CHAPTER -1

AN INTRODUCTION

Commodity market is an important constituent of the financial

markets of any country. It is the market where a wide range of

products, viz., precious metals, base metals, crude oil, energy and

soft commodities like palm oil, coffee etc. are traded. It is important

to develop a vibrant, active and liquid commodity market. This

would help investors hedge their commodity risk, take speculative

positions in commodities and exploit arbitrage opportunities in the

market.

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

organised 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 in1960s resulted in virtual dismantling of

the commodity futures market. It is only in the last decade that

commodity futures exchanges have been actively encouraged

however, the markets have not grown to significant levels.

A commodity derivatives market (or exchange) is, in simple terms,

nothing more or less than a publicmarketplace where commodities

are contracted for purchase or sale at an agreed price for delivery

1

at aspecified date. These purchases and sales, which must be

made through a broker who is a member of an organized

exchange, are made under the terms and conditions of a

standardized futures contract.Commodity prices do vibrate more

rapidly and provide profitable opportunities, accordinglyrecessions,

depressions and booms offer many opportunities to scoop up

profits. Exchange TradedDerivatives can be broadly classified

into Futures and Options.

Evolution of the commodity market in India

Although India has a long history of trade in commodity

derivatives, this segment remained underdeveloped due to

government intervention in many commodity markets to control

prices. The production, supply and distribution of many agricultural

commodities are still governed by the state and forwards and

futures trading are selectively introduced with stringent controls.

While free trade in many commodity items is restricted under the

Essential Commodities Act (ECA), 1955, forward and futures

contracts are limited to certain commodity items under the Forward

Contracts (Regulation) Act (FCRA), 1952.

The first commodity exchange was set up in India by Bombay

Cotton Trade Association Ltd., and formal organized futures

trading started in cotton in 1875. Subsequently, many exchanges

came up in different parts of the country for futures trade in various

commodities. The Gujrati Vyapari Mandali came into existence in

1900 which has undertaken futures trade in oilseeds first time in

2

the country. The Calcutta Hessian Exchange Ltd and East India

Jute Association Ltd were set up in 1919 and 1927 respectively for

futures trade in raw jute. In 1921, futures in cotton were organized

in Mumbai under the auspices of East India Cotton Association

(EICA). Many exchanges were set up in major agricultural centres

in north India before world war broke out and they were mostly

engaged in wheat futures until it was prohibited. The existing

exchanges in Hapur, Muzaffarnagar, Meerut, Bhatinda, etc were

established during this period. The futures trade in spices was first

organized by India Pepper and Spices Trade Association (IPSTA)

in Cochin in 1957. Futures in gold and silver began in Mumbai in

1920 and continued until it was prohibited by the government by

mid-1950s. Options are though permitted now in stock market,

they are not allowed in commodities. The commodity options were

traded during the pre-independence period. Options on cotton

were traded until they along with futures were banned in 1939

(Ministry of Food and Consumer Affairs, 1999). However, the

government withdrew the ban on futures with passage of FCRA in

1952. The Act has provided for the establishment and constitution

of Forward Markets Commission (FMC) for the purpose of

exercising the regulatory powers assigned to it by the Act. Later,

futures trade was altogether banned by the government in 1966 in

order to have control on the movement of prices of many

agricultural and essential commodities.

After the ban of futures trade all the exchanges went out of

business and many traders started resorting to unofficial and

informal trade in futures. On recommendation of the Khusro

Committee in 1980 government reintroduced futures on some

3

selected commodities including cotton, jute, potatoes, etc. As part

of economic liberalization of 1990s an expert committee on

forward markets under the chairmanship of Prof. K.N. Kabra was

appointed by the government of India in 1993. Its report submitted

in 1994 recommended the reintroduction of futures which were

banned in 1966 and also to widen its coverage to many more

agricultural commodities and silver. In order to give more thrust on

agricultural sector, the National Agricultural Policy 2000 has

envisaged external and domestic market reforms and dismantling

of all controls and regulations in agricultural commodity markets. It

has also proposed to enlarge the coverage of futures markets to

minimize the wide fluctuations in commodity prices and for hedging

the risk arising from price fluctuations. In line with the proposal

many more agricultural commodities are being brought under

futures trading.

4

ABOUT THE REPORT

Title Of The Study:

The present study titled as “A project report on the COMMODITY

DERIVATIVE MARKETS”.

Objective of the study:

The following objectives of the present study are:

o To understand about the commodity derivative market.

o To know about the commodity derivative markets

instruments.

Limitations of the study:

The following limitations of the present study are:

o The period for the study is limited.

o The study deals only with the Indian market.

Data And Methodology:

For the purpose of the present study the secondary data was

used. The secondary data were collected from journals, internet ,

book and newspaper.

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Presentation of the study:

Following are the Presentation of the study;

Chapter-1 Gives an introduction to the study.

Chapter-2 Deals with an overview of commodity exchanges

in India.

Chapter-3 Deals with profile of Commodity derivative market.

Chapter-4 Recent news reports relating to commodity

derivatives .

Chapter-5 Conclusion

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CHAPTER-2

COMMODITY EXCHANGES- AN OVERVIEW

Commodity exchanges are defined as centres where futures trade

is organized in a widersense; it is taken to include any organized

market place where trade is routed through onemechanism,

allowing effective competition among buyers and among sellers.

This would includeauction-type exchanges, but not wholesale

markets, where trade is localized, but effectivelytakes place

through many non-related individual transactions between different

permutationsof buyers and sellers.

Role of Commodity Exchanges

Commodity exchanges provide platforms to suit the

variedrequirements of customers. Firstly, they help in price

discovery as players get to set future prices which are also made

available toall participants. Hence, a farmer in the southern part of

India would be able to know the bestprice prevailing in the country

which would enable him to take informed decisions. For this

tohappen, the concept of commodity exchanges must percolate

down to the villages. Today thefarmers base their choice for next

year's crop on current year's price. Ideally this decisionought to be

based on next year's expected price. Futures prices on the

platforms of commodityexchanges will hopefully move farmers of

our country from the current 'cobweb' effect whereadditional

7

acreage comes under cultivation in the year subsequent to one

when a commodityhad good prices; consequently the next year the

commodity price actually falls due to oversupply.

Secondly, these exchanges enable actual users (farmers, agro

processors, industry where thepredominant cost is commodity

input/output cost) to hedge their price risk given the uncertaintyof

the future - especially in agriculture where there is uncertainty

regarding the monsoon andhence prices. This holds good also for

non-agro products like metals or energy products aswell where

global forces could exert considerable influence. Purchasers are

also assured of afixed price which is determined in advance,

thereby avoiding surprises to them. It must beborne in mind that

commodity prices in India have always been woven firmly into

theinternational fabric. Today, price fluctuations in all major

commodities in the country mirrorboth national and international

factors and not merely national factors.

Thirdly, by involving the group of investors and speculators,

commodity exchanges provideliquidity and buoyancy to the

system.

Lastly, the arbitrageurs play an important role in balancing the

market as arbitrage conditions,where they exist, are ironed out as

arbitrageurs trade with opposite positions on differentplatforms and

hence generate opposing demand and supply forces which

ultimately narrowsdown the gaps in prices.

