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For Marwadi Shares & Finance Ltd.


Submitted By: ROHIT PARMAR (Batch 2006-08)


BRACTs Vishwakarma Institute of Management, Kondhwa Pune- 411014 1 ACKNOWLEDGEMENT It is great pleasure for me to acknowledge the kind of help and guidance receive d to me during my project work. I was fortunate enough to get support from a lar ge number of people to whom I shall always remain grateful.

I would like to express my sincere gratitude to Mr. Pratik Tanna and Mr. Ravi Ta ndon for giving me this opportunity to undergo this lucrative project with Marva di Finance Pvt. Ltd. and also for their great guidance and advice on this projec t, without which I will not be able to complete this project. I am very thankful to our Director Sir Dr. Sharad Joshi for giving me valuable suggestion and encouragement to bring out good project. I am very thankful to my mentor Prof. Mr. Mahesh Halale for him inspiration and for initiating diligent efforts and expert guidance in course of my study and co mpletion of the project and I am very thankful to my project guide for giving me timely and concrete guidance for making this project successful. I would like to thankful to customers and staff members of Marwadi S hares & Finance Pvt. Ltd. For helped me during the project report and providing me more and more valuable information for my project report. I would thank to God for their blessing and my Parents also for the ir valuable suggestion and support in my project report. I would also like to thank our friends and those who have helped us during this project directly or indirectly.

Rohit Parmar .


Sr. No. Page No. 1




3 1. EXECUTIVE SUMMARY One of the interesting developments in financial market over the last 15 to 20 y ears has been the growing popularity of derivatives. In many situations , both hedgers and speculators find it more attractive to trade a derivative on an asset, commodity than to trade asset and commodity itself. Some commodity derivatives are traded on exchanges. In this report I have included history of commodity market. Than I have include d commodity market in India. And after that I have discussed the mechanism of trading in commodity market in India. In this report I have taken a first look at forward, futures and options contrac t and other risk management instruments. Than after I have discuss the main comp

onents of future commodity trading like contract size, what actual margin is and delivery system etc. There are mainly three types of traders: hedgers, speculat ors and arbitrageurs. In the next section I discuss about the two major commodity exchanges in India t hat is MCX AND NCDEX. How they are worked for developing this commodity market i n India. And I have also given the list of other commodity exchanges in India. P ut / call ratio (P/C Ratio) is a market sentiment indicator that shows the relat ionship between the numbers of put to calls traded. One can use put/call ratio a s market indicator .Then after I have discussed about the present scenario of co mmodity market in India. In the next I have tried to analyze the trading pattern and investmen t pattern of commodity traders and other investors. This I have done through t he help of QUESTIONER, which contains 15 questions. On the basis of different charts prepared, I have at the end given the research findings and conclusion. And on the basis of my findings I h ave given suggestion and recommendation


2.1 OBJECTIVE OF THE PROJECT REPORT To analyze the view of commodity traders. To make understand the process of future commodity trading in India. To know the investment pattern of commodity traders and people. 2.2 SCOPE OF THE PROJECT REPORT For analyze the trading pattern and investment pattern of commodity traders and government servants, I have taken data from the local area of the Rajkot city.

5 3. INTRODUCTION Instability of commodity prices has always been a major concern of the producers as well as the consumers in an agriculture dominated country like India. Farmer s direct exposure to price fluctuations, for instance, makes it too risky for man y farmers to invest in otherwise profitable activities. There are various ways t o cope with this problem. Apart from increasing the stability of the market, various factors in the farm s ector can better manage their activities in an environment of unstable prices through derivative markets. These markets serve a risk -shifting function, and c an be used to lock -in prices instead of relying on uncertain price developments . There are a number of commodity-linked financial risk management instru ments, which are used to hedge prices through formal commodity exchanges

, over -the-counter (OTC) market and through intermediation by financial and specialized institutions who extend risk management services. (See UNCT AD, 1998 for a comprehensive survey of instruments) These instruments are f orward, futures and option contracts, swaps and commodity linked -bonds. W hile formal exchanges facilitate trade in standardized contracts like futures an d options, other instruments like forwards and swaps are tailor made contracts t o suit to the requirement of buyers and sellers and are available over-the count er. In general, these instruments are classified based on the purpose for which they are primarily used for price hedging, as part of a wider marketing strategy, or for price hedging in combination with other financial deals. While forward cont racts and OTC options are trade related instruments, futures, exchange tr aded options and swaps between banks and customers are primarily pr ice hedging instruments. In the case of swaps between intermedia ries and producers, and commodity linked loans and bonds (CL&BS) price hedging are combined with financial deals. Forwards contracts are mostly OTC agreements to purchase or sell a specific amou nt of a commodity on a predetermined future date at a predetermined price. T he terms and conditions of a forward contract are rigid and both the parties are obligated to give and take physical delivery of the commodity on the exp iry of contract. The holders of forward contracts face spot (ready) price risk. When the prevailing spot price of the underlying commodity is higher than the agreed price on expiry of the contract, the buyer gains and the seller loose s. The futures contracts are refined version of forwards by which the parties ar e insulated from bearing spot risk and are traded in organize exchanges. A detai led discussion on the futures contracts is presented in the next chapter.

6 Both forwards and futures contracts have specific utility to commodity prod ucers, merchandisers and consumers. Apart from being a vehicle for risk transfe r among hedgers and from hedgers to speculators, futures markets also play a maj or role in price discovery.

Typology of risk management instruments The price risk refers to the probability of adverse movements i n prices of commodities, services or assets. Agricultural products, unli ke others, have an added risk. Many of them being typically seasonal would attract only lower price during the harvest season. The forward and futures contracts are efficient risk management tools, which ins ulate buyers, and sellers from unexpected changes in future price movement s. These contracts enable them to lock-in the prices of the products well in a dvance. Moreover, futures prices give necessary indications to producers and con sumer s about the likely future ready price and demand and supply conditions of the commodity traded. The cash market or ready delivery market on t he other hand is a time-tested market system, which is used in all forms of business to transfer title of goods.


4.3 VISION OF THE COMPANY To be a world class financial services provider by arranging all conceivable financial services under one roof at affordable price through cost-effe ctive delivery systems and achieve organic growth in business by adding newer l ines of business. 4.4 COMPANY PROFILE: Marwadi Sales and Finance P. Ltd. started in the year 1994 when acqu ired membership of National Stock Exchange of India Ltd. That was the time when Govt. had just started liberalization. Capital market being at the base of every thing else was among the first few sectors taken up for liberalization and alignment with global benchmarks. NSE was therefore a result of Governments policy to modernize stock market and give our investors a cost - effective tradi ng and settlement system. They enter into the stock market coincided with Government s initiative to gi ve a modern Stock exchange. Marwadi had then very presciently felt that this dev elopment would change the very structure and content of the market. Then, wh en Depository system was introduced to automate the settlement system, we beca me the first Corporate DP in 1998 to bring this concept to investor s doorstep i n Saurashtra. Marwadi had very early on seen that the future lay in the ability to network and use technology to its fullest possible extent. 8 Relying on your judgment, we used technology extensively which resulted in effic ient client servicing. It also saw the synergy that lay in providing a bouquet of services under one ro of. It is this realization that led us in the year 2003 to go for me mbership of National Level Commodity Exchanges, which were set up as part of Govt s policy to bring commodity market on par with the capital market i

n terms of integrity and practices. They bold initiatives starting with our journey from capital market up to commod ities market has given us synergies in operations, enabling us to pass on the advantage to customers. As an organization, have achieved a leader s position by ensuring total satisfac tion of customers through world class services. Utilize ultra modern technology for timely, seamless and accurate data processi ng. Proactively seek customers feedback in improving upon our service de livery modes. Promptly respond to customer issues in order to maximize clients s atisfaction. Products & Services offers: Equity & Derivatives: Can look for an easy and convenient way to invest in equity and take positions i n the futures and options market using their research and tools. To start tradin g in Equity, all you need to do is open an online trading account. You can call them and they will have their representative meet you. You can get help opening the account and get guidance on how to trade in Equity. Commodity: You can enter the whole new world of commodity futures. Investors looking for a fast-paced dynamic market with excellent liquidity can NOW trade in Commodity Fu tures Market. The Commodity Exchange is a Public Market forum and anyone can pla y in these vital Commodity Markets. Marwadi Commodity Broker (P) Ltd can certain ly be your point of entry to the Commodity Markets. Marwadi is a registered trad ing-cum-clearing member of NCDEX and MCX. Internet Trading: Making the right trade at the right time! E-Broking service, which br ings you experience of online buying and selling of shares with just a click. 9 A detail resource like live quotes, charts, research and advice helps you take p roper decisions. Their robust risk management system and 128 bit encryption give s you a complete security about money, shares, and transaction documents. IPO: An active player in the primary market with waste customer base and reaching distribution network spread through out the lands. Then breathe Saurashtra peni nsula. Marwadi offer bidding for all booked bills IPOs being floated through NSE networ k. Marwadi offer services to customer such as advises on the minimum lot to applied in case of refer and details and data to be furnished into IPO form. Marwadi scripts even fill up the form for related clients. Marwadi offer bidding services at all major location in Saurashtra and Kutch the re by enabled the interline investors to subscribes qualitative IPOs.

Mutual Funds: Transact in a wide range of Mutual Funds. Mutual Funds are an attractive means o f saving taxes and diversifying your investment portfolio. So if you are looking to invest in mutual funds, Marwadi offers you a host of mutual fund choices und er one roof; backed by in-depth information and research to help you invest smartly.

PMS: Can you analyze the prices of 1,500 shares every morning? Can you afford to gamb le only on the recommendations from your friends and the information ov erload from magazines and financial dailies? And, of course, more importantly, if you happen to be a High Net worth Individual, do you have the time to judge which advice is reliable, authentic and has the least chance of failure? With M arwadi PMS, you can be assured that your investments are in safe hands! Give you r portfolio the expert edge to smoothly steer towards wealth creation. Cash Market Services: Marwadi also F & O market to all clients in to entire Saurashtra and Kutch regio n, which they cover through, distributed cover. Marwadi offer cash market trading services for the both retail and in station cl ients at all the certain Saurashtra and Kutch where placed either a branch or franchise o r sub broker

10 4.5 HIRARCHY STRUCTURE Board of Director

General Manager

DP Front gy




DP Back (Compliance) Software


4.6 COMPANY INFORMATION: Name: Marwadi Shares & Finance Ltd.

Head Office : Marwadi Financial Center Nr. Kathiawad Gymkhana Dr. R adhakrishnana Road Rajkot 360 001 C.E.O.: Mr. Jeyakumar A. S.

Directors: rwadi

Mr. Ketan Marwadi Mr. Deven Marwadi Mr. Sandeep Ma

General Manager:

Mr. Hareshbhai Maniar

E-Mail: Web Site:

11 4.7 COMPANYS MILESTONE: 1992: Marwadi Shares And Finance Pvt. Ltd. was incorporated 1996: Became a corporate member of national Stock Exchange of India. 1998: Became a member of Saurashtra Kutch Stock Exchange. 1999: Launched Depository services of Depository Participant under National Securities Depository Ltd. 2000: Commenced Derivative Trading after obtaining registration as a Clearing an d Trading Member in NSE 2003: (MCBPL) became a corporate member of The National Commodity and Derivative s Exchange of India Ltd. 2004: Became a corporate member of The Stock Exchange, Mumbai. 2004: Launched Depository Services of Depository Participant under Centr al Depository

Services (India) Ltd. 2006: MSFPL converted to Public Limited (Marwadi Shares And Finance Limited)


Capital Market: National Stock Exchange of India Ltd. Bombay Stock Exchange Ltd. Saurashtra-Kutc h Stock Exchange Ltd. Over-the-Counter Exchange of India Ltd.

Commodities Derivatives: National Commodity & Derivatives Exchange Ltd. Multi Commodity Exchange of India Ltd. Depository Operations: National Securities Depositories Ltd. (NSDL) Central Depository Services (India) Ltd.

