ASTUDYON

“COMMODITIESTRADING-INVESTMENTAND

SPECULATION”

SUBMITTEDINTHEPARTIALFULFILMENTOF THEREQUIREMENTOF
“MASTEROFBUSINESSADMINISTRATION”IN

DECLARATION

Iherebydeclarethattheprojectreporton“COMMODITIESTRADING-
INVESTMENTANDSPECULATION”hasbeensubmittedundertheguidanceofXXXX,

Professor,DepartmentofCommerce,VivekanandaSchoolofPostGraduate
Studies,Panjagutta.
 Ifurtherdeclarethatitisanoriginalworkdonebymeasapartofmy
academiccourseandhasnotbeensubmittedelsewhereforanydegreeor
diploma.Theobservationsandconclusionswritteninthisreportarebasedon
thedatacolectedbyme.

XXXX

ACKNOWLEDGEMENT

Itakethisopportunitytothankalthosewhohavebeenofhelptomeinthe

completionofthisproject.

Iwouldliketoappreciatetheguidanceandco-operationprovidedtomebyour

projectguideXXXX(facultyofBusinessManagement)inthecompletionofthis
 project.

IamalsogratefultoXXX,DirectorXXXandalthefacultymemberswhohave

directlyorindirectlyhelpedmeinpreparingthisprojectreport.

CONTENTS

CHAPTERS PAGENO:

I INTRODUCTION 5-15

II INDUSTRYPROFILE 16-17

III NEEDFORTHESTUDY OBJECTIVES,METHODOLOGY&LIMITATIONS 18-19

IV COMMODITYFUTURESCONTRACT 20-26
V COMMODITYTRADING 27-43

VI PARTICIPANTSINCOMMODITYMARKET 44-48

VII REGULATORYFRAMEWORKFOR 49-71

COMMODITYTRADINGININDIA

VIII ANALYSIS 72-77

X CONCLUSIONS&RECOMMENDATIONS 78-79

XI BIBLIOGRAPHY 80

INTRODUCTION

Indianmarketshaverecentlythrownopenanewavenueforretailinvestorsand
traderstoparticipatecommodityderivatives.Forthosewhowanttodiversifytheir
portfoliosbeyondshares,bondsandrealestate,commoditiesarethebestoption.

Tilsomemonthsago,thiswouldn’thavemadesense.Forretailinvestorscouldhave
doneverylittletoactualyinvestincommoditiessuchasgoldandsilveroroilseedsinthe
futuresmarket.Thiswasnearlyimpossibleincommoditiesexceptforgoldandsilveras
therewaspracticalynoretailavenueforpumpingincommodities.

However,withthesettingupofthreemulti-commodityexchangesinthecountry,
retailinvestorscannowtradeincommodityfutureswithouthavingphysicalstocks.
 Commoditiesactualyofferimmensepotentialtobecomeaseparateassetclassfor
market-savvyinvestors,arbitrageursandspeculators.Retailinvestors,whoclaimto
understandtheequitymarkets,mayfindcommoditiesanunfathomablemarket. But
commoditiesareeasytounderstandasfarasfundamentalsofdemandandsupplyare
concerned.Retailshouldunderstandtheriskadvantagesoftradingincommoditiesfutures
beforetakingaleap.Historicaly,pricingincommoditiesfutureshasbeenlessvolatile
comparedwithequityandbonds,thusprovidinganefficientportfoliodiversificationoption.

Infact,thesizeofthecommoditiesmarketsinIndiaisalsoquitesignificant.Ofthe
country’sGDPofRs.13,20,730crore(Rs.13,207.3bilion),commoditiesrelated
(anddependent)industriesconstituteabout58percent.

Currently,thevariouscommoditiesacrossthecountryclockanannualturnoverof
Rs.1,40,000crore(Rs.1,400bilion).Withtheintroductionoffuturestrading,thesizesof
thecommoditiesmarketgrowmanyfoldshereon.
 DEFINITIONOFCOMMODITIES

Anyproductthatcanbeusedforcommerceoranarticleofcommercewhichistraded
onanauthorizedcommodityexchangeisknownascommodity.Thearticleshouldbemovable
ofvalue,somethingwhichisboughtorsoldandwhichisproducedorusedasthesubjector
barterorsale.Inshortcommodityincludesalkindsofgoods.ForwardContracts(Regulation)
Act(FCRA),1952defines“goods”as“everykindofmovablepropertyotherthanactionable
claims,moneyandsecurities”.

Incurrentsituation,algoodsandproductsofagricultural(includingplantation),
mineralandfossiloriginarealowedforcommoditytradingrecognizedundertheFCRA.The
nationalcommodityexchanges,recognizedbytheCentralGovernment,permitscommodities
whichincludeprecious(goldandsilver)andnon-ferrousmetals:cerealsandpulses;ginnedand
un-ginnedcotton;oilseeds,oilsandoilcakes;rawjuteandjutegoods;sugarandgur;potatoes
andonions;coffeeandtea;rubberandspices.Etc.

Intheworldofbusiness,acommodityisanundifferentiatedproductwhosemarket
valuearisesfromtheowner’srighttoselratherthantouse.Examplecommoditiesfrom
thefinancialworldincludeoil(soldbythebarrel),wheat,bulkchemicalssuchassulfuricacid
andevenporkbelies.

NEEDOFCOMMODITYMARKETININDIA

Achievinghedgingefficiencyisthemainreasontooptforfuturescontracts.For

instance,inFebruary,2007,Indiahadtopay$52perbarrelmoreforimportingoilthanwhat

theyhadtopayaweekago.Theutilityofafuturescontactforhedgingorriskmanagement

presupposesparalelornear-paralelrelationshipbetweenthespotandfuturespricesover

time.Inotherwords,theefficiencyofafuturescontractforhedgingessentialyenvisages

thatthepricesinthephysicalandfuturesmarketsmoveincloseunisonnotonlyinthesame

direction,butalsobyalmostthesamemagnitude,sothatlossesinonemarketareoffsetby

gainsintheother.

Ofcourse,suchapricerelationshipbetweenthespotandfuturesmarketsissubject

totheamountofcarryingorstoragecoststilthematuritymonthofthefuturescontract.

Theoreticaly(andidealy),inaperfectlycompetitivemarketwithsurplussuppliesand

abundantstocksroundtheyear,thefuturespricewilexceedthespotpricebythecostof

storagetilthematurityofthefuturescontract.Butsuchstoragecostdeclinesasthe
 contractapproachesmaturity,therebyreducingthepremiumorcontangocommandedbythe

futurescontractoverthespotdeliveryoveritslifeandeventualybecomeszeroduringthe

deliverymonthwhenthespotandfuturespricesvirtualyconverge.Theefficiencyofa

futurescontractforhedgingdependsontheprevalenceofsuchanidealpricerelationship

betweenthespotandfuturesmarkets.

COMMODITIESEXCHANGES

Abriefdescriptionofcommodityexchangesarethosewhichtradeinparticular

commodities,neglectingthetradeofsecurities,stockindexfuturesandoptionsetc.,

th
Inthemiddleof19 centuryintheUnitedStates,businessmenbeganorganizing

marketforumstomakethebuyingandselingofcommoditieseasier.Thesecentralmarket

placesprovidedaplaceforbuyersandselerstomeet,setqualityandquantitystandards,

andestablishrulesofbusiness.Agriculturalcommoditiesweremostlytradedbutaslonga

s therearebuyersandselers,anycommoditycanbetraded.

ThemajorcommoditymarketsareintheUnitedKingdomandintheUSA.InIndia

thereare25recognizedfutureexchanges,ofwhichtherearethreenationallevelmulti-

commodityexchanges.Afteragapofalmostthreedecades,GovernmentofIndiahas

alowedforwardtransactionsincommoditiesthroughOnlineCommodityExchanges,a

modificationoftraditionalbusinessknownasAdhatandVaydaVyapartofacilitatebetter

riskcoverageanddeliveryofcommodities.

THETHREEEXCHANGESARE

 NationalCommodity&DerivativesExchangeLimited(NCDEX)
 MultiCommodityExchangeofIndiaLimited(MCX)

 NationalMulti-CommodityExchangeofIndiaLimited(NMCEIL)

AltheexchangeshavebeensetupunderoveralcontrolofForwardMarketCommission(FMC)

ofGovernmentofIndia.

NationalCommodity&DerivativesExchangesLimited(NCDEX)

NationalCommodity&DerivativesExchangesLimited(NCDEX)locatedinMumbaiisa

publiclimitedcompanyincorporatedonApril23,2003undertheCompaniesAct,1956andhad

commenceditsoperationsonDecember15,2003.Thisistheonlycommodityexchangeinthe

countrypromotedbynationallevelinstitutions.ItispromotedbyICICIBankLimited,Life

InsuranceCorporationandNationalBankforAgricultureandRuralDevelopment(NABARD)

andNationalStockExchangeofIndiaLimited(NSE).Itisaprofessionalymanagedonline

multicommodityexchange.NCDEXisregulatedbyForwardMarketCommissionandis

subjectedtovariouslawsofthelandliketheCompaniesAct,StampAct,ContractsAct.,

ForwardCommission(Regulation)Actand*variousotherlegislations.

MultiCommodityExchangeofIndiaLimited(MCX)

HeadquarteredinMumbaiMultiCommodityExchangeofIndiaLimited(MCX),isan

independentandde-mutualisedexchangewithapermanentrecognitionfromGovernmentof

India.KeyshareholdersofMCXareFinancialTechnologies(India)Ltd.,StateBankofIndia,

UnionBankofIndia,CorporationBank,BankofIndiaandCanaraBank.MCXfacilitatesonline

trading,clearingandsettlement.

AltheexchangeshavebeensetupunderoveralcontrolofForwardMarket
Commission(FMC)ofGovernmentofIndia.

CommodityexchangeinIndiaplaysanimportantrolewherethepricesofany

commodityarenotfixed,inanorganizedway.Earlieronlythebuyerofproduceandits

selerinthemarketjudgedupontheprices.Othersneverhadasay.Today,commodity

exchangesarepurelyspeculativeinnature.Beforediscoveringtheprice,theyreachtothe

producers,end-users,andeventheretailinvestors,atagrassrootslevel.Itbringsaprice

transparencyandriskmanagementinthevitalmarket.

Abigdifferencebetweenatypicalauction,whereasingleauctioneerannouncesthe

bids,andtheExchangeisthatpeoplearenotonlycompetingtobuybutalsotosel.By

Exchangerulesandbylaw,noonecanbidunderahigherbid,andnoonecanoffertosel

higherthansomeoneelse’sloweroffer.Thatkeepsthemarketasefficientaspossible,and

keepsthetradersontheirtoestomakesurenoonegetsthepurchaseorsalebeforetheydo.

NationalBoardofTrade

MultiCommodityExchangeofIndia

NationalCommodity&DerivativesExchangesofIndiaLtd.,

CommodityExchange Products
Nationalboardoftrade,Indore Soya,mustard
Nationalmulticommodityexchange,Ahmedabad Multiple
Ahmedabadcommodityexchange Castor,cotton
RajadhaniOil&Oilseeds Mustard
VijaiBeoparChamberLtd.,Muzzaffarnagar Gur
Rajkotseeds,Oil&bulionexchange Castor,groundnut
IPSTA,Cochin Pepper
Chamberofcommerce,Hapur Gur,mustard
BhatindaOmandOilExchange Gur
Other(mostlyinactive)

CommodityExchangesRegisteredinIndia
CommodityExchange ProductsTraded
BhatindaOm&OilExchangeLtd., Gur
SunflowerOil
Cotton(SeedandOil)
Safflower(Seed,OilandOilCake)
TheBombaycommodityExchangeLtd Groundnut(NutandOil)
CastorOil,Castorseed
Sesamum(OilandOilcake)
Ricebran,ricebranoilandoilcake
Crudepalmoil
The Rajkot Seeds Oil& Bulion Merchants GroundnutOil,CastroSeed
AssociationLtd.
TheKanpurCommodityExchangeLtd., Rapeseed/Mustardseedoilandcake.
TeMeeerutAgrocommoditiesExchangeCo.,Ltd. Gur
TheSpicesandOilseedsexchangeLtd.,Sangli Turmeric
AhmedabadCommoditiesExchangeLtd Cottonseed,castorseed
VijayBeoparChamberLtd.,Muzaffarnagr Gur
IndiaPepper&SpiceTradeAssociation,Kochi Pepper
RajadhaniOilsandOilseedsExchangeLtd.,Delhi Gur,Rapeseed/MustardSeedSugar

NationalBoardofTrade,Indore
TheChamberofCommerce,Hapur
TheEastIndiaCottonAssociation,Mumbai
ThecentralIndiaCommercialExchangeLtdGwaliar
TheeastIndiaJute&HessainExchangeLtd.,
Kolkata
FirstCommodityExchangeofIndiaLtd.,Kochi
TheCoffeeFuturesExchangeIndiaLtdBangalore
NationalMultiCommodityExchangeofIndiaLtd.,/
Ahmedabad
Nationalcommodity & Derivatives Exchange
Limited
Grade–M
Rapeseed/MustardSeed/Oil/Cake
Soyabean/Meal/Oil/CrudePalmOil
Gur,Rapeseed/Mustardseed
Cotton
Gur
Hessain,Sacking
Copra,CoconutOil&CopraCake
Coffee
GurRBDPamolien
CrudePalmOil,Copra
Rapeseed/MustardSeed,SoyBean
Cotton(Seed,Oil,OilCake)
Safflower(Seed,Oil,andOilcake)
Groundnut(Seed,Oil,andOilcake)
Sugar,Sacking,Gram
Coconut(OilandOilcake)
Castor(OilandOilcake)
Sesamum(Seed,Oil,andOilcake)
Linseed(Seed,Oil,andOilcake)
RiceBranOil,Pepper,Guarseed
Aluminumingots,Nickel,tinVanaspati,
Rubber,Copper,Zinc,Lead
SoyBean,RefinedSoyoil,Mustard
Seed
ExpelerMustardOil
RBDPalmoleinCrudePalmOil
 Mediumstaplecotton
LongStapleCotton
Gold,Silver

CashCommodity

Acashcommoditymustmeetthreebasicconditionstobesuccessfulytradedinthefutures

market:

1.Ithastobestandardizedand,foragriculturalandindustrialcommodities,mustbeina

basic,raw,unprocessedstate.Therearefuturescontractsonwheat,butnotonflour.

