MITTAL SCHOOL OF BUSINESS

School of BBA Faculty of Financial Markets

Name of the faculty member: Dr Pratap Singh
Course Code: FIN239 Course Title: Commodity Market
Academic Task No: 01 Academic Task Title:
Date of Allotment:31/01/2022 Date of Submission:20/02/2022
Student Roll No: Student Reg. No: 11908681
Term:06 Section: Q1914
Max. Marks: Marks. Obtained:
Evaluation Parameters
Learning Outcomes: (Student to write briefly about learnings obtained from the
academic tasks)
➢ Helps in applying the theoretical concepts to real life situations.
➢ Helps in improving analytical and writing skills.

Declaration: I declare that this Assignment is my individual work. I have not

copied it from any other students work or from any other source except where
due acknowledgement is made explicitly in the text, nor has any part been
written for me by any other person.

Evaluation Criterion: Rubrics on different parameters

Student’ Signature.

General Observations Suggestions for Improvement Best part of

assignment

Evaluator’s Signature and Date

 1. What is commodity market?

A commodity market is a marketplace where investors trade several

commodities like spices, energy, precious metals, crude oil within a
country.

In recent times, the Forward Market of Commissions allowed around 120

commodities to perform future trading within India.
Investors who is focusing on diversifying their portfolio can invest in both
perishable and non-perishable products.
It will help all the investors face lesser risks and provide a boundary against
the growing inflation rate in the country.

Types of commodities in the market

Commodities are divided into two different categories: hard and soft
commodities.
Hard Commodities
Hard commodities consist of natural resources that is mined or extracted.
The hard commodities are classified into two categories:
1) Metals – Gold, Silver, Zinc, Copper, Platinum
2) Energy – Natural gas, Crude oil, gasoline, heating oil

Soft Commodities
Soft commodities refer to those commodities that are grown and cared for
rather than extracted or mined. The soft commodities are classified into
two categories:
1) Agriculture – Rice, Corn, Wheat, Cotton, Soybean, Coffee, Salt, Sugar
2) Livestock and meat – Feeder cattle, live cattle, Egg
India has 22 different commodity exchanges that have been formed under
the Forward Markets Commission. There are 4 popular commodity
exchanges for trading in India:
1) Indian Commodity Exchange (ICEX)
2) National Multi Commodity Exchange of India (NMCE)
3) Multi Commodity Exchange of India (MCX)
4) National Commodity and Derivative Exchange (NCDEX)
There are two major participants in the commodity market:
Speculators
Speculators are traders in the commodity market that continuously check
the price of commodities and tell the future price movement.
If they expect the price to go upwards, they buy a commodity contract and
instantly sell them as soon as the price goes upwards.
Similarly, if they expect the price to go downwards, they sell their
commodity contracts and buy back when the price falls.
The primary intention of every speculator is to learn a large amount of
profit in any type of market.
Hedgers
Hedgers are normally manufacturers and producers who protect
themselves from the risk by using the commodity futures market.
Let us understand with the help of an example:
If a farmer expects that there will be fluctuations in the price during crop
harvesting, he can hedge his position. To protect himself from the risk, he
will enter into the futures contract.
If the crop price goes down in the market, the farmer can compensate for
all the loss and by booking profits in the future market.
Similarly, if the price of crops goes up during crop harvesting, the farmer
can suffer from a loss in the future market, and he can repay it by selling
his crop at a higher price in the local market.
 2. What is the need of derivatives in the commodity
markets?
Derivatives evolved from simple commodity future contracts into a diverse
group of financial instruments that apply to every kind of asset, including
mortgages, insurance and many more. Futures
contracts, Swaps, (Exchange-traded Commodities (ETC), forward
contracts, etc. are examples. They can be traded through formal exchanges
or through Over-the-counter (OTC). Commodity market derivatives unlike
credit default derivatives, for example, are secured by the physical assets
or commodities.

Forward contracts
A forward contract is an agreement between two parties to exchange at a
fixed future date a given quantity of a commodity for a specific price
defined when the contract is finalized. The fixed price is also called forward
price. Such forward contracts began as a way of reducing pricing risk in
food and agricultural product markets. By agreeing in advance on a price
for a future delivery, farmers were able protect their output against a
possible fall of market prices and in contrast buyers were able to protect
themselves against a possible rise of market prices.
Forward contracts, for example, were used for rice in seventeenth century
Japan.

Futures contract
Future contracts are standardized forward contracts that are transacted
through an exchange. In futures contracts the buyer and the seller stipulate
product, grade, quantity and location and leaving price as the only variable.

Agricultural futures contracts are the oldest, in use in the United States for
more than 170 years. Modern futures agreements, began in Chicago in the
1840s, with the appearance of grain elevators. Chicago, centrally located,
emerged as the hub between Midwestern farmers and east coast
consumer population centers.

Swaps
A swap is a derivative in which counter parties exchange the cash flows of
one party's financial instrument for those of the other party's financial
instrument. They were introduced in the 1970s

Exchange-traded commodities (ETCs)

Exchange-traded commodity is a term used for commodity exchange
traded funds (which are funds) or commodity exchange traded notes
(which are notes). These track the performance of an underlying
commodity index including total return indices based on a single
commodity. They are similar to ETFs and traded and settled exactly like
stock funds. ETCs have market maker support with guaranteed liquidity,
enabling investors to easily invest in commodities.
They were introduced in 2003.

