Indian Commodity Market Repaired)

8/4/2019 Indian Commodity Market Repaired)

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INDIAN COMMODITY MARKET

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1.COMMODITY1.1 Origin COMMODITY

Middle English commoditee, from Anglo of-French commoditee, from

Latin commoditat-, commoditas, from commodus.

First Known Use: 15th century

1.2 Meaning of COMMODITY

physical substance, such as food, grains, and metals, which is in-

terchangeable with another product of the same type, and

which investors buy or sell, usually through futures contracts. The price of

the commodity is subject to supply and demand. Avoiding risk is actually the

reason exchange trading of the basic agricultural products began. For example,

a farmer risks the cost of producing a product ready for market at sometime in

the future because he doesn't know what the selling price will be.

A commodity may be defined as an article, a product or material that as

bought and sold. It can be classified as every kind of movable property, except

Actionable Claims, Money & Security. 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 investors

should understand the, risks and advantages of trading in commodities futures

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before taking a leap. Historically, pricing incommodities futures has been less

volatile compared with equity and bonds, thus providing an efficient portfolio

diversification option.

More generally, a product which trades on a commodity exchange; this

would also includeforeign currencies and financial instruments and indexes.

Generally speaking, any tangible good can be categorized as a commodity.

A commodity is typically a bulk good such as gold, silver, natural gas, and oil. A

commodity may also be a bulk food product like grain, oats, corn, beef, pork

bellies, and coffee. Traditionally, a commodity was merely a good, subject to sale

or barter. Today however, a commodity can also represent an investment vehicle.

One example is commodity futures. A commodity is traded at the commodities

exchange. A commodities exchange not only facilitates the commodity trade, but

also establishes and enforces rules and regulations pertaining to the commodity

trading process. Depending on its use and trading purpose, a commodity may

come in two types

Cash commodity and

Spot commodity whereas,

A cash commodityis an actual commodity that is under a futures contract.

A spot commodity on the other hand, is one that is traded on a spot

market, pending delivery.

In fact, the size of the commodities markets in India is also quite

significant. Of the country's GDP of Rs 13, 20,730 crores (Rs 13,207.3 billion),

commodities related (and dependent) industries constitute about 58 per cent.


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Currently, the various commodities across the country clock an annual turnover of

Rs 1, 40,000 crores (Rs1, 400 billion). With the introduction of futures trading, the

size of the commodities market grows many folds here on.

1.3 Types of COMMODITIES

Commodities are further broadly divided into four different parts; which are

shown in the diagram below:

COMMODITY

PRECIOUS

METALS

Silver

Gold

BASE METALS

Copper

Zinc

Aluminum

Nickel

Lead

ENERGIES

Crude oil

Natural Gas

AGRI

PRODUCTS

Spices

Pulses

Oil


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2.COMMODITY MARKETommodity markets deal in raw materials that are amenable to grading

and that can be stored for considerable periods without deterioration.

Originally, the commodity markets started off as a way for farmers to sell

their goods at a guaranteed price in the future. Because farmers had no way of

knowing whether the harvest would turn out good or bad, it provided a way for

them to lock in some profits before going to market. The commodity market also

provided a way for buyers to get a price they thought was fair.

Commodity is an important constituent of the financial market of any

country. It is the market where a wide range of products are traded.It is impor-

tant to develop a vibrant, active and liquid commodity market. This would help

investors hedge their commodity risk, take speculative positions in commodities

and exploit arbitrage opportunities in the market.

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2.1 History of COMMODITY MARKET

Commodities markets, both historically and in modern times, have had

tremendous economic impact on nations and people. The impact of commodity

markets throughout history is still not fully known, but it has been suggested that

rice futures may have been traded in China as far back as 6,000 years ago.

Whereas, its said that the U.S. commodity markets began in the 19th century

with the trading of staples such as cattle, wheat, corn and pigs. And according to

Investopedia, the very first commodities markets began in Sumer, dealing with

sheep and goats. Contracts took the shape of small baked clay tokens made in the

shape of the animals that they represented; the Sumerians considered them more

binding.

The economic impact of the development of commodity markets is hard

to overestimate. Through the 19th century "the exchanges became effective

spokesmen for, and innovators of, improvements in transportation, warehous-

ing, and financing, which paved the way to expanded interstate and interna-

tional trade."

Commodity market, organized traders' exchange in which standardized,

graded products are bought and sold. Worldwide, there are 48 major commodity

exchanges that trade over 96 commodities, ranging from wheat and cotton to

silver and oil. An independent U.S. regulatory agency, the Commodity Futures

Trading Commission was established in 1974 to regulate commodity markets. In

1982, the Chicago Mercantile Exchange introduced a futures contract for Stan-

dard & Poor's 500 U.S. companies that allow investors to speculate on the future

prices of those stocks.


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2.2 Size of the COMMODITY MARKET

The trading of commodities consists ofdirect physical trading and deriva-

tives trading. Exchange traded commodities have seen an upturn in the volume

of trading since the start of the decade. This was largely a result of the growing

attraction of commodities as an asset class and a proliferation of investment op-

tions which has made it easier to access this market.

The global volume of commodities contracts traded on exchanges in-

creased by a fifth in 2010, and a half since 2008, to around 2.5 billion million

contracts. During the three years up to the end of 2010, global physical exports of

commodities fell by 2%, while the outstanding value of OTC commodities deriva-

tives declined by two-thirds as investors reduced risk following a five-fold increase

in value outstanding in the previous three years. Trading on exchanges in China

and India has gained in importance in recent years due to their emergence as sig-

nificant commodities consumers and producers. China accounted for more than

60% of exchange-traded commodities in 2009, upon its 40% share in the previous

year.

Commodity assets under management more than doubled between 2008

and 2010 to nearly $380bn. Inflows into the sector totaled over $60bn in 2010,

the second highest year on record, down from the record $72bn allocated to

commodities funds in the previous year. The bulk of funds went into precious

metals and energy products. The growth in prices of many commodities in 2010

contributed to the increase in the value of commodities funds under manage-

ment.


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2.3 Commodity Derivatives Market

Derivative Market can broadly be classified as commodity derivative mar-

ket and financial derivative market. As the name suggest, commodity derivatives

trade contracts for which the underlying assets is a commodity like, wheat, soya

bean ,cotton etc or precious metal like Gold and Silver. Financial derivatives mar-

kets trade contract that have a financial assets or variable as the underlying. The

most financial derivatives are those, which have equity, interest rate and ex-

change rate as the underlying. Financial derivatives are used to hedge the expo-

sure to market risk. The commodity derivatives differ from the financial deriva-

tives mainly in the following two aspects: Firstly,due to the bulky nature of the

Underlying assets, physical settlement in commodity derivatives creates the need

for warehousing.Secondly, in the case of commodities, the quality of the asset

underlying a contract can vary largely.


