Post on 07-Apr-2018
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Ohio University Christ College Academy For Management Education 1
EXECUTIVE SUMM ARY
The summer Internship project was done at Bhas Commodities Pvt. Ltd. The
objective of the internship was to study the role of commodity futures in Indian
commodities market and the trading procedures by members of the exchange and also
to have a first hand experience in the field of commodities derivatives. The internship
also helped in getting exposed to various functions of the company like capital market
services, commodities derivatives and depository participant services, it also helped in
having a first hand experience in platform of trading and participate in mock trading
which the company contests to improve the efficiency of the employees of the company.
The internship also helped in gaining knowledge and experience in the field of
sales and marketing of the financial service products offered by the company, it also
helped in studying the market by meeting the clients as they are the main market
participants and has good knowledge about the market, the internship made available a
great opportunity to discusses about the various aspects of commodity market and its
working and also to gain relevant, real world experience in the operation and customer
services.
The internship was about A Study on Commodities Derivatives Market a
market survey was conducted to collect data pertaining commodity market and what the
customers feels about the market. Project details, findings, suggestions and conclusion
are detailed in project report.
The organizations background, its infrastructure, set up, its branches,
hierarchy etc have been researched by discussing with the employees of the
organization, reading the in house manuals and exchange manuals and visiting, the
company website. The various product and services offered by the company is also
listed in the project report.
A SWOT analysis has also been done for the company to identify the
strengths, weaknesses, opportunities and threats of the company compared to its
competitors and the industry standards.
The balance sheet of the company has been studied and various ratios like
Solvency Ratio, Profitability Ratio, Efficiency Ratio, and Liquidity Ratio was conducted to
find out the financial standing of the company and its strengths to the company.
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The commodity derivative and the futures trading in commodities is a new
concept and has ample scope for future studies and also to identify new techniques in
the market as the commodities derivatives market is growing daily.
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INTRODUCTION
In 2004 an X-NRI Indian Family started Bhas Commodities (P) Ltd, Bhas Securities (P)
Ltd and Pulikot Credits and Investment (P) Ltd managed by Mr. Varuthunny.P.I the
Chairman of the Group. The Registered and Head office of the company is situated in
Sultan Bathery, Wynad, Kerala.
The company provides a wide range of financial services from securities derivative
trading, commodity trading, depository services, research and advisory services,
consumer secured and unsecured loans against shares and mortgage. The primary
objective of the company is to generate medium to long-term capital growth (2-3 years)
by identifying undervalued stocks and those with growth opportunities from a select listof well researched stocks. The Secondary objective of the company is to provide a
helping hand to the investors and to guide the investors on the right path and to protect
the investors from the risks arising as share trading and commodities trading are
exposed to more risks. The objective of the company by entering the commodities
futures market is to help and save the farmers from price fluctuations and the
Manufactures, Exporters and Traders from the scarcity of the commodities they deal
with and to help in timely delivery of the products to their customers.
Bhas Securities achieved a tremendous growth in stock broking within a very short span
of its journey. The company stared off with a very wider concept of internet trading in
Kerala. The experts of the company with a highly potential caliber enable and help the
client in taking the most prudential investment portfolio. What the company feels about
the prudent investor is that he/she must have the right plan and he/she must trade on
active liquid stocks where he/she can recoup high rate of return with minimum risk. For
the market, it is the trend that matter and not the price at which he/she enter into.
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Profile of the company
Bhas Commodities (P) Ltd
The company is a Corporate Member of National Commodity and Derivatives Exchange
(NCDEX), Multi Commodity Exchange of India (MCX) and India Pepper and Spice Trade
Association (IPSTA). The Regional office is at Kozhikode. The branches of the company
are expanding steadily. Besides Kerala, Karnataka and Tamilnadu where the company is
now having branches, further expansions are also planned to other parts of India by the
company management. Majority of the staff members are NCFM Certified professionals
who provide trading strategies suited to the business interests of each individual orbusiness house.
Bhas Securities (P) Ltd
The Company is a registered broker at the National Stock Exchange (NSE), Bombay
Stock Exchange (BSE) and a Corporate Member of Cochin Stock Exchange. Share
broking is undertaken at all branches where commodity broking is carried out. The
service in share broking include on line buying of share/securities through NSE/BSE,
Depository Services, Internet Trading and giving proper advices in selecting stocks for
short term as well as for long term investment.
Pulikot Credits and Investments (P) Ltd
The Company is a RBI registered Non Banking Finance Company (NBFC) focusing on
vehicle hire purchase, loans on commodity, share, gold and other fully secured loans.
The Management is planning expansion of its services in the commodity and equity
sectors to other parts of India and abroad. This includes taking membership in
Commodity Exchanges outside India.
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The profile of NCDEX and MCX Ex changes which the company is a member of
and has its trade with: All the exchanges have been set up under overall control of
Forward Market Commission (FMC) of Government of India.
National Commodity & Derivatives Exchange Limited (NCDEX): National
Commodity & Derivatives Exchange Limited (NCDEX) located in Mumbai is a public
limited company incorporated on April 23, 2003 under the Companies Act, 1956 and had
commenced its operations on December 15, 2003.This is the only commodity exchange
in the country promoted by national level institutions. It is promoted by ICICI Bank
Limited, Life Insurance Corporation of India (LIC), National Bank for Agriculture and
Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). It is
a professionally managed online multi commodity exchange. NCDEX is regulated by
Forward Market Commission and is subjected to various laws of the land like the
Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and
various other legislations.
Multi Commodity Exchange of India Limited (MCX): Headquartered in MumbaiMulti Commodity Exchange of India Limited (MCX), is an independent and de-mutulised
exchange with a permanent recognition from Government of India. Key shareholders of
MCX are Financial Technologies (India) Ltd., State Bank of India, Union Bank of India,
Corporation Bank, Bank of India and Canara Bank. MCX facilitates online trading,
clearing and settlement operations for commodity futures markets across the country.
MCX started offering trade in November 2003 and has built strategic alliances with
Bombay Bullion Association, Bombay Metal Exchange, Solvent Extractors Association of
India, Pulses Importers Association and Shetkari Sanghatana.
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BHAS BRANCHES
1. Bhas Pvt Ltd, Cochin, Kerala.
2. Bhas Pvt Ltd, Calicut, Kerala.
3. Bhas Pvt Ltd, Kalpetta, Kerala.
4. Bhas Pvt Ltd, Meenagady, Kerala.
5. Bhas Pvt Ltd, Mananthavady, Kerala.
6. Bhas Pvt Ltd, Meppady, Kerala.
7. Bhas Pvt Ltd, Gudalur, Tamilnadu.
8. Bhas Pvt Ltd, Ootty, Tamilnadu.
9. Bhas Pvt Ltd, Gonikkoppa, Karnataka.
BHAS FRANCHISES
10.D.J. Systems, Sulthan Bathery, Kerala.
11.Kuriakose Brothers Spices Pvt Ltd, Sulthan Bathery, Kerala.
12.Agro Indus, Cochin, Kerala.
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Products and Services
Shares
Account opening
Depositary participant account opening
Demat dematerialization of shares. Convert share certificates to electronic
form. This gives the share holders the option to hold share certificates in the
demat mode instead of having them in physical paper form. These electronic
balances could be easily transferred thereby eliminating the hassles of
physical transfer and settlement system, which may involve bad delivery,
fake share certificate etc.
Platform for trading information about shares, how to trade and which
shares to invest.
Commodity
Account opening
Depositary participant account opening for the purpose of delivery.
Demat dematerialization of warehouse receipts. Dematerialization refers to
the process of conversion of the physical paper (warehouse receipts) into the
electronic balance.
