Lakshmi Mittal

ArcelorMittal, CEO
Aditya Mittal 
UNIT - III
 FINANCIAL MARKETS AND GOVERNMENT POLICIES
• By 1990, the term “globalization” had become
a catch-phrase (slogan) to describe the
phenomenon (occurrence) of an increasingly
integrated and interdependent world
economy that exhibited free flow of goods,
services and capital.
• After more than four decades of heavy
regulation and low rate of economic growth,
Indian government opened the economy in
1991 to market forces and promoted
modernisation of financial institutions.
• For four decades (nearly) after Independence,
India had the followed a development strategy
based on extensive government direction.
• This includes broad public ownership of
commercial enterprises, government approval
for new investment by large private companies,
substantial protection against imports, strict
limitations on foreign investment and a
government policy framework that posed
obstacles to the development of capital
markets.
• Most finance for investment projects was sourced
through banks, which were heavily administered by the
government.
• Financial Markets were constrained (controlled) by five
particular government policies:

1. The government controlled almost all of the banking

system.
2. The insurance and pension fund industry was government-
owned.
3. Nearly all interest rates were set by the government.
4. Banks had to meet high reserve requirements.
5. Listing by private firms in the capital markets needed
government approval on new capital issues.
 ROLE OF CAPITAL MARKET
IN
ECONOMIC DEVELOPMENT
• Increased efficiency in the financial sector is
expected to direct financial resources into the
sectors where the productivity is the maximum.
Thus, in turn, is expected to increase the rate of
economic growth.
• Faster economic growth is then expected to
reduce poverty.
• The govt. policies have moved a substantial
distance over the past few years towards free
markets for goods and finance.
• Countries with better policies have
significantly faster rates of economic growth.
Improvements in capital markets would
provide movement to growth.
 CAPITAL MARKET INSTITUTIONS
• For the smooth functioning of the capital
market a proper coordination among the
organizations and segments is a prerequisite.
• In order to regulate, promote and direct the
progress of the Indian Capital Market, the
government has set up 'Securities and
Exchange Board of India' (SEBI) in 1992. SEBI
is the supreme authority governing and
regulating the Capital Market of India.
• Since its creation, SEBI has sought to improve
the structure and functioning of stock exchanges
and ensure disclosure and investor protection.
• It has grown rapidly from an initial staff of 10 to
a current capacity of more than 150.
• The functions entrusted to the Board under the
Act include protection of the interest of investors
and regulating the business in stock exchanges
and other securities markets, regulating the
working of stock broker and intermediaries
associated with the securities markets,
Registering and
regulating the Foreign
Institutional Investors,
Venture Capital Funds,
Mutual Funds as well as
keeping a check on
fraudulent and unfair
trade practices and
insider trading in
securities.
 BOMBAY STOCK EXCHANGE
• The Bombay Stock Exchange, the oldest stock
exchange in India, was founded in 1875. one of
the leading exchanges in the country.

• Twenty two other stock exchanges also operates

in India. There are some 7,000 listed stocks, 7,000
brokers who are members of the 23 exchanges
along with an estimated 1,00,000 sub-brokers
who interface with investors, a million active
traders, and perhaps 20 million citizens who hold
equities in some form, usually a mutual fund.
• Despite its long history and large number of
listed stocks, the equity market has had major
problems also.
84 years (August 30, 1930)
NATIONAL STOCK EXCHANGE (NSE)
• The NSE was established in 1994 as a
competitor to the Bombay Stock Exchange
(BSE).
• NSE was backed by major financial institutions,
led by IDBI. The exchange introduced
nationwide screen-based trading with a dish-
to-satellite data transmission system that
provides instant trading access to brokers any
where in India.
• It spent more than $100 million in developing
its system, which now has immediate access
through more than 1,500 locations throughout
the country.
• NSE inspired the BSE and other exchanges to
adopt computerized systems and reform
trading rules and procedures.
• BSE shifted from an “open outcry” trading
system to a screen-based system, making
major investments in equipment, and revised
its own procedures to provide transparency
for investors.
NATIONAL STOCK EXCHANGE (NSE)
• The NSE was established in 1994 as a
competitor to the Bombay Stock Exchange
(BSE).
• NSE was backed by major financial institutions,
led by IDBI. The exchange introduced
nationwide screen-based trading with a dish-
to-satellite data transmission system that
provides instant trading access to brokers
anywhere in India.
 NATIONAL STOCK EXCHANGE (NSE)
• The National Stock Exchange (NSE) operates a
nation-wide, electronic market, offering trading in
Capital Market, Derivatives Market and Currency
Derivatives segments including equities, equities
based derivatives, Currency futures and options,
equity based ETFs, Gold ETF and Retail
Government Securities.
• Today NSE network stretches to more than 1,500
locations in the country and supports more than 2,
30,000 terminals.
 NATIONAL SECURITIES DEPOSITORY LIMITED
(NSDL)

