Transcription

'A Study on FinancialDerivatives'Mr. AKHIL SEBASTIANGuest Lecturer, Sacred Heart College, Thevara ,Cochin, Kerala

Rs. 200/ISBN: 978-1-387-46926-0First Edition: New Delhi, 2016Copyright 2016, Mr. AKHIL SEBASTIANAll rights reservedPublished and Printed by ISARA SOLUTIONSB-15, Vikas Puri, New Delhi 110018

ACKNOWLEDGEMENTAt the outset let me express my heartfelt thanks to my guide Dr. Gilroy Rozario,Faculty of Commerce, Sacred Heart College, Thevara for his careful guidance and wholehearted support throughout this dissertation work.I would like to express my sincere gratitude to Dr.A.M. Viswambharan, M.Phil.Course Coordinator, for his constant encouragement and advice during the course of mystudy.I am very grateful to Dr Mathew Jose K, Head of the Department, for the supportand encouragement extended to me during the period of my study.I am highly grateful to Dr.(Fr.) Prasanth Palackapilly, our principal for thesuggestions and for providing me all the facility for carrying out this work successfully.I am also grateful to the library staff of Sacred Heart College, Thevara. And Iextend my sincere thanks to Dr.Jeevanad.E.S for his guidance for data analysis.I also extend my sincere thanks to my friends for help and support during thevarious stages of my dissertation work.My heartfelt thanks to my parents for the encouragement and support forcompleting my dissertation.Above all I thank the Almighty God for giving me the courage and wisdom totake up this work and complete it in time.AKHIL SEBASTIAN

CONTENTSChapter 1: INTRODUCTION1.1 STATEMENT OF THE PROBLEM . 21.2 SIGNIFICANCE OF THE STUDY . 31.3 SCOPE OF THE STUDY . 41.4 OBJECTIVES OF THE STUDY . 41.5 DEFINITION OF KEY TERMS. . 41.6 HYPOTHESES . 71.7 RESEARCH METHODOLOGY . 81.7.1POPULATION . 817.2DATA SOURCE . 817.3PERIOD OF SURVEY . 91.7.4PILOT SURVEY . 91.7.5DATA ANALYSIS . 101.8LIMITATIONS OF THE STUDY . 131.9CHAPTERISATION OF THE STUDY . 131.10 REFERENCES . 14Chapter 2: REVIEW OF LITERATURE2.1 INTRODUCTION . 152.2 REFERENCES . 28

Chapter 3: FINANCIAL DERIVATIVES – THEORETICALBACKGROUND3.1 MEANING AND DEFINITION . 353.2 EVOLUTION OF DERIVATIVES . 383.2.1. DERIVATIVES DESIGNED BY GREEK PHILOSOPHERS . .403.2.2. DERIVATIVES IN THE MIDDLE AGES . 403.2.3. ORIGIN OF MODERN DERIVATIVE TRADING . 423.3. DERIVATIVE TRADING IN INDIA. 433.3.1. DEVELOPMENT OF DERIVATIVE TRADING IN INDIA . 453.4 OVER THE COUNTER DERIVATIVES VS EXCHANGETRADED DERIVATIVES . 483.5 TYPES AND CLASSIFICATION OF DERIVATIVES . 493.5.1 FORWARDS . 533.5.2 FUTURES . 533.5.2.1 Understanding the basic terms . 543.5.2.2 Basic mechanism of futures . 573.5.2.3 Settlement of futures contracts on indexand individual securities. 593.5.3 OPTIONS. 603.5.3.1 Important terminology . 623.5.3.2 Exercising the option. 643.5.3.3 Settlement of options contracts on index and individualsecurities. 643.5.4 SWAPS. .66

