Money Market

As per RBI definitions “A market for short terms financial assets that are close substitute
for money, facilitates the exchange of money in primary and secondary market”.

• The money market is a mechanism that deals with the lending and borrowing of
short term funds (less than one year).
• A segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded.
• It doesn’t actually deal in cash or money but deals with substitute of cash like
trade bills, promissory notes & govt papers which can convert into cash without
any loss at low transaction cost.
• It includes all individual, institution and intermediaries.

Features of Money Market

• It is a market purely for short-terms funds or financial assets called near money.
• It deals with financial assets having a maturity period less than one year only.
• In Money Market transaction can not take place formal like stock exchange, only
through oral communication, relevant document and written communication
transaction can be done.
• Transactions have to be conducted without the help of brokers.
• It is not a single homogeneous market, it comprises of several submarket like call
money market, acceptance & bill market.
• The components of Money Market are the commercial banks, acceptance houses
& NBFC (Non-banking financial companies).

Objective of Money Market

• To provide a parking place to employ short term surplus funds.
• To provide room for overcoming short term deficits.
• To enable the central bank to influence and regulate liquidity in the economy
through its intervention in this market.
 • To provide a reasonable access to users of short-term funds to meet their
requirement quickly, adequately at reasonable cost.
Instrument of Money Market
 Commercial papers.
 Certificate of deposit.
 Inter-bank participation certificates.
 Repo instrument
 Banker's Acceptance
 Repurchase agreement
 Money Market mutual fund

Treasury Bills (T-Bills)

• (T-bills) are the most marketable money market security.
• They are issued with three-month, six-month and one-year maturities.
• T-bills are purchased for a price that is less than their par(face) value; when they
mature, the government pays the holder the full par value.
• T-Bills are so popular among money market instruments because of affordability
to the individual investors.
Certificate of deposit (CD)
• A CD is a time deposit with a bank.
• Like most time deposit, funds can not withdraw before maturity without paying a
penalty.
• CD’s have specific maturity date, interest rate and it can be issued in any
denomination.
• The main advantage of CD is their safety.
• Anyone can earn more than a saving account interest.
Commercial paper (CP)
• CP is a short term unsecured loan issued by a corporation typically financing day
to day operation.
 • CP is very safe investment because the financial situation of a company can easily
be predicted over a few months.
• Only company with high credit rating issues CP’s.
• CP is issued to and held by individuals, banking companies, other corporate
bodies registered or incorporated in India and unincorporated bodies, Non-
Resident Indians (NRIs) and Foreign Institutional Investors (FIIs).
• Denomination: min. of 5 lakhs and multiple thereof.
• Maturity: min. of 7 days and a maximum of up to one year from the date of issue

Repurchase agreement (Repos)

It is a transaction in which two parties agree to sell and repurchase the same security.
Under such an agreement the seller sells specified securities with an agreement to
repurchase the same at a mutually decided future date and a slightly higher price. The
Repo/Reverse Repo transaction can only be done at Mumbai between parties approved by
RBI and in securities as approved by RBI (Treasury Bills, Central/State Govt securities).
Banker's Acceptance
• A banker’s acceptance (BA) is a short-term credit investment created by a non-
financial firm.
• BA’s are guaranteed by a bank to make payment.
• Acceptances are traded at discounts from face value in the secondary market.
• BA acts as a negotiable time draft for financing imports, exports or other
transactions in goods.
• This is especially useful when the credit worthiness of a foreign trade partner is
unknown

Structure of Indian Money Market

ORGANISED STRUCTURE
1. Reserve bank of India.
2. DFHI (discount and finance house of India).
3. Commercial banks
i. Public sector banks
 SBI with 7 subsidiaries
Cooperative banks
20 nationalized banks
ii. Private Banks
Indian Banks
Foreign banks
4. Development bank
IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc.
UNORGANISED SECTOR
1. Indigenous banks
2 Money lenders
3. Chits
4. Nidhis
III. CO-OPERATIVE SECTOR
1. State cooperative
i. central cooperative banks
Primary Agri credit societies
Primary urban banks
2. State Land development banks
central land development banks
Primary land development banks
Disadvantage of Money Market
• Purchasing power of your money goes down, in case of up in inflation.
• Absence of integration.
• Absence of Bill market.
• No contact with foreign Money markets.
• Limited instruments.
• Limited secondary market.
• Limited participants.
Capital Market

MEANING OF CAPITAL MARKET

The capital market is a market for financial assets which have a long or indefinite
maturity. Generally, it deals with long term securities which have a maturity period of
above one year.

