in SLR requirement reduces lendable resources of banks and pushes up

interest rates.

Cash Reserve Ratio

Cash reserve Ratio (CRR) is the amount of funds that banks have to park with RBI. If RBI

decides to increase the cash reserve ratio, the available amount with banks would reduce. The

central bank increases CRR to impound surplus liquidity.CRR serves two purposes:


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It ensures that a portion of bank deposits are always available to meet withdrawal

demand

It enables that RBI control liquidity in the system and thereby, inflation by tying their

hands in lending money. The current CRR is 6%

Impact of CRR change:

When there is a change in the CRR, the first impact is seen in the banks. For banks, the rise in

CRR would mean that a larger proportion of funds will be with RBI, while a fall in rate will

mean a lower proportion will be with the apex bank.

Bank Rate

Unlike other policy rates, the banks rate is purely a signaling rate and most interest rate are

delinked from the bank rate. Also, the bank rate is the indicative rate at which RBI lends

money to other banks (or financial institutions).The bank rate signals the central banks long

term outlook on interest rates. If the bank rate moves up, long term interest rates also tend

to move up, and vice-versa.

Movement in key policy rates in India

Effective Rate Reverse Repo

Rate

Repo Rate Cash Reserve

Ratio

JUNE 27 2010 4.50% 5.75% 6.00%

(Table 3.1: Movement in Key Policy Rates)

Base rate:

The new benchmark rate below which banks will not provide loans is termed as base rate. It

is linked to the cost of funds and will replace the benchmark prime lending rate or BPLR, and


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bring in transparency in loan pricing.RBI have given banks the flexibility to fix their base

rate.

Sector Exempt: The base rate will not apply to concessional loans for agriculture, exports,

and other specified sectors.

Provisions and Contingent Assets / Liabilities

The Bank creates a provision when there is a present obligation as a result of a past event that

probably requires an outflow of resources and a reliable estimate can be made of the amountof the obligation. A disclosure for contingent liability is made when there is a possible

obligation or a present obligation that may but probably will not require an outflow of

resources. When there is a possible obligation or a present obligation in respect of which the

likelihood of outflow of resources is remote, no provision or disclosure is made.


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CHAPTER 4

Research Methodology

RESEARCH METHODOLOGY


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4.1 INTRODUCTION

Research in common parlance refers to a search for knowledge. Research is termed as a

scientific & systematic search for pertinent information on specific topic. According to

Redman and Mory define research as a systematized effort to gain new knowledge.

Thus, term Research refers to the systematic method of consisting of enunciating

problem, collecting the facts or data, analyzing the facts and reaching a certain conclusion

either in the form of solutions towards concerned problem or in certain generalizations for

some theoretical formulation.

Research Design:

A Research Design is the arrangement of conditions for collection and analysis of data in a

manner that aims to combine relevance to the research purpose with economy in procedure.

Research Design is blueprint of the research.

Sample Design: It deals with method of selecting items to be observed for the given study by

analyze a group of population size available.

For e.g. Sample Size is One (Bank of Baroda) from the population of various Banks

operating in India (Nationalized =19, Private players=7, Co-operative, RRB, Foreign banksetc.)

4.2 COLLECTION OF DATA:

1. Primary Data Collection:

Primary data is originally gathered specifically on project hand. Project obtains

information for various future payoff strategies from India Infoline Research teams. It

offers much greater accuracy and reliability.

Observation method by Research team of company.

2. Secondary Data Collection:


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After doing the data collection in primary method, the researcher did the

collection through the secondary data. In this there are several types such as:

General library: Books of Fundamental research, Valuation techniques.

Trade-Books: Capital Market magazine, Business papers etc.

Press releases & Media: RBI policy releases, Govt. Policy etc.

Internet :Collecting an annuals reports and some major announcements

through official website Bank of Baroda

4.3 TYPE OF RESEARCH:

Analytical Research:

In analytical research, researcher has to use facts or information already available for

carry out an intensive research. Project mainly undergoes an analytical research. Project

collects a various available facts regarding Macro-economy and Micro-economy view.

Project collects a five years financial of company through annual reports. Banking

impacts of various factors is analyzed to form some concrete information.

Statistically Data Used:

CAGR (%) is determined for last five years (2006-2010) to understand it is annual

compounding growth.

Y-o-Y (%) is also calculated for knowing a upward or downward bias of various

parameters of company.

Projected earning of next two years is determined by using a CAGR (%) and its

impacted factors in economic conditions.