12 4.9 SERVICES OF MARWADI: Stock broking: Cash Market Derivatives Trading Margin Trading Internet Trading

Commodities Broking: Commodities Futures Financing Against Commodities Depository Service: NSDL CDSL IPO Subscription Services Mutual Fund Products Portfolio management Insurance Se rvices Qualitative Research in Stock & Commodities

FUTURE SERVICES: Private Banking Sector Forex Market Commodities Demat Service Product Enhancement in commodity market

4.10 THE COMPLETE INVESTMENT DESTINATION: It provides comprehensive range of investment services. Thats advantage of having all the services investor need under one roof. Stock broking: It offers complete range of pre-trade and post-trade services on the BSE and the NSE. Whether an investor come into its conveniently environment, or issue ins truction over the

13 phone, its highly trained team and sophisticated equipment ensure smooth transac tions and prompt services. E-Broking and Web-Based Services: It is one of the offers online trading on site, high bandw idth leased lines, secure services and a customs-built user interface give you an international standards trading experience. It also gives regular tra ding hours, and access to information, analysis of information, and a range of m onitoring tools. Trading Terminals-Money pore Express: It offer its sub-broker and approved/authorized user fully equipped trading term inals- Money pore Express, at the location of investors choice. It is fully fun ctional terminal, with a variety of helpful features like market watch, order en try, order confirmation, charts, and trading calls, all available in resizable windows. And it can be operated through the keyboard using F1 for buy, F2 for s ell. Depository Participant Services: It offers DP services mean hassle-free, depository participants with NSDL and CDSL. speedy settlements. It is

Premium Research Services: Its research team offers a package of fee-based services, including daily t

echnical analysis, research reports, and advice on clients existing investments. It is research beyond desk and company-provider reports. If you have an equi ty portfolio, you know that the pace of life in the world of stocks and shares i s frantic. Managing your portfolio means you have to take firm, informed decisio ns, and quickly! 4.11 BRANCHES: Marwadi has spread throughout Gujarat state with our 28 branches and now taking on Pan - India mantle with branches, now having come up in Hyderabad, Chennai Ba ngalore, Pune, Nasik, Kolhapur and Delhi. More out-of-Gujarat branches are on th e anvil in order to be a conspicuous player at national level. As on today they are serving about 75,000 clients spread out over 554 pin code locations through a network of about 300 intermediaries such as sub-brokers, franchisees and authorized persons.

14 Also other branches of Marwadi in different cities like..

Ahmedabad Amreli Anand Baroda Bhavnagar Bhuj Delhi Dhoraji Dhangadhra Gondal ar Gandhidham

Jamnagar Junagadh Keshod Manavadar Mithapur Mumbai Okha Porbandar Surat Surendranag Veraval


5.1 INTRODUCTION 5. ABOUT THE COMMODITY Keeping in view the experience of even strong and developed economies of the wor ld, it is no denying the fact that financial market is extremely volatile by nat ure. Indian financial market is not an exception to this phenomenon. The attenda nt risk arising out of the volatility and complexity of the financial market is an important concern for financial analysts. As a result, the logical need is fo r those financial instruments which allow fund managers to better manage or redu ce these risks. The emergence of the market for derivative products, most notably forwards, futu res and options, can be traced back to the willingness of risk-averse economic a gents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by lockingin asset prices. As instruments of risk management, these generally do not influence th e fluctuations in the underlying asset prices. However, by locking-in asset pri ces, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. 5.2 COMMODITIES Organized futures market evolved in India by the setting up of "Bombay Cotton Tr ade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Co tton Trade Association, a separate association by the name "Bombay Cotton Exchan ge Ltd." was constituted. Futures trading in oilseeds was organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, whic

h carried on futures trading in groundnut, castor seed and cotton. Before the S econd World War broke out in 1939 several futures markets in oilseeds were funct ioning in Gujarat and Punjab. A three-pronged approach has been adopted to revive and revitalize the market. Firstly, on policy front many legal and administrative hurdles in the functioning of the market have been removed. Forward trading was permitted in cotton and jute goods in 1998, followed by some oilseeds and their de rivatives, such as groundnut, mustard seed, sesame, cottonseed etc. in 1999. A s tatement in the first ever National Agriculture Policy, issued in July, 2000 by the government that futures trading will be encouraged in increasing number of a gricultural commodities was indicative of welcome change in the governm ent policy towards forward trading. 16 Secondly, strengthening of infrastructure and institutional capabilities of the regulator and the existing exchanges received priority. Thirdly, as the existing exchanges are slow to adopt reforms due to legacy or lack of resources, new promoters with resources and professional approach were being attract ed with a clear mandate to set up dematerialized, technology driven exchanges wi th nationwide reach and adopting best international practices. The year 2003 marked the real turning point in the policy framework for commodit y market when the government issued notifications for withdrawing all p rohibitions and opening up forward trading in all the commodities. This period also witnessed other reforms, such as, amendments to the Essential Commodities A ct, Securities (Contract) Rules, which have reduced bottlenecks in the devel opment and growth of commodity markets. Of the country s total GDP, commodit ies related (and dependent) industries constitute about roughly 50-60 %, which itself cannot be ignored. Most of the existing Indian commodity exchanges are single commodity platforms; are regional in nature, run mainly by entities which trade on them resulting in substantial conflict of interests, opaque in their functioning and have not used technology to scale up their operations and reach to bring down their co sts. But with the strong emergence of: National Multi-commodity Exchang e Ltd., Ahmedabad (NMCE), Multi Commodity Exchange Ltd., Mumbai (MCX), National Commodities and Derivatives Exchange, Mumbai (NCDEX), and National B oard of Trade, Indore (NBOT), all these shortcomings will be addressed rapi dly. These exchanges are expected to be role model to other exchanges and are li kely to compete for trade not only among themselves but also with the existing e xchanges. The current mindset of the people in India is that the Commodity exchan ges are speculative (due to non delivery) and are not meant for actual users. O ne major reason being that the awareness is lacking amongst actual users. In Ind ia, Interest rate risks, exchange rate risks are actively managed, but the same does not hold true for the commodity risks. Some additional impediments are cent ered on the safety, transparency and taxation issues. 5.3 WHY COMMODITIES MARKET? India has very large agriculture production in number of agri-commodities, which needs use of futures and derivatives as price-risk management system. Fundamentally price you pay for goods and services depend greatly on how well business handle risk. By using effectively futures and derivatives, busines ses can minimize risks, thus lowering cost of doing business.

17 Commodity players use it as a hedge mechanism as well as a means of making money. For e.g. in the bullion markets, players hedge their risks by usin g futures Euro-Dollar fluctuations and the international prices affecting it. For an agricultural country like India, with plethora of mandis, trading in over 100 crops, the issues in price dissemination, standards, certification and ware housing are bound to occur. Commodity Market will serve as a suitable alternati ve to tackle all these problems efficiently. 5.4 COMMODITY FUTURES: Commodity futures are simply the standard futures contracts trad ed through exchange. These contracts have their respective commodity as underl ying asset and derive the dynamics from it. Such contracts allow the participant to buy and sell certain commodity at a certain price for future delivery. Futur es trading is a natural outgrowth of the problem of maintaining a year-round sup ply of seasonal products like agriculture crops. The best thing about a commodit y futures contract is that it is generally leveraged giving opportunity to all t ypes of investors to participate. Characteristically, such a contract has an exp iry and delivery attached with it. 5.5 WHY TRADE IN COMMODITIES? 1. Big market-diverse opportunities India, a country with a population of over one billion, has an economy based on agriculture, precious metals and base metals. Thus, trading in commodities provides lucrative market opportunities for a wider section of participants of diverse interests like investors, arbitrage rs, hedgers, traders, manufacturers, planters, exporters and importers. 2. Get to the sore Commodity trading has been a breakthrough in expanding the investment from investing in a metal company to trading in metal itself. 3. Huge potential Commodity exchanges see a tremendous daily turnover of more than Rs.15,000 cores . This gives a lunge potential to market participant to make profits. 4. Exploitable fundamental The fundamental for commodity trading is simple price is a function of demand and supply so is hedging, by taking appropriate contract. This makes thing s really easy to understand and exploit. 18 5. Portfolio diversifier Commodity futures derive their prices from the underlying commod ity and commodity prices cannot become zero. Commodity has a global presence a nd their prices move with global economics and hence, its a good portfolio divers ifier. 5.6 ADVANTAGE OF FUTURES TRADING

Futures trading remove the hassles and costs of settlement and storage for trade rs who do not want custody. Though, the most lucrative element of futures trading is that it allows investor s to participate and trade at nominal costs at a much lesser amount: No longer need to put the whole amount for trading; only the margin is required. No sales tax is applicable if the trade is required off. Sales tax is applicable only if a trade results in delivery. Traders can short sell. If a trader buys an equivalent contract back before the contract expires, he will be able to profit from a falling price. This is diffi cult in spot marketers because it requires the seller to borrow the commodity. It is next to impossible for retail investors in case of something like gold. All participants trade exactly the same notional right i.e. those defined on the standard contract, so the market grows deeper and more liquid in the standard f utures contract than in spot bullion where different qualities of bullion exit, each of which has different prices. Greater liquidity provides a reliable real-time price something which is absolut ely not available in the OTC bullion market. 5.7 CHARACTERISTICS OF FUTURES TRADING

A "Futures Contract" is a highly standardized contract with certain distinct fea tures. Some of the important features are as under: Futures trading is necessarily organized under the auspices of a market associati on so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules & By e-laws of the association. It is invariably entered into for a standard variety known as the "basis variety " with permission to deliver other identified varieties known as "tenderable var ieties". The units of price quotation and trading are fixed in these contracts, parties to the contracts not being capable of altering these units. 19 The delivery periods are specified. The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other pre-specified delivery centers. In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the con tract and contracts are settled by payment of differences without any physical delivery of goods taking place. 5.8 COMMODITY DERIVATIVES IN INDIA Commodity derivatives have a crucial role to play in the price risk ma nagement process especially in any agriculture dominated economy. Derivatives li ke forwards, futures, options, swaps etc are extensively used in many developed and developing countries in the world. The Chicago Mercantile Exchange; Chicago Board of Trade; New York Mercantile Exchange; International Petroleum Exchange, London; London Metal Exchange; London Futures and Options Exchange; Marche a Term e International de France; Sidney Futures Exchange; Singapore International

