5. Physical markets (Spot markets) :
A market where goods, both perishable and non-
perishable, are sold for cash and delivered
immediately or within a short period of time
Delivery and payment within 11 days
Forward markets/contracts
Delivery of goods and/or payment of price after
11 days.
6. Future Markets
An agreement entered on an exchange to
trade a commodity of specified quality at a
specified time in future
Standardization of contract
Trading in exchange
Clearinghouse
7. Forwards Futures
Characteristics Forward Contracts Futures Contract
Competitiveness of price Depends on the negotiation Yes
Default risk Some No
Ease of re-contracting or offset Depends on the negotiation Yes
Physical delivery Yes Seldom
Search cost & transaction cost
Risk of dishonour
Dispute settlement
Trading in exchange
Clearinghouse
Standardization of contracts
8. Contract specification
• Size of the contract
• Basis Grade
• Deliverable grade
• Contract Months
• Delivery places
• 11 bales; delivery=55 bales
• Shankar-6; Fine
• Good, Fully Good, Fine,
Superfine
• Every month, 3 active contracts
• Ahmedabad
10. Speculation:
Buying or Selling of futures with the aim of
making a quick profit.
Arbitrage:
Act of taking opportunity of taking advantage
between the price difference between two
different markets for the same stock or
commodity.
Hedging:
Selling or Buying a commodity on a particular
date with corresponding Buying & Selling on
future date to offset price risk
11. Introduction to Indian Future markets
Evolution of the concept.
Uncertainty of future.
People want safety
Such people come together
Price agreement started In Europe and Japan
Trading sophistication in 19th Century in USA
12. History
• More than 125 yrs old
Bombay Cotton Trade Association – 1875
Active futures markets in various commodities like Bullion,
oilseeds, wheat, jute, cotton etc.
• During the World War II Futures trading in most
of the commodities suspended.
• 1952 Forward Contracts Regulation Act passed.
• Till the late 1990s futures trading prohibited /
suspended in all major commodities.
13. Reopening of the Markets
• As process of liberalization of economy started in
90s the Futures trading permitted in an increasing
number of commodities after 1991 (Coffee, Jute,
Sugar, Edible Oilseed complex)
• The “National Agricultural Policy” announced in
July 2000 emphasized the need for allowing futures
trading in agricultural commodities for risk
management and price discovery.
• Futures trading permitted in all the commodities
(April 2003)
15. Exponential Growth of markets
• 22 Recognized Exchanges
4 ‘National’ Exchanges
– MCX, NCDEX , NMCE and ICEX
18 Regional Exchanges
• Futures trading presently conducted
over 100 commodities.
• Volume and value of trading
16. Volume and Value of Trade
Commodity Derivatives
Year Volume
(In Mn. tonnes)
Value
(in Rs. crores)
2000-01 17.98 27,386
2001-02 21.77 34,495
2002-03 31.46 66,530
2003-04 49.30 1,29,363
2004-05 194.21 5,71,759
2005-06 678.88 21,55,122
2006-07 612.93 36,76,926
2007-08 557.34 40,65,989
2008-09 686.34 52,48,956
2009-10
(Feb 10)
841.85 62,33,824
17. 100 Commodities Available for Trading
– Metals - Gold, Silver, Copper, Zinc, Copper,
Aluminum etc.
– Food grains - Gram, Pulses, Maize, etc.
– Energy _ Crude Oil, Natural Gas etc.
– Spices - Turmeric, Pepper, etc.
– Edible oilseed complexes like groundnut,
mustardseed, cottonseed, sunflower, rice bran,
soy oil, etc.
– Fibres - Cotton, Jute, etc.
– Other - Castorseed, Gur,
18. Regulation
• Purpose:
To ensure that markets perform the
twin economic functions of
price discovery and
risk management efficiently.
19. Scheme of Regulation
Three Tier System
1. Central Government has the powers to
permit/prohibit Commodities for futures
trading
2. FMC has the powers to regulate.
3. Exchanges have the powers to regulate as
per their Articles/Bye-Laws approved by
FMC.