Average and Growth (%) in dividend yield and retention is studied for

understanding it future market value of Bank of Baroda script.


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CHAPTER 5

Data Analysis and Interpretation


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DATA ANALYSIS AND INTERPRETATION

7.1 FUTURES PAYOFFS

Futures contracts have linear payoffs. In simple words, it means that thelosses as well

as profits for the buyer and the seller of a futures contract areunlimited. These linear payoffs

are fascinating as they can be combined withoptions and the underlying to generate various

complex payoffs.

Payoff for buyer of futures: Long futures

The payoff for a person who buys a futures contract is similar to the payoff for a

person who holds an asset. He has a potentially unlimited upside as well as a potentially

unlimited downside. Take the case of a speculator who buys a two month SBI futures

contract stands at 2220. The underlying asset in this case is the SBI script. When the index

moves up, the long futures position starts making profits, and when the script moves down it

starts making losses. Figure shows the payoff diagram for the buyer of a futures contract.

(Figure 7.1: Payoff for buyer of futures: Long futures)


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Payoff for seller of futures: Short futures

The payoff for a person who sells a futures contract is similar to the payoff for a person who

shorts an asset. He has a potentially unlimited upside as well as a potentially unlimited

downside.

For E.g. Take the case of a speculator who sells a two-month SBI futures contract when the

SBI script at 2220. The underlying asset in this case is the SBI scrip. When the script moves

down, the short futures position starts making profits, and when the script moves up, it starts

making losses.

Figure shows the payoff diagram for the seller of a futures contract.

(Figure 7.2: Payoff for seller of futures: Short futures)

Pricing Futures:

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

r =Cost of financing (using continuously compounded interest rate)


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T =Time till expiration in years e =2.71828

Hedging: Long security, sell futures

Futures can be used as an effective risk-management tool.

For E.g. Take the case of an investor who holds the shares of a company and gets

uncomfortable with market movements in the short run. He sees the value of his security

falling from `450 to `390. In the absence of stock futures, he would either suffer the

discomfort of a price fall or sell the security in anticipation of a market upheaval. With

security futures he can minimize his price risk. All he need do is enter into an offsetting stock

futures position, in this case, take on a short futures position. Assume that the spot price of

the security he holds is `390. Two-month futures cost him `402. For this he pays an initial

margin. Now if the price of the security falls any further, he will suffer losses on the security

he holds. However, the losses he suffers on the security will be offset by the profits he makes

on his short futures position. Take for instance that the price of his security falls to `350. The

fall in the price of the security will result in a fall in the price of futures. Futures will now

trade at a price lower than the price at which he entered into a short futures position. Hence

his short futures position will start making profits. The loss of`40 incurred on the security he

holds, will be made up by the profits made on his short futures position.

Index futures in particular can be very effectively used to get rid of the market risk of a

portfolio. Every portfolio contains a hidden index exposure or a market exposure. This

statement is true for all portfolios, whether a portfolio is composed of index securities or not.

Suppose we have a portfolio of ` 1 million which has a beta of 1.25. Then a

complete hedge is obtained by selling `1.25 million of Nifty futures.


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7.2 OPTIONS PAYOFF:

Payoff for buyer of call option

The figure shows the profits/losses for the buyer of a three-month SBI Script 2250

call option. As can be seen, as the spot Script rises, the call option is in-the-money. If upon

expiration, Script closes above the strike of 2250, the buyer would exercise his option and

profit to the extent of the difference between the Script-close and the strike price. The profitspossible on this option are potentially unlimited. However if Script falls below the strike of

2250, he lets the option expire. His losses are limited to the extent of the premium he paid for

buying the option.

(Figure 7.3: Payoff for buyer of call option)


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Payoff for writer of call option

The figure shows the profits/losses for the seller of a three-month SBI Script 2250 call option.

As the spot Script rises, the call option is in-the-money and the writer starts making losses. If

upon expiration, Script closes above the strike of 2250, the buyer would exercise his option

on the writer who would suffer a loss to the extent of the difference between the Script -close

and the strike price. The loss that can be incurred by the writer of the option is potentially

unlimited, whereas the maximum profit is limited to the extent of the up-front option

premium of`

86.60 charged by him.