• In mid-1996, NSE began guaranteeing

execution of trades through a new clearing
corporation. This removed a major risk that
had always been in the past and forced BSE to
respond with improved clearance procedures.
• In late 1996, the NSDL was inaugurated.
Which provides a means by which securities
trading takes place using electronic channels.
• NSDL, the first and largest depository in India,
established in August 1996. which follows
international standards that handles most of
the securities held and settled in
dematerialised form in the Indian capital
market.
• Using innovative and flexible technology systems, NSDL
works to support the investors and brokers in the
capital market of the country.
• NSDL aims at ensuring the safety and soundness of
Indian marketplaces by developing settlement solutions
that increase efficiency, minimises risk and reduce
costs.
• At NSDL, they play central role in developing products
and services that will continue to nurture the growing
needs of the financial services industry.
• In the depository system, securities are held in
depository accounts, which is more or less similar to
holding funds in bank accounts.
• Transfer of ownership of securities is done through
simple account transfers. This method does away
with all the risks and hassles normally associated
with paperwork.
• Consequently, the cost of transacting in a depository
environment is considerably lower as compared to
transacting in certificates.
FOREIGN INSTITUTIONAL INVESTORS (FIIs)

• DEFINITION of 'Foreign Institutional

Investors - FIIs' An investor or investment fund
that is from or registered in a country outside of
the one in which it is
currently investing. Institutional investors include
hedge funds, insurance companies, pension funds
and mutual funds.
• Hedge Funds are most often set up as private
investment partnerships that are open to a limited
number of investors and require a very large initial
minimum investment. Investments in Hedge
Funds are illiquid as they often require investors keep
their money in the fund for at least one year.

• 'Pension Fund' A fund established by an employer to

facilitate and organize the investment of employees'
retirement funds contributed by the employer and
employees.
• Since 1993, foreign Institutional Investors (FIIs) have
began to take an active interest in the Indian capital
market.
• There are a total of over 500 registered FIIs, though
most of them are small. About 20 large foreign
investors are present in the market, including firms
such as Merrill Lynch, Jardine Fleming, Pioneer,
Lehman Brothers and Hong Kong Shanghai Bank.
• The number has grown gradually as the experience of
the pioneers convinced others that the Indian market
did provide an opportunity for placing capital with
prospects of profitable investment.
STOCK INDICES
 STOCK INDICES
• An index is a number that represents the changes in
a set of values between a base time period and
another time period.
• Similarly, a stock index represents change in the
value of a set of stocks, which constitute the index,
over a base year.
• Sensex and Nifty are the two major stock indices of
India.
• Just as the thermometer measures temperature of
a person, a stock index determines whether the
market is cold or feverish.
• This enables the investors to know the market
trend and direction in which it is moving. Two
main objectives of stock indices are:
1. To reflect market direction
2. To indicate day to day fluctuations in the
prices of scrips.

