A Study on Derivative Market in India

International Journal of Engineering and Management Research e-ISSN: 2250-0758 | p-ISSN: 2394-6962
Volume-12, Issue-3 (June 2022)
www.ijemr.net https://doi.org/10.31033/ijemr.12.3.13
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A Study on Derivative Market in India
Dr. Cirappa I B1
and Tejashwini K C2
1
Associate Professor, Department of Studies and Research in Commerce, Davangere University, Shivagangothri, Davangere,
INDIA
2
Research Scholar, Department of Studies and Research in Commerce, Davangere University, Shivagangothri, Davangere,
INDIA
1
Corresponding Author: tejashwinikc8@gmail.com
ABSTRACT
Since 1991, thanks to economic policy liberalization,
the Indian economy has entered an era in which Indian
businesses can no longer disregard global markets. Prior to
the 1990s, the prices of a variety of commodities, metals, and
other assets were carefully regulated. Others, which were not
rolled, were primarily dependant on regulated input costs. As
a result, there was no uncertainty and, as a result, no price
fluctuations. However, in 1991, when the process of
deregulation began, the prices of most items were
deregulated. It has also resulted in the exchange being
partially deregulated, easing trade restrictions, lowering
interest rates, and making significant advancements in
foreign institutional investors' access to the capital markets,
as well as establishing market-based government securities
pricing, among other things. Furthermore, portfolio and
securities price volatility and instability were influenced by
market-determined exchange rates and interest rates. As a
result, hedging strategies employing a variety of derivatives
were exposed to a variety of risks. The Indian capital market
will be examined in this study, with a focus on derivatives.
Keywords-- Derivatives, Capital Market, Futures, Options
I. INTRODUCTION
Long-term loans with a maturity of more than a
year should be sought out in the capital market. The capital
markets are stock exchanges that provide funding by
issuing shares or common stock in the primary market and
allowing subsequent trading in the secondary market.
Bond Markets, which provide finance through the primary
market's issuance of bonds and subsequent secondary
market trading, are also included in Capital Markets. The
financial system of any country is a complex system that
includes financial institutions such as banks, non-banking
financial companies (NBFCs), regulators, and products,
among other things. The Indian financial system can be
classified into two categories: banking and allied services
institutions and regulators, and financial market
institutions and regulators. The banking sector includes the
Reserve Bank of India, Public Sector Banks, Private Sector
Banks, Cooperative Banks, and Foreign Banks. NBFCs
and organizations such as LIC, GIC, and others play a key
role in the financial sector. During the previous decade, the
globalization and liberalization wave has swept the globe,
resulting in enormous growth in international trade and
business. As a result, there has been a significant increase
in global demand for international money and financial
products. In this regard, changes in interest rates, exchange
rates, and stock market prices on various financial markets
have increased the financial risks to the corporate world.
Unfavorable changes have taken place. Even the business
world's survival was in peril. New financial instruments,
sometimes known as financial derivatives, have been
established in the financial markets to deal with such risks.
The primary purpose of these instruments is to give price
commitments for future dates in order to protect against
future price variations and so reduce the severity of
financial risks. Not only that, but they also provide profit
opportunities for those ready to take more risks. To put it
another way, these tools make it simpler to shift risk from
those who wish to avoid it to those who are willing to
accept it.
II. REVIEW OF LITERATURE
Ravichandran, (2008)1
Investor preferences for various
capital market investment strategies were explored, with a
focus on derivatives. According to the survey, even for
experts, investing in the markets is a significant challenge
in the current environment. Derivatives are a valuable tool
for minimizing the risk of stock market investing and
attaining the best results. According to the paper, investors
should be aware of the various hedging and speculation
strategies that can be used to mitigate risk. Investors who
understand the multiple uses of derivatives can reduce risk
and increase profits.
Talati and Sanghvi (2010)2
An attempt was made to
determine investor awareness and perceptions of hedge
funds as an investment channel, with a focus on Gujarat. It
was observed that there was limited awareness of hedge
funds in the study area. The investors were uninformed of
the advantages of participating in hedge funds, as well as
the fundamentals of how hedge funds operate. Gujarati

investors preferred to invest in government securities and
nationalized bank fixed deposits because they knew their
money would be safe, even if the profits were lower.
Tripathi (2014)3
The impact of derivative trading on
investor perceptions was explored. Indian investors,
according to the survey, prefer to invest in real estate and
insurance because they are high-yielding and low-risk
investments. It was determined that over 75% of investors
are aware of derivatives, with 74% having made a
derivatives investment. The most common users are those
who invest 10% – 20% of their overall investment in
derivatives, followed by those who invest 20% – 35% of
their whole investment in derivatives. 76 percent of
derivatives users have put their money into options that
offer risk diversification and significant returns for a small
investment. Men account for 72 percent of the derivative
market, while women account for only 28 percent,
according to the poll. He discovered that education, career,
and gender have no impact on derivative investing
behaviour during his investigation. Income, on the other
hand, has been proven to have a significant impact in
derivatives. According to him, investors employ these
assets for a variety of purposes, such as risk management,
profit improvement, speculation, and arbitrage.
III. OBJECTIVES OF THE STUDY
1. To look at the history of India's capital market.
2. The goal of this research is to assess the Indian
derivatives market's performance.
3. To look into the elements that drive derivative market
growth.
IV. RESEARCH METHODOLOGY
Always be sceptical of the information provided
by sources, especially if the information was gathered for a
specific purpose or to address a specific issue.
Furthermore, many secondary sources do not clearly
describe issues such as the study's purpose, data collection,
analysis, and interpretation, making it difficult for the
researcher to assess their significance. To solve this
challenge, I attempted to triangulate secondary data by
utilizing a variety of sources.
Research Journals, Trade Magazines, Bank
Annual Reports, and the Internet are used to obtain
information for the problem. While researching, Evolution
of Derivatives and Import and Factors, I focused on as
much recent material as possible. I kept up with the latest
developments in this subject by reading papers published
in academic journals and trade magazines. I also used
secondary data from online discussion forums.
Furthermore, as opposed to agriculture or manufacturing,
today's economic success of any country is heavily based
on the service sector. The future economy's backbone is
now services. India has previously set the path for
revolution in the industrial and agricultural sectors, and it
is now legalizing financial futures trading. India has the
infrastructure and capability to trade a wide range of
financial futures, such as stock market indices, Treasury
bills, gilt-edged securities, foreign currencies, cost of
living indexes, and stock market indexes, among others.
India's financial derivatives market has enormous growth
potential due to all of these factors.
V. EVOLUTION OF DERIVATIVE
MARKET IN INDIA
India has gone from a controlled economy to a
world where prices fluctuate on a daily basis. Risk
management methods have gained popularity in India in
recent years as a result of the liberalization process and the
Reserve Bank of India's (RBI) efforts to build a currency
forward market. Derivatives are a key component of the
liberalization process for risk management. The NSE
began the process of establishing a derivatives market in
India after examining the market's needs. In India,
derivatives trading began in July 1999.
Table 1: Represents the Evolution of Trading in India
Year Description
14th
December 1995 The NSE requested authorization from the SEBI to trade index futures.
18th
November 1996
The L.C. Gupta Committee was established by SEBI to design a policy framework
for index futures.
11th
May 1998 The report of the L.C. Gupta Committee was submitted.
7th
July 1999 The Reserve Bank of India (RBI) has approved the use of OTC forward rates.
24th
May 2000 For futures and options trading on an Indian index, SIMEX chose Nifty.
25th
May 2000 NSE and BSE were given permission by SEBI to trade index futures.
9th
June 2000 The trading of BSE sensex futures began on the BSE.
12th
June 2000 Nifty futures trading began on the NSE.
31st
August 2000 At SIMEX, futures and options on the Nifty was traded for the first time.
June 2001 At the NSE, you can trade equity index options.

July 2001 At the NSE, you can trade stock options.
NSE – 9th
November 2002 BSE offers single futures trading.
June 2003 Interest rate futures are traded on the NSE.
13th
September 2004 BSE offers weekly options.
1st
January 2008 BSE trades the Chhota (Mini) Sensex.
1st
January 2008 At the BSE, you can trade mini index futures and options.
NSE – 29th
August, 2008
Futures at NSE
Currency exchange trading started
BSE – 2nd
October, 2008
Futures at BSE
Currency exchange trading started
VI. CONCEPT OF DERIVATIVES
The term "derivative" refers to something that is
derived from something else. The underlying asset may be
a commodity or a financial asset, and its value is
determined by a variety of factors. When it comes to
financial derivatives, we can claim that they are extremely
complex items that don't have any inherent worth. The
value of derivatives goods is usually determined by
changes in the value of other derivatives products, known
as the Underlying, which can be anything from stock
prices to interest rates to snowfall and commodity prices.
The value of a derivative changes when the value of the
underlying changes, therefore without the underlying, the
derivative has no value. In the sense that they safeguard
investors against various financial risks, derivatives are
analogous to insurance products. Financial derivatives are
described as "a security produced from a debt instrument,
share, loan, whether secured or unsecured, risk instrument,
contract for differences, or any other kind of security,"
according to the Securities Contract Regulation Act of
1996. “A contract whose value is determined by the prices,
or an index of prices, of underlying securities.” Derivative
products first appeared on the market a few years ago, and
they serve as a hedge against price fluctuations in various
items. Although a variety of derivatives products have
been available in the market for centuries, real derivatives
trading did not begin until the 1970s. Financial contracts
whose value is related to the value of an underlying asset
are known as derivatives. They are sophisticated financial
instruments used for a variety of purposes, including
hedging and gaining access to new assets or markets. The
majority of derivatives are traded over-the-counter (OTC)
(OTC). Some transactions, like as options and futures, are,
however, traded on specialist exchanges. The CME Group
(Chicago Mercantile Exchange and Chicago Board of
Trade), the Korea Exchange, and Eurex are the three
largest derivatives exchanges.
Derivatives are a type of financial instrument that
has been around for a long time. The first futures contracts,
for example, may be traced back to Mesopotamia in the
second millennium BC. However, until the 1970s, the
financial instrument was not frequently employed. The
introduction of new valuation techniques propelled the
derivatives market's rapid growth.
VII. PROS OF DERIVATIVES MARKET
Derivatives, unsurprisingly, have a big impact on
modern finance because they give financial markets a lot
of benefits:
1. The contracts are typically used for hedging risks
because the value of the derivatives is tied to the
value of the underlying asset. An investor, for
example, might buy a derivative contract whose
value moves in the opposite direction of the value
of an asset he or she owns. Profits from the
derivative contract may be used to cover losses in
the underlying asset.
2. The price of the underlying asset is typically
determined via derivatives. Futures spot prices,
for example, can be used to approximate the price
of a commodity.
3. Derivatives are thought to improve the efficiency
of financial markets. One can imitate the payout
of assets by using derivative contracts. To avoid
arbitrage opportunities, the prices of the
underlying asset and the corresponding derivative
tend to be in equilibrium.
4. Derivatives can help businesses gain access to
assets or markets that might otherwise be
unavailable. Interest rate swaps allow a
corporation to get a better interest rate than it
could get from direct borrowing.
VIII. CONS OF DERIVATIVES MARKET
Despite the benefits that derivatives bring to the
financial markets, they also have some substantial
disadvantages. During the Global Financial Crisis of 2007-
2008, the flaws had severe effects. Financial institutions
and securities all around the world have collapsed due to
the fast devaluation of mortgage-backed securities and
credit-default swaps.

1. Derivatives' extreme volatility exposes them to
potentially massive losses. The complex
architecture of the contracts makes valuing them
extremely difficult, if not impossible. As a result,
they are exposed to a high level of risk.
2. Derivatives are often seen as speculative
instruments. Unreasonable speculation can result
in significant losses due to the inherently
dangerous nature of derivatives and their
unpredictable behaviour.
3. Although derivatives traded on exchanges often
go through a thorough due diligence procedure,
some over-the-counter contracts may not have a
due diligence baseline. As a result, there's a
chance of a counter-party default.
IX. CLASSIFICATION OF
DERIVATIVES
Cotton and pepper are examples of commodity
derivatives, while financial derivatives include stocks, and
foreign exchange is the most common sort of derivative in
the world. Futures, swaps, forwards, puts, calls, swap
options, and index-linked derivatives are the eight sub-
categories of financial derivatives. Different types of
derivatives are available to investors and traders, and they
are detailed in depth below.
X. FORWARDS AND FUTURES
These are financial contracts that bind the
contract's buyers to buy an asset at a pre-determined price
on a pre-determined date in the future. The nature of both
forwards and futures is roughly the same.
Forwards, on the other hand, are more flexible
contracts because the parties can specify the underlying
commodity, as well as the amount and transaction date.
Futures, on the other hand, are standardized contracts
exchanged on exchanges.
SWAPS
Swaps are derivative contracts that allow two
parties to exchange cash flows. Swaps often entail the
replacement of a fixed cash flow with a floating cash flow.
Interest rate swaps, commodity swaps, and currency swaps
are the most common types of swaps.
OPTIONS
The buyer of the contracts is given the option to
buy or sell the underlying asset at a specified price, but not
the responsibility to do so. The buyer can exercise the
option on the maturity date (European options) or any date

