Perception of Investors towards Derivative Market with Special Reference to Indore District

Integration in the world’s commodity and financial market because of globalization and liberalization of the countries across the world, various types of risks for market players have increased viz. Market Risks, Interest Rate Risk, Foreign Exchange Risk, Inflation Risk etc. successful management of such type of risks have become major issue for market players and business houses. This has increased the scope of Financial Engineering-the application of financial derivatives to manage risk.

INTRODUCTION

 
Integration in the world’s commodity and financial market because of globalization and liberalization of the countries across the world. Various types of risks for market players have increased viz.  Market Risks, Interest Rate Risk, Foreign Exchange Risk, Inflation Risk etc.  Due to successful management of such type of risks have become major issue for market players and business houses. This has increased the scope of Financial Engineering-the application of financial derivatives to manage risk.
Today, in India the most of the index and equity derivative business is concentrated in the NSE, which accounts for almost 100% of the equity derivative business. The growth of the equity derivative business in India has been an unprecedented one.                                                 
With a start of average daily volume of Rs.10 crores has developed into a business opportunity of around Rs.30,000 crores per day. This volume of trade is more than 100 times gross domestic product of India.
If we look onto the figures of market turnover in the Stock market, almost 80% of turnover in Nifty is dedicated to derivative trading and remaining 20% is for cash market. This alarming increase in the derivative trading have alarmed the researchers to find out the reasons for such increase and to the way the market players are using derivatives in their trade.

LITERATURE REVIEW

The researchers all over the world have done research on derivative trading and were able to find out various facts about derivative and its trading. In this literature review efforts have been done to bring into the picture the research done about various issues throughout the world by the researchers. The literature review on the various issues is as follows:


 
Derivative as Risk Management Tool
•    Bose, Suchismita conducted research on “The Indian Derivatives Market Revisited” in the year 2006. They found that Derivatives products provide certain important economic benefits such as risk management or redistribution of risk away from risk-averse investors towards those more willing and able to bear risk. Derivatives also help price discovery, i.e. the process of determining the price level for any asset based on supply and demand. These functions of derivatives help in efficient capital allocation in the economy; at the same time their misuse also poses a threat to the stability of the financial sector and the overall economy.
Liquidity
•    Routledge, Bryan and Zin, Stanley E of Carnegie Mellon University conducted research on “Model Uncertainty and Liquidity” in year 2001.  Extreme market outcomes are often followed by a lack of liquidity and a lack of trade. This market collapse seems particularly acute for markets where traders rely heavily on a specific empirical model such as in derivative markets. In this paper we capture model-uncertainty explicitly using an Epstein-Wang (1994) uncertainty-averse utility function with an ambiguous underlying asset-returns distribution. To explore the connection of uncertainty with liquidity, we specify a simple market where a monopolist financial intermediary makes a market for a proprietary derivative security. The market-maker chooses bid and ask prices for the derivative, then, conditional on trade in this market, chooses an optimal portfolio and consumption. We explore how uncertainty can increase the bid-ask spread and, hence, reduces liquidity. In addition, "hedge portfolios" for the market-maker, an important component to understanding spreads, can look very different from those implied by a model without uncertainty. Our infinite-horizon example produces short, dramatic decreases in liquidity even though the underlying environment is stationary.
 Spot Future Relationship
•    Dheeraj Mishra, R Kannan and Sangeeta D Mishra (2006), tried to find out the spot - future parity relationship in case of index futures in the Indian stock market. NSE Nifty has been chosen as underlying asset. It also aims at exploring different factors responsible for the violation of spot-future parity relationship. It was found that there exists a theoretical relationship between spot, futures and other relevant variables as dividend yield, maturity etc. the paper also aimed at finding out whether there exists an arbitrage profit due to violation of spot future. It was found that arbitrage profits are higher for far month future contracts than for near month future contracts. Arbitrage profits are more for undervalued future markets than overvalued future markets.
Volatility in the Market due to Derivative Trading
•    Sen Shankar Som and Ghosh Santanu Kumar (2006) studied the relationship between stock market liquidity and volatility and risk. The paper also deals with time series data by applying “Cochrane Orchutt two step procedures”. An effort has been made to establish a relation between liquidity and volatility in this paper. It has been found that here is a statistically significant negative relationship between risk and stock market liquidity. Finally it is concluded that there is no significant relationship between liquidity and trading activity in terms of turnover.
 

