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Analysis of Investment in Stock Market & Portfolio Management Using Instrument Derivatives Futures

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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

was the dominant institution in those days and business in its loan

securities used to be transacted towards the close of the eighteenth

century.

By 1830's business on corporate stocks and shares in Bank and

Cotton presses took place in Bombay. Though the trading list was

broader in 1839, there were only half a dozen brokers recognized

by banks and merchants during 1840 and 1850.

The 1850's witnessed a rapid development of commercial

enterprise and brokerage business attracted many men into the

field and by 1860 the number of brokers increased into 60.

In 1860-61 the American Civil War broke out and cotton supply from

United States of Europe was stopped; thus, the 'Share Mania' in

India begun. The number of brokers increased to about 200 to 250.

However, at the end of the American Civil War, in 1865, a

disastrous slump began (for example, Bank of Bombay Share which

had touched Rs 2850 could only be sold at Rs. 87).

At the end of the American Civil War, the brokers who thrived out of

Civil War in 1874, found a place in a street (now appropriately

called as Dalal Street) where they would conveniently assemble

and transact business. In 1887, they formally established in

Bombay, the "Native Share and Stock Brokers' Association" (which

is alternatively known as "The Stock Exchange "). In 1895, the

Stock Exchange acquired a premise in the same street and it was

B.R.C.M. College of Business Administration, Surat


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inaugurated in 1899. Thus, the Stock Exchange at Bombay was

consolidated.

Growth Pattern of the Indian Stock Market

Sr.No.

As on 31st

December194

6196

11971

1975

1980

1985 1991 1995

1No. ofStockExchanges

7 7 8 8 9 14 20 22

2No. ofListed Cos.

1125

1203

1599

1552

2265

4344 6229 8593

3

No. ofStockIssues ofListed Cos.

1506

2111

2838

3230

3697

6174 8967 11784

4

Capital ofListedCos. (Cr.Rs.)

270 7531812

2614

3973

9723 32041 59583

5

Marketvalue ofCapital of

ListedCos. (Cr.Rs.)

971

129

2

267

5

327

3

675

0 25302

11027

9 478121

6

Capital perListed Cos.(4/2)(Lakh Rs.)

24 63 113 168 175 224 514 693

7

MarketValue ofCapital per

ListedCos. (LakhRs.)(5/2)

86 107 167 211 298 582 1770 5564

8

Appreciated valueof CapitalperListed Cos.(Lakh Rs.)

358 170 148 126 170 260 344 803



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COMPANY PROFILE

Kotak Securities Limited

Kotak Securities Ltd., a subsidiary of Kotak Mahindra Bank Limited,

is one of Indias largest private brokerage and distribution house,

set up in 1994, by Mr. Uday Kotak; it has equity participation from

Goldman Sachs L. I. P. (25%).

Kotak Securities is a corporate member of both the Bombay Stock

Exchange (BSE) and the National Stock Exchange (NSE). Its

operations include stock broking, distribution of various Investment

products including private and secondary placement of debt and

equity, mutual funds, fixed deposits and the like. Currently Kotak

Securities is one of the largest broking houses in India with offices

in more than fifteen cities. In India as well as a presence in US,

Europe and the Middle East (through our associate companies

Kotak Mahindra U.K. Limited and Kotak Mahindra International

Limited, Kotak Mahindra Inc).

Our core strengths are our expertise in equity research and a wide

retail distribution network. We have an outstanding research

division involved in macro economic studies, industry and

company specific equity research, with analyst specializing in

particular economic sectors and large cap stocks.

In August 2000, Kotak Securities launched Kotakstreet.com, its e

broking service for retail investors on the net and currently has over

20,000 registered users.



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Kotak Securities Limited is one of the larger players in distribution of

IPOs - it was ranked number One in 2003-04 as Book Running

Lead Manager in public equity offerings by PRIME Database. It has

also won the Best Equity House Award from Finance Asia - April2004.

The Company has a full-fledged Research division involved in

macro economic studies, sectoral research and Company specific

equity research combined with a strong and well networked sales

force which helps deliver current and up-to-date market information

and news.

Kotak Securities Limited is also a depository participant with

National Securities Depository Limited (NSDL) and Central

Depository Services Limited (CDSL) providing dual benefit services

wherein the investors can use the brokerage services of the

Company for executing the transactions and the depository services

for settling them.

The Company has 113 branches servicing around 1,00,000

customers, through our own offices and a large franchisee network.

Its has an Online presence through Kotakstreet.com where we

offer Internet Broking services and also online IPO and Mutual Fund

Investments.

Kotak Securities Limited manages assets over Rs. 1700 crores

through its Portfolio Management Services (PMS) servicing high

net worth clients with a large investible surplus through its preferred

client services in the mass affluent and wealth management

segments.



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OBJECTIVE OF THE STUDY

To provide basic idea of different stock market investment

instruments to investor.

To provide knowledge to investor about various type of

risk associated with various investment instruments.

To provide investor knowledge about P\E, P\BV and Beta

that would help them in selection of script and creation of

portfolio.

To help investor in learning about derivative instrument

future for the purpose of speculation and hedging.



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METHODOLOGY OF THE PROJECT

Research problem:To identified the Stock Market Investment Avenue and methods to

help investor in selection of script to create portfolio. And the

measures of hedging the portfolio with the use of derivative

instrument future.

Research design:

Research design is exploratory as the basic objective is to identified

the stocks and methods to create and protect portfolio.

Data collection:

Primary data : - Primary data are collected by my regularly

tracking the stock price of various script selected

Secondary data :- Secondary data are collected from various

journals , websites and financial news paper.



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LIMITATIONS OF THE PROJECT

The time duration given to complete the report was

not sufficient.

The report is basically is made between the horizon of

two months and the situation of market is very

dynamic so the conclusion or the return might not

reflect the true picture.



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ANALYSIS OF INVESTMENT

WHAT IS INVESTMENT?

Investment is the activity, which is made with the objective of

earning some sort of positive returns in the future. It is the

commitment of the funds to earn future returns and it involves

sacrificing the present investment for the future return. Every

person makes the investment so that the funds he has increases as

keeping cash with himself is not going to help as it will not generate

any returns and also with the passage of time the time value of the

money will come down. As the inflation will rise the purchasing

power of the money will come down and this will result that the

investor who does not invest will become more poor as he will not

have any funds whose value have been increased. Thus every

person whether he is a businessman or a common man will make

the investment with the objective of getting future returns.