Wheatiswheat(althoughdifferenttypesofwheathavedifferentfuturescontracts).The

milerwhoneedswheatfuturestohelphimavoidlosingmoneyonhisflourtransactionswith

customerswouldn’tneedflourfutures.Agivenamountofwheatyieldsagivenamountof

flourandthecostofconvertingwheattoflourisfairlyfixedhencepredictable.

2.Perishablecommoditiesmusthaveanadequateshelflife,becausedeliveryonafutures

contractisdeferred.

3.Thecashcommodity’spricemustfluctuateenoughtocreateuncertainty,whichmeansboth

riseandpotentialprofit.

Unlikeastock,whichrepresentsequityinacompanyandcanbeheldforalongtime,ifnot

indefinitely,futurescontractshavefinitelives.Theyareprimarilyusedforhedging

commodityprice-fluctuationrisksorfortakingadvantageofpricemovements,ratherthan

forthebuyingorselingoftheactualcashcommodity.Theword“contract”isusedbecausea

futurescontractrequiresdeliveryofthecommodityinastatedmonthinthefutureunless
thecontractisliquidatedbeforeitexpires.

Thebuyerofthefuturescontract(thepartywithalongposition)agreesonafixed

purchasepricetobuytheunderlyingcommodity(wheat,goldorT-bils,forexample)form

theselerattheexpirationofthecontract.Theselerofthefuturescontract(theparty

withashortposition)agreestoseltheunderlyingcommoditytothebuyeratexpirationat

thefixedsalesprice.Astimepasses,thecontract’spricechangesrelativetothefixed

priceatwhichthetradewasinitiated.Thiscreatesprofitsorlossesforthetrader.

Inmostcases,deliverynevertakesplace.Instead,boththebuyerandtheseler,acting

independentlyofeachother,usualyliquidatetheirlongandshortpositionsbeforethe

contractexpires:thebuyerselfuturesandtheselerbuysfutures.

TheBrettonWoodssystemoffixedexchangerates

ThechieffeaturesoftheBrettonWoodssystemwereanobligationforeachcountryto

adoptamonetarypolicythatmaintainedtheexchangerateofitscurrencywithinafixed

value-plusorminusonepercent–intermsofgold;andtheabilityoftheIMFtobridge

temporaryimbalancesofpayments.

The“peggedrate”or“parvalue”currencyregime

Whatemergedwasthe“peggedrate”currencyregime.Memberswererequiredtoestablish

aparityoftheirnationalcurrenciesintermsofgold(a“peg”)andtomaintainexchange

rateswithinplusorminus1%ofparity(a“band”)byinterveningintheirforeignexchange

markets(thatis,buyingorselingforeignmoney).
The“reservecurrency”

Inpractice,however,sincetheprincipal“Reservecurrency”wouldbetheU.Sdolar,this

meantthatothercountrieswouldpettheircurrenciestotheU.Sdolar,and–once

convertibilitywasrestored–wouldbuyandselU.Sdolarstokeepmarketexchangerates

withinplusorminus1%ofparity.Thus,theU.Sdolartookovertherolethatgoldhadplayed

underthegoldstandardintheinternationalfinancialsystem.

Meanwhile,inordertobolsterfaithinthedolar,theU.Sagreedseparatelytolinkthe

dolartogoldattherateof$35perounceofgold.Membercountriescouldonlychangetheir

parvaluewithIMFapproval,whichwascontingentonIMFdeterminationthatitsbalancesof

paymentswasina“fundamentaldisequilibrium”.
 3.1INDUSTRYPROFILE

NationalCommodityandDerivativesExchangeLimited(NCDEX)isaprofessionalymanaged
on-linemulticommodityexchangepromotedbyICICIBankLimited(ICICIBank),Life
InsuranceCorporationofIndia(LIC),NationalBankforAgricultureandruralDevelopment
(NABARD)andNationalStockExchangeofIndiaLimited(NSE).CanaraBank(PNB),CRISIL
Limited(formerlytheCreditRatingInformationServicesofIndiaLimited),GoldmanSachs,
IndianFarmersFertiliserCooperativeLimited(IFFCO)andPunjabNationalBankby
subscribingtotheequityshareshavejoinedtheinitialpromotersasshareholdersofthe
Exchange.NCDEXistheonlycommodityexchangeinthecountrypromotedbynationallevel
institutions.Thisuniqueparentageenablesittoofferabouquetofbenefits,whichare
currentlyinshortsupplyinthecommoditymarkets.Theinstitutionalpromotersand
shareholdersofNCDEXareprominentplayersintheirrespectivefieldsandbringwiththem
institutionalbuildingexperience,trust,nationwidereach,technologyandriskmanagement skils.

NCDEXisapubliclimitedcompanyincorporatedonApril23,2003undertheCompaniesAct,
1956.ItobtaineditscertificateforcommencementofBusinessonMay9,2003.Itcommenced
itsoperationsonDecember15,2003.
NCDEXisanation-level,technologydrivende-mutualisedon-linecommodityexchangewithan
independentBoardofDirectorsandprofessionalmanagement–bothnothavinganyvested
interestincommoditymarkets.Itiscommittedtoprovideaworld-classcommodityexchange
platformformarketparticipantstotradeinawidespectrumofcommodityderivatives
drivenbybestglobalpractices,professionalismandtransparency.NCDEXisregulatedby
ForwardMarketsCommission.NCDEXissubjectedtovariouslawsofthelandlikethe
ForwardContracts(Regulation)Act,CompaniesAct,StampAct,ContractActandvarious
otherlegislations.

NCDEXislocatedinMumbaiandoffersfacilitiestoitsmembersabout550centres
throughoutIndia.Thereachwilgradualybeexpandedtomorecentres.
NCDEXcurrentlyfacilitiestradingof57commodities–

Agriculture

Barley,Cashew,Castorseed,Chana,Chili,Coffee–Arabica,Coffee –
Robusta,CrudePalmOil,CottonSeedOilcake,ExpelerMustardOil,Groundnut(inshel),
GroundnutExpelerOil,Guargum,GuarSeeds,Gur,Jeera,Jutesackingbags,Indian
ParboiledRice,IndianPusaBasmatiRice,IndianTraditionalBasmatiRice,IndianRawRice,
Indian28.5mmCotton,Indian31mmCotton,MasoorGrainBold,MediumStapleCotton,
MenthaOil,MulberryGreenCocoons,MulberryRawSilk,MustardSeed,Pepper,Potato,Ra
w Jute,Rapeseed-MustardSeedOilcake,RBDPalmolein,RefinedSoyOil,Rubber,Sesame
Seeds,Soyabean,Sugar,YelowSoybeanMeal,Tur,Tumeric,Urad,V–797Kapas,Wheat,
YelowPeas,YelowRedMaize.

Metals

AluminiumIngot,ElectrolyticCopperCathode,Gold,MildSteelIngots,NickelCathode,Silver,
SpongeIron,ZincIngot.
Energy
BrentCrudeOil,FurnaceOil.
Atsubsequentphasestradinginmorecommoditieswouldbefacilitated

MultiCommodityExchange(MCX)isanindependentcommodityexchangebasedin

India.Itwasestablishedin2003andisbasedinMumbai.Ithasanaveragedaily

turnoverofaroundUS$1.55bilion.MCXoffersfuturestradinginAgricultural

Commodities,Bulion,Ferrous&Non-ferrousmetals,Pulses,Oils&Oilseeds,Energy,.
.
NEEDFORTHESTUDY

Thestudyofcommodityisundertakentoanalyzethetrading

Practiceswithspecialreferencetocommodityastoolofrisk

Managementtechniques.
 OBJECTIVES

 TostudytheconceptsofcommoditiesTradinginIndia.

 TostudyofTheVariousTrendsInCommodityTrading

 ToStudyTheRoleofCommoditiesInIndianFinancial Markets

 TostudyIndetailTheRoleofFuturesAndForwards.

 Toanalyzethepresentsituationofthecommoditiesin

Indianmarketandsuggestforanyimprovementsthere after.
 METHODOLOGY

Toachievetheobjectofstudyingthecommoditiesmarketinstockmarketdatahave

beencolected.Research

methodologycarriedforthisstudyispurelyfromSecondarydatafromvariouswebsites

mentionedbelow.

WEBSITES:

www.wikipedia.com

www.investopedia.com

www.google.com
 LIMITATIONSOFTHESTUDY

Thestudyislimitedto“CommodityTrading–InvestmentandSpeculation”inthe

Indiancontext.

1Thestudycannotsayastotalyperfectasitissubjectedtoanyalteration.

2.Thestudyisnotbasedontheinternationalperspectiveof

commoditymarkets.Itislimitedtonationallevelonly.
 5.1COMMODITYFUTURESCONTRACT

CommodityFutureTradingisregulatedbytheforwardMarketCommissionandcommodity

futureContractsareregulatedundertheFMCAct.1995.

Exchangetradedcommodityfuturescontractsaretradedofspecific

commoditytobedeliveredatthecontractedprice.Irrespectiveofanychangesofmarket

price.Butbothbuyersandselersarealowedtoliquidatethecontractbycashsettlement

ofpricedifferencesbetweenthecontractedpriceandliquidatedpricenotlaterthanthe

lasttradingsessionofthecontractmonth.

StandardizationinCommodityFuturesContract.

InthefuturestradingIndustry,acommodityisanarticleofcommerceoraproductthat

lendsitselftostandardizationforthepurposeofafuturescontract.Commodities

popularlytradedonexchangesareinitsrawform.Aptlyfuturesaretradedonwheatnoton

flour,coffeefuturesaretraded,buttherearenofuturestradedontea,crudeoilfutures

aretradedbutpetrolfuturesarenot,goldfuturesaretradedbutdiamondsarenot.

CommodityFuturesV/SEquityInvestments

Individualswhopurchaseequityorequity-basedmutualfundsarepurchasingsharesof

ownershipwilincreaseovertime.Afuturecontractisanagreementtobuyorsela

specificamountofacommodityataspecificdateinthefuture.Itistypicalyashort-term

(1-30month)transactionthathastobecarriedforwardattheendofthecontracttenure.

Ownershipisoftheunderlyingcommodity,whichhastogainvalueforthecommodityfutures
 buyertogainprofit.

DeliverableV/SCashSettledCommodities

Twoclassesofagriculturalcommoditiestypicalyreferredtointradingagricultural

commoditiesaredeliverableandcashsettledcommodities.Deliverablecommodities

referredtothosecommoditiesthattheshortposition(seler)asrighttomakedeliveryfor

whichthelongposition(buyer)astherighttotakethedelivery.Mostcommoditiestradedon

India’snationalmulticommodityexchangesaredeliverablecommodities.

DISTINCTIONBETWEENFUTURES&FORWARDSCONTRACTS

ForwardContract:

ForwardContractisanagreementtobuyorselanassetonaspecifieddateforspecified

price.Oneofthepartiestothecontractassumesalongpositionandagreestobuythe

underlyingassetonacertainspecifiedfuturedateforacertainspecifiedprice.Theother

partyassumesashortpositionandagreestoseltheassetonthesamedateforthesame

price.Othercontractdetailslikedeliverydate,priceandquantityarenegotiated

bilateralybythepartiestothecontractarenormalytradedoutsidetheexchange.

Features:

Thesalientfeaturesofforwardcontractsare:

 Theyarebilateralcontractsandhenceexposedtocounter-partyrisk.

 Eachcontractiscustomdesigned,andhenceisuniqueintermsofcontractsize

expirationdateandtheassettypequality.
 Thecontractpriceisgeneralynotavailableinpublicdomain.

 Ontheexpirationdate,thecontracthastobesettledbydeliveryoftheasset.