Monetary Exchange; The Singapore Commodity Exchange; Kuala Lumpur Comm odity Exchange ; Bolsa de Mercadorias & Futuros (in Brazil), the Buenos Aires Grain Exchange; Shanghai Metals Exchange; China Commodity Futures Exchange; Bei jing Commodity Exchange, etc are some of the leading commodity exchanges in th e world engaged in trading of derivatives in commodities. However, they have been utilized in a very limited scale in India Although India has a long history of trade in commodity derivatives, this segment remained und erdeveloped due to government intervention in many commodity markets to con trol prices. The government controls the production, supply and distribution of many agricultural commodities and only forwards and futures trading are permi tted in certain commodity items. Free trade in many commodity items is restricte d under the Essential Commodities Ac, 195, and forward and futures contracts ar e limited to certain commodity items under the Forward Contracts (Regulation) Ac t, 1952. The first commodity exchange was set up in India by Bombay Cotton Tr ade Association Ltd., and formal organized futures trading started in cotton in 1875. Subsequently, many exchanges came up in different pa rts of the country for futures trade in various commodities. The Gujarati Vyapar i Mandali came into existence in 1900, which has undertaken futures trade in oil seeds first time in the country. The Calcutta Hessian Exchange Ltd and East India Jute Association Ltd were set up in 1919 and 1927 respectivel y for futures 20 trade in raw jute. In 1921, futures in cotton were organized in Mumbai under the auspices of East India Cotton Association. Many exchanges came up in the agricu ltural centers in north India before world war broke out and engaged in wheat fu tures until it was prohibited. The exchanges in Hapur, Muzaffarnagar, Meerut , Bhatinda, etc were established during this period. The futures trade in spices was firs organized by IPSTA in Cochin in 1957. Futures in gold and silver began in Mumbai in 1920 and continued unt il the government prohibited it by mid-1950s. Later, futures trade was altoge ther banned by the government in 1966 in order to have control on the movement o f prices of many agricultural and essential commodities. Options are though perm itted now in stock market, they are not allowed in commodities. The commodity op tions were traded during the pre-independence period. Options on cotton were tr aded until the along with futures were banned in 1939. However, the government withdrew the ban on futures with passage of Forward Contract (Regulation) Act in 1952. After the ban of futures trade many exchanges went out of business and many trad ers started resorting to unofficial and informal trade in futures. On recommendation of the Khusro Committee in 1980 government reintroduced futures on some selected commodities including cotton, jute, potatoes, etc. Further in 1993 the government of India appointed an expert committee on forward markets under the chairmanship of Prof. K.N. Kabra and the report of the commi ttee was submitted in 1994 which recommended the reintroduction of futures alre ady banned and to introduce futures on many more commodities including si lver. In tune with the ongoing economic liberalization, the National Agric ultural Policy 2000 has envisaged external and domestic market reforms and dis mantling of all controls and regulations in agricultural commodity markets. It has also proposed to enlarge the coverage of futures markets to mini mize the wide fluctuations in commodity prices and for hedging the risk emerging from price fluctuations. In line with the proposal many more agricultural commo dities are being brought under futures trading. In India, currently there are 15 commodity exchanges actively undertaking tradin g in domestic futures contracts, while two of them, viz., India Pepper and Spice Trade Association (IPST), Cochin and the Bombay Commodity Exchange (BCE) Ltd. have been recently upgraded to international exchanges to deal in inte rnational contracts in pepper and castor oil respectively. Another 8 exchanges are proposed and some of them are expected to start operation shortly. Th

ere are 4 exchanges, which are specifically approved for undertaking forward deals in cotton. More detailed account of these exchanges has been prese nted.

21 The proposed study is primarily based on the visit of seven leading exchanges vi z., IPST Cochin, which deal in domestic and international contracts in pepp er; BCE Ltd., a multy-commodity international exchange where futures in castor oil, castor seed, sunflower oil, RBD Palmolein etc are traded; The East India C otton Association (EICA) Ltd., Bombay, which is a specialized exchange dealing i n forwards and futures in cotton; South India Cotton Association (SICA , Coimbat ore which deals in forward contracts in cotton; Coffee Futures Exchange India Lt d., (COFEI) Bangalore which undertakes coffee futures trading; Kanpur Commodity Exchange (KCE) which deals with futures contracts in mustard oil and gur; and Th e Chamber of Commerce, Hapur which undertakes futures trading in gur and potatoe s. 5.9 MECHANICS OF FUTURES TRADING Futures are a segment of derivative markets. The value of a futures contract is derived from the spot (ready) price of the commodity underlying the contract. Th erefore, they are called derivatives of spot market. The buying and selling of f utures contracts take place in organized exchanges. The members of exchange s are authorized to carryout trading in futures. The trading members buy a nd sell futures contract for their own account and for the account of non-tradin g members and other clients. All other persons interested to trade in futures co ntracts, as clients must get themselves registered with the exchange as register ed non-members. 5.10 WHAT IS A COMMODITY FUTURE EXCHANGE?

Exchange is an association of members, which provides all organizational support for carrying out futures trading in a formal environment. These exchanges are m anaged by the Board of Directors, which is composed primarily of the members of the association. There are also representatives of the government and public n ominated by the Forward Markets Commission. The majority of members of the Board have been chosen from among the members of the Association who have trading and business interest in the exchange. The chief executive officer and his team in day-to-day administration assist the Board. There are different clas ses of members who capitalize the exchange by way of participation in the form o f equity, admission fee, security deposits, registration fee etc. a. Ordinary Members: They are the promoters who have the right to have own accoun t transactions without having the right to execute transactions in the trading r ing. They have to place orders with trading members or others who have the right to trade in the e xchange. 22 b. Trading Members: These members execute buy and sell orders in the trading rin g of the exchange on their account, on account of ordinary members and other cli ents. c. Trading-cum-Clearing Members: They have the right to trade and also to parti

cipate in clearing and settlement in respect of transactions carried out on thei r account and on account of their clients. d. Institutional Clearing Members: They have the right to participate in clearin g and settlement on behalf of other members but do not have the trading rights. e. Designated Clearing Bank: It provides banking facilities in respect of pay-in , payout and other monetary settlements. The composition of the members in an exchange however varies. In so me exchanges there are exclusive clearing members, broker members and registered non -member s in addition to the above category of members.


Futures contracts are an improved variant of forward contracts. They are agreeme nts to purchase or sell a given quantity of a commodity at a predetermined price , with settlement expected to take place at a future date. While forward contrac ts are mainly over-the-counter and tailor-made which physical delivery futures s ettlement standardized contracts whose transactions are made in formal exchanges through clearing houses and generally closed out before delivery. The closing o ut involves buying a different times of two identical contracts for the purchase and sale o the commodity in question, with each canceling the other out. The fu tures contracts are standardized in terms of quality and quantity, and place a nd date of delivery of the commodity. The commodity futures contracts in India a s defined by the FMC has the following features: (a) Trading in futures is necessarily organized under the auspices of a recogniz ed association so that such trading is confined to or conducted through m embers of the association in accordance with the procedure laid down in the Rules and Bye-laws of the association. (b) It is invariably entered into for a standard variety known as the basis v ariety with permission to deliver other identified varieties known as tender able varieties. (c) The units of price quotation and trading are fixed in these cont racts, parties to the contracts not being capable of altering these units. (d) The delivery periods are specified.

23 (e) The seller in a futures market has the choice to decide whether to deliver g oods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other pre-specified delivery centers. (f) In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any p hysical delivery of goods taking place. The terms and specifications of futu res contracts vary depending on the commodity and the exchange in which it is traded. The major terms and conditions of contracts traded in six sample exchanges in In dia. These terms are standardized and applicable across the trading comm unity in the respective exchanges and are framed to promote trade in the resp ective commodity For example, the contract size is important for better manageme nt of risk by the customer. It has implications for the amount of money that can be gained or lost relative to a given change in price levels. I also affect the margins required and the commission charged. Similarly, the margin to be depos ited with the clearing house has implications for the cash position of customers

because it blocks cash for the period of the contract to which he is a party th e strength and weaknesses of contract specifications are discussed under constra ints and policy options. 5.12 WHO ARE THE PARTICIPANTS IN FUTURES MARKET?

Broadly, speculators who take positions in the market in an attempt to benefit f rom a correct anticipation of future price movements, and hedgers who transact i n futures market with an objective of offsetting a price risk on the physical ma rket for a particular commodity make the futures market in that commodity. Although it is difficult to draw a line of distinction between hedgers and speculators, the former category consists of manufacturing companies, merch andisers, and farmers. Manufacturing companies who use the commodity as a raw ma terial buy futures to ensure its uninterrupted supply of guaranteed quality at a predetermined price, which facilitates immunity against price fluctuations. Whi le exporters in addition to using the price discovery mechanism for g etting better prices for their commodities seek to hedge against their overs eas exposure by way of locking-in the price by way of buying futures contrac ts, the importers utilize the liquid futures market for the purpose of hedging their outstanding position by way of selling futures contracts. Futures market helps farmers taking informed decisions about their crop pattern on the basis of the futures prices and reduces the risk associated with variations in their sales re venue due to 24 unpredictable future supply demand conditions. Above all, there are a large number of brokers who intermediate between hedgers and speculators create the market for futures contracts. 5.13 COMMODITY ORDERS

The buy and sell orders for commodity futures are executed on the trading floor where floor brokers congregate during the trading hours stipulated by the exchange. The floor brokers/trading members on receipt of orders fr om clients or from their office transmits the same to others on the trading floo r by hand signal and by calling out the orders (in an open outcry system they wo uld like to place and price. After trade is made with another floor broker who t akes the opposite side of the transaction for another customer or for his own ac count, the details of transactions are passed on to the clearing house through a transaction slip on the basis o which the clearinghouse verifies the match and adds to its records. Following the experiences of stock exchanges wit h electronic screen based trading commodity exchanges are also movin g from outdated open outcry system to automated trading system. Many l eading commodity exchanges in the world including Chicago Mercantile Exc hange (CME), Chicago Board of Trade (CBOT), International Petroleum Exch ange (IPE), London, have already computerized the trading activities. In India, coffee futures exchange, Bangalore has already put in place the screen based trading and many others are in the process of computeriza tion. To add to modernization efforts, the Bombay Commodity Exchange (BCE ) has initiated for a common electronic trading platform connecting all comm odity exchanges to conduct screen based trading. In electronic trading, tra ding takes place through a centralized computer network system to which al l buy and sell orders and their respective prices are keyed in from various term

inals of trading members. The deal takes place when the central computer finds m atching price quotes for buy and sell. The entire procedural steps involved in e lectronic trading beginning from placing the buy/sell order to the confirmation of the transaction have been shown in figure -2.1 below.

25 Order and Execution flows in electronic future trade Confirmation BUYER SELLER Comfirmation Order Output t COMPUTER Verifaction of Order der CREDIT RISK Order Inpu COMPUTER Verifaction of Or CREDIT RISK

Legitimitate Order Legitimate Are Trasferred ELECTRONIC TRADING Order are Transferred Orders are matched EXECUTION Transfer of Position CLEARING HOUSE


Position CLEARING MEMBER and margin settlement

5.14 ROLE OF CLEARING HOUSE Clearinghouse is the organizational set up adjunct to the futures exchang e which handles all back-office operations including matching up of each buy an d sell transactions, execution, clearing and reporting of all transactions, sett lement of all transactions on maturity by paying the price difference or by arra nging physical delivery, etc., and assumes all counterparty risk on behalf of bu yer and seller. It is important to understand that the futures market is design ed to provide a proxy for the ready (spot) market and thereby acts as a prici ng mechanism and not as part of, or as a substitute for, the ready market. The buyer or seller of futures contracts has two options before the maturity of the contract. First, the buyer (seller) may take (give) physical delivery of the commodity at the delivery point approved by the exchange after the contract mat ures. The second option, which distinguishes futures from forward contracts is t hat, the buyer (seller) can offset the contract 26 by selling (buying) the same amount of commodity and squaring off his position. For squaring of a position, the buyer (seller) is not obligated to sell (buy) the original contract. Instead, the clearinghouse may substitute any contract of the same specifications in the process of daily matching . As delivery time approaches, virtually all contracts are settled by offset as those who have bought (long) sell to those who have sold (short). This offsettin g reduces the open position in the account of all traders as they approach the m aturity date of the contract. The contracts, if any, which remain unsettled by o ffset until maturity date are settled by physical delivery. The clearinghouse plays a major role in the process explained above by intermediating between the buyer and seller. There is no clearingho use in a forward market due to which buyers and sellers face counterparty risk. In a futures exchange all transactions are routed through and guaranteed by the clearinghouse which automatically becomes a counterpart to each transaction. It assumes the position of counterpart to both sides of the transaction. It sells contract to the buyer and buys the identical contract from the seller. Ther efore, traders obtain a position vis --vis the clearing house. It ensures default risk-free transactions and provides financial guarantee on the strength of funds contributed by its members and through collection of margins (discus sed in section 2.3), marking-to-market all outstanding contracts, position limit s imposed on traders, fixing the daily price limits and settlement guarantee fun d. The organizational structure and membership requirements of clearinghouses vary from one exchange to the other. The Bombay Commodity Exchange and Cochin pepper exchange have set up separate independent corporations (na mely, Prime Commodities Clearing Corporation of India Ltd, and First Commoditi es Clearing Corporation of India Ltd., respectively) for handling clearing and g uarantee of all futures transactions in the respective exchanges. While coffee e xchange has clearing house as a separate division of the exchange, many other ex changes like Chamber of Commerce, Hapur; Kanpur Commodity Exchange and cotto n exchange in Bombay run in-house clearinghouse as part of the respec tive exchanges. The clearing and guaranty are managed in these exchange s by a separate committee (normally called the Clearing House Committee). The membership in the clearinghouse requires capital contribution in the f orm of equity, security deposit, admission fee, registration fee, guaran

