z

A REPORT ON

COMMODITY DERIVATIVES
WITH REFERENCE TO ZEN SECURITIES PVT. LIMITED. HYDERABAD

Project report submitted to J.N.T.University, Kakinada in partial fulfillment for the Award of the Degree of

MASTER OF BUSINESS ADMINISTRATION

Submitted by xxxxxxxx Regd.No.123456789

Under the esteemed guidance of Mr. G.V.SURYA PRASAD M.COM.,MBA,,MPHIL Lecturer in school of management studies

==================================================== JAWAHARLAL NEHRU TECHNOLOGICAL UNIVERSITY School of Management studies KAKINADA Batch -2010-12

DECLARATION

I, B.K.Prasad hereby declare that the Project Report that is being submitted here which is a result of the completion of the project on commodity derivatives with reference to Zen Securities Limited, HYDERABAD. The report has been written and submitted by me under the personal guidance of Mr.G.V.SURYA.PRASAD, faculty in the school of management studies, Jawaharlal Technological University Kakinada I further declare that it is my original work done as a part of my academic course and as not been submitted elsewhere.

B.K.PRASAD

ACKNOWLEDGEMENT

The completion of the project gives me an opportunity to convey my gratitude to all those who are in the finance helped me to reach a stage where I have the confidence to launch my career in the competitive world. I would like to express my heart full thanks to Mr. SURENDAR REDDY of ZEN SECURITIES LTD for his inspiration and timely help in completing the project. I owe my sincere thanks to our Director Mr. K. VIJAY KUMAR for having provided me with an opportunity to do this project in the area of my choice. The project would not have been possible without my faculty guide Mr.

G.V.SURYA.PRASAD for his excellent guidance who poured his whole hearted support and encouragement throughout my project. I take the opportunity to express my gratitude to the management and members of the JNTU for providing me an opportunity to have this project work done. Finally, I would like to thank my friends and my family members for their continuous encouragement and support during the entire course of the project.

(B.K.Prasad)

INDEX CONTENTS Pgno. 6

Chapter 1
INTRODUCTION 1.1 Executive summary 1.2 Introduction to Derivatives 1.3 Objective of the study 1.4 Scope of the study 1.5 Need of the study 1.6 Research methodology 1.7 Limitations of the study

7 8 10 10 10 10 11

Chapter 2
COMPANY PROFILE 2.1 Zen Securities Limited 2.2 Services offered by Zen securities

12

13 15

Chapter 3
INDUSTRY PROFILE 3.1 Industry overview 3.2 The regulatory authority 3.3 SEBI 3.4 MCX 3.5 NCDEX

18

19 20 21 23 25

Chapter 4
REVIEW OF THE LITERATURE 4.1 Definition of derivatives 4.2 History of derivatives 4.3 Types of derivatives

31

31 31 32
4

4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13

Trading futures Trading options About the commodity Commodity futures Advantages of futures Trading Mechanics of future trading Commodity orders Commodity derivatives in India Dematerialization & settlement of warehouse receipts Role of clearing house

34 39 43 46 46 47 52 56 58 61

Chapter 5
RESEARCH METHODOLOGY

65 66

Chapter 6
ANALYSIS & INTERPRETATION 6.1 6.2 Gold Crude oil

68

69 76

Chapter 7
RESEARCH FINDING S CONCLUSION SUGGESTIONS ABBREVATIONS BIBILOGRAPHY

83 84 86 87 88 89

List of tables and figures

CONTENTS Figure 1.1 Figure 3.1 Figure 3.2

TABLE- 3.1

Pg N0. 10 25 27 28

Typology of risk management system Commodities traded in MCX Commodities traded in NCDEX
Exchanges and commodities in which futures contracts are traded.

Figure 4.1 Figure 4.2 Table 6.1 Figure 6.1 Table 6.2 Figure 6.2 Figure 6.3

Types of derivatives Orders and execution flows in electronic future trade Trade list of gold Graph showing price fluctuations of gold Trade list of crude oil Graph showing price fluctuations of crude oil Graph showing correlation b/w gold & crude oil

34 54 75 76 80 83 83

CHAPTER 1 INTRODUCTION

1.1 EXECUTIVE SUMMARY

One of the interesting developments in financial market over the last 15 to 20 years has been the growing popularity of derivatives. In many situations, both hedgers and speculators find it more attractive to trade a derivative on an asset, commodity than to trade asset and commodity itself. Some commodity derivatives are traded on exchanges. In this report I have included history of commodity market. And after that I have discussed the mechanism of trading in commodity market in India. In this report I have taken a first look at forward, futures and options contract and other risk management instruments. Then after I have discussed the main components of future commodity trading like contract size, what actual margin is and delivery system etc. In the next section I discussed about the two major commodity exchanges in India that is MCX and NCDEX. How they are worked for developing this commodity market in India. And I have also given the list of other commodity exchanges in India.Then after I have discussed about the present scenario of commodity market in India. In the next I tried to analyze the trading pattern and investment pattern of commodity traders and other investors. This I have done through the help of historical data. On the basis of different charts prepared, I have at the end given the research findings and conclusion. And on the basis of my findings I have given suggestion and recommendation

1.2 INTRODUCTION TO DERIVATIVES

Instability of commodity prices has always been a major concern of the producers as well as the consumers in an agriculture dominated country like India. Farmers direct exposure to price fluctuations, for instance, makes it too risky for many farmers to invest in otherwise profitable activities. There are various ways to cope with this problem. Apart from increasing the stability of the market, various factors in the farm sector can better manage their activities in an environment of unstable prices through derivative markets. These markets serve a risk -shifting function, and can be used to lock -in prices instead of relying on uncertain price developments. There are a number of commodity-linked financial risk management instruments, which are used to hedge prices through formal commodity exchanges, over -the-counter (OTC) market and through intermediation by financial and specialized institutions who extend risk management services. These instruments are forward, futures and option contracts, swaps and commodity linked -bonds. While formal exchanges facilitate trade in standardized contracts like futures and options, other instruments like forwards and swaps are tailor made contracts to suit to the requirement of buyers and sellers and are available over-the counter. In general, these instruments are classified based on the purpose for which they are primarily used for price hedging, as part of a wider marketing strategy, or for price hedging in combination with other financial deals. While forward contracts and OTC options are trade related instruments, futures, exchange traded options and swaps between banks and customers are primarily price hedging instruments. In the case of swaps between intermediaries and producers, and commodity linked loans and bonds (CL&BS) price hedging are combined with financial deals. Forwards contracts are mostly OTC agreements to purchase or sell a specific amount of a commodity on a predetermined future date at a predetermined price. The terms and conditions of a forward contract are rigid and both the parties are obligated to give and take physical delivery of the commodity on the expiry of contract. The holders of forward contracts face spot (ready) price risk. When the prevailing spot price of the underlying commodity is higher than the agreed price on expiry of the contract, the buyer gains and the seller looses. The futures contracts are refined version of forwards by which the parties are insulated from bearing spot risk and are traded in organize exchanges. A detailed discussion on the futures contracts is presented in the next chapter.
9

Both forwards and futures contracts have specific utility to commodity producers, merchandisers and consumers. Apart from being a vehicle for risk transfer among hedgers and from hedgers to speculators, futures markets also play a major role in price discovery. Typology of risk management instruments

Fig. 1.1 The price risk refers to the probability of adverse movements in prices of commodities, services or assets. Agricultural products, unlike others, have an added risk. Many of them being typically seasonal would attract only lower price during the harvest season. The forward and futures contracts are efficient risk management tools, which insulate buyers, and sellers from unexpected changes in future price movements. These contracts enable them to lock-in the prices of the products well in advance. Moreover, futures prices give necessary indications to producers and consumers about the likely future ready price and demand and supply conditions of the commodity traded. The cash market or ready delivery market on the other hand is a time-tested market system, which is used in all forms of business to transfer title of goods.

10

1.3 OBJECTIVE OF THE STUDY:

To study the concepts of commodities trading in india. To study the role of commodities in Indian financial markets. To study in detail the role of futures and forwards. To know the investment pattern of commodity traders and people. To analyze the present situation of the commodities in Indian market and suggest for any improvements thereafter.

1.4 SCOPE OF THE STUDY:

For analyzing the trading pattern and investment pattern of commodities and to observe the fluctuations, I have taken data from the zenmoney. The study has only made a humble attempt at the evaluation of derivatives market only in Indian context. The study is limited to commodity derivatives.

1.5 NEED FOR THE STUDY: The study is undertaken to analyse the trading practices with special reference to commodity as tool of risk management techniques.
The study is to understand why commodity derivatives are required and the role they can play in risk management. To understand the functioning of commodity-linked financial risk management instruments in India. And also to analyze the reasons for price fluctuations in non-agricultural commodities like gold and crude oil.

1.6 RESEARCH METHODOLOGY To achieve the object of studying the commodities market in stoick market data have been collected.

11

primary data It refers to the first hand information and the data is collected through the way of interactions with the employees of ZEN MONEY. Secondary data: Company records, magazines, journals and websites were made use to collect secondary data regarding indices, operations of commodity market and growth patterns. The following are the steps involved in the study: 1. Selection of contract: The future contract selection is done for gold and crude oil and the contract duration is for three months. 2. Data collection: The data of gold and crude oil has been collected from the website www.ncdex.com. The data collected from different websites, journals, newspapers, textbooks and zenmoney has been used in preparation of project report.

1.7 LIMITATIONS OF THE STUDY:

Limitations are the limiting lines that restrict the work in some way or other. In this research study also there were some limiting factors, some of them are as under: The study is not based on international perspective of commodity markets. It is limited to national level only. The trade list for 3 months is considered ie., from 19apr2011 to 20 aug 2011. The study is limited for gold and crude oil. The analysis is confined to future contracts of gold and crude oil. The time period for project is 6 weeks.

12

CHAPTER 2 COMPANY PROFILE

13

COMPANY PROFILE

2.1 ZEN SECURITIES LTD.

Zen Securities Limited is one of the leading Hyderabad based financial services companies providing Financial and Investment related Services and Products. The Company commenced its membership on The Hyderabad Stock Exchange Ltd., Hyderabad as a proprietary concern of M/s K. Ravindra Babu, which was converted to a Limited company in February 1995 to Zen Securities Ltd. It has the distinction of being the First Corporate Member from Hyderabad and also the first A.P. based broking firm to start trading on the National Stock Exchange (NSE). ZEN is a registered Member on the Capital Market Segment and Futures & Options segment of NSE and a registered Member on the Capital Market Segment of BSE. ZEN is also a Depository Participant (DP) with National Securities Depository Ltd. (NSDL) and also with Central Depositories Services Ltd. (CDSL). ZEN is also a SEBI Registered Portfolio Manager offering Portfolio Management Services to customers. Zen Comtrade Pvt. Limited: It is a 100% subsidiary of ZSL and is a member of National Commodities & Derivatives Exchange Limited (NCDEX) and Multi Commodity Exchange (MCX). ZSL operates from Hyderabad and has branches/franchisees in Andhra Pradesh, Tamil Nadu and Orissa.