It must be pointed out that while the monsoon conditions affect the

prices of agro-basedcommodities, the phenomenon of

globalization has made prices of other products such asmetals,

8

energy products, etc., vulnerable to changes in global politics,

policies, growthparadigms, etc. This would be strengthened as the

world moves closer to the resolution of theWTO impasse, which

would become a reality shortly. Commodity exchanges would

provide avaluable hedge through the price discovery process while

catering to the different kind ofplayers in the market.

There are more than 20 recognised commodity futures exchanges

in India under the purviewof the Forward Markets Commission

(FMC). The country's commodity futures exchanges aredivided

majorly into two categories:

• National exchanges

• Regional exchanges

The four exchanges operating at the national level (as on 1st

January 2010) are:

i) National Commodity and Derivatives Exchange of India Ltd.

(NCDEX)

ii) National Multi Commodity Exchange of India Ltd. (NMCE)

iii) Multi Commodity Exchange of India Ltd. (MCX)

iv) Indian Commodity Exchange Ltd. (ICEX) which started trading

operations on November27, 2009

The leading regional exchange is the National Board of Trade

(NBOT) located at Indore. Thereare more than 15 regional

commodity exchanges in India.

9

Trade Performance of leading Indian Commodity Exchanges

for January 2010

INDIAN COMMODITY EXCHANGES

Some of the features of national and regional exchanges are listed

below:

National Exchanges

• Compulsory online trading

• Transparent trading

• Exchanges to be de-mutualised

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• Exchange recognised on permanent basis

• Multi commodity exchange

• Large expanding volumes

Regional Exchanges

• Online trading not compulsory

• De-mutualisation not mandatory

• Recognition given for fixed period after which it could be

given for re-regulation

• Generally, these are single commodity exchanges.

Exchanges have to apply for tradingeach commodity.

• Low volumes in niche markets

Commodity Exchanges in India

NO. Exchanges Main Commodities

1. Multi Commodity

Exchange of India Ltd.

Mumbai*

Gold, Silver, Copper, Crude Oil,

Zinc, Lead, Nickel, Natural gas,

Aluminium, Mentha Oil,

rude_Palm_Oil, RefinedSoya Oil,

Cardamom, Guar Seeds, Kapas,

Potato,Chana\Gram, Melted

Menthol Flakes, Almond,

Wheat,Barley, Long Steel, Maize,

Soybean Seeds, Gasoline US,

Tin, Kapaskhali, Platinum,

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Heating Oil

2.

National Commodity And

Derivative Exchange

Mumbai*

Guar Seed, Soy Bean, Soy Oil,

Chana,RM Seed, Jeera,

Turmeric, Guar Gum, Pepper,

Cotton Cake, Long Steel,

Gur, Kapas, Wheat, Red Chilli,

Crude Oil, Maize, Gold,

Copper, Castor Seeds, Potato,

Barley, KachhiGhani

Mustard Oil, Silver, Indian 28 Mm

Cotton, Platinum

3.

National Multi

Commodity Exchange of

India Limited

Ahmedabad*

Rape/Mustard Seed, Guar

Seeds, Nickel, Jute, Refined

Soya Oil, Zinc, Rubber, Chana\

Gram, Isabgul, Lead, Gold,

Aluminium, Copper, Turmeric,

Copra, Silver, Raw Jute,Guar

Gum, Pepper, Coffee Robusta,

Castor Seeds, Mentha

Oil

4.

Indian Commodity

Exchange Limited,

Gurgaon *

Gold, Crude Oil, Copper, Silver

5.National Board of Trade.

IndoreSoy bean, Soy Oil

6.Chamber Of

Commerce,HapurGur, Mustard seed

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7.Ahmedabad Commodity

Exchange Ltd.

Castor seed

8.Rajkot Commodity

Exchange Ltd, Rajkot

Castorseed

9.

Surendranagar Cotton &

Oilseeds Association Ltd,

S.nagar

Kapas

10.The Rajdhani Oil and

Oilseeds Exchange Ltd.,

Delhi

Gur, Mustard Seed

11. Haryana Commodities

Ltd.,Sirsa

Mustard seed, Cotton seed Oil

Cake

12. India Pepper & Spice,

Trade Association. Kochi

Pepper Domestic-MG1,Pepper

550 G/L

13. Vijay Beopar Chamber

Ltd.,MuzaffarnagarGur

14.The Meerut Agro

Commodities Exchange

Co. Ltd., Meerut

Gur

15. Bikaner Commodity

Exchange Ltd.,BikanerGuarseed,

16.First Commodity

Exchange of India Ltd,

Kochi

Coconut oil

17. The Bombay Commodity

Exchange Ltd. Mumbai

Castorseed

18. The Central India

Commercial Exchange Mustard seed

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Ltd,Gwalior

19. Bhatinda Om & Oil

Exchange Ltd., Batinda.Gur

20. The Spices and Oilseeds

Exchange Ltd., SangliTurmeric

21.The East India Jute &

Hessian Exchange Ltd,

Kolkatta

Raw Jute

22. The East India Cotton

Association Mumbai.Cotton

NCDEX

National Commodity & Derivatives Exchange Limited (NCDEX), a

national level online multi-commodityexchange, commenced

operations on December 15, 2003. The Exchange hasreceived a

permanent recognition from the Ministry of Consumer Affairs, Food

and PublicDistribution, Government of India as a national level

exchange. The Exchange, in just over twoyears of operations,

posted an average daily turnover (one-way volume) of around Rs

4500-5000 crore a day (over USD 1 billion). The major share of the

volumescomes from agriculturalcommodities and the balance from

bullion, metals, energy and other products. Trading isfacilitated

through over 850 Members located across around 700 centers

(having ~20000trading terminals) across the country. Most of these

terminals are located in the semi-urbanand rural regions of the

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country. Trading is facilitated through VSATs, leased lines and

theInternet.

Structure of NCDEX

NCDEX has been formed with the following objectives:

• To create a world class commodity exchange platform for the

market participants.

• To bring professionalism and transparency into commodity

trading.

• To inculcate best international practices like de-materialised

technology platforms, low cost solutions and information

dissemination into the trade.

• To provide nationwide reach and consistent offering.

• To bring together the entities that the market can trust.

Shareholders of NCDEX

NCDEX is promoted by a consortium of four institutions. These are

National Stock Exchange(NSE), ICICI Bank Limited, Life Insurance

Corporation of India (LIC) and National Board forAgriculture and

Rural Development (NABARD). Later on their shares were diluted

and moreinstitutions became shareholders of NCDEX. These are

Canara Bank, CRISIL Limited, Indian Farmers Fertilisers

Cooperative Limited (IFFCO), Punjab National Bank (PNB),

Goldman Sachs, Intercontinental Exchange (ICE) and Shree

Renuka Sugars Ltd.All the ten shareholders (now ICICI is not a

shareholder of NCDEX) bring along with themexpertise in closely

related fields such as agriculture, rural banking, co-operative

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expertise,risk management, intensive use of technology, derivative

trading besides institution buildingexpertise.

