Difference between equity and derivatives.

Difference between Equities and Derivatives.

(Difference between Equities and Derivatives in hindi)

EQUITIES:

Equity is typically referred to as shareholder equity (also known as shareholders' equity), or owners equity (for privately held companies), which represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company's debt was paid off.

DERIVATIVES:

Derivatives is defined as “a financial contract whose value is derived from the value of an

underlying asset or simply underlying”

Derivatives have no direct value in and of themselves -- their value is based on the expected

future price movements of their underlying asset.

The most common types of derivatives are futures, options, forwards and swaps.

STEPS TO INVEST IN EQUITIES:

The Trading procedure involves the following steps:

1. Selection of a broker:

The buying and selling of securities can only be done through SEBI registered brokers who are members of the Stock Exchange. The broker can be an individual, partnership firms or corporate bodies. So the first step is to select a broker who will buy/sell securities on behalf of the investor or speculator.

2. Opening Demat Account with Depository:

Demat (Dematerialized) account refer to an account which an Indian citizen must open with the depository participant (banks or stock brokers) to trade in listed securities in electronic form. Second step in trading procedure is to open a Demat account.

The securities are held in the electronic form by a depository. Depository is an institution or an organization which holds securities (e.g. Shares, Debentures, Bonds, Mutual (Funds, etc.) At present in India there are two depositories: NSDL (National Securities Depository Ltd.) and CDSL (Central Depository Services Ltd.) There is no direct contact between depository and investor. Depository interacts with investors through depository participants only.

Depository participant will maintain securities account balances of investor and intimate investor about the status of their holdings from time to time.

3. Placing the Order:

After opening the Demat Account, the investor can place the order. The order can be placed to the broker either (DP) personally or through phone, email, etc.

Investor must place the order very clearly specifying the range of price at which securities can be bought or sold. e.g. “Buy 100 equity shares of Reliance for not more than Rs 500 per share.”

4. Executing the Order:

As per the Instructions of the investor, the broker executes the order i.e. he buys or sells the securities. Broker prepares a contract note for the order executed. The contract note contains the name and the price of securities, name of parties and brokerage (commission) charged by him. Contract note is signed by the broker.

5. Settlement:

This means actual transfer of securities. This is the last stage in the trading of securities done by the broker on behalf of their clients. There can be two types of settlement.

(a) On the spot settlement:

It means settlement is done immediately and on spot settlement follows. T + 2 rolling settlement. This means any trade taking place on Monday gets settled by Wednesday.

(b) Forward settlement:

It means settlement will take place on some future date. It can be T + 5 or T + 7, etc. All trading in stock exchanges takes place between 9.55 am and 3.30 pm. Monday to Friday.

STEPS TO INVEST IN DERIVATIVES.

Trading in Commodity future comprises of four simple steps.

Step 1: Choosing a Broker:

There are following entities in the trading system:

1. Trading cum Clearing Member (TCM) 

• Trading cum Clearing Member (TCM)  Can carry out the transactions (trading, clearing and settling) on their own account and also on clients accounts. 

• The exchange assigns an ID to each TCM

• Each TCM  can have more than one user.

• The unique TCM ID functions as a reference for all orders/trades of different users.

Eligibility Criteria 

Following entities are eligible to apply for membership, subject to the regulatory norms and provisions:

• Corporates 

• Registered Partneship Fims 

• LLPs

• Sole Proprietors/ Individuals

Net worth:

• Min Rs 100 Lakhs 

2. Professional Clearing Member (PMC) 

• These members can carry out the transactions i.e settlement and clearing for their clients who have traded though TMC’s or as TM’s. 

• PCM are entitled only to clear and settle trades executed by trading cum clearing members or trading members of exchange.

            Eligibility Criteria 

Following entities are eligible to apply for membership, subject to the regulatory norms and provisions:

• Any companies & insitutions

Net worth:

• Min Rs 500 Lakhs

3. Trading Member (TM) 

• Member who can only trade through their account or on account of their client and will  clear their trade though PMC/STCM 

• TM’s have no right to clear or settle such trades. 

• All TMs must be affiliated with any one of the institutional trading-cum-clearing member or professional clearing members having clearing rights on exchange. 

Eligibility Criteria 

Following entities are eligible to apply for membership, subject to the regulatory norms and provisions:

• Corporates 

• Registered Partneship Fims 

• LLPs

• Sole Proprietors/ Individuals 

            Net worth:

• Min Rs 10 Lakhs for Non Corporate & Rs 25 Lakhs for Corporates 

4. Strategic Trading cum Clearing Member (STCM) 

• This is up gradation from TCMs  to STCMs.

• Such members can trade on their own account, and also on account of their client. 

• They can clear and settle trades of theirs as well as of others who are not allowed to trade and are not allowed to settle and clear. 

Structure of Electronic Trading

Step 2: Depositing money.

