CHAPTER – 6

SUMMARY, CONCLUSION AND SUGGESTIONS

6.1 INTRODUCTION

There have been substantial regulatory, structural,

institutional and operational changes in the securities market

during the last decade. These have been carried out with an

objective to improve the market efficiency, enhancing

transparency and checking unfair trade practices. As a result of

the reforms several changes have also taken place in the

operation of securities markets such as automated on-line

trading. It enabled trading terminals of the National Stock

Exchange and Bombay Stock Exchange to be available across

the country and making geographical location of an exchange

irrelevant; reduction in settlement period and opening of the

stock markets to foreign portfolio investors etc. In addition to

these developments, India is perhaps one of the real emerging

markets in South Asia region that has introduced derivatives

products on its two principal existing exchanges, viz. the BSE and

NSE.

To assist market participants to manage risk better through

hedging, speculation and arbitrage, Securities Contracts

(Regulations) Act [SCRA] was amended in 1995. Derivatives

trading commenced in June 2000 in the Indian securities market

on the NSE and BSE. The market, presently, offers index futures

and index options on three indices. Stock options and stock

futures on individual stocks and futures in interest rate products

329

like national 91 day T- Bills and 10 - year bonds are also

available.

6.2 REVIEW OF LITERATURE

The introduction of stock index futures has profoundly

changed the nature of trading on stock exchanges. The concern

over how trading in futures contracts affects the spot market for

underlying assets has been an interesting subject for the

investors, market makers, academicians, exchanges and

regulators alike. Edwards (1988), Harris (1989), Herbst & Maberly

(1992), Jagadeesh & Subrahmanyam (1993), and Antoniou &

Holmes (1995) have brought out that the introduction of stock

index futures has caused an increase in spot market volatility in

the short run, while there is no significant change in volatility in

the long run.

The apparent increase in volatility has been attributed to

increased information flow in the market through the channel of

futures trading. However, the studies undertaken by Schwert

(1999), Bessembinder and Seguin (1992), Kamara et al., (1992),

and Darrat and Rahman (1995) categorically deny any increase

in spot market volatility resulting from the introduction of futures

trading. Though there is still disagreement as to whether futures

trading increases or decreases the volatility of spot prices.

6.3 NEED AND SCOPE OF THE STUDY

Despite the existence of a well-developed stock market for

over a hundred years, trading on derivative contracts in India

(Index Futures) started only in June 2000. It is but natural that

330

the market players took time to understand the intricacies

involved in the operation of these new instruments. This is

clearly reflected in the growth of business in the index futures

contracts during the period of study, i.e., from June 2000 to June

2005. The growth can best be said to be modest not only in

terms of the number of contracts involved but also in terms of

value of such contracts (Gupta, 2003). Since the introduction of

index futures in India is a recent phenomenon, there has hardly

been any attempt to examine the impact of their introduction on

stock market volatility and liquidity.

This study encompassed data on daily prices of two major

stock indices, viz. the S&P CNX Nifty and BSE Sensex. In the case

of NSE, the study has been conducted for a period of five years

from June 2000 to June 2005. On the other hand, in the case of

BSE it is for two years from June 2000 to June 2002.

6.4 OBJECTIVES OF THE STUDY

The objectives of the study are:

(i) To make a comparative analysis of regulatory structure for

stock index futures market in India with developed markets.

(ii) To study the effect of stock index futures on stock market

volatility.

(iii) To analyse the stock market liquidity conditions after

introduction of stock index futures.

(iv) To make suggestions with regard to the working of stock

markets in India.

331

6.5 RESEARCH DESIGN

The data for this study has been collected from the

respective websites of NSE and BSE. At the first stage, regulatory

framework of stock index futures in India has been compared

with that of Australia, Singapore, South Africa and USA on the

basis of ten selected parameters.

At the second stage the volatility condition in the market

has been measured through the use of following measures:

(a) Close-to-close prices

(b) Open-to-open prices

(c) Intra-day volatility

(i) Based upon highest-to-highest prices

(ii) Based upon lowest-to-lowest prices.

In order to test the null hypotheses of equal variance, F-test

has been used to measure the statistical significance of

variances.

