The document provides an overview of risk management techniques in the capital markets such as derivatives, hedging, and portfolio management. It discusses key concepts like systematic and unsystematic risk, and tools used to reduce risk like diversification. The summary also introduces some of the major stock exchanges in India like NSE and BSE, and describes the products and services offered by Unicon Securities related to trading equities, commodities, and distributing financial products.

1. 1. INTRODUCTION
In India, National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)
introduced financial derivatives in the year 2000. Derivatives allow managing risks more
effectively by reducing the burden of risk and allowing either hedging or taking only one
risk at a time. It is indeed rewarding but involves a great deal of risk. Investing in
financial securities is considered to be one of the best avenues for investing one’s savings
while it is acknowledged to be one of the most risky for investment. Investment is the
employment of funds with the aim of earning additional income or capital appreciation. It
has two attributes i.e., time and risk. The sacrifice that has to be made by the investor is
certain but return in the future is uncertain. Every investor is exposed to risk of market
price of fluctuations. Derivatives were evolved to curtail the risk of market price
fluctuations in the commodity market. Derivatives have been in use way back in 13th
century onwards and later it was developed for the securities market.
Risk is a characteristic future of all commodity and capital market. Prices of all
commodities like wheat, cotton, rice, coffee, tea, silver, gold etc are subject to
fluctuations in demand and supply over time. Producers of commodities cannot be sure of
the price that they produce may fetch when they are ready for sale. Similarly prices of
shares and debentures or bond etc are subject to fluctuations. In the same way the foreign
exchange are also subject to fluctuations. In the current economic scenario, investments
in financial markets have become more complicated. Investing in securities such as
shares, debentures, bond etc are profitable as well as interesting and attracts people from
all walks of life irrespective of their occupation, economic status, education or family
background. Risk reduction is one of the main issues for an investor as it is directly
related to the return on the investments.
1

2. Some of the risk management techniques used in the capital market now a day is:
• Risk avoidance
• Combination
• Diversification
• Risk transfer
• Portfolio investment
• Hedging
The project entries “A STUDY ON HEDGING EFFECTIVENESS IN INDEX
FUTURE” deals with the construction of a profitable portfolio on the basis of risk-return
evaluation and loss minimization using hedging. The companies are selected on the basis
of their industrial performance. Investing in individual securities involves lot of risks. It
is better to invest in-group of securities to reduce risk. Selecting the group of securities is
an important task. Investors are interested in maximizing the return with minimum risk,
here ten securities have been selected for constructing the portfolio these securities are
representatives of different sector. The securities selected are SBI BANK, HDFC BANK,
WIPRO, INFOSYS, MAHINDRA, MARUTI SUZUKI, HUL, ITC, CIPLA and
RANBAXY. There exist a considerable degree of different in return and risk of various
portfolios.
PORTFOLIO MANAGEMENT
Investing in securities such as shares, debentures and bonds is profitable as well
as existing. It is indeed rewarding, but involves a great deal of risk and calls for scientific
as well as artistic skill. In such investment both rational as well as emotional responses
are involved. Investing in financial securities is now considered to be one of the most
risky avenues of investments.
It is rare to investors investing their savings in a single security. Instead they tend
to invest in a group of securities. Such as group of securities is called as Portfolio.
Creation of a portfolio helps to reduce risk without sacrificing returns.
2

3. Portfolio management deals with the analysis of individual securities as well as
with the theory and practice of optimally combining securities into portfolios. An
investor who understands the fundamental principles and analytical aspects of portfolio
management has a better chance of success.
An investor considering investments in securities is faced with the problem of
choosing from among a large number of securities. His choice depends upon the risk
returns characteristics of individual securities. He would attempt to choose the most
desirable securities and like to allocate his funds over this group of securities. Again he is
faced with the problem of deciding which securities to hold and how much to invest in
each. The investor faces an infinite number of possible portfolios differ from those of
individual securities combining to form a portfolio. The investor tries to choose the
optimal portfolio taking into consideration the risk return characteristics of all possible
portfolios.
TECHNICAL ANALYSIS
Technical analysis is a method of evaluating securities by analyzing the statistics
generated by market activity, such as past prices and volume. Technical analysis do not
attempt to measure a security’s intrinsic value, but instead use charts and other tools to
identify patterns that can suggest future activity.
Just as there are many investment styles on the fundamental side, there are also
many different types of technical traders. Some rely on chart patterns, others use
technical indicators and oscillators and most use some combination of the two. In any
case, technical analyst’s exclusive use of historical price and volume data is what
separates them from their fundamental counterparts. Unlike fundamental analysts,
Technical analysts don’t care whether a stock is undervalued- the only thing that matters
is a security’s past trading data and what information this data can provide about where
the security might move in the future.
1. The market discounts everything.
2. Price moves in trends.
3. History trends to repeat itself.
3

4. INVESTMENT ANALYSIS
Investment is the employment of funds on assets with the aim of earning income
or capital appreciation. Investment has two attributes namely time and risk. Present
consumption is sacrificed to get a return in the future. The sacrifice that has to be borne is
certain, but the return in the future may be uncertain. This attribute of investment
indicates the risk factor. The risk is undertaken with a view to reap some return from the
investment. Investment means some monetary commitment.
RISK
Every investment is characterized by return and risk. Risk can be defined in terms
of variability I returns. “Risk is the potential for variability in returns”. An investment
whose returns are fairly stable is considered to be low risk investment, where as an
investment whose returns fluctuate significantly is considered to be a high-risk
investment. Equity shares whose returns fluctuate significantly are considered to be a
high-risk investment and those are considered as risky investment.
ELEMENTS OF RISK
The total variability in return of a security represents the total risk of that security.
Systematic risk and unsystematic risk are the two components of total risk. Thus
Systematic risk /
Total risk
Unsystematic risk
SYSTEMATIC RISK
The impact of economic, political and social changes is system wide and that
portion of total variability in security returns caused by such system wide factors is
referred to as systematic risk. Systematic risk is further sub divided into interest rate risk,
market risk and purchasing power risk.
4

5. UNSYSTEMATIC RISK
The risk of price changes due to the unique circumstances of a specific security,
as opposed to the overall market. The risk can be virtually eliminated from a portfolio
through diversification. This risk is unique of peculiar to a company or industry and
affects it in addition to the systematic risk affecting all securities. The unsystematic or
unique risk affecting specific securities arises from two sources:
• The operating environment of the company, and
• The financing pattern adopted by the company. These two types of
unsystematic are referred to as business risk and financial risk
respectively.
INDUSTRY PROFILE
The capital market is the market for securities, where companies and government
can raise long term funds. The capital market includes the stock market and the bond
market. The capital market is basically divided into:
• Primary market
• Secondary market
The primary market is the part of capital market that deals with the issuing of new
securities.
The secondary market is the financial market for trading of securities that have already
been issued in an initial private or public offering.
OTC EXCHANGE OF INDIA (OTCEI)
The OTC Exchange of India (OTCEI) has been setup to provide cost effective and
convenient platforms for raising finance from the capital market. OTCEI was promoted
by a consortium of financial institutions sated its operations in 1992. It is a ring less,
electronic, nation wider stock exchange committed to providing entrepreneurs with a
smooth economical vehicle for going public and investors with a fair, sable and efficient
market. Thus the OTCEI brings investors and promoters closer together.
5

