Page 219 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes Derivatives are the most modern financial instruments in hedging risk. The individuals and
firms who wish to avoid or reduce risk can deal with the others who are willing to accept the risk
for a price. A common place where such transactions take place is called the ‘derivative market’.
As the financial products commonly traded in the derivatives market are themselves not primary
loans or securities, but can be used to change the risk characteristics of underlying asset or
liability position, they are referred to as ‘derivative financial instruments’ or simply ‘derivatives.’
These instruments are so called because they derive their value from some underlying instrument
and have no intrinsic value of their own. The world over, derivatives are a key part of the
financial system.

Did u know? Forwards, futures, options, swaps, caps floor collar etc. are some of more
commonly used derivatives.

11.1.1 Characteristics of Derivatives

The important characteristics of derivatives are as follows:

Derivatives possess a combination of novel characteristics not found in any form of assets.
It is comfortable to take a short position in derivatives than in other assets. An investor is
said to have a short position in a derivatives product if he is obliged to deliver the
underlying asset in specified future date.
Derivatives traded on exchanges are liquid and involves the lowest possible transaction
costs.
Derivatives can be closely matched with specific portfolio requirements.
The margin requirements for exchange-traded derivatives are relatively low, reflecting
the relatively low level of credit-risk associated with the derivatives.
Derivatives are traded globally having strong popularity in financial markets.
Derivatives maintain a close relationship between their values and the values of underlying
assets; the change in values of underlying assets will have effect on values of derivatives
based on them.

In a Treasury bond futures contract, the derivatives are straightforward.
11.1.2 Criteria for Derivatives Trading

In the derivatives market there shall be a two-level system of members viz., clearing members
and non-clearing members. The clearing member takes the responsibility for settlement of
trades on behalf of the non-clearing member. Thus, the clearing member acts as a guarantor for
the non-clearing member. The clearing member shall have a minimum net worth of ` 300 lakh
as per the SEBI’s definition and shall made a deposit of ` 50 lakh with the Exchange/Clearing
Corporation in the form of liquid assets such as cash. Fixed deposits pledged in the name of the
exchange, or other securities.

11.1.3 Derivatives Market in India

The most notable development concerning the secondary segment of the Indian capital market
is the introduction of derivatives trading in June 2000. The Securities Exchange Board of India
(SEBI) approved derivatives trading based on futures contracts at both BSE and NSE in accordance
with the rules/bye laws and regulations of the stock exchanges. Both BSE and NSE have made a
beginning with equity derivatives with the introduction of stock index futures.

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