(Figure 7.4: Payoff for writer of call option)


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Payoff for buyer of put option

The figure shows the profits/losses for the buyer of a three-month SBI Script 2250 put

option. As the spot Script falls, the put option is in-the-money. If upon expiration, Script

closes below the strike of 2250, the buyer would exercise his option and profit to the extent of

the difference between the strike price and Script-close. The profits possible on this option

can be as high as the strike price. However if Script rises above the strike of 2250, he lets the

option expire. His losses are limited to the extent of the premium he paid for buying the

option.

(Figure 7.5: Payoff for buyer of put option)


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Payoff for writer of put option

(Figure 7.6: Payoff for writer of put option)

The figure shows the profits/losses for the seller of a three-month SBI Script 2250 put

option. As the spot Script falls, the put option is in-the-money and the writer starts making

losses. If upon expiration, Script closes below the strike of 2250, the buyer would exercise his

option on the writer who would suffer a loss to the extent of the difference between the strike

price and Script-close. The loss that can be incurred by the writer of the option is a maximum

extent of the strike price (Since the worst that can happen is that the asset price can fall to

zero) whereas the maximum profit is limited to the extent of the up-front option premium of

`61.70 charged by him.


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One month calls and puts trading at different strikes

The spot price is 1250. There are five one-month calls and five one-month puts

trading in the market. The call with a strike of 1200 is deep in-the-money and hence trades at

a higher premium. The call with a strike of 1275 is out-of-the-money and trades at a low

premium. The call with a strike of 1300 is deep-out-of-money. Its execution depends on the

unlikely event that the price of underlying will rise by more than 50 points on the expiration

date. Hence buying this call is basically like buying a lottery. There is a small probability that

it may be in-the-money by expiration in which case the buyer will profit. In the more likely

event of the call expiring out-of-the-money, the buyer simply loses the small premium

amount of` 27.50. Table shows the payoffs from buying calls at different strikes. Similarly,

the put with a strike of 1300 is deep in-the-money and trades at a higher premium than the at-

the-money put at a strike of 1250. The put with a strike of 1200 is deep out-of-the-money and

will only be exercised in the unlikely event that underlying falls by 50 points on the

expiration date

Underlying Strike price of options Call Premium(Rs.) Put Premium(R

1250 1200 80.1 18.15

1250 1225 63.65 26.5

1250 1250 49.45 37

1250 1275 37.5 49.8

(Table 7.1: One month calls and puts trading at different strikes)


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Payoff for seller of call option at various strikes

The figure shows the profits/losses for a seller of calls at various strike prices. The in-the

money option has the highest premium of`80.10 whereas the out-of-the-money option has

the lowest premium of` 27.50.

(Figure 7.7: Payoff for seller of call option at various strikes)

Payoff for buyer of put options at various strikes

The figure shows the profits/losses for a buyer of puts at various strike prices. The in-the

money option has the highest premium of`64.80 whereas the out-of-the-money option has

the lowest premium of` 18.50.


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(Figure 7.8: Payoff for buyer of put options at various strikes)

Bull spreads - Buy a call and sell another

A spread trading strategy involves taking a position in two or more options of the

same type, that is, two or more calls or two or more puts. A spread that is designed to profit if

the price goes up is called a bull spread. It is basically done utilizing two call options having

the same expiration date, but different exercise prices. The buyer of a bull spread buys a call

with an exercise price below the current index level and sells a call option with an exercise

price above the current index level. The spread is a bull spread because the trader hopes to

profit from a rise in the index. The trade is a spread because it involves buying one option

and selling a related option.

Compared to buying the underlying asset itself, the bull spread with call options limits

the trader's risk, but the bull spread also limits the profit potential.

Payoff for a bull spread created using call options

The figure shows the profits/losses for a bull spread. The payoff obtained is the sum

of the payoffs of the two calls, one sold at `40 and the other bought at `80. The cost of

setting up the spread is `40 which is the difference between the call premium paid and the

call premium received. The downside on the position is limited to this amount. As the index

moves above 3800, the position starts making profits (cutting losses) until the index reaches

4200. Beyond 4200, the profits made on the long call position get offset by the losses made


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on the short call position and hence the maximum profit on this spread is made if the index on

the expiration day closes at 4200. Hence the payoff on this spread lies between -40 to 360.

Somebody who thinks the index is going to rise, but not above 4200. Hence he does not want

to buy a call at 3800 and pay a premium of 80 for an upside he believes will not happen. In

short, it limits both the upside potential as well as the downside risk. The cost of the bull

spread is the cost of the option that is purchased, less the cost of the option that is sold. It

gives the profit/loss incurred on a spread position as the index changes. Figure shows the

payoff from the bull spread.

