TITLE OF THE STUDY:
Impact of Derivative Trading on the Volatility of the Underlying Assets with Special Reference to LKP Securities Limited
INTRODUCTION:
A derivative is a security with a price that is dependent upon or derived from one or more underlying assets. The derivative itself is a contract between two or more parties based upon the asset or assets. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes. Derivative products like futures and options are important instruments of price discovery, portfolio diversification and risk hedging. The current scenario shows that the volatility spillover between spot
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The increasing investments in derivatives have attracted my interest in this area. Through the use of derivative products, it is possible to partially or fully transfer price risks by locking-in asset prices. As the volume of trading is tremendously increasing in derivatives market, this analysis will be of immense help to the investors. Generally, two types of different opinions exist in Derivative Market. One is that derivatives trading increases stock market volatility due to high degree of leverage, low transaction costs and hence increases speculation & destabilizes the market. On the other hand, another thought claims that futures market plays an important role in price discovery, enhances market efficiency and reduces asymmetry information of spot market and has beneficial effect on the underlying cash market. This gives rise to the controversy among the researchers, academicians and investors on the effect of derivatives on the underlying market volatility. The basic need is to understand Different kinds of investors to invest in equity & derivative and to face high risk and get high returns. Company proves to an option for the investors. Studying the performance of investing equity & derivative for few months considering their analysis. To get good return. To know how derivatives can be use for hedging. To know the outcome of Equity and Derivative. How to …show more content…
The perception that futures market can lead to decline in volatility in spot market is common. However, the converse is also true. As a result, the impact of trading derivatives on the volatility of spot market is widely debated and the role of derivatives trading has been the focus of ample recent attention. Increased regulation on derivatives has been put into practice, regardless of the lack of reliable statistical evidence that derivatives trading is associated with change in volatility. However we cannot disregard the benefits of derivatives trading as it plays an important role in price discovery, portfolio diversification and hedging. Some experts in financial markets also hold a view that derivatives markets solely create market efficiency and hence, find no ground for regulation within the financial sector and derivatives trading. There are still disagreements on what role derivatives trading play regarding the stock market volatility. Taking into consideration the above factors there is a need to study the impact of derivatives contracts on Indian market. The focus area of this thesis is to investigate the role of Index futures & Stock futures trading on the volatility of the Indian spot markets. The aim of this study is to bring perspectives to the ongoing debate about the role of derivatives in capital markets. Thus, the main research question of this thesis is:
World Bank International Task Force on Commodity Risk Management in Developing Countries. ¡°Dealing With Commodity Price Volatility In Developing Countries: A Proposal For A Market-Based Approach.¡± Discussion Paper for the Roundtable on Commodity Risk Management in Developing Countries. World Bank. Washington, DC: 24 September 1999.
The behaviour of markets and investors, the decision making in the market place and the dynamics of demand and supply in any given market cannot be determined with a hundred percent accuracy. However master minds in the past have designed various techniques and theories that help investors make a particular buying decision, or to make choices logically. These theories and techniques help today’s investors to peep into the future and make almost immaculate predictions regarding the future behaviour of the market and the ongoing trends. A lay man night view the decision making of an investor as being solely based upon speculation but in reality every move that an investor makes today in the market place is backed up by sound calculation and theories. Two of the most talked about and essential theories or concepts that are related to the market dynamics and that will be discussed at length in this assignment are Efficient Market Theory and Behavioural Finance.
Caterpillar Inc. also faces the risk of its cash flow and earnings being affected by fluctuations in the exchange rates of currency, commodity prices, and interest rates. To control for this, the company’s Risk Management Policy ensures prudent management of interest rates, commodity prices, and exchange rates of foreign currency by allowing the use of derivative financial instruments. According to the policy, the derivative financial instruments are not supposed to be used for the purpose of speculation. In its pricing strategy, Caterpillar Inc. faces the risk of difficult shipping of its products. This risk can be encountered by offering its products on instalments and lease to its loyal customers (Caterpillar, Inc. (CAT), 2011).
The expanding global market has created both staggering wealth for some and the promise of it for others. Business is more competitive than ever before, and every business, financial or product-based, regardless of size or international presence is obligated to operate as efficiently as possible. A major factor in that efficient operation is to take advantage of every opportunity to maximize profits. Many multinational organizations have used derivatives for years in financial risk management activities. These same actions that can protect multinational organizations against interest rate futures and currency fluctuations can be used to create profits for those same organizations.
