Commodities Market - Snapshot (1)

8/12/2019 Commodities Market - Snapshot (1)

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Commodity Market

Study Material on

Commodity Market

Compiled by: -

Prof. Anil Suvarna

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Syllabus

No. Contents

Section 1: Introduction to Derivatives

1.1 Derivatives defined

1.2 Products, participants and functions

1.3 Derivatives markets

Section 2: Instruments available for trading

2.1 Forward contracts

2.2 Introduction to futures

2.3 Introduction to options

Section 3: Indian History in Commodities

3.1 Its Evolution in India

3.2 Te !a"ra committee report

3.3 #eadin$ commodit% markets of India& '(), *(DE), *'(E

Section 4: Commodity Market: Theoretical s!ects

+.1 'aor (ommodit% E-can$e

+.2 e$ulation of commodit% markets

+.3 /tructure of (ommodit% 'arket

+.+ Deliver% Process

+.0 % coose (ommodities over Euities

Section ": Commodity Market: #ractical s!ects

0.1 Pricin$ commodit% futures& Te cost of carr% model

0.2 (ommodities 'arkets 4verall Perspective

0.3 e$ulator% framework

0.+ Product *otes on 5$ro and 'etal (ommodities

Section $: #ractical Session

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Introduction to Derivatives

The origin of derivatives can be traced back to the need of farmers to protect themselves

against fluctuations in the price of their crop. From the time it was sown to the time it was

ready for harvest farmers would face price uncertainty. Through the use of simplederivative products it was possible for the farmer to partially or fully transfer price risks

by locking. in asset prices. These were simple contracts developed to meet the needs of

farmers and were basically a means of reducing risk. ! farmer who sowed his crop in "une

faced uncertainty over the price he would receive for his harvest in September. #n years of

scarcity he would probably obtain attractive prices. $owever during times of oversupply

he would have to dispose off his harvest at a very low price. Clearly this meant that the

farmer and his family were e%posed to a high risk of price uncertainty.

&n the other hand a merchant with an ongoing re'uirement of grains too would face a

price risk - that of having to pay e%orbitant prices during dearth although favorable pricescould be obtained during periods of oversupply. (nder such circumstances it clearly made

sense for the farmer and the merchant to come together and enter into a contract whereby

the price of the grain to be delivered in September could be decided earlier. )hat they

would then negotiate happened to be a futures. type contract which would enable both

parties to eliminate the price risk.

#n *+,+ the Chicago oard of Trade or C&T was established to bring farmers and

merchants together. ! group of traders got together and created the to.arrive/ contract that

permitted farmers to lock in to price upfront and deliver the grain later. These to-arrive

contracts proved useful as a device for hedging and speculation on price changes. These

were eventually standardi0ed and in *123 the first futures clearing house came into

e%istence. Today derivative contracts e%ist on a variety of commodities such as corn

pepper cotton wheat silver etc. esides commodities derivatives contracts also e%ist on

a lot of financial underlying like stocks interest rate e%change rate etc.

Derivatives defined

! derivative is a product whose value is derived from the value of one or more underlying

variables or assets in a contractual manner. The underlying asset can be e'uity fore%commodity or any other asset. #n our earlier discussion we saw that wheat farmers may

wish to sell their harvest at a future date to eliminate the risk of a change in prices by that

date. Such a transaction is an e%ample of a derivative. The price of this derivative is driven

by the spot price of wheat which is the underlying. in this case.

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The Forwards Contracts 45egulation6 !ct *132 regulates the forward7 futures contracts in

commodities all over #ndia. !s per this the Forward Markets Commission 4FMC6

continues to have 8urisdiction over commodity forward7 futures contracts. 9erivatives

trading in securities were introduced in 2*.

The term ;security< in the Securities Contracts 45egulation6 !ct *13= 4SC5!6 was

amended to include derivative contracts in securities. Conse'uently regulation of

derivatives came under the purview of Securities >%change oard of #ndia 4S>#6. )e

thus have separate regulatory authorities for securities and commodity derivative markets.

9erivatives are securities under the SC5! and hence the trading of derivatives is

governed by the regulatory framework under the SC5!. The Securities Contracts

45egulation6 !ct *13= defines ;derivative< as

! security derived from a debt instrument share loan whether secured or

unsecured risk instrument or contract for differences or any other form of security. ! contract which derives its value from the prices or inde% of prices of underlying

securities.

Products, participants and functions

9erivative contracts are of different types. The most common ones are forwards futures

options and swaps. ?articipants who trade in the derivatives market can be classified under

the following three broad categories.

$edgers

Speculators

!rbitragers.

Hedgers:The farmer/s e%ample that we discussed about was a case of hedging. $edgers

face risk associated with the price of an asset. They use the futures or options markets to

reduce or eliminate this risk.

Speculators:Speculators are participants who wish to bet on future movements in the price

of an asset. Futures and options contracts can give them leverage@ that is by putting in

small amounts of money upfront they can take large positions on the market. !s a result of

this leveraged speculative position they increase the potential for large gains as well as

large losses.

Arbitragers:!rbitragers work at making ?rofit by taking advantage of discrepancy

between prices of the same product across different markets. #f for e%ample they see the

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futures price of an asset getting out of line with the cash price they would take offsetting

positions in the two markets to lock in the ?rofit

Derivatives markets

9erivative markets can broadly be classified as commodity derivative market and financial

derivatives markets. !s the name suggest commodity derivatives markets trade contracts

for which the underlying asset is a commodity. #t can be an agricultural commodity like

wheat soybeans rapeseed cotton etc or precious metals like gold silver etc. Financial

derivatives markets trade contracts that have a financial asset or variable as the underlying.

The more popular financial derivatives are those which have e'uity interest rates and

e%change rates as the underlying. The most commonly used derivatives contracts are

forwards futures and options.

Spot versus forward transaction

(sing the e%ample of a forward contract let us try to understand the difference between a

spot and derivatives contract. >very transaction has three components trading clearing and

settlement. ! buyer and seller come together negotiate and arrive at a price. This is

trading. Clearing involves finding out the net outstanding that is e%actly how much of

goods and money the two should e%change. For instance ! buys goods worth 5s.* from

and sells goods worth 5s.3 to . &n a net basis ! has to pay 5s.3 to . Settlement is

the actual process of e%changing money and goods.

#n a spot transaction the trading clearing and settlement happens instantaneously i.e. .on

the spot. Consider this e%ample. &n *st "anuary 2, !ditya wants to buy some gold. The

goldsmith 'uotes 5s.= per * grams. They agree upon this price and !ditya buys 2

grams of gold. $e pays 5s.*2 takes the gold and leaves. This is a spot transaction.

Aow suppose !ditya does not want to buy the gold on the *st "anuary but wants to buy it a

month later. The goldsmith 'uotes 5s.= *3 per * grams. They agree upon the forward

price for 2 grams of gold that !ditya wants to buy and !ditya leaves. ! month later he

pays the goldsmith 5s.*2 B and collects his gold. This is a forward contract a contract

by which two parties irrevocably agree to settle a trade at a future date for a stated priceand 'uantity. Ao money changes hands when the contract is signed. The e%change of

money and the underlying goods only happens at the future date as specified in the

contract. #n a forward contract the process of trading clearing and settlement does not

happen instantaneously.

The trading happens today but the clearing and settlement happens at the end of the

specified period. ! forward is the most basic derivative contract. )e call it a derivative

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because it derives value from the price of the asset underlying the contract in this case

gold. #f on the *st of February gold trades for 5s.=3 in the spot market the contract

becomes more valuable to !ditya because it now enables him to buy gold at 5s.=*3. #f

however the price of gold drops down to 5s.3 11 he is worse off because as per the

terms of the contract he is bound to pay 5s.= *3 for the same gold. The contract has now

lost value from !ditya/s point of view. Aote that the value of the forward contract to the

goldsmith varies e%actly in an opposite manner to its value for !ditya.

Exchange traded versus !" derivatives

9erivatives have probably been around for as long as people have been trading with one

another. Forward contracting dates back at least to the *2th century and may well have

been around before then. These contracts were typically &TC kind of contracts. &ver the

counter 4&TC6 derivatives are privately negotiated contracts. Merchants entered into

contracts with one another for future delivery of specified amount of commodities atspecified price. ! primary motivation for pre - arranging a buyer or seller for a stock of

commodities in early forward contracts was to lessen the possibility that large swings

would inhibit marketing the commodity after a harvest. ater many of these contracts were

standardi0ed in terms of 'uantity and delivery dates and began to trade on an e%change.