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3.INTERNATIONAL COMMODITY EXCHANGESSOME LEADING EXCHANGE OF THE WORLD

SR.NO. GLOBAL COMMODITY EXCHANGES

1. New York Mercantile Exchange (NYMEX)

2. London Metal Exchange (LME)

3. Chicago Board of Trade (CBOT)

4. New York Board of Trade (NYBOT)

5. Kansas Board of Trade

6. Winnipeg Commodity Exchange, Manitoba

7. Dalian Commodity Exchange, China

8. Bursa Malaysia Derivatives exchange

9. Singapore Commodity Exchange (SICOM)

10. Chicago Mercantile Exchange (CME), US


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11. London Metal Exchange

12. Tokyo Commodity Exchange (TOCOM)

13. Shanghai Futures Exchange

14. Sydney Futures Exchange

15. London International Financial Futures and Options Exchange (LIFFE)

16. National Multi-Commodity Exchange in India (NMCE), India

17. National Commodity and Derivatives Exchange (NCDEX), India

18. Multi Commodity Exchange of India Limited (MCX), India

19. Dubai Gold & Commodity Exchange (DGCX)

20. Dubai Mercantile Exchange (DME), (joint venture between Dubaiholding and the New York Mercantile Exchange (NYMEX)


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3.1 Regulators

Each exchange is normally regulated by a national governmental (or semi-

governmental) regulatory agency:

COUNTRY REGULATORY AGENCY

Australia Australian Securities and Investments Commission

Chinese

mainland

China Securities Regulatory Commission

Hong Kong Securities and Futures Commission

India Securities and Exchange Board of India and Forward Markets

Commission (FMC)

Singapore Monetary Authority of Singapore

UK Financial Services Authority

USA Commodity Futures Trading Commission

Malaysia Securities Commission


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Recent years have witnessed a steep rise in the creation of the commodity

exchanges along with a consistent expansion of the existing ones. The United

States, Japan, United Kingdom, Brazil, Australia, Singapore are homes to leading

commodity futures exchanges in the world.

3.2 Worlds Major Commodity Exchanges:

The New York Mercantile Exchange (NYMEX)

The New York Mercantile Exchange is the world's biggest exchange for

trading in physical commodity futures.It is the primary trading forum for energy

products and precious metals. The Exchange has been inexistence for 132 years

and performs trades through two divisions, the NYMEX divisions, which deals in

energy and platinum and the COMEX division which trades in all the other metals.A major contribution of the Exchange has been to develop and launch energy

futures and options contract in 1978 to facilitate price transparency and risk

management in this key market. Exchange has become a significant part of the

commercial, civic and cultural life of New York. Exchange also clears trades for

market participants who which to avoid counter-party credit risk by using stan-

dardized contracts for Natural Gas, Crude Oil, Refined products and Electricity.Commodities traded: Light Sweet Crude Oil, Natural gas, Heating Oil, Gasoline,

BOB Gasoline, Electricity, Propane, Gold, Silver, Copper, Aluminum, Platinum, Pal-

ladium, etc.


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London Metal Exchange (LME)

The London Metal Exchange (LME) is the world's premier non-ferrous

market, with highly liquid contracts. It is an innovative exchange that has main-

tained its traditional strengths in a modern business environment by remaining

close to its core users by ensuring that its contracts continue to meet the high ex-

pectations of a demanding industry. It has become highly successful with a trad-

ing turnover value of more than US$2000 billion per annum and contributes sub-

stantially to the invisible earnings.

The Exchange was formed in 1877 as a direct consequenceof the indus-

trial revolution witnessed in Britain in the 19th Century. The primary focus of LME

is providing a market for participants from the non-ferrous base metals related

industry to safe guard against risk due to movements in base metal prices and

also arrive at a price that sets the benchmark globally. The exchange trades 24

hours a day through an inter-office telephone marketand also through an elec-tronic trading platform. It is famous for its open-outcry trading between ring deal-

ing members that takes place on the market floor.

Commodities Traded: Aluminum, Copper, Nickel, Lead, Tin, Zinc, Aluminum Al-

loy, North American Special Aluminum Alloy (NASAAC), Polypropylene, Linear Low

Density Polyethylene, etc.

The Chicago Board of Trade (CBOT)

Thefirst commodity exchange established on the world was the Chicago

Board of Trade (CBOT).During the year 1848 by a group of Chicago merchants

who were keen to establish a central market place for trade.This was situated in

the premises of a flour store during its first four years, Prior to this farmers often


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found no buyers for the grain they had transported to Chicago. Given the high

transport cost, they have been left with little choice but to dump the unsold pro-

duce in the near by lake.

Presently, the Chicago Board of Trade is one of the leading exchanges in

the world for trading in futures and options. More than 50 contracts on futures

and options are been offered by CBOT. Currently through open-outcry and/or

electronically. CBOT is the oldest existing commodity exchange in the world hav-

ing established in the year 1848. Initially, CBOT dealt only in agricultural com-

modities like corn, wheat, soybeans, and oats. Futures contracts in CBOT evolved

over a period of time to facilitate trading in non-storable agricultural commodities

and non-agricultural products like gold and silver. The first electronic trading sys-

tem in CBOT was introduced in 1994 after more than 150 years of open auction

trading where traders used to meet to buy and sell futures contracts.

Commodities traded: - Corn, Soybeans, Soybean Oil, Soybean Meal, Wheat, Oats,

Ethanol, Rough Rice, Gold, and Silver etc.

Tokyo Commodity Exchange (TOCOM)

The Tokyo Commodity Exchange (TOCOM) is the second largest commod-

ity futures exchange in the world with trade in metals and energy contracts. It

has made rapid advancements in commodity trading globally since inception 20years back. One of the biggest reasons for this is the initiative TOCOM took to-

wards establishing Asia as the benchmark for price discovery and risk manage-

ment incommodities like the Middle East Crude Oil. TOCOM's recent tie-up with

the MCX to explore cooperation and business opportunitiesis seen as one of the

steps towards providing a platform for futures price discovery in Asia for Asian


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players in Crude Oil since the demand-supply situation in US that drives the

MYMEX is different from the demand-supply in Asia.

In January 2003, in a major overhaul over its computerized trading sys-

tem,TOCOM fortified its clearing system in June by being the first commodity Ex-

change in Japan to introduce an in-house clearing system.

Commodities Traded: - Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum, Pal-

ladium, Aluminum, Rubber, Etc.

Chicago Mercantile Exchange (CME)

Chicago Mercantile Exchange (CME) is the largest futures exchange in the

US and the largest futures clearing house in the world for futures and options

trading Formed in 1898 primarily to trade in agricultural commodities, the CME

introduced the world's financial futures more than 30 years ago.Today it trades

heavily in interest rate futures, Stock indices and foreign exchange futures. Itsproducts often serve as a financial benchmark and witness the larges the open in-

terest in futures contracts compared to any other exchange in the world. The

commodities futures profile of CME consists of livestock, dairy and forest prod-

ucts and enables small family farms to large agri-businesses to manage their price

risks.

Trading in the CME can be done either through pit trading or electronically.Commodities Traded:- Butter, Milk, Diammonium Phosphate, Feeder cattle, Fro-

zen Pork bellies, Lean Hogs, live Cattle, Non-fat Dry Milk, Urea, Urea Ammonium

Nitrate,Etc.


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4.COMMODITY MARKET IN INDIA4.1 Introduction to INDIAN COMMODITY MARKET

ndia, a commodity based economy where two-third of the one billion

population depends on agricultural commodities, surprisingly has an

under developed commodity market. The vast geographical extent of India and

her huge population is aptly complemented. The broadest classification of the

Indian Market can be made in terms of the commodity market and the bond

market.

India Commodity Market can be subdivided into the following two categories:

Wholesale Market

Retail Market

The traditional wholesale market in India dealt with whole sellers who

bought goods from the farmers and manufacturers and then sold them to the re-

tailers after making a profit in the process. It was the retailers who finally sold the

goods to the consumers. With the passage of time the importance of whole sell-

ers began to decline due to various reasons. In recent years, the extent of the re-

tail market (both organized and unorganized) has evolved in leaps and bounds. In

fact, the success stories of the commodity market of India in recent years has

mainly centered on the growth generated by the Retail Sector. Almost every

commodity under the sun both agricultural and industrial is now being provided

at well distributed retail outlets throughout the country.

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Moreover, the retail outlets belong to both the organized as well as the unor-

ganized sector.

The unorganized retail outlets of the yesteryears consist of small shop

owners who are price takers where consumers face a highly competitive

price structure.