tee fund contribution in addition to net worth requirement depending on its o rganizational structure. For example, in the Bombay Commodity Exchange the minim um capital requirement for membership in its clearinghouse as applicable to trading-cum-clearing members is Rs.50,000 each toward equity and security deposit, Rs. 500 as annual subscription, and additionally, m embers are 27 required to have net worth of Rs.3 lakhs. Similarly, coffee exchange prescribed Rs.5 lakh each towards equity and guarantee fund contribution and Rs.40,000 towa rds admission fee for a trading-cum-clearing member. However, in exchanges where clearing house is a part of the exchange the payment requirements are low er. For example, Kanpur Commodity Exchange prescribed only Rs.25,00,000 R s.1000 and Rs.500 respectively towards security deposit, registration fee and annual fee for a clearing cum-trading member. For ensuring financial integrity of the exchange and for counterparty risk -free trade position (exposure) limits have been imposed on clearing members. These l imits which are stringent in some cases and are liberal in other cases are norma lly linked to the members contribution towards equity capital or security d eposit or a combination of both and settlement guarantee fund. In Bombay Commodity Exchange the exposure limit of a clearing member is the sum of 50 times the face value of contribution to equity capital of the clearinghous e and 30 times the security deposit the member has maintained with the clearinghouse. While coffee exchange prescribes the limit of 80 times the sum of members equity investment and the contribution to the guarantee fund, the co tton exchange, Bombay, has stipulated a liberal exposure limit on open positi ons. It has a limit of 200 and 1500 units (recall that one contract unit is equi valent to 93.5 quintals respectively for composite and institutional members. Th e Cochin pepper exchange has fixed a net exposure limit of 60 units ( equivalent to 1500 quintals) for domestic contract and 90 units (equivalent to 2250 quintals) for international contract. Moreover, setting up of settlement gu arantee fund ensures enough financial strength in case the clearinghouse faces d efault. The Kanpur Commodity Exchange maintains a trade guarantee fund with a corpus of Rs.100 lakhs while the coffee exchange in addition to a guarantee fund the exch ange has substituted itself as party to clear all transactions. Yet another check on the possible default is through prescribing maximu m price fluctuation on any trading day, which helps limit the probable profit/l oss from each unit of transaction. The relevant data on permitted price limit ha s been presented. Its clear from the table that the maximum profit/loss potentia l from trade in each contract unit varies from as low as Rs. 800 for potato futu res in Chamber of Commerce, Hapur to as high as Rs. 15,000 in pepper exchange, C ochin. Similarly, given the permissible open position of 200 units for a trading -cum-clearing member and maximum price fluctuation of Rs. 150 per 100 kg f or cotton futures in the cotton exchange, Bombay, the maximum potential loss/pro fit in a trading day works out to be Rs.28.05 lakhs!

28 Margins Margins (also called clearing margins) are good -faith deposits ke pt with a clearinghouse usually in the form of cash. There are two types of m argins to be maintained by the trader with the clearinghouse: initial margin an d maintenance or variation margins. Initial margin is a fixed amount per contra ct and does not vary with the current value of the commodity traded. Margins are deposited with the clearing house in advance against the expected exposu re of the trading member on his account and on account of the clients. The membe

r who executes trade for them in turn collects this amount from the clients. Gen erally, the margin is payable on the net exposure of the member. Net exposure is the sum of gross exposure (buy quantity or sale quantity, whiche ver is higher, multiplied by the current price of the contract) on account of tr ades executed through him for each of his clients and gross exposure of trades carried out on his own account. However, for squaring-off transactions carried o ut only at the clients level, fresh margins are not required. The margin is refu ndable after the client liquidates his position or after the maturity of the contract. Maintenance margin which usually ranges from 60 to 80 per cent of initial margin is also required by the exchange. Variation margin is to compensate the r isk borne by the clearinghouse on account of price volatility of the commod ity underlying the contract to which it is a counterparty. A debit in the mar gin account due to adverse market conditions and consequent change in the value of contract would lead to initial margin falling below the maintenance level. The clearinghouse restores initial margin through margin calls to the c lient for collecting variation margin. In case of an increase in value of the co ntract, marking- to-market ensures that the holder gets the payment equivalent t o the difference between the initial contract value and its change over the life time of the contract on the basis of its daily price movements. If the member is not able to pay the variation margin, he is bound to square off his position or else the clearinghouse will be liquidating the position. The margins have important bearing on the success of futures. As they are non- interest bearing deposits payable to the clearinghouse up-front work ing capital of any trading entity gets blocked to that extent. While a higher ma rgin requirement prevents traders from participating in trading, a lower margin makes the clearinghouse vulnerable to any default due to its weak financial str ength otherwise. Internationally, many developed exchanges maintain a low margin on positions due to their better financial strength along with massive volume o f trade resulting in large income accruing to them. However, this has not been the case with many exchanges in India. For example, a s shown in table 2.2 the initial margin liability for transacting the minimum lot size in pepper is 29 Rs.30, 000 for domestic contracts and US$ 312.50 for international contracts .Si milarly, the volume of transactions. These clearinghouses deal in many exchanges in India is abysmally low making their existence financially unviable. Most of the exchanges in additions to keeping mandatory margins maintain a settlement guarantee fund. The fund set up with the contribution from members o f clearing house is used for guaranteeing financial performance of all members. This fund absorbs losses not covered by margin deposits of the defaulted member. The clearinghouse ensures this by settling the default transactions by properly compensating the traders paying the amount of difference at the closing out rat e. How does futures contract facilitate hedging against price risk? The futures contracts are designed to deal directly with the credit risk involve d in locking-in prices and obtaining forward cover. These contracts can be used for hedging price risk and discovering future prices. For commodities tha t compete in world or national markets, such as coffee, there are many rel atively small producers scattered over a wide geographic area. These widely d ispersed producers find it difficult to know what prices are available, and the opportunity for producer, processor, and merchandiser to ascertain their likely cost for coffee and develop long range plans is limited. Futures trading, used in the Midwest for grains and similar farm commodities since 1859, and adapted f

or coffee in 1955, provides the industry with a guide to what coffee is wor th now as well as todays best estimate for the future. Moreover, since all transactions are guaranteed through a central body, clearing house, which is the counter party to each buyer and seller ensuring zero default risk , market participants need not worry about their counterparts creditworthiness. Hedge is a purchase or sale on a futures market intended to offset a price risk on the physical (ready) market. It involves establishing a position in the futur es market again ones position or firm commitments in the physical market. The producers who seek to protect themselves from an expected decline in prices of their commodity in future go for short hedge (also called sell hedge). He u ndertakes the following operations in the market to lock- in the price in advanc e which he is going to receive after the product. I ready for physical sale. We assume that the producer anticipates a harvest of 5 metric tones (equivalent to 2 units of contracts in Cochin pepper exchange) of pepper in March, the futures price for March delivery of the specific variety of pepper is Rs.8400 per quinta l (Rs.2.10lakh per unit, and the prevailing (say, October) ready market price is Rs.8100 per quintal. a) In October, the producer goes short (sells) in the futures market selling 2 M arch futures contracts at Rs.8400 per quintal. This is called price fixing. 30 b) In the delivery month, futures prices dropped to Rs.8200 per quintal and the producer sells pepper in the ready market for Rs.8200. c) Simultaneously, he closes out his short position in futures by buying (long position) 2 March futures contracts at Rs.8200 per quintal. The result is that the producer sold futures contract at Rs.8400 and bought the same futures contract at Rs.8200 per quintal making a net gain of Rs.200 per quintal or Rs.5000 per contract. For the physical sale, the producer received the market price of Rs.8200 prevail ing on the day of the sale and the gain of Rs.200 per quintal from closing-out o f futures contracts makes him to realize Rs.8400 per quintal as initially locked -in by price-fixing. If the price realized in the ready market is lower than th e price in future contract, the loss on the physical market is compensated by th e higher price realized on the future contract. On the other hand, if the price in the ready market is higher than in futures contract, the gain in the ready ma rket is offset by the loss on the repurchase of the futures contract. Since futures market prices move in tandem with the ready market prices over the course of time tending to converge as the contract matures, a gain in the futur es market in a developed commodity market under normal conditions, will be offse t by a loss in the ready market, or vice versa. However, market imperfections w ill lead to the basis risk emerging from the mismatch between the gain/loss from the futures market not compensated by loss/gain in the ready market . Meaning of Derivatives The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived". A derivative is a financial instrument, which der ives its value from some other financial price. This other financial price is call ed underlying. The most common underlying assets include stocks, bonds, commod ities, currencies, livestock, interest rates and market indexes. A wheat farmer may wish to contract to sell his harvest at a future date to elim inate the risk of a change in prices by that date. The price for such a contract would obviously depend upon the current spot price of wheat. Such a transaction could take place on a wheat forward market. Here, the wheat forward is the deriv ative and wheat on the spot market is the underlying. The terms derivative contract, d erivative product, or derivative are

used interchangeably.

31 Examples of Derivatives

Consider how the value of mutual fund units changes on a day-to-day basis. Dont m utual fund units draw their value from the value of the portfolio of securities under the schemes? A very simple example of derivatives is cloth, which is derivative of cotton. Th e price of cloth depends upon the price of cotton, which in turn depends upon the demand, and supply of cotton... Arent these examples of derivatives? Yes, these are. And you know what, these examples prove that derivatives are not so new to us. There are two broad types of derivatives: Financial derivatives: - Here the underlying includes treasuries, bonds, stocks, stock index, foreign exchange etc. Commodity derivatives: Here the underlying is a commodity such as wheat, cotton, peppers, turmeric, corn, soybeans, rice crude oil etc. 5.15 HISTORY

The history of derivatives is surprisingly longer than what most people think. S ome texts even find the existence of the characteristics of derivative cont racts in incidents of Mahabharata. Traces of derivative contracts can even be found in incidents that date back to the ages before Jesus Christ. The first organized commodity exchange came into existence in the early 1700s in Japan. The first formal commodities exchange, the Chicago board of trade ( CBOT), was formed in 1848 in the US to deal with the problem of credit risk and to provide centralized location to negotiate forward contracts, where forw ard contracts on various commodities were standardized around 1865.The prima ry market intention of the CBOT was to provide a centralized location known in a dvance for buyers and sellers to negotiate forward contracts. In 1865, the CBOT went one step further and listed the first futures contracts. In 1919, Chicago But ter and Egg Board, a spin-off of CBOT, was recognized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized futures exchanges, indeed the two lar gest financial 32 exchanges of any kind in the world today. From then on, futures contracts have r emained more or less in the same form, as we know them today. The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world is based o n S & P 500 index, traded on Chicago Mercantile Exchange. During the mid eight ies, financial futures became the most active derivative instruments generating

volumes many times more than the commodity futures. Index futures, futures on Tbills and Euro-Dollar futures are the three most popular futures contracts trade d today. Other popular international exchanges that trade derivatives are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan, MATIF in France et c. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or overproduction. Although trading in agricultural and other commodities has been the driving force behind the development of d erivatives exchanges, the demand for products based on financial instruments such as bond, currencies, stocks and stock indiceshas now far outstripped that f or the commodities contracts. India has been trading derivatives contracts in silver, gold, spices, coffee, co tton and oil etc for decades in the gray market. Trading derivatives contracts i n organized market was legal before Morarji Desais government banned forward contracts. Derivatives on stocks were traded in the form of Teji and Mandi in unorganized markets. Recently futures contract in various commodities was allowe d to trade on exchanges. In June 2000, National Stock Exchange and Bombay Stock Exchange started trading in futures on Sensex and Nifty. Options trading on Sensex and Nifty commenced i n June 2001. Very soon thereafter trading began on options and futures in 31 prominent stocks in the month of July and November respectively. The derivatives market in India has grown exponentially, especially at NSE. Stock Futures are the most hi ghly traded contracts on NSE accounting for around 55% of the total turnover of derivatives at NSE, as on Apr il 13, 2005


A derivative as a term conjures up visions speculative dealings and comes across as an e of a few smart finance professionals. In ative transaction helps to cover risk, which rities on which the derivative is based and a investor, can benefit immensely.

of complex numeric calculations, instrument which is the prerogativ reality it is not so. In fact, a deriv would arise on the trading of secu small

A derivative security can be defined as a security whose value depends on the va lues of other underlying variables. Very often, the variables underlying the derivative securities are the prices of traded securities.

