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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
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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.
B.R.C.M. College of Business Administration, Surat
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.
B.R.C.M. College of Business Administration, Surat
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
B.R.C.M. College of Business Administration, Surat
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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 $,)-days. These treasury bills are issued
through an auction procedure. The yield is determined on the
basis of bids tendered and accepted.
1ank@FI 1onds
Most of the institutional bonds are in the form of promissory notes
transferable by endorsement and deli+ery. These are negotiable
certificates' issued by the inancial Institutions such as the
I7!I
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been issued both as regular income bonds and as discounted long-
term instruments deep discount bonds6.
Pu'5ic Sector Undertakin7s CPSU 1onds
S/ !onds are medium and long term obligations issued by public
sector companies in hich the go+ernment share holding is
generally greater than *"B. Some S/ bonds carry ta3
e3emptions. The minimum maturity is * years for ta3able bonds and
5 years for ta3-free bonds. S/ bonds are generally not guaranteed
by the go+ernment and are in the form of promissory notes
transferable by endorsement and deli+ery. S/ bonds in electronicform demat6 are eligible for repo transactions.
An in+estor can participant in +arious schemes floated by mutual
fund instead of buying e:uity shares. In mutual funds in+est in
e:uity shares fi3ed income securities. There are three broad
types of mutual fund schemes.
@roth schemes
Income schemes
!alanced schemes
B.R.C.M. College of Business Administration, Surat
"UTU$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
B.R.C.M. College of Business Administration, Surat
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$TI2ES6 :
A financial deri+ati+e is an instrument hose +alue is deri+ed from
the +alue of underlying asset. It may be +ieed as a side bet on the
asset. The most import financial deri+ati+es from the point of +ie of
in+estors areH
Dptions
utures.
B.R.C.M. College of Business Administration, Surat
RE$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.
B.R.C.M. College of Business Administration, Surat
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.
B.R.C.M. College of Business Administration, Surat
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.
$d;anta7es of random 4ortfo5io
• Easier to keep a track on the market as not much time
asted in the analysis.
• This portfolio seems to ha+e perform better in short term as
script are generally hich are performing better at that time.
• Tips are a+ailable e+ery here for the in+estor to pouch.
• It is the e3perience of the indi+idual that can fetch him good
return.
Disad;anta7es of random 4ortfo5io
• There is e+ery chance that you may select a script that has a
+ery bad background in the market.
• 9ot e+ery time the tips pay off for you. Lou need to ha+e
strong reason to select that script.
• Such portfolios are not able to sustain hen there is a crisis
in the market.
• There is a +ery high risk and return in+ol+e in such portfolio.
B.R.C.M. College of Business Administration, Surat
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Disad;anta7es of sector 4ortfo5io
• It is a highly risky portfolio as risk associated ith the sector
directly affects the performance of the portfolio.
• These types of portfolios are not suited for long-term in+estor
as risk taken for the return can be too high.
There is alays the possibly many scripts in the sector may not be
gi+ing that much good attracti+e return as others. They may eat the
profits from other scripts.
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T!e P@E ratio as a 7uide to in;estment decisions
Earnings per share alone mean absolutely nothing. In order to get a
sense of ho e3pensi+e or cheap a stock is' you ha+e to look at
earnings relati+e to the stock price and hence employ the
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R$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
B.R.C.M. College of Business Administration, Surat
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
!"#$% &'#('&"#)*&%#%"&%#%"
&'#'+&"#)*&'#"*&$#*)&,#**
! %)#$- . %,
B.R.C.M. College of Business Administration, Surat
Total Portfolio Invest/ent = 10,00,000 Rs#
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RETURN ON INDI2IDU$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 "$$&.50 "2.),
"0 @;AOD 0.," """".,0 "2#2.#0 "*.)0
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RETURN IN DEFENSI2E PORT FOLIO
TOT$L PORTFOLIO IN2EST"ENT K &......
2$LUE OF PORTFOLIO $S ON
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"ODR$TE PORTFOLIO
SR NO# S/RIPT 1ET$ PRI/E ON
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RETURN ON INDI2IDU$L S/RIPTS
&ST "ONT3
SR NO# S/RIPT 1ET$
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RET1RN IN MODRATE PORT FOLIO
TOT$L PORTFOLIO IN2EST"ENT K &......@: Rs##
2$LUE OF PORTFOLIO $S ON
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$GGRESSI2E PORTFOLIO
SR NO# S/RIPT 1ET$ PRI/E ON
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RETURN ON INDI2IDU$L S/RIPTS
&ST "ONT3
SR NO# S/RIPT 1ET$ ;T7 ".0& *&5.00 ,"*.2* $.0,2 I9DSLS ".05 2&5&.$* 2#2#.&* -*.0*
$ D9@C ".02 ""&".,* ""$,.)0 -).,)
) 4E;IA9CE ".0* ))".0* *00.** "$.)&
* SATLAM ".2$ 5$".** 5,&.,* *.2"
, S!I9 ".0& &0).&0 #55.*0 -$.0$
5 TATA DE4 "."" )$).20 *"".20 "5.5$
# TATA MDTE4 "."& ,$&.** #",.20 25.,2
& TATA STEE; "."$ $5&.00 )$".00 "$.52
"0 I4D ".$$ ),".50 *20.)* "2.52
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RETURN IN $GGRESSI2E PORT FOLIO
TOT$L PORTFOLIO IN2EST"ENT K &......@: Rs#
2$LUE OF PORTFOLIO $S ON
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Inter4retation of Random Portfo5io
• As in the theoretical ay e ha+e scene that the !eta shos
the mo+ement or change in the price of script +is--+is inde3.
And a !eta " is more riskier and hence should gi+e more
return as compared to the script ha+ing !eta U ". as the
person is taking more risk then he should get more return.
!ut in our case e ha+e scene that Moderate portfolio
ha+ing !eta U " has gi+en more return as compared to
Aggressi+e ortfolio.
• So e can easily say that the in+estment in e:uity market is
subGect to market risk and any one ha+ing long-term
in+estment hori(on should only enter into e:uity market. This
analysis that has been carried out as only for a period of
to month there are chances that in the long run aggressi+e
portfolio ould outperform the other portfolio
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DERI2$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
B.R.C.M. College of Business Administration, Surat
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Analysis of Investment in Stock Market & Portfolio Management Using Instrument Derivatives – Futures
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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.
B.R.C.M. College of Business Administration, Surat
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