The organized sectors on the other hand are owned by various business

houses like Pantaloons, Reliance, Tata and others. Such markets are usually

selling a wide range of articles agricultural and manufactured, edible and

inedible, perishable and durable.

Modern marketing strategies and other techniques of sales promotion

enable such markets to draw customers from every section of the society. How-

ever the growth of such markets has still centered on the urban areas primarily

due to infrastructural limitations. Considering the present growth rate, the total

valuation ofthe Indian Retail Market is estimated to cross Rs. 10,000 billion in

the year 2010. Demand for commodities is likely to become four times by 2012

than what it presently is.

4.2 Evolution of Indian commodity market

Although India has a long history of trade in commodity derivatives, this

segment remained underdeveloped due to government intervention in many

commodity markets to control prices. The production, supply and distribution of

many agricultural commodities are still governed by the state and forwards and

futures trading are selectively introduced with stringent controls. While free trade

in many commodity items is restricted under the Essential Commodities Act


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(ECA), 1955, forward and futures contracts are limited to certain commodity

items under the Forward Contracts (Regulation) Act (FCRA), 1952 .

The first commodity exchange was set up in India by Bombay Cotton Trade

Association Ltd, and formal organized futures trading started in cotton in 1875.

Subsequently, many exchanges came up in different parts of the country for fu-

tures trade in various commodities. The Guajarati Vyapari Mandalicame into ex-

istence in 1900which has undertaken futures trade inoilseeds first time in the

country. The Calcutta Hessian Exchange Ltd and East India Jute Association Ltd

was set up in 1919 and 1927respectively for futures trade in raw jute. In 1921, fu-

tures in cotton were organized in Mumbai under the auspices of East.

India Cotton Association (EICA). Many exchanges were set up in major ag-

ricultural centres in north India before world war broke out and

they were mostly engaged in wheat futures until it was prohibited. The existing

exchanges in Hapur, Muzaffarnagar, Meerut, Bhatinda, etc. were established dur-

ing this period. The futures trade in spices was first organized by India Pepper

and Spices Trade Association (IPSTA) in Cochin in 1957. Futures in gold and silver

began in Mumbai in 1920 and continued until it was prohibited by the govern-

ment by mid-1950s.

Options are though permitted now in stock market, they are not allowed in

commodities. The commodity options were traded during the pre-independence

period. Options on cotton were traded until they along with futures were banned

in 1939 (Ministry of Food and Consumer Affairs, 1999). However, the government

withdrew the ban on futures with passage ofFCRA in 1952.The Act has provided


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for the establishment and constitution of Forward Markets Commission (FMC) for

the purpose of exercising the regulatory powers assigned to it by the Act. Later,

futures trade was altogether banned by the government in 1966in order to have

control on the movement of prices of many agricultural and essential

commodities.

After the ban of futures trade all the exchanges went out of business and

many traders started resorting to unofficial and informal trade in futures. On

recommendation of the Khusro Committee in 1980 government reintroduced fu-

tures on some selected commodities including cotton, jute, potatoes, etc. As part

of economic liberalization of 1990s an expert committee on forward markets

under the chairmanship of Prof. K.N.Kabra was appointed by the government of

India in 1993. Its report submitted in 1994recommended the reintroduction of

futures which were banned in 1966 and also to widen its coverage to many more

agricultural commodities and silver. In order to give more thrust on agricultural

sector, the National Agricultural Policy 2000 has envisaged external and domes-

tic market reforms and dismantling of all controls and regulations in agricul-

tural commodity markets. It has also proposed to enlarge the coverage of futures

markets to minimize the wide fluctuations in commodity prices and for hedging

the risk arising from price fluctuations. In line with the proposal

many more agricultural commodities are being brought under futures trading.

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


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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) Mumbai, Multi Commodity Exchange of

India Limited (MCX) Mumbai and National Multi-Commodity Exchange of India

Limited (NMCEIL) Ahmadabad. There are other regional commodity exchanges

situated in different parts of India.

4.3 Why are commodity derivate required?

India is among the top 5 producerof the most of the commodities in addi-

tion to being a major consumerof bullion and energy products. Agriculture con-

tributes more than 23% to be GDPof Indian economy. It employees around 57%

of the labour force on a total of 185 million hectares of land. Agriculture sector is

an important factor to achieving a GDP growth of 8.10. All this indicates that In-

dia can be promoted as a major centre for trading of commodity derivatives.

It is important to understand why commodity derivatives are required

and the role they can play in risk management. It is common knowledge that

prices of commodities, metals, shares and currencies fluctuate over time. The

possibility of adverse price change in future creates risk for business. Derivativesare used to reduce or eliminate price risk arising from unforeseen price change.A

derivatives is a financial contract whose price depends on, or is derived from the

price of another assets.


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4.4 Two important derivatives are FUTURES AND OPTIONS:-

(1) Commodity Future Contract:-

A future contract is an agreement for buying or selling a commodity for a

predetermined delivery price at as specific future time. Futures are standardized

contractthat are traded on organized facture exchanges that ensure performance

of the contract and remove the default risk. The commodity futures have existed

since the Chicago Board of Trade (CBOT) was established in 1848 to bring farmers

and merchants together the major function of future market is to transfer price

riskfrom hedger to speculators.

For example suppose a farmer is expecting the crop of paddy to be ready in two

months time, but is worried that the price of paddy may decline in this period. In

order to minimize his risk. He can enter into a future contract to sell his crop in

two months time at a price determined now.

Just take another example. All we know that woolen garments demand picks up

in winter season. A garment factory owner can by a factory contract of cotton to

get the raw material for his products as predetermined price. This way both time

is able to hedge their risk arising from a possible adverse change in the price of

theirs commodity or raw material.

(2) Commodity Option Contract:-

Like futures, options are also financial instruments used for hedging and

speculation. The commodity option holder has the right, but not the obligation

to buy (or sell) a specified quantity of a commodity at specified price on or be-

fore a specified date. Option contract involve two parties the seller of the op-


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tion writes the option in favor of the buyer (holder) who pays a certain premium

to the seller as a price for the option. There are two types of commodity options.

A call optiongives the holder a right to buy a commodity at an agreed price,

while a put option gives the holder a right to sell a commodity at an agreed

price on or before a specified date which is called expiry date.

The option holder will exercise the option only if it is beneficial to him,

otherwise he will let the option lapse. Suppose a farmer buys a put option to sell

10 MT of wheat at a price of Rs. 13000/- MT and pays a premium of Rs. 500/-

MT. If the price wheat decline, to say Rs. 1000/-MT before expiry, the farmer will

the exercise his option and sell h is wheat at the agreed price of Rs. 1300/- MT.

However, if the market price of wheat increase by Rs. 1000/-MT, it will be better

for the farmer to sell it directly in the open market at the spot price, rather than

his option to sell at Rs. 13000/- MT.

Future and options trading therefore helps in hedging the price risk an

also provide investment opportunity to speculators who are willing to assume

risk for a possible return. Future trading and the ensuing discovery of price can

help farmers to deciding which crops to grow. They can also help in building a

competitive their earning because non-hedging of the risk would increase the

Volatility of their quarterly earnings. Thus future and options market perform im-

portant functions that can not be ignored in modern business environment at thesame time. It is true that too much speculative activity in essential commodities

would de-stabilize the markets and therefore, these markets are normally regu-

lated as per the law of the country. Option on trading is not permittedtill now in

commas.


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Explanation:

4.5 Nature of Commodities:-

Commodities are real assets that are produced and consumed in an indus-

trial or other process. In contrast, other asset classes of interest rates, currency or

equity represent financial claims on different aspects of real assets.This aspect of commodities ha a number of dimensions, including:

1. Consumption goods

Commodities are primarily consumption goods rather than investment

products. This means that demand is not purely price dependent. In addition,

some commodities may display characteristics not normally found in financial as-

sets.

