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Management Of Financial Risk Through Equity Derivatives

Article · March 2024

DOI: 10.47750/pnr.2022.13.S09.1277

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 Management Of Financial Risk Through Equity
Derivatives

Jyoti Ainapur 1*, Shailaja Kheni 2

1
Department of MBA, GNDEC Bidar, India
[email protected]
2
Department of Management Studies, VTU, Center for Post Graduate Studies, Kalburagi, India
[email protected]
*Corresponding author: [email protected],
DOI: 10.47750/pnr.2022.13.S09.1277

In the present scenario equity derivatives are the most essential tools in the financial market. Derivative instruments provide an
opportunity to earn a profit for those investors who are willing to take higher risks. Financial Derivative instruments include
Futures contract Option contract, Index futures and Index option. The main crux of this paper is to study how investors are trading
in financial derivatives to hedge their risk and to measure their satisfaction level towards trading these instruments. Investors
viewpoint is measured in terms of price discovery, risk management and satisfaction level. Primary data is collected from 173
respondents who were actively trading in F&O segments in Bidar city of Karnataka State. The study resulted that, there is a
significant relationship between risk management & price discovery on satisfaction level of investors trading in derivatives and
using derivatives for risk management.

Key word: Futures, Hedge, Options; Risk, Satisfaction.

INTRODUCTION
Due to the rapid growth of international trade and business, the introduction of derivatives has greatly impacted the
profitability of the investors. The derivatives have become very popular in the world of finance due to their various
advantages. Its increasing popularity indicates that the demand for derivatives is getting greater. The purpose of these
instruments is to provide protection against volatility in the future. The main purpose of derivative instruments is to
reduce the risk of financial volatility. This is the analysis of derivatives traders who make educated guesses regarding
the future performance of a particular stock. It involves taking into account the past performance and the prevailing
market conditions.

RESEARCH QUESTIONS

1. To analyze whether investors are using Financial derivatives as a risk management tool for hedging against
risk
2. To assess whether investors are using Financial derivatives for price discovery of underlying security in
different market
3. To study the satisfaction level of financial derivative traders based on two variables Risk management and
Price Discovery.

LITERATURE REVIEW

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Many companies use financial derivatives to manage the risk, it is used to hedge the risk which is being faced by the
company(Ramzan, 2018) . Derivative traders are having lack of knowledge and need high investment initially but
developing countries have realized its importance. (Rishi Manrai, 2015). The most important drivers to use derivatives
for risk management (Risk management) (Sahoo & Sahoo, 2020). Business is all about taking risk. What matters is
how the risk is handled(Malleswari, 2013). To mitigate the volatility of exchange rates and interest rates risk investors
use derivatives (Jones, 2018) Trading in derivatives help improve market liquidity, raises skills and knowledge among
market players, and is vital ingredient of market reforms such as the transition to rolling Settlement(Malleswari, 2013)
.With the advent of derivatives many products emerged satisfying the needs of investors. In India, stock futures and
stock options are helping the investors in many ways.(Durga & Podile, 2020) Cash market and CNX NIFTY and
derivatives are positively correlated .(Movalia, 2015) derivative markets are affected by Legal environment .(Thinh
et al., 2020) Risk management controls factor maintains the strongest impact on the intention to use Financial
derivatives(Vu et al., 2020). Investors consider derivatives less speculative than equity by the investor . (Gupta &
Mokshmar, 2018). Factors for trading in derivatives market are expected return, past trend, risk appetite, investment
horizon, and investment objectives(Bhattrai, 2016). Portuguese firms use derivatives with the objective of hedging
(Silva & Dias, 2001). More profit can be earned with hedging risk of interest and exchange rate (Rishi Manrai, 2015)

RESEARCH METHODOLOGY

The present study is descriptive in nature. Snow ball sampling and Purposive sampling method were used for data
collection. Data collected from both primary and secondary source . The primary data was collected through structured
questionnaire from Futures and Options traders in Bidar city.
Population & Sample size: The population consists of investors trading in Futures and Options segment in Bidar City
and total population was 320. Sample size was chosen as 173. Secondary data was collected from published reports
by derivative market, stock market website in India.
Data Analysis: SPSS version 25 software was used for analysis. Factor Analysis, Regression Descriptive statistics
and One way ANOVA with Post Hoc Scheffe was used to test the hypothesis.

FINDINGS AND DISSCUSSION

Table:1 Sampling adequacy and sampling significance

KMO 0.924
Bartlett’s Test of Sphericity (Approx.Chi-Square) 1120.519
D.F 55
Significance 0.000
KMO sampling adequacy test is used to measure the significance of sampling and reliability of collected data. KMO
value is 0.924(>0.5) in above table:1 and p value is 0. So there is a significant relationship among components and it
is good model fit for conducting factor analysis.

