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Chapter-4 NSE (National Stock Exchange of India) Cash and F&O Markets

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Page 1: Chapter-4 NSE (National Stock Exchange of India) Cash and ...shodhganga.inflibnet.ac.in/bitstream/10603/89942/13/13chapter 4.pdf · Chapter-4 NSE (National Stock Exchange of India)

Chapter-4

NSE (National Stock Exchange of India)

Cash and F&O Markets

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Chapter- 4 NSE (National Stock Exchange of India) Cash and F&O Markets

4.1 Background of NSE

Capital market reforms in India have outstlipped the process of liberalization in

most other sectors of the economy. However, the creation of an independent capital

market regulator was the initiation of this reform process. After the formation of the

Securities Market regulator, the Securities and Exchange Board of India (SEBI), attention

were drawn towards the ineiTiciencies of the bourses and the need was felt for better

regulation, discipline and accountability. A Committee recommended the creation of a

2nd stock exchange in Mumbai called the "NariOlw/ Srock Exchange". The Committee

suggested the fonnation of an exchange, which would provide investors across the

country a single, screen based trading platform. operated through a VSAT network.

It was on this recommendation that setting up of NSE as a technology driven

exchange was conceptualized. NSE has set up its trading system as a nation-wide, fully

automated screen based trading system. It has written for itself the mandate to create a

world-class exchange and use it as an instrument of change for the industry as a whole

through competitive pressure. NSE was incorporated in 1992 and was given recognition

as a stock exchange in April 1993. It started operations in June 1994. with trading on the

Wholesale Debt Market Segment. Subsequently it launched the Capital Market Segment

in November 1994 as a trading platform for equities and the Futures and Options

Segment in June 2000 for various derivative instruments.

NSE was set up with the objectives of:

• Establishing a nationwide trading facility for all types of securities;

• Ensuring equal access to investors all over the country through an appropriate

communication network;

• Providing a fair, efficient and transparent securities market USlllg electronic

trading system;

• Enabling shorter settlement cycles and book entry settlements; and

• Meeting international benchmarks and standards.

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NSE has been able to take the stock market to the doorsteps of the investors. The

technology has been harnessed to deliver the services to the investors across the country

at the cheapest possiblc cost. It provides a nation-wide. screen-based, automated trading

system, with a high degree of transparency and equal access to investors irrespective of

geographical location. The high level of information dissemination through on-line

system has helped in integrating retail investors on a nation-wide basis. The standards set

by the exchange in terms of market practices, products, technology and service standards

have become industry benchmarks and are being replicated by other market participants.

Within a very shol1 span of timc. NSE has been able to achieve all the objectives

for which it was set up. It has been playing a leading role as a change agent in

transforming the Indian Capital Markets to its present form. The Indian Capital Markets

are a far cry from what they used to be a decade ago in terms of market practices.

infrastructure, technology, risk management, clearing and scttlement and investor service.

Table-4.1 Chronological Establishmcnt of the NSE

Event Dale Elapsed timc (lears)

Idea. first proposed June 1991 0

Decision to build market NovcllliJf'r 1992 1.4

M,mageria Iteam in pbct, J.ll1llalY 1993 1.6

Market design re.Jllicd May 1993 1.9

Regulatory clearances ubtaincd DCCl'llliJer 19'13 2 -.:>

Firstintcnnediaryenrolled l,lIludry 1 f)9-l 2.6

Stdrt of trading November 1994 3,4

Takeoff NovemlX'r 199.5 -1.-1

4.2 Market Segments of NSE

NSE provides an electronic trading platform for of all types of securities for

investors under one roof - Equity. Corporate Debt. Central and State Government

Securities. T-Bills, Commercial Papers (CPs), Certificate of Deposits (CDs). Warrants,

Mutual Funds (MFs) units, Exchange Traded Funds (ETFs). Derivatives like Index

Futures, Index Options, Stock Futures. Stock Options, Futures on Interest Rates etc.,

107

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which makes it one of the few exchanges in the world providing trading facility for all

types of securities on a single exchange. The Exchange provides trading in 3 different

segments viz., Wholesale Debt Market (WDM) segment. Capital Market (CM) segment

and the Futures & Options (F&O) segment. Details of all three segments are as below.

Market Segments

I. Wholesale Debt Market segment:

The Wholesale Debt Market segment provides the trading platform for

trading of a wide range of debt securities, which includes State and Central

Government securities, T-Bills, PSU Bonds, Corporate Debentures, CPs, CDs etc.

However, along with these financial instruments, NSE has also launched various

products e.g. FIMMDA-NSE MIBIDfMIBOR owing to the market need. A

reference rate is said to be an accurate measure of the market price. In the fixed

income market. it is the interest rate that the market respects and closely matches.

In response to this, NSE started computing and disseminating the NSE Mumbai

Inter-bank Bid Rate (MIBID) and NSE Mumbai Inter-Bank Offer Rate (MIBOR).

Owing to the robust methodology of computation of these rates and its extensive

use, this product has become very popular among the market pal1icipants.

Keeping in mind the requirements of the banking industry, Fls, MFs, insurance

companies, who have substantial investments in sovereign papers, NSE also

started the dissemination of its yet another product. the 'Zero COUpOIl Yield

Curve'. This helps in valuation of sovereign securities across all maturities

irrespective of its liquidity in the market. The increased activity in the government

securities market in India and simultaneous emergence of MFs (Gilt MFs) had

given rise to the need for a well-defined bond index to measure the returns in the

bond market. NSE constructed such an index the, 'NSE Government Securities

Index'. This index provides a benchmark for portfolio management by various

investment managers and gilt funds.

II. Tbe Capital Market segment

The Capital Market segment offers a fully automated screen based trading

system. known as the National Exchange for Automated Trading (NEAT) system.

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l

d

This operates on a price/time priolity basis and enables members from aeross the

country to trade with enom10US ease and efficiency. Various types of securities

e.g. equity shares, warrants, debentures etc. are traded on this system. The average

daily turnover in the CM Segment of the Exchange during 2006-07 was nearly Rs.

