commodity markets
TRANSCRIPT
INDEX
Section TOPIC PAGE NO.
I. Evolution of Derivatives Parties Involved Commonly Used Derivatives
II. Commodity and Commodity Market Difference Between Commodity and Financial
Derivatives Commodities Traded Evolution of the commodity market in World
Evolution of the commodity market in IndiaIII. Trading Exchanges in India
MCX NCDEX NMCE
IV. Trading and Settlement Procedure Trading Procedure Clearing and Settlement Procedure
V. Commodity Analysis Gold Guar Seed
VI. Impediments in development of commodity exchanges
VII. Possible Recommendations
VIII. Conclusion
IX. Bibliography
1
Evolution 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 simple
derivative 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.
A farmer who sowed his wheat in rainy season, faced uncertainty over the price he would
receive for his produce i.e. wheat. If there is scarcity of commodity he has produced, he
would probably obtain attractive prices. And if the supply is more, he would have to sale
off his harvest at a very low price. This means that the farmer was exposed to a high risk
of price uncertainty.
At the same time, a merchant trading in wheat, with high demand of wheat would face a
price risk that of having to pay exorbitant prices during this period, although he will
receive high prices. Under such situation it would be good if farmer and merchant come
together and enter under a contract where they would decide the price at which they want
to settle. This way they can eliminate any price risk.
In 1848, CBOT (Chicago Board of Trade), was established to bring farmers and
merchants together. A 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 standardised, and in 1925 the first futures clearing house came
into existence.
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Definition of Derivative
Securities Contracts (Regulation) Act, 1956 (SCRA) defines derivatives as:
“A security derived from a debt instrument, share, loan whether secured or
unsecured, risk instrument or contract for differences or any other form of
security.”
“A contract which derives its value from the prices, or index of prices, of
underlying securities.”
In simple words a 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 equity, forex, any commodity or any other asset. As mentioned earlier, 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 example of a derivative. The price of this
derivative is driven by the spot price of wheat, which is the “underlying” in this case.
Derivatives markets
Derivative markets can broadly be classified as commodity derivative market and
financial derivatives markets. As the name suggest, commodity derivatives markets trade
contracts for which the underlying asset is a commodity. It 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
equity, interest rates and exchange rates as the underlying. The most commonly used
derivatives contracts are forwards, futures and options which discussed in detail later.
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Derivative products initially emerged as hedging devices against fluctuations in
commodity prices, and commodity-linked derivatives remained the sole form of such
products for almost three hundred years. Financial derivatives came into spotlight in the
post-1970’s period due to growing instability in the financial markets. However, since
their emergence, these products have become very popular and by 1990’s, they accounted
for about two-thirds of total transactions in derivative products. In recent years, the
market for financial derivatives has grown tremendously in terms of variety of
instruments available, their complexity and also turnover. In the class of equity
derivatives the world over, futures and options on stock indices have gained more
popularity than on individual stocks.
Parties involved in derivativesDerivative contracts are of different types. The most common ones are forwards, futures,
options. Participants who trade in the derivatives market can be classi_ed under the
following three broad categories hedgers, speculators, and arbitragers.
1. Hedgers: Hedgers face risk associated with the price of an asset. They use the futures
or options markets to reduce or eliminate this risk. The farmer's example that we
discussed about was a case of hedging.
Derivatives
Commodity DerivativesE.g.: wheat, soyabean guar seed, gold etc
Financial DerivativesE.g.: equity interest rate etc
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2. 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. As a
result of this leveraged speculative position, they increase the potential for large gains as
well as large losses.
3. Arbitragers: Arbitragers work at making profits by taking advantage of discrepancy
between prices of the same product across different markets. If, for example, they see the
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 profit.
Some commonly used derivativesHere 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.
Forwards: As 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.
Futures: A 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 standardised and exchange traded.
Options: There are two types of options - calls and puts. Calls give the buyer the right
but not the obligation to buy a given quantity of the underlying asset, at a given price on
or before a given future date. Puts give the buyer the right, but not the obligation to sell a
given quantity of the underlying asset at a given price on or before a given date.
Warrants: Options generally have lives of upto one year, the majority of options traded
on options exchanges having a maximum maturity of nine months. Longer-dated options
are called warrants and are generally traded over-the-counter.
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Baskets: Basket options are options on portfolios of underlying assets. The underlying
asset is usually a weighted average of a basket of assets. Equity index options are a form
of basket options.
Swaps: Swaps are private agreements between two parties to exchange cashflows 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 cashflows between
the parties in the same currency.
Currency swaps: These entail swapping both principal and interest between the parties,
with the cashflows in one direction being in a different currency than those in the
opposite direction.
Commodity and Commodities market
INTRODUCTION
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Derivatives as a tool for managing risk first originated in the commodities markets. They
were then found useful as a hedging tool in financial markets as well. In India, trading in
commodity futures has been in existence from the nineteenth century with organized
trading in cotton through the establishment of Cotton Trade Association in 1875. Over a
period of time, other commodities were permitted to be traded in futures exchanges.
Regulatory constraints in 1960s resulted in virtual dismantling of the commodities future
markets. It is only in the last decade that commodity future exchanges have been actively
encouraged. However, the markets have been thin with poor liquidity and have not grown
to any significant level.
COMMODITY
Commodity is defined as any bulk good traded on an exchange or in the cash market.
One of the first forms of trade between individuals began by what is called the barter
system wherein goods were traded for goods. Lack of a medium for exchange was the
sole initiator of this system. People sold what they had in excess and bought what they
lacked. Animals were the first few commodities to be exchanged.
Some examples of commodities include grain, oats, gold, oil, beef, silver, and natural gas.
These markets are the meeting places of buyers and sellers of an ever-expanding list of
commodities that today includes agricultural goods, metals and petroleum, but also
products such as financial instruments, foreign currencies and stock indexes that trade on
a commodity exchange.
Commodity Exchange is a platform where different types of market participants trade in
wide spectrum of commodity derivatives. In other words, prices of contracts can be
determined at present for goods to be delivered in future. This helps people to avoid wide
fluctuations in the prices of the commodities. The Government issued notifications on
1.4.2003 permitting futures trading in the commodities, with the issue of these
notifications futures trading is not prohibited in any commodity. Options trading in
commodity are, however presently prohibited.
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In fact, the size of the commodities markets in India is also quite significant. Of
the country’s GDP of Rs 13, 20,730 crore (Rs 13,207.3 billion), commodities related
(and dependent) industries constitute about 58 per cent.
Currently, the various commodities across the country clock an annual turnover of Rs 1,
40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the
commodities market grows many folds here on.
Difference between commodity and financial derivatives
The basic concept of derivative contract remains the same whether the underlying
happens be a commodity or a financial asset. However there are some features which are
very peculiar to commodity derivative markets. In the case of financial derivatives, most
of these contracts are cash settled. Even in the case of physical settlement, financial assets
are not bulky and do not need special facility for storage. Due to the bulky nature of the
underlying assets, physical settlement in commodity derivatives creates the need for
warehousing. Similarly, the concept of varying quality of asset does not really exist as far
as financial underlying are concerned.
However in the case of commodities, the quality of the asset underlying a contract can
vary largely. This becomes an important issue to be managed. We have a brief look at
these issues.
Physical settlement
Physical settlement involves the physical delivery of the underlying commodity, typically
at an accredited warehouse. The seller intending to make delivery would have to take the
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commodities to the designated warehouse and the buyer intending to take delivery would
have to go to the designated warehouse and pick up the commodity. This may sound
simple, but the physical settlement of commodities is a complex process. The issues
faced in physical settlement are enormous. There are limits on storage facilities in
different states. There are restrictions on interstate movement of commodities. Besides
state level Octroi and duties have an impact on the cost of movement of goods across
locations. The process of taking physical delivery in commodities is quite different from
the process of taking physical delivery in financial assets.
We take a general overview at the process flow of physical settlement of commodities.
Later on we will look into details of how physical settlement happens on the NCDEX.
Delivery notice period
Unlike in the case of equity futures, typically a seller of commodity futures has the option
to give notice of delivery. This option is given during a period identified as `delivery
notice period'.
Such contracts are then assigned to a buyer, in a manner similar to the assignments to a
seller in an options market. However what is interesting and different from a typical
options exercise is that in the commodities market, both positions can still be closed out
before expiry of the contract. The intention of this notice is to allow verification of
delivery and to give adequate notice to the buyer of a possible requirement to take
delivery. These are required by virtue of the fact that the actual physical settlement of
commodities requires preparation from both delivering and receiving members.
Typically, in all commodity exchanges, delivery notice is required to be supported by a
warehouse receipt. The warehouse receipt is the proof for the quantity and quality of
commodities being delivered. Some exchanges have certified laboratories for verifying
the quality of goods. In these exchanges the seller has to produce a verification report
from these laboratories along with delivery notice. Some exchanges like LIFFE, accept
warehouse receipts as quality verification documents while others like BMF-Brazil have
independent grading and classification agency to verify the quality.
In the case of BMF-Brazil a seller typically has to submit the following documents:
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A declaration verifying that the asset is free of any and all charges, including
fiscal debts related to the stored goods.
