Page 33 - DCOM510_FINANCIAL_DERIVATIVES

Financial Derivatives

Notes Stock Markets. Thus is has been observed that the Sensex is an effective proxy for the Indian
stock markets. Higher liquidity in the product essentially translates to lower impact cost of
trading in Sensex futures. The arbitrage between the futures and the equity market is further
expected to reduce impact cost. Immense retail participation to the extent of 80-90 percent is
expected in India based on following factors:
1. Stock index futures will require lower capital adequacy and margin requirements as
compared to margins carry forward of individual scrips.

2. The brokerage costs on index futures will be much lower.
3. Savings in cost is possible through reduced bid-ask spreads where stocks are traded in
packaged forms.

4. The impact cost will be much lower in case of stock index futures as opposed to dealing in
individual scrips.
The market is conditioned to think in terms of the index and therefore, would prefer to trade in
stock index futures. Further, the chances of manipulation are much lesser.
The stock index futures are expected to be extremely liquid given the speculative nature of our
markets the overwhelming retail participation expected to be fairly high. It is poised to become
the most liquid contract in the world in terms of number of contracts traded, if not in terms of
notional value. The advantage to the equity or cash market is in the fact that they would become
less volatile as most of the speculative activity would shift to stock index futures. The stock
index futures market should ideally have more depth, volumes, and act as a stabilising factor for
the cash market. However, it is too early to base any conclusions on the volume or to form any
firm trend.

Self Assessment

Fill in the blanks:
10. ……………………… was designed not only as a barometer of market movement but also
to be a foundation of the new world like index futures, index options and index funds.
11. An ……………………… is an indicator of the broad market.
12. The …………………………. are expected to become the most liquid contract in the country.

Task Like our stock markets, the Indian derivatives markets are also becoming heavily
dependent on a few instruments. For instance, futures in three blue-chip companies such
as Satyam Computers, Reliance Industries and Infosys Technologies, have accounted for
as much as 42% of the total turnover in the derivatives segment of the National Stock
Exchange in June, 2002. Stock futures of Satyam Computers, Infosys Technologies and
HPCL accounted for 37% of the total turnover in May 2002, 35% in April 2002 and 34% in
March 2002. Comment.

2.6 Application of Index

Besides serving as a barometer of the economy/market, the index also has other applications in
finance.

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