3.6 MARKET PARTICIPANTS IN DERIVATIVEMARKET. 673.7 USES OF DERIVATIVES . 683.8 CRITIQUES OF DERIVATIVES . 693.9 COMMONLY TRADED EXCHANGE DERIVATIVES . 723.10 DERIVATIVES MARKET IN INDIA . 763.10.1DERIVATIVE PRODUCTS TRADED AT BSE . 763.10.2DERIVATIVE PRODUCTS TRADED AT NSE . 763.11 MEMBERSHIP CATEGORIES IN THE DERIVATIVESMARKET. 773.12 DEVELOPMENT AND REGULATION OF DERIVATIVEMARKETS BY SECURITIES AND EXCHANGE BOARD OFINDIA (SEBI). . 783.12.1 SEBI GUIDELINES FOR DERIVATIVES MARKET . 803.13 TRENDS IN DERIVATIVES SEGMENT. 833.14 REFERENCES. . 88Chapter 4 : PERCEPTION OF INVESTORS TOWARDSFINANCIAL DERIVATIVES4.1 INTRODUCTION . 914.2 PROFILE OF THE RESPONDENTS. 934.2.1 GENDER WISE CLASSIFICATION OF INVESTORS . 934.2.2 AGE WISE CLASSIFICATION OF INVESTORS . 95

4.2.3 EDUCATION WISE CLASSIFICATION OF INVESTORS.984.2.4 OCCUPATION WISE CLASSIFICATION OF INVESTORS .994.2.5 INCOME WISE CLASSIFICATION OF INVESTORS.1034.3 DERIVATIVE TRADING – AN INSIGHT . 1064.3.1 EXPERIENCE WISE CLASSIFICATION OF RESPONDENTS. 1064.3.2 EXPERIENCE IN DERIVATIVE TRADING. 1074.3.3 FREQUENCY IN FUTURE AND OPTIONSDERIVATIVE TRADING .1084.3.4 FUTURE AND OPTIONS TRADING – RISK ENDURANCE . 1104.3.5 DERIVATIVE TRADING: LEVEL OF INVESTMENT . 1114.3.6 FUTURES AND OPTIONS – RATE OF RETURN .1124.3.7 DERIVATIVES – A LOSS HEDGER . 1144.3.8 DERIVATIVES: INVESTOR’S PREFERENCE .1154.3.9 FUTURES AND OPTIONS TRADING: SOURCES INFLUENCED INDERIVATIVE TRADING .1164.3.10 DERIVATIVE TRADING: WHY DO INVESTORSTRADE/INVEST IN DERIVATIVES?.1174.4 SATISFACTION LEVEL OF INVESTORS INDERIVATIVE TRADING.1174.5 DIFFICULTY IN FUTURES AND OPTIONS TRADING . 1264.6 PERFORMANCE OF DERIVATIVE MARKET . 1324.7 BARRIERS IN DERIVATIVE TRADING. 1374.8 RISK AND RETURNS FROM FINANCIALDERIVATIVES .141

4.9 DERIVATIVE TRADING: SOCIO – DEMOGRAPHICCROSS ANALYSIS. 1424.9.1 SOCIO DEMOGRAPHIC CROSS ANALYSIS: GENDER ANDDERIVATIVES TRADING 1424.9.2 SOCIO DEMOGRAPHIC CROSS ANALYSIS: GENDER ANDFREQUENCY DERIVATIVES TRADING1444.9.3 SOCIO DEMOGRAPHIC CROSS ANALYSIS: GENDER ANDEXPERIENCE IN DERIVATIVES TRADING 1454.9.4 SOCIO DEMOGRAPHIC CROSS ANALYSIS: AGE ANDEXPERIENCE IN DERIVATIVES TRADING. 1464.9.5 SOCIO DEMOGRAPHIC CROSS ANALYSIS: AGE ANDDERIVATIVES TRADING 1484.9.6 SOCIO DEMOGRAPHIC CROSS ANALYSIS: AGE ANDFREQUENCY IN DERIVATIVES TRADING. 1494.9.7 SOCIO DEMOGRAPHIC CROSS ANALYSIS:EDUCATION AND EXPERIENCE IN STOCK MARKET1514.9.8 SOCIO DEMOGRAPHIC CROSS ANALYSIS: EDUCATION ANDDERIVATIVE IN STOCK MARKET1524.9.9 SOCIO DEMOGRAPHIC CROSS ANALYSIS:EDUCATION AND YEARS OF EXPERIENCE 154Chapter 5 : SUMMARY OF FINDINGS,CONCLUSION AND SUGGESTIONS5.1 INTRODUCTION. 1565.2 SUMMARY OF FINDINGS . 157

