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commodity derivatives market

  1. 1. CHAPTER -1 AN INTRODUCTIONCommodity market is an important constituent of the financialmarkets of any country. It is the market where a wide range ofproducts, viz., precious metals, base metals, crude oil, energy andsoft commodities like palm oil, coffee etc. are traded. It is importantto develop a vibrant, active and liquid commodity market. Thiswould help investors hedge their commodity risk, take speculativepositions in commodities and exploit arbitrage opportunities in themarket.Derivatives as a tool for managing risk first originated in thecommodities markets. They werethen found useful as a hedgingtool in financial markets as well. In India, trading incommodityfutures has been in existence from the nineteenthcentury with organised trading in cottonthrough the establishmentof Cotton Trade Association in 1875. Over a period of time,othercommodities were permitted to be traded in futuresexchanges. Regulatory constraints in1960s resulted in virtualdismantling of the commodity futures market. It is only in thelastdecade that commodity futures exchanges have been activelyencouraged however, the markets have not grown to significantlevels.A commodity derivatives market (or exchange) is, in simple terms,nothing more or less than a publicmarketplace where commodities 1
  2. 2. are contracted for purchase or sale at an agreed price for deliveryat aspecified date. These purchases and sales, which must bemade through a broker who is a member of an organizedexchange, are made under the terms and conditions of astandardized futures contract.Commodity prices do vibrate morerapidly and provide profitable opportunities, accordinglyrecessions,depressions and booms offer many opportunities to scoop upprofits. Exchange TradedDerivatives can be broadly classifiedinto Futures and Options.Evolution of the commodity market in IndiaAlthough India has a long history of trade in commodityderivatives, this segment remained underdeveloped due togovernment intervention in many commodity markets to controlprices. The production, supply and distribution of many agriculturalcommodities are still governed by the state and forwards andfutures trading are selectively introduced with stringent controls.While free trade in many commodity items is restricted under theEssential Commodities Act (ECA), 1955, forward and futurescontracts are limited to certain commodity items under the ForwardContracts (Regulation) Act (FCRA), 1952.The first commodity exchange was set up in India by BombayCotton Trade Association Ltd., and formal organized futurestrading started in cotton in 1875. Subsequently, many exchangescame up in different parts of the country for futures trade in variouscommodities. The GujratiVyapariMandali came into existence in 2
  3. 3. 1900 which has undertaken futures trade in oilseeds first time inthe country. The Calcutta Hessian Exchange Ltd and East IndiaJute Association Ltd were set up in 1919 and 1927 respectively forfutures trade in raw jute. In 1921, futures in cotton were organizedin Mumbai under the auspices of East India Cotton Association(EICA). Many exchanges were set up in major agricultural centresin north India before world war broke out and they were mostlyengaged in wheat futures until it was prohibited. The existingexchanges in Hapur, Muzaffarnagar, Meerut, Bhatinda, etc wereestablished during this period. The futures trade in spices was firstorganized by India Pepper and Spices Trade Association (IPSTA)in Cochin in 1957. Futures in gold and silver began in Mumbai in1920 and continued until it was prohibited by the government bymid-1950s. Options are though permitted now in stock market,they are not allowed in commodities. The commodity options weretraded during the pre-independence period. Options on cottonwere traded until they along with futures were banned in 1939(Ministry of Food and Consumer Affairs, 1999). However, thegovernment withdrew the ban on futures with passage of FCRA in1952. The Act has provided for the establishment and constitutionof Forward Markets Commission (FMC) for the purpose ofexercising the regulatory powers assigned to it by the Act. Later,futures trade was altogether banned by the government in 1966 inorder to have control on the movement of prices of manyagricultural and essential commodities.After the ban of futures trade all the exchanges went out ofbusiness and many traders started resorting to unofficial andinformal trade in futures. On recommendation of the Khusro 3
  4. 4. Committee in 1980 government reintroduced futures on someselected commodities including cotton, jute, potatoes, etc. As partof economic liberalization of 1990s an expert committee onforward markets under the chairmanship of Prof. K.N. Kabra wasappointed by the government of India in 1993. Its report submittedin 1994 recommended the reintroduction of futures which werebanned in 1966 and also to widen its coverage to many moreagricultural commodities and silver. In order to give more thrust onagricultural sector, the National Agricultural Policy 2000 hasenvisaged external and domestic market reforms and dismantlingof all controls and regulations in agricultural commodity markets. Ithas also proposed to enlarge the coverage of futures markets tominimize the wide fluctuations in commodity prices and for hedgingthe risk arising from price fluctuations. In line with the proposalmany more agricultural commodities are being brought underfutures trading. 4
  5. 5. ABOUT THE REPORT Title Of The Study:The present study titled as “A project report on the COMMODITYDERIVATIVE MARKETS”. Objective of the study:The following objectives of the present study are: o To understand about the commodity derivative market. o To know about the commodity derivative markets instruments. Limitations of the study:The following limitations of the present study are: o The period for the study is limited. o The study deals only with the Indian market. Data And Methodology: For the purpose of the present study the secondary data wasused. The secondary data were collected from journals, internet ,book and newspaper. 5
  6. 6. Presentation of the study: Following are the Presentation of the study; Chapter-1Gives an introduction to the study. Chapter-2Deals with an overview of commodity exchanges in India. Chapter-3 Deals with profile of Commodity derivative market. Chapter-4Recent news reports relating to commodity derivatives.Chapter-5 Conclusion 6
  7. 7. CHAPTER-2 COMMODITY EXCHANGES- AN OVERVIEWCommodity exchanges are defined as centres where futures tradeis organized in a widersense; it is taken to include any organizedmarket place where trade is routed through onemechanism,allowing effective competition among buyers and among sellers.This would includeauction-type exchanges, but not wholesalemarkets, where trade is localized, but effectivelytakes placethrough many non-related individual transactions between differentpermutationsof buyers and sellers.Role of Commodity ExchangesCommodity exchanges provide platforms to suit thevariedrequirements of customers. Firstly, they help in pricediscovery as players get to set future prices which are also madeavailable toall participants. Hence, a farmer in the southern part ofIndia would be able to know the bestprice prevailing in the countrywhich would enable him to take informed decisions. For thistohappen, the concept of commodity exchanges must percolatedown to the villages. Today thefarmers base their choice for nextyears crop on current years price. Ideally this decisionought to bebased on next years expected price. Futures prices on theplatforms of commodityexchanges will hopefully move farmers ofour country from the current cobweb effect whereadditionalacreage comes under cultivation in the year subsequent to one 7