 Ifthepartywishestoreversethecontract,ithastocompulsorilygotothesame

counterparty,whichoftenresultsinhighpricesbeingchanged.

Howeverforwardcontractincertainmarkershavebecomeverystandardized,asinthecase

offoreignexchange,therebyreducingtransactioncostsandincreasingtransactionvolume.

Thisprocessofstandardizationreachesitslimitintheorganizedfuturesmarket.

Forwardcontractsareveryusefulinhedgingandspeculation.Theclassichedgingapplication

wouldbethatofanexporterwhoexpertstoreceivepaymentindolarsthreemonthslater.

Heisexposedtotheriskofexchangeratefluctuations.Byusingthecurrencyforward

markettoseldolarsforward,hecanlockontoaratetodayandreducehisuncertainty.

Similarlyanimportswhoisrequiredtomakeapaymentindolarstwomonthshencecan

reducehisexposuretoexchangeratefluctuationsbydolarsforward.

Ifaspeculatorhasinformationoranalysis,whichforecastsanupturninaprice,thenhecan

golongontheforwardmarketinsteadofthecashmarket.Thespeculatorwouldgolongon

theforward,waitforthepricetorise,andthentakeareversingtransactiontobook

profits.Speculatorsmaywelberequiredtodepositamartinupfront.However,thisis

generalyarelativelysmalproportionofthevalueoftheassetsunderlyingtheforward

contacttheuseofforwardmarketsheresuppliesleveragetothespeculator.
 LimitationsofForwardMarkets

Forwardmarketsworld-wideareafflictedbyseveralproblems:

 Lackofcentralizationtrading

 Iliquidity,and

 Counterpartyrisk

Inthefirsttwoofthese,thebasicproblemisthatoftoomuchflexibilityandgenerality.

Theforwardmarketislikearealestatemarketinthatanytwoconsentingadultscanform

contractsagainsteachother.Thisoftenmakesthemdesigntermsofdeal,whicharevery

convenientinthatspecificsituation,butmakesthecontractsnon-tradeable.

Counterpartyriskarisesfromthepossibilityofdefaultbyanyonepartytothe

transaction.Whenoneofthetwosidestothetransactiondeclaresbankruptcy,theother

suffers.Evenwhenforwardmarketstradestandardizedcontracts,andhenceavoidthe

problemofliquidity,stilthecounterpartyriskremainsaveryseriousissue.

FuturesContracts:

Futuresmarketsweredesignedtosolvetheproblemsthatexitinforwardmarkets.A

futurescontractisanagreementbetweentwopartiestobuyorselanassetatacertain

timeinthefutureatacertainprice.Butunlikeforwardcontracts,thefuturescontracts

arestandardizedandexchangetraded.Tofacilitateliquidityinthefuturescontacts,the

exchangespecifiescertainstandardfeaturesofcontract.Itisastandardizedcontract

withstandardunderlyinginstrument,astandardquantityandqualityofunderlying

instrumentthatcanbedelivered,(orwhichcanbeusedforreferencepurposesin
 settlement)andastandardtimingofsuchsettlement.Afuturescontractmaybeoffset

priortomaturitybyenteringintoanequalandoppositetransaction.Morethan99%of

futurestransactionsareoffsetthisway.

Thestandardizeditemsinafuturescontractare:

 Quantityofunderlying

 Qualityofunderlying

 Thedateandmonthofdelivery

 Theunitsofpricequotationandminimumpricechange

 Locationofsettlement.

Distinctionbetweenfuturesandforwardscontracts

FUTURES FORWARDS

Tradeonanorganizedexchange OTCinnature

Standardizedcontractterms Customizedcontractterms

Hencemoreliquid Hencelessliquid

Requiresmarginpayment Nomarginhappensattendsofperiod
Forwardcontractsareoftenconfusedwithfuturescontracts.Theconfusionisprimarily

becausebothserveessentialythesameeconomicfunctionofalocatingriskinthepresence

offuturepriceuncertainty.Howeverfuturesareasignificantimprovementoverthe

forwardcontractsastheyeliminatecounterpartyriskandoffermoreliquidity.

COMMODITYFUTURESTERMINOLOGY

Basic:Thedifferencebetweenthecurrentcashpriceandthefuturepriceofthesame

commodityforagivencontractmonth.

BearMarket:Aperiodofdecliningmarketprices.

BulMarket:Aperiodofrisingmarketprices.

Broker:Acompanyorindividualthatexecutesfuturesandoptionsordersonbehalfof

financialandcommercialinstitutionsandorthegeneralpublic.

Cash(spot)Market:Aplacewherepeoplebuyandseltheactualcashcommodities,i.e.,grain

elevator,livestockmarket,etc.

FuturesPrice:Thepriceatwhichthefuturescontracttradesinthefuturesmarket.

Expirydate:Itisthedatespecifiedinthefuturescontract.Thisisthelastdayonwhich

thecontractwilbetraded,attheendofwhichitwilceasetoexit.

Commission(brokerage)fee:Afeechangedbyabrokerforexecutingatransaction.

Convergence:Atermreferringtocashandfuturespricestendingtocometogetherasthe

futurescontractnearsexpiration.

Cross–hedging:Hedgingacommodityusingadifferentbutrelatedfuturescontractwhen
thereisnofuturescontractforthecashcommoditybeinghedgedandthecashandfuture

marketsfolowsimilarpricetrends.

DailyTradingLimit:Themaximumpricechangesetbytheexchangeeachdayforacontract.

DayTraders:Speculatorswhotakepositionsinfuturesoroptionscontractsandliquidate

thempriortothecloseofthesametradingday.

Delivery:Thetransferofthecashcommodityfromtheselerofafuturescontractthe

buyerofafuturescontract.

Forward(cash)contract:Acashcontractonwhichaseleragreestodeliveraspecificcash

commoditytabuyerataspecifictimeinthefuture.

FundamentalAnalysis:Amethodofanticipatingfuturespricemovementusingsupplyand

demandinformation.
 COMMODITYTRADING

COMMODITYMARKETTRADINGMCHANISM

Everymarkettransactionconsistsofthreecomponents–

trading,clearingandsettlement.

TRADING

ThetradingsystemontheCommoditiesexchangeprovidesafulyautomatedscreen-

basedtradingforfuturesoncommoditiesonanationwidebasisaswelasanonline

monitoringandsurveilancemechanism.Itsupportsanorderdrivenmarketandprovides

completetransparencyoftradingoperations.Afterhourstradinghasalsobeenproposed

forimplementationatalaterstage.

TheNCDEXsystem supportsanorderdrivenmarket,whereordersmatch

automaticaly.Ordermatchingisessentialyonthebasisofcommodity,itsprice,timeand

quantity.Alquantityfieldsareinunitsandpriceinrupees.Theexchangespecifiesthe

unitoftradingandthedeliveryunitforfuturescontractsonvariouscommodities.The

exchangenotifiestheregularlotsizeandticksizeforeachofthecontractstradedfrom

timetotime.Whenanyorderentersthetradingsystem,itisanactiveorder.Ittriesto

findamatchontheothersideofthebook.Ifitfindsamatch,atradeisgenerated.Ifit

doesnotfindamatch,theorderbecomespassiveandgetsqueuedintherespective

outstandingorderbookinthesystem,Timestampingisdoneforeachtradeandprovidesthe

possibilityforacompleteaudittrailifrequired

COMMODITYFUTURESTRADINGCYCLE
NCDEXtradescommodityfuturescontractshavingone-month,two-monthandthree-month
th
expirycycles.Alcontractsexpireonthe20 oftheexpirymonth.ThusaJanuary
th
expirationcontractwouldexpireonthe20 ofJanuaryandaFebruaryexpirycontract
th th
wouldceasetradingonthe20 February.Ifthe20 oftheexpirymonthisatradingholiday,

thecontractsshalexpireontheprevioustradingday.Newcontractswilbeintroducedon

thetradingdayfolowingtheexpiryofthenearmonthcontract.FolowingFigureshowsthe

contractcycleforfuturescontractsonNCDEX.

Jan Feb Mar Apr

Time

Jan20contract
Feb20contract

March20contract

April20contract

May20contract

June20contra

ORDERTYPESANDTRADINGPARAMETERS

Anelectronictradingsystemalowsthetradingmemberstoenterorderswith
 variousconditionsattachedtothemaspertheirrequirement.Theseconditionsarebroadly

dividedintothefolowingcategories:

 Timeconditions
 Priceconditions
 Otherconditions

Severalcombinationsoftheabovearepossibletherebyprovidingenormous

flexibilitytousers.Theordertypesandconditionsaresummarizedbelow.Ofthese,the

ordertypesavailableontheNCDEXsystemareregularlotorder,stoplossorder,immediate

orcancelorder,goodtildayorder,goodtilcanceledorder,goodtilorderandspreadorder.

TIMECONDITIONS

1.Goodtildayorder:

Adayorder,asthenamesuggestsisanorderwhichisvalidforthedayonwhichitis

entered.Iftheorderisnotexecutedduringtheday,thesystemcancelstheorder

automaticalyattheendofthedayExample:AtraderwantstogolongonMarch1,2004in

refinedpalmoilonthecommodityexchange.AdayorderisplacedatRs.340/-10kg.Ifthe

marketdoesnotreachthispricetheorderdoesnotgetfiledevenifthemarkettouches

Rs.341andcloses.Inotherwordsdayorderisforaspecificpriceandiftheorderdoesnot

getfiledthatday,onehastoplacetheordergainthenextday.

2.Goodtilcanceled(GTC)

AGTCorderremainsinthesystemuntiltheusercancelsit.Consequently,itspans

tradingdays,ifnottradedonthedaytheorderisentered.Themaximumnumberofdaysan

ordercanremaininthesystemisnotifiedbytheexchangefromtimetotimeafterwhich
theorderisautomaticalycanceledbythesystem.Eachdaycountedisacalendarday

inclusiveofholidays.Thedayscountedareinclusiveofthedayonwhichtheorderisplaced

andtheorderiscanceledfromthesystemattheendofthedayoftheexpiryperiod.

Example:AtraderwantstogolongonrefinedpalmoilwhenthemarkettouchesRs.400/-10

kg.Theoreticaly,theorderexistsuntilitisfiledup,evenifittakesmonthsforitto

happen.TheGTCorderontheNCDEXiscanceledattheendofaperiodofsevencalendar

daysfromthedateofenteringanorderorwhenthecontractexpires,whicheverisearlier.

3.Goodtildate(GTD)

AGTDorderalowstheusertospecifythedatetilwhichtheordershouldremaininthe

systemifnotexecuted.ThemaximumdaysalowedbythesystemarethesameasinGTC

order.Attheendthisday/date,theorderiscanceledfromthesystem.Eachday/date

countedareinclusiveoftheday/dateonwhichtheorderisplacedandtheorderis

Canceledfromthesystemattheendoftheday/dateoftheexpiryperiod.

4.ImmediateorCancel(IOC):

AnIOCorderalowstheusertobuyorselacontractassoonastheorderisreleased

intothesystem,failingwhichtheorderiscanceledfromthesystem.Partialmatchis

possiblefortheorder,andtheunmatchedportionsoftheorderiscanceledimmediately.

5.Alornoneorder:

Alornoneorder(AON)isalimitorder,whichistobeexecutedinitsentirety,ornot

atal.Unlikeafil-or-kilorder,anal-or-noneorderisnotcanceledifitisnotexecutedas
soonasitisrepresentedintheexchange.Anal-or-noneorderpositioncanbeclosedout

withanotherAONorder.

6.FilorKilorder:

Thisorderisalimitorderthatisplacedtobeexecutedimmediatelyandifthe

orderisunabletobefiledimmediately,itgetscanceled.

PRICECONDITIONS

1.LimitOrder:

Anordertobuyorselastatedamountofacommodityataspecifiedprice,orata

betterprice,ifobtainableatthetimeofexecution.Thedisadvantageisthattheorder

maynotgetfiledatalifthepriceofthatdaydoesnotreachspecifiedprice.

2.Stop-loss:

Astop-lossorderisanorder,placedwiththebroker,tobuyorselaparticular

futurescontractatthemarketpriceifandwhenthepricereachesaspecifiedlevel.

Futurestradersoftenusestopordersinanefforttolimittheamounttheymightloseif

thefuturespricemovesagainsttheirpositionStopordersarenotexecuteduntiltheprice

reachesthespecifiedpoint.Whenthepricereachesthatpointthestoporderbecomesa

marketorder.Mostofthetime,stopordersareusedtoexitatrade.But,stoporderscan

beexecutedforbuying/selingpositionstoo.Abuystoporderisinitiatedwhenonewants

tobuyacontractorgolongandaselstoporderwhenonewantstoselorgoshort.The

ordergetsfiledatthesuggestedstoporderpriceoratabetterprice.Example:Atrader
 haspurchasedcrudeoilfuturesatRs.750perbarrel.HewishestolimithislosstoRs.50a

barrel.Astoporderwouldthenbeplacedtoselanoffsettingcontractifthepricefalsto

Rs.700perbarrel.Whenthemarkettouchesthisprice,stopordergetsexecutedandthe

traderwouldexitthemarket.Forthestop-lossselorder,thetriggerpricehastobe

greaterthanthelimitprice.