A provisional delivery order of the good to BM&F (Brazil), issued by the
warehouse.
A warehouse certificate showing that storage and regular insurance have been
paid.
Assignment
Whenever delivery notices are given by the seller, the clearing house of the exchange
identifies the buyer to whom this notice may be assigned. Exchanges follow different
practices for the assignment process. One approach is to display the delivery notice and
allow buyers wishing to take delivery to bid for taking delivery. Among the international
exchanges, BMF, CBOT and CME display delivery notices. Alternatively, the clearing
houses may assign deliveries to buyers on some basis. The Indian commodities
exchanges have alsoadopted this method.
Any seller/ buyer who has given intention to deliver/ been assigned a delivery has an
option square off positions till the market close of the day of delivery notice. After the
close of trading, exchanges assign the delivery intentions to open long positions.
Assignment is done typically either on random basis or first-in-first out basis. In some
exchanges, the buyer has the option to give his preference for delivery location.
The clearing house decides on the daily delivery order rate at which delivery will be
settled. Delivery rate depends on the spot rate of the underlying adjusted for discount/
premium quality and freight costs. The discount/ premium for quality and freight costs
are published the clearing house before introduction of the contract. The most active spot
market is normally taken as the benchmark for deciding spot prices. Alternatively, the
delivery rate is determined based on the previous day closing rate for the contract or the
closing rate for the day.
Delivery
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After the assignment process, clearing house/ exchange issues a delivery order to the
buyer. The exchange also informs the respective warehouse about the identity of the
buyer. The buyer required to deposit a certain percentage of the contract amount with the
clearing house as margin against the warehouse receipt. The period available for the
buyer to take physical delivery is stipulated by the exchange. Buyer or his authorised
representative in the presence of seller or his representative takes the physical stocks
against the delivery order. Proof of physical delivery having been effected forwarded by
the seller to the clearing house and the invoice amount is credited to the seller's account.
In India if a seller does not give notice of delivery then at the expiry of the contract the
positions are cash settled by price difference exactly as in cash settled equity futures
contracts.
Warehousing
One of the main differences between financial and commodity derivatives are the need
warehousing. In case of most exchange-traded financial derivatives, all the positions are
cash settled. Cash settlement involves paying up the difference in prices between the time
the contract was entered into and the time the contract was closed. For instance, if a
trader buys futures on a stock at Rs.100 and on the day of expiration, the futures on that
stock close Rs.120, does not really have to buy the underlying stock. All he does is take
the difference of Rs.20 cash. Similarly the person who sold this futures contract at
Rs.100, does not have to deliver the underlying stock. All he has to do is pay up the loss
of Rs.20 in cash.
In case of commodity derivatives however, there is a possibility of physical settlement.
Which means that if the seller chooses to hand over the commodity instead of the
difference in cash, the buyer must take physical delivery of the underlying asset. This
requires the exchange to make an arrangement with warehouses to handle the settlements.
The efficacy of the commodities settlements depends on the warehousing system
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available. Most international commodity exchanges used certified warehouses (CWH) for
the purpose of handling physical settlements.
Such CWH are required to provide storage facilities for participants in the commodities
markets and to certify the quantity and quality of the underlying commodity. The
advantage of this system is that a warehouse receipt becomes good collateral, not just for
settlement of exchange trades but also for other purposes too. In India, the warehousing
system is not as efficient as it is in some of the other developed markets. Central and state
government controlled warehouses are the major providers of agri-produce storage
facilities. Apart from these, there are a few private warehousing being maintained.
However there is no clear regulatory oversight of warehousing services.
Quality of underlying assets
A derivatives contract is written on a given underlying. Variance in quality is not an issue
in case of financial derivatives as the physical attribute is missing. When the underlying
asset is a commodity, the quality of the underlying asset is of prime importance. There
may be quite some variation in the quality of what is available in the marketplace. When
the asset is specified, it is therefore important that the exchange stipulate the grade or
grades of the commodity that are acceptable. Commodity derivatives demand good
standards and quality assurance/ certification procedures. A good grading system allows
commodities to be traded by specification.
Currently there are various agencies that are responsible for specifying grades for
commodities. For example, the Bureau of Indian Standards (BIS) under Ministry of
Consumer Affairs specifies standards for processed agricultural commodities whereas
AGMARK under the department of rural development under Ministry of Agriculture is
responsible for promulgating standards for basic agricultural commodities. Apart from
these, there are other agencies like EIA, which specify standards for export oriented
commodities.
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Different commodities traded in commodity market
In all there are around 40 forty commodities traded in the different commodity markets.
These commodities are basically divided in four main types, namely:
Agricultural commodities which consist of all agricultural products like cotton,
wheat, jowar, coffee, guar gum, soyabean, seas am, mustard oil, etc
Precious metals which include gold and silver
Base metals include other metals like tin copper, magnesium
Energy includes commodities like crude oil, brent crude oil, furnace oil.
All these commodities have different set of features different characteristics, different
dealing methods, and different margins. Due to these differences these commodities
require different contracts which some extra rules relating to delivery, trading, quality
specifications, warehousing requirements, settlement procedure, etc.
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Evolution of the commodity market in World
Early forward contracts in the US addressed merchants' concerns about ensuring that
there were buyers and sellers for commodities. However “credit risk” remained a serious
problem. To deal with this problem, a group of Chicago businessmen formed the
Chicago Board of Trade (CBOT) in 1848. The primary intention of the CBOT was to
provide a centralised location known in advance for buyers and sellers to negotiate
forward contracts. In 1865, the CBOT went one step further and listed the first
“Exchange traded” derivatives contract in the US, these contracts were called “futures
contracts”. In 1919, Chicago Butter and Egg Board, a spin-off of CBOT, was reorganised
to allow futures trading. Its name was changed to Chicago Mercantile Exchange
(CME). The CBOT and the CME remain the two largest organised futures exchanges,
indeed the two largest ” financial” exchanges of any kind in the world today.
The first stock index futures contract was traded at Kansas City Board of Trade.
Currently the most popular stock index futures contract in the world is based on S&P 500
index, traded on Chicago Mercantile Exchange. During the mid eighties, financial futures
Commodity Markets
Precious Metals Others Metals
Agriculture Energy
14
became the most active derivative instruments generating volumes many times more than
the commodity futures. Index futures, futures on T-bills and Euro-Dollar futures are the
three most popular futures contracts traded today. Other popular international exchanges
that trade derivatives are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE
in Japan, MATIF in France, Eurex etc. Some of the oldest and most famous stock
exchanges in the world are as follows:-
COUNTRY EXCHANGE
United States of America
Chicago Board of Trade (CBOT)
Chicago Mercantile Exchange
New York Cotton Exchange
New York Mercantile Exchange
New York Board of Trade
The Winnipeg Commodity Exchange
Canada The Winnipeg Commodity Exchange
Brazil
Brazilian Futures Exchange Commodities
and Futures Exchange
Australia Sydney Futures Exchange Ltd.
China
Beijing Commodity Exchange Shanghai
Metal Exchange
Hong Kong Hong Kong Futures Exchange
Japan
Tokyo International Financial Futures Exchange
Kansai Agricultural Commodities Exchange
Tokyo Grain Exchange
Malaysia Kuala Lumpur commodity Exchange
Singapore Singapore Commodity Exchange Ltd.
France Le Nouveau Marche MATIF
Russia
The Russian Exchange
MICEX/ Relis Online St. Petersburg Futures Exchange
Spain The Spanish Options Exchange
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Citrus Fruit and Commodity Futures Market of
Valencia
United Kingdom
The London International Financial Futures
Options exchange
Evolution Commodity Market In India
The organized trading in commodity futures markets has a long history in India. In 1875,
the first commodity futures exchange was set up in Mumbai under the guidance of
Bombay Cotton Traders Association. During 1900-1920 many futures markets were set
up including raw jute futures market in Kolkata (1912) and wheat futures market in
Hapur (1913). A number of other exchanges appeared between 1920 and 1940 trading
such commodities as raw jute, jute products, pepper, turmeric, potatoes, sugar, castor
seed, groundnuts, groundnut oil, rice, wheat, etc. With the outbreak of World War II and
in its aftermath trading in forward and futures contracts as well as options was either
outlawed, as part of the Government's drive to contain inflation, or made impossible
through price controls. This situation persisted until 1952, when the Government
introduced the Forward Contracts (Regulation) Act, which to this day controls all
transferable forward contracts and futures. Through this act Forward Market Commission
(FMC) was established to oversee the working of future exchanges in India. The Act
allowed futures market trade in a number of commodities (but excluded some which were
seen as essential foods, such as sugar and food grains). During 1960s, the government
either banned or suspended futures trading in several commodities, including cotton, raw
jute, edible oilseeds and their products. Futures' trading in pepper, turmeric, castor seed,
linseed, etc. was, however still permitted. In 1977, futures' trading in non-edible oilseeds
like castor seed and linseed was forbidden. The reason for this crackdown on futures
markets was that, in Government's view, these markets helped driving up prices for
commodities, by giving free rein to speculators. The Government's policies underwent a
change in the late 1970s, when futures trade in gur and potato was allowed on the
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recommendations of Khusro Committee. This committee recommended the revival of
futures trading in a wide range of commodities, but little action resulted.