(Figure 7.9: Payoff for a bull spread created using call options)

Broadly, we can have three types of bull spreads:

1. Both calls initially out-of-the-money.

2. One call initially in-the-money and one call initially out-of-the-money, and

3. Both calls initially in-the-money.

The decision about which of the three spreads to undertake depends upon how much

risk the investor is willing to take. The most aggressive bull spreads are of type 1. They cost

very little to set up, but have a very small probability of giving a high payoff.


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Table Expiration day cash flows for a Bull spread using two-month calls

The table shows possible expiration day profit for a bull spread created by buying

calls at a strike of 3800 and selling calls at a strike of 4200. The cost of setting up the spread

is the call premium paid (`80) minus the call premium received (`40), which is `40. This is

the maximum loss that the position will make. On the other hand, the maximum profit on the

spread is limited to `360. Beyond an index level of 4200, any profits made on the long call

position will be cancelled by losses made on the short call position, effectively limiting the

profit on the combination.

Nifty Buy Jan 3800 Call Sell Jan 4200 Call Cash Flow Profit&Loss (Rs.

3700 0 0 0 -40

3750 0 0 0 -40

3800 0 0 0 -40

3850 50 0 50 10

3900 100 0 100 60

3950 150 0 150 110

4000 200 0 200 160

4050 250 0 250 210

4100 300 0 300 260

4150 350 0 350 310

4200 400 0 400 360

4250 450 0 450 410

4300 500 -50 450 410

(Table 7.2: Bull spread created using call options)

Bear spreads - sell a call and buy another

A spread trading strategy involves taking a position in two or more options of thesame type, that is, two or more calls or two or more puts. A spread that is designed to profit if

the price goes down is called a bear spread. This is basically done utilizing two call options

having the same expiration date, but different exercise prices. How a bull is spread different

from a bear spread? In a bear spread, the strike price of the option purchased is greater than

the strike price of the option sold. The buyer of a bear spread buys a call with an exercise

price above the current index level and sells a call option with an exercise price below the

current index level. The spread is a bear spread because the trader hopes to profit from a fall


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in the index. The trade is a spread because it involves buying one option and selling a related

option.

Compared to buying the index itself, the bear spread with call options limits the

trader's risk, but it also limits the profit potential. In short, it limits both the upside potential

as well as the downside risk.

A bear spread created using calls involves initial cash inflow since the price of the call sold is

greater than the price of the call purchased. Table gives the profit/loss incurred on a spread

position as the index changes. Figure shows the payoff from the bear spread.

(Figure 7.10: Bear spreads - sell a call and buy another)

Broadly we can have three types of bear spreads:

1. Both calls initially out-of-the-money.

2. One call initially in-the-money and one call initially out-of-the-money, and

3. Both calls initially in-the-money.


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The decision about which of the three spreads to undertake depends upon how much risk the

investor is willing to take. The most aggressive bear spreads are of type 1. They cost very

little to set up, but have a very small probability of giving a high payoff. As we move from

type 1 to type 2 and from type 2 to type 3, the spreads become more conservative and cost

higher to set up. Bear spreads can also be created by buying a put with a high strike price and

selling a put with a low strike price.

The figure shows the profits/losses for a bear spread. As can be seen, the payoff obtained is

the sum of the payoffs of the two calls, one sold at ` 150 and the other bought at `50. The

maximum gain from setting up the spread is ` 100 which is the difference between the call

premium received and the call premium paid. The upside on the position is limited to this

amount. As the index moves above 3800, the position starts making losses (cutting profits)

until the spot reaches 4200. Beyond 4200, the profits made on the long call position get offset

by the losses made on the short call position. The maximum loss on this spread is made if the

index on the expiration day closes at 2350. At this point the loss made on the two call

position together is `400 i.e. (4200-3800). However the initial inflow on the spread being

`100, the net loss on the spread turns out to be 300.The downside on this spread position is

limited to this amount. Hence the payoff on this spread lies between +100 to -300.

Table Expiration day cash flows for a Bear spread using two-month calls

The table shows possible expiration day profit for a bear spread created by selling one market

lot of calls at a strike of 3800 and buying a market lot of calls at a strike of 4200. The

maximum profit obtained from setting up the spread is the difference between the premium

received for the call sold (` 150) and the premium paid for the call bought (`50) which is `

100.