GOVERNANCE

The governance of NCDEX vests with the Board of Directors.

None of the Board of Directorshas any vested interest in

commodity futures trading. The Board comprises persons of

eminence,each an authority in their own right in the areas very

relevant to the Exchange.Board appoints an executive committee

and other committees for the purpose of managingactivities of the

Exchange. The executive committee consists of Managing Director

of theExchange who would be acting as the Chief Executive of the

Exchange, and also other membersappointed by the board. Apart

from the executive committee the board has

constitutedcommittees like Membership committee, Audit

Committee, Risk Committee, NominationCommittee,

Compensation Committee and Business Strategy Committee,

which help the Boardin policy formulation.

NCDEX Products

NCDEX currently offers an array of more than 50 different

commodities for futures trading.The commodity segments covered

include both agri and non-agri commodities [bullion, energy,metals

(ferrous and non-ferrous metals) etc]. Before identifying a

commodity for trading, theExchange conducts a thorough research

into the characteristics of the product, its market andpotential for

futures trading. The commodity is recommended for approval of

Forward MarketsCommission, the Regulator for commodity

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exchanges in the country after approval by theProduct Committee

constituted for each of such product and Executive Committee of

theExchange.

Exchange Membership

Membership of NCDEX is open to any person, association of

persons, partnerships, co-operativesocieties, companies etc. that

fulfills the eligibility criteria set by the Exchange. FIs, NRIs,Banks,

MFs etc are not allowed to participate in commodity exchanges at

the moment. All themembers of the Exchange have to register

themselves with the competent authority beforecommencing their

operations. NCDEX invites applications for Members from persons

who fulfillthe specified eligibility criteria for trading commodities.

The members of NCDEX fall intofollowing categories:

1. Trading cum Clearing Member (TCM):

Members can carry out the transactions (Trading, clearing

and settlement) on their own account and also on their

clients' accounts. Applicants accepted for admission as TCM

are required to pay the requisite fees/ deposits and also

maintain net worth as explained in the following section.

2. Professional Clearing Members (PCM):

Members can carry out the settlement and clearing for their

clients who have traded through TCMs or traded as TMs.

Applicants accepted for admission as PCMs are required to

pay the requisite fee/ deposits and also maintain net worth.

3. Trading Member (TM):

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Member who can only trade through their account or on

account of their clients and will however have to clear their

trade through PCMs/STCMs.

4. Strategic Trading cum Clearing Member (STCM):

This is up gradation from the TCM to STCM. Such member

can trade on their own account, alsoon account of their

clients. They can clear and settle these trades and also clear

and settletrades of other trading members who are only

allowed to trade andare not allowed to settleand clear.

Capital requirements

NCDEX has specified capital requirements for its members.

On approval as a member ofNCDEX, the member has to

deposit the following capital:

Base Minimum Capital (BMC)

Base Minimum Capital comprises of the following:

• Interest Free Cash Security Deposit

• Collateral Security Deposit

Interest Free Cash Security Deposit

An amount of Rs. 15 Lacs by Trading cum Clearing Members

(TCM) and Rs. 25 Lacs by Professional Clearing Members

(PCM) is to be provided in cash. The same is to be provided by

issuing a cheque / demand draft payable at Mumbai in favour of

National Commodity & Derivatives Exchange Limited.

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Collateral Security Deposit

The minimum-security deposit requirement is Rs. 15 Lacs for

TCM and Rs. 25 Lacs for PCM. All Members have to comply

with the security deposit requirement before the activation of

their trading terminal. Members may opt to meet the security

deposit requirement by way of the following:

Cash

The same is to be provided by issuing a cheque / demand draft

payable at Mumbai in favour of'National Commodity &

Derivatives Exchange Limited'.

Bank Guarantee

Banks guarantee in favour of NCDEX as per the specified

format. The minimum term of thebank guarantee should be 12

months.

Fixed Deposit Receipt

Fixed Deposit Receipts (FDRs) issued by approved banks are

accepted. The FDR should beissued for a minimum period as

specified by the Exchange from time to time from any of

theapproved banks.

Government of India Securities

National Commodity Clearing Limited (NCCL) is the approved

custodian for acceptance ofGovernment of India Securities. The

securities are valued on a daily basis and a haircut asprescribed

the Exchange is levied.

Additional Base Capital (ABC)

19

In case the members desire to increase their limit, additional

capital may be submitted to

NCDEX in the following forms:

Cash

Cash Equivalents

Bank Guarantee (BG)

Fixed Deposit Receipt (FDR)

Government of India Securities

Bullion

Shares (notified list)

The haircut for Government of India securities shall be 25%

and 50% for the notified shares.

Fees structure for membership

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Clearing and Settlement System

Clearing

National Commodity Clearing Limited (NCCL) undertakes clearing

of trades executed on theNCDEX. Only clearing members

including professional clearing members (PCMs) are entitledto

clear and settle contracts through the clearing house. At NCDEX,

after the trading hours onthe expiry date, based on the available

information, the matching for deliveries takes placefirstly, on the

basis of locations and then randomly, keeping in view the factors

such as availablecapacity of the vault/warehouse, commodities

already deposited and dematerialized and offeredfor delivery etc.

Matching done by this process is binding on the clearing members.

Aftercompletion of the matching process, clearing members are

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informed of the deliverable/receivable positions and the

unmatched positions. Unmatched positions have to be settled

incash. The cash settlement is only for the incremental gain/ loss

as determined on the basis offinal settlement price

Settlement

Futures contracts have two types of settlements, the Mark-to-

Market (MTM) settlement whichhappens on a continuous basis at

the end of the day, and the final settlement which happenson the

last trading day of the futures contract. On the NCDEX, daily MTM

settlement in respectof admitted deals in futures contracts are

cash settled by debiting/ crediting the clearingaccounts of clearing

members (CMs) with the respective clearing bank. All positions of

CM,brought forward, created during the day or closed out during

the day, are mark to market atthe daily settlement price or the final

settlement price on the contract expiry.

The responsibility of settlement is on a trading cum clearing

member for all trades done on hisown account and his client's

trades. A professional clearing member is responsible for

settlingall the participants’ trades which he has confirmed to the

Exchange. Few days before expirydate, as announced by

Exchange from time to time, members submit delivery

informationthrough delivery request window on the trader

workstation provided by NCDEX for all openposition for a

commodity for all constituents individually. NCDEX on receipt of

such informationmatches the information and arrives at a delivery

position for a member for a commodity. Theseller intending to

make delivery takes the commodities to the designated

22

warehouse. Thesecommodities have to be assayed by the

Exchange specified assayer. The commodities have tomeet the

contract specifications with allowed variances. If the commodities

meet thespecifications, the warehouse accepts them. Warehouse

then ensures that the receipts getupdated in the depository system

giving a credit in the depositor's electronic account. Theseller then

gives the invoice to his clearing member, who would courier the

same to the buyer'sclearing member. On an appointed date, the

buyer goes to the warehouse and takes physicalpossession of the

commodities.

Clearing Days and Scheduled Time

Daily Mark to Market settlement where 'T' is the trading day

Mark to Market Pay-in (Payment): T+1 working day.