TYPES OF INVESTMENT:-

There are basically three types of investments from which the

investors can choose. The three kinds of investment have their ownrisk and return profile and investor will decide to invest taking into

account his own risk appetite. The main types of investments are: -



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Economic investments:-

These investments refer to the net addition to the capital stock of

the society. The capital stock of the society refers to the

investments made in plant, building, land and machinery which are

used for the further production of the goods. This type of

investments are very important for the development of the economy

because if the investment are not made in the plant and machinery

the industrial production will come down and which will bring down

the overall growth of the economy.

Financial Investments:-

This type of investments refers to the investments made in the

marketable securities which are of tradable nature. It includes the

shares, debentures, bonds and units of the mutual funds and any

other securities which is covered under the ambit of the Securities

Contract Regulations Act definition of the word security. The

investments made in the capital market instruments are of vital

important for the country economic growth as the stock market

index is called as the barometer of the economy.

General Investments:-

These investments refer to the investments made by the common

investor in his own small assets like the television, car, house,

motor cycle. These types of investments are termed as the

household investments. Such types of investment are important for

the domestic economy of the country. When the demand in the

domestic economy boost the over all productions and the

manufacturing in the industrial sectors also goes up and this causes

rise in the employment activity and thus boost up the GDP growth



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rate of the country. The organizations like the Central Statistical

Organization (CSO) regularly takes the study of the investments

made in the household sector which shows that the level of

consumptions in the domestic markets.



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CHARACTERISICS OF INVESTMENT

Certain features characterize all investments. The following are the

main characteristics features if investments: -

1.Return: -

All investments are characterized by the expectation of a return. In

fact, investments are made with the primary objective of deriving a

return. The return may be received in the form of yield plus capital

appreciation. The difference between the sale price & the purchase

price is capital appreciation. The dividend or interest received from

the investment is the yield. Different types of investments promise

different rates of return. The return from an investment depends

upon the nature of investment, the maturity period & a host of other

factors.

2.Risk: -

Risk is inherent in any investment. The risk may relate to loss of

capital, delay in repayment of capital, nonpayment of interest, or

variability of returns. While some investments like government

securities & bank deposits are almost risk less, others are more

risky. The risk of an investment depends on the following factors.

0 The longer the maturity period, the longer is the risk.

1 The lower the credit worthiness of the borrower, the higher is

the risk.

The risk varies with the nature of investment. Investments in

ownership securities like equity share carry higher risk compared to

investments in debt instrument like debentures & bonds.



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IMPORTANCE

In the current situation, investment is becomes necessary for

everyone & it is important & useful in the following ways:

1. Retirement planning: -

Investment decision has become significant as people retire

between the ages of 55 & 60. Also, the trend shows longer life

expectancy. The earning from employment should, therefore, be

calculated in such a manner that a portion should be put away as a

savings. Savings by themselves do not increase wealth; these must

be invested in such a way that the principal & income will be

adequate for a greater number of retirement years. Increase in

working population, proper planning for life span & longevity have

ensured the need for balanced investments.

2. Increasing rates of taxation: -

Taxation is one of the crucial factors in any country, which introduce

an element of compulsion, in a persons saving. In the form

investments, there are various forms of saving outlets in our

country, which help in bringing down the tax level by offering

deductions in personal income.

For examples: -

0 Unit linked insurance plan,

1 Life insurance,

2 National saving certificates,

3 Development bonds,

4 Post office cumulative deposit schemes etc.



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3. Rates of interest: -

It is also an important aspect for sound investment plan. It varies

between investment & another. This may vary between risky & safe

investment, they may also differ due different benefits schemes

offered by the investments. These aspects must be considered

before actually investing. The investor has to include in his portfolio

several kinds of investments stability of interest is as important as

receiving high rate of interest.

4. Inflation: -

Since the last decade, now a days inflation becomes a continuous

problem. In these years of rising prices, several problems are

associated coupled with a falling standard of living. Before funds

are invested, erosion of the resource will have to be carefully

considered in order to make the right choice of investments. The

investor will try & search outlets, which gives him a high rate of

return in form of interest to cover any decrease due to inflation. He

will also have to judge whether the interest or return will becontinuous or there is a likelihood of irregularity. Coupled with high

rate of interest, he will have to find an outlet, which will ensure

safety of principal. Beside high rate of interest & safety of principal

an investor also has to always bear in mind the taxation angle, the

interest earned through investment should not unduly increase his

taxation burden otherwise; the benefit derived from interest will be

compensated by an increase in taxation.



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5. Income: -

For increasing in employment opportunities in India., investment

decisions have assumed importance. After independence with the

stage of development in the country a number of organization &

services came into being.

For example: -

The Indian administrative services,

Banking recruitment services,

Expansion in private corporate sector,

Public sector enterprises,Establishing of financial institutions, tourism, hotels, and education.

More avenues for investment have led to the ability & willingness of

working people to save & invest their funds.

6. Investment channels: -

The growth & development of country leading to greater economicactivity has led to the introduction of a vast array of investment

outlays. Apart from putting aside saving in savings banks where

interest is low, investor have the choice of a variety of instruments.

The question to reason out is which is the most suitable channel?

Which media will give a balanced growth & stability of return? The

investor in his choice of investment will give a balanced growth &

stability of return? The investor in his choice of investment will have

try & achieve a proper mix between high rates of return to reap the

benefits of both.

For example: -

0 Fixed deposit in corporate sector

1 Unit trust schemes.



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INVESTMENTS AVENUES:-

There are various investments avenues provided by a country to its

people depending upon the development of the country itself. The

developed countries like the USA and the Japan provide variety of

investments as compared to our country. In India before the post

liberalization era there were limited investments avenues available

to the people in which they could invest. With the opening up of the

economy the number of investments avenues have also increased

and the quality of the investments have also improved due to the

use of the professional activity of the players involved in thissegment. Today investment is no longer a process of trial and error

and it has become a systematized process, which involves the use

of the professional investment solution provider to play a greater

role in the investment process.

Earlier the investments were made without any analysis as the

complexity involved the investment process were not there and also

there was no availability of variety of instruments. But today as the

number of investment options have increased and with the variety

of investments options available the investor has to take decision

according to his own risk and return analysis.

An investor has a wide array of Investment Avenue. They are

as under:



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Investment

Fixed Income

Deposits

Life Insurance

Precious

Tax Sheltered

Real Estate

Financial Derivatives

Mutual Fund

Equity


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Types of Equity Instruments:

Ordinary Shares

Ordinary shareholders are the owners of a company, and each

share entitles the holder to ownership privileges such as dividends

declared by the company and voting rights at meetings. Losses as

well as profits are shared by the equity shareholders. Without any

guaranteed income or security, equity shares are a risk investment,

bringing with them the potential for capital appreciation in return for the

additional risk that the investor undertakes in comparison to debt

instruments with guaranteed income.

