Summary, Findings and Conclusion

Chapter Seven Summary, Findings and Conclusion Introduction Summary Major Findings Recommendations Conclusion 335

INTRODUCTION Globalization and liberalization have increased the international trade and financial transactions manifold in the recent years. It has, in turn, raised all types of risks including market risk, liquidity risk, price risk and interest rate risk. Managing these risks has become a major task for finance managers worldwide and it spurred financial innovations to mitigate risks. This has led to the emergence of a class of innovative financial instruments called derivatives. Financial derivative is a widely discussed topic in the recent years due to its tremendous growth in terms of volume of trade, number of contracts traded and variety of products. However the complex nature of the product, uncertainties involved in trading and lack of knowledge about trading techniques are some of the critical issues to be solved. Moreover house mortgage issue in U.S, fall of Lehman brothers, US recession which in turn led to global recession, has all created a negative image to financial derivatives. Skillful use of derivatives is essential to mitigate the loss suffered from spot market. Hence it is necessary for anyone who handles derivatives to know the art of dealing with derivatives in an efficient way. The process of reducing loss by efficient use of derivatives assumes importance and is known as hedging. This chapter provides a summary of the study and gives some recommendations based on research findings. This chapter is subdivided into three main sections: A) Summary B) Major findings of the study C) Recommendations. 336

A) SUMMARY This study is an earnest attempt to understand some aspects of financial derivatives as a hedge tool. Though financial derivatives were introduced as a hedge tool, it is still not widely used. In spite of the measures taken by the regulatory authorities in our country to control the volume of speculative transactions, derivatives segment remains mostly a domain of speculators. Statement of the Research Problem Existing research literatures do not conclusively present the extent of hedge usage among individual derivative traders and how far they help in mitigating the risk. Present study is an earnest attempt to cover this research gap. Following research questions bring the problem into sharp focus: Does Indian derivatives market exhibit hedge effectiveness? If so, to what extent? What is the extent of use of derivatives for hedging by traders? Is there any room for promoting hedge habits among individual traders? Objectives 1. To assess the extent of hedge effectiveness of financial derivatives traded in India. 2. To examine the attitude of individual derivative traders towards hedge. 3. To compare the general profile, awareness level and trading beliefs of hedgers and non-hedgers 4. To identify and evaluate the perceived problems of derivative traders. 5. To analyse the nature of influence of various intermediaries on trading decisions of individual traders. 6. To make recommendations to improve the functioning of financial derivatives market, if needed. 337

Scope and Significance of the Study Chapter 7 Summary, Findings and Conclusion Scope of the study is limited to some selected stock and index futures. The study is confined to the use of derivatives by individual share traders in Kerala. Though derivatives were introduced as a risk management tool its usage for hedge purpose by individual traders seems to be lacking. Speculative activities are gaining popularity in the derivative segment. Hence it is necessary to assess the usage level of derivatives for hedging among individual traders. This study covers mainly three different aspects 1) extent of hedge effectiveness 2) need for promoting derivatives as a hedge tool and 3) how to fill the gap if any, between the hedge effectiveness and the present level of adoption of derivatives to hedge. Models Developed for the Study 1. Conceptual model for the study. 2. Working model. 3. Model showing present scenario of Indian derivative market. 4. Financial derivatives as a hedge tool An acceptance model Variables for the study Based on the conceptual model developed for the study, relevant variables were identified such as coverage of potential loss, satisfaction level, hedge attitude, future behaviour, awareness, probable loss, risk level, percentage of risk coverage, stock prices, duration of contracts, variety of contracts and frequency of awareness programs. 338