Mark to Market Pay-out (Receipt): T+1 working day.

Final settlement for Futures Contracts

The settlement schedule for Final settlement for futures contracts

is given by the Exchange indetail for each commodity.

Timings for Funds settlement:

Pay-in: On Scheduled day as per settlement calendars.

Pay-out: On Scheduled day as per settlement calendars.

Commodities Traded on NCDEX

NCDEX gives priority to commodities that are most relevant to

India, and where the pricediscovery process takes place

domestically. The products chosen are based on certain

23

criteriasuch as price volatility, share in GDP, correlation with global

markets, share in external trade,warehousing facilities, traders

distribution, geographical spread, varieties etc.

Spices Oil and Oilseeds Precious MetalsPepper Castor Seed Gold

Chilli Sesame Seeds SilverJeera Cotton Seed Oilcake Platinum

Turmeric Soy Bean Metals

Coriander Refined Soy Oil SteelCereals Soybean meal (local & export) CopperWheat Mustard Seed Zinc

Barley KachhiGhani Mustard Oil AluminiumMaize

(Yellow/Red)

Rapeseed - Mustard Seed Oil NickelPulses Crude Palm Oil Energy

Chana RBD Palmolein Crude OilMasoor Groundnut in shell Furnace Oil

Yellow Peas Groundnut Expeller Oil Thermal Coal

Others Plantation Products Brent Crude OilGuar Seeds Rubber Natural Gas

Potato Coffee-Robusta Cherry AB Fibres

Mentha Oil Cashew Indian 28.5 mm

CottonGuar Gum Polymers V -797 KapasCER Polypropylene Medium Staple

CottonGur Linear Low density KapasAlmond Polyvinyl Chloride Raw Jute

MCX

Multi Commodity Exchange of India Ltd (MCX) (BSE: 534091)

is an independent commodity exchange based in India. It was

established in 2003 and is based in Mumbai. The turnover of the

exchange for the fiscal year 2009 was US$ 1.24 trillion, and in

24

terms of contracts traded, it was in 2009 the world's sixth largest

commodity exchange. (MCX offers futures trading in bullion,

ferrous and non-ferrous metals, energy, and a number of

agricultural commodities (mentha oil, cardamom, potatoes, palm

oil and others).

In 2011, MCX has taken the fifth spot among the global commodity

bourses in terms of the number of futures contracts traded. Based

on the latest data from Futures Industry Association (FIA), during

the period between January and June this year, about 127.8

million futures contracts were traded on MCX.

MCX has also set up in joint venture the MCX Stock Exchange.

Earlier spin-offs from the company include the National Spot

Exchange, an electronic spot exchange for bullion and agricultural

commodities, and National Bulk Handling Corporation (NBHC)

India's largest collateral management company which provides

bulk storage and handling of agricultural products.

In February 2012, MCX has come out with a public issue of

6,427,378 Equity Shares of Rs. 10 face value in price band of 860

- 1032 Rs. per equity share to raise around $134 million. It is the

first ever IPO by an Indian exchange.

It is regulated by the Forward Markets Commission.

MCX is India's No. 1 commodity exchange with 83% market

share in 2009

The exchange's main competitor is National Commodity &

Derivatives Exchange Ltd

25

Globally, MCX ranks no. 1 in silver, no. 2 in natural gas, no.

3 in crude oil and gold in futures trading (But actual volume is

far behind CME group volume as Silver is traded in 30 Kg

lots on MCX whereas CME traded in Approx 155 kg Lot size

same in Gold 1 kg : 3. Kg Approx and Crude 100 Barrels :

1000 Barrels on CME) and major volume in manipulated as

there in no strict regulation in Indian markets just to Excalate

the prices of Shares of company. Also the major volume

comes from Arbitration of CME and MCX which is also not

legal to do.

The highest traded item is gold.

MCX has several strategic alliances with leading exchanges

across the globe

As of early 2010, the normal daily turnover of MCX was

about US$ 6 to 8 billion

MCX now reaches out to about 800 cities and towns in India

with the help of about 126,000 trading terminals

COMMODITIES TRADED ON MCX

METAL BULLION

Aluminium, Copper, Lead, Nickel, Steel Long (Bhavnagar), Steel Long (Govindgarh), Steel Flat, Tin, Zinc

Gold, Gold HNI, Gold M, i-gold, Silver, Silver HNI, Silver M,, Silver Micro

FIBER ENERGY

Cotton L Staple, Cotton M Brent Crude Oil, Crude Oil, Furnace

26

Staple, Cotton S Staple, Cotton Yarn, Kapas, Jute

Oil, Natural Gas, M. E. Sour Crude Oil, ATF, Electricity(Now delisted), Carbon Credit

SPICES PLANTATIONS

Cardamom, Jeera, Pepper, Red Chilli, Turmeric, Cumin Seed, Coriander

Arecanut, Cashew Kernel, Coffee (Robusta), Rubber

PULSES PETROCHEMICALS

Chana, Masur, Yellow Peas, Tur, Urad

HDPE, Polypropylene(PP), PVC

OIL & OIL SEEDS

Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cotton Seed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli, Mustard Oil, Mustard Seed (Jaipur), Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Refined Sunflower Oil, Rice Bran DOC, Rice Bran Refined Oil, Sesame Seed, Soymeal, Soy Bean, Soy Seeds

CEREALS OTHERS

Maize, Barley, Rice, Sharbati Rice, Basmati Rice, Wheat

Guargum, Guar Seed, Gurchaku, Mentha Oil, Potato (Agra), Potato (Tarkeshwar)

NMCE

National Multi Commodity Exchange of India Ltd. (NMCE) was

promoted by Central Warehousing Corporation (CWC), National

Agricultural Cooperative Marketing Federation of India (NAFED),

Gujarat Agro-Industries Corporation Limited (GAICL), Gujarat

27

State Agricultural Marketing Board (GSAMB), National Institute of

Agricultural Marketing (NIAM), and Neptune Overseas Limited

(NOL). While various integral aspects of commodity economy, viz.,

warehousing, cooperatives, private and public sector marketing of

agricultural commodities, research and training were adequately

addressed in structuring the Exchange, finance was still a vital

missing link. Punjab National Bank (PNB) took equity of the

Exchange to establish that linkage. Even today, NMCE is the only

Exchange in India to have such investment and technical support

from the commodity relevant institutions.

The Department of Consumer Affairs in the Ministry of Consumer

Affairs, Food and Public Distribution -Government of India, is the

apex regulatory body governing all commodity exchanges. Various

powers to provide regulatory supervision, besides the powers to

grant or withdraw recognition of any exchange rests with this

Department of the Government of India. The Forward Markets

Commission (FMC) was set up in 1953 to provide regulatory

advice to the Government and have closer regulatory interaction

with the commodity exchanges. Most of the regulatory powers of

the Central Government have been delegated to the FMC. For

example, FMC has powers to approve the Memorandum and

Articles of Associations as well as Byelaws of the Exchange. It has

also powers to conduct inspection of accounts of the

exchanges/their members, inquire into the affairs of the exchange.

In an emergency, it can even suspend trading. All contracts for

futures trade have to be approved by the FMC before they can be

launched on the exchange. As a self-regulatory organization,

NMCE also plays an important role by ensuring that the provisions

28

in the Articles of Association and Byelaws etc. are followed in letter

and spirit. The regulation by the Exchange is rule-based and

incorporated in the software itself. Regulation involving human

intervention and of discretionary nature is implemented through

various committees of professional and experts. Special care is

taken while constituting these committees to ensure that there is

no conflict of interest.

NMCE facilitates electronic derivatives trading through robust and

tested trading platform, Derivative Trading Settlement System

(DTSS), provided by CMC. It has robust delivery mechanism

making it the most suitable for the participants in the physical

commodity markets. It has also established fair and transparent

rule-based procedures and demonstrated total commitment

towards eliminating any conflicts of interest. It is the only

Commodity Exchange in the world to have received ISO

9001:2000 certification from British Standard Institutions (BSI).

NMCE was the first commodity exchange to provide trading facility

through internet, through Virtual Private Network (VPN).

NMCE follows best international risk management practices. The

contracts are marked to market on daily basis. The system of

upfront margining based on Value at Risk is followed to ensure

financial security of the market. In the event of high volatility in the

prices, special intra-day clearing and settlement is held. NMCE

was the first to initiate process of dematerialization and electronic

transfer of warehoused commodity stocks. The unique strength of

NMCE is its settlements via a Delivery Backed System, an

imperative in the commodity trading business. These deliveries are

29

executed through a sound and reliable Warehouse Receipt

System, leading to guaranteed clearing and settlement.

The NMCE is India's third-largest commodities exchange behind

the Multi-Commodity Exchange (MCX) and the National

Commodity & Derivatives Exchange (NCDEX) and has grown

significantly as commodity trading in India has rebounded from the

2008 financial crisis. NMCE is India's top listed

of coffee and rubber contracts and seeks to broaden into

the currency derivatives and spot markets.

30

CHAPTER- 3

COMMODITY DERIVATIVE MARKETS - A PROFILE

Commodity futures markets have a long history in India. Cotton

was the first commodity to attract futures trading in the country

leading to the setting up of the Bombay Cotton Trade Association

Ltd in 1875. The Bombay Cotton Exchange Ltd. was established in

1893 followingthe widespread discontent amongst leading cotton

mill owners and merchants over the functioning of Bombay Cotton

Trade Association.

Subsequently, many exchanges came up in different parts of the

country for futures trading in various commodities. Futures trading

in oilseeds started in 1900 with the establishment of the Gujarati

Vyapari Mandali, which carried on futures trade in groundnut,

castor seed and cotton.

Before the Second World War broke out in 1939, several futures

markets in oilseeds were functioning in Gujarat and Punjab.

Futures trading in wheat existed at several places in Punjab and

Uttar Pradesh, the most notable of which was the Chamber of

Commerce at Hapur, which began futures trading in wheat in 1913

and served as the price setter in that commodity till the outbreak of

the Second World War in 1939.

Futures trading in bullion began in Mumbai in 1920 and

subsequently markets came up in other centres like Rajkot, Jaipur,

Jamnagar, Kanpur, Delhi and Kolkata. Calcutta Hessian Exchange

31

Ltd. was established in 1919 for futures trading in raw jute and jute

goods. But organized futures trading in raw jute began only in

1927 with the establishment of East Indian Jute Association Ltd.

These two associations amalgamated in 1945 to form the East

India Jute & Hessian Ltd. to conduct organized trading in both raw

jute and jute goods. In due course several other exchanges were

also created in the country to trade in such diverse commodities as

pepper, turmeric, potato, sugar and gur (jaggery).

After independence, with the subject of `Stock Exchanges and

futures markets' being brought under the Union list, responsibility

for regulation of commodity futures markets devolved on Govt. of

India. A Bill on forward contracts was referred to an expert

committee headed by Prof. A. D. Shroff and select committees of

two successive Parliaments and finally in December 1952 Forward

Contracts (Regulation) Act, 1952, was enacted.

The Act provided for 3-tier regulatory system:

a) An association recognized by the Government of India on the

recommendation

b) The Forward Markets Commission (it was set up in

September 1953) and

c) The Central Government.

India was in an era of physical controls since independence and

the pursuance of a mixed economy set up with socialist proclivities

had ramifications on the operations of commodity markets and

commodity exchanges. Government intervention was in the form of

buffer stock operations, administered prices, regulation on trade

32

and input prices, restrictions on movement of goods, etc.

Agricultural commodities were associated with the poor and were

governed by polices such as Minimum Price Support and

Government Procurement. Further, as production levels were low

and had not stabilized, there was the constant fear of misuse of

these platforms which could be manipulated to fix prices by

creating artificial scarcities. This was also a period which was

associated with wars, natural calamites and disasters which

invariably led to shortages and price distortions. Hence, in an era

of uncertainty with potential volatility, the government banned

futures trading in commodities in the 1960s.

The Khusro Committee which was constituted in June 1980 had

recommended reintroduction of futures trading in most of the major

commodities, including cotton, kapas, raw jute and jute goods and

suggested that steps may be taken for introducing futures trading

in commodities, like potatoes, onions, etc. at appropriate time. The

government, accordingly initiated futures trading in Potato during

the latter half of 1980 in quite a few markets in Punjab and Uttar

Pradesh.

With the gradual trade and industry liberalization of the Indian

economy pursuant to the adoption of the economic reform

package in 1991, GOI constituted another committee on Forward

Markets under the chairmanship of Prof. K.N. Kabra. The

Committee which submitted its report in September 1994

recommended that futures trading be introduced in the following

commodities:

Basmati Rice

33

Cotton, Kapas, Raw Jute and Jute Goods

Groundnut, rapeseed/mustard seed, cottonseed, sesame

seed, sunflower seed, safflowerseed, copra and soybean

and oils and oilcakes

Rice bran oil

Castor oil and its oilcake

Linseed

Silver

Onions

The committee also recommended that some of the existing

commodity exchanges particularly the ones in pepper and

castorseed, may be upgraded to the level of international futures

markets.

UNCTAD and World Bank joint Mission Report "India: Managing

Price Risk in India's Liberalized Agriculture: Can Futures Market

Help? (1996)" highlighted the role of futures markets as market

based instruments for managing risks and suggested the

strengthening of institutional capacity of the Regulator and the

exchanges for efficient performance of these markets. Another

major policy statement, the National Agricultural Policy, 2000, also

expressed support for commodity futures. The Expert Committee

on Strengthening and Developing Agricultural Marketing (Guru

Committee: 2001) emphasized the need for and role of futures

trading in price risk management and in marketing of agricultural

produce. This Committee's Group on Forward and Futures

34

Markets recommended that it should be left to interested

exchanges to decide the appropriateness/usefulness of

commencing futures trading in products (not necessarily of just

commodities) based on concrete studies of feasibility on a case-to-

case basis. It, however, noted that all the commodities are not

suited for futures trading. For a commodity to be suitable for

futures trading it must possess some specific characteristics. The

liberalized policy being followed by the Government of India and

the gradual withdrawal of the procurement and distribution channel

necessitated setting in place a market mechanism to perform the

economic functions of price discovery and risk management.

