NISM Series VIII · Unit 8 of 10 · about 15% of the paper
Legal and regulatory environment: NISM Series VIII notes and practice questions
Who permits derivatives, who regulates them, who is eligible to trade and what safeguards exist. Questions here test exact names and rules.
What to know in Unit 8
- SCRA, SEBI Act and committees.
- Eligibility of securities and members.
- Investor protection and risk disclosure.
Key terms, examples and exam traps
SCRA
The Securities Contracts (Regulation) Act, 1956 regulates trading in securities and, after amendment, recognises derivatives as securities.
Example. The law that defines securities and allows derivatives trading on recognised exchanges.
Exam trap. This statement is false: The SCRA bans all derivatives trading.
SEBI Act
The SEBI Act, 1992 gives SEBI the power to regulate the securities market, including derivatives, and protect investors.
Example. The statute that created the regulator and gave it powers.
Exam trap. This statement is false: The SEBI Act regulates only banks.
L.C. Gupta Committee
The Dr. L. C. Gupta Committee (1998) recommended the introduction of derivatives trading in India and laid out the regulatory framework.
Example. A committee that paved the way for derivatives in India.
Exam trap. This statement is false: The committee banned derivatives in 1998.
J.R. Varma Committee
The Prof. J. R. Varma Committee recommended risk containment measures, including margining systems, for derivatives trading.
Example. A committee whose report shaped margin and risk measures.
Exam trap. This statement is false: The Varma committee recommended banning index futures.
Eligibility of stocks
Stocks are admitted to derivatives based on criteria such as market capitalisation, free float, trading frequency and volatility.
Example. A stock must meet liquidity and size tests to get derivatives contracts.
Exam trap. This statement is false: Any listed company can have derivatives.
Trading member
A trading member of the derivatives segment must be registered with SEBI, meet net-worth and certification norms, and have qualified dealers.
Example. A broker must hold the NISM certificate for its dealers.
Exam trap. This statement is false: Trading members need no certification.
Certification requirement
Dealers and persons who handle derivatives business must pass the NISM derivatives certification examination.
Example. A sales trader must hold the examination certificate to deal.
Exam trap. This statement is false: Anyone can deal in derivatives without certification.
Risk disclosure document
Brokers must give clients a risk disclosure document explaining the risks of derivatives, including leverage and the possibility of losing the entire margin.
Example. A client must read and acknowledge the risks before trading.
Exam trap. This statement is false: A risk disclosure document is optional.
Client registration
Clients must complete KYC and sign a client-broker agreement before trading derivatives.
Example. A new client signs the standard forms before the first trade.
Exam trap. This statement is false: A client can trade before completing KYC.
Contract note
A broker must issue a contract note for every trade, showing price, time, brokerage and charges, usually within 24 hours.
Example. A client receives a document confirming the details of her trade.
Exam trap. This statement is false: A contract note is optional.
Segregation of client funds
Brokers must keep client funds and securities separate from their own and must not use them for proprietary trading.
Example. A broker holds client money in a separate account.
Exam trap. This statement is false: Brokers may use client funds for their own trades.
Minimum contract size
SEBI prescribes a minimum value for a derivatives contract at the time of its introduction, reviewed periodically, so that lot sizes are meaningful.
Example. A contract lot is set to meet the regulator's minimum value.
Exam trap. This statement is false: The exchange can fix any tiny contract value.
Suitability
Intermediaries must ensure that derivatives trading is suitable for the client given experience, income and risk appetite.
Example. A broker checks that a retail client understands leverage before allowing trades.
Exam trap. This statement is false: Suitability is irrelevant to broking.
Prohibition of insider trading
Using unpublished price-sensitive information to trade stock derivatives is an offence under SEBI rules.
Example. An insider buys stock futures before the company announces a merger.
Exam trap. This statement is false: Insider trading rules apply only to shares and not to derivatives.
Investor Protection Fund
Exchanges maintain a fund to compensate clients of defaulting members within prescribed limits.
Example. A client of a failed broker receives compensation from the exchange fund.
Exam trap. This statement is false: The fund compensates every market loss.
Grievance redressal and arbitration
Disputes between clients and brokers can be taken to the exchange's arbitration, investor service cells and SEBI's complaint system.
Example. A client files a complaint and seeks arbitration against a broker.
Exam trap. This statement is false: Clients have no recourse for disputes.
Surveillance
Exchanges and SEBI monitor derivatives markets for manipulation, with measures such as position limits and bans.
Example. A regulator flags unusually concentrated positions.
Exam trap. This statement is false: Surveillance covers only the cash market.
Proprietary versus client trades
Brokers must distinguish their own proprietary trades from client trades and ensure they are reported and handled separately.
Example. A broker's own account trades are tagged separately from client orders.
Exam trap. This statement is false: Proprietary and client trades are mixed together.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “Eligibility of stocks”?
- A long put's profit at expiry = max(strike − spot, 0) − premium; break-even = strike − premium.
- Brokers must give clients a risk disclosure document explaining the risks of derivatives, including leverage and the possibility of losing the entire margin.
- Stocks are admitted to derivatives based on criteria such as market capitalisation, free float, trading frequency and volatility.
- The MWPL caps the total open positions across all traders in a stock's derivatives; when it reaches 95% the stock enters a ban period.
Q2. Which statement best describes “Suitability”?
- Cash-and-carry arbitrage buys the underlying in the cash market and sells the future when the future is expensive relative to fair value.
- Using unpublished price-sensitive information to trade stock derivatives is an offence under SEBI rules.
- Intermediaries must ensure that derivatives trading is suitable for the client given experience, income and risk appetite.
- For European options, the call price minus the put price equals the present value relationship of spot and strike; deviations offer arbitrage.
Q3. Which statement best describes “Certification requirement”?
- Exchange-traded futures remove counterparty risk through the clearing corporation, while forwards leave it with the counterparty.
- A clearing member is authorised to clear and settle trades with the clearing corporation, for itself or for trading members.
- A long futures position buys the contract and gains when the price rises above the entry price and loses when it falls.
- Dealers and persons who handle derivatives business must pass the NISM derivatives certification examination.
Q4. Which statement best describes “Contract note”?
- Exposure margin is an additional margin over and above SPAN margin, collected to cover risk beyond that measured.
- Contango is a market in which futures prices are higher than the spot price, normally due to carrying costs.
- A broker must issue a contract note for every trade, showing price, time, brokerage and charges, usually within 24 hours.
- Non-speculative business losses from derivatives can be set off against other business income and carried forward for eight years if returns are filed on time.
Q5. Which term is described here? Brokers must keep client funds and securities separate from their own and must not use them for proprietary trading.
- Proprietary versus client trades
- Stock index
- Risk disclosure document
- Segregation of client funds
Q6. Which statement best describes “L.C. Gupta Committee”?
- The Dr. L. C. Gupta Committee (1998) recommended the introduction of derivatives trading in India and laid out the regulatory framework.
- A butterfly spread uses three strikes to profit if the price stays near the middle strike, with limited risk and limited reward.
- Delta measures the change in an option's price for a ₹1 change in the underlying. Calls have delta between 0 and 1; puts between −1 and 0.
- An exchange fixes the underlying, lot size, tick size, expiry cycle and settlement method for each derivatives contract.
Frequently asked questions
How much of NISM Series VIII comes from Unit 8?
Unit 8 (Legal and regulatory environment) usually carries about 15% of the questions. The whole exam has 100 questions and the pass mark is 60%.
What should I study in NISM Series VIII Unit 8?
SCRA, SEBI Act and committees. Eligibility of securities and members. Investor protection and risk disclosure.
Are these NISM Series VIII practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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