The &TC derivatives markets have the following features compared to e%change-traded

derivatives:

The management of counter-party 4credit6 risk is decentrali0ed and located within

individual institutions.

There are no formal centrali0ed limits on individual positions leverage or

margining.

There are no formal rules for risk and burden-Sharing.

There are no formal rules or mechanisms for ensuring market stability and

integrity and for safeguarding the collective interests of market participants.

The &TC contracts are generally not regulated by a regulatory authority and the

e%change/s self-regulatory organi0ation although they are affected indirectly by

national legal systems banking supervision and market surveillance.

The &TC derivatives markets have witnessed rather sharp growth over the last few years

which have accompanied the moderni0ation of commercial and investment banking and

globali0ation of financial activities. The recent developments in information technology

have contributed to a great e%tent to these developments. )hile both e%change-traded and

&TC derivative contracts offer many benefits the former have rigid structures compared to

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the latter. The largest &TC derivative market is the interbank foreign e%change market.

Commodity derivatives the world over are typically e%change-traded and not &TC in

nature.

Some commonly used derivatives

$ere we define some of the more popularly used derivative contracts. Some of these

namely futures and options will be discussed in more details at a later stage.

#orwards: !s we discussed a forward contract is an agreement between two entities to

buy or sell the underlying asset at a future date at today/s pre-agreed price.

#utures: ! futures contract is an agreement between two parties to buy or sell the

underlying asset at a future date at today/s future price. Futures contracts differ from

forward contracts in the sense that they are standardi0ed and e%change traded.

ptions: There are two types of options - calls and puts. Calls give the buyer the right but

not the obligation to buy a given 'uantity of the underlying asset at a given price on or

before a given future date. ?uts give the buyer the right but not the obligation to sell a

given 'uantity of the underlying asset at a given price on or before a given date.

$arrants: &ptions generally have lives of upto one year the ma8ority of options traded on

options e%changes having a ma%imum maturity of nine months. onger-dated options are

called warrants and are generally traded over-the-counter.

%askets: asket options are options on portfolios of underlying assets. The underlying

asset is usually a weighted average of a basket of assets. >'uity inde% options are a form of

basket options.

Swaps: Swaps are private agreements between two parties to e%change cash Dows in the

future according to a prearranged formula. They can be regarded as portfolios of forward

contracts. The two commonly used swaps are :

Interest rate swaps: These entail swapping only the interest related cash flowsbetween the parties in the same currency.

Currency swaps: These entail swapping both principal and interest between the

parties with the cash flows in one direction being in a different currency than those

in the opposite direction.

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Swaptions: Swaptions are options to buy or sell a swap that will become operative at the

e%piry of the options. Thus a swaption is an option on a forward swap.

Instruments available for trading

#n recent years derivatives have become increasingly popular due to their applications for

hedging speculation and arbitrage. efore we study about the applications of commodity

derivatives we will have a look at some basic derivative products. )hile futures and

options are now actively traded on many e%changes forward contracts are popular on the

&TC market.

#orward contracts

! forward contract is an agreement to buy or sell an asset on a specified date for a

specified price. &ne of the parties to the contract assumes a long position and agrees to buy

the underlying asset on a certain specified future date for a certain specified price. Theother party assumes a short position and agrees to sell the asset on the same date for the

same price. &ther contract details like delivery date price and 'uantity are negotiated

bilaterally by the parties to the contract. The forward contracts are normally traded outside

the e%changes.

The salient features of forward contracts are:

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They are bilateral contracts and hence e%posed to counter party risk. >ach contract

is custom designed and hence is uni'ue in terms of contract si0e e%piration date

and

The asset type and 'uality.

The contract price is generally not available in public domain.

&n the e%piration date the contract has to be settled by delivery of the asset.

#f the party wishes to reverse the contract it has to compulsorily go to the same

counterparty which often results in high prices being charged.

$owever forward contracts in certain markets have become much standardi0ed as in the

case of foreign e%change thereby reducing transaction costs and increasing transactions

volume. This process of standardi0ation reaches its limit in the organi0ed futures market.

Forward contracts are very useful in hedging and speculation. The classic hedging

application would be that of an e%porter who e%pects to receive payment in dollars threemonths later. $e is e%posed to the risk of e%change rate fluctuations. y using the currency

forward market to sell dollars forward he can lock on to a rate today and reduce his

uncertainty. Similarly an importer who is re'uired to make a payment in dollars two

months hence can reduce his e%posure to e%change rate fluctuations by buying dollars

forward.

#f a speculator has information or analysis which forecasts an upturn in a price then he

can go long on the forward market instead of the cash market. The speculator would go

long on the forward wait for the price to rise and then take a reversing transaction to book

profits.

Speculators may well be re'uired to deposit a margin upfront. $owever this is generally a

relatively small proportion of the value of the assets underlying the forward contract. The

use of forward markets here supplies leverage to the speculator.

&imitations of forward markets

Forward markets world-wide are affected by several problems:

ack of centrali0ation of trading

#lli'uidity and

Counterparty risk

#n the first two of these the basic problem is that of too much fle%ibility and generality.

The forward market is like a real estate market in that any two consenting adults can form

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contracts against each other. This often makes them design terms of the deal which are

very convenient in that specific situation but makes the contracts non-tradeable.

Counterparty risk arises from the possibility of default by any one party to the transaction.

)hen one of the two sides to the transaction declares bankruptcy the other suffers. >ven

when forward markets trade standardi0ed contracts and hence avoid the problem of

illi'uidity still the counterparty risk remains a very serious issue.

Introduction to futures

Futures markets were designed to solve the problems that e%ist in forward markets. !

futures contract is an agreement between two parties to buy or sell an asset at a certain time

in the future at a certain price. ut unlike forward contracts the futures contracts are

standardi0ed and e%change traded. To facilitate li'uidity in the futures contracts the

e%change specifies certain standard features of the contract. #t is a standardi0ed contractwith standard underlying instrument a standard 'uantity and 'uality of the underlying

instrument that can be delivered

4or which can be used for reference purposes in settlement6 and a standard timing of such

settlement. ! futures contract may be offset prior to maturity by entering into an e'ual and

opposite transaction. More than 11E of futures transactions are offset this way.

The standardi0ed items in a futures contract are:

uantity of the underlying

uality of the underlying

The date and the month of delivery

The units of price 'uotation and minimum price change

ocation of settlement

Distinction between futures and forwards contracts

Fundamentally forward and futures contracts have the same function: both types

of contracts allow people to buy or sell a specific type of asset at a specific time at a givenprice.

$owever it is in the specific details that these contracts differ. First of all futures contracts

are e%change-traded and therefore are standardi0ed contracts. Forward contractson the

other hand are private agreements between two parties and are not as rigid in their stated

terms and conditions. ecause forward contracts are private agreements there is always a

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chance that a party may defaulton its side of the agreement. Futures contracts

have clearing housesthat guarantee the transactions which drastically lowers the

probability of default to almost never.

Secondly the specific details concerning settlement and deliveryare 'uite distinct.

For forward contracts settlement of the contract occurs at the end of the contract. Futures

contracts are marked-to-marketdaily which means that daily changes are settled day by

day until the end of the contract. Furthermore settlement for futures contracts can occur

over a range of dates. Forward contracts on the other hand only possess one settlement

date.

astly because futures contracts are 'uite fre'uently employed speculators who bet

on the direction in which an asset/s price will move they are usually closed out prior to

maturity and delivery usually never happens. &n the other hand forward contracts

are mostly used by hedgers that want to eliminate the volatilityof an asset/s priceand delivery of the asset or cash settlementwill usually take place.

#utures terminology

Spot price:The price at which an asset trades in the spot market.

Futures price:The price at which the futures contract trades in the futures market.

Contract cycle:The period over which a contract trades. The commodity futures

contracts on the AC9>G have one-month two-months and three-month e%piry cycles

which e%pire on the 2thday of the delivery month. Thus a "anuary e%piration contract

e%pires on the 2th of "anuary and a February e%piration contract ceases trading on the

2th of February. &n the ne%t trading day following the 2th a new contract having a

three-month e%piry is introduced for trading.