6. NATIONAL STOCK EXCHANGE (NSE)
National Stock Exchange (NSE) of India commenced its operations in the capital
market on 3rd November 1994 in Mumbai. The recommendations of Pherwani committee
led to the beginning of NSE.
The main objective of NSE is to establish a nationwide trading facility for
equities, debt and hybrids:
 To ensure equal access to investors all over the country through appropriate
communication network.
 To provide a fair, efficient and transparent security market to investors by using
an electronic communication network.
 To enable shorter settlement cycle and book entry system.
 To meet current international standards of securities market.
NSE 50-INDEX
The NSE 50 Index, commonly known as Nifty. It is a market capitalization
weighted index. It was introduced in April 1996, replacing the earlier NSE-100. The
objective of the NSE 50- Index is
• To reflect the market movement more accurate.
• To provide fund manager with a bench mark for measuring portfolio performance.
• To establish a basis for introducing index based derivative product.
BOMBAY STOCK EXCHANGE (BSE)
The stock exchange, Mumbai, popularly known as “BSE” was established in 1875
as “the native share and stock brokers association. It is the oldest one in Asia, even older
than the Tokyo Stock Exchange, which was established in 1878. It is a voluntary non-
profit making association of persons (AOP) and is currently engaged in the process of
converting itself into demutualised and corporate entity. It has evolved over the years into
its present status as the premier stock exchange in the country. It is the first stock
exchange in the country to have obtained permanent recognition in 1956 from the
government of India under the Securities Contract (Regulation) Act, 1956.
6

7. The exchange, while providing an efficient and transparent market for trading in
securities, debt and derivatives upholds the interests of the investors and ensures
redressed of their grievances whether against the companies or its own member-brokers.
It also strives to educate enlighten the investors by conducting investor education
programs and making available to them necessary informative inputs.
A governing board having 20 directors is the APEX body, which decides the
policies and regulates the affairs of the exchange. The governing board consists of 9
elected directors, who are from the broking community (one third of them retire every
year by rotation), three SEBI nominees, six public representatives and an executive
director and chief operating officer.
The executive director as the chief executive officer is responsible for the day-to-
day administration of the exchange and the chief operating officer and other heads of
departments assist him.
The exchange has inserted new rule No. 126 A in its Rules, byelaws and
Regulations pertaining to constitution of the executive committee of the exchange.
Accordingly, an executive committee, consisting of 3 elected directors, 3 SEBI nominees
or public representatives, executive director, CEO and Chief Operating Officer has been
constituted. The committee considers judicial and quasi matters, in which the governing
board has powers as an Appellate Authority, matters regarding annulment of transactions,
Admission, continuance and suspension of member brokers, declaration of a member
broker as defaulter, norms, procedures and other matters relating to arbitration, fees,
deposits, margins and other moneys payable by the member brokers to the exchange etc.
SEBI’s POWER IN RELATION TO STOCK EXCHANGE
The SEBI ordinance has given it the following powers:-
1. It may call periodical returns from Stock Exchange.
2. It has the power to prescribe maintenance of certain documents by the stock
exchanges.
3. SEBI may call upon the exchange or any mate to furnish explanation or
information relating to the affairs of the stock exchange or any member.
7

8. 4. It has the power to approve byelaws of the stock exchange for regulation and
control of contracts.
5. It can amend byelaws of stock exchange.
6. In certain areas it can license the dealers in securities.
1.1 COMPANY PROFILE
UNICON SECURITIES PRIVATE LIMITED
UNICON is a financial services company which has emerged as a one-stop
investment solutions provider. It was founded in 2004 by two visionary and flamboyant
entrepreneurs, Mr. Gajendra Nagpal and Mr. Ram M. Gupta, who possess expertise in
the field of Finance. The company is headquartered in New Delhi, and has its corporate
office in Mumbai with regional offices in Kolkata, Chennai, Hyderabad and Noida.
UNICON is a professionally managed company led by a team with outstanding
managerial acumen and cumulative experience of more than 400 man years in the
financial markets The Company is supported by more than 4500 Uniconians and has a
team of over 900 business offices in 235 cities across India.
With a customer base of over 200,000 the Unicon Group has an eye for the
intricate financial needs of its clients and caters to both their short – term and long – term
financial needs through a comprehensive bouquet of investment services. It has been
founded with the aim of providing world class investing experience to the investing
community. These services range from offline & online trading in equity, commodities
and currency derivatives to debt markets to corporate finance and portfolio management
services. The company has a sizable presence in the distribution of 3rd party financial
products like mutual funds, insurance products and property broking. It also provides
expert Advisory on Life Insurance, General Insurance, Mutual Funds and IPO’s. The
distribution network is backed by in-house back office support to provide prompt and
efficient customer service
The Equity broking arm – UNICON Securities Pvt. Ltd offers personalized
premium services on the NSE, BSE & Derivatives market. The Commodity broking arm
Unicon Commodities Pvt. Ltd offers services in Commodity trading on NCDEX and
8

9. MCX. The UNICON group also has a PCG division providing investments solutions for
High Net worth Individuals. The Corporate Advisory Services arm – Unicon Capital
Services (P) Ltd offers entire gamut of Investment Banking services to corporate.
UNICON can boast of some of the most respected names in the private equity
space like Sequoia Capitals, Nexus India Capital and Subhkam Ventures as its
shareholders.
MISSION :
“To create long term value by empowering individual investors through superior
financial services supported by culture based on highest level of teamwork, efficiency
and integrity”.
VISION :
“To provide the most useful and ethical Investment Solutions - guided by values driven
approach to growth, client service and employee development”.
9

10. GROUP COMPANIES
FIXED INCOME &
INVESTMENT
BANKING
UNICON
CAPTIAL
SERVICES Pvt.
Ltd.
DISTRIBUTION
FINANCE (SHARES UNICON
& IPO)
INSURANCE
UNICON ADVISORS Pvt.
FINCAP Pvt. Ltd.
Ltd.
UNICON
FINANCIAL
INTERMEDIARIE
S Pvt. Ltd.
COMMODITIES
TRADING IN TRADING
EQUITIES &
DERIVATIVES
UNICON
UNICON COMMODITIE
SECURITIES S Pvt. Ltd.
Pvt. Ltd. REAL ESTATES
UNICON
REAL
ESTATES Pvt.
Ltd.
10

11. PRODUCT AND SERVICES
Unicon customers have the advantage of trading in all the market segments
together in the same window, as we understand the need of transactions to be executed
with high speed and reduced time. At the same time, they have the advantage of having
all Advisory Services for Life Insurance, General Insurance, Mutual Funds and IPO’s
also.
Unicon is a customer focused financial services organization providing a range of
investment solutions to our customers. We work with clients to meet their overall
investment objectives and achieve their financial goals. Our clients have the opportunity
to get personalized services depending on their investment profiles. Our personalized
approach enables clients to achieve their Total Investment Objectives.
Our key product offerings are as follows:
11

12. E
q
ui
ty
C
o
m
m
o
di
ty
D
e
p
os
it
or
y
D
is
tri
b
ut
io
n 12

13. 1. EQUITY:
UniconEasy
Browser based trading terminal that can be accessed by a unique ID and password. This
facility is available to all our online customers the moment they get registered with us
UniconSwift
Application based terminal for active traders. It provides better speed, greater analytical
features & priority access to Relationship Managers. Greater exposure for trading on the
margin available.
2. COMMODITY:
Unicon offers a unique feature of a single screen trading platform in MCX and
NCDEX.Unicon offers both Offline & Online trading platforms.
Live Market Watch for commodity market (NCDEX, MCX) in one screen.
Add any number of scrips in the Market Watch.
Tick by tick live updation of Intraday chart.
Greater exposure for trading on the margin available
Common window for market watch and order execution.
Key board driven short cuts for punching orders quickly.
Real time updation of exposure and portfolio.
Facility to customize any number of portfolios & watchlists.
Market depth, i.e. Best 5 bids and offers, updated live for all scripts.
Facility to cancel all pending orders with a single click.
Instant trade confirmations
Stop-loss feature.
13

