The major backbone of the economy Essay Example

The major backbone of the economy Essay Example The major backbone of the economy Essay The major backbone of the economy Essay India has started the innovations in financial markets very late. Some of the recent developments initiated by the regulatory authorities are very important in this respect. Futures trading have been permitted in certain commodity exchanges. Mumbai Stock Exchange has started futures trading in cottonseed and cotton under the BOOE and under the East India Cotton Association. Necessary infrastructure has been created by the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) for trading in stock index futures and the commencement of operations in selected scripts. Liberalised exchange rate management system has been introduced in the year 1992 for regulating the flow of foreign exchange. A committee headed by S. S. Tarapore was constituted to go into the merits of full convertibility on capital accounts. RBI has initiated measures for freeing the interest rate structure. It has also envisioned Mumbai Inter Bank Offer Rate (MIBOR) on the line of London Inter Bank Offer Rate (LIBOR) as a step towards introducing Futures trading in Interest Rates and Forex. Badla transactions have been banned in all 23 stock exchanges from July 2001. NSE has started trading in index options based on the NIFTY and certain Stocks. In the decade of 1990s revolutionary changes took place in the institutional infrastructure in Indias equity market. It has led to wholly new ideas in market design that has come to dominate the market. These new institutional arrangements, coupled with the widespread knowledge and orientation towards equity investment and speculation, have combined to provide an environment where the equity spot market is now Indias most sophisticated financial market. One aspect of the sophistication of the equity market is seen in the levels of market liquidity that are now visible. The market impact cost of doing program trades of Rs. 5 million at the NIFTY index is around 0. 2%. This state of liquidity on the equity spot market does well for the market efficiency, which will be observed if the index futures market when trading commences. Indias equity spot market is dominated by a new practice called Futures Style settlement or account period settlement. In its present scene, trades on the largest stock exchange (NSE) are netted from Wednesday morning till Tuesday evening, and only the net open position as of Tuesday evening is settled. The future style settlement has proved to be an ideal launching pad for the skills that are required for futures trading. Stock trading is widely prevalent in India, hence it seems easy to think that derivatives based on individual securities could be very important. The index is the counter piece of portfolio analysis in modern financial economies. Index fluctuations affect all portfolios. The index is much harder to manipulate. This is particularly important given the weaknesses of Law Enforcement in India, which have made numerous manipulative episodes possible. The market capitalisation of the NSE-50 index is Rs. 2. 6 trillion. This is six times larger than the market capitalisation of the largest stock and 500 times larger than stocks such as Sterlite, BPL and Videocon. If market manipulation is used to artificially obtain 10% move in the price of a stock with a 10% weight in the NIFTY, this yields a 1% in the NIFTY. Cash settlements, which is universally used with index derivatives, also helps in terms of reducing the vulnerability to market manipulation, in so far as the short-squeeze is not a problem. Thus, index derivatives are inherently less vulnerable to market manipulation. A good index is a sound trade of between diversification and liquidity. In India the traditional index- the BSE sensitive index was created by a committee of stockbrokers in 1986. It predates a modern understanding of issues in index construction and recognition of the pivotal role of the market index in modern finance. The flows of this index and the importance of the market index in modern finance, motivated the development of the NSE-50 index in late 1995. Many mutual funds have now adopted the NIFTY as the benchmark for their performance evaluation efforts. If the stock derivatives have to come about, the should restricted to the most liquid stocks. Membership in the NSE-50 index appeared to be a fair test of liquidity. The 50 stocks in the NIFTY are assuredly the most liquid stocks in India. The choice of Futures vs. Options is often debated. The difference between these instruments is smaller than, commonly imagined, for a futures position is identical to an appropriately chosen long call and short put position. Hence, futures position can always be created once options exist. Individuals or firms can choose to employ positions where their downside and exposure is capped by using options. Risk management of the futures clearing is more complex when options are in the picture. When portfolios contain options, the calculation of initial price requires greater skill and more powerful computers. The skills required for pricing options are greater than those required in pricing futures. In India, the futures market for commodities evolved by the setting up of the Bombay Cotton Trade Association Ltd. , in 1875. A separate association by the name Bombay Cotton Exchange Ltd was established following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association. With the setting up of the Gujarati Vyapari Mandali in 1900, the futures trading in oilseed began. Commodities like groundnut, castor seed and cotton etc began to be exchanged. Raw jute and jute goods began to be traded in Calcutta with the establishment of the Calcutta Hessian Exchange Ltd. in 1919. The most notable centres for existence of futures market for wheat were the Chamber of Commerce at Hapur, which was established in 1913. Other markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar, Chandausi, Meerut, Saharanpur, Hathras, Gaziabad, Sikenderabad and Barielly in U. P. The Bullion Futures market began in Bombay in 1990. After the economic reforms in 1991 and the trade liberalization, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K. N. Kabra. The Committee recommended that futures trading be introduced in basmati rice, cotton, raw jute and jute goods, groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils and oilcakes of all of them, rice bran oil, castor oil and its oilcake, linseed, silver and onions. All over the world commodity trade forms the major backbone of the economy. In India, trading volumes in the commodity market have also seen a steady rise to Rs 5,71,000 crore in FY05 from Rs 1,29,000 crore in FY04. In the current fiscal year, trading volumes in the commodity market have already crossed Rs 3,50,000 crore in the first four months of trading. Some of the commodities traded in India include Agricultural Commodities like Rice Wheat, Soya, Groundnut, Tea, Coffee, Jute, Rubber, Spices, Cotton, Precious Metals like Gold Silver, Base Metals like Iron Ore, Aluminium, Nickel, Lead, Zinc and Energy Commodities like crude oil, coal. Commodities form around 50% of the Indian GDP. Though there are no institutions or banks in commodity exchanges, as yet, the market for commodities is bigger than the market for securities. Commodities market is estimated to be around Rs 44,00,000 Crores in future. Assuming a future trading multiple is about 4 times the physical market, in many countries it is much higher at around 10 times.