Expiry date:#t is the date specified in the futures contract. This is the last day on which the

contract will be traded at the end of which it will cease to e%ist.

elivery unit:The amount of asset that has to be delivered under one contract. For

instance the delivery unit for futures on ong Staple Cotton on the AC9>G is 33 bales.

The delivery unit for the Hold futures contract is * kg.

!asis:asis can be defined as the futures price minus the spot price. There will be a

different basis for each delivery month for each contract. #n a normal market basis will bepositive. This reflects that futures prices normally e%ceed spot prices.

Cost of carry:The relationship between futures prices and spot prices can be summari0ed

in terms of what is known as the cost of carry. This measures the storage cost plus the

interest that is paid to Finance the asset less the income earned on the asset.

"nitial margin: The amount that must be deposited in the margin account at the

time a futures contract is first entered into is known as initial margin.

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Marking#to#market $M%M&: #n the futures market at the end of each trading day the

margin account is ad8usted to reflect the investor/s gain or loss depending upon the futures

closing price.

Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure

that the balance in the margin account never becomes negative. #f the balance in the margin

account falls below the maintenance margin the investor receives a margin call and is

e%pected to top up the margin account to the initial margin level before trading commences

on the ne%t day.

Introduction to options

#n this section we look at another interesting derivative contract namely options. &ptionsare fundamentally different from forward and futures contracts. !n option gives the holder

of the option the right to do something. The holder does not have to e%ercise this right. #n

contrast in a forward or futures contract the two parties have committed themselves to

doing something. )hereas it costs nothing 4e%cept margin re'uirements6 to enter into a

futures contract the purchase of an option re'uires an upfront payment.

ption terminology

Commodity options: Commodity options are options with a commodity as the underlying.

For instance a gold options contract would give the holder the right to buy or sell a

specified 'uantity of gold at the price specified in the contract.

Stock options:Stock options are options on individual stocks. &ptions currently trade on

over 3 stocks in the (nited States. ! contract gives the holder the right to buy or sell

shares at the specified price.

!uyer of an option:The buyer of an option is the one who by paying the option premium

buys the right but not the obligation to e%ercise his option on the seller7 writer.

'riter of an option:The writer of a call7 put option is the one who receives the option

premium and is thereby obliged to sell7 buy the asset if the buyer e%ercises on him.

There are two basic types of options call options and put options.Call option: ! call option gives the holder the right but not the obligation to buy an asset

by a certain date for a certain price.

Put option:! put option gives the holder the right but not the obligation to sell an asset by

a certain date for a certain price.

(ption price:&ption price is the price which the option buyer pays to the option seller. #t

is also referred to as the option premium.

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Expiration date:The date specified in the options contract is known as the e%piration date

the e%ercise date the strike date or the maturity.

Strike price:The price specified in the options contract is known as the strike price or the

e%ercise price.

Different types of ptions

American options: !merican options are options that can be e%ercised at any time upto the

e%piration date. Most e%change-traded options are !merican.

European options:>uropean options are options that can be e%ercised only on thee%piration date itself. >uropean options are easier to analy0e than !merican options and

properties of an !merican option are fre'uently deduced from those of its >uropean

counterpart.

"n#t)e#money option:!n in-the-money 4#TM6 option is an option that would lead to a

positive cash flow to the holder if it were e%ercised immediately. ! call option on the

inde% is said to be in-the-money when strike price 4i.e. spot price I strike price6 #f the

inde% is much higher than the strike price the call is said to be #TM. #n the case of a put

the put is #TM if the inde% is below the strike price.

At#t)e#money option:!n at-the-money 4!TM6 option is an option that would lead to 0ero

cash flow if it were e%ercised immediately. !n option on the inde% is at-the-money when

the current inde% e'uals the strike price 4i.e. spot price J strike price6.

(ut#of#t)e#money option:!n out-of-the-money 4&TM6 option is an option that would

lead to a negative cash flow if it were e%ercised immediately. ! call option on the inde% is

out-of-the-money when the current inde% stands at a level which is less than the strike

price 4i.e. spot price D strike price6. #f the inde% is much lower than the strike price the call

is said to be deep &TM. #n the case of a put the put is &TM if the inde% is above the strike

price.

"ntrinsic value of an option:The option premium can be broken down into two

components K intrinsic value and time value. The intrinsic value of a call is the amount theoption is #TM if it is #TM. #f the call is &TM its intrinsic value is 0ero. ?utting it another

way the intrinsic value of a call is Ma% L 4S t-6N which means the intrinsic value of a call

is the greater of or 4St-6.Similarly the intrinsic value of a put is Ma%L4-S t6Ni.e. the

greater of or 4-St6. is the strike price and St6 O is the spot price.

%ime value of an option:The time value of an option is the difference between its

premium and its intrinsic value. oth calls and puts have time value. !n option that is

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&TM or !TM has only time value. (sually the ma%imum time value e%ists when the

option is !TM. The longer the time to e%piration the greater is an option/s time value all

else e'ual. !t e%piration an option should have no time value.

Indian 'istory in "ommodities

Introduction

#ndia a commodity based economy where two-

third of the one billion population depends on

agricultural commodities surprisingly has an

under developed commodity market. (nlike thephysical market futures markets trades in

commodity are largely used as risk management

4hedging6 mechanism on either physical

commodity itself or open positions in commodity

stock. For instance a 8eweler can hedge his inventory against perceived short-term

downturn in gold prices by going short in the future markets. The article aims at know

how of the commodities market and how the commodities traded on the e%change. The

idea is to understand the importance of commodity derivatives and learn about the market

from #ndian point of view. #n fact it was one of the most vibrant markets till early Ps. #ts

development and growth was shunted due to numerous restrictions earlier. Aow with most

of these restrictions being removed there is tremendous potential for growth of this market

in the country.

"ommodity

Commodities actually offer immense potential to become a separate asset class for market-

savvy investors arbitrageurs and speculators. 5etail investors who claim to understand the

e'uity markets may find commodities an unfathomable market. ut commodities are easy

to understand as far as fundamentals of demand and supply are concerned. 5etail investors

should understand the risks and advantages of trading in commodities futures before taking

a leap. $istorically pricing in commodities futures has been less volatile compared with

e'uity and bonds thus providing an efficient portfolio diversification option.

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#n fact the si0e of the commodities markets in #ndia is also 'uite significant. &f the

country/s H9? of 5s *B 2PB crore 45s *B2P.B billion6 commodities related 4and

dependent6 industries constitute about 3+ per cent.

Currently the various commodities across the country clock an annual turnover of 5s *

, crore 45s *, billion6. )ith the introduction of futures trading the si0e of the

commodities market grows many folds here on.

It(s Evolution in India

ombay Cotton Trade !ssociation td. set up in *+P3 was the first organi0ed futures

market. ombay Cotton >%change td. was established in *+1B following the widespread

discontent amongst leading cotton mill owners and merchants over functioning of ombay

Cotton Trade !ssociation. The Futures trading in oilseeds started in *1 with the

establishment of the Hu8arati Qyapari Mandali which carried on futures trading in

groundnut castor seed and cotton. Futures/ trading in wheat was e%istent at several places

in ?un8ab and (ttar ?radesh. ut the most notable futures e%change for wheat was

chamber of commerce at $apur set up in *1*B. Futures trading in bullion began in Mumbai

in *12. Calcutta $essian >%change td. was established in *1*1 for futures trading in raw

8ute and 8ute goods. ut organi0ed futures trading in raw 8ute began only in *12P with the

establishment of >ast #ndian "ute !ssociation td. These two associations amalgamated in

*1,3 to form the >ast #ndia "ute R $essian td. to conduct organi0ed trading in both 5aw

"ute and "ute goods. Forward Contracts 45egulation6 !ct was enacted in *132 and the

Forwards Markets Commission 4FMC6 was established in *13B under the Ministry ofConsumer !ffairs and ?ublic 9istribution. #n due course several other e%changes were

created in the country to trade in diverse commodities.