An example of a simple derivative contract: Rohan buys a futures contract. He will make a profit of Rs. 1200 if the price of Infosys rises by Rs. 1200. If the price is unchanged Ram will receive nothing. If the stock price of Infosys falls by Rs. 1000 he will lose Rs. 1000. As we can see, the above contract depends upon the price of the Infosys scrip, w hich is the underlying security. Similarly, futures trading has already started in Sensex futures and Nifty futures. The underlying security in this case is the BSE Sensex and NSE Nifty. There are basically of 3 types of Derivatives and Futures: Forwards and Futures Options Swaps


Options Forwards



Put Commodity Interest Rate 34 FORWARD CONTRACT

Call Securities Currency

A forward contract is an agreement to buy or sell an asset on a specified date f or a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying assed on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to dell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to

the contract. The forward contracts are normally traded outside the exchanges. The salient features of forward contracts are: They are bilateral contracts hence exposed to counter-party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. it has to compulsorily go to the same counter party, which often results in high price being charged. Limitation of forward market: Forward market world-wide are afflicted by several problems: Lack of centralization Illiquidity Counterparty risk In the first two of these, the basic problem is that of too much f lexibility and generality. The forward market is like a real estate market in t hat any two consenting adults can form contracts against each other. This often makes them design terms of the deal which are very convenient in that specific s ituation, but makes the contracts non-tradable. Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankrup tcy, the other suffers. Even when forward market trade standardized cont racts, and hence avoids the problem of illiquidity, still the counterparty r isk remains very serious issue. Illustration Sahil wants to buy a Laptop, which costs Rs 30,000 but he has no cash to buy it outright. He can only buy it 3 months hence. He, however, fears that prices of l aptop will rise 35 3 months from now. So in order to protect himself from the rise in prices Sahil enters into a contract with the laptop dealer that 3 months from now he will buy the laptop for Rs 30,000. What Sahil is doing is that he is locking the cur rent price of a LAPTOP for a forward contract. The forward contract is settle d at maturity. The dealer will deliver the asset to Sahil at the end of three mo nths and Sahil in turn will pay cash equivalent to the LAPTOP price on delivery. FUTURES CONTRACT Futures markets were designed to solve the problems that exist in forward market . A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. So, the counter party to a future contract is the clearing corporation of the approp riate exchange. To facilitate liquidity in the futures contracts, the exchange s pecifies certain standard features of the contract. It is a standardized contrac

t with standard underlying instrument, a standard quantity and quality of the un derlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. Future contracts are often settled in cash or cash equivalents, rather than re quiring physical delivery of the underlying asset. A futures contract may be off set prior to maturity by entering into an equal and opposite transaction. More t han 99% of futures transaction is offset this way. The standardized items in a futures contract are: Quantity of the Underlying. Quality of the Underlying. The date and month of delivery. The units of price quotation and minimum price change. Location of settlement. Distinction between futures and forwards contracts: Forward contracts are often confused with futures contracts. The confus ion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterp arty risk and offer more liquidity. The distinction between futures and forwards are summarized below:

36 Futures 1.Trade on an organized exchange 2.Standardized contract terms s 3.Hence more liquid 4.Requires margin payments 5.Settlement happens at the end of 1.OTC in nature


2.Customized contract term 3.Hence less liquid 4.No margin payment

5.follows daily settlement period.

OPTIONS CONTRACT Option means several things to different people. It may refer to choice or alter

native or privilege or opportunity or preference or right. To have option is nor mally regarded good. One is considered unfortunate without any options. Options are valuable since they provide protection against unwanted, uncertain happening s. They provide alternatives to bail out from a difficult situation. Options can be exercised on the happening of certain events. Options may be explicit or implicit. When you buy insurance on your house, it is an explicit option that will protect you in the event there is a fire or a thef t in your house. If you own shares of a company, your liability is limited. Limi ted liability is an implicit option to default on the payment of debt. Options have assumed considerable significance in finance. They can be written o n any asset, including shares, bonds, portfolios, stock indices currencies, etc. They are quite useful in risk management. How are options defined in finance? W hat gives value to options? How are they valued? An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain da te. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties. For example, that Rohit discover a bungalow that Rohit love to purchase. Un fortunately, Rohit won t have the cash to buy it for another three months. Rohit talk to the owner and negotiate a deal that gives Rohit an option to buy the bu nglow in three months for a price of Rs.20,00,000. The owner agrees, but for thi s option, Rohit pay a price of Rs.50,000. Now, consider two theoretical situations that might arise:

1. It is discovered that the bunglow is actually having a historical importance! As a result, the market value of the bunglow increases to Rs. 50,00,000. Becaus e the owner sold Rohit the 37 option, he is obligated to sell Rohit the bunglow for Rs.20,00,000. In the end, Rohit stand to make a profit of Rs.29, 50,000. (Rs.50,00,000Rs.20,00,000Rs.50,000).

2. While touring the bunglow, Rohit discover not only that the walls are chock-full of asbestos, but also that it is a home place of numerous rats . Though Rohit originally thought Rohit had found the bunglow of Rohit dreams, Rohit now consider it worthless. On the upside, because Rohit bought an opt ion, Rohit are under no obligation to go through with the sale. Of cours e, Rohit still lose the Rs.50,000 price of the option. This example demonstrates two very important points. First, when Rohit buy an option, Rohit have a right but not an obligation to do something. Rohit can always let the expiration date go by, at which point the option becomes wor thless. If this happens, Rohit lose 100% of Rohit investment, which is the money Rohit used to pay for the option. Second, an option is merely a contract that d eals with an underlying asset. For this reason, options are called derivatives; means an option derives its value from something else. In our example, the bungl ow is the underlying asset. Most of the time, the underlying asset is a stock or an index. Types of Options

There are two types of options:

Call Options: - It gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position o n a stock. Buyers of calls hope that the stock will increase substantially befor e the option expires. Put Option: - It gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short positi on on a stock. Buyers of puts hope that the price of the stock will fall before the option expires. Participants in the Options Market There are four types of participants in options markets depending on the positio n they take: 1. Buyers of calls 2. Sellers of calls 3. Buyers of puts 4. Sellers of put

38 People who buy options are called holders and those who sell options are called writers; furthermore, buyers are said to have long positions, and selle rs are said to have short positions. Here is the important distinction between buyers and sellers: Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose. Call writers and put writers (sellers), however, are obligated to b uy or sell. This means that a seller may be required to make good on a promis e to buy or sell. Terminology Associated With The Options Market. Option Price: - Option price is the price, which the option buyer pays to the op tion seller. It is also referred to as the option premium. Expiration Date: - The date specified in the options contract is know n as the expiration date, the exercise date, the strike date or the maturity. Strike Price: - The price specified in the options contract is known as the stri ke price or the exercise price. Listed Options: - An option that is traded on a national options exchange such a s the National Stock Exchange is known as a listed option. These have fixed stri ke prices and expiration dates. Each listed option represents a predetermined nu mber of shares of company stock (known as a contract). In-the-money Option: - An in-the-money (ITM) option is an option that would lead to a positive cashflow to the holder if it were exercised immediately. A call o ption on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the in dex is much higher than the strike price, the call is said to be deep ITM. In th e case of a put, the put is ITM if the index is below the strike price. At-the-money Option: - An at-the-money (ATM) option is an option that would lead

to zero cashflow if it were exercised immediately. An option on the index is at -the-money when the current index equals the strike price (i.e. spot price = str ike price). Out-of-the-money Option:- An out-of-the-money (OTM) option is an option that would lead to a negative cash flow when exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level, which i s less than the strike price (i.e. spot price < strike price). If the index is m uch lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price. Depending on when an option can be exercised, it is classified in on of the following two categories: 39 American Options: - American options are options that can be exercised at any ti me upto the expiration date. Most exchange-traded options are American. European Options: - European options are options that can be exercised only on t he expiration date itself. European options are easier to analyze than Americ an options, and properties of an American option are frequently deduced from those of its European counterpart. TRADING IN OPTIONS

If one buys an option contract he is buying the option, or "right" to trade a pa rticular underlying instrument at a stated price. An option that gives you the right to eventually make a purchase at a predetermi ned price is called a "call" option. If you buy that right it is called a long c all; if you sell that right it is called a short call. An option that gives you the right to eventually make a sale at a predetermined price is called a "put" option. If you buy that right it is called a long put; i f you sell that right it is called a short put. Trading in Call Suppose a call option with an exercise/strike price equal to the price of the un derlying (100) is bought today for premium Re.1. Profit/ Loss for a Long Call. At expiry, if the securitys price has fallen below the strike price, the option w ill be allowed to expire worthless and the position has lost Re.1. This is the m aximum amount that you can 40 lose because an option only involves the right to buy or sell, not the obligatio n. In other words, if it is not in your interest to exercise the option you dont have to and so if you are an option buyer your maximum loss is the premium you have paid for the right. If, on the other hand, the securitys price rises, the value of the option will in crease by Re.1 for every Re.1 increase in the securitys price above the strike pr ice (less the initial Re.1 cost of the option). Note that if the price of the underlying increases by Re.1, the option purchaser breaks even - breakeven is reached when the value of the option at expiry is eq ual to the initial purchase price. For our call option, the breakeven price is 1 01. If the price of the security is greater than 101, the call buyer makes money .

Profit/Loss for a short call.

Here profit is limited to the premium received for selling the right to buy at t he exercise price - again Re.1. For every Re.1 rise in the price of the underlying security above the exercise price the option falls in value by Re.1. Here again, the breakeven point is 101. Trading in Put: Consider that a put option with an exercise/strike price equal to the price of t he underlying (100) is bought today for premium Re.1.

41 Profit/Loss graph for a Long Put.

At expiry the put is worth nothing if the securitys price is more than the strike price of the option but, as with the long call, the option buyers loss is limite d to the premium paid. The breakeven for this option is 99, so the put purchaser makes money if the u nderlying security is priced below 99 at expiry. Profit/Loss graph for a short put.

Here profit is limited to the premium received for selling the right to sell at the strike price. For every Re.1 fall in the price of the underlying security be low the strike price the option falls in value by Re.1. Here again, the breakeven point is 99.

42 Difference between Future and Options



Obligation Both the buyer and the seller are under obligation to fulfill the contract. Risk g. Profit The buyer and seller are subject to unlimited risk of losin

The buyer and seller have unlimited potential to gain. and not the obligation whereas fulfill the contract. The seller is subj the buyer has a limited potential to los to gain while the buyer has

The buyer of the option has the right the seller is under obligation to ect to unlimited risk of losing whereas e. The seller has limited potential unlimited potential to gain. Price Behavior It is one-dimensional the underlying only.

as its price depends





It is bi-dimensional as its price depends upon both the price and the volatility of the underlying. Payoff near payoff Linear payoff Nonli


and Strike price is fixed and price

Strike price Price is zero and strike price moves moves Price s always positive Price is always zero

Price i

Risk at risk

Both long and short at risk

Only short

SWAP CONTRACT: Swaps are similar to futures and forwards contracts in providing hedge against financial risk. A swap is an agreement between two parties, called cou nter parties, to trade cash flows over a period of time. Swaps arrangements are quite flexible and are useful in many financial situation. Two most popular s waps are currency swaps and interest-rate swaps. These two swaps can be comb ined when interest on loans in two currencies are 43 swapped. The development of swaps in the eighties is a significant development. The interest rate and currency swap markets enable firms to arbitrage are dif ferences between capital markets. They make use of their comparative ad vantage of borrowing in their domestic market and arranging swaps for inter est rates or currencies that they cannot easily access. 1. Interest rate swaps: - These entail swapping only the interest related cash f lows between the parties in the same currency. Currency swaps: - These entail swapping both principal and interest between the parties, with the cash flows in one direction being in a different currency than those in the opposite direction.