The capital market is the market for securities, where companies and governments
can raise long term funds. It is a market in which money is lend for periods longer than a
year. The capital market includes the stock market and the bond market.
• “Stock market” is a term used to describe the physical location where the buying
and selling of stocks take place.
• The correct term to be used in pertaining to the physical location for trading
stocks is “stock exchange.”
• The Stock market in India consists of about approx. twenty two stock exchanges.
• The stock exchanges constitute a market where securities issued by the Central &
State Govt., Public bodies & Joint Stock companies are traded.

1 Primary Market:

Primary market is market for new issue or new financial claim & it is
also called new issue market. The primary market deals with those securities
which are issued to the public for the 1st time. In the primary market, borrower
exchange new financial securities for long term funds. Thus primary market
facilitates capital formation.
There are three ways by which a company may raise a capital in
primary market. They are Public issue, Right issue, and preferential allotment.
 2 Secondary Markets:-

Secondary Market is a market for secondary sale of security. In other

word, securities which have already passed through the new issue market are
trade in this market. It provide continues and regular market for buying and
selling of securities. The stock exchange in India is regulated under the securities
Act, 1956.
Meaning of stock

• A stock is a small share that represents a partial ownership of a company.

• Stocks are issued by companies in order to raise capital.
• Stock is also referred to as equity, & it is limited to particular number of shares.

Types of Share

• Defensive Shares – These are the shares of stabilized & mature companies. Over
the years these companies have standard practices for dividend payments.
• Cyclical Shares – These are the shares of companies engaged in trade cycle.
During boom they do extremely well & during recessionary phase, they hit the
bottom.
• Discount Shares – These are the shares whose market price is lower than the par
value or book value.
• Growth Shares – These are the shares of those companies whose assets, sales
turnover & profits are growing rapidly.

New Issue Market

• To promote a new company
• To expand an existing company
• To diversify the production
 • To meet the regular working capital requirements
• To capitalize the reserves
3 ways to raise equity capital in the primary market
 Public issue
 Rights issue
 Preferential allotment

Public issue
 A company informs the public
 If the issue is oversubscribed the pattern of allotment should be decided
 The balance amount to be called by one or two calls
 If the investor fails to pay the shares are liable to be forfeited
 The shares are entitled for dividend from the date of allotment
 Public issue prices may be determined at predetermined price or on the basis of
bids

Rights Issue
• A company sends a ‘letter of offer 'A B C D
• A is for acceptance of the rights and application for additional shares
• B is for the shareholders wants to renounce the rights in favor of someone else
• C is meant for rights have been renounced by the original allottee
• D is to be used to make a request for split forms

Preferential allotment
“An issue of equity by a listed company to selected investors at a price which may or
may not be related to the prevailing market price”
Bulls & Bears Market
Bulls Market - Bull markets occur when a particular nation experiences high
economic production, low unemployment level, and low inflation rates
 Bears Market – It follow the down trends in the economy. Such indicators of
economic downfall are increased unemployment and inflation. These causes the fall
of stock prices.

Bombay Stock Exchange

• Established as "The Native Share & Stock Brokers' Association" in 1875
• Oldest stock exchange in Asia.
• Today, BSE is the world's number 1 exchange in terms of the number of listed
companies & worlds 5th in transaction numbers.
• BSE has two of world's best exchanges, Deutsche Börse and Singapore
Exchange, as its strategic partners.
• The BSE Index, SENSEX, is India's first stock market index that enjoys an iconic
stature , and is tracked worldwide.

SENSEX
• BSE Sensex is a value-weighted index composed of 30 stocks.
• It consists of the 30 largest and most actively traded stocks, representative of
various sectors.
• SENSEX is calculated using the "Free-float Market Capitalization" methodology
• The base period of SENSEX is 1978-79 and the base value is 100 index points.
• SENSEX is calculated every 15 seconds.