• The utility of a stock market index lies in a

positive relationship with returns to different
securities.
• The BSE-Sensex consists of 30 selected
stocks and the Nifty consists of 50
selected stocks.
• Most of these companies are blue chip
companies having a very good track
record. As they are actively traded, the
index shares have a very high liquidity.
• Blue Chip A nationally recognized, well-
established and financially sound company.
Blue chips generally sell high-quality, widely
accepted products and services. Blue chip
companies are known to weather downturns
and operate profitably in the face of adverse
economic conditions, which helps to contribute
to their long record of stable and reliable
growth.
• A stock market index is created by selecting a
group of stocks that represent the whole
market or a specified sector or segment of the
market. As index is calculated with reference
to a base period and a base index value.
• Stock market indices are useful for a variety of
reasons. Some of them are:
1. They provide a historical comparison of
returns on money invested in the stock
market against other forms of investments
such as gold or debt.
2. They can be used as a standard against which
to compare the performance of an equity
fund.
3. It is the lead indicator of the performance of
the overall economy or a sector of the
economy.
4. Stock indices reflect highly up-to-date
information.
5. Modern financial applications, such as Index
Funds, Index Futures and Index Options, play
an important role in financial investments and
risk management.
BSE SENSEX AND OTHER INDEX NUMBERS
BSE SENSEX AND OTHER INDEX NUMBERS

• The BSE-Sensitive Index is a “market

capitalization-weighted” index of 30 stocks
representing a sample of large, well-
established and financially sound companies.
The BSE-SENSEX is the benchmark index of the
Indian capital markets with wide acceptance
among individual investors, institutional
investors, foreign investors and fund
managers.
 OBJECTIVES OF THE INDEX
1. To measure the market movement: Given its
long history and wise acceptance, no other index
matches the BSE-SENSEX in reflecting market
movements and sentiments. SENSEX is widely
used to describe the
mood in the Indian Stock Markets.
2. Benchmark for Funds Performance: The
inclusion of blue chip companies and balanced
industry representation in the SENSEX makes it
the ideal benchmark for FUND MANAGERS to
compare the performance of their funds.
3. For Index-based Derivative Products:
Institutional investors, money managers and
small investors all refer to the BSE-SENSEX for
their specific purpose. The BSE-SENSEX is in
effect proxy for the Indian Stock Markets. The
country’s first derivative product i.e., Index-
Futures was launched on BSE-SENSEX.
CRITERIA FOR SELECTION OF SCRIPS IN SENSEX
• The eligibility criteria to be included in the
SENSEX can be specified as follows:
1. Market Capitalization: The scrip should figure
in the top 100 companies listed by market
capitalization. Also market capitalization of
each scrip should be more than 0.5% of the
total market capitalization of the Index i.e., the
minimum weight should be 0.5%.
 Market Capitalization
• Definition: Market capitalization is the aggregate
valuation of the company based on its current share
price and the total number of outstanding stocks.
• Description: Market capitalization is one of the
most important characteristics that helps the
investor determine the returns and the risk in the
share. It also helps the investors choose the stock
that can meet their risk and diversification criterion.
• For instance, a company has 2 Crores
outstanding shares and the current market price
of each share is Rs100.
• Then Market capitalization of this company will
be 200,00,000 x 100=Rs 200 crore.
• Stocks of companies are of three types. The
stocks with a market cap of Rs 10,000 crore or
more are large cap stocks. Company stocks
with a market cap between Rs 2 crore and 10
crore are mid cap stocks and those less than
Rs 2 crore market cap are small cap stocks.
2. Liquidity and Trading Frequency: The scrip
should have been traded on each and every
trading day for the last one year. Exceptions can
be made for extreme reasons like scrip
suspension and so on.
3. Number of Trades: The scrip should be among
the top 150 companies listed by average
number of trades per day for the last one year.
4. Value of shares traded: The scrip should be
among the 150 companies listed average value
of shares traded per day for the last one year.
5. Trading Activity: The average number of shares
traded per day as a percentage of the total number
of outstanding shares of the company should be
grater than 0.05% for the last one year.
Whenever the composition of the index is changed,
the continuity of historical series of index values is
re-established by correlating the value of the
revised index to the old index (index before
revision).
scrip selection would take into account a balanced
representation of the listed companies in the BSE.
The index companies should be leaders in their
industry group.
 SENSEX MOVEMENT