In this case the maximum loss obtained is limited to `300. Beyond an index level of 4200,

any profits made on the long call position will be canceled by losses made on the short call

position, effectively limiting the profit on the combination.


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(Table 7.3: Bear spreads - sell a call and buy another)

Calendar spread

A calendar spread is a position in an underlying with one maturity which is hedged by an

offsetting position in the same underlying with a different maturity: for example, a short

position in a July futures contract on Reliance and a long position in the August futures

contract on Reliance is a calendar spread. Calendar spreads attract lower margins because

they are not exposed to market risk of the underlying. If the underlying rises, the July contract

would make a profit while the August contract would make a loss.

Nifty Buy Jan 4200 Call Sell Jan 3800 Call Cash Flow Profit&Loss (R

3700 0 0 0 100

3750 0 0 0 100

3800 0 0 0 100

3850 0 -50 -50 503900 0 -100 -100 0

3950 0 -150 -150 -50

4000 0 -200 -200 -100

4050 0 -250 -250 -150

4100 0 -300 -300 -200

4150 0 -350 -350 -250

4200 0 -400 -400 -300

4250 50 -450 -400 -300


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7.3 SECTORAL ANALYSIS ON BANKING SECTOR

(Figure 7.11: Sectoral Analysis)

Parameters Effect on Banking Sector

Economy Global economy is under recession showing

captures upswings and downswings manifesting in

the business cycles. Consequently, movements in general

activity level are expected to generate direct impact on bank.

Rupee-Dollar Fluctuations Export oriented sector is greatly affected by Rupee-Dollar

Fluctuations. IT, Textiles, Diamonds etc are affecting a forex

Transactions to Banks

Crude Oil Rate India is one of the largest Importer of Oil & Gas which leads

to generation of forex transaction to Banks

Inter Bank Rate LIBOR and Interbank rate is very efficient in deciding a short term

Inter bank lending for maintaining profitability and liquidity.

FDI Global economy must correlate for attracting a FDI in INDIA for

eneratin rowth in Indian econom and Bankin sector

Macro-Economy

(Table 7.4: Macro Economy)


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7.3.1Macro-Economic Context:

The global economy is recovering faster than expected from the global crisis amidst

ongoing policy support and improving financial market conditions. The recovery process is

led by EMEs, especially those in Asia, as growth remains weak in advanced economies. Theglobal economy continues to face several challenges such as high levels of unemployment,

which is close to 10% in the US and the Euro area. In its World Economic Outlook update for

April 2010, the International Monetary Fund(IMF) has projected that global growth will

recover from a decline of ( 0.6%) in 2009 to a growth of 4.2% in 2010 and a growth of 4.3%

in 2011.Among the advanced economies, the United States is off to a better start than Europe

and Japan. IMF projected that US GDP growth will recover from ( 2.4%) in 2009 to 3.1% in

2010. Growth in Euro area will recover from ( 4.1%) in 2009 to 1.0% in 2010. Amongst

EMEs, China continues to grow at a rapid pace, led mainly by domestic demand. Chinas

growth is forecast at 10% in 2010, with India also at a rapid pace of 8.8%. Malaysia and

Thailand have recovered to register positive growth in the second half of 2009. Indonesia

recorded positive growth throughout 2009. Global headline inflation rates rose between

November 2009 and January 2010, softened in February 2010 on account of moderation of

food, metal and crude prices and again rose marginally in some major economies in March

2010.

The Global economy, which was stunted by the impact of unprecedented Global

Meltdown of 2008-09 witnessed gradual recovery through the last year, supported largely by

extraordinary policy intervention by the Government and Central banks of countries across

globe. The pace of recovery, however, remained uneven across countries, with tepid growth

by advanced economies and faster growth by emerging and developing economies. Although

recovery process continue to progress, the recent sovereign debt crisis in several European

countries has created new hurdles in the way of sustainable growth and stability. The falloutand contagion effect of European debt crisis has, however, been contained to a European

Union, IMF, European central bank. However, should there be any case of default or

restricting of sovereign European debt, it can adversely affect market sentiments, cause

interest rates to rise, impact capital flows eventually affecting growth process. This apart, for

sustaining global recovery and growth momentum the challenges will be surmounting high

unemployment rate, high fiscal deficit and high debt to GDP ratio prevailing especially in

case of Developed countries and need to unwind fiscal and monetary stimulus measures

sometimes in future.


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The global GDP, as projected by World bank recently, is expected to grow by 3.3% in

2010 and 2011 as against contraction

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