14

Services Offered by Zen Securities Limited: 1. Investment advisory services 2. Trading in cash market of NSE and BSE 3. Trading in Futures and Options on NSE and BSE 4. Internet Trading in Stocks, futures and Options both NSE and BSE 5. Mutual Funds advisory service 6. Depository Services in Both NSDL and CDSL 7. Trading in Commodities on MCX and NCDEX 8. Portfolio Management Services 9. NRI Investor Services 10. PAN Application Service 11. Mutual Fund KYC Registration Service 12. New Pension System(NPS) 13. Fixed Income Securities / Fixed Deposits / RBI Bonds / Tax Saving Bonds

15

2.2 ZEN SERVICES Stock Broking Zen Securities Limited provides the following equity related trading services to the investors: 1. Capital Market Segment of NSE 2. Futures & Options segment of NSE 3. Capital Market Segment of BSE 4. Capital Market Segment of BSE ZEN operates out of a spacious office in Hyderabad and has over 100 branches in the state of Andhra Pradesh, Orissa and Tamil Nadu. The Company has over 50 VSAT installations with over 300 CM trading terminals and over 150 F&O trading terminals. All the trading terminals are connected via a gigabit Ethernet. Zen has a Virtual Private Network (VPN) to provide trading backbone to all the branches. Zen has a strong compliance department that ensures compliance to all the guidelines of SEBI / SCRA / the Stock Exchanges / Depositories and all other regulatory and statutory bodies. Zen has an internal audit department that conducts regular audit of the operations. The company has a robust centralized Risk Management system. Commodity Broking ZEN Securities provides trading in Commodities through its subsidiary, Zen Comtrade Pvt. Ltd. Zen Comtrade Pvt. Ltd. is a member of: 1. National Commodities & Derivatives Exchange Limited (NCDEX) and 2. Multi Commodities Exchange (MCX) PMS (Portfolio Management Services) Portfolio Management Services may be the right option for individuals who: Want to invest their money in equities but do not have the required expertise. Are equipped with the required awareness and knowledge to invest in equities but do not have time to actively manage their portfolio.
16

Why ZEN PMS? In today's markets, equity investment has become a more involved activity and demands a greater awareness and in depth understanding of the business and economic variables that affect equity valuations. Stocks operate in a wonderful tax environment, with no tax on long-term capital gains and a minimal 10% tax on short-term capital gains. Also in this economy, there are no investment avenues other than stocks and real estate to earn inflation adjusted positive return and stocks offer more liquidity than real estate. Zen's portfolio managers fully understand these advantages of stocks and make them work in your favor. Zen's portfolio managers are supported by a strong research bureau that is well equipped to understand the market and deliver superior returns. Each portfolio is personalized keeping in mind your investment parameters, including return expectations, objectives, time horizon, liquidity constraints, a distinctive tax status, and most importantly, personal risk tolerances. New Pension System Zen Securities Limited is registered as POP (Point of Presence) for NPS-PFRDA. It takes care of functions relating to registration of subscribers, undertaking KYC verification, receiving contributions and instructions from subscribers and transmission of the same to designated NPS intermediaries. It has 25 branches that are acting as Point of Presence Service Providers (POP-SP) which provides services like subscriber registration, receiving regular contributions, modifications in address, nominations, bank details, grievance handling and MIS uploading etc. NRI Services ZEN Securities offers a total solution to its NRI clients. They offer services under the RBI's Portfolio Investment Scheme (PIS) to buy and sell shares through the Indian stock exchanges. They coordinate with the RBI approved Bank to open an NRI account. They also open the Brokerage account and the Demat Account for the NRI. These three accounts will be opened simultaneously in the NRI's name. They will coordinate the transfer of shares to/from NRI's demat account and money to/from NRI's bank account as per the settlement. They have setup a separate NRI Services team to guide the NRI through the application process and the day to day investment process.
17

Depository Services Zen is a depository participant offering flexible, cost effective and transparent depository services to its clients .Zen is a depository participant with the National Securities Depository Limited and Central Depository Services (India) Limited for trading and settlement of dematerialized shares. Zen performs clearing services for all securities transactions through its accounts. Zen offers depository services to create a seamless transaction platform execute trades through Zen Securities and settle these transactions through the Zen Depository Services. Zen Depository Services is a part of our value added services for our clients that creates multiple interfaces with the client and provides for a solution that takes care of all your needs. Basic Services Provided by Zen DP 1. Account Opening 2. Account Transfers - Market and Off-Market 3. De-materialization 4. Re-materialization 5. Pledge

18

CHAPTER 3 INDUSTRY PROFILE

19

INDUSTRY PROFILE

3.1 INDUSTRY OVERVIEW Commodity trading is one facility that investors can explore for investing their money. The Indian commodity market has undergone lots of changes due to the changing global economic scenario; thus throwing up many opportunities in the process. Demand for commodities both in the domestic and global market is estimated to grow by four times than the demand currently is by the next five years. The four categories of trading commodities include: 1. Energy (including crude oil, heating oil, natural gas and gasoline) 2. Metals (including gold, silver, platinum and copper) 3. Livestock and Meat (including lean hogs, pork bellies, live cattle and feeder cattle) 4. Agricultural (including corn, soybeans, wheat, rice, cocoa, coffee, cotton and sugar). Despite having a robust economy, indias share in the global commodity market is not as big as estimated. Except gold the share in other sectors of the commodity market is not very significant. India accounts for 3% of the global oil demands and 2% of global copper demands. In agriculture indias contribution to international trade volume is rather less compared to huge production base available. Various infrastructure development projects that are undertaken in india are being seen as a key growth driver in the coming days. The commodities and futures market in the country is regulated by Forward Markets Commission (FMC).

20

3.2 THE REGULATORY AUTHORITY: FMC Forward markets commission (FMC) headquartered at mumbai, is a regulatory authority for commodity futures market in india. It is a statutory body set up under forward contracts (regulation) act 1952. The exchanges are required to get prior approval of the FMC for opening of each contract in commodities which are notified under the relevant sections in FCRA 1952. The functions of FMC are as follows: a) To advice the central government in respect of the recognition or the withdrawal of recognition from any association or in respect of any other matter arising out of the administration of forward contracts act 1952. b) To keep forward market under observation and to take such actions in relation to them, as it may consider necessary, in exercise of the powers assigned to it by or under the act. c) To collect and whenever the commission thinks it necessary, to publish information regarding the trading conditions in respect of goods to which any of the provisions of the act is made applicable, including information regarding supply, demand and prices, and to submit to the central government, periodical reports on the working of forward markets relating to such goods. d) To make recommendations generally with a view to improving the organization and working of forwards markets e) To undertake the inspection of the accounts and other documents of any recognized association or registered association or any member of such association whenever it considers necessary. The commission functions under the administrative control of the ministry of consumer affairs, food & public distribution, department of consumer affairs, government of india. The act provide that the commission shall consist of not less than two but not exceeding four members appointed by the central government, out of them one being nominated by the central government to be the chairman of the commission. Currently the commission comprises of two members among whom Mr Ramesh Abhishek, IAS is the chairman, and Dr.M.Mathisekaran, IES is a member of the commission.

21

3.3 SEBI Introduction In 1988 the Securities and Exchange Board of India (SEBI) was established by the Government of India through an executive resolution, and was subsequently upgraded as a fully autonomous body (a statutory Board) in the year 1992 with the passing of the Securities and Exchange Board of India Act (SEBI Act) on 30th January 1992. In place of Government Control, a statutory and autonomous regulatory board with defined responsibilities, to cover both development & regulation of the market, and independent powers had been set up. Paradoxically this is a positive outcome of the Securities Scam of 1990-91. The basic objectives of the Board were identified as 1. 2. 3. 4. To protect the interests of investors in securities To promote the development of Securities Market To regulate the securities market and For matters connected there with or incidental there to

SEBI has introduced the comprehensive regulatory measures, prescribed registration norms, the eligibility criteria, the code of obligations and the code of conduct for different intermediaries like, bankers to issue, merchant bankers, brokers and sub-brokers, registrars, portfolio managers, credit rating agencies, underwriters and others. It has framed bye-laws, risk identification and risk management systems for Clearing houses of stock exchanges, surveillance system etc. which has made dealing in securities both safe and transparent to the end investor. Another significant event is the approval of trading in stock indices (like S&P CNX Nifty & SENSEX) in 2000. A market Index is a convenient and effective product because of the following reasons: 1. 2. 3. 4. It acts as a barometer for market behavior; It is used to benchmark portfolio performance; It is used in derivative instruments like index futures and index options; It can be used for passive fund management as in case of Index Funds.

22

SEBI - SEBI Administration The Securities and Exchange Board of India Act, 1992 is having retrospective effect and is deemed to have come into force on January 30, 1992. Relatively a brief act containing 35 sections, the SEBI Act governs all the Stock Exchanges and the Securities Transactions in India. A Board by the name of the Securities and Exchange Board of India (SEBI) was constituted under the SEBI Act to administer its provisions. It consists of one Chairman and five members. One each from the department of Finance and Law of the Central Government, one from the Reserve Bank of India and two other persons and having its head office in Bombay and regional offices in Delhi, Calcutta and Madras. The Central Government reserves the right to terminate the services of the Chairman or any member of the Board. The Board decides questions in the meeting by majority vote with the Chairman having a second or casting vote. Section 11 of the SEBI Act provides that to protect the interest of investors in securities and to promote the development of and to regulate the securities market by such measures, it is the duty of the Board. It has given power to the Board to regulate the business in Stock Exchanges, register and regulate the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers, etc., also to register and regulate the working of collective investment schemes including mutual funds, to prohibit fraudulent and unfair trade practices and insider trading, to regulate take-over, to conduct enquiries and audits of the stock exchanges, etc. All the stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deed, registrars to an issue, merchant bankers, underwriters, portfolio managers, investment advisers and such other intermediary who may be associated with the Securities Markets are to register with the Board under the provisions of the Act, under Section 12 of the Sebi Act. The Board has the power to suspend or cancel such registration. The Board is bound by the directions vested by the Central Government from time to time on questions of policy and the Central Government reserves the right to supersede the Board. The Board is also obliged to submit a report to the Central Government each year, giving true and full account of its activities, policies and programs. Any one of the aggrieved by the Board's decision is entitled to appeal to the Central Government.

23

COMMODITY FUTURES EXCHANGES THE PROFILE AND REGULATORY ENVIRONMENT

3.4 Overview of MCX MCX an independent and de-mutualized multi commodity exchange has permanent recognition from Government of India for facilitating online trading, clearing and settlement operations for commodity futures markets across the country. Key shareholders of MCX include Financial Technologies (I) Ltd., State Bank of India (Indias largest commercial bank) & associates, Fidelity International, National Stock Exchange of India Ltd. (NSE), National Bank for Agriculture and Rural Development (NABARD), HDFC Bank, SBI Life Insurance Co. Ltd., Union Bank of India, Canara Bank, Bank of India, Bank of Baroda and Corporation Bank. Headquartered in Mumbai, MCX is led by an expert management team with deep domain knowledge of the commodity futures markets. Through the integration of dedicated resources, robust technology and scalable infrastructure, since inception MCX has recorded many first to its credit. MCX has built strategic alliances with some of the largest players in commodities eco-system, namely, Bombay Bullion Association, Bombay Metal Exchange, Solvent Extractors' Association of India, Pulses Importers Association, Shetkari Sanghatana, United Planters Association of India and India Pepper and Spice Trade Association. Vision and Mission The vision of MCX is to revolutionize the Indian commodity markets by empowering the market participants through innovative product offerings and business rules so that the benefits of futures markets can be fully realized .Offering 'unparalleled efficiencies', 'unlimited growth' and 'infinite opportunities' to all the market participants.

24

Commodities

Gold, Gold HNI, Gold M, I-Gold, Silver, Silver HNI, Silver M Castor Oil, Castor Seeds, Coconut Cake, Coconut Oil, Cottonseed, Crude Palm Oil, Groundnut Oil, Kapasia Khalli (Cottonseed Oilcake), Mustard /Rapeseed Oil, Mustard Seed (Sirsa), RBD Palmolein, Refined Soy Oil, Refined Sunflower Oil, Sesame Seed, Soymeal, Soy Seeds Cardamom, Jeera, Pepper, Red Chilli Aluminium, Copper, Lead, Nickel, Sponge Iron, Steel Flat, Steel Long (Bhavnagar), Steel Long (Gobindgarh), Tin, Zinc Cotton Long Staple , Cotton Medium Staple, Cotton Short Staple, Cotton Yarn, Kapasii Chana, Masur, Tur, Urad, Yellow Peas,

Basmati Rice, Maize, Rice, Sarbati Rice, Wheat

Brent Crude Oil, Crude Oil, Furnace Oil Middle East Sour Crude Oil

Arecanut, Cashew Kernel, Rubber High Density Polyethylene (HDPE), Polypropylene (PP), PVC Guar Seed, Guar gum, Gurchaku, Mentha Oil, Potato, Sugar M-30,
Fig. 3.1

25

PROFILE National Commodity & Derivatives Exchange Limited (NCDEX) is a professionally managed online multi commodity exchange promoted by ICICI Bank Limited (ICICI Bank), Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India Limited (NSE), Punjab National Bank (PNB), CRISIL Limited (formerly the Credit Rating Information Services of India Limited), Indian Farmers Fertilizer Cooperative Limited (IFFCO) and Canara Bank by subscribing to the equity shares have joined the initial promoters as shareholders of the Exchange. NCDEX is the only commodity exchange in the country promoted by national level institutions. This unique parentage enables it to offer a bouquet of benefits, which are currently in short supply in the commodity markets. The institutional promoters of NCDEX are prominent players in their respective fields and bring with them institutional building experience, trust, nationwide reach, technology and risk management skills. NCDEX is a public limited company incorporated on April 23, 2003 under the Companies Act, 1956. It obtained its Certificate for Commencement of Business on May 9, 2003. It has commenced its operations on December 15, 2003. NCDEX is a nation-level, technology driven de-mutualized on-line commodity exchange with an independent Board of Directors and professionals not having any vested interest in commodity markets. It is committed to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. Forward Market Commission regulates NCDEX in respect of futures trading in commodities. Besides, NCDEX is subjected to various laws of the land like the Companies Act, Stamp Act, Contracts Act, Forward Commission (Regulation) Act and various other legislations, which impinge on its working. NCDEX is located in Mumbai and offers facilities to its members in more than 550 centers throughout India. The reach will gradually be expanded to more centers.NCDEX currently facilitates trading of 45 commodities. At subsequent phases trading in more commodities would be facilitate.
26