Preference Shares

Unlike equity shares, preference shares entitle the holder to dividends

at fixed rates subject to availability of profits after tax. If preference

shares are cumulative, unpaid dividends for years of inadequate

profits are paid in subsequent years. Preference shares do not

entitle the holder to ownership privileges such as voting rights at

meetings.

Equity Warrants

These are long term rights that offer holders the right to purchase

equity shares in a company at a fixed price (usually higher than the

current market price) within a specified period. Warrants are in the

nature of options on stocks.


EQUITY SHARES: -


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Classification in terms of Market Capitalisation

Market capitalisation is equivalent to the current value of a company

i.e. current market price per share times the number of outstanding

shares. There are Large Capitalisation companies, Mid-Cap

companies and Small-Cap companies. Different schemes of a fund

may define their fund objective as a preference forLarge or Mid or

Small-Cap companies' shares. Large Cap shares are more liquid and

hence easily tradable. Mid or Small Cap shares may be thought of

as having greater growth potential. The stock markets generally

have different indices available to track these different classes ofshares.

Classification in terms of Anticipated Earnings

In terms of the anticipated earnings of the companies, shares are

generally classified on the basis of their market price in relation to

one of the following measures:

* Price/Earnings Ratio is the price of a share divided by the

earnings per share, and indicates what the investors are willing

to pay for the company's earning potential. Young and/or fast

growing companies usually have high P/E ratios. Established

companies in mature industries may have lower P/E ratios. The

P/E analysis is sometimes supplemented with ratios such as

Market Price to Book Value and Market Price to Cash Flow per

share.

Dividend Yield for a stock is the ratio of dividend paid per share

to current market price. Low P/E stocks usually have high

dividend yields. In India, at least in the past, investors have

indicated a preference for the high dividend paying shares. What

matters to fund managers is the potential dividend yields based on

earnings prospects.



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Based on companies' anticipated earnings and in the light of the

investment management experience the world over, stocks are

classified in the following groups:

Cyclical Stocks are shares of companies whose earnings are

correlated with the state of the economy. Their earnings (and

therefore, their share prices) tend to go up during upward economic

cycles and vice versa. Cement or Aluminium producers fall into

this category, just as an example. These companies may

command relatively lower P/E ratios, and have higher dividend pay-

outs.

Growth Stocks are shares of companies whose earnings are

expected to increase at rates that exceed normal market levels.

They tend to reinvest earnings and usually have high P/E ratios and

low dividend yields. Software or information technology

company shares are an example of this type. Fund managers

try to identify the sectors or companies that have a high growth

potential.

Value Stocks are shares of companies in mature industries

and are expected to yield low growth in earnings. These

companies may, however, have assets whose values have not

been recognised by investors in general. Fund managers try to

identify such currently under-valued stocks that in their opinion

can yield superior returns later. A cement company with a lot of

real estate and a company with good brand names are

examples of potential value shares.



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Many instruments give regular income. Debt instruments may be

secured by the assets of the borrowers as generally in case of

Corporate Debentures, or be unsecured as is the case with Indian

Financial Institution Bonds.

A debt security is issued by a borrower and is often known by the

issuer category, thus giving us Government Securities and Corporate

Securities or FI bonds. Debt instruments are also distinguished by their

maturity profile. Thus, instruments issued with short-term maturities,

typically under one year, are classified as Money Market Securities.

Instruments carrying longer than one-year maturities are generally

called Debt Securities.

Most debt securities are interest-bearing. However, there are

securities that are discounted securities or zero-coupon bonds that

do not pay regular interest at intervals but are bought at a discount

to their face value. A large part of the interest-bearing securities are

generally Fixed Income-paying, while there are also securities that

pay interest on a Floating Rate basis.

A Review of the Indian Debt Market

The Wholesale Debt Market segment deals in fixed income

securities and is fast gaining ground in an environment that has

largely focused on equities.

The Wholesale Debt Market (WDM) segment of the Exchange

commenced operations on June 30, 1994. This provided the first

formal screen-based trading facility for the debt market in the

country.


FIXED INCOME SECURITIES


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This segment provides trading facilities for a variety of debt

instruments including Government Securities, Treasury Bills and

Bonds issued by Public Sector Undertakings/ Corporates/ Banks

like Floating Rate Bonds, Zero Coupon Bonds, Commercial Papers,Certificate of Deposits, Corporate Debentures, State Government

loans, SLR and Non-SLR Bonds issued by Financial Institutions,

Units of Mutual Funds and Securitized debt by banks, financial

institutions, corporate bodies, trusts and others.

Large investors and a high average trade value characterize this

segment. Till recently, the market was purely an informal market

with most of the trades directly negotiated and struck between

various participants. The commencement of this segment by NSE

has brought about transparency and efficiency to the debt market,

along with effective monitoring and surveillance to the market.



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Business Growth in WDM Segment

Year

Market

Capitalisation(Rs.crores)

Number

ofTrades

Net Traded

Value(Rs.crores)

Average

Daily Value(Rs.crores)

Average

Trade Size(Rs.crores)

2005-2006

1,553,448 60,159 458,434.94 1,833.74 7.62

2004-2005

1,461,734 124,308 887,293.66 3,028.31 7.14

2003-2004

1,215,864 189,518 1,316,096.24 4,476.52 6.94

2002-

2003

864,481 167,778 1,068,701.54 3,598.32 6.37

2001-2002

756,794 144,851 947,191.22 3,277.48 6.54

2000-2001

580,835 64,470 428,581.51 1,482.98 6.65

1999-2000

494,033 46,987 304,216.24 1,034.75 6.47

1998-1999

411,470 16,092 105,469.13 364.95 6.55

1997-1998

343,191 16,821 111,263.28 377.16 6.61

1996-1997

292,772 7,804 42,277.59 145.28 5.42

1995-1996

207,783 2,991 11,867.68 40.78 3.97

1994-1995

158,181 1,021 6,781.15 30.41 6.64

Instruments in the Indian Debt Market

Certificate of Deposit

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Certificates of Deposit (CD) are issued by scheduled commercial

banks excluding regional rural banks. These are unsecured

negotiable promissory notes. Bank CDs have a maturity period of 91

days to one year, while those issued by FIs have maturitiesbetween one and three years.

Commercial Paper

Commercial paper (CP) is a short term, unsecured instrument

issued by corporate bodies (public & private) to meet short-term

working capital requirements. Maturity varies between 3 months and

1 year. This instrument can be issued to individuals, banks,

companies and other corporate bodies registered or incorporated in

India. CPs can be issued to NRIs on non-repatriable and non-

transferable basis.

Corporate Debentures

The debentures are usually issued by manufacturing companies with

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 values

are based on yield-to-maturity. All publicly issued debentures are

listed on exchanges.