National stock exchange

 It established in the year 1994
 It is a ringless,national, computerised exchange.
 It has two segments: the whole sale debt market&capital market segment
 NSE is the first exchange in the world to employ the satellite technology.
 A satellite link up is called VSAT
 All trades on NSE are guaranteed by the National securities clearing corporation.
The Role of Stock Exchanges

• Raising Capital for Business – It facilitates companies to raise capital through

selling of shares to the investing public.
• Mobilizing savings for investment – When people invest in shares it leads to most
rational allocation (agriculture, commerce, industry), as otherwise it remains idle
in deposits with banks
• Facilitating company growth – Companies views acquisition as an opportunity to
expand their horizon. Stock market is one of the simplest and most common ways
for a company to grow by acquisition or fusion.
• Creating investment opportunities for small investors – It enables small investor
to invest in shares as per their affordability.
• Government capital-raising for development projects – It may decide to borrow
money for several projects (sewage & water treatment, housing) by selling
securities known as bonds.
• Barometer of the economy - Movement of share prices and in general of the stock
indexes can be an indicator of the general trend in the economy.

Dematerialization is the process wherein share certificates or other securities held in

physical form are converted into electronic form and credited to demat account of an
investor opened with a depository participant. SEBI has made a compulsory trading of
shares of all the companies listed in stock exchanges in demat form, in order to eliminate
the risk of bad delivery and forged shares.

Rematerialization is the process of conversion of electronic holdings of securities into

physical certificate form. For Rematerialization of scrip’s, the investor has to fill up a
remat request form (RRF) and submit it to depository participant (DP). The DP forwards
the request to depository after verifying the investor’s balances. Depository in turn
intimates the registrar or Issuer Company, & the company prints and dispatches the same
to the investor.

Depository system.

• Depository system is a facility for holding securities which enables securities

transactions to be processed by book entry.
• To achieve this purpose, the Depository may immobilize the securities or
dematerialize them(so that they exist only as electronic records)
• In India, depository is an organization which holds the beneficial owner’s
securities in electronic form, through a registered depository participant.
• A depository functions somewhat similar to a commercial bank. To avail of the
services offered by a depository, the investor has to open an account with a
registered DP.

There are essentially four players in the depository system;

The Depository- is a firm wherein the securities of the investors are held in electronic
form. It functions as a custodian of securities of its clients. The name of the Depository
appears in the records of the issuer as the registered owner of securities. At present, there
are two depositories in India. Namely,

 National securities depository ltd (NSDL)

 Central depository services (India) ltd. (CDSL)

NSDL which commenced operation during November 1996 was promoted by IDBI; UTI
&[Link] commenced operation during February 1999. It was promoted by Mumbai
stock exchange in association with Bank of Baroda, Bank of India, State Bank of India
and HDFC Bank.
  The Participant- is an agent of the depository. He functions as a bridge
between the depository and the beneficial owner. Both the depository and
the participant have to be registered with the SEBI.

 The Beneficial Owner- a person whose name is recorded as such with a

depository. A beneficial owner is the real owner of the securities who has
lodged associated with the securities.

 The Issuer- is the company which issues the security. It maintains a

register for recording the names of the registered owner of the securities,
the depositories.

The important services offered by depository system are:

• Dematerialization.
• Rematerialization.
• Electronic settlement of trade.
• Nomination facility
• Electronic credit of securities allotted in public, rights and bonus issue.
• Pledging of dematerialized securities.
• Freezing of demat accounts.
• Stock lending/borrowing facilities.
• Internet facilities like “Easi” and “Easiest”, etc.

Advantages of depository system:

• Reduction in paper work.

• Elimination of risks associated with physical scrips such as theft, forgery,
mutilation, loss of share certificates etc.
• Elimination of bad deliveries.
• Increased liquidity of scrips through speedy settlements and reduction in delays in
registrations.
• Low transaction costs for purchases and sale of securities compared to physical
mode.
• No stamp duty on transfer of securities.
• Facilitate the issuer companies to update the information regarding shareholders
and to communicate with them in better ways.
• Attract foreign investors and promoting foreign investment.
• Emergence of healthy and efficient capital market.
• Greater opportunity for the development of sophisticated custodial services etc.

Functions of Securities and exchange board of India (SEBI)?

The SEBI, set up in 1988 was given statutory recognition in 1992 on

recommendations of the Narasimhan committee. Among other things the board
has been mandated to create an environment which would facilitate mobilization
of adequate resource through the securities market & its efficient allocation.