The National Agriculture Policy announced in July 2000 and the

announcements of Hon'ble Finance Minister in the Budget Speech

for 2002-2003 were indicative of the Governments resolve to put in

place a mechanism of futures trade/market. As a follow up, the

Governmentissued 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. An option

trading in commodity is, however presently prohibited. The year

2003 is a landmark in the history of commodity futures market

witnessing the establishment and recognition of three new national

exchanges [National Commodity and Derivatives Exchange of

India Ltd. (NCDEX), Multi Commodity Exchange of India Ltd

(MCX) and National Multi Commodity Exchange of India Ltd.

(NMCE)] with on-line trading and professional management. Not

only was prohibition on forward trading completely withdrawn, the

new exchanges brought capital, technology and innovation to the

market.

35

These markets depicted phenomenal growth in terms of number of

products on offer, participants, spatial distribution and volume of

trade. Majority of the trade volume is contributed by the national

level exchanges whereas regional exchanges have a very less

share. With developments on way, the commodity futures

exchanges registered an impressive growth till it saw the first ban

of two pulses (Tur and Urad) towards the end of January 2007.

Subsequently the ban of two more commodities from cereals

group i.e. Wheat and Rice in the next month. The commodity

market regulator, Forward Markets Commission as a measure of

abundant caution, suspended futures trading in Chana, Soya oil,

Rubber and Potato w.e.f. May 7, 2008. However, with the easing

of inflationary pressure, the suspension was allowed to lapse on

November 30, 2008. Trading in these commodities resumed on

December 4, 2008.

Later on futures trading in wheat was re-introduced in May 2009.

These bans affected participants' confidence adversely. In May

2009, futures’ trading in sugar was suspended. Due to mistaken

apprehensions that futures trading contributes to inflation, futures

trading in rice, urad, tur and sugar has been temporarily

suspended.

Issues and Concerns of Commodity Derivative Markets in

India

Commodity derivative markets have traditionally been a

contentious issue at various policy forums across the world,

particularly with the imbroglio created by allegations from various

corners that they encourage excessive speculation and are

36

therefore responsible for the recent commodity price escalation.

While this suspicion of excessive speculation in the commodity

markets has always been there among policymakers in developing

nations like India, it has become more widespread since 2008 in

the wake of worldwide inflationary pressures on food and energy.

The sudden deflation in the value of various assets underlying

different derivatives, which includes commodity derivatives, in the

wake of the global meltdown has provoked greater apprehension

about the economic utility of futures markets. The suspicion has

reached such a high that even the U.S., the biggest proponent of

market forces with the most active commodity exchanges in the

world, is considering new modes of regulation, and is also

investigating the role of commodity derivative trading in the steep

rise in prices of wheat, rice, and crude oil.

On the other hand, ever since commodity derivative trading was

allowed in India in the new millennium, there has always been a

hue and cry against such markets, with the alleged notion of

excessive “speculation”, though there has rarely been any

evidence for it. Rather than recognizing the potential economic

utility of commodity derivative markets in price discovery and risk

management, the government has been more apprehensive about

its alleged ill-effects. As a result, over time, futures’ trading has

been subjected to strict regulations, and certain commodities have

been inflicted with occasional bans. Thus, while the “disutility” of

the market is yet to be proven, the overcautious behaviour of the

government has never really allowed the market to develop and

prove its utility.

37

Hence, in the midst of doubts and debates on the utility of

commodity futures markets and against the background of

conflicting views and vista, there is a need to list various issues

and concerns in the development of futures exchanges. This

presents the agenda for research on commodity futures markets in

India, from both theoretical and empirical perspectives. While at a

more general level, probably the most succinct statement on

presenting a research agenda for commodity markets exists in a

paper by Rutten1, an attempt to do so in the Indian context is

missing from the literature so far.

Strengthening the Scope of Commodity Derivative Trading

The issue of expanding the scope of commodity derivative trading

is apparently normative and value judgmental. This is primarily

because of a large group of people who feel that commodity

derivative trading should not be allowed at all and hence the

question of expanding its scope does not arise. However, there are

enough strong arguments in favour of strengthening commodity

derivatives markets and developing supportive market institutions

and awareness. The role of commodity futures markets becomes

even more compelling with India moving toward greater trade

liberalization, particularly in the context of agriculture, and getting

further exposed to the volatilities of international trade and finance.

Commodity futures is a market mechanism that is viable for risk

management and price discovery, and such institutions can help

“bail out” the economy from the vagaries of international trade.

Despite the realization of the need for commodity derivative trading

in India and the subsequent resumption of trade in the new

38

millennium, the statutes dictating derivative trading are old and

outmoded. Derivative markets have been functioning under the

Forward Contracts Regulation Act (FCRA), which dates back to

1952. The world has undergone a significant change since then,

and so have the dynamics of international trade and finance, and

the domestic economies of the developing world. In the process,

there has been a transformation in trading patterns, methods and

practices in physical and derivative markets, warehousing, and

transport norms. Newer risks and risk management instruments

are being innovated and operationalized worldwide in various

exchanges. There are non-trade–related market participants who

have helped provide liquidity to markets worldwide. Information

and communication technology has brought about changes in the

institutional processes. International trade and financial linkages

with the domestic economy are also different from what they were

sixty years ago in an economy that was insulated from external

forces and stimuli. Hence, there is an utmost need to strengthen

and expand the scope of commodity derivative trading. However,

merely expanding the scope of trading might even lead unbridled

market forces to play havoc with the functioning of the market,

thereby creating a negative dent on economic wellbeing. For

markets to operate effectively and efficiently there is a need for

appropriate regulation as well. Hence, there is a clear case for

strengthening the FMC by providing it with more autonomy.

With this objective, the Union Government had moved a Bill in the

last Lok Sabha to amend the FCRA. The Bill was scrutinized over

a long period by a specially appointed Standing Committee of the

Parliament. But the Ordinance lapsed before its provisions could

39

be implemented, and the Amendment Bill also lapsed following the

dissolution of that Lok Sabha. However, with the constitution of the

new Lok Sabha, there is renewed hope for an amendment.

FCRA is essentially an enabling Act, and the FMC, set up under

the provisions of the Act, is more an advisory and monitoring body

than one with regulatory powers. As per the statute, the real

regulatory powers remain in the hands of the Central Government,

while the FMC’s role is supposed to be that of being one of offering

recommendation and advises to the Ministry. Over time, the FMC

has acquired a few regulatory powers circuitously under the by-

laws of the associations recognized by the Act.

An amendment to the FCRA will usher in a new era in commodity

derivative trading by expanding the scope and instruments of

trading, and by strengthening the regulatory powers of the FMC.