!he )abra committee report

!fter the introduction of economic reforms since "une *11* and the conse'uent gradual

trade and industry liberali0ation in both the domestic and e%ternal sectors the Hovernment

of #ndia appointed in "une *11B a committee on Forward Markets under chairmanship of

?rof. .A. abra. The committee was setup with the following ob8ectives:

To assess

The working of the commodity e%changes and their trading practices in #ndia

and to make suitable recommendations with a view to making them compatible

with those of other countries

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16/73

Anil Suvarna

Commodity Market

The role of the Forward Markets Commission and to make suitable

recommendations with a view to making it compatible with similar regulatory

agencies in other countries so as to see how effectively these agencies can cope

up with the reality of the fast changing economic scenario.

To review the role that forward trading has played in the #ndian commodity

markets during the last * years.

To e%amine the e%tent to which forward trading has special role to play in

promoting e%ports.

To suggest amendments to the Forward Contracts 45egulation6 !ct in the light of

the 5ecommendations particularly with a view to effective enforcement of the !ct

to check illegal forward trading when such trading is prohibited under the !ct.

To suggest measures to ensure that forward trading in the commodities in which it

is allowed to be operative remains constructive and helps in maintaining priceswithin reasonable limits.

To assess the role that forward trading can play in marketing7 distribution system in

the commodities in which forward trading is possible particularly in commodities

in which resumption of forward trading is generally demanded.

The committee submitted its report in September *11,. The recommendations of the

committee were as follows

The Forward Markets Commission 4FMC6 and the Forward Contracts 45egulation6!ct *132 would need to be strengthened.

9ue to the inade'uate infrastructural facilities such as space and telecommunication

facilities the commodities e%changes were not able to function effectively.

>nlisting more members ensuring capital ade'uacy norms and encouraging

computeri0ation would enable these e%changes to place themselves on a better

footing.

#n-built devices in commodity e%changes such as the vigilance committee and the

panels of surveyors and arbitrators be strengthened further.

The FMC which regulates forward7 futures trading in the country should continue

to act a watch.dog and continue to monitor the activities and operations of the

commodity e%changes. !mendments to the rules regulations and bye-laws of the

commodity e%changes should re'uire the approval of the FMC only.

#n the conte%t of globali0ation commodity markets in #ndia could not function

effectively in an isolated manner. Therefore some of the commodity e%changes

16


17/73

Anil Suvarna

Commodity Market

particularly the ones dealing in pepper and castor seed be upgraded to the level of

international futures markets.

The ma8ority of the committee recommended that futures trading be introduced in the

following commodities:

The liberali0ed policy being followed by the government of #ndia and the gradual

withdrawal of the procurement and distribution channel necessitated setting in place a

market mechanism to perform the economic functions of price discovery and risk

management.

The national agriculture policy announced in "uly 2 and the announcements in the

budget speech for 22-2B were indicative of the governments resolve to put in place a

mechanism of futures trade7market. !s a follow up the government issued notifications on

*7,72B permitting futures trading in the commodities with the issue of these

notifications futures trading is not prohibited in any commodity. !n option trading in

commodity is however presently prohibited.

Different types of "ommodities !raded

)orld-over one will find that a market e%its for almost all the commodities known to us.These commodities can be broadly classified into the following:

Pulses: Chana (rad R Tur

Spices: ?epper 8eera Chilli Turmeric R Cardamom

Precious *etals: Hold Silver ?latinum etc

ther *etals: Aickel !luminum Copper etc

+gro%ased "ommodities: )heat Corn Cotton &ils &ilseeds.

Soft "ommodities: Coffee Cocoa Sugar etc

&iveStock: ive Cattle ?ork ellies etc

Energy: Crude &il Aatural Has Hasoline etc

thers: Huar Seed )heat Sugar Mentha &il ?otato apas Soya >tc.

&eading commodity markets of India

17

asmati rice Cotton and kapas inseed

5aw 8ute Hroundnut rapeseed7mustard seed Silver

5ice bran oil Castor oil and its oilcake &nions


18/73

Anil Suvarna

Commodity Market

Conse'uently four commodity e%changes have been approved to commence business in

this regard. They are:

Multi Commodity >%change 4MCG6 located at Mumbai.

Aational Commodity and 9erivatives >%change td 4AC9>G6 located at Mumbai.

Aational Multi Commodity >%change 4AMC>6 located at !hmadabad. Aational oard of Trade 4A&T6 located at #ndore.

*ulti "ommodity Exchange

*ulti "ommodity Exchange 4*"-6 is an independent commodity e%changebased in

#ndia. #t was established in 2B and is based in Mumbai. #t has an average daily turnover

of around (S*.33 billion. MCG offers futures trading in !gricultural Commodities

ullion Ferrous R Aon-ferrous metals ?ulses &ils R &ilseeds >nergy ?lantations

Spices and other soft commodities.

MCG has also setup in 8oint venture the Aational Spot >%change a purely agricultural

commodity e%change and Aational ulk $andling Corporation 4A$C6 which provides

bulk storage and handling of agricultural products.

MCG is an independent and de-mutilated multi commodity e%change. #t was inaugurated

on Aovember * 2B by Mr. Mukesh !mbani Chairman and Managing 9irector

5eliance #ndustries td.@ and has permanent recognition from the Hovernment of #ndia for

facilitating online trading clearing and settlement operations for commodities futures

market across the country. Today MCG features amongst the world/s top three bullion

e%change and top four energy e%change. MCG offers a wide spectrum of opportunities to a

large cross section of participants including producers7 processors traders corporate

regional trading centre importers e%porters co-operatives and industry associations

amongst others. $ead'uartered in the financial capital of #ndia Mumbai MCG is led by an

e%pert management team with deep domain knowledge of the commodities futures market.

?resently the average daily turnover of MCG is around (S9*.33 bn 45s.P crore -

!pril 2=6 with a record peak turnover of (S9B.1+ bn 45s.*P 1+P crore6 on !pril 2

2=. #n the first calendar 'uarter of 2= MCG holds more than 33E market share of the

total trading volume of all the domestic commodity e%changes. The e%change has alsoaffected large deliveries in domestic commodities signifying the efficiency of price

discovery.

eing a nation-wide commodity e%change having state-of-the-art infrastructure offering

multiple commodities for trading with wide reach and penetration MCG is well placed to

tap the vast potential poised by the commodities market.

18
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Anil Suvarna

Commodity Market

+chievement and #eatures

)ith a growing share of P2E MCG continues to be #ndia/s Ao. * commodity

e%change

Hlobally MCG ranks no. * in silver no. 2 in natural gas no. B in crude oil and gold

in futures trading

MCG has * strategic alliances with leading commodity e%change across the globe

The average daily turnover of MCG is about (S 2.+ billion

MCG now reaches out to about 3 cities in #ndia with the help of about *

trading terminals

MCG C&M9>G is #ndia/s first and only composite commodity futures price inde%

ive Trading Since Aovember * 2B

!verage 9aily Turnover K 5s. +2B2 crores 4Single Sided6

$ighest Single 9ay Turnover - 5s.*P1+P.=3 Crores

Crude &il ?eak 9aily Turnover: +1.B ac barrels 45s.23, Cr6

&pen #nterest: Crude oil 4*+ lakh barrels6 Hold 4+ Tons6 Silver 43 tons6

&perations from 3O centers with over *O members R 3O Trading

Terminals 4T)S6 Connectivity through QS!T #nternet leased line etc.

5eal-time price R information dissemination through website and info vendors.

19


20/73

Anil Suvarna

Commodity Market

!urnover in Different "ommodities Segments

20


21/73

Anil Suvarna

Commodity Market

.ational "ommodity and Derivatives Exchange &td

AC9>G is the only commodity e%change in the country promoted by national level

institutions. This uni'ue parentage enables it to offer a bou'uet of benefits which are

currently in short supply in the commodity markets. The institutional promoters and

shareholders of AC9>G are prominent players in their respective fields and bring with

them institutional building e%perience trust nationwide reach technology and risk

management skills.

AC9>G is a public limited company incorporated on !pril 2B 2B under the Companies

!ct *13=. #t obtained its Certificate for Commencement of usiness on May 1 2B. #t

commenced its operations on 9ecember *3 2B.

AC9>G is a nation-level technology driven de-mutualised on-line commodity e%change

with an independent oard of 9irectors and professional management - both not having

any vested interest in commodity markets. #t is committed to provide a world-class

commodity e%change platform for market participants to trade in a wide spectrum of

commodity derivatives driven by best global practices professionalism and transparency.

AC9>G is regulated by Forward Markets Commission. AC9>G is sub8ected to variouslaws of the land like the Forward Contracts 45egulation6 !ct Companies !ct Stamp !ct

Contract !ct and various other legislations. #t is located in Mumbai and offers facilities to

its members about 33 centres throughout #ndia. The reach will gradually be e%panded to

more centers.

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22/73

Anil Suvarna

Commodity Market

!urnover in Different "ommodities Segments

22


23/73

Anil Suvarna

Commodity Market

.ational *ulti "ommodity Exchange /.*"E0

Aational Multi Commodity >%change of #ndia td. 4AMC>6 was promoted by Central

)arehousing Corporation 4C)C6 Aational !gricultural Cooperative Marketing

Federation of #ndia 4A!F>96 Hu8arat !gro-#ndustries Corporation imited 4H!#C6

Hu8arat State !gricultural Marketing oard 4HS!M6 Aational #nstitute of !gricultural

Marketing 4A#!M6 and Aeptune &verseas imited 4A&6. )hile various integral aspects

of commodity economy vi0. warehousing cooperatives private and public sector

marketing of agricultural commodities research and training were ade'uately addressed in

structuring the >%change finance was still a vital missing link. ?un8ab Aational ank

4?A6 took e'uity of the >%change to establish that linkage. >ven today AMC> is theonly >%change in #ndia to have such investment and technical support from the commodity

relevant institutions.

AMC> facilitates electronic derivatives trading through robust and tested trading platform

9erivative Trading Settlement System 49TSS6 provided by CMC. #t has robust delivery

mechanism making it the most suitable for the participants in the physical commodity

markets. #t has also established fair and transparent rule-based procedures and

demonstrated total commitment towards eliminating any conflicts of interest. #t is the only

Commodity >%change in the world to have received #S& 1*:2 certification from

ritish Standard #nstitutions 4S#6. AMC> was the first commodity e%change to provide

trading facility through internet through Qirtual ?rivate Aetwork 4Q?A6.

AMC> follows best international risk management practices. The contracts are marked to

market on daily basis. The system of upfront margining based on Qalue at 5isk is followed

to ensure financial security of the market. #n the event of high volatility in the prices

special intra-day clearing and settlement is held. AMC> was the first to initiate process of

demateriali0ation and electronic transfer of warehoused commodity stocks. The uni'ue

strength of AMC> is its settlements via a 9elivery acked System an imperative in the

commodity trading business. These deliveries are e%ecuted through a sound and reliable)arehouse 5eceipt System leading to guaranteed clearing and settlement.

23


24/73

Anil Suvarna

Commodity Market

*arket Share of .ational Exchange in India

24


25/73

Anil Suvarna

Commodity Market

*a1or "ommodity Exchange

! commodities exchange is an exc)ange where various commodities and derivatives

products are traded. Most commodity marketsacross the world trade in agricultural

products and other ra* materials 4like *)eat barley sugar mai+e cotton cocoa

coffee milkproducts oilmetals etc.6 and contracts based on them. These contracts

can include spot prices for*ards futures and options on futures. &ther

sophisticated products may include interest rates environmental instrumentss*aps

or ocean freight contracts.

#n today/s world of speciali0ation we see that domestic and international commodity

e%changes have also grabbed on to the concept of focusing in on an area of e%pertise. The

most robust commodity e%changes in the world today and their specialty commodities

include:

.ew 2ork %oard of !rade /.2%!0 - which includes coffee cocoa cotton

orange 8uice and sugar.

.ew 2ork *ercantile Exchange /.2*E-0 - which speciali0es in energy

products such as crude and heating oil gasoline natural gas coal propane as well

as metal such as gold silver platinum copper aluminum and palladium.

"hicago %oard of !rade /"%!0 - which speciali0es in bonds and more

traditional commodities such as corn 7 mai0e oats rough rice soybeans soybean

meal soybean oil and wheat.

25
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Commodity Market

"hicago *ercantile Exchange /"*E0- which speciali0es in bond futures and

more traditional commodities such as live and feeder cattle lumber beef boneless

beef trimmings lean hogs fro0en pork bellies fresh pork bellies milk and butter.

&ondon *etal Exchange /&*E0- which speciali0es in the trading of metals such

as copper lead 0inc aluminum tin and nickel.

&ondon "ommodity Exchange 3 Euro next - which speciali0es in the trading of

commodities such as grains and meat.

I"E #utures - the #nternational ?etroleum >%change speciali0es in commodities

such as crude and heating oil natural gas and unleaded gasoline

Shanghai *etal Exchange /S'*E0 - one of the national level futures e%changesof China was established on 2+ May*112. S$M> is a non-profit self-regulating

corporation. The e%change was created for trading in non-ferrous metals and

currently contracts for several non-ferrous metals including copper aluminum

lead0inctin and nickel.

)ansas %oard of !rade - ansas oard of Trade in (S speciali0es in hard red

winter wheat. $ard winter wheat constitutes the ma%imum of (S production. This

e%change is benchmark for bread wheat prices.

!okyo "ommodity Exchange /!"*0 - Tokyo Commodity >%change

4T&C&M6 is the largest e%change in "apan and second largest commodity

e%change in the world for futures and options. Crude oil gasoline kerosene gas

oil gold silver aluminium platinum and rubber are the commodities that are

actively traded.

&ondon International #inancial #utures and ptions Exchange /&I##E0

ondon #nternational Financial Futures and &ptions >%change 4#FF>6 also know

as >uro ne%t. !mong actively commodities trades are cocoa robusta coffee corn

potato rapeseed sugar and wheat. 5obusta coffee prices are determined throughthis e%change.

Dalian "ommodity Exchange - 9alian Commodity >%change in China trades in

corn and soybean. The e%change is planning to introduce futures and options in

crude oil power steel and plastic.

26
http://www.cme.com/http://www.lme.co.uk/http://www.euronext.com/https://www.theice.com/homepage.jhtmlhttp://en.wikipedia.org/wiki/Shanghai_Metal_Exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Chinahttp://en.wikipedia.org/wiki/May_28http://en.wikipedia.org/wiki/1992http://en.wikipedia.org/wiki/Metalhttp://en.wikipedia.org/wiki/Copperhttp://en.wikipedia.org/wiki/Aluminumhttp://en.wikipedia.org/wiki/Leadhttp://en.wikipedia.org/wiki/Zinchttp://en.wikipedia.org/wiki/Tinhttp://en.wikipedia.org/wiki/Nickelhttp://www.cme.com/http://www.lme.co.uk/http://www.euronext.com/https://www.theice.com/homepage.jhtmlhttp://en.wikipedia.org/wiki/Shanghai_Metal_Exchangehttp://en.wikipedia.org/wiki/Futures_exchangehttp://en.wikipedia.org/wiki/Chinahttp://en.wikipedia.org/wiki/May_28http://en.wikipedia.org/wiki/1992http://en.wikipedia.org/wiki/Metalhttp://en.wikipedia.org/wiki/Copperhttp://en.wikipedia.org/wiki/Aluminumhttp://en.wikipedia.org/wiki/Leadhttp://en.wikipedia.org/wiki/Zinchttp://en.wikipedia.org/wiki/Tinhttp://en.wikipedia.org/wiki/Nickel


27/73

Anil Suvarna

Commodity Market

"hicago %oard of !rade /"%!0

This commodity e%change was established in *+,+. #t trades in financial and agricultural

contracts. &riginally this e%change only traded agricultural commodities such as corn

soybeans and wheat. Aow it offers futures and options contracts on a variety of products

including Silver Hold >nergy and (.S. Treasury bonds. More than 3 different options

and futures contractsare traded by over B= C&T members through open outcryand e-

Trading.Qolumes at the e%change in 2Bwere a record breaking ,3, million contracts.

&n*2 "uly2P the C&T merged with the CM>and ceased to e%ist as an independent

entity.

History

4567,

C&T listed the first ever standardi0ed e%change traded forward contracts which were

called futures contracts. #n *1*1 the Chicago utter and >gg oard a spin-off of the

C&T was reorgani0ed to enable member traders to allow future trading and its name

was changed to Chicago Mercantile >%change4CM>6.

