Page 32 - DCOM510_FINANCIAL_DERIVATIVES

Unit 2: Derivatives Market in India

world like index futures, index options and index funds. A trillion calculations were expended Notes
to evolve the rules inside the S&P CNX Nifty index. The results of this work are remarkably
simple:
(a) The correct size to use is 50,
(b) Stocks considered for the S&P CNX Nifty must be liquid by the ‘impact cost’ criterion,
(c) The largest 50 stocks that meet the criterion go into the index.

S & P CNX Nifty is a contrast to the adhoc methods that have gone into index construction in the
preceding years, where indexes were made out of intuition and lacked a scientific basis. The
research that led up to S& P CNX Nifty is well respected internationally as a pioneering effort in
better understanding how to make a stock market index.
The Nifty is uniquely equipped as an index for the index derivatives market owing to its:

(a) Low market impact cost; and
(b) High hedging effectiveness.
The good diversification of Nifty generates low initial thus making it easier to do arbitrage for
index derivatives.

2.5 SENSEX

The Stock Exchange, Mumbai created history by launching the first exchange traded financial
derivatives product in India, the Sensex Futures.

2.5.1 Sensex Index

An Index is an indicator of the broad market. For instance, tracking the changes in the Sensex
enables one to effectively gauge market movements. The BSE Sensex, first compiled in 1986, is
a market capitalisation weighted index of 30 scripts. It represents 30 large well-established and
financially sound companies. The Sensex also has the largest social recall attached with it. It was
the first index to be launched by any Exchange in India and has acquired a unique place in the
collective memory of investors. It facilitates investors to relate to the market.
The most important advantage is that, as one of the oldest and reliable barometers of the Indian
Stock Market, it provides time series data over a fairly long period of time. The primary
consideration in, minimising changes in the composition of the BSE 30 has been for historical
purposes. However, the structural and market driven changes are taken into consideration.

!
Caution While an index must represent the current state of an evolving market, it should
concurrently maintain the track record of changes in the Indian capital markets.
The Sensex represents a broad spectrum of companies in a variety of industries. It represents 14
major industry groups, which are large enough to be used for effective hedging.

2.5.2 Trading in Sensex Futures

Given the lower cost structure and the overwhelming popularity of the Sensex, Sensex futures
are expected gamer large volumes. The Sensex futures are expected to become the most liquid
contract in the country. This is because institutional investors in India and abroad, money
managers and small investors use the Sensex when it comes to describing the mood of the Indian

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