OTHERCONDITIONS

Marginsfortradinginfutures:

Marginisthedepositmoneythatneedstobepaidtobuyorseleachcontract.The

marginrequiredforafuturescontract.Themarginrequiredforafuturescontractis

betterdescribedasperformancebondorgoodfaithmoney.Themarginlevelsaresetbythe

exchangesbasedonvolatility(marketconditions)andcanbechangedatanytime.Themargin

requirementsformostfuturescontractsrangefrom2%to15%ofthevalueofthecontract.

Inthefuturesmarket,therearedifferenttypesofmarginsthatatraderhasto

maintain.Wewildiscusstheminmoredetailswhenwetalkaboutriskmanagementinthe

nextchapter.Atthisstagewelookatthetypesofmarginsastheyapplyonmostfutures

exchanges.

 Initialmargin:Theamountthatmustbedepositedbyacustomeratthetimeof

enteringintoacontractiscaledinitialmargin.Thismarginismeanttocoverthelargest

potentiallossinoneday.Themarginisamandatoryrequirementofpartieswhoare

enteringintothecontract.

 Maintenancemargin:Atraderisentitledtowithdrawanybalanceinthemargin

accountinexcessoftheinitialmargin.Toensurethatthebalanceinthemarginaccount

neverbecomesnegative,amaintenancemargin,whichissomewhatlowerthantheinitial
 margin,isset.Ifthebalanceinthemarginaccountfalsbelowthemaintenancemargin,the

traderreceivesamargincalandisrequestedtodepositextrafundstobringittothe

initialmarginlevelwithinaveryshortperiodoftime.Theextrafundsdepositedareknown

asavariationmargin.Ifthetraderdoesnotprovidethevariationmargin,thebrokercloses

outthepositionbyoffsettingthecontract.

 Additionalmargin:Incaseofsuddenhigherthanexpectedvolatility,theexchange

calsforanadditionalmargin,whichisapreemptivemovetopreventbreakdown.Thisis

imposedwhentheexchangefearsthatthemarketshavebecometoovolatileandmayresult

insomepaymentscrisis,etc.,

 Mark-to-Marketmargin(MTM):Attheendofeachtradingday,themarginaccountis

adjustedtoreflectthetrader’sgainorloss.Thisisknownasmarkingtomarkettheaccount

ofeachtrader.Alfuturescontractsaresettleddailyreducingthecreditexposuretoone

day’smovement.Basedonthesettlementprice,thevalueofalpositionsismarked-to-

marketeachdayaftertheofficialclose,i.e.,theaccountsareeitherdebitedorcredited

basedonhowwelthepositionsfaredinthatday’stradingsession.Iftheaccountfals

belowthemaintenancemarginlevelthetraderneedstoreplenishtheaccountbygiving

additionalfunds.Ontheotherhand,ifthepositiongeneratesagain,thefundscanbe

withdrawn(thosefundsabovetherequiredinitialmargin)orcanbeusedtofundadditional trades.

Justasatraderisrequiredtomaintainamarginaccountwithabreaker,aclearinghouse

memberisrequiredtomaintainamarginaccountwiththeclearinghouse.Thisisknownas

clearingmargin.Inthecaseofclearinghousemember,thereisonlyanoriginalmarginandno

maintenancemargin.Clearinghouseandclearinghousemarginshavebeendiscussedfurther
 indetailunderthechapteronclearingandsettlement.

SETTLEMENT

Futurescontractshavetwotypesofsettlements,theMTMsettlementwhich

happensonacontinuousbasisattheendofeachday,andthefinalsettlementwhichhappens

onthelasttradingdayofthefuturescontract.OntheNCDEX,dailyMTMsettlementand

finalMTMsettlementinrespectofadmitteddealinfuturescontractsarecashsettledby

debiting/creditingtheclearingaccountsofCMswiththerespectiveclearingbank.Al

positionsofaCM,broughtforward,createdduringthedayorclosedoutduringtheday,are

markedtomarketatthedailysettlementpriceorthefinalsettlementpriceatthecloseof

tradinghoursonaday.

 Dailysettlementprice:Dailysettlementpriceistheconsensusclosingpriceasarrived

afterclosingsessionoftherelevantfuturescontractforthetradingday.However,inthe

absenceoftradingforacontractduringclosingsessions,dailysettlementpriceiscomputed

asperthemethodsprescribedbytheexchangefromtimetotime.

 Finalsettlementprice:Finalsettlementpriceistheclosestpriceoftheunderlying

commodityonthelasttradingdayofthefuturescontract.Alopenpositionsinafutures

contractceasetoexistafteritsexpirationday.

Settlementmechanism:

Settlementofcommodityfuturescontractsisalittledifferentfromsettlementof

financialfutures,whicharemostlycashsettled.Thepossibilityofphysicalsettlement

makestheprocessalittlemorecomplicated.

` Typesof
Settlement

FinalSettlement
DailySettlement
 DailySettlementPrice

Handlesdailypricefluctuation FinalSettlementPrice
foraltrades(marktomarket)

Handlesfinalsettlementofa
l
openoppositions

Dailyprocessatendofday mentisdone Oncontractexpirydate Thisis

donetotakecareofdailypricefluctuationsforaltrades.Altheopenpositionsofthe

membersaremarkedtomarketattheendofthedayandprofit/lossisdeterminedasbelow:

 Onthedayofenteringintothecontract,itisthedifferencebetweentheentryvalue

anddailysettlementpriceforthatday.

 Onanyinterveningdays,whenthememberholdsanopenposition,itisthedifferent

betweenthedailysettlementpriceforthatdayandthepreviousday’ssettlementprice.

Finalsettlement

Onthedateofexpiry,thefinalsettlementpriceisthespotpriceontheexpiryday.

Thespotpricesarecolectedfrommembersacrossthecountrythroughpoling.Thepoled

bid/askpricesarebootstrappedandthemidofthetwobootstrappedpricesistakenasthe

finalsettlementprice.Theresponsibilityofsettlementisonatradingcumclearingmember

foraltradesdoneonhisownaccountandhisclient’strades.Aprofessionalclearing

memberisresponsibleforsettlingaltheparticipantstrades,whichhehasconfirmedtothe

exchange.

Ontheexpirydateofafuturescontract,membersarerequiredtosubmitdelivery
information throughdeliveryrequestwindowonthetraderworkstationsprovidedby

NCDEXforalopenpositionsforacommodityforalconstituentsindividualy.NCDEXon

receiptofsuchinformationmatchestheinformationandarrivesatadeliverypositionfora

memberforacommodity.Adetailedreportcontainingalmatchedandunmatchedrequests

isprovidedtomembersthroughtheextranet.

Pursuanttoregulationsrelatingtosubmissionofdeliveryinformation,failuretosubmit

deliveryinformationforopenpositionsattractspenalchargesasstipulatedbyNCDEXfrom

timetotime.NCDEXalsoaddsalsuchopenpositionsforamember,forwhichnodelivery

informationissubmittedwithfinalsettlementobligationsofthememberconcernedand

settledincash.

Non-fulfilmentofeitherthewholeorpartofthesettlementobligationsistreated

asaviolationoftherules,bye-lawsandregulationsofNCDEX,andattractspenalchargesas

stipulatedbyNCDEfromtimetotime.InadditionNCDEXcanwithdrawanyoralofthe

membershiprightsofclearingmemberincludingthewithdrawaloftradingfacilitiesofal

tradingmembersclearingthroughsuchclearingmembers,withoutanynotice.Further,the

outstandingpositionsofsuchclearingmemberand/ortradingmembersand/orconstituents,

clearingandsettlingthroughsuchclearingmember,maybeclosedoutforthwithorany

thereafterbytheexchangetotheextentpossible,byplacingattheexchange,counter

ordersinrespectoftheoutstandingpositionofclearingmemberwithoutanynoticetothe

clearingmemberand/ortradingmemberand/orconstituent.NCDEXcanalsoinitiatesuch

otherriskcontainmentmeasures,asitdeemsappropriatewithrespecttotheopen

positionsoftheclearingmembers.Itcanalsotakeadditionalmeasureslikeimposing
penalties,colectingappropriatedeposits,invokingbankguaranteesorfixeddeposit

receipts,realizingmoneybydisposingoffthesecuritiesandexercisingsuchotherrisk

containmentmeasuresasitdeemsfitortake

furtherdisciplinaryaction.

Settlementmethods

SettlementoffuturescontractsontheNCDEXcanbedoneinthreeways–by

physicaldeliveryoftheunderlyingasset,byclosingoutopenpositionsandbycash

settlement.Weshallookateachoftheseinsomedetail.OntheNCDEXalcontracts

settlingincasharesettledonthefolowingdayafterthecontractexpirydate.Al

contractsmaterializingintodeliveriesaresettledinaperiod2-7daysafterexpiry.The

exactsettlementdayforeachcommodityisspecifiedbytheexchange.

Physicaldeliveryoftheunderlyingasset

Foropenpositionsontheexpirydayofthecontract,thebuyerandtheselercan

announceintentionsfordelivery.Deliveriestakeplaceintheelectronicform.Alother

positionsaresettledincash.

Whenacontractcomestosettlement/theexchangeprovidesalternativeslike

deliveryplace,monthandqualityspecifications.Tradingperiod,deliverydateetc.areal

definedasperthesettlementcalendar.Amemberisboundtoprovidedeliveryinformation.

Ifhefailstogiveinformation,itisclosedoutwithpenaltyasdecidedbytheexchange.A

membercanchooseanalternativemodeofsettlementbyprovidingcounterpartyclearing

memberandconstituent.Theexchangeishowevernotresponsiblefor,norguarantees

settlementofsuchdeals.Thesettlementpriceiscalculatedandnotifiedbytheexchange.
Thedeliveryplaceisveryimportantforcommoditieswithsignificanttransportationcosts.

Theexchangealsospecifiesthepreciseperiod(dateandtime)duringwhichthedeliverycan

bemade.Formanycommodities,thedeliveryperiodmaybeanentiremonth.Thepartyin

theshortposition(seler)getstheopportunitytomakechoicesfromthesealternatives.

Theexchangecolectsdeliveryinformation.Thepricepaidisnormalythemostrecent

settlementprice(withapossibleadjustmentforthequalityoftheassetand–thedelivery

location).Thentheexchangeselectsapartywithanoutstandinglongpositiontoaccept

delivery.

Asmentionedabove,afterthetradinghoursontheexpirydate,basedonthe

availableinformation,thematchingfordeliveriesisdone,firstly,onthebasisoflocations

andthenrandomlykeepinginview factorssuchasavailablecapacityofthe

vault/warehouse,commoditiesalreadydepositedanddematerializedandofferedfor

deliveryandanyotherfactorasmaybespecifiedbytheexchangefromtimetotime.After

completion of the matching process,clearing members are informed of the

deliverable/receivablepositionsandtheunmatchedpositions.Unmatchedpositionshaveto

besettledincash.Thecashsettlementisdoneonlyfortheincrementalgain/lossas

determinedonthebasisofthefinalsettlementprice.

Anybuyerintendingtotakephysicalshastoputarequesttohisdepository

participant.TheDPuploadssuchrequeststothespecifieddepositorywhointurnforwards

thesametotheregistrarandtransferagent(R&Tagent)concerned.Afterdueverification

oftheauthenticity,theR&Tagentforwardsdeliverydetailstothewarehousewhichin

turnarrangestoreleasethecommoditiesafterdueverificationoftheidentityof

recipient.Onaspecifiedday,thebuyerwouldgotothewarehouseandpickupthephysicals.
 Theselerintendingtomakedeliveryhastotakethecommoditiestothedesignated

warehouse.Thesecommoditieshavetobeassayedbytheexchangespecifiedassayer.The

commoditieshavetomeetthecontractspecificationswithalowedvariances.Ifthe

commoditiesmeetthespecifications,thewarehouseacceptsthem.Warehousesthenensure

thatthereceiptsgetupdatedinthedepositorysystemgivingacreditinthedepositor’s

electronicaccount.Theselerthengivestheinvoicetohisclearingmember,whowould

courierthesametothebuyer’sclearingmember.

NCDEXcontractsprovideastandardizeddescriptionforeachcommodity.The

descriptionisprovidedintermsofqualityparametersspecifictothecommodities.Atthe

sametime,itisrealizedthatwithcommodities,therecouldbesomeamountofvariancesin

quality/weightetc.,duetonaturalcauses,whicharebeyondthecontrolofanyperson.