NCDEX PRODUCT Agro Products

Cashew Chana Coffee Arabica Common Raw Rice Crude Palm Oil Expeller Mustard Oil Grade A Raw Rice Groundnut Expeller Oil Guar Seeds Jeera Lemon Tur Indian Raw Rice Indian 31 mm Cotton Masoor Grain Bold Mentha Oil Mulberry Raw Silk Pepper Rapeseed-Mustard Seed Oilcake Refined Soy Oil Sesame Seeds Sugar Turmeric V-797 Kapas Yellow Peas

Castor Seed Chilli Coffee Robusta Common Parboiled Rice Cotton Seed Oilcake Grade A Parboiled Rice Groundnut (in shell) Guar gum Gur Jute sacking bags Indian Parboiled Rice Indian 28 mm Cotton Maharashtra Lal Tur Medium Staple Cotton Mulberry Green Cocoons Mustard Seed Raw Jute RBD Palmolein Rubber Soyabean Yellow Soybean Meal Urad Wheat Yellow Red Maize

Base Metals Electrolytic Copper Cathode Mild Steel Ingots

Precious Metals Gold Silver

Fig. 3.2

27

TABLE- 3.1 EXCHANGES AND COMMODITIES IN WHICH FUTURES CONTRACTS ARE TRADED. NO EXCHANGE COMMODITY (both domestic and international

India Pepper & Spice Trade Pepper Association, Kochi (IPSTA) Vijai Beopar Chambers Muzaffarnagar Rajdhani Oils & Oilseeds Ltd., contracts)

Guar, Mustard seed

Exchange Ltd., Delhi Bhatinda Om & Oil Exchange Ltd., Bhatinda The Chamber Hapur The Meerut Agro Commodities Exchange Ltd., Meerut The Bombay of Commerce,

Guar, Mustard seed its oil & oil cake

Guar

Guar, Potatoes and Mustard seed

Guar

Commodity Oil seed Complex, Castor oil international contracts

Exchange Ltd., Mumbai

Rajkot Seeds, Oil & Bullion oil & cake, cottonseed, its oil & cake, Merchants Association, Rajkot The Ahmedabad cotton (kapas) and RBD palmolein. cottonseed,

Commodity Castorseed, oil and oilcake

Exchange, Ahmedabad The East India Jute & Hessian Exchange Ltd., Calcutta The East India Ltd., Cotton

10

Hessian & Sacking

11

Association

Mumbai Cotton

28

12

The

Spices

&

Oilseeds

Exchange Ltd., Sangli.

Turmeric

Soya

seed,

Soyaoil

and

Soya

meals.

Rapeseed/Mustardseed oil 13 National Indore Board of Trade, RBD

and oilcake and

Palmolien ( Also granted in-principle approval of Nationwide Multi-commodity Status) Exchange

14

The first Commodities Exchange of India Ltd., Kochi Central India Commercial

Copra/coconut, its oil & oil cake

15

Exchange Ltd., Gwalior E-sugar India Ltd., Mumbai National Multi-Commodity of India

Guar and Mustard seed

16

Sugar

**17

Exchange Ahmedabad Coffee

Ltd., Several Commodities

18.#

Futures

Exchange

India Ltd., Bangalore Surendranagar Cotton Oil & Oilseeds , Surendranagar E-Commodities Ltd., New Delhi National Commodity &

Cofee

19

Cotton, Cottonseed, Kapas

20

Sugar (trading yet to commence)

21** Derivatives, Mumbai Multi

Exchange Ltd., Several Commodities

22**

Commodity

Exchange

Ltd., Mumbai

Several Commodities

29

23

Bikaner

commodity

Mustard Guarseed. Guar Gum

seeds

its

oil

& oilcake, Gram.

ExchangeLtd., Bikaner

24

Haryana Ltd.,Hissar

Commodities

Mustard seed complex

25

Bullion Association Ltd.,Jaipur

Mustard seed complex

In-principle approval for trading in the specified commodities has been given to the following Exchanges/proposed Exchanges:-

Serial. No. 1. 2.

Name of the Association

Commodities

M/s. NCS InfoTech Ltd., Hyderabad Unites Planters Association of South India, Connors (u/s 14B)

Sugar Tea

3.

SGI Commodity Exchange, Mumbai

Soya bean Ground nut their oils and oilcakes.

30

CHAPTER 4 REVIEW OF LITERATURE

31

REVIEW OF LITERATURE 4.1 Derivatives

The term "Derivative" indicates that it has no independent value, i.e. its value is entirely "derived". A derivative is a financial instrument, which derives its value from some other financial price. This other financial price is called underlying. The most common underlying assets include stocks, bonds, commodities, currencies, livestock, interest rates and market indexes. A wheat farmer may wish to contract to sell his harvest at a future date to eliminate the risk of a change in prices by that date. The price for such a contract would obviously depend upon the current spot price of wheat. Such a transaction could take place on a wheat forward market. Here, the wheat forward is the derivative and wheat on the spot market is the underlying. The terms derivative contract, derivative product, or derivative are used interchangeably. Examples of Derivatives A very simple example of derivatives is cloth, which is derivative of cotton. The price of cloth depends upon the price of cotton, which in turn depends upon the demand, and supply of cotton. There are two broad types of derivatives: Financial derivatives: - Here the underlying includes treasuries, bonds, stocks, stock index, foreign exchange etc. Commodity derivatives: Here the underlying is a commodity such as wheat, cotton, peppers, turmeric, corn, soybeans, rice crude oil etc. 4.2 HISTORY The first organized commodity exchange came into existence in the early 1700s in Japan. The first formal commodities exchange, the Chicago board of trade (CBOT), was formed in 1848 in the US to deal with the problem of credit risk and to provide centralized location to negotiate forward contracts, where forward contracts on various commodities were standardized around 1865.The primary market intention of the CBOT was to provide a centralized location known in advance for buyers and sellers to negotiate forward contracts. In 1865, the CBOT went one step further and listed the first futures contracts. In 1919, Chicago Butter and Egg Board, a spin-off of CBOT, was recognized to allow futures trading. Its name was changed to Chicago Mercantile Exchange (CME). The CBOT and the CME remain the two largest organized futures exchanges, indeed the two largest
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financialexchanges of any kind in the world today. From then on, futures contracts have remained more or less in the same form, as we know them today. The first stock index futures contract was traded at Kansas City Board of Trade. Currently the most popular stock index futures contract in the world is based on S & P 500 index, traded on Chicago Mercantile Exchange. During the mid eighties, financial futures became the most active derivative instruments generating volumes many times more than the commodity futures. Index futures, futures on T-bills and Euro-Dollar futures are the three most popular futures contracts traded today. Other popular international exchanges that trade derivatives are LIFFE in England, DTB in Germany, SGX in Singapore, TIFFE in Japan, MATIF in France etc. However, the advent of modern day derivative contracts is attributed to the need for farmers to protect themselves from any decline in the price of their crops due to delayed monsoon, or overproduction. Although trading in agricultural and other commodities has been the driving force behind the development of derivatives exchanges, the demand for products based on financial instruments - such as bond, currencies, stocks and stock indiceshas now far outstripped that for the commodities contracts. India has been trading derivatives contracts in silver, gold, spices, coffee, cotton and oil etc for decades in the gray market. Trading derivatives contracts in organized market was legal before Morarji Desais government banned forward contracts. Derivatives on stocks were traded in the form of Teji and Mandi in unorganized markets. Recently futures contract in various commodities was allowed to trade on exchanges.

4.3 TYPES OF DERIVATIVES There are basically of 3 types of Derivatives and Futures: 1. 2. 3. Forwards and Futures Options Swaps

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Fig.4.1 FORWARD CONTRACT A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underlying assed on a certain specified future date for a certain specified price. The other party assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantity are negotiated bilaterally by the parties to the contract. The forward contracts are normally traded outside the exchanges. The salient features of forward contracts are: They are bilateral contracts hence exposed to counter-party risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset type and quality. The contract price is generally not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. It has to compulsorily go to the same counter party, which often results in high price being charged.

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Limitation of forward market: Forward market world-wide are afflicted by several problems: Lack of centralization Illiquidity Counterparty risk In the first two of these, the basic problem is that of too much flexibility and generality. The forward market is like a real estate market in that any two consenting adults can form contracts against each other. This often makes them design terms of the deal which are very convenient in that specific situation, but makes the contracts non-tradable. Counterparty risk arises from the possibility of default by any one party to the transaction. When one of the two sides to the transaction declares bankruptcy, the other suffers. Even when forward market trade standardized contracts, and hence avoids the problem of illiquidity, still the counterparty risk remains very serious issue. Illustration Sahil wants to buy a Laptop, which costs Rs 30,000 but he has no cash to buy it outright. He can only buy it 3 months hence. He, however, fears that prices of laptop will hike 3 months from now. So in order to protect himself from the rise in prices Sahil enters into a contract with the laptop dealer that 3 months from now he will buy the laptop for Rs 30,000. What Sahil is doing is that he is locking the current price of a LAPTOP for a forward contract. The forward contract is settled at maturity. The dealer will deliver the asset to Sahil at the end of three months and Sahil in turn will pay cash equivalent to the LAPTOP price on delivery. 4.4 FUTURES CONTRACT Futures markets were designed to solve the problems that exist in forward market. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. So, the counter party to a future contract is the clearing corporation of the appropriate exchange. To facilitate liquidity in the futures contracts, the exchange specifies certain standard features of the contract. It is a standardized contract with standard underlying instrument, a standard quantity and quality of the underlying instrument that can be delivered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. Future contracts are
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often settled in cash or cash equivalents, rather than requiring physical delivery of the underlying asset. A futures contract may be offset prior to maturity by entering into an equal and opposite transaction. More than 99% of futures transaction is offset this way. The standardized items in a futures contract are: Quantity of the Underlying. Quality of the Underlying. The date and month of delivery. The units of price quotation and minimum price change. Location of settlement. Distinction between futures and forwards contracts: Forward contracts are often confused with futures contracts. The confusion is primarily because both serve essentially the same economic functions of allocating risk in the presence of future price uncertainty. However futures are a significant improvement over the forward contracts as they eliminate counterparty risk and offer more liquidity. The distinction between futures and forwards aresummarizedbelow.

Futures 1.Trade on an organized exchange 2.Standardized contract terms 3.Hence more liquid 4.Requires margin payments

Forwards 1.OTC in nature 2.Customized contract terms 3.Hence less liquid 4.No margin payment 5.Settlement happens at the

5.follows daily settlement

end period

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OPTIONS CONTRACT Option means several things to different people. It may refer to choice or alternative or privilege or opportunity or preference or right. To have option is normally regarded good. Options are valuable since they provide protection against unwanted, uncertain happenings. They provide alternatives to bail out from a difficult situation. Options can be exercised on the happening of certain events. An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties. Options may be explicit or implicit. When you buy insurance on your house, it is an explicit option that will protect you in the event there is a fire or a theft in your house. If you own shares of a company, your liability is limited. Limited liability is an implicit option to default on the payment of debt. Options have assumed considerable significance in finance. They can be written on any asset, including shares, bonds, portfolios, stock indices currencies, etc. They are quite useful in risk management. For example, Rohit discover a bungalow that Rohit love to purchase. Unfortunately, Rohit won't have the cash to buy it for another three months. Rohit talk to the owner and negotiate a deal that gives Rohit an option to buy the bungalow in three months for a price of Rs.20,00,000. The owner agrees, but for this option, Rohit pay a price of Rs.50,000. Now, consider two theoretical situations that might arise: 1. It is discovered that the bungalow is actually having a historical importance! As a result, the market value of the bungalow increases to Rs. 50,00,000. Because the owner sold rohit the option, he is obligated to sell Rohit the bungalow for Rs.20,00,000. In the end Rohit stand to make a profit of Rs.29, 50,000. (Rs.50,00,000Rs.20,00,000Rs.50,000). 2. While touring the bungalow, Rohit discover not only that the walls are chock-full of asbestos, but also that it is a home place of numerous rats. Though Rohit originally thought Rohit had found the bungalow of Rohit dreams, Rohit now consider it worthless. On the upside, because Rohit bought an option, Rohit are under no obligation to go through with the sale. Of course, Rohit still loss the Rs.50,000 price of option.
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This example demonstrates two very important points. First, when Rohit buy an option, Rohit have a right but not an obligation to do something. Rohit can always let the expiration date go by, at which point the option becomes worthless. If this happens, Rohit lose 100% of Rohit investment, which is the money Rohit used to pay for the option. Second, an option is merely a contract that deals with an underlying asset. For this reason, options are called derivatives; means an option derives its value from something else. In our example, the bun glow is the underlying asset. Most of the time, the underlying asset is a stock or an index. Types of Options There are two types of options: Call Options: - It gives the holder the right to buy an asset at a certain price within a specific period of time. Calls are similar to having a long position on a stock. Buyers of calls hope that the stock will increase substantially before the option expires. Put Option: - It gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires. People who buy options are called holders and those who sell options are called writers; furthermore, buyers are said to have long positions, and sellers are said to have short positions. Here is the important distinction between buyers and sellers: Call holders and put holders (buyers) are not obligated to buy or sell. They have the choice to exercise their rights if they choose. Call writers and put writers (sellers), however, are obligated to buy or sell. This means that a seller may be required to make good on a promise to buy or sell.

