Page 221 - DCOM507_STOCK_MARKET_OPERATIONS

Stock Market Operations

Notes Volatility is measured as the yearly standard deviation of the daily exchange rate series. Exchange
Board of India (SEBI) banned it for good in 2001. A series of reforms of the stock market between
1993 and 1996 paved the way for the development of exchange-traded equity derivatives markets
in India. In 1993, the government created the NSE in collaboration with state-owned financial
institutions. NSE improved the efficiency and transparency of the stock markets by offering a
fully automated screen-based trading system and real-time price dissemination. In 1995, a
prohibition on trading options was lifted. In 1996, the NSE sent a proposal to SEBI for listing
exchange-traded derivatives. The report of the L.C. Gupta Committee, set up by SEBI,
recommended a phased introduction of derivative products, and bi-level regulation (i.e., self-
regulation by exchanges with SEBI providing a supervisory and advisory role). Another report,
by the J. R. Verma Committee in 1998, worked out various operational details such as the
margining systems. In 1999, the Securities Contracts (Regulation) Act of 1956, or SC(R)A, was
amended so that derivatives could be declared ‘securities.’ This allowed the regulatory framework
for trading securities to be extended to derivatives. The Act considers derivatives to be legal and
valid, but only if they are traded on exchanges. Finally, a 30-year ban on forward trading was
also lifted in 1999.
The economic liberalization of the early nineties facilitated the introduction of derivatives
based on interest rates and foreign exchange. A system of market-determined exchange rates
was adopted by India in March 1993. In August 1994, the rupee was made fully convertible on
current account. These reforms allowed increased integration between domestic and international
markets, and created a need to manage currency risk. The figure shows how the volatility of the
exchange rate between the Indian rupee and the US dollar has increased since 1991. The easing of
various restrictions on the free movement of interest rates resulted in the need to manage
interest rate risk.

Self Assessment

Fill in the blanks:
1. ....................................... are those assets whose value is determined from the value of some
underlying assets.
2. The underlying asset may be equity, commodity or .......................................
3. Derivatives are the most modern financial instruments in ....................................... risk.

4. The individuals and firms who wish to .......................................or reduce risk can deal with
the others who are willing to ....................................... the risk for a price.
5. A common place where such transactions take place is called the .......................................

Caselet Forward Contract Effect on U.S. Dollar

n October 2007 the pound hit a 26 year high over the U.S dollar and it was possible to
achieve over 2 dollars to 1 pound. At the same time, Tim Montgomery, a software
Iprogrammer from Sussex, was buying a boat from Florida. He had been out there a
few times, had chosen his vessel and was waiting for the paperwork to come through so he
could transfer the U.S Dollars for the purchase. Tim was obviously pleased that the exchange
rate was as favourable as it had already saved him a further £4500 from the time he had
made his initial enquiries.
Contd...

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