Hence/NCDEXcontractsalsoprovidetolerancelimitsforvariances.Adeliveryistreated

asgooddeliveryandacceptedifthedeliverylieswithinthetolerancelimits.However,to

alowforthedifference,theconceptofpremiumanddiscounthasbeenintroduced.Goods

thatcometotheauthorizedwarehousefordeliveryaretestedandgradedasperthe

prescribedparameters.Thepremiumanddiscountratesapplydependingonthelevelof

variation.Thepricepayablebythepartytakingdeliveryisthenadjustedasperthe

premium/discountratesfixedbytheexchange.Thisensuresthatsomeamountofleewayis

providedfordelivery,butatthesametime,thebuyertakingdeliverydoesnotface

windfalloss/gainduetothequantity/qualityvariationatthetimeoftakingdelivery.This,

tosomeextent,mitigatesthedifficultyindeliveringandreceivingexactquality/quantity

ofcommodity.
 Closingoutbyoffsettingpositions

Mostofthecontractsaresettledbyclosingoutopenpositions.Inclosingout,the

oppositetransactioniseffectedtocloseouttheoriginalfuturesposition.Abuycontract

isclosedoutbyasaleandasalecontractisclosedoutbyabuy.Forexample,aninvestorwho

tookalongpositionintwogoldfuturescontractsontheJanuary30,2004at6090,canclose

hispositionbyselingtwogoldfuturescontractsonFebruary27,2004atRs.5928.Inthis

case,overtheperiodofholdingthepositionhehassufferedalossofRs.162perunit.This

losswouldhavebeendebitedfromhismarginaccountovertheholdingperiodbywayofMTM

attheendofeachday,andfinalyatthepricethathecloseshisposition,thatisRs.5928in

thiscase.

CASHSETTLEMENT

Contractsheldtilthelastdayoftradingcanbecashsettled.Whenacontractis

settledincash,itismarkedtothemarketattheendofthelasttradingdayandal

positionsaredeclaredclosed.Thesettlementprinceonthelasttradingdayissetequalto

theclosingspotpriceoftheunderlyingassetensuringtheconvergenceoffuturepricesand

thespotprices.Forexampleaninvestortookashortpositioninfivelongstaplecotton
th
futurescontractsonDecember15atRs.6950.On20 February,thelasttradingdayofthe

contract,thespotpriceoflongstaplecottonisRs.6725.Thisisthesettlementpricefor

hiscontract.Asaholderofashortpositiononcotton,hedoesnothavetoactualdeliverthe

underlyingcottonbutsimplytakesawaytheprofitofRs.225pertradingunitofcottonin
theformofcashentitiesinvolvedinphysicalsettlement.

ENTITLESINVOLVEDINPHYSICALSETTLEMENT:

Physicalsettlementofcommoditiesinvolvesthefolowingthreeentities–an

accreditedwarehouse,registrar&transferagentandanassayer.Wewilbrieflylookat

thefunctionsofeachaccreditedwarehouse.

ACCREDITEDWAREHOUSE

NCDEXspecifiedaccreditedwarehousesthroughwhichdeliveryofaspecific

commoditycanbeaffectedandwhichwilfacilitateforstorageofcommodities.Forthe

servicesprovidedbythem,warehouseschargeafeethatconstitutesstorageandother

chargessuchasinsurance,assayingandhandlingchargesoranyotherincidentalcharges

folowingarethefunctionsofanaccreditedwarehouse.

THEFUTURESBASIS

Thecost-of-carrymodelexplicitlydefinestherelationshipbetweenthefutures

priceandtherelatedspotprice.Thedifferencebetweenthespotpriceandthefutures

priceiscaledthebasis.Weseethatasafuturescontractnearsexpiration,thebasis

reducestozero.Thismeansthatthereisaconvergenceofthefuturespricetothepriceof

theunderlyingasset.Thishappensbecauseifthefuturespriceisabovethespotprice

duringthedeliveryperioditgivesrisetoacleararbitrage.

VariationofBasisovertime

Thefigureshowshowbasischangesovertime.Asthetimetoexpirationofacontract
 reduces,thebasisreduces.Towardsthecloseoftradingonthedayofsettlement,the

futurespriceandthespotpriceconverge.TheclosingpricefortheAprilgoldfutures

contractistheclosingvalueofgoldinthespotmarketonthatday.

Opportunityfortraders.Incaseofsucharbitragethetradercanshorthisfutures

contract,buytheassetfromthespotmarketandmakethedelivery.Thiswilleadtoa

profitequaltothedifferencebetweenthefuturespriceandspotprice.Astradersstart

exploitingthisarbitrageopportunitythedemandforthecontractwilincreaseandfutures

priceswilfalleadingtotheconvergenceofthefuturepricewiththespotprice.Ifthe

futurespriceisbelowthespotpriceduringthedeliveryperiodalpartiesinterestedin

buyingtheassetinthespotmarkedmakingaprofitequaltothedifferencebetweenthe

futurepriceandthespotprice.Asmoretraderstakealongpositionthedemandforthe

particularassetwouldincreaseandthefuturespricewouldrisenulifyingthearbitrage

opportunity.

 Asthedateofexpirationcomesnear,thebasisreduces=

ofthefuturespricetowardsthespotprice(Figure6,1).Onthedateofexpiration,the

basisiszero.Ifitisnot,thenthereisanarbitrageopportunity.Arbitrageopportunities

canalsoarisewhenthebasis(differencebetweenspotandfuturesprice)orthespreads

differencebetweenpricesoftwofuturescontracts)duringthelifeofacontractare

incorrect.Atalaterstageweshallookathowthesearbitrageopportunitiescanbe exploited.

 Thereisnothingbutcostofcarryrelatedarbitragethatdrivesthebehaviorof

thefuturespriceinthecaseofinvestmentassets.Inthecaseofconsumptionassets,we

needtofactorinthebenefitprovidedbyholdingthephysicalcommodity.
 Transactionscostsareveryimportantinthebusinessofarbitrage.
 PARTICIPANTSINCOMMODITYMARKET

Foramarkettosucceed/itmusthavealthreekindsofparticipant’s–hedgers,

speculatorsandarbitragers.Theconfluenceoftheseparticipantsensuresliquidityand

efficientpricediscoveryonthemarket.Commoditymarketsgiveopportunityforalthree

kindsofparticipants.

Hedging

Manyparticipantsinthecommodityfuturesmarketarehedgers.Theusethe

futuresmarkettoreduceaparticularriskthattheyface.Thisriskmightrelatetothe

priceofwheatoroiloranyothercommoditythatthepersondealsin.Theclassichedging

exampleisthatofwheatfarmerwhowantstohedgetheriskoffluctuationsinthepriceof

wheataroundthetimethathiscropisreadyforharvesting.Byselinghiscropforward,he

obtainsahedgebylockingintoapredeterminedprice.Hedgingdoesnotnecessarilyimprove

thefinancialoutcome;indeed,itcouldmaketheoutcomeworse.Whatitdoeshoweveris

thatitmakestheoutcomemorecertain.Hedgerscouldbegovernmentinstitutions,private

corporationslikefinancialinstitutions,tradingcompaniesandevenotherparticipantsin

thevaluechain,forinstancefarmers,extractors,ginners,processorsetc.,whoare

influencedbythecommodityprices.

HedgeRatio

Hedgeratioistheratioofthesizeofpositiontakeninthefuturescontractstothesizeof

theexposureintheunderlyingasset.Sofarintheexamplesweused,weassumedthatthe

hedgerwouldtakeexactlythesameamountofexposureintherefuturescontractasinthe
underlyingasset.Forexample,ifthehedgersexposureintheunderlyingwastotheextent

of11balesofcotton,thefuturescontractsenteredintowereexactlyforthisamountof

cotton.Wewereassumingherethattheoptimalhedgeratioisone.Insituationswherethe

underlyingassetinwhichthehedgerhasanexposureisexactlythesameastheasset

underlyingthefuturescontractheuses,andthespotandfuturesmarketareperfectly

correlated,ahedgeratioofonecouldbeassumed.Inalothercases,ahedgeratioofone

maynotbeoptimal.Belowequationgivestheoptimalhedgeratio,onethatminimizesthe

varianceofthehedger’sposition.

Where:

AC*.“””‘= ,S,duringaperiodoftimeequaltothelifeofthehedge

AF= ,F,duringaperiodoftimeequaltothelifeofthehedge
a
deviationofAS F:=

CoefficientofcorrelationbetweenAsandAFh=

Speculation

Anentityhavinganopiniononthepricemovementsofagivencommoditycan

speculateusingthecommoditymarket.Whilethebasicsofspeculationapplytoanymarket,

speculatingincommoditiesisnotassimpleasspeculatingonstocksinthefinancialmarket.

Foraspeculatorwhothinksthesharesofagivencompanywilrise.Itiseasytobuythe

sharesandholdthemforwhateverdurationhewantsto.However,commoditiesarebulky

productsandcomewithalthecostsandproceduresofhandlingtheseproducts.The

commoditiesfuturesmarketsprovidespeculatorswithaneasymechanismtospeculateon

thepriceofunderlyingcommodities.
 TotradecommodityfuturesontheNCDEX,acustomermustopenafuturestrading

accountwithacommodityderivativesbroker.Buyingfuturessimplyinvolvesputtinginthe

marginmoney.Thisenablesfuturestraderstotakeapositionintheunderlyingcommodity

withouthavingtoactualyholdthatcommodity.Withthepurchaseoffuturescontractona

commodity,theholderessentialymakesalegalybindingpromiseorobligationtobuythe

underlyingsecurityatsomepointinthefuture(theexpirationdateofthecontract).We

lookhereathowthecommodityfuturesmarketscanbeusedforspeculation.

Todayaspeculatorcantakeexactlythesamepositionongoldbyusinggoldfutures

contracts.Letusseehowthisworks.GoldtradesatRs.6000per10gmsandthree-months

goldfuturestradesatRs.6150.Tables7.3givesthecontractspecificationsforgoldfutures.

Theunitoftradingis100gmsandthedeliveryunitforthegoldfuturescontractonthe

NCDEXis1kg.HebuysonekgofgoldfutureswhichhaveavalueofRs.6,15,000.Buyingan

assetinthefuturesmarketsonlyrequiremakingmarginpayments.Totakethisposition,he

paysamarginofRs.1,20,000.ThreemonthslatergoldtradesatRs.6400per10gms.Aswe

know,onthedayofexpiration,thefuturespriceconvergestothespotPrice(elsethere

wouldbearisk-freearbitrageopportunity).HecloseshislongfuturespositionatRs.64,000

intheprocessmakingaprofitofRs.25,000onaninitialmargininvestmentofRs.1,20,000.

Thisworksouttoanannualreturnof83percent.Becauseoftheleveragetheyprovide,

commodityfuturesformanattractivetoolforspeculators.

Speculation:BearishCommodity,SelFutures:

Thiscanalsobeusedbyaspeculatorwhobelievesthatthereislikelytobeexcess

supplyofaparticularcommodityinthenearfutureandhencethepricesarelikelytoseea

fal.Howcanhetradebasedonthisopinion?Intheabsenceofadeferralproduct,there
wasn’tmuchhecoulddotoprofitfromhisopinion.Todayalheneedstodoisselcommodity

futures.

Letusunderstandhowthisworks.Simplearbitrageensuresthatthepriceofa

futurescontractonacommoditymovescorrespondinglywiththepriceoftheunderlying

commodity.Ifthecommoditypricerises,sowilthefuturesprice.Ifthecommodityprice

fals/sowilthefuturesprice.Nowtakethecaseofthetraderwhoexpectstoseeafalin

thepriceofcotton.Heselstentwo-monthscottonfuturescontractwhichisfordeliveryof

550balesofcotton.ThevalueofthecontractisRs.4,00,000.Hepaysasmalmarginonthe

same.Threemonthslater.Ifhishunchwerecorrectthepriceofcottonfals.Sodoesthe

priceofcottonfutures.HecloseouthisshortfuturespositionatRs.3,50,000,makinga

profitofRs.50,000.

Arbitrage

Acentralideainmoderneconomicsisthelawofoneprice.Thisstatesthatina

competitivemarket,iftwoassetsareequivalentfromthepointofviewofriskandreturn,

theyshouldselatthesameprice.Ifthepriceofthesameassetisdifferentintwo

markets,therewilbeoperatorswhowilbuyinthemarketwheretheassetselscheapand

selinthemarketwhereitiscostly.Thisactivitytermedasarbitrage,involvesthe

simultaneouspurchaseandsaleofthesameoressentialysimilarsecurityintwodifferent

marketsforadvantageouslydifferentprices.Thebuyingcheapandswelingexpensive

continuestilpricesinthetwomarketsreachequilibrium.Hence,arbitragehelpsto

equalizepricesandrestoremarketefficiency.
eT
F=(S+ )e
 Where:

Costoffinancing(annualized)

T =

U = .

REGULATORYFRAMEWORKFORCOMMODITYTRADINGININDIA

Atpresenttherearethreetiersofregulationsofforward/futurestradingsystem

inIndia,namely,governmentofIndia,ForwardMarketsCommission(FMC)andcommodity

exchanges.Theneedforregulationarisesonaccountofthefactthatthebenefitsof

futuresmarketsaccrueincompetitiveconditions.