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Terminology Associated With The Options Market. Option Price: - Option price is the price, which the option buyer pays to the option seller. It is also referred to as the option premium. Expiration Date: - The date specified in the options contract is known as the expiration date, the exercise date, the strike date or the maturity. Strike Price: - The price specified in the options contract is known as the strike price or the exercise price. Listed Options: - An option that is traded on a national options exchange such as the National Stock Exchange is known as a listed option. These have fixed strike prices and expiration dates. Each listed option represents a predetermined number of shares of company stock (known as a contract). In-the-money Option: - An in-the-money (ITM) option is an option that would lead to a positive cash flow to the holder if it were exercised immediately. A call option on the index is said to be in-the-money when the current index stands at a level higher than the strike price (i.e. spot price > strike price). If the index is much higher than the strike price, the call is said to be deep ITM. In the case of a put, the put is ITM if the index is below the strike price. At-the-money Option: - An at-the-money (ATM) option is an option that would lead to zero cash flow if it were exercised immediately. An option on the index is at-the-money when the current index equals the strike price (i.e. spot price = strike price). Out-of-the-money Option:- An out-of-the-money (OTM) option is an option that would lead to a negative cash flow when exercised immediately. A call option on the index is out-of-the-money when the current index stands at a level, which is less than the strike price (i.e. spot price < strike price). If the index is much lower than the strike price, the call is said to be deep OTM. In the case of a put, the put is OTM if the index is above the strike price. Depending on when an option can be exercised, it is classified in on of the following two categories: American Options: - American options are options that can be exercised at any time upto the expiration date. Most exchange-traded options are American.

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European Options: - European options are options that can be exercised only on the expiration date itself. European options are easier to analyze than American options, and properties of an American option are frequently deduced from those of its European counterpart. 4.5 TRADING IN OPTIONS If one buys an option contract he is buying the option, or "right" to trade a particular underlying instrument at a stated price. An option that gives you the right to eventually make a purchase at a predetermined price is called a "call" option. If you buy that right it is called a long call; if you sell that right it is called a short call. An option that gives you the right to eventually make a sale at a predetermined price is called a "put" option. If you buy that right it is called a long put; if you sell that right it is called a short put. Trading in Call Suppose a call option with an exercise/strike price equal to the price of the underlying (100) is bought today for premium Re.1. Profit/ Loss for a Long Call.

At expiry, if the securitys price has fallen below the strike price, the option will be allowed to expire worthless and the position has lost Re.1. This is the maximum amount that you can lose because an option only involves the right to buy or sell, not the obligation. In other words, if it is not in your interest to exercise the option you dont have to and so if you are an option buyer your maximum loss is the premium you have paid for the right.

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If, on the other hand, the securitys price rises, the value of the option will increase by Re.1 for every Re.1 increase in the securitys price above the strike price (less the initial Re.1 cost of the option). Note that if the price of the underlying increases by Re.1, the option purchaser breaks even breakeven is reached when the value of the option at expiry is equal to the initial purchase price. For our call option, the breakeven price is 101. If the price of the security is greater than 101, the call buyer makes money. Profit/Loss for a short call.

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

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

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

Difference between Future and Options Futures Options The buyer of the option has the right and not the seller obligation is under

Both the buyer and the seller Obligation are under obligation the contract. to fulfill

whereas

the

obligation to fulfill the contract. The seller is subject to unlimited risk of losing whereas the buyer has a limited potential to lose. The seller has limited potential to gain while the buyer has

Risk

The buyer and seller are subject to unlimited risk of losing.

Profit

The buyer and seller have unlimited potential to gain.

unlimited potential to gain.

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Price

It is one-dimensional as its price Depends on the price of

It is bi-dimensional as its price

Behavior

Depends upon both the price and the volatility of the underlying. Nonlinear payoff Strike price is fixed and price moves Price is always positive Only short at risk

the underlying only. Linear payoff

Payoff Price and Strike price Price Risk

Price is zero and strike price moves

Price is always zero Both long and short at risk

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

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4.6 ABOUT THE COMMODITY INTRODUCTION Keeping in view the experience of even strong and developed economies of the world, it is no denying the fact that financial market is extremely volatile by nature. Indian financial market is not an exception to this phenomenon. The attendant risk arising out of the volatility and complexity of the financial market is an important concern for financial analysts. As a result, the logical need is for those financial instruments which allow fund managers to better manage or reduce these risks. The emergence of the market for derivative products, most notably forwards, futures and options, can be traced back to the willingness of risk-averse economic agents to guard themselves against uncertainties arising out of fluctuations in asset prices. By their very nature, the financial markets are marked by a very high degree of volatility. Through the use of derivative products, it is possible to partially or fully transfer price risks by lockingin asset prices. As instruments of risk management, these generally do not influence the fluctuations in the underlying asset prices. However, by locking-in asset prices, derivative products minimize the impact of fluctuations in asset prices on the profitability and cash flow situation of risk-averse investors. COMMODITIES MARKET Organized futures market evolved in India by the setting up of "Bombay Cotton Trade Association Ltd." in 1875. In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name "Bombay Cotton Exchange Ltd." was constituted. Futures trading in oil seeds was organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab. A three-pronged approach has been adopted to revive and revitalize the market. Firstly, on policy front many legal and administrative hurdles in the functioning of the market have been removed. Forward trading was permitted in cotton and jute goods in 1998, followed by some oilseeds and their derivatives, such as groundnut, mustard seed, sesame, cottonseed etc. in 1999. A statement in the first ever National Agriculture Policy, issued in July, 2000 by the government that futures trading will be encouraged in increasing number of agricultural commodities was indicative of welcome change in the government policy towards forward trading.
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Secondly, strengthening of infrastructure and institutional capabilities of the regulator and the existing exchanges received priority. Thirdly, as the existing exchanges are slow to adopt reforms due to legacy or lack of resources, new promoters with resources and professional approach were being attracted with a clear mandate to set up dematerialized, technology driven exchanges with nationwide reach and adopting best international practices. The year 2003 marked the real turning point in the policy framework for commodity market when the government issued notifications for withdrawing all prohibitions and opening up forward trading in all the commodities. This period also witnessed other reforms, such as, amendments to the Essential Commodities Act, Securities (Contract) Rules, which have reduced bottlenecks in the development and growth of commodity markets. Of the country's total GDP, commodities related (and dependent) industries constitute about roughly 50-60 %, which itself cannot be ignored. Most of the existing Indian commodity exchanges are single commodity platforms; are regional in nature, run mainly by entities which trade on them resulting in substantial conflict of interests, opaque in their functioning and have not used technology to scale up their operations and reach to bring down their costs. But with the strong emergence of: National Multi-commodity Exchange Ltd., Ahmedabad (NMCE), Multi Commodity Exchange Ltd., Mumbai (MCX), National Commodities and Derivatives Exchange, Mumbai (NCDEX), and National Board of Trade, Indore (NBOT), all these shortcomings will be addressed rapidly. These exchanges are expected to be role model to other exchanges and are likely to compete for trade not only among themselves but also with the existing exchanges. The current mindset of the people in India is that the Commodity exchanges are speculative (due to non delivery) and are not meant for actual users. One major reason being that the awareness is lacking amongst actual users. In India, Interest rate risks, exchange rate risks are actively managed, but the same does not hold true for the commodity risks. Some additional impediments are centered on the safety, transparency and taxation issues. WHY COMMODITIES MARKET? India has very large agriculture production in number of agri-commodities, which needs use of futures and derivatives as price-risk management system. Fundamentally price you pay for goods and services depend greatly on how well business handle risk. By using effectively futures and derivatives, businesses can minimize risks, thus lowering cost of doing business.

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

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

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CHARACTERISTICS OF FUTURES TRADING A "Futures Contract" is a highly standardized contract with certain distinct features. Some of the important features are as under: Futures trading is necessarily organized under the auspices of a market association so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules & Bye-laws of the association. It is invariably entered into for a standard variety known as the "basis variety" with permission to deliver other identified varieties known as "tenderable varieties". The units of price quotation and trading are fixed in these contracts, parties to the contracts not being capable of altering these units. The delivery periods are specified. The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other pre-specified delivery centers. In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery of goods taking place. 4.10 MECHANICS OF FUTURES TRADING Futures are a segment of derivative markets. The value of a futures contract is derived from the spot (ready) price of the commodity underlying the contract. Therefore, they are called derivatives of spot market. The buying and selling of futures contracts take place in organized exchanges. The members of exchanges are authorized to carryout trading in futures. The trading members buy and sell futures contract for their own account and for the account of non-trading members and other clients. All other persons interested to trade in futures contracts, as clients must get themselves registered with the exchange as registered nonmembers.