  8. 8. when a commodityhad good prices; consequently the next year thecommodity price actually falls due to oversupply.Secondly, these exchanges enable actual users (farmers, agroprocessors, industry where thepredominant cost is commodityinput/output cost) to hedge their price risk given the uncertaintyofthe future - especially in agriculture where there is uncertaintyregarding the monsoon andhence prices. This holds good also fornon-agro products like metals or energy products aswell whereglobal forces could exert considerable influence. Purchasers arealso assured of afixed price which is determined in advance,thereby avoiding surprises to them. It must beborne in mind thatcommodity prices in India have always been woven firmly intotheinternational fabric. Today, price fluctuations in all majorcommodities in the country mirrorboth national and internationalfactors and not merely national factors.Thirdly, by involving the group of investors and speculators,commodity exchanges provideliquidity and buoyancy to thesystem.Lastly, the arbitrageurs play an important role in balancing themarket as arbitrage conditions,where they exist, are ironed out asarbitrageurs trade with opposite positions on differentplatforms andhence generate opposing demand and supply forces whichultimately narrowsdown the gaps in prices.It must be pointed out that while the monsoon conditions affect theprices of agro-basedcommodities, the phenomenon ofglobalization has made prices of other products such asmetals,energy products, etc., vulnerable to changes in global politics, 8
  9. 9. policies, growthparadigms, etc. This would be strengthened as theworld moves closer to the resolution of theWTO impasse, whichwould become a reality shortly. Commodity exchanges wouldprovide avaluable hedge through the price discovery process whilecatering to the different kind ofplayers in the market.There are more than 20 recognised commodity futures exchangesin India under the purviewof the Forward Markets Commission(FMC). The countrys commodity futures exchanges aredividedmajorly into two categories:• National exchanges• Regional exchangesThe four exchanges operating at the national level (as on 1stJanuary 2010) are:i) National Commodity and Derivatives Exchange of India Ltd.(NCDEX)ii) National Multi Commodity Exchange of India Ltd. (NMCE)iii) Multi Commodity Exchange of India Ltd. (MCX)iv) Indian Commodity Exchange Ltd. (ICEX) which started tradingoperations on November27, 2009The leading regional exchange is the National Board of Trade(NBOT) located at Indore. Thereare more than 15 regionalcommodity exchanges in India. 9
  10. 10. Trade Performance of leading Indian Commodity Exchangesfor January 2010INDIAN COMMODITY EXCHANGESSome of the features of national and regional exchanges are listedbelow:National Exchanges• Compulsory online trading• Transparent trading• Exchanges to be de-mutualised• Exchange recognised on permanent basis 10
  11. 11. • Multi commodity exchange• Large expanding volumesRegional Exchanges • Online trading not compulsory • De-mutualisation not mandatory • Recognition given for fixed period after which it could be given for re-regulation • Generally, these are single commodity exchanges. Exchanges have to apply for tradingeach commodity. • Low volumes in niche marketsCommodity Exchanges in India NO. Exchanges Main Commodities Gold, Silver, Copper, Crude Oil, Zinc, Lead, Nickel, Natural gas, Aluminium, Mentha Oil, rude_Palm_Oil, RefinedSoya Oil, Multi Commodity Cardamom, Guar Seeds, Kapas, 1. Exchange of India Ltd. Potato,ChanaGram, Melted Mumbai* Menthol Flakes, Almond, Wheat,Barley, Long Steel, Maize, Soybean Seeds, Gasoline US, Tin, Kapaskhali, Platinum, Heating Oil 11
  12. 12. Guar Seed, Soy Bean, Soy Oil, Chana,RM Seed, Jeera, Turmeric, Guar Gum, Pepper, National Commodity And Cotton Cake, Long Steel,2. Derivative Exchange Gur, Kapas, Wheat, Red Chilli, Mumbai* Crude Oil, Maize, Gold, Copper, Castor Seeds, Potato, Barley, KachhiGhani Mustard Oil, Silver, Indian 28 Mm Cotton, Platinum Rape/Mustard Seed, Guar Seeds, Nickel, Jute, Refined Soya Oil, Zinc, Rubber, National Multi ChanaGram, Isabgul, Lead, Commodity Exchange of3. Gold, Aluminium, Copper, India Limited Turmeric, Copra, Silver, Raw Ahmedabad* Jute,Guar Gum, Pepper, Coffee Robusta, Castor Seeds, Mentha Oil Indian Commodity4. Exchange Limited, Gold, Crude Oil, Copper, Silver Gurgaon * National Board of Trade.5. Soy bean, Soy Oil Indore Chamber Of6. Gur, Mustard seed Commerce,Hapur 12
  13. 13. Ahmedabad Commodity Castor seed 7. Exchange Ltd. Rajkot Commodity Castorseed 8. Exchange Ltd, Rajkot Surendranagar Cotton & 9. Oilseeds Association Ltd, Kapas S.nagar The Rajdhani Oil and10. Oilseeds Exchange Ltd., Gur, Mustard Seed Delhi Haryana Commodities Mustard seed, Cotton seed Oil11. Ltd.,Sirsa Cake India Pepper & Spice, Pepper Domestic-MG1,Pepper12. Trade Association. Kochi 550 G/L Vijay Beopar Chamber13. Gur Ltd.,Muzaffarnagar The Meerut Agro14. Commodities Exchange Gur Co. Ltd., Meerut Bikaner Commodity15. Guarseed, Exchange Ltd.,Bikaner First Commodity16. Exchange of India Ltd, Coconut oil Kochi The Bombay Commodity Castorseed17. Exchange Ltd. Mumbai 13
  14. 14. The Central India Mustard seed 18. Commercial Exchange Ltd,Gwalior Bhatinda Om & Oil 19. Gur Exchange Ltd., Batinda. The Spices and Oilseeds 20. Turmeric Exchange Ltd., Sangli The East India Jute & 21. Hessian Exchange Ltd, Raw Jute Kolkatta The East India Cotton 22. Cotton Association Mumbai.NCDEXNational Commodity & Derivatives Exchange Limited (NCDEX), anational level online multi-commodityexchange, commencedoperations on December 15, 2003. The Exchange hasreceived apermanent recognition from the Ministry of Consumer Affairs, Foodand PublicDistribution, Government of India as a national levelexchange. The Exchange, in just over twoyears of operations,posted an average daily turnover (one-way volume) of around Rs4500-5000 crore a day (over USD 1 billion). The major share of thevolumescomes from agriculturalcommodities and the balance frombullion, metals, energy and other products. Trading isfacilitatedthrough over 850 Members located across around 700 centers(having ~20000trading terminals) across the country. Most of these 14
  15. 15. terminals are located in the semi-urbanand rural regions of thecountry. Trading is facilitated through VSATs, leased lines andtheInternet.Structure of NCDEXNCDEX has been formed with the following objectives: • To create a world class commodity exchange platform for the market participants. • To bring professionalism and transparency into commodity trading. • To inculcate best international practices like de-materialised technology platforms, low cost solutions and information dissemination into the trade. • To provide nationwide reach and consistent offering. • To bring together the entities that the market can trust.Shareholders of NCDEXNCDEX is promoted by a consortium of four institutions. These areNational Stock Exchange(NSE), ICICI Bank Limited, Life InsuranceCorporation of India (LIC) and National Board forAgriculture andRural Development (NABARD). Later on their shares were dilutedand moreinstitutions became shareholders of NCDEX. These areCanara Bank, CRISIL Limited, Indian FarmersFertilisersCooperative Limited (IFFCO), Punjab National Bank (PNB),Goldman Sachs, Intercontinental Exchange (ICE) and ShreeRenuka Sugars Ltd.All the ten shareholders (now ICICI is not ashareholder of NCDEX) bring along with themexpertise in closely 15
  16. 16. related fields such as agriculture, rural banking, co-operativeexpertise,risk management, intensive use of technology, derivativetrading besides institution buildingexpertise.GOVERNANCEThe governance of NCDEX vests with the Board of Directors.None of the Board of Directorshas any vested interest incommodity futures trading. The Board comprises persons ofeminence,each an authority in their own right in the areas veryrelevant to the Exchange.Board appoints an executive committeeand other committees for the purpose of managingactivities of theExchange. The executive committee consists of Managing Directorof theExchange who would be acting as the Chief Executive of theExchange, and also other membersappointed by the board. Apartfrom the executive committee the board hasconstitutedcommittees like Membership committee, AuditCommittee, Risk Committee, NominationCommittee,Compensation Committee and Business Strategy Committee,which help the Boardin policy formulation.NCDEX ProductsNCDEX currently offers an array of more than 50 differentcommodities for futures trading.The commodity segments coveredinclude both agri and non-agri commodities [bullion, energy,metals(ferrous and non-ferrous metals) etc]. Before identifying acommodity for trading, theExchange conducts a thorough researchinto the characteristics of the product, its market andpotential forfutures trading. The commodity is recommended for approval of 16
