Commodity Markets Project Rough

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INTRODUCTION

Indian markets have recently thrown open a new avenue for retail investors and traders to

participate commodity derivatives. For those who want to diversify their portfolios beyond

shares, bonds and real estate, commodities are the best option.Till some months ago, this

wouldnt have made sense. For retail investors could have done very little to actually invest in

commodities such as gold and silver or oilseeds in the futures market. This was nearly

impossible in commodities except for gold and silver as there was practically no retail avenue

for pumping in commodities. However, with the setting up of three multi-commodity

exchanges in the country, retail investors can now trade in commodity futures without having

physical stocks. Commodities actually offer immense potential to become a separate asset class

for market-savvy investors, arbitrageurs and speculators. Retail investors, who claim to

understand the equity markets, may find commodities an unfathomable market. But

commodities are easy to understand as far as fundamentals of demand and supply are

concerned. Retail should understand the risk advantages of trading in commodities futures

before taking a leap. Historically, pricing in commodities futures has been less volatile

compared with equity and bonds, thus providing an efficient portfolio diversification option. In

fact, the size of the commodities markets in India is also quite significant. Of the countrys GDP

of Rs.13,20,730 crore ( Rs.13,207.3 billion) commodities related (and dependent) industries

constitute about 58 per cent. Currently, the various commodities across the country clock an

annual turnover of Rs.1,40,000 crore ( Rs.1,400 billion). With the introduction of futures

trading, the sizes of the commodities market grow many folds here on.

DEFINITION OF COMMODITIES

Any product that can be used for commerce or an article of commerce which is traded on an

authorized commodity exchange is known as commodity. The article should be movable of

value, something which is bought or sold and which is produced or used as the subject or barter

or sale. In short commodity includes all kinds of goods. Forward Contracts (Regulation) Act

(FCRA), 1952 defines goods as every kind of movable property other than actionable

claims,money and securities. In current situation, all goods and products of agricultural

(including plantation), mineral and fossil origin are allowed for commodity trading

recognized under the FCRA. The national commodity exchanges, recognized by

the Central Government, permits commodities which include precious (gold and

silver) and non-ferrous metals: cereals and pulses; ginned and un-ginned cotton;

oilseeds, oils and oilcakes; raw jute and jute goods; sugar and gur;potatoes and


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onions; coffee and tea; rubber and spices. Etc.In the world of business, a commodity is an

undifferentiated product whose market value arises from the owners right to sell rather than

to use. Example commodities from the financial world include oil (sold by the barrel), wheat,

bulk chemicals such as sulfuric acid and even pork bellies.

NEED OF COMMODITY MARKET IN INDIA

Achieving hedging efficiency is the main reason to opt for futures contracts. For instance, in

February, 2007, India had to pay $ 52 per barrel more for importing oil than what they had to

pay a week ago. The utility of a futures contact for hedging or risk management presupposes

parallel or near-parallel relationship between the spot and futures prices over time. In other

words, the efficiency of a futures contract for hedging essentially envisages that the prices in

the physical and futures markets move in close unison not only in the same

direction, but also by almost the same magnitude, so that losses in one market

are offset by gains in the other. Of course, such a price relationship between the spot and

futures markets is subject to the amount of carrying or storage costs till the maturity month of

the futures contract. Theoretically ( and ideally), in a perfectly competitive market

with surplus supplies and abundant stocks round the year, the futures price will

exceed the spot price by the cost of storage till the maturity of the futures

contract. But such storage cost declines as the contract approaches maturity,

thereby reducing the premium or contango commanded by the futures contract

over the spot delivery over its life and eventually becomes zero during the

delivery month when the spot and futures prices virtually converge. The

efficiency of a futures contract for hedging depends on the prevalence of such an

ideal price relationship between the spot and futures markets.

COMMODITIES EXCHANGES

A brief description of commodity exchanges are those which trade in particular commodities,

neglecting the trade of securities, stock index futures and options etc.,In the middle of 19th

century in the United States, businessmen began organizing market forums to make the buying


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and selling of commodities easier. These central market places provided a place for buyers and

sellers to meet, set quality and quantity standards, and establish rules of business. Agricultural

commodities were mostly traded but as long as there are buyers and sellers, any

commodity can be traded.The major commodity markets are in the United Kingdom and in theUSA. In India there are 25 recognized future exchanges, of which there are three national level

multi-commodity exchanges. After a gap of almost three decades, Government of India has

allowed forward transactions in commodities through Online Commodity Exchanges, a

modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk

coverage and delivery of commodities.

THE THREE EXCHANGES ARE

National Commodity & Derivatives Exchange Limited ( NCDEX)

Multi Commodity Exchange of India Limited ( MCX)

National Multi-Commodity Exchange of India Limited ( NMCEIL)

All the exchanges have been set up under overall control of Forward Market Commission (FMC)

of Government of India.

National Commodity & Derivatives Exchanges Limited ( NCDEX)

National Commodity & Derivatives Exchange Limited (NCDEX) is an online multi commodity

exchange based in india. It was incorporated as a private limited company incorporated on 23April 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of

Business on 9 May 2003. It has commenced its operations on 15 December 2003. NCDEX is a

closely held private company which is promoted by national level institutions and has an

independent Board of Directors and professionals not having vested interest in commodity

markets. NCDEX is a public limited company incorporated on 23 April 2003 under the

Companies Act, 1956. NCDEX is regulated by forward market commission (FMC) in respect of

futures trading in commodities. Besides, NCDEX is subjected to various laws of the land like the

Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various

other legislations, which impinge on its working. On 3 February 2006, the FMC found NCDEXguilty of violating settlement price norms and ordered the exchange to fire one of their

executive. NCDEX is located in Mumbai and offers facilities in more than 550 centres in India.

NCDEX also offers as an information product, an agricultural commodity index. This is a value

weighted index,called DHAANYA and is computed in real time using the prices of the 10 most

liquid commodity futures traded on the NCDEX platform. Dhaanya aims to provide a reliable

benchmark for the traded Agri-commodities in India. Many investors doesn't understand how


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NCDEX futures work. For the informed buyer, the commodity futures market is a good way to

buy quality products at wholesale prices.

