MODULE V

STOCK EXCHANGES & DERIVATIVES

National Stock Exchange [NSE]
NSE was promoted by leading Financial Institutions at the behest of the
Government of India and was incorporated in November 1992. It received the
recognition as a stock exchange in April 1993, NSE has been set up to provide a
modern, fully automated screen-based trading system with national reach. The
Exchange has brought about unparalleled transparency, speed, efficiency,
safety and market integrity.It has set up facilities that serve as a model for the
securities industry interms of systems, practices and procedures.
Ownership and Management
NSE is jointly owned by a set of leading Indian and International
financialinstitutions, banks, insurance companies, private equity funds, mutual
funds,venture capital funds, etc. It is managed by professionals who do not
directly or indirectly trade in the exchange. The trading rights are withthe
trading members who offer their services to the investors. The Board of NSE,
which deals with the policy issues, comprises of senior executives from
promoter institutions and eminent professionals, but does not have any
representation from trading members. The Board consists of a Chairman,
Managing Director, Deputy Managing Director and 15 Directors.
The Executive Committees, which include trading members, set out rulesand
parameters to manage the day to day affairs of the exchange. There are three
separate executive committees for managing the Capital Market and
Wholesale Debt Market segments, Futures and Options segment and Currency
Derivatives segment.
Features and Specialities of NSE
NSE is the third largest stock exchange in the world in terms of number of
equity shares traded and is the eighth largest derivative exchange. NSE was the
first exchange in the world to use satellite communication technology for
trading. NSE has established a disaster back-up site at Chennai which backs up
every transaction in NSE on a real time basis.
Trading Segments of NSE
NSE offers an easy and efficient trading platform for a wide range ofsecurities
under one roof. NSE provides trading facility in four differentsegments as
detailed below. NSI alamanes.
1. Wholesale Debt Market [WDM] Segment
Wholesale Debt Market [WDM] segment deals with the trading of
debtsecurities like Central and State Government securities, T-bills,
PSUBonds, Corporate Debentures, Commercial Papers, Certificate
ofDeposits, etc.
2. Capital Market Segment
Capital Market segment deals with equity shares, warrants,
debentures,mutual funds, exchange traded funds, etc. The fully
automated screen based trading system used in this segment is known
as the NationalExchange for Automated Trading [NEAT] system. This
system operateson a price cum time priority basis by which an order
gets matchedwhenever it finds a suitable coun ffer.
3. Futures and Options [F&O] Segment
Futures and Options [F&O] segment of the NSE conducts trade
inderivative instruments like Index Futures, Index Options, Stock
Futures,Stock Options, etc. Operations of the Derivatives segment
started inJune 2000. Interest Rate Futures was introduced for the first
time inIndia by NSE in August 2009.
4. Currency Derivatives Segment
Currency Derivatives segment at NSE started on 29 August 2008 withthe
launching of Currency Futures trading in US Dollar-Indian Rupee[USD-
INR].
Membership in NSE
There are basically two types of memberships in NSE
(1) Trading Membership and
(2) Clearing Membership. In clearing membership there are threecategories
like self clearing members, clearing members and professionalclearing
members.
The Trading Members
The trading members have the exclusive right to trade. Any person
canbecome a trading member by complying with the prescribed
eligibilitycriteria. The factors evaluated for giving trading membership are
 corporatestructure, capital adequacy, track record, education, experience,
etc. The trading members are admitted to any one or more of the four
trading segments of the NSE.The following are the conditions for becoming
a trading member.
i) The applicant must be a graduate. If the applicant is a firm at
leasttwo partners must be graduates. if the applicant is company
atleast two directors must be graduates.
ii) The applicant must have two years experience in securities market.
iii) The applicant shall not be a defaulter in any stock exchange.
iv) The applicant must not have been debarred by SEBI from
associatingwith capital market operations.
v) The applicant must be solely in the business of securities and
mustnot be engaged in any fund based activity.
vi) In the case of a corporate applicant the minimum paid up capital
should be 30 lakhs.
Clearing Members
The trades executed on the exchange are cleared and settled by clearing
members. The trading members in the capital market segment are clearing
members also. In F&O segment, members who are registered as self-clearing
members, can clear and settle their own trades. Those registeredas trading
cum clearing members, can clear and settle own transactionsand that of other
trading members. Besides these there is another categorycalled professional
clearing members who do not trade but only cleartrades executed by others.