At the final stage condition of liquidity has been measured

by using the coefficient of elasticity of trading (CET) ratio. This

new measure is similar to price elasticity measure. The CET has

been computed on the basis of information on prices and

volumes of trading data.

6.6 FINDINGS OF THE STUDY

Following is the summary of results and findings on the

empirical analysis as contained in the chapters third, fourth and

fifth of the present study.

332

6.6.1 Comparison of Regulatory Framework of Stock

Index Futures

Regulatory framework of stock index futures in India,

Australia, Singapore, South Africa and USA has been compared

on the following basis:

(a) Regulatory Body for Stock Index Futures

In India, the SEBI is the highest authority for derivatives

trading also. Being a legislative body there is minimal

interference from the government for operations of stock market.

The SEBI always takes rational decision as per the requirement of

market.

In Australia, Australia Stock Exchange (ASX) is the highest

governing body for derivatives instruments. Index futures in

Australia are similar to popular e-mini futures on the S&P 500

index, the NASDAQ 100 index in the US and the mini FTSE 100

Index Futures in the UK.

In Singapore, Asia Pacific’s first demutualized and

integrated securities and derivatives exchange was established

on 1 Dec. 1999. The Singapore Exchange (SGX) came into force

with the merger of Stock Exchange of Singapore (SES) and

Singapore International Monetary Exchange (SIMEX). In

Singapore now SGX is responsible for working of different

derivatives products including stock index futures.

In South Africa, FTSE/JSE Advisory Committee is authorised

to manage the regulations of stock index futures.

333

Stock index futures in United States of America are jointly

controlled by the New York Stock Exchange, American Stock

Exchange and Chicago Mercantile Exchange with the help of

NASDAQ National Market System.

(b) Underlying Instrument

In India, for the NSE, Nifty serves the purpose of underlying

instrument; and in the case of BSE, it is sensex. So, the value of

stock index futures in India purely depends on the movement of

Nifty and Sensex.

In Australia, contracts are entered over the ASX index, ASX

50 index, and ASX 200 property trusts sector index. Actually, ASX

50 index and ASX 200 index represent around 75 per cent and

90 per cent of total ASX domestic stock market capitalization

respectively.

In Singapore, Morgan Stanley Capital International (MSCI)

Free Index is used as underlying asset for stock index futures.

South Africa Stock Exchange offers a large number of stock

index futures contracts, such as FTSE/JSE Top 40 Index futures,

FTSE/JSE INDI 25 Index Futures, FTSE/JSE FINI 15 Index Futures,

and FTSE/JSE FNDI 30 Index Futures. So, underlying instrument

for above products are their concerned stock index, i.e., FTSE/JSE

Top 40 Index, FTSE/JSE INDI 25 Index, FTSE/JSE FINI 15 Index and

FTSE/JSE FNDI 30 Index.

As Chicago Mercantile Exchange (CME) is pioneer in starting

modern times stock index futures since April 21, 1982, it is now

offering different stock index futures such as CME S&P 500

334

Futures, CME E-Mini S&P 500 futures, CME E-Mini S&P Asia 50

Futures, CME NASDAQ 100 Futures, and CME E-Mini NASDAQ 100

Futures contracts. So, underlying Instruments for the above

contracts are their respective indices for above specific

categories.

(c) Contract Size

In India the market lot size for Nifty futures is 200 or

multiples thereof. On the BSE, contract size is 50 or multiples

thereof.

In Australia, the system for contract size is slightly different.

The dollar value of each ASX Mini Index Futures Contract is based

on a $ 10 per index point multiplier.

In Singapore, the value of one Singapore MSCI Future is

equal to S$200 multiplied by the current index value.

In South Africa, the value or worth of a stock index futures

contract in Rand is the price of contract multiplied by ten. If the

price of the share index futures contract is 5000 then value of

one contract is R50000 (5000 10)

Due to availability of different stock index futures in USA,

the contract size is also different for each contract. In case of

CME S&P 500 Futures contract size is calculated by multiplying

CME S&P 500 Futures price by $250. For small investors CME E-

Mini S&P 500 futures, it is CME E-Mini S&P 500 futures price

multiplied by $50.

335

(d) Maturity Date/Last Trading Day

In Australia, the third Friday of the maturity month,

provided this day is a trading day. And last trading day is the

business day preceding the maturity date.