• SENSEX has crossed 12,000 mark in March –

April 2006, which was then considered to be
the peek point.
• BSE SENSEX had witnessed more than 100%
return during 2004-07, over a period of 3
years. SENSEX crossed 20,000 mark in 2007.
• Sensex hits 29000: Thank falling oil prices not
Modi govt policies
 CALCULATION OF SENSEX
• SENSEX is calculated using a “Market
Capitalization – weighted” methodology. As
per this system the level of index at any point
time reflect the total market value of 30
component stocks relative to be base period.
• The base period of SENSEX is 1978-79.
• The actual total market value of the stock in
the index during the base period has been set
equal to an indexed value of 100.
• This is often indicated by the notation 1978-79 =
100. the closing SENSEX is computed taking the
weighted average of all the trades on SENSEX
constituents in the last 15 minutes of the trading
session.
• If a SENSEX constituent (component) has not traded in
the last 15 minutes, the last traded price is taken for
computation of the index closure.

• The use of the Index closure Algorithm

{An algorithm (pronounced AL-go-rith-um) is a
procedure or formula for solving a problem.} prevents
any intentional manipulation of the closing index value.
 NIFTY
• NIFTY is being considered as an indicator of stock
price movements, like SENSEX in India. NIFTY is
being considered as an indicator of stock price
movement, like SENSEX, NIFTY also having base
value 1,000 in the year 1995, was in the range of
2000-2500 in the year 2004-05.
• NIFTY’s value was in the range of 1300-2000
during 2000-04. it has witnessed bullish trend in
value and crosses the 4,500 market in 2007. The
average return from NIFTY has been
approximately 80%-100% during 2004-07.
• In 2015 it crossed 8,000 mark recently in the
month of Jan, 2015.
• The main features of Nifty are:
1. The total traded value of all Nifty stock is
approximately 62% of the traded value of all
the stock (82 approx.) on the NSE.
2. Nifty represents about 45% of the total market
capitalization.
3. Ideal for derivatives trading.
• People analyze the NIFTY fluctuations and
consider it as a barometer of the corporate
sector’s performance.
• Whenever the demand for the stocks of major
organizations listed at increases, the NIFTY
value also increase proportionately. It could be
due to demand by investors in India or Foreign
Institutional Investors.
• It is generally believed that the share market
become bullish and the economy is said to be
in good mood if NIFTY crosses 4,000, otherwise
it is bearish.
 CRITERIA FOR SELECTION OF COMPANIES INCLUDED IN NIFTY

1. MARKET CAPITALIZATION: All companies to

be included in the INDEX should have a
market capitalization of Rs.5 billion or more.
(one billion is equalent 1,000,000,000 = one
hundred crores). All selected securities bear
a weight in the index in proportion of their
market capitalization.
2. LIQUIDITY: For inclusion in the index, the
security should have traded for 85% of the
trading days at an impact cost of less than
1.5%.
• Impact Cost: it is defined as the cost of
executing a transaction in a security in
proportion to the weightage of its market
capitalization as against the index market
capitalization at any point of time.
3. Base date and Value: The base period selected
for S&P CNX NIFTY INDEX is the close of prices
on November 3, 1995, which marks the
completion of one year of operations of NSE’s
Capital Market Segment.
• The base value of the index was set at 1000
and a base capital of Rs.2.06 trillion.
 DEFINITION OF 'STANDARD AND POOR'S CNX NIFTY'
• A stock index endorsed by Standard & Poor's and composed of
50 of the largest and most liquid stocks found on the National
Stock Exchange (NSE) of India. It is commonly used to represent
the market for benchmarking Indian investments.
• Similar to other major stock indexes like the S&P 500,
companies must meet certain requirements in terms of market
capitalization and liquidity before they can be considered for
inclusion in the index. 

• CNX stands for the Credit Rating Information Services of India

Limited (CRISIL) and the National Stock Exchange of India (NSE).
These two bodies own and manage the index within a joint
venture called the India Index Services and Products Ltd. (IISL).
Without the additional abbreviation to S&P CNX, the index
name would be S&P CRISIL NSE Index.
OTHER NSE INDICES

• CNX NIFTY JUNIOR

• S&P CNX 500
• CNX MIDCAP 200
DERIVATIVES
MARKET
Derivative is . . . .

A Derivative is a Financial Instrument whose

value depends on – is derived from – the value
of some other financial instrument, called the
underlying asset.

