INTRODUCTION TO COMMODITY MARKET

“COMMODITY”

Any product that can be used for commerce or an article of

commerce which is traded on an authorized commodity exchange is

known as commodity. The article should be movable of value, something

which is bought or sold and which is produced or used as the subject or

barter or sale. In short commodity includes all kinds of goods. Indian

Forward Contracts (Regulation) Act (FCRA), 1952 defines “goods” as

“every kind of movable property other than actionable claims, money and

securities”.

In current situation, all goods and products of agricultural

(including plantation), mineral and fossil origin are allowed for

commodity trading recognized under the FCRA. The national commodity

exchanges, recognized by the Central Government, permits commodities

which include precious (gold and silver) and non-ferrous metals, cereals

and pulses, ginned and un-ginned cotton, oilseeds, oils and oilcakes, raw

jute and jute goods, sugar and gur, potatoes and onions, coffee and tea,

rubber and spices. Etc.

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COMMODITY EXCHANGE

A commodity exchange is an association or a company or any

other body corporate organizing futures trading in commodities for which

license has been granted by regulating authority.

COMMODITY FUTURES

A Commodity futures is an agreement between two parties to buy

or sell a specified and standardized quantity 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 risk

associated with frequent price volatility. The loss due to price volatility

can be attributed to the following reasons:

CONSUMER PREFERENCES

In the short-term, their influence on price volatility is small since it

is a slow process permitting manufacturers, dealers and

wholesalers to adjust their inventory in advance.

CHANGES IN SUPPLY

They are abrupt and unpredictable bringing about wild fluctuations

in prices. This can 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.

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THE OBJECTIVES OF COMMODITY FUTURES

Hedging with the objective of transferring risk related to the

possession of physical assets through any adverse moments in

price. 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.

Price stabilization along with balancing demand and supply

position. Futures trading leads to predictability in assessing the

domestic prices, which maintains stability, thus safeguarding

against any short term adverse price movements. Liquidity in

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 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.

BENEFITS OF COMMODITY FUTURES MARKETS

The primary objectives of any futures exchange are authentic price

discovery and an efficient price risk management. The beneficiaries

include those who trade in the commodities being offered in the exchange

as well as those who have nothing to do with futures trading.

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It is because of price discovery and risk management through the

existence of futures exchanges that a lot of businesses and services are

able to function smoothly.

1. PRICE DISCOVERY

Based on inputs regarding specific market information, the demand

and supply equilibrium, weather forecasts, expert views and

comments, inflation rates, Government policies, market dynamics,

hopes and fears, buyers and sellers conduct trading at futures

exchanges. This transforms in to continuous price discovery

mechanism. The execution of trade between buyers and sellers

leads to assessment of fair value of a particular commodity that is

immediately disseminated on the trading terminal.

2. PRICE RISK MANAGEMENT

Hedging is the most common method of price risk management. It

is strategy of offering price risk that is inherent in 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 business

from adverse price change. This could dent the profitability of their

business. Hedging benefits who are involved in trading of

commodities like farmers, processors, merchandisers,

manufacturers, exporters, importers etc.

3. IMPORT- EXPORT COMPETITIVENESS

The exporters can hedge their price risk and improve their

competitiveness by making use of futures market. A majority of

traders which are involved in physical trade internationally intend

to buy forwards. The purchases made from the physical market

might expose them to the risk of price risk resulting to losses.

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The existence of futures market would allow the exporters to hedge

their proposed purchase by temporarily substituting for actual

purchase till the time is ripe to buy in physical market. In the

absence of futures market it will be meticulous, time consuming

and costly physical transactions.

4. PREDICTABLE PRICING

The demand for certain commodities is highly price elastic. The

manufacturers have to ensure that the prices should be stable in

order to protect their market share with the free entry of imports.

Futures contracts will enable predictability in domestic prices. The

manufacturers can, as a result, smooth out the influence of changes

in their input prices very easily. With no futures market, the

manufacturer can be caught between severe short-term price

movements of oils and necessity to maintain price stability, which

could only be possible through sufficient financial reserves that

could otherwise be utilized for making other profitable

investments.

5. BENEFITS FOR FARMERS/AGRICULTURALISTS:

Price instability has a direct bearing on farmers in the absence of

futures market. There would be no need to have large reserves to

cover against unfavorable price fluctuations. This would reduce the

risk premiums associated with the marketing or processing margins

enabling more returns on produce. Storing more and being more

active in the markets. The price information accessible to the

farmers determines the extent to which traders/processors increase

price to them. Since one of the objectives of futures exchange is to

make available these prices as far as possible, it is very likely to

benefit the farmers.

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6. CREDIT ACCESSIBILITY

The absence of proper risk management tools would attract the

marketing and processing of commodities to high-risk exposure

making it risky business activity to fund. Even a small movement

in prices can eat up a huge proportion of capital owned by traders,

at times making it virtually impossible to payback the loan. There

is a high degree of reluctance among banks to fund commodity

traders, especially those who do not manage price risks. If in case

they do, the interest rate is likely to be high and terms and

conditions very stringent. This posses a huge obstacle in the

smooth functioning and competition of commodities market.

Hedging, which is possible through futures markets, would cut

down the discount rate in commodity lending.

7. IMPROVED PRODUCT QUALITY

The existence of warehouses for facilitating delivery with grading

facilities along with other related benefits provides a very strong

reason to upgrade and enhance the quality of the commodity to

grade that is acceptable by the exchange. It ensures uniform

standardization of commodity trade, including the terms of quality

standard: the quality certificates that are issued by the exchange-

certified warehouses have the potential to become the norm for

physical trade.

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HISTORY OF EVOLUTION OF

COMMODITY MARKETS

Commodities future trading was evolved from need of assured

continuous supply of seasonal agricultural crops. The concept of

organized trading in commodities evolved in Chicago, in 1848. But one

can trace its roots in Japan. In Japan merchants used to store Rice in

warehouses for future use. To raise cash warehouse holders sold receipts

against the stored rice. These were known as “rice tickets”.

Eventually, these rice tickets become accepted as a kind of

commercial currency. Latter on rules came in to being, to standardize the

trading in rice tickets. In 19th century Chicago in United States had

emerged as a major commercial hub. So that wheat producers from Mid-

west attracted here to sell their produce to dealers & distributors.

Due to lack of organized storage facilities, absence of uniform

weighing & grading mechanisms producers often confined to the mercy

of dealers discretion. These situations lead to need of establishing a

common meeting place for farmers and dealers to transact in spot grain to

deliver wheat and receive cash in return. Gradually sellers & buyers

started making commitments to exchange the produce for cash in future

and thus contract for “futures trading” evolved.

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Similarly producer who not intended to deliver his produce to

dealer could pass on the same responsibility to someone else. The price

of such contract would dependent on the price movements in the wheat

market. Latter on by making some modifications these contracts

transformed in to an instrument to protect involved parties against

adverse factors such as unexpected price movements and unfavorable

climatic factors. This promoted traders entry in futures market, which had

no intentions to buy or sell wheat but would purely speculate on price

movements in market to earn profit. That’s why Chicago Board of Trade

(CBOT) was established in 1848. In 1870 and 1880s the New York

Coffee, Cotton and Produce Exchanges were born.

Agricultural commodities were mostly traded but as long as there

are buyers and sellers, any commodity can be traded. In 1872, a group of

Manhattan dairy merchants got together to bring chaotic condition in

New York market to a system in terms of storage, pricing, and transfer of

agricultural products. In 1933, during the Great Depression, the

Commodity Exchange, Inc. was established in New York through the

merger of four small exchanges – the National Metal Exchange, the

Rubber Exchange of New York, the National Raw Silk Exchange, and the

New York Hide Exchange. The largest commodity exchange in USA is

Chicago Board of Trade, The Chicago Mercantile Exchange, the New

York Mercantile Exchange, the New York Commodity Exchange and

New York Coffee, sugar and cocoa Exchange. Worldwide there are major

futures trading exchanges in over twenty countries including Canada,

England, India, France, Singapore, Japan, Australia and New Zealand.

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INDIA AND THE COMMODITY MARKET

HISTORY OF COMMODITY MARKET IN INDIA

The history of organized commodity derivatives in India goes back

to the nineteenth century when Cotton Trade Association started futures

trading in 1875, about a decade after they started in Chicago. Over the

time datives market developed in several commodities in India.

Following Cotton, derivatives trading started in oilseed in Bombay

(1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur

(1913) and Bullion in Bombay (1920). However many feared that

derivatives fuelled unnecessary speculation and were detrimental to the

healthy functioning of the market for the underlying commodities,

resulting in to banning of commodity options trading and cash settlement

of commodities futures after independence in 1952.

The parliament passed the Forward Contracts (Regulation) Act,

1952, which regulated contracts in Commodities all over the India. The

act prohibited options trading in Goods along with cash settlement of

forward trades, rendering a crushing blow to the commodity derivatives

market. Under the act only those associations/exchanges, which are

granted reorganization from the Government, are allowed to organize

forward trading in regulated commodities.

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The act envisages three tire regulations: (i) Exchange which

organizes forward trading in commodities can regulate trading on day-to-

day basis; (ii) Forward Markets Commission provides regulatory

oversight under the powers delegated to it by the central Government.

(iii) The Central Government- Department of Consumer Affairs, Ministry

of Consumer Affairs, Food and Public Distribution- is the ultimate

regulatory authority. The commodities future market remained

dismantled and remained dormant for about four decades until the new

millennium when the Government, in a complete change in a policy,

started actively encouraging commodity market. After Liberalization and

Globalization in 1990, the Government set up a committee (1993) to

examine the role of futures trading.

The Committee (headed by Prof. K.N. Kabra) recommended

allowing futures trading in 17 commodity groups. It also recommended

strengthening Forward Markets Commission, and certain amendments to

Forward Contracts (Regulation) Act 1952, particularly allowing option

trading in goods and registration of brokers with Forward Markets

Commission. The Government accepted most of these recommendations

and futures’ trading was permitted in all recommended commodities. It is

timely decision since internationally the commodity cycle is on upswing

and the next decade being touched as the decade of Commodities.