14. 3. DEPOSITORY:
Unicon Depository Services offers dematerialization services as a participant in Central
Depository Services Limited (CDSL), through its Depository operations. The company
believes in efficient and cost-effective and integrated service support to its brokerage
business. Unicon Securities Private Limited, as a depository participant, will offer
depository accounts for individual investors as well as corporates which will enable them
to transact in the dematerialized segment, without any hassles.
Depository offer a safe, convenient way to hold securities as compared to holding
securities in paper form. Our service provides an integrated single platform for all our
clients ensuring a risk free, efficient and prompt depository process.
4. DISTRIBUTION:
Unicon is fast emerging as a leader in the Insurance and Mutual Funds distribution
space. Unicon has over 100 branches and a huge number of “Business Development
Executives” who help to source and service the customers throughout the country.
Unicon is fast becoming the preferred “Vendor Independent” distribution houses
because of providing efficient service like free pick-up of collection of cheques/DD’s,
Keeping track of the premiums etc to its customers.
14

15. Unicon offers the following distribution products:-
 IPO's
 Mutual Funds
 Insurance
 Properties
NRI SERVICES:
15

16. With India becoming the epicentre of growth the Global Indian feels the need
to be connected to the domestic growth story.
Unicon now offers a convenient and hassle-free way of
I
vesting in the Indian Securities Market to the people who are living outside
India and wish to participate in the Indian Growth story.
Procedure for NRI operations in Indian Capital Markets:-
 The NRI can deal with only one bank at any point of time.
 He is allowed to invest only 5% of the paid up capital of a company. The
aggregate paid up value of equity of any company purchased by all NRI's and
OCBs cannot exceed 10 percent of the paid up capital of the company and in
the case of convertible debentures, the aggregate paid up value of each series
of debentures purchased by all NRI's and OCBs cannot exceed 10 % of the
paid up value of each series of convertible debentures.
 He can enter only into delivery based trades, all deliveries must only be
routed through beneficiary accounts and not directly through the broker.
 Shares bought by him cannot be sold unless the payout of the same is
received from exchange.
 All purchase and sale transactions have to be reported to the RBI by the
designated bank.
 Original broker’s contract notes have to be submitted to the designated Bank
branch, within 24 hours of the transaction.
 He will be required to make bill to bill payments/ settlements. No adjustments
16

17. 5. BACK OFFICE:
Unicon through its online back-office aims to increase the transparency and
provides you the link to view the details of your account online anytime and
anywhere.
Here you have the advantage of viewing the following reports online:
 Sauda Details
 Financial Ledger
 Net position for the day
 Net position Detail (for the complete financial year)
 E-Contract Note
6. FIXED INCOME:
 The Fixed income vertical of UNICON Group deals in Sovereign Paper and
Money Market/Fixed Income Instruments Broadly, it undertakes following:
17

18.  Dealing in all types of money market instruments viz. Commercial paper
(Origination & Placement), Certificate of Deposit and Treasury Bills both in
Primary and Secondary market.
 Dealing in Government securities (including securities of Oil, Fertilizer &
Food Bonds) and other PSU/ Corporate bonds with counterparties like Banks,
Primary Dealers, Mutual Funds, Insurance Companies, Regional Rural Banks,
Cooperative Banks, Central & State PSUs, Housing Finance Companies,
NBFCs & Corporates.
 Retailing of Central, State Government Securities and Bonds to PF Trusts,
Universities
 Advisory Services to PF Trusts.
 Arrangers for Private placement of Bonds & placing it with Banks, Mutual
funds, Insurance Companies & Corporates.
 Securitization of receivable portfolio of Housing Finance Companies& Bank.
7. INVESTMENT BANKING:
The Investment Banking arm of Unicon Capital Services (P) Ltd. caters to the funding
requirements of corporates. Our wide experience and market knowledge as a leading
securities firm ensures that clients’ requirements are met at optimum cost. By constantly
improving our knowledge capital and remaining focused on client needs, we aim to
create significant value for our clients by helping them execute the right capitalization
strategy. We also intend to initiate merchant banking services (Capital Markets
Fundraising) in the short term (Merchant Banking License pending)
18

19. CURRENCY DERIVATIVES:
Currency Futures
Currently in India, US Dollar Indian Rupee (USD INR) currency futures are traded
on the NSE and MCX. Since its introduction in Aug 2008, USD INR futures have
seen a 1500% burst in volume growth. Unicon offers clients the opportunity to trade
this product, either in online or offline mode as per their needs. The product provides
ample liquidity to function both as a speculative tool and as a hedging instrument for
exporters and importers. The attractive features of the product are as follows
19

20. are
qu
ote
d
in
dol
lar
s
For
ex
por
ter
s
an
d
im
por
ter
s,
no
cre
dit
lin
e
req
uir
ed
fro
m
the
20

21. Unicon Advantage :
Se
cur
itie
s
can
be
use
d
for
eit
her
seg
me
nt
–
Eq
uit
y
Other awaited products
21

22. Eu
ro
IN
R
is
ex
pec
ted
to
be
intr
od
uce
d
an
yti
me
no
w
SE
BI
has
als
o
rec
om
me
nd
ed
22

23. 8. PORTFOLIO MANAGEMENT:
Portfolio Management Services
Gone are the days when an investor could directly participate in the capital markets,
for they have not only become far more complex in terms of compliances,
methodologies, effects and analysis but also need a constant tracking mechanism. As
is the case globally, the Indian investor has also realized the advantages of seeking
professional advice in order to not only manage but also augment his portfolio.
The Portfolio Management Schemes of the Company offer Discretionary Schemes
(Unicon Optimizer & Unicon Growth) for Individuals, Corporate Bodies, Partnership
firms, Proprietors, Non Resident Indians etc. The Company is registered with SEBI
enabling it to undertake Portfolio Management activities under a specific license.
The Schemes, duly approved by SEBI, are managed by a highly competent team
comprising of portfolio managers and equity strategists, backed by a team of
fundamental, technical and derivatives analysts. The principle objectives are to
identify investment opportunities through globally recognized analytical
methodologies, given pre-defined risk parameters construct portfolios to incorporate
client objectives periodically review of portfolios in order to consistently deliver
returns surpassing the benchmarked index and tailor-make portfolios to incorporate a
judicious mix of equity, quazi-equity, money market instruments and derivate
products.
23

24. PMS is a very personalized service wherein each portfolio has to be specifically
constructed in order to reflect the objective and risk appetite of a particular client. Our
qualified managers are constantly evolving methodologies and financial models that
provide them with a composite mix of:
1.
M
e
di
u
m
te
r
m
c
o
m
pr
is
in
g
of
v
al
u
e
in
v
es
ti
n
g
24

25. 25

26. UNICON PMS provides following benefits:


S


P


P


S


T

26

27. 1.3 OBJECTIVE OF THE STUDY
For the effectiveness of the study the objectives are:
PRIMARY OBJECTIVE:
1. To find out the effectiveness of index futures as a Hedging instrument.
SECONDARY OBJECTIVE:
2. To study about the impact of hedging in the derivative market.
3. To know about the emphasis of hedging in the future trading.
4. To analyze the effectiveness of hedging to reduce the risk.
5. To visualize about the Derivative market.
1.4 NEED FOR THE STUDY
The study on hedging strategies has been done to help the stock holders to control
their losses. With the help of this project the stock holders can focus on areas were
hedging strategies is required.
Capital market in India is always uncertain. Anything can happen in the market. A
stock picker carefully purchases securities based on a sense that they are worth more than
the market price. While doing so he faces a risk that the entire market moves against him
and generates losses even though the underlying idea was correct. To exit from this we
have to make securities independent from index through hedging with index futures.
Hedging with index futures removes the unwanted exposure of index movements. This
project can serve as a guide to bring new ideas to the stock holders.
27

28. 1.5 SCOPE OF THE STUDY
1. The study is attempted to assess the power of hedging technique using index
future.
2. This study aims at providing an insight into the operations of hedging strategies.
Hedging provides security to the investment and also reduces the level of risk
borne by the investors.
3. The study describes the strategies to select the right hedging techniques based on
the requirements of the investors.
1.6. LIMITATIONS OF THE STUDY
1. The conclusion cannot be conclusive as market fluctuations are unpredictable.
2. Index futures are only considered for Hedging.
3. The beta value for risk assessment is not precisely correct as it changes from time
to time.
4. The duration of the study was limited to period of three month so that the
extensive and deep study could not be possible.
5. The study is depending mostly on the web information.
6. Brokerages are not taken into consideration.
7. The study was limited only to UNICON SECURITIES PVT LTD, Chennai.
28

29. 1.6.1. Three Types of Exclusions from Effectiveness Testing:
In defining how hedge effectiveness will be assessed, an entity must specify whether it
will include in that assessment all of the gain or loss on a hedging instrument.
a. If the effectiveness of a hedge with an option contract is assessed based on
changes in the option's intrinsic value, the change in the time value of the contract would
be excluded from the assessment of hedge effectiveness.
b. If the effectiveness of a hedge with an option contract is assessed based on
changes in the option's minimum value, that is, its intrinsic value plus the effect of
discounting, the change in the volatility value of the contract would be excluded from the
assessment of hedge effectiveness.
c. If the effectiveness of a hedge with a forward or futures contract is assessed
based on changes in fair value attributable to changes in spot prices, the change in the fair
value of the contract related to the changes in the difference between the spot price and
the forward or futures price would be excluded from the assessment of hedge
effectiveness.
2. REVIEW OF LITERATURE
2.1. NEWSPAPER ARTICLE:
SENSEX SEEMS TO HIT MAX IN 2011: SAYS MADHUMITHA GHOSH
"The first quarter of 2011 would start with third quarter results and would face events like
Budget in the latter part. We expect better allocations towards India from foreign
institutions based on India growth story," Unicon Securities Vice-President Research
Madhumita Ghosh said.
However, experts cautioned that pressure in the form of higher inflation and interest rates
may act as spoilsport. Also currency appreciation is expected with increased inflow and
recovery.
29

30. The past year saw the Sensex hitting its record closing level of 21004.96 points on Diwali
day, November 5. However, the index could not surpass its highest intra-day level of
21,206.77 points, scaled on February 10, 2008.
While the performance of the country's most valued firm Reliance Industries was not up
to the mark, a number of other blue-chips, mostly from auto, banking, pharmacy and IT
space, performed well.
Some of the key stocks that gave impressive returns to investors included Bajaj
Auto, Tata Motors, TCS, Hidalgo, M&M, ICICI Bank, HDFC Bank and SBI.
2.2. MAGAZINE ARTICLE:
NMDC Ltd - Q3 FY11 Result Update - Unicon Investment
Solutions
At CMP the stock is trading at PE multiple of FY12E 12x and EV/EBITDA of
8x which is quite attractive compared to its peers. Considering the strong
demand for iron ore and robust expansion plan of the company.
• NMDC registered a strong top-line growth of 65% to INR 26.2 bn in Q3FY11
(22% above our estimate of INR 23,890 mn) supported by increased mining
coupled with better realization of iron ore prices. On QoQ basis, top line
increased marginally by 6.6%.
• EBITDA increased 87% YoY to INR 20,159 mn. EBITDA margin expanded
899 bps in Q3FY11 to 76.9%.
• The Net profit of the company stood at INR 15,180.3 mn in Q3FY11 (13%
above our estimate of INR 13,350 mn).
At CMP the stock is trading at PE multiple of FY12E 12x and EV/EBITDA of
8x which is quite attractive compared to its peers. Considering the strong
demand for iron ore and robust expansion plan of the company, we maintain our
buy rating on the stock with a target price of INR 350.
30

31. 2.3. HEDGING’S EFFECTIVENESS TESTED BY DIFFERENT SCHOLARS:
Butterworth and Holmes (2000) studied hedging effectiveness of FTSE -100 and
FTSE Mid 250 index futures contracts. They found that FTSE-100 provided effective
hedge for portfolio dominated by large firms and FTSE Mid 250 was equally effective for
portfolios dominated by small capitalizations stocks.
Brails ford et al. (2000) estimated hedge ratio by several techniques for the Australian
All Ordinary Share Price index futures contract. Yang (2009) showed that M-GARCH
dynamic hedge ratio provides largest degree of reduction in variance of returns.
Nonetheless, some recent studies for example Lien et al (2011) and Moosa (2003) have
reported that basic OLS approach outperforms other advanced models of hedge ratio
estimation. In India very few studies were conducted on the hedging effectiveness of the
Futures contract.
Roy and Kumar (2007) studied hedging effectiveness of wheat futures in India.
They used conventional OLS method for hedge ratio estimation and found wheat futures
contracts do not provide effective hedge in avoiding risk. Bhaduri and Durai (2008)
examined hedging effectiveness of Nifty Futures. They found OLS based strategy
provided better hedge in shorter time horizons. However, at higher time horizons
bivariate GARCH clearly dominates. Further, Kumar et al (2008) examined hedging
effectiveness of constant and time varying hedge ratio of Nifty Futures, Gold Futures and
Soybean futures. Their results showed that the time varying hedge ratio provided greatest
variance reduction as compared to other hedges based on constant hedge ratio.
Investors studying the market often come across a security, which they believe is
intrinsically undervalued. It may be the case that the profits and the profits the quality of
the company make it seem worth a lot more than the market think. A stock picker
carefully purchases securities based on a sense that they worth more than the market
price. When doing so, he faces two kinds of risks:
31

32. 1. His understanding can be wrong, and the company is really not worth more
than the market price, or
2. The entire market moves against him and generates losses even though the
underlying idea was correct.
Choice of hedging instruments:
The literature on the choice of hedging instruments is very scant. Among the
available studies, Géczy et al. (1997) argues that currency swaps are more cost-effective
for hedging foreign debt risk, while forward contracts are more cost-effective for hedging
foreign operations risk. This is because foreign currency debt payments are long-term and
predictable, which fits the long-term nature of currency swap contracts. Foreign currency
revenues, on the other hand, are short-term and unpredictable, in line with the short-term
nature of forward contracts. A survey done by Marshall (2000) also points out that
currency swaps are better for hedging against translation risk, while forwards are better
for hedging against transaction risk. This study also provides anecdotal evidence that
pricing policy is the most popular means of hedging economic exposures.
These results however can differ for different currencies depending in the sensitivity of
that currency to various market factors. Regulation in the foreign exchange markets of
various countries may also skew such results.
Production and Trade vs. Hedging Decisions
An important issue for multinational firms is the allocation of capital among different
countries production and sales and at the same time hedging their exposure to the varying
exchange rates. Research in this area suggests that the elements of exchange rate
uncertainty and the attitude toward risk are irrelevant to the multinational firm's sales and
production decisions (Broll, 1993). Only the revenue function and cost of production are
to be assessed, and, the production and trade decisions in multiple
Countries are independent of the hedging decision.
The implication of this independence is that the presence of markets for hedging
instruments greatly reduces the complexity involved in a firm’s decision making as it can
32

33. separate production and sales functions from the finance function. The firm avoids the
need to form expectations about future exchange rates and formulation of risk preferences
which entails high information costs.
FACTORS AFFECTING HEDGING DECISIONS:
The following section describes the factors that affect the decision to hedge and then the
factors affecting the degree of hedging are considered.
 Firm size: Firm size acts as a proxy for the cost of hedging or economies of
scale. Risk management involves fixed costs of setting up of computer systems
and training/hiring of personnel in foreign exchange management. Moreover,
large firms might be considered as more creditworthy counterparties for forward
or swap transactions, thus further reducing their cost of hedging. The book value
of assets is used as a measure of firm size.
 Leverage: According to the risk management literature, firms with high
leverage have greater incentive to engage in hedging because doing so reduces
the probability, and thus the expected cost of financial distress. Highly levered
firms avoid foreign debt as a means to hedge and use derivatives.
 Liquidity and profitability: Firms with highly liquid assets or high
profitability have less incentive to engage in hedging because they are exposed to
a lower probability of financial distress. Liquidity is measured by the quick ratio,
i.e. quick assets divided by current liabilities). Profitability is measured as EBIT
divided by book assets.
 Sales growth: Sales growth is a factor determining decision to hedge as
opportunities are more likely to be affected by the underinvestment problem. For
these firms, hedging will reduce the probability of having to rely on external
financing, which is costly for information asymmetry reasons, and thus enable
them to enjoy uninterrupted high growth.
33

34. HEDGING USING INDEX FUTURES
Stock index futures can be used to hedge the risk in a well-diversified portfolio of
stocks. Here the strategy employed is “HAS PORTFOLIO SHORT NIFTY”. It is
explained as follows:
When one owns a portfolio of shares and there are chances that market will fall in
the near future, it could be a very uncomfortable feeling. Or it could be that the market
is in a few days of volatility and the investor is not the kind who can handle such
anxiousness. The union budget being a common and reliable source of such volatility
market volatility is always enhanced for one week before or two weeks after a budget.
This is particularly a problem if it is required to sell shares in the near future, for
example, for buying a car or financing children’s education. This planning can go
wrong if, by the time the shares are sold, Nifty has dropped sharply.
There are traditionally two things that one can try in such situations.
1. Sell shares immediately. The sentiment generates panic selling which is
rarely optimal for the investor.
2. Do nothing; i.e. suffer the pain of the volatility. This leads to political
pressures for government to do so something when stock prices fall.
Now with index futures there is a third and remarkable alternative for those who are
not satisfied with the above two alternatives:
Remove the exposure to index fluctuations temporarily using index futures. This
allows rapid response to market condition, without panic selling of shares. It allows an
investor to be in total control of his risk, instead of doing nothing and suffering the risk.
The idea here is quite is simple. Each portfolio contains a hidden index exposure. This
statement is true for all portfolios; most of the portfolio risk is accounted for by index
fluctuations (unlike individual stocks, where only 30-60% of the stock risk is accounted
34

35. for by index fluctuations). Hence, a position LONG PORTFOLIO + SHORT NIFTY
can often become one-tenth as risky as the LONG PORTFOLIO position.
LONG HEDGE
In a long hedge one buys futures contract. The hedger is either currently short
the cash good or has a future commitment to buy the good at the spot price that will
exist at a later date. In either case, any subsequent price rise would lead to profit in the
futures market and losses in the cash good market. The hedger must also be aware that
prices might fall leading to a profit in the cash good market and loss in the future
market. The hedger must thus be reasonably sure that price changes of the cash position
and changes in the futures price will be correlated.
SHORT HEDGE
In a short hedge, one sells futures contracts. Here the hedger fears that prices
will fall and if they do loss will be sustained in the spot market. The shot hedger either
currently long the cash good or has a commitment to sell it on a future date at an
unknown price. With the hedge in place if prices do indeed decline, loss will be
incurred on the cash position but there will be a profit in the futures position. As a result
any loss that arising from cash position can be minimized with a hedge in that place.
HEDGE RATIO
Hedge ratio is referred to the number of futures contracts required to be sold or
bought provide maximum offset of risk of a given value of investment in shares or other
goods. This depends on the following:
• Value of a future contract
• Value of the portfolio or stock to be hedged and
• Sensitivity of the movement of the portfolio price to that of the index (beta)
35

36. It is calculated using the following formula.
Hedge ratio = value of shares or portfolio * beta value / value of futures per
contract.
The hedge ratio is closely related to the correlation between the asset (portfolio of
shares) to be hedged and underlying (index) from which the future is derived.
Accidental offsetting:
Using the same example above, assume that the forward contract was not an
exchange traded instrument but a bilateral, uncollateralized contract. If the counterparty
to the forward contract had a sudden, severe deterioration in its credit standing then the
offset between the change in the value of the future commodity purchase and the change
in fair value of the hedging instrument would be accidental. This is because the effect of
the change in the credit standing of the counterparty is unrelated to and dominates the
effect of changes in the commodity price. The optimal hedge ratio of 1.11 to one (ie
hedging 100t of purchases with a forward contract volume of 90t) would still be driven
by the commodity price changes but because of the credit risk related change of the value
of the forward contract the hedging relationship would no longer have the systematic
offset of fair value changes regarding the commodity risk that would otherwise result
from a hedge ratio of 1.11 to one.
Qualitative assessment:
An entity acquired a 100,000 CU debt instrument that pays 6-month Libor
semi-annually. The maturity of the instrument is 2 years. Entity A is exposed to interest
rate decreases and would like to eliminate the risk of changes in the variability in the cash
flows by entering into an interest rate swap whereby it would pay 6-month Libor semi-
annually (aligned with the cash flows received on the bond) and would receive a fixed
rate. For simplification the effect of credit risk is being ignored in this example.
36

37. Entity A wants to hedge the exposure to the variability of the cash flows using an existing
interest rate swap with the same remaining maturity and variable payments but a different
fixed rate (reflecting the interest level when the swap was originally entered into). Entity
A considered the fair value of the swap at the inception of the swap to be immaterial.
Hence, if there are no differences in the other critical terms, hedge ineffectiveness would
result from the swap’s fair value at the time of designating it as the hedging instrument.
This hedge ineffectiveness arises because of the effect of interest rate changes on that fair
value as well as the unwinding of the discount on that amount.
HEDGING STRATEGIES
A number of strategies are available for hedging with derivatives. But in
hedging with futures contracts, that too, with index features, four strategies are
identified. They are listed below:
• Have portfolio / short index futures
• Have funds / long index futures
• Long stock / short index futures
• Short stock / long index futures.
3. RESEARCH METHODOLOGY
INTRODUCTION
Research methodology is a way to systematically solve the research problem. It
may be understood as a science of studying how research is done scientifically. In it we
study the various steps that are generally adopted by researcher in studying his research
problem along with the logic behind them.
The methodology used for carrying out the present study covers title of the study
and significance of the study. Aims and objectives of the study, research hypothesis,
37

38. Research design, sampling design, pilot study, method for data collection, operation
definition statistical Analysis, limitation of the study and chapterisation.
3.1. NATURE OF DATA:
 Primary data
 Secondary data
Primary data: -
The primary data are those, which are collected for the first time and thus
happen to be original character.
 Observation :
The stock market is closely observed for volatility. The trend is changing
every second and the readings are mostly taken from intra-day calculation. The
index changes reflect in the investment decision and the market is very vicious
by its own way. The data collected may become obsolete on the same day itself.
 Interview :
By interviewing the analyst the data can be collected. The data collected by
means of analyst is reliable to some days. Technical analysis and fundamental
analysis are done.
 Questionnaires:
The questionnaires are given to the stock brokers and got the answers. The
answer may be biased and incorrect. It depends on the person answering the
questions. Questionnaires won’t work every time.
Secondary data:
38

39. Secondary data are those which have already been collected by someone else and
which already had been passed through the statistical process. The secondary data for the
study was collected through books, web.
3.2. SOURCES OF DATA
The study has used secondary data from various financial journals, websites and
the fact sheets of those concerned mutual fund companies.
3.3. TOOLS USED:
 Beta value analysis
 Index future analysis
1) BETA VALUE ANALYSIS
Beta value is a measure of systematic risk or non divisible risk of a security. Beta
show how the price of a security responds to market forces. Beta measures the degree to
which any portfolio of stocks is affected as compared to the effect on the market as a
whole.
Beta = N∑ x y - ∑ x ∑ y
N ∑ x2 - ∑ x2
Where,
‘N’ is the number of data points or Number of observations
‘X’ is the bench mark returns, and
‘Y’ is the investment returns.
Note: beta values are taken from NSE site
CALCULATION
 Amount of investment made = no of shares * share price of the company as on the
particular date.
39

40.  No of shares = investment in each company / share price (closing)
 Portfolio beta amount = beta value of each company * portfolio amount
 Beta of the portfolio = value of the beta amount / value of the portfolio.
INDEX FUTURE ANALYSIS
 Amount of nifty sold = portfolio amount * beta of the portfolio
 No of nifty sold = amount of nifty to be sold / closing price of nifty future
 Nifty lot = 50
 No of nifty to be verified = no of nifty to be sold / nifty sold
 Hedged value = nifty * no of nifty to be hedged * lot
Note: Closing price of nifty’s are taken from NSE site
The following diagram represents the movement of nifty index according to the
investments.
MEASURING HEDGING EFFECTIVENESS:
Selecting an appropriate hedge effectiveness methodology is vitally important, since the
wrong choice can produce spurious and misleading results. There are accounting
standards (IAS39, FAS133) in place for hedge accounting, but these are based on very
general principles and allow a significant amount of flexibility.
The four main methods to measure hedge effectiveness are:
• Critical Term Match Method
• Dollar-Offset Method
• Regression Analysis
• Risk Reduction Method
40

41. The Critical Term Match Method:
Allows the assumption that a hedge can be considered “perfect” without an on-going
assessment of effectiveness. For instance, an interest rate swap is likely to be a perfect
hedge if the following parameters in both loan (hedged instrument) and swap (hedge) are
identical:
• notional amounts
• terms
• payment and fixing dates
• amortization schedules
• reference rates
• day conventions
Often, however, these parameters do not (fully) match, so other methods should be
applied. Before introducing these, let us turn our attention to the term “reference
exposure”. It is possible to review an underlying with an existing hedging instrument or
to compare it to an Ideal Designated-Risk Hedge (IDRH). We use the IDRH as the
reference exposure, on the basis of which we define an ideal hedge for an underlying
instrument. Intuitively for a floating rate loan, the IDRH is an interest rate swap in which
we receive floating rate and pay fixed rate. Note: The ideal swap’s floating leg has
identical terms to those of the loan.
Dollar Offset Method and Regression Analysis:
In both cases - Dollar Offset Method and Regression Analysis – the cumulative change of
the hypothetical swap cash flows (net payments) is compared to the cumulative change of
the actual swap cash flows (net payments). The next step is to use this data to implement
either the Dollar Offset Method or Regression Analysis for both retrospective and
prospective analysis. Note: It is important to perform analyses for both historical and
future periods.
41

42. Now consider a loan and a swap in relation to which an analysis of hedge accounting is to
be performed. The instruments have the parameters outlined in table 1. As you can see,
the actual swap is not an ideal hedge for this loan. The receive leg pays semi-annually
according to 6-month Euribor. For an ideal swap, there should be monthly payments (1-
month Euribor). Common sense tells one that the actual swap has fairly reasonable
hedging properties, as 1-month and 6-month Euribor rates behave similarly. This would
not be the case, however, for 1-month Euribor versus 10-year swap rate. The below
example explains the hedging mechanism:
TABLE-1: Details of the hedged item (loan) and hedging instrument (swap)
Hedged item Hedging IDRH
instrument
Type of contract Loan Actual swap Ideal swap
notional (EUR) 1 000 000 1 000 000 1 000 000
settlement date 8.09.2009 8.09.2009 8.09.2009
maturity date 8.09.2022 8.09.2022 8.09.2022
Receive leg
payment frequency NA semi- Monthly
annually
coupon accrual day NA act/360 act/360
convention
reference rate NA 6M Euribor 1M Euribor
Pay leg
payment frequency Monthly annually Monthly
coupon accrual day act/360 30/360 act/360
convention
reference rate 1M Euribor fixed fixed
@4.189% @4.189%
The results of any effectiveness test need to be interpreted in the context of hedging
objectives. This interpretation is usually facilitated by defining effectiveness ’thresholds’
for the test (referred to as ’lower’ and ’upper’ in our explanation). For example, the actual
swap is an effective hedge according to the Regression Analysis if the correlation is
42

43. between 0.8 and 1.0, the slope of the regression line is between 0.8 and 1.25 and the
determination coefficient (R-squared) is above 0.64.
The results show that the hedge surpasses both Dollar Offset and Regression Analysis for
prospective periods. But there is a different outcome in the retrospective analysis:
According to the regression test, it is an effective hedge but fails the Dollar Offset test.
TABLE-2: Dollar-Offset Analysis (retrospective):
Effective hedge test
lower upper result test
DOR threshold 80% 125% NA NA
compliance level 80% 100% 59,72 FAIL!
%
Compliance level
number of 43
compliments
sample size 72
compliance level 59,72%
TABLE-3: Dollar-Offset Analysis (prospective)
Effective hedge test
lower upper result test
DOR threshold 80% 125% NA NA
compliance level 80% 100% 88.57 PASS!
%
Compliance level
number of 62
compliments
sample size 70
compliance level 88.57%
43

44. TABLE-4: Regression Analysis (retrospective)
Effective hedge test
Lower upper result test
correlation 0.800 1.000 0.979 PASS!
R2 0.640 1.000 0.958 PASS!
slope 0.800 1.250 0.989 PASS!
CHART-1: REGRESSION ANALYSIS:
44

45. TABLE-5: Regression Analysis (prospective)
Effective hedge test
Lower upper result Test
correlation 0.800 1.000 0.984 PASS!
R2 0.640 1.000 0.968 PASS!
slope 0.800 1.250 0.981 PASS!
CHART-2: PROSPECTIVE REGRESSIONN ANALYSIS:
4. DATA ANALYSIS:
4.1. DESCRIPTIVE STATISTICS:
45

46. This study uses daily price changes of dollar spot, dollar futures data on the
nearby contract and Non-Deliverable Forwards (NDF) from January 2, 2009 to December
28, 2010. The data are from data-stream and Bloomberg. The closing data of the dollar
spot futures data are from 4:00 p.m. on the basis of New York Standard time. The price
changes of all time series are calculated as follows:
RSTτ = STt − STt −1 (1)
RFTτ = FTt − FTt −1 (2)
The terms, RSTτ means the price change of dollar cash price. RFTτ Represent the
daily price changes of Dollar futures and NDFs. Where STt and STt −1 are the Dollar spot
price at time t and at time t-1 respectively. FTt And FTt −1 is the closing price of the Dollar
futures and NDFs at time t and at time t-1 respectively.
The summary statistics for the daily dollar spot and futures, 1 month NDF and 3
month NDF data.
Furthermore, all the Dollar exchange spot, futures and NDFs series are tested to
ensure whether they are stationary. As we expected the level variables are all non-
stationary which means that each has a unit root in its autoregressive representation. This
indicates that each series is non-stationary, necessitating the calculation of first
differences and the difference series are then checked for the presence of a unit root. We
see that the ADF and the PP tests clearly reject the null hypothesis of the presence of a
unit root for each series, implying that the difference series are indeed stationary, that is,
I(0).
Since it is established that each series is I (1), the next step is to test the co-
integration relationship between dollar spot and futures as well as between dollar spot
and NDFs. We employ the Johansen co-integration test. According to the test results,
there is a co-integration relationship between the level variables of dollar cash and futures
data. However there is no co-integration relationship between the level variables of dollar
spot and NDFs data. Therefore, when we estimated the optimal hedge ratio and hedge
performance of Dollar futures markets we incorporate the error-correction term in our
46

47. hedging model suggested by Engle and Granger (1987). The error correction term
imposes the long-run restrictions into this short-run model.
Measures for skewness and excess kurtosis indicate that all foreign currency
series are significantly skewed and leptokurtic with respect to the normal distribution.
The Bera-Jacque statistics for the return series of the Dollar exchange spot, futures and
NDFs are statistically significant, indicating the presence of serial correlation (linear
dependencies). This suggests the presence of autoregressive conditional
heteroskedasticity, i.e. volatility clustering, which can be properly modeled by the ARCH
framework of Engle (1982) and Bollerslev (1986).
Data summary statistics for daily dollar spot exchange rate and dollar futures
exchange rate from January 2, 2009 to December 28, 2010. Return of spot exchange rate
and futures exchange rate is defined as the value: RSTτ = STt − STt −1 , RFTτ = FTt − FTt −1 ,
where STt and FTt is the spot and futures exchange value at time t .
B-J is the Bera-Jarque test for normality. The statistic is
 skewness 2 (kurtosis − 3) 2 
B-J = T  + 

 6 24 

2
PB-J is distributed X 2 under the null of normality. ***. ** indicate the significance at
the 0.1 and 0.5 percent level, respectively.
The relation between spot and future exchange rates and their variance is shon below. İt
denoted the rate of return depends on the exchange rates.
TABLE-6: Dollar spot and futures exchange rates:
Spot Futures
Rate Return Rate Return
47

48. Mean 1270.98 -0.14 1273.27 -0.15
Median 1284.00 -0.10 1286.50 -0.20
Maximum 1365.20 21.50 1367.00 23.50
Minimum 1165.60 -23.10 1167.70 -21.00
Standard 44.52 5.72 44.46 5.78
deviation
Skewness -0.54 0.19 -0.52 0.21
Kurtosis 2.09 4.37 2.07 4.13
J-B 40.53*** 40.89*** 39.79*** 29.49***
TABLE-7: NDF Forwards exchange rates:
1 Month NDF 3Month NDF
Rate Return Rate Return
Mean 1273.37 -0.17820 1278.18 -0.1684
Median 1286.70 -0.2000 1290.80 -0.1000
Maximum 1366.00 23.5000 1370.00 25.0000
Minimum 1168.40 -22.0000 1173.60 -21.5000
Standard 44.5554 5.7638 44.3099 5.8661
deviation
Skewness -0.5204 0.21031 -0.4821 0.2169
Kurtosis 2.0676 4.3436 2.0442 4.3427
J-B 39.9444*** 40.5556*** 37.7108*** 40.7382***
A. Ederington (1979) Risk Minimization Hedge:
Ederington (1979) suggests that the minimum variance hedge model in which
the spot position is considered fixed and the optimal hedge ratio (number of futures
contract per spot contract) is determined from the Ordinary Least Squares (OLS)
regression of spot price changes on futures price changes. The optimal hedge ratio
represents the minimum risk level for the spot/futures portfolio and consists of the
covariance between the spot and futures divided by the variance of the futures. The
objective of the hedger is to minimize the variance of the price changes for the Dollar
48

49. exchange spot rate/futures rate portfolio. The expected price change and variance of the
hedged position are established as follows;
RSTt − RSTt −1 = α + β ( RFTt − RFTt −1 ) + ε t (3)
Where RSTt − RSTt −1 represents the price change of the Dollar spot exchange rate
from t-1 to t, RFTt − RFTt −1 represents the price change of the Dollar futures, 1 month and
3 month NDFs exchange rate from t-1 to t. β is the optimal hedge ratio estimated by the
Ordinary Least Squares (OLS) regression. The slope coefficient of equation (3) is used as
the measure of optimal hedge ratio under the conventional hedge model system. We also
define the optimal hedge ratio as the covariance between Dollar cash and futures and
between Dollar cash and NDF.
The hedge ratios of 0.97636 for Dollar futures, 0.98794 and 0.96597 for 1 month
NDFs and 3 month NDFS imply that 0.97636 daily contract, 0.98794 1 month NDFs and
0.96597 3 month NDFs of the Dollar futures and forwards markets needs to be shorted
for a long position of 1 spot exchange to minimize the variance of the hedged position
value change. This hedge ratio is considerably less than one, which implies that the
Dollar futures and forwards exchange are more volatile than the Dollar spot exchange
rate.
Hedging effectiveness (HE) of Dollar futures and NDFs markets can be measured
as the percent reduction in the variance of the unhedged Dollar spot position by the risk
minimization hedge as follows;
Var (∆C t ,t +1 ) − Var (∆Portfolio t ,t +1 )
HE = Var (∆C t ,t +1 )
(4)
For example, the minimum variance of the Dollar spot exchange and futures portfolio
value change is as follows:
[Cov( ∆C t ,t +1 , ∆Ft ,t +1 )] 2
Var (∆Portfolio t ,t +1 ) = Var (∆C t ,t +1 ) − (5)
Var ( ∆Ft ,t +1 )
49

50. The same equation is applied for the minimum variance between Dollar spot and
NDFs portfolio value changes. Consequently, from the above equations 4 and 5, we
employ the following equation (6) to figure out the hedge performance between Dollar
futures market and NDFs market.
[Cov(∆C t ,t +1 , ∆ t ,t +1 )] 2
HE = =ρ2 (6)
Var (∆C t ,t +1 )Var (∆Ft ,t +1
Where ρ 2 is the population coefficient of determination between Dollar spot
and futures exchange changes as well as Dollar spot and forwards rate change, and it can
be estimated as RP2P, the sample coefficient of determination of regression 3. Table 2
reports RP2P, of 0.9736, 0.9914, and 0.9817 so that a 97.36%, 99.14%, and 98.17%
reduction of the daily variance of the Dollar spot position has been achieved by the risk
minimum hedging strategy. In details, If we have a long position of one (1) Dollar
portfolio at foreign exchange spot market theoretically we have to take a short position of
0.97636 contract at the Dollar futures market to hedge the downside risk of Dollar spot
position during the period from January 2, 2009 to December 28, 2010. As a result, the
variance reduction for the hedged portfolio is 97.36% compared with the unhedged spot
position. In case of Dollar forward markets, the risk adverse hedger has to sell 0.9914 and
0.9817 NDFs to cover the downside risk in Dollar spot position.
The estimation results of optimal hedge ratio using conventional minimum variance
hedge model with constant hedge ratio to Dollar futures and NDFs market
To determine the optimal hedge ratio of One-dollar futures, 1 month NDFs and 3 month
NDFs to cover the downside risk of Dollar spot position, the following regression is
estimated using time-matched daily data for the period from January 2, 2009 to
December 28, 2010.
( RSTτ − RSTt −1 ) = α + β ( RFTt + RFTt −1 ) + ε t
50

51. where ε t = ∑i =1α i ε t −i + η t , the dependent variable is the price change of Dollar spot
p
exchange rate and the independent variable is the price changes of Dollar futures and
NDFs from day t and t+1, β coefficient represents the minimum risk hedge ratio
(number of futures and NDFs contracts per one(1) Dollar spot position), and the
coefficient of determination, R 2 , measures the hedging effectiveness in terms of the
percent reduction of the variance of the unheeded spot position. *** indicates the
significance at the 1% percent level. Asymptotic t-statistics are given in parentheses.
TABLE-8:
1 Month 3 Month
Futures Markets NDF Market NDF Market
+0.00531 -0.00764 -0.02100
α
(0.04198P)P (-0.3189) (-0.6009)
Hedging 0.97636*** +0.98794*** +0.96597***
Ratio ( β ) (134.28) (+237.45) (162.01)
Hedging
Effectivene 0.9736 0.9914 0.9817
ss ( R 2 )
F 18032.26*** 56371.00** 26250.29***
B. Vicariate GARCH and ECT-ARCH Hedge:
The results of optimal hedge ratio using the Dollar NDF markets using
bivariate ECT-ARCH (1) and GARCH (1, 1) models
Estimates of the following bivariate GARCH (1, 1) model are established as follows;
RSTτ = α 0 s + e st ,
RFTτ = α 0 f + e ft
 es , t   h ss ,t h sf ,t 
e  ψ t −1 ∼ N (0,HBtB), H t = h h ff ,t 
 f ,t   sf ,t 
51

52.  hss , t   a1  b11 b12 b13   hss ,t −1   c11 c 12 c13   ε s2,t −1 
a  + b    
b23   hsf ,t −1  + c 21 c 23  ε s ,t −1 , ε f ,t −1 
 
HBtB=  hsf ,t  =  2   21 b22   c 22 
h ff , t 
   a3  b31
   b32 b33  h ff ,t −1  c31
   c32 c33   ε 2 ,t −1 
 f 
where RSTτ and RFTτ are the Dollar spot rate and NDF forwards price changes,
respectively, eτ is a (2x1) vector of residuals, ψ τ −1 is the information set at time t-1, HBt
B is a (2x2) conditional variance-covariance matrix of residuals, and the a , b and c
matrices are assumed to be diagonal. The model is estimated using time-matched daily
from January 2, 2009 to December 28, 2010. ***, **, * indicate the significance at the 1,
5, and 10 percent level, respectively.
TABLE-9:
Standard deviation is given in parentheses.
1 Month NDF market 3Month NDF markets
a 0s +0.011649 +0.08571
(+0.20868) (+0.18024)
a0 f +0.02309 +0.10459
(+0.21050) (+0.17804)
a11 +22.49248*** +23.21146***
(+0.78934) (+1.71877)
a 22 +22.64801*** +28.29347***
(+0.71437) (+2.96977)
a33 +22.53457*** +29.45349***
52

53. (+0.72771) (+4.90508)
b11 +0.32758*** +0.42171***
(+0.03306) (+0.04051)
b22 +0.32385*** +0.30601***
(+0.03158) (0.07292)
b33 +0.32822*** +0.28779***
(+0.03143) (+0.11809)
c11 +0.23891*** +0.11394***
(0.02730) (+0.02928)
c 22 +0.23833*** +0.11144***
(+0.02609) (+0.02955)
c 33 +0.23778*** +0.11859***
(0.02524) (0.03073)
Log-L -894.23 -1181.00
HR +0.99537*** +0.98082***
(+0.01060) (+0.01985)
The following chart indicates the changes in the first
quarter of the financial year in s&p cnx nifty index values.
It shows an increasing phase in the starting of march and
then decrease in the month of may.
53

54. The stock market shows a gradual increase till 1970, and then it started to decline. The
derivatives are still in implement phase in India so it will take time and programs for
making it popular. The economic changes always keeps the market volatile and the future
advancements will lead to better growth in the market.
The extension of trend line on the changes in the future market:
54

55. 55

56. 5.1. INTREPRETATION AND FINDINGS
An overall comparison of the Hedged portfolio and Portfolio without Hedging
and Descriptive hedging was made. It was found that in case of portfolio without hedging
the investor incurred a loss of Rs. 760.7 where as in case of all time hedging he incurred a
profit of Rs.12, 675, after trading the investor would have earn profit to Rs.11, 914.3 and
in case of descriptive hedging he incurred a profit of Rs.4, 58,424.3 So this study reveals
the following facts about hedging: -
Hedging helps to minimize the risk:
 In case of hedged position the investor was able to make a profit in Descriptive
hedging and reduce loss in All Time Hedging.
 Though hedging minimizes risk, it is not possible always. If the index moves up
from the day of hedging, then it can be loss.
 Higher the beta value higher will be the risk.
 The time of applying these strategies has an important role in determining the
effectiveness of hedging.
6.1. SUGGESTIONS
On the basis of analysis made and findings reached at, following suggestions are
forwarded to existing investors and prospective investors.
 If one wants to hedge with portfolio, the portfolio must consist of scrip’s from
different sectors and here index futures are better for hedging, since they are
convenient and represent the true nature of the security market as a whole. The
advantage is that risk within the portfolio can be minimized completely and the
portfolio will only be affected by the market risk.
 Investor should read Newspapers, Business Journals, and Websites etc to get the
awareness about the stock market situations and factors, which will affect the
stock market. He should give keen attention on the activities of the major players
in the market.
56

57.  Hedging is actually a tool to reduce the losses that may arise from the market risk.
Its primary objective is loss minimization, not profit maximization.
 If the trend of the market is to move up, instead of hedging in index futures,
option is more advisable.
 The investor should not stick on one strategy in the whole time; he should change
his strategies according to their market situations.
 With the expectation of making huge profit from derivatives one should not trade
and speculate in the market. It is very risky and may incur huge losses.
 The hedger will have to be a strategic thinker and also one who thinks positively.
He should be able to comprehend market trend and fluctuations. Otherwise the
strategies adopted by him will earn him only losses.
6.2. CONCLUSION
Hedging with index futures proved to be an effective instrument. Through the
index futures hedging we reduce the unnecessary risk of the index movement. Thus
hedging reduces the loss from the portfolio. Our study also finds out that India’s
derivative market is not much established because it introduced in India at 2000. Still
many investors don’t know about derivatives and its use correctly. Index in coming
future, the derivative market will show a remarkable growth.
Hedging does not remove losses. The best that can be achieved using hedging is
the removal of unwanted exposure (i.e. Unnecessary Risk). The hedged position will
make less profit than the un-hedged position. In some cases it makes an additional profit
also. One should not enter into a hedging strategy hoping to make excess profits. All that
come out of hedging is to reduce risk.
57

58. BIBLIOGRAPHY:
 Economic times(PTI, Jan 2, 2010, 02.34pm IST)
 economy watch(Feb 18, 2010 – NMDC Ltd - Q3 FY11 Result Update)
 www.unicon.com
 www.sebi.india.com
 www.stockchart.com
 www.journals.com
58