Properregulationisneededtocreatecompetitiveconditions.Intheabsenceof

regulation,unscrupulousparticipantscouldusetheseleveragedcontractsformanipulating
prices.Thiscouldhaveundesirableinfluenceonthespotprices,therebyaffectinginterests

ofsocietyatlarge.Regulationisalsoneededtoensurethatthemarkethasappropriate

riskmanagementsystem.Intheabsenceofsuchasystem,amajordefaultcouldcreatea

chainreaction.

Theresultantfinancialcrisisinafuturesmarketcouldcreatesystematicrisk.

Regulationisalsoneededtoensurefairnessandtransparencyintrading,clearing,

settlementandmanagementoftheexchangesoastoprotectandpromotetheinterestof

variousstakeholders,particularlynon-memberusersofthemarket.

RULESGOVERNINGCOMMODITYDERIVATIVESEXCHANGES

ThetradingofcommodityderivativesontheNCDEXisregulatedbyForward

MarketsCommission(FMC).UndertheForwardContracts(Regulation)Act,1952,forward

tradingincommoditiesnotifiedundersection15oftheActcanbeconductedonlyonthe

exchanges,whicharegrantedrecognitionbythecentralgovernment(Departmentof

ConsumerAffairs,MinistryofConsumerAffairs,FoodandPublicDistribution).Althe

exchanges,whichdealwithforwardcontracts,arerequiredtoobtaincertificateof

registrationfromtheFMCBesides,theyaresubjectedtovariouslawsofthelandlikethe

CompaniesAct,StampAct,ContractsAct,ForwardCommission(Regulation)Actandvarious

otherlegislations,whichimpingeontheirworking.

ForwardMarketsCommissionprovidesregulatoryoversightinordertoensure

financialintegrity(i.e.topreventsystematicriskofdefaultbyonemajoroperatororgroup

ofoperators),marketintegrity(i.e.toensurethatfuturespricesaretrulyalignedwiththe

prospectivedemandandsupplyconditions)andtoprotectandpromoteinterestof

customers/nonmembers.Itprescribesthefolowingregulatorymeasures:
1. Limitonnetopenpositionasoncloseofthetradinghouses.Sometimeslimit

isalsoimposedonintra-daynetopenposition.Thelimitisimposedoperator-wise/andin

somecases,alsomemberwise.

2. Circuitfiltersorlimitonpricefluctuationstoalowcoolingofmarketinthe

eventofabruptupswingordownswinginprices.

3. Specialmargindeposittobecolectedonoutstandingpurchasesorsales

whenpricemovesupordownsharplyaboveorbelowthepreviousdayclosingprice.By

makingfurtherpurchases/salesrelativelycostly,thepriceriseorfalissobereddown.This

measureisimposedonlyontherequestoftheexchange.

4. Circuitbreakersorminimum/maximumprices.Theseareprescribedto

preventfuturespricesfromfailingbelowasrisingabovenotwarrantedbyprospective

supplyanddemandfactors.Thismeasureisalsoimposedontherequestoftheexchange.

5. Skippingtradingincertainderivativesofthecontractclosingthemarket

foraspecifiedperiodandevenclosingoutthecontract.Theseextremearetakenonlyin

emergencysituations.

Besidestheseregulatorymeasures,theF.C)R)Actprovidesthataclient’spositioncannotbe

appropriatedbythememberoftheexchange,exceptwhenawrittenconsentistaken

withinthreedaystime.TheFMCispersuadingincreasingnumberofexchangestoswitch

overtoelectronictrading,clearingandsettlementwhichismorecustomer/friendly.The

FMChasalsoprescribedsimultaneousreportingsystemfortheexchangesfolowingopenout

crysystem.

Thesestepsfacilitateaudittrailandmakeitdifficultforthememberstoindulgein
malpracticeliketradingaheadofclients,etc.TheFMChasalsomandatedaltheexchanges

folowingopenoutcrysystemtodisplayataprominentplaceinexchangepremises,thename,

address,telephonenumberoftheofficerofthecommissionwhocanbecontactedforany

grievance.Thewebsiteofthecommissionalsohasaprovisionforthecustomerstomake

complaintandsendcommentsandsuggestionstotheFMC.OfficersoftheFMChavebeen

instructedtomeetthemembersandclientsonarandombasis,whenevertheyvisit

exchanges,toascertainthesituationontheground,insteadofmerelyattendingmeetingsof

theboardofdirectorsandholdingdiscussionswiththeofficebearers.

TRADINGDAYS

TheexchangeoperatesonaldaysexceptSaturdayandSundayandonholidaysthat

itdeclaresfromtimetotime.Otherthantheregulartradinghours,tradingmembersare

providedafacilitytoplaceordersofflinei.e.outsidetradinghours.Thesearestoredby

thesystembutgettradedonlyoncethemarketopensfortradingonthefolowingworking

day.

Thetypesoforderbooks,tradebooks,pricelimits,matchingrulesandother

parameterspertainingtoeachoralofthesesessionsisspecifiedbytheexchangetothe

membersviaitscircularsornoticesissuedfromtimetotime.Memberscanplaceorderson

thetradingsystemduringthesesessions,withintheregulationsprescribedbytheexchange

asperthesebyelaws,rulesandregulations,fromtimetotime.
TERMSANDCONDITIONSOFCOMMODITIES.

Thebasictermsandconditionsofcommoditiesareasfolows.

Commodity TradingSession Lotsize Initial

Margins
Gold 10amto11.30pm 1kg 5%
Goldmini 10amto11.30pm 100kg 5%
Silver 10amto11.30pm 30kg 5%
Silvermini 10amto11.30pm 5kg 5%
Steellong 10amto5.00pm 25mt 5%
Steelflat 10amto5.00pm 25mt 5%
Lightsweet 10amto11.30pm 100bbls 4%
Crudeoil
Naturalgas 10amto11.30pm 500mmbtu 4%
RBD 10amto5.00pm 1mt 4%
palmolein
Refined 1mt 4%
soyoil
Rubber 10amto11.30pm 1mt 5%
Soyseed 1mt 4%
Blackpaper 10amto5.00pm 1mt 8%
Kapas 10amto5.00pm 4mt 5%
Castoroil 10amto5.00pm 1mt 4%
Castorseed 10amto5.00pm 1mt 4%
Copper 10amto11.30pm 1mt 5%
Nickel 10amto11.30pm 500kg 5%
Tin 10amto11.30pm 250kg 8%
Guarseed 10amto5.00pm 5mt 7%
Chana(Gram) 10amto5.00pm 5mt 5%
Urad (black 10amto5.00pm 20mt 5%
Matpe)
Yelowpeas 10amto5.00pm 20mt 5%
Tur (pigeon 10amto5.00pm 10mt 5%
peas)

Note:inwintertimingsfrom10.00amto11.55pm
Tradinghoursandtradingcycle

Theexchangeannouncesthenormaltradinghours/openperiodinadvancefromtime

totime.Incasenecessary,theexchangecanextendorreducethetradinghoursbynotifying

themembers.Tradingcycleforeachcommodity/derivativecontracthasastandardperiod,

duringwhichitwilbeavailablefortrading.

Contractexpiration

Derivativescontractsexpireonapre-determineddateandtimeuptowhichthe

contractisavailablefortrading.Thisisnotifiedbytheexchangeinadvance.Thecontract

expirationperiodwilnotexceedtwelvemonthsorastheexchangemayspecifyfromtime

totime.

Tradingparameters

Theexchangefromtimetotimespecifiesvarioustradingparametersrelatingto

thetradingsystem.Everytradingmemberisrequiredtospecifythebuyorselordersas

eitheranopenorderoracloseorderforderivativescontracts.Theexchangealsoprescribes

differentorderbooksthatshalbemaintainedonthetradingsystemandalsospecifies

variousconditionsontheorderthatwilmakeiteligibletoplaceitinthosebooks.

Theexchangespecifiestheminimumdisclosedquantityforordersthatwilbe

alowedforeachcommodity/derivativescontract.Italsoprescribedthenumberofdays

afterwhichGoodTilCanceledorderswilbecanceledbythesystem.Itspecifies

parameterslikelotsizeinwhichorderscanbeplaced,pricestepsinwhichshalbeentered

onthetradingsystem,positionlimitsinrespectofeachcommodityetc.
Failureoftradingmemberterminal

Intheeventoffailureoftradingmembersworkstationand/orthelossofaccessto

thetradingsystem,theexchangecanatitsdiscretionundertaketocarryoutonbehalfof

thetradingmemberthenecessaryfunctionswhichthetradingmemberiseligiblefor.Only

requestsmadeinwritinginaclearandprecisemannerbythetradingmemberwouldbe

considered.Thetradingmemberisaccountableforthefunctionsexecutedbytheexchange

onitsbehalfandhastoindemnitytheexchangeagainstanylossesorcostsincurredbythe

exchange.

Tradeoperations

Tradingmembershavetoensurethatappropriateconfirmedorderinstructionsareobtained

fromtheconstituentsbeforeplacementofanorderonthesystem.Theyhavetokeep

relevantrecordsordocumentsconcerningtheorderandtradingsystemordernumberand

copiesoftheorderconfirmationslip/modificationslipmustbemadeavailabletothe

constituents.

Thetradingmemberhastodisclosetotheexchangeatthetimeoforderentrywhetherthe

orderisonhisownaccountoronbehalfofconstituentsandalsospecifyordersforbuyor

selasopenorcloseorders.Tradingmembersaresolelyresponsiblefortheaccuracyof

detailsofordersenteredintothetradingsystemincludingordersenteredonbehalfof

theirconstituents.Tradersgeneratedonthesystemareirrevocableandblockedin1.The

exchangespecifiesfromtimetotimethemarkettypesandthemannerifany,inwhich

tradecancelationcanbeeffected.

Whereatradecancelationispermittedandtradingmemberwishestocancelatrade,itcan

bedoneonlywiththeapprovaloftheexchange.
Marginrequirements

Subjecttotheprovisionsascontainedintheexchangebye-lawsandsuchotherregulations

asmaybeinforce,everyclearingmember/inrespectofthetradesinwhichheispartyto,

hastodepositamarginwithexchangeauthorities.

Theexchangeprescribesfromtimetotimethecommodities/derivativescontracts,the

settlementperiodsandtradetypesforwhichmarginwouldbeattracted.

TheexchangeleviesinitialmarginonderivativescontractsusingtheconceptofValueat

Risk(VaR)oranyotherconceptastheexchangemaydecidefromtimetotime.Themargin

ischargedsoastocoverone-daylossthatcanbecounteredonthepositionon99%ofthe

days.Additionalmarginsmaybeleviedfordeliverablepositions,onthebasisofVaRfrom

theexpiryofthecontracttiltheactualsettlementdateplusamark-upfordefault.

Themarginhastobedepositedwiththeexchangewithinthetimenotifiedbytheexchange.

Theexchangealsoprescribescategoriesofsecuritiesthatwouldbeeligibleforamargin

deposit,aswelasthemethodofvaluationandamountofsecuritiesthatwouldberequired

tobedepositedagainstthemarginamount.

Theprocedureforrefund/adjustmentofmarginsisalsospecifiedbytheexchange

fromtimetotime.Theexchangecanimposeuponanyparticulartradingmemberorcategory

oftradingmemberanyspecialorothermarginrequirement.Onfailuretodepositmargin/s

asrequiredunderthisclause,theexchange/clearinghousecanwithdrawthetradingfacility

ofthetradingmember.Afterthepay-out,theclearinghousereleasesalmargins.

Unfairtradingpractices

Notradingmembershouldbuy,sel,dealinderivativescontractsinafraudulentmanner,or
 indulgeinanyunfairtradepracticesincludingmarketmanipulation.Thisincludesthe

folowing;ifEffect,takeparteitherdirectlyorindirectlyintransactions,whicharelikely

tohaveeffectofartificialy,raisingordepressingthepricesofspot/derivatives

contracts.

Indulgeinanyact,whichiscalculatedtocreateafalseormisleadingappearanceof

trading,resultinginreflectionofprices,whicharenotgenuine.

 Buy,selcommodities/contractonhisownbehalforonbehalfofapersonassociatedwith

himpendingtheexecutionoftheorderofhisconstituentorofhiscompanyordirectorfor

thesamecontract.

 Delaythetransferofcommoditiesinthenameofthetransferee. Indulgein

falsificationofhisbooks,accountsandrecordsforthepurposeofmarketmanipulation.

 Whenactingasanagent,executeatransactionwithaconstituentatapriceotherthan

thepriceatwhichitwasexecutedontheexchange.

 Eithertakeoppositepositiontoanorderofaconstituentorexecuteoppositeorders

whichheisholdinginrespectoftwoconstituentsexceptinthemannerlaiddownbythe

exchange.

CLEARING

Asmentionedearlier,NationalSecuritiesClearingCorporationLimited(NSCCL)

undertakesclearingoftradesexecutedontheNCDEX,AldealsexecutedontheExchange

areclearedandsettledbythetradingmembersonthesettlementdatebythetrading

membersthemselvesasclearingmembersorthroughotherprofessionalclearingmembersin

accordancewiththeseregulations/byelawsandrulesoftheexchange.
 LASTDAYOFTRADING

Lasttradingdayforaderivativecontractinanycommodityisthedateasspecified

intherespectivecommoditycontract.Ifthelasttradingdayasspecifiedintherespective

commoditycontractisaholiday,thelasttradingdayistakentobethepreviousworkingday

ofexchange.Ontheexpirydateofcontracts,thetradingmembers/clearingmembershave

togivedeliveryinformationasprescribedbytheexchangefromtimetotime.Ifatrading

member/clearingmemberfailstosubmitsuchinformationduringthetradinghoursonthe

expirydateforthecontract/thedealshavetobesettledasperthesettlementcalendar

applicableforsuchdeals,incash-togetherwithpenaltyasstipulatedbytheexchangedeals

enteredintothroughtheexchange.Theclearingmembercannotoperatetheclearing

accountforanyotherpurpose.

RULESGOVERNINGINVESTORGRIEVANCES,ARBITRATION

Inmatterswheretheexchangeisapartytothedispute,thecivilcourtsatMumbai

haveexclusivejurisdictionandinalothermatters,propercourtswithintheareacovered

undertherespectiveregionalarbitrationcenterhavejurisdictioninrespectofthe

arbitrationproceedingsfaling/conductedinthatregionalarbitrationcenter.

PROCEDUREFORARBITRATION:

Theapplicationhastosubmittotheexchangeapplicationforarbitrationinthe

specifiedform(FormNo.1/1A)alongwiththefolowingenclosures.

1. Thestatementofcase(containingaltherelevantfactsaboutthedisputeand

reliefsought).
2. Thestatementofaccounts

3. Copiesofmembers–constituentagreement

4. Copiesoftherelevantcontractnotes,invoiceanddeliverychalan.

DELIVERYPROCEDURE

Theclientshouldfolowthefolowingproceduretotakedeliveryofthecommodity
st
1 day–Buyer/selerinformstheexchangeabouttheirintentions.
th
5 day–Buyerisrequiredtomakepaymentinaccordancetothequantityalocatedtohim.
th
6 day–selerisrequiredtodeliverthegoodsatthedeliverycentersspecifiedbythe

Exchangeby12.00noon.Buyercanpickupthedeliveryfrom12.00noonto4.00pm
th
7 day–ThePaymentwilbereleasedtotheseler

COSTPHYSICALDELIVERY

FixedCosts Rs
Group4receiptcharges 350
Group4Managerialcharges 3000
Group4Movementcharges 5000
PackingAWBCuttingcharges 500
ValuationCharges 5000
Totalfixedcost 13850
Variablecost
Loading/unloadingcharges 0
Insuranceonflight 0.15/per1000

ESTIMATEDMARKET

Physical Physical 3Times 5Times

Multiple
p.a Perday multiple Perday
(Rs.bn)
(Rs.Crs) Perday
Bulion 400 160 480 800
Metals 600 240 720 1200
Agri 5000 2000 6000 10000
Energy 5000 2000 6000 10000
Total 11000 4400 13200 22000

GOLDPROFILE

Thecolapseofequitymarketsandthearrivaloflowinterestrateshaveincreasedthe
investorpresenceinalternativeinvestmentssuchasgold.InIndia,goldhastraditionaly
playedamulti-facetedrole.Apartfrombeingusedforadornmentpurpose,ithasalso
servedasanassetofthelastresortandahedgeagainstinflationandcurrency
depreciation.Butmostimportantly,ithasmostoftenbeentradedasaninvestment.

Goldsupplyprimarilycomesfrommineproduction,officialsectorsalesofglobalcentral
banks,oldgoldscrapandnetdisinvestmentsofinvestedgold.Outofthetotalsupplyof3870
tonslastyear,66%wasfrommineproduction,20%fromoldgoldscrapand14%fromofficial
sectorsales.Demandglobalyemanatesfromfabrication(jeweleryandotherfabrication),
Barhoarding,NetproducerhedgingandImpliedinvestment.

GoldcontinuestooccupyaprominentpartinruralIndianeconomyandasignificantpartof
theruralcreditmarketrevolvesaroundbulionassecurity.Indiaisthelargestconsumerof
goldintheworldaccountingformorethan23%ofthetotalworlddemandannualy.According
tounofficialestimates,Indiahasmorethan13,000tonnesofhoardedgold,whichtranslates
toaroundRs6,50,000crore.Inspiteofitspredominantposition,especialyinthegold
marketwhereIndiaisthelargestimporter,Indiahastraditionalybeenapriceseekerin
theglobalbulionmarket.

BuliontradinginIndiareceivedamajorfilip.FolowingthechangesintheGoldPolicy
announcedbytheGovernmentofIndia,in1997underexport-importPolicy1997-2002.Asper
thepolicy,scheduledcommercialbanksareauthorizedbytheReserveBankofIndia(RBI)to
importgoldandsilverforsaleindomesticmarketwithoutanImportlicenseorsurrendering
 theSpecialImportLicense(SIL).BulionisimportedintoIndiabybanksandfourdesignated
tradingagenciesactingascanalizingagentsandconsigneesforoverseassuppliers,whoin
turnseltodomesticwholesaletraders,fabricators,etc.Thepriceriskisborneeitherby
thefabricatorortheretailconsumer.Thewholesaletraders,fabricatorsandinvestorsdo
nothaveanyeffectivetooltohedgetheirpriceriskingold/silver.
Indiabeingthelargestconsumerofgoldintheworld,withminimaldomesticsupply,the
demandismetmainlyfromimports.
Goldistheoldestpreciousmetalknowntoman.Therefore,itisatimelysubjectforseveral
reasons.Itistheopinionofthemoreobjectivemarketexpertsthatthetraditional
investmentvehiclesofstocksandbondsareintheareasoftheiral-timehighsandmaybe
dueforaseverecorrection.
Tofulyappreciatewhy8,000yearsofexperiencesay“goldisforever",weshouldreview
whytheworldrevereswhatEngland'smostfamouseconomist,JohnMaynardKeynes,
cynicalycaledthe“barbarousrelic."
Whygoldis"goodasgold"isanintriguingquestion.However,wethinkthatthemore
pragmaticancientEgyptianswereperhapsmoreaccurateinobservingthatgold'svaluewas
afunctionofitspleasingphysicalcharacteristicsanditsscarcity.
 Goldisprimarilyamonetaryassetandpartlyacommodity.

 Morethantwothirdsofgold'stotalaccumulatedholdingsaccountas'valuefor
investment'withcentralbankreserves,privateplayersandhigh-caratJewelery.
 Lessthanonethirdofgold'stotalaccumulatedholdingsisasa'commodity'for
JeweleryinWesternmarketsandusageinindustry.
 TheGoldmarketishighlyliquidandgoldheldbycentralbanks,othermajor
institutionsandretailJewelerykeepcomingbacktothemarket.
 DuetolargestocksofGoldasagainstitsdemand,itisarguedthatthecoredriver
oftherealpriceofgoldisstockequilibriumratherthanflowequilibrium.
 Economicforcesthatdeterminethepriceofgoldaredifferentfrom,andinmany
casesopposedtotheforcesthatinfluencemostfinancialassets.
 SouthAfricaistheworld'slargestgoldproducerwith394tonsin2001,folowedby
USandAustralia.
 Indiaistheworld'slargestgoldconsumerwithanannualdemandof800tons.

WorldGoldMarkets
 Londonasthegreatclearinghouse
 NewYorkasthehomeoffuturestrading
 Zurichasaphysicalturntable
 Istanbul,Dubai,SingaporeandHongKongasdoorwaysto important

 consumingregions
 TokyowhereTOCOMsetsthemoodofJapan
 MumbaiunderIndia'sliberalizedgoldregime

TABLE-

IndiainWorldGoldIndustry
(RoundedFigures) India(InTons) World(InTons) %Share
TotalStocks 13000 145000 9
CentralBankholding 400 28000 1.4
AnnualProduction 2 2600 0.08
AnnualRecycling 100-300 1100-1200 13
AnnualDemand 800 3700 22
AnnualImports 600 - -
AnnualExports 60 - -

IndianGoldMarket
 GoldisvaluedinIndiaasasavingsandinvestmentvehicleandisthesecond
preferredinvestmentafterbankdeposits.
 Indiaistheworld'slargestconsumerofgoldinjeweleryasinvestment.
 InJuly1997theRBIauthorizedthecommercialbankstoimportgoldforsaleorloan
tojewelersandexporters.Atpresent,13banksareactiveintheimportofgold.

 Thisreducedthedisparitybetweeninternationalanddomesticpricesofgoldfrom
57percentduring1986to1991to8.5percentin2001.
 ThegoldhoardingtendencyiswelingrainedinIndiansociety.

 Domesticconsumptionisdictatedbymonsoon,harvestandmarriageseason.Indian
jeweleryofftakeissensitivetopriceincreasesandevenmoresotovolatility.

 Inthecitiesgoldisfacingcompetitionfromthestockmarketandawiderangeof
consumergoods.
 Facilitiesforrefining,assaying,makingthemintostandardbarsinIndia,as
comparedtotherestoftheworld,areinsignificant,bothqualitativelyandquantitatively.

MarketMovingFactors

 Abovegroundsupplyfromsalesbycentralbanks,reclaimedscrapandofficialgold
loans
 Producer/minerhedginginterest
 Worldmacro-economicfactors-USDolar,Interestrate

 Comparativereturnsonstockmarkets
 Domesticdemandbasedonmonsoonandagriculturaloutput

FrequencyDist.ofGoldLondonFixingVolatilityfrom1995tildate

PercentageChange > 2-5% <

Daily
Numberoftimes 4 54 2147
Percentagetimes 0.2 2.4 97.4
Weekly
Numberoftimes 3 62 376
Percentagetimes 0.7 14.1 85.3
 Biggestpricemovementsince1995

BetweenSeptember24andOctober5,1999,dailypriceswitnessedaralyofmorethan21%,
basedonsurprisedannouncementby15Europeancentralbanksofafive-yearsuspensionon
alnewsalesofgoldfromtheirreserves.

WhyInvestinGold

Addinggoldtoaportfoliointroducesanentirelydifferentassetclass-atangible&real
assetwhichincreasestheportfolio'sdegreeofdiversification.

Effectiveportfoliodiversifier

 Asdepictedabove,whiletheoveralreturnofaportfoliowithoutgoldis14%,that
ofaportfoliowithgoldisover16%.Henceanalocationofphysicalgoldinafinancial
portfolionotjusthelpsreducetheimpactofthevolatilitycreatedbytheotherasset
classeslikeequity,bondsetc.,butalsoincreasestheaveragereturnoveraperiodoftime.
 Afinancialportfoliocontaininggoldisgeneralymorerobustbecauseitimproves
thestabilityandpredictabilityofbetteraveragereturns.
 Superiortootheralternativeassetclasses

 Goldisthemostliquidassetclassduetoitsuniversalacceptanceasanalternative
tocurrency,andalsobecauseglobaly,thegoldmarketisfunctional24x7.

 Samecannotbesaidaboutanyotherassetclassastheytakemuchlongertimeto
liquidate(from1daytoupto3-4months).

Effectivehedgeagainstcurrencyrisk

 Duetoitsinverserelationshiptodolar,goldhasalwaysprovedtobeaneffective
hedgeoveraperiodoftime.
 EffectivehedgeagainstInflation

 AstudyconductedbyWGCinUKshowsthatoneounceofGoldwouldconsistently
purchasethesameamountofgoods&servicesasitwouldhavedone400yearsago,makingit
theperfecthedgeagainstinflationoveralongperiodoftime.

OtherReasons

 MoreliquidascomparedtotheotherassetclassesGoldcanbebought,soldortraded
globaly.
 Performanceofgoldnotlinkedtoperformanceofanycompany,industryor
government.
 Goldneedsnoprofessionalmanagerunlikemutualfunds
 Goldisanasset,whichisnotsimultaneouslyaliability,unlikestocks.

 Itdoesn'trequirepolitical&socialstabilitytosurvive,infactitthrivesunder
worstsocietalconditions.
 Golddoesn'teverlooseitsintrinsicvalue.

InspiteofthegrowingdemandforgoldinIndia,averageretailhouseholdhasseldom
considered“investingingold”becauseoftheabsenceofanefficientandeffective
platform.MCXbridgesthisrequirementbyintroducinganidealinvestmentplatformfor
 investmentingoldbyretailhousehold.“i-gold”.

Whatisi-gold?

"i-gold”isaplatformwhichfacilitatesinteligentinvestmentingoldwithanoptionof
PhysicalorDematholdingofgold.

Featuresofi-gold

 Transparentpricing.

 Assuredquality&purity
 OptionofDemating

 Noriskofstorage
 Simpleprocess

AdvantagestoanInvestor

 Anidealplatformforsystematicinvestmentingold.
 Transparentscreenbasedpriceatparwiththeprevailingspotprice.

 OptionsofloanagainstDematgoldfromBanks/FinancialInstitutions.