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WHAT IS A COMMODITY FUTURE EXCHANGE? Exchange is an association of members, which provides all organizational support for carrying out futures trading in a formal environment. These exchanges are managed by the Board of Directors, which is composed primarily of the members of the association. There are also representatives of the government and public nominated by the Forward Markets Commission. The majority of members of the Board have been chosen from among the members of the Association who have trading and business interest in the exchange. The chief executive officer and his team in day-to-day administration assist the Board. There are different classes of members who capitalize the exchange by way of participation in the form of equity, admission fee, security deposits, registration fee etc. a. Ordinary Members: They are the promoters who have the right to have own account transactions without having the right to execute transactions in the trading ring. They have to place orders with trading members or others who have the right to trade in the exchange. b. Trading Members: These members execute buy and sell orders in the trading ring of the exchange on their account, on account of ordinary members and other clients. c. Trading-cum-Clearing Members: They have the right to trade and also to participate in clearing and settlement in respect of transactions carried out on their account and on account of their clients. d. Institutional Clearing Members: They have the right to participate in clearing and settlement on behalf of other members but do not have the trading rights. e. Designated Clearing Bank: It provides banking facilities in respect of pay-in, payout and other monetary settlements. The composition of the members in an exchange however varies. In so me exchanges there are exclusive clearing members, broker members and registered non -members in addition to the above category of members. WHAT IS COMMODITY FUTURES CONTRACT? Futures contracts are an improved variant of forward contracts. They are agreements to purchase or sell a given quantity of a commodity at a predetermined price, with settlement expected to take place at a future date. While forward contracts are mainly over-the-counter and tailor-made which physical delivery futures settlement standardized contracts whose
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transactions are made in formal exchanges through clearing houses and generally closed out before delivery. The closing out involves buying a different times of two identical contracts for the purchase and sale o the commodity in question, with each canceling the other out. The futures contracts are standardized in terms of quality and quantity, and place and date of delivery of the commodity. The commodity futures contracts in India as defined by the FMC has the following features: (a) Trading in futures is necessarily organized under the auspices of a recognized association so that such trading is confined to or conducted through members of the association in accordance with the procedure laid down in the Rules and Bye-laws of the association. (b) It is invariably entered into for a standard variety known as the basis variety with permission to deliver other identified varieties known as tender able varieties. (c) The units of price quotation and trading are fixed in these contracts, parties to the contracts not being capable of altering these units. (d) The delivery periods are specified. (e) The seller in a futures market has the choice to decide whether to deliver goods against outstanding sale contracts. In case he decides to deliver goods, he can do so not only at the location of the Association through which trading is organized but also at a number of other pre-specified delivery centers. (f) In futures market actual delivery of goods takes place only in a very few cases. Transactions are mostly squared up before the due date of the contract and contracts are settled by payment of differences without any physical delivery of goods taking place. The terms and specifications of futures contracts vary depending on the commodity and the exchange in which it is traded. The major terms and conditions of contracts traded in six sample exchanges in India. These terms are standardized and applicable across the trading community in the respective exchanges and are framed to promote trade in the respective commodity For example, the contract size is important for better management of risk by the customer. It has implications for the amount of money that can be gained or lost relative to a given change in price levels. I also affect the margins required and the commission charged. Similarly, the margin to be
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deposited with the clearing house has implications for the cash position of customers because it blocks cash for the period of the contract to which he is a party the strength and weaknesses of contract specifications are discussed under constraints and policy options. WHO ARE THE PARTICIPANTS IN FUTURES MARKET? Broadly, speculators who take positions in the market in an attempt to benefit from a correct anticipation of future price movements, and hedgers who transact in futures market with an objective of offsetting a price risk on the physical market for a particular commodity make the futures market in that commodity. Although it is difficult to draw a line of distinction between hedgers and speculators, the former category consists of manufacturing companies, merchandisers, and farmers. Manufacturing companies who use the commodity as a raw material buy futures to ensure its uninterrupted supply of guaranteed quality at a predetermined price, which facilitates immunity against price fluctuations. While exporters in addition to using the price discovery mechanism for getting better prices for their commodities seek to hedge against their overseas exposure by way of locking-in the price by way of buying futures contracts, the importers utilize the liquid futures market for the purpose of hedging their outstanding position by way of selling futures contracts. Futures market helps farmers taking informed decisions about their crop pattern on the basis of the futures prices and reduces the risk associated with variations in their sales revenue due to unpredictable future supply demand conditions. Above all, there are a large number of brokers who intermediate between hedgers and speculators create the market for futures contracts. How does futures contract facilitate hedging against price risk? The futures contracts are designed to deal directly with the credit risk involved in locking-in prices and obtaining forward cover. These contracts can be used for hedging price risk and discovering future prices. For commodities that compete in world or national markets, such as coffee, there are many relatively small producers scattered over a wide geographic area. These widely dispersed producers find it difficult to know what prices are available, and the opportunity for producer, processor, and merchandiser to ascertain their likely cost for coffee and develop long range plans is limited. Futures trading, used in the Midwest for grains and similar farm commodities since 1859, and adapted for coffee in 1955, provides the industry with a guide to what coffee is worth now as well as todays best estimate for the future. Moreover, since all transactions are guaranteed through a central body, clearing house, which
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is the counter party to each buyer and seller ensuring zero default risk, market participants need not worry about their counterparts creditworthiness. Hedge is a purchase or sale on a futures market intended to offset a price risk on the physical (ready) market. It involves establishing a position in the futures market again ones position or firm commitments in the physical market. The producers who seek to protect themselves from an expected decline in prices of their commodity in future go for short hedge (also called sell hedge). He undertakes the following operations in the market to lock-in the price in advance which he is going to receive after the product. I ready for physical sale. We assume that the producer anticipates a harvest of 5 metric tones (equivalent to 2 units of contracts in Cochin pepper exchange) of pepper in March, the futures price for March delivery of the specific variety of pepper is Rs.8400 per quintal (Rs.2.10lakh per unit, and the prevailing (say, October) ready market price is Rs.8100 per quintal. a. In October, the producer goes short (sells) in the futures market selling 2 March futures contracts at Rs.8400 per quintal. This is called price fixing. b. In the delivery month, futures prices dropped to Rs.8200 per quintal and the producer sells pepper in the ready market for Rs.8200. c. Simultaneously, he closes out his short position in futures by buying (long position) 2 March futures contracts at Rs.8200 per quintal. The result is that the producer sold futures contract at Rs.8400 and bought the same futures contract at Rs.8200 per quintal making a net gain of Rs.200 per quintal or Rs.5000 per contract. For the physical sale, the producer received the market price of Rs.8200 prevailing on the day of the sale and the gain of Rs.200 per quintal from closing-out of futures contracts makes him to realize Rs.8400 per quintal as initially locked -in by price-fixing. If the price realized in the ready market is lower than the price in future contract, the loss on the physical market is compensated by the higher price realized on the future contract. On the other hand, if the price in the ready market is higher than in futures contract, the gain in the ready market is offset by the loss on the repurchase of the futures contract. Since futures market prices move in tandem with the ready market prices over the course of time tending to converge as the contract matures, a gain in the futures market in a developed commodity market under normal conditions, will be offset by a loss in the ready market, or vice versa. However, market imperfections will lead to the basis risk emerging from the
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mismatch between the gain/loss from the futures market not compensated by loss/gain in the ready market. 4.9 COMMODITY ORDERS The buy and sell orders for commodity futures are executed on the trading floor where floor brokers congregate during the trading hours stipulated by the exchange. The floor brokers/trading members on receipt of orders from clients or from their office transmits the same to others on the trading floor by hand signal and by calling out the orders (in an open outcry system they would like to place and price. After trade is made with another floor broker who takes the opposite side of the transaction for another customer or for his own account, the details of transactions are passed on to the clearing house through a transaction slip on the basis o which the clearinghouse verifies the match and adds to its records. Following the experiences of stock exchanges with electronic screen based trading commodity exchanges are also moving from outdated open outcry system to automated trading system. Many leading commodity exchanges in the world including Chicago Mercantile Exchange (CME), Chicago Board of Trade (CBOT), International Petroleum Exchange (IPE), London, have already computerized the trading activities. In India, coffee futures exchange, Bangalore has already put in place the screen based trading and many others are in the process of computerization. To add to modernization efforts, the Bombay Commodity Exchange (BCE) has initiated for a common electronic trading platform connecting all commodity exchanges to conduct screen based trading. In electronic trading, trading takes place through a centralized computer network system to which all buy and sell orders and their respective prices are keyed in from various terminals of trading members. The deal takes place when the central computer finds matching price quotes for buy and sell. The entire procedural steps involved in electronic trading beginning from placing the buy/sell order to the confirmation of the transaction have been shown in figure -2.1 below.

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FIG 4.2 DIFFERENCE BETWEEN COMMODITY AND FINANCIAL DERIVATIVES The basic concept of a derivative contract remains the same whether the underlying happens to be a commodity or a financial asset. However, there are some features which are very peculiar to commodity derivative markets. In the case of financial derivatives, most of these contracts are cash settled. Since financial assets are not bulky, they do not need special facility for storage even in case of physical settlement. On the other hand, due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. Similarly, the concept of varying quality of asset does not really exist as far as financial underlyings are concerned. However, in the case of commodities, the quality of the asset underlying a contract can vary largely. This becomes an important issue to be managed.

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We have a brief look at these issues. I. Physical Settlement Physical settlement involves the physical delivery of the underlying commodity, typically at an accredited warehouse. The seller intending to make delivery would have to take the commodities to the designated warehouse and the buyer intending to take delivery would have to go to the designated warehouse and pick up the commodity. This may sound simple, but the physical settlement of commodities is a complex process. The issues faced in physical settlement are enormous. There are limits on storage facilities in different states. There are restrictions on interstate movement of commodities. Besides state level octroi and duties have an impact on the cost of movement of goods across locations. The process of taking physical delivery in commodities is quite different from the process of taking physical delivery in financial assets.We take a general overview at the process flow of physical settlement of commodities. Later on in chapter 9, we will look into the details of physical settlement through the Exchange providing platform for commodity derivatives trading, National Commodity and Derivatives Exchange Limited (NCDEX). Delivery notice period Unlike in the case of equity futures, typically a seller of commodity futures has the option to give notice of delivery. This option is given during a period identified as `delivery notice period'. Assignment Whenever delivery notices are given by the seller, the clearing house of the Exchange identifies the buyer to whom this notice may be assigned. Exchanges follow different practices for the assignment process. Delivery The procedure for buyer and seller regarding the physical settlement for different types of contracts is clearly specified by the Exchange. The period available for the buyer to take physical delivery is stipulated by the Exchange. Buyer or his authorized representative in the presence of seller or his representative takes the physical stocks against the delivery order. Proof of physical delivery having been effected is forwarded by the seller to the clearing house and the invoice amount is credited to the seller's account.
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The clearing house decides on the delivery order rate at which delivery will be settled. Delivery rate depends on the spot rate of the underlying adjusted for discount/ premium for quality and freight costs. The discount/ premium for quality and freight costs are published by the clearing house before introduction of the contract. The most active spot market is normally taken as the benchmark for deciding spot prices. II. Warehousing

One of the main differences between financial and commodity derivative is the need for warehousing. In case of most exchange-traded financial derivatives, all the positions are cash settled. Cash settlement involves paying up the difference in prices between the time the contract was entered into and the time the contract was closed. For instance, if a trader buys futures on a stock at Rs.100 and on the day of expiration, the futures on that stock close at Rs.120, he does not really have to buy the underlying stock. All he does is take the difference of Rs.20 in cash. Similarly, the person who sold this futures contract at Rs.100 does not have to deliver the underlying stock. All he has to do is pay up the loss of Rs.20 in cash. In case of commodity derivatives however, there is a possibility of physical settlement. It means that if the seller chooses to hand over the commodity instead of the difference in cash, the buyer must take physical delivery of the underlying asset. This requires the Exchange to make an arrangement with warehouses to handle the settlements. The efficacy of the commodities settlements depends on the warehousing system available. Such warehouses have to perform the following functions: Earmark separate storage areas as specified by the Exchange for storing commodities; Ensure proper grading of commodities before they are stored; Store commodities according to their grade specifications and validity period; and Ensure that necessary steps and precautions are taken to ensure that the quantity and grade of commodity, as certified in the warehouse receipt, are maintained during the storage period. This receipt can also be used as collateral for financing. In India, NCDEX has accredited over 775 delivery centers which meet the requirements for the physical holding of goods that are to be delivered on the platform. As future trading is delivery based, it is necessary to create the logistics support for the same.

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III. Quality of Underlying Assets A derivatives contract is written on a given underlying. Variance in quality is not an issue in case of financial derivatives as the physical attribute is missing. When the underlying asset is a commodity, the quality of the underlying asset is of prime importance. There may be quite some variation in the quality of what is available in the marketplace. When the asset is specified, it is therefore important that the Exchange stipulate the grade or grades of the commodity that are acceptable. Commodity derivatives demand good standards and quality assurance/ certification procedures. A good grading system allows commodities to be traded by specification. Trading in commodity derivatives also requires quality assurance and certifications from specialized agencies. In India, for example, the Bureau of Indian Standards (BIS) under the Department of Consumer Affairs specifies standards for processed agricultural commodities. AGMARK, another certifying body under the Department of Agriculture and Cooperation, specifies standards for basic agricultural commodities. 4.10 COMMODITY DERIVATIVES IN INDIA Commodity derivatives have a crucial role to play in the price risk management process especially in any agriculture dominated economy. Derivatives like forwards, futures, options, swaps etc are extensively used in many developed and developing countries in the world. However, they have been utilized in a very limited scale in India Although India has a long history of trade in commodity derivatives, this segment remained underdeveloped due to government intervention in many commodity markets to control prices. The government controls the production, supply and distribution of many agricultural commodities and only forwards and futures trading are permitted in certain commodity items. Free trade in many commodity items is restricted under the Essential Commodities Act, 1956, and forward and futures contracts are limited to certain commodity items under the Forward Contracts (Regulation) Act, 1952. The first commodity exchange was set up in India by Bombay Cotton Trade Association Ltd., and formal organized futures trading started in cotton in 1875. Subsequently, many exchanges came up in different parts of the country for futures trade in various commodities. The Gujarati Vyapari Mandali came into existence in 1900, which has undertaken futures trade in oilseeds first time in the country. The Calcutta Hessian Exchange Ltd and East India Jute Association Ltd were set up in 1919 and 1927 respectively for futures trade in raw jute.
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In 1921, futures in cotton were organized in Mumbai under the auspices of East India Cotton Association. Many exchanges came up in the agricultural centers in north India before world war broke out and engaged in wheat futures until it was prohibited. Futures in gold and silver began in Mumbai in 1920 and continued until the government prohibited it by mid-1950s. Later, futures trade was altogether banned by the government in 1966 in order to have control on the movement of prices of many agricultural and essential commodities. Options are though permitted now in stock market, they are not allowed in commodities. The commodity options were traded during the pre-independence period. Options on cotton were traded until the along with futures were banned in 1939. However, the government withdrew the ban on futures with passage of Forward Contract (Regulation) Act in 1952. After the ban of futures trade many exchanges went out of business and many traders started resorting to unofficial and informal trade in futures. On recommendation of the Khusro Committee in 1980 government reintroduced futures on some selected commodities including cotton, jute, potatoes, etc. Further in 1993 the government of India appointed an expert committee on forward markets under the chairmanship of Prof. K.N. Kabra and the report of the committee was submitted in 1994 which recommended the reintroduction of futures already banned and to introduce futures on many more commodities including silver. In tune with the ongoing economic liberalization, the National Agricultural Policy 2000 has envisaged external and domestic market reforms and dismantling of all controls and regulations in agricultural commodity markets. It has also proposed to enlarge the coverage of futures markets to minimize the wide fluctuations in commodity prices and for hedging the risk emerging from price fluctuations. In line with the proposal many more agricultural commodities are being brought under futures trading. In India, currently there are 15 commodity exchanges actively undertaking trading in domestic futures contracts, while two of them, viz., India Pepper and Spice Trade Association (IPST), Cochin and the Bombay Commodity Exchange (BCE) Ltd. have been recently upgraded to international exchanges to deal in international contracts in pepper and castor oil respectively. Another 8 exchanges are proposed and some of them are expected to start operation shortly. There are 4 exchanges, which are specifically approved for undertaking forward deals in cotton.
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4.11 Dematerialization and Settlement of Warehouse Receipts