Subsidiaries of NSE
The NSE is functioning in an efficient way by entrusting many of itsmajor
responsibilities to the associate or subsidiary companies formedfor such
purposes. The following are the important subsidiaries of NSE.
1) National Securities Clearing Corporation Ltd. [NSCCL]
This is a fully owned subsidiary of NSE which was incorporated in
August1995. It commenced operations in April 1996. NSCCL, the first
securitiesclearing corporation in the country, carries out the clearing and
settlementof the trades executed in the equities and derivatives
segment of NSE. Italso undertakes settlement of transactions on other
 stock exchanges like the OTCEI. At present NSCCL settles trades under
the T+2 rolling settlement.
2. National Securities Depository Ltd. [NSDL]
To avoid the problems involved in the physical movement of
securitiesand also for promoting trading and settlement of securities
indematerialised form NSDL was formed. NSE formed NSDL jointly
withIDBI and UTI. NSDL commenced operations in November 1996 and
isthe first depository in India.
3. National Commodities and Derivatives Exchange Ltd.[NCDEX]
This is a professionally managed on-line multi commodity exchange
promoted by NSE, LIC, NABARD, Canara Bank, Punjab National
Bank,Indian Farmer's Fertiliser Cooperative Ltd. [IFFCO] etc. It was
incorporated on 23 April 2003 and commenced operations on 15 th
December 2003. It is head quartered in Mumbai. Currently
NCDEXfacilitates trading of major agricultural commodities, precious
metals, basemetals, energy products and polymers.
4. National Commodity Clearing Ltd. [NCCL]
This is a company jointly incorporated by NSE and NCDEX in 2006 forthe
clearing and settlement needs of the commodity markets.
5. NSE Infotech Services Ltd. [NSETECH]
Information technology has been the back bone behind the
concept,formation and successful running of NSE. It is very important to
give aspecial focus on the effective utilisation of information technology
toretain the primacy of NSE in the securities market. Accordingly NSE
Infotech Services Ltd. was incorporated to cater to the
informationtechnology needs of the NSE and all its group companies.
6. NSE.IT Ltd.
[NSE.IT]This is another 100% subsidiary of NSE which was incorporated
in October 1999 to provide special thrust to NSE's technology edge. It
provides the securities industry with products, services and solutions
thatensures transparency and efficiency in the trading, clearing and
riskmanagement systems. It also provides consultancy services.
7. India Index Services and Products Ltd.
[IISL]India Index Services and Products Ltd was set up in May 1998 and
is ajoint venture of NSE and CRISIL Ltd. It provides a variety of indicesand
index related services and products. It operates in association withthe
Standard and Poor [S & P], the world's leading provider of equityindices.
 IISL is India's first specialised company focusing on index as acore
product. It maintains over 96 equity indices.
8. DotEx International Ltd.
[DotEx Intl. Ltd.]This is also a 100% subsidiary of NSE. DotEx provides
products like on-line streaming data feed, Intra-day snapshot data feed,
end of the daydata and historical data.
9. Power Exchange India Ltd. [PXIL]
This is India's first institutionally promoted power exchange that aims
toprovide innovative and credible solutions to transform the Indian
power markets. It was primarily promoted by NSE and NCDEX on 22
October 2008. The products offered for trading are electricity contracts.
Bombay Stock Exchange [BSE]
Bombay Stock Exchange which was established as the "Native Share and Stock
Broker's Association" in 1875 is the oldest stock exchange in Asia. The
exchange is situated in P.J. Towers, Dalal Street, Mumbai.The name BSE is now
synonymous with Dalal Street [Broker's Street].Currently about 5,000
companies have been listed in BSE. The trading platform of BSE is known as
BSE On-Line Trading [BOLT] system.
BSE has got three types of trading segments and memberships such as:
1) Cash Segment [Equity Segment]. This is also called as Deposit Based
Membership
2) Derivative Segment
Major International Stock Exchanges
The following are some of the major international stock exchanges.
NASDAQ Stock Market
NASDAQ Stock Market which is popularly known as NASDAQ [National
Association of Securities Dealers Automated Quotations] is the world's largest
electronic screen based stock exchange based in the US and headquartered in
New York City.
In 1961 the US Congress authorised the Securities and Exchange Commission
[SEC] to conduct a study of the fragmentation in the overthe counter' market.
The SEC suggested automation as a possible solutionand authorised the
National Association of Securities Dealers (NASD]for the implementation of the
proposed stock market automationtrade began on 8 February
1971,programme. Consequently NASDAQ was brought into existence and
NASDAQ was the first stock exchange to introduce the screen base dtrading.
New York Stock Exchange (NYSE]
The New York Stock Exchange (NYSE) which is one of the oldest and currently
the second largest stock exchange of the world. It made ahumble beginning on
17 May 1792. It was formed on that day by 24stock brokers and merchants
from the New York City through signing aagreement under a Buttonwood tree
which later came to be known athe Button wood Agreement. This agreement
was made at a street called the Wall Street in the New York City and the trades
used to take placethere till 1836. Hence the name Wall Street became a
synonym to NYSE The first listed company in the NYSE was the Bank of New
York.
London Stock Exchange
The trading in shares in London began with the need to finance two historical
voyages. One was the Muscovy Company's attempt to reach China and the
other was East India Company's voyage aimed at India and the East. Unable to
finance these expensive journeys privately, the companies raised money by
selling shares to merchants giving them aright to a portion of any profit
eventually made from the voyages. The trading in the stocks of East India
Company began in 1688. This idea of raising capital soon caught up and it is
estimated that there were joint stock companies in London, by the year 1695.
Tokyo Stock Exchange (TSE)
The Tokyo Stock Exchange (TSE) located in Tokyo, Japan is the third largest
stock exchange of the world based on volume of trade. It was established on
15 May 1878 and trading began on 1 June 1878,In 1943 the exchange was
combined with ten other stock exchanges in major Japanese cities to form a
single stock exchange. The combined exchange was shut down shortly after
the bombing in Nagasaki. The TSE reopened on 16 May 1949.
On 30 April 1999 the exchange switched to electronic trading for all
transactions. Currently its operating hours are from 9.00 a.m. to 11.00a.m. and
from 12.30 p.m. to 3.00p.m.
Shanghai Stock Exchange [SSE]
The Shanghai Stock Exchange is the first stock exchanges, operating
independently in the People's Republic of China. The market for share trading
in Shanghai began in the late 1860s.The other two stock exchanges in China
are the Shenzhen Stock Exchangeand the Hong Kong Stock Exchange. The
Shanghai Stock Exchange isthe world's sixth largest stock market. Unlike the
Hong Kong StockExchange, the Shanghai Stock Exchange is still not entirely
open to foreigninvestors due to the strict capital account controls exercised by
theChinese authorities.