5.3 TESTING OF HYPOTHESES . 1635.4 CONCLUSION . 1665.5 SUGGESTIONS . 168BIBLIOGRAPHY . 170APPENDIX . 178

LIST OF TABLES.Table 1.1: The table showing the recommended level of fit indices . 12Table 3.1: Instrument wise Volume and Turnover . 74Table 3.2: Trends in Equity Derivatives Market . 84Table 4.1: Cronbach’s Alpha Reliability Test . 93Table 4.2: Gender wise classification of Respondents . 94Table 4.3: Means, Standard deviation and z value for Gender . 95Table 4.4: Age wise classification of Respondents . 95Table 4.5: Means, Standard deviation and F value for Age . 96Table 4.6: Multiple Comparison Of Age Groups . 97Table 4.7: Education wise classification of the Respondents . 98Table 4.8: Means, Standard deviation and F value for Education . 99Table 4.9: Occupation wise classification of the respondents . 100Table 4.10: Means, Standard deviation and z value for Occupation . 101Table 4.11: Multiple Comparisons . 102Table 4.12: Income wise classification . 103Table 4.13: Means, Standard deviation and F value for Income . 104Table 4.14: Multiple Comparisons . 105Table 4.15: Experience wise classification of Respondents . 106Table 4.16: Experience in Derivative trading . 107Table 4.17: Frequency in derivative trading. 109Table 4.18: Investor’s personal level of tolerance for investment risk . 110Table 4.19: Amount invested in derivative instruments . 111Table 4.20: Average return from derivative products . 113Table 4.21: Loss covered by hedging the derivatives . 114Table 4.22: Derivatives: Investor’s preference. 115Table 4.23: Sources influenced in derivative Trading . 115Table 4.24: Reasons for derivative trading . 117Table 4.25: Model fit Indices for CFA Level of satisfaction . 119Table 4.26: The regression Coefficients -Level of satisfaction. 119Table 4.27: Means, Standard deviation and z value for satisfaction . 125Table 4.28: Model fit Indices for CFA Problem. 126Table 4.29: The regression Coefficients –Problem . 127Table 4.30: Model fit Indices for CFA Modulating Factor . 132Table 4.31: The regression Coefficients -Modulating Factor . 133Table 4.32: Model fit Indices for CFA for reasons behind comparatively

less derivative Trading in Kerala . 137Table 4.33: The regression Coefficients –Reasons. 138Table 4.34: Correlation between risk and returns . 142Table 4.35: Gender * Do you trade in Financial Derivatives Cross tabulation . 143Table 4.36: Chi-Square Tests . 144Table 4.37:Gender * How frequently do you trade in derivatives Cross tabulation . 144Table 4.38: Chi-Square Tests . 145Table 4.39: Gender * Experience in stock market Cross tabulation . 145Table 4.40: Chi-Square Tests . 146Table 4.41: Age * Experience in stock market Cross tabulation . 147Table 4.42: Chi-Square Tests . 148Table 4.43: Age * Do you trade in Financial Derivatives Cross tabulation . 148Table 4.44: Chi-Square Tests . 149Table 4.45: Age * How frequently do you trade in derivatives Cross tabulation . 150Table 4.46: Chi-Square Tests . 150Table 4.47: Education * Experience in stock market Cross tabulation . 151Table 4.48: Chi-Square Tests . 152Table 4.49: Education * Do you trade in Financial Derivatives Cross tabulation . 153Table 4.50: Chi-Square Test . 153Table 4.51: Education * Years of experience in derivatives trading Cross tabulation. 154Table 4.52: Chi-Square Tests . 155

LIST OF FIGURES.Figure 3.1: General Classification of Derivatives . 49Figure 3.2: Mechanism of futures. 57Figure 3.3: Trends of Equity Derivatives at NSE (Crores) . 86Figure 4.1: Sex wise classification of Investors. 94Figure 4.2: Age wise classification of investors . 96Figure 4.3: Education wise Classification . 98Figure 4.4: Occupation wise classification. 100Figure 4.5: Income wise classification of Investors . 104Figure 4.6: Experience wise classification of investors . 107Figure 4.7: Experience in Derivative trading . 108Figure 4.8: Frequency in derivative trading . 109Figure 4.9: Investors level of tolerance for investment risk . 111Figure 4.10: Amount invested in derivative instruments. 112Figure 4.11: Average return from derivative products . 113Figure 4.12: Loss covered by hedging the derivatives . 115Figure 4.13: Model for measuring investor satisfaction. 123Figure 4.14: Model for measuring investor satisfaction. 124Figure 4.15: Model for measuring investor difficulty . 130Figure 4.16: Model for measuring investor difficulty . 131Figure 4.17: Model evaluating the efficiency of Derivatives market. 135Figure 4.18: Model evaluating the efficiency of Derivatives market. 136Figure 4.19: Hindrances in Derivatives market . 140Figure 4.20: Hindrances in Derivatives market . 141

