Presentation speaks about Physical Market and importance of Electronic Exchange

2. A commodity refers to any goods,
merchandise or produce of land that can
be bought and sold.
A commodity is an article or product that
is used for commerce
is movable
is used for commerce
is movable
has a value
can be brought and sold
is produced or used as a subject in a
barter or sale

3. TheTheTheThe ChicagoChicagoChicagoChicago BoardBoardBoardBoard ofofofof TradeTradeTradeTrade (CBOT)(CBOT)(CBOT)(CBOT) definesdefinesdefinesdefines aaaa
commoditycommoditycommoditycommodity asasasas:::: “An article of commerce or a
product that can be used for commerce. In a
narrow sense, products traded on an authorizednarrow sense, products traded on an authorized
commodity exchange. Types of commodities
include agricultural products, metals,
petroleum, foreign currency and financial
instruments, to name a few.”

4. Referred to as “cashcashcashcash andandandand carrycarrycarrycarry marketmarketmarketmarket” or the
“spotspotspotspot marketmarketmarketmarket”.
In this market, the seller agrees to deliver the
commodity and the buyer agrees to make thecommodity and the buyer agrees to make the
payment “on the spot”. This agreement
between the seller and buyer is termed as
“spotspotspotspot contractcontractcontractcontract”.

5. AdvantageAdvantageAdvantageAdvantage:::: Buyer can select and buy the
specific commodity required.
LimitationLimitationLimitationLimitation:::: The inherent characteristic of the
physical market is that the transactions in
this market are subject to pricepricepriceprice riskriskriskrisk....

6. ProducersProducersProducersProducers use inputs such as seeds, fertilizers, labour
and implements to produce raw materials.
AssemblersAssemblersAssemblersAssemblers andandandand TradersTradersTradersTraders purchase these materials in
bulk.
ProcessorsProcessorsProcessorsProcessors orororor manufacturersmanufacturersmanufacturersmanufacturers then convert these rawProcessorsProcessorsProcessorsProcessors orororor manufacturersmanufacturersmanufacturersmanufacturers then convert these raw
materials into finished goods.
DistributorsDistributorsDistributorsDistributors who are generally wholesalers procured
the finished goods.
From distributors goods reach consumersconsumersconsumersconsumers through
retailersretailersretailersretailers....

7. Traders, brokers and commission agents act
as “intermediariesintermediariesintermediariesintermediaries” connecting the other
participants and the various segments of the
value chain.
Farmers
Primary
Aggregat
or
Sales
Comm
ission
Agent
Buyer
Commission
Agent
Processor
Wholesaler
Raw /
Finished
Product
Processor
Retailer
Auction
MARKETMARKETMARKETMARKET
YARDYARDYARDYARD
Fig: Physical agricultural commodity market structure

8. PRODUCER
Katcha Arathiyas
(Commission
Agents)
STOCKIST
PVT.
AGENCY
GOVT.
AGENCY
Pakka Arathiyas
(Commission
Agents)
PROCESSOR
OIL
WHOLESALER
INDUSTRIAL
USER
OTHER
CONSUMER
EXPORTER
Fig: Value chain for Castor seeds

9. In India agricultural commodities are traded
in wholesale markets called mandismandismandismandis....
Setting up Mandis
ProductsProducts
Participants
Mandi Fee
Trading

10. 1111stststst TypeTypeTypeType:::: The farmer approaches the trader for
a price quote. When they mutually agree on a
price, the produce is considered to be sold to
the trader.
2222ndndndnd TypeTypeTypeType:::: It is an “outcryoutcryoutcryoutcry auctionauctionauctionauction” for which
there is a designated time at each mandi. The
auction is done in sequence, typically going
from a lot with a fixed grade to the next.

11. PricePricePricePrice:
No real time price dissemination in Mandi.
Wide difference between Farm GateFarm GateFarm GateFarm Gate Price
and ConsumerConsumerConsumerConsumer priceand ConsumerConsumerConsumerConsumer price
ClearingClearingClearingClearing has to be done immediately for cash
contracts.
Delivery & paymentDelivery & paymentDelivery & paymentDelivery & payment has to be made within 11111111
days

12. APMCAPMCAPMCAPMC ActActActAct is a State Act constituted by each State
to establish and regulate agricultural markets. The
whole geographical area in the State is divided and
declared as a market area wherein the markets are
managed by the Market Committees constituted bymanaged by the Market Committees constituted by
the State Govt.
TheTheTheThe EssentialEssentialEssentialEssential CommoditiesCommoditiesCommoditiesCommodities Act,Act,Act,Act, 1955195519551955 was enacted
to ensure easy availability of essential
commodities to the consumers and to protect
them from exploitation by unscrupulous traders.

13. Lack of proper price dissemination and transparency in
price discovery process.
Very fragmented, isolated and unorganized markets.
Restrictions in interstate movement of goods.
Lack of proper certification and standardization ofLack of proper certification and standardization of
commodities.
Lack of proper warehousing and transportation
facilities.
Long chain of intermediaries.

14. Cartelization of intermediaries with multiple levels of
intermediation.
Processors not allowed to buy directly from cultivators in most
states.
Excessive dependence on and consequent exploitation by
money lenders.
Distress sales by farmers.
Stock limits in essential commodities.
High volatility of spot market prices.
States having different tax and tariff structures

16. In physical market a wide gap exists between
the prices paid by the end-consumers and
price received by the farmers.
Reasons:
Very high costs of intermediation.Very high costs of intermediation.
Farmers’ ignorance about the spot price of the
commodity in the mandi – Leads to distress sales.
Price uncertainty making it difficult to predict the
market accurately.
Lack if effective mechanism to eliminate price risk.

17. Develop a common Indian market by setting up a
national-level electronic spot market that area
accessible to across the country.
Provide effective, transparent method of
discovering nationwide spot price in variousdiscovering nationwide spot price in various
commodities.
Create a market where farmers can get the best
prices and receive prompt payments.
Facilitate better efficiency in procurement and bring
down the levels and costs of intermediation.

18. Create a market where traders, processors and end
users can procure agricultural produces at a
competitive price without any quality and counter
party risk.
Provide quality certification, warehousing facilities
and other services.
Create a structured, organized and standardized
spot market to help the future exchanges in
facilitating physical delivery in agricultural
commodities.

20. CashCashCashCash ForwardForwardForwardForward TransactionsTransactionsTransactionsTransactions
Cash transactions in the physical market
involve two types of contracts that require:
1. Immediate delivery in the spot market.
2. Delivery of a specific commodity to the buyer2. Delivery of a specific commodity to the buyer
sometime in the future.
The second type of contract that specifies
delivery of a commodity to the buyer at a future
date is called a “cashcashcashcash forwardforwardforwardforward contractcontractcontractcontract”.

21. A forward contract is a bilateral agreement in
which a buyer and seller agree upon the
delivery of a specified quality and quantity of
an asset on a specified future date at a
predetermined price.
Long PositionLong PositionLong PositionLong Position: Party agrees to buy the commodity
Short PositionShort PositionShort PositionShort Position: Party agrees to sell the commodity

22. Forward contracts are over-the-counter
(OTC) contracts.
Each contract is custom designed
Only parties to the contract know theOnly parties to the contract know the
contract price.
On the expiration date, the contract has
to be settled by delivery of the asset.

23. TradingTradingTradingTrading: In a trading process, the buyer with the
demand for the product interacts with the seller
supplying the product. The buyer and seller negotiate
and arrive at an agreement regarding quantity, quality
and price.
ClearingClearingClearingClearing: In the clearing process, the buyer and seller
decide on the quantum of goods and the amount of
cash that would be exchanged among them.
SettlementSettlementSettlementSettlement: In this process, the actual exchange
happens

24. In a spotspotspotspot transactiontransactiontransactiontransaction, trading, clearing and
settlement happen simultaneously and
instantaneously – that is “onononon thethethethe spotspotspotspot”.
In a forwardforwardforwardforward transactiontransactiontransactiontransaction, cash does not changeIn a forwardforwardforwardforward transactiontransactiontransactiontransaction, cash does not change
hands on the date of entering into the
contract. Hence, in forward contract, the
trading, clearing and settlement do not happen
simultaneously

25. The contracts are private and negotiated bilaterally
between two parties.
The prices are not transparent.
No regulations for establishing market stability and
protection of market players.protection of market players.
Lack of standardization leads to illiquidity in the
absence of a secondary market.
The profit or loss is realized only on the maturity date.
Settlement is only through actual delivery or offsetting
by cash delivery.

26. These contracts are exchange-traded version
of forward contracts.
Future contracts contain standard
specifications.specifications.
Need not be settled through physical delivery.
Can be closed by entering into an equal and
opposite contract.

27. Price discovery and price dissemination
Price risk management
Price stability
Common platform for all traders
Low transaction costs
Absence of counter party credit risk
Lower credit risk
Liquidity

28. Characteristics
Price determination
Function of the marketFunction of the market
Advantages
Limitations

29. Forward ContractsForward ContractsForward ContractsForward Contracts Future ContractsFuture ContractsFuture ContractsFuture Contracts
• These contracts are
OTC contracts
• Bilateral contract –
Counter-part risk
• Futures are exchange traded
• Large number of participants –
Exchange takes care of risk management
• Contracts are standardised
•Each contract is custom
designed
• Contract has to settled
by the delivery of asset
on the expiration date.
• Contracts is a price fixing contract. The
buyer or seller is obligated to close the
contract.
• In futures market, actual delivery of
good takes place only in few cases.
Transaction are squared up before due
date with the payment of difference

30. Forward ContractsForward ContractsForward ContractsForward Contracts Future ContractsFuture ContractsFuture ContractsFuture Contracts
• Forward Price for an asset depend on
following:
Spot or Cash price at the time of
transaction
Carrying cost
• Future markets have a
large number of market
participants. Price discovery
takes place based on
following:Carrying cost
Transportation cost
Storage cost
Others – Interest, dividend
Neither market mechanism nor
price discovery
following:
Supply
Demand
Market perception of
the above two situation

31. Forward ContractsForward ContractsForward ContractsForward Contracts Future ContractsFuture ContractsFuture ContractsFuture Contracts
• Simple agreement to buy
or sell an asset at a certain
future time for a certain
price.
• Traded in OTC market and
• This markets perform various
important economic functions. These
market meet the needs of the 3
groups of futures market:
Those who wish to discover• Traded in OTC market and
not in an exchange.
• Neither market nor
exchange has role to play
in the transaction
Those who wish to discover
information about future prices
Those who wish to speculate or
exploit any arbitrage opportunity
Those who wish to hedge their
price risk.

32. Forward ContractsForward ContractsForward ContractsForward Contracts Future ContractsFuture ContractsFuture ContractsFuture Contracts
• These contract has no
margin system.
• Contracts are customised
• Contracts contain standard
specification of the underlying asset.
• Absence of credit risk. At the most
credit risk is limited to one day
and the contract terms can
include specification as
agreed upon between the
buyer and seller.
movement of futures prices.
• High liquidity
• High leverage
• Price Stabilisation
• Easy and convenient access to all
market participants

33. Forward ContractsForward ContractsForward ContractsForward Contracts Future ContractsFuture ContractsFuture ContractsFuture Contracts
• Contracts are bilateral. Therefore,
there are no exchange guarantee.
• Prices are not transparent
• Profit are loss are realised only on
• Perfect hedge is not
possible due to
standardisation of
contracts.
the maturity date.
• Settlement only through delivery.
Closing out is not possible.
• Lack of standardisation – No
Secondary market.
• Futures contracts cannot
be tailored to the specific
needs of firms and financial
institutions.