As on August 2003, there are 21 commodity exchanges in operation in India dealing in
futures trading in 35 commodities (FMC website). Out of these, two exchanges viz.,
Indian Pepper and Spice Trade Association (IPSTA), Cochin and the Bombay
Commodity Exchange (BCE) Ltd. have the status of international exchange and deal in
international contracts (transacting party could be a foreign national also) in pepper and
castor oil respectively. The commodities in which futures trading is done by other
exchanges are: pepper, turmeric, gur, castor seed, hessian, jute sacking, cotton, potato,
castor oil, soya bean and its oil and cake, coffee, mustard seed and its oil and oilcake,
groundnut and its oil, sunflower oil, copra/coconut and its oil and oilcake, cottonseed and
its oil and oilcake, kapas, RBD palmolein, rice bran and its oil and oilcake, sesame seed
and its oil and oilcake, safflower seed and its oil and oilcake, and sugar.
Commodity Trading Exchanges in India
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Forward Market Commission
In India commodity markets are governed by Forward Market Commission The
Forward Contract (Regulation) Act was enacted in 1952. this act passed in the
parliament to regulate the futures markets and avoid the exploitation of farmers by
middlemen and cruel landlords. In 1966, in the aftermath of a severe drought and
escalating food prices, forward trading was banned in most commodities to make it easier
for the government to impose price controls. A long settled over the commodity markets.
That was unfortunate. Futures and forward contracts allow market participants to
transfer risks from those wary of it to those who are hungry for it. Those most vulnerable
Ministry of Consumer affairs
Forward Market
Commission
Commodity Exchanges
National Level Stock
Exchange
Regional Level Stock
Exchange
NCDEX MCX NMCE20 Regional Exchanges
18
to risk-the farming community-have suffered over the subsequent decades. Not only was
the economics of the ban suspect, but also turned a blind eye to a natural dispensation
among Indians to trade in commodities. Forward trading in commodities is mentioned in
Kautilya’s Arthashastra. The Bombay Cotton Trade Association set up a futures market
for cotton in 1875, a mere decade after the Chicago Board of Trade opened for business.
Subsequently, India developed vibrant forward markets in a host of commodities.
In November 2003, Mukesh Ambani, was speaking at the inauguration of
MCX, a spanking new national, multi- commodity exchange. The government has
decided to clear the way for forward trading in commodities once again. Mukesh says
that MCX and the other exchanges are sitting on a market worth $ 600 billion a year
(or Rs 30 lakh crore).
Currently, the annual value of all commodity futures traded in India is $ 135
billion, far less than the potential 4600 billion. What is significant, however, is the
speed at which the gap is being narrowed. “Volumes in commodity futures have perked
up from Rs 20,000 crore- 30,000 crore per annum before the liberalization of futures
trading, to around Rs 5.71 lakhs crore per annum today. The natural instinctive genius of
the Indian trader has come into play”, says S. Sundereshan, Chairman, FMC (forward
market commission), which regulates commodity futures market in India
Commodities’ trading is now one of the latest trend in the town. Volumes grew by
over 900 % between financial years 2002-03 and 2004-05. “The growth of the
commodities business has been beyond what was originally projected. With new
commodity contracts getting launched sequentially, the average daily futures volumes
could scale upwards of Rs 140,000 crore”, says Vineet Bhatnagar, country manager of
Refco (India), one of the largest non- bank futures players globally. With national level
exchange of India (MCX) and the National commodities Derivatives Exchange
(NCDEX) yet to complete two years of full- fledged commercial operations, the growth
in commodity futures trading is almost as spectacular as India’s success in business
process outsourcing.
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Commodity Exchanges
In India there are about 25 commodity exchanges, these include exchanges at national
level and regional level commodity exchanges. Of all these exchanges there are only
three national level commodity exchanges. And these are National Commodity And
Derivatives Exchange (NCDEX), Multi Commodity Exchange (MCX), National
Commodity Exchange (NMCE). But among these NCDEX and MCX are quite functional
in the country. The basic difference between the national level and regional level
exchanges is their area of their operations and the technology used by the exchanges.
1. Multi Commodity Exchange of India Limited (MCX):
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MCX an independent multi commodity exchange has permanent recognition from
Government of India for facilitating online trading, clearing and settlement operations for
commodity futures markets across the country. It was inaugurated in November 2003 by
Mr. Mukesh Ambani. It is headquartered in Mumbai. The key shareholders of MCX are
Financial Technologies (India) Ltd., State Bank of India, NABARD, NSE, HDFC Bank,
State Bank of Indore, State Bank of Hyderabad, State Bank of Saurashtra, SBI Life
Insurance Co. Ltd., Union Bank of India, Bank of India, Bank of Baroda, Canara Bank,
Corporation Bank.
MCX offers futures trading in the following commodity categories: Agri
Commodities, Bullion, Metals- Ferrous & Non-ferrous, Pulses, Oils & Oilseeds, Energy,
Plantations, Spices and other soft commodities.
Today MCX is offering spectacular growth opportunities and advantages to a
large cross section of the participants including Producers / Processors, Traders,
Corporate, Regional Trading Centers, Importers, Exporters, Cooperatives, and Industry
Associations.
In a significant development, National Stock Exchange of India Ltd. (NSE),
country’s largest exchange and National Bank for Agriculture and Rural Development
(NABARD), country’s premier agriculture development bank announced their strategic
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participation in the equity of MCX on June 15, 2005. This new partnership of NSE and
NABARD with MCX makes MCX consortium the largest distribution network across the
country.
MCX is an ISO 9001:2000 online nationwide multi commodity exchange. It has
over 900 members spread across 500 centers across the country, with more than 750
VSAT’s and leased line connections and 5,000 and more trading terminals that provide a
transparent robust and trustworthy trading platform in more than 50 commodity futures
contract with a wide range of commodity baskets which includes metals, energy and
agriculture commodities. Exchange has pioneered major innovations in Indian
commodities market, which has become the industry benchmarks subsequently.
MCX is the only Exchange which has got three international tie-ups which is with
Tokyo Commodity Exchange (TOCOM), the 250 year old Baltic Freight Exchange,
London, Dubai Metals & Commodity Centre (DMCC) & Dubai Gold & Commodity
Exchange (DGCX), the strategic initiative of Government of Dubai. MCX has to its
credit, setting up of the National spot exchange (NSEAP), which connects all India
APMC markets thereby contributing in the implementation of Government of India’s
vision to create a common Indian market
The trading system of MCX is state-of-the-art, new generation trading platform
that permits extremely cost effective operations at much greater efficiency. The Exchange
Central System is located in Mumbai, which maintains the Central Order Book.
Exchange Members located across the country are connected to the central system
through VSAT or any other mode of communication as may be decided by the Exchange
from time to time. The controls in the system are system driven requiring minimum
human intervention. The Exchange Members places orders through the Traders Work
Station (TWS) of the Member linked to the Exchange, which matches on the Central
System and sends a confirmation back to the Member Settlement: Exchange maintains
electronic interface with its Clearing Bank. All Members of the Exchange are having
their Exchange operations account with the Clearing Bank.
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All debits and credits are affected electronically through such accounts only. All
contracts on maturity are for delivery. MCX specifies tender and delivery periods. A
seller or a short open position holder in that contract may tender documents to the
Exchange expressing his intention to deliver the underlying commodity. Exchange would
select from the long open position holder for the tendered quantity. Once the buyer is
identified, seller has to initiate the process of giving delivery and buyer has to take
delivery according to the delivery schedule prescribed by the Exchange Players involved
in commodities trading like commodity exchanges, financial institutions, and banks have
a feeling that the markets are not being fully exploited. Education and regulation are the
main impediments to the growth of commodity trading. Producers, farmers and agri-
based companies should enter into formal contracts to hedge against losses. The use of
commodity exchanges will create more trading opportunities; result in an integrated
market and better price discoveries.
MCX offers trading in various Products which include Gold, Silver, Castor
Seeds, Soy Seeds, Castor Oil, Refined Soy Oil, Soymeal, RBD Palmolein, Crude Palm
Oil, Groundnut Oil, Sesame Seed, Mustard /Rapeseed Oil, Cottonseed, Mustard Seed
(Hapur), Mustard Seed (Jaipur), Soy Seeds, Castor Oil, Refined Soy Oil, Soymeal, RBD
Palmolein, Groundnut Oil, Sesame Seed, Mustard Seed (Jaipur), Pepper, Red Chilli,
Jeera, Turmeric, Copper, Nickel, Tin, Aluminium , Chana, Rice, Wheat, Maize, Crude
Oil, Rubber, Cashew, Guar Seed, Polypropylene (PP), High Density Polyethylene
(HDPE).
2. National Commodity and Derivatives Exchange
(NCDEX)
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NCDEX is a public limited company incorporated on April 23, 2003 under
the Companies Act, 1956. It obtained its Certificate for Commencement of Business
on May 9, 2003. It has commenced its operations on December 15, 2003.