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Floating Rate Bonds (FRB)

These are short to medium term interest bearing instruments

issued by financial intermediaries and corporates. The typical

maturity of these bonds is 3 to 5 years. FRBs issued by financial

institutions are generally unsecured while those from private

corporates are secured. The FRBs are pegged to different reference

rates such as T-bills or bank deposit rates. The FRBs issued by the

Government of India are in the form of Stock Certificates or issued

by credit to SGL accounts maintained by the RBI.

Government Securities

These are medium to long term interest-bearing obligations issued

through the RBI by the Government of India and state governments.

The RBI decides the cut-off coupon on the basis of bids received

during auctions. There are issues where the rate is pre-specified and

the investor only bids for the quantity. In most cases the coupon is

paid semi-annually with bullet redemption features.

Treasury Bills

T-bills are short-term obligations issued through the RBI by the

Government of India at a discount. The RBI issues T-bills for different

tenures: now 91 -days and 364-days. These treasury bills are issued

through an auction procedure. The yield is determined on the

basis of bids tendered and accepted.

Bank/FI Bonds

Most of the institutional bonds are in the form of promissory notes

transferable by endorsement and delivery. These are negotiable

certificates, issued by the Financial Institutions such as the

IDBI/ICICI/ IFCI or by commercial banks. These instruments have



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been issued both as regular income bonds and as discounted long-

term instruments (deep discount bonds).

Public Sector Undertakings (PSU) Bonds

PSU Bonds are medium and long term obligations issued by public

sector companies in which the government share holding is

generally greater than 51%. Some PSU bonds carry tax

exemptions. The minimum maturity is 5 years for taxable bonds and

7 years for tax-free bonds. PSU bonds are generally not guaranteed

by the government and are in the form of promissory notes

transferable by endorsement and delivery. PSU bonds in electronicform (demat) are eligible for repo transactions.

An investor can participant in various schemes floated by mutual

fund instead of buying equity shares. In mutual funds invest in

equity shares & fixed income securities. There are three broad

types of mutual fund schemes.

Growth schemes

Income schemes

Balanced schemes


MUTUAL FUND SCHEMES


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It is just like fixed income securities earn a fixed return. However,

unlike fixed income securities, deposits are negotiable or

transferable. The important types of deposits in India are:

Bank deposits

Company deposits

Postal deposits.

It provides benefits to those who participate in them. The most

important tax sheltered saving schemes in India is:

Employee provident fund scheme

Public provident fund schemes

National saving certificate

In a broad sense, life insurance may be viewed as an investment.

Insurance premiums represent the sacrifice & the assured sum the

benefit. In India, the important types of insurance polices are:

Endowment assurance policy

Money back policy

Whole life policy

Premium back term assurance policy


DEPOSITS

TAX-SHELTERED SAVING SCHEMESTAX-SHELTERED SAVING SCHEMES

LIFE INSURANCE


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For the bilk of the investors the most important asset in their

portfolio is a residential house. In addition to a residential house,

the more affluent investors are likely to be interested in the following

types of real estate:

Agricultural land

Semi-urban land

PRECIOUS OBJECTS: -

It is highly valuable in monetary terms but generally they are small

in size. The important precious objects are:

Gold & silver

Precious stones

Art objects

FINANCIAL DERIVATIVES: -

A financial derivative is an instrument whose value is derived from

the value of underlying asset. It may be viewed as a side bet on the

asset. The most import financial derivatives from the point of view of

investors are:

Options

Futures.


REAL ESTATE

PRECIOUS OBJECTS

FINANCIAL DERIVATIVES


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RISK RETURN OF VARIOUS INVESTMENT

AVENUES

Every investment is characterized by return & risk. Investors

intuitively understand the concept of risk. A person making an

investment expects to get some return from the investment in the

future. But, as future is uncertain, so is the future expected return. It

is this uncertainty associated with the returns from an investment

that introduces risk into an investment. Risk arises where there is a

possibility of variation between expectation and realization with

regard to an investment.

Meaning of Risk

Risk & uncertainty are an integrate part of an investment

decision. Technically risk can be define as situation where

the possible consequences of the decision that is to be taken

are known. Uncertainty is generally defined to apply to

situations where the probabilities cannot be estimated.

However, risk & uncertainty are used interchangeably.



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Types of risks

1. Systematic risk: -

Systematic risk is non diversifiable & is associated with the

securities market as well 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

way that the prices of all stocks will more in the same direction.

Example: -

During a boom period prices of all securities will rise & indicate that

the economy is moving towards prosperity. Market risk, interest rate

risk & purchasing power risk are grouped under systematic risk.

RISKS

SYSTAMATICUNSYSTAMATIC

Market Risk Business Risk

Interest Rate Risk Financial Risk

Purchasing power Risk



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1. Systematic Risk

(A) Market risk

Market risk is referred to as stock variability due to changes in

investors attitudes & expectations. The investor reaction towards

tangible and intangible events is the chief cause affecting market

risk.

(B) Interest rate risk

There are four types of movements in prices of stocks in the

markets. These may termed as (1) long term, (2) cyclical (bull and

bear markets), (3) intermediate or within the cycle, and (4) 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 investment & lower the fluctuations in

prices.

(C) Purchasing Power risk

Purchasing power risk is also known as inflation risk. This risk

arises out of change in the prices of goods & services and

technically it covers both inflation and deflation periods. During the

last two decades it has been seen that inflationary pressures have

been continuously affecting the Indian economy. Therefore, in India

purchasing power risk is associated with inflation and rising prices

in the economy.



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2. Unsystematic Risk: -

The importance of unsystematic risk arises out of the uncertainty

surrounding of particular firm or industry due to factors like labourstrike, consumer preferences and management policies. These

uncertainties directly affect the financing and operating enviourment

of the firm. Unsystematic risks can owing to these considerations be

said to complement the systematic risk forces.

(A) Business risk

Every corporate organization has its own objectives and goals and

aims at a particular gross profit & operating income & also accepts

to provide a certain level of dividend income to its shareholders. It

also hopes to plough back some profits. Once it identifies its

operating level of earnings, the degree of variation from this

operating level would measure business risk.

Example:-

If operating income is expected to be 15% in a year, business risk

will be low if the operating income varies between 14% and 16%. If

the operating income were as low as 10% or as high as 18% it

would be said that the business risk is high.