 
Trading Volume of Stocks and Open Interest
•    Shenbagraman (2004) reviewed the role of some non-price variables such as open interests, trading volume and other factors, in the stock option market for determining the price of underlying shares in cash market. The study covered stock option contracts for four months from Nov. 2002 to Feb. 2003 consisting 77 trading days. The study concluded that net open interest of stock option is one of the significant variables in determining future spot price of underlying share. The results clearly indicated that open interest based predictors are statistically more significant than volume based predictors in Indian context. The following exhibit gives the snapshot view of the results of studies on volatility effect of Stock Index Futures.
FII Trading
•    All the existing studies found that the Equity return has a significant and positive impact on the FII (Agarwal, 1997; Chakrabarti, 2001; and Trivedi & Nair, 2003). But given the huge volume of  investments, foreign investors could play a role of market makers and book their profits i.e., they can buy financial assets when the prices are declining thereby jacking-up the asset prices and sell when the asset prices are increasing (Gordon & Gupta, 2003). Hence, there is a possibility of bi-directional relationship between FII and the equity returns.
International Market and its Impact on Indian Derivative Market
•    Masih AM, Masih R, Quarterly Review of Economics and Finance, 2007, Volume: 37, Page: 859-885, “Global Stock Futures: A Diagnostic Analysis of a Selected Emerging and Developed Markets with Special Reference to India”, Tools used:  correlation coefficients , granger’s causality test, augmented Dicky Fuller test (ADF), Elliott, Rothenberg and Stock point optimal test. The Authors, through this paper, have tried to find out what kind of relationship exists between emerging and developed futures markets of selected countries.

Arbitrage Opportunities in Derivative Market

•    Kumar Dr. R. & Chandra Abhijeet, “Individual Investor’s Sentiments and Asset Pricing”
June2000. Individuals often invest in securities based on approximate rule of thumb, not strictly in tune with market conditions. Their emotions drive their trading behavior, which in turn drives asset (stock) prices. Investors fall prey to their own mistakes and sometimes other’s mistakes, referred to as herd behavior. Markets are efficient, increasingly proving a theoretical concept as in practice they hardly move efficiently. The purely rational approach is being subsumed by a broader approach based upon the trading sentiments of investors. The present paper documents the role of emotional biases towards investment (or disinvestment) decisions of individuals, which in turn force stock prices to move.
 





 
Broker’s awareness/ investors awareness
•    Srivastava Sandeep, Yadav Surendra S, Jain P K, “Derivative Trading in Indian Stock Market: Brokers Perception”, September, 2008, Volume 20, Number 3 Review
The  authors  conducted  a  survey  of  brokers  in  the  recently  introduced  derivatives markets  in  India  to  examine  the  brokers'  assessment  of  market  activity  and  their  perception  of  the  benefits  and  costs  of  derivative  trading.  The  need  for  such  a  study  was  felt  as  previous  studies  relating  to  the  impact  of  derivative  securities  on  the  Indian  stock  market  do  not  cover  the  perception  of  market  participants  who  form  an  integral  part  of  the  functioning  of  derivative  markets.  The  issues  covered  in  the  survey  included: a)  perception  of  brokers  about  the  attractiveness  of  different  derivative  securities  for  clients;  b)  profile  of  clients  dealing  in  derivative  securities;  c)  popularity  of  a  particular  derivative  security  out  of  the  total  set;  d)  different  purposes  for  which  the  clients  are  using  these  securities  in  order  of  preference;  e)  issues  concerning  derivative  trading;  f)  reasons  for  non usage  of  derivatives  by  some  investors  and  g)pricing,  liquidity  and  informational  efficiency  of  the  derivative  market. Derivative  securities  have  penetrated  the  Indian  stock  market  and  it  emerged  that  investors  are  using  these  securities  for  different purposes, namely,  risk  management, profit  enhancement,  speculation  and  arbitrage.  High  net  worth  individuals  and  proprietary  traders  account  for  a  large  proportion  of  broker  turnover.  Interestingly, some  retail  participation  was  also  witnessed  despite  the  fact  that  these  securities  are  considered  largely  beyond  the  reach  of  retail  investors  (because  of  complexity  and  relatively  high  initial  investment). Further,  there  is  a  need  to  popularize  option  instruments  because  they  may  prove  to  be  a  useful  medium  for  enhancing  retail  participation  in  the  derivative  market.
Transactions
•    Naresh Gopal, University of Madras, “Views of the Market Participants on Trading, Regulations in the Derivatives Market”, Indian Institute of Capital Markets 9th Capital Markets Conference Paper, January 25, 2006, The dynamic growth of the Derivatives market, particularly Futures & Options and the perceived risks to the financial sector, continue to stimulate debate on the proper regulation of these instruments. Even though this market was initially fuelled by various expert teams survey, regulatory framework, recommendations byelaws and rules there is still a debate on the existing regulations such as why is regulation needed? When and where regulation needed? What are reasonable and attainable goals of these regulations? Therefore this article critically examines the views of market participants on the existing regulatory issues in trading Derivative securities in Indian capital market conditions.
Future pricing
Refet S. Gurkaynak , Bilkent University, Justin Wolfers University of Pennsylvania, Macroeconomic Derivatives: “An Initial Analysis of Market-Based Macro Forecasts, Uncertainty and Risk”, January 2006, Federal Reserve Bank of San Francisco Working Paper No. 2005-26, In September 2002, a new market in Economic Derivatives was launched allowing traders to take positions on future values of several macroeconomic data releases. We provide an initial analysis of the prices of these options. We find that market-based measures of expectations are similar to survey-based forecasts although the market-based measures somewhat more accurately predict financial market responses to surprises in data.