In India, for the NSE and BSE, the last Thursday of the

maturity month. If the last Thursday is a trading holiday then the

preceding day of maturity date.

In Singapore, last trading day is the second last business

day of the contract month. A business day is defined as a day on

which the Singapore stock market is open for trading.

In South Africa, the last trading day for stock index futures

contract is 3rd Thursday of March, June, September and

December or previous business day if a public holiday falls on 3rd

Thursday. This rule is common for all four major stock index

futures contracts prevalent in South Africa.

In USA, the last trading day is the Thursday prior to the

third Friday of the contract month for CME S&P 500 Futures and

CME NASDAQ 100 Futures. The last trading day is slightly

different in case of CME E-Mini S&P 500 futures, CME E-Mini S&P

Asia 50 Futures, and CME E- Mini NASDAQ-100 Futures. In the

case of these contracts, the last trading day is third Friday of the

contract month and trading can occur up to 8.30 a.m. (Chicago

time).

(e) Trading Cycle

336

The lifetime of each series is, generally, three months

worldwide. At any point of time there are three series open for

trading. It is applicable both in case of NSE and BSE.

In Australia, trading cycle is based on four months basis

such as March/June/September/December cycle. So, trading in

Australia Stock Exchange is based on above four months of the

year.

In Singapore, contract months are two nearest serial

months and four quarterly contract months.

South African market follows the Australian Stock Exchange

(ASX) for trading cycle. As per rules of FTSE/JSE trading in stock

index futures takes places on four months basis that means in

March, June, September and December and this trading cycle is

common for all stock index futures contracts famous in South

Africa. Similarly, in USA contract months are March, June,

September and December for all contracts.

(f) Settlement Basis

In India, for both the NSE and BSE, stock index futures are

marked to market and final settlement will be cash settled on a

(T+1) basis.

All ASX Mini Index Futures remaining open at maturity are

cash settled. This method is used to settle major index futures

contracts internationally including contracts over the S&P 500,

the S&P 100 and Dow Jone Industrial Average in USA and over

the Nikkei 225 and Nikkei 300 in Japan.

337

In Singapore, upon expiry Singapore MSCI Futures will be

cash settled by one last marking-to-market.

Stock index futures contracts are cash settled in South

Africa and USA.

(g) Final Settlement Price

In India, daily settlement price is the closing price of futures

contract for the trading day and the final settlement price shall

be the closing price of the underlying index on the last trading

day. Above rule is applicable both at the NSE and BSE.

In Australia, the settlement price used is the ASX Futures

Opening Price Index Calculation (OPIC). The OPIC is based on the

opening price of each stock in the index on the morning following

the last trading day.

In Singapore, the final settlement price is based on the

average value of the MSCI Singapore Free Index taken at one

minute interval in the last one hour of trading, together with the

closing MSCI Singapore index value on the last trading day,

excluding the highest and lowest values.

In USA, all open positions at the close of the final trading

day are settled in cash to the special opening quotation on Friday

morning of the S & P 500 index for CME S&P 500 Futures and

CME E-Mini S&P 500 Futures contracts. In case of CME E-Mini S&P

Asia 50 Futures and CME NASDAQ 100 Futures are settled in cash

to the special opening quotation on Friday Morning of the S&P

Asia 50 Index and NASDAQ 100 Index respectively.

338

In South Africa, the price at which a share index futures

contract expires shall be the average of the index taken every 60

seconds (100 iterations). The first calculation being at 12:01 and

the last at 13:40 on the expiry date.

(h) Margin Requirements

In Indian capital market, there is a provision of upfront

initial margin on daily basis. Initial margin is the amount required

to open a margin account for trading. And maintenance margin

must be maintained in a margin account.

All futures contracts traded on the ASX are registered,

cleared and settled by ASX’s wholly owned subsidiary Options

Clearing House Pty. Ltd. (OCH). Both buyers and sellers of ASX

Index futures contracts must pay an initial margin which is

determined by OCH according to the volatility of the underlying

index.

In Singapore no full payment equivalent to the contract

value is required upon initiating a futures position, the buyer and

seller must put up a margin deposit with the broker. This initial

margin is set by the SGX and is typically about 5-10 per cent of

the contract value.

FTSE/JSE in South Africa does not specify any margin

requirements in the shape of initial margin, maintenance margin

and variation margin.