(B) Financial Risk: -

Financial risk in a company is associated with the method through

which it plans its financial structure. If the capital structure of a

company tends to make earning unstable, the company may fail

financially. How a company raises funds to finance its needs and

growth will have an impact on its future earnings and consequently

on the stability of earnings. Debt financing provides a low cost

source of funds to a company, at the same time providing financial



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leverage for the common stock holders. As long as the earnings of

the company are higher than the cost of borrowed funds, the

earning per share of common stock is increased. Unfortunately, a

large amount of debt financing also increases the variability of thereturns of the common stock holder & thus increases their risk. It is

found that variation in returns for shareholders in levered firms

(borrowed funds company) is higher than in unlevered firms. The

variance in returns is the financial risk.



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Risk Return Of Various Investment Alternatives

Managem

ent

Decision

Required

InvestmentMarketRisk

Business

Risk

Interest

Risk

PurchasingPower

Risk

H Growth stock H H L L

HSpeculative

common stockH H L L

M Blue chips M M L L

M

Convertible

referred stock M M L L

LConvertible

debenturesM M L L

LCorporate

bondsL L H H

LGovernment

bondsL L H H

LShort-term

bonds

L L L H

LMoney market

fundsL L L H

O Life insurance L L L H

OCommercial

banksL L L H

O Unit trusts L L L M-H

O Saving a/c L L L H

O Cash L L L H

So, there are so many investment options & the different option

have different benefits & limitations in the sense risk associated

with it. So it is difficult for them to chose option, which give

maximum return at minimum risk.

PORTFOLIO

Meaning of portfolio:-



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Portfolio

A combination of securities with different risk & return

characteristics will constitute the portfolio of the investor. Thus, a

portfolio is the combination of various assets and/or instruments of

investments. The combination may have different features of risk &

return, separate from those of the components. The portfolio is also

built up out of the wealth or income of the investor over a period of

time, with a view to suit his risk and return preference to that of the

portfolio that he holds. The portfolio analysis of the risk and return

characteristics of individual securities in the portfolio and changesthat may take place in combination with other securities due to

interaction among themselves and impact of each one of them on

others.

An investor considering investments in securities is faced with the

problem of choosing from among a large number of securities. His

choice depends upon the risk and return characteristics of individual

securities. He would attempt to choose the most desirable

securities and like to allocate is funds over this group of securities.

Again he is faced with the problem of deciding which securities to

hold and how much to invest in each. The investor faces an infinite

number of possible portfolios or groups of securities. The risk and

return characteristics of portfolio differ from those of individual

securities combining to form a portfolio. The investor tries to choose

the optimal portfolio taking in to consideration the risk return

characteristics of all possible portfolios.

As the economy and the financial environment keep changing the

risk return characteristics of individual securities as well as

portfolios also change. This calls for periodical review and revision

of investment portfolios of investors. An investor invests his funds in

a portfolio expecting to get a good return consistent with the risk



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that he has to bear. The return realized from the portfolio has to be

measured and the performance of the portfolio has to be evaluated.

It is evident that rational investment activity involves creation of aninvestment portfolio. Portfolio management comprises all the

processes involved in the creation and maintenance of an

investment portfolio. It deals specifically with the security analysis,

portfolio analysis, portfolio selection, portfolio revision and portfolio

evaluation. Portfolio management makes use of analytical

techniques of analysis and conceptual theories regarding rational

allocation of funds. Portfolio management is a complex process

which tries to make investment activity more rewarding and less

risky.



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Before designing a portfolio one will have to know the intention ofthe investor or the returns that the investor is expecting from his

investment. This will help in adjusting the amount of risk. This

becomes an important point from the point of view of the portfolio

designer because if the investor will be ready to take more risk at

the same time he will also get more returns. This can be more

appropriately understood from the figure drawn below.

R1

Expected ReturnsExpected Returns

R2

Risk less

InvestmentM1 M2

Risk

From the above figure we can see that when the investor is ready

to take risk of M1, he is likely to get expected return of R1, and if

the investor is taking the risk of M2, he will be getting more returns

i.e. R2. So we can conclude that risk and returns are directly

related with each other. As one increases the other will also

increase in same of different proportion and same if one

decreases the other will also decrease.


PORTFOLIO DESIGN


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From the above discussion we can conclude that the investors

can be of the following three types:

1. Investors willing to take minimum risk and at the same time

are also expecting minimum returns.

2. Investors willing to take moderate risk and at the same time

are also expecting moderate returns.

3. Investors willing to take maximum risk and at the same time

are also expecting maximum returns.



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Your age will help you determine what a good mix is / portfolio is

Age Portfolio

below 30 80% in stocks or mutual funds10% in cash10% in fixed income

30 t0 40 70% in stocks or mutual funds

10% in cash20% in fixed income

40 to 50 60% in stocks or mutual funds10% in cash30% in fixed income

50 to 60 50% in stocks or mutual funds10% in cash40% in fixed income

above 60 40% in stocks or mutual funds10% in cash50% in fixed income

These aren't hard and fast allocations, just guidelines to get you

thinking about how your portfolio should look. Your risk profile will

give you more equities or more fixed income depending on your

aggressive or conservative bias. However, it's important to always

have some equities in your portfolio (or equity funds) no matter

what your age. If inflation roars back, this will be the portion of your

investments that protects you from the damage, not your fixed

income.

Also, the fixed income of your portfolio should be diversified. If you

buy bonds and debentures directly or if you invest in FDs, then

make sure you have at least five different maturities to spread out

the interest rate risk.


PORTFOLIO AGE RELATIONSHIP


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Diversifying in equities and bonds means more than buying a

number of positions. Each position needs to be scrutinized as to

how it fits into the stocks or bonds that already are in your portfolio,

and how they might be affected by the same event such as higherinterest rates, lower fuel prices, etc. Put your portfolio together like

a puzzle, adding a piece at a time, each one a little different from

the other but achieving a uniform whole once the portfolio is

complete.

Types of portfolio for study:

In portfolio Design, we are considering only two types of portfolio.

They are as follow:

1. Random Portfolio

2. Sector Portfolio

1. Random portfolio

Random portfolio consists of the scripts that are randomly selected

by the investor by its own knowledge and preference of the stocks.

Here there is no analysis is done of the script, they are selected on

the tips and buts received by the investors from the external

sources.

Features of random portfolio

There is no method used for selection of the script in the

portfolio.

Selection is based on the individual criteria for the scripts.

The investment is made for higher return in short term.



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Generally in India most of the portfolio are selected

according to this random methods as no investor himself in

that much analysis of the script.

Advantages of random portfolio

Easier to keep a track on the market as not much time

wasted in the analysis.

This portfolio seems to have perform better in short term as

script are generally which are performing better at that time.

Tips are available every where for the investor to pouch.

It is the experience of the individual that can fetch him good

return.

Disadvantages of random portfolio

There is every chance that you may select a script that has a

very bad background in the market.

Not every time the tips pay off for you. You need to have

strong reason to select that script.