Hypotheses As part of the study, 11 hypotheses were developed and tested using appropriate tools. A summary of the results of hypothesis testing is given below: Null Hypothesis There is no significant difference in the awareness level of hedgers and nonhedgers regarding different aspects of derivatives trading. There is no significant difference in the composition of hedgers and non-hedgers in different regions of Kerala. There is no significant difference in the demographic pattern of hedgers and non-hedgers There is no significant difference in the distribution of ranks given by respondents to different problems in derivatives trading. Frequency of hedge is independent of satisfaction on hedge coverage. Table 7.1: Summary of Hypothesis Testing Test of Result Hypothesis (95% Confidence Level) T test p value is less than.05 and null hypothesis is rejected. Chi-Square Test p value is greater than.05 and hence accept null hypothesis Chi-Square Test p value is greater than.05 and hence accept null hypothesis Chi-Square Test p value is less than.05 and hence reject null hypothesis Chi-Square Test p is less than.05. Hence null hypothesis is rejected 339

Future behaviour of hedgers is independent of satisfaction on hedge coverage There is no significant difference in the assistance obtained by hedgers and nonhedgers from stock broking firms. There is no significant difference in the distribution of ranks given by hedgers for the most influencing intermediaries There is no significant difference in the distribution of ranks given by non-hedgers for the most influencing intermediaries Futures and spot series are non-stationary Chi-Square Test T test Chi-Square Test Chi-Square Test Unit Root - Dickey Fuller Test Out of four aspects identified for future behavior, in case of one aspect Future use of hedge p value is less than.05. Hence reject null hypothesis. But in case of other three aspects Recommend hedge, Would continue to trade, Welcome new products, p value is greater than.05 and hence null hypothesis is accepted. p value is less than.05 in case of Advice to hedge hence null hypothesis is rejected and in other two cases, Number of awareness programs and Proper training on how to hedge p value is greater than.05 and hence accept null hypothesis. p value is less than.05 and hence reject null hypothesis p value is less than.05 and hence reject null hypothesis p value is less than.05 for first difference series and hence reject null hypothesis. Thus futures and 340

spot series are stationary at first difference. Futures and spot series are not Engle-Granger p value is less than.05 and hence cointegrated test of reject null hypothesis. Thus futures Cointegration and spot series are cointegrated. Research Design The study used descriptive research design. Hedge effectiveness was verified with relevant data and tools. It also involves analyzing the risk perception, risk assumption and risk mitigation with risk management tools by individual traders. Sample design for primary data The respondents for the study were investors/traders of financial derivatives market with special reference to Kerala. From among the defined population of 65 SBFs only 26 SBFs were having offices in northern, southern and central regions of Kerala. Hence, these 26 SBFs formed the sample frame for selection of respondents. Multi-Stage sampling technique was used for the selection of respondents from stock broking firms. The whole of Kerala state was divided into three regions north, south and central. Two districts from each region were selected using random sampling. From north Kerala Kozhikkode and Malappuram were selected, from Central Kerala, Ernakulam and Thrissur were selected and Kottayam and Trivandrum from the South Kerala. From the 26 stock broking firms, 15 were selected on random basis and two branches of these 15 SBFs from each region were selected at random. Thus, a total of 90 branches were selected for the study. Respondents from these branches were selected randomly. 341

Sample size In case of non-hedgers, standard deviation of pilot study was 13.46. Expected standard error is taken as 1.5 and Z value at 95% confidence level is 1.96. Hence sample size of non-hedgers is found to be 310. In case of hedgers, standard deviation of pilot study was 3.27. Expected standard error is taken as.92 and Z value at 95% confidence level 1.96. Hence sample size of hedgers is 50 respondents. Tools for data collection Structured questionnaire, participant and non-participant observation, unstructured interviews were used for collecting data. Both ranking and scaling questions were included in the questionnaire. Five point Likert scale was used to measure the awareness while attitude of investors was measured using semantic differential scale. Behavioural intentional scale was also used to understand the predictable future behaviour of respondents. Pilot Study and Reliability Test Based on the pilot study a reliability test was conducted and Cronbach alpha of 0.85 for questionnaire 1 and 0.809 for questionnaire 2 was obtained which shows that the questionnaires are reliable. Sample Design for Secondary Data From the sample frame of stock futures in 24 sectors, near month expiry hedge efficiency was calculated by selecting a sample of 24 stock futures each from 24 different sectors on random basis. Overall hedge efficiency for three expiries were calculated based on 15 stock futures randomly selected from the 24 stock futures. Out of the seven market indices, three were selected, to assess the hedge efficiency. 342

