DERIVATIVE MARKETS IN INDIA-SOME THOUGHTS
Introduction
The term "Derivative" indicates the value which is entirely "derived" from the value of the asset such as securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, linked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securities.
Derivatives have been included in the definition of Securities in The Securities Contracts (Regulations) Act, as a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security; a contract which derives its value from the prices, or index of prices, of underlying securities.
Derivatives include options and futures. Certain options are short-term in nature and are issued by investors. These options may be long-term in nature and are issued by companies in the process of financing their activities. The trading in derivatives are things of US origin and in US the Organized exchanges began trading in options on equities in 1973 and on debt from 1982.
âDerivatives' initially, had its reference to the bank transaction when banks created deposits out of primary deposits. The primary deposit is received by banks and the same is lent on book credit. The bank does not give cash to the borrower but provides him with a cheque book and allows him to draw for payment. When these cheques presented in the bank, they create deposits and they were referred to as the derivatives. In a similar fashion, the stocks are traded in exchanges either as spot - delivery against payment or on forward market - delivery on future payment. This may or may not happen, but the purpose is to prevent any fall in price of stocks which is insurance the risk of volatility in prices. The derivatives market consists of forward contract, futures contract, options trading and swaps market.
Structure of Derivative Markets
Derivative trading in India takes place either on a separate and independent Derivative Exchange or on a separate segment of an existing Stock Exchange. Derivative Exchange/Segment function as a Self-Regulatory Organization (SRO) and SEBI acts as the oversight regulator. The clearing & settlement of all trades on the Derivative Exchange/Segment would have to be through a Clearing Corporation/House, which is independent in governance and membership from the Derivative Exchange/Segment.
Derivatives in Indian capital market
In November 1996 L.C.Gupta Committee was set up and in 1998 the recommendations of L.C.Gupta Committee was accepted by the Government. Subsequently in February 1999, Securities Contract (Amendment) Act was passed and definition of derivatives was inserted in SCRA. In June 2000, the actual trading in Index Futures started on Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).
SEBI has also framed suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lay's down the provisions for trading and settlement of derivative contracts. The Rules, Bye-laws & Regulations of the Derivative Segment of the Exchanges and their Clearing Corporation/House have to be framed in line with the suggestive Bye-laws.
Economic functions of a derivatives market:
The derivatives market performs a number of economic functions:
1. It helps in transferring risks from risk averse people to risk oriented people
2. It helps in the discovery of future as well as current prices
3. It catalyze entrepreneurial activity
4. It increase the volume traded in markets because of participation of risk averse
People in greater numbers
5. It increase savings and investment in the long run
The participants in a derivative market are:
Hedgers use futures or options markets to reduce or eliminate the risk associated with price of an asset.
Speculators use futures and options contracts to get extra leverage in betting on future movements in the price of an asset. They can increase both the potential gains and potential losses by usage of derivatives in a speculative venture.
Arbitragers are in business to take advantage of a discrepancy between prices in two different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they will take offsetting positions in the two markets to lock in a profit.
Types of Derivatives:
Forwards
A forward contract is a customized contract between two entities, where Settlement takes place on a specific date in the future at today's pre-agreed price.
Futures
A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Futures contracts are special types of forward contracts in the sense that the former are standardized exchange-traded contracts
Options:
Options are of two types - calls and puts. Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date.
Warrants:
Options generally have lives of upto one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter.
LEAPS:
The acronym LEAPS means Long-Term Equity Anticipation Securities. These are options having a maturity of upto three years.
Baskets:
Basket options are options on portfolios of underlying assets. The underlying asset is usually a moving average or a basket of assets. Equity index options are a form of basket options.
Swaps
Swaps are private agreements between two parties to exchange cash flows in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts.
Interest rate swaps: These entail swapping only the interest related cash flows between the parties in the same currency.
Currency swaps: These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.
SwaptionsSwaptions are options to buy or sell a swap that will become operative at the expiry of the options. Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating.
Dr.R.SRINIVASAN is a Post graduate in commerce and Management. He received his doctoral degree from Alagappa University in 1997. He is now Working as an ASSOCIATE PROFESSORin Post graduate and Research Department of Corporate Secretaryship at Bharathidasan Government College for Women (Autonomous), Pondicherry University, Puducherry.He currently teaches Accounting , financial management and Research Methodology Subjects. Before Joining BGCW, he was teaching in SNR College, Coimbatore, Sindhi college, Chennai& T.S.Narayanasamy College, Chennai for eight years. He was with the industry for a short term at Salzar Electronics Pvt. Ltd, Coimbatore. He has about 20 years of teaching experience and having research experience of 15 years. His interests are in Accounting and finance, Capital Market, Quantitative Methods. He underwent the Faculty Development Programme at Indian Institute of Management Ahmedabad during 2000-01. He has presented 20 papers in national and international conferences and has published twenty papers in the areas of Finance and Human resource Management in National Journals. Co-authored a book titled, âInvestors Protection, published by Raj Publications, New Delhi He has delivered lectures in contemporary finance topics at Pondicherry University. He is involved in consultancy projects for Godrej Saralee, Chennai in the areas of Statistical Applications. He has supervised a number of research projects in the area of corporate finance and Human Resource Management. He is the Board of examiner in corporate Secretaryship and Management for the past two decades.
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