The important functions of SEBI are as follows;

o Regulating the business in stock market & other securities market.

o Registering & regulating the working of stock brokers & other
intermediaries associated with the securities market.
o Registering & regulating the working of collective investment schemes
including mutual funds.
o Promoting & regulating the self- regulatory organizations.
o Prohibiting fraudulent & unfair trade practices relating to securities
market.
o Promoting investor’s education & training of intermediaries of securities
market.
o Prohibiting insider trading in securities.
o Regulating substantial acquisition of shares & takeover of companies.
o Performing such functions and exercising such powers under the
provisions of the capital issues (control) Act, 1947 and securities contracts
 (regulations) Act, 1956, as may be delegated to it by the central
government

SEBI has been vested with wide –ranging powers.

Firstly, to oversee constitution as well as the operations of mutual funds including

presentation of accounts, following the decision to allow the entry of private sector &
joint sector mutual funds. Secondly, all stock exchanges in the county have been brought
under the annual inspection regime of SEBI for ensuring orderly growth of stock markets
& investor’s protection. Thirdly, with the repealing of the capital issues (control) Act,
1947, in May 1992, SEBI has been made the regulatory authority in regard to new issues
of companies. Fourthly, with effect from 1995, the SEBI has been empowered to impose
penalties on different intermediaries for defaults.

DERIVATIVE MARKETS

Introduction
The emergence of the market for derivative products, most notably forwards, futures and
options, can be traced back to the willingness of risk-averse economic agents to guard
themselves against uncertainties arising out of fluctuations in asset prices. By their very
nature, the financial markets are marked by a very high degree of volatility. Through the
use of derivative products, it is possible to partially or fully transfer price risks by
locking-in asset prices. As instruments of risk management, these generally do not
influence the fluctuations in the underlying asset prices. However, by locking-in asset
prices, derivative products minimize the impact of fluctuations in asset prices on the
profitability and cash flow situation of risk-averse investors.
Derivative products initially emerged, as hedging devices against fluctuations in
commodity prices and commodity-linked derivatives remained the sole form of such
products for almost three hundred years. The financial derivatives came into spotlight in
post-1970 period due to growing instability in the financial markets. However, since their
emergence, these products have become very popular and by 1990s, they accounted for
about two-thirds of total transactions in derivative products. In recent years, the market
for financial derivatives has grown tremendously both in terms of variety of instruments
available, their complexity and also turnover. In the class of equity derivatives, futures
and options on stock indices have gained more popularity than on individual stocks,
especially among institutional investors, who are major users of index-linked derivatives.
Even small investors find these useful due to high correlation of the popular indices with
various portfolios and ease of use. The lower costs associated with index derivatives vis-
vis derivative products based on individual securities is another reason for their growing
use.

The following factors have been driving the growth of financial derivatives:

1. Increased volatility in asset prices in financial markets,

2. Increased integration of national financial markets with the international markets,
3. Marked improvement in communication facilities and sharp decline in their costs,
4. Development of more sophisticated risk management tools, providing economic agents
a wider choice of risk management strategies, and
5. Innovations in the derivatives markets, which optimally combine the risks and returns
over a large number of financial assets, leading to higher returns, reduced risk as well
as trans-actions costs as compared to individual financial assets.

Derivative 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, commodity or any other asset. For
example, wheat farmers may wish to sell their harvest at a future date to eliminate the
risk of a change in prices by that 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
“equity derivative” to include “A security derived from a debt instrument, share, loan
whether secured or unsecured, risk instrument or contract for differences or any other
form of security.” A contract, which derives its value from the prices, or index of prices,
of underlying securities. The derivatives are securities under the SC(R) A and thus the
regulatory framework under the SC(R) A governs the trading of derivatives.

Derivative can be defined as

Derivatives are those assets whose value is determined from the value of some
underlying assets. The underlying asset may be equity, commodity or currency. The list
of derivative assets is long.
The derivatives are 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. Forwards, futures, options, swaps, caps floor collar etc. are some of more
commonly used derivatives. The world over, derivatives are a key part of the financial
system.

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 future contract the derivatives are straight-forward.

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. SEBI approved derivatives
trading based on Futures Contracts at both BSE and NSE in accordance with the rules/by
laws and regulations of the Stock Exchanges. A beginning with equity derivatives has
been made with the introduction of stock index futures by BSE and NSE.
Stock Index Futures contract allows for the buying and selling of the particular stock
index for a specified price at a specified future date. Stock Index Futures, inter alia, help
in overcoming the problem of asymmetries in information. Information asymmetry is
mainly a problem in individual stocks as it is unlikely that a trader has market-wide
private information. As such, the asymmetric information component is not likely to be
present in a basket of stocks. This provides another rationale for trading in Stock Index
Futures. Trading in index derivatives involves low transaction cost in comparison with
trading in underlying individual stocks comprising the index. While the BSE introduced
Stock Index Futures for S&P CNX Nifty comprising 50scrip’s.
Stock Index Futures in India are available with one month, two month and three month
maturities. While derivatives trading based on the Sensitive Index (Sensex) commenced
at the BSE on June 9, 2000, derivatives trading based on S&P CNX Nifty commenced at
the NSE on June 12, 2000. SIF is the first attempt in the development of derivatives
trading.
Exchange-Traded and Over-the-Counter Derivative Instruments

OTC (over-the-counter) contracts, such as forwards and swaps, are bilaterally negotiated
between two parties. The terms of an OTC contract are flexible, and are often customized
to fit the specific requirements of the user. OTC contracts have substantial credit risk,
which is the risk that the counterparty that owes money defaults on the payment. In India,
OTC derivatives are generally prohibited with some exceptions: those that are
specifically allowed by the Reserve Bank of India (RBI) or, in the case of commodities
(which are regulated by the Forward Markets Commission), those that trade informally in
“havala” or forwards markets.
An exchange-traded contract, such as a futures contract, has a standardized format that
specifies the underlying asset to be delivered, the size of the contract, and the logistics of
delivery. They trade on organized exchanges with prices determined by the interaction of
many buyers and sellers. In India, two exchanges offer derivatives trading: the Bombay
Stock Exchange (BSE) and the National Stock Exchange (NSE). However, NSE now
accounts for virtually all exchange-traded derivatives in India, accounting for more than
99% of volume in 2003-2004. Contract performance is guaranteed by a clearinghouse,
which is a wholly owned subsidiary of the NSE. The Margin requirements and daily
marking-to-market of futures positions substantially reduce the credit risk of exchange-
traded contracts, relative to OTC contracts.
Derivative Products
Derivative is a product/contract which does not have any value on its own i.e. it derives
its value from some underlying.
Forward contracts
• A forward contract is one to one bi-partite contract, to be performed in the future,
at the terms decided today. (E.g. forward currency market in India).
• Forward contracts offer tremendous flexibility to the parties to design the contract
in terms of the price, quantity, quality (in case of commodities), delivery time and
place.
• Forward contracts suffer from poor liquidity and default risk.
Future contracts
 • 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.
• Every futures contract is a forward contract. They are entered into through
exchange, traded on exchange and clearing corporation/house provides the
settlement guarantee for trades are of standard quantity; standard quality (in case
of commodities).have standard delivery time and place.

Forward / Future Contracts

Features Forwards Futures

Operational Not traded on Traded on exchange
Mechanism exchange
Contract Differs from trade to Contracts are standardized con
Specifications trade. tracts.
Counterparty Risk Exists Exists, but assumed by Clearing
Corporation/ house.
Liquidation Profile Poor Liquidity as Very high Liquidity as contracts are
contracts standardized contracts.
are tailor maid
contracts.
Price Discovery Poor; as markets are Better; as fragmented markets are brought
fragmented. to the common platform.

Options
An option is a contractual agreement that gives the option buyer the right, but not the
obligation, to purchase (in the case of a call option) or to sell (in the case of a put option)
a specified instrument at a specified price at any time of the option buyer’s choosing by
or before a fixed date in the future. Upon exercise of the right by the option holder, an
option seller is obliged to deliver the specified instrument at the specified price.
Options are instruments whereby the right is given by the option seller to the option
buyer to buy or sell a specific asset at a specific price on or before a specific date.
• Option Seller - One who gives/writes the option. He has an obligation to perform,
in case option buyer desires to exercise his option.
• Option Buyer - One who buys the option. He has the right to exercise the option
but no obligation.
• Call Option - Option to buy.
• Put Option - Option to sell.
• American Option - An option which can be exercised anytime on or before the
expiry date.
• European Option - An option which can be exercised only on expiry date.
• Strike Price/ Exercise Price - Price at which the option is to be exercised.
• Expiration Date - Date on which the option expires.

Features of Options

The important features of options contracts are as follows:

• The option is exercisable only by the owner, namely the buyer of the option.
• The owner has limited liability.
• Owners of options have no right affordable to shareholders such as voting right
and dividend right.
• Options have high degree of risk to the option writers.
• Options are popular because they allow the buyer profits from favourable
movements in exchange rate.
• Options involve buying counter positions by the option sellers.
• Flexibility in investors needs.
• No certificates are issued by the company.
• An investor who writes a call option against stock held in his portfolio is said to
be selling ‘covered options’. Options sold without the stock to back them up are
 called ‘naked options’.

Differences between Futures and Options

Futures Options
Both the parties are obliged to perform Only the seller (writer) is obligated to
the contract. perform the contract.

No premium is paid by either parties. The buyer pays the seller (writer) a
premium.
The holder of the contract is exposed The buyer's loss is restricted to downside
to the entire spectrum of downside risk risk
and has potential for all the upside to the premium paid, but retains upward
return. indefinite potentials.

The parties of the contract must The buyer can exercise option any time
perform at the settlement date. They are prior to the expiry date
not obligated to perform before the date. .

Options are of two basic types:

The Call and the Put Option

A call option gives the holder the right to buy an underlying asset by a
certain date for a certain price. The seller is under an obligation to fulfill the
contract and is paid a price of this which is called “the call option premium or call
option price”.
A put option, on the other hand gives the holder the right to sell an
underlying asset by a certain date for a certain price. The buyer is under an
obligation to fulfill the contract and is paid a price for this, which is called “the
put option premium or put option price”. The price at which the underlying asset
 would be bought in the future at a particular date is the “Strike Price” or the
“Exercise Price”. The date on the options contract is called the “Exercise date”,
“Expiration Date” or the “Date of Maturity”.

Advantages and Disadvantages of Options

Advantages
There is limited risk for many options strategies. The trader can lose the entire premium,
but that amount is known when the position is initiated.
• There are no margin calls for many strategies.
• Options offer a wide range of strategies for a variety of conditions.
• Options offer a way to add to futures positions without spending any more money
or premiums. Thus, the option trader has more leverage.
• With a forward and futures contract, the inventor is committed to a future
transaction; with an option, he enjoys the right to go ahead but he can walk away
from the deal if he so desires.
• There is limited risk for many options strategies. The trader can lose the entire
premium, but that amount is known when the position is initiated. There are no
margin calls for many strategies.
• Options offer a wide range of strategies for a variety of conditions

Disadvantages
There are more complex factors affecting premium prices for options. Volatility and time
to expiration are often more important than price movement.
• Many options contracts expire weeks before the underlying futures. This can be
an occasional often occurs close to the final trading day of futures. However, this
should not be construed to mean that commercials cannot use the options to
hedge.
• Option premiums don’t move tick for tick with the futures (unless they’re deep in
the money). This can be frustrating to have the market move in your direction, yet
lose premium value.
 • The trader pays a premium to enter a market when buying options. When
volatility is high, premiums can be very expensive. The trade is paying for time,
so the premium becomes an eroding asset. On the other side, options sellers can
receive price premiums, but they have margin requirements.
• Currently, there is more liquidity in futures contracts than there is in most options
a contract. Entry and exist from some markets can be difficult. Even if positions
entered with a limit order, exiting can be a problem, unless the option is in the
money. Of course, the option buyer can exercise the option, receive a futures
position, and then liquidate the futures.

Role of FDI in Indian economy

As the fourth-largest economy in the world in purchasing power parity (PPP)
terms, India is a preferred destination for foreign direct investments (FDI). India has
strengths in telecommunication, information technology and other significant areas such
as auto components, chemicals, apparels, pharmaceuticals, and jewellery. Despite a surge
in foreign investments, rigid FDI policies resulted in a significant hindrance. However,
due to some positive economic reforms aimed at deregulating the economy and
stimulating foreign investment, India has positioned itself as one of the front-runners of
the rapidly growing Asia Pacific Region. India's recently liberalised FDI policy permits
up to a 100% FDI stake in ventures. Industrial policy reforms have substantially reduced
industrial licensing requirements, removed restrictions on expansion and facilitated easy
access to foreign technology and FDI. The upward moving growth curve of the real-
estate sector owes some credit to a booming economy and liberalized FDI regime. A
number of changes were approved on the FDI policy to remove the cap in most of the
sectors. Restrictions will be relaxed in sectors as diverse as civil aviation, construction
development, industrial parks, commodity exchanges, petroleum and natural gas, credit-
information services, Mining etc. The future of Indian economy is brighter because of its
huge human resources, rapidly upcoming service sector, availability of large number of
competent professionals, vast market for every product, increasing impact of
consumerism, absence of controls and licenses, interest of foreign entrepreneurs in India
and existence of four hundred million middle class people. Today, India provides highest
returns on FDI than any other country in the world.

FDI in India
Compared to most industrializing economies, India followed a fairly restrictive foreign
private investment policy until 1991 – relying more on bilateral and multilateral loans
with long maturities. Inward foreign direct investment (FDI, or foreign investment, or
foreign capital hereafter) was perceived essentially as a means of acquiring industrial
technology that was unavailable through licensing agreements and capital goods import.
Technology imports were preferred to financial and technical Collaborations. Even for
technology licensing agreements, there were restrictions on the rates of royalty payment
and technical fees.
However, the 1980s witnessed a gradual relaxation of the foreign investment rules
perhaps best symbolized by the setting up of Maruti, a central government joint venture
small car project with Japan’s Suzuki Motors in 1982. It was followed by Pepsi’s entry in
the second half of the decade, to primarily export processed food products from Punjab,
and also to bottle its well known beverages for the domestic market.

Reforms in FDI
All this changed since 1991. Foreign investment is now seen as a source of scarce capital,
technology and managerial skills that were considered necessary in an open, competitive,
world economy. India sought to consciously ‘benchmark’ its policies against those of the
rapidly growing south-east Asian economies to attract a greater share of the world FDI
inflows. Over the decade, India not only permitted foreign investment in almost all
sectors of the economy (barring agriculture, and, until recently, real estate), but also
allowed foreign portfolio investment – thus practically divorcing foreign investment from
the erstwhile technology acquisition effort. Further, laws were changed to provide foreign
firms the same standing as the domestic ones.
 Financial Yearwise FDI inflows in US Dollar in
million

40,000
34,83535,180
35,000

30,000
Amount of FDI inflows

25,000 22,826

20,000
15,483
15,000
8,961
10,000
6,130 5,035 6,051
4,322
5,000

0
1991- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2008-
2000 02 03 04 05 06 07 08 09

Foreign Direct Investment in India is permitted as under the

following forms of investments:
• Through financial collaborations.
• Through joint ventures and technical collaborations.
• Through capital markets via Euro issues.
• Through private placements or preferential allotments.

FDI is not permitted in the following industrial sectors:

• Arms and ammunition.
• Atomic Energy.
• Railway Transport.
• Coal and lignite.
• Mining of iron, manganese, chrome, gypsum, sulphur, gold,
diamonds, copper, zinc.
Foreign direct investments in India are approved through two
routes:

1. Automatic approval by RBI: The Reserve Bank of India accords

automatic approval within a period of two weeks (provided certain
parameters are met) to all proposals involving:
• Foreign equity up to 50% in 3 categories relating to mining activities.
• Foreign equity up to 51% in 48 specified industries.
• Foreign equity up to 74% in 9 categories.
Investments in high-priority industries or for trading companies
primarily engaged in exporting are given almost automatic approval by
the RBI.

FDI in India on automatic route is not allowed in the following

sectors:
• Proposals that require an industrial license and cases where foreign
investment is more than 24% in the equity capital of units
manufacturing items reserved for the small scale industries.
• Proposals in which the foreign collaborator has a previous
venture/tie-up in India.
• Proposals relating to acquisition of shares in an existing Indian
company in favour of a Foreign/Non-Resident Indian (NRI)/Overseas
Corporate Body (OCB) investor; and
• Proposals falling outside notified sectoral policy/caps or under sectors
in which FDI is not permitted and/or whenever any investor chooses to
make an application to the Foreign Investment Promotion Board and
not to avail of the automatic route.
2. FIPB Route: Foreign Investment Promotion Board (FIPB) is a
competent body to consider and recommend foreign direct investment,
which do not come under the automatic route. Normal processing time
of an FDI proposal in FIPB is 4 to 6 weeks. FIPB is located in the
Department of Economic Affairs, Ministry of Finance. Its constitution is
as follows:
• Secretary, Department of Economic Affairs (Chairman)
• Secretary, Department of Industrial Policy & Promotion (Member)
• Secretary, Department of Commerce (Member)
• Secretary, (Economic Relation), Ministry of External Affairs (Member)
FIPB can co-opt Secretaries to the Govt. of India and other top officials
of financial institutions, banks and professional experts of industry and
commerce, as and when necessary.

Country Sources of FDI

Among countries, Mauritius has been the largest direct investor in India. Firms
based in Mauritius invested over US$20 billion in India between August 1991 and July
2007 or over two-fifth of total FDI inflows during that period (Table 2). However, this
data is rather misleading. Mauritius has low rates of taxation and an agreement with India
on double tax avoidance regime. To take advantage of that situation, many companies
have set up dummy companies in Mauritius before investing to India. Also, a major part
of the investments from Mauritius to India are actually round-tripping by Indian firms,
not unlike that between Mainland China and Hong Kong. The United States (US) is the
second largest investor in India. The total capital flows from the US was around US$6.
billion between August 1991 and July 2007, which accounted for 12 percent of the FDI
inflows. Most of the US investments were directed to the fuels, telecom, electrical
equipment, food processing, and services sectors. The United Kingdom (UK) and the
Netherlands are India’s third and fourth largest FDI inflows. The investments from these
countries to India are primarily concentrated in the power/energy, telecom, and
transportation sectors. Japan was the fourth largest source of cumulative FDI inflows in
India between 1991 and 2007, but inflows from Japan to India have decreased during this
time period. This is opposite to the general trend. This is particularly interesting because
Japan’s FDI outflows in 2006 increased by 10 percent to reach a record US$50 billion,
the second highest since 1990.3 It is hard to explain the recent decline of Japanese FDI to
India and it might as well be a temporary anomaly.4 India, however, continues to be one
of the biggest recipients of Japanese Official Development Assistance (ODA). Most of
the assistance was in building infrastructure, including electricity generation,
transportation, and water supply. It is plausible that Japanese government assistance has
crowded out some private sector investment from Japan. The top sectors attracting FDI
inflows from Japan to India (January 2000 to November 2006) have been transportation
(54 percent), electrical equipment (7 percent), telecom, and services (3 percent).

SHARE OF TOP INVESTING COUNTRIES FDI EQUITY INFLOWS

Amount Rupees in crores (US$ in million)

Ranks Country Cumulative inflows

1 MAURITIUS 204,196
(45,778)
2 SINGAPORE 42,040
(9,518)
3 U.S.A. 35,536
(7,919)
4 U.K. 24,746
(5,611)
5 NETHERLANDS 19,539
(4,359)
6 CYPRUS 16,468
(3,613)
7 JAPAN 16,421
(3,611)
8 GERMANY 12,069
(2,712)
9 U.A.E. 6,830
 (1,507)
10 FRANCE 6,639
(1,469)

FDI Inflows by Sector

Cumulative FDI inflows reached just over US$60 billion between August 1991 and July
2007. Since 2002, some sectors such as electrical equipment, services, drugs and
pharmaceuticals, cement and gypsum products, metallurgical industries have also been
doing very well in attracting FDI. The electrical equipment sector and the services sector
in particular received the largest shares of total FDI inflows between August 1991 and
July 2007. These were followed by the telecommunications, transportation, fuels, and
chemicals sectors. The Department of Industrial Policy and Promotion has recently
modified the classifications of the sectors and data released from August 2007 has been
based on the new sectoral classifications. According to that classification, the top
performers are the services and computer software & hardware sectors. Clearly, India has
attracted significant overseas investment interest in services. It has been the main
destination for off-shoring of most services as back-office processes, customer interaction
and technical support (UNCTAD, 2007). Indian services have also ventured into other
territories such as reading medical X-rays, analyzing equities, and processing insurance
claims. According to some reports, however, increasing competition is making it more
difficult for Indian firms to attract and keep BPO employees with the necessary skills,
leading to increasing wages and other costs.