MULTI COMMODITY EXCHANGE

Multi Commodity Exchange of India Ltd (MCX) is an independent commodity exchange based inindia.It was established in 2003 and is based in Mumbai.The turnover of the exchange for the

fiscal year 2009 was US$ 1.24 trillion, and in terms of contracts traded, it was in 2009 the

world's sixth largest commodity exchange. MCX offers futures trading in bullion, ferrous and

non-ferrous metals, energy, and a number of agricultural commodities (mentha oil, cardamom,

potatoes, palm oil and others).In 2012, MCX has taken the third spot among the global

commodity bourses in terms of the number of future conracts traded. Based on the latest data

from futures industry association (FIA), during the period between January and June this year,

about 127.8 million futures contracts were traded on MCX .MCX has also set up in joint venture

the MCX Stock Exchange. Earlier spin-offs from the company include the National SpotExchange, an electronic spot exchange for bullion and agricultural commodities, and National

Bulk Handling Corporation (NBHC) India's largest collateral management company which

provides bulk storage and handling of agricultural products. In February 2012, MCX has come

out with a public issue of 6,427,378 Equity Shares of Rs. 10 face value in price band of 860 -

1032 Rs. per equity share to raise around $134 million. It is the first ever IPO by an Indian

exchange.It is regulated by the Forward Markets Commission.MCX is India's No. 1 commodity

exchange with 83% market share in 2009.The exchange's main competitor is National

Commodity & Derivatives Exchange Ltd .Globally, MCX ranks no. 1 in silver, no. 2 in natural gas,

no. 3 in crude oil and gold in futures trading (But actual volume is far behind CME group volumeas Silver is traded in 30 kg lots on MCX whereas CME traded in Approx 155 kg Lot size same in

Gold 1 kg : 3. kg Approx and Crude 100 Barrels : 1000 Barrels on CME) and major volume in

manuplated as there in no strict regulation in Indian markets just to Excalate the prices of

Shares of company. Also the major volume comes from Arbitration Of CME and MCX which is

also not legal to do. The highest traded item is gold.MCX has several strategic alliances with

leading exchanges across the globe As of early 2010, the normal daily turnover of MCX was

about US$ 6 to 8 billionMCX now reaches out to about 800 cities and towns in India with the

help of about 126,000 trading terminals MCX COMDEX is India's first and only composite

commodity futures price index.

National Multi-Commodity Exchange

The NMCE is India's third-largest commodities exchange behind the Multi-Commodity Exchange

(MCX) and the National Commodity & Derivatives Exchange (NCDEX) and has grown

significantly as commodity trading in India has rebounded from the 2008 financial crisis. NMCE

is India's top lister ofcoffee and rubber contracts and seeks to broaden into the currency
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derivatives and spot markets. The National Multi Commodity Exchange of India Ltd. (NMCE)

was conceived and promoted in 1999 by a group of Indian commodity-based corporations and

public agencies, and listed its first contracts on 24 commdities in November 2002.[1]

As of

October 2009, the NMCE now lists futures contracts on a total of 44 different commodities,

ranging copra to menthol, and boasts over 300 trading members. NMCE is currently India'sthird-largest commodity and derivatives exchange as measured by average daily turnover,

behind market dominator MCX and close rival NCDEX. However, NMCE recorded a spectacular

year-on-year leap in trading for the first half of 2009 of over 500%, according to India's

Economic Times, to 12.8 billion Indian rupees compared to rival NCDEX's more modest 30%

increase to 26.3 billion rupees.[2]

Market leader MCX recorded 29% growth over the same

period to hit average daily turnover of 185.3 billion rupees. Continued recent growth in India's

commodity trading means the NMCE's market will soon be joined by a fourth new exchange

competitor, currently named the Indian Commodity Exchange (ICEX)

COMMODITY TRADING

COMMODITY MARKET TRADING MECHANISM

Every market transaction consists of three componentstrading, clearing and settlement.

TRADING

The trading system on the Commodities exchange provides a fully automated screen-based

trading for futures on commodities on a nationwidebasis as well as an online monitoring and

surveillance mechanism. It supports an order driven market and provides complete

transparency of tradingoperations. After hours trading has also been proposed for

implementation at alater stage.

The NCDEX system supports an order driven market, where orders match automatically. Order

matching is essentially on the basis of commodity, its price, time and quantity. All quantity

fields are in units and price in rupees. The exchange specifies the unit of trading and the

delivery unit for futures contracts on various commodities. The exchange notifies the regular

lot size and tick size for each of the contracts traded from time to time. When any order enters

the trading system, it is an active order. It tries to find a match on the other side of the book. If

it finds a match, a trade is generated. If it does not find a match, the order becomes passiveand gets queued in the respective outstanding order book in the system, Time stamping is done

for each trade and provides the possibility for a complete audit trail if required.

SETTLEMENT
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Futures contracts have two types of settlements, the MTM settlement which happens on a

continuous basis at the end of each day, and the final settlement which happens on the last

trading day of the futures contract. On the NCDEX, daily MTM settlement and final MTM

settlement in respect of admitted deal in futures contracts are cash settled by

debiting/crediting the clearing accounts of CMs with the respective clearing bank. All positions

of a CM, brought forward, created during the day or closed out during the day, are marked tomarket at the daily settlement price or the final settlement price at the close of trading hours

on a day.

Daily settlement price: Daily settlement price is the consensus closing price as arrived afterclosing session of the relevant futures contract for the trading day. However, in the absence of

trading for a contract during closing sessions, daily settlement price is computed as per the

methods prescribed by the exchange from time to time.

Final settlement price: Final settlement price is the closest price of the underlyingcommodity on the last trading day of the futures contract. All open positions in a futures

contract cease to exist after its expiration day.