Such portfolios are not able to sustain when there is a crisis

in the market.

There is a very high risk and return involve in such portfolio.



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2. Sector specific portfolio

Sector specific portfolio includes securities of those companies

which are in the same business. Sector portfolios are very useful

when there is a particular sector which is doing very good and has a

bright future a head. Sector portfolio has the securities of those

companies that engage in same kind of business.

e.g. In late 1990s sector that was providing the highest return was

information technology. Investors who have invested their money

in these securities had earned very high return.

Features of sector portfolio

Script form the same group of companies that are in to the

similar type of business.

Maximum exposure to the industry/sector. So any news or

event has the direct effect on the portfolio.

Risk regarding the portfolio increases as it is expose to

sector specific ups and downs.

Useful investment tools for speculator and short-sellers.

It is better suited for the sectors which have been providing

good revenue in the near past.

Advantages of sector portfolio

It is better suited to investors who are willing to take risk.

It provides better short term return then other portfolios.

It is easy to keep a watch on one sector rather than many.

You can have a good command over the things happening.

Limited exposure to other sectors keeps the portfolio safe

from the performance of other sectors in the economy.



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Disadvantages of sector portfolio

It is a highly risky portfolio as risk associated with the sector

directly affects the performance of the portfolio.

These types of portfolios are not suited for long-term investor

as risk taken for the return can be too high.

There is always the possibly many scripts in the sector may not be

giving that much good attractive return as others. They may eat the

profits from other scripts.



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Book value is based on historical costs, not current values, but can

provide an important measure of the relative value of a company

over time. Book value can be figured as assets minus liabilities, or

assets minus liabilities and intangible items such as goodwill; either

way, the figure that results is the company's net book value. This is

contrasted with its market capitalization, or total share price value,

which is calculated by multiplying the outstanding shares by their

current market price.

You can also compare a company's market value to its book

value on a per-share basis. Divide book value by the number of

shares outstanding to get book value per share and compare the

result to the current stock price to help determine if the company's

stock is fairly valued. Most stocks trade above book value because

investors believe that the company will grow and the value of its

shares will, too. When book value per share is higher than the

current share price, a company's stock may be undervalued and a

bargain to investors.

In case of our sensex as we can see that it is currently trading at a

P/B ratio of 4.41 this shows the average P/B ratio prevailing in the

market. So any script trading below the P/B of 4.41 can said to be

under valued if we keep the BSE SENSEX as bench mark. But it

would be advisable for an investor to also look at the sector leaders

P/B ratio to know what is the common industry P/B and based on

that he can decide about whether to invest in the company or not.

As such there is no guarantee that low P/B would able to give

better return but this stocks are considered to be undervalued so

one can think that this companies are undervalued so chances of

appreciation are very high in case of low P/B scrip. Such companies

having low P/B ratio can be considered as value stock and one can

thin about investing in those companies.



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The P/E ratio as a guide to investment decisions

Earnings per share alone mean absolutely nothing. In order to get a

sense of how expensive or cheap a stock is, you have to look at

earnings relative to the stock price and hence employ the P/E ratio.

The P/E ratio takes the stock price and divides it by the last four

quarters' worth of earnings. If AB ltd is currently trading at Rs. 20 a

share with Rs. 4 of earnings per share (EPS), it would have a P/E of

5. Big increase in earnings is an important factor for share value

appreciation. When a stock's P-E ratio is high, the majority of

investors consider it as pricey or overvalued. Stocks with low P-E'sare typically considered a good value. However, studies done and

past market experience have proved that the higher the P/E, the

better the stock.

First, one can obtain some idea of a reasonable price to pay for the

stock by comparing its present P/E to its past levels of P/E ratio.

One can learn what is a high and what is a low P/E for the individual

company. One can compare the P/E ratio of the company with that

of the market giving a relative measure. One can also use the

average P/E ratio over time to help judge the reasonableness of the

present levels of prices. All this suggests that as an investor one

has to attempt to purchase a stock close to what is judged as a

reasonable P/E ratio based on the comparisons made. One must

also realize that we must pay a higher price for a quality company

with quality management and attractive earnings potential.

In the case if we look at the benchmark of BSE sensex on 1st of

December it is trading at a P/E of 24.49. So if we just keep the

benchmark P/E in mind then we can say that any stock which is

trading bellow the P/E of 24.49 is available cheaply. But for an

investor it is also advisable to look at the industry P/E as it is more

important because just looking at the above position we can see



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that SBI is trading at a very low P/E of around 8 but ifyou see that

in banking sector that to public sector banks the normal industry

P/E is 8 all most all banks are trading around 8 or bellow the P/E of

8.

So always it is advisable to look at what is the P/E of industry in

which we want to invest to get the better idea, because if we take

the example of IT industry there almost you will find companies

around P/E of 30. so if any IT company having of P/E would

considered to be a cheap option for the investor to invest in to. So

the investor should also look at the industry average P/E. The new

investor can know about the industry P/E or any other companies

P/E in any financial magazine or from the internet also if he does

not know how to calculate the P/E or is not having the data

available with them.

The formula for calculating the P/E ratio is


P/E = Current Market Price

Earning Per Share


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RANDOM PORTFOLIO

Random portfolio consists of the scripts that are randomly selected

by the investor by its own knowledge and preference of the stocks.

Here there is no analysis is done of the script, they are selected on

the tips and buts received by the investors from the external

sources.

We are considering BETA factorto design ourRandom Portfolio.

Beta Factor Beta indicates the proportion of the yield of a

portfolio to the yield of the entire market (as indicated by some

index). If there is an increase in the yield of the market, the yield of

the individual portfolio may also go up. If the index goes up by 1.5%

and the yield of your portfolio goes up by 0.9%, the beta is 0.9/1.5

i.e 0.6. in other words, beta indicates that for every 1 % increase in

the market yield, the yield of the portfolio goes up by 0.6%. High

beta shares do move higher than the market when the market rises

and the yield of the fund declines more than the yield of the marketwhen the market falls. In the Indian context a beta of 1.2% is

considered very bullish.

You can be indifferent to market swings if you know your stocks

well. Or you can put your portfolio into neutral or bias for the upside

if you're bullish or a little for the downside if you're bearish. One way

to do that is to have a mix of stocks that have certain betas in your

portfolio. When investors are bullish on the market, they like to have

high beta stocks in their portfolios because if they're right, then their

stocks go up faster than the market in general, and their

performance is better than the market. If investors are bearish on

the market, then they use the low beta or negative beta stocks

because their portfolios will go down less than the market and their

performance will be better than the general market. And if they want

to be neutral, they can then make sure that they have stocks with a



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beta of 1 or develop a portfolio that has stocks with betas greater

than 1 and less than 1 so that they have the whole portfolio with an

average beta of 1.