Meaning of Derivatives
A derivative is a financial instrument whose value is derived from the value of
an underkying asset. The underlying asset can be commodity,
equity,bond,foerign exchange rate, stoc indices etc.
Types of derivatives
Derivatives markets can be broadly classified into commodity derivatives
market and financial derivatives market
• Commodity derivatives – underlying assets are shares, bonds, interest
rate, exchange rate etc
• Financial derivatives – underlying assets will be gold, oil, metal etc.

Multi Commodity Exchange [MCX]

The Multi Commodity Exchange of India Ltd. [MCX) is a premier commodity
exchange in India. The Multi Commodity Exchange is an independent
commodity exchange established to facilitate on-line trading.clearing and
settlement operations for commodity futures across thecountry,The Multi
Commodity Exchange of India Ltd. started operations inNovember 2003. It is
headquartered in Mumbai, MCX is a commodity futures exchange. It is an
exchange promoted by Financial Technologies[India] Ltd, in association with
NYSE Euronext, SBI and its associates,NABARD, NSE, SBI Life Insurance Co. Ltd.,
Bank of India, Bank ofBaroda, Union Bank of India, Corporation Bank, Canara
Bank, HDPCBank, ICICI Ventures, IL&FS, Citi Group and Pid Fund [Mauritius]
Ltd.
Features of MCX
1. MCX has got permanent recognition of the Government of India,
2. Presently it holds a market share of over 80% of the Indiancommodity
futures market.
3.It has got more than 2,000 registered members who operateover 1,00,000
trader work stations across the country.
4.The exchange has emerged as the sixth largest and one among thefastest
growing commodity futures exchange in the world. It is theworld's largest
exchange in Silver, the second largest in Gold, Copperand Natural Gas and the
third largest in Crude Oil futures with respectto number of contracts traded,
5. MCX offers more than 40 commodities including agriculturalcommodities,
metals, fuels, petrochemicals, etc.
6. For globally traded commodities the MCX enables domesticparticipants to
trade in Indian currency,
7.MCX has got strategic alliances with various leading internationalexchanges,
National Commodity and Derivative Exchange Ltd [NCDEX)
National Commodity and Derivatives Exchange Ltd. [NCDEX) is acommodity
exchange established in Mumbai on 23 April 2003 as a publiclimited company
under the Companies Act 1956. NCDEX has beenpromoted by a consortium of
four institutions viz. NSE, ICICI bank, LICand NABARD.
It is managed by an independent Board of Directors and professionalsnot
having any trading interest in commodity markets. The promoters donot
participate in the day to day activities of the exchange. NCDEX is regulated by
the Forward Market Commission. Besides it issubjected to various laws like the
Companies Act, Stamp Act, ContractsActs, Forward Commission [Regulation]
Act, etc.
Currently NCDEX is facilitating trading of many agricultural
commodities,metals, etc.
Financial Derivatives
The term 'financial derivatives' or simply 'derivatives' is used to refer to
financial instruments which derive their value from some underlying financial
assets. The underlying assets could be shares, bonds, T-bills,currencies and
even indices of these various assets [e.g., Nifty 50 orSensex]. The main
objective of derivatives is to transfer the risk of price fluctuations of the
underlying assets, from one party to another who is willing to take it. Thus
derivatives help in reducing risk arising from the future uncertainty of prices.
Derivatives derive their names from their respective underlying assets. For
example, if the underlying asset of a derivative is equity, it is called equity
derivative; derivative on indices are called index derivatives andso on.Trading
in financial derivatives commenced in the Indian stock exchanges, in June
2000. At present the equity derivative market is the most active derivative
market in India.
Definition
The Securities Contract [Regulations] Act 1956 defines derivatives as:"A
security derived from a debt instrument, share, loan whether securedor
unsecured, risk instrument, or contract for differences or any otherform of
security. It is a contract which derives value from the prices, orindex of prices,
of underlying securities"
Participants in the Derivative Market
Based on the applications that the derivatives are put to by the participants
who trade in derivative market, they can be classified under the following
three broad categories.
1) Hedgers
Hedgers participate in the derivative market to avoid the risk associated
with the price of an asset. Their main objective is to safeguard
theirexisting position by reducing risk rather than making profit. They
use futures or options market to reduce or eliminate the price risk. For
example a person who buys futures may buy put option also. In other
 words, ahedger normally takes an opposite position in the derivative
market toreduce risk associated with the purchase or sale of underlying
asset.