The Profile of Futures Exchanges (mcx and ncdex)

5.17 Overview of MCX MCX an independent and de-mutulised multi commodity exchange has permanent r ecognition from Government of India for facilitating online trading, clearing an d settlement operations for commodity futures markets across the country. Key shareholders of MCX include Financial Technologies (I) Ltd., State Ba nk of India (Indias largest commercial bank) & associates, Fidelity Intern ational, National Stock Exchange of India Ltd. (NSE), National Bank for Agriculture and Rural Development (NABARD), HDFC Bank, SBI Lif e

44 Insurance Co. Ltd., Union Bank of India, Canara Bank, Bank of India, Bank of Bar oda and Corporation Bank. Headquartered in Mumbai, MCX is led by an expert management team with deep do main knowledge of the commodity futures markets. Through the integration of dedi cated resources, robust technology and scalable infrastructure, since inception MCX has recorded many first to its credit. Inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing Director, Reliance Industries Ltd, MCX offers futures trading in the following commodity categories: Agri Commodities, Bullion, Metals- Ferrous & Non-fe rrous, Pulses, Oils & Oilseeds, Energy, Plantations, Spices and other soft co mmodities. MCX has built strategic alliances with some of the largest players in commoditie s eco-system, namely, Bombay Bullion Association, Bombay Metal Exchang e, Solvent Extractors Association of India, Pulses Importers Association, She tkari Sanghatana, United Planters Association of India and India Pepper and Spice Trade Association. Today MCX is offering spectacular growth opportunities and advantages to a large cross section of the participants including Producers / Processors, Tr aders, Corporate, Regional Trading Centers, Importers, Exporters, Coo peratives, Industry Associations, amongst others MCX being nation-w ide commodity exchange, offering multiple commodities for trading wi th wide reach and penetration and robust infrastructure, is well placed to tap this vast potential. 5.18 Vision and Mission The vision of MCX is to revolutionize the Indian commodity markets by empowering the market participants through innovative product offerings and business rules so that the benefits of futures markets can be fully realized .Offering unparalleled efficiencies , unlimited growth and infinite opportunities to all the market participants.

45 Commodities Gold, Gold HNI, Gold M, I-Gold, Silver, Silver HNI, Silver M Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cottonseed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli (Cottonseed Oilcake), Mustard /Rapeseed Oil, Mustard Seed (Sirsa ), RBD Palmolein, Refined Soy Oil, Refined Sunflower Oil, Sesame Seed, Soymeal, Soy Seeds

Cardamom, Jeera, Pepper, Red Chilli Aluminium, Copper, Lead, Nickel, Sponge Iron, Steel Flat, Steel Long (Bhavnagar), Steel Long (Gobindgarh), Tin, Zinc Cotton Long Staple , Cotton Medium Staple, Cotton Short Staple, Cotton Yarn, Kapasii Chana, Masur, Tur, Urad, Yellow Peas, Basmati Rice, Maize, Rice, Sarbati Rice, Wheat

Brent Crude Oil, Crude Oil, Furnace Oil Middle East Sour Crude Oil Arecanut, Cashew Kernel, Rubber High Density Polyethylene (HDPE), Polypropylene (PP), PVC Guar Seed, Guar gum, Gurchaku, Mentha Oil, Potato, Sugar M-30,

46 5.19 Benefits to Participants The mark of a true exchange market is that it provides equal opportunities to al l participants without any bias. This is the central belief of MCX and towards t hat it shall be our endeavor to provide all our participants with eq ually rewarding opportunities. MCX would harmoniously meet the requireme nts of all the stakeholders in the commodity ecosystem in the most impartial man ner. Benefits to Industry Hedging the price risk associated with futures contractual commitments. Spaced o ut purchases possible rather than large cash purchases and its storage. Efficien t price discovery prevents seasonal price volatility. Greater flexibility, certainty and transparency in procuring commodities would a id bank lending. Facilitate Informed lending Hedged positions of producers and processors would reduce the risk of default fa ced by banks Lending for agricultural sector would go up with greater transparency in pricing and storage. Commodity Exchanges to act as distribution network to retail agri-finance from Banks to rural households. Provide trading limit finance to Traders in commodities Exchanges. Benefits to Exchange Members Access to a huge potential market much greater than the securities and cash mark et in commodities. MCX would leverage on the vast experience of NSE in the capital markets and NABARD for its strong presence in the rural agricultural markets Robust, scalable, state-of-art technology deployment. Member can trade in multiple commodities from a single point, on real time basis . Traders would be trained to be Rural Advisors and Commodity Specialists and th rough them multiple rural needs would be met, like bank credit, information dissemination, etc.

47 5.20 WINNING EDGE Value Proposition - MCX s most important differentiator and strength is that it is an independent and a de-mutualized exchange since inception. This is further strengthened by participation from different constituents of the market, such as banks, financial institutions, warehousing companies and other stakeholders of the marketplace. Moreover, experienced professionals with deep knowledge of the commodity markets as well as exchange management experience manag e MCX. Neutral Image - MCX has de-mutualized status from inception that allows formatio n of a broad, collaborative business partnership. Strategic Equity Partnerships - MCX has consolidated it base by enterin g into strategic equity partnership with leading nationalized banks like State Bank of India, HDFC Bank, National Stock Exchange (NSE), National Ba nk for Agriculture and Rural Development (NABARD), State Bank of Indor e, State Bank of Hyderabad, State Bank of Saurashtra, SBI Life Insurance Co . Ltd., Union Bank of India, Bank Of India, Bank Of Baroda, Canara Bank, Corporation Bank. Trade Support - MCX has already tied up exclusively with some of the lar gest players in this eco-system, namely, Bombay Bullion Association, Bombay Meta l Exchange, Solvent Extractors Association of India, Pulses Importers Associati on, Shetkari Sanghatana, United Planters Association of India and India P epper and Spice Trade Association. FTIL: Technology Partner - It is here that MCX gets the strategic advantage of having Financial Technologies (India) Ltd. as its technology partner for de livering technologically advanced solutions to market participants. FTIL s prove n class of end-to-end Exchange Trading technologies addressing Trading / Surveil lance / Clearing and Settlement operations would deliver a cutting-edge to the M CX Trade Life Cycle i.e. Pre-Trade, Trade and Post-Trade operations. In additi on to its (technology) technological capabilities, FTIL also brings to MCX it s deep engagements with technology giants such as Microsoft / Intel and HP which would be used to gain the competitive edge in gaining foothold in global markets.



The trading system of MCX is state-of-the-art, new generation trading platform t hat permits extremely cost effective operations at much greater efficiency. The Exchange Central System is located in Mumbai, which maintains the Central Order Book. Exchange Members located across the country are connected to the central s ystem through VSAT or any other mode of communication as may be decided b y the Exchange from time to time. The Exchange would gradually also consi der providing an internet based access. The controls in the system are system driven requiring minimum human intervention. The Exchange Members places orders through the Traders Work Station (TWS) of the Member linked to the Excha nge, which matches on the Central System and sends a confirmation bac k to the Member. Risk Management The macro objective of MCX s Risk Management System is to financially secure the marketplace and its participants at all times, without increasing the operation al cost or compliance overheads of market participants. Some of the bas ic parameters of Risk Management are as follows: Risk Management parameters

Real-time Margining. Quantity (position) limits. Exposure limits linked to value of outstanding positions ployed. Daily Loss Limits. Daily Price Limits. Special Margins. and the capital de

Settlement The Clearing and Settlement System of the Exchange is system driven and rule bas ed.

49 Clearing Bank Interface Exchange maintains electronic interface with its Clearing Bank. All Members of t he Exchange are having their Exchange operations account with the Clearing Bank. All debits and credits are affected electronically through such accounts only. Delivery and Final Settlement All contracts on maturity are for delivery. MCX specifies tender and delivery pe

riods. For example, such periods can be from 8th working day till the 15th day o f the month - where 15th is the last trading day of the contract month - as tender and/or delivery p eriod. A seller or a short open position holder in that contract may ten der documents to the Exchange expressing his intention to deliver the underly ing commodity. Exchange would select from the long open position holder for the tendered quantity. Once the buyer is identified, seller has to initiate the proc ess of giving delivery and buyer has to take delivery according to the delivery schedule prescribed by the Exchange. 5.22 TECHNOLOGY EDGE

Exchange markets and operations will undergo a paradigm shift in their behavior and would be increasingly driven for providing integrated processes and services to the trading community. Moreover, Exchanges today need to deliver highest lev els of service backed by strong technology to bring increased participation a t lowest possible costs .It is here that MCX gets the strategic advantage of ha ving Financial Technologies (India) Ltd. as its technology partner for deliverin g technologically advanced solutions to market participants. FTIL s proven class of end-to-end Exchange Trading technologies addressing Trading / Surveillance / Clearing and Settlement operations would deliver a cutting-edge to the MCX Trade Life Cycle i.e. Pre-Trade, Trade and Post-Trade operations.



National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally ma naged online multi commodity exchange promoted by ICICI Bank Limited (ICICI Bank ), Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE). Punjab National Bank (PNB), CRISIL Limited (formerly the Credit Rating I nformation Services of India Limited), Indian Farmers Fertilizer Cooperative Lim

ited (IFFCO) and Canara Bank by subscribing to the equity shares have joined the initial promoters as shareho lders of the Exchange. NCDEX is the only commodity exchange in the country pro moted by national level institutions. This unique parentage enables it to offer a bouquet of benefits, which are currently in short supply in the commodity mark ets. The institutional promoters of NCDEX are prominent players in their respec tive 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 has commenced its operations on December 15, 2003.

NCDEX is a nation-level, technology driven de-mutualized on-line commodi ty exchange with an independent Board of Directors and professionals not having any vested interest in commodity markets. It is committed to provide a world-cla ss commodity exchange platform for market participants to trade in a wide spectr um of commodity derivatives driven by best global practices, professionalism and transparency. Forward Market Commission regulates NCDEX in respect of futures trading in commo dities. Besides, NCDEX is subjected to various laws of the land like the Compani es Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and va rious other legislations, which impinge on its working. 51 NCDEX is located in Mumbai and offers facilities to its members in more than 550 centers throughout India. The reach will gradually be expanded to more centers. NCDEX currently facilitates trading of 45 commodities - Cashew, Castor See d, Chana, Chilli, Coffee - Arabica, Coffee - Robusta, Common Parboiled Rice, Com mon Raw Rice, Cotton Seed Oilcake, Crude Palm Oil, Expeller Mustard Oil, Groundn ut (in shell), Groundnut Expeller Oil, Grade A Parboiled Rice, Grade A Raw Rice, Guar gum, Guar Seeds, Guar, Jeera, Jute sacking bags, Indian 28 mm Cotton , Ind ian 31 mm Cotton , Lemon Tur, Maharashtra Lal Tur, Masoor Grain Bold, Medium St aple Cotton, Mentha Oil , Mulberry Green Cocoons , Mulberry Raw Silk , Rapeseed - Mustard Seed, Pepper, Raw Jute, RBD Palmolein, Refined Soy Oil , Rubber, Sesame Seeds, Soy Bean, Sponge Iron, Sugar, Turmeric, Urad (Black Mat pe), V-797 Kapas, Wheat, Yellow Peas, Yellow Red Maize, Yellow Soybean M eal, Electrolytic Copper Cathode, Mild Steel Ingots, Sponge Iron, Gold, Silver, Brent Crude Oil, Furnace Oil. At subsequent phases trading in more commodities would be facilitated.