Commodity exchange in India plays an important role where the

prices of any commodity are not fixed, in an organized way. Earlier only

the buyer of produce and its seller in the market judged upon the prices.

Others never had a say. Today, commodity exchanges are purely

speculative in nature. Before discovering the price, they reach to the

producers, end-users, and even the retail investors, at a grassroots level. It

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brings a price transparency and risk management in the vital market. A

big difference between a typical auction, where a single auctioneer

announces the bids and the Exchange is that people are not only

competing to buy but also to sell. By Exchange rules and by law, no one

can bid under a higher bid, and no one can offer to sell higher than

someone else’s lower offer.

That keeps the market as efficient as possible, and keeps the traders

on their toes to make sure no one gets the purchase or sale before they do.

Since 2002, the commodities future market in India has experienced an

unexpected boom in terms of modern exchanges, number of commodities

allowed for derivatives trading as well as the value of futures trading in

commodities, which crossed $ 1 trillion mark in 2006. Since 1952 till

2002 commodity datives market was virtually non- existent, except some

negligible activities on OTC basis. In India there are 25 recognized future

exchanges, of which there are three national level multi-commodity

exchanges.

After a gap of almost three decades, Government of India has

allowed forward transactions in commodities through Online Commodity

Exchanges, a modification of traditional business known as Adhat and

Vayda Vyapar to facilitate better risk coverage and delivery of

commodities. The three exchanges are: National Commodity &

Derivatives Exchange Limited (NCDEX) Mumbai, Multi Commodity

Exchange of India Limited (MCX) Mumbai and National Multi-

Commodity Exchange of India Limited (NMCEIL) Ahmedabad.There

are other regional commodity exchanges situated in different parts of

India.

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LEGAL FRAMEWORK FOR REGULATING

COMMODITY FUTURES IN INDIA

The commodity futures traded in commodity exchanges are

regulated by the Government under the Forward Contracts Regulations

Act, 1952 and the Rules framed there under. The regulator for the

commodities trading is the Forward Markets Commission, situated at

Mumbai, which comes under the Ministry of Consumer Affairs Food and

Public Distribution

FORWARD MARKETS COMMISSION (FMC)

It is statutory institution set up in 1953 under Forward Contracts

(Regulation) Act, 1952. Commission consists of minimum two and

maximum four members appointed by Central Govt. Out of these

members there is one nominated chairman. All the exchanges have been

set up under overall control of Forward Market Commission (FMC) of

Government of India.

NATIONAL COMMODITIES & DERIVATIVES EXCHANGE

LIMITED (NCDEX)

National Commodities & Derivatives Exchange Limited (NCDEX)

promoted by ICICI Bank Limited (ICICI Bank), Life Insurance

Corporation of India (LIC), National Bank of Agriculture and Rural

Development (NABARD) and National Stock Exchange of India Limited

(NSC). Punjab National Bank (PNB), Credit Ratting Information Service

of India Limited (CRISIL), Indian Farmers Fertilizer Cooperative

Limited (IFFCO), Canara Bank and Goldman Sachs by subscribing to the

equity shares have joined the promoters as a share holder of exchange.

NCDEX is the only Commodity Exchange in the country promoted by

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national level institutions. NCDEX is a public limited company

incorporated on 23 April 2003. NCDEX is a national level technology

driven on line Commodity Exchange with an independent Board of

Directors and professionals not having any vested interest in Commodity

Markets.

It is committed to provide a world class commodity exchange

platform for market participants to trade in a wide spectrum of

commodity derivatives driven by best global practices, professionalism

and transparency. NCDEX is regulated by Forward Markets Commission

(FMC). NCDEX is also subjected to the various laws of land like the

Companies Act, Stamp Act, Contracts Act, Forward Contracts Regulation

Act and various other legislations. NCDEX is located in Mumbai and

offers facilities to its members in more than 550 centers through out

India. NCDEX currently facilitates trading of 57 commodities.

COMMODITIES TRADED AT NCDEX

BULLION : Gold KG, Silver, Brent

Minerals : Electrolytic Copper Cathode, Aluminum

Ingot, Nickel Cathode, Zinc Metal Ingot,

Mild steel Ingots

Oil and Oil seeds : Cotton seed, Oil cake, Crude Palm Oil,

Groundnut (in shell), Groundnut expeller

Oil, Cotton, Mentha oil, RBD Pamolein,

RM seed oil cake,

Pulses : Urad, Yellow peas, Chana, Tur, Masoor,

Grain : Wheat, Indian Pusa Basmati Rice, Indian

parboiled Rice (IR- 36/IR-64), Indian raw

Rice (ParmalPR-106), Barley, Yellow red

maize

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Spices : Jeera, Turmeric, Pepper

Plantation : Cashew, Coffee Arabica, Coffee Robusta

Energy : Crude Oil, Furnace oil

MULTI COMMODITY EXCHANGE OF INDIA LIMITED

(MCX)

Multi Commodity Exchange of India Limited (MCX) is an

independent and de-mutulized exchange with permanent reorganization

from Government of India, having Head Quarter in Mumbai. Key share

holders of MCX are Financial Technologies (India) Limited, State Bank

of India, Union Bank of India, Corporation Bank of India, Bank of India

and Cnnara Bank. MCX facilitates online trading, clearing and settlement

operations for commodity futures market across the country. MCX started

of trade in Nov 2003 and has built strategic alliance with Bombay Bullion

Association, Bombay Metal Exchange, Solvent Extractors Association of

India, pulses Importers Association and Shetkari Sanghatana. MCX deals

wit about 100 commodities.

COMMODITIES TRADED AT MCX

Bullion : Gold, Silver, Silver Coins,

Minerals : Aluminum, Copper, Nickel, Iron/steel,

Tin, Zinc, Lead

Oil and Oil seeds : Castor oil/castor seeds, Crude Palm oil/

RBD Pamolein, Groundnut oil, Mustard/

Rapeseed oil, Soy seeds/Soy

meal/Refined Soy Oil, Coconut Oil Cake,

Copra, Sunflower oil, Sunflower Oil

cake, Tamarind seed oil,

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Pulses : Chana, Masur, Tur, Urad, Yellow peas

Grains : Rice/ Basmati Rice, Wheat, Maize,

Bajara, Barley,

Spices : Pepper, Red Chili, Jeera, Cardamom,

Cinnamon, Clove, Ginger,

Plantation : Cashew Kernel, Rubber, Areca nut, Betel

nuts, Coconut, Coffee,

Fiber and others : Kapas, Kapas Khalli, Cotton (long staple,

medium staple, short staple), Cotton

Cloth, Cotton Yarn, Gaur seed,

Petrochemicals : High Density Polyethylene (HDPE),

Polypropylene (PP), Poly Vinyl Chloride

(PVC)

Energy : Brent Crude Oil, Crude Oil, Furnace Oil,

Middle East Sour Crude Oil, Natural Gas

NATIONAL MULTI COMMODITY EXCHANGE OF

INDIA LIMITED (NMCEIL)

National Multi Commodity Exchange of India Limited (NMCEIL)

is the first de-mutualised Electronic Multi Commodity Exchange in India.

On 25th July 2001 it was granted approval by Government to organize

trading in edible oil complex. It is being supported by Central

warehousing Corporation Limited, Gujarat State Agricultural Marketing

Board and Neptune Overseas Limited. It got reorganization in Oct 2002.

NMCEIL Head Quarter is at Ahmedabad.

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INTERNATIONAL COMMODITY EXCHANGES

Futures’ trading is a result of solution to a problem related to the

maintenance of a year round supply of commodities/ products that are

seasonal as is the case of agricultural produce. The United States, Japan,

United Kingdom, Brazil, Australia, Singapore are homes to leading

commodity futures exchanges in the world.

THE NEW YORK MERCANTILE EXCHANGE (NYMEX)

The New York Mercantile Exchange is the world’s biggest

exchange for trading in physical commodity futures. It is a primary

trading forum for energy products and precious metals. The exchange is

in existence since last 132 years and performs trades trough two

divisions, the NYMEX division, which deals in energy and platinum and

the COMEX division, which trades in all the other metals.

COMMODITIES TRADED

Light sweet crude oil, Natural Gas, Heating Oil, Gasoline, RBOB

Gasoline, Electricity Propane, Gold, Silver, Copper, Aluminum,

Platinum, Palladium, etc.

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LONDON METAL EXCHANGE

The London Metal Exchange (LME) is the world’s premier non-

ferrous market, with highly liquid contracts. The exchange was formed in

1877 as a direct consequence of the industrial revolution witnessed in the

19th century. The primary focus of LME is in providing a market for

participants from non-ferrous based metals related industry to safeguard

against risk due to movement in base metal prices and also arrive at a

price that sets the benchmark globally.

COMMODITIES TRADED

Aluminum, Copper, Nickel, Lead, Tin, Zinc, Aluminum Alloy,

North American Special Aluminum Alloy (NASAAC), Polypropylene,

Linear Low Density Polyethylene, etc.

THE CHICAGO BOARD OF TRADE

The first commodity exchange established in the world was the

Chicago Board of Trade (CBOT) during 1848 by group of Chicago

merchants who were keen to establish a central market place for trade.

Presently, the Chicago Board of Trade is one of the leading exchanges in

the world for trading futures and options. More than 50 contracts on

futures and options are being offered by CBOT currently through open

outcry and/or electronically.

COMMODITIES TRADED

Corn, Soybean, Oil, Soybean meal, Wheat, Oats, Ethanol, Rough

Rice, Gold, Silver etc.

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TOKYO COMMODITY EXCHANGE (TOCOM)

The Tokyo Commodity Exchange (TOCOM) is the second largest

commodity futures exchange in the world. It trades in to metals and

energy contracts. One of the biggest reasons for that is the initiative

TOCOM took towards establishing Asia as the benchmark for price

discovery and risk management in commodities like the Middle East

Crude Oil. In Jan 2003, in a major overhaul of its computerized trading

system, TOCOM fortified its clearing system in June by being first

commodity exchange in Japan to introduce an in-house clearing system.

TOCOM launched options on gold futures, the first option contract in

Japanese market, in May 2004.

COMMODITIES TRADED

Gasoline, Kerosene, Crude Oil, Gold, Silver, Platinum, Aluminum,

Rubber, etc

CHICAGO MERCANTILE EXCHANGE

The Chicago Mercantile Exchange (CME) is the largest futures

exchange in the US and the largest futures clearing house in the world for

futures and options trading. Formed in 1898 primarily to trade in

Agricultural commodities, the CME introduced the world’s first financial

futures more than 30 years ago. Its products often serves as a financial

benchmark and witnesses the largest open interest in futures profile of

CME consists of livestock, dairy and forest products and enables small

family farms to large Agri-business to manage their price risks.

COMMODITIES TRADED

Butter milk, Diammonium phosphate, Feeder cattle, frozen pork

bellies, Lean Hogs, Live cattle, Non-fat Dry Milk, Urea etc

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COMMODITY MARKET WORKS

There are two kinds of trades in commodities. The first is the spot

trade, in which one pays cash and carries away the goods. The second is

futures trade. The underpinning for futures is the warehouse receipt. A

person deposits certain amount of say, good X in a ware house and gets a

warehouse receipt.

A person can buy or sale a commodity future on an exchange based

on his expectation of where the price will go. Futures have something

called an expiry date, by when the buyer or seller either closes (square

off) his account or give/take delivery of the commodity. The broker

maintains an account of all dealing parties in which the daily profit or

loss due to changes in the futures price is recorded. Squiring off is done

by taking an opposite contract so that the net outstanding is nil.

For commodity futures to work, the seller should be able to deposit

the commodity at warehouse nearest to him and collect the warehouse

receipt. The buyer should be able to take physical delivery at a location of

his choice on presenting the warehouse receipt. But at present in India

very few warehouses provide delivery for specific commodities.

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Following diagram gives a fair idea about working of the

Commodity market.

Today Commodity trading system is fully computerized. Traders

need not visit a commodity market to speculate. With online commodity

trading they could sit in the confines of their home or office and call the

shots. The commodity trading system consists of certain prescribed steps

or stages as follows:

I. Trading: At this stage the following is the system implemented-

Order receiving

Execution

Matching

Reporting

III. Settlement: This stage has following system followed as follows-

- Marking to market

- Receipts and payments

- Reporting

- Delivery upon expiration or maturity.

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INVEST IN A COMMODITY MARKET

WITH WHOM INVESTOR CAN TRANSACT A BUSINESS?

An investor can transact a business with the approved clearing

member of previously mentioned Commodity Exchanges. The investor

can ask for the details from the Commodity Exchanges about the list of

approved members.

WHAT IS IDENTITY PROOF?

When investor approaches Clearing Member, the member will ask

for identity proof. For which Xerox copy of any one of the following can

be given

a) PAN card Number

b) Driving License

c) Vote ID

d) Passport

WHAT STATEMENTS SHOULD BE GIVEN FOR BANK PROOF?

The front page of Bank Pass Book and a canceled cheque of a

concerned bank. Otherwise the Bank Statement containing details can be

given.

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WHAT ARE THE OTHER FORMS TO BE SIGNED BY THE

INVESTOR?

The clearing member will ask the client to sign

a) Know your client form

b) Risk Discloser Document

The above things are only procedure in character and the risk

involved and only after understanding the business, he wants to transact

business.

WHAT ASPECTS SHOULD BE CONSIDERED WHILE

SELECTING A COMMODITY BROKER?

While selecting a commodity broker investor should ideally keep

certain aspects in mind to ensure that they are not being missed in any

which way. These factors include

Net worth of the broker of brokerage firm.

The clientele.

The number of franchises/branches.

The market credibility.

The references.

The kind of service provided- back office functioning being

most important.

Credit facility.

The research team.

These are amongst the most important factors to calculate the

credibility of commodity broker.

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BROKER

The Broker is essentially a person of firm that liaisons between

individual traders and the commodity exchange. In other words the

Commodity Broker is the member of Commodity Exchange, having

direct connection with the exchange to carry out all trades legally. He is

also known as the authorized dealer.

HOW TO BECOME A COMMODITY TRADER/BROKER OF

COMMODITY EXCHANGE?

To become a commodity trader one needs to complete certain legal

and binding obligations. There is routine process followed, which is

stated by a unit of Government that lays down the laws and acts with

regards to commodity trading. A broker of Commodities is also required

to meet certain obligations to gain such a membership in exchange. This

sum has been determined by Multi Commodity Exchange.

HOW TO BECOME A MEMBER OF COMMODITY

EXCHANGE?

To become member of Commodity Exchange the person should

comply with the following Eligibility Criteria.

1. He should be Citizen of India.

2. He should have completed 21 years of his age.

3. He should be Graduate or having equivalent qualification.

4. He should not be bankrupt.

5. He has not been debarred from trading in Commodities by

statutory/regulatory authority,

There are following three types of Memberships of Commodity

Exchanges.

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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 or any

other Government or non-Government entity can become a TCM.

There are two types of TCM, 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 desired to register as TCM 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 interview by Membership Admission Committee

and committee is also empowered to frame rules or criteria relating to

selection or rejection of a member.

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 exchange as an Institutional Trading-cum-clearing

Member (ITCM).

The member may be allowed to make deals for himself as well as

on behalf of his clients and clear and settle such deals. ITCMs can also

appoint sub-brokers, authorized persons and Trading Members who

would be registered as trading members.

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PROFESSIONAL CLEARING MEMBER (PCM)

A PCM 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.

MEMBERSHIP DETAILS FOR NCDEX

Trading-cum-clearing Member: - TCM

Sr. No. Particulars NCDEX: TCM

1 Interest Free Cash Security Deposit 15.00 Lakhs

2 Collateral Security Deposit 15.00 Lakhs

3 Admission Fee 5.00 Lakhs

4 Annual Membership Fees 0.50 Lakhs

5 Advance Minimum Transaction Charges 0.50 Lakhs

6 Net worth Requirement 50.00 Lakhs

Professional Clearing Membership: - PCM

Sr. No. Particulars NCDEX: PCM

1 Interest Free Cash Security Deposit 25.00 Lakhs

2 Collateral Security Deposit 25.00 Lakhs

3 Annual Subscription Charges 1.00 Lakhs

4 Advance Minimum Transaction Charges 1.00 Lakhs

5 Net worth Requirement 5000.00 Lakhs

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CURRENT SCENARIO IN

INDIAN COMMODITY MARKET

NEED OF COMMODITY DERIVATIVES FOR INDIA

India is among top 5 producers of most of the Commodities, in

addition to being a major consumer of bullion and energy products.

Agriculture contributes about 22% GDP of Indian economy. It employees

around 57% of the labor force on total of 163 million hectors of land

Agriculture sector is an important factor in achieving a GDP growth of 8-

10%.

TRENDS IN VOLUME CONTRIBUTION ON THE

THREE NATIONAL EXCHANGES

PATTERN ON MULTI COMMODITY EXCHANGE (MCX):-

MCX is currently largest commodity exchange in the country in

terms of trade volumes, further it has even become the third largest in

bullion and second largest in silver future trading in the world. Coming to

trade pattern, though there are about 100 commodities traded on MCX,

only 3 or 4 commodities contribute for more than 80 percent of total trade

volume. As per recent data the largely traded commodities are Gold,

Silver, Energy and base Metals.

26

PATTERN ON NATIONAL COMMODITY & DERIVATIVES

EXCHANGE (NCDEX)

NCDEX is the second largest commodity exchange in the country

after MCX. However the major volume contributors on NCDEX are

agricultural commodities. But, most of them have common inherent

problem of small market size, which is making them vulnerable to market

manipulations and over speculation. About 60 percent trade on NCDEX

comes from guar seed, chana and Urad (narrow commodities as specified

by FMC).

PATTERN ON NATIONAL MULTI COMMODITY EXCHANGE

(NMCE)

NMCE is third national level futures exchange that has been

largely trading in Agricultural Commodities. Trade on NMCE had

considerable proportion of commodities with big market size as jute

rubber etc. But, in subsequent period, the pattern has changed and slowly

moved towards commodities with small market size or narrow

commodities. Analysis of volume contributions on three major national

commodity exchanges reveled the following pattern,

MAJOR VOLUME CONTRIBUTORS

Majority of trade has been concentrated in few commodities that

are

Non Agricultural Commodities (bullion, metals and energy)

Agricultural commodities with small market size (or narrow

commodities) like guar, Urad, Mentha etc.

27

TRADE STRATEGY

It appears that speculators or operators choose commodities or

contracts where the market could be influenced and extreme speculations

possible. In view of extreme volatilities, the FMC directs the exchanges

to impose restrictions on positions and raise margins on those

commodities. Consequently, the operators/speculators chose another

commodity and start operating in a similar pattern. When FMC brings

restrictions on those commodities, the operators once again move to the

other commodities.

BENEFICIARIES

So far the beneficiaries from the current nature of trading are

Exchangers: - making profit from mounting volumes

Arbitragers

Operators

In order to understand the extent of progress the trading the trading

in Commodity Derivatives has made towards its specified objectives

(price discovery and price risk management), the current trends are

juxtaposed against the specification

REASONS FOR PREVAILING TRADE PATTERN

No wide spread participation of all stake holders of commodity

markets. The actual benefits may be realized only when all the stake

holders in commodity market including producers, traders, consumers etc

trade actively in all major commodities like rice, wheat, cotton etc.

28

Some Suggestions to make futures market as a level playing field

for all stake holders:-

Creation of awareness among farmers and other rural participants

to use the futures trading platform for risk mitigation.

Contract specifications should have wider coverage, so that a large

number of varieties produced across the country could be included.

Development of warehousing and facilities to use the warehouse

receipt as a financial instrument to encourage participation farmers.