In USA, the margin price limits are set on a quarterly basis

and are based on percentages of 5 per cent, 10 per cent, 15 per

cent, and 20 per cent. New limits go into effect at the beginning

339

of each calendar quarter. The percentages (5 per cent, 10 per

cent, 15 per cent and 20 per cent) are based on the average

closing price of the lead month futures contracts in December,

March, June and September.

(i) Pricing/Valuation of Stock Index Futures Contract

Theoretically, fair price of a Stock Index Futures Contract is

derived from the well celebrated cost of carry model.

Accordingly, Stock Index Futures price depends upon (Hull,

2003):

- Spot index value

- Cost of carry or interest rate

- Carry return, i.e., dividend expected on securities

comprising the index.

Mathematically

F = Se (r – y) t

Where,

F = Futures Price

S = Spot value of index

e = Exponential constant with value 2.718

r = cost of carry or interest cost

y = carry return / dividend income

t = Time of maturity in years.

Above model is common for all stock index futures traded

around the globe.

(j) Trading Hours

340

In Australia, normal trading takes place from 6.00 a.m. to

5.00 p.m. and 5.30 p.m. to 8.00 p.m. (Sydeny time). Overseas

trading takes place 8.00 p.m. to 5.30 a.m.

In India, trading hours are different for the NSE and BSE. At

BSE trading takes place between 9.30 a.m. to 3.30 p.m. and at

NSE 9.55 a.m. to 3.30 p.m. As compared to Australian Stock

Exchange, in India there is no separate provision for overseas

participants. ASX operates for stock index futures for 23 hours,

but Indian stock markets are working for just six hours.

In Singapore, trading of stock index futures takes place

between 8.45 a.m. – 12.35 p.m. and 2.00 p.m. – 5.15 p.m. It is

important to note that the timings for underlying stock market

trading are from 9.00 a.m. – 12.30 p.m. and 2.00 p.m. – 5.00

p.m. (Monday-Friday) with a pre-open session from 8.30 a.m. –

9.00 a.m. and a pre-close session from 5.00 p.m. – 5.06 p.m.

Trading hours for all stock index futures contracts are the

same at 13:40 on 3rd Thursday of March, June, September and

December in South Africa.

In USA, for CME E-Mini S&P 500 futures contracts, CME E-

Mini S&P Asia 50 Futures contracts, and CME E-Mini NASDAQ 100

Futures contracts there is virtually 24 hours trading (Chicago

time) on the CME Globex platform (Sundays from 5.00 p.m. to

Friday 3.15 p.m. Daily shutdown for maintenance is 4.30 p.m. –

5.00 p.m.).

6.6.2 Impact of Stock Index Futures on Stock Market

Volatility

341

In this study, two research issues relating index futures

have been studied. First issue is related to the impact of

introduction of stock index futures on the underlying stock

market volatility. Second, a comparison is made of futures

market volatility with spot market volatility. Both these issues

have been studied in relation to the National Stock Exchange and

Bombay Stock Exchange.

6.6.2(1) Volatility Conditions in Market before and after

Introduction of Stock Index Futures

Under this head the volatility conditions in the market have

been studied in two periods, i.e., before introduction of stock

index futures and after introduction of stock index futures. First

period starts from June 1995 to May 2000 (before the start of

trading of stock index futures); and the second from June 2000 to

June 2005 (after the start of trading of stock index futures). The

following measures of volatility have been used to study the

impact of stock index futures on volatility of spot market

volatility:

(a) Open-to-open prices

(b) Intra-day volatility

(i) Based upon lowest prices

(ii) Based upon highest prices.

(c) Close-to-close prices.

6.6.2 (2) National Stock Exchange (NSE)

At NSE security description for stock index futures is

N FUTIDX NIFTY. The underlying instrument is S&P CNX Nifty

342

index. And contract is traded in the size of 200 or multiples

thereof.

To study impact of stock index futures on nifty, two window

periods have been used; first period starts from June 1995 to

May 2000 (before the start of trading of stock index futures) and

the second from June 2000 to June 2005 (after the start of

trading of stock index futures).

6.6.2(3) Bombay Stock Exchange (BSE)

At Bombay Stock Exchange security description for stock

index futures is BSX. And the underlying instrument is BSE 30

Sensex. At BSE, contract is traded in the size of 50 or multiples

thereof.