A beta for a stock is derived from historical data. This means it has

no predictive value for the future, but it does show that if the stock

continues to have the same price patterns relative to the market in

general as it has in the past, you've got a way of knowing how your

portfolio will perform in relation to the market. And with a portfolio

with an average beta of 1, you can create your own index fund

since you'll move more or less in tandem with the market.



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Interpretation of BetaInterpretation of Beta

WhenWhen B = 1B = 1 means that the scrip has same volatility as comparedmeans that the scrip has same volatility as compared

to Index. Suitable for moderate investor.to Index. Suitable for moderate investor.

WhenWhen B>1B>1 means that scrip is more volatile as compared to marketmeans that scrip is more volatile as compared to market

suitable for aggressive investors.suitable for aggressive investors.

WhenWhen B


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DEFENSIVE PORTFOLIO

SR NO. SCRIPT BETA PRICE ON 2-01-2006 Wi

1 ACC 0.72 530.45 9.68

2 CIPLA 0.78 440.00 10.48

3 DR REDDY 0.69 963.00 9.27

4 GRASIM 0.76 1375.3 10.22

5 HDFC BANK 0.76 713.45 10.22

6 ITC 0.81 140.10 10.89

7 RANBUXY 0.69 444.35 9.27

8 HERO HONDA 0.8 846.10 10.75

9 HDFC 0.82 1191.3 11.02

10 GLAXO 0.61 1111.6 8.20

Total Portfolio Beta = Wi * BETA

=6.97 +8.18+6.40+7.76+7.76

+8.82+6.40+8.60+9.04+5.00

= 74.93 ~ 75


Total Portfolio Investment = 10,00,000 Rs.


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RETURN ON INDIVIDUAL SCRIPTS

1ST MONTH

SR NO. SCRIPT BETA 2-01-200631-01-

06 RETURNIN %

1 ACC 0.72 530.45 574.20 8.25

2 CIPLA 0.78 440.00 442.25 0.51

3 DR REDDY 0.69 963.00 1121.25 16.43

4 GRASIM 0.76 1375.30 1454.25 5.74

5 HDFC BANK 0.76 713.45 762.45 6.87

6 ITC 0.81 140.10 154.80 10.49

7 RANBUXY 0.69 444.35 399.40 -10.12

8 HERO HONDA 0.80 846.10 857.20 1.31

9 HDFC 0.82 1191.30 1339.70 12.46

10 GLAXO 0.61 1111.60 1282.80 15.40

2ND MONTH

SR NO. SCRIPT BETA 2-01-06 28-02-06 RETURNIN %

1 ACC 0.72 530.45 626.30 18.072 CIPLA 0.78 440.00 552.15 25.49

3 DR REDDY 0.69 963.00 1306.10 35.63

4 GRASIM 0.76 1375.30 1742.60 26.71

5 HDFC BANK 0.76 713.45 737.15 3.32

6 ITC 0.81 140.10 172.45 23.09

7 RANBUXY 0.69 444.35 429.50 -3.34

8 HERO HONDA 0.80 846.10 889.30 5.11

9 HDFC 0.82 1191.30 1365.65 14.64

10 GLAXO 0.61 1111.60 1315.55 18.35



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RETURN IN DEFENSIVE PORT FOLIO

TOTAL PORTFOLIO INVESTMENT = 10,00,000

VALUE OF PORTFOLIO AS ON 28-02-2006 = 1166628.41

TOTAL RETURN IN % TERM = 16.66 %


TOTAL RETURN ON PORTFOLIO= 1166628.41 - 1000000

= 166628.41


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MODRATE PORTFOLIO


1 BHARTI 0.99 340.05 10.73

2 GUJARAT AMBUJA 0.86 79.30 9.32

3 BAJAJ AUTO 0.85 450.05 9.21

4 HLL 0.88 195.10 9.53

5 HINDALCO 1.00 146.20 10.83

6 LT 0.86 1825.65 9.32

7 MTNL 0.89 142.15 9.64

8 ZEE 0.90 157.90 9.75

9BHEL

1.00 1389.90 10.83

10 PNB 1.00 472.00 10.83


= 10.62 + 8.01+7.83+8.39+10.83+

8.01+8.58+8.78+10.83+10.83

= 92.72 ~ 93


Total Portfolio Investment = 10,00,000/- Rs.


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1ST MONTH

SR NO. SCRIPT BETA 2-01-2006

31-01-

06 RETURNIN %

1 BHARTI 0.99 340.05 357.25 5.06%

2 GUJARAT AMBUJA 0.86 79.30 88.55 11.66%

3 BAJAJ AUTO 0.85 450.05 513.25 14.04%

4 HLL 0.88 195.10 195.25 0.08%

5 HINDALCO 1.00 146.20 164.80 12.72%

6 LT 0.86 1825.65 2172.10 18.98%

7 MTNL 0.89 142.15 141.70 -0.32%

8 ZEE 0.90 157.90 164.70 4.31%

9 BHEL 1.00 1389.90 1795.60 29.19%

10 PNB 1.00 472.00 465.35 -1.41%

2ND

MONTH

SR NO. SCRIPT BETA2-01-2006 28-02-

06RETURN

IN %

1 BHARTI 0.99 340.05 361.05 6.18%

2 GUJARAT AMBUJA 0.86 79.30 88.30 11.35%

3 BAJAJ AUTO 0.85 450.05 550.10 22.23%

4 HLL 0.88 195.10 243.70 24.91%

5 HINDALCO 1.00 146.20 153.35 4.89%

6 LT 0.86 1825.65 2396.95 31.29%

7 MTNL 0.89 142.15 142.65 0.35%

8 ZEE 0.90 157.90 196.60 24.51%

9 BHEL 1.00 1389.90 2027.00 45.84%

10 PNB 1.00 472.00 442.10 -6.33%



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RETURN IN MODRATE PORT FOLIO

TOTAL PORTFOLIO INVESTMENT = 10,00,000/- Rs..

VALUE OF PORTFOLIO AS ON 28-02-2006 = 1162912.70/- Rs.



TOTAL RETURN ON PORTFOLIO

= 1162912.70 Rs. - 1000000 Rs.

= 162912.70 Rs.


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AGGRESSIVE PORTFOLIO


1 ICICI BANK LTD 1.09 597.00 9.64

2 INFOSYS 1.07 2979.35 9.46

3 ONGC 1.02 1191.65 9.02

4 RELIANCE 1.05 441.05 9.28

5 SATYAM 1.23 731.55 10.88

6 SBIN 1.09 904.90 9.64

7 TATA POWER 1.11 434.20 9.81

8 TATA MOTER 1.19 639.55 10.52

9 TATA STEEL 1.13 379.00 9.99

10 WIPRO 1.33 461.70 11.76


=10.50+10.12+9.20+9.75+13.38+

10.50+10.89+12.52+11.29+15.64 = 113.80 ~ 114


Total Portfolio Investment = 10,00,000/- Rs.