Table:2 Factor-1: Risk Management influences trading in financial derivatives

Items Factor loading

Derivative instruments are useful to hedge against risk 0.819
Risk can be minimized in derivative trading by locking price 0.762
Derivative instruments are useful for in speculation, arbitrage and risk management 0.820
Derivative instruments are tolls for profitability and risk control 0.749

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 We can only hedge risk in derivative to some extent but may not earn more profit by 0.759
trading in derivatives market
Derivatives make good returns only when we take some risk 0.762
% of variance extraction(cumulative) 61.048
Eigen value 3.663
Mean 24.68
Reliability (Cronbach’s Alpha) 0.870
Exploratory factor analysis via principal components extraction with Varimax rotation is been used to reduce the items
into single variable. Internal consistency and reliability is assessed by computing Cronbach’s Alpha coefficient .As
per table Table-2 Factor -1 is labeled as Risk Management influences trading in financial derivatives. The factor
analysis states that all items are having factor loading greater than 0.5 which indicates that all items belong to one
group. The factor influences about 61.04% to the investor behavior in trading financial derivatives for Risk
Management. The construct is having 0.870 the study is reliable on the instrument for quantifying investment
influences and the Eigen value is 3.663 which is ≥ 1 and KMO test is 0.924. The factor analysis reveals that the data
satisfies all the selection criteria condition.

Graph:1 Factor-1: Risk Management influences trading in financial derivatives

Graph:1 shows that one component is extracted based on the item value greater than one is the potential component
explains the 61% of variance.

Table:3 Factor-2: Price Discovery influences trading in financial derivatives

Items Factor loading

Investors can discover price of underlying security in derivative segment 0.767
Derivative market helps in price discovery in the spot market and vice versa 0.767
% of variance extraction(cumulative) 76.7
Eigen value 1.534
Mean 8.2
Reliability (Cronbach’s Alpha) 0.691

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Exploratory factor analysis via principal components extraction with Varimax rotation is been used to reduce the items
into single variable. Internal consistency and reliability is assessed by computing Cronbach’s Alpha coefficient .As
per table Table-3 Factor -2 is labeled as Price Discovery influences trading in financial derivatives. The factor analysis
states that all items are having factor loading greater than 0.5 which indicates that all items belong to one group. The
factor influences about 76.7% to the investor behavior in trading financial derivatives for Price Discovery. The
construct is having 0.691 the study is reliable on the instrument for quantifying investment influences and the Eigen
value is 1.534 which is ≥ 1 and KMO test is 0.924. The factor analysis reveals that the data satisfies all the selection
criteria condition.

Graph:2 Price Discovery influences trading in financial derivatives

Graph:2 shows that one component is extracted based on the item value greater than one is the potential component
explains the 76.7% of variance.

Table:4 Factor-3: Satisfaction level influences trading in financial derivatives

Items Factor loading

Expected returns earned 0.681
Expected level of risk 0.646
Information provided by experts(through Media and Stock brokers) 0.740
% of variance extraction(cumulative) 68.91
Eigen value 2.067
Mean 12.21
Reliability (Cronbach’s Alpha) 0.774

Exploratory factor analysis via principal components extraction with Varimax rotation is been used to reduce the items
into single variable. Internal consistency and reliability is assessed by computing Cronbach’s Alpha coefficient .As
per table Table-3 Factor -2 is labeled as Satisfaction Level influences trading in financial derivatives. The factor
analysis states that all items are having factor loading greater than 0.5 which indicates that all items belong to one
group. The factor influences about 68.91% to the investor behavior in trading financial derivatives for Satisfaction
Level. The construct is having 0.774 the study is reliable on the instrument for quantifying investment influences and

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the Eigen value is 2.067 which is ≥ 1 and KMO test is 0.924. The factor analysis reveals that the data satisfies all the
selection criteria condition.

Graph:3 Satisfaction level influences trading in financial derivatives

Graph:3 shows that one component is extracted based on the item value greater than one is the potential component
explains the 68.91% of variance.

Table-5 Descriptive statistics

Factor Statement Mean Standard Deviation Skewness Kurtosis
Risk 1 4.13 0.80 -1.32 2.69
Management 2 4.16 0.76 -1.37 3.84
3 4.10 0.87 -1.25 2.01
4 4.17 0.84 -1.29 2.22
5 4.02 0.95 -1.23 1.44
6 4.04 0.92 -1.45 2.48
Price Discovery 7 4.09 0.80 -1.12 1.83
8 4.15 0.93 -1.36 2.01
Satisfaction level 9 4.20 0.91 -1.24 1.33
10 4.05 0.86 -1.35 2.66
11 3.96 1.0 -1.320 1.60
Table-5 shows that Mean of eleven (11) statements ranged from 3.96 to 4.20 with standard deviation ranging from
0.76 to 1.0. The results of Skewness indicate that the tail on the left side is longer than on the right site (left skewed).
The results of Kurtosis are positive it indicates that it is leptokurtic distribution.