Tools for analysis Apart from percentages and descriptive statistics like Mean, Median, Mode, Standard Deviation etc., tools like Multi-Dimensional Scaling, Cointegration, Error Correction Model, Z test, Chi-Square test, Friedman test etc. were also used to arrive at meaningful conclusions. Period of the study Secondary data for assessing the hedge effectiveness were compiled for five years from April 2007 to March 2012. Primary data were collected from the sample respondents in 2010 and 2011. Limitations of the study 1. As there were no related studies, difficulty was experienced in developing appropriate methodology and techniques for the study. Effort has been taken to avoid mistakes. Alternative techniques can also be used to analyse the data and test the hypotheses to establish relationships between the variables. 2. There may be a number of variables affecting the trading habits of individuals but study focuses only on selected number of variables. Hence, there may be inadequate coverage of some dimensions of derivative application. 3. Financial derivatives are a wider topic with variety of products, but the present study is limited to hedge effectiveness of only two products, stock futures and index futures. 4. Since the derivative traders using financial derivatives for hedge are few in number, a small sample size of 50 hedgers could only be collected. 343

Chapter Scheme Chapter 1 gives an introduction to the present study and also explains the design of the study. Chapter 2 presents the literature review, which provides a setting for the study, gathered from different sources based on which research gap for the study was found out. Chapter 3 is a theoretical framework of the study covering different concepts and theories, trends in global scenario, Indian scenario, Hedge mechanism etc. Chapter 4 gives the analysis of hedge effectiveness of Indian futures market. Chapters 5 assess the hedge effectiveness of Index futures in Indian derivatives market. Chapter 6 deals with the analysis of attitude and behaviour of individual traders in Kerala. It covers demographic profile, awareness level, influence of intermediaries, hedge habits. Chapter 7 concludes the study with a listing of major findings and recommendations. B) MAJOR FINDINGS OF THE STUDY Major findings of this study are summarised below. It is categorised under two main sections Hedge effectiveness and Attitude of derivative traders. a) HEDGE EFFECTIVENESS Assessing the extent of hedge effectiveness of Indian derivatives was one of the main objectives of the study. This section is again divided into three subsections; Hedge efficiency of Indian stock futures and indices, Hedge effectiveness of Indian stock futures and indices, Satisfaction level of hedgers. Hedge Efficiency of Indian Stock Futures and Indices Results of analysis on hedge efficiency of near month expiries and all expiries combined together are presented here separately. 344

Near Month Hedge Efficiency: 1. Vast majority of stock futures (96%) shows average hedge efficiency of 80% and above. 2. 38% of stock futures exhibit an average hedge efficiency of 100% and above, while 50% exhibit an average hedge efficiency of 90 to 100% and 8% of the stock futures exhibit an average hedge efficiency of 80 to 90% and only 4% have hedge efficiency of less than 80%. 3. Backwardation and Contango analysis shows that in Indian stock futures market, instances of hedge efficiency were more than the instances of hedge inefficiency between the periods 2007-08 to 2011-12. 4. October-December quarter seems to be the efficient quarter with highest ratio of hedge efficiency. Overall Hedge Efficiency: 5. Regarding overall hedge efficiency, 80% of Indian stock futures exhibit an average hedge ratio of 80% or above 6. Around 70% of stock futures show that near month contracts are more efficient while the rest 30% shows that next month futures are more efficient. Hedge efficiency of far month contracts is comparatively less and seems to be more volatile. 7. Backwardation and Contango analysis shows that in case of 73% of stock futures, instances of hedge efficiency are more than the instances of hedge inefficiency. 8. In a vast majority of stock futures (86%), frequency of positive hedges is higher for near month contracts followed by next month and then far month contracts. 345

Hedge Effectiveness of Stock Futures and Index Futures 9. Based on the average hedge efficiency of near month futures, 95.8% of Indian stock futures are found to be effective as per the standard ratio 80% to 120% set by SFAS 133. 10. Based on yearly average hedge efficiency of near month futures, 67% of stock futures are found to be effective in all the five years under study. 11. Based on the overall hedge efficiency of three expiries for the last five years from 2007-08 to 2011-12, 80% of stock futures are found to be effective when compared with the standard ratio. 12. Error correction model shows that the hedge efficiency of S&P CNX Nifty is 82.29% which can be inferred as effective according to standard set by SFAS 133. However Bank Nifty and CNX IT have a hedge efficiency of only 72.97% and 50.67% respectively. Hence they are found to be ineffective as it is less than the standard set by SFAS 133. Satisfaction Level of Hedgers 13. Majority, 60% of hedgers have a regular habit of hedging. 14. On an average, hedgers are having only 50% hedge coverage. 15. Hedgers are found to be satisfied in all aspects of hedging except awareness programs conducted by stock broking firms. 16. Chi-Square test of hypothesis shows that frequency of hedge is dependent on satisfaction of hedge coverage. 346

17. Hypothesis testing shows that future use of derivatives for hedge is dependent on the satisfaction of hedge coverage. 18. Regarding preference of products for hedge, 34% of hedgers prefer stock options while 26% each prefer index futures and index options equally. Least preferred is stock futures. b) ATTITUDE OF DERIVATIVE TRADERS This subsection presents the results of analysis of five different aspects; Demographic profile, behavior of derivative traders, Beliefs and emotions, Problems in derivative trading and Role of intermediaries. Demographic Profile of Respondents 19. Demographic details show that 43.05% of derivative traders are in the age group 30 to 45 years, 42.22% are having Degree as their educational qualification and 50.56% are Employees in private or public sector. 20. Majority of the respondents, 53.61%, have less than five years of experience in stock market and 38.9% have 1 to 2 years of experience in derivatives market. 21. Chi-Square test result shows that there is no significant difference in the demographic pattern of hedgers and non-hedgers. Behaviour of Derivative Traders 22. Regarding the trading habit, 36.94% are having a habit of frequently trading in derivatives while 28.61% trade occasionally, 20.28% trade always and 14.17% trade rarely in this segment. 347

23. Regarding preference of products for trading, out of 360 respondents 119 respondents (33%) give first preference to stock futures, 77respondents (21%) give first preference to stock options, 81(23%)to index futures and 83(23%) to index options. 24. Regarding future behaviour of traders study finds that hedgers are of the opinion that they will definitely continue to trade in derivatives while non-hedgers are of the opinion that they may probably continue to trade. Beliefs, Emotions and Feelings of Derivative Traders 25. Mean score of awareness level of non-hedgers is 20.98 and of hedgers is 27.82 in a scale with maximum score 40which shows that non- hedgers are aware of different aspects of derivatives trading while hedgers are fairly aware. T test result shows that there is significant difference in the awareness level of hedgers and nonhedgers. It is inferred that hedgers are more aware than non-hedgers, as the mean score is higher for hedgers. 26. Around 56% of non-hedgers are least aware about the concept called Hedge. Vast majority of non-hedgers 87% have given preference to trade in derivatives due to several reasons like profit making, fund leverage, to supplement income etc. Only 13% have given first preference for covering the loss from spot market as the primary reason for trading on derivatives. 27. Mean score of attitude of hedgers towards derivative trading is 39.18 and mean scores of attitude of non-hedgers is 37.66 in a scale with maximum score of 60.This can be inferred as both hedgers and non-hedgers are having mildly positive belief towards different aspects of trading. 348

28. 66.1% of non-hedgers are of the opinion that lack of awareness about hedge is the reason for not using derivatives for hedge. Vast majority of non-hedgers (83%) are interested in learning hedge techniques. Problems Faced by Derivative Traders 29. Chi-Square test shows that there is significant difference in the ranking given by respondents to different problems faced in derivatives trading. 30. The study found that problems faced by derivative traders can be viewed from two different dimensions. Firstly based on Services provided and secondly on the basis of Market mechanism. From the point of view of Services provided, lack of training was found to be the most crucial problem while from the point of view of Market mechanism, maintenance of margin money was found to be the most severe problem faced by derivative traders. Role of Intermediaries 31. Both hedgers and non-hedgers are of the opinion that stock brokers should promote hedge. It was found that lack of support from SBFs was the main reason why non - hedgers are not doing hedge. 32. Both hedgers and non-hedgers rarely get assistance from SBFs and both are neutral regarding the opinion about effect of such assistance, awareness program etc. 33. Friedman test result shows that for hedgers experienced people seems to be the most influencing one followed by SBFs. For non-hedgers, SBFs seems to be the most influencing intermediary followed by experienced people. 34. Hedgers are of the opinion that friends and relatives have influenced them to hedge rather than SBFs, awareness programs, etc. 349

Thus, based on the above findings, present scenario of financial derivatives segment can be depicted as follows: LOW USAGE LEVEL Hedge Effectiveness GAP LOW AWARENESS LESS TRAINING 80% to 95% Satisfaction of hedgers LESS SUPPORT FROM SBFs On an average hedge ratio is only 50% FUTURE BEHAVIOUR PROBABLY MARGIN MONEY DISSATISFED with the outcome OF AWARENESS PROGRAMS Fig.7.1: Present Scenario A Schematic Representation 350

From the study it was found that there is a wide gap between hedge effectiveness on one side and lack of its usage by traders on the other side as clearly depicted in fig.7.1. Hence the question arises, why hedge habits are lacking when there is enough logic for it? Some of the reasons for this are lack of promotional activities, lack of awareness and lack of training on technical aspects of hedge. As far as the hedgers are concerned their hedge coverage ratio is only around 50% while the secondary result shows that a good strategy of hedge may even result in 80% to 95% hedge coverage. How can this gap be reduced? How can the hedge habits be promoted? How can the hedge coverage ratio be increased? These questions lead to the necessity of providing recommendations for improving the efficiency of financial derivatives market C) RECOMMENDATIONS To mitigate the gap between hedge effectiveness on one side and less usage of derivatives for hedge on the other side, several promotional measures need to be taken. An important problem to be solved is how to improve the average hedge coverage ratio from 50% to 80% or more. Proper guidance should be given to hedgers in this regard. Most of the hedgers are not aware of their optimal hedge ratio. If a proper hedge portfolio is created hedge coverage can be increased to around 80 to 90%. Following steps is recommended to be followed to increase the hedge coverage: 1. Identify the amount exposed to risk. 2. Calculate optimal hedge ratio. 3. Hedge the amount based on optimal hedge ratio. 4. Select proper combination of derivative products for hedge. 351

Lack of training and Maintenance of margin money is yet another problem. Stock broking firms should play a significant role by providing proper training sessions to traders. Opportunities to have special forums for discussions with experts in derivatives trading should be available. Daily settlement and maintenance of margin money has to be modified. Traders can be given more time to fill the variation in the margin money. This will simplify the risk to traders and as a result more traders will be attracted to trade. Awareness level of derivative traders on hedge concepts, especially nonhedgers, is very poor. To increase the awareness on hedge, stock broking firms should conduct awareness programs with special focus on hedge strategies. A demo trading session can be conducted. Special focus should be given to extent of risk exposure, extent of coverage, hedge ratio, popular strategies like straddle, strangle, delta hedge etc. People entering derivatives market should have a basic knowledge about different aspects of trading. Special training sessions on technical aspects need to be conducted on regular basis and course completion certificates can be issued. Stock exchanges should introduce new certification programs with special focus to hedge. Non-hedgers are mostly influenced by stock broking firms. Hence role played by stock broking firms in promoting hedge habits of non-hedgers should be improved. Special aid can be given by regulatory authorities to stock broking firms, to take promotional measures. Lack of experts in this field is yet another problem. To solve this problem a panel of investment experts who are specialized in different trading strategies can be formed. Each stock broking firm may have an investment expert who can guide the traders in selecting proper hedge position. 352