Margin Call portrays the last night of good times on Wall Street; when a disastrous speculation in the mortgage markets is leading to the firm’s collapse. Its main focus is the actions taken by the employees during the subsequent financial collapse. The movie begins with the first victim Eric Dale, Head of Risk and Management, being fired from his position. On his way out the door, Eric Dale hands a USB drive to Peter Sullivan, a Senior Risk Analyst, who realizes the firm and the market are clearly trembling on the brink. That night, Sullivan finishes Dale's project and discovers that current volatility in the firm's portfolio of mortgage-backed securities will soon exceed the historical volatility levels of the positions. Because of unwarranted leverage, if the firm's assets decrease by 25% in value, the firm will suffer a loss greater than its market capitalization. Will Emerson, Head of Trading is contacted by Peter, Will takes a look to and calls his boss Sam Rogers, Investment Floor Head. Others are called in for an all-night emergency meeting until the CEO John Tuld arrives to make very drastically decisions. After a series of meetings, Jared Cohen, Investment Division Head, proposes to quickly sell all of the toxic assets before the market learns of their worthlessness, thereby limiting the firm's exposure. Although, management colleagues wrestle with the ethical implications of their decisions it is decided to save the company and go along with the fire sale of the toxic assets. Unfortunately, it was also decided that Sarah Robertson, Chief Risk Management Officer, would be used as the scapegoat stating that she did not communicated or warned the executives about the risks on these mortgages on time.
In conclusion, hedging risk with financial derivatives can give firm range of benefits such as lower probability of having financial distress, lower value of debt ratio, and earn tax benefit. It can be concluded that firm should hedge risk using financial derivatives because lot evidence shows that firm using this strategy is more successful than those who are not. However, since different type of companies facing different risks, they should not necessarily use the same hedging strategy.
B) The stylized feature of volatility clustering in financial data cannot be explained using linear models and estimation methods such as OLS. This is because one of the underlying assumptions of OLS is that is a constant and is the basis for measuring volatility. A GARCH(1,1) model is able to model this feature because it estimates a model for , which allows the variance to change over time.
Making business decisions involves choosing between alternative courses of action. Many factors affect business decisions, yet analysis typically focuses on finding the alternative that offers the highest return on investment or the greatest reduction in costs. Some decisions are based on little more than an intuitive understanding of the situation because available information is too limited to allow a more systematic analysis. In other cases, intangible factors such as convenience, prestige, and environmental considerations are more important than strictly quantitative factors. In all situations, managers can reach a sounder decision if they identify the consequences of alternative choices in financial terms. This unit
Machiraju, H. R. , 2002. International Financial Markets And India. 1st ed. New Delhi: New Age International.
The main aim of this paper is to define and explain the theoretical approach that is mainly concerned about the situation of conflict between market players; such approach is often referred to as ‘Game Theory’. This study will focus on critical examination of theoretical and practical implications that are linked with game theory and strategic-decision making process. Economic issues related with applying game theory in the real world environment will also be addressed. Game theory is built on assumptions and observations done by many academics and non-academics in the past but only started to receive an appropriate scholarly attention and were put into economical context in 20th Century. These will be explained in greater detail in the next section.
(Campbell R. Harvey). The value of these derivatives is determined by fluctuations in the underlying asset. Derivatives are traded on exchanges like the CBOE, CME and OTC markets.
...ting in hedging activities in the financial futures market companies are able to reduce the future risk of rising interest rates. By participating in the financial futures market companies are able to trade financial instruments now for a future date (Block & Hirt, 2005).
The data collection of the study is based on the secondary data. The data for the variables (CPI, Exchange rate) were obtained from RBI website. The data for the 5 bank’s monthly share prices (HDFC bank, AXIS Bank, ICICI Bank, IDBI Bank and YES Bank) were obtained from the NSE websites. The data for the study was taken for period of 36 months, which are the most recent 3 years data from 1st January 2009 to 31st December 2011 because to measure the impact of the variables chosen on the banks stock returns, post-recession. The data for all variables is monthly. The studies like Ibrahim (1999), Patra and Poshakwale (2006) and Liow et al. (2006) capture long-term movements in volatility by used monthly returns to avoid spurious correlation problem.
Amaranth made huge bets on the market moving in one direction, the direction of their leveraged bets. Although the fund’s investors would have significant returns if the trades went as planned, this strategy cannot effectively minimize risk. Also, futures contracts that Amaranth engaged in have higher risk than equities because of the leverage given to futures traders. Amaranth was therefore exposed to high level of risks, which will be discussed in the later section. The Amaranth debacle was mainly due to the insufficient risk management steps taken and the incorrect bets on the
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.