52 NCDEX PRODUCTS Agro Products Cashew Chana Coffee - Arabica mon Raw Rice alm Oil Mustard Oil w Rice eller Oil Guar Seeds Jeera bags Lemon Tur led Rice Indian Raw Rice Cotton Indian 31 mm Cotton Masoor Grain Bold tha Oil ns Mulberry Raw Silk Pepper eed-Mustard Seed Oilcake Rubber Sesame Seeds Sugar n Meal Turmeric Soyabean Yellow Soybea Urad Castor Seed Chilli Coffee - Robusta Com Common Parboiled Rice Crude P Cotton Seed Oilcake Expeller Grade A Parboiled Rice Grade A Ra Groundnut (in shell) Groundnut Exp Guar gum Gur Jute sacking Indian Parboi Indian 28 mm Maharashtra Lal Tur Medium Staple Cotton Men Mulberry Green Cocoo Mustard Seed Raw Jute Rapes RBD Palmolein Refined Soy Oil

V-797 Kapas Yellow Peas Base Metals Electrolytic Copper Cathode Mild Steel Ingots

Wheat Yellow Red Maize

Precious Metals Gold Silver

53 Regulation of Commodity Futures Merchandising and stockholding of many commodities in India have always bee n regulated through various legislations like the Essential Commodities Act, 195 5 (ECA, 1955) and Forward Contracts (Regulation) Act, 1952, (FCRA, 1952) and Pre vention of Black marketing and Maintenance of Supplies of Commodities Act, 1980 . The ECA, 1955 gives powers to control production, supply, distribution, etc. of essential commodities for maintaining or increasing supplies and for securing their equitable distribution and availability at fair prices. Using the powers under the ECA, 1955 various Ministries/ Departments of the Central Government have issued control orders for regulating production/distribution/quality aspects/movement etc. pertaining to the commo dities which are essential and administered by them. The FCRA, 1952 provided for 3-tier regulatory system for commodity futures tradi ng in India: (a) An association recognized by the Government of India on the recommendation o f Forward Market Commission, (b) The Forward Markets Commission and (c) The Central Government Stock exchanges and futures markets being a part of t he Union list their regulation is the responsibility of the central government. All types of forward contracts in India are governed by the provisions of the FC RA, 1952. The Act divides commodities into three categories with reference to extent of regulation. (a) The commodities in which futures trading can be organized under the auspices of recognized association,

(b) The commodities in which futures trading is prohibited and (c) The free commodities which are neither regulated nor prohibited. While optio ns in goods are prohibited by the FCRA, 1952, the ready delivery contracts re main outside its purview. The ready delivery contract as defined by the Act is the one which provides for the delivery of goods and payment of a price therefor e, either immediately or within a period not exceeding eleven days after the dat e of the contract. All ready delivery contracts where the delivery of goods and/ or payment for goods is not completed within eleven days from the date of the co ntract are forward contracts. The Act classified forward contracts into two:

(a) Specific delivery contracts and 54 (b) Other than specific delivery contracts or futures contracts. Specif ic delivery contract means a forward contract which provides for the actual del ivery of specific qualities or types of goods during a specified time period at a price fixed thereby or to be fixed in the manner thereby agreed and in wh ich the names of both the buyer and the seller are mentioned. The specific delivery contracts are of two types: transferable and non-transfe rable. The distinction between the transferable specific delivery (TSD) contracts and non - transferable specific delivery (NTSD) contracts is based on the transferability of the rights or obligations under the contract. Forward trading in TSD and NTSD contracts are regulated by the government. As per the se ction 15 of the FCRA, 1952 every forward contract in notified goods (currently 3 6 commodity items) which is entered into except those between members of a recog nized association or through or with any such member is treated as illegal or vo id (see appendix I for the list). As per the section 17(1) of the Act, 82 items are prohibited for forward contract (see appendix II for the list). The secti on 18(1) of the Act exempts the NTSD contracts from the regulatory provisions. However, over the years the regulatory provisions of the Act were applied t o the NTSD contracts and 79 commodity items are currently prohibited for N TSD contracts under section 17 of the Act (see appendix III for the list). Moreo ver, another 15 commodity items are brought under the regulatory provisions of t he section 15 of the Act out of which trading in the NTSD contract has been susp ended in 12 items (see appendix IV for the list). At present, the NTSD contracts in cotton, raw jute and jute goods are permitted only between, through or with the members of the associations specifically recognized for the purpose. Subsequent to the report of the Committee on Forward Markets (known as the Kabra Committee) submitted in 1994 the government has so far permitted futures trading in nearly 35 commodities under the auspices of 23 commodity exchanges located in different parts of the country. The commodities in which futures trading is permitted are: pepper, turmeric, gur, castorseed, Hessian, jute sacking, cotton, potato, castor oil soyabean and its oil and cake, coffee, mustardseed and its oil and oilcake, groun d nut and its oil, sunflower oil, copra/coconut and its oil and oilc ake, cottonseed and its oil and oilcake, kapas, RBD palmolein, rice bran and its oil and oilcake, sesame seed and its oil and oilcake, safflower seed an d its oil and oilcake, and sugar. This list may get enlarged with the repeal of ECA, 1955 and with further liberalization of farm sector as envisaged in the National Agricultural

Policy, 2000 and the Union Budget, 2002-03.

55 The exchanges are required to get prior approval of the FMC for opening of each contract in commodities which are notified under the relevant sections in FCRA 1952. Regulation is essential especially in a private ownership and market orien ted system to ensure the necessary checks and balances in the system. Ho wever, stringent and continuous regulation for long period of time would do no good to the system. The initial stringent regulation should ensure that a foolproof and growth oriented control system in terms of set up of the exchange and its sound management, a clearinghouse which can promote trade and its financ ial integrity, sound and facilitating contract terms and conditions, etc. is in place. The exchanges are already assumed to be self-regulatory agencies. Their r ole must get strengthened further along with FMC minimizing its role as a facili tator making the existing regulation an appropriate regulation.

56 Table-I. Exchanges and Commodities in which futures contracts are traded. No. COMMODITY 1. India Pepper & Spice Trade Association, Kochi (IPSTA) 2. Vijai Beopar Chambers Ltd., Pepper (both domestic and international contracts) Muzaffarnagar Guar, Mustard seed 3. Rajdhani Oils & Oilseeds Exchange Ltd., Delhi Bhatinda Om & Oil Exchange 4. Ltd., Bhatinda Guar, Mustard seed its oil & oilcake Guar 5. 6. Guar , Potatoes Mustard seed Exchange Ltd., Meerut Oilseed Complex 7. Exchange Ltd., Mumbai The Chamber of Commerce, Hapur The Meerut Agro Commodities and Guar The Bombay Commodity Exchange

8. Merchants Association, Rajkot 9. Exchange, Ahmedabad 10.

Rajkot Seeds, Oil & Bullion The Ahmedabad Commodity

The East India Jute & Hessian

* Castor oil international contracts Castor seed, Groundnut, its oil & cake, cottonseed, its oil & cake, cotton (kapas) and RBD palmolein. Castorseed, cottonseed, its oil and oilcake Exchange Ltd., Calcutta Hessian & Sacking The East India Cotton Association Ltd., Mumbai Cotton The Spices & Oilseeds Exchange Ltd., Sangli. Turmeric Soya seed, Soyaoil and Soya meals. Rapeseed/Mustardseed its oil and oilcake and RBD





Trade, Indore

14. Exchange of India Ltd., Kochi



Commodities wide

Palmolien ( Also granted in-principle approval of Nation Multi- commodity Exchange Status)See para 8) Copra/coconut, its oil & oilcake

57 Central India Commercial Exchange Ltd., Gwalior 16. r

Guar and Mustard seed E-sugar India Ltd., Mumbai Suga

**17 National Multi-Commodity Exchange of India Ltd., Ahmedabad Several Commodities (Please see the site of the Exchange at Coffee Futures Exchange India Ltd., Bangalore 19 ndranagar 20 Delhi National Commodity Cotton, Cottonseed, Kapas Sugar (trading yet Coffee Surendranagar Cotton Oil & Oilseeds , Sure E-Commodities Ltd., New

& Derivatives , Exchange Ltd.,

to commence)

Several Commodities (Please see the site of the 21** Mumbai Exchange 22.** Ltd., Mumbai

at Multi Commodity Exchange

Bikaner 23 Several Mustard 24 25 Mustard

commodity Exchange Ltd., Bikaner Commodities (Please see the site of the Exchange at seeds its oil & oilcake, Gram. Guar seed. Guar Gum Haryana Commodities Ltd., Hissar Bullion Association Ltd., Jaipur seed complex

Mustard seed Complex

4. In-principle approval for trading in the specified commodities has been given to the following Exchanges/proposed Exchanges:Serial. No. Name of the Association Commodities 1. M/s. NCS InfoTech Ltd., Hyderabad Sugar 2. Unites Planters Association of South India, Connors (u/s 14B) Tea 3. SGI Commodity Exchange, Mumbai nd nut their oils and oilcakes. Soya bean Grou

58 These Associations/Exchanges are at different stages of completing the procedura l formalities for setting up the exchange/commencing trading. 5. After assessing the market situation and taking into account the recommendations made by the Board of Directors of the Exchange, the FMC prescr ibes various regulatory measures from time to time, for prudential regulation o f futures/forward trading. 6. Under a World Bank aided Grant Scheme to support development of commodity futures markets in India, a number of consultancy assignments, trai ning programmes, study tours, office automation of FMC etc. have been undertake n. The project was successfully completed on 31st October, 2000. A Pla n Scheme under the 10th Five Year Plan for generating awareness about t he activities, mechanism and benefit of futures trading among farmers is being i mplemented. 7. Under a USAID Technical Co-operation programmed on Commodity Fu tures, the Government of India has entered into an agreement with USAID for c apacity building in Indian commodities derivatives market. The capacity buildi ng includes training, seminars, consultancy studies and visits to foreign regula tors and exchanges. The short term component of this programmes likely to be com pleted by the end of November, 2004. 8. In enhancing the institutional capabilities for futures trading the idea of setting up of National Commodity Exchange(s) has been pursued since 199 9. Three such Exchanges, viz, National Multi-Commodity Exchange of India Ltd., ( NMCE), Ahmedabad, National Commodity & Derivatives Exchange (NCDEX), Mumbai, a nd Multi Commodity Exchange (MCX), Mumbai have become operational. National Sta

tus implies that these exchanges would be automatically permitted to conduct fut ures trading in all commodities subject to clearance of bye-laws and cont ract specifications by the FMC. While the NMCE, Ahmedabad commen ced futures trading in November, 2002, MCX and NCDEX, Mumbai commenced operatio ns in October/ December, 2003 respectively. 9. The Government has proposed to initiate steps to integrate the commod ities markets and securities markets. A Working Group set up in this connection has submitted its report to the Government indicating the road map for conver gence of securities and commodities derivatives markets and their regulatory sys tems. 5.24 COMMODITY FUTURES MARKETS IN INDIA: PRESENT SCENARIO Major reforms have been initiated in commodity futures markets in India since th e last few years. An article1 by this author in this Journal compared the growth trajectories being followed by the commodity derivatives market vis--vis the securities derivatives markets in India at the dawn of the millennium. It was observed that though derivatives 59 trading commenced in the securities market only in June 2000 it was growing at g reat speed while the commodity derivatives markets which were operational for ab out 48 years by then was only gradually waking up. However, subsequent fe w years have witnessed major changes in the commodity spectrum despite t he several institutional constraints in which commodity derivatives markets s till function. Commodity futures trading in India was in a state of hibernation for four decades, which was marked by suspicion on the benefits of futures trading. This is replaced by policy, institutional and market activism in the la st few years. This is partly a response to the predominant role being assigned t o the market forces in price determination and the consequent need for providing market-based derisking tools. It is also the result of a growing awareness that derivatives trading do perform substantial risk mitigating functions to the sta keholders. This resurgence of interest in commodity derivatives is timely since global commodity cycle is on the upswing, and experts have predicted that we are in the decade of the commodities. Concomitant to the newfound policy initiatives the market has responded by setti ng up modern institutions (Nation-wide Multi-Commodity Exchanges, (NMCE) an d adapting some of the best practices such as electronic trading and clearing. The projections of commodity derivatives trading, though widely variant in the r ange of Rs. 30-50 trillion and needs to be calibrated with sound assumptions, indicat e the enormous potential of this sector not only in terms of trading but also in terms of the opportunities for developing value-added services in terms of qu ality warehousing, gradation and certification services, financial intermedi ation, modern marketing practices, modern clearing and settlement me chanism. Once the market becomes liquid the old complaint, that the Indian commo dity derivatives markets do not meet the basic objectives of price discovery (with many studies indicating backwardation common place) and risk mana gement may also vanish. The most important changes that have taken place in the commodity futures space were the removal of prohibition on futures trading in a large number of commodit ies and the facilitation of setting up modern, demutualised exchanges by the Gov ernment of India. These two initiatives together are becoming instrumental in ch

anging the contours of the commodity futures markets in India in terms of both p articipation and practices. There are, however, still a number of obstacles in f ully exploiting the opportunities available to the commodity eco- system. The vi ews expressed and the approach suggested in this paper is of the author and not necessarily of NSE.