• Once the Broker is chosen and Documentation is done every client get a unique Code from the broker.

• All future communication between the client and TM is recorded with the same Unique code also known as ‘Client Code’.(Combination of Alphabets and Number)

Guidelines

1. All clients must be registered clients at the members back office.

2. The Unique code is to be allotted to each client and it should be alphanumeric and no special characters can be used.

3. The same client should not be allotted multiple codes. 

Initial Margin

• The amount that must be deposited by a client a the time of entering into a contract is called “initial margin”.

• this margin is meant to cover the potential loss in one day.

• It is a mandatory requirement.

• It ranges from 5% to 15% of the value of contract, with min of 5% ,except for Gold @ 4% min.

Step 3: Trading Plan:

• Once the Trading account is ready with Initial Margin been paid up, it is the time to execute the trading plan.

• Trading plan is the workable trading idea about, which asset contract to deal.

• Trading plan consists of:

• Which Commodity to deal?

• What position to create – Short or Long?

• At what price the futures contract be entered? 

•  Should  there be any Stop Loss, to minimize the trading risk 

• Can take up huge position just by paying small margin amount.

• Thus earn potential profit and so loss. 

• 
  

Step 4: Clearing & Settlement:

1. Futures Contracts have 2 Types of Settlement :

1. Mark to Market (MTM) , Settlement  which happens on a continuous basis at the end of each day 

2. Final Settlement , which happens on the last trading day

All exchanges have both system cash & delivery mechanism.

1. Cash 

If you want cash settlement, you need to indicate at the time of placing the order that you don’t intend to deliver the item. 

2. Delivery 

If you plan to take or make delivery, you need to have the require warehouse receipt. 

FUNCTIONS OF STOCK EXCHANGE (EQUITIES):

• Providing liquidity and Marketability to Existing Securities:

Stock Exchange provides a ready and continuous market for buying and selling securities. It provides a platform where shares can be sold and bought by buyers and sellers.

• Pricing of Securities:

Based on the forces of demand & supply, Stock Exchange helps in putting a value on the securities which provide instant data to both buyers and sellers and thus helps in the pricing of securities.

• Safety of Transaction:

All participants associated with a stock exchange are well regulated, and are required to work within the legal framework given by the regulator. Such a system ensures the safety of transactions. In India, all trading is regulated by SEBI.

• Contributes to Economic Growth: 

People get a chance to buy and sell their shares, letting them invest money. Stock exchange provides a platform by which savings get channelized into the most productive investment proposals, which leads to capital formation & economic growth.

• Spreading of Equity Culture:

 Stock exchanges have extensive information on the listed companies, which is further available to the public. This data helps in educating public about investments in securities which leads to spreading of wider ownership of shares.

• Providing Scope for Speculation: 

Securities,when purchased solely with a view of gaining profit through price movement to a target is called speculation. Stock exchanges provide scope within the provisions of law for speculating in a restricted and controlled manner.

FUNCTIONS OF DERIVATIVES MARKET.

1. Management of risk

Management of different types of risk through various strategies like hedging, arbitraging, spreading etc is one of the important services provided by the derivatives to control, avoid and manage such risk.

2. Price discovery

Price discovery means revealing information about future cash market prices through future market. Derivatives provide such mechanism.

3. Liquidity and reduce transaction cost

In derivatives trading no immediate full amount of the transaction is required because of margin trading. Hence it enhances liquidity and reduces transaction cost in the markets of underlying assets.

4. Measurement of market:

Derivatives serve as barometers, of the future trends in price which result in the discovery of new prices both in spot and futures markets. They help in getting information regarding trading to the society which enable to discover tue equilibrium price in the market.

5. Efficiency in trading

Financial derivatives allow for free trading of risk components and that leads to improving market efficiency. Traders can use a position in one or more financial derivatives as a substitute for a position in underlying security.

6. Speculation and arbitrage

Derivatives can be used o acquire risk rather than to hedge against risk. Thus some individuals will enter into the contract to speculate on the value of the underlying asset. Likewise the individuals will also look for arbitrage opportunities and make profit.

7. Hedging 

Hedge or mitigate risk occurs in the underlying by entering into a derivative contract whose value moves in the opposite direction to their underlying position. Hedging also occurs when an individual buys an asset and sells it using futures contract.

8. Price stabilization function

Derivatives market helps to keep a stabilization influence on spot prices  by reducing the short term fluctuations.

 

9. Gearing of value:

Special care and attention about financial derivatives provide leverage (or gearing), such that a small movement in the underlying value can cause a large difference in the value of the derivatives.

 

10. Encourage competition

The derivatives trading encourage the competitive trading in the market, different risk taking preferences at market operators like, speculators, hedgers, traders, arbitrageurs etc, resulting in increase and trading volume in the country.

HIGH RISK = HIGH RETURNS

HAPPY INVESTING.