Among the changes proposed in the Bill, an important intervention

is to bring about a change in the definition of “commodities” to

facilitate trading in derivative contracts for intangibles like

commodity indices, weather derivatives, etc. From the perspective

of new instruments for trading, the amendment will increase that

scope by legalizing options trading in commodity derivatives. On

the transaction and settlement side, it will set aside the outmoded

and archaic norm of physical delivery for contract settlement, and

will allow for cash settlement of futures contracts. The amendment

will also allow institutional investors like banks and mutual funds,

foreign institutional investors, financial institutions, and foreign

individuals to trade in commodity futures. This will help increase

liquidity in the market, and thereby augment price risk

management and price discovery. However, it is not that the

40

amendment is only in favour of unrelenting and unbridled market

forces; it is also about regulation. It releases the FMC from the

clangs of being traditionally described as an advisory body to the

Ministry of Consumer Affairs, and renders it the distinction of being

an “autonomous” regulatory body, in a process of its up-gradation

and expansion with more regulatory and judicial authority.

On the other hand, contrary to the clause under the FCRA

amendment of rendering more teeth to the FMC, there have also

been talks regarding the convergence of the Securities and

Exchange Board of India (SEBI), the regulator of the equity

markets, and the FMC. While government machineries have often

been arguing in favour of a merger on grounds that a common

regulator is in a better position to regulate and develop the various

markets synergically and in sync with each other, there are also

compelling arguments against the merger4. In my previous

article4, as has also been acknowledged in the literature5, 6, there

have been arguments that commodity exchanges are not stock

exchanges. Commodity exchanges are essentially institutions that

are adjunct to the physical market, and are supposed to perform

complementary functions in order to improve commodity

transactions in the various nodes of the value chain. While stock

prices are determined at centralised locations – in the

headquarters of stock exchanges, commodity prices vary across

locations, quality characteristics, end-usage patterns, and

seasons. Moreover, the stock market players are primarily those

who earn regular income from dividend or interest, or profit from

speculation – they are not hedgers like commodity players. Hence,

the various microstructure as well as the macro-level institutional

41

issues are different for the two forms of markets, and each

requires specialised treatments in terms of regulation, rather than

a common treatment.

The possible conflict of ideas has also brought to the fore the issue

of a super regulator above all the market regulators – something

that the USA has been contemplating ever since the outbreak of

the financial crisis. The feasibility of such an idea deserves a

critical examination before it receives acceptance or outright

rejection in the Indian context.

Another important issue is the relationship of spot and futures

markets and how the efficiency of physical markets can help

players in the futures markets. One critical element that emerged

from the paper was the need for development of nationwide,

information-technology enabled spot markets for futures

exchanges to perform their price discovery and price risk

management functions efficiently. This, definitely, has to attract the

attention of researchers and policymakers. There is a critical need

for development of such cases for buttressing these contentions

further.

Rules Governing Commodity Derivatives Exchanges

/Participants

The trading of commodity derivatives on the NCDEX is regulated

by Forward Markets Commission (FMC). In terms of Section 15 of

the Forward Contracts (Regulation) Act, 1952 (the Act),forward

contracts in commodities notified under section 15 of the Act can

be entered into onlyby or through a member of a recognized

association, i.e, commodity exchange as popularlyknown. The

42

recognized associations/commodity exchanges are granted

recognition underthe Act by the central government (Department of

Consumer Affairs, Ministry of ConsumerAffairs, Food and Public

Distribution). All the Exchanges, which permit forward contracts

fortrading, are required to obtain certificate of registration from the

Central Government. Theother legislations which have relevance

to commodity trading are the Companies Act, StampAct, Contracts

Act, Essential Commodities Act 1955, Prevention of Food

Adulteration Act, 1954and various other legislations, which

impinge on their working.

Forward Markets Commission provides regulatory oversight in

order (to ensure financial integrityto prevent systematic risk of

default by one major operator or group of operators), market

integrity (to ensure that futures prices are truly aligned with the

prospective demand andsupply conditions) and to protect and

promote interest of customers/ non-members. Some ofthe

regulatory measures by Forward Markets Commission include:

1. Limit on net open position as on the close of the trading

hours. Sometimes limit is also imposed on intra-day net open

position. The limits are imposed member- wise and client

wise.

2. Circuit-filters or limit on price fluctuations to allow cooling of

market in the event of abrupt upswing or downswing in

prices.

3. Special margin deposit to be collected on outstanding

purchases or sales when price moves up or down sharply

43

above or below the previous day closing price. By making

further purchases/sales relatively costly, the price rise or fall

is sobered down. This measure is imposed by the Exchange

(FMC may also issue directive).

4. Circuit breakers or minimum/maximum prices: These are

prescribed to prevent futures prices from falling below as

rising above not warranted by prospective supply and

demand factors. This measure is also imposed on the

request of the exchanges (FMC may also issue directive).

5. Stopping trading in certain derivatives of the contract, closing

the market for a specified period and even closing out the

contract. These extreme measures are taken only in

emergency situations.

Besides these regulatory measures, a client's position cannot

be appropriated by the memberof the Exchange. No member

of an Exchange can enter into a forward contract on his

ownaccount with a non-member unless such member has

secured the consent of the non-memberin writing to the

effect that the sale or purchase is on his own account. The

FMC is persuadingincreasing number of exchanges to switch

over to electronic trading, clearing and settlement,which is

more safe and customer-friendly. The FMC has also

prescribed simultaneous reportingsystem for the exchanges

following open out-cry system. These steps facilitate audit

trail andmake it difficult for the members to indulge in

malpractices like trading ahead of clients, etc.The FMC has

also mandated all the exchanges following open outcry

system to display at aprominent place in exchange premises,

44

the name, address, telephone number of the officer ofthe

commission who can be contacted for any grievance. The

website of the commission alsohas a provision for the

customers to make complaint and send comments and

suggestions tothe FMC. Officers of the FMC meet the

members and clients on a random basis, visit exchanges,to

ascertain the situation on the ground to bring in development

in any area of operation of themarket.

Participants in commodity Derivative Market

Hedgers

Many participants in the commodity futures market are

hedgers. They use the futures market to reduce a particular

risk that they face. This risk might relate to the price of any

commodity that the person deals in. The classic hedging

example is that of wheat farmer who wants to hedge the risk

of fluctuations in the price of wheat around the time that his

crop is ready for harvesting. By selling his crop forward, he

obtains a hedge by locking in to a predetermined price.

Hedging does not necessarily improve the financial outcome;

indeed, it could make the outcome worse. What it does

however is, that it makes the outcome more certain. Hedgers

could be government institutions, private corporations like

financial institutions, trading companies and even other

participants in the value chain, for instance farmers,

extractors, ginners, processors etc., who are influenced by

the commodity prices.

45

There are basically two kinds of hedges that can be taken. A

company that wants to sell an asset at a particular time in the

future can hedge by taking short futures position. This is

called a short hedge. A short hedge is a hedge that requires

a short position in futures contracts. As we said, a short

hedge is appropriate when the hedger already owns the

asset, or is likely to own the asset and expects to sell it at

some time in the future.

Similarly, a company that knows that it is due to buy an asset

in the future can hedge by taking long futures position. This

is known as long hedge. A long hedge is appropriate when a

company knows it will have to purchase a certain asset in the

future and wants to lock in a price now.

Speculators

If hedgers are the people who wish to avoid price risk,

speculators are those who are willing to take such risk.

These are the person who takes positions in the market &

assume risks to profit from price fluctuations in fact the

speculators consume market information make forecasts

about the prices & put money in these forecasts. An entity

having an opinion on the price movements of a given

commodity can speculate using the commodity market.

While the basics of speculation apply to any market,

speculating in commodities is not as simple as speculating

on stocks in the financial market. For a speculator who thinks

the shares of a given company will rise, it is easy to buy the

shares and hold them for whatever duration he wants to.

46

However, commodities are bulky products and come with all

the costs and procedures of handling these products. The

commodities futures markets provide speculators with an

easy mechanism to speculate on the price of underlying

commodities. To trade commodity futures on the NCDEX, a

customer must open a futures trading account with a

commodity derivatives broker. Buying futures simply involves

putting in the margin money. This enables futures traders to

take a position in the underlying commodity without having to

actually hold that commodity. With the purchase of futures

contract on a commodity, the holder essentially makes a

legally binding promise or obligation to buy the underlying

security at some point in the future (the expiration date of the

contract).

Arbitrage

A central idea in modern economics is the law of one price.

This states that in a competitive market, if two assets are

equivalent from the point of view of risk and return, they

should sell at the same price. If the price of the same asset is

different in two markets, there will be operators who will buy

in the market where the asset sells cheap and sell in the

market where it is costly. This activity termed as arbitrage.

The buying cheap and selling expensive continues till prices

in the two markets reach equilibrium. Hence, arbitrage helps

to equalise prices and restore market efficiency.

F = (S + U)erT

47

Where: r = Cost of financing (annualised)

T = Time till expiration

U = Present value of all storage costs

The cost-of-carry ensures that futures prices stay in tune with the

spot prices of the underlying assets. The above equation gives the

fair value of a futures contract on an investment commodity.

Whenever the futures price deviates substantially from its fair

value, arbitrage opportunities arise. To capture mispricing that

result in overpriced futures, the arbitrager must sell futures and

buy spot, whereas to capture mispricing that result in underpriced

futures, the arbitrager must sell spot and buy futures. In the case

of investment commodities, mispricing would result in both, buying

the spot and holding it or selling the spot and investing the

proceeds. However, in the case of consumption assets which are

held primarily for reasons of usage, even if there exists a

mispricing, a person who holds the underlying may not want to sell

it to profit from the arbitrage

48

CHAPTER-4

NEWS REPORTS

1. A total of 120 varieties of different pulse crops comprising

chickpea (27), pigeonpea (16), urdbean (17), mungbean

(19), field pea (10), lentil (11), rajmash (2), cowpea (7), guar

(5), horse gram (3), mothbean (2) and lathyrus (1) have been

released during 2007-2012.

NEW DELHI: In India about 120 pulses varieties have been

developed and released during 2007-2012 by the State

Agricultural Universities and Krishi Vigyan Kendras.

The information was given by Harish Rawat, Minister of State

for Agriculture and Food Processing Industries in a written

reply to a question in the upper house of Indian Parliament.

At present, Indian Council of Agricultural Research (ICAR) is

busy with various research programmes on different pulse

crops at Indian Institute of Pulse Research (IIPR), Kanpur.

The research programmes include basic and strategic

research related to crop improvement, production and

protection technologies in different pulse crops.

Improved varieties and recommended agronomic practices

developed as a result of the research efforts of National

Agricultural Research System have increased yield potential

of different pulses crops.

49

2. Mainland China’s gold imports from Hong Kong rose sharply

by 98.84% year-on-year to 75.84 metric tons in July this year,

according to the latest export data released by Census and

Statistics Department of the Hong Kong government. Country

imported 38.14 metric tons of gold from Hong Kong a year earlier.

BEIJING: It was the first rise in China's gold imports after

three months of slightly lower imports. Shipments were a

record 103.64 metric tons in April. China doesn’t publish

such data.

According to the government data, China's gold imports from

Hong Kong advanced sharply by 344.87% year-on-year to

458.628 metric tons in the first seven months of this year

compare to 103.09 metric tons a year earlier.

China’s gold imports advanced due to people renewed their

buying of gold to hedge against financial market’s turmoil and

weaker currencies with increasing concerns about the

Chinese economy and stock and property markets.

Exports of gold to Hong Kong from China were 30.03metric

tons in July, up from 27.50 metric tons in June.

China is the world’s second-biggest consumer of gold, after

India, but is expected to take the top spot soon. This year

China’s imports via Hong Kong during the first 10 months of

the year are more than three times higher than the same

period last year.

50

CHAPTER-5

CONCLUSION

The trade in global commodity market is worth US $600 billion;

India should put in place world standard trading exchanges to tap

this huge global commodities market while protecting the interests

of the domestic farmers from sharp price fluctuations. For

achieving this goal, we have to equip ourselves with the

appropriate markets instruments and institutions by building a

commodity trading exchange of global standards. Amidst the

turmoil of a risky market, stiff competition and many introduction

failures, the commodity derivatives industry needs a conceptual

model that incorporates all aspects relevant to the success and

failure of commodity derivatives. In order to meet this need, a new

and integrative approach towards commodity derivatives

management is needed, which makes it easier to gain insight into

the viability of new commodity derivatives before introduction, to

assess and improve the viability of existing commodity derivatives

At a time when India is fast catching up with the world’s leading

manufacturing centres and being home to back office work of the

leading global companies, new multi commodity exchanges, using

latest technologies, can help accelerate the process and also help

financial markets to allocate finance to right sectors. It’s a right

step in the direction of integration with the global commodity

markets. India being a developing country where majority of

population is still dependent on the agriculture, modern

commodities exchanges can be used as tool to improve the life of

such people, by making commodities market more efficient.

51

Instability of commodity prices has always been a major concern of

the producers, processors, traders as well as the consumers in

agriculture -dominated country like India. Commodity exchanges

provide a mechanism to lock-in prices, thus insulating the

participants from the adverse price risk. Commodity market helps

the farmer by signalling him the price that is expected to prevail in

future; so he can decide which crop to grow, thus making his

expectations aligned with the market. Farmers can also cover their

risk by locking in the price by selling their crop in futures market

(selling futures).Farmers’ direct exposure to price fluctuations, for

instance, makes it too risky for many farmers to invest in otherwise

profitable activities. There are various ways to cope with this

problem. Apart from increasing the stability of the market, various

actors in the farm sector can better manage their activities in an

environment of unstable prices through commodity exchanges. It

must be ensured that this system (futures) actually benefits the

farmers, and not just traders. For this, central and state

government agencies have to take necessary steps, including

rapid expansion of rural warehousing facilities.

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BIBLIOGRAPHY

BOOKS:-

COMMODITY MARKET (NCFM module)

DERIVATIVES MARKET (NCFM module)

COMMODITY DERIVATIVE MARKET AND

APPLICATION

- NEIL C. SCHOFIELD

NEWSPAPER

ECONOIMICS TIMES

WEBLIOGRAPHY:-

www.nseindia.com

www.mcxindia.com

www.commodityonline.com

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