2. Speculators
Speculators are market participants who buy or sell securities with the
expectation of favourable price movement in future. They take calculated risk
as their trade is based on anticipated price movements in future.Speculators
do not have any real interest in the underlying asset. Their intention is just to
make profit from fluctuations in prices.Speculators normally have shorter
holding time for their positions ascompared to hedgers. If the price movement
is favourable, speculatormakes huge profits and vice versa.
3. Arbitrageurs
Arbitrage simply means buying from one market and selling the same
immediately in another market, taking advantage of price differences.
Arbitrageurs look for price differences in different markets and try to take
advantage before such price discrepancy is corrected by the market,For
example, if the price of an asset is less in the spot [cash] market than the
futures market, an arbitrageur will buy the asset from the spot market and sell
it in the futures market and earn profit. Similarly if there is pricedifference for
a stock in BSE and NSE, arbitraguèrs will act immediately and make gains out of
such differences.
Features of Derivatives
The following are some of the important features of derivative contracts.
1) The value of derivatives depends on the price movements of them in
underlying assets.
2) The contracts are fulfilled or transacted through a recognised exchange and
clearing house as in the case of futures and options.In the case of forwards and
swaps, contracts are settled mutually.
3) The parties involved are obliged to exercise their contracts orsettle theim
bilaterally. In the case of options the parties have a right to get the contract
executed or cancell the same giving up the option
4) erivatives are different from securities. Securities are assetswhile derivatives
are only contracts.
5) Derivatives are contracts tradeable through exchanges.

Functions of Derivative Markets

Derivative market performs a number of economic functions which are listed
below:
 Risk Management:
The most important use of the derivative marketis risk management.
The derivative market helps to transfer risk to thosewho are willing to
assume risk. In other words, derivative market helpsto transfer the risk
from the hedgers to the speculators. The risk management for an
investor consists of three aspects as follows.
 Identifying and measuring the actual level of risk that the
investoris carrying,
 Identifying the level of risk that the investor is willing to take and
 Buying or selling of derivative contracts so as to match the
actualand desired level of risk.
 Price Discovery:
One of the primary functions of the derivative market is price discovery.
Prices in an organised derivative market reflect the perception of market
participants about the future and lead the pricesof the underlying asset
to the perceived level. The prices of derivatives converge with the prices
of the underlying assets, on the expiry date ofthe derivative contract.
Thus derivatives help in discovering probable future prices of the
underlying assets.
 Market Efficiency:
Efficient markets are fair and competitive and do not allow an investor
to make risk free profit. Derivatives assist in improving the efficiency of
the markets by providing a self correctingmechanism through arbitrage.
Arbitrageurs try to make risk free profitfrom price differences existing in
different markets. Their actions quickly narrow down such price
differences and reduce the market inefficiencies.
 Increase in Savings and Investments:
 With small amount of marginor option money, large volume of trade is
possible in derivative markets.Thus derivative markets enable the
market participants to expand theirvolume of operations.
 Developing Entrepreneurship and Employment:
An importantincidental benefit that flows from derivative trading is that
it acts as acatalyst for new entrepreneurial activity. Derivatives markets
offer lotof opportunities to unemployed and talented youth having
entrepreneurial skills. Further, they also energise others to create new
businesses, newproducts and new employment opportunities.
Types of Financial Derivatives
Derivative contracts are of different types. The most common types of financial
derivative contracts are Forwards, Futures, Options and Swaps.
Forward Contracts
A 'forward contract' or simply a 'forward' is a contract between two parties to
buy or sell an asset on a certain future date for a certain price that is pre-
decided on the date of the contract. The future date is called as the expiry date
and the pre-decided price is referred as the forward price or delivery price.
Forward contracts are private contracts between two parties where the terms
and conditions are mutually determined.There is no transfer of money or asset
at the time of contract. Therefore a forward contract simply sets a price on the
contract day, for a trade that would take place on a future date.
Definition
A forward contract can be defined as "an agreement between two parties in
which one party, the buyer, enters into an agreement with the other party, the
seller that he would buy from the seller an underlying asset onthe expiry date
at the forward price".Thus a forward contract is different from a spot market
contract which involves immediate transfer of asset as well as payment. The
party who agrees to buy the asset on a future date is referred to asa long
investor and is said to have a "long position'. Similarly the party who agrees to
sell the asset on a future date is referred to as a short investor and is said to
have 'short position'. Forwards are non standardised contracts that are
tailored to meet specific needs of the parties. In the forward market
individuals/institutions trade through negotiations on a'one to one basis'.The
underlying assets of these contracts can include financial securities [like equity
shares or stock indices], currencies, interest rates, etc.-
Settlement of Forward Contracts
When a forward contract expires, there could be elther physical settlementor
cash settlement of the contract.
Physical Settlement
A forward contract can be settled by physical delivery of the underlying asset
by the seller to the buyer and the payment of the agreed forward price by the
buyer to the seller, on the agreed settlement date. The main disadvantage of
the physical settlement is that it results in high transaction costs in terms of
actual purchase and transfer of the security. Further if the buyer is not actually
interested in holding the security then he will have to incur further transaction
cost in disposing off the security.
Cash settlement
Without actual delivery or receipt of the security, the contract may be settled
by paying cash. Each party either pays or receives cash equal to the net loss or
profit arising out of their respective position before the expiry of the period of
contract.
Advantages of Forward Contracts
 Forward contracts can be used to hedge or lock-in the future price
ofpurchase or sale of an asset.
 Generally no margins are required to be paid at the time of enteringinto
the contract and hence forwards involve no initial cost.
 Since these are tailor-made contracts, the terms and conditionscan be
designed to suit the requirements of the parties concerned.
 The price risk due to fluctuations can be avoided completelythrough
forward contracts.
Drawbacks of Forwards
Forward contracts have some serious drawbacks. An important limitation of
the forward contracts is that they are subject to default risk. Regardlessof
whether the contract is for physical or cash settlement there is a chance for
one party not honouring the agreement. This leads to a loss for the other
party. This risk of incurring losses due to any of the two parties defaulting is
known as 'Default risk', 'Counter Party risk' or'Credit risk'. The main reason
behind such risk is the absence of any dependable mediator between the
parties, who could have undertaken the responsibility of ensuring that both
parties fulfil their obligations arisingout of the contract,Since forwards are not
exchange traded they have no ready liquidity. Itis difficult to cancel the
contract once it is made. It is difficult to get acounter party agreeing the terms
and conditions. Forward contracts do not allow the parties to make any gain
from favourable price movements happening before the settlement date ofthe
contract
,The above limitations of forward contracts led to the emergence of
another derivative instrument, i.e., futures contracts.
Futures Contracts
Like a forward contract a futures contract or simply futures, also is an
agreement between two parties in which the buyer agrees to buy
anunderlying asset from the seller on a future date at a price agreed at the
time of the agreement. But futures contract differ from forward contracts in
the sense that futures are not private agreements but are standardised
contracts for which a recognised exchange acts as intermediary. All the
terms and conditions other than the price of the futures are set by the stock
exchange, Futures are settled in cash or by physical delivery ofthe
underlying asset,
Definition
A futures contract can be defined aslised agreement between the buyer of
the contract and the seller, traded on a recognised futures exchange to buy
or sell a certain underlying asset at a certain date in future at a pre-set
price",The future date is called the 'delivery date' or 'final settlement
date',The pre-set price is called the 'futures price'. The price of the
underlying asset on the delivery date is called the 'settlement price'. The
contract size fixed is referred as the 'lot size', Financial futures trading takes
place in the case of assets like individual stocks, stock indices,
currencies,interest rate, etc.
Standardisation in Futures
The standards fixed by the exchange with respect to futures include
thefollowing.
a) Specifying the underlying asset
 b) The contract size i.e. the amount and units of the underlying assetper
contract
c) Quality or grade of the asset [if applicable] to be delivered
d) Delivery month
e) Last trading date
f) The currency in which the futures contract is to be quoted
g) Minimum permissible price fluctuations and
h) Type of settlement procedure, i.e., either cash settlement or physical
settlement, etc.
Since the futures contracts are traded through exchanges, the settlement of
the contract is guaranteed by the exchange and the clearing corporation.
Unlike the forward contracts the counter party to the futures contract isthe
clearing agent of the appropriate exchange. Therefore the buyer and the
seller of the futures contract are protected against the counter-partyrisk.In
case one party defaults, the exchange and clearing corporation step inand
fulfil the obligation of the defaulted party so that the other party gets the
contract executed. For this purpose, the exchange/clearing corporation
holds an amount as a security from both the parties. This amount is called
the margin money [which may be between 5% to 20% of the total contract
value] and can be in the form of cash or other financial assets.
Since the futures contracts are traded on the stock exchanges, the parties
have the flexibility of closing out the contract prior to the maturity by
squaring off the transaction at any time before the expiry of the period.
Characteristics of Futures
The following are the important characteristics of the futures.
a) The futures are standardised contracts and therefore ensures compliance
by the parties.
b)Futures contracts are traded on organised exchanges with anassociated
clearing corporation who act as the middlemenbetween the contracting
parties.
c) The performance of the contract can be either through delivery ofthe
asset (though rare, as in the case of commodities and bonds) orcash
settlement as in the case of most of the financial assets.
 d) The contract buyer is called 'long' and the seller 'short'. Both longand
short parties pay margin to the exchange which is used as the guarantee for
their performance of the contract.
e) Generally the margins paid are marked to the market price everyday. At
the end of every trading day the margin account is adjusted to reflect the
investor's gain or loss depending upon the futures closing price. This is
known as 'marking to the market'.
f) When the contract is liquidated the parties will be refunded the initial
margin plus or minus any gain or loss that occurred during the tenure of the
contract.
g) One can buy or sell a specific number of futures contract to match his
quantity requirement.

Difference between Forwards and Futures

Forwards Futures
Forwards are informal and Formal contracts are traded in
privately negotiated contracts
organised exchanges
Delivery of the underlying asset
Majority of the futures are
is essential settled in cash payments
Not standardised Standardised contracts
Very low liquidity High liquidity
Settlement date can be set by
Settlement dates are declared
the parties by the exchange
Higher counter party risk No counter party risk, the
exchange provides guarantee
No money is involved at the Both the buyers and sellers are
time of entering contract required to make an initial
deposit called margin
No clearing house Settlement is through clearing
house

Options
Options contracts are instruments that give the holder a right to buy or sell
the underlying asset at a predetermined price. An option can be either a
'call' or a 'put'. A call option gives the buyer, a right to buy the asset at a
 given price. This given price is called 'strike price'. It should be noted that
while the holder of the call option has a right to demand sale of asset from
the seller, the seller has the obligation and not the right. For example, if
the buyer wants to buy the asset, the seller, has to sell it. He does not have
a right. Similarly a 'put' option gives the buyer a right to sell the asset at the
'strike price' to the buyer. Here the buyer of the put option has the right to
sell and the seller of the option has the obligation to buy. Thus in any
options contract, the right to exercise the option is vested with the buyer of
the contract. The seller of the contract has only the obligation and has no
right at all. As the seller of the contract bears the obligation, he gets a
compensation called 'premium'. Therefore the pricepaid for buying an
option contract is called "option premium'.The buyer of a call option will
not exercise his option [to buy] if the price of the asset in the spot market is
less than the strike price of the call, on the date of expiry of the contract.
The buyer of a put option will not exercise his option [to sell] if the price
expiry of the asset in the spot market is more than the strike price of the
put on expiry.
Types of Options
The following are the different types of options.
Call Option
In a call option, the option holder has the right [but no obligation] to buy the
asset at the predetermined price. The contract got this name since holder has
the right to 'call' for the item from the seller, if needed. The buyer of the call
option does not have an obligation to buy if he does not want to do so. The
option holder will exercise his right to buy the underlying asset if the price of
the underlying asset in the market is more than the strike price, on or before
the expiry date of the contract. For example, if A enters into a contract with B
where A has the right [but no obligation] to purchase 1,000 shares of XYZ
company from B for*100, at any time within three months, it is a call option.
For getting thisright A will pay to B an option premium of [say]* 1 per share. A
will exercise his option when the market price of the shares is more than*100.
A's profit [per share] will be the difference between the market price of the
security on the strike date less 100. If A is not exercising his option he will have
to pay a compensation of 1000 to B.
Put Optionis
In put option the option holder has the right to sell or not to sell the asset. The
contract got this name since the holder has the option to 'put' the asset to the
writer of the contract. The person who has the right to sell the underlying asset
is the buyer of the put option. Since the buyer of the put option has the right
[but no obligation] to sell the underlying asset, he will exercise his right if the
market price of the underlying asset is less than the strike price on or before
the expiry of the contract period. For example, in the above case if A enters
into a contract with B where A has the right [but no obligation] to sell 1,000
shares of XYZ companyto B for 100, at an option premium of [say]*1 per share,
at any time within [say] three months, it is a put option. A will exercise his
option when the market price of the shares is less than 100. If the marketprice
of the share goes down to 85, A's profit will be ? 15,000[100-85 x 1,000]. In
case A is not exercising his option as the marketprice has gone beyond 100, the
compensation payable to B will be just 1,000.In option contracts the profit
chance of the option holder is unlimited depending upon the difference
between the price agreed and the marketprice. But his maximum loss will be
limited to the option premium. On the other hand, for the option writer the
profit chance is limited to theoption premium and loss chance is unlimited.
Double Option
The third type of option is called double option. It is a call cum put option
where the option holder acquires the right [but not obligation] to buy or sell
the underlying asset. The premium for the double option would be the sum of
the premia for the call and put options.
European Options and American Options Each of the above types of options
can be divided into the following two categories depending upon the method
of exercising them.
a) European Options: Those options which can be exercised only onthe
expiration date are called European options. For example, all options based on
the indices such as Nifty, Bank Nifty, CNX IT or Sensex tradedat the stock
exchanges are European options which can be exercised bythe buyer only on
the final settlement date.
b) American Options: Those options which can be exercised on anyday on or
before the expiry date are called American options. For example,all options on
individual stocks like Telco, L&T, Infosys, SBI and anyother similar scrips traded
at the exchanges are American options.
Differences Between Futures and Options
Futures Options

Both the buyer and the seller are The buyer of the option has the right
under obligation to fulfil the contract and not any obligation where as the
seller is under anobligation to fulfil
the contract if and when the buyer
exercises his right
The buyer and seller havethe risk of .The seller has the risk of unlimited
unlimited loss loss, maximum loss of the buyer is
limited to the option premium
The buyer and the sellerhave the The buyer has the potential to make
potential to make unlimited gain as unlimited gain while the seller has
well as loss the potential only tomake gain
limited to the option premium. Buyer
has a limitedloss [option premium]
only andthe seller has unlimited risk

The price of futures is based on the The price of option is based onthe
price ofthe underlying asset alone price of the underlying asset and its
volatility i.e. the degree to which the
price of theunderlying asset fluctuate