To study the impact of stock index futures on Sensex, two

window periods have been used. First period starts from June

1998 to May 2000 (before the start of trading of stock index

futures); and the second from June 2000 to June 2002 (after the

start of trading of stock index futures). In the case of BSE, in the

initial years of introduction of stock index futures, the trading

volume was reasonably good. But then thereafter the reverse

trend started, and the volume of stock index futures turnover at

BSE decreased. Due to this reason the study in case of BSE has

been conducted for two years only as after the year 2002 the

volume of stock index futures was negligible for statistical

calculations.

6.6.2 (4) Relative Volatility: Index Futures and Spot

Markets

343

In this section of the study the relative volatility of futures

and spot market in respect of both the indices has been studied.

It helped to find whether index futures are more or less volatile

than the underlying spot index.

Following hypothesis was stated in statistical terms:

HO = (Index Futures) = (Spot index)

HA = (Index Futures) ≠ (Spot index)

6.6.2(5) Results – Impact on Volatility

Chapter-4 aimed at examining the impact of index futures

introduction on stock market volatility. Further, it has also

examined the relative volatility of spot market and futures

market. The study utilized daily price data (high, low, open, and

close) for the BSE Sensex and S&P CNX Nifty Index. Data

pertaining to the period from June 9, 2000 to May 31, 2002 has

been used for the BSE Index Futures, and from June 12, 2000 to

June 30, 2005 for Nifty Index Futures.

The empirical results reported here indicated that the

overall volatility of the underlying stock market has not declined

after the introduction of index futures on both the indices.

Therefore, the null hypotheses Ho(1) and Ho(2) stand

accepted as no change has been observed in the volatility

after introduction of index futures. And the alternative

hypotheses HA(1) and HA(2) thus stand rejected as the

344

volatility of index future was not found to be different

from spot index is rejected.

It must, however, be noted that since the introduction of

index futures the Indian stock market has witnessed several

changes in its market micro structure such as abolition of the

traditional badla system, reduction in trading cycle etc.

Therefore, these results should be interpreted in the light of

these changes. In fact, there is some evidence that the futures

volatility is lower in comparison to the underlying stock market

indices for both the markets.

6.6.3 Impact of Stock Index Futures on Market

Liquidity

In Chapter-5, the impact of Stock Index Futures on Stock

Market liquidity has been studied. Although there are many

techniques to measure the liquidity condition in market, varying

from Bid-Ask Spreads, Market Volumes, Market Capitalization to

Impact Cost, yet none of these techniques recognize the role of

price for liquidity conditions. The solution of this unanswered

problem is Coefficient of Elasticity of Trading (CET). Coefficient of

Elasticity of Trading uses both aspects, i.e., trading volume and

prices to study liquidity position.

6.6.3(1) Impact on Liquidity due to Change in Closing

Price of N FUTIDX NIFTY

(a) Increase in Price and CET > 1

CET >1 explains that price increase is supported by more

than proportionate change in the volume. In all, sixteen months

345

reflected this trend. During these months despite an increasing

trend in prices, the buyers were still buying. It provided more

liquidity to the market.

(b) Decline in Prices and CET >1

This range has explained a new phenomenon, i.e., decline

in prices is supported by more than proportionate change in

volumes. During the period of study, ten months were showing

this trend. As per this range, people were buying more due to

change or decline in prices. This is quite natural that everyone

tries to test his luck in the market when prices are approachable.

Again, the investors/traders were providing more liquidity to the

market.

(c) Increase in Prices and CET<1 (BULL RUN)

This range is denoted by bull run condition in the market,

i.e., when the prices go up the buyers shown little interest in

buying. During the whole period of study, eighteen months

reflected this condition. In these months price increase was

reacted by less than proportionate change in the volumes. This

might be due to the booking of profits in bullish conditions.

(d) Decline in Prices and CET<1 (BEAR HUG)

Bear Hug is a condition which signifies that prices are going

down but buyers are not interested in buying. During the period

of study, sixteen months were found under bear hug. Generally,

due to decline in prices buyers buy more. These trends have

their own impact on the market liquidity.