  17. 17. Forward MarketsCommission, the Regulator for commodityexchanges in the country after approval by theProduct Committeeconstituted for each of such product and Executive Committee oftheExchange.Exchange MembershipMembership of NCDEX is open to any person, association ofpersons, partnerships, co-operativesocieties, companies etc. thatfulfills the eligibility criteria set by the Exchange. FIs, NRIs,Banks,MFs etc are not allowed to participate in commodity exchanges atthe moment. All themembers of the Exchange have to registerthemselves with the competent authority beforecommencing theiroperations. NCDEX invites applications for Members from personswho fulfillthe specified eligibility criteria for trading commodities.The members of NCDEX fall intofollowing categories: 1. Trading cum Clearing Member (TCM): Members can carry out the transactions (Trading, clearing and settlement) on their own account and also on their clients accounts. Applicants accepted for admission as TCM are required to pay the requisite fees/ deposits and also maintain net worth as explained in the following section. 2. Professional Clearing Members (PCM): Members can carry out the settlement and clearing for their clients who have traded through TCMs or traded as TMs. Applicants accepted for admission as PCMs are required to pay the requisite fee/ deposits and also maintain net worth. 17
  18. 18. 3. Trading Member (TM): Memberwho can only trade through their account or on account of their clients and will however have to clear their trade through PCMs/STCMs. 4. Strategic Trading cum Clearing Member (STCM): This is up gradation from the TCM to STCM. Such member can trade on their own account, alsoon account of their clients. They can clear and settle these trades and also clear and settletrades of other trading members who are only allowed to trade andare not allowed to settleand clear.Capital requirements NCDEX has specified capital requirements for its members. On approval as a member ofNCDEX, the member has to deposit the following capital:Base Minimum Capital (BMC)Base Minimum Capital comprises of the following: • Interest Free Cash Security Deposit • Collateral Security Deposit Interest Free Cash Security Deposit An amount of Rs. 15 Lacs by Trading cum Clearing Members (TCM) and Rs. 25 LacsbyProfessional Clearing Members (PCM) is to be provided in cash. The same is to be provided by issuing a cheque / demand draft payable at Mumbai in favour of National Commodity & Derivatives Exchange Limited. 18
  19. 19. Collateral Security Deposit The minimum-security deposit requirement is Rs. 15 Lacs for TCM and Rs. 25 Lacs for PCM. All Members have to comply with the security deposit requirement before the activation of their trading terminal. Members may opt to meet the security deposit requirement by way of the following: Cash The same is to be provided by issuing a cheque / demand draft payable at Mumbai in favour ofNational Commodity & Derivatives Exchange Limited. Bank Guarantee Banks guarantee in favour of NCDEX as per the specified format. The minimum term of thebank guarantee should be 12 months. Fixed Deposit Receipt Fixed Deposit Receipts (FDRs) issued by approved banks are accepted. The FDR should beissued for a minimum period as specified by the Exchange from time to time from any of theapproved banks.Government of India SecuritiesNational Commodity Clearing Limited (NCCL) is the approvedcustodian for acceptance ofGovernment of India Securities. Thesecurities are valued on a daily basis and a haircut asprescribedthe Exchange is levied.Additional Base Capital (ABC) 19
  20. 20. In case the members desire to increase their limit, additionalcapital may be submitted toNCDEX in the following forms: Cash Cash Equivalents Bank Guarantee (BG) Fixed Deposit Receipt (FDR) Government of India Securities Bullion Shares (notified list) The haircut for Government of India securities shall be 25% and 50% for the notified shares. Fees structure for membership 20
  21. 21. Clearing and Settlement SystemClearingNational Commodity Clearing Limited (NCCL) undertakes clearingof trades executed on theNCDEX. Only clearing membersincluding professional clearing members (PCMs) are entitledtoclear and settle contracts through the clearing house. At NCDEX,after the trading hours onthe expiry date, based on the availableinformation, the matching for deliveries takes placefirstly, on thebasis of locations and then randomly, keeping in view the factorssuch as availablecapacity of the vault/warehouse, commoditiesalready deposited and dematerialized and offeredfor delivery etc.Matching done by this process is binding on the clearing members.Aftercompletion of the matching process, clearing members are 21
  22. 22. informed of the deliverable/receivable positions and theunmatched positions. Unmatched positions have to be settledincash. The cash settlement is only for the incremental gain/ lossas determined on the basis offinal settlement priceSettlementFutures contracts have two types of settlements, the Mark-to-Market (MTM) settlement whichhappens on a continuous basis atthe end of the day, and the final settlement which happenson thelast trading day of the futures contract. On the NCDEX, daily MTMsettlement in respectof admitted deals in futures contracts arecash settled by debiting/ crediting the clearingaccounts of clearingmembers (CMs) with the respective clearing bank. All positions ofCM,brought forward, created during the day or closed out duringthe day, are mark to market atthe daily settlement price or the finalsettlement price on the contract expiry.The responsibility of settlement is on a trading cum clearingmember for all trades done on hisown account and his clientstrades. A professional clearing member is responsible forsettlingall the participants’ trades which he has confirmed to theExchange. Few days before expirydate, as announced byExchange from time to time, members submit deliveryinformationthrough delivery request window on the traderworkstation provided by NCDEX for all openposition for acommodity for all constituents individually. NCDEX on receipt ofsuch informationmatches the information and arrives at a deliveryposition for a member for a commodity. Theseller intending tomake delivery takes the commodities to the designated 22
  23. 23. warehouse. Thesecommodities have to be assayed by theExchange specified assayer. The commodities have tomeet thecontract specifications with allowed variances. If the commoditiesmeet thespecifications, the warehouse accepts them. Warehousethen ensures that the receipts getupdated in the depository systemgiving a credit in the depositors electronic account. Theseller thengives the invoice to his clearing member, who would courier thesame to the buyersclearing member. On an appointed date, thebuyer goes to the warehouse and takes physicalpossession of thecommodities.Clearing Days and Scheduled TimeDaily Mark to Market settlement where T is the trading dayMark to Market Pay-in (Payment): T+1 working day.Mark to Market Pay-out (Receipt): T+1 working day.Final settlement for Futures ContractsThe settlement schedule for Final settlement for futures contractsis given by the Exchange indetail for each commodity.Timings for Funds settlement:Pay-in: On Scheduled day as per settlement calendars.Pay-out: On Scheduled day as per settlement calendars.Commodities Traded on NCDEXNCDEX gives priority to commodities that are most relevant toIndia, and where the pricediscovery process takes placedomestically. The products chosen are based on certain 23