Assist in actual delivery buying and selling
Pay in, pay out
Platform for trading buy or sell for all clients, communicating to clients
about the fluctuations in the daily market. Providing information to clients
about the market how to trade, factors to be looked in while trading to
protect profits and minimize losses.
Credits and Investments
Provide credits for vehicle hire purchase, loans on commodity, share, gold and other
fully secured loans.
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SWOT ANALYSIS
STRENGTHS
Bhas Pvt. Ltd being the first of its kind in Wyanad district, it has a more loyal
customer base.
The company does trading through Leased line MPSL, which is more
advanced than VSAT since trading is done through the leased line it is much
faster, reduces mistakes and easier to monitor, the company also has the
required infrastructure and technological support to handle very large
number of clients and investors.
The workforce consists of young talented determined people between the
age group of 25 35; hence they are more innovative and risk takers whiletrading.
WEAKNESSES
Compared to its competitors Bhas Pvt. Ltd has less brand value.
Converting farmers from trading in spot market to future market.
e.g.; In the case of gold jewellery people are more comfortable going to a
known pawn broker then to a jewellery showroom, even though the quality is
better in the showroom. It is the same case in the commodity market.
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OPPORTUNITIES
Opening up of Indian economy has provided the company with a very good
opportunity to grow. This trend is expected to continue for years to come.
With the economy expected to be more liberal in the forthcoming years the
company is poised to attain new heights.
The company being only two years old and new in the market has more scope
to diversify the services it offers in the near future.
Wyanad being a commodity dominated market; it can be converted into a
potential investors market.
Commodities strong performance this year should bode well for currencies
and equities associated with the sector, including emerging markets.
Banks and Insurance coming in into the commodities market would be a
boom to the commodity market.
THREATS
Financial Services is open to unstable political scenario, like change in the
government, or implementation of new budgets by state and central
governments.
Unfavorable government policies and levy of new taxes will demoralize the
investors from making new investments.
As India is becoming an open economy and government policies favoring
foreign investments there are chances of foreign investors entering the
market and becoming a threat.
Fund buying and selling malpractices, because of this many commodities
have been banned from trading.
There is a huge space for employee retention because they find the work
very hectic, and holidays provided by the exchange are only three days,
there is no uniformity on holidays between exchanges.
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FINANCIAL ANALYSIS
For the financial analysis purposes the Balance Sheet and Profit and loss accounts of
Bhas Commodities were taken up for two years 2006 and 2007.
The data were analyzed for assessing the financial position and performance of the
company in the terms of efficiency, solvency and profitability.
The issued, subscribed and paid up capital increased by Rs.9 lakhs compared to the
previous year. In 2006 2007 the Profit after Tax has increased from Rs.34401 to
Rs.47600. While the current assets have decreased by Rs.3 lakhs, current liabilities have
also decreased by Rs.12 lakhs. The unsecured loans and advances have increased from
Rs.60 lakhs to Rs.78 lakhs
No dividend has been paid as the Bhas Commodities Pvt. Ltd has utilized the profits to
set off losses carried forward from the previous years.
Solvency Ratio
For the year ended 31st march 2006: 0.5833
For the year ended 31st march 2007: 0.6666
Ideal ratio is above 1.
Profitability Ratio
Return on Shareholders equity capital
For the year ended 31st march 2006: 0.0052
For the year ended 31st march 2007: 0.0061
Earnings per share ratio
For the year ended 31st march 2006: 0.0521
For the year ended 31st march 2007: 0.0618
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Efficiency Ratio
Debt Equity ratio
For the year ended 31st march 2006: 0.4090
For the year ended 31st march 2007: 0.7272
Earnings per share
For the year ended 31st march 2006: 0.0521
For the year ended 31st march 2007: 0.0618
Liquidity Ratio
Current ratio
For the year ended 31st march 2006: 0.5833
For the year ended 31st march 2007: 0.6666
Quick ratio
For the year ended 31st march 2006: 0.5833
For the year ended 31st march 2007: 0.6666
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Remarks and Comments on the Ratios
Return on capital employed reflects the overall efficiency of how the capital is employed.
This ratio is useful in making capital budgeting decisions, higher the ratio higher
efficiency.
Return on shareholders equity is another measure of profitability. Higher the ratio better
is the performance.
Proprietary ratio indicates the strength of the company.
Debt equity ratio establishes relationship between outside liabilities of a business and
the owners equity. Debt equity ratio has increased from 0.409 in 2006 to 0.7272 which
shows how much debt financing has been used in the business. A high ratio means that
claims of creditors are greater than those of the owners.
Earnings per share indicate whether or not the firms earnings power on per share basis
has changed over a period. Earnings per share simply show the profitability of the firm
on per share basis. Increase in Earnings per share is due issue of additional equity
shares.
Current ratio is a measure of the firms short term solvency. It indicates the availability
of current assets in rupees for every one rupee of current liability. The current ratio
represents a margin of safety for creditors. Since the value of current ratio is less than
one does not mean the company is not doing well, this is because the current ratio is a
test of quantity, not quality.
Quick ratio establishes a relationship between quick, or liquid, assets and current
liabilities. Generally a quick ratio of 1 to 1 is considered to represent a satisfactory
current financial condition. Quick ratio is same as the current ratio for the company
because there is no inventory. Quick ratio has improved from 0.5833 in 2006 to 0.6666
in 2007 this could be due to the increase in the quick assets.
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Figure 1 Trading Structure in a Derivative market
History of Commodity Market
Evolution of commodity market
Commodities futures trading have evolved from the need for ensuring continuous supply
of seasonal agricultural crops in Japan, merchants stored rice in warehouses for future
use. In order to raise cash, warehouse holders sold receipts against the stored rice.
These were known as rice tickets Eventually such rice tickets became accepted as a
kind of general commercial currency. Rules came into being, to standardize the tradingin rice tickets.
The concept of organized trading in commodities evolved in the middle of 19th century,
in Chicago, United States. Chicago had emerged as a major commercial hub with
railroad and telegraphs lines connecting it with the rest of the world, thereby attracting
wheat producers from Mid-West to sell their products to the dealers and distributors.
However, lack of organized storage facilities and absence of a uniform weighing/
grading mechanism often confined them to the mercy of dealers discretion. This led to
inherent need to establish a common meeting place both for framers and dealers to
transact in spot grain-to deliver wheat and receive cash in return. This happened in
1848.
Gradually, the framers (sellers) and dealers (buyers) started to make commitments to
exchange the produce for cash in future. This is have the contract for futures trading
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evolved whereby the producer would agree to sell his produce (wheat) to the buyer at a
future delivery date at an agreed upon price. In this way the framers knew in advance
about what he would receive for his produce and the dealer would know about his costs
involved. This arrangement was beneficial to both the producer and the trader.
These contracts became popular very quickly and started changing hands even before
the delivery date of the product. If a dealer is not interested in taking delivery of the
product, he would sell his contract to someone who needed the same. Similarly, the
framer who did not intend to deliver his crop would pass on the responsibility to
another. The price of the contract would depend on the price movements in the wheat
market.
With some more modification, such contracts gradually transformed into an instrument
to protect the parties involved against adverse factors like unexpected price movements,
unfavorable climatic factors etc. For example during bad weather people having
contracts to sell wheat would be interested to hold more valuable contracts due to
supply shortages. Conversely if there is oversupply the sellers contract value would
decline. This prompted the entry of traders in futures market who had no intentions to
buy or sell wheat but would purely speculate on price movements in the market to earn
profit.