Development of physical market through uniform grading and

standardization and more transparent price mechanisms.

Delivery system of exchanges is not good enough to attract

investors. E.g.- In many commodities NCDEX forces the delivery

on people with long position and when they tend to give back the

delivery in next month contract the exchange simply refuses to

accept the delivery on pretext of quality difference and also

auctions the product. The traders have to take a delivery or book

losses at settlement as there are huge differences between two

contracts and also sometimes few contracts are not available for

trading for no reason at all.

Contract sizes should have an adequate range so that smaller

traders can participate and can avoid control of trading by few big

parties.

Setting of state level or district level commodities trading helpdesk

run by independent organization such as reputed NGO for

educating farmers.

Warehousing and logistics management structure also needs to be

created at state or area level whenever commodity production is

above a certain share of national level.

29

Though over 100 commodities are allowed for Derivatives trading,

in practice only a few commodities derivatives are popular for

trading. Again most of the trade takes place only on few

exchanges. This problem can possibly solved by consolidating

some exchanges.

Only about 1% to 5% of total commodity derivatives traded in

country are settled in physical delivery due to insufficiencies in

present warehousing system. As good delivery system is the back

bone of any Commodity trade, warehousing problem has to be

handled on a war footing.

At present there are restrictions in movement of certain goods from

one state to another. These needs to be removed so that a truly

national market could develop for commodities and derivatives.

Regulatory changes are required to bring about uniformity in Octri

and sales tax etc. VAT has been introduced in country in 2005, but,

has not yet been uniformly implemented by all states.

A difficult problem in Cash settlement of Commodities Derivatives

contract is that, under Forward Contracts Regulation Act 1952 cash

settlement of outstanding contracts at maturity is not allowed. That

means outstanding contracts at maturity should be settled in

physical delivery. To avoid this participants square off their their

positions before maturity. So in practice contracts are settled in

Cash but before maturity. There is need to modify the law to bring

it closer to the wide spread practice and save participants from

unnecessary hassle.

30

COMMODITIES

STEEL

GENERAL CHARACTERISTICS

Steel is an alloy of iron and carbon, containing less than 2%

carbon, 1% manganese and small amount of silicon, phosphorus, sulphur

and oxygen. Steel is most important engineering and construction

material in the world. Steel compared to other materials of its type has

low production costs. The energy required for extracting iron from ore is

about 25% of what is needed for extracting aluminum. There are

altogether about 2000 grades of steel developed of which 1500 grades are

high-grade steels. The large number of grades gives steel the

characteristics of basic production material.

CATEGORIES OF STEEL

Steel market is primarily divided in to two main categories- flat

and long. A flat carbon steel product is a plate product or a (hot or cold)

rolled strip product. Plate products vary in dimensions from 10 mm to

200 mm and thin flat rolled products from 1 mm to 10 mm. Plate

products are used for ship building, construction, large diameter welded

31

pipes and boiler applications. Thin flat products find end use applications

in automotive body panels, domestic ‘white goods’ products, ‘tin cans’

and the whole host of other products from office furniture to heart

pacemakers. Plates, HR coils and HR Sheet, CR Sheet and CR coils,

GP/GC (galvanized plates and coils) pipes etc. are included in this

category. A long steel product is a road or a bar. Typical rod product are

the reinforcing rods made from sponge iron for concrete, ingots, billets,

engineering products, gears, tools, etc.

Sponge Iron/ Direct reduced iron (DRI): This is a high quality

product produced by reducing iron ore in a solid state and is primarily

used as an iron input in electric arc furnace (EAF) steel making process.

There are a number of coal-based sponge iron/DRI plants (in the eastern

and central region) and also three natural gas based plants (in western part

of the country) in the country.

GLOBAL SCENARIO

The total output of the word crude steel in 2006 stood at 945

million tons, resulting in a growth of 6.7% over the previous year. China

is the word’s largest crude steel producer in the year 2006 with around

220.12 million tons of steel production, followed by Japan and USA.

USA was largest importer of steel products, both finished and semi

finished, in 2005, followed by China and Germany. The words largest

exporter of semi-finished and finished steel was Japan in 2005, followed

by Russia and Ukraine. China is the largest consumer now and

consumption of steel by China is estimated to increase by 12-13% in

2007.

32

INDIAN SCENARIO

India is the 8th largest producer of the steel with an annual

production of 36.193 million tons, while the consumption is around 30

million tons. Iron & steel can be freely exported and imported from India.

India is a net exporter of steel. The Government of India has taken a

number of policy measures, such as removal of iron & steel industry from

the list of industries reserved for public sector, deregulation of price and

distribution of iron & steel and lowering import duty on capital goods and

raw materials, since liberalization for the growth and development of

Indian iron & steel industry. After liberalization India has seen huge scale

addition to its steel making capacity. The country faces shortage of iron

and steel materials.

FACTORS INFLUENCING DEMAND & SUPPLY OF

STEEL LONG AND STEEL FLAT

The demand for steel is dependent on the overall health of the

economy and the in fracture development activities being undertaken.

The steel prices in the Indian market primarily depend on the domestic

demand and supply conditions, and international prices. Government and

different producer and consumer associations regularly monitor steel

prices. The duty imposed on import of steel and its fractions also have an

impact on steel prices. The price trend in steel in Indian markets has been

a function of World’s economic activity. Prices of input materials of iron

and steel such as power tariff, fright rates and coal prices, also contribute

to the rise in the input costs for steel making.

33

WHEAT

Wheat is cereal grain and consumed worldwide. Wheat is more

popular than any other cereal grain for use in baked goods. Its popularity

stems from the gluten that forms when lour is mixes with water. Wheat is

the most widely grown cereal grain in the world.

GLOBAL AND INDIAN SCENARIO

The world wheat production in the recent years has been observed

to be hovering between 555 million tons to 625 million tons a year. The

biggest cultivators of wheat are EU 25, China, India, USA, Russia,

Australia, Canada, Pakistan, Turkey and Argentina. EU 25, China, India

and US are the four largest producers account for around 60% of total

global production.

World’s wheat consumption is continuously growing with growth

in a population, as it is one of the major staple foods across the world.

The major consuming countries of wheat are EU, China, India, Russia,

USA and Pakistan. India has largest area in the world under wheat.

However, in terms of production, India is second largest behind China. In

India, Wheat is sown during October to December and harvested during

March to May. The wheat marketing season in India is assumed to begin

from April every year. The major wheat producing states in India are

Utter Pradesh, Punjab, Haryana, Madhya Pradesh, Rajastan and Bihar.

Which together account for around 93% of total production. In terms of

productivity, Punjab stands first followed by Haryana, Rajastan, UP,

Gujarat, Bihar and MP.

34

Indian wheat is largely soft/medium hard, medium protein, bread

wheat. India is also produces around 1.5 million tons of durum wheat,

mostly in central and western India, which is not segregated and marketed

separately. India consumes around 72-74 million tons of Wheat every

year.

There are around 1000 large flourmills in India, with a milling

capacity of around 15 million tons. The total procurement of wheat by

Government agencies during last 15 years from 8 to 20 million tons,

accounting for only 15-20% of the total production. India exported

around 5 m illion tons subsidized by Government in 2004-05, as a result

of surplus stock. Recently Govt. took decision to import wheat in view of,

declining stocks and increasing demand.

KEY MARKET MOVING FACTORS

Price tends to be lower as harvesting progresses and produce starts

coming in to the market. At the time sowing and before harvesting price

tend to rise in a view of tight supply situation. Weather has profound

influence on wheat production. Temperature plays crucial role towards

maturity of wheat and productivity.

Change in Minimum Support Price (MSP) by Govt. and the stock

available with Food corporation of India and the release from official

stock influence of the price. Though, international trade is limited, the ups

and downs in the production and consumption at all the major/minor

producing and consuming nation dose influence the long term price trend.

Contract specifications of Wheat

35

Contract Period Five Months

Trading Period Mondays through Saturdays

Trading session Monday to Friday:

10.00 am to 5.00 pm

Saturday:

10.00 am to 2.00 pm

Trading

Trading unit 10 MT

Quotation based value 1 Quintal

Maximum order size 500 MT

Tick size (minimum

Price movement)

10 Paise

Price Quotation Ex-warehouse Delhi (including all taxes,

levies and sales tax/ VAT, as the case may

be)

Daily price limits 4%

Initial margin 5%

Special margin In case of additional volatility, a special

margin at such other percentage, as deemed

fit will be imposed immediately on, both buy

and sale side in respect of all outstanding

position, which will remain in force of next 2

days, after which the special margin will be

relaxed.

Maximum Allowable

Open Position

Clientwise- 20000 MT, Member wise-80000

MT or 20% of open position, which ever is

higher.

Delivery

36

Delivery unit 10 MT with tolerance limit of 5%

Delivery Margin 25%

Delivery Center(s) Warehouses at Delhi

Quality Specifications

Wheat of Standard Mill variety confirming to the following quality

standerds will be delieverable. The material will be tested using a 3mm

sieve.

Defects

(a) Foreign Matter

(organic/inorganic)

2.0% (Max)

(b) Damaged Kernels 2.00 (Max) provided that infestation damaged

not to exceed 1 per 100 kernels.

(c) Shrunken Shriveled

& broken grains

3.00% (Max)

Total defects (a+b+c)

Acceptable up to

Rejected total defect is

Below 6%

8% With rebate on 1:1 basis

Above 8%

Teat weight up to 76

kg/hl

76kg/hl. Min. acceptable with rebate of 150

grams per kg/hl or pro-rata variance in hector

liter weight deducted per quintal Below 74

kg/hl

Rejected Below 74 kg/hl

Moisture

Acceptable

Reject able

11%

(Max)13% With rebate 1:1

Above 13%

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QUALITY SPECIFICATIONS

Wheat of Standard Mill variety conforming to the following quality

standards will be deliverable; The material will be tested by using 3 mm

sieve.