Swaps
The meaning of the word swap is to exchange. In capital market terminology,
'swap' is a derivative instrument used to reduce financial risk through the
process of exchange. Swap is an exchange of cash payment obligations in
which each party to the swap prefers the payment pattern of the other party.
In the case of interest rate swap one party exchanges a fixed rate obligation
with a floating rate obligation of the other party. For example Mr. Xhaving a
fixed rate loan swaps it with Mr. Y, who has a floating rate loan. Here X expects
that the floating rate would be beneficial to him infuture while Y calculates
that fixed rate would be attractive in future. In the case of currency swap an
obligation denominated in a particular currency is exchanged with the
obligation in another currency. Forexample Mr. X having obligation payable
after three months in Dollar,may swap his obligation with another currency
expecting favourable currency rate fluctuation after three months. Swap
enables each party to obtain the mode of payment of the other party in
exchange of his own. A swap is an agreement for an exchange of one asset for
another, one liability for another or one stream of cash flow for another.
Swaps can be defined as private agreements between two parties in which
both the parties are obliged to exchange some specified cash flows at periodic
intervals in future for a fixed period of time according to a pre-arranged
formula. It can be seen that swap is a combination of forwards by two
counterparties entered into for making benefit from the fluctuations in the
currency exchange rate, interest rateor any other similar underlying
asset .Unlike other derivatives which involve a one time settlement, a swap
agreement involves exchanges at multiple points of time in future. Also the
cash flows of a swap may be fixed in advance. The life span of aswap can range
from 2 years to 15 years.
Features of Swaps
The following are the important features of a swap.
a) Swap is Basically a Forward: A swap is nothing but a combinationof
forwards. So it has all the properties of forward contracts.
b) Double Coincidence of Wants: Swap requires that two parties withequal and
opposite needs must come into contact with each other tomake the contract a
reality.
c) Necessity of an Interediary: As seen above, swap requires themeeting of two
counterparties with opposite but matching needs. Thishas created the need for
an intermediary to bring both the parties together.Usually financial institutions
and broking firms play this role by taking advantage of their knowledge of the
diverse needs of the customers
d) Settlement: Though a specified amount is mentioned in the swapagreement,
there is no exchange of principal. A stream of payment isexchanged with
another stream. There could be streams of cash flowsrather than a single
payment as in the case of other derivatives.
e) Long Term Agreement: Generally, forward contracts are made forshort term
only, because of the high risk involved otherwise. But swapsare in the nature
of long term agreement. Swaps can be said as longterm forwards. For the
meaningful exchange of a fixed rate for a floatingrate or vice versa, it requires
a comparatively long term contract.
f) Comparative Credit Advantage: Borrowers expecting comparativeadvantage
in floating rate will swap the rate with the borrowers expectingcomparative
advantage in fixed rate. Thus both the parties could benefitfrom the deal.ii)
Types of Swaps
The following are the commonly used swaps.
a) Interest Rate Swaps: In interest rate swap one type of interest payment [say
floating rate of interest] is exchanged for another [say fixed rate of interest] at
one or more pre-specified dates in future. For example suppose A holds a 15
year housing loan for 1,00,000 at a fixed interest rate of 8% and B holds a
similar loan for a floating interest rate that will fluctuate during the life time of
the loan. If both the parties want to exchange their interest rate payments,
they can engage in an interestrate swap. A company may borrow money at
fixed rate of interest with an anticipationof swap towards floating rate in
future if it finds that floating rate would be advantageous in future or vice
versa.The first interest swap deal was made in 1981 between IBM and
WorldBank.
b) Currency Swaps: In currency swaps one currency is exchanged for another
one based on pre-specified terms and on pre-determined dates.A currency
swap is a foreign exchange agreement between two parties to exchange a
given amount of one currency for another and after a specified period of time.
Currency swaps are derivative products that help to manage exchange rate and
interest rate risks on long term liabilities. It provides a mechanism for shifting a
loan from one currency to another. Currency swap enables the exchange of
interest payments denominated in two different currencies for a specified
term along with the exchange of principals. In a typical currency swap the
parties involved will perform the following.

Recent Trends in Indian Capital Market

The past two decades have made remarkable changes in the securities market
in India. Since liberalisation of Indian economy in 1991, the capital market also
witnessed unprecedented changes. Such changes and developments include
growth in the volume of trade, the number of market intermediaries, the
number of listed securities, turnover on stock exchanges, number of investors,
etc. Along with the above developments, the profile of the investors,
issuersand intermediaries has changed significantly. The market has witnessed
lot of fundamental changes resulting in reduction of transaction cost and
significant improvements in efficiency, transparency and safety.
The following is a brief summary of some of the important reforms
anddevelopments that took place in the Indian securities market since 1991
1) SEBI Act 1992
SEBI Act 1992 was the first step towards the regulation of the Indian securities
market. The Act created a market regulator named SEBI,with the main
objective of:i) protecting the interest of the investors in securitiesi) promoting
the development of securities market andiii) regulating the securities
market.The regulatory jurisdiction of SEBI extends over companies, in
additionto all intermediaries and persons associated with securities market.
Underthe Act, SEBI has been given full authority over the securities market
inIndia.
2. Disclosure and Investor Protection [DIP] Guidelines
With the cancellation of Capital Issues [Control] Act 1947 in 1992,
thegovernment's control over issue of capital, pricing of issues, fixing
ofpremium and rate of interest on debentures, etc., came to an
end.Thereafter, the market forces are allowed to allocate financial
resourcesamong the competing users. SEBI has issued DIP guidelines to
the issuersand intermediaries and modifies such guidelines from time to
time toensure that the market participants observe high standards of
integrityand fair dealings.
2) Investor Protection Measuress
a) In order to protect the interest of the investors SEBI has made
itmandatory for all the market participants to disclose all the critical
specified formats on all significant occasions.
b) The Central Government has established an Investor Education
andProtection Fund in October 2001 for the promotion of
awarenessamong the investors and protection of their interests.
 c) Department of Economic Affairs, Department of Company
Affairs,SEBI and the stock exchanges have set up investor
grievancesredressal mechanisms.
d) The exchanges also maintain Investor Protection Funds to take careof
investor claims.
e) All regulatory agencies and investor associations are
organisinginvestor education and awareness programmes.
3) Screen Based Trading
Prior to 1992, the trading on stock exchanges in India used to take place
through an open out cry system. The out cry system did not allow
immediate matching or recording of trade. It was a time consuming
method and imposed limitations on trading. In order to provide
efficiency, liquidity and transparency, NSE and other exchanges
introduced a nationwide on-line, fully automated screen based trading
system. In the screen based method of trading, a member or a client can
enter an order into the computer, for the quantity of securities and the
price atwhich he desires to transact. The transaction gets executed
automatically whenever the order finds a matching sale or a buy order
from a counterparty. This system allows a large number of investors,
irrespective oftheir geographical locations, to trade with one another,
which improvesthe depth and liquidity of the market. Due to the
introduction of screen based trading system, the open out crysystem has
disappeared from India. Presently, almost all the securitiestransactions
take place through electronic order matching.In the beginning, the
screen based trading system has brought the stockexchange to the
premises of the brokers rather than the brokers going tothe exchange.
Later, the system has brought the exchange to the homesor offices of
the investors through personal computers. As of now, theexchanges are
brought into the pockets of the clients through hand held mobile
devices.