Trading in futures as a result became a very profitable mode of activity that encouraged
the entry of other commodities in the futures market thereby creating a platform to set
up a body that can regulate and supervise these contracts. Thus, during 1848, the
Chicago Board of Trade was established. It was initially formed as a common location
known both to the buyers and sellers to negotiate forward contracts.
In the early 20th century, as communication and transportation became more advanced,
centralized warehouses were built in the principal market centers to distribute goods
more economically. Agricultural commodities were the most commonly traded, but it let
to the fact that a market can flourish for any underlying as long as there is an active
pool of buyers and sellers
In the 1870s and 1880s the New York Coffee, Cotton and Produce Exchanges were
born. The largest commodity exchanges in USA are the Chicago Board of Trade, The
Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York
Commodity Exchange and the New York Coffee, Sugar and Cocoa Exchange. Worldwide
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there are major futures trading exchanges in over twenty countries including Canada,
England, India, France, Singapore, Japan, Australia and New Zealand.
The various exchanges are constantly looking for new products in which to trade
futures. In USA, futures trading are regulated by an agency of the Department of
Agriculture called the Commodity Futures Trading Commission. It regulates the futures
exchanges, brokerage firms, money managers and commodity advisors.
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INTRODUCTION TO DERIVATIVES
Derivatives are financial contracts, which derive their value from an underlying asset.
The underlying asset can be equity, commodity, foreign exchange, interest rates, real
estate or any other asset. Broadly four types of derivatives are traded, namely forwards,
futures, options and swaps.
Derivative contracts can be traded either in an exchange or over-the-counter.
Exchange: Exchange is a central marketplace for buyers & sellers. The contracts are
standardized to ensure that the prices mean the same to everyone in the market. The
prices in an exchange are determined in the form of a continuous auction by the
members who are acting on behalf of their clients, companies or themselves. This
auction provides a readily available, widely accepted reference price for the underlying,
a process that is called price discovery. All participants of a futures contract are subject
to the same specifications of quality, quantity & delivery terms. The Exchange does not
take positions in the market nor can it advise people on what positions to take. The
responsibility of the Exchange is to ensure that the market is fair & orderly. All
Exchanges are governed by regulatory authority & are aware of the identity of anyone
holding a substantial position. Members violating the rules can be subject to fines or
other penalties.
Over-the-counter: OTC is an alternative trading platform, linked to a network of
dealers who do not physically meet but instead communicate through a network of
phones & computers. Trades are usually transacted between financial institutions that
can also act as market makers for the commonly traded instruments. All transactions
over the telephone are recorded, in case of future disputes that may arise. The buyer &
seller to suit their requirements can customize the contracts traded in these markets.
Hence, terms of the contract need not be specified as in the case of an Exchange.
There are three types of OTC markets:
(a) Traditional dealer market: In this, the dealers act as market makers by maintaining bid
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and offer quotes. The dealers communicate the quotes and the execution prices are
negotiated upon over the telephone and sometimes through an electronic bulletin board.
It is bilateral trading as only the two ends of a phone observe prices at a given point of
time.
(b) Electronic Broking Market (EBM): This is similar to the electronic trading platforms used
by exchanges. These are considered to be over the counter since the contracts are less
standardized. The EBM neither sets the contract design nor clears the derivative
transactions.
(c) Proprietary trading platform market: This is a combination of the first two in which a
dealer sets up his own proprietary electronic trading platform. The dealer quotes the
bids and asks exclusively for the market participants to observe his quotes only and not
each other's. In this form of trading the dealer acts as the counter party to every trade
so that half of the credit risk in the market is his.
Meaning of Forward, Futures
Aforward contract is an agreement between two parties to buy or sell an asset at a
future date for price agreed upon while signing the agreement. Forward contract is not
traded on an exchange. The terms and conditions of forward contracts are customized
based on negotiations between the counter parties. It is the oldest form of derivative
contract.
Afutures contract is an agreement between two parties to buy or sell a specified and
standardized quantity and quality of an asset at a certain time in the future at a price
agreed upon at the time of entering into the contract on the futures exchange.
Difference between Spot and Futures markets
Commodities can be transacted in both the spot as well as in the futures markets.
Although the two markets are separated, they are interrelated nevertheless. The
commodities are physically bought or sold on a negotiated basis in the spot market,
which is generally considered as the actual physical market for immediate delivery. Most
often, the contract requires for the actual delivery of the commodity traded to be made.
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It may also specify for immediate or forward delivery in the future at a set time.
The futures market, however, facilitates buying and selling of standardized contractual
agreements (for future delivery) of the underlying asset as the specific commodity and
not the physical commodity itself. The formulation of a futures contract is very specific
regarding the quality of the commodity, the quantity to be delivered and the date for
delivery. However, it does not involve immediate transfer of ownership of the
commodity, unless resulting in delivery. Thus, in the futures markets, commodities can
be bought or sold irrespective of whether one has possession of the underlying
commodity or not.
The physical markets for commodities deal in either cash or spot contract for ready
delivery and payment within 11 days, or forward (not futures) contracts for delivery of
goods and/or payment of price after 11 days. These contracts are essentially party to
party contracts, and are fulfilled by the seller giving delivery of goods of a specified
variety of a commodity as agreed to between the parties. In case of unforeseen
situations which prevent buyers or sellers from receiving or giving deliveries then in such
cases contracts may be cash settlement mutually.
The futures market, unlike the physical markets, trade in futures contracts primarily for
the purpose of risk management that is hedging on commodity stocks or forward buys
and sells. Most of these contracts are squared off before maturity and thus rarely end in
deliveries. Speculators, who are key players in the futures markets, also use these
contracts to benefit from price movements and are hardly interested in taking or giving
delivery of commodities.
The term Basis refers to the difference in spot and futures prices of a commodity. The
spot price is the real price of the physical commodity while the futures price refers to the
price of a contract being traded in the futures market. Although, the prices of the spot
and futures are different they do have the tendency to parallel each other due to their
relationship. Irrespective of the market condition, the futures and spot prices tend to
equalize as the maturity date for the contract approaches. A future contract approaching
expiration date becomes, in effect, a spot contract.
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Evolution of Commodity futures in India
The history of futures trading in commodities in India is almost as old as that of US. It
has, however, passed through a turbulent past. India's first organized futures market
was the Bombay Cotton Trade Association Ltd., which was set up in 1875. Futures
trading in oilseeds started with the setting up of Gujarati Vyapari Mandali in 1900. Gold
futures trading began in Mumbai in 1920. During the first half of the 20th century, there
were several commodity futures exchanges trading in jute, pepper, turmeric, potatoes,
sugar, etc.
However, during the 1940s to 1960s, trading in forwards and futures became difficult as
a result of price controls. Major policy decisions taken after Independence, mainly
because of the then prevailing scarcity situation, adversely affected the development of
futures and forwards markets in the country. In 1952, the Forward Contract Regulation
Act was passed which controls all transferable forward and futures contracts. This again
put restriction on futures trading. During the 1960s and 70s, the Government of India
suspended trading in several commodities like cotton, jute, edible oilseeds, etc. as the
government felt that these markets were increasing the prices of commodities.
The government's twin policies of offering to buy agricultural produce at a "minimum
support price" (MSP) and gaining a monopoly in storage/transportation/distribution of
agricultural produce along with a ban on futures and options trading were the majorfactors that weakened the agro-commodity markets in the country.
The government appointed two committees to study this sector i.e. the Dantwala
Committee in 1966 and the Khusro Committee in 1980, which recommended the
reintroduction of futures trading in major commodities. The government finally brought
back forward trading in agricultural commodities in the early 1980's. But, it was done for
commodities that did not have a very significant role in the economy - such as castor
seed and castor oil, jaggery, jute, pepper, potato and turmeric. Several localized
exchanges started trading in the same commodity, each of them with a local
broker/wholesale-merchandiser. But, even after a decade, none of the markets achieved
the levels of liquidity that existed prior to the ban on commodity futures trading.