  24. 24. criteriasuch as price volatility, share in GDP, correlation with globalmarkets, share in external trade,warehousing facilities, tradersdistribution, geographical spread, varieties etc. Spices Oil and Oilseeds Precious Metals Pepper Castor Seed Gold Chilli Sesame Seeds Silver Jeera Cotton Seed Oilcake Platinum Turmeric Soy Bean Metals Coriander Refined Soy Oil Steel Cereals Soybean meal (local & export) Copper Wheat Mustard Seed Zinc Barley KachhiGhani Mustard Oil Aluminium Maize Rapeseed - Mustard Seed Oil Nickel Pulses (Yellow/Red) Crude Palm Oil Energy Chana RBD Cake Palmolein Crude Oil Masoor Groundnut in shell Furnace Oil Yellow Peas Groundnut Expeller Oil Thermal Coal Others Plantation Products Brent Crude Oil Guar Seeds Rubber Natural Gas Potato Coffee-Robusta Cherry AB Fibres Mentha Oil Cashew Indian 28.5 mm Guar Gum Polymers V -797 Kapas Cotton CER Polypropylene Medium Staple Gur Linear Low density Kapas Cotton Almond Polyvinyl Chloride Raw Jute PolyethyleneMCXMulti Commodity Exchange of India Ltd (MCX) (BSE: 534091)is an independent commodity exchange based in India. It wasestablished in 2003 and is based in Mumbai. The turnover of theexchange for the fiscal year 2009 was US$ 1.24 trillion, and in 24
  25. 25. terms of contracts traded, it was in 2009 the worlds sixth largestcommodity exchange. (MCX offers futures trading in bullion,ferrous and non-ferrous metals, energy, and a number ofagricultural commodities (mentha oil, cardamom, potatoes, palmoiland others).In 2011, MCX has taken the fifth spot among the global commoditybourses in terms of the number of futures contracts traded. Basedon the latest data from Futures Industry Association (FIA), duringthe period between January and June this year, about 127.8million 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 agriculturalcommodities, and National Bulk Handling Corporation (NBHC)Indias largest collateral management company which providesbulk storage and handling of agricultural products.In February 2012, MCX has come out with a public issue of6,427,378 Equity Shares of Rs. 10 face value in price band of 860- 1032 Rs. per equity share to raise around $134 million. It is thefirst ever IPO by an Indian exchange.It is regulated by the Forward Markets Commission.  MCX is Indias No. 1 commodity exchange with 83% market share in 2009  The exchanges main competitor is National Commodity & Derivatives Exchange Ltd 25
  26. 26.  Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no. 3 in crude oil and gold in futures trading (But actual volume is far behind CME group volume as Silver is traded in 30 Kg lots on MCX whereas CME traded in Approx 155 kg Lot size same in Gold 1 kg : 3. Kg Approx and Crude 100 Barrels : 1000 Barrels on CME) and major volume in manipulated as there in no strict regulation in Indian markets just to Excalate the prices of Shares of company. Also the major volume comes from Arbitration of CME and MCX which is also not legal to do.  The highest traded item is gold.  MCX has several strategic alliances with leading exchanges across the globe  As of early 2010, the normal daily turnover of MCX was about US$ 6 to 8 billion  MCX now reaches out to about 800 cities and towns in India with the help of about 126,000 trading terminals COMMODITIES TRADED ON MCXMETAL BULLIONAluminium, Copper, Lead,Nickel, Steel Long Gold, Gold HNI, Gold M, i-gold,(Bhavnagar), Steel Long Silver, Silver HNI, Silver M,, Silver(Govindgarh), Steel Flat, MicroTin, ZincFIBER ENERGYCotton L Staple, Cotton M Brent Crude Oil, Crude Oil, Furnace 26
  27. 27. Staple, Cotton S Staple, Oil, Natural Gas, M. E. Sour CrudeCotton Yarn, Kapas, Jute Oil, ATF, Electricity(Now delisted), Carbon CreditSPICES PLANTATIONSCardamom, Jeera, Pepper, Arecanut, Cashew Kernel, CoffeeRed Chilli, Turmeric, Cumin (Robusta), RubberSeed, CorianderPULSES PETROCHEMICALSChana, Masur, Yellow Peas, HDPE, Polypropylene(PP), PVCTur, UradOIL & OIL SEEDSCastor Oil, Castor Seeds, Coconut Cake, Coconut Oil, CottonSeed, Crude Palm Oil, Groundnut Oil, KapasiaKhalli, Mustard Oil,Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein,Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice BranRefined Oil, Sesame Seed, Soymeal, Soy Bean, Soy SeedsCEREALS OTHERSMaize, Barley, Rice, Guargum, Guar Seed, Gurchaku,Sharbati Rice, Basmati Mentha Oil, Potato (Agra), PotatoRice, Wheat (Tarkeshwar)NMCENational Multi Commodity Exchange of India Ltd. (NMCE) waspromoted by Central Warehousing Corporation (CWC), NationalAgricultural Cooperative Marketing Federation of India (NAFED),Gujarat Agro-Industries Corporation Limited (GAICL), Gujarat 27
  28. 28. State Agricultural Marketing Board (GSAMB), National Institute ofAgricultural Marketing (NIAM), and Neptune Overseas Limited(NOL). While various integral aspects of commodity economy, viz.,warehousing, cooperatives, private and public sector marketing ofagricultural commodities, research and training were adequatelyaddressed in structuring the Exchange, finance was still a vitalmissing link. Punjab National Bank (PNB) took equity of theExchange to establish that linkage. Even today, NMCE is the onlyExchange in India to have such investment and technical supportfrom the commodity relevant institutions.The Department of Consumer Affairs in the Ministry of ConsumerAffairs, Food and Public Distribution -Government of India, is theapex regulatory body governing all commodity exchanges. Variouspowers to provide regulatory supervision, besides the powers togrant or withdraw recognition of any exchange rests with thisDepartment of the Government of India. The Forward MarketsCommission (FMC) was set up in 1953 to provide regulatoryadvice to the Government and have closer regulatory interactionwith the commodity exchanges. Most of the regulatory powers ofthe Central Government have been delegated to the FMC. Forexample, FMC has powers to approve the Memorandum andArticles of Associations as well as Byelaws of the Exchange. It hasalso powers to conduct inspection of accounts of theexchanges/their members, inquire into the affairs of the exchange.In an emergency, it can even suspend trading. All contracts forfutures trade have to be approved by the FMC before they can belaunched on the exchange. As a self-regulatory organization,NMCE also plays an important role by ensuring that the provisions 28
  29. 29. in the Articles of Association and Byelaws etc. are followed in letterand spirit. The regulation by the Exchange is rule-based andincorporated in the software itself. Regulation involving humanintervention and of discretionary nature is implemented throughvarious committees of professional and experts. Special care istaken while constituting these committees to ensure that there isno conflict of interest.NMCE facilitates electronic derivatives trading through robust andtested trading platform, Derivative Trading Settlement System(DTSS), provided by CMC. It has robust delivery mechanismmaking it the most suitable for the participants in the physicalcommodity markets. It has also established fair and transparentrule-based procedures and demonstrated total commitmenttowards eliminating any conflicts of interest. It is the onlyCommodity Exchange in the world to have received ISO9001:2000 certification from British Standard Institutions (BSI).NMCE was the first commodity exchange to provide trading facilitythrough internet, through Virtual Private Network (VPN).NMCE follows best international risk management practices. Thecontracts are marked to market on daily basis. The system ofupfront margining based on Value at Risk is followed to ensurefinancial security of the market. In the event of high volatility in theprices, special intra-day clearing and settlement is held. NMCEwas the first to initiate process of dematerialization and electronictransfer of warehoused commodity stocks. The unique strength ofNMCE is its settlements via a Delivery Backed System, animperative in the commodity trading business. These deliveries are 29
  30. 30. executed through a sound and reliable Warehouse ReceiptSystem, leading to guaranteed clearing and settlement.The NMCE is Indias third-largest commodities exchange behindthe Multi-Commodity Exchange (MCX) and the NationalCommodity & Derivatives Exchange (NCDEX) and has grownsignificantly as commodity trading in India has rebounded from the2008 financial crisis. NMCE is Indias top listedof coffee and rubber contracts and seeks to broaden intothe currency derivatives and spot markets. 30
  31. 31. CHAPTER- 3 COMMODITY DERIVATIVE MARKETS - A PROFILECommodity futures markets have a long history in India. Cottonwas the first commodity to attract futures trading in the countryleading to the setting up of the Bombay Cotton Trade AssociationLtd in 1875. The Bombay Cotton Exchange Ltd. was established in1893 followingthe widespread discontent amongst leading cottonmill owners and merchants over the functioning of Bombay CottonTrade Association.Subsequently, many exchanges came up in different parts of thecountry for futures trading in various commodities. Futures tradingin oilseeds started in 1900 with the establishment of the GujaratiVyapariMandali, which carried on futures trade in groundnut,castor seed and cotton.Before the Second World War broke out in 1939, several futuresmarkets in oilseeds were functioning in Gujarat and Punjab.Futures trading in wheat existed at several places in Punjab andUttar Pradesh, the most notable of which was the Chamber ofCommerce at Hapur, which began futures trading in wheat in 1913and served as the price setter in that commodity till the outbreak ofthe Second World War in 1939.Futures trading in bullion began in Mumbai in 1920 andsubsequently markets came up in other centres like Rajkot, Jaipur,Jamnagar, Kanpur, Delhi and Kolkata. Calcutta Hessian ExchangeLtd. was established in 1919 for futures trading in raw jute and jute 31
  32. 32. goods. But organized futures trading in raw jute began only in1927 with the establishment of East Indian Jute Association Ltd.These two associations amalgamated in 1945 to form the EastIndia Jute & Hessian Ltd. to conduct organized trading in both rawjute and jute goods. In due course several other exchanges werealso created in the country to trade in such diverse commodities aspepper, turmeric, potato, sugar and gur (jaggery).After independence, with the subject of `Stock Exchanges andfutures markets being brought under the Union list, responsibilityfor regulation of commodity futures markets devolved on Govt. ofIndia. A Bill on forward contracts was referred to an expertcommittee headed by Prof. A. D. Shroff and select committees oftwo successive Parliaments and finally in December 1952 ForwardContracts (Regulation) Act, 1952, was enacted.The Act provided for 3-tier regulatory system: a) An association recognized by the Government of India on the recommendation b) The Forward Markets Commission (it was set up in September 1953) and c) The Central Government.India was in an era of physical controls since independence andthe pursuance of a mixed economy set up with socialist proclivitieshad ramifications on the operations of commodity markets andcommodity exchanges. Government intervention was in the form ofbuffer stock operations, administered prices, regulation on tradeand input prices, restrictions on movement of goods, etc. 32
  33. 33. Agricultural commodities were associated with the poor and weregoverned by polices such as Minimum Price Support andGovernment Procurement. Further, as production levels were lowand had not stabilized, there was the constant fear of misuse ofthese platforms which could be manipulated to fix prices bycreating artificial scarcities. This was also a period which wasassociated with wars, natural calamites and disasters whichinvariably led to shortages and price distortions. Hence, in an eraof uncertainty with potential volatility, the government bannedfutures trading in commodities in the 1960s.The Khusro Committee which was constituted in June 1980 hadrecommended reintroduction of futures trading in most of the majorcommodities, including cotton, kapas, raw jute and jute goods andsuggested that steps may be taken for introducing futures tradingin commodities, like potatoes, onions, etc. at appropriate time. Thegovernment, accordingly initiated futures trading in Potato duringthe latter half of 1980 in quite a few markets in Punjab and UttarPradesh.With the gradual trade and industry liberalization of the Indianeconomy pursuant to the adoption of the economic reformpackage in 1991, GOI constituted another committee on ForwardMarkets under the chairmanship of Prof. K.N. Kabra. TheCommittee which submitted its report in September 1994recommended that futures trading be introduced in the followingcommodities: Basmati Rice Cotton, Kapas, Raw Jute and Jute Goods 33
  34. 34. Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflowerseed, copra and soybean and oils and oilcakes Rice bran oil Castor oil and its oilcake Linseed Silver OnionsThe committee also recommended that some of the existingcommodity exchanges particularly the ones in pepper andcastorseed, may be upgraded to the level of international futuresmarkets.UNCTAD and World Bank joint Mission Report "India: ManagingPrice Risk in Indias Liberalized Agriculture: Can Futures MarketHelp? (1996)" highlighted the role of futures markets as marketbased instruments for managing risks and suggested thestrengthening of institutional capacity of the Regulator and theexchanges for efficient performance of these markets. Anothermajor policy statement, the National Agricultural Policy, 2000, alsoexpressed support for commodity futures. The Expert Committeeon Strengthening and Developing Agricultural Marketing (GuruCommittee: 2001) emphasized the need for and role of futurestrading in price risk management and in marketing of agriculturalproduce. This Committees Group on Forward and FuturesMarkets recommended that it should be left to interestedexchanges to decide the appropriateness/usefulness of 34
  35. 35. commencing futures trading in products (not necessarily of justcommodities) based on concrete studies of feasibility on a case-to-case basis. It, however, noted that all the commodities are notsuited for futures trading. For a commodity to be suitable forfutures trading it must possess some specific characteristics. Theliberalized policy being followed by the Government of India andthe gradual withdrawal of the procurement and distribution channelnecessitated setting in place a market mechanism to perform theeconomic functions of price discovery and risk management.The National Agriculture Policy announced in July 2000 and theannouncements of Honble Finance Minister in the Budget Speechfor 2002-2003 were indicative of the Governments resolve to put inplace a mechanism of futures trade/market. As a follow up, theGovernmentissued notifications on 1.4.2003 permitting futurestrading in the commodities, with the issue of these notificationsfutures trading is not prohibited in any commodity. An optiontrading in commodity is, however presently prohibited. The year2003 is a landmark in the history of commodity futures marketwitnessing the establishment and recognition of three new nationalexchanges [National Commodity and Derivatives Exchange ofIndia Ltd. (NCDEX), Multi Commodity Exchange of India Ltd(MCX) and National Multi Commodity Exchange of India Ltd.(NMCE)] with on-line trading and professional management. Notonly was prohibition on forward trading completely withdrawn, thenew exchanges brought capital, technology and innovation to themarket.These markets depicted phenomenal growth in terms of number ofproducts on offer, participants, spatial distribution and volume of 35