5. Shorter Trading Cycles

Consequent upon the computerisation of trading, rolling settlement
ofT+5 was introduced, All exchanges moved towards rolling settlement
from December 2001. Later, the settlement period was reduced to T+ 3
days. Currently T+2 settlement cycle is followed in all the stock
exchanges in India.
6. Derivatives Trading
To enable the market participants to manage risks better through
hedging, speculation and arbitrage, the Securities Contract Regulation
Act was amended in 1995 and lifted the ban on options trading in
securities. Presently, the market offers Index Futures and Index Options
on various indices of NSE and BSE
7. Demutualisation of Stock Exchanges
Earlier, the stock exchanges were owned, managed and controlled bythe
brokers. Disputes among the brokers quite often affected the integrity of
the exchanges.In order to reduce the dominance of the trading
members in the management of the stock exchanges, demutualisation
regulations were enforced on the exchanges. Accordingly, there shall be
at least 50% non-broker representation in the Board of the exchanges.
Managementof the exchange and trading membership are separated
from one another.Presently all the recognised exchanges are
demutualised.
8. Establishment of Depositories
The settlement system existed earlier led to several risks due to the
physical movement of paper securities and the time taken for
settlement.Usually, transfer of securities by the companies in favour of
the purchaser took a lot of time. To solve these problems, depositories
were establishedby enacting the Depositories Act in 1996.Depositories
succeeded in ensuring free transferability of securities withspeed and
accuracy through the conversion of securities into electronicor
dematerialised form. Currently the two depositories in India – NSDLand
CDSL-are providing instantaneous electronic transfer of securities,To
support this venture the stamp duty on the transfer of demat securities
has been waived by the government. As of now, almost all
securitytransfers are carried out in demat form. This has completely
eliminatedproblems associated with bad deliveries. Now all new public
issues, rightsissues and offer for sale must be in the dematerialised form.
9. Risk Management Systems
With a view to avoiding any kind of market failures, the regulators as
well as exchanges have initiated several steps. The risk management
system includes capital adequacy of members,adequate margin
requirements, limits on exposure and turnover, indemnityinsurance, on-
line position monitoring, automatic disablement, etc. An efficient market
 surveillance system to detect and prevent pricemanipulations is also in
operation. Exchanges have set up trade/settlement guarantee funds for
meetingshortages arising out of non fulfilment or partial fulfilment of
obligationsby the members in a settlement,
10.Integration with Global Markets
Indian securities market is getting increasingly integrated with the global
financial markets. Indian companies have been permitted to
raiseresources from abroad through issue of ADRs, GDRs, etc. Similarly,
Indian companies are permitted to list their securities on foreign stock
exchanges. The Indian stock exchanges are permitted to set up trading
terminals abroad. Currently access to the trading platform of Indian
stock exchanges is available from any where in the world through
internet.
11.Initiatives in G-See Market
The government securities market also witnessed several
significanttransformation by implementing major institutional and
operationa lchanges. In the primary market, government securities are
issued throughauction system by the RBI at market related rates. The
types of bondsissued have been diversified and include floating rate
bonds, capital indexbonds, zero coupon bonds, etc.
Non-competitive bids are accepted from retail investors to widen the
investor base, Primary dealers are appointed to ensure marketability of
G-sees. In addition to the above, the RBI has introduced electronic
ordermatching system in the G-sec, market also.
12) Other Measures
Application Supported by Blocked Amount [ASBA] With effect from July
2008 SEBI introduced ASBA as a new mode ofpayment in public issues.
Later the facility was extended to rights issuealso. Under this system the
application money remains blocked in thebank account of the applicant
till the allotment is finalised.
b) Launch of Currency Futures Currency Futures were launched on USD-
INR pair from August 2008.
c) Exit Option for Regional Stock Exchanges
SEBI issued guidelines on exit option for regional stock exchanges
whoserecognition was either withdrawn or refused by SEBI,d) Issue of
Capital and Disclosure Requirements [ICDR]Regulations 2009