4868,

C&T begins trade in first non-grain product with a Silver futures contract and C&T

started trade in B kilo gold future in *1P,.

489,

Members of the C&T start Chicago oard &ptions >%change 4C&>6 the world/s first

stock options e%change.

489;,

C&T launches first interest rate futures contract Hovernment Aational Mortgage

!ssociation futures@ sets stage for a huge increase in trading volume a new era of growth

and trading instruments for futures e%changes around the world.

4887,

C&T launches ?ro8ect ! its after-hours electronic trading system for futures and futures-

options.

4889,

C&T launches the C&T 9ow "ones #ndustrial !verage #nde%U

futures and options onfutures contracts. C&T opens the world/s largest trading floor = s'. ft. for financial

futures and futures-options on February *+ *11P.

merged to form the CM> Hroup.

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28/73

Anil Suvarna

Commodity Market

!rading Products

Today the C&T supports the trading of four product types - agricultural metals interest

rates and the 9ow.

+gricultural "ommodities!gricultural commodities include items such as corn soybeans 4meal and oil6 ethanol

oats wheat and rice. Trading in these products is standardi0ed as to 'uantities and product

condition. For e%ample agricultural products are traded in a raw 7 unprocessed state.

*etal "ommodities

The most common metal commodities are gold and silver - the price of which is stated in

dollars per ounce. The most familiar trading 'uantities on the C&T include:

* ounce Hold Futures

Mini-si0ed Hold - BB.2 fine troy ounces of gold

3 ounce Silver Futures

Mini-si0ed Silver - * troy ounces of silver

Dow #utures

9ow futures include the 9ow "ones !#H Commodity inde% the 9ow "ones #ndustrial

!verage Futures and the mini-si0ed 9ow. The strategy of trading in 9ow futures is also

called trading the markets. )ith 9ow futures you are attempting to predict the future

direction of the stock market and the 9ow in particular.

Interest >ates

Finally the last product type offered by the C&T falls into the category of interest rates.

The most common of the interest rate trades includes treasury bonds fed funds and

municipal bonds. )hen trading in the interest rate market you are attempting to capitali0e

on the long and short term changes in the yield curve. Said another way you/re taking a

financial position that interest rates are going to rise or fall in the future.

ther "ommodities

There are many other commodities that can be traded from tin to coffee beans or stock

inde%es to pork bellies.

"hicago *ercantile Exchange4!he *erc6

Chicago Mercantile >%change is an !merican financial e%changebased in Chicago. The

CM> was founded in *+1+ as the Chicago utter and >gg oard. &riginally the e%change

was a not-for-profit organi0ation. The e%change demutuali0ed in Aovember 2 went

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Anil Suvarna

Commodity Market

public in 9ecember 22and merged with the Chicago oard of Tradein "uly 2P. The

Chief >%ecutive &fficer of the Merc is Craig S. 9onohue.

!nother one of the ma8or e%changes is in Chicago as well. This one popularly known as

CM> has been in business for over a hundred years. The main commodities traded here

are live and feeder cattle hogs pork bellies lumber milk butter and fertili0er. Aow it

serves as a marketplace for stock inde% interest rate foreign e%change and single-stock

futures. &ne of the fairly uni'ue instruments being traded is the weather and real estate

derivatives. These future contracts speculate on weather anywhere in the world at

different times of the year.

&n &ctober *P 2= the Chicago Mercantile >%change announced the purchase of the

Chicago oard of Tradefor + billion in stock re8oining the two financial institutions as

CM> Hroup #nc. C&T currently uses outsourced technology platforms but will move to

CM>/s Hlobe% trading system. This will provide much of the merger/s anticipated savings.

The merger will also strengthen the combined group/s position in the global derivatives

market

!rading *ethods

Trading is conducted in two methods@ an open outcry format and the CM> Hlobe%U

electronic trading platform. !ppro%imately P percent of total volume at the e%change

occurs on CM> Hlobe%.

pen utcry

"*E ?lobex

.ew 2ork *ercantile Exchange /.2*E-0

The Aew Vork Mercantile >%change 4AVM>G6 is the world/s largest physical commodity

e%change and oldest e%changes located in Aew Vork City. #t speciali0es in petroleum and

metal products. #ts two principal divisions are the Aew Vork Mercantile >%change and the

Aew Vork Commodities >%change 4C&M>G6 which were once independent companies

but are now merged.The Aew Vork Mercantile >%change is now traded publicly as its

parent company@ AVM>G $oldings became listed on the Aew Vork Stock >%changeonAovember *P 2= under the ticker symbol AMG.

The Aew Vork Mercantile >%change handles billions of dollars worth of energy products

metals and other commodities being bought and sold on the trading floor and the

overnight electronic trading computer systems. The prices 'uoted for transactions on the

e%change are the basis for prices that people pay for throughout the world.

29
http://en.wikipedia.org/wiki/Initial_public_offeringhttp://en.wikipedia.org/wiki/2002http://en.wikipedia.org/wiki/Chicago_Board_of_Tradehttp://en.wikipedia.org/w/index.php?title=Craig_S._Donohue&action=edithttp://en.wikipedia.org/wiki/October_17http://en.wikipedia.org/wiki/October_17http://en.wikipedia.org/wiki/2006http://en.wikipedia.org/wiki/Chicago_Board_of_Tradehttp://en.wikipedia.org/wiki/Open_outcryhttp://en.wikipedia.org/wiki/Worldhttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/New_York_Cityhttp://en.wikipedia.org/wiki/Companieshttp://en.wikipedia.org/wiki/Mergedhttp://en.wikipedia.org/wiki/New_York_Stock_Exchangehttp://en.wikipedia.org/wiki/November_17http://en.wikipedia.org/wiki/2006http://en.wikipedia.org/wiki/Energyhttp://en.wikipedia.org/wiki/Metalshttp://en.wikipedia.org/wiki/Buyhttp://en.wikipedia.org/wiki/Sellhttp://en.wikipedia.org/wiki/Tradehttp://en.wikipedia.org/wiki/Computerhttp://en.wikipedia.org/wiki/Financial_transactionhttp://en.wikipedia.org/wiki/Worldhttp://en.wikipedia.org/wiki/Initial_public_offeringhttp://en.wikipedia.org/wiki/2002http://en.wikipedia.org/wiki/Chicago_Board_of_Tradehttp://en.wikipedia.org/w/index.php?title=Craig_S._Donohue&action=edithttp://en.wikipedia.org/wiki/October_17http://en.wikipedia.org/wiki/2006http://en.wikipedia.org/wiki/Chicago_Board_of_Tradehttp://en.wikipedia.org/wiki/Open_outcryhttp://en.wikipedia.org/wiki/Worldhttp://en.wikipedia.org/wiki/Commodityhttp://en.wikipedia.org/wiki/New_York_Cityhttp://en.wikipedia.org/wiki/Companieshttp://en.wikipedia.org/wiki/Mergedhttp://en.wikipedia.org/wiki/New_York_Stock_Exchangehttp://en.wikipedia.org/wiki/November_17http://en.wikipedia.org/wiki/2006http://en.wikipedia.org/wiki/Energyhttp://en.wikipedia.org/wiki/Metalshttp://en.wikipedia.org/wiki/Buyhttp://en.wikipedia.org/wiki/Sellhttp://en.wikipedia.org/wiki/Tradehttp://en.wikipedia.org/wiki/Computerhttp://en.wikipedia.org/wiki/Financial_transactionhttp://en.wikipedia.org/wiki/World


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Commodity Market

>stablished for over *B years and located in the heart of The City of ondon the ondon

Metal >%change is the worldWs premier non-ferrous metals market. The ondon Metal

>%change or M> is the futures e%changewith the world/s largest market in optionsand

futures contractson baseand other metals. !s the M> offers contracts with daily e%piry

dates up to three months from trade date along with longer dated contracts it also allows

for cash trading. #t offers hedging worldwide reference pricing and storage for physical

delivery of trades. The M> is a highly li'uid market and in 2= achieved volumes of +P

million lots e'uivalent to +* billion annually and between B3-,3 billion on an

average business day. 9espite its ondon location the M> is a global market with an

international membership and with more than 13E of its business coming from overseas.

'istory

The ondon Metal Market and >%change Company were founded in *+PPbut the market

traces its origins back to *3P* during the reign of ueen >li0abeth period and the opening

of the 5oyal >%change. !t first only copperwas traded leadand 0incwere soon added butonly gained official trading status in *12. The e%change was closed over )) ##and did

not re-open until *132. &ther metals traded e%tended to include aluminum4*1P+6 nickel

4*1P16 and aluminum alloy 4*1126. ase metals are traded through the M> since 2. #n

23 the >%change launched the worldWs first futures contracts for plastics@ for

polypropylene and linear low density polyethylene with the introduction of regional

plastics contracts in 2P. #n addition it offers M> minis which are smaller-si0ed

contracts for copper aluminum and 0inc plus an inde% contract 4M>G6.

The >%change is forward looking and is in the process of implementing its ;2 by 2 developing two streams of organic growth from non-ferrous into ferrous metals and from Futures into &TC trading. #t is designed to double

trading volumes at the M> within the ne%t three to five years.

*ember of the Exchange

!malgamated Metal TradinH MF Hlobal Metdist Trading

Aati%is Commodity Markets SociXtX HXnXrale Sucden 4(6 imited

Calyon Financial SAC Triland Metals Sempra Metals

M!5>G Financial imited arclays Capital

$orld "ommodities Exchanges Aolumes


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Commodity Market

Source: >%change data

Percentage $ise Aolumes

Source: >%change data

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Commodity Market

>egulation of commodity markets

Structure of "ommodity *arket

33

"ountry Exchange >egulator

B@S@+ Chicago oard of Trade

Chicago Mercantile >%change

Aew Vork oard of Trade

Aew Vork Mercantile >%change

ansas City oard of Trade

CommodityFuture Trading

Commission

India Aational Commodity R 9erivatives

>%change

AationalMulti-Commodity >%change

Forward Markets

Commission

B@) ondon Metal >%change

>urone%t ondon #nternational

Financial Futures >%change

Financial Services !uthority

4*1+=6

"hina 9alian Commodity >%change

Shanghai Futures >%changeChinaSecurities 5egulatory

Commission

Ministry of Consumer

Affairs

FMC

Commodity Exchange
http://en.wikipedia.org/wiki/Commodity_Futures_Trading_Commissionhttp://en.wikipedia.org/wiki/Commodity_Futures_Trading_Commission


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Delivery Process

Pre>eCuisite for Delivery

pen a commodity demat account

9eliveries at >%changes take place in demat form. #t is mandatory to open an 9emat

account with both the depositories i.e. AS9 R C9S.

Sales !ax >egistration

oth seller R buyer should have sales ta% registration at the location of the warehouse. #n

case the client does not have a sales ta% registration he has to appoint a CRF agent for the

same.

;9 Days advance intimation to delivery team@

$arehouse "ost

34

National Exchange Regional Exchange

NCDEX

MCX

NMCE

NBOT ! other RegionalExchange


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The warehouse cost has to be borne by the holder of the commodity till the time he holds

the commodity in the warehouse. )arehousing cost differs from commodity to commodity

as prescribed the warehouses from time to time.

Aalidity Date

#t means the date up to which the commodity is valid for delivery on the e%change

platform. !fter the e%piry of the validity date the commodity should be either withdrawn

from warehouse or further revalidated if final e%piry date is not reached.

*argins

The client has to pay all applicable margins i.e. #nitial 7e%posure 7additional 7tender period

R delivery period margins for his open position marked for delivery from time to time as

per the rates prescribed by the >%changes.

Delivery Process

35

"ettlement of

#remium$

Discounts %

sales Tax

#ay Out of

Commodity$

Funds

Deli&ery

'ntension

Ta(e

#osition

) Days

#rior

) Days

#rior


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Commodity Market

Delivery Process for Seller

36

Exchange of

Buyers %

"ellers

'dentity

#ay*'n of

Commodity$

Funds

Matching By

Exchange

#ay

Deli&ery

Margin) Days

#rior

O+en a

Commodity

Demat A$C ,ith

Designated D-#

Contact the

.arehousefor

A&aila/ility of

"+ace

Assayer ta(es

"am+le and

'ssues a 0uality

Re+ort

'f A++ro&ed /y

Assayer Clienthas to su/mit

Commodity

De+osit form

along ,ith

Assayer

RE#ORT

Client 1et

Demat Credit in

his A$c after the

"tandard

Deduction


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Commodity Market

Delivery Process for %uyer

37

Ta(e #hysical

Commodity to

the .arehouse

for Assaying

.arehouse'ssues s Recei+t

against the

De+osit of

Commodity

Ta(e O+en

#osition

Mar( Deli&ery

'ntension

#ay*in$ #ay*

out of funds$

Commodity


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Commodity Market

Daily !ime of Different Exchange

Exchange !iming IS!

Tokyo Commodity >%change 3.B am K *2 pm

Shanghai Metal >%change =.B am - *2.B pm

ondon Metal >%change3:2 ?M - *:B ?M 4)inter6

,:2 ?M - 1:B ?M 4Summer6

C&M>G7AVM>G7C&T=:, ?M - **:B ?M 4)inter6

3:, ?M - *:B ?M 4Summer6

MCG R AC9>G*: !M - 2B:33 ?M 4)inter6

*: !M - 2B:B ?M 4Summer6

$hy choose "ommodities over ECuities

#n developed countries commodity market is 5 timesbigger than e'uity markets.

38

"ales Tax

"ettlement

Re&alidate 'f

2alidity of 's

in has to /e

Extended

Remat if Client

,ant #hysical

Deli&ery or 's in

has Ex+ired
http://en.wikipedia.org/wiki/Shanghai_Metal_Exchangehttp://www.lme.co.uk/http://en.wikipedia.org/wiki/Shanghai_Metal_Exchangehttp://www.lme.co.uk/


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Market has grown from 2 Cr in 2B to *, Cr in 2= per day R e%pected to

be around 23 Cr till 9ec 2P.

ow number of commodities therefore choice is easy.

Ao need to go into e%otic ma0e of financial statements created by corporate world.

Margins are low@ therefore return ratios are favorable on winning deals.

Ao single individual can control on longer terms basis on demand and supply in

commodities.

9oes not involve individual 7 company specific risk.

"ommodity Derivatives and #inancial Derivatives

C(MM("%, E-"A%"ES F"/A/C"A0 E-"A%"ES

Commodity 9erivatives are settled by actual

deliveries

Financial 9erivatives are only cash settled

today

uantity and 'uality differences e%ist Ao such differences e%ist

$olding cost includes assaying warehousing

R insurance costs

$olding costs normally consists of only

interest costs.

?hysical markets are seasonal in nature Cash markets are active throughout the year.

Factors #mpacting :

9emand R Supply

#mport->%port 5egulations

Hovernment #ntervention

Factors #mpacting :

Hlobal R ocal >conomic Condition ?erformance of the entity

Ta%ation Structure

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"omparative returns from Aarious +sset "lasses

Commodity

$'ndices 3nits Fe/!4

Months ago 5Months ago 6Months ago 7ear ago

#rice 8 #rice 8 #rice 8 #rice 8

MCX Energy - 96 !:; )-< 56! *6-9 496 *9

#e++er Rs$9!!(gs 96< 94:) *;-9 999!) 9!-) 99)

>eera Rs$(gs 9!;


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Pricing commodity futures

!he cost of carry model

)e use arbitrage arguments to arrive at the fair value of futures. For pricing purposes we

treat the forward and the futures market as one and the same. A futures contract is nothing

but aforward contract that is exchange traded and that is settled at the end of each day .

The buyer who needs an asset in the future has the choice between buying the underlying

asset today in the spot market and holding it or buying it in the forward market. #f he buysit in the spot market today it involves opportunity costs. $e incurs the cash outlay for

buying the asset and he also incurs costs for storing it. #f instead he buys the asset in the

forward market he does not incur an initial outlay. $owever the costs of holding the asset

are now incurred by the seller of the forward contract who charges the buyer a price that is

higher than the price of the asset in the spot market. This forms the basis for the cost-of-

carry model where the price of the futures contract is defined as:

FJS-C 4*6

)here:

F -Futures price

S -Spot price

C -$olding costs or carry costs

The fair value of a futures contract can also be e%pressed as:

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FJ S 4*Or6r 426

)here:

r ?ercent cost of financing

T Time till e%piration

)henever the futures price moves away from the fair value there would be opportunities

for arbitrage. #f FIS 4*Or6r or FYS 4*Or6r arbitrage would e%ist. )e know what are the spot

and futures prices but what are the components of holding costsZ The components of

holding cost vary with contracts on different assets. !t times the holding cost may even be

negative. #n the case of commodity futures the holding cost is the cost of financing plus

cost of storage and insurance purchased. #n the case of e'uity futures the holding cost is

the cost of financing minus the dividends returns.

>'uation 426 uses the concept of discrete compounding where interest rates are

compounded at discrete intervals for e%ample annually or semiannually. ?ricing ofoptions and other comple% derivative securities re'uires the use of continuously

compounded interest rates. Most books on derivatives use continuous compounding for

pricing futures too. )hen we use continuous compounding e'uation 426 is e%pressed as:

F- SerT 4B6

)here:

r Cost of financing 4using continuously compounded interest rate6


e 2.P*+2+

So far we were talking about pricing futures in general. To understand the pricing of

commodity futures let us start with the simplest derivative contract . a forward contract.

)e use e%amples of forward contracts to e%plain pricing concepts because forward

contracts are easier to understand. $owever the logic for pricing a futures contract is

e%actly the same as the logic for pricing a forward contract. )e begin with a forward

contract on an asset that provides the holder with no income and has no storage or other

costs. Then we introduce real world factors as they apply to investment commodities and

later to consumption commodities.

Consider a three-month forward contract on a stock that does not pay dividend. !ssume

that the price of the underlying stock is 5s., and the three-month interest rate is 3E per

annum. )e consider the strategies open to an arbitrager in two e%treme situations.

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Suppose that the forward price is relatively high at 5s.,B. !n arbitrager can borrow 5s.,

from the market at an interest rate of 3E per annum buy one share in the spot market and

sell the stock in the forward market at 5s.,B. !t the end of three months the arbitrager

delivers the share and receives 5s.,B. The sum of money re'uired to pay off the loan is ,e.3[.23 -,.3. y following this strategy the arbitrager locks in a profit of 5s.,B. -

5s.,.3 J 5s.2.3 at the end of the three month period.

Suppose that the forward price is relatively low at 5s.B1. !n arbitrager can short one share

for 5s.,@ invest the proceeds of the short sale at 3E per annum for three months and take

a long position in a three-month forward contract. The proceeds of the short sale grow to

,e .3[.23J ,.3 in three months. !t the end of the three months the arbitrager pays

5s.B1 takes delivery of the share under the terms of the forward contract and uses it to

close his short position in the process making a net gain of 5s.*.3 at the end of three

months.

Pricing futures contracts on investment commodities

#n the e%ample above we saw how a futures contract on gold could be priced using

arbitrage arguments and the cost-of-carry model. #n the e%ample we considered the gold

contract was for * grams of gold. $ence we ignored the storage costs. $owever if the

one-month contract was for a * kgs of gold instead of * Hms then it would involve

non-0ero holding costs which would include storage and insurance costs. The price of the

futures contract would then be 5s.P+=.+ plus the holding costs. Table 4*6 gives the

indicative warehouse charges for accredited warehouses7 vaults that will function as

delivery centres for contracts )arehouse charges include a fi%ed charge per deposit of

commodity into the warehouse and a per unit per week charge. The per unit charges

include storage costs and insurance charges.

)e saw that in the absence of storage costs the futures price of a commodity that is an

investment asset is given by FJSerT.Storage costs add to the cost of carry. #f is the

present value of all the storage costs that will be incurred during the life of a futures

contract it follows that the futures price will be e'ual to

FJ 4SO(6 erT 4,6

)here:

r Cost of financing 4annuali0ed6


( ?resent value of all storage costs

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For ease of understanding let us consider a one-year futures contract on gold. Suppose the

fi%ed charge is 5s.B* per deposit upto 3 kgs. and the variable storage costs are 5s.33

per week it costs 5s.B*P to store one kg of gold for a year432 weeks6. !ssume that the

payment is made at the beginning of the year. !ssume further that the spot gold price is

5s.= per * grams and the risk-free rate is PE per annum. )hat would the price of one

year gold futures be if the delivery unit is one kgZ

FJ4SO(6 e rT

J 4=OB*O2+=6 e .P[*

J =,=1,.P=

"ommodity #ixed "harges $arehouse "harges per unit3week?old 4= ;; per )?

)e see that the one-year futures price of a kg of gold would be 5s.= ,=1,.P=. The one-

year futures price for * grams of gold would be about 5s.=,=1. Aow let us consider a

three-month futures contract on gold. )e make the same assumptions the fi%ed charge is

5s.B* per deposit upto 3 kgs and the variable storage costs are 5s.33 per week. #t costs

5s.*23 to store one kg of gold for three months4*B weeks6. !ssume that the storage costs

are paid at the time of deposit. !ssume further that the spot gold price is 5s.= per *

grams and the risk-free rate is PE per annum. )hat would the price of three month gold

futures if the delivery unit is one kgZ

F J 4SO(6 e rT

J 4=OB*OP*36 e .P[.23

J =**=B3.3

)e see that the three-month futures price of a kg of gold would be 5s.=**=B3.3. The

three-month futures price for * grams of gold would be about 5s.=**=.

?ricing futures contracts on consumption commodities

)e used the arbitrage argument to price futures on investment commodities. For

commodities that are consumption commodities rather than investment assets the arbitrage

arguments used to determine futures prices need to be reviewed carefully. Suppose we

have

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FI4S O (6 e rT 436

To take advantage of this opportunity an arbitrager can implement the following strategy:

orrow an amount SO( at the risk-free interest rate and use it to purchase one unit of the

commodity and pay storage costs.

Short a forward contract on one unit of the commodity.

#f we regard the futures contract as a forward contract this strategy leads to a profit of F -

4S O (6 e rT at the e%piration of the futures contract. !s arbitragers e%ploit this opportunity

the spot price will increase and the futures price will decrease until >'uation 436 does not

hold well.

Suppose ne%t that

F Y 4S O (6 e rT 4=6

#n case of investment assets such as gold and silver many investors hold the commoditypurely for investment. )hen they observe the ine'uality in e'uation 4=6 they will find it

profitable to trade in the following manner:

Sell the commodity save the storage costs and invest the proceeds at the risk-free

interest rate.

Take a long position in a forward contract.

This would result in a profit at maturity of (S + U e r!" # relative to the position that the

investors would have been in had they held the underlying commodity. !s arbitragers

e%ploit this opportunity the spot price will decrease and the futures price will increase

until e'uation 4=6 does not hold well. This means that for investment assets e'uation 4,6

holds good. $owever for commodities like cotton or wheat that are held for consumption

purpose this argument cannot be used. #ndividuals and companies who keep such a

commodity in inventory do so because of its consumption value not because of its value

as an investment. They are reluctant to sell these commodities and buy forward or futures

contracts because these contracts cannot be consumed. Therefore there is unlikely to be

arbitrage when e'uation 4=6 holds good. #n short for a consumption commodity therefore

F YJ 4S O (6 e rT 4P6

That is the futures price is less than or e'ual to the spot price plus the cost of carry.

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Commodity Market

"ommodities *arkets verall Perspective

%ackground

Commodities e%changes in #ndia were established in 2B with MCG commencing

operations in Aov 2B and AC9>G in 9ec 2B. The national-level online

commodity e%changes were established primarily for the purpose of 4*6 >fficient

?rice 9iscovery 426 ?rice 5isk Management

#nitially AC9>G was the leader in Commodities >%changes as volumes of agri-

commodities picked up substantially but later on MCG took the lead in

#nternational commodities which helped MCG become the largest e%change

cornering almost +3E - 1E of the total average daily business of 5s. 23

crores 4MCG K 5s.22 K 5s.2B crores 7 AC9>G K 5s.2-5s.23 crores6

per day.

The present growth in commodities markets can be attributed to the following:

4*6 &verall downturn in other asset classes especially e'uity

markets globally led investors to look at commodities markets

for returns.

426 #ncreased volatility in commodities in the past * year or so have

generated interest amongst traders globally to particip

Commodities Market - Snapshot (1)

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Transcript of Commodities Market - Snapshot (1)