Table-6 Mean value of all factors with reference to Age Group

Age Groups Below 25 26-35 years 36-45 years 46-55 years 56 and above years
years
RISK 4.17 4.07 4.11 4.06 4.13
MANAGEMENT

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 PRICE 4.20 4.07 4.15 3.96 4.28
DISCOVERY
SATISFACTION 4.14 4.12 4.03 3.91 3.97
LEVEL
The results in table-6 explain that there are differences in the age groups with respect the Risk management, Price
Discovery, and satisfaction level. Therefore one way ANOVA test with post-hoc Scheffe test were conducted to
investigate the mean difference in the age groups. Table-7 shows that the significance value is greater than 0.05, hence
they are not statistically significant.

Table-7 One way ANOVA results for Risk Management, Price Discovery and Satisfaction level factors for three
different age groups

Sum of df Mean F Sig

Squares Square
RISK Between Groups 0.233 4 0.058 0.125 0.973
MANAGEMENT Within Groups 78.019 168 0.464
78.252 172
Total

PRICE Between Groups 1.162 4 0.291 0.499 0.737

DISCOVERY 97.916 168 0.583
Within Groups 99.078 172
Total

SATISFACTION Between Groups 0.887 4 0.222 0.367 0.832

LEVEL 101.519 168 0.604
Within Groups 102.406 172
Total

Table-8 Post Hoc Scheffe test for factors Risk Management, Price Discovery and Satisfaction level with
reference to Age Group

variable factors Mean differences Significant value Inference

1 0.094 0.982 Not significant
2 -0.094 0.982 Not significant
RISK
3 -0.054 0.999 Not significant
MANAGEMENT
4 -0.109 0.992 Not significant
5 -0.041 1.0 Not significant
1 0.127 0.965 Not significant
2 -0.127 0.965 Not significant
Age Group PRICE
3 -0.040 1.0 Not significant
DISCOVERY
4 -0.231 0.916 Not significant
5 0.085 0.998 Not significant
1 0.023 1.0 Not significant
SATISFACTION 2 -0.023 1.0 Not significant
LEVEL 3 -0.106 0.987 Not significant
4 -0.227 0.925 Not significant

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 5 -0.168 0.978 Not significant
The results of Post Hoc Schefee test are statistically significant because the p values are greater than 0.05

Table:9 Results of Regression Analysis

Model Variable Beta R2 Adjusted R2 Significance(p)

1 Risk 0.752 0.566 0.564 0.000*
management(dependent
variable Satisfaction
level)
2 Price 0.689 0.475 0.472 0.000*
Discovery(dependent
variable Satisfaction
level)

Level of significance= * 0.05 level and n=173

H0a: Risk management factor does not influences the level of satisfaction of investors trading in financial derivatives

H1a: Risk management factor influences the level of satisfaction of investors trading in financial derivatives

Table :9 Shows that p value is less than 0.05 .Hence H0a is rejected the result proves that, Risk management factor
influences the level of satisfaction of investors trading in financial derivatives.

H0b: Price discovery factor does not influences the level of satisfaction of investors trading in financial derivatives.

H1b: Price discovery factor influences the level of satisfaction of investors trading in financial derivatives.

Table :9 Shows that p value is less than 0.05 .Hence H0b is rejected the result proves that ,Price discovery factor
influences the level satisfaction of investors trading in financial derivatives.

CONCLUSION

In this study three factors were set to measure to know how investors are trading in financial derivatives to hedge the
risk. The factor score revealed that the respondents are using derivatives for risk management of their investment and
price discovery of the underlying security in different markets. Risk management and price discovery factors influence
on satisfaction level of investors trading in futures and options. The study also reveals that Risk management, price
discovery and satisfaction are not dependent on age group of investors.

REFERENCES

1. Bhattrai, H. (2016). Topic : Factors Affecting Investment Decision in Nepalese Derivatives Market. 6(7), 6–8.
2. Durga, S., & Podile, V. (2020). a Paper on a Review on Stock Futures and Stock Options With Reference To Nse and Bse. European
Journal of Molecular & Clinical Medicine, 7(4), 1096.
3. Gupta, D., & Mokshmar, P. (2018). Factors Affecting the Perception of Investors Towards Equity and Derivatives in Indore City.
International Journal of Research -GRANTHAALAYAH, 6(2), 274–282. https://doi.org/10.29121/granthaalayah.v6.i2.2018.1573
4. Jones, T. M. (2018). A study on derivatives as risk management tools for business corporates. 4(6), 35–39.
5. Malleswari, B. (2013). Derivatives as a Tool of Risk Management. International Journal of Humanities and Social Science Invention
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4(4), 4–7.
7. Ramzan, I. (2018). Role of Financial Derivatives in Risk Management. SSRN Electronic Journal, 1–15.
https://doi.org/10.2139/ssrn.3264962

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 8. Rishi Manrai. (2015). Investor Behavior towards Derivative Markets in Indian Context. IOSR Journal of Business and Management,
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9. Sahoo, A., & Sahoo, S. (2020). What Drives Derivatives: An Indian Perspective. Journal of Risk and Financial Management, 13(6),
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10. Silva, J. M. S. B., & Dias, J. C. G. (2001). A survey into the use of derivatives by non-financial Portuguese firms. 24th Annual Congress
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