For example, zero or negative price may occur in electricity markets where

generators seek to ensure that their plants are dispatched for contiguous blocks

of time longer than a simple slot for which separate time bids are accepted. This is

driven by the desire of the generator to shed excess output as electricity cannot

be stored.

2. Non standard structure

Commodities are generally not standardized.This reflects the heteroge-

neous nature of commodity production in terms of quality or grade. This contrasts

with other financial assets that are homogenous. This dictates that the commod-

ity market has two layers.


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The physical or cash market that trades a range of commodities of varying

quality, location and structure, and a commodity derivatives market that trades

arrange of instruments on (artificially) standardized commodities. This is driven by

the need to facilitate trading. It creates basis risk in commodity derivatives.

3. Cost of production

Commodity prices frequently gravitate towards the cost of production.

This is because the market will adjust over time. If prices are significantly above or

below the cost of production (including a "normal" profit component), then sup-

ply will adjust in the longer term.

4. Price behavior

Commodity prices display seasonality and may change over different

phases of the commodity life. Seasonal patterns in consumption and production

are manifested in recurring behavior of prices and volatility. Forward prices of

commodities will generally change as time to maturity changes.


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The structure of commodity markets dictates that there are several types

of participants active in the trading of commodities and commodity derivatives.

The structure of the participants and the nature of their activities/motivations are

more complex than in other asset classes.

The major participants in commodity markets include:


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Explanation:

1. Commodity Producers/Consumers:-

These participants have natural underlying outright long (producers) and

short (consumers) positions in the relevant commodity. The inherent risk-

exposure drives the use of commodity derivatives by producers and users.

The application of commodity derivatives in frequently driven by the pat-

tern of cash flows. Producers must generally make significant capital investments

(sometime significant in scale) to undertake the production of the commodity.

This investment must generally be made in advance of production and sale of the

commodity. This means that the producer is exposed to the price fluctuations in

the commodity.

If prices decline sharply, then revenues may be insufficient to cover the

cost of servicing the capital investment (including debt service). This means that

there is a natural tendency for producers to hedge at levels that ensure adequate

returns without seeking to optimize the potential returns from higher returns.

This may also be necessitated by the need to secure financing for the project.

Consumer hedging behavior is more complex. Consumer desire to under-

take hedges is influenced by availability of substitute products and the ability to

pass on higher input costs in its own product market. In many commodities, pro-

ducer and consumer deal directly with each other. The form of arrangement may

include negotiated bilateral long term supply or purchase contracts between the


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producers and consumers. The contracts may include fixed. Price arrangements to

reduce the price risk for both parties.

These arrangements create a number of difficulties. These include lack of

transparency, low liquidity and exposure to counterparty credit risk. The bilat-

eral structure also creates potential adverse performance incentives. This reflects

the fact that the contracts combine supply/purchase obligations and price risk

elements in a single contract.

2. Commodity Processors:-

These participants have limited outright price exposure.This reflects the

fact the processors have a spread exposure to the price differential between the

cost of the input and the cost of the output. For example, oil refiners are exposed

to the differential between the price of the crude oil and the price of the refined

oil products (diesel, gasoline, heating oil, aviation fuel, etc.). The nature of the ex-

posure drives the types of hedging activity and the instruments used.

3. Commodity Traders:

Commodity markets have complex trading arrangements. This may includethe involvement of trading companies (such as the Japanese trading companies

and specialized commodity traders). Where involved, the traders act as an agent

or principal to secure the sale/purchase of the commodity. Traders increasingly

seek to add value to pure trading relationship by providing derivative/risk man-

agement expertise.Traders also occasionally provide financing & other services.


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Commodity traders have complex hedging requirements, depending on the

nature of their activities.

A trader as a pure agent will generally have no price exposure. Where a

trader acts as a principal, it will generally have outright commodity price risk that

requires hedging. Where traders provide ancillary services such as commodity de-

rivatives as the principal, the market risk assumed will need to be hedged or man-

aged.

4. Financial Institution/Dealers: -

Dealer participation in commodity markets is primarily as a provider of

finance or provider of risk management products. The dealers' role is similar to

that in the derivative market in other asset classes. The dealers provide credit

enhancement, speed, immediacy of execution and structural flexibility. Dealers

frequently bundle risk management products with other financial services such as

provision of finance.

5. Investors: -

This covers financial investors seeking to invest incommodities as a dis-tinct and a separate asset class of financial investment.The gradual recognition

of commodities as a specific class of investment assets is an important factor that

has influenced the structure of commodity derivatives markets.


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4.7 Different segments of COMMODITY MARKET

There are two major segments of the commodities market. They are

Over-the-counter (OTC) marketand

Exchange-traded market.

Both these markets are given below.

Over-the-counter (OTC) market:-

Over-the-counter means that there is no formal structure of trading and

parties trade on the basis of bilateral understanding. In terms of commodity

trading, OTC represents spot trading of commodities. Since the structure is not

formal, it is also referred as customized market". Almost all the trading that

takes place over in these markets is delivery based.

It is entirely unregulated with respect to disclosure of information

between the parties; therefore, the trades that take place are subject to

counter-party risk. Like an ordinary contract each counter-party relies on the

other side to fulfill their obligation.

.

OTC Contract:- OTC contract is a mutual contract between two parties in which

they agree on how a particular trade or agreement will be settled in future. To

put it in simple words, which location will the settlement takes place, the specific


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date in future when the contract will be honored and the pre-arranged price for

fulfilling the contract. Forwards and swaps are examples of such contracts.

Exchange-traded market:-

Exchange-traded market also known as derivatives market is the place

where commodities are traded over the exchange. It is standardized in nature

and decently regulated. An exchange acts as an intermediary to all commodity

transactions, and takes initial margin from both sides of the trade to act as a

guarantee. All the commodity exchanges are overseen by Forward Market Com-

mission.

4.8 COMPARATIVE ANALYSIS OF COMMODITY AND EQUITY MARKETS

FACTORS COMMODITY MARKETS EQUITY MARKET

Percentage Returns Gold gives 10-15 %re-

turns on the conservative

basis.

Returns in the range of

15-20 % on annual basis.

Initial Margins Lower in the range of

4-5-6%.

Higher in the range of 25-

40%.

Arbitrage Opportunities Exists on 1-2 month con-

tracts. There is a small

difference in prices but in

case of commodities,

which it is in large ton-

nage makes a huge dif-

Significant Arbitrage Op-

portunities exists.


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ference.

Price Movements Price movements are

purely based on the sup-

ply and demand.

Prices movements based

on the expectation of fu-

ture performance.

Price Changes. Price changes are due to

policy changes, change

sin tariff and duties.

Price changes can also be

due to Corporate actions,

Dividend announce-

ments, Bonus shares /Stock splits.

Future Predictability Predictability of future

prices is not in the con-

trol due to factors like

Failure of Monsoon and

Formation of El-ninos atPacific.

Predictability of future

performance is reasona-

bly high, which is sup-

plemented by the History

of management per-formance.

Volatility Lower Volatility. Higher Volatility.

Securities Transaction

Act Application.

Securities Transaction Act

is not applicable to com-modity futures trading

Securities Transaction Act

is applicable to equitymarkets trading


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5.COMMODITY EXCHANGE

ommodity exchange for buying and selling commodities for future

delivery.

Originally, a commodity exchange is a market organized to allow for the

selling and buying of commodities. Commodities, which are hard goods, as op-

posed to services, may be bought and sold on a commodity exchange in three

types of markets:

Cash,

Futures and

Options

Cocoa, corn, crude oil, and gold are a few examples of commodities

traded on a commodity exchange. A commodity exchange is considered to be es-

sentially public because anybody may trade through its member firms. The com-

modity exchange itself regulates the trading practices of its members while prices

on a commodity exchange are determined by supply and demand.