before the maturity date, depending on the option type
(American options).
XI. FINDINGS AND DISCUSSIONS
The economic policy liberalization since 1991,
the Indian economy has entered an era in which Indian
businesses can no longer ignore global markets. Prior to
the 1990s, many commodities, metals, and other assets
were subject to price controls. Others that were not
implemented relied primarily on regulated input pricing.
As a result, there was less uncertainty and hence less price
fluctuation. However, after 1991, when the deregulation
process began, most goods prices were deregulated. It has
also resulted in partial deregulation of exchange rates, the
abolition of trade regulations, interest rate reductions,
significant reforms for foreign institutional investors'
capital market access, and the implementation of market-
based pricing of government assets, among other things.
All of these measures have exacerbated price volatility in
India for a variety of commodities and services, affecting
both producers and consumers. Furthermore, portfolio and
securities price volatility and instability were influenced by
market-determined exchange rates and interest rates. As a
result, hedging strategies employing a variety of
derivatives were exposed to a variety of risks.
Futures trading provides a risk-reduction
mechanism to farmers, producers, exporters, importers,
investors, bankers, traders, and others, which is vital for
any country. According to Alan Greenspan, Chairman of
the US Federal Reserve Board, “the diversity of derivative
products generated in recent years has increased economic
efficiency.”
These contracts have the economic function of
reconfiguring previously integrated risks and transferring
them to those who are most willing to assume and manage
each risk component. The creation of futures markets in
many countries has contributed significantly to the balance
of payments in terms of invisible gains through fees and
other costs paid by foreigners for using the markets.
XII. CONCLUSION
A derivative product, or simply 'derivative,' must
be distinguished from the underlying cash asset. A cash
asset is an asset that is purchased or sold in the cash
market on traditional delivery conditions. As a result, the
term "derivative" means "without intrinsic value." It
denotes that its value is entirely derived from the value of
the cash asset. The first important thing to remember about
derivatives is that they are forward or futures contracts,
which are contracts for delivery and payment at a future
date. They are typically used to facilitate the hedging of
the price risk of a cash asset. In the market, they're known
as 'Risk Management Tools.' Futures trading in
commodities began in India in the 1950s, however there
was a dramatic drop in futures trading in the 1960s.
Exchanges were shut down one by one, owing to price
increases in a variety of commodities tied to speculation on
these exchanges.
As a result, the Central Government issued a
notification outlawing derivatives trading in 1969. India's
futures markets made a big resurgence in the late 1990s,
compelling the Central Government to relax the ban on
futures trading in October 1999. The Indian Pepper and
Spice Trade Association was granted permission in 1996
to turn its Pepper Futures Exchange into an International
Pepper Exchange, and the Civil Supplies Ministry agreed
in principle to enable futures trading in Basmati rice. The
importance of derivatives in India's capital market was
proven in this study.
REFERENCES
[1] Ravichandran, K. (2008). A study on Investors
Preferences towards various investment avenues in capital
market with special reference to derivatives. Journal of
Contemporary Research in Management, 3(3).
[2] Bharati, Pathak. (2008). Indian financial systems.
Delhi: Pearson Education, pp. 42-45.
[3] Susan, Thomas (ed). (2003). Derivative markets in
India. New Delhi: Tata McGraw-Hill, pp. 45-67.
[4] Reforms in Secondary Markets in India, Working
paper from National stock exchange (NSE), India.
(2000).
[5] Mohammed Rubani. (2017). A study on derivatives
market in India. International Journal of Business
Administration and Management, 7(1).
[6] John C. Hull. (2004). Introduction to futures and
options market. New Delhi: Prentice Hall of India, pp.
295-97.
[7] L. C, Gupta. (Chairman) et al. (1997-1998). Report of
the committee on regulatory framework for derivatives
trading, SEBI.
[8] T.V., Somanathan. (2000). Derivatives. New Delhi:
Tata McGraw-Hill, pp. 238-239.
[9]
https://corporatefinanceinstitute.com/resources/knowledge/
trading-investing/derivatives/.

A Study on Derivative Market in India

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