346

6.6.3 (2)Impact on Liquidity due to Change in the Opening

Price of N-FUTIDX NIFTY

(a) Increase in Prices and CET > 1

From June 2000 to June 2005 seventeen months reflected

this condition. Although human behaviour discourages new

buyings when prices are going up. But this was not in the case of

stock index futures market. This trend provided more liquidity to

market.

(b) Decline in Prices and CET > 1

During the period of study eleven months were reflecting

this situation. As per this trend people were buying more due to

declining prices. This is a natural behaviour of buyers to try their

luck in the market when prices are within their reach. And the

market participants were providing more liquidity to the market.

(c) Increase in Prices and CET < 1 (BULL RUN)

During the period of study, sixteen months were found

under Bull Run situation. In these months increase in prices was

reacted by less than proportionate change in the volume. This

situation may be caused due to the reaction of market

participants, who have booked profits under bull run.

(d) Decline in Prices and CET < 1 (BEAR HUG)

347

During the period of study sixteen months were found

under bear hug. During these particular months decline in prices

is reacted by less than proportionate change in the turnover.

6.6.3 (3) Impact on Liquidity due to Change in Highest

Prices of N FUTIDX NIFTY

(a) Increase in Prices and CET > 1

During the period of study, twenty-one months were

reflecting this situation. It means during these months although

prices were going up but market participants were still buying

more. This provided more depth to the market in the context of

liquidity.

(b) Decline in Prices and CET > 1

From June 2000 to June 2005, this trend was noticed for

twelve months. During these months prices were declining and

market participants showed positive interest towards market.

And it led to more liquidity in the market.

(c) Increase in Prices and CET<1 (BULL RUN)

Throughout the period of study twelve months were found

under bull run condition. In these months price increase was

reacted by less than proportionate change in the volumes.

(d) Decline in Prices and CET <1 (BEAR HUG)

During the period of study fifteen months were found under

bear hug. Generally buyers buy more when prices are declining.

6.6.3(4) Impact on Liquidity due to Change in the Lowest

Prices of N FUTIDX NIFTY

348

(a) Increase in prices and CET>1

During the period of study, twenty-one months reflected

this condition. It means although the prices went up yet market

participants were still buying more. No doubt, human behaviour

discourages to buy more when prices are going up. But it was not

so in the case of stock index futures market. This behaviour

provided more liquidity to the market.

(b) Decline in Prices and CET >1

From June 2000 to June, 2005 eleven months reflected this

situation. During these months market participants were buying

more due to decline in prices as per the human behaviour.

Everyone tries to test his luck in the market when prices are

within reach. Again, it provided more liquidity to the market.

(c) Increase in Prices and CET<1 (BULL RUN)

During the period of study, thirteen months were found

under Bull Run. In these months price increase was responded by

less than proportionate change in the volumes. This situation

might be the result of booking of profits by market participants.

(d) Decline in Prices and CET < 1 (BEAR HUG)

From July 2000 to June 2005, fifteen months were found in

bearish hug. During these particular months decline in prices was

responded by less than proportionate change in the turnovers.

6.6.3(5) Impact on Liquidity due to Change in Closing

Price of BSX

(a) Increase in Prices and CET > 1

349

CET>1 means that price increase is supported by more

than proportionate change in the volume. This trend persisted for

nine months only during the whole period of study. During these

months, despite an increasing trend in prices the buyers were

still buying. It provided more liquidity to the market.

(b) Decline in Prices and CET>1

This range is explaining a new phenomenon, i.e., decline in

prices is supported by more than proportionate change in

volumes. During the period of study, seven months reflected this

trend. As per this range people were buying more due to change

or decline in prices. This is a natural buying behaviour, since one

tries to test one’s luck in the market when prices are

approachable. Again, the investors/traders provided more

liquidity to the market.

(c) Increase in Prices and CET<1 (BULL-RUN)

This range is denoted by bull run condition in the market,

i.e., prices keep to move up but buyers show no interest in

buying. During the whole period of study only two months

reflected this condition. In these months increase in prices was

responded by less than proportionate change in the volumes.

This might be due to the booking of profits in bullish conditions.

(d) Decline in Prices and CET<1 (BEAR HUG)

Bear Hug is a condition which signifies that buyers are not

interested in buying even when the prices keep on declining.