15.036 crores.

III. Futures & Options segment

Futures & Options segment of NSE provides trading in derivatives

instruments like Index Futures. Index Options, Stock Options, Stock Futures and

Futures on interest rates. Though only four years into its' operations. the futures

and options segment of NSE has made a mark for itself globally. In the Futures

and Options segment, trading in Nifty and CNX IT index and 203 single stocks

are availablc. W.c.f. June 1 2007, futures and options would be available on 213

single stocks. The average daily turnover in the F&O Segment of the Exchange

during 2006-07 was nearly Rs. 45.000 crores.

£:\1

\\1 )\1

l·&()

TOlal

Table- 4.2 NSE Market segments details

No. of "~::>11~~~n'~,.Market ~Icmbcrs <:.:::~~;:' Securities/ , ,: ~~'~lia,lisation

~.-;:~~t.:.:;.;:.!.-: .•. :.'.-IT~.·.;-: Contracts :~il'jl~J{Jl~- crorc) ~ ;;;;~:<k. - Available qrljil~~J~f;:.'

1,01.12

(1.1

X~S

t,OOI)<.I

3252

U,U41 h

3,.1(7):'()

1,7~.\.R')1

-l'ratling Volume

(Rs.'ttQrc) nn:

1.()4:\2K~

219,10()

9,52U,r'(I-l

+l(),2h'J

~O,2('.;;

IJ)~"7,6U:1

2,18.\,1,\1) --~---------

(:_xclullc;, :".u;'l)Clllkd ~Turitie~.

Inclll~k~ .) ~ifty !ufun:.., .. l (::":X IT FUlurt.'~ •. ) bank nifty, 334 nifty inde" opli(lIl~,4()2 ~I()ck tUlUrt._~, .;(10 (:~X IT "Plj\fll~ ,4:")B bank indl:'i. !'\lIions, 11,-1.1.11.-' "r()(k upli()f) and t8- illtnc;-.{ r.I!C r\lrllrC~ (ontf,lCl:-.

lndudc:, nlJ(iUll.l1 IUfI1U\C! [(SlriJ..<.' Price + Pn:millm) X (2lunlily1 in C.1~1.' of ind\.'x oplillll:' :\nd :.tDck "I)\i,m~.

DC) n,)\ .\d~1 up III lulal bec.w:.c of multip!.: Il1l'mhlTShip,

The year 2006-07 witnessed a total trading volume of Rs. 9,520,664 crore (US $

2.184,140 million) as against Rs. 6.869,332 crore (US $ 1,575,896 million) in the

preceding year.

109

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4.3 NSE Cash Market

The National Stock Exchange commenced its operations in 1994 as a first step in

reforming the securitics market through improved technology and introduction of best

practices in management. It started with the concept of an independent governing body

without any broker representation thus ensuring that the operators' interests were not

allowed to dominate the governance of the exchange. Before the NSE was set up. trading

on the stock exchanges in India used to take place through open outcry without use of

information technology for immediate matching or recording of tradcs.

This was time consuming and inefficient. The practice of physical trading

imposed limits on trading volumes as well as, the speed with which new information was

incorporated into prices. To obviate this, the NSE introduced Screen Based Trading

System (SBTS) where a member can punch into the computer the quantities of shares and

the prices at which he wants to transact. The transaction is executed as soon as the quote

punched by a trading member finds a matching sale or buys quote from counter-party.

SBTS electronically matches the buyer and seller in an order-driven system or finds the

customer the best price available in a quote-driven system, and hence cuts down on time,

cost and risk of error as well as on the chances of fraud. SBTS enables distant

participants to trade with each other, improving the liquidity of the markets. The high

speed with which trades are executed and the large number of participants who can trade

simultaneously allows faster incorporation of price-sensitive information into prevailing

prices. This increases the informational efficiency of markets. With SBTS, it becomes

possible for market participants to see the full market, which helps to make the market

more transparent, leading to increased investor confidence. The NSE started nation-wide

SBTS, which have provided a completely transparent trading mechanism. Regional

exchanges lost a lot of business to NSE, forcing them to introduce SBTS. Today, India

can boast that almost 100% trading takes place through electronic order matching.

Prior to the setting up of NSE. trading on stock exchanges in India took place

without the usc of information technology for immediate matching or recording of trades.

The practice of physical trading imposed limits on trading volumes as well as the speed

with which the new information was incorporated into prices. The unscrupulous operators

used this information asymmetry to manipulate the market. The information asymmetry

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f- helped brokers to perpetrate a manipulative practice known as "gala". Gala is a practice

of cxtracting highest price of the day for "buy" transaction irrespective of the actual price

at which the purchase was actually done and give lowest price of the day for "sell"

transactions irrespective of the price at which sale was made. The clients did not have any

method of verifying the actual price. The electronic and now fully online trading

introduced by the NSE has made such manipulation difficult. It has also improved

liquidity and made the entire operation more transparent and efficient.

The NSE has set up a clearing corporation to provide legal counterparty guarantee

to each trade thereby eliminating counterparty risk. The National Securities Clearing

Corporation Ltd. (NSCCL) commenced operations in April 1996. Counterparty risk is

guaranteed through fine-tuned risk management systems and an innovative method of on­

line position monitoring and automatic disablement. Principle of "innovation" is

implemented by NSE capital market segment. Under this principle, NSCCL is the

counterparty for every transaction and, therefore, default risk is minimized. To support

the assured settlement, a "settlement guarantee fund" has been created. A large settlement

guarantee fund provides a cushion for any residual risk. As a consequence, despite the

fact that the daily traded volumes on the NSE run into thousands of crores of rupees,

credit risk no longer poses any problem in the marketplace.

4.3.1 Clearing & Settlement

While NSE provides a platform for trading to its trading members, the National Securities

Clearing Corporation Ltd. (NSCCL) determines the funds/securities obligations of the

trading members and ensures that trading members meet their obligations. Thc core

processes involved in clearing and settlemcnt are:

• Trade Recording: The key details about the trades are recorded to provide basis

for settlement. These details are automatically recorded in the electronic trading

system of the exchanges.