The major recommendations can be summarised as follows: 1. Practice of hedge based on optimal hedge ratio is to be popularized. 2. Separate training sessions on hedge can be conducted. 3. Stock exchanges can introduce new certification programs with special focus to hedge. 4. Each stock broking firm may have an investment expert who can guide the traders in selecting proper hedge strategy. 5. Present system of maintenance of margin money need to be simplified so as to reduce the burden of traders. Traders can be given more time to fill the variance in margin money. 6. Stock broking firms, as a major influencing intermediary, should undertake more advertising campaigns and use of celebrities to advertise can attract more attention from general public. 7. A group of investment experts can be made available to clear the doubts of traders through different media like telephone, emails, online communication etc. 8. SEBI, which is the regulatory body and stock exchanges like NSE and BSE and regional stock exchanges, may set up separate funds to promote the role of SBFs. AN ACCEPTANCE MODEL The study has developed a notable model for promoting financial derivatives as a hedge tool. By undertaking proper measures, the gap between hedge effectiveness and its usage level can be reduced. Following Acceptance Model Fig 7.2 depicts how the critical issues can be handled efficiently for a better functioning of financial derivatives market. 353

Hedge Management and Promotional Measures Optimal Hedge Ratio- Proper combination of derivative products Awareness Programs Technical Training Sessions Sessions on Hedge Strategies Increase in Hedge coverage ratio to 80% and above Reduction in Margin money Special forums to clear clarifications of investors Increase in awareness level of Non-hedgers Increasing role of Stock Broking Firms (SBFs) Satisfaction on Hedge coverage Satisfaction on Training sessions by SBFs Satisfaction on Margin money Increase in usage level of Hedge Financial Derivatives as a Hedge Tool Future behaviour will shift from probably to definitely Fig.7.2: Financial Derivatives as a Hedge Tool An Acceptance Model 354

CONCLUSION Derivatives are one of the fastest growing and widely used financial innovations which have their impact on financial markets, monetary policies, investment avenues, regulatory framework and even on research and academics. Derivatives segment has emerged as an area of utmost care and concern due to its anomalous behaviour. Innovations in financial theory, increased computerization and changes in capital market have all contributed to the growth of financial derivatives market. It was noted that Korean exchange stood first among the world exchanges in terms of the volume of derivative contracts traded in 2011 while the Indian exchange, NSE, was in the fifth position. But in 2012, Chicago Mercantile Exchange CME Group occupied the top position and NSE has come up to the third position. It is interesting to note that NSE secures the top five positions in case of all the three products namely stock futures, Index futures and index options except stock options. While comparing the derivatives traded in different regions, it was noted that Asia pacific region has the major share. Equity derivatives have the maximum growth rate when compared to other categories like commodity derivatives, currency derivatives etc. On an average the annual growth rate of derivatives traded in India is 24%. It was noted that index options have the maximum growth rate in 2012 when compared to index futures, stock options and stock futures. This study has mainly focused on the hedge effectiveness of Indian futures market and also the attitude and behaviour of financial derivative traders. From the detailed analysis of primary and secondary data it is concluded that, on one side Indian derivatives market is effective in hedging while on the other side majority of traders are unaware of 355

proper hedge techniques. Over use of speculation will dampen the efficient derivative system and hence steps should be taken to improve the hedge habits of derivative traders. Study also assessed traders beliefs and behavioural patterns and arrived at the conclusion that there is a need to popularize hedge habits among derivative traders. Thus, it can be concluded that by undertaking several innovative measures the usage level of financial derivatives for hedge can be increased. By reducing some of the complexities in the system like lack of training, margin money maintenance etc. new traders will be attracted to hedge. It is necessary to maximize the participants in the derivatives segment so as to have a smooth flow of Indian derivatives segment. Study concludes that promoting financial derivatives as a hedge tool is need of the hour. This is possible by bridging the gap between extent of hedge effectiveness on one side and its less popularity among derivative traders on the other side. 356