During the period of study, only six months were found under

350

Bear Hug. Generally, due to decline in prices buyers buy more.

These trends have their own impact on the market liquidity.

6.6.3(6) Impact on Liquidity due to Change in Opening

Price of BSX

(a) Increase in Prices and CET > 1

From June 2000 to June 2002 seven months reflected this

condition. Although human behaviour discourages new buyings

when prices are going up, yet this was not in the case of stock

index futures market. This trend provided more liquidity to

market.

(b) Decline in Prices and CET > 1

During the period of study, four months were found to have

this situation. As per this trend people were buying more due to

decline in prices. This is a natural behaviour of buyers to try their

luck in the market when prices are within their reach. And the

market participants provided more liquidity to the market.

(c) Increase in Prices and CET < 1 (BULL RUN)

During the period of study four months were found under

the Bull Run situation. In these months increase in prices was

responded by less than proportionate change in the volumes.

This situation might be caused due to the reaction of market

participants, who booked profits under bull run.

(d) Decline in Prices and CET < 1 (BEAR HUG)

351

During the period of study, nine months were found under

bear hug. During these particular months, decline in prices was

responded by less than proportionate change in the turnover.

6.6.3 (7) Impact on Liquidity due to Change in Highest

Prices of BSX

(a) Increase in Prices and CET > 1

During the period of study eight months were reflecting this

situation. It means during these months although prices were

going up but market participants were still buying more. This

provided more depth to the market in context of liquidity.

(b) Prices Decline and CET > 1

From June 2000 to June 2002, three months showed this

trend. During these months, the prices were declining and the

market participants showed a positive interest towards the

market. And it led to more liquidity in the market.

(c) Increase in Prices and CET<1 (BULL RUN)

During the whole period of study five months were found

under the bull run condition. In these months increase in prices

was responded by less than proportionate change in the

volumes.

(d) Decline in Prices and CET <1 (BEAR HUG)

During the period of study, eight months were found under

bear hug. But generally, as per the buying behaviour the buyers

buy more when prices decline.

352

6.6.3 (8) Impact on Liquidity due to Change in the Lowest

Prices of BSX

(a) Increase in Prices and CET>1

During the whole period of study nine months reflected this

condition. Despite an increase in prices the market participants

were still buying. Generally, human behaviour discourages to buy

more when prices show an upward trend. But this was not so in

the case of stock index futures market. This behaviour provided

more liquidity to the market.

(b) Decline in Prices and CET >1

From June 2000 to June 2002, four months reflected this

situation. During these months the market participants were

buying more due to decline in prices and it was as per the

natural behaviour. Everyone tries to test his luck in the market

when prices are within the reach. This situation provided more

liquidity to the market.

(c) Increase in Prices and CET<1 (BULL RUN)

During the period of study five months were found under

the Bull Run situation. In these months increase in prices was

responded by less than proportionate change in the volumes.

This situation might have arisen due to booking of profits by

market participants.

(d) Decline in Prices and CET < 1 (BEAR HUG)

From July 2000 to June 2002, six months were found in

bearish hug. During these particular months the decline in prices

353

was responded by less than proportionate change in the

turnovers.

6.7 SUGGESTIONS FOR INDIAN SECURITIES MARKET

Although Indian security markets are emerging as an

important destination for investors, there is still a need for

further improvement in varied areas of their operations. As

compared to other developed markets; there are certain aspects

where policy-makers, regulators and other participants of the

market can play an important role. The suggestions for making

Indian securities markets more efficient, are depicted in Figure

6.1.

354

Figure 6.1

Suggestions for making Indian Securities Markets

more Efficient

Legal Operational Risk Risk

Pre-Settlement Custody Risk Risk

Settlement Improvement Risk in Efficiency

Legal Risk

1. Legal Framework: As per the comparative study made in

chapter 3, the settlement system for securities can have a

well founded, clear and transparent legal basis in the

relevant jurisdictions.

355

Pre-Settlement Risk

2. Trade Confirmation: Confirmation of trade between direct

market participants can occur as soon as possible after its

execution, but not later than the trade date (T+0). If

confirmation of trade by indirect market participants (such

as institutional investors) is required, then it should occur

as soon as possible after its execution, preferably on (T+0),

but not later than (T+1).