Defects: -

1. Foreign Matter (organic/inorganic)

2. Damaged Kernel

3. Sunken, Shriveled and Broken

grains

Total Defects (a+b+c)

Acceptable

Rejected if total defects

2.0% (maximum)

2.0% (maximum) provided that

infestation damaged not exceed 1

Per 100 kernels.

3.00% (maximum)

Below 6%

Up to 8% with rebate on 1:1 basis

Above 8%

Total Weight

Up to 74 kg/hl

Below 74 kg/hl

76 kg/hl. (minimum)

Acceptable with rebate of 150

grams per kg/hl or pro-rata

variance in hector liter weight

deducted per quintal weight

delivered.

Rejected

Moisture

Acceptable

Reject able

11% (maximum)

Up to 13% with rebate 1:1

Above 135

Packing Packing should be in B Twill once

used 100kg jute bags, the tare

weight deduction per bag for net

weight calculation shall be 1 kg per

quintal of gross weight.

38

COMMODITY DERIVATIVES – THE NEED

India being an agricultural economy is among the top-5 producers

of most of the commodities, in addition to being a major consumer of

bullion and energy products. Agriculture contributes about 22% to the

GDP of the Indian economy. It employees around 57% of the labor force

on a total of 163 million hectares of land. Agriculture sector is an

important factor in achieving a GDP growth of 8-10%. All this indicates

that India can be promoted as a major center for trading of commodity

derivatives.

It is unfortunate that the policies of FMC during the most of 1950s

to 1980s suppressed the very markets it was supposed to encourage and

nurture to grow with times. It was a mistake other emerging economies of

the world would want to avoid. However, it is not in India alone that

derivatives were suspected of creating too much speculation that would

be to the detriment of the healthy growth of the markets and the farmers.

Such suspicions might normally arise due to a misunderstanding of the

characteristics and role of derivative product. It is important to

understand why commodity derivatives are required and the role they can

play in risk management. It is common knowledge that prices of

39

commodities, metals, shares and currencies fluctuate over time. The

possibility of adverse price changes in future creates risk for businesses.

Derivatives are used to reduce or eliminate price risk arising from

unforeseen price changes. A derivative is a financial contract whose price

depends on, or is derived from, the price of another asset.

Two important derivatives are futures and options.

1. COMMODITY FUTURES CONTRACTS

A futures contract is an agreement for buying or selling a commodity

for a predetermined delivery price at a specific future time. Futures are

standardized contracts that are traded on organized futures exchanges

that ensure performance of the contracts and thus remove the default

risk. The commodity futures have existed since the Chicago Board of

Trade (CBOT, www.cbot.com) was established in 1848 to bring

farmers and merchants together. The major function of futures

markets is to transfer price risk from hedgers to speculators. For

example, suppose a farmer is expecting his crop of wheat to be ready

in two months time, but is worried that the price of wheat may decline

in this period. In order to minimize his risk, he can enter into a futures

contract to sell his crop in two months’ time at a price determined

now. This way he is able to hedge his risk arising from a possible

adverse change in the price of his commodity.

2. COMMODITY OPTIONS CONTRACTS

Like futures, options are also financial instruments used for hedging

and speculation. The commodity option holder has the right, but not

the obligation, to buy (or sell) a specific quantity of a commodity at a

specified price on or before a specified date. Option contracts involve

two parties – the seller of the option writes the option in favor of the

40

buyer (holder) who pays a certain premium to the seller as a price for

the option. There are two types of commodity options: a ‘call’ option

gives the holder a right to buy a commodity at an agreed price, while a

‘put’ option gives the holder a right to sell a commodity at an agreed

price on or before a specified date (called expiry date). The option

holder will exercise the option only if it is beneficial to him; otherwise

he will let the option lapse.

For example, suppose a farmer buys a put option to sell 100 tonnes

of wheat at a price of `1000 per tonne and pays a ‘premium’ of `10 per

tonne (or a total of `1000). If the price of wheat declines to say `950

before expiry, the farmer will exercise his option and sell his wheat at the

agreed price of `1000 per tonne. However, if the market price of wheat

increases to say `1050 per tonne, it would be advantageous for the farmer

to sell it directly in the open market at the spot price, rather than exercise

his option to sell at `1000 per tonne.

Futures and options trading therefore helps in hedging the price

risk and also provide investment opportunity to speculators who are

willing to assume risk for a possible return. Further, futures trading and

the ensuing discovery of price can help farmers in deciding which crops

to grow. They can also help in building a competitive edge and enable

businesses to smoothen their earnings because non-hedging of the risk

would increase the volatility of their quarterly earnings. Thus futures and

options markets perform important functions that can not be ignored in

modern business environment. At the same time, it is true that too much

speculative activity in essential commodities would destabilize the

markets and therefore, these markets are normally regulated as per the

laws of the country.

41

DIFFERENCE BETWEEN A COMMODITY AND

FINANCIAL DERIVATIVE

The basic concept of a derivative contract remains the same

whether the underlying happens to be a commodity or a financial asset.

However there are some features which are very peculiar to commodity

derivative markets. In the case of financial derivatives, most of these

contracts re cash settled.

Even in the case of physical settlement, financial assets are not

bulky and do not need special facility for storage. Due to the bulky nature

of the underlying assets, physical settlement in commodity derivatives

creates the need for warehousing. Similarly, the concept of varying

quality of asset does not really exist as far as financial underlying are

concerned.

However in the case of commodities, the quality of the asset

underlying a contract can vary largely. This becomes an important issue

to be managed.

42

PHYSICAL SETTLEMENT

Physical settlement involves the physical delivery of the

underlying commodity, typically at an accredited warehouse. The

seller intending to make delivery would have to take the

commodities to the designated warehouse and the buyer intending

to take delivery would have to go to the designated warehouse and

pick up the commodity. This may sound simple, but the physical

settlement of commodities is a complex process. The issues faced

in physical settlement are enormous. There are limits on storage

facilities in different states.

There are restrictions on interstate movement of commodities.

Besides state level octroi and duties have an impact on the cost of

movement of goods across locations. The process of taking

physical delivery in commodities is quite different from the process

of taking physical delivery in financial assets.

WAREHOUSING

One of the main differences between financial and a commodity

derivative is the need for warehousing. In case of most exchange

traded financial derivatives, all the positions are cash settled. Cash

settlement involves paying up the difference in prices between the

time the contract was entered into and the time the contract was

closed. For instance, if a trader buys futures on a stock at Rs.100

and on the day of expiration, the futures on that stock close Rs.120,

he does not really have to buy the underlying stock. All he does is

take the difference of Rs.20 in cash.

43

Similarly the person who sold this futures contract at Rs.100, does

not have to deliver the underlying stock. All he has to do is pay up

the loss of Rs.20 in cash. In case of commodity derivatives

however, there is a possibility of physical settlement.

This means that if the seller chooses to hand over the commodity

instead of the difference in cash, the buyer must take physical

delivery of the underlying asset. This requires the exchange to

make an arrangement with warehouses to handle the settlements.

The efficacy of the commodities settlements depends on the

warehousing system available. Most international commodity

exchanges used certified warehouses (CWH) for the purpose of

handling physical settlements.

Such CWH are required to provide storage facilities for

participants in the commodities markets and to certify the quantity

and quality of the underlying commodity. The advantage of this

system is that a warehouse receipt becomes good collateral, not just

for settlement of exchange trades but also for other purposes too. In

India, the warehousing system is not as efficient as it is in some of

the other developed markets.

Central and state government controlled warehouses are the major

providers of agricultural produce storage facilities. Apart from

these, there are a few private warehousing being maintained.

However there is no clear regulatory oversight of warehousing

services.

44

QUALITY OF UNDERLYING ASSETS

A derivatives contract is written on a given underlying. Variance in

quality is not an issue in case of financial derivatives as the

physical attribute is missing. When the underlying asset is a

commodity, the quality of the underlying asset is of prime

importance. There may be quite some variation in the quality of

what is available in the marketplace.

When the asset is specified, it is therefore important that the

exchange stipulate the grade or grades of the commodity that are

acceptable. Commodity derivatives demand good standards and

quality assurance/ certification procedures. A good grading system

allows commodities to be traded by specification.

Currently there are various agencies that are responsible for

specifying grades for commodities. For example, the Bureau of

Indian Standards (BIS) under Ministry of Consumer Affairs

specifies standards for processed agricultural commodities whereas

AGMARK under the department of rural development under

Ministry of Agriculture is responsible for promulgating standards

for basic agricultural commodities. Apart from these, there are

other agencies like EIA, which specify standards for export

oriented commodities.

45

INDIAN COMMODITY DERIVATIVE MARKET

MILESTONES

Organized commodity derivatives in India started as early as 1875,

barely about a decade after they started in Chicago. However, many

feared that derivatives fuelled unnecessary speculation and were

detrimental to the healthy functioning of the markets for the underlying

commodities.

This resulted in ban on cash settlement of commodity futures were

banned in 1952. Until 2002 commodity derivatives market was virtually

non-existent, except some negligible activity on an OTC basis. In

September 2005, the country has 3 national level electronic exchanges

and 21 regional exchanges for trading commodity derivatives.

As many as eighty (80) commodities have been allowed for

derivatives trading. The value of trading has been booming and is likely

to touch $5 Trillion in a few years.

46

HISTORY

The history of organized commodity derivatives in India goes back

to the nineteenth century when the Cotton Trade Association started

futures trading in 1875, barely about a decade after the commodity

derivatives started in Chicago. Over time the derivatives market

developed in several other ommodities in India. Following cotton,

derivatives trading started in oilseeds in Bombay (1900), raw jute and jute

goods in Calcutta (1912), wheat in Hapur (1913) and in Bullion in

Bombay (1920).

However, many feared that derivatives fuelled unnecessary

speculation in essential commodities, and were detrimental to the healthy

functioning of the markets for the underlying commodities, and hence to

the farmers. With a view to restricting speculative activity in cotton

market, the Government of Bombay prohibited options business in cotton

in 1939. Later in 1943, forward trading was prohibited in oilseeds and

some other commodities including food-grains, spices, vegetable oils,

sugar and cloth.