  36. 36. trade. Majority of the trade volume is contributed by the nationallevel exchanges whereas regional exchanges have a very lessshare. With developments on way, the commodity futuresexchanges registered an impressive growth till it saw the first banof two pulses (Tur and Urad) towards the end of January 2007.Subsequently the ban of two more commodities from cerealsgroup i.e. Wheat and Rice in the next month. The commoditymarket regulator, Forward Markets Commission as a measure ofabundant caution, suspended futures trading in Chana, Soya oil,Rubber and Potato w.e.f. May 7, 2008. However, with the easingof inflationary pressure, the suspension was allowed to lapse onNovember 30, 2008. Trading in these commodities resumed onDecember 4, 2008.Later on futures trading in wheat was re-introduced in May 2009.These bans affected participants confidence adversely. In May2009, futures’ trading in sugar was suspended. Due to mistakenapprehensions that futures trading contributes to inflation, futurestrading in rice, urad, tur and sugar has been temporarilysuspended.Issues and Concerns of Commodity Derivative Markets inIndiaCommodity derivative markets have traditionally been acontentious issue at various policy forums across the world,particularly with the imbroglio created by allegations from variouscorners that they encourage excessive speculation and aretherefore responsible for the recent commodity price escalation.While this suspicion of excessive speculation in the commodity 36
  37. 37. markets has always been there among policymakers in developingnations like India, it has become more widespread since 2008 inthe wake of worldwide inflationary pressures on food and energy.The sudden deflation in the value of various assets underlyingdifferent derivatives, which includes commodity derivatives, in thewake of the global meltdown has provoked greater apprehensionabout the economic utility of futures markets. The suspicion hasreached such a high that even the U.S., the biggest proponent ofmarket forces with the most active commodity exchanges in theworld, is considering new modes of regulation, and is alsoinvestigating the role of commodity derivative trading in the steeprise in prices of wheat, rice, and crude oil.On the other hand, ever since commodity derivative trading wasallowed in India in the new millennium, there has always been ahue and cry against such markets, with the alleged notion ofexcessive “speculation”, though there has rarely been anyevidence for it. Rather than recognizing the potential economicutility of commodity derivative markets in price discovery and riskmanagement, the government has been more apprehensive aboutits alleged ill-effects. As a result, over time, futures’ trading hasbeen subjected to strict regulations, and certain commodities havebeen inflicted with occasional bans. Thus, while the “disutility” ofthe market is yet to be proven, the overcautious behaviour of thegovernment has never really allowed the market to develop andprove its utility.Hence, in the midst of doubts and debates on the utility ofcommodity futures markets and against the background ofconflicting views and vista, there is a need to list various issues 37
  38. 38. and concerns in the development of futures exchanges. Thispresents the agenda for research on commodity futures markets inIndia, from both theoretical and empirical perspectives. While at amore general level, probably the most succinct statement onpresenting a research agenda for commodity markets exists in apaper by Rutten1, an attempt to do so in the Indian context ismissing from the literature so far.Strengthening the Scope of Commodity Derivative TradingThe issue of expanding the scope of commodity derivative tradingis apparently normative and value judgmental. This is primarilybecause of a large group of people who feel that commodityderivative trading should not be allowed at all and hence thequestion of expanding its scope does not arise. However, there areenough strong arguments in favour of strengthening commodityderivatives markets and developing supportive market institutionsand awareness. The role of commodity futures markets becomeseven more compelling with India moving toward greater tradeliberalization, particularly in the context of agriculture, and gettingfurther exposed to the volatilities of international trade and finance.Commodity futures is a market mechanism that is viable for riskmanagement and price discovery, and such institutions can help“bail out” the economy from the vagaries of international trade.Despite the realization of the need for commodity derivative tradingin India and the subsequent resumption of trade in the newmillennium, the statutes dictating derivative trading are old andoutmoded. Derivative markets have been functioning under theForward Contracts Regulation Act (FCRA), which dates back to 38
  39. 39. 1952. The world has undergone a significant change since then,and so have the dynamics of international trade and finance, andthe domestic economies of the developing world. In the process,there has been a transformation in trading patterns, methods andpractices in physical and derivative markets, warehousing, andtransport norms. Newer risks and risk management instrumentsare being innovated and operationalized worldwide in variousexchanges. There are non-trade–related market participants whohave helped provide liquidity to markets worldwide. Informationand communication technology has brought about changes in theinstitutional processes. International trade and financial linkageswith the domestic economy are also different from what they weresixty years ago in an economy that was insulated from externalforces and stimuli. Hence, there is an utmost need to strengthenand expand the scope of commodity derivative trading. However,merely expanding the scope of trading might even lead unbridledmarket forces to play havoc with the functioning of the market,thereby creating a negative dent on economic wellbeing. Formarkets to operate effectively and efficiently there is a need forappropriate regulation as well. Hence, there is a clear case forstrengthening the FMC by providing it with more autonomy.With this objective, the Union Government had moved a Bill in thelast Lok Sabha to amend the FCRA. The Bill was scrutinized overa long period by a specially appointed Standing Committee of theParliament. But the Ordinance lapsed before its provisions couldbe implemented, and the Amendment Bill also lapsed following thedissolution of that Lok Sabha. However, with the constitution of thenew Lok Sabha, there is renewed hope for an amendment. 39
  40. 40. FCRA is essentially an enabling Act, and the FMC, set up underthe provisions of the Act, is more an advisory and monitoring bodythan one with regulatory powers. As per the statute, the realregulatory powers remain in the hands of the Central Government,while the FMC’s role is supposed to be that of being one of offeringrecommendation and advises to the Ministry. Over time, the FMChas acquired a few regulatory powers circuitously under the by-laws of the associations recognized by the Act.An amendment to the FCRA will usher in a new era in commodityderivative trading by expanding the scope and instruments oftrading, and by strengthening the regulatory powers of the FMC.Among the changes proposed in the Bill, an important interventionis to bring about a change in the definition of “commodities” tofacilitate trading in derivative contracts for intangibles likecommodity indices, weather derivatives, etc. From the perspectiveof new instruments for trading, the amendment will increase thatscope by legalizing options trading in commodity derivatives. Onthe transaction and settlement side, it will set aside the outmodedand archaic norm of physical delivery for contract settlement, andwill allow for cash settlement of futures contracts. The amendmentwill also allow institutional investors like banks and mutual funds,foreign institutional investors, financial institutions, and foreignindividuals to trade in commodity futures. This will help increaseliquidity in the market, and thereby augment price riskmanagement and price discovery. However, it is not that theamendment is only in favour of unrelenting and unbridled marketforces; it is also about regulation. It releases the FMC from theclangs of being traditionally described as an advisory body to the 40
  41. 41. Ministry of Consumer Affairs, and renders it the distinction of beingan “autonomous” regulatory body, in a process of its up-gradationand expansion with more regulatory and judicial authority.On the other hand, contrary to the clause under the FCRAamendment of rendering more teeth to the FMC, there have alsobeen talks regarding the convergence of the Securities andExchange Board of India (SEBI), the regulator of the equitymarkets, and the FMC. While government machineries have oftenbeen arguing in favour of a merger on grounds that a commonregulator is in a better position to regulate and develop the variousmarkets synergically and in sync with each other, there are alsocompelling arguments against the merger4. In my previousarticle4, as has also been acknowledged in the literature5, 6, therehave been arguments that commodity exchanges are not stockexchanges. Commodity exchanges are essentially institutions thatare adjunct to the physical market, and are supposed to performcomplementary functions in order to improve commoditytransactions in the various nodes of the value chain. While stockprices are determined at centralised locations – in theheadquarters of stock exchanges, commodity prices vary acrosslocations, quality characteristics, end-usage patterns, andseasons. Moreover, the stock market players are primarily thosewho earn regular income from dividend or interest, or profit fromspeculation – they are not hedgers like commodity players. Hence,the various microstructure as well as the macro-level institutionalissues are different for the two forms of markets, and eachrequires specialised treatments in terms of regulation, rather thana common treatment. 41
  42. 42. The possible conflict of ideas has also brought to the fore the issueof a super regulator above all the market regulators – somethingthat the USA has been contemplating ever since the outbreak ofthe financial crisis. The feasibility of such an idea deserves acritical examination before it receives acceptance or outrightrejection in the Indian context.Another important issue is the relationship of spot and futuresmarkets and how the efficiency of physical markets can helpplayers in the futures markets. One critical element that emergedfrom the paper was the need for development of nationwide,information-technology enabled spot markets for futuresexchanges to perform their price discovery and price riskmanagement functions efficiently. This, definitely, has to attract theattention of researchers and policymakers. There is a critical needfor development of such cases for buttressing these contentionsfurther.Rules Governing Commodity Derivatives Exchanges/ParticipantsThe trading of commodity derivatives on the NCDEX is regulatedby Forward Markets Commission (FMC). In terms of Section 15 ofthe Forward Contracts (Regulation) Act, 1952 (the Act),forwardcontracts in commodities notified under section 15 of the Act canbe entered into onlyby or through a member of a recognizedassociation, i.e, commodity exchange as popularlyknown. Therecognized associations/commodity exchanges are grantedrecognition underthe Act by the central government (Department ofConsumer Affairs, Ministry of ConsumerAffairs, Food and Public 42
  43. 43. Distribution). All the Exchanges, which permit forward contractsfortrading, are required to obtain certificate of registration from theCentral Government. Theother legislations which have relevanceto commodity trading are the Companies Act, StampAct, ContractsAct, Essential Commodities Act 1955, Prevention of FoodAdulteration Act, 1954and various other legislations, whichimpinge on their working.Forward Markets Commission provides regulatory oversight inorder (to ensure financial integrityto prevent systematic risk ofdefault by one major operator or group of operators), marketintegrity (to ensure that futures prices are truly aligned with theprospective demand andsupply conditions) and to protect andpromote interest of customers/ non-members. Some oftheregulatory measures by Forward Markets Commission include: 1. Limit on net open position as on the close of the trading hours. Sometimes limit is also imposed on intra-day net open position. The limits are imposed member- wise and client wise. 2. Circuit-filters or limit on price fluctuations to allow cooling of market in the event of abrupt upswing or downswing in prices. 3. Special margin deposit to be collected on outstanding purchases or sales when price moves up or down sharply above or below the previous day closing price. By making further purchases/sales relatively costly, the price rise or fall 43
  44. 44. is sobered down. This measure is imposed by the Exchange (FMC may also issue directive).4. Circuit breakers or minimum/maximum prices: These are prescribed to prevent futures prices from falling below as rising above not warranted by prospective supply and demand factors. This measure is also imposed on the request of the exchanges (FMC may also issue directive).5. Stopping trading in certain derivatives of the contract, closing the market for a specified period and even closing out the contract. These extreme measures are taken only in emergency situations. Besides these regulatory measures, a clients position cannot be appropriated by the memberof the Exchange. No member of an Exchange can enter into a forward contract on his ownaccount with a non-member unless such member has secured the consent of the non-memberin writing to the effect that the sale or purchase is on his own account. The FMC is persuadingincreasing number of exchanges to switch over to electronic trading, clearing and settlement,which is more safe and customer-friendly. The FMC has also prescribed simultaneous reportingsystem for the exchanges following open out-cry system. These steps facilitate audit trail andmake it difficult for the members to indulge in malpractices like trading ahead of clients, etc.The FMC has also mandated all the exchanges following open outcry system to display at aprominent place in exchange premises, the name, address, telephone number of the officer ofthe commission who can be contacted for any grievance. The 44
  45. 45. website of the commission alsohas a provision for thecustomers to make complaint and send comments andsuggestions tothe FMC. Officers of the FMC meet themembers and clients on a random basis, visit exchanges,toascertain the situation on the ground to bring in developmentin any area of operation of themarket.Participants in commodity Derivative MarketHedgersMany participants in the commodity futures market arehedgers. They use the futures market to reduce a particularrisk that they face. This risk might relate to the price of anycommodity that the person deals in. The classic hedgingexample is that of wheat farmer who wants to hedge the riskof fluctuations in the price of wheat around the time that hiscrop is ready for harvesting. By selling his crop forward, heobtains a hedge by locking in to a predetermined price.Hedging does not necessarily improve the financial outcome;indeed, it could make the outcome worse. What it doeshowever is, that it makes the outcome more certain. Hedgerscould be government institutions, private corporations likefinancial institutions, trading companies and even otherparticipants in the value chain, for instance farmers,extractors, ginners, processors etc., who are influenced bythe commodity prices.There are basically two kinds of hedges that can be taken. Acompany that wants to sell an asset at a particular time in the 45
  46. 46. future can hedge by taking short futures position. This iscalled a short hedge. A short hedge is a hedge that requiresa short position in futures contracts. As we said, a shorthedge is appropriate when the hedger already owns theasset, or is likely to own the asset and expects to sell it atsome time in the future.Similarly, a company that knows that it is due to buy an assetin the future can hedge by taking long futures position. Thisis known as long hedge. A long hedge is appropriate when acompany knows it will have to purchase a certain asset in thefuture and wants to lock in a price now.SpeculatorsIf hedgers are the people who wish to avoid price risk,speculators are those who are willing to take such risk.These are the person who takes positions in the market &assume risks to profit from price fluctuations in fact thespeculators consume market information make forecastsabout the prices & put money in these forecasts. An entityhaving an opinion on the price movements of a givencommodity can speculate using the commodity market.While the basics of speculation apply to any market,speculating in commodities is not as simple as speculatingon stocks in the financial market. For a speculator who thinksthe shares of a given company will rise, it is easy to buy theshares and hold them for whatever duration he wants to.However, commodities are bulky products and come with allthe costs and procedures of handling these products. The 46