3. Settlement Cycles: Rolling settlement can be adopted in

all the securities markets. Final settlement should occur not

later than (T+3). The benefits and costs of a settlement

cycle shorter than (T+3) should be evaluated.

4. Central Counter Parties (CCPs): The benefits and costs

of a CCP should be evaluated. Where such a mechanism is

introduced, the CCP can rigorously control the risks it

assumes.

5. Securities Lending: Securities lending and borrowing (or

repurchase agreements and other economically equivalent

transactions) may be encouraged as a method for

expediting the settlement of securities transactions.

Settlement Risk

6. Central Securities Depositories (CSDs): Securities may

be immobilized or dematerialized and transferred by book

entry in CSDs to the greatest extent possible.

356

7. Delivery Versus Payment (DVP): CSDs can eliminate

principal risk by linking securities transfers to funds

transfers in a way that achieves delivery versus payment.

8. Timing of Settlement Finality: Final settlement can

occur not later than the end of settlement day. Intra-day or

real time finality should be provided for where ever

necessary so as to reduce risks.

9. Cash Settlement Assets: Assets used to settle the

ultimate payment obligations arising from securities

transactions may carry little or no credit or liquidity risk.

Efforts must be taken to protect CSD members from

potential losses and liquidity pressures which may arise due

to faulty assets used for that purpose.

Operational Risk

10. Operational Reliability: The sources of operational risk in

the clearing and settlement process can be identified and

minimized through an appropriate system of controls and

procedures. The systems should be reliable and secure.

Contingency plans and back up facilities may be

established to allow timely recovery of operations and

completion of the settlement process.

Custody Risk

11. Protection of Customers Securities: Entities holding

securities in custody may employ accounting practices and

safekeeping procedures that fully protect customers’

357

securities. It is essential that customers’ securities be

protected against the claims of a custodian’s creditors.

Improvement in Efficiency

The following suggestions may be implemented to further

improve efficiency, liquidity and to reduce volatility:

12. Futures contracts on more number of indices can be

introduced.

13. Mini size (smaller value contracts) may be permitted.

14. Efforts may be made to look at margin imposition system

and reduce margins without compromising on the integrity

of the market.

15. Presently, institutional participation appears to be

negligible in the total turnover, therefore, efforts should be

made to enhance their role in derivatives participation.

Other Issues

16. Governance: Governance engagements for CSDs and CCPs

can be designed so as to fulfil public interest requirements

and to promote the objectives of owners and users.

17. Access: CSDs and CCPs may have objective and publicly

disclosed criteria for participation that permit fair and open

access.

18. Efficiency: While maintaining safe and secure operations,

securities settlement systems can be cost effective in

meeting the requirements of users.

358

19. Communication Procedures and Standards: Securities

settlement systems can use or accommodate the relevant

international communication procedures and standards in

order to facilitate efficient settlement of cross border

transactions.

20. Transparency: CSDs and CCPs may provide market

participants with sufficient information so as to enable the

participants to identify and evaluate accurately the risks

and costs associated with using the services provided by

them.

21. Regulation and Oversight: Securities settlement

systems may be subject to transparent and effective

regulation and oversight. There should be cooperation

between central banks, securities regulators and other

concerned authorities.

22. Risks in Cross Border Links: CSDs that establish links to

settle cross border trades may design and operate such

links to reduce effectively the risks associated with cross

border settlements.

6.8 RECOMMENDATIONS FOR FUTURE RESEARCH

The research is not a destination, it is a continuous journey.

The basic purpose of research is to contribute to the existing pool

of knowledge. The present study has been done in the

introductory years of derivatives products in Indian stock

markets. The following list enumerates some topics that have

359

been identified for further research pertaining to subject-matter

related to the present study:

(i) A comparative study of regulatory structure for stock

futures, stock options, interest rate options and other

derivatives products can be undertaken.

(ii) This study evaluated the effect of stock index futures on

stock market volatility, which can be further extended

for stock future, stock options, interest rate options and

other derivatives products.

(iii) It would be quite interesting to assess the CET across

different derivatives products. The true potential of CET

for analysis can be judged when such measurement is

done at individual scrip level.

(iv) This study specifically excluded financial derivatives and

commodity derivatives. Therefore, an industry specific

study can also be carried out.

360