A commodity exchange provides the rules, procedures, and physical for commod-

ity trading, oversees trading practices, and gathers and disseminates marketplace

information. Commodity exchange transactions take place on the commodity ex-

change floor, in what is called a pit, and must be affected within certain time lim-

C


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its. Floor traders, floor brokers and futures commissions merchants working on

the floor of a commodity exchange must be registered by the SEC.

5.1 Role of COMMODITY EXCHANGE

Commodity exchanges provide platforms to suit the varied requirements of cus-

tomers.

Firstly, these exchanges enable actual users (farmers, agro processors, industry

where the predominant cost is commodity input/output cost) to hedge their

price risk given the uncertainty of the future - especially in agriculture where

there is uncertainty regarding the monsoon and hence prices. This holds


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good also for non-agro products like metals or energy products as well where

global forces could exert considerable influence. Purchasers are also assured of a

fixed price which is determined in advance, thereby avoiding surprises to them. It

must be borne in mind that commodity prices in India have always been woven

firmly into the international fabric. Today, price fluctuations in all major com-

modities in the country mirror both national and international factors and not

merely national factors.

Secondly, by involving the group of investors and speculators, commodity

exchanges provide liquidity and buoyancy to the system.

Lastly, the arbitrageurs play an important role in balancing the market as

arbitrage conditions, where they exist, are ironed out as arbitrageurs trade with

opposite positions on different platforms and hence generate opposing demand

and supply forces which ultimately narrows down the gaps in prices. It must be

pointed out that while the monsoon conditions affect the prices of agro-based

commodities, the phenomenon of globalization has made prices of other products

such as metals, energy products, etc., vulnerable to changes in global politics,

policies, growth paradigms, etc. This would be strengthened as the world moves

closer to the resolution of the WTO impass, which would become a reality shortly.


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Commodity exchanges are institutions which provide a platform for trad-

ing in commodity futures just as how stock markets provide space for trading

in equities and their derivatives.


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6.STRUCTURE OF COMMODITY EXCHANGE INDIA

In India there are 21 regional exchanges and three national level multi-

commodityexchanges


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After a gap of almost three decades, Government of India has allowed for-

ward transactions in commodities through Online Commodity Exchanges, a modi-

fication of traditional business known as Adhat and Vayda Vyapar to facilitate bet-

ter risk coverage and delivery of commodities. The three exchanges are:

(1) National Commodities & Derivatives Exchange Limited (NCDEX)

National Commodities & Derivatives Exchange Limited (NCDEX) promoted

by ICICI Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), Na-

tional Bank of Agriculture and Rural Development (NABARD) and National Stock

Exchange of India Limited (NSC). Punjab National Bank (PNB), Credit Ratting In-

formation Service of India Limited (CRISIL), Indian Farmers Fertilizer Cooperative

Limited (IFFCO), Canara Bank and Goldman Sachs by subscribing to the equity

shares have joined the promoters as a share holder of exchange. NCDEX is the

only Commodity Exchange in the country promoted by national level institutions.

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

is a national level technology driven on line Commodity Exchange with an inde-

pendent Board of Directors and professionals not having any vested interest in

Commodity Markets.

It is committed to provide a world class commodity exchange platform for

market participants to trade in a wide spectrum of commodity derivatives driven

by best global practices, professionalism and transparency.

NCDEXis regulated byForward Markets Commission (FMC). NCDEX is also

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

Act, Forward Contracts Regulation Act and various other legislations.


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NCDEX is located in Mumbai and offers facilities to its members in more

than 550 centers through out India. NCDEX currently facilitates trading of

57 commodities.

COMMODITIES TRADED at NCDEX:-

BULLION Gold KG, Silver, Brent

MINERALS Electrolytic Copper Cathode, Aluminum Ingot,

NickelCathode, Zinc Metal Ingot, Mild steel In-

gots

OIL AND OILSEEDS rude Palm Oil, Groundnut (in shell),Groundnut

ntha oil, RBD Pamolein, RM seed oilcake, Refined

PULSES Urad, Yellow peas, Chana, Tur, Masoor

GRAIN Wheat, Indian Pusa Basmati Rice, Indian par-

boiled Rice (IR-36/IR-64), Indian raw Rice (Par-

malPR-106), Barley, Yellow red maize

SPICES Jeera, Turmeric, Pepper

PLANTATION Cashew, Coffee Arabica, Coffee Robusta

FIBERS AND OTHERS Guar Gum& seeds, Jute sacking bags, Indian cot-

ton

ENERGY Crude Oil, Furnace oil


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(2) Multi Commodity Exchange of India Limited (MCX)

Headquartered in Mumbai, MCX is a demutualised nation wide electronic

commodity future exchange. Set up byFinancial Technologies (India) Ltd. perma-

nent recognition from government of India for facilitating online trading, clearing

and settlement operations for future market across the country. The exchange

started operation in Nov, 2003.

MCX equity partners include, NYSE Euro next, State Bank of India and its

associated, NABARD NSE, SBI Life Insurance Co. Ltd. Bank of India, Bank of Baroda,

Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, etc.

MCX is well known for bullion and metal trading platform.

Bullion Gold, Silver, Silver Coins

Minerals Aluminum, Copper, Nickel, Iron/steel, Tin, Zinc,

Lead

Oil and Oil seeds Castor oil/castor seeds, Crude Palm oil/ RBD

Pamolein,Groundnut ,Mustard/ Rapeseed oilPulses Chana, Masur, Tur, Urad, Yellow peas

Grains Rice/ Basmati Rice, Wheat, Maize, Bajara, Barley

Spices Pepper, Red Chili, Jeera, Cardamom, Cinnamon,


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Clove,Ginger,etc

Plantation Cashew Kernel, Rubber, Areca nut, Betel nuts, Co-

conut,Coffee,etc

Fiber and others Kapas, KapasKhalli, Cotton cloth/yarn,Gaur seed

&gum, Gur and Sugar ,Khandsari, Mentha Oil.

Petrochemicals High Density Polyethylene (HDPE), Polypropylene

(PP), PolyVinyl Chloride (PVC)

Energy Brent Crude Oil, Crude Oil, Furnace Oil, Middle East

Sour Crude Oil, Natural Gas

The exchanges follow best international risk managementpractices and

provide a financially secure environment by putting in place a suitable risk man-

agement mechanism (system of upfront margining based on the Value at Risk

margining system, daily mark to market and special intra-day clearing and settle-

ment in the event of high volatility in prices). The performance of the contracts

registered by the exchange are guaranteed either by the exchange or its clearing

house.

The exchanges also maintain their own Trade/Settlement Guarantee Fund,

which can be used in case of any default. Some exchanges have also prescribed

certain minimum capital adequacy norms.


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(3) National Multi Commodity Exchange of India Limited (NMCEIL)

(National Multi Commodity Exchange of India Ltd.) is the first de-metalized

electronic commodity exchange of India granted the National exchange on Govt.

of India and operational since 26th Nov, 2002.

Promoters of NMCE are, Central warehousing corporation (CWC), National

Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat Agro-

Industries Corporation Limited (GAICL), Gujarat state agricultural Marketing Board

(GSAMB), National Institute of Agricultural Marketing (NIAM) and Neptune Over-

seas Ltd. (NOL). Main equity holders are PNB.

The Head Office of NMCE is located in Ahmadabad. There are various

commodity trades on NMCE Platform including Agro and non-agro commodities.