After Independence, the Parliament passed Forward Contracts

(Regulation) Act, 1952 which regulated forward contracts in commodities

all over India. The Act applies to goods, which are defined as any

movable property other than security, currency and actionable claims.

The Act prohibited options trading in goods along with cash settlements

of forward trades, rendering a crushing blow to the commodity

derivatives market. Under the Act, only those associations/exchanges,

which are granted recognition by the Government, are allowed to

47

organize forward trading in regulated commodities. The Act envisages

three-tier regulation:

1. The Exchange which organizes forward trading in commodities

can regulate trading on a day-to-day basis;

2. The Forward Markets Commission provides regulatory oversight

under the powers delegated to it by the central Government, and

3. The Central Government - Department of Consumer Affairs,

Ministry of Consumer Affairs,

Food and Public Distribution - is the ultimate regulatory authority.

The already shaken commodity derivatives market got a crushing blow

when in 1960s, following several years of severe draughts that forced

many farmers to default on forward contracts (and even caused some

suicides), forward trading was banned in many commodities considered

primary or essential. As a result, commodities derivative markets

dismantled and went underground where to some extent they continued as

OTC contracts at negligible volumes. Much later, in 1970s and 1980s the

Government relaxed forward trading rules for some commodities, but the

market could never regain the lost volumes.

CHANGE IN GOVERNMENT POLICY

After the Indian economy embarked upon the process of

liberalization and globalisation in 1990, the Government set up a

Committee in 1993 to examine the role of futures trading. The

Committee (headed by Prof. K.N. Kabra) recommended allowing

futures trading in 17 commodity groups. It also recommended

strengthening of the Forward Markets Commission, and certain

amendments to Forward Contracts (Regulation) Act 1952,

48

particularly allowing options trading in goods and registration of

brokers with Forward Markets Commission. The Government

accepted most of these recommendations and futures trading was

permitted in all recommended commodities.

Commodity futures trading in India remained in a state of

hibernation for nearly four decades, mainly due to doubts about the

benefits of derivatives. Finally a realization that derivatives do

perform a role in risk management led the government to change

its stance. The policy changes favouring commodity derivatives

were also facilitated by the enhanced role assigned to free market

forces under the new liberalization policy of the Government.

Indeed, it was a timely decision too, since internationally the

commodity cycle is on the upswing and the next decade is being

touted as the decade of commodities.

MODERN COMMODITY EXCHANGES

To make up for the loss of growth and development during the four

decades of restrictive government policies, FMC and the

Government encouraged setting up of the commodity exchanges

using the most modern systems and practices in the world. Some of

the main regulatory measures imposed by the FMC include daily

mark to market system of margins, creation of trade guarantee

fund, back-office computerization for the existing single

commodity Exchanges, online trading for the new Exchanges,

demutualization for the new Exchanges, and one-third

representation of independent Directors on the Boards of existing

Exchanges etc.

49

Responding positively to the favourable policy changes, several

Nation-wide Multi-Commodity Exchanges (NMCE) have been set

up since 2002, using modern practices such as electronic trading

and clearing. The national exchanges operating in the Indian

commodity futures market are the Multi-Commodity Exchange of

India (MCX), National Commodity and Derivative Exchange of

India (NCDEX) and National Multi Commodity Exchange of India

(NMCE). Recently, one new national exchange has been given

permission to start and another regional exchange has been

permitted to upgrade to a national exchange. In line with its

modern financial infrastructure, India is one of the few countries

worldwide to have commodities’ delivery in electronic

(dematerialised) form.Selected Information about the two most

important commodity exchanges in India [Multi-Commodity

Exchange of India Limited (MCX), and National Multi-

Commodity & Derivatives

EXCHANGE OF INDIA LIMITED (NCDEX)] ARE

GIVEN BELOW:

MCX

Headquartered in Mumbai, Multi Commodity Exchange of India

Ltd (MCX) is a state-of-the-art electronic commodity futures exchange.

The demutualised Exchange set up by Financial Technologies (India) Ltd

(FTIL) has permanent recognition from the Government of India to

facilitate online trading, and clearing and settlement operations for

commodity futures across the country.

50

Having started operations in November 2003, today, MCX holds a

market share of over 80% of the Indian commodity futures market, and

has more than 2000 registered members operating through over 100,000

trader work stations, across India. The Exchange has also emerged as the

sixth largest and amongst the fastest growing commodity futures

exchange in the world, in terms of the number of contracts traded in

2009. MCX offers more than 40 commodities across various segments

such as bullion, ferrous and non-ferrous metals, and a number of agri-

commodities on its platform. The Exchange is the world's largest

exchange in Silver, the second largest in Gold, Copper and Natural Gas

and the third largest in Crude Oil futures, with respect to the number of

futures contracts traded.

MCX has been certified to three ISO standards including ISO

9001:2000 Quality Management System standard, ISO 14001:2004

Environmental Management System standard and ISO 27001:2005

Information Security Management System standard. The Exchange’s

platform enables anonymous trades, leading to efficient price discovery.

Moreover, for globally-traded commodities, MCX’s platform enables

domestic participants to trade in Indian currency.

The Exchange strives to be at the forefront of developments in the

commodities futures industry and has forged strategic alliances with

various leading International Exchanges, including Euronext-LIFFE,

London Metal Exchange (LME), New York Mercantile Exchange,

Shanghai Futures Exchange (SHFE), Sydney Futures Exchange, The

Agricultural Futures Exchange of Thailand (AFET), among others. For

MCX, staying connected to the grassroots is imperative. Its domestic

alliances aid in improving ethical standards and providing services and

facilities for overall improvement of the commodity futures market.

51

KEY SHAREHOLDERS

Promoted by FTIL, MCX enjoys the confidence of blue chips in

the Indian and international financial sectors. MCX's broad-based

strategic equity partners include NYSE Euronext, State Bank of India and

its associates (SBI), National Bank for Agriculture and Rural

Development (NABARD), National Stock Exchange of India Ltd (NSE),

SBI Life Insurance Co Ltd, Bank of India (BOI) , Bank of Baroda (BOB),

Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, Fid

Fund (Mauritius) Ltd. - an affiliate of Fidelity International, ICICI

Ventures, IL&FS, Kotak Group, Citi Group and Merrill Lynch.

NCDEX

National Commodity & Derivatives Exchange Limited (NCDEX)

is a professionally managed on-line multi commodity exchange. The

shareholders of NCDEX comprises of large national level institutions,

large public sector bank and companies. 

PROMOTER SHAREHOLDERS

ICICI Bank Limited (ICICI)*, Life Insurance Corporation of India

(LIC), National Bank for Agriculture and Rural Development

(NABARD) and National Stock Exchange of India Limited (NSE).

OTHER SHAREHOLDERS

Canara Bank, Punjab National Bank (PNB), CRISIL Limited,

Indian Farmers Fertiliser Cooperative Limited (IFFCO), Goldman Sachs,

Intercontinental Exchange (ICE) and Shree Renuka Sugars Limited

52

NCDEX is the only commodity exchange in the country promoted

by national level institutions. This unique parentage enables it to offer a

bouquet of benefits, which are currently in short supply in the commodity

markets. The institutional promoters and shareholders of NCDEX are

prominent players in their respective fields and bring with them

institutional building experience, trust, nationwide reach, technology and

risk management skills. NCDEX is a public limited company

incorporated on April 23, 2003 under the Companies Act, 1956. It

obtained its Certificate for Commencement of Business on May 9, 2003.

It commenced its operations on December 15, 2003. 

NCDEX is a nation-level, technology driven de-mutualised on-line

commodity exchange with an independent Board of Directors and

professional management - both not having any vested interest in

commodity markets. It is committed to provide a world-class commodity

exchange platform for market participants to trade in a wide spectrum of

commodity derivatives driven by best global practices, professionalism

and transparency. NCDEX is regulated by Forward Markets Commission.

NCDEX is subjected to various laws of the land like the Forward

Contracts (Regulation) Act, Companies Act, Stamp Act, Contract Act and

various other legislations.

NCDEX headquarters are located in Mumbai and offers facilities to

its members from the centres located throughout India. The Exchange, as

on May 21, 2009 when Wheat Contracts were re-launched on the

Exchange platform, offered contracts in 59 commodities - comprising 39

agricultural commodities, 5 base metals, 6 precious metals, 4 energy, 3

polymers, 1 ferrous metal, and CER. The top 5 commodities, in terms of

volume traded at the Exchange, were Rape/Mustard Seed, Gaur Seed,

Soyabean Seeds, Turmeric and Jeera.

53

THE GROWTH

The growth paradigm of India’s commodity markets is best

reflected by the figures from the regulator’s official website, which

indicated that the total value of trade on the commodity futures market in

the financial year 2008/09 was INR52.49 lakh crore (over US$1 trillion)

as against INR40.66 lakh crore in the preceding year, registering a growth

of 29.09%, even under challenging economic conditions globally. The

main drivers of this impressive growth in commodity futures were the

national commodity exchanges. MCX, NCDEX and NMCE along with

two regional exchanges – NBOT Indore and ACE, Ahmedabad –

contributed to 99.61% of the total value of commodities traded during

2008/09.

54

UNRESOLVED ISSUES AND

FUTURE PROSPECTS

Even though the commodity derivatives market has made good

progress in the last few years, the real issues facing the future of the

market have not been resolved. Agreed, the number of commodities

allowed for derivative trading have increased, the volume and the value

of business has zoomed, but the objectives of setting up commodity

derivative exchanges may not be achieved and the growth rates

witnessed may not be sustainable unless these real issues are sorted out as

soon as possible. Some of the main unresolved issues are discussed

below.

Cash versus Physical Settlement

It is probably due to the inefficiencies in the present warehousing

system that only about 1% to 5% of the total commodity

derivatives trades in the country are settled in physical delivery.

Therefore the warehousing problem obviously has to be handled on

a war footing, as a good delivery system is the backbone of any

commodity trade.