  47. 47. commodities futures markets provide speculators with aneasy mechanism to speculate on the price of underlyingcommodities. To trade commodity futures on the NCDEX, acustomer must open a futures trading account with acommodity derivatives broker. Buying futures simply involvesputting in the margin money. This enables futures traders totake a position in the underlying commodity without having toactually hold that commodity. With the purchase of futurescontract on a commodity, the holder essentially makes alegally binding promise or obligation to buy the underlyingsecurity at some point in the future (the expiration date of thecontract).ArbitrageA central idea in modern economics is the law of one price.This states that in a competitive market, if two assets areequivalent from the point of view of risk and return, theyshould sell at the same price. If the price of the same asset isdifferent in two markets, there will be operators who will buyin the market where the asset sells cheap and sell in themarket where it is costly. This activity termed as arbitrage.The buying cheap and selling expensive continues till pricesin the two markets reach equilibrium. Hence, arbitrage helpsto equalise prices and restore market efficiency.F = (S + U)erTWhere: r = Cost of financing (annualised) T = Time till expiration 47
  48. 48. U = Present value of all storage costsThe cost-of-carry ensures that futures prices stay in tune with thespot prices of the underlying assets. The above equation gives thefair value of a futures contract on an investment commodity.Whenever the futures price deviates substantially from its fairvalue, arbitrage opportunities arise. To capture mispricing thatresult in overpriced futures, the arbitrager must sell futures andbuy spot, whereas to capture mispricing that result in underpricedfutures, the arbitrager must sell spot and buy futures. In the caseof investment commodities, mispricing would result in both, buyingthe spot and holding it or selling the spot and investing theproceeds. However, in the case of consumption assets which areheld primarily for reasons of usage, even if there exists amispricing, a person who holds the underlying may not want to sellit to profit from the arbitrage 48
  49. 49. CHAPTER-4 NEWS REPORTS1. A total of 120 varieties of different pulse crops comprising chickpea (27), pigeonpea (16), urdbean (17), mungbean (19), field pea (10), lentil (11), rajmash (2), cowpea (7), guar (5), horse gram (3), mothbean (2) and lathyrus (1) have been released during 2007-2012. NEW DELHI: In India about 120 pulses varieties have been developed and released during 2007-2012 by the State Agricultural Universities and KrishiVigyanKendras. The information was given by Harish Rawat, Minister of State for Agriculture and Food Processing Industries in a written reply to a question in the upper house of Indian Parliament. At present, Indian Council of Agricultural Research (ICAR) is busy with various research programmes on different pulse crops at Indian Institute of Pulse Research (IIPR), Kanpur. The research programmes include basic and strategic research related to crop improvement, production and protection technologies in different pulse crops. Improved varieties and recommended agronomic practices developed as a result of the research efforts of National Agricultural Research System have increased yield potential of different pulses crops. 49
  50. 50. 2. Mainland China’s gold imports from Hong Kong rose sharplyby 98.84% year-on-year to 75.84 metric tons in July this year,according to the latest export data released by Census andStatistics Department of the Hong Kong government. Countryimported 38.14 metric tons of gold from Hong Kong a year earlier. BEIJING: It was the first rise in Chinas gold imports after three months of slightly lower imports. Shipments were a record 103.64 metric tons in April. China doesn’t publish such data. According to the government data, Chinas gold imports from Hong Kong advanced sharply by 344.87% year-on-year to 458.628 metric tons in the first seven months of this year compare to 103.09 metric tons a year earlier. China’s gold imports advanced due to people renewed their buying of gold to hedge against financial market’s turmoil and weaker currencies with increasing concerns about the Chinese economy and stock and property markets. Exports of gold to Hong Kong from China were 30.03metric tons in July, up from 27.50 metric tons in June. China is the world’s second-biggest consumer of gold, after India, but is expected to take the top spot soon. This year China’s imports via Hong Kong during the first 10 months of the year are more than three times higher than the same period last year. 50
  51. 51. CHAPTER-5 CONCLUSIONThe trade in global commodity market is worth US $600 billion;India should put in place world standard trading exchanges to tapthis huge global commodities market while protecting the interestsof the domestic farmers from sharp price fluctuations. Forachieving this goal, we have to equip ourselves with theappropriate markets instruments and institutions by building acommodity trading exchange of global standards. Amidst theturmoil of a risky market, stiff competition and many introductionfailures, the commodity derivatives industry needs a conceptualmodel that incorporates all aspects relevant to the success andfailure of commodity derivatives. In order to meet this need, a newand integrative approach towards commodity derivativesmanagement is needed, which makes it easier to gain insight intothe viability of new commodity derivatives before introduction, toassess and improve the viability of existing commodity derivativesAt a time when India is fast catching up with the world’s leadingmanufacturing centres and being home to back office work of theleading global companies, new multi commodity exchanges, usinglatest technologies, can help accelerate the process and also helpfinancial markets to allocate finance to right sectors. It’s a rightstep in the direction of integration with the global commoditymarkets. India being a developing country where majority ofpopulation is still dependent on the agriculture, moderncommodities exchanges can be used as tool to improve the life ofsuch people, by making commodities market more efficient. 51
  52. 52. Instability of commodity prices has always been a major concern ofthe producers, processors, traders as well as the consumers inagriculture -dominated country like India. Commodity exchangesprovide a mechanism to lock-in prices, thus insulating theparticipants from the adverse price risk. Commodity market helpsthe farmer by signalling him the price that is expected to prevail infuture; so he can decide which crop to grow, thus making hisexpectations aligned with the market. Farmers can also cover theirrisk by locking in the price by selling their crop in futures market(selling futures).Farmers’ direct exposure to price fluctuations, forinstance, makes it too risky for many farmers to invest in otherwiseprofitable activities. There are various ways to cope with thisproblem. Apart from increasing the stability of the market, variousactors in the farm sector can better manage their activities in anenvironment of unstable prices through commodity exchanges. Itmust be ensured that this system (futures) actually benefits thefarmers, and not just traders. For this, central and stategovernment agencies have to take necessary steps, includingrapid expansion of rural warehousing facilities. 52