These markets also provide implied probabilities of the full range of specific outcomes, allowing us to measure uncertainty, assess its driving forces, and compare this measure of uncertainty with the dispersion of point-estimates among individual forecasters (a measure of disagreement). Few of the behavioral anomalies present in surveys of professional forecasts survive in equilibrium, and that these markets are remarkably well calibrated. Finally we assess the role of risk, finding little evidence that risk-aversion drives a wedge between market prices and probabilities in this market.
OBJECTIVES OF THE  STUDY
To analyze the Perception of investors towards derivative market with special reference to Indore district.
RESEARCH METHODOLOGY
Questionnaire method of sampling is used to collect the data from 50 respondents who are the clients of various broking houses of Indore. Percentage analysis & Z test Tools used for analysis.
ANALYSIS AND INTERPRETATION OF DATA
Part A
Most of the respondents (44%) are of the age group 31-40.Majority of the respondents (65%) are male. Most of the respondents (38%) are graduates followed by Post graduates. Most of the respondents (29%) are entrepreneurs and Working Executives. most of the respondents (38%) are having an Income level of 1- 5alcs followed by respondents having income level 5-10 lacs.
Most of the respondents (40%) are influenced by friends and relatives followed by brokers.
Most of the respondents (49%) said that News Papers and Financial Experts help them to minimize their risk. Most of the respondents (29%) invest in stock index future followed by stock index option.

CONCLUSION
After going through the Study of investor perception for investment in derivatives market, some worthful results were found out in the light of awareness. In this study derivative market is dominated by male investor with an age group of 31-40.
Investor rejected that they are not affected by spot market movement and even excess return does not affect their decision of investment in derivatives. In study the factor “broker feel problem in providing suggestions about derivative trading” but it was found that they are interested in providing suggestions about derivative trading.
In the study, it was found that derivatives are used as risk Hedging tool and the trend of the spot market affects the trading of Derivatives. But an interesting fact to note down here is that around 80 % of out of the overall amount invested is in derivative market and rest in the cash market. It clearly signifies that the most of the amount is for speculation and not for hedging.
In study, investor perception about derivative is influenced by the popularity of stock and also affected by the trading of FII and movement in International market.  Most of them (43%) invested about 5-10% of their income on investments and only 9% invested more than 20% of their income on investments. Respondents perceived that Market Risk and Credit risk are the two major risk observed in capital markets.

LIMITATIONS OF THE STUDY
•    The nature of the market is dynamic so as a result the perception of the investors may keep on varying.
•    Sample size of the research has been restricted to 50 and in Indore district only.
•    This research is focused on the investors perception towards Equity and Index Derivative Market only.
•    Lack of awareness- the awareness about Investment in Derivative Market is not up to the mark among investor and thus it is very difficult to communicate.











BIBLIOGRAPHY/WEBLIOGRAPHY
•    B.Prasanna Kumar, M.V. Supriya, “S&P CNX Nifty Futures at NSE, India: An Empirical Analysis”, Asia-Pacific Business Review, Vol. 3, No. 1, pp. 67-90, January-June 2007.
•    Bhatia Shalini, “Do the S&P CNX Nifty Index And Nifty Futures Really Lead/Lag?” NSE research paper, November, 2007.
•    Chaturvedula Chakrapani Venkata IBS Hyderabad, “Price Effects of Introduction of Derivatives: Evidence from India”, The Icfai University Journal of Applied Economics, Vol. VII, No. 5, pp. 59-75, September 2008.

•    Hull John.C., “Options, Futures and others Derivative”, Sixth Edition and Third Impression 2007


•    Masih A.M., Masih R, “Global Stock Futures: A Diagnostic Analysis of a Selected Emerging and Developed Markets with Special Reference to India”, Quarterly Review of Economics and Finance, 2007, Volume: 37, Page: 859-885

•    Rakshit Debdas, Chartterjee Chanchal, “Accounting for Financial Derivatives: An Overview”, The     Icfai Journal of Accounting Research, Vol. 7, No. 1, pp. 24-35, January 2008.
•    Rao Ramana, “Impact of Financial Derivative Products on Spot Market Volatility: A Study on   Nifty”, T.A. Pai Management Institute, Icfai Journal of Derivatives Markets, Vol. IV, No. 1, pp. 7-16, January 2007
•    Sarkar Asani, “Indian Derivatives Market”, The OXFORD companion to economics in India, 2006.
 
•    http://www.bseindia.com
•    http://www.elsevier.com/locate/joep

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