60 1. Securities Market and Commodity Derivatives Markets Rush vs. Slow Grow th? (NSE News, December 2001). A comparative profile of the commodity derivatives markets with that of the nascent securities derivatives market was made since n o comparison of the Indian derivatives markets would be useful with any counter part. This was because of the chequered history of Indian commodity derivative s trading from that of a flourishing market formally started in 1875 with the setting up of the Bombay Cotton Association but which went into disrepute during the scarcity decades of the 1960s and 70s. A comparison revealed that the rapid strides made by the securities derivat ives segment in a short span was because of its sound institutional frame work i n the spot side while the spot market acted as a drag on the progress of the der ivatives markets in commodities. 2. The NMCEs marked a major paradigm shift in the institutional struc ture and market architecture of commodity futures markets. Drawing heavily from the NSE model in the securities markets these institutions are expected to unleash a chain of value added functions in the commodity derivatives markets as well as in the commodity spot market through a host of extra function s they are expected to perform. These include warehouse receipt based deliveries which would require transferability and negotiability of warehouse receipts and its de-materialization, entry of corporate, banks, financial institutions and FI Is in commodity futures trading, dissemination of information relating to the ph ysical markets and prices, adoption of the best technology in trading, clearing and settlement and so on. The NMCEs have started exhibiting a penchant for inn ovations as reflected in their attempts at co- opting warehousing agencies, b ringing about transferability and de-mating of warehouse receipts account, though in a limited manner (because of the absence of a legal frame work) assoc iation of banks (for other than trading activities as trading in comm odities is still prohibited for banks) polling of price information from the spo t markets(from mandies)commencement of evening trading session to align domestic markets with the global markets and so on(see Economic Survey 2003-04). 3. Several studies particularly by Jain & Naik (1999), Thomas (2003), Sahade van (2002) etal have indicated that only in a few cases the commodity futures ma rkets performed its basic objective of discovering efficient prices. While the s tudies focus were different the general picture emerging was that only in the cas e of commodities with reasonable volumes of trading, like castor seed and pepper , the markets achieved the objective of price discovery to some extent. However, since the markets in general were too shallow the results were not unexpected.


6.1 TITLE OF THE PROJECT REPORT A study of the commodity market 6.2 SAMPLE DESIGN:

6.2.1 SAMPLING TYPE In this project convenient sampling method is used for the selection of customer . 6.2.2 SAMPLING UNIT To define sampling unit, one must answer the question that who is to be surveyed . In this project sampling units are commodity traders and govt. Servants. 6.2.3 Sample size The sample size of the survey was 100 people.


62 6.4 FIELDWORK: In order to gather the primary data associated with my survey commodity traders and government servants over a selected hub of areas in Rajkot, i have undergone an extensive fieldwork. The basic purpose of the fieldwork was, obviously, to r ecord responses of target people. 6.4 LIMITATIONS

This survey was restricted to Rajkot city. The sample size for the survey of people was limited to 100 respondents, which m ight not be representing the whole country. The results are totally derived from the respondents answers. There might be a di fference between the actual and projected results. Research also depends on surveyors bias & his/her ability to analyze the data & d raw conclusion. The time duration to carry out the survey of all the areas of Rajkot was very sh ort.

63 7. DATA ANALYSIS (1). Gender Ratio:



(2). Age:

Age 20 30 25

30 40 45

Above 40 30

(3). Educational Qualification:

Qualification Graduate 40

Post Graduate 35

Under Graduate 25

(4). Occupation:

Professional Sector Employee of Govt. Sector 25


Employee of Pvt.

30 31


64 5. Interested pattern of the people:

Securities 74 Mutual Funds Post Office Insurance Real Assets Govt. Bonds IPO Gold/Silver Stock Market Others

Nos. Bank 55 78 68 35 45 42 35 56 58

As above we can see that most of people like to invest in bank, Post Office a nd Insurance. And also many people prefer to invest in stock market but less tha n compare to Bank, Post office and insurance. Because of many people scare about their money risk, they scare to invest in stock market.

65 6. People prefer category to invest in stock market:

Instruments Derivatives Commodity

No. Equity 53 39


When ask the people about investment in stock market most of people give his fir st preference in Equity and second preference in derivatives and last preference in commodity. Because many people dont know about commodity, so there is lack of awareness about the commodity.

66 7. Factors which people take in consideration while they are taking the decision to deal with commodity?

Factors Self Analysis Tips from Export Tips from friends/Relatives Business Channels Newspapers Others

No. of People 22 22 17 14 15 10

When we ask the respondents that how they take decision about investment, most o f respondent give his first preference to tips from expert and Self analysis after t hat other factor which are tips from friends/relatives, Business Channels, Newsp apers and Others. So

thus respondent reach at their own decision.

67 8. Factors which play a crucial role when they make decision to invest in stock market?

Factors Risk Reduction Speculative Motive Leverage Benefit Investment Arbitrage Benefit

No. of People 28 19 25 16 22

After investigating the factors which have been given the maximum importance by investors which trading in commodities we have come up with risk reduction as the first priority with 28 People while 28 people have considered it as a leverage b enefit. So in future possibility can be growth in commodity market.

68 9. Duration of attachment with commodity market?

Duration Less than 1 year 1 to 5 year 5 to 10 Year Above 10 Year

No. of People 5 14 12 8

After asking about the duration of attachment I know that most of investor is co nnect with commodity about 1 to 5 Years but not satisfied change in present figu re. So first of all try to aware the investor about commodity.

. 69 10. Products which is most of prefer by investor:

Product Metal Crops Oil Cereals & Pulse Spices Energy Bullions Others

No. of People 25 45 29 28 36 44 38 55

Product preferred by people 60 50 40 30 20 10 0 55 45 36 29 28 No. of People


44 38

Metal Cereals & Pulse Spices hers

Crops Energy

Oil Bullions Ot

As we see that most of respondent gives first priority to Crops and second prior ity to Energy. And after that they give priority to Bullions, Spices, Oil, etc. But als o some of people give his preference to other product.

70 11. People prefer to deal with:

Type of Trading Square up mode Arbitrage Intraday Hedging Delivery Based

No. of People 12 9 11 10 6

After investigate to respondent, I know that most of investor like to square up m ode in commodity market and after that their second priority is intraday. So this is t he types of trading which is preferred by investor.

71 12. Which exchange prefers to deal by people?

Name of the exchange MCX NCDEX

No. of people 21 18

Preferred Exchange of People


MCX 54%

After investigate to respondent, I know that most of investor like to invest in MCX and after that their second priority goes to NCDEX.

72 13. How do you view your self?

Investor type No. of People Trader 21 Speculator 36 Short Term Investor 40

Investor Type Short Term Investor Speculator Trader 0 50 No. of People 10 20 30 40

After getting response from respondent I see that most of investor view their se lves as Short Term Investor and also some view their selves as Speculator and Trader.

73 14. In which of the company people prefer to deal more and more time?

Name of the Company No. of people Marwadi 20 Kotak Street (online)

15 Motilal Oswal 15 ICICI Direct. Com 17 India bulls 18 Other 15

Company preferred to invest by People

Other, 15 India bulls, 18 ICICI Direct. Com, 17 Marwadi, 20 Kotak Street (online), 15 Motilal Oswal, 15 Marwadi ICICI Direct. Com Kotak Street (online) India bulls Motilal Oswal Other

After getting response from respondent I know that most of my respondent prefers company to invest Marwadi. And after that some of prefers India Bull s and ICICI Direct.Com.


Commodity derivatives have a crucial role to play in the price risk management process. Especially in any agriculture dominated economy. Derivativ es like forwards, futures, options, swaps etc are extensively used in ma ny developed as well as developing countries in the world. However, they hav e been utilized in a very limited scale in India The production, supply and distribution of many agricultural commodi ties are controlled by the government and only forwards and futures trading ar e permitted in certain commodity items. The most things I have seen are that the awareness of future commodity tradi ng is still not there. People who knows, they believe that operators and big players in the market drive this future commodity market. Most of peoples feel that the qualities of the commodities are not as per the requirement. For the process of taking or giving delivery in future commodity market is l engthy, costly, and required so many documents. The option trading is still not allowed in commodity market so the risk mana gement process is incomplete. Because we all know that future trading has its ow n limits. The account opening process of future commodity trading is lengthy and requires more documents. The delivery centers of commodities are very less in India compare to other developed countries. People still considering that to invest in commodity market is very risky. 75 People still considering commodity market for speculation rather tha n business purpose. The whole industry is highly sensitive towards internationals environmental and political factors. national and


(1). NAME: (2). ADDRESS:

(3). CONTACT NO. (4). PROFESSION: (5). SEX: _

(6). AGE:


(6). Where do you invest your saving? Bank Real Assets Gold/Silver If Others, Please specify. Mutual Fund Post Office Insurance Govt. Bonds IPO Stock Market

(7). If you invest in stock market, where do you invest your savings? Equity Derivatives Commodity

(8). How you reach at investment decision? Self analysis Business channels Tips from Experts Newspapers Tips from friends/relatives Other (Specify)

(9). Which factor plays a crucial role when you make a decision to invest in sto ck Market? Risk Reduction Investment Speculative Motive Arbitrage Benefit Leverage Benefit

(10). Duration of attachment with commodity market? Less than 1 year More than 10 year (11). Which of the following product prefer by you for your investment? Metal Crops lse Spices Energy Bullions If others, please specify _ (12). Which type of trading you prefer to deal with? Square up mode Hedging Arbitrage Delivery based Intraday Oil Cereals & Pu 1 to 5 year 5 to 10 year

77 (13). Which exchange you prefer to deal with? MCX NCDEX

(14). How do you view your self? Trader Speculator Short term investor

(15). In which of the company you would like to deal more and more time? Marwadi Motilal Oswal Kotak Street (online) India Bulls ICICI direct. Com Others Specify

78 10. SUGGESTION & RECOMMENDATION The FMC should allow Option trading in commodity market in India. The FMC has to take some steps to increase the awareness of future c ommodity trading India. The FMC has to encourage the mutual fund companies and institutional investo rs to invest in commodity market in India. The government has to allow FIIs to invest in commodity market in India in f uture market not in option. The FMC should have concrete plan to stop Dabba trading in commodity market in India. The FMC should increase the range of commodities in future commodi ties in commodity market in India. To motivate the commodity business in India the FMC should come up with some rebate in taxes. The FMC should increase the delivery centers of commodities in India. As commodity market is very potential for business, the angel co. should thi nk about various ways to attract the customers.