At first, only professional institutional investors had access, but online

exchanges opened some ETC markets to almost anyone. ETCs were
introduced partly in response to the tight supply of commodities in 2000,
combined with record low inventories and increasing demand from
emerging markets such as China and India.

Over-the-counter (OTC) commodities derivatives

Over The Counter (OTC) commodities derivatives trading originally
involved two parties, without an exchange. Exchange trading offers greater
transparency and regulatory protections. In an OTC trade, the price is not
generally made public. OTC commodities derivatives are higher risk but
may also lead to higher profits.
 3. How does a speculator make money through
derivatives? Give example of any one commodity.

Speculators earn a profit when they offset futures contracts to their

benefit. To do this, a speculator buys contracts then sells them back at a
higher (contract) price than that at which they purchased them.
Conversely, they sell contracts and buy them back at a lower (contract)
price than they sold them. In either case, if successful, a profit is made.

Often times, speculators specialize in particular commodities. If the

speculator is a CME member, you’ll find them in their favorite trading pits
at the exchange. For example, a private speculator may specialize in
Eurodollars and trade only in the Eurodollar pit day after day. Each
speculator will trade according to his or her own style. Some traders are
scalpers who buy and sell futures contracts quickly when prices move only
a fraction of a cent. Others are day traders who will buy and sell throughout
the day, closing their position before the session ends. Others are position
traders who may hold their positions for days, weeks or months at a time.

Speculators enter the futures market when they anticipate prices are going
to change. While they put their money at risk, they won’t do so without
first trying to determine to the best of their ability whether prices are
moving up or down.

Speculators analyses the market and forecast futures price movement as

best they can. They may engage in the study of the external events that
affect price movement or apply historical price movement patterns to the
current market. In any case, the smart speculator doesn’t operate blind.

A speculator who anticipates upward price movement would want to take

advantage by buying future contract.
If predictions are correct, then the contracts can be sold later at a profit. If
it’s expected that prices were going to move downward, the speculator
would want to sell now and, if all goes as planned, buy back later at a lower
price.

A commodity is a basic good used in commerce that is interchangeable

with other goods of the same type. Traditional examples of commodities
include grains, gold, beef, oil, and natural gas.

4. How an arbitrageur makes risk free profit through

an arbitrage trade?
An arbitrageur is an individual who earns profits by taking advantage of
inefficiencies in financial markets. Arbitrage opportunities arise when an
asset is priced differently between multiple markets at the same time. Such
price differences are inefficiencies resulting from deficiencies in the
marketplace.

A successful arbitrageur profits by simultaneously purchasing financial

assets at a lower price and selling them at a higher price, pocketing the
difference. By taking advantage of the inefficiencies, arbitrageurs can earn
risk-free profits because the financial assets being traded are equivalent.
In turn, the actions of the arbitrageur result in greater market efficiency by
causing asset prices to equalize.

Arbitrage can be used whenever any stock, commodity, or currency may

be purchased in one market at a given price and simultaneously sold in
another market at a higher price. The situation creates an opportunity for
a risk-free profit for the trader.
The concept of arbitrage is quite simple. By taking advantage of price
differences in equivalent assets, an arbitrageur can make risk-free profits
by buying low and selling high.

Suppose you can buy avocados from a farm at $1.00 each. Soon after, you
sell the avocados to a local restaurant at $1.50 each. In this case, you earn
a profit of 50 cents for each avocado you sell.

Financial arbitrage is similar, but the prices of financial assets can change
on a moment’s notice. To take advantage of price differences in assets
like stocks, the transactions must occur simultaneously to ensure that the
prices do not change during the transaction.

An arbitrageur uses trading strategies designed to profit from small

differences in the price of equivalent assets. The assets can be stocks,
bonds, currencies, commodities, or any other financial instruments that
can be bought and sold. Deficiencies in financial markets, such as delays in
updating stock prices, can result in prime opportunities for an arbitrageur.

To conduct arbitrage, an investor purchases stocks on one exchange while

simultaneously selling the same stock on another exchange. If the
transaction happens simultaneously, there is no chance that the stock
price will change during the transaction. By selling the same stock at a
higher price, the arbitrageur can earn a risk-free profit equal to the
difference between the mispriced assets.

Due to the incremental price differences and time-sensitive nature, most

arbitrage trades involve institutional investors, such as hedge funds or
banks. For most retail investors who trade stocks on their smartphones,
arbitrage trades are difficult because of the significant technical resources
required to trade simultaneously between various stock exchanges.

Also, the price difference between the two financial assets can be
minuscule. Large sums of money are required to take advantage of small
price differences to ensure that arbitrage trades are profitable and
worthwhile.

By taking advantage of market inefficiencies, arbitrageurs help the

financial system by causing prices to equalize through a system of supply
and demand. When an arbitrageur buys an asset from cheaper markets
and sells the same asset in more expensive markets, the demand for the
asset in the cheaper market will increase, causing prices to go up. In
contrast, the more expensive market will see an increase in supply, causing
prices to decrease.