NSDL, the first depository in the country was established in the year 1996 to remove the difficulties arising out of use of physical (paper) certificates for settlement of trades on stock exchanges and improving settlement efficiency. The depository system has successfully met its objectives. On the basis of the success of demat, rolling settlements were introduced and today, India is one among the few countries that have T + 2 rolling settlement system. With the increase in activity in the commodities futures market and establishment of national level screen-based multi-commodities exchanges, need for an efficient settlement system in that market is felt. Broadly, a commodity futures contract may be settled either by cash or by delivery of commodity depending upon the terms of the trade, demand of the buyer and rules of the exchange. If the trade is expected to be settled by way of delivery of commodity, the clearing house of the commodity exchange will receive warehouse receipts from the seller instead of actual commodities and pass such warehouse receipts over to the buyer. In case of national commodity exchanges, buyers and sellers could operate from different parts of the country and if warehouse receipts are in physical form, the warehouse receipts have to be delivered across the country from the seller to the buyer which could lead to systemic inefficiencies. Warehouse receipts are title documents issued by warehouses to depositors against the commodities deposited in the warehouses. These documents are transferred by endorsement and delivery. Either the original depositor or the holder in due course (transferee) can claim the commodities from the warehouse. Warehouse receipts in physical form suffer all the disadvantages of the paper form of title documents. Some of these limitations are as follows:

Need for splitting the warehouse receipt in case the depositor has an obligation to transfer only a part of the commodities;

Need to move the warehouse receipt from one place to another with risk of theft/mutilation, etc. if the transferor and transferee are at two different locations;

Risk of forgery.

Drawing lessons from the depository system for securities, NSDL and national level multicommodity exchanges have worked out a scheme to extend depository services for settling trades in commodity futures. Investors trading in commodity futures may follow the steps
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enumerated below to avail of depository services for receiving and delivering warehouse receipts. How to open a demat account for warehouse receipts? The securities demat account cannot be used for warehouse receipts. A separate account exclusively for warehouse receipts has to be opened. The agreement to open such account is different from the agreement used for securities account. Can demat account be opened with any Depository Participant (DP)? NSDL has enabled all its DPs to extend these services. But, national multi-commodity exchanges have empanelled some DPs for this purpose. A demat account can be opened only with such empanelled DPs. Who will issue warehouse receipts that can be dealt in NSDL depository system? Warehouses, that have entered into an agreement with NSDL and multi-commodity exchange, will issue depository eligible warehouse receipts. At present, NSDL has agreements with two multi-commodity exchanges viz., National Commodity & Derivatives Exchange Limited (NCDEX) and Multi Commodity Exchange of India Limited (MCX) and about 20 warehouses that hold Thirty Five commodities in their custody. An accountholder who wants warehouse receipt balances in its demat account, will have to quote the demat account number specifically opened for this purpose. Warehouse will credit warehouse receipts in the demat account using "corporate action" facility offered by NSDL. The balances so created can be used for transfer or settlement of commodity futures trade. What are the commodities for which warehouse receipts can be credited in demat accounts? At present, warehouse receipts for Thirty Five commodities deposited with the 20 warehouses can be credited to demat accounts. These commodities are Barley, Castor Seeds, Chana, Chilli, Coriander, Cotton Seed Oil Cake, Furnace Oil, Gold, Guar, Guar Gum, Gur, Jeera, Lemon Tur , Maharashtra Lal Tur, Maize, Masoor Grain Bold , Medium Staple Cotton, Mentha Oil, Pepper, Potato, Rapeseed Mustard, Raw Jute, Rubber, Sesame Seed, Silver,

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Soya Bean Seeds, Soya Meal Cold, Steel Long, Sugar, Turmeric, Wheat, Yellow Peas, Yellow Soyabean Meal, Black Pepper and Cardamon. How to give delivery of warehouse receipts in the depository system? Procedure for giving delivery of warehouse receipts is similar to giving delivery in securities market. Warehouse receipts may be transferred to the Clearing Member's account using Delivery Instruction Slip (DIS). However, in place of ISIN, Commodity Identifier (C-Id) will have to be quoted. How to claim delivery of commodities against warehouse receipts credited in the demat account? Commodities described in the warehouse receipts can be claimed for delivery by making a request in "Physical Delivery Request Form" for the desired quantity. Such request will reach the Registrar electronically through depository system. Registrar will send the details of the accountholder, including his/her signature, to the warehouse to enable the warehouse to release the delivery. The accountholder needs to submit to the warehouse, the acknowledgment given by the DP for the purpose of taking delivery. Warehouse may deliver the commodity after satisfying itself based on the details given in the "Physical Delivery Request Form" acknowledgment and details of accountholder given by the Registrar. The securities in the depository system are identified with ISIN number. How will the commodities be identified? The commodities in the NSDL Depository system are identified by a 12 digit commodity identifier [(C-Id), similar to the ISIN] and a commodity descriptor. The C-Id will include details of the commodity and its quality grade. The commodity descriptor describes the commodity more specifically, including the location in which the commodities are deposited. e.g. C-Id for Guar Seed deposited in VCO warehouse is INC000000223. The commodity descriptor for the said C-Id is 'NCDEX VCO WAREHOUSE JODHPUR GARSEDJDR GAR9116 METRIC TON 15SP04 '. The descriptor includes details related to the commodity exchange, warehouse, name of commodity, grade of commodity, expiry date (validity) and unit of measurement.

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4.12 ROLE OF CLEARING HOUSE Clearinghouse is the organizational set up adjunct to the futures exchange which handles all back-office operations including matching up of each buy and sell transactions, execution, clearing and reporting of all transactions, settlement of all transactions on maturity by paying the price difference or by arranging physical delivery, etc., and assumes all counterparty risk on behalf of buyer and seller. It is important to understand that the futures market is designed to provide a proxy for the ready (spot) market and thereby acts as a pricing mechanism and not as part of, or as a substitute for, the ready market. The buyer or seller of futures contracts has two options before the maturity of the contract. First, the buyer (seller) may take (give) physical delivery of the commodity at the delivery point approved by the exchange after the contract matures. The second option, which distinguishes futures from forward contracts is that, the buyer (seller) can offset the contract by selling (buying) the same amount of commodity and squaring off his

position. For squaring of a position, the buyer (seller) is not obligated to sell (buy) the original contract. Instead, the clearinghouse may substitute any contract of the same specifications in the process of daily matching. As delivery time approaches, virtually all contracts are settled by offset as those who have bought (long) sell to those who have sold (short). This offsetting reduces the open position in the account of all traders as they approach the maturity date of the contract. The contracts, if any, which remain unsettled by offset until maturity date are settled by physical delivery. The clearinghouse plays a major role in the process explained above by intermediating between the buyer and seller. There is no clearinghouse in a forward market due to which buyers and sellers face counterparty risk. In a futures exchange all transactions are routed through and guaranteed by the clearinghouse which automatically becomes a counterpart to each transaction. It assumes the position of counterpart to both sides of the transaction. It sells contract to the buyer and buys the identical contract from the seller. Therefore, traders obtain a position vis --vis the clearing house. It ensures default risk-free transactions and provides financial guarantee on the strength of funds contributed by its members and through collection of margins (discussed in section 2.3), marking-to-market all outstanding contracts, position limits imposed on traders, fixing the daily price limits and settlement guarantee fund. The organizational structure and membership requirements of clearinghouses vary from one exchange to the other. The Bombay Commodity Exchange and Cochin pepper exchange have
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set up separate independent corporations (namely, Prime Commodities Clearing Corporation of India Ltd, and First Commodities Clearing Corporation of India Ltd., respectively) for handling clearing and guarantee of all futures transactions in the respective exchanges. While coffee exchange has clearing house as a separate division of the exchange, many other exchanges like Chamber of Commerce, Hapur; Kanpur Commodity Exchange and cotton exchange in Bombay run in-house clearinghouse as part of the respective exchanges. The clearing and guaranty are managed in these exchanges by a separate committee (normally called the Clearing House Committee). The membership in the clearinghouse requires capital contribution in the form of equity, security deposit, admission fee, registration fee, guarantee fund contribution in addition to net worth requirement depending on its organizational structure. For example, in the Bombay Commodity Exchange the minimum capital requirement for membership in its clearinghouse as applicable to trading-cum-clearing members is Rs.50,000 each toward equity and security deposit, Rs. 500 as annual subscription, and additionally, members arerequired to have net worth of Rs.3 lakhs. Similarly, coffee exchange prescribed Rs.5 lakh each towards equity and guarantee fund contribution and Rs.40,000 towards admission fee for a trading-cum-clearing member. However, in exchanges where clearing house is a part of the exchange the payment requirements are lower. For example, Kanpur Commodity Exchange prescribed only Rs.25,00,000 Rs.1000 and Rs.500 respectively towards security deposit, registration fee and annual fee for a clearing cum-trading member. For ensuring financial integrity of the exchange and for counterparty risk -free trade position (exposure) limits have been imposed on clearing members. These limits which are stringent in some cases and are liberal in other cases are normally linked to the members contribution towards equity capital or security deposit or a combination of both and settlement guarantee fund. In Bombay Commodity Exchange the exposure limit of a clearing member is the sum of 50 times the face value of contribution to equity capital of the clearinghouse and 30 times the security deposit the member has maintained with the clearinghouse. While coffee exchange prescribes the limit of 80 times the sum of members equity investment and the contribution to the guarantee fund, the cotton exchange, Bombay, has stipulated a liberal exposure limit on open positions. It has a limit of 200 and 1500 units (recall that one contract unit is equivalent to 93.5 quintals respectively for composite and institutional members. The Cochin pepper
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exchange has fixed a net exposure limit of 60 units (equivalent to 1500 quintals) for domestic contract and 90 units (equivalent to 2250 quintals) for international contract. Moreover, setting up of settlement guarantee fund ensures enough financial strength in case the clearinghouse faces default. The Kanpur Commodity Exchange maintains a trade guarantee fund with a corpus of Rs.100 lakhs while the coffee exchange in addition to a guarantee fund the exchange has substituted itself as party to clear all transactions. Yet another check on the possible default is through prescribing maximum price fluctuation on any trading day, which helps limit the probable profit/loss from each unit of transaction. The relevant data on permitted price limit has been presented. Its clear from the table that the maximum profit/loss potential from trade in each contract unit varies from as low as Rs. 800 for potato futures in Chamber of Commerce, Hapur to as high as Rs. 15,000 in pepper exchange, Cochin. Similarly, given the permissible open position of 200 units for a tradingcum-clearing member and maximum price fluctuation of Rs. 150 per 100 kg for cotton futures in the cotton exchange, Bombay, the maximum potential loss/profit in a trading day works out to be Rs.28.05 lakhs! Margins Margins (also called clearing margins) are good -faith deposits kept with a clearinghouse usually in the form of cash. There are two types of margins to be maintained by the trader with the clearinghouse: initial margin and maintenance or variation margins. Initial margin is a fixed amount per contract and does not vary with the current value of the commodity traded. Margins are deposited with the clearing house in advance against the expected exposure of the trading member on his account and on account of the clients. The member who executes trade for them in turn collects this amount from the clients. Generally, the margin is payable on the net exposure of the member. Net exposure is the sum of gross exposure (buy quantity or sale quantity, whichever is higher, multiplied by the current price of the contract) on account of trades executed through him for each of his clients and gross exposure of trades carried out on his own account. However, for squaring-off transactions carried out only at the clients level, fresh margins are not required. The margin is refundable after the client liquidates his position or after the maturity of the contract.
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Maintenance margin which usually ranges from 60 to 80 per cent of initial margin is also required by the exchange. Variation margin is to compensate the risk borne by the clearinghouse on account of price volatility of the commodity underlying the contract to which it is a counterparty. A debit in the margin account due to adverse market conditions and consequent change in the value of contract would lead to initial margin falling below the maintenance level. The clearinghouse restores initial margin through margin calls to the client for collecting variation margin. In case of an increase in value of the contract, markingto-market ensures that the holder gets the payment equivalent to the difference between the initial contract value and its change over the lifetime of the contract on the basis of its daily price movements. If the member is not able to pay the variation margin, he is bound to square off his position or else the clearinghouse will be liquidating the position. The margins have important bearing on the success of futures. As they are non-interest bearing deposits payable to the clearinghouse up-front working capital of any trading entity gets blocked to that extent. While a higher margin requirement prevents traders from participating in trading, a lower margin makes the clearinghouse vulnerable to any default due to its weak financial strength otherwise. Internationally, many developed exchanges maintain a low margin on positions due to their better financial strength along with massive volume of trade resulting in large income accruing to them. However, this has not been the case with many exchanges in India. For example, as shown in table 2.2 the initial margin liability for transacting the minimum lot size in pepper is Rs.30, 000 for domestic contracts and US$ 312.50 for international contracts .Similarly, the volume of transactions. These clearinghouses deal in many exchanges in India is abysmally low making their existence financially unviable. Most of the exchanges in additions to keeping mandatory margins maintain a settlement guarantee fund. The fund set up with the contribution from members of clearing house is used for guaranteeing financial performance of all members. This fund absorbs losses not covered by margin deposits of the defaulted member. The clearinghouse ensures this by settling the default transactions by properly compensating the traders paying the amount of difference at the closing out rate.