21. Economic Functions of the Futures Markets
1. PRICE DISCOVERY
• Price Discovery takes place in the Spot
Markets also.
• But its for the Present only.
• Its also inefficient and localized.
Price Discovery in Futures Markets -
i) Efficient
ii) Takes place at National level
iii) Available for future Months.
22. 2. Price Risk Management or Hedging
• Futures Markets provide facility –
To Companies to protect themselves against the
adverse movements in the prices of raw materials or
products
Exporters – hedge against an increase in the price of their
inputs at the time of meeting export commitments.
Stockiest - hedge the value of their inventory against a price
decline
Processors- hedge against an increase in the price of raw
material.
To farmers to protect against the adverse movement
in the prices of their produce.
23. Other Benefits
1. Price Stabilization
2. Auto Regulation of consumption and
storage
3. Financing of Marketing Operations
4. Value addition to farmers.
24. 1. Price Stabilization
If futures prices >> spot prices
- selling in futures and buying in spot
If futures prices << spot prices
- buying in futures and selling in spot
• Both the processes reduce gap between spot
and future
• Therefore gap between prices in season and off
season reduces.
25. 2. Auto Regulation of consumption and storage
High future prices indicate less availability of commodity
in future.
Therefore tendency to consume less and store more
Low future prices indicate more availability of commodity
in future.
Therefore tendency to consume more and store less
This process avoids over/under consumption and
unnecessary hoarding of commodity
26. 3. Financing of the Marketing Operations
1. Credit needs of primary producers are high and access
to credit is tough.
2. Farmer forced to sell in spot because of immediate
need of money.
3, If waits for higher prices then has to take finance on
the basis of warehouse receipt but there is substantial
haircut.
4. Futures Contracts may provide better security to Bank.
5. Federal Bank has started financing on the basis of
futures contracts in Kerala.
27. 4. Value Addition to Farmer
1. Farmers go for sale of ungraded
produce.
2. Emphasis on grading in futures market
increasing awareness about grading
3. Grading may increase overall realization.
4. Some share of value addition goes to
farmer
28. The farmers can derive benefit from these markets
First Phase
• Farmers can be benefited by Futures Markets by using
price signals for better bargaining capacity. This requires
creation of awareness and dissemination of price
information
Second Phase
Utilization of knowledge and information-
For taking pre sowing and post sowing decisions
For finalizing marketing strategy after harvest
Third Phase
Direct Participation in the Market –
For selling the produce
For pure hedging
29. Aggregation
Aggregation brings to the Exchange platform those
farmers who are unable to participate in futures
trading because of the following constraints:
Large contract sizes.
Lack of awareness
Unable to meet quality standards
High membership fees, Bank guarantees etc
Technological requirements.
30. • What do corporate want to hedge?
• Uncertainty in prices of raw material or finished
goods. Especially if it is large enough to bother
them.
• For instance, a yarn manufacturer is exposed to cotton
price fluctuations which is close to 80% of his costs.
• A poultry feed manufacturer is exposed to price
fluctuations in soy and maize which account for over 70%
of his costs.
• A builder is exposed to steel price variation as it forms
15 – 18% of the construction costs.
31. 31
• Do we need two markets?
• Yes, spot market clears the goods for immediate consumption.
• Forward markets cater to the needs of discovering and sending
future price signal to the participants who can use it for future
planning.
• Does spot market compete with forward /futures market?
• No, they complement each other. The roles of these markets are
clear and categorical.
• What is the use of having two market for the same asset?
• Since the asset is the same, both spot and forward markets should
exhibit similar movement in price for an external event. This makes
it convenient to create a near equal but opposite position in one
market to that created in the other through the process of hedging.
32. What is a commodity futures exchange?
A futures exchange is a financial
market where different groups of
participants trade commodity-linked
contracts