 Convenienceofbuyinggoldattheinvestorsdiscretion-withoutvisitingtheoutlet
unliketoday

 AssuredQuality&Purity24k,995&999finenessgoldbarsimportedfromLBMA
approvedoverseassuppliers
 Deliveryat4locationsAhmedabad,Delhi,Kolkata&Mumbai
 AdvantagestoaJeweler

 Aplatformtotradeinphysicalgoldwithshorter&100%guaranteeddeliverycycle
visavisfuturesmarket.
 Transparentscreenbasedpriceatparwiththeprevailingspotprice.

 Efficientdistributionsystem(fromthecustodiantotheenduser)
 AssuredQuality&Purity-24k,995&999finenessgoldbarsLBMAapproved

 Seamlessplatform(buying&seling)fortransaction
 EasilyaccessiblethroughanexistingstockbrokerwhoisamemberofMCX
 Deliveryat4locationsAhmedabad,Delhi,Kolkata&Mumbai

Requisitesforbuyingi-gold

 CommodityDemataccountwithNSDL/CDSL

 AccountwithamemberbrokerofMCX
 BankaccountwithanyoneclearingbanksofMCX

Howdoesitwork?

Day1-6-Buy/seldependingonmarginmoneywiththebroker/exchangebasedonMarkto
Market(MTM).

Day7-IntimatethestatusoftheirrespectiveopenpositiontoBuyers&Selers.

Day8-SelermembersMUSTdepositthephysicalgoldintheGroup4vault/deliverthrough
dematform.

Day9-Pay-inoffundsbyBuyermembersagainsttheirdeliverycommitments(obligation).

Day9-Pay-outofcommodity

Physicaldeliveryofgold(Docs:Authorisationformfiledandsignedalongwiththe
photographoftheinvestor/authorizedpersonofthebroker,proofofidentity.(photoid
card)
Dematandholdindemataccount(Docs:CommodityDepositFormCDFandOriginalAlocation
Letter)

Costsstructure

Brokerage(Buy/sel) 0.50–1.00%oftransactionvalue

ServiceTaxonbrokerage 12.24%onbrokerage

Demat&Remat Rs.100/-200/-pertransaction

Custody&Insurance Rs.7,200p.a.per(1k.g)

VAT 1%oftransactionvalue

SalesTaxagencycharge 0.50%-1.00%(requiredforselingphysical
gold)

Dematandholdindemataccount(Docs:CommodityDepositFormCDFandOriginalAlocation
Letter)

Costsstructure

Brokerage(Buy/sel) 0.50–1.00%oftransactionvalue
 ServiceTaxonbrokerage 12.24%onbrokerage

Demat&Remat Rs.100/-200/-pertransaction

Custody&Insurance Rs.7,200p.a.per(1k.g)

VAT 1%oftransactionvalue

SalesTaxagencycharge 0.50%-1.00%(requiredforselingphysical
gold)

TaxTreatment

WealthTax
 InvestmentuptoRs.15lacsduringafinancialyearisexempted

 Investment> .15lacswilattract1%ofthevalueofassets(includinggold)ason
31stMarchofeveryyear.

Capitalgainstax
 Shorttermifboughtandsoldwithin36monthsattheapplicabletaxrate
 Longtermifsoldafter36monthsattheapplicabletaxrate

ANALYSIS

Objective:Theobjectiveoftheanalysisistoevaluatetheprofit/losspositionofhedger.
Thisanalysisisdonebasedonthesampledata.ThesampleistakenasGoldcommodityof
DecembertoJanuaryprices.Thedeliveryunitis1kg.Tradingunitis100gm.Quotation/base
valueRs.per10gms.OfGoldwith999.99finess.Ticksizeis5paise.AsthecommodityGold
isvolatileinnature,itischosenasasampleforanalysis.Thespotpriceandfuturespriceis
takenfromvariousnewspapers.Likeeconomictimes,businessstandardandbusinessline.Of
course,fromtheNCDEX(NationalCommodity&DerivativesExchangeLimited)

Limitations:
1)Thesampleischosenascommodityfuturecontractgold100gmgold.

2)ThestudyisconfinedtoDecember2007toJanuary2008monthonly.

3)Thedatagatherediscompletelyrestrictedtothespotandfuturepricesofcommodity
gold100gms.OfDecembertoJanuary27,2008andhencecannotbetakenuniversaly.

4)Ourstudyislimitedtothetradingstrategies.Forhedging,thisincludeslonghedgeand
shorthedge.

GoldFutureContractSpecifications

TypeofContract FuturesContractSpecifications
NameofCommodity Gold

Tickersymbol GOLD100MUM

Tradingsystem NCDEX'sTradingSystem

Ex-MumbaiinclusiveofCustomsDutyandOctroi,excluding
Basis
SalesTax/VAT.

Unitoftrading 100grams.

Deliveryunit 100grams.

Quotation/basevalue Rsper10GramsofGoldwith995fineness

Ticksize Re1

Upto999.9finenessbearingaserialnumberandidentifying
stampofarefinerapprovedbytheExchange.

Qualityspecification
Listofapprovedrefinersisavailableatthefolowing

URL:www.ncdex.com\downloads\refiners_ .pdf

Quantityvariation None

Deliverycenter Mumbai

Additionaldeliverycentres Ahmedabad

AsperdirectionsoftheForwardMarketsCommissionfrom
timetotime,currently-

MondaysthroughFridays:
Tradinghours
10:00AMto11:30PM*
Saturdays:
10:00AMto02:00PM
Ontheexpirydate,contractsexpiringonthatdaywilnotbe
 availablefortradingafter5PM.TheExchangemayvarythe
abovetimingwithduenotice.

th
20 dayofdeliverymonth
If20thhappenstobeaholiday,aSaturdayoraSundaythen
Duedate/ExpiryDate
theduedateshalbeimmediatelyprecedingtradingdayother
thanaSaturdayoftheExchange.

Uponexpiryofthecontractsaltheoutstandingpositions
shouldresultincompulsorydelivery.Apenaltyofminimum5%
Deliveryspecification
(offinalsettlementprice)wouldbeimposedonlongsand
shortsiftheyfailtomeettheirdeliveryobligation.

Upontheexpiryofthecontractaltheoutstandingopen
ClosingofContracts
positionshouldresultincompulsorydelivery.

Tradinginafarmonthcontractwilopenonthe10thdayofthe
monthinwhichnearmonthcontractisduetoexpire.Ifthe
OpeningofContracts
10thhappenstobeanon-
tradingday,contractswouldopenon thenexttradingday.

Contractswouldbeopenedasperthelaunchcalendargiven
No.ofactivecontracts
below

Dailypricefluctuationlimitis(+-)4%.Ifthetradehitsthe
prescribeddailypricelimittherewilbeacoolingoffperiod
for15minutes.Tradewilbealowedduringthiscoolingof
Pricelimit periodwithinthepricebandof(+-)4%.Thereaftertheprice
bandwouldberaisedbyanother50%oftheexistinglimiti.e
(+ -)2%.
Notrade/ordershalbepermittedduringthedaybeyondthe
 revisedlimitof(+ -)6%exceptsuchfurthervariationsas
maybepermittedbytheregulators.
Onthefirstdayofanynewcontract,thelimitondailyprice
fluctuationwilbereckonedwithreferencetotheopening
price.Onthesecondandsubsequentdays,thedailyprice
fluctuationlimitwilbereckonedwithreferencetothemark-
to-marketrateofthepreviousclosingday.

Memberwise:6MTor15%ofmarketwideopenposition,
whicheverishigherClient-wise-2MT
Positionlimits Theabovelimitswilnotapplytobonafidehedgers.For
bonafidehedgerstheExchangewildecidethelimitsonacase-
to-casebasis.

Goldbarsof995/999.9fineness
A premium wilbegivenforfinenessabove995.The
Qualityalowance(forDelivery)
settlementpriceformorethan995finenesswilbecalculated
at(Actualfineness/995)*FinalSettlementPrice.

Incaseofadditionalvolatility,aspecialmarginofatsuch
otherpercentage,asdeemedfit,wilbeimposedimmediately
SpecialMargin onbothbuyandselsideinrespectofaloutstandingpositions,
whichwilremaininforcefornext2days,afterwhichthe
specialmarginwilberelaxed.

LaunchCalendar. Gold100Grams
LaunchDate ContractExpiringin

21stNovember2007 December2007,January2008,February2008

December2007 March2008

January2008 April2008

February2008 May2008

March2008 June2008

April2008 July2008

May2008 August2008

June2008 September2008

July2008 October2008

August2008 November2008

September2008 December2008

Note:LaunchdatesforcontractslaunchedinDecember2007andthereafterwouldbe10thof
themonthinwhichthenearmonthcontractisduetoexpireandifthe10thhappenstobea
tradingholidayattheExchange,thenearcontractwouldbelaunchedonthenexttradingday.

Hedging

Manyparticipantsinthecommodityfuturesmarketarehedgers.Theyusethefutures
markettoreduceaparticularriskthattheyface.Thisriskmightrelatetothepriceof
 wheatoroiloranyothercommoditythatthepersondealsin.Theclassichedgingexampleis
thatofwheatfarmerwhowantstohedgetheriskoffluctuationsinthepriceofwheat
aroundthetimethathiscropisreadyforharvesting.Byselinghiscropforward,heobtains
ahedgebylockingintoapredeterminedprice.Hedgingdoesnotnecessarilyimprovethe
financialoutcome;indeed,itcouldmaketheoutcomeworse.Whatitdoeshoweveris,thatit
makestheoutcomemorecertain.Hedgerscouldbegovernmentinstitutions,private
corporationslikefinancialinstitutions,tradingcompaniesandevenotherparticipantsin
thevaluechain,forinstancefarmers,extractors,ginners,processorsetc.,whoare
influencedbythecommodityprices.

Typesofhedging

1) Longhedge
2) Shorthedge

Longhedge

Hedgesthatinvolvetakingalongpositioninafuturescontractareknownaslonghedges.A
longhedgeisappropriatewhenacompanyknowsitwilhavetopurchaseacertainassetin
thefutureandwantstolockinapricenow.

Shorthedge

Ashorthedgeisahedgethatrequiresashortpositioninfuturescontracts.Aswesaid,a
shorthedgeisappropriatewhenthehedgeralreadyownstheasset,orislikelytoownthe
assetandexpectstoselitatsometimeinthefuture.Forexample,ashorthedgecouldbe
usedbyacottonfarmerwhoexpectsthecottoncroptobereadyforsaleinthenexttwo
months.Ashorthedgecanalsobeusedwhentheassetisnotownedatthemomentbutis
likelytobeownedinthefuture.Forexample,anexporterwhoknowsthatheorshewil
receiveadolarpaymentthreemonthslater.Hemakesagainifthedolarincreasesinvalue
relativetotherupeeandmakesalossifthedolardecreasesinvaluerelativetotherupee.
 Ashortfuturespositionwilgivehimthehedgehedoes.

CONCLUSION

 ThetradingincommodityderivativesstartedonDec.–2003.

 Withinashortspanof3yearsthetradingvolumeincommodityderivatives

increasedinarapidmanner,nowitgoingtoequalizewiththefinancialderivativestrading
 volumes.

 Firstderivativesemergedashedgingproductsincommodities.

 Thesecommoditiesaretheriskmanagementinstrumentswhichtransfersthepricing

riskstootherparties.

 Internationaly,commodityderivativesareexchange-traded.

 Inthebulishmarket,theinvestorscanearnprofitsbybuyingthecommodity

futures.

 Inthebearishmarket,theinvestorscanearnprofitsbyselingthecommodity

futures.

 Thehedgerscantransfertheirriskstootherpartiesbywaysoflonghedgeand

shorthedge.

 Thespeculatorscanbuildlargepositionswithlittlemarginsbywayofleverageand

theirprofit/losspotentialisunlimited.

 Thearbitragerscanalsoearnrisklessprofitsbywaysofcash–and-carryarbitrage

andreversecash-in-carryarbitrage.

 ThesecommodityproductsareverymuchnewtoIndia.

 TheSEBIistakingnecessaryactionstocreateawarenessintotheinvestors.

RECOMMENDATIONS

 Thecommoditiesareverycomplexfinancialinstruments.Hencetheinvestorshould

takeatmostcarewhiletrading.
 InIndia,thecommoditiesonlyhavecommodityfutures,andtheoptionsin

commoditiesshouldbeintroduced.

 TheSEBIandtheStockExchangesshouldtakemoreactions(investor’sawareness

programmes)tocreateawarenessandknowledgeinbetweentheinvestors.

 Althepersonsandintermediariesassociatedwiththecommodityderivative

marketsmustfulfiltheminimumeducation(NCFM).

 Byusingthetradingstrategies(longhedgeandshorthedge)theproducerscan

transfersthepricingrisk.

 Theagreecommodityproducerscangetbetterpricesfortheirproductioninthe

marketbywayofefficientpricediscoverywiththehelpoffutureprices.

 Byusingthesecommodityfuturesthefarmerscanbenefitbywayofshort-seling.

 Byusingcommodityfuturesinventoryriskwilbeminimized.
 BIBLIOGRAPHY

WEBSITES:

www.wikipedia.com

www.investopedia.com

www.google.com