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CHAPTER 5 RESEARCH METHODOLOGY

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RESEARCH METHODOLOGY
Definition: Research is an organized, systematic, data-based, critical, scientific inquiry into a specific problem that needs a solution. Scientific research has the goal of solving problems and establishing a step-by step logical, organized, and rigorous method to identify problems, gathers data, analyses the data, and draw valid conclusions there form.

AIM OF THE STUDY

The study is conducted to know the trading pattern of commodity derivatives and factors affecting the prices of gold & crude oil.

SOURCES OF DATA:
The data was collected through primary data It refers to the first hand information and the data is collected through the way of interactions with the employees of ZEN MONEY. Secondary data: Company records, magazines, journals and websites were made use to collect secondary data regarding indices, operations of commodity market and growth patterns.

Selection of contract: The future contract selection is done for gold and crude oil and the
contract duration is for three months.

DATA ANALYSIS
Analysis is done using Tables, Graphs & the market conditions existing during project. Duration: 6 weeks

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Limitations 1.The trade list for 3 months is considered ie., from 19apr2011 to 20 aug 2011. 2.The study is limited for gold and crude oil. 3.The analyses is confined to future contracts of gold and crude oil.

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CHAPTER 6 ANALYSIS AND INTERPRETATION

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ANALYSIS & INTERPRETATION

6.1GOLD: Gold is the oldest precious metal known to man and for thousands of years it has been valued as a global currency, a commodity, an investment and simply an object of beauty. Major Characteristics Gold (Chemical Symbol-Au) is primarily a monetary asset and partly a commodity. Gold is the world's oldest international currency. Gold is an important element of global monetary reserves. With regards to investment value, more than two-thirds of gold's total accumulated holdings is with central banks' reserves, private players, and held in the form of highkarat jewellery. Less than one-third of gold's total accumulated holdings are used as commodity for jewellery in the western markets and industry. Demand and Supply Scenario Gold demand in 2010 reached a 10-year high of 3,812.2 tonnes, worth US$150billon, as a result of; strong growth in jewellery demand; the revival of the Indian market; strong momentum in Chinese gold demand and a paradigm shift in the official sector, where central banks became net purchasers of gold for the first time in 21 years. China was the world's largest gold producer with 340.88 tonnes in 2010, followed by the United States and South Africa. In 2010, India was the world's largest gold consumer with an annual demand of 963 tonnes. The total supply of gold coming onto the market in 2010 reached 4,108 tonnes, a rise of 2% from 2009 levels.

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Global Scenario London is the worlds biggest clearing house. Mumbai is under India's liberalized gold regime. New York is the home of gold futures trading. Zurich is a physical turntable. Istanbul, Dubai, Singapore, and Hong Kong are doorways to important consuming regions. Tokyo, where TOCOM sets the mood of Japan.

Indian Scenario India is the largest market for gold jewellery in the world. 2010 was a record year for Indian jewellery demand; at 745.7 tonnes, annual demand was 13% above the previous peak in 1998. In local currency terms, Indian jewellery demand more than doubled in 2010. A 20% rise in the rupee price of gold combined with a 69% rise in the volume of demand, pushed up the value of gold demand by 101% to compares with 2009 demand of 669 billon. The rising price of gold, particularly in the latter half of 2010, created a 'virtuous circle' of higher price expectations among Indian consumers, which fuelled purchases, thereby further driving up local prices. Factors Influencing the Market Above ground supply of gold from central bank's sale, reclaimed scrap, and official gold loans. Hedging interest of producers/miners. World macroeconomic factors such as the US Dollar and interest rate, and economic events. Commodity-specific events such as the construction of new production facilities or processes, unexpected mine or plant closures, or industry restructuring, all affect metal prices. In India, gold demand is also determined to a large extent by its price level and volatility. 1,342 billion. This

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Measurement Weight Conversion Table To convert from Troy ounces Million ounces Grams Kilograms Tonnes Kilograms Kilograms Kilograms Troy ounces Troy ounces Troy ounces Avoirdupois ounces Short tone To Grams Tonnes Troy ounces Troy ounces Troy ounces Tolas Taels Bahts Grains Avoirdupois ounces Penny weights Troy ounces Metric tonne Multiply by 31.1035 31.1035 0.0321507 32.1507 32,150.70 85.755 26.7172 68.41 480.00 1.09714 20.00 0.911458 0.9072

Purity Gold purity is measured in terms of karat and fineness: Karat: pure gold is defined as 24 karat Fineness: parts per thousand Thus, 18 karat = 18/24 of 1,000 parts = 750 fineness

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Gold trade list from 19-apr-2011 to 20-aug-2011: Here I have taken the trade list of the expired contract on October 5th 2011 Date 19-Apr-11 20-Apr-11 21-Apr-11 23-Apr-11 25-Apr-11 26-Apr-11 27-Apr-11 28-Apr-11 29-Apr-11 30-Apr-11 2-May-11 3-May-11 4-May-11 5-May-11 6-May-11 7-May-11 9-May-11 10-May-11 11-May-11 12-May-11 13-May-11 14-May-11 16-May-11 17-May-11 18-May-11 19-May-11 20-May-11 21-May-11 23-May-11 24-May-11 25-May-11 26-May-11 27-May-11 28-May-11 30-May-11 Open(Rs) 22405 22431 22499 22596 22810 22540 22594 22849 22924 23305 23137 22799 23043 22834 22451 22523 22564 22698 22885 22569 22671 22556 22555 22517 22500 22488 22440 22641 22676 22786 22917 23000 22905 23055 23020 Close(Rs) 22431 22415 22517 22794 22652 22524 22751 22917 23229 23481 23314 23025 22743 22376 22405 22512 22664 22800 22527 22559 22547 22585 22535 22358 22505 22423 22651 22656 22789 22866 22981 22907 23043 23054 23031 PCP(Rs) 22442 22431 22415 22517 22794 22652 22524 22751 22917 23229 23481 23314 23025 22743 22376 22405 22512 22664 22800 22527 22559 22547 22585 22535 22358 22505 22423 22651 22656 22789 22866 22981 22907 23043 23054
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31-May-11 1-Jun-11 2-Jun-11 3-Jun-11 4-Jun-11 6-Jun-11 7-Jun-11 8-Jun-11 9-Jun-11 10-Jun-11 11-Jun-11 13-Jun-11 14-Jun-11 15-Jun-11 16-Jun-11 17-Jun-11 18-Jun-11 20-Jun-11 21-Jun-11 22-Jun-11 23-Jun-11 24-Jun-11 25-Jun-11 27-Jun-11 28-Jun-11 29-Jun-11 30-Jun-11 1-Jul-11 2-Jul-11 4-Jul-11 5-Jul-11 6-Jul-11 7-Jul-11 8-Jul-11 9-Jul-11 11-Jul-11 12-Jul-11 13-Jul-11 14-Jul-11

22995 22854 22989 22811 22937 22964 22970 22881 22820 22893 22804 22817 22624 22671 22715 22796 22800 22888 22941 22933 22928 22679 22449 22494 22368 22414 22436 22177 22040 22006 22048 22255 22490 22461 22618 22650 22812 23052 23225

22949 23033 22851 22933 22935 22981 22906 22794 22861 22805 22819 22636 22627 22690 22762 22859 22888 22920 22924 23001 22682 22436 22470 22350 22370 22414 22180 21897 21970 22018 22241 22473 22438 22595 22627 22750 22971 23196 23282

23031 22949 23033 22851 22933 22935 22981 22906 22794 22861 22805 22819 22636 22627 22690 22762 22859 22888 22920 22924 23001 22682 22436 22470 22350 22370 22414 22180 21897 21970 22018 22241 22473 22438 22595 22627 22750 22971 23196
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15-Jul-11 16-Jul-11 18-Jul-11 19-Jul-11 20-Jul-11 21-Jul-11 22-Jul-11 23-Jul-11 25-Jul-11 26-Jul-11 27-Jul-11 28-Jul-11 29-Jul-11 30-Jul-11 1-Aug-11 2-Aug-11 3-Aug-11 4-Aug-11 5-Aug-11 6-Aug-11 8-Aug-11 9-Aug-11 10-Aug-11 11-Aug-11 12-Aug-11 13-Aug-11 16-Aug-11 17-Aug-11 18-Aug-11 19-Aug-11 20-Aug-11

23201 23325 23387 23526 23296 23438 23234 23392 23410 23533 23460 23402 23388 23555 23475 23507 23920 24110 24100 24243 24700 25235 25788 26202 25796 25700 25729 26260 26400 27280 27597 Table 6.1

23277 23359 23518 23334 23401 23205 23407 23409 23538 23453 23418 23364 23543 23520 23507 23806 24055 24065 24156 24651 25242 25731 26204 25673 25640 25688 26225 26394 27174 27550 27954

23282 23277 23359 23518 23334 23401 23205 23407 23409 23538 23453 23418 23364 23543 23520 23507 23806 24055 24065 24156 24651 25242 25731 26204 25673 25640 25688 26225 26394 27174 27550

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30000

25000

20000

pcp(rs)

15000 PCP(Rs) 10000

5000

0 19-Apr-11

19-May-11

19-Jun-11

19-Jul-11

19-Aug-11

Date Fig6.1 gold

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6.2Crude oil: General characteristics:

Crude oil is a mixture of hydrocarbons that exists in a liquid phase in natural underground reservoirs. Oil and gas account for about 60 per cent of the total world's primary energy consumption.

Almost all industries including agriculture are dependent on oil in one way or other. Oil & lubricants, transportation, petrochemicals, pesticides and insecticides, paints, perfumes, etc. are largely and directly affected by the oil prices.

Aviation gasoline, motor gasoline, naphtha, kerosene, jet fuel, distillate fuel oil, residual fuel oil, liquefied petroleum gas, lubricants, paraffin wax, petroleum coke, asphalt and other products are obtained from the processing of crude and other hydrocarbon compounds.

The prices of crude are highly volatile. High oil prices lead to inflation that in turn increases input costs; reduces non-oil demand and lower investment in net oil importing countries.