National Commodity & Derivatives Exchange Limited (NCDEX) is a
professionally managed online multi commodity exchange promoted by ICICI Bank
Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for
Agriculture and Rural Development (NABARD) and National Stock Exchange of
India Limited (NSE). Punjab National Bank (PNB), CRISIL Limited (formerly the
Credit Rating Information Services of India Limited), Indian Farmers Fertiliser
Cooperative Limited (IFFCO) and Canara Bank by subscribing to the equity
shares have joined the initial promoters as shareholders of the Exchange. NCDEX is
the only commodity exchange in the country promoted by national level institutions.
This unique parentage enables it to offer a bouquet of benefits, which are currently in
short supply in the commodity markets. The institutional promoters of NCDEX are
prominent players in their respective fields and bring with them institutional building
experience, trust, nationwide reach, technology and risk management skills.
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NCDEX is regulated by Forward Market Commission in respect of futures
trading in commodities. Besides, NCDEX is subjected to various laws of the land like
the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation)
Act and various other legislations, which impinge on its working.
NCDEX is located in Mumbai and offers facilities to its members in more
than 390 centres throughout India. The reach will gradually be expanded to more
centres.
NCDEX is a nation-level, technology driven de-mutualized on-line
commodity exchange with an independent Board of Directors and professionals not
having any vested interest in commodity markets. It is committed to provide a world-
class commodity exchange platform for market participants to trade in a wide
spectrum of commodity derivatives driven by best global practices, professionalism
and transparency.
NCDEX currently facilitates trading of thirty six commodities - Cashew, Castor
Seed, Chana, Chilli, Coffee, Cotton, Cotton Seed Oilcake, Crude Palm Oil, Expeller
Mustard Oil, Gold, Guar gum, Guar Seeds, Gur, Jeera, Jute sacking bags, Mild Steel
25
Ingot, Mulberry Green Cocoons, Pepper, Rapeseed Mustard Seed ,Raw Jute, RBD
Palmolein, Refined Soy Oil, Rice, Rubber, Sesame Seeds, Silk, Silver, Soy Bean,
Sugar, Tur, Turmeric, Urad, Wheat, Yellow Peas, Yellow Red Maize & Yellow
Soybean Meal. At subsequent phases trading in more commodities would be
facilitated.
3. National Multi Commodity Exchange (NMCE)
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NMCE is the first to get the ‘National’ status and be fully operational
Demutualised Corporate Structure leading to a reliable, effective, impartial and
rule-based management by professionals having no trade interest.
Convergence of all the offers and bids emanating from all over the country in a
Single Electronic Order Book of the Exchange ensuring equal access to all
intermediaries.
Participation of diverse interests like Importers, Exporters, Growers, Brokers,
Traders, etc., using an electronic trading system providing a fair, efficient and
transparent commodities market.
Fair Trading Practice ensured through inbuilt checks and balances in the System.
Use of LEMDA based margining at 99.9% VAR (Value at Risk) system for the
initial margin.
Warehouse Receipt System based Delivery of Underlying Commodities meeting the
current international standards; its endeavor is to fulfill its mission in letter and
spirit.
First to establish a Trade Guarantee Fund, thereby offering guaranteed clearing
and book entry settlements by assuming counter-party risks.
Real Time Price & Trade Data Dissemination
NMCE Market Surveillance Program
NMCE would bring about the convergence of large-scale processors, traders,
and farmers along with banks. NMCE would provide a common ground for
fixation of future prices of a number of commodities enabling efficient price
discovery/forecast. In addition, hedging using different and diverse commodities
would also be possible with help of NMCE. In short, NMCE is leading
27
transition of highly fragmented, controlled and restricted commodity
economy to globally integrated, efficient and competitive environment in the
21st Century.
Trading and Settlement Procedure At
Commodity Market
TRADING
28
The various aspects in trading are as follows:
a) Placing the order
b) Methods of trading
c) Kinds of orders
d) Kinds of margins
e) Pricing of futures
f) Closing out the positions
a) Placing the order In futures market an order should contain specifications such as buy or sell, the number
of contracts, the month of contract, type and quality of the commodity, the exchange, the
price specifications and the period of validity. Usually, orders are placed by telephone,
with brokers representing users and producers. If an order is executed the client receives
a confirmation. The Investor who agrees to buy assumes a long futures position and the
investor who agrees to sell assumes a short futures position.
b) Methods of Trading The trading in future exchanges is carried out through two methods. They are
i. Open outcry
ii. Electronic trading
i. Open Outcry
Open outcry trading is a face to face and highly activated form of trading used on the
floors of the exchanges. In open outcry system the futures contracts are traded in pits. A
pit is a raised platform in octagonal shape with descending steps on the inside that permit
buyers and sellers to see each other. Normally only one type of contract is traded in each
pit like a Eurodollar pit, Live Cattle pit, etc.
29
The trading process consists of an auction in which all bids ad offers on each of the
contracts are made known to the public and everyone can see the market's best price. To
place an order under this method, the customer calls a broker, who time-stamps the order
and prepares an office order ticket. The broker then sends the order to a booth on the
exchange floor called broker's floor booth. There, a floor order ticket is prepared, and a
clerk hand delivers the order to the floor trader for execution. In some cases, the floor
clerk may use hand signals to convey the order to floor traders. Large orders typically go
directly from the customer to the broker's floor booth. The floor trader, standing in a
central location i.e. trading pit, negotiates a price by shouting out the order to other floor
traders, who bid on the order using hand signals. Once filled, the order is recorded
manually on the order parties in the trade. At the end of each, the clearing house settles
trades by ensuring that no discrepancy exists in the matched-trade information.
ii. Electronic Trading
Electronic trading systems have become increasingly popular in the past decade. The
driving factor for the rise in the popularity of these systems is their potential to improve
efficiency and lower the cost of transactions. In addition, electronic trading systems
make exchanges available to remote investors in real time, which is an important benefit
in the present situation of increased trading from remote locations.
Electronic trading is an automated trade execution system with three key components.
1. Computer terminals, where customer orders are keyed in the and trade confirmations
are received.
2. A host computer that processes trade.
3. A network that links the terminals to the host computer.
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Customers may enter orders directly into the terminal or phone in the order to a broker.
With electronic order matching systems, the host computer matches bids with offers
according to certain rules that determine an order's priority. Priority rules on most
systems include price and time of entry. In some cases, priority rules may also include
order size, type of order and identity of the customer who placed the order.
In the simplest case, matching occurs when a trader places a buy order at a price equal to
higher than the price of an existing sell order for the same contract. The host computer
automatically executes the order, so that trades are matched immediately. Trades are
then cleared immediately, as long as the host computer is lined to the clearing house.
After hours Electronic trading System
After-hours electronic trading first began in 1992 at CME (Chicago Mercantile
Exchange). This was introduced to meet the needs of an increasingly integrated global
economy and to have an access to the currency price protection around the clock.
Electronic trading system is used in the open outcry exchanges after the day trading is
over.
c) Kinds of orders The orders (under an open outcry / electronic system) can be placed in different ways,
including:
Market Order
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This is the most common type of order. No specific price is mentioned. Only the
position to be taken-long/short is stated. When this kind of order is placed, it gets
executed irrespective of the current market price of that particular asset.
Market on open
The order will be executed on the market open within the opening range. This trade is
used to enter a new trade, or exit an open trade.
Market on Close
The order will be executed on the market close. The fill price will be within the closing
range, which may, in some markets, be substantially different from the settlement price.
This trade is also used to enter a new trade, or exit an open trade.
Limit Order
An order to buy or sell a stated amount of a commodity at a specified price, or at a better
price, if obtainable at the time of execution. The disadvantage is that the order may not
get filled at all if the price for that day does not reach the specified price.
Stop-Loss Order
A stop-loss order is an order, placed with the broker, to buy or sell a particular futures
contract at the market price if and when the price reaches a specified level. Futures
traders often use stop orders in an effort to limit the amount they might lose if the futures
price moves against their position. Stop orders are not executed until the price reaches
the specified point. When the price reaches that point the stop order becomes a market
order. Most of the time, stop orders are used to exit a trade. But, stop orders can be
executed for buying/selling positions too. A "buy" stop order is initiated when one wants
to buy a contract or go long and a "sell" stop order when one wants to sell or go short.
The order gets filled at the suggested stop order price or at a better price.
Example: A trader wants to purchase a crude oil futures contract at Rs.750 per barrel. He
wishes to limit his loss to Rs.50 a barrel. A stop order would then be placed to sell an
32
offsetting contract if the price falls to Rs.700 per barrel. When the market touches this
price, stop order gets executed and the trader would exit the market.
Day order
Day orders are good for only one day, the day the order is placed.
Example: A trader wants to go long on September 1, 2003 in Refined Palm Oil in a
commodity exchange. A day order is placed at Rs. 340/10 kg. If the market does not
reach this price the order does not get filled even if the market touches Rs.341 and closes.
In other words, day order is for a specific price and if the order does not get filled that
day, one has to place the order again the next day.
Good Till Cancelled (GTC) Order
It is an open order to buy or sell that remains active until the order gets filled in the
market, or is cancelled by the person who placed the order.
Example: A trader wants to go long on Refined Palm oil when the market touches
Rs.400/10 kg. The order exists until it is filled up, even if it takes months for it to
happen. The order is always open until the order is cancelled or the contract expires.
Fill or Kill order
This order is a limit order that is sent to the pit to be executed immediately and if the
order is unable to be filed immediately, it gets cancelled.
All or None order
All or None order (AON) is a limit order, which is to be executed in its entirety, or not at
all. Unlike a fill-or-kill order, an all-or-none order is not cancelled if it is not executed as
soon as it is represented in the exchange. An all-or-none order position can be closed out
with another AON order.
Spread Order
A simple spread order involves two positions, one long and one short. They are taken in
the same commodity with different months (calendar spread) or in closely related
33
commodities. Prices of the two futures contract therefore tend to go up and down
together, and gains on one side of the spread are offset by losses on the other. The
spreaders goal is to profit from a change in the difference between the two futures prices.
The trader is virtually unconcerned whether the entire price structure moves up or down,
just so long as the futures contract he bought goes up more (or down less) than the futures
contract he sold.
OCO Order
It is called One cancels the Other (OCO) order. The order placed so as to take advantage
of price movement, which consists of both a Stop and a Limit price. Once one level is
reached, one half of the order will be executed (either Stop or Limit) and the remaining
order cancelled (either Limit or Stop). This type of order would close the position if the
market moved to either the stop rate or the limit rate, thereby closing the trade and at the
same time, cancelling the other entry order.
Example: A trader has a buy position at Rs.14, 000/tonne on Soybean. He wishes to have
both stop and limit orders in order to fill the order in a particular price range. A stop
order is placed at Rs. 14,100/tonne and a limit order at Rs.13, 900/tonne. If the market
trades as Rs. 13,900/tonne, the limit order gets filled and the stop order immediately gets
cancelled. The trader exists the market at Rs.13, 900/tonne.
d) Kinds of Margin Margin is the deposit money that needs to be paid to buy or sell each contract. The
margin required for a futures contract is better described as performance bond or good
faith money. The margin levels are set by the exchanges based on volatility (market
conditions) and can be changed at any time. The margin requirements for most futures
contracts range from 2% to 15% of the value of the contract.
34
The different types of margins in futures that a trader has to maintain are as under:
Initial Margin
The amount that must be deposited by a customer at the time of entering into a contract is
called initial margin. This margin is meant to cover the largest potential loss in one day.
The margin is a mandatory requirement for parties who are entering into the contract.
Maintenance Margin
A trader is entitled to withdraw any balance in the margin account in excess of the initial
margin. To ensure that the balance in the margin account never becomes negative, a
maintenance margin, which is somewhat lower than the initial margin, is set. If the
balance in the margin account falls below the maintenance margin, the trader receives a
margin call and is requested to deposit extra funds, to bring it to the initial margin level
within a very short period of time.
Additional Margin
In case of sudden higher than expected volatility, the exchange calls for an additional
margin, which is a preemptive move to prevent breakdown. This is imposed when the
exchange fears that the markets have become too volatile and may result in some
payments crisis, etc.
Mark-to-Market Margin
At the end of each trading day, the margin account is adjusted to reflect the trader's gain
or loss. This is known as marking to market the account of each trader. All futures
contracts are settled daily reducing the credit exposure to one-day's movement. Based on
the settlement price, the value of all positions is marked-to-the-market each day after the
official close i.e. the accounts are either debited or credited based on how well the
positions faired in that day's trading session. If the account falls below the maintenance
margin level the trader needs to replenish the account by giving additional funds. On the
other hands, if the position generates a gain, the funds can be withdrawn (those funds
above the required initial margin) or can be used to fund additional trades.
35
e) Pricing of Futures In futures contract the price is predetermined. The seller knows how much he is going to
be paid and the buyer knows how much he is going to pay at a future date. As futures
contracts are standardized according to quantity, quality and location, it is price that is the
only factor on which buyers and sellers can bargain. The price in futures market is
determined by a mechanism called Price discovery.
Price discovery
It is the process of arriving at a figure in which one person buys and another sells a
futures contract for a specific expiration date. In an active futures market, the process of
price discovery continues from the market's opening until its close. The prices are freely
and competitively derived. Future prices are therefore considered to be superior to the
administered prices or the prices that are determined privately. Further the low
transaction costs and frequent trading encourages wide participation in futures markets
lessening the opportunity for control by a few buyers and sellers.
In an active futures markets the free flow of information is vital. Futures exchanges act
as a focal point for the collection and dissemination of statistics on supplies,
transportation, storage, purchases, exports, imports, currency values, interest rates and
other pertinent information. Any significant change in this data is immediately reflected
in the trading pits as traders digest the new information and adjust their bids and offers
accordingly. As a result of this free flow of information, the market determines the best
estimate of today and tomorrow’s prices and it is considered to be the accurate reflection
of the supply and demand for the underlying commodity. Price discovery facilitates this
free flow of information, which is vital to the effective functioning of futures market.
Interpretation of Price charts and tables
Example: NCDEX Cotton Futures Prices on Thursday, September 4, 2005.
36
Contract
Month
Open High Low Settle Lifetime
High
Lifetime
Low
Open
Interest
Sept 262.75 263.50 261.50 262.00 270.50 238.00 33922
Dec 266.25 267.50 264.75 266.75 268.00 235.50 141307
Estimated Volume 38,000; volume Wed 38592; open interest 348967+987
The first line of the table: Cotton 5,000 Kg; Rs per 10 Kg. This indicates that the table
applies to the NCDEX Cotton contract, the contract size is 5,000 Kg, and the prices
shown in the table are in units of Rs per Kilograms.
Opening Price : The open or opening price is the price or range of prices for the day's
first trades, registered during the period designated as the opening of the market or the
opening call.
Closing Price : The closing price is the price or range of prices at which the commodity
futures contracts are traded during the brief period designated as the market close or on
the closing call (i.e. last minute of the trading day).
Highest Price: The word high refers to the highest price at which a commodity futures
contract is traded during the day.
Lowest Price: Low refers to the lowest price at which a commodity futures contract is
traded during the day.
Settlement Price: This is abbreviated as settle in most of the pricing tables. There will be
many trades occurring in the last few minutes. Settlement price is computed from the
range of closing prices. Settlement price is important to calculate the daily gains, losses
and margin requirements. It is used by the clearing house to calculate the market value of
outstanding positions held by its members.
37
Change: The change refers to the change in settlement prices from the previous days
close to the current day's close.
Lifetime high and low: They refer to the highest and lowest prices recorded for each
contract from the first day it traded to the present.
Open Interest: It refers to the number of outstanding contracts for each maturity month.
In the line at the bottom of the table, Est. vol. indicates the estimated volume of trading
for that day. Vol. Wed. indicates the trading volume for the previous day. Open interest
refers to the total open interest for all contract months combined at the end of the day's
trading session. Then the figure +987 indicates an increase of 987 contracts from the
open interest of the previous day.
Patterns of Futures Prices
As the maturity date approaches the futures prices show different patterns. Based on
these patterns the markets can be predicted.
Normal Markets: Markets where the prices increase as the time to maturity increases.
Inverted Markets:Markets where the price is a decreasing function of the time to
maturity.
Convergence of futures price to spot price
As the delivery month of a future contract approaches the futures prices converges to the
spot price of the underlying asset. When the delivery period is reached the futures price
equals or is very close to the spot price. This happens because if the futures price is
above the spot price during the delivery period it gives rise to a clear arbitrage
38
opportunity for traders. In case of such arbitrage the trader can short his futures contract,
buy the asset from the spot market and make the delivery. This will lead to a profit equal
to the difference between the futures price and spot price. As traders start exploiting this
arbitrage opportunity the demand for the contract will increase and futures prices will
fall leading to the convergence of the future price with the spot price. If the futures price
is below the spot price during the delivery period all parties interested in buying the asset
will take a long position. The trader would buy the contract and sell the asset in the spot
market making a profit equal to the difference between the future price and the spot
price. As more traders take a long position the demand for the particular asset would
increase and the futures price would rise nullifying the arbitrage opportunity.
f) Closing out the Positions The futures contracts are squared-off before the delivery date. Most of the traders choose
to closeout their positions prior to the delivery period specified in the contract. Closing
out means taking opposite positions of trade from the original one.
Continuing from Example 1 : The Mumbai investor who bought the December soybean
futures on September 2, 2005 can close out the position by selling (i.e. going short) one
December futures contract on any date before the agreed upon delivery date. The Indore
investor who sold the Soybean futures can closeout by buying one December contract at
any time before the Delivery date. The investor's total gain or loss is determined by the
change in the futures prices between the date of entering in to the contract and date of
closing out the contract.
CLEARING AND SETTLEMENT
INTRODUCTION
39
Most of the futures contracts do not lead to the actual physical delivery of the underlying
asset. The settlement is by closing out, physical delivery or cash settlement. All these
settlement functions are taken care of by an exchange-clearing house, called clearing
house / corporation, in futures transactions.
Clearing HouseA clearing house is a system by which exchanges guarantee the faithful compliance of all
trade commitments undertaken on the trading floor or electronically over the electronic
trading systems. The main task of the clearing house is to keep track of all the
transactions that take place during a day so that the net position of each of its members
can be calculated. It guarantees the performance of the parties to each transaction. It is
responsible for:
Effecting timely settlement
Trade registration and follow up
Control of the evolution of open interest
Financial clearing of the payment flow
Physical settlement (by delivery) or financial settlement (by price difference) of
contracts.
Administration of financial guarantees demanded by the participants.
Functions of the clearing houseClearing house has a number of members, who are mostly financial institutions
responsible for the clearing and settlement of commodities traded on the exchanges. The
margin accounts for the clearing house members are adjusted for gains and losses at the
end of each day (in the same way as the individual traders keep margin accounts with the
40
broker). In the case of clearing house members only the original margin is required (and
not maintenance margin). Everyday the account balance for each contract must be
maintained at an amount equal to the original margin times the number of contracts
outstanding. Thus depending on a day's transactions and price movement the members
either need to add funds or can withdraw funds from their margin accounts at the end of
the day. The brokers who are not the clearing members need to maintain a margin
account with the clearing house member through whom they trade in the clearing house.
Provisions Regarding Members Of The Clearing House
REGULATION OF CLEARING HOUSEExchanges shall prescribe the process from time to time for the functioning and
operations of the Clearing House and to regulate the functioning and operations of the
Clearing House for the settlement of non-depository deals.
CLEARING HOUSE TO DELIVER COMMODITIES AT
DISCRETIONThe Clearing House is entitled at its discretion to deliver commodities, which it has
received from a member under these Regulations to another member who is entitled
under these Regulations to receive delivery of commodities of a like kind or to instruct a
member to give direct delivery of commodities which he has to deliver.
41
Processes of a clearing house
NO LIEN ON CONSTITUTUENT'S COMMODITIESWhen a member is declared a defaulter neither the Exchange nor the creditor of the
defaulter shall be entitled to any lien on the commodities delivered by him to the Clearing
House on account of his Constituents.
CLEARING CODE AND FORMS
42
Member Trading Report Statement of commitments
Checking
Trading Roo Price information Commitments information
Clearing Section-Report on Margins In-out
Input
Computer Processing
OutputStatement of account for daily Settlement Daily clearing account (Mark to Market) Exchange Trading fee Exchange Tax Liability Reserve
Statement of Margines Margin Required - Margin
PaymentMargin required or refundable
Amount to be paid or received
Margin required is to be paid by cash or substitutable securities. Margin refundable is to
To be made through account transfer at the contracted bank by noon of 2 business days after
A member shall be allotted a Clearing Code, which must appear on all forms used by the
member connected with the operation of the Clearing House. The Clearing Forms and
Formats to be used by the members shall be prescribed by the Clearing House.
SIGNING OF CLEARING FORMSThe member or his Clearing Assistant shall sign all Clearing Forms
SPECIMEN SIGNATURESA member shall file with the Clearing House specimens of his own signature and of the
signatures of his Clearing Assistants. The member and his Authorised Representative in
the presence of an officer of the Exchange or of the Clearing House shall sign the
specimen signatures card.
CLEARANCE BY MEMBERS ONLYClearing members including professional Clearing Members only shall be entitled to
clear and settle contracts through the Clearing House.
CHARGES FOR CLEARINGThe Exchange shall from time to time prescribe the scale of clearing charges for the
clearance and settlement of transactions through the Clearing House.
CLEARING HOUSE BILLSThe Clearing House shall periodically render bills for the charges, fees, fines and other
dues payable by members to the Exchange which would also include the charges for the
use of the property as well as the charges, fines and other dues payable on account of the
business cleared and settled through the Clearing House and debit the amount payable by
members to their accounts. All such bills shall be paid within a week of the date on
which they are rendered.
LIABILITY OF THE CLEARING HOUSE
43
The only obligation of the Clearing House shall be to facilitate the delivery and payment
in respect of commodities, transfer deed and any other documents between members.
SETTLEMENT METHODSA contract can be settled in three ways:
By physical delivery of the underlying asset.
Closing out by offsetting positions.
Cash settlement.
Closing Out
Most of the contracts are settled by closing out. In closing out, the opposite transaction is
effected to close out the original futures position. A buy contract is closed out by a sale
and sale contract is closed out by a buy.
Cash Settlement
When a contract is settled in cash it is marked to the market at the end of the last trading
day and all positions are declared closed. The settlement price on the last trading day is
set equal to the closing spot price of the underlying asset ensuring the convergence of
future prices and the spot prices.
Commodity Physical settlement schedule for
pay in/payout’s
Soyabean T+7
Refined soyabean oil T+7
Rapeseed mustard seed T+7
Rapeseed mustard seed oil T+7
RBD Palmolein T+7
Crude palm oil T+7
44
Medium staple cotton T+10
Long staple cotton T+10
Gold T+2
Silver T+4
T’ is the date of expiry of the contract.
Cash settlement on T+1 for all contracts.
Process of Dematerlization:-
Dematerlization refers to issues of an electronic credit, instead of vault/
warehouse receipt, to the depositor against the deposit of commodity. Any person (a
consultant) seeking to dematerialize a commodity has to open an account with an
approved depository participant.
In case of agri commodities the constituent delivers the commodity to the
exchange-approved warehouses. The commodity brought by the constituent is checked to
the quality by the exchange-approved assayers before the deposit of the same is accepted
by the warehouse. If the quality of the commodity is a per the norms defined and notified
by the exchange from time to time, the warehouse accepts the commodity and sends
conformation in the requisite form to the R&T agent who upon verification, confirms the
deposit of such commodity to the depository for giving credit to the demat account of the
said constituent.
In case of precious metals, the commodity must be accompanied with the
assayers’ certificate. The vault accepts the precious metal, after verifying the contents of
assayers’ certificate with the precious metal being deposited. On acceptance, the vault
issues an acknowledgement to the constituent and sends confirmation in the requisite
45
format to the R&T agent who upon verification, confirms the deposit of such precious
metal to the depository for giving credit to the demat account of the said constituent.
Process of re-materialization:-
Seller client of member
Warehouse
R & T AgentAccepts Goods
NSDL
Submits commodities & Demat Request Form
Sends data to NSDL via R & T Agent
46
Re-materialization refers to issue of physical delivery against the credit in the demat
account of the constituent. The constituent seeking to rematerialize his commodity
holding has to make a request to his DP then routes his request through the depository
system to the R& T agent issues the authorization addressed to the vault/warehouse to
release physical delivery to the constituent.
Commodity AnalysisStudy on some commodities that are traded in the commodity markets. Commodities
selected are which are traded widely in the market. So commodities like gold and guar
are selected. This analysis contains brief description if product, factors affecting its
supply and demand,
1. Gold
For centuries, gold has meant wealth, prestige, and power, and its rarity and natural
beauty have made it precious to men and women alike. Owning gold has long been a
safeguard against disaster. Many times when paper money has failed, men have turned to
gold as the one true source of monetary wealth. Today is no different. While there have
been fluctuations in every market and decided downturns in some, the expectation is that
gold will hold its own. There is a limited amount of gold in the world, so investing in
gold is still a good way to plan for the future. Gold is homogeneous, indestructible and
fungible. These attributes set gold apart from other commodities and financial assets and
tend to make its returns insensitive to business cycle fiuctuations. Gold is still bought
(and sold) by different people for a wide variety of reasons ñ as a use in jewellery, for
industrial applications, as an investment and so on.
47
Traditionally South Africa has been the largest producers of gold in the world accounting
for almost 80% of all non communist output in 1970. Although it retained its position as
the single largest gold producing country, its share had fallen to around 17% by 1999
because of high costs of mining and reduced resources. In contrast other countries like
US, Australia, Canada and China have increased their output exponentially with output
from developing countries like Peru and other Latin American countries also increasing
impressively.
Global and domestic Demand-Supply
The demand for gold may be categorized under two heads consumption demand and
investment demand. Consumption of gold differs according to type, namely industrial
applications and jewellery. The special feature of gold used in industrial and dental
applications is that some of it cannot be salvaged and thus is truly consumed. This is
unlike consumption in the form of jewellery, which remains as stock and can reappear at
future time in market in another form.
Consumer demand accounts for almost 90% of total gold demand and the demand for
jewelry forms 89% of consumer demand.
1996 1997 1998 1999 2000
--------------------------------------------------------------------------------------------
India 506.98 736.84 814.91 838.86 855.34
USA 331.56 362.04 428.29 459.71 387.55
China 374.48 406.83 314.45 343.38 329.38
SE Asia 329.69 204.04 51.63 265.62 267.18
Saudi 184.75 199.06 208.39 199.37 221.14
Turkey 153.03 201.86 172.00 139.03 207.15
World Markets
48
Today's gold market is a round-the-world, round-the-clock business, played out largely
on dealers' trading screens. The core of the business, however, remains in the key markets
of London, as the great clearing house, New York as the home of futures trading, Zurich
as a physical turntable, Istanbul, Dubai, Singapore and Hong Kong as doorways to
important consuming regions and Tokyo where the Commodity Exchange (TOCOM) sets
the mood of Japan. Even Paris still has a small market, a reminder of the days when the
French were great hoarders, while Mumbai has increasing importance under India's
liberalised gold regime that permits official imports through local markets.
Domestic ScenarioIndia is the world's largest consumer of gold. According to Gold Field Minerals Service,
in 2001 it absorbed around 700 tons from the world market, compared to just 320 tons in
1994; that is without taking into account the recycling of scrap from the immense stock
of close to 10,000 tons built up on the sub-continent in the last few hundred years, or gold
imported for jewellery manufacture and re-export.
During 1990-95, India’s share in global gold demand is placed at about 402 tons (16.4
per cent) a year, including imports into India. This should be viewed against its share of
0.6 per cent in world trade. On the other hand, India exported about 23 tons in 1995
accounting for a negligible part of world trade.
Gold is valued in India as a savings and investment vehicle and is the second preferred
investment behind bank deposits. India is the world’s largest consumer of gold in
jewellery (much of which is purchased as investment). However, gold has to compete
with the stock market, investment in internet industries, and a wide range of consumer
goods. In the rural areas 22 carat jewellery remains the basic investment.
Jewellery
India is the world's foremost gold jewellery fabricator and consumer with fabricator and
consumption annually of over 600 tons according to GFMS. Measures of consumption
49
and fabrication are made more difficult because Indian jewellery often involves the re-
making by goldsmiths of old family ornaments into lighter or fashionable designs and the
amount of gold thus recycled is impossible to gauge. Estimates for this recycled jewellery
vary between 80 tons and 300 tons a year. GFMS estimates are that official gold bullion
imports in 2001 were 654 tons.
Factors affecting the price of Gold
Uncontrolled and uncertain supply
Besides new mining supply, the available supply of gold in the market is made up of
three major ‘above-ground sources’. In recent years, the growth in gold supply has come
from these ‘aboveground’ sources.
Reclaimed scrap, or gold reclaimed from jewelry and other industries such as
electronics
and dentistry;
Official, or central-bank, sales
50
Gold loans made to the market from official gold reserves for borrowing and
lending purposes.
The supply from these sources is not determined easily, so it is not possible to estimaye
the total supply.
Fluctuating and uncertain demand
The deregulation of the Indian gold market during the 1990s brought about a dramatic
change. Jewellery demand increased from 208 tons in 1991 to peak at 658 tons in 1998,
while demand for investment bars grew from 10 tons in 1991 to 116 tons in 1998, and
registered 85 tons in 2002. India in 2001 it absorbed around 700 tons from the world
market compared to just 320 tons in 1994; that is without taking into account the
recycling of scrap.
In India the rural population accounts for approximately 70% of national gold demand.
Thus India’s annual gold consumption is dictated both by the monsoon, with its effect on
the harvest, and the marriage season. Between 1998-2001 annual Indian demand for gold
in jewellery exceeded 600 tons, however in 2002, due to rising and volatile prices and a
poor monsoon season, this dropped back to 490 tons.
The major factors influencing demand for gold in India are,
Generation of large market surplus in rural areas as a result of all round increase
in agricultural production
Unaccounted income/wealth generated mainly in the service sector
Domestic gold prices relative to those of ordinary shares and international gold
prices
Wide and unforeseen price variation
51
Economic forces that determine the price of gold are different from, and in many cases
opposed to, the forces that influence most financial assets.
Econometric studies indicate that the price of gold is determined by two sets of factors:
‘supply’ and ‘macro-economic factors’.
Supply and the gold price are inversely related. In the case of ‘macro-economic factors’,
the U.S. dollar tends to be inversely related to gold, while inflation and gold tend to move
in tandem with each other. Also, high low-interest rates are generally a positive factor for
gold. Overall, the impact of all of these determinants on the gold price is judged to be
neutral-to-positive at this time. Also there is low to negative correlation between returns
on gold and those on stock markets
An Article from ‘The Hindu’
Demand for gold set to remain strong
World price likely to reach $500 an ounce by the end of 2005.
Oil-dollar-gold price link broken Alternative for speculative investors Nine-
month sale in India exceeds that of whole of 2004.
52
MUMBAI 7 th November, 2005 :World Gold Council (WGC) data reveal that in the first
nine months of 2005, Indian demand was up at 645 tonnes (470 tonnes) and Indians
bought 642 tonnes of the metal more than the whole of last year. Besides, it is expected
that with the festive and wedding seasons in full swing, the full year figure could well
break the previous record of 795 tonnes in 1998. According to the WGC, following the
astonishing growth witnessed in the first half of 2005, when total consumer demand rose
55 per cent.
With the U.S. dollar at a two-year high and oil prices having peaked, the alternative to
investors seems to have been gold. Madhusudan Daga, Bullion Analyst and Consultant,
Goldfield Mineral Services, attributed the spectacular rise to open speculative positions
in the U.S. "This time the link between gold, oil and the U.S. dollar seems to have been
broken. While gold has traditionally had a direct link with oil prices and an inverse one
with the U.S. dollar, this time, gold has moved up in consonance with falling oil and
rising dollar."
In India, investment demand in the first nine months of 2005 was up 50 per cent at 105
tonnes (71 tonnes) and in the July-September period, it was up 56 per cent. Globally, the
price moved up to $488 per ounce from $458 per ounce in July. Mr. Daga was confident
that prices would cross the $500 per ounce mark by the year-end.
Sanjeev Agarwal, Managing Director, Indian Subcontinent, World Gold Council, "Gold
has been on the up because over the last few years, with the U.S. dollar weakness and the
huge deficit in the U.S., the investors have been looking at other options like housing,
hedge funds and gold. Also, oil prices have moved up in last six months. So gold has been
seen as a means of diversification of portfolio."
"The underlying prospects for gold in India remain very good. The economy continues to
perform." according to the WGC.
53
Trading system NCDEX's Trading System
Trading Hours
Monday to Friday
Trading Hours - 10.00 a.m. to 4.00 p.m. & 5.00 p.m. to 11.00
p.m.
Closing session – 11.15 p.m. to 11.30 p.m. or as may be decided
and notified by the Exchange from time to time
Unit of trading 1 kg
Delivery unit 1 kg
Quotation/Base Value Rs per 10 Grams of Gold with 999.9 fineness
Tick size Re 1 or as may be notified by the Exchange from time to time
Price band Limit 10%. Limits will not apply if the limit is reached during
final 30 minutes of trading
Quality specification
Not less than 995 fineness bearing a serial number and
identifying stamp of a refiner approved by NCDEX. List of
approved refiners will be available with the Exchange and also
on its web site: www.ncdex.com
Quantity Variation None
No. of active contracts 3 concurrent month contracts or as may be notified by the
Exchange from time to time
Delivery center Mumbai as also other centers as may be notified by the Exchange
from time to time
Opening Date The first 3 contracts will be launched on March 31, 2004.
54
Subsequently, trading in any contract month will open on the
21st day of the month or as may be decided by the Exchange
from time to time.
Due date 20th day of the delivery month, if 20th happens to be a holiday
then previous working day
Position limits Member-wise: Max (Rs 200 Crores, 15% of open interest)
Client-wise: Max (Rs 100 Crores, 10% of open interest)
Premium/Discounting
The price adjustment will be given for the fineness below 999.9.
The settlement price for less than 999.9 fineness will be
calculated as: (actual fineness / 999.9) Settlement Price
55
2. Guar Seed
Introduction:-
Guar, or cluster bean, (Cyamopsis tetragonoloba (L.) Taub) is a drought-tolerant
annual legume crop. Guar is being grown in India since ancient time and the Tender
Green Guar is an important source of nutrition to animals and humans and is consumed
as a vegetable and cattle feed The Guar legume plant is an agricultural product grown in
arid zones of west and North West India and parts of Pakistan.
India accounts for 80% of the total guar produced in the world and 70% is
cultivated in Rajasthan. Apart from Rajasthan, it is being grown mainly in Gujarat,
Haryana and Punjab. It is also grown in some parts of Uttar Pradesh and Madhya
Pradesh.
Global Scenario:-
56
Pakistan, Sudan and parts of USA are the other major Guar growing countries.
75% of the Guar Gums or their derivatives produced in India are exported mainly to USA
and European countries. The value added derivatives of Guar Powder are used by the
various industries in India as well as abroad.
Geographic/Agronomic suitability:
Guar grows best in sandy soils and it needs moderate, intermittent rainfall with
lots of sunshine. Too much precipitation can cause the plants to become leafier, thereby
reducing the number of pods and/or the number of seeds per pod which affects the size
and yield of the seeds. Guar is a rain fed monsoon crop, which requires 8-15 inch of rain
in 3-4 spell and is generally sown after the monsoon rainfall in the second half of July to
early August and is harvested in October - November. Guar requires 2 rainfalls before
sowing, one when the crop buds, and one rainfall when the crop comes up well and the
blossoming starts.
The Guar has the properties to regenerate soil nitrogen and the endosperm of guar
seed is an important hydrocolloid widely used across a broad spectrum of industries.
Rajasthan accounts for 70% of the Guar Seed cultivation.