Settlement mechanism:

Settlement of commodity futures contracts is a little different from settlement of financial

futures, which are mostly cash settled. The possibility of physical settlement makes the process

a little more complicated. Daily mark to market settlement is done till the date of the contract

expiry. This is done to take care of daily price fluctuations for all trades. All the open positions

of the members are marked to market at the end of the day and profit/loss is determined as

below:

On the day of entering into the contract, it is the difference between the entry value anddaily settlement price for that day.

On any intervening days, when the member holds an open position, it is the differentbetween the daily settlement price for that day and the previous days settlement price.

Final settlement

On the date of expiry, the final settlement price is the spot price on the expiry day. The

spot prices are collected from members across the country through polling. The polled bid/ask

prices are bootstrapped and the mid of the two bootstrapped prices is taken as the finalsettlement price. The responsibility of settlement is on a trading cum clearing member for all

trades done on his own account and his clients trades. A professional clearing member is

responsible for settling all the participants trades, which he has confirmed to the exchange.


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On the expiry date of a futures contract, members are required to submit delivery

information through delivery request window on the trader workstations provided by NCDEX

for all open positions for a commodity for all constituents individually. NCDEX on receipt of

such information matches the information and arrives at a delivery position for a member for a

commodity. A detailed report containing all matched and unmatched requests is provided to

members through the extranet.

Pursuant to regulations relating to submission of delivery information, failure to submit delivery

information for open positions attracts penal charges as stipulated by NCDEX from time to time.

NCDEX also adds all such open positions for a member, for which no delivery information is

submitted with final settlement obligations of the member concerned and settled in cash.

Non-fulfillment of either the whole or part of the settlement obligations is treated as a

violation of the rules, bye-laws and regulations of NCDEX, and attracts penal charges as

stipulated by NCDE from time to time. In addition NCDEX can withdraw any or all of the

membership rights of clearing member including the withdrawal of trading facilities of all

trading members clearing through such clearing members, without any notice. Further, the

outstanding positions of such clearing member and/or trading members and/or constituents,

clearing and settling through such clearing member, may be closed out forthwith or any

thereafter by the exchange to the extent possible, by placing at the exchange, counter orders in

respect of the outstanding position of clearing member without any notice to the clearing

member and / or trading member and / or constituent. NCDEX can also initiate such other risk

containment measures, as it deems appropriate with respect to the open positions of the

clearing members. It can also take additional measures like imposing penalties, collecting

appropriate deposits, invoking bank guarantees or fixed deposit receipts, realizing money by

disposing off the securities and exercising such other risk containment measures as it deems fit

or take further disciplinary action.

CLEARING

As mentioned earlier, National Securities Clearing Corporation Limited (NSCCL)

undertakes clearing of trades executed on the NCDEX, All deals executed on the Exchange are

cleared and settled by the trading members on the settlement date by the trading membersthemselves as clearing members or through other professional clearing members in accordance

with these regulations/bye laws and rules of the exchange.

PARTICIPANTS IN COMMODITY MARKET

For a market to succeed/ it must have all three kinds of participants hedgers, speculators and

arbitragers. The confluence of these participants ensures liquidity and efficient price discovery

on the market. Commodity markets give opportunity for all three kinds of participants.


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Hedging

Many participants in the commodity futures market are hedgers. The use the futures

market to reduce a particular risk that they face. This risk might relate to the price of wheat or

oil or any other commodity that the person deals in. The classic hedging example is that of

wheat farmer who wants to hedge the risk of fluctuations in the price of wheat around the time

that his crop is ready for harvesting. By selling his crop forward, he obtains a hedge by locking into a predetermined price. Hedging does not necessarily improve the financial outcome; indeed,

it could make the outcome worse. What it does however is that it makes the outcome more

certain. Hedgers could be government institutions, private corporations like financial

institutions, trading companies and even other participants in the value chain, for instance

farmers, extractors, ginners, processors etc., who are influenced by the commodity prices.

Hedge Ratio

Hedge ratio is the ratio of the size of position taken in the futures contracts to the size of the

exposure in the underlying asset. So far in the examples we used, we assumed that the hedgerwould take exactly the same amount of exposure in there futures contract as in the underlying

asset. For example, if the hedgers exposure in the underlying was to the extent of 11 bales of

cotton, the futures contracts entered into were exactly for this amount of cotton. We were

assuming here that the optimal hedge ratio is one. In situations where the underlying asset in

which the hedger has an exposure is exactly the same as the asset underlying the futures

contract he uses, and the spot and futures market are perfectly correlated, a hedge ratio of one

could be assumed. In all other cases, a hedge ratio of one may not be optimal.

Speculation

An entity having an opinion on the price movements of a given commodity can speculate using

the commodity market. While the basics of speculation apply to any market, speculating in

commodities is not as simple as speculating on stocks in the financial market. For a speculator

who thinks the shares of a given company will rise. It is easy to buy the shares and hold them

for whatever duration he wants to. However, commodities are bulky products and come with

all the costs and procedures of handling these products. The commodities futures markets

provide speculators with an easy mechanism to speculate on the price of underlying

commodities.

To trade commodity futures on the NCDEX, a customer must open a futures trading

account with a commodity derivatives broker. Buying futures simply involves putting in themargin money. This enables futures traders to take a position in the underlying commodity

without having to actually hold that commodity. With the purchase of futures contract on a

commodity, the holder essentially makes a legally binding promise or obligation to buy the

underlying security at some point in the future (the expiration date of the contract). We look

here at how the commodity futures markets can be used for speculation.


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Today a speculator can take exactly the same position on gold by using gold futures contracts.

Let us see how this works. Gold trades at Rs.6000 per 10 gms and three-months gold futures

trades at Rs.6150. Tables 7.3 gives the contract specifications for gold futures. The unit of

trading is 100 gms and the delivery unit for the gold futures contract on the NCDEX is 1 kg. He

buys one kg of gold futures which have a value of Rs.6,15,000. Buying an asset in the futures

markets only require making margin payments. To take this position, he pays a margin ofRs.1,20,000. Three months later gold trades at Rs.6400 per10 gms. As we know, on the day of

expiration, the futures price converges to the spot Price (else there would be a risk-free

arbitrage opportunity). He closes his long futures position at Rs.64,000 in the process making a

profit of Rs.25,000 on an initial margin investment of Rs.1,20,000. This works out to an annual

return of 83percent. Because of the leverage they provide, commodity futures form an

attractive tool for speculators.

Speculation: Bearish Commodity, Sell Futures:

This can also be used by a speculator who believes that there is likely to be excess

supply of a particular commodity in the near future and hence the prices are likely to see a fall.

How can he trade based on this opinion? In the absence of a deferral product, there wasnt

much he could do to profit from his opinion. Today all he needs to do is sell commodity futures.

Let us understand how this works. Simple arbitrage ensures that the price of a futures

contract on a commodity moves correspondingly with the price of the underlying commodity.

If the commodity price rises, so will the futures price. If the commodity price falls/so will the

futures price. Now take the case of the trader who expects to see a fall in the price of cotton.

He sells ten two-months cotton futures contract which is for delivery of 550 bales of cotton.

The value of the contract is Rs.4,00,000. He pays a small margin on the same. Three months

later. If his hunch were correct the price of cotton falls. So does the price of cotton futures. He

close out his short futures position at Rs.3,50,000, making a profit of Rs.50,000.

Arbitrage

A central idea in modern economics is the law of one price. This states that in a

competitive market, if two assets are equivalent from the point of view of risk and return, they

should sell at the same price. If the price of the same asset is different in two markets, there

will be operators who will buy in the market where the asset sells cheap and sell in the market

where it is costly. This activity termed as arbitrage, involves the simultaneous purchase and

sale of the same or essentially similar security in two different markets for advantageously

different prices. The buying cheap and swelling expensive continues till prices in the two

markets reach equilibrium. Hence, arbitrage helps to equalize prices and restore marketefficiency.

REGULATORY FRAMEWORK FOR COMMODITY TRADING IN INDIAAt present there are three tiers of regulations of forward/futures trading system in India,

namely, government of India, Forward Markets Commission(FMC) and commodity exchanges.


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The need for regulation arises on account of the fact that the benefits of futures markets accrue

in competitive conditions.Proper regulation is needed to create competitive conditions. In the absence of

regulation, unscrupulous participants could use these leveraged contracts for manipulating

prices. This could have undesirable influence on the spot prices, thereby affecting interests of

society at large. Regulation is also needed to ensure that the market has appropriate riskmanagement system. In the absence of such a system, a major default could create a chain

reaction.

The resultant financial crisis in a futures market could create systematic risk. Regulation

is also needed to ensure fairness and transparency in trading, clearing, settlement and

management of the exchange so as to protect and promote the interest of various

stakeholders, particularly non-member users of the market.

RULES GOVERNING COMMODITY DERIVATIVES EXCHANGES

The trading of commodity derivatives on the NCDEX is regulated by Forward Markets

Commission (FMC). Under the Forward Contracts (Regulation) Act, 1952, forward trading incommodities notified under section 15 of the Act can be conducted only on the exchanges,

which are granted recognition by the central government (Department of Consumer Affairs,

Ministry of Consumer Affairs, Food and Public Distribution). All the exchanges, which deal with

forward contracts, are required to obtain certificate of registration from the FMC Besides, they

are subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act,

Forward Commission (Regulation) Act and various other legislations, which impinge on their

working.

Forward Markets Commission provides regulatory oversight in order to ensure financial

integrity (i.e. to prevent systematic risk of default by one major operator or group of

operators), market integrity (i.e. to ensure that futures prices are truly aligned with the

prospective demand and supply conditions) and to protect and promote interest of customers/nonmembers. It prescribes the following regulatory measures:

Limit on net open position as on close of the trading houses. Some times limit is alsoimposed on intra-day net open position. The limit is imposed operator-wise/ and in

some cases, also member wise.

Circuit filters or limit on price fluctuations to allow cooling of market in the event ofabrupt upswing or downswing in prices.

Special margin deposit to be collected on outstanding purchases or sales when pricemoves up or down sharply above or below the previous day closing price. By making

further purchases/sales relatively costly, the price rise or fall is sobered down. This

measure is imposed only on the request of the exchange.

Circuit breakers or minimum/maximum prices. These are prescribed to prevent futuresprices from failing below as rising above not warranted by prospective supply and

demand factors. This measure is also imposed on the request of the exchange.

Skipping trading in certain derivatives of the contract closing the market for a specifiedperiod and even closing out the contract. These extreme are taken only in emergency

situations.


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Besides these regulatory measures, the F.C)R) Act provides that a clients position cannot be

appropriated by the member of the exchange, except when a written consent is taken within

three days time. The FMC is persuading increasing number of exchanges to switch over to

electronic trading, clearing and settlement which is more customer/friendly. The FMC has also

prescribed simultaneous reporting system for the exchanges following open out cry system.

These steps facilitate audit trail and make it difficult for the members to indulge in malpractice

like trading ahead of clients, etc. The FMC has also mandated all the exchanges following open

outcry system to display at a prominent place in exchange premises, the name, address,

telephone number of the officer of the commission who can be contacted for any grievance.

The website of the commission also has a provision for the customers to make complaint and

send comments and suggestions to the FMC. Officers of the FMC have been instructed to meet

the members and clients on a random basis, whenever they visit exchanges, to ascertain the

situation on the ground, instead of merely attending meetings of the board of directors and

holding discussions with the office bearers.

TRADING DAYS

The exchange operates on all days except Saturday and Sunday and on holidays that it

declares from time to time. Other than the regular trading hours, trading members are

provided a facility to place orders offline i.e. outside trading hours. These are stored by the

system but get traded only once the market opens for trading on the following working day.

The types of order books, trade books, price limits, matching rules and other parameters

pertaining to each or all of these sessions is specified by the exchange to the members via its

circulars or notices issued from time to time. Members can place orders on the trading system

during these sessions, within the regulations prescribed by the exchange as per these bye laws,rules and regulations, from time to time.

Trading hours and trading cycle

The exchange announces the normal trading hours/open period in advance from time to

time. In case necessary, the exchange can extend or reduce the trading hours by notifying the

members. Trading cycle for each commodity/derivative contract has a standard period, during

which it will be available for trading.

Contract expiration

Derivatives contracts expire on a pre-determined date and time up to which the

contract is available for trading. This is notified by the exchange in advance. The contract

expiration period will not exceed twelve months or as the exchange may specify from time to

time.


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Trading parameters

The exchange from time to time specifies various trading parameters relating to the

trading system. Every trading member is required to specify the buy or sell orders as either an

open order or a close order for derivatives contracts. The exchange also prescribes different

order books that shall be maintained on the trading system and also specifies various

conditions on the order that will make it eligible to place it in those books.The exchange specifies the minimum disclosed quantity for orders that will be allowed

for each commodity/derivatives contract. It also prescribed the number of days after which

Good Till Cancelled orders will be cancelled by the system. It specifies parameters like lot size

in which orders can be placed, price steps in which shall be entered on the trading system,

position limits in respect of each commodity etc.

Failure of trading member terminal

In the event of failure of trading members workstation and/ or the loss of access to the

trading system, the exchange can at its discretion undertake to carry out on behalf of the

trading member the necessary functions which the trading member is eligible for. Only requestsmade in writing in a clear and precise manner by the trading member would be considered.

The trading member is accountable for the functions executed by the exchange on its behalf

and has to indemnity the exchange against any losses or costs incurred by the exchange.

Trade operations

Trading members have to ensure that appropriate confirmed order instructions are obtained

from the constituents before placement of an order on the system. They have to keep relevant

records or documents concerning the order and trading system order number and copies of the

order confirmation slip/modification slip must be made available to the constituents.

The trading member has to disclose to the exchange at the time of order entry whether the

order is on his own account or on behalf of constituents and also specify orders for buy or sell

as open or close orders. Trading members are solely responsible for the accuracy of details of

orders entered into the trading system including orders entered on behalf of their constituents.

Traders generated on the system are irrevocable and blocked in 1. The exchange specifies from

time to time the market types and the manner if any, in which trade cancellation can be

effected.

Where a trade cancellation is permitted and trading member wishes to cancel a trade, it can be

done only with the approval of the exchange.

Margin requirements

Subject to the provisions as contained in the exchange bye-laws and such other regulations asmay be in force, every clearing member/in respect of the trades in which he is party to, has to

deposit a margin with exchange authorities.

The exchange prescribes from time to time the commodities/derivatives contracts, the

settlement periods and trade types for which margin would be attracted.

The exchange levies initial margin on derivatives contracts using the concept of Value at Risk

(VaR) or any other concept as the exchange may decide from time to time. The margin is


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charged so as to cover one-day loss that can be countered on the position on 99% of the days.

Additional margins may be levied for deliverable positions, on the basis of VaR from the expiry

of the contract till the actual settlement date plus a mark-up for default.

The margin has to be deposited with the exchange within the time notified by the exchange.

The exchange also prescribes categories of securities that would be eligible for a margin

deposit, as well as the method of valuation and amount of securities that would be required tobe deposited against the margin amount.

The procedure for refund/adjustment of margins is also specified by the exchange from

time to time. The exchange can impose upon any particular trading member or category of

trading member any special or other margin requirement. On failure to deposit margin/s as

required under this clause, the exchange/clearing house can withdraw the trading facility of the

trading member. After the pay-out, the clearing house releases all margins.

Unfair trading practices

No trading member should buy, sell, deal in derivatives contracts in a fraudulent manner, orindulge in any unfair trade practices including market manipulation. This includes the

following; if Effect, take part either directly or indirectly in transactions, which are likely to have

effect of artificially, raising or depressing the prices of spot/derivatives contracts.

Indulge in any act, which is calculated to create a false or misleading appearance of

trading, resulting in reflection of prices, which are not genuine.

Buy, sell commodities/contract on his own behalf or on behalf of a person associated withhim pending the execution of the order of his constituent or of his company or director for the

same contract.

Delay the transfer of commodities in the name of the transferee. Indulge in falsification ofhis books, accounts and records for the purpose of market manipulation.

When acting as an agent, execute a transaction with a constituent at a price other than theprice at which it was executed on the exchange.

Either take opposite position to an order of a constituent or execute opposite orders whichhe is holding in respect of two constituents except in the manner laid down by the exchange.

LAST DAY OF TRADING

Last trading day for a derivative contract in any commodity is the date as specified in the

respective commodity contract. If the last trading day as specified in the respective commodity

contract is a holiday, the last trading day is taken to be the previous working day of exchange.

On the expiry date of contracts, the trading members/ clearing members have to give deliveryinformation as prescribed by the exchange from time to time. If a trading member/clearing

member fails to submit such information during the trading hours on the expiry date for the

contract/the deals have to be settled as per the settlement calendar applicable for such deals,

in cash-together with penalty as stipulated by the exchange deals entered into through the

exchange. The clearing member cannot operate the clearing account for anyother purpose


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GOLD

INTRODUCTION

Gold is a unique asset based on few basic characteristics. First, it is primarily a monetary

asset, and partly a commodity. As much as two thirds of golds total accumulated holdings

relate to store of value considerations. Holdings in this category include the central bank

reserves, private investments, and high-cartage jewelry bought primarily in developing

countries as a vehicle for savings. Thus, gold is primarily a monetary asset. Less than one

third of golds total accumulated holdings can be considered a commodity, the jewelry

bought in Western markets for adornment, and gold used in industry.

The distinction between gold and commodities is important. Gold has maintained its value

in after-inflation terms over the long run, while commodities have declined. Some analysts

like to think of gold as a currency without a country. It is an internationally recognized

asset that is not dependent upon any governments promise to pay. This is an important

feature when comparing gold to conventional diversifiers like T-bills or bonds, which unlike

gold, do have counter-party risk.Gold is a monetary metal whose price is determined byinflation, by fluctuations in the dollar and U.S. stocks, by currency-related crises, interest

rate volatility and international tensions, and by increases or decreases in the prices of other

commodities. The price of gold reacts to supply and demand changes and can be influenced

by consumer spending and overall levels of affluence. Gold is different from other precious

metals such as platinum, palladium and silver because the demand for these precious

metals arises principally from their industrial applications. Gold is produced primarily for

accumulation; other commodities are produced primarily for consumption. Golds value

does not arise from its usefulness in industrial or consumable applications. It arises from its

use and worldwide acceptance as a store of value. Gold is money.

WHAT MAKES GOLD SPECIAL?

Timeless and Very Timely Investment:

For thousands of years, gold has been prized for its rarity, its beauty, and above all, for its

unique characteristics as a store of value. Nations may rise and fall, currencies come and go,

but gold endures. In todays uncertain climate, many investors turn to gold because it is an

important and secure asset that can be tapped at any time, under virtually any

circumstances. But there is another side to gold that is equally important, and that is its day-

to-day performance as a stabilizing influence for investment portfolios. These advantagesare currently attracting considerable attention from financial professionals and

sophisticated investors worldwide.

Gold is an effective diversifier:

Diversification helps protect your portfolio against fluctuations in the value of any one-asset

class. Gold is an ideal diversifier, because the economic forces that determine the price of


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gold are different from, and in many cases opposed to, the forces that influence most

financial assets.

Gold is the ideal gift:

In many cultures, gold serves as a family treasure or a wealth transfer vehicle that is passedon from generation to generation. Gold bullion coins make excellent gifts for birthdays,

graduations, weddings, holidays and other occasions. They are appreciated as much for

their intrinsic value as for their mystical appeal and beauty. And because gold is available in

a wide range of sizes and denominations, you dont need to be wealthy to g ive the gift of

gold.

Gold is highly liquid:

Gold can be readily bought or sold 24 hours a day, in large denominations and at narrow

spreads. This cannot be said of most other investments, including stocks of the worlds

largest corporations. Gold is also more liquid than many alternative assets such as venture

capital, real estate, and timberland. Gold proved to be the most effective means of raising

cash during the 1987 stock market crash, and again during the 1997/98 Asian debt crisis. So

holding a portion of your portfolio in gold can be invaluable in moments when cash is

essential, whether for margin calls or other needs.

Gold responds when you need it most:

Recent independent studies have revealed that traditional diversifiers often fall during times

of market stress or instability. On these occasions, most asset classes (including traditional

diversifiers such as bonds and alternative assets) all move together in the same direction.There is no cushioning effect of a diversified portfolio leaving investors disappointed.

However, a small allocation of gold has been proven to significantly improve the consistency

of portfolio performance, during both stable and unstable financial periods. Greater

consistency of performance leads to a desirable outcome an investor whose expectations

are met.

THE REASON WHY INVESTORS OWN GOLD

There are six primary reasons why investors own gold: They may never be more relevant

than they are today.

1. As a hedge against inflation.2. As a hedge against a declining dollar.3. As a safe haven in times of geopolitical and financial market instability.4. As a commodity, based on golds supply and demand fundamentals.5. As a store of value.
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6. As a portfolio diversifier.

HEDGE AGAINST INFLATION

Gold is renowned as a hedge against inflation. The most consistent factor determining the

price of gold has been inflation - as inflation goes up, the price of gold goes up along with it.

Since the end of World War II, the five years in which U.S. inflation was at its highest were

1946, 1974, 1975, 1979, and 1980. During those five years, the average real return on

stocks, as measured by the Dow, was -12.33%; the average real return on gold was 130.4%.

Today, a number of factors are conspiring to create the perfect inflationary storm:

extremely simulative monetary policy, a major tax cut, a long term decline in the dollar, a

spike in oil prices, a huge trade deficit, and Americas status as the worlds biggest debtor

nation. Almost across the board, commodity prices are up despite the short-term absence of

a weakening dollar which is often viewed as the principal reason for stronger commodityprices.

Oil, Inflation and Gold

Although the prices of gold and oil don't exactly mirror one another, there is no question

that oil prices do affect gold prices. If oil prices rise or fall sharply, investors can expect a

corresponding reaction in gold prices, often with a lag.

There have been two major upward moves in the price of gold since it was freed to float in

1968. The first occurred between 1972 and 1974 when oil prices climbed 325%, from $2.44

to $10.36. During the same period, gold prices rose 268% (on a quarterly average basis)

from $47.45 to $174.76. The second major price move occurred between 1978 and 1980,

when oil prices increased 105%, from $12.70 to $26.00. Over the same period, quarterly

average gold prices rose 254% from $178.33 to $631.40.

GOLD - HEDGE AGAINST A DECLINING DOLLAR

Gold is bought and sold in U.S. dollars, so any decline in the value of the dollar causes the

price of gold to rise. The U.S. dollar is the world's reserve currency - the primary medium for

international transactions, the principal store of value for savings, the currency in which the

worth of commodities and equities are calculated, and the currency primarily held as

reserves by the world's central banks. However, now that it has been stripped of its goldbacking, the dollar is nothing more than a fancy piece of paper.

GOLD AS A SAFE HAVEN

Despite the fact that the United States is the worlds only remaining superpower, there are

many problems festering around the world, any one of which could explode with little

warning. Gold has often been called the "crisis commodity" because it tends to outperform
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other investments during periods of world tensions. The very same factors that cause other

investments to suffer cause the price of gold to rise. A bad economy can sink poorly run

banks. Bad banks can sink an entire economy. And, perhaps most importantly to the rest of

the world, the integration of the global economy has made it possible for banking and

economic failures to destabilize the world economy. As banking crises occur, the public

begins to distrust paper assets and turns to gold for a safe haven. When all else fails,governments rescue themselves with the printing press, making their currency worth less

and gold worth more. Gold has always risen the most when confidence in government is at

its lowest.

GOLD - SUPPLY AND DEMAND

First, demand is outpacing supply across the board. Gold production is declining; copper

production is declining; the production of lead and other metals is declining. It is very

difficult to open new mines when the whole process takes about seven years on average,

making it hard to address the supply issue quickly. Gold output in South Africa, the world's

largest gold producer, fell to its lowest level since 1931 this past year as the rand's gains

prompted Harmony Gold Mining Co. and rivals to close mines despite 16 year highs in the

gold price.