6.1 Regulatory authority for commodity Market

Forward Markets Commission (FMC)

The Forward Markets Commission (FMC) headquartered at Mumbai, is the

regulatory authority for commodity derivatives in India. It is a statutory body set

up in1953 under the Forward Contracts (Regulation) Act, 1952. FMC is in turn

supervised by the Ministry of Consumer Affairs, Food and Public Distribution,Govt. of India.

The act provides that the commission shall consist of not less than two but

not exceeding four members appointed by the Central Govt. out of them being

nominated by the Central Govt. be the chairman thereof.


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Thefunctions of the Forward Markets Commission are as follows:

1. To advise the Central Government in respect of the recognition or thewithdrawal of recognition from any association or in respect of any other

matter arising out of the administration of the Forward Contracts (Regula-

tion) Act 1952;

2. To keep forward markets under observation and to take such action in re-lation to them, as it may consider necessary, in exercise of the powers as-

signed to it by or under the Act;

3. To collect and whenever the Commission thinks it necessary, to publishinformation regarding the trading conditions in respect of goods to which

any of the provisions of the act is made applicable, including information

regarding supply, demand and prices, and to submit to the Central Gov-

ernment, periodical reports on the working of forward markets relating to

such goods;

4. To make recommendations generallywith a view to improving the organi-zation and working of forward markets;

5. To undertake the inspection of the accountsand other documents of anyrecognized association or registered association or any member of such

association whenever it considerers it necessary;


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6.2 Regulatory Measures Evolved By FMC

1. Limit on open position of an individual operator to prevent over-trading;

2. Limit on price fluctuation to prevent abrupt upswing or downswing in

prices;

3.Special Margin deposits to be collected on outstanding purchases or sales

to curb excessive speculators activity through financial restraints;

4. Minimum / Maximum prices to be prescribed to prevent futures prices

from falling below the levels that are not remunerative and from rising be-

low the levels not warranted by genuine supply and demand factors;

5. During shortages, extreme steps like skipping trading in certain deliveries

of the contracts, closing the markets for a specified period and even closing

out the contracts to overcome the emergency situations are taken;


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7 HOW COMMODITY MARKET WORKS

There are two kinds of trades in commodities. The first is the spot trade,

in which one pays cash and carries away the goods. The second is futures trade.

The under pinning for futures is the warehouse receipt. A person deposits certain


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amount of say, good X in a ware house and gets a warehouse receipt which allows

him to ask for physical delivery of the good from the warehouse but some one

trading in commodity futures need not necessarily posses such a receipt to strike

a deal.

A person can buy or sale a commodity future on an exchange based on his

expectation of where the price will go. Futures have something called an expiry

date, by when the buyer or seller either closes (square off) his account or

give/take delivery of the commodity. The broker maintains an account of all deal-

ing parties in which the daily profit or loss due to changes in the futures price is

recorded. Squiring off is done by taking an opposite contract so that the net out-

standing is nil.

For commodity futures to work, the seller should be able to deposit the

commodity at warehouse nearest to him and collect the warehouse receipt. The

buyer should be able to take physical delivery at a location of his choice on pre-

senting the warehouse receipt. But at present in India very few warehouses pro-

vide delivery for specific commodities.


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Following diagram gives a fair idea about working of the Commodity market.

Today Commodity trading system is fully computerized. Traders need not

visit a commodity market to speculate. With online commodity trading they could

sit in the confines of their home or office and call the shots.


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The commodity trading system consists of certain prescribed steps or

stages as follows:

I. Trading: - At this stage the following is the system implemented-

-Order receiving

-Execution

-Matching

-Reporting

-Supervision

-Price limits

-Position limits

II. Clearing: - This stage has following system in place-

-Matching

-Registration

-Clearing limits

-Notation

-Margining

-Price limits

-Position limits

-Clearing house.III. Settlement: - This stage has following system followed as follows-

-Marking to market

-Receipts and payments

-Reporting

-Delivery upon expiration or maturity.


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8 THE NCDEX SYSTEMvery market transaction consists of three components i.e. trading, clearing

and settlement.

A brief overview of how transactions happen on the NCDEXs market.

8.1 TRADING:-

The trading system on the NCDEX provides a fully automated screen

based trading for futures on commodities on a nationwide basis as well as

online monitoring and surveillance mechanism.It supports an order driven mar-

ket and provides complete transparency of trading operations. Order matching is

essential 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 finds 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 passive and 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 re-

quired. NCDEX trades commodity futures contracts having one month, two

month and three month expiry cycles.

All contracts expire on the 20th of the expiry month. Thus a January expi-

ration contract would expire on the 20th of January and a February expiry con-

tract would cease trading on the 20th of February. If the 20th of the expiry month

is a trading holiday, the contracts shall expire on the previous trading day. New

E


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contracts will be introduced on the trading day following the expiry of the near

month contract.

The figure shows the contract cycle for futures contracts on NCDEX

8.2 CLEARING:-

National Securities Clearing Corporation Limited (NSCCL) undertakes clear-

ing of trades executed on the NCDEX. The settlement guarantee fund is main-

tained and managed by NCDEX. Only clearing members including professional

clearing members (PCMs) only are entitled to clear and settle contracts through

the clearing house.At NCDEX, after the trading hours on the expiry date, based

on the available information, the matching for deliveries takes place firstly, on

the basis of locations and then randomly, keeping interviewthe factors such as

available capacity of the vault/warehouse, commodities already deposited and

dematerialized and offered for delivery etc. Matching done by this process is


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binding on the clearing members. After completion of the matching process,

clearing members are informed of the deliverable/ receivable positions and the

unmatched positions. Unmatched positions have to be settled in cash.

The cash settlement is only for the incremental gain/loss as determined on the

basis of final settlement price.

8.3 SETTLEMENT:-

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 settle-

ment which happens on the last trading day of the futures contract . On the

NCDEX, daily MTM settlement and the final MTM settlement in respect of ad-

mitted deals in futures contracts are cash settled by debiting/crediting the clear-

ing 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 market

to market at the daily settlement price or the final settlement price at the close of

trading hours on a day.

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

expiry day. 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 clear-

ing member is responsible for settling all the participants trades, which he hasconfirmed to the exchange. On the expiry date of a futures contract, members

submit delivery information through delivery request window on the trader work-

stations provided by NCDEX for all open positions for a commodity for all con-

stituents individually. NCDEX on receipt of such information matches the informa-


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tion and arrives at delivery position for a member for a commodity. The seller in-

tending to make delivery takes the commodities to the designated warehouse.

These commodities have to be as said by the exchange specified as saver.

The commodities have to meet the contract specifications with allowed variances.

If the commodities meet the specifications, the warehouse accepts them. Ware-

house then ensures that the receipts get updated in the depository system giv-

ing a credit in the depositors electronic account.The seller the gives the invoice

to his clearing member, who would courier the same to the buyers clearing

member. On an appointed date, the buyer goes to the warehouse and takes

physical possession of the commodities.

Membership Details for NCDEX:-

Speculator Trading-cum-clearing Member: - TCM

Sr.No. PARTICULARS NCDEX: TCM

1 Interest Free Cash Security Deposit 15.00 Lakhs

2 Collateral Security Deposit 15.00 Lakhs

3 Admission Fee 5.00 Lakhs

4 Annual Membership Fees 0.50 Lakhs

5 Advance Minimum Transaction Charges 0.50 Lakhs

6 Net worth Requirement 50.00 Lakhs


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9 HOW TO INVEST IN COMMODITY MARKETWith whom investor can transact a business?

An investor can transact a business with the approved clearing member of

previously mentioned Commodity Exchanges. The investor can ask for the details

from the Commodity Exchanges about the list of approved members.

What is Identity Proof?