Pricing Pattern:-
Guar seed has shelf life of more than 3 years without losing out on any of its
properties or qualities. It requires the barest minimum maintenance and handling
environment. The price range of Guar seed ranges from Rs 850/- per qtl to Rs 6500/- qtl.
57
The Value Chain:-
Farmer
Agent (mandi) stockist
Broker
Split Processing Units
Broker
Powder Processing Units
Industrial use (local/export)
Consumer
Various Industrial applications of Guar Powder:-
Food, pet-food, nutritional products and pharmaceuticals.
Personal care products.
Household products.
Paints.
Textiles and carpets.
58
Mining and flocculation.
Oils, gas and other deep well operations.
Paper.
Impediments in development of commodity exchanges
Agricultural commodity Futures exchanges in India are still not developed as compared
to other countries. The dominant political ideology during early years after independence
dealt a severe blow to development of futures exchanges in India. It is only after the onset
of liberalization during 1990s that attitude towards futures trading has changed and its
potential benefits are now being acknowledged in the policy circles. However, there are
still a number of impediments in their growth many of which are on account of regulatory
provisions while others relate to the practices of trade prevalent in these exchanges. As a
result of these impediments membership of commodity exchanges and volume of futures
transactions have remained low.
The membership of a majority of agricultural commodity exchanges have either remained
stagnant or declined during last few years. Small and stagnant number of members proves
that the business of trading in futures is not considered attractive. Examples of a few
exchanges will illustrate this point. The number of active members in Kochin pepper
exchange declined from 55 in 1999 to 33 in 2001. In castor oil exchange at Mumbai it
declined from 8 to 5, in Potato exchange at Hapur, it declined from 36 to 21 and in
Cotton exchange it declined from 15 to 7 during the same period. In most of the
agricultural commodity exchanges, less than 10 per cent of the registered members are
actually actively trading.
These are definite pointers to deep malaise afflicting the futures trading business in India.
Similarly, the volume of transactions in agricultural commodity exchanges have been
very low except in pepper exchange at Cochin, Gur exchange at Hapur, Castor seed
exchange at Ahmedabad, Gur exchanges at Bhatinda and Muzaffarnagar, Soya exchange
at Indore and Jute exchange at Kolkata where the annual transaction exceeded Rs. 2000
Crores during 2000-01. The average volume of transaction of other exchanges was less
59
than Rs. 100 Crores during 2000-01. Some of the reasons for low membership and low
volume of transactions in agricultural commodity exchanges are discussed below:
o Most of the exchanges still follow open outcry system. This stystem is not
considered to be efficient and transparent. The chances of manipulations are quite
high in open outcry system. This is the reason why the Forward Market
Commission has been emphasizing on the need for automation and has made it
mandatory to have on-line trading system for all the commodity exchanges that
are set up newly. There is a global trend towards electronic trading; even the
exchanges that have a legacy of open outcry (and the concomitant problem of
floor brokers keen on defending their turf) are now moving towards electronic
trading.
o Most of the agricultural commodity exchanges in India are beset with the problem
of poor infrastructure. They even lack basic infrastructure like modern trading
ring, warehousing facilities. independent clearing house
o Under the existing system, users of exchange, i.e. traders, hedgers, speculators,
etc need to register their full details with Forward Market Commission. This is not
in tune with foreign exchanges norms. This adds unrequired regulatory costs. This
becomes a significant issue in India where there is large expandable economy.
o Due to history of ban on futures trading a “Havala” or unorganized marketwas
built and they continue to exist now. A large portion of future is diverted to this
market. Due to there long existence they have built up good reputation in terms of
liquidity and integrity some of these markets trade as much as 20-30%higher than
registered markets.
o There is widespread lack of awareness the role and technique of trading among
the potential beneficiaries. Only traditional players who have been participating in
60
such trading either in formal markets or gray markets. This acts as a barrier to the
growth of futures trading in India.
o Currently, Indian tax law does not permit losses on a futures transaction to
be treated as a business expense to be offset against, say, a profit on the
underlying physical trade (unless there is a definite underlying contract).
o A major flaw in Indian commodities futures market is the practice of having an
exclusive futures exchange for each commodity. This has happened due to
historical reasons. Futures exchanges got set up in specific regions in which there
was an active spot market for a particular agricultural commodity. As a result the
volumes available at each exchange are so miniscule that it does not permit large
investments required to create a modem derivative exchange.
o No futures market can exist in the absence of variability in the prices. Through a
host of diverse measures such as price controls, price support operations,
procurement and distribution schemes, buffer stock operations, restriction on
storage and movement, etc. the government has tried to virtually eliminate price
risks. There are also commodity based specialized government agencies like
NAFED, Cotton Corporation of India, Jute Corporation of India, etc. which
control supplies of some farm products. In the presence of these restrictions the
futures markets can't be expected to develop and play any meaningful role in price
discovery of agricultural commodities.
61
Recommendations
Electronic/Modern Technique
Markets in are traditional type, so there are huge amount of manipulations in it. So it’s
necessary for the governing body to use modern technique for trading in futures to avoid
such manipulations and provide its members with fair trading.
Create Awareness among Farmers
In India many farmers, traders are not aware about the existence of commodity markets.
Inspite of efforts taken by the government to create awareness it is still not enough to
attract farmers and traders towards the commodity and regulated markets. This is due to
lack of educational facilities to farmers.
Permitting FII and mutual-fund participation :-
Currently, regulations do not permit FIIs and mutual funds to participate in
commodity trading in India. Removal of these restrictions is likely to provide further
depth to the commodity markets as FIIs are likely to trade actively across various
commodity markets and asset classes globally to take advantage of arbitrage
opportunities.
Increasing corporate and retail participation :-
Commodity trading in India is still at a nascent stage, with the majority of volume
attributable to traders, industry associations and speculators. Corporate and retail
62
participation is negligible. However, I believe this will change once the contracts mature
and there is sufficient liquidity. Up to now only a few companies have used commodity
exchanges to hedge on a trial basis. Their full entry will boost liquidity and trading
volume.
Create Infrastructure
Commodity markets lack proper infrastructural facilities which are necessary for
conducting trading smoothly. So it is necessary to have good infrastructural facilities to
improve commodity markets. It should have proper ordering, filling , processing, storage,
dispatching facilities.
Contract of Smaller Value
Exchanges should come with concept like contract of smaller value. A contract of smaller
would be able to attract the small investors to play in the markets. This could enable to
abolish the monopoly of few existing members. This can also help these exchanges to
increase the number of their members.
Introduction of options Transaction volume will rise further if the regulator opens up the commodity
exchanges for commodity option trading. Currently, only trading in commodity futures is
permissible. Globally, trading volume from options is 20-30 % of the futures volume,
implying that India exchanges could get a further 20-30 % boost in commodity trading
volume.
63
Warehousing Facility
All the exchanges have their warehouses at a particular place i.e. the place where it is
traded in huge numbers or place where it is produced. So it is necessary for the exchanges
to locate heir warehouses at various places as it is possible to deliver and collect the
goods. This could help in increasing percentage of delivery.
Compulsory Delivery
Exchanges can also try with compulsory delivery contracts. This contract can be helpful
basically for farmers through which they can sell off their produce at reasonable prices.
64
ConclusionIn spite of the best efforts of the government and the banks, the credit off take for
agricultural sector is not increasing to the desired extent. For this to happen, deepening of
agricultural credit market is necessary. If farmers have access to market-based price
insurance through futures markets, they will be able to benefit from higher income by
commercial farming and the potential profitability of specialization. The higher
investment required for commercial and hi-tech farming will boost the demand for farm
credit. The policy environment governing the Indian agricultural sector is rapidly
evolving. Several measures have been adopted which suggest that international price and
competition is likely to intensify in agriculture sector in near future. In order to enable the
Indian farmers to meet these challenges comprehensively, the policy environment will
have to be suitably changed. The market forces will have to be given a much greater
freedom to discover prices. It is in this context that futures markets assume a very
important role in facilitating discovery of prices and devising new and effective risk
management tools for the benefit of farming economy. The opening of futures trading in
several commodities, after an almost 40-year gap, is a welcome step. Futures trading is
employed in all major global commodities markets as an effective hedge against
fluctuating prices. However, in India a great deal of groundwork, such as strengthening
Forward Market Commission, amending Forward Contract Act, 1952 and modifying
Essential Commodities Act, Minimum Support Price Mechanism, etc., needs to be done
if the futures markets are to efficiently carry out their function as a mechanism of price
discovery and risk management. There is a need to put in place a strong, but not
excessive, regulatory regime that will ensure transparency and efficient trading and
encourage development of futures trade. Efficient futures markets will stabilize the
incomes of the farmers and provide an incentive to go for capital-intensive cash crops.
This, in turn, will increase the demand for agricultural credit. Higher and stable income
of the farmers will help in emergence of a sustainable credit market in rural areas with
high demand for credit coupled with high percentage of repayment of loans.
65
Bibliography
Books/ magazine: - NCFM Form National Stock Exchange.
Bank Quest
Websites: - www.mcxindia.com
www.ncdex.com
www.ficci.com
www.iibf.org
www.motilaloswal.com
Newspapers: - Hindustan Times
The Economic Times
66