Growing Demand - China, India and Gold

India is the largest gold-consuming nation in the world. China, on the other hand, has the

fastest-growing economy in modern history. Both India and China are in the process of

liberalizing laws relating to the import and sale of gold in ways that will facilitate goldpurchases on a huge scale. China is teaching the West something new. Its economy, growing

at 9 percent per year, is expected to become the second largest in the world by 2020,

behind only the United States. Last year Americans spent $162 billion more on Chinese

goods than the Chinese spent on U.S. products. That gap has been growing by more than 25

percent per year. China's consumer class, meanwhile, is spending on everything from bagels

to Bentleys and will soon outnumber the entire U.S. population. China's explosive growth

"could be the dominant event of this century," says Stapleton Roy, former U.S. ambassador

to China. "Never before has a country risen as fast as China is doing." China recently passed

legislation that will allow the country's four major commercial banks to sell gold bars to

their customers in the near future. Currently, individuals in China are only allowed to buygold-backed certificates from the Bank of China and the Industrial and Commercial Bank of

China.

GOLD STORE OF VALUE

One major reason investors look to gold as an asset class is because it will always maintain

an intrinsic value. Gold will not get lost in an accounting scandal or a market collapse.


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Economist Stephen Harmston of Bannock Consulting had this to say in a 1998 report for the

World Gold Council, although the gold price may fluctuate, over the very long run gold

has consistently reverted to its historic purchasing power parity against other commodities

and intermediate products. Historically, gold has proved to be an effective preserver of

wealth. It has also proved to be a safe haven in times of economic and social instability. In a

period of a long bull run in equities, with low inflation and relative stability in foreignexchange markets, it is tempting for investors to expect continual high rates of return on

investments. It sometimes takes a period of falling stock prices and market turmoil to focus

the mind on the fact that it may be important to invest part of ones portfolio in an asset

that will, at least, hold its value. Today is the scenario that the World Gold Council report

was referring to in 1998.

GOLD - PORTFOLIO DIVERSIFIER

The most effective way to diversify your portfolio and protect the wealth created in the

stock and financial markets is to invest in assets that are negatively correlated with those

markets. Gold is the ideal diversifier for a stock portfolio, simply because it is among the

most negatively correlated assets to stocks. Investment advisors recognize that

diversification of investments can improve overall portfolio performance. The key to

diversification is finding investments that are not closely correlated to one another. Because

most stocks are relatively closely correlated and most bonds are relatively closely correlated

with each other and with stocks, many investors combine tangible assets such as gold with

their stock and bond portfolios in order to reduce risk. Gold and other tangible assets have

historically had a very low correlation to stocks and bonds. Although the price of gold can be

volatile in the short-term, gold has maintained its value over the long-term, serving as a

hedge against the erosion of the purchasing power of paper money. Gold is an important

part of a diversified investment portfolio because its price increases in response to events

that erode the value of traditional paper investments like stocks and bonds.


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TRADING PARAMETERS FOR GOLD IN COMMODITY EXCHANGE MARKET

Authority

Trading of Gold futures may be conducted under such terms and conditions as specified in

the Rules, Byelaws & Regulations and directions of the Exchange issued from time to time.

Unit of Trading

The unit of trading of Gold shall be 1 Kg and 100gm mini lot. Bids and offers may be

accepted in lots of Gold shall be 1 Kg or multiples thereof.

Months Traded In

Trading in Gold futures may be conducted in the months as specified by the Exchange from

time to time.

Tick Size

The tick size of the price of Gold shall be Re. 1.00.

Basis Price

The basis price of Gold shall be Ex-Mumbai inclusive of Customs Duty and Octroi, excluding

Sales Tax.

Unit for Price Quotation

The unit of price quotation for Gold shall be in Rupees per 10 gms of Gold with 995

Fineness.

Hours of Trading

The hours of trading for futures in Gold shall be as follows: Mondays through Fridays 10.00 AM to 11.30 PM

Saturdays 10.00 AM to 02.00 PM

Or as determined by the Exchange from time to time. All timings are as per Indian

Standard Timings (IST)

Last Day of Trading

Last day of trading for Gold shall be 20th calendar day of contract month, if 20th

happens to

be a holiday or a Saturday or a Sunday, then the previous working day, which is other than a

Saturday.

Mark to Market

The outstanding positions in futures contract in Gold would be marked to market daily

based on the Daily Settlement Price (DSP) as determined by the Exchange.

Position limits

At the commodity level, the member-wise position limit will be a maximum of 6 MT or15%

of market-wide open position whichever is higher. The Client-wise position limit will be a


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maximum of 2 MT. Both position limits will be subject to NCDEX Regulations and directions

from time to time. The above position limits will not apply to bona fide hedgers as

determined by the Exchange.

Margin Requirements

NCDEX will use Value at Risk (VaR) based margin calculated at 99% confidence interval forone day time horizon. NCDEX reserves the right to change, reduce or levy any additional

margins including any mark up margin.

Special Margin

In case of additional volatility, a special margin of at such other percentage, as deemed fit,

will be imposed immediately on both buy and sell side in respect of all outstanding

positions, which will remain in force for next 2 days, after which the special margin will be

relaxed.

Pre-Expiry Additional Margin

There will be an additional margin imposed for the last 2 trading days, including the expiry

date of the Gold contract. The additional margin will be added to the normal exposure

margin and will be increased by 5% everyday for the last 2 trading days of the contract.

Delivery Margins

In case of open positions materializing into physical delivery, delivery margins as may be

determined by the Exchange from time to time will be charged. The delivery margins will

be calculated based on the number of days required for completing the physical delivery

settlement (the look-ahead period and the risks arising thereof).

Arbitration

Disputes between the members of the Exchange inter-se and between members and

constituents, arising out of or pertaining to trades done on NCDEX shall be settled

through arbitration. The arbitration proceedings and appointment of arbitrators shall be as

governed by the Bye-laws and Regulations of the Exchange.