CHAPTER 1:INTRODUCTION

IntroductionDerivatives are an important breed of financial instrument which are central totoday‘s financial markets. In India, the derivative market segment is very popular andquite active. It is very clear that in currency markets, commodity markets and stockmarkets involving all the market participants face considerable risk on account of pricefluctuations regarding assets traded in these markets. In a financial market system,derivatives can improve a market‘s efficiency by price discovery, liquidity and transferof risk. Moreover, investors and business houses use derivatives to hedge or managetheir risks. The unfamiliarity and complexity of trading in derivatives has created an airof doubt among the investors inducing them to take differing perspectives onderivatives.A derivative instrument helps to hedge the risk involved in the trading of anunderlying asset. In short derivatives are those financial instruments which derive valuefrom an underlying asset or index. The underlying assets are of two types, namelycommodities like gold, cotton, pepper etc. and financial assets like shares, currencies,bonds etc. Based on the underlying assets, the derivatives are classified into commodityand financial derivatives. The basic purpose of these instruments is to providecommitments to prices for future dates for giving protection against adverse movementsin future prices, in order to reduce the extent of financial risks. Not only this, they alsoprovide opportunities to earn profit for those persons who are ready to go for higherrisks. In other words, these instruments, indeed, facilitate to transfer the risk from thosewho wish to avoid it to those who are willing to accept the same. Therefore, by lock-inasset prices investors can minimize the impact of price fluctuations with profitability.1

IntroductionThe derivative instruments are traded for a variety of reasons. Butin India,derivatives are used as investment option, to hedge pre-existing asset risk by setting up afavorable position in the financial market and to use them to profit from the pricemovements through speculation. Therefore, the emergence of derivative products likeforwards, futures, options and swaps in market has triggered the investors to invest inthese instruments as a guard to face uncertainties with a chance to earn profitability.This chapter gives a broad outlook on the research problem as well as thepreference of derivatives as an investment option among the investors. The initial pagesof this chapter highlight the statement of the problem, objectives, significance of thestudy, methodology and main limitations faced during the study.1.1STATEMENT OF THE PROBLEMIn Kerala, the retail investors see derivative instruments as a risky investmentoption because many of them lack the basic knowledge regarding their purpose andmodus operandi. Most of the investors withdraw their investment decision in financialderivative due to lack of knowledge and technical support. A close examination of thederivative market brings out the fact that the retail investors are ready to invest in thederivatives with a support extended by a third party. The investors are encouraged toinvest in these instruments through intermediaries like stock brokers and financialexperts. The retail investors leave their investment decision in derivatives in the handsof the intermediaries. Even the most experienced investors in the market is facingdifficulties due to lack of information at the right time.2

IntroductionThe stakeholders in the market like, SEBI and organized exchanges haveadopted various measures and have set up guidelines to protect the interest of theinvestors. The exchanges and intermediaries are organizing various awarenessprograms, workshops and campaigns targeting the promotion of derivatives tradingamong the investors. The recent activities of the stakeholders, have influenced manyinvestors to trade in derivatives with help of intermediaries. A detailed enquiry amonginvestors, experts and intermediaries gave an insight into the present situation. On thisbasis, the study focused on the investor‘s preference in Futures and Options segmentand brought out the problems confronted by them.Therefore, a study on investor‘s preference towards Futures and Options wasconducted in Ernakulam district among retail investors to find out the reasons for theirpreference towards Futures and Options segment in derivatives market, their level ofsatisfaction, the rate of returns, and to find out the problems faced by the investors inderivative market segment.1.2SIGNIFICANCE OF THE STUDYDerivatives are important tools for risk management in the financial market. Thisresearch does not confine to investors preference towards Futures and Options butthrows light on their level of satisfaction, their risk and returns, the factors influencingtheir decision to trade in them and the problems faced by retail investors in derivativemarket segment. This study is also intended to attract the investors towards derivativemarket segment. The derivatives can not only act as an investment option but can beused an effective tool to manage financial risk. I hope this study will give an insight tothe retail investors and various other stakeholders like stock brokers, financial experts,professionals, institutional investors, academicians, researchers, statutory bodies etc.3