55

A International Research Journal of Finance and Economics - Issue

2 (2006) 161 particularly difficult problem in cash settlement of

commodity derivative contracts is that at present, under the

Forward Contracts (Regulation) Act 1952, cash settlement of

outstanding contracts at maturity is not allowed. In other words, all

outstanding contracts at maturity should be settled in physical

delivery. To avoid this, participants square off their positions

before maturity. So, in practice, most contracts are settled in cash

but before maturity. There is a need to modify the law to bring it

closer to the widespread practice and save the participants

fromunnecessary hassles.

THE REGULATOR

As the market activity pick-up and the volumes rise, the market

will definitely need a strong and independent regular, similar to the

Securities and Exchange Board of India (SEBI) that regulates the

securities markets. Unlike SEBI which is an independent body, the

Forwards Markets Commission (FMC) is under the Department of

Consumer Affairs (Ministry of Consumer Affairs, Food and Public

Distribution) and depends on it for funds. It is imperative that the

Government should grant more powers to the FMC to ensure an

orderly development of the commodity markets. The SEBI and

FMC also need to work closely with each other due to the inter-

relationship between the two markets.

LACK OF ECONOMY OF SCALE

There are too many (3 national level and 21 regional) commodity

exchanges. Though over 80 commodities are allowed for

derivatives trading, in practice derivatives are popular for only a

56

few commodities. Again, most of the trade takes place only on a

few exchanges. All this splits volumes and makes some exchanges

unviable. This problem can possibly be addressed by consolidating

some exchanges. Also, the question of convergence of securities

and commodities derivatives markets has been debated for a long

time now. The Government of India has announced its intention to

integrate the two markets. It is felt that convergence of these

derivative markets would bring in economies of scale and scope

without having to duplicate the efforts, thereby giving a boost to

the growth of commodity derivatives market. It would also help in

resolving some of the issues concerning regulation of the derivative

markets. However, this would necessitate complete coordination

among various regulating authorities such as Reserve Bank of

India, Forward Markets commission, the Securities and Exchange

Board of India, and the Department of Company affairs etc.

TAX AND LEGAL BOTTLENECKS

There are at present restrictions on the movement of certain goods

from one state to another. These need to be removed so that a truly

national market could develop for commodities and derivatives.

Also, regulatory changes are required to bring about uniformity in

octroi and sales taxes etc. VAT has been introduced in the country

in 2005, but has not yet been uniformly implemented by all states.

57

TERMS AND DEFINITIONS RELATED TO

COMMODITY MARKET

Accruals:- Commodities on hand ready for shipment, storage and

manufacture

Arbitragers: - Arbitragers are interested in making purchase and

sale in different markets at the same time to profit from price

discrepancy between the two markets.

At the Market: - An order to buy or sell at the best price possible

at the time an order reaches the trading pit.

Basis: - Basis is the difference between the cash price of an asset

and futures price of the underlying asset. Basis can be negative or

positive depending on the prices prevailing in the cash and futures.

Basis grade: - Specific grade or grades named in the exchanges

future contract. The other grades deliverable are subject to price of

underlying futures

Bear: - A person who expects prices to go lower.

Bid: - A bid subject to immediate acceptance made on the floor of

exchange to buy a definite number of futures contracts at a specific

price.

Breaking: - A quick decline in price.

Bulging: - A quick increase in price.

Bull: - A person who expects prices to go higher.

Buy on Close: - To buy at the end of trading session at the price

within the closing range.

Buy on opening: - To buy at the beginning of trading session at a

price within the opening range.

58

Call: - An option that gives the buyer the right to a long position in

the underlying futures at a specific price, the call writer (seller)

may be assigned a short position in the underlying futures if the

buyer exercises the call.

Cash commodity: - The actual physical product on which a

futures contract is based. This product can include agricultural

commodities, financial instruments and the cash equivalent of

index futures.

Close: - The period at the end of trading session officially

designated by exchange during which all transactions are

considered made “at the close”.

Closing price: - The price (or price range) recorded during the

period designated by the exchange as the official close.

Commission house: - A concern that buys and sells actual

commodities or futures contract for the accounts of customers.

Consumption Commodity: - Consumption commodities are held

mainly for consumption purpose. E.g. Oil, steel

Cover: - The cancellation of the short position in any futures

contract buys the purchase of an equal quantity of the same futures

contract.

Cross hedge: - When a cash commodity is hedged by using futures

contract of other commodity.

Day orders: - Orders at a limited price which are understood to be

good for the day unless expressly designated as an open order or

“good till canceled” order.

Delivery: - The tender and receipt of actual commodity, or in case

of agriculture commodities, warehouse receipts covering such

commodity, in settlement of futures contract. Some contracts settle

59

in cash (cash delivery). In which case open positions are marked to

market on last day of contract based on cash market close.

Delivery month: - Specified month within which delivery may be

made under the terms of futures contract.

Delivery notice: - A notice for a clearing member’s intention to

deliver a stated quantity of commodity in settlement of a short

futures position.

Derivatives: - These are financial contracts, which derive their

value from an underlying asset. (Underlying assets can be equity,

commodity, foreign exchange, interest rates, real estate or any

other asset.) Four types of derivatives are trades forward, futures,

options and swaps. Derivatives can be traded either in an exchange

or over the counter.

Differentials: - The premium paid for grades batter than the basis

grade and the discounts allowed for the grades. These differentials

are fixed by the contract terms on most exchanges.

Exchange: - Central market place for buyers and sellers.

Standardized contracts 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 members who are acting on

behalf of their clients, companies or themselves.

Forward contract: - It is an agreement between two parties to buy

or sell an asset at a future date for price agreed upon while signing

agreement. Forward contract is not traded on an exchange. This is

oldest form of derivative contract. It is traded in OTC Market. Not

on an exchange. Size of forward contract is customized as per the

terms of agreement between buyer and seller. The contract price of

forward contract is not transparent, as it is not publicly disclosed.

Here valuation of open position is not calculated on a daily basis

60

and there is no requirement of MTM. Liquidity is the measure of

frequency of trades that occur in a particular commodity forward

contract is less liquid due to its customized nature. In forward

contracts, counter- party risk is high due to customized & bilateral

nature of the transaction. Forward contract is not regulated by any

exchange. Forward contract is generally settled by physical

delivery. In this case delivery is carried out at delivery center

specified in the customized bilateral agreement.

Futures Contract:- It is an agreement between two parties to buy

or sell a specified and standardized quantity and quality of an asset

at certain time in the future at price agreed upon at the time of

entering in to contract on the futures exchange. It is entered on

centralized trading platform of exchange. It is standardized in

terms of quantity as specified by exchange. Contract price of

futures contract is transparent as it is available on centralized

trading screen of the exchange. Here valuation of Mark-to-Mark

position is calculated as per the official closing price on daily basis

and MTM margin requirement exists. Futures contract is more

liquid as it is traded on the exchange. In futures contracts the

clearing-house becomes the counter party to each transaction,

which is called novation. Therefore, counter party risk is almost

eliminated. A regulatory authority and the exchange regulate

futures contract. Futures contract is generally cash settled but

option of physical settlement is available. Delivery tendered in case

of futures contract should be of standard quantity and quality as

specified by the exchange.

61

Futures commission merchant: - A broker who is permitted to

accept the orders to buy and sale futures contracts for the

consumers.

Futures Funds: - Usually limited partnerships for investors who

prefer to participate in the futures market by buying shares in a

fund managed by professional traders or commodity trading

advisors.

Futures Market:-It facilitates buying and selling of standardized

contractual agreements (for future delivery) of underlying asset as

the specific commodity and not the physical commodity itself. The

formulation of futures contract is very specific regarding the

quality of the commodity, the quantity to be delivered and date for

delivery. However it does not involve immediate transfer of

ownership of commodity, unless resulting in delivery. Thus, in

futures markets, commodities can be bought or sold irrespective of

whether one has possession of the underlying commodity or not.

The futures market trade in futures contracts primarily for the

purpose of risk management that is hedging on commodity stocks

or forward buyers and sellers. Most of these contracts are squared

off before maturity and rarely end in deliveries.

Hedging: - Means taking a position in futures market that is

opposite to position in the physical market with the objective of

reducing or limiting risk associated with price.

In the money: - In call options when strike price is below the price

of underlying futures. In put options, when the strike price is above

the underlying futures. In-the-money options are the most

expensive options because the premium includes intrinsic value.

62

Index Futures: - Futures contracts based on indexes such as the S

& P 500 or Value Line Index. These are the cash settlement

contracts.

Investment Commodities: - An investment commodity is

generally held for investment purpose. e.g. Gold, Silver

Limit: - The maximum daily price change above or below the

price close in a specific futures market. Trading limits may be

changed during periods of unusually high market activity.

Limit order: - An order given to a broker by a customer who has

some restrictions upon its execution, such as price or time.

Liquidation: - A transaction made in reducing or closing out a

long or short position, but more often used by the trade to mean a

reduction or closing out of long position.

Local: - Independent trader who trades his/her own money on the

floor of the exchanges. Some local act as a brokers as well, but are

subject to certain rules that protect customer orders.

Long: - (1) The buying side of an open futures contract or futures

option; (2) a trader whose net position in the futures or options

market shows an excess of open purchases over open sales.

Margin: - Cash or equivalent posted as guarantee of fulfillment of

a futures contract (not a down payment).

Margin call: - Demand for additional funds or equivalent because

of adverse price movement or some other contingency.

Market to Market: - The practice of crediting or debating a

trader’s account based on daily closing prices of the futures

contracts he is long or short.

Market order: - An order for immediate execution at the best

available price.

63

Nearby: - The futures contract closest to expiration.

Net position: - The difference between the open contracts long and

the open contracts short held in any commodity by any individual

or group.

Offer: - An offer indicating willingness to sell at a given price

(opposite of bid).

On opening: - A term used to specify execution of an order during

the opening.

Open contracts: - Contracts which have been brought or sold

without the transaction having been completed by subsequent sale,

repurchase or actual delivery or receipt of commodity.

Open interest: - The number of “open contracts”. It refers to

unliquidated purchases or sales and never to their combined total.

Option: - It gives right but not the obligation to the option owner,

to buy an underlying asset at specific price at specific time in the

future.

Out-of-the money: - Option calls with the strike prices above the

price of the underlying futures, and puts with strike prices below

the price of the underlying futures.

Over the counter: - It is alternative trading platform, linked to

network of dealers who do not physically meet but instead

communicates through a network of phones & computers.

Pit: - An octagonal platform on the trading floor of an exchange,

consisting of steps upon which traders and brokers stand while

trading (if circular called ring).

Point: - The minimum unit in which changes in futures prices may

be expressed (minimum price fluctuation may be in multiples of

points).

64

Position: - An interest in the market in the form of open

commodities.

Premium: - The amount by which a given futures contract’s price

or commodity’s quality exceeds that of another contract or

commodity (opposite of discount). In options, the price of a call or

put, which the buyer initially pays to the option writer (seller).

Price limit: - The maximum fluctuation in price of futures contract

permitted during one trading session, as fixed by the rules of a

contract market.

Purchase and sales statement: - A statement sent by FMC to a

customer when his futures option has been reduced or closed out

(also called ‘P and S”)

Put: - In options the buyer of a put has the right to continue a short

position in an underlying futures contract at the strike price until

the option expires; the seller (writer) of the put obligates himself to

take a long position in the futures at the strike price if the buyer

exercises his put.

Range: - The difference between high and low price of the futures

contract during a given period.

Ratio hedging: - Hedging a cash position with futures on a less or

more than one-for-one basis.

Reaction: - The downward tendency of a commodity after an

advance.

Round turn: - The execution of the same customer of a purchase

transaction and a sales transaction which offset each other.

Round turn commission: - The cost to the customer for executing

a futures contract which is charged only when the position is

liquidated.

65

Scalping: - For floor traders, the practice of trading in and out of

contracts through out the trading day in a hopes for making a series

of small profits.

Settlement price: - The official daily closing price of futures

contract, set by the exchange for the purpose of setting margins

accounts.

Short: - (1) The selling of an option futures contract. (2) A trader

whose net position in the futures market shows an excess of open

sales over open purchases.

Speculator: - Speculator is an additional buyer of the commodities

whenever it seems that market prices are lower than they should

be.

Spot Markets:-Here commodities are physically brought or sold

on a negotiated basis.

Spot price: - The price at which the spot or cash commodity is

selling on the cash or spot market.

Spread: - Spread is the difference in prices of two futures

contracts.

Striking price: - In options, the price at which a futures position

will be established if the buyer exercises (also called strike or

exercise price).

Swap: - It is an agreement between two parties to exchange

different streams of cash flows in future according to

predetermined terms.

Technical analysis (charting): - In price forecasting, the use of

charts and other devices to analyze price-change patters and

changes in volume and open interest to predict future market trends

(opposite of fundamental analysis).

66

Time value: - In options the value of premium is based on the

amount of time left before the contract expires and the volatility of

the underlying futures contract. Time value represents the portion

of the premium in excess of intrinsic value. Time value diminishes

as the expiration of the options draws near and/or if the underlying

futures become less volatile.

Volume of trading (or sales): - A simple addition of successive

futures transactions (a transaction consists of a purchase and

matching sale).

Writer: - A sealer of an option who collects the premium payment

from the buyer.

67

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, India has an opportunity to chase a US$ 600 billion market

opportunity, this would have to be done through connecting village

mandis and the urban markets through commodity exchanges.

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 centers 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.

68

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.

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 signaling 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 cop 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. Modern commodities market namely MCX,

NCME, NCDEX use latest technology in their operations, they are

transparent, demutualised, and investor friendly. All these attributes, help

them in attracting retail investors and farmers thereby increasing the

69

depth in the market and making it more efficient. But there are problems

as there are 22 exchanges which trade in only a few commodities. Despite

the different systems of exchanges, the combined volumes of trading of

all exchanges are marginal compared to production levels. These

exchanges are not transparent in their operations, limited and closed in

nature of membership. All the measures to reform them have been met

with stiff resistance from these exchanges and only one or two have

agreed to reform themselves.

Also the derivatives trading in the securities market means most of

its infrastructure and skills can be used by the commodity derivatives

market and they can work together. There is also a proposal to use

regional stock exchanges for trading in commodity derivatives.

In the end all one can say is that there is huge potential in

commodity derivatives market, if are able to tap this potential, this would

change the lives of our farmers and provide new investment opportunities

to the investors in the country.

All this would require a concentrated effort on the part of central

and state governments and the trading community. Rules and regulations

must be harmonized across different states and trading community should

be encouraged to adopt modern trading practices.

70

ANALYSIS

Survey was conducted across Mumbai City (in areas like Andheri,

Santacruz, Bandra Church gate) to judge the awareness of peoples

regarding investment in Commodity Market.

COMMODITY MARKET

Questionnaire for Investors

1. Do you have any investment plan?

a. YES b. NO

(if no move to question no. 4)

2. If, yes, where you would like to invest your money?

a. Bank F.D. b. Share Market c. Commodity Market

d. Other (specify)

3. Why you prefer specific investment?

---------------------------------------------------------------------------------

4. If no, why?

a. Not aware about invest avenues b. Insufficient income

c. Other (specify)

5. Do you aware about Commodity Market?

a. YES b. NO

(if no move to question no 12)

6. Are you willing to invest in Commodity Market?

(If in Q. 2 Commodity Market, skip this question)

a. If YES, why? -----------------------------------------------------------

b. If NO, why? -----------------------------------------------------------

(If no move to the Question no.10)

71

7. If yes, which Commodity Exchange you will prefer for

investment?

a. MCX b. NCDEX c. NMCE d. Other (specify)

f. Can’t Say

8. Why you prefer specific Commodity Exchange for investment?

(if answer to Q.7 f, skip this question)

---------------------------------------------------------------------------------

9. In which Commodities you will prefer to Invest? And why?

a. Bullion b. Agricultural c. Metals d. Fossils/Energy

---------------------------------------------------------------------------------

---------------------------------------------------------------------------------

10.What is your perception about Commodity Market?

a. Less Risky b. Risky c. Very Risky

11.What you think Commodity Market Advertisements (hoardings,

prints etc) are explanatory enough to give needed useful

information?

a. YES b. NO

12.Gender

a. Male b. Female

13.Age Group

a. Below 21 Years b. 21 years – 30 years

c. 31 years – 40 years d. 41 years – 50 years

14.Occupation

a. Govt. Job b. Private Job c. Business d. Other (specify)

15.Income Group (Per month)

a. Nil b. Below 10,000/- c. 10,000 – 20,000/-

d. 20,000 – 30,000/- e. Above 30,000/-

72

QUANTITATIVE ANALYSIS

1. INVESTOR’S PREFERENCES

Analysis of data revels that majority of people prefer investment in

Real Estate (28.81% of total sample) which specified in other category

investment and it is greater than share market investment preference.

2. People’s knowledge about Commodity Market

73

Very few people heard of commodity market. Vast majority of

people are unaware about Commodity Market.

3. Investor’s interested to invest in Commodity Market: (Out of

those, who know Commodity Market)

Though some people heard of commodity market due to lack of

complete knowledge about it half of then are not interested in investing in

Commodity Market.

Above data revels that majority of commodity investors like to

invest in Bullion (Gold & Silver).

5. PERCEPTION ABOUT COMMODITY MARKET

74

Analysis of data shows that majority of people who are aware

about commodity market; feel that investment in commodity market is

very risky. So efforts should be done to minimize the risk in commodity

investment and make peoples about minimum risk in commodity

investment.

6. Opinion about Commodity Market Advertisements

(Expressed by those who know commodity market)

There is no second opinion amongst commodity investors, that

commodity market advertisements do not give all the necessary

information.

QUALITATIVE ANALYSIS

1. INVESTMENT PREFERENCES

Most of the investors prefer least risky investment which gives

higher returns. That is why majority (70% of sample) of people

interested in investments other than Share and commodity market.

Very less number of people (only 7%) showed their interest in

investment in commodity market. Main reason for this is lack of

awareness and complete information about commodity market.

75

2. COMMODITY EXCHANGES

People who are interested in commodity investment showed more

concern towards NCDEX; for its brand name and people think

there might be surety of transaction at NCDEX.

3. COMMODITIES

Bullion is most preferred commodity for investment. Because one

can expect maximum returns from such investment due to rapidly

increasing prices of bullion in market.

4. ADVERTISEMENTS

Commodity market Advertisements should be more informative.

And it is the failure of commodity market’s advertisement

campaign to attract people’s attention; as majority of people are not

aware about commodity market.

76

COMMODITY MARKET

Questionnaire for Officials

1. What is MCX/ NCDX/ NMCE/…….

---------------------------------------------------------------------------------

2. History behind formation of MCX/ NCDX/

NMCE/………………..

---------------------------------------------------------------------------------

3. What are the departments at MCX/ NCDX/ NMCE/……….

---------------------------------------------------------------------------------

4. How work is done in each department?

---------------------------------------------------------------------------------

5. How one can become broker at MCX/ NCDX/ NMCE/………….

---------------------------------------------------------------------------------

6. How one can become member of MCX/ NCDX/ NMCE………..

---------------------------------------------------------------------------------

77

BIBLIOGRAPHY

Trading Commodities and Financial Futures: A Step by Step

guide to Mastering the Market, 3rd Edition by George

Kleinman

Options, Futures and Other Derivatives by Johan C. Hull

http://commodities.in

http://finance.indiamart.com/markets/commodity/

http://www.commoditiescontrol.com

http://www.mcxindia.com

http://www.ncdex.com

MCX Certified Commodity Professional Reference Material

Business World (15th September 2003)

Business World (4th December 2006)

http://investmentz.co.in

http://trade.indiainfoline.com

http://www.finance.indiamart.com

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