DELIVERY PROCEDURES

Unit of Delivery

The unit of delivery for Gold shall be 1 kg.

Delivery Size

Delivery is to be offered and accepted in lots of 1 kg Net only or multiples thereof. No

quantity variation is permitted as per contract specification.

Delivery Requests


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The procedure for Gold delivery is based on the contract specifications as per Exhibit IA and

Exhibit IB. All the open positions shall have to be compulsorily delivered either

by giving delivery or taking delivery as the case may be. That is, upon expiry of the

contracts, any seller with open position shall give delivery of the commodity. The

corresponding buyer with open position as matched by the process put in place by the

Exchange shall be bound to settle by taking physical delivery. In the event of default byseller or buyer to give delivery or take delivery, as the case may be, such defaulting seller or

buyer will be liable to penalty as may be prescribed by the Exchange from time to time.

The Buyers and the Sellers need to give their location preference through the front end of

the trading terminal. If the Sellers fail to give the location preference then the allocation to

the extent of his open position will be allocated to the base location.

Quality Standards

The contract quality for delivery of Gold futures contracts made under NCDEX Regulations

shall be Gold conforming to the quality specification indicated in the contract. No lower

grade/quality shall be accepted in satisfaction of futures contracts for delivery except as and

to the extent provided in the contract specifications. Delivery of higher grade would be

accepted with premium.

Packaging

The gold bars to be accepted at the designated vault shall be directly imported and

hallmarked from the approved list of refiners through the approved logistic agency i.e.

Brinks Arya India (Pvt.) Ltd. or their affiliates / associates. The Gold bars delivered at the

Exchange designated vault, indicated in Exhibit 4, should bear the refinery serial no. and

accompanied with the Refinery certificate. Gold held at the NCDEX approved vaults will

be on un -allocated basis i.e. it will be co mingled with those gold bars pertaining to the

participants of NCDEX. These bars will be of 1 Kg only.

Standard Allowances

No standard allowance is allowed on account of sample testing.

Weight

The quantity of Gold received and or delivered at the NCDEX designated vault would be

determined / calculated by the weight together with serial number as indicated in the

enclosed Refinery certificate submitted at the time of delivery into the designated vault

and would be binding on all parties.

Good / Bad delivery Norms

Gold delivery into NCDEX designated Warehouse would constitute good delivery or bad

delivery based on the good / bad delivery norms as per Exhibit 3. The list contained in

Exhibit 3 is only illustrative and not exhaustive. NCDEX would from time to time review

and update the good / bad delivery norms retaining the trade / industry practices.


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Accredited Assayer

NCDEX has approved the Assayer for quality testing and certification of Gold

received at the designated warehouse. The quality testing and certification of Gold

will be undertaken only by the approved Assayer. The assayer details are given in theExhibit 2

alongside the warehouses.

Quality Testing Report

Gold delivered into the NCDEX designated vault. This must be accompanied with the

certificate from the LBMA approved Refinery. A specimen of the certificate issued by

LBMA approved refinery is posted under Exhibit 6.

Assayer Certificate

Testing and quality certificate issued by NCDEX approved Assayer for Gold delivered

at

designated warehouse in Mumbai, Ahmedabad and at such other locations

announced

by the Exchange from time to time shall be acceptable and binding on all parties.

Each

delivery of Gold at the warehouse must be accompanied by a certificate from NCDEX

approved Assayer in the format as per Exhibit 4.

Validity period

The validity period of the Assayers Certificate for Gold is till the withdrawal from the

warehouse.

Electronic transfer

Any buyer or seller receiving and or effecting Gold would have to open a depository

account with an NCDEX empanelled Depository Participant (DP) to hold the Gold inelectronic form. On settlement, the buyers account with the DP would be credited

with

the quantity of Gold received and the corresponding sellers account would be

debited.

The Buyer wanting to take physical delivery of the Gold holding has to make a

request in


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prescribed form to his DP with whom depository account has been opened. The DP

would route the request to the warehouse for issue of the physical commodity i.e.

Gold to the buyer and debit his account, thus reducing the electronic balance to the

extent of Gold

so rematerialized.

Charges

All charges and costs payable at the designated warehouse towards delivery of Gold

including sampling, grading, weighing, handling charges, storage etc. from the date

of

receipt into designated warehouse upto date of pay in & settlement shall be paid by

the

seller.

No refund for warehouse charges paid by the seller for full validity period shall be

given

to the seller or buyer for delivery earlier than the validity period. All charges and

costs associated & including storage, handling etc. after the pay out shall be borne

by the buyer. Warehouse storage charges will be charged to the member / client by

the respective Depository Participant. The Assayer charges for testing and quality

certification should be paid to the Assayer directly at the delivery location either by

cash / cheque / demand draft.

Duties & levies

All duties, levies etc. up to the point of sale will have to be fully borne by the seller

and

shall be paid to the concerned authority. All related documentation should be

completed

before delivery of Gold into the NCDEX accredited warehouse.

Stamp Duty

Stamp duty is payable on all contract notes issued as may be applicable in the State

from where the contract note is issued or State in which such contract note isreceived

by the client.

Taxes

Service tax


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Service tax will be payable by the members of Commodity Exchanges on the gross

amount charged by them from their clients on account of dealing in commodities.

Sales Tax / VAT

Local taxes/ VAT wherever applicable is to be paid by the seller to the sales tax/VAT

authorities on all contracts resulting in delivery. Accordingly the buyer will have topay

the taxes/VAT to the seller at the time of settlement. Members and / or their

constituents requiring to receive or deliver Gold should register with the relevant

tax/VAT authorities of the place where the delivery is proposed to be received /

given. In the event of sales tax exemption, such exemption certificate should be

submitted before settlement of the obligation. There will be no exemptions on

account of resale or second sale in VAT regime.

Premium / Discount

Premium & Discount on the Gold delivered will be provided by the Exchange on the

basis of quality specifications:

The Exchange will communicate the premium / discounts amount applicable. Such

amount will be adjusted to the members account through the supplementary

settlement.

Commodity Markets Project Rough

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