If enough arbitrage trades are conducted, the prices of assets between the
two markets will equalize and maximize overall efficiency. When market
prices are equalized with no potential for arbitrage, it is known as an
arbitrage equilibrium.

5. If you are holding a portfolio of different

commodities; how you will manage the risk of
portfolio value going down? What way
derivative can be used to manage the risk?

If you are investing in equity-related avenues to get high returns on

your investment portfolio without weighing the risks, you might not be
heading in the right direction. Every investment is exposed to certain risk
factors and the biggest mistake an investor makes is ignoring such risks.

Handle asset allocation properly

While asset allocation of your portfolio is largely dependent on equity,
debt and cash, it also depends on many personal factors such as your age,
risk tolerance, savings and financial goals. Thus, asset allocation is not only
about equity and debt but also about your situation, which plays a big role.
For instance, when it comes to asset allocation, a financial adviser will give
different advice to a 25-year- o l d and a 50-year-old. The advice will
also
differ for an age group if one is married and has kids or is single and
independent.

Diversify your investment

When you diversify your investment portfolio across investment product
types, your risk on the overall portfolio reduces. For instance, suppose you
invest 30% in stock A, 20% in insurance, 30% in fixed deposits and 20% in
real estate. So, if stock A price falls, your loss gets limited because 70% of
your investments are in other avenues.

Monitor your investments regularly

At times, the asset allocation you did a year ago might not work as per the
current market situation. In such a scenario, if you don’t monitor your
investments from time to time, the investment risk on your portfolio can
surge. Thus, it becomes important to keep a track of your investment
holdings. You must evaluate them on a timely basis because it helps bring
your portfolio back to proper asset allocation, in turn helping minimize the
risks.

Identify your risk tolerance capacity

Every individual has capacity to take risk while investing in the market. One
must determine the extent of risk one can take as per their age, income,
dependents, etc. while making investments. “Often, investors take more
risk than is warranted. And it gets highlighted when there is a market
downturn. Understanding your risk tolerance and the risks in your
investment portfolio could go a long way in avoiding emotional upheavals
as well as help you safeguard your money during adversities.

Maintain adequate liquidity

Keep expenses for 3-12 months in liquid and accessible asset classes.
Accumulating high volatility products can produce poor outcomes if you
need the money when that product or asset is going through a down cycle.
By having a cushion of liquid assets, you can let your higher volatility
products produce the intended outcomes by being invested in them for the
long-term.

Invest through the rupee-cost averaging method

With the help of the rupee cost averaging method, the cost at which you
buy units of stocks or mutual funds get an average out. This way, you get a
higher number of units when the market is down, and get the least number
of units when the market is up. To benefit from rupee cost averaging, you
need to invest through SIP or Systematic Investment Plan mode. SIP also
helps reduce the volatility factor, and as a result overall gain increases on
your investment portfolio.

6. What would be your suggestion to Maruti Udyog

Ltd. In a scenario of rising commodity prices like
steel, rubber, crude and other mettles that are
used in car production?
Prices of industrial commodities, including copper, steel, aluminum, lead,
nickel as well as precious metals such as gold and silver have seen a sharp
surge recently in the international market.

As the economic activities around the world are gearing up, the production
and demand for such commodities have risen.

The price of copper has risen over 27 percent in the last year while that of
steel has gained more than 17 percent. Aluminum rallied around 13
percent, zinc 21 percent, nickel 20 percent while iron ore more than 75
percent in the last one-year period.

Among precious metals, gold and silver prices have jumped over 25
percent and 53 percent, respectively.
This rally in the commodity prices was on the back of a number of factors.
These are:

Demand from China

An important factor behind the rally in the commodity prices from their
March lows has been the rising demand from China. The manufacturing
activities in the major Asian economy has been on the rise. This can be seen
as the Chinese factory output in November hit a 20-month high.

Supply disruptions

As the demand for industrial commodities was rising with the easing of
lockdowns globally, the supply chains are still disturbed and the
transportation issues prevail, pushing up commodity prices.

When material cost dominates the product manufacturing expenses

acquire materials for less money or amount or else find other ways to use
the material less in the building process. Always try to buy the materials in
large lots so that it will reduce the cost of the material. Try to find the right
and proper material so that it will play vital role in cost reduction also in
the production for quality purpose, if not then do not buy the goods.
To reduce the amount of discard materials always provide perfect training
and tooling. Try to establish the lean manufacturing dynamism like for
example TQM for savings.

Industry cost reduction scheme must be properly administered in an

organization by setting realistic standard Cost reduction should be
operated in every department in an organization especially the production
department in other to make sure that the numbers of finished goods are
properly accounted for. Target and standard should not be vague set as
this will be unrealistic in the course of comprising planned cost in an
organization. For effective cost control to be achieved there should be
proper data collection, data analysis and control administration. The target
fixed cost in an undertaken should not be treated as permanent form. They
should be reviewed whenever necessary and should be revised when
conditions change.