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1ST MONTH


06 RETURNIN %

1 ICICI BANK LTD 1.09 597.00 609.25 2.05

2 INFOSYS 1.07 2979.35 2880.30 -3.32

3 ONGC 1.02 1191.65 1237.30 3.83

4 RELIANCE 1.05 441.05 480.15 8.87

5 SATYAM 1.23 731.55 746.75 2.08

6 SBIN 1.09 904.90 886.35 -2.05

7 TATA POWER 1.11 434.20 471.80 8.66

8 TATA MOTER 1.19 639.55 708.45 10.779 TATA STEEL 1.13 379.00 404.45 6.72

10 WIPRO 1.33 461.70 529.70 14.73

2ND MONTH


06 RETURN

IN %1 ICICI BANK LTD 1.09 597.00 615.25 3.06

2 INFOSYS 1.07 2979.35 2828.95 -5.05

3 ONGC 1.02 1191.65 1136.40 -4.64

4 RELIANCE 1.05 441.05 500.55 13.49

5 SATYAM 1.23 731.55 769.65 5.21

6 SBIN 1.09 904.90 877.50 -3.03

7 TATA POWER 1.11 434.20 511.20 17.73

8 TATA MOTER 1.19 639.55 816.20 27.62

9 TATA STEEL 1.13 379.00 431.00 13.72

10 WIPRO 1.33 461.70 520.45 12.72



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RETURN IN AGGRESSIVE PORT FOLIO

TOTAL PORTFOLIO INVESTMENT = 10,00,000/- Rs.

VALUE OF PORTFOLIO AS ON 28-02-2006 =10,84,397.28/- Rs.



TOTAL RETURN ON PORTFOLIO

= 1084397.28 Rs - 1000000Rs

= 84397.28 Rs.


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Interpretation of Random Portfolio

As in the theoretical way we have scene that the Beta shows

the movement or change in the price of script vis--vis index.

And a Beta >1 is more riskier and hence should give more

return as compared to the script having Beta < 1. as the

person is taking more risk then he should get more return.

But in our case we have scene that Moderate portfolio

having Beta < 1 has given more return as compared to

Aggressive Portfolio.

So we can easily say that the investment in equity market is

subject to market risk and any one having long-term

investment horizon should only enter into equity market. This

analysis that has been carried out was only for a period of

two month there are chances that in the long run aggressiveportfolio would outperform the other portfolio



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DERIVATIVES

Derivatives is a product whose value is derived from the value of

one or more basic variables, called bases (underlying asset, index,

or reference rate), in a contractual manner. The underlying asset

can be equity, forex or commodity or any other asset. For example,

wheat farmer may wish to sell their harvest at a future date to

eliminate the risk of a change in prices by the date. Such a

transaction is an example of a derivative. The price of this derivative

is driven by the spot price of wheat which is the underlying.

In the Indian context the Securities Contracts (Regulation) Act.

1956 (SC(R)A) defines derivative to include

1. A security derived from a debts instrument, share, loan

whether secured or unsecured, risk instrument or contract for

differences or any other form of security.

2. A contract, which derives its value from the prices, or index

of price, of underlying securities.

The derivatives are securities under the (SC(R)A) and hence the

trading of derivatives is governed by the regulatory framework

under the (SC(R)A).



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TYPES OF DERIVATIVES

The most commonly used types of derivatives are as follows:

o Forwards: A forward contract is a customized contract

between two entities, where settlement takes place on a

specific date in the future at todays pre-agreed price.

o Futures: A future contract is an agreement between two

parties to buy or sell an asset at a certain time in the

future at a certain price. Future contracts are special

types of forward contract in the sense that the former are

standardized exchange-traded contracts.

o Options: Options are of two types call and put. Calls

give the buyer the right but not the obligation to buy a

gives quantity of the underlying asset, at a given price on

or before a given future date. Plus give the buyer theright, but not the obligation to sell a given quantity of the

underlying asset at a given price on or before a given

date.



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INTRODUCTION TO FUTURE

Future markets were designed to solve the problems that exist in

forward markets. A future contract is an agreement between two

parties to buy or sell an asset at a certain time in the future at a

certain price. But unlike forward contracts, the future contracts are

standardized and exchange traded. To facilitate liquidity in the

future contracts, the exchange specifies certain standard features of

the contract. It is a standardized contract with standard underlying

instrument, a standard quantity and quality of the underlying

instrument that can be delivered, (or which can be used for

reference purpose in settlement) and a standard time of such

settlement. A future contract may be offset prior to maturity by

entering into an equal and opposite transaction. More than 99% of

future transactions ate offset this way.

The standardized items in a future contract are:

Quantity of the underlying.

Quality of the underlying.

The date and the month of delivery.

The units of price quotation and minimum price change.

Location of settlement.

FEATURES OF A FUTURE CONTRACT

Future contracts are organized / standardized contracts,

which are traded on the exchanges.

These contracts, being standardized and traded on the

exchanges are very liquid in nature.

In futures market, clearing corporation/ house provides

the settlement guarantee.



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DISTINCTION BETWEEN FUTURE AND FORWARDDISTINCTION BETWEEN FUTURE AND FORWARDCONTRACTS:CONTRACTS:

Future contracts are often confused with future contracts. The

confusion is primarily because both serve essentially the same

economic functions of allocating risk in the presence of future price

uncertainty. However futures are a significant improvement over the

forward contracts as they eliminate counterparty risk and offer more

liquidity.

Features Forward ContractFuture Contract

Operational

Mechanism

Not traded on

exchange

Traded on exchange

Contract

Specifications

Differs from trade to

trade.

Contracts are

standardized

contracts.

Counterparty Risk Exists Exists, but assumed

by Clearing

Corporation/ house.

Liquidation Profile Poor Liquidity as

contracts are tailor

maid contracts.

Very high Liquidity as

contracts are

standardized

contracts.

Price Discovery Poor; as markets are

fragmented.

Better; as fragmented

markets are brought to

the common platform.

FUTURE TERMINOLOGYFUTURE TERMINOLOGY



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Spot Price: The price at which an asset trades in the spot

market.

Future Price: The price at which the future contracts trades

in the market.

Contract Cycle: The period over which a contract trades.

The index futures contracts on the NSE have one-month,

two-months and three-months expiry cycle, which expire on

28202250-project-report-on-portfolio-management (1)

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