When investor approaches Clearing Member, the member will ask for

identity proof. For which Xerox copy of any one of the following can be given

a) PAN card Number

b) Driving License

c) Vote ID

d) Passport

What statements should be given for Bank Proof?

The front page of Bank Pass Book and a canceled cheque of a concerned

bank. Otherwise the Bank Statement containing details can be given.

What are the particulars to be given for address proof?

In order to ascertain the address of investor, the clearing member will in-

sist on Xerox copy of Ration card or the Pass Book/ Bank Statement where the

address of investor is given.


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What are the other forms to be signed by the investor?

The clearing member will ask the client to sign

a) Know your client form

b) Risk Discloser Document

The above things are only procedure in character and the risk involved and

only after understanding the business, he wants to transact business.

What aspects should be considered while selecting a commodity broker?

While selecting a commodity broker investor should ideally keep certain

aspects in mind to ensure that they are not being missed in any which way. These

factors include:-

Net worth of the broker of brokerage firm.

The clientele.

The number of franchises/branches.

The market credibility.

The references.

The kind of service provided- back office functioning being most important.

Credit facility.

The research team.

These are amongst the most important factors to calculate the credibilityof Commodity broker.


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9.1 DOS AND DONTS FOR TRADING IN COMMODITY MARKET

When you begin commodity there are some dos and donts that you

should keep in mind. Its important to go through this list especially if you are a

beginner and you are about to just begin trading. These tips and guidance men-

tioned below will help you to smoothly run the trading while not making many

mistakes.

You should ensure that the broker and the brokerage that you are using is

the established one and is registered one. Thus the broker should be hav-

ing the contract note which is signed by authorized signatory.

You should also ask for periodic statements of trading account in order to

keep a record on the transactions that you have made using a forex trading

account.

You should not get carried away by what other research or commodity re-

search analyst are saying but should always use your own judgmentwhen-ever thinking of buying and selling of a particular commodity taking into

the factor the risk involved.

Remember its your money that is being talked about here and you should

not go by someone elses judgmentbut should do our homework well.

Do not give your trading accounts user name password or login ID to any

one.

Also do not perform any transaction on any website which is not secured.

Secured web sites are the one which begin with https.Your transaction is

always safe on such a web sites.


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10 MAJOR TRADERS IN COMMDITY MARKETS

THE EXPLANATIONOF THE ABOVE TRADERS ARE GIVEN BELOW;

10.1 HEDGERS

A Hedger can be Farmers, manufacturers, importers and exporter. A

hedger buys or sells in the futures market to secure the future price of a com-

modity intended to be sold at a later date in the cash market. This helps protect

against price risks.

The holders ofthe long position in futures contracts (buyers of the com-

modity), are trying to secure as low a price as possible. The short holders of the

contract(sellers of the commodity) will want to secure as high a priceas possible.

The commodity contract, however, provides a definite price certainty for both

parties, which reduces the risks associated with price volatility. By means of

futures contracts, Hedging can also be used as a means to lock in an acceptable


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price margin between the cost of the raw material and the retail cost of the final

product sold.

EXAMPLE:

A silversmith must secure a certain amount of silver in six months time for ear-

rings and bracelets that have already been advertised in an upcoming catalog

with specific prices. But what if the price of silver goes up over the next six

months? Because the prices of the earrings and bracelets are already set, the ex-

tra cost of the silver can't be passed onto the retail buyer, meaning it would be

passed onto the silversmith. The silversmith needs to hedge, or minimize her risk

against a possible price increase in silver. How? The silversmith would enter the

futures market and purchase a silver contract for settlement in six months time

(let's say June) at a price of $5 per ounce. At the end of the six months, the price

of silver in the cash market is actually $6 per ounce, so the silversmith benefits

from the futures contract and escapes the higher price. Had the price of silver de-

clined in the cash market, the silversmith would, in the end, have been better off

without the futures contract. At the same time, however, because the silver mar-

ket is very volatile, the silver maker was still sheltering himself from risk by enter-

ing into the futures contract. So that's basically what a hedger is: the attempt to

minimize risk as much as possible by locking in prices for a later date purchase

and sale.

Someone going long in a securities future contract now can hedge against

rising equity prices in three months. If at the time of the contract's expiration the

equity price has risen, the investor's contract can be closed out at the higher

price. The opposite could happen as well: a hedger could go short in a contract

today to hedge against declining stock prices in the future. A potato farmer would


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hedge against lower French fry prices, while a fast food chain would hedge

against higher potato prices. A company in need of a loan in six months could

hedge against rising in the interest rates future, while a coffee beanery could

hedge against rising coffee bean prices next year.

10.2 Speculator:

Other commodity market participants, however, do not aim to minimize

risk but rather to benefit from the inherently risky nature of the commodity mar-

ket. These are the speculators, and they aim to profit from the very price change

that hedgers are protecting themselves against. A hedger would want to mini-

mize their risk no matter what they're investing in, while speculators want to in-

crease their riskand therefore maximize their profits. In the commodity market, a

speculator buying a contract low in order to sell high in the future would most

likely be buying that contract from a hedger selling a contract low in anticipation

of declining prices in the future.

Unlike the hedger, the speculator does not actually seek to own the com-

modity in question. Rather, he or she will enter the market seeking profits by off

setting rising and declining prices through the buying and selling of contracts.

In a fast-paced market into which information is continuously being fed,

speculators and hedgers bounce off of--and benefit from--each other. The closerit gets to the time of the contract's expiration, the more solid the information en-

tering the market will be regarding the commodity in question. Thus, all can ex-

pect a more accurate reflection of supply and demand and the corresponding

price. Regulatory Bodies the United States' futures market is regulated by the

Commodity Futures Trading Commission, CFTC, and an independent agency of the


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U.S. government. The market is also subject to regulation by the National Futures

Association, NFA, a self-regulatory body authorized by the U.S. Congress and sub-

ject to CFTC supervision.

LONG SHORT

HEDGER Secure a price now to

protect against future ris-

ing prices

Secure a price now to

protect against future

declining prices

SPECULATOR Secure a price now in

anticipation of rising

prices

Secure a price now in

anticipation of declining

prices

A Commodity broker and/or firm must be registered with the CFTC in or-

der to issue or buy or sell futures contracts. Futures brokers must also be regis-

tered with the NFA and the CFTC in order to conduct business. The CFTC has the

power to seek criminal prosecution through the Department of Justice in cases of

illegal activity, while violations against the NFA's business ethics and code of con-

duct can permanently bar a company or a person from dealing on the futures ex-

change. It is imperative for investors wanting to enter the futures market to un-

derstand these regulations and make sure that the brokers, traders or companies

acting on their behalf are licensed by the CFTC.


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10.3 Arbitrage:

Arbitrage refers to the opportunity of taking advantage between the

price difference between 2 different markets for that same stock or commodity.

In simple terms one can understand by an example of a commodity selling

in one market at price x and the same commodity selling in another market at

price x + y. Now this y, is the difference between the two markets is the arbitrage

available to the trader. The trade is carried simultaneously at both the markets so

theoretically there is no risk. (This arbitrage should not be confused with the word

arbitration, as arbitration is referred to solving of dispute between two or more

parties.)The person who conducts and takes advantage of arbitrage in stocks,

commodities, interest rate bonds, derivative products, foreign exchange is know

as an arbitrageur. An arbitrage opportunity exists between different markets be-

cause there are different kind of players in the market, some might be specula-

tors, others jobbers, some market-markets, and some might be arbitrageurs.

In India there are a good amount of Arbitrage opportunities between

NCDEX, MCX in commodities.

11 RISK ASSOCIATED WITH COMMODITIES MARKETS


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o risk can be eliminated, but the same can be transferred to some-

one who can handle it better or to someone who has the appetite

for risk. Commodity enterprisesprimarily face the following classes of risk.