Once futures trading became operational, in spite of liberalization, it has been difficult
for trade to be transferred from illegal black markets, which have zero tax liability and
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no reporting requirements to the legal authorities as compared to the regulated
markets, where taxes & reporting are part of the legal procedures. Further, responding
to the need for commodity futures in India, in 1993, a committee was set-up for
assessing the scope for forwards and futures trading in commodities and for
recommending steps to be taken for development of futures trading in India. The
Committee so instituted was known as the Kabra Committee and much of its
recommendations have been implemented.
Whereas, with the current initiatives of the regulators, these markets have shown
revolutionary changes in the last few years, with the National-level multi commodity
exchanges in India showing tremendous potential to tap the commodity derivatives
market.
Meaning and objectives of commodity futures
A commodity futures contract is an agreement between two parties to buy or sell a
specified and standardized quantity and quality of a commodity at a certain time in
future at a price agreed upon at the time of entering into the contract on the commodity
futures exchange.
The need for a futures market arises mainly due to the hedging function that it can
perform. Commodity markets, like any other financial instrument, involve risks
associated with frequent price volatility. The loss due to price volatility can be attributed
to the following two reasons:
Consumer Preference: In the short- term, their influence on price volatility is small
since it is a slow process permitting manufacturers, dealers & wholesalers to adjust their
inventory in advance.
Changes in Supply: They are abrupt & unpredictable bringing about wild fluctuations
in prices. This can be especially noticed in agricultural commodities where the weather
plays a major role in affecting the fortunes of people involved in this industry. The
futures market has evolved to neutralize such risks through a mechanism; namely
hedging.
The objectives of commodity futures:
Hedging with the objective of transferring risk related to the possession of
physical assets through any adverse movements in price.
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Liquidity and Price discovery to ensure base minimum volume in trading of a
commodity through market information and demand-supply factors that
facilitates a regular and authentic price discovery mechanism.
Maintaining buffer stock and better allocation of resources as it augments
reduction in inventory requirement and thus the exposure to risks related with
price fluctuation declines. Resources can thus be diversified for investments.
Futures trading leads to predictability in assessing the domestic prices, which
maintains stability, thus safeguarding against short-term adverse price
movements. Liquidity in the contracts of the commodities traded also ensures in
maintaining the equilibrium between demand and supply.
Flexibility, certainty and transparency in purchasing commodities facilitate bank
financing. Predictability in the prices of commodity would lead to stability, which
in turn would eliminate the risks associated with running the business of trading
commodities. This would make funding easier and less stringent for banks to
commodity market players.
Pricing commodity futures
The relationship between cash price and futures price can be explained in terms of cost
of carry. Cost of carry is an important element in determining pricing relationship
between spot and futures prices as well as between prices of futures contracts of
different expiry months. According to the cost of carry model, futures prices depend on
the spot price of a commodity and the cost of storing the commodity from the date of
spot price to the date of delivery of the futures contract. Cost of storage and insurance
and cost of financing constitute cost of carry. Estimated cost of futures price is also
called "Full carry futures price".
Cost of carry model: The cost of carry model can be defined .as:
F=S+C (Where F=Futures price S=Spot price C=Cost of carry)
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Exchange membership
Membership of Exchange is open to any person, association of persons, partnerships,
co-operative societies, companies etc. that fulfill the eligibility criteria set by the
exchange. All the members of the exchange have to register themselves with the
competent authority before commencing their operations. Membership categories are
different for different exchanges, membership types are explained in detail as under.
Trading-cum-Clearing Member (TCM)
A TCM is entitled to trade on his own account as well as on account of his clients, and
clear and settle trades himself. A sole proprietor, partnership firm, a joint Hindu
Undivided Family (HUF), a corporate entity, a cooperative society, a public sector
organization, statutory organization or any other Government or non-Government entitycan become a TCM.
There are two types of Trading-cum-Clearing (TCM) memberships, namely, TCM-1 and
TCM-2. TCM-1 refers to transferable non-deposit based membership and TCM-2 refers
to non-transferable deposit-based membership.
A person desirous of being registered, as a Trading-cum-Clearing-Member is required to
submit an application as per the format prescribed under the business rules, along with
all enclosures, fee and other documents specified therein. He is required to go through
an interview by the Membership Admission Committee and the committee is entitled to
accept or reject his application. The Committee is also empowered to frame rules or
criteria relating to admission of membership. After taking into account the report of the
Membership Admission Committee, the Board takes a final decision relating to selection
or rejection of a member. On selection, the member is required to execute and submit
an Undertaking called as "Trading-cum-Clearing-Member Undertaking" as data as per
format prescribed under the business rules. On selection and after complying with all the
requirements stated above and also after payment of admission fee, security deposit,
VSAT charges, etc., the member becomes entitled to trade on his own account as well
as on account of his clients.
If a Trading-cum-Clearing-Member is desirous of clearing, either all or part of his trades
through an Institutional Trading-cum-Clearing-Member (ITCM) or a Professional Clearing
Member (PCM), he is allowed to do so.
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Institutional Trading-Cum-Clearing Member (ITCM)
Only an Institution / Corporate can be admitted by the Exchange as a member,
conferring upon them the right to trade and clear through the Clearing House of the
Exchange as an Institutional Trading-cum Clearing Member (ITCM). Moreover, the
Member may be allowed to make deals for himself as well as on behalf of his clients and
clear and settle such deals. Further the ITCMs can also appoint sub-brokers, authorized
persons and Trading Members who would be registered as Trading Members in the
exchange at the request of the ITCM. The ITCM will clear and settle trades on behalf of
the sub-brokers, authorized persons and such Trading Members who are registered in
the exchange at their request, subject to the terms and conditions specified by the
exchange.
Professional Clearing Member (PCM)
A PCM is entitled to clear and settle trades executed by other members of the exchange.
A corporate entity and an institution only can apply for PCM. The Member would be
allowed to clear and settle trades of such members of the exchange who choose to clear
and settle their trades through such PCM.
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Participants in Commodity derivatives Market
Hedgers
Futures contracts have been used as financial offsets to cash market risk for more than
a century. Futures to reduce or limit the price risk of the physical asset. Hedging is an
insurance used to avoid or reduce price risks associated with any kind of futures
transaction.
The degree of effectiveness of a hedge is determined by the percentage of the actual
gain or loss incurred in a futures transaction. Though most hedges reduce risks related
to price variations, they do not eliminate them altogether.
"Margin" for futures contracts is usually between 5% and 10% of the contract value and
is put up in good faith, indicating the buyer or seller's willingness to pay or deliver theentire amount if the contract is held until delivery. Because margin requirements are so
low, it is possible to hedge small or large quantities of commodities. In fact, the low
margins required for trading in futures contract provide high "leverage" for traders. This
is because; the traders can take large exposures even by investing marginal (small)
amount of deposit with the exchange.
Speculators
When supplies of a commodity are greater than the present demand or need, prices
tend to decline. If supplies appear to fall short of demand, prices trend upward.
Estimating market supply and demand conditions are the challenges faced by market
participants. It is generally accepted that speculators are interested in making fast
money by anticipating future price movements. Commodity futures allow speculators to
create high leveraged positions. A speculator accepts the risk that hedgers seek to
avoid, giving the market the liquidity required to service hedge participants effectively
by providing the market with the necessary bids and offers for a continuous flow of
transactions. Speculation is the opposite of hedging. A speculator holds no offsetting
cash market position and deliberately incurs price risk in order to benefit from price
movements.
A speculator is an additional buyer of commodities whenever it seems that market prices
are lower than they should be. Consumers consider this to be against their best interest.
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Conversely, when it appears that prices are too high, a speculator becomes an active
seller.
Individual speculators tend to trade a smaller number of contracts than hedgers and
hold market positions for a shorter time, so several of them may be needed to offset
one large hedge order. The maximum number of contracts that can be held by anyone
speculator is limited by exchange rules.
The less capital required makes speculating in futures contracts very attractive. If the
total value of the contract had to be paid, the rate of return on most commodities would
be extremely small. The small margin provides speculators with the necessary leverage
to generate a substantial rate of return. On the other side it also generates substantial
risk.
Arbitragers
Arbitragers are interested in making purchases and sales in different markets at the
same time to profit from price discrepancy between the two markets. So arbitragers are
interested in locking in a minimum profit by simultaneously entering into transactions in
two or more markets. An arbitrager knows the minimum profit potential at the time of
entering into transactions. In todays financial markets, most arbitrage opportunities
occur either between regions, delivery periods or a combination of these conditions.
Arbitrage means locking in a profit by simultaneously entering into transactions in two or
more markets. If the relationship between spot prices and futures prices in terms of
basis or between prices of two futures contracts in terms of spread changes, it gives rise
to arbitrage opportunities. Difference in the equilibrium prices determined by the
demand and supply at two different markets also gives opportunities to arbitrage. The
futures price must be equal to the spot price plus cost of carrying the commodity to the
futures delivery date else arbitrage opportunity arises.
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ADVANCED CONCEPTS IN COMMODITY FUTURES
Hedging
Hedging means taking a position in the futures market that is opposite to a position in
the physical market with the objective of reducing or limiting risks associated with price
changes. Hedging is a two-step process. For instance, if the hedger is going to buy a
commodity in the cash market at a future date, he buys the futures contract now and
when he buys the commodity in the cash market, the futures contract is squared off to
reduce or limit the risk of the purchase price. If the hedger is going to sell a commodity
in the cash market in the future, he sells the futures contract now and when he sells the
commodity in the cash market, the futures contract is squared off to reduce or limit the
risk of the sales price.Buying hedge or Long hedge
Buying hedge is also called as Long hedge. Buying hedge means buying a futures
contract to hedge a cash position. Buying hedge strategy is used by dealers, consumers,
fabricators, etc. who have taken or will be taking an exposure in the physical market.
Usesof buying hedge strategy
To protect increase in the cost of raw material
To replace inventory at a lower prevailing cost
To protect uncovered forward sale of finished products
Selling hedge or Short hedge
Selling hedge is also called Short hedge. Selling hedge means selling a futures contract
to hedge a cash position. Selling hedge strategy is used by dealers, consumers,
fabricators, etc. who have taken or will be taking an exposure in the physical market.
Uses of selling hedge strategy
To protect the price of finished products
To protect inventory not covered by forward sales.
To protect prices of estimated production of finished products.
Rolling over the Hedge Positions
If the time period required for a hedge position is later than the expiration date of the
current futures contracts, the hedger can roll over the hedge position. Rolling over the
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hedge position means closing out the existing position in one futures contract and
simultaneously taking a new position in a futures contract with a later expiration date. If
a person wants to reduce or limit the risk due to fall in prices of the finished material to
be sold after 6 months and if futures contracts up to 2 months are liquid, then he can
roll over the short hedge position three times till the date when the actual physical sale
takes place. Every time the hedge position is rolled over, there is a possibility of basis
risk but at the same time it limits or reduces the price risk.
Advantages & Limitations of Hedging
Advantages:
1. Hedging reduces or limits the price risk associated with the physical commodity.
2. Hedging is used to protect the price risk of a commodity for long periods by rolling
over contracts.
3. Hedging makes business planning more flexible without interfering with routine
business operations.
4. Hedging can facilitate low cost financing
Limitations:
1. Hedging cannot eliminate the price risk associated with the physical commodity in
totality due to the standardized nature of futures contract.
2. Because of basis risk, hedging may not provide full protection against adverse price
changes.
3. Hedging involves transaction costs.
4. Hedging may require closing out a futures position before it enters into the delivery
period.
Speculation
Speculation means anticipating future price movements to make profits from it. The
main objective of speculation in a commodity futures market is to take risks & profit
from anticipated price changes in the futures price of an asset. A speculator will buy
futures contracts (long position) if he anticipates an increase in the price of the
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commodity in future and he will sell futures contracts (short position) if he anticipates a
fall in the price of the commodity in future.
Long position in futures
Long position in a commodity futures contract without any exposure in the cash market
is called a speculative transaction. Long position in futures for speculative purpose
means buying a futures contract in anticipation of increase in the price before expiry of
contract. If the price of the futures contract increases before the expiry of the contract
then the trader makes profit on squaring off the position and if the prices of the futures
contract decrease then the trader makes losses.
Speculators can also be classified into two categories; long and short speculators. Long
speculators are those who expect the price to rise above the current level and assume
risks by buying futures contracts.
Shortposition in futures
Short position in a commodity futures contract without any exposure in the cash market
of the commodity means a speculative transaction. Short position in futures for
speculative purposes means selling a futures contract in anticipation of decrease in the
price before expiry of the contract. If prices of the futures contract decrease before
expiry of the contract then the trader makes profits on squaring off the position and if
prices of the futures contract increase then the trader makes losses.
Short speculators are those who expect the price to fall and consequently sell futures
contracts. In futures market, the total short selling position, made up of short hedgers
and short speculators, and the total long buying position, made up of long hedgers and
long speculators, must always be equal. Any excess of short over long hedging must be
balanced by an equal amount of long over short speculation.
The role of speculation in Futures Markets
One of the prominent concerns about the functioning of the commodity futures markets
and its effect on the distribution of manpower is speculation. Speculation provides the
depth and flow that is key to the functioning of a futures market. There will be very high
illiquidity in the futures market if firms after entering a trade to buy or sell have to wait
till a suitable bid or offer arose since the availability of commodities in physical may not
always necessarily match with the firm's decision to buy or sell commodities.
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There are also misconceptions rife about speculation being similar to gambling. Although
the intention of both the speculators and gamblers is to profit by taking risks, the
gambler creates risk when none exist, the speculator on the other hand takes risk that is
already prevalent in the market and as a result plays an economically significant role. A
proper and accurate assessment and interpretation of the fundamental factors that drive
the market forces determines the extent of success in speculating in the futures markets
while in gambling it is only a matter of chance. In fact, the important function of price
discovery in the futures markets is a direct outcome of the exercise of information
gathering in the underlying commodities being done by the speculators.
Speculation is also not similar to manipulation. A manipulator tries to push prices in the
reverse direction of the market equilibrium while the speculator forecasts the movement
in prices and this effort would eventually bring the prices closer to the market
equilibrium. If the futures markets do not adhere to the relevant risk management
requirements of growers, manufacturers, traders and processors, they would not survive
since their correlation with the underlying physical market would be nonexistent.
Meaning of spread trading
Spread refers to difference in prices of two futures contracts. An understanding of
spread relationship in terms of fair spread is essential to earn speculative profit.
Considerable knowledge of a particular commodity is also necessary to enable the trader
to use spread trading strategy. When actual spread between two futures contracts of
the same commodity widens, buy the near month contract because it is under- priced
and sell the far month contract because it is overpriced. When actual spread between
two futures contracts of the same commodity narrows, sell near month contract because
it is overpriced and buy far month contract because it is under priced.
A calendar spread is a spread between the same variable at two points in time. A
calendar spread for the price of an agricultural product prior to and after a harvest
might be of interest, as might be the calendar spread between the price of natural gas
in summer and winter.
An intra-commodity spread consists of one long future and one short. Both have the
same underlying, but different maturities.
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An inter-commodity spread is a long-short position in futures on different underlying
commodities.
Both typically have the same maturity
Spreads can also be constructed with futures traded on different exchanges. Typically
this is done using futures on the same underlying, either to earn arbitrage profits or, in
the case of the underlying commodity, to create an exposure to price spreads between
two geographically separate delivery points.
Buying a spread
Buying a spread is an intra-commodity spread strategy. It means buying a near month
contract and simultaneously selling a far month contract. This strategy is adopted when
the near month contract is under priced or the far month contract is overpriced. A trader
of the above strategy buys the near month contract and sells the far month contract
when the spread is not fair and squares off the positions when the spread corrects and
the contracts are traded at fair spread.
Selling a spread
Selling a spread is also an intra commodity spread strategy. It means selling a near
month contract and simultaneously buying a far month contract. This strategy is
adopted when the near month contract is overpriced or the far month contract is under
priced. A trader of the above strategy sells near the month contract and buys the far
month contract when the spread is not fair and squares off the positions when the
spread corrects and the contracts are traded at fair spread.
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Clearing, Settlement and Delivery Mechanism
Clearing and Settlement procedure
Exchange to Regulate: The Exchange has specified the processes, procedures, and
operations that every Clearing member shall be required to follow for participation in the
clearing and settlement activities and operating their bank accounts with the Clearing
Banks appointed by the Exchange.
Functions of the Clearing Bank : The Exchange appoints few Clearing Banks viz. SBI,
HDFC Bank, Induslnd Bank, UTI Bank, Citibank, Union bank of India, Bank of India, and
Corporation Bank, ICICI etc. for transfer of funds between clearing members and the
Exchange.
Members to have accounts with the Clearing Bank: Every Member of theExchange shall have designated bank accounts with any of such branches of the
designated Clearing Bank, which has electronic funds transfer facility. Members shall
operate the Settlement account only for the purpose of settlement of deals entered
through the Exchange for the payment of margin money and for any other purpose as
may be specified by the Exchange. Every member of the Exchange is required to open
the following accounts with any of the clearing banks stated above:
Settlement Account or Clearing account- in which the member will not have
cheque book facility for issuing cheques to any outsiders. He can only issue
cheques from this account for transfer of money from this account to his Client
Account. Apart from any such transfer, only the Exchange will have the power
to withdraw money from this account by way of direct debit instructions. In
respect of all pay in, margins, charges and other dues payable to the Exchange,
the Exchange will send direct debit instructions to the bank advising them to
debit the settlement account of the respective member by such payable
amount.
Client Account- in which the member can deposit all cheques, cash, etc.
received from clients and from this account members can issue cheques to their
clients towards their receivables. The member has cheque book facility for this
account and he will also be entitled to issue transfer instructions to the bank for
transferring money from this account to the Settlement account to meet his pay
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in or margin obligations.
The Clearing Banks act as per the instructi ons of the Exchange: Exchange shall
instruct the Clearing Banks as to the debits and credits to be carried out for settlement
of funds between members. For this purpose, members of the Exchange will be required
to submit a letter to the bank, as per the format given in the business rules for
authorizing the Exchange to issue such debit and credit instructions. The Clearing Bank
shall act as per the instructions received from the Exchange for the movement of funds.
Instructions of the Exchange as to the debits and credits to a member's account shall be
deemed to be irrevocable, confirmed and binding. In order to enable the Exchange to
issue such instructions for debiting their account and also to authorize the Exchange in
respect of freezing the account or to hold further debits, every member will be required
to submit a written undertaking addressed to the bank to such effect. This undertaking
will also authorize the bank to sweep the Client account of the respective member for
any shortfall in the settlement account. Besides, the Exchange will also have the power
to freeze various accounts of the member maintained with the Clearing bank, in case of
any default or shortfall in pay in or margin account.
Clearing Banks inform exchange in case of default in funds settlement:
If there is any funds default arising out of the instructions received from the Exchange,
the Clearing Bank shall inform the Exchange immediately.
Clearing Account(s) of Exchange in the Clearing Bank :
The Exchange maintains its Settlement account with the Clearing bank and all money
received from the members towards pay in or margin, shall be used appropriately for
settlement.
Operational Procedure:
The operational procedure related to the settlement account, pay in and payout activities
and theexact time schedule in order to maintain financial discipline shall be adhered to
by members of theExchange. The operational procedure, are:
After the end of the trading session every day, a file can be downloaded to the
TWS of the members through FTP (file transfer protocol), which will contain details
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of all transactions executed by the member on that day, positions carried forward
from the previous day, closing position of the day including net obligation of the
member.
The net obligation report will further provide the amount of margin deposit,
margin utilized, available deposit / margin required, pay in / payout amount,
transaction fee payable / receivable, etc. The net obligation report is available and
can be downloaded terminal wise. It is also consolidated at the member's level in
terms of net obligation payable / receivable.
On the basis of this file, the Exchange will generate an automated statement for
debit and credit of settlement accounts of the respective members by the amount
payable / receivable by them. This file will be sent electronically to the bank the
next day in the morning at 9:00 AM.
The process of the files being processed by the bank is as follows:
The pay-in files are processed
Then the pay-out files are processed
The margin deficit files are then processed
Throughout the day, shortage files (information containing details of deficit
payment) are processed.
The member must have sufficient clear balance in his settlement account so as to affect
such debits. In case the amount of margin is payable, the member is not allowed to
trade until he deposits the required margin along with additional deposits to enable him
to create fresh positions. For collection of such required margin amount, the bank will
run the margin file at 10 am and report to the Exchange electronically the successful
debits. However, to pay an additional amount towards margin, the member has to send
a fax to Exchange specifying the amount he is interested in paying towards additional
deposit / margin. On the basis of this written request, the Exchange will forward
individual debit instructions to the bank for debiting the respective settlement account
and crediting the Exchange settlement account. As soon as the Exchange gets such
confirmation, the limits are accordingly increased.
Thereafter, at 10.30 am, the bank will run the debit files in respect of pay-in. The
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member must have sufficient balance in his account to meet his pay in
obligation. By 10.45 am, the Exchange will receive confirmation about the
successful and failed instructions. In respect of failed instructions, the member is
immediately suspended from trading. He is allowed to trade only when he
deposits the pay in obligation.
In this process, trading permission is allowed to only those members who settle
their margin as well as pay in obligation before 11 am. In case a member fails to
meet the pay in obligation by 11 am on T +1, the Exchange may commence the
process of squaring off his positions after 11 am, depending on the magnitude of
the problem.
Role of clearing house
Regulation of the clearing house: The Exchange Clearing House monitors and
performs all activities related to delivery, funds settlement, margining, managing the
settlement guarantee fund, etc.
Functions of the Clearinghouse: The Clearing House will collect margins from the
members, effect pay in and payout and monitor delivery and settlement process. For
carrying out such activities, it may appoint various agencies as its agents and may
delegate such activities and responsibilities to such agencies, as it may desire.
Clearing House to deliver: The Clearing House will allocate deliveries, which it has
received from the selling member to the buyer and the same shall be binding on the
buyer.
Lien on Member's deposits and deliveries: When a member is declared a defaulter,
all deposits, margins, delivery documents and other assets of the defaulting memberlying with the Exchange shall be under lien and first charge of the Exchange,
irrespective of the fact whether such assets or deposits belong to the member or his
clients. No client or any other person can claim any charge or right on any such deposit,
margin or delivery documents under any circumstances.
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Clearing Assistants for the Clearing House: In respect of delivery of precious
metals (gold and silver), a Clearing Member may nominate Clearing Assistants (not more
than two for each delivery center), who shall be competent to sign on behalf of such a
member all clearing forms, vouchers, claim notes, receipts and other documents and
transact on his behalf all such business as is necessary to be transacted in all matters
connected with the operations of the Clearing House. Each Clearing Assistant shall be
issued an Identity Card by the Exchange, which shall be displayed by him on his person
during his presence at the Clearing House premises. The member may apply for a
clearing assistant. A Clearing Member who has to give or take delivery of precious
metals or any other tender /delivery documents shall either be present personally in the
Clearing House or be represented by his Clearing Assistant at the appropriate time.
Clearing Code and Clearing Forms: A member shall be allotted a Clearing Code,
which must appear on all forms used by the member connected with the operations of
the Clearing House. The member or his Clearing Assistant shall sign all Clearing Forms.
Specimen Signatures:A member shall file with the Clearing House specimens of his
own signature and of the signatures of his Clearing Assistants.
Delivery and payment through Custodians and Clearing Members: The Clearing
House maintains a register of Custodians, Banks, Trust Companies and other firms
approved by the Executive Committee which may act for members and their
constituents in giving and taking delivery of precious metals.
Notices and Directions: All Clearing Members shall comply with the instructions,
resolutions, orders, notices, directions and decisions of the Executive Committee in all
matters connected with the operations of the Clearing House.
Liability of the Clearing House: The Clearing House shall not be deemed to
guarantee the title, ownership, genuineness, regularity or validity of any delivery passing
through the Clearing House and the only obligation of the Clearing House in this matter
shall be to facilitate the delivery and payment in respect of delivery.
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Liability of the Exchange: No liability shall attach either to the Exchange, its officials,
or to the Executive Committee or any member of the Executive Committee by reason of
anything done or omitted to be done by the Clearing House in the course of its
operations, nor shall the Exchange, its officials, or the Executive Committee or any
member of the Executive Committee be liable to answer in any way for the title,
ownership, genuineness, quality, quantity or validity of any delivery or any other
documents passing through the Clearing House, nor shall any liability be attached to the
Exchange, its officials, the Executive Committee or any Member of the Executive
Committee in any way in respect of such delivery and any other documents.
False or misleading statements: The Exchange may fine, suspend or expel a
clearing member who makes any false or misleading statement in the Clearing Forms
required to be submitted in conformity with these Regulations or any resolutions, orders,
notices, directions and decisions of the Clearing House.
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Delivery Procedure
Delivery Period:
Each Futures Contract for specified delivery month shall be deemed to have entered the
delivery period from such date of its expiry month, as specified by the Exchange in the
relevant contract. The futures contract can result in delivery of the underlying
commodity within this period on designated tender days fixed by the Exchange.
Provided that the Exchange will have the right to fix, alter, extend or postpone such
delivery period, if it is expedient to do so.
Designated Tender Days:
The tendering of deliveries shall be permitted only on specific tender days during the
delivery period. The Exchange notifies such tender days in advance.
Delivery Logic
Delivery logic refers to the type of choices available to the buyers and sellers having
open positions during tender / delivery period, for delivery of the commodity. The
different delivery option's are "seller's option", "both option" and "compulsory delivery"
Seller's option:
In the "seller's option", the seller having an open position of a contract during the
tender / delivery period will have the option to give delivery. In this case, it is obligatory
for the buyer, who has been marked, to accept delivery or pay penalty.
In a "seller's option", the short position holders who communicate their intention for
giving delivery are matched with the corresponding intentions of the long position
holders for taking delivery, Any short position holder having an "open position" on the
tender / delivery date shall have the option to tender for deliveryof his short position
and the long position holder will be obligated to accept delivery. If there are no
sufficient long position holders who have given their intention, then the delivery will be
marked on a random basis to open long position holders (buyers of the contract) and it
is obligatory for them to take delivery. In case the long position holders fails to lift the
delivery, penalty will be imposed for failure and the open position of the seller and the
buyer will be closed out at the due date rate.
Compulsory Delivery
In case of "compulsory delivery", both buyers and sellers with open positions during the
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tender/delivery (T/P D/P) period, if marked for delivery, or upon the expiry of the
contract, are obligated to take / give delivery of the commodity.
Both Option
In the case of "both option", the delivery will be executed only when both buyers and
sellers agree to take / give delivery. If they do not give intention for delivery, such open
positions are cash settled at the due date rate.
Delivery Orders:
All deliveries tendered by Members on designated tender days shall be in the form of
"Delivery Orders" issued in favor of the buyers, as per instructions of Exchange. The
Delivery Orders shall be filled up in the prescribed form and shall clearly state the
contract particulars including quantity, quality and the delivery center, along with full
postal address of the place where goods are stored. The Delivery Orders must be
received by Exchange by 3 pm (or the time specified in the contract specification) on the
specified delivery days; otherwise it is treated as valid only for the subsequent delivery
day.
Each delivery order issued shall be in multiples of minimum deliverable lots and shall be
designated for only one delivery center and one location in such center. The tenderer of
delivery order shall also clearly disclose the identity of the Member/Registered Non-
Member, if any, who shall be performing the delivery. The seller shall not issue delivery
order at a place where there is a restriction against movement of goods from such place
by any person or Government authority or local authority at the time of issuing such
delivery order. The seller shall, at his cost, give permit to the buyer wherever such
permit is necessary for movement of goods. If the seller is unable to supply such permit
to the buyer, it will be treated as no delivery and he shall be liable to pay such penalty
as may be applicable for failure to tender delivery. Delivery Order once submitted cannot
be withdrawn or cancelled or changed, unless so agreed by the exchange in writing.
Delivery Lot:
The Contracts traded at Exchange are deliverable in such lots as may be specified for
respective commodities. Members with short open positions opting to tender deliveries
shall be permitted to issue Delivery Orders only in such lots. Any member with an open
position of such number of contracts that is not convertible into multiples of deliverable
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lots shall be required to square-up such outstanding "odd lots" before expiry of the
contract so as to make the total deliverable quantity a deliverable lot. Incase any
member fails to square-up the outstanding odd lots before the contract expires resulting
in odd lot positions at the end of the contract expiry day, delivery up to the nearest
completed delivery lot will take place in the usual manner, while the residual odd lot will
be settled as specified in the contract specification.
Provided further that the place of delivery, which may be opted by the respective seller
and buyer above shall be permitted only at the delivery centers approved by the
Exchange for that commodity.
Permissible limits for the Delivered commodity
The delivery shall be deemed to have been provisionally completed for each delivery
order whenever the seller has delivered the quantity for that delivery order within the
tolerance limit as may be specified from time to time. The delivery is considered as fully
complete only after the buyer lifts delivery and confirms receipt of delivery with the
same quantity and quality. Provided that if no confirmation or objection is received from
the buyer within such time, as may be notified by the Exchange for a specific
commodity, delivery is considered as complete without any further recourse available to
the buyer.
Delivery Grades
Members tendering delivery will have the option of delivering such grades of
Commodities as permitted by Exchange. The buyer will not have any option to select a
particular grade and the delivery offered by the seller and allocated by the Exchange
shall be binding on him. The Member tendering delivery will clearly specify the grade to
be delivered in the Delivery Order. Once the delivery grade is specified, it cannot be
changed for the same Delivery Order. Such delivery grade shall be in conformity with
the surveyor's certificate accompanied by the tender document.
Delivery Centers:
Delivery centers shall be such centers as may be notified by the Exchange for respective
commodities. Members are obliged to tender delivery orders only at such centers as may
be required by the Exchange.
Freight Adjustment factor I Discount I Premium on up country delivery:
The Exchange notifies the Discount/Premium for delivery of Specified commodities at
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various delivery centers.
Pricing of Delivery Orders
The basis price for a Delivery Order shall be the settlement price of the concerned
contract on the day (which shall be a designated tender day) on which the delivery is
tendered. The basis price arrived at as above will have to be adjusted by applying
Freight adjustment factor / Discount / Premium on up country delivery and the discount
/ premium in respect of quality.
Taxes, Duties, Cess and other Levies:
All taxes, duties, cess, or other levies shall be on account of the Member taking delivery
as a buyer. All sellers tendering goods shall have the necessary Sales Tax registration
and obtain other licenses, if any, required by them. In case the selling member does not
have a Sales Tax Registration number then he can appoint an Agent/Nominee who has
the required Sales Tax Registration and deliver the goods through him. The Member
giving delivery and the Member taking delivery will exchange appropriate tax forms as
provided in law and as customary, and neither of the parties will unreasonably refuse to
do so. In case any of the members or their clients fail to provide necessary forms in
respect of sales tax resulting into pecuniary loss to either of the party, the Exchange will
impose a charge on the party in default and after collection thereof, will pass on the
same to the member, who or whose client has suffered such loss. In addition to the
above, the Exchange can impose additional penalty on the party in default.
Allocation of Delivery Orders
Exchange shall allocate all Delivery Orders received on tender days/ expiry day from
Members holding short open positions to Members holding long open positions before 5
p.m. on the same day, when the tender document is received. The allocation of Delivery
Orders shall be done in a fair and equitable manner by Exchange. The decision of the
Exchange shall be final and binding.
Delivery Procedure:
The Member or his client or final endorsee in possession of a Delivery Order shall be
obliged to take delivery within such period, as may be specified by the Exchange for a
specific commodity. He is also entitled to lift delivery on various days during such
defined period, provided that on each day he has to lift at least 1/1Oth of his total
allocated delivery. In the event that the Member or his client in possession of a Delivery
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Order is unable to lift the material within the prescribed days after the receipt of the
Delivery Order, the seller shall claim and receive compensation at such rate, as may be
decided by the Exchange for that specific commodity in respect of warehouse charges,
insurance charges, etc. In the same manner if the seller fails to give delivery on the
scheduled date or if the seller's representatives are not available to affect delivery, the
buyer shall claim and receive compensation at such rate, as may be specified by the
Exchange for that specific commodity. The Buyer has to intimate to the seller the
schedule for taking delivery of the tendered goods in advance, with a copy to the
Exchange. The Seller has to confirm and intimate in writing to the buyer with a copy to
Exchange in advance about his confirmation to deliver as scheduled or change in the
delivery schedule.
Brokerage:
The Exchange may specify the maximum and minimum brokerage rates, which shall be
adhered to by members of the Exchange while dealing with their clients. Such brokerage
rates may be in terms of commodity specific absolute figure or in terms of percentage
on the value of a contract irrespective of the class of a commodity. Such brokerage
amount must be shown separately in the contract notes to be issued by the members to
their clients. The maximum brokerage rate for the time being is 1 % in case of non-
delivery transactions and 2% (plus expenses incurred for delivery, etc.) in case of
transactions resulting into delivery.
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Regulatory Framework
Forward Contracts Regulation Act, 1952
The Constitution of India brought the subject of STOCK EXCHANGES AND FUTURES
MARKET in Union list. As a result, the responsibility for regulation of commodity futures
markets devolved on Government of India. The Commodity Exchanges in India are
governed and regulated under the Forward Contracts (Regulation) Act, 1952 and Rules
framed there under.
It provides for a 3 tier regulatory system, namely:
. An association recognized by the Government of India on recommendation of Forward
Markets Commission (FMC)
. The Forward Markets Commission (it was set up in Sept 1953) and
. The Central GovernmentForward Markets Commission
The Forward Markets Commission, under the Ministry of Consumer Affairs, Food and
Public Distribution, Government of India is the regulating authority for all Commodity
Futures Exchanges in India.
Functions ofthe Forward Markets Commission - Statutory
(a) To advise the Central Government in respect of the recognition of or the withdrawal
of recognition from any association or in respect of any other matter arising out of the
administration of this Act;
(b) To keep forward markets under observation and to take such action in relation to
them as it may consider necessary, in exercise of the powers assigned to it by or under
this Act;
(c) To collect and whenever the Commission thinks it necessary, publish information
regarding the trading conditions in respect of goods to which any of the provisions of
this Act is made applicable, including information regarding supply, demand and prices
and to submit to the Central Government periodical reports on the operation of this Act
and on the working of forward markets relating to such goods;
(d) To make recommendations generally with a view to improving the organization and
working of forward markets;
(e) To undertake the inspection of accounts and other documents of any recognized
association or registered association or any member of such association whenever it
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considers it necessary; and
(f)To perform such other duties and exercise such other powers as may be assigned to
the Commission by or under this Act, or as may be prescribed. Principal Features of the
FC(R) Act, 1952 are:
The act enables the regulating authority to take such action as may be considered
desirable in respect of specified commodities and specified area without
automatically applying the entire provisions of the act to all commodities in all
areas in sec 15
The act prohibits option trading in all commodities
The act ordinarily exempted non transferable specific delivery contracts from
regulation sec 18(1)
The act ordinarily covers transferable specific delivery contract as well as hedge
contracts
The act empowers the Government to prohibit forward contracts in particular
commodity by a notification sec 17
The act provides for grant of recognition to associations concerned with forward
trading sec 6
The act provides that the regulation of forward markets should ordinarily take place
through the governing bodies of recognized associations sec 11
The act empowers the Central Government to appoint not more than four members
on the governing bodies of recognized associations sec 6(2b)
It provides for a machinery for the supervision and regulation of the governing
bodies from the point of public interest this machinery is the forward markets
commission
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Commodity Futures Market: The economic perspective
Authentic price discovery and an efficient price risk management are the primary
objectives for any futures exchange. The beneficiaries include not only those who trade
in the commodities being offered in the exchange but also those who have nothing to do
with futures trading. It is due to the price discovery and risk management through the
existence of the futures exchanges that a lot of businesses and services are able to
function smoothly.
Economic Benefits of Commodity Futures Markets
1) Price Discovery: The buyers and sellers at the futures exchange conduct trading
based on their assessment of inputs regarding specific market information, expert views
and comments, the demand and supply equilibrium, government policies, inflation rates,weather forecasts, market dynamics, hopes and fears which transforms into a
continuous price discovery mechanism. The execution of trades between buyers and
sellers leads to assessment of the fair value of a particular commodity that is
immediately disseminated on the trading terminal.
Futures exchanges do not act as a mode for setting the prices of commodities. These
are free markets that act as a platform to bring together, in open auction, all forces that
influence the pricing of the commodity. When these markets keep on assimilating and
absorbing new information on a continuous basis throughout the trading day, this
information gets transformed into a single benchmark figure. This figure is the market
price agreed upon by both the buyer and seller. It is for this reason that rational market
participants and commodity traders view futures as a leading price indicator.
2) Price-Risk Management: Hedging is the most common method of price risk
management. It is the strategy of offsetting price risk that is inherent in a spot market
by taking an equal but opposite position in the futures market. Futures markets are used
as a mode by hedgers to protect their businesses from adverse price changes, which
could dent the profitability of their business. Hedging benefits participants who