• Trade Confirmation: The parties to a trade agree upon the terms of trade like

security, quantity, price, and settlement date, but not the coullterparty, which is

the NSCCL. The electronic system automatically generates confirmation by direct

participants.

I II

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• Determination of Obligation: The next step is determination of what counter­

parties owe. and what counter-parties are due to receive on the settlement date.

The NSCCL interposes itself as a central counterparty between the counterparties

to trades and nets the positions so that a member has security wise net obligation

to receive or deliver a security and has to either payor receive funds.

• Pay-in of Funds and Securities: The members bring in their funds/securities to

the NSCCL. They make available required seclllities in designated accounts with

the depositories by the prescribed pay-in time. The depositories move the

securities available in the accounts of members to the account of the NSCCL.

Likewise members with funds obligations make available required funds in the

designated accounts with clearing banks by the prescribed pay-in time. The

NSCCL sends electronic instructions to the clearing banks to debit member's

accounts to the extent of payment obligations. The banks process these

instructions. debit accounts of members and credit accounts of the NSCCL.

• Pay-out of Funds and Securities: After processing for shortages of

funds/securities and arranging for movement of funds from surplus banks to

deficit banks through RBI clearing, the NSCCL sends electronic instructions to

the depositories/clearing banks to release pay-out of secUlities/funds. The

depositOlics and clearing banks debit accounts of the NSCCL and credit accounts

of members. Settlement is complete upon release of payout of funds and securities

to custodians/members.

• Risk Managcmcnt: A sound risk management system is integral to an efficient

settlement system. The NSCCL ensures that trading members' obligations are

commensurate with their net worth. It has put in place a comprehensive risk

management system, which is constantly monitored and upgraded to pre-empt

market failures. It monitors the track record and performance of members and

their net worth; undertakes on-line monitoring of members' positions and

exposure in the market collects margins from members and automatically disables

members if the limits are breached. The risk management methods adopted by

NSE have brought the Indian financial market in line with the international

markets. The robustness of the risk management system of NSE was amply

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proved by the timely and default free settlement on highly volatile days like May

14 & ]7, 2004, the two days when the market witnessed a fall of nearly 7.87% &

12.24% respectively. However, due to the robustness of the NSE's risk

management system, tight controls of member positions. stlingent margining etc.

the settlements went through smoothly without any disruptions or disorder in the

markets.

4.3.2 Settlement Agencies

The NSCCL, with the help of clearing members, custodians, clearing banks and

depositories settles the trades executed on exchanges. Tbe roles of each of these entities

are explained below:

• NSCCL: The NSCCL is responsible for post-trade activities of a stock exchange.

Clearing and settlement of trades and risk management are its central functions. It

clears all trades, determines obligations of members, arranges for pay-in of

funds/securities, receIves funds/ securities, processes for shortages In

funds/securities, arranges for pay-out of funds/ securities to members, guarantees

settlement, and collects and maintains margins/collateral! base capital!other funds.

It is the countcrparty to all settlement obligations of the members.

• Clearing Members: They are responsible for settling their obligations as

deterrnined by the NSCCL. They have to make available funds and/or securities

in the designated accounts with clearing bank/depositories, as the case may be, to

meet their obligations on the settlement day.

• Custodians: Custodian is a clealing member but not a trading member. He settles

trades assigned to him by trading members. He is required to confirm whether he

is going to settle a particular trade or not. If it is confirmed, the NSCCL assigns

that obligation to that custodian and the custodian is required to settle it on the

settlement day.

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• Clearing Banks: Every clearing memher is required to open a dedicated clearing

account with one of the clearing hanks. Based on his ohligation as determined

through clearing. the clearing member makes funds available in the clearing

account for the pay-in and receives funds in case of a payout.

• Depositories: Depositories help in the settlement of the dcmaterialized securities.

Each custodianJclearing member is required to maintain a clearing pool account

with the depositories. He is required to make available the required securities in

the dcsignated account on settlement day. The depository runs an electronic file to

transfer the securities from accounts of the custodians/clearing member to that of

NSCCL. As per the schedule of allocation of securities detem1ined by the

NSCCL, the depositories transfer the securities on the pay-out day from the

account of the NSCCL to those of members/custodians.

• Professional Clearing lVlember: NSCCL admits special category of members

namely, professional clearing members. Professional Clearing Member (PCM)

may clear and settle trades executed for their clients (individuals. institutions etc.).

In such an event, the functions and responsibilities of the PCM would be similar

to Custodians. PCMs may also undertake clearing and settlement responsibility

for trading members. In such a case, the PCM would settle the trades carried out

by the trading members connected to them. A PCM has no trading rights but has

only clearing rights, i.e. he clears the trades of his associate trading members and

institutional clients.

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4.3.3 Settlement Cycles

NSCCL clears and settles trades as per well-defined settlement cycles, as

presented in Table-4.3. Since the beginning of the financial year 2003, all securities are

being traded and settled under T +2 rolling settlement. The NSCCL notifies the

consummated trade details to clearing mcmbers/ custodians on the trade day. The

custodians aftinn back the tradcs to NSCCL by T + I day. Based on the affirmation,

NSCCL nets the positions of counterparties to determine their obligations. A clearing

member has to pay-in/pay-out funds and/or securities. A member has a security-wise net

obligation to receive/deliver a security. The obligations arc netted for a member across all

securities to determine his fund obligations and he has to either payor receive funds.

Members' pay-inJpay-out obligations are determined latest by T + 1 day and are forwarded

to them on the same day so that they can settle their obligations on T +2 day. The

securities/funds arc paid-in/ paid-out on T +2 day and the settlement is complete in 3 days

from the end of the trading day.

liS

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Table- 4.3 Settlement Cycle in Capital Market Segment

Activity T +2 Rolling Settlement

Trading T

Custodial Confirmation T+l

Determination of Obligation T+I

Securities/Funds Pay-in T+2

Securities/Funds Pay-out T+2

Valuation Debit T+2

Auction T+3

Bad Delivery Reporting T+4

Auction Pay-iniPay-out T+5

• Close Out T+5 • R~\tificd Bad Delivery Pay-in/Pay-out T+6

Re-bad Delivery Reporting T+8

Close Out of Re-bad Delivery T+9

Fig-4.1 Business Growth of NSE Capital Market Segment

2SI I,llilll ,------------------------------T I II,! ~ iii

" ~) ,l,Il ~ I , ~

?(III,'11111 h,lll )41 ;,;; ~

-:,11011

~ (,.1111()

\(11)(1 ';j

1011,1 11 111 -I)IIMI 0 , ,.(11 M I ~J)

" 2,1 II ~ I " .< ;'11,1 H II I

1,(1(111

, I " - LL: ~

r, r; ~, r, r,

" c ,

2 " ~ ; ;;:

:r " ~ ::::i 0- ~ 0- ,

~ ~ c ,

i. ;;: 1

'" L L "L t-=-I '.:1 g , 0- - F, ~i C. C, " "3 ~ , ~ " , -- .0 , " ;;: ; ;;: 1 ~" ;

Month & YC;lr

116

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4.4 NSE Futures & Options Market

The derivatives trading on NSE commenced on June 12111 2000 with futures

trading on S&P CNX Nifty Index. Subsequently the product base has been increased to

include trading in options on S&P CNX Niliy Index, futures and option on CNX IT

Index, futures and options on single stocks (213 stock as at end June 20(7) and futures on

interest rate. The turnover in the derivatives segment has witnessed considerable growth

since inception. In the global market NSE ranks first (1'1) in terms of number of contracts

traded in the Single Stock Futures, second (2"'1) in Asia in terms of number of contracts

traded in equity derivatives instrument. Since inception, NSE established itself as the sole

market leader in this segment in the country with more than 99% market share.

Fig-4.2 NSE F&O Business Growth

HIIII,U()O .,---------------------------, -l5,OOO

7(1IJ,OO{l 411,01111

(l! \()Jll'll)

~ .itlll,OO(1

35,otlO E

~ ell ·lIIO,OOII

~ ~ J.IIJ,OI){1

, 3D,OOIl ~

'" 25,U()(J ~

" '"10110(1 r!:: - ,- - - :>.

';i 15,000 Q

10.(1)0 ~ ~

5,tlO()

(j

Following Fig-4.3 will givc comparison betwecn NSE Cash and F&O Market growth and

clearly retlected that F&O Market has out stripped Cash market by miles.

117

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Fig-4.3 Monthly Turnover at Cash and Derivatives Segments of NSE (Rs. in Crore)

8()(X)00

70WOO 60(x)OI.)

50WOO 40C()OO

30WOO 2()WO()

-a- Equllres

10lXlOO o ..Jt+H#tt-t-t=I ~iIi!iIi ~i!i.!Ei!i!~~~=-=----==~~ __ _

::: -,

o "I

-x N ;:: ::: --,

-0 ~ "! "·1 t: ~

;., ~ -

"I ~ ,..., -- 25 -~ "! "I

~

.:--::: '"' ,..., '-'

~ ~

~ :t .". Or - 0 ~ 0 25 -. 25 - -'";1 ~ N '";1 N ~ 0

c ..!. ::: .... :,.; ::: '"' ~ ,...,

"" -, ,..., ~ ~

Fig-4.4 Progress of Futures & Options Markets on NSE

-Launch on June 13 2005 of BANK Nifty

O/', -0 N C -,

Steps to new heights ............ . ·lntroduCE;d 65 new securities ·Enhancement of number of strikes for

--'NlJmb>?r 1 i~--I NIFTY Options SIry:k Futures \--._...... • - . .1

. jll tb,::. ·.A,ne!."! I 'Instltutional

,.--~-----; participation 'Introduced at Its highest CNX IT & additional r---.---..-..i securities , ·Launch of Interest Rate,

-12 new FutUres I -- - securities __

"I ;!'!.!LOO",cILLJ _--,QCilf were added . .,.--- .----

Products ·Achieved I 'Index Options new heights ~NIFTY) in all our

'Stock Options ----.-------~ 'Stock Futures projucts

On JlIn~ 12. L.:lrgest '-c- -- -'

zr{ln Q,:;:rjvatlYes ·Launch of the ExcharKJe in Futures &. India optic,ns r- .. --.--Segment , ·Product Index. Futures - S&P I CNX NIFTY •

2000-01 2001-02 2002-03 2003-04 2004-05 2005 onwards

6 '-C ::Q 0 - - 25 N ~·t ";l ..!. ~ c y -;:; ::: ~ ;.,... ....,

118

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4.4.1 Futures and options market instruments

The National Stock Exchange of India Limited has launched different products as

an instrument for trading over the period of years. The instruments are:

I. S&P CNX Nifty Futures

2. S&P CNX Nifty Options

3. CNXIT Futures

4. CNXIT Options

5. Bank Nifty Futures

6. Bank Nifty Options

7. Futures on Individual Securities

8. Options on Individual Securities

Growth of various F&O Market instrument from the beginning of the trade can be seen

from following graph.

Fig-4.5 Share of Various Derivative Instruments in Turnover in Derivatives

Segment of NSE

40 "Yo

20%

or. =0

~ ~ -=> ~.' ":'

"-""

" :::E

0

"" '" "-J>:

~.

=0

;:;; ~

~

o lnd:-x O;~inn~ ,Call'

a Stn.:k () p[iol1~ ! 1\,,}

119

;? :5 ~ ":' " ~

;!

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The advantages of trading in [ndex Futures are:

• The contracts are highly liquid

• Index Futures provide higher leverage than any other stocks

• [t requires low initial capital requirement

• It has lower risk than buying and holding stocks

• It is just as easy to trade the short side as the long side

• Only have to study one index instead of [OO's of stocks

• Settled in cash and therefore all problems related to bad delivery, forged, fake

certificates, etc can be avoided.

The reasons for stock index futures emerglllg as the most popular Derivative

Instrument are as follows

• Institutiona[ and other large equity holders tend to concentrate their attention

on p0l1folio hedging.

• Index futures are the Illost cost-efficient hedging devices.

• A stock index unlike individual stock prices cannot be easily manipulated.

• Stock index futures are Illore liquid and more popular than individual stock

futures.

Tab[e-4.4 Market Share for the different products in the NSE Derivative Scgmcnt

Year Index Stock Index Stock

Futures Futures Options Options

2006-2007 30.50'70 58.20% 8.30% 3.00%

200S-2006 31.38'70 57.87% 7.02% 3.74%

2004-200S 30.32'70 58.27% 4.79% 6.63%

2003-2004 26.03% 61.30% 2.48% 10.20%

2002-2003 9.99% 65.14% 2.10% 22.76%

2001-2002 21.08'70 50.54% 3.69% 24.69%

2000-2001 100.00% - - -

Tab[c-4.S National stock Exchange (NSE) has the following derivative products

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Products Index Futures Index Options Futures on Options On Individual Individual Securities Securities

Underlying S&P CNX Nifty S&P CNX Nifty 213 securities 213 securities Instrument stipulated by stipulated by

SEB! SEBI Type European American Trading Cycle Maximum of 3- Same as Index Same as index Same as index

Month trading futures futures futures cycle. At any point in time, There will be 3 Contracts available

I) near month. 2) mid month & 3) far month duration

Expiry Day Last Thursday of Same index Same as index Same as index the

as

expiry month futures futures futures Contract Size Pem1itted lot size Same index As stipulated As stipulated by

as IS by 200 & multiples futures NSE (not less NSE (not less thereof than Rs.2 lacs) than Rs.2 lacs)

Price Steps Re.0.05 Re.0.05 Base Price- Previous day Theoretical value previous day Same as Index

closing First day Nifty value of the options closing value of options of trading contract anived at underlying

based on Black- security Scholes model

Base Price- Daily settlement daily close price Daily Same as Index settlement

Subsequent price price options Price Bands Operating ranges Operating ranges Operating Operating

are kept at + 10 % for are kept at ranges are kept ranges for are

99% of the base at+ 20 % kept at 99% of pnce the base price

Quantity Freeze 20,000 units or 20,000 units or Lower of I % of Same as

greater greater Market wide individual

position limit futures

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• The stock index being an average is less volatile than individual stock prices.

In a futures market. the clearing house stands as the guarantor, and its risk is

minimized if the stock index is used.

• Futures on individual stocks can be used as a vehicle for manipulating their

prices in the cash market.

• Regulatory complexity is less in the case of stock index futures than in other

kinds of equity derivatives.

4.4.2 Futures and options market Contract cycle

The figure shows the contract cycle for futures contracts on NSE's derivatives

market. As can be seen, at any given point of time, three contracts are available for

trading a near-month, a middle-month and a far-month. For example as the January

contract expires on the last Thursday of the month, a new three-month contract starts

trading from the following clay, once more making available three index futures contracts

for tracling.

Fig 4.6 NSE Futures and options market Cycle

Jan

Jan 30 .:ontr,,,t ~

Feb 27 .:ontract ..

\hr

\!ar 27 contract 4 ~

Apr 2~ contract •

\!ay 29 contract

Apr .. Tim~

Jun 26 contract

4.4.3 Futures and options market Contract Specification

The contract specification for derivatives tracled on NSE is summarized as below.

The index futures and index options contracts traded on NSE arc based on S&P CNX

Nifty Index and CNX IT Index, while stock futures and options are based on individual

securities traded in the Capital market segment of NSE. Interest rate future contracts are

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available on Notional 91 day t-bill and Notional 10 year bonds (6% coupon bearing and

zero coupon bond). While the index options are European stylc. stock options are

Amcrican style. At any point of time there arc three contract months available for trading.

with I month, 2 months and 3 months to expiry. These contracts expire on last Thursday

of the expiry month and have a maximum of 3-month expiration cycle. A new contract is

introduced on the next trading day following the expiry of the near month contract. All

the derivatives contracts are presently cash settled.

Contract Specifications of Equity based derivatives traded in NSE

Ulltier/rill" _ b

I. Indc" Futures anu Options

2. Futures/Options on Inuividual Indiviuual Sccurities

Exchallge of Trade

: S&P CNX Nifty and CNX IT

: IlllliYidual Securities. At present 53 stocks

National Stock Exchange of India Limited

SeclIrity descriptor

I. S&P CNX Nifty Futures N FUTlDX NIFTY i\IATURITY DATE 2. S&P CNX Nifty Options N OPTIDX NIFTY i\IATURITY DATE

STRIKE PRICE OPTYP 3. Futures on individual securities N FUTSTK ABC MATURITY DATE ~. Options on individual sccuritiesN OPTSTK ABC \lATURITY DATE

STRIKE PRICE OP TYP

Contract Size

I.

2.

S&P CNX Nilly Futures / S&P CNX Nifty Options

Futures / Options on individual securities

Strike price illtenal

Permitted lot size 200 and multiples then: of (minillluill value Rs.2 Iakh)

Minimulll value of Rs 2 Lakh for each Individual Security

1. sSeP CNX Nifty Options Rs. 10/-

Options un individual securities:

PricL' Steps

Price Banus

Between Rs.2.50 and Rs. 100.00

dcpellllin~ on the price or underlvin~ c ~ U

Rs.0.05

i\ut Applicahk

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Trading Cycle

Expiry dat.:

Settlement basis

I.

2.

3.

Indn Futures / Futures

on individual securities

Index Options

Options on individual

securities

Settlement price

I. S&P CNX Nifty Futures / Futures

Illdex Options /options

on individual security

i\laximuIll Df three montil trading cycle

- n.:ar Illontil( one). tile next month (twO)

and th.: far mllnth (three I. Nc\\ seriL~s

of contract \\-ill he introduCL'd on till' n.:xt

trading day follll\ving expiry of ncar

Illontil contract

Thc last TiltH-,day of the cxpiry nllJnth

or the Previous trading d~IY if th.: last

Thursdav of til.: Illontil is ;1 tradinl.! _ c

iloliday

Mark to Market and final scttlement

be settled in cash on T + I basis

Premium settleillent on T + I Basis and

Final Exercise settleillent on T + I basis

Preillium settlement on T + I basis ami

option Exercise settlement on T +2 basis.

Daily settlement price will be the closing price on individual sccurities of the

futures contracl', for the trading day and

the I1nal settlemcnt price shall be the c1osin~ value of the underhin,! index/

~- ~ ~

security on the last trading day ~ <,.. ~

The settlemcnt price shall be closing

I)ricc of underJviw' security _ c •

4.4.4 Introduction of strike prices for option contracts

NSE introduces option strikes on a daily basis based on the pnce of the

underlying. With regard to options on stocks and CNX IT index the Exchange provides a

minimum of seven strike prices for every option type (i.e. Call & Put) during the trading

month. At any time, there are at least three strikes in-the-money (ITM), three strikes out­

of-thc-money (OTM) and one strike at-the-money (ATM). The number of strikes

provided in options on Nifty, Nifty Junior, CNX 100, CNX IT and Bank Nifty are related

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to the range in which prevIous day's closing value of Nifty index falls as per the

following table

Table-4.6 Strike Prices for Option Contracts

Nifty Index Level Strike Interval Scheme of strikes to be Introduced

(ITM-ATM-OTM)

Up to 2000 25 4-1-4

> 2001 up to 4000 50 4-1-4

>4001 up to 6000 50 5-1-5

> 6000 50 6-1-6

4.4.5 Eligibility Criteria for selection of Securities and Indices

SEBI vide its Circular NO.SEBIIDNPD/Cir-26/2004/07116 dated July 16, 2004

has revised the eligibility criteria for introducing Futures & Options contracts on Stocks

and Indices. Based on the above circular, the following criteria will be adopted by the

Exchange w.e.f September 1,2004, for selecting stocks and indices on which Futures &

Options contracts would be introduced.

1. Eligibility criteria of stocks

o The stock shall be chosen from amongst the top 500 stocks in terms of

average daily market capitalization and average daily traded value in the

previous six months on a rolling basis.

o The stock's median quarter-sigma order size over the last six months shall

be not less than Rs, 0.10 million (Rs. 1 lac). For this purpose, a stock's

quarter-sigma order size shall mean the order size (in value terms)

required to cause a change in the stock price equal to one-quarter of a

standard deviation.

o The market wide position limit in the stock shall not be less than Rs. 500

million (Rs. 50 crores). The market wide position limit (number of shares)

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shall be valued taking the closing prices of stocks in the underlying cash

market on the date of expiry of contract in the month. The market wide

position limit of open position (in terms of the number of underlying

stock) on futures and option contracts on a particular underlying stock

shall be lower of:

30 times the average number of shares traded daily, during the

previous calendar month, in the relevant underlying security in the

underlying segment,

or

• 20% of the number of shares held by non-promoters in the relevant

underlying security i.e. free-float holding.

o If an existing security fails to meet the eligibility criteria for three months

consecutively, then no fresh month contract shall be issued on that

security.

o Further, the members may also refer to circular no. NSCCIF&OIC&S/365

dated August 26, 2004, issued by NSCCL regarding Market Wide Position

Limit, wherein it is clarified that a stock which has remained subject to a

ban on new position for a significant part of the month consistently for

three months, shall be phased out from trading in the F&O segment.

However, the existing unexpired contracts may be permitted to trade till expiry

and new strikes may also be introduced in the existing contract months.

2. Eligibility criteria of'Indices

o Futures & Options contracts on an index can be introduced only if 80% of

the index constituents are individually eligible for derivatives trading.

However, no single ineligible stock in the index shall have a weightage of

more than 5% in the index. The index on which futures and options

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contracts are permitted shall be required to comply with the eligibility

criteria on a continuous basis.

o SEEI has subsequently modified the above criteria; vide its clarification

issued to the Exchange "The Exchange may consider introducing

derivative contracts on an index if the stocks contributing to 80%

weightage of the index are individually eligible for derivative trading.

However, no single ineligible stocks in the index shall have a weightagc of

more than S% in the index."

o The above criteria is applied every month, if the index fails to meet the

eligibility criteria for three months consecutively, then no fresh month

contract shall be issued on that index, However, the existing unexpired

contacts shall be permitted to trade till expiry and new strikes may also be

introduced in the existing contracts.

3, Selection criteria for unlisted companies

For unlisted companies corning out with initial public offering, if the net

public offer is Rs. 500 crs. or more, then the Exchange may consider introducing

stock options and stock futures on such stocks at the time of its' listing in the cash

market. New securities being introduced in the F&O segment are based on the

eligibility criteria which take into consideration average daily market

capitalization, average daily traded value, the market wide position limit in the

security, the quarter sigma values and as approved by SEE!. The average daily

market capitalization and the average daily traded value would be computed on

the 15 th of each month, on a rolling basis, to arrive at the list of top 500 securities.

Similarly, the quarter sigma order size in a stock would also be calculated on the

I Sth of each month, on a rolling basis, considering the order book snapshots of

securities in the previous six months and the market wide position limit (number

of shares) shall be valued taking the closing prices of stocks in the underlying

cash market on the date of expiry of contract in the month.

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------------------------------------ -------- ----

4.4.6 Trading Mechanism

The derivatives trading system at NSE is called NEAT-F&O trading system. It

provides a fully automated, screen-based trading for all kind of derivative products

availahle on NSE. It supports an anonymous order driven market, which operates on a

strict price/time priority. It provides tremendous flexibility to users in terms of kinds of

orders that can be placed on the system. Various time and price related conditions like

Immediate or Cancel. LimitlMarket Price. Stop Loss. etc. can be built into an order.

The NEAT-F&O trading system distinctly identifies two groups of users. The

trading user more popularly known as trading member has access to functions such as,

order entry, order matching and order & trade management. The clearing user (clearing

member) uses the trader workstation for the purpose of monitoring the trading member(s)

for whom he clears the trades. Additionally, he can enter and set limits on positions,

which a trading member can take.

The Trading Members(TM) have access to functions such as order entry, order

matching, order and trade management. It provides tremendous flexibility to users in

terms of kinds of orders that can be placed on the system. Various conditions like Good­

till-Day, Good-till-Cancelled, Good-till-Date, Immediate or Cancel, LimitlMarket price,

Stop loss, etc. can be built into an order. The trading terminals of F&O segment are

available in 500 cities at the end of March 2007. Besides the trading can also be carried

through the Internet by investors.

4.4.7 Membership criteria

NSE admits members on its derivatives segment in accordance with the rules and

regulations of the exchange and the norms specified by SEB!. NSE follows 2-tier

memhership structure stipulated by SEBI to enable wider participation. Those interested

in taking membership on F&O segment are required to take membership of CM and F&O

segment or CM, WDM and F&O segment. Trading and clearing mcmbers are admittcd

separately. Essentially, a Clearing Member (CM) docs clearing for all his Trading

Members (TMs), undertakes risk management and performs actual settlement. There are

three types of CMs:

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• Self' Clearillg Member: A SCM clears and settles trades executed by him only

either on his own account or on account of his clients.

• Trolling Member Clearillg Member: TM-CM is a CM who is also aTM. TM-CM

may clear and settle his own proprietary trades and c1ient"s trades as well as clear

and settle for other TMs.

• Professiollal Clearillg Member rCM is a CM who is not a TM. Typically, banks

or custodians could become a PCM and clear and settle for TMs.

4.4.8 Clearing and settlement

NSCCL undertakes clearing and settlement of all deals executed on the NSEs

F&O segment. It acts as legal counterparty to all deals on the F&O segment and

guarantees settlement.

4.4.8.1 Clearing

The first step in clearing process is working out open positions or obligations of

members. A CM's open position is arrived at by aggregating the open position of all the

TMs and all custodial participants clearing through him, in the contracts in which they

have traded. A TM's open position is arrived at as the summation of his proprietary open

position and clients open positions. in the contracts in which they have traded. While

entering orders on the trading system, TMs are required to identify the orders, whether

proprietary (if they are their own trades) or client (if entered on behalf of clients).

Proprietary positions are calculated on net basis (buy-sell) for each contract. Clients'

positions are anived at by summing together net (buy-sell) positions of each individual

client for each contract. A TMs open position is the sum of propIietary open position,

client open long position and client open short position.

4.4.8.2 Settlement

All futures and options contracts are cash settled. i.e. through exchange of cash.

The underlying for index futures/options of the Nifty index cannot be delivered. These

contracts, therefore. have to be settled in cash. Futures and options on individual

securities can be delivered as in the spot market. However, it has been currently

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mandated that stock options and futures would also be cash settled. The settlement

amount for a CM is netted across all their TMs/clients in respect of MTM. premium and

final exercise settlement. For the purpose of settlement, all CMs are required to open a

separate bank account with NSCCL designated clearing banks for F&O segment.

4.4.8.2.1 Settlement of Futures Contracts on Index or Individual Securities

Futures contracts have two types of settlements, the MTM settlement which

happens on a continuous basis at the end of each day, and the final settlement which

happens on the last trading day of the futures contract.

• MTM Settlement for Futures:

All futures contracts for each member are marked-to-market to the daily

settlement plice of the relevant futures contract at the end of each day. The CMs

who have suffered a loss are required to pay the mark-to-market (MTM) loss

amount in cash which is in turn passed on to the CMs who have made a MTM

profit. This is known as daily mark-to-market settlement. CMs are responsible to

collect and settle the daily MTivl profits/losses incurred by the TMs and their

clients clearing and settling through them. Similarly, TMs are responsible to

collect/pay losses/ profits from/to their clients by the next day. The pay-in and

pay-out of the mark-to-market settlement are effected on the day following the

trade day (T + I). After completion of daily settlement computation, all the open

positions are reset to the daily settlement price. Such positions become the open

positions for the next day.

• Final Settlement for Futures:

On the expiry day of the futures contracts, after the close of trading hours,

NSCCL marks all positions of a CM to the final settlement price and the resulting

profit/loss is settled in cash. Final settlement loss/profit amount is debited/credited

to the relevant CM's clearing bank account on the day following expiry day of the

contract.

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• Settlement Prices for Futures:

Daily settlement price on a trading day is the closing pnce of the respective

futures contracts on such day. The closing price for a futures contract is cUlTently

calculated as the last half an hour weighted average price of the contract in the

F&O Segment of NSE. Pinal settlement price is the closing price of the relevant

underlying index/security in the Capital Market segment of NSE, on the last

trading day of the Contract. The closing price of the underlying Index/security is

currently its last half an hour weighted average value in the Capital Market

Segment of NSE.

4.4.8.2.2 Settlement of Options Contracts on Index or Individual Securities

Options contracts have three types of settlements, daily premium settlement, and interim

exercise settlement in the case of option contracts on securities and final settlement.

• Daily Premium Settlement for Options:

Buyer of an option is obligated to pay the premium towards the options

purchased by him. Similarly, the seller of an option is entitled to receive the

premium for the option sold by him. The premium payable amount and the

premium receivable amount are netted to compute the net premium payable or

receivable amount for each client for each option contract. The CMs who have a

premium payable position arc required to pay the premium amount to NSCCL

which in turn passed on to the members who have a premium receivable position.

This is known as daily premium settlement. CMs are also responsible to collect

and settle for the premium amounts from the TMs and their clients clearing and

settling through them. The pay-in and pay-out of the premium settlement is on

T + I day. The premium payable amount and premium receivable amount are

directly credited/debited to the CMs clearing bank account.

• Interim Exercise Settlement:

Interim exercise settlement takes place only for option contracts on individual

securities. An investor can exercise his in-the-money options at any time during

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trading hours, through his trading member. Interim exercise settlement is effected

for such options at the close of the trading hours, on the day of exercise, Valid

exercised option contracts arc assigned to short positions in the option contract

with the same series (i.e. having the same underlying. same expiry date and same

strike price). on a random basis. at the client level. The CM who has exercised the

option receives the exercise settlement value per unit of the option from the CM

who has been assigned the option contract.

• Final Exercise Settlement:

Final Exercise settlement is effected for option positions at in-the-money strike

prices existing at the close of trading hours, on the expiration day of an option

contract. All long positions at in-the-money strike prices are automatically

assigned to short positions in option contracts with the same series, on a random

basis. Final settlement loss/prollt amount for option contracts on Index is

debited/credited to the relevant CMs clearing bank account on T + I day. Final

settlement loss/profit amount for option contracts on Individual Securities is

debited/ credited to the relevant CMs clearing bank account on T +2 day. Open

positions, in option contracts, cease to exist after their expiration day.

4.4.9 Risk management system

The salient features of risk containment measures on the F&O segment are:

• Anybody interested in taking membership of F&O segment is required to take

membership of "CM and F&O" or "CM. WDM and F&O". An existing member

of CM segment can also take membership of F&O segment. The details of the

eligibility criteria for membership of F&O segment are given in the chapter on

regulations in this book.

• NSCCL charges an upfront initial margin for all the open positions of a CM up to

client level. It follows the VaR based margining system through SPAN system.

NSCCL computes the initial margin percentage for each Nifty index futures

contract on a daily basis and informs the CMs. The CM in turn collects the initial

margin from the TMs and their respective clients.

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• NSCCL's on-line position monitoring system monitors a CM's open positions on

a real-time basis. Limits are set for each CM based on his base capital and

additional capital deposited with NSCCL. The on-line position monitoring system

generates alerts whenever a CM reaches a position limit set up by NSCCL.

NSCCL monitors the CMs and TMs for mark to market value violation and for

contract-wise position limit violation.

• CMs are provided with a trading terminal for the purpose of monitoring the open

positions of all the TMs clearing and settling through them. A CM may set

exposure limits for a TM clearing and settling through him. NSCCL assists the

CM to monitor the intra-day exposure limits set up by a CM and whenever a TM

exceeds the limits, it withdraws the trading facility provided to such TM.

• A separate Settlement Guarantee Fund for this segment has been created out of

the capital deposited by the members with NSCCL.

4.4.10 Margins

The margining system for F&O segment is as below:

• Initial margin: Margin in the F&O segment is computed by NSCCL up to client

level for open positions of CMsrrMs. These are required to be paid up-li'ont on

gross basis at individual client level for client positions and on net basis for

proprietary positions. NSCCL collects initial margin for all the open positions of a

CM based on the margins computed by NSE-SPAN. A CM is required to ensure

collection of adequate initial margin from his TMs up-front. The TM is required

to collect adequate initial margins up-front from his clients.

• Premium Margin: In addition to Initial Margin, Premium Margin is charged at

client level. This margin is required to be paid by a buyer of an option till the

premium settlement is complete.

• Assignment IVlargin for Options on Securities: Assignment margin is levied in

addition to initial margin and premium margin. It is required to be paid on

assigned positions of CMs towards interim and final exercise settlement

obligations for option contracts on individual securities, till such obligations are

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fulfilled. The margin is charged on the net exercise settlement value payable by a

CM towards interim and final exercise settlement.

• Client Margins: NSCCL intimates all members of the margin liability of each of

their client. Additionally members are also required to report details of margins

collected from clients to NSCCL. which holds in trust client margin monies to the

extent reported by the member as having been collected form their respective

clients.

4.4.11 Present scenario of NSE F&O

Following are the observations of NSE F&O market in present circumstances.

• Single-stock futures continue to account for a sizable proportion of the F&O

segment. It constituted 60 per cent of the total turnover during June 2007 A

primary reason attributed to this phenomenon is that traders are comfortable with

single-stock futures than equity options. as the former closely resembles the

erstwhile "Badia" system.

• On relative terms. volumes in the index options segment continue to remain poor.

This may be due to the low volatility of the spot index. Typically. options are

considered more valuable when the volatility of the underlying (in this case, the

index) is high. A related issue is that brokers do not cam high commissions by

recommending index options to their clients, because low volatility leads to

higher waiting time for round-trips.

• Put volumes in the index options and equity options segment have increased since

January 2002. The call-put volumes in index options have decreased from 2.86 in

January 2002 to 1.32 in June 2007. The fall in call-put volumes ratio suggests that

the traders are increasingly becoming pessimistic on the market.

• Farther month futures contracts are still not actively traded. Trading In equity

options on most stocks for even the next month was non-existent.

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• Daily option price variations suggest that traders use the F&O segment as a less

risky alternative (read substitute) to generate profits from the stock price

movements. The fact that the option premiums tail intra-day stock prices is

evidence to this. If calls and puts arc not looked as just substitutes for spot

trading. the intra-day stock price variations should not have a one-to-one impact

on the option premiums.

Overall NSE is one of the emerging Futures & Options Exchange in the world and

comparison betwcen NSE and rest of the exchanges in the world can be done based

on single stock futures. Index Futures. Single Stock Options and Index Options as

given in the following table.

Tahle-4.7 Comparison of NSE with other World Exchanges in terms of F&O

Instruments

(As on June 20(7)

PrOdth:t S,inglt' Sto, .. k Futures Index Futurt'!Io ~inglt.' Slu" .. k Options Inde" Optinns

:\~E', I ~t \\ Ilh 57~3-e8 10th with 7~~~3: Positinl1 !..':()ntracts -trh with J6~6~~;': re>ntr,)ct5 J -hh wit h -J<)n J 1:< ('(ll1tf";)l'f'-; 1'0ntr;1cl.<:

:\ame of :\UJ11ber :'\umber \umber :"ame of :,\"'uml

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