The value of derivative is linked to risk or volatility in

Either financial asset, transaction, market rate, or
contingency, and creates a product
 Case 1

• Suppose You require Gold in March, 2015

• The Current Price (Jan.2015)of Gold is Rs
27,900 per 10 gram.
• You are of the fear that by the March the
price of Gold will reach Rs 28,500.
• You approach to Goldsmith who offer you to
buy Gold in March @Rs 28,100 from him.
 Case 1 contd..
• Here the Price is determined today i. e (for
January Future Delivery in March).
• So from the Current price of Gold we have
derived the price of March. It is called
Derivative.
• Here Derivative is Gold March Contact.
 Case -2
• Suppose there are two Companies A & B
• A is Indian Importer and B is USA based Exporter.
• A import some goods worth US $ 1 Million from B on Credit.
• Payment will be made after 90 days.
• Since Payments are to be made after a period of time
i. e after 3 months, Currency price might fluctuate by that
time.
• Due to these fluctuation in Exchange Rate( US $/Rs)
Importer might have to pay more in terms of Rupees.
 Derivative- Concept
• To derive something from something.
• A product whose price depends upon the
underlying Assets.
• A Contract which does not have any
Independent value, its value is derived from
the other( underlying Asset)
• The Underlying assets can be Commodity,
Financial Assets, Currency, Interest Rate
bearing Security, Index etc.
• Derivatives are meant essentially to facilitate
temporarily HEDGING of price risk of inventory
holding or a financial/commercial transaction
over a certain period.
• Risk in trading derivatives may change
depending on what happens to the underlying
asset.
• Derivative Securities are available as follows:
 DEFINITION OF 'HEDGE’
• Making an investment to reduce the risk of
adverse price movements in an asset.
Normally, a hedge consists of taking an
offsetting position in a related security, such as
a futures contract.
 Foreign Exchange
Agricultural
Rate
Commodities
Interest Rates

Stocks Underlying Assets Bonds

T-Bill
Crude Oil
Precious Metals
• The derivatives market performs a number of
economic functions like:

Helps in managing risks

Helps in the discovery of future prices
Increases the volume traded in markets because
of participation of risk unwilling people in greater
numbers
Increases savings and investment in the long run
The derivative can be divided as follows:-
 COMPONENTS OF A DERIVATIVES EXCHANGE:

• A derivatives exchange is made up of four

components like product, trading mechanism,
clearing facility, and settlement procedure.
 PRODUCT
• Derivatives exchange trade products like future
and options. An example of such a product
could be a stock futures contract on an index,
or option on a security or option on a
commodity.
• All aspects of the traded contract would need
to be specified, including the expiration date,
date of making delivery and the quantity of the
goods which will be delivered.
 TRADING

• A derivatives exchange needs a trading

system. The trading takes place in anonymity
(secrecy), where individuals all across the
country have equal access to the trading floor.
Therefore, prices are transparent.
 CLEARING
• Trading on a derivatives exchange takes place
anonymously which means that the buyer
does not know the identity of the seller, and
vice versa.
• This would only be feasible if credit risks were
eliminated. This is done through innovation at
the clearing corporation.
 SETTLEMENT

• The derivatives can involve the exchange of

funds and goods. The derivatives exchange has
established smooth procedures for
settlement.
• The participants in a derivatives market are of
three types.

 Hedgers
Speculators
Arbitrageurs
 Advantages of derivatives
over Equity Trading
• The financial derivative instruments futures and options
have the following advantages.
 derivatives can be uses as convenient substitute for
other investments, leaving risks and rewards unchanged.
Derivatives can be used to hedge the risk and can help
manage the risks inherent in a business.
Derivatives can used speculatively to increase risk and
reward through leverage (control).
Derivatives are also the basis for modern financial
engineering.
 Futures
• The FUTURES on stock index futures and
individual stocks can be traded as derivatives
instruments, the former is more popular
(STOCK INDEX).
• The details of futures are:
 Equity or Stock Futures
• Equity futures is a contact to buy (long) or
Sell (Short) the Equity/ Stock of a particular
company at a organized stock/ derivative
exchange.
• Example:-
– RIL, ABB, Dabur, ACC etc. Futures contact traded
at NSE F&O segment for three month category i.e.
1 month, 2 month, 3 months
 Index futures or stock Index Futures
• In case of index futures the underlying assets
is not a single stock but a Market Index that
consists of group of stocks. These contracts
are based on the stock market indices.
• Example: S& P 500 futures traded at NYSE,
Nifty Futures at NSE ( India), Nikki 225 at
Tokyo Stock Exchange, Bank Nifty at NSE, CNX
at NSE, CNX 100 at NSE.
 Product Specifications BSE-30 Sensex Futures

• Contract Size/multiplier - 50
• Expiry day - last Thursday of the month
• Settlement basis - cash settled
• Contract cycle - 3 months
• Active contracts - 3 nearest months
 Product Specifications
S&P CNX Nifty Futures

• Contract Size/multiplier – 200

• Expiry day - last Thursday of the month
• Settlement basis - cash settled
• Contract cycle - 3 months
• Active contracts - 3 nearest months
 SETTLEMENT OF INDEX FUTURES
• Index based derivatives worldwide are cash
settled i.e., settlement of these trades takes
place only through the settlement of the
difference in the buy/sell price and final
settlement price of the contract.
• They are designated as cash-settled
derivatives contract.
 OPTIONS
• An option is the right, but not the obligation,
to buy or sell something at a stated date at a
stated price.

• Options are the standardized financial

contracts that allows the buyer (holder) of the
options, i.e. the right at the cost of option
premium, not the obligation, to buy or sell a
specified asset at a set price on or before a
specified date through exchanges.
 Important Terminology
in Option Contract
• Option Buyer: The person or the Party who buy the option contract.
• Option Writer: Also known as option seller, the person or party who
gives right to other party to buy or sell the underlying asset.
• Call Option: Right to buy the Underlying asset .
• Put option: Right to sell the underlying asset.
• Exercise price or Strike Price: the Price at which option will be
exercised is known as Strike Price
• Option Price: Also known as Option Premium, it is the amount which
the option Buyer pay to the Option Seller for buying the option
contract. It is paid at the time of entering into contract.
• Spot Price: Current price prevailing at a particular time in the Market is
known as Spot price.
• Specified date: The date on which option can
be exercised is called Specified date or
maturity date or expiration date.

Styles of OPTIONS:
• European Style option: The option that can
be exercised only at the expiration date is
called European Option.
• American Style Option: The option that can
be exercised at any time up to and including
expiration date is called American Option.
 Call Options
• A call option gives the holder (buyer/ one who is long
call), the right to buy specified quantity of the
underlying asset at the strike price on or before
expiration date.

• The seller (one who is short call) however, has the

obligation to sell the underlying asset if the buyer of
the call option decides to exercise his option to buy.

• Example: An investor buys One America call option

on Infosys at the strike price of Rs. 3500 at a
premium of Rs. 100. If the market price of Infosys on
any day before of expiry is more than Rs. 3500, the
option will be exercised.
 Put Options
• A Put option gives the holder (buyer/ one who
is long Put), the right to sell specified quantity
of the underlying asset at the strike price on or
before an expiry date.
• The seller of the put option (one who is short
Put) however, has the obligation to buy the
underlying asset at the strike price if the buyer
decides to exercise his option to sell.
• Right to sell is called a Put Option.
 For Call Option
• In- the –Money Option : A option is said to be
In- the –money, when the underlying stock
price is greater than the strike price. (S>k).
• At-the –Money: A option is said to be In- the –
money, when the underlying stock price is equal
to the Strike price. (S=k).
• Out-of –Money:- A option is said to be In- the –
money, when the underlying stock price is less
than the strike price. (S<k).
 For Put Option
• In- the –Money Option : A option is said to be
In- the –money, when the underlying stock
price is less than the strike price. (S<k).
• At-the –Money: A option is said to be In- the –
money, when the underlying stock price is equal
to the Strike price. (S=k).
• Out-of –Money:- A option is said to be In- the –
money, when the underlying stock price is
greater than the strike price. (S>k).