Introduction1.3SCOPE OF THE STUDYThe study on investor‘s preference towards Futures and Options is limited toErnakulam District. The study aims to bring out the level of satisfaction, risk and returnsand problems faced by an investors trading in financial derivatives in the state of Kerala.The study is aimed to motivate the investors in investing derivative market segment andto highlight the derivatives as a best choice of investment in the present scenarios. Theststudy was carried out for a period of seven months, starting from March 1 2016 tothSeptember 30 2016.1.4OBJECTIVES OF THE STUDY To analyze the relationship between the risk and returns from Futures andOptions trading to an investor in Ernakulam District. To examine the reasons considered for trading in Futures and Optionsderivatives. To assess the level of financial satisfaction from derivative trading. To identify the problems faced by the investors in Futures and Options trading.1.5DEFINITION OF KEY TERMSDerivatives: Derivatives are broad set of instruments whose value depend on someunderlying assets. The value is derived from underlying financial or physical assets. It isa financial instrument which derives its value/price from the underlying assets.F&O Segment: The organized exchanges provide trading facilities for the trading inderivatives. The National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)have commenced trading in derivative market instruments, now trading in Index futures,IndexOptions and Stock options and futures.4

IntroductionRisk Management: Risk management is the process of evaluating the chance of loss ofor harm and then taking steps to combat the potential risk.Hedge: A hedge in an investment is done to reduce the risk of price movements in anasset. It‘s a risk management strategy used in limiting or offsetting probability of lossfrom fluctuations in the prices of commodities, currencies or securities. It‘s a transfer ofrisk without insurance.Speculation: Speculation involves trading in a financial instrument involving high risk,in expectation of significant returns. The motive is to take maximum advantage fromfluctuations in the market.Futures Contract: Futures Contract means a legally binding agreement to buy or sellthe underlying security on a future date. Future contracts are the organized/standardizedcontracts in terms of quantity, quality (in case of commodities), delivery time and placefor settlement on any date in future. The contract expires on a pre-specified date whichis called the expiry date of the contract. On expiry, futures can be settled by delivery ofthe underlying asset or cash. Cash settlement enables the settlement of obligationsarising out of the future contract in cash.Cash Settlement: It is process of performing a futures contract by payment of moneydifference rather than physical delivery of the commodity.Contract Month: Contract month means the month in which the F&O Segment of theexchange require a contract to be finally settled.Margin Money: When a person enters a futures contract, he need not pay the full valueof the contract upfront-only a small percentage needs to be paid. That payment is called5

Introductionmargin money. Usually margin money would be a percentage ranging from 10% to ashigh as 35 or 40% in times of heavy volatility. For example – the margin required forbuying 1 lot of reliance futures now is 15.70%. I.e., approximately Rs 29,000.00. Theactual margin money required to be maintained changes every day, specified by theNSE.Display on the Trading Screen: Futures are displayed on the trading screen just likeequities. Each future contract will be in a coded form just like equities. Future contractsare displayed in alphabetical order. For a share / index / commodity, 3 contracts will bedisplayed. The near month contracts are listed first. The trading screen would also showthe open price, high, low, traded quantity etc.Long and Short Positions: Unsettled or open purchase position at any point of time iscalled a long position and unsettled sales position at any time point of time is called ashort position.Marked to Market: Futures contracts are monitored regularly by the authorities.Hence, Futures prices are marked to market. It means that every change in value to theinvestor is shown in the investor‘s account at the end of each trading day. Theimplication is that, if your futures position is in profits on a particular day, your accountis credited with that much of profits

Course Coordinator, for his constant encouragement and advice during the course of my . ORIGIN OF MODERN DERIVATIVE TRADING. 42 3.3. DERIVATIVE TRADING IN . 3.5 TYPES AND CLASSIFI