Namely:

The price Risk,

The quantity Risk,

The yield/output risk and

The political Risk

Explanation of the above Risk-

The price risk:-

The chance there will be unexpected changes in a financial price, including

currency (foreign exchange) risk, interest rate risk, and commodity price risk.

Basically, it's the risk the you will lose money due to a fall in the market

price of a security that you own.

The quantity risk:-

Occurs when the quantity of an asset to be hedged is uncertain.

The risk that an insufficient amount of an investment will be hedged and

will result in a loss of the unhedged portion.

The yield/output risk:-

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The risk of experiencing an adverse shift in market interest rates associ-

ated with investing in a fixed income instrument. The risk is associated with either

a flattening or steepening of the yield curve, which is a result of changing yields

among comparable bonds with different maturities.

When market yields change, this will impact the price of a fixed-income in-

strument. When market interest rates, or yields, increase, the price of a bond will

decrease and vice versa.

The political Risk:-

It is a type of risk that can be understood and managed with reasoned

foresight and investment.

Broadly, political risk refers to any political change that alters the ex-

pected outcome and value of a given economic action by changing the probability

of achieving business objectives..

Talking about the nationwide commodity exchanges, the risk of the

counter party not fulfilling his obligations on due date or at any time therefore is

the most common risk.

This risk is mitigated by collection of the following margins:-

1. Initial margins

2. Exposure margins3. Mark to Market on daily positions.

4. Surveillance


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12 WHATS IN STORE FOR COMMODITIES MARKETS: (UNIONBUDGET-2011)

he Union Budget 2010-11 has mainly focused on broad-based

growth for the country and priority has been given to food security.

The budget has incorporated measures covering the investment scenario, fiscal

consolidation and infrastructure. Initiatives have been introduced for sustained

and inclusive growth. The main focus of the Finance Ministry is now to revert to

the high GDP growth, remove weakness at different levels of governance, im-

prove public delivery mechanism and ensure better management of supply-

demand imbalance.

1. Import duty on Silver has been raised from Rs1,000/kg to Rs1,500/kg and

this move could affect the demand pattern of the white metal.

2. Precious metal prices have risen sharply in the last year and this

has affected demand for these commodities in India. If cost pressures on

the commodity continue to rise then demand could be affected further.

3. Customs duty on Gold and Platinum has also been raised from Rs200 per 10

grams toRs300 per 10 grams. This rise in customs duty is negative for the

gems and jewelry sector in India. The move will make gold and platinum

costlier commodities, thereby hurting demand and imports will come

down. But one aspect for gold demand from the Indian perspective is that

demand for jewelry can never die out as gold has a traditional value at-

tached in India. The country has held its position as the world's largest gold

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consuming nation in 2009 as consumer demand boosted in the fourth-

quarter.

4. Basic customs duty on Gold Ore and Concentrates reduced from

2% (according to value) to a specific duty of Rs140 per 10 grams of gold

content with full exemption from special additional duty. Further, excise

duty on refined gold made from such ore or concentrate reduced from 8%to a specific duty of Rs280 per 10 grams. This move will help to boost do-

mestic gold refining capacity in India.

5. The budget has overall tried to incorporate measures for each sector. This

gives the country scope for further improvement in GDP growth. Special

emphasis is placed on infrastructure growth which could help to boost de-

mand for steel.

6. The budget provides Rs173,552cr for infrastructure and this accounts for

more than 46%of the total plan allocation. Though no specific mention has

been made with regard to Steel, growth in infrastructure will obviously

translate into growth for the steel sector as well.

7. For the metals sector as well the budget could prove beneficial as 45% has

been allocated for the infrastructure space. This could lead to demand for

steel and other metals.


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13 FUTURES PROSPECTSith the gradual withdrawal of the Govt. from various sectors in the

post liberalization era, the need has been left that various opera-

tors in the commodities market be provided with a mechanism to hedge and

transfer their risk. Indias obligation under WTO to open agriculture sector to

world trade require future trade in a wide variety of primary commodities and

their product to enable divers market functionaries to cope with the price volatil-

ity prevailing n the world markets.

Following are some of applications, which can utilize the power of the

commodity market and create a win-win situation for all the involved parties:-

Regulatory approval/permission to FIIS to trading in the commodity

market.

Active Involvement of mutual fund industry of India.

Permission to Banks for acting as Aggregators and traders.

Active involvement of small Regional stock exchanges.

Newer Avenues for trading in Foreign Derivatives Exchanges.

Convergence of variance market.

Amendment of the commodities Act and Implementers of VAT.

Introduction of option contract.

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14 RESEARCH METHODOLOGY

14.1 Research Objective:

To study the awareness about commodity futures among the retail

Indian investors.

14.2 Research Type:

Descriptive

14.3 Research Method:

Survey through Questionnaire method

14.4 Research Sample Size:100 retail investors from Mumbai region


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14.5 Research Findings:

1.Awareness about Commodity Mar-

kets

ANALYSIS

Nearly 50% of the people are unaware about the commodity market.

Corrective steps to be taken to create awareness among the people.

2. Various sources of information on commodity markets

ANALYSIS


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News channels are the most important sources of information.

Some people are aware about this due to they business line.

3. People advise commodity market products to investors

ANALYSIS

Around 40% of the people act as advisor for commodity market.

4. Reasons for not trading into the commodity market


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ANALYSIS

31% of people are not trading due to lack of time and interest.

34% are not trading due to lack of understanding.

5. Commodities in which people mainly trade

ANALYSIS

As Agricultural products are only 19% we con say, by creating awareness to

the farmers commodity exchanges can get better turn over.

6. Purpose for trading into the commodity markets


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ANALYSIS

45% of the people are speculating in the commodity market.

7. Factors affecting commodity market the most

ANALYSIS

34% of the people think, speculations lead so no other factors effect

commodity market.

8. Scope of commodity futures in India


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ANALYSIS

30% of the people are not aware about commodity market.

Maximum people are aware about the future growth of this market.

15 CONCLUSIONThis decade is termed as Decade of Commodities.

India is one of the top producers of large number of commodities and also

has a long history of trading in commodities and related derivatives. The Com-

modities Derivatives market has seen ups and downs, but seems to have finally

arrived now it has made enormous progress in terms of technology, transpar-

ency and trading activity. Interestingly, this has happened only after the Gov-

ernment protection was removed from a number of Commodities, and market

force was allowed to play their role.

As majority of Indian investors are not aware of organized commodity

market; their perception about is of risky to very risky investment. Many of them

have wrong impression about commodity market in their minds. It makes them

specious towards commodity market. Firstly, we should make the general people


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think positive about the COMMODITY MARKET as well concerned authorities have

to take initiative to make commodity trading process easy and simple and the

knowledge can be spread by arranging seminars targeting general publics and

people who are more risk takers in stock markets even news channels are better

source for creating awareness. There is no doubt that in near future commodity

market will become Hotspot for Indian farmers rather than spot market. And

producers, traders as well as consumers will be benefited from it. But for this to

happen one has to take initiative to standardize and popularize the Commodity

Market.

16 References:Books and Journals

COMMDITY MARKET(CHATNANI ,N,)

COMMODITY FUNDAMENTALS(SPURGA. R.)

IUP ON COMMODITY MARKETS: Recent Trends(ALGIRI-D.)

Newspapers and Articles

ECONOMIC TIMES

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TIMES OF INDIA

Websites

www.ncdex.com

business. mapsofindia.com

www.indiainfoline.com

indian-commodity.com

www.bcel.org

en.wikipedia.org/wiki

Indian Commodity Market Repaired)

Documents

Transcript of Indian Commodity Market Repaired)