Crude oil Units (Average Gravity):

1 US barrel = 42 US gallons. 1 US barrel = 158.98 litres. 1 tonne = 7.33 barrels . 1 short ton = 6.65 barrels .

Note: barrels per tonne vary from origin to origin.

Global Scenario:

Oil accounts for 40 per cent of the world's total energy demand. The world consumes about 76 million bbl/day of oil. United States (20 million bbl/d), followed by China (5.6 million bbl/d) and Japan (5.4 million bbl/d) are the top oil consuming countries.

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Balance recoverable reserve was estimated at about 142.7 billion tones (in 2002), of which OPEC was 112 billion tones.

OPEC fact sheet:

OPEC stands for 'Organization of Petroleum Exporting Countries'. It is an organization of eleven developing countries that are heavily dependent on oil revenues as their main source of income. The current Members are Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. OPEC controls almost 40 percent of the world's crude oil. It accounts for about 75 per cent of the world's proven oil reserves. Its exports represent 55 per cent of the oil traded internationally.

Indian Scenario
India ranks among the top 10 largest oil-consuming countries. Oil accounts for about 30 per cent of India's total energy consumption. The country's total oil consumption is about 2.2 million barrels per day. India imports about 70 per cent of its total oil consumption and it makes no exports. India faces a large supply deficit, as domestic oil production is unlikely to keep pace with demand. India's rough production was only 0.8 million barrels per day. The oil reserves of the country (about 5.4 billion barrels) are located primarily in Mumbai High, Upper Assam, Cambay, Krishna-Godavari and Cauvery basins. Balance recoverable reserve was about 733 million tones (in 2003) of which offshore was 394 million tones and on shore was 339 million tones. India had a total of 2.1 million barrels per day in refining capacity. Government has permitted foreign participation in oil exploration, an activity restricted earlier to state owned entities. Indian government in 2002 officially ended the Administered Pricing Mechanism (APM). Now crude price is having a high correlation with the international market price. As on date, even the prices of crude bi-products are allowed to vary +/- 10% keeping in line with international crude price, subject to certain government laid down norms/ formulae.

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Disinvestment/restructuring of public sector units and complete deregulation of Indian retail petroleum products sector is under way.

Prevailing Duties & Levies on Crude Oil:

Particulars Basic Customs Duty Cess NCCD* Education cess Octroi War fedge Rates 10% Rs.1800 per metric tonne Rs.50 per metric tonne 2% 3% Rs.57 per metric tonne

Market influencing factors:

OPEC output and supply . Terrorism, Weather/storms, War and any other unforeseen geopolitical factors that causes supply disruptions.

Global demand particularly from emerging nations. Dollar fluctuations. DOE / API imports and stocks. Refinery fires & funds buying.

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Crude oil trade list from 19-apr-2011 to 20-aug-2011: Here I have taken the trade list of the expired contract on October 19th 2011 Date 19-Apr-11 20-Apr-11 21-Apr-11 23-Apr-11 25-Apr-11 26-Apr-11 27-Apr-11 28-Apr-11 29-Apr-11 30-Apr-11 2-May-11 3-May-11 4-May-11 5-May-11 6-May-11 7-May-11 9-May-11 10-May-11 11-May-11 12-May-11 13-May-11 14-May-11 16-May-11 17-May-11 18-May-11 19-May-11 20-May-11 21-May-11 23-May-11 24-May-11 25-May-11 26-May-11 27-May-11 28-May-11 30-May-11 Open(Rs) 5039 5099 5201 5230 5239 5231 5227 5260 5265 5297 5232 5289 5201 5131 4769 4692 4716 4780 4915 4745 4694 4740 4701 4600 4655 4735 4662 4698 4681 4664 4687 4816 4783 4777 4754 Close(Rs) 5094 5180 5205 5236 5203 5224 5244 5300 5282 5297 5318 5260 5152 4873 4730 4692 4795 4887 4795 4720 4709 4741 4685 4585 4754 4684 4687 4702 4624 4690 4798 4790 4780 4777 4743 PCP(Rs) 4803 5094 5180 5205 5236 5203 5224 5244 5300 5282 5297 5318 5260 5152 4873 4730 4692 4795 4887 4795 4720 4709 4741 4685 4585 4754 4684 4687 4702 4624 4690 4798 4790 4780 4777
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31-May-11 1-Jun-11 2-Jun-11 3-Jun-11 4-Jun-11 6-Jun-11 7-Jun-11 8-Jun-11 9-Jun-11 10-Jun-11 11-Jun-11 13-Jun-11 14-Jun-11 15-Jun-11 16-Jun-11 17-Jun-11 18-Jun-11 20-Jun-11 21-Jun-11 22-Jun-11 23-Jun-11 24-Jun-11 25-Jun-11 27-Jun-11 28-Jun-11 29-Jun-11 30-Jun-11 1-Jul-11 2-Jul-11 4-Jul-11 5-Jul-11 6-Jul-11 7-Jul-11 8-Jul-11 9-Jul-11 11-Jul-11 12-Jul-11 13-Jul-11 14-Jul-11

4780 4842 4713 4723 4716 4676 4640 4635 4737 4764 4649 4654 4600 4617 4481 4445 4355 4308 4391 4370 4385 4310 4269 4417 4250 4331 4419 4375 4376 4389 4372 4495 4466 4502 4430 4401 4370 4462 4480

4832 4744 4682 4663 4721 4667 4631 4748 4754 4668 4649 4596 4585 4511 4465 4369 4356 4358 4358 4426 4291 4271 4272 4260 4300 4428 4389 4367 4381 4383 4478 4442 4499 4427 4429 4375 4453 4523 4379

4743 4832 4744 4682 4663 4721 4667 4631 4748 4754 4668 4649 4596 4585 4511 4465 4369 4356 4358 4358 4426 4291 4271 4272 4260 4300 4428 4389 4367 4381 4383 4478 4442 4499 4427 4429 4375 4453 4523
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15-Jul-11 16-Jul-11 18-Jul-11 19-Jul-11 20-Jul-11 21-Jul-11 22-Jul-11 23-Jul-11 25-Jul-11 26-Jul-11 27-Jul-11 28-Jul-11 29-Jul-11 30-Jul-11 1-Aug-11 2-Aug-11 3-Aug-11 4-Aug-11 5-Aug-11 6-Aug-11 8-Aug-11 9-Aug-11 10-Aug-11 11-Aug-11 12-Aug-11 13-Aug-11 16-Aug-11 17-Aug-11 18-Aug-11 19-Aug-11 20-Aug-11

4399 4458 4452 4415 4487 4478 4528 4530 4491 4504 4468 4403 4389 4334 4380 4303 4246 4190 3907 3990 3835 3824 3819 3808 3919 3956 4006 4013 4021 3801 3848

4450 4461 4384 4495 4462 4528 4532 4528 4499 4500 4432 4388 4338 4337 4302 4252 4193 3981 3991 3931 3868 3741 3774 3861 3986 3965 3990 4026 3847 3856 3835

4379 4450 4461 4384 4495 4462 4528 4532 4528 4499 4500 4432 4388 4338 4337 4302 4252 4193 3981 3991 3931 3868 3741 3774 3861 3986 3965 3990 4026 3847 3856

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6000

5000

4000

pcp(rs)

3000 PCP(Rs) 2000 PCP(Rs)

1000

0 19-Apr-11

19-May-11

19-Jun-11

19-Jul-11

19-Aug-11

Date Fig6.2 crude oil Graph between crude oil and Gold:
30000 25000 20000 15000 10000 5000 0 PCP(GOLD) PCP(CRUDE OIL)

The above graph shows that gold and crude oil both are negatively correlated. Fig 6.3

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CHAPTER 7

84

RESEARCH FINDINGS
The present project work has been undertaken to study the commodity derivatives on futures contract. This has been done using two contracts one each from gold and crude oil. In my study the following reasons have been identified for fluctuations in prices of gold and crude oil. Reasons for fluctuations of gold prices: The instability of the American economy has made many investors nervous, and there's been a lot of speculation about buying gold as a safe alternative to a market that continues to tank. Devaluation of The Dollar. With taxes cut, and government spending for high ticket items, such as the war in Iraq, continuing to rise, new money gets printed as fast as the presses can roll it out. The US dollar continues to lose its value compared to the Euro, the Yen and the Canadian dollar, as evidenced by the growing number of international tourists coming to the States, taking advantage of the comparatively cheap prices. Fear of Bank Failures. The Federal Deposit Insurance Corporation (FDIC) is expecting many bank failures in the next few years, due to the imploding housing bubble throughout the country, where too many loans were made, using shaky interest rate mechanisms. The resulting credit crunch will make it harder for people to take out loans, eliminating the biggest money maker for these banks.

Reasons for fluctuations of crude prices:

Like most of the things you buy, oil prices are affected by supply and demand. More demand, like the summer driving season, drives higher prices. There is usually less demand in the winter, since only the Northeast U.S. uses heating oil. Traders in oil futures bid on the price of oil based on what they think the future price will be. They look at projected supply and demand to determine the price. If traders think demand will increase because the global economy is growing, they will drive up the price of oil. Major factors determining oil prices: 1. US crude oil inventory levels: We all know that most of the crude oil that US uses gets imported from other countries which are rich in oil. To prevent the nation from going without oil, the governments has invested in building and maintaining about
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three months worth of reserve capacity of oil. That means if these OPEC countries decide to not export oil to US for whatever reason for a short period of time, the country can survive on just the reserves for three months! Also US is the largest consumer of oil in the entire world. Whenever the reserve capacity falls down in US for any reason (such as cold winter or heavy travel), the demand for oil goes up and that pushes the oil prices to end up higher. 2. Instability in Middle East. Middle East still currently supplies 80% of world oil. The only other big supplier outside of Middle East are Russia and Venezuela which are not our best friends. The Middle east countries have been facing political difficulties in forming stable democratic governments. So whenever there is power struggle in these countries, investors get concerned about the supply of oil and start selling their holdings which push the prices up. 3. Influence of Cartel (OPEC): Many of the OPEC countries have their entire economy based on high oil prices. Therefore for market manipulation at times they reduce the supply of crude oil by reducing production and that again increases the cost of a barrel of oil. 4. Recession: In a recession people reduce the amount they spent on travelling . Travelling industry is one of the biggest consumer of oil. Therefore in a recession demand for oil reduces. That in turn brings the prices down for oil in the market. 5. Speculations: Similar to MBS many investment bankers have created complex products around the crude oil prices. There are many double and triple indexed funds which are based on the price of oil. If uncertainty is high these products amplify the impacts on the actual prices and prices go up and down much more faster. You will be surprised to know how big of a role speculations play on the actual price of oil to consumers.

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CONCLUSION
Commodity derivatives have a crucial role to play in the price risk management process. Especially in any agriculture dominated economy. Derivatives like forwards, futures, options, swaps etc are extensively used in many developed as well as developing countries in the world. However, they have been utilized in a very limited scale in India The production, supply and distribution of many agricultural commodities are controlled by the government and only forwards and futures trading are permitted in certain commodity items. The most things I have seen are that the awareness of future commodity trading is still not there. People who knows, they believe that operators and big players in the market drive this future commodity market. Most of peoples feel that the qualities of the commodities are not as per the requirement. For the process of taking or giving delivery in future commodity market is lengthy, costly, and required so many documents. The option trading is still not allowed in commodity market so the risk management process is incomplete. Because we all know that future trading has its own limits. From the research study conducted on commodity derivatives, the fluctuations in commodity prices of gold and crude oil are observed for the past 3months and graphs are plotted to analyse these fluctuations. By analyzing the graphs it is observed that there is a negative correlation existing between gold and crude oil e. the prices of gold are increasing for the last three months. While the prices of crude oil are decreasingSo there exists a negative correlation between gold and crude oil.

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SUGGESTIONS
The commodities are very complex financial instruments. Hence the investor should take at most care while trading. In india, the commodities only have commodity futures, and the options in commodities should be introduced. The SEBI and stock exchanges should take more actions to create awareness and knowledge in between the investors.

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ABBREVATIONS
BCE CL&BS IPST MCX NCDEX NMCE OPEC OTC Cochin and the Bombay Commodity Exchange Ltd. commodity linked loans and bonds India Pepper and Spice Trade Association Multi-commodity exchange National Commodity & Derivatives Exchange Limited National Multi-Commodity Exchange of India Ltd., Organization of Petroleum Exporting Countries Over -the-counter

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BIBILOGRAPHY
Web Sites referred: 1) www.mcxindia.com 2) www.ncdex.com 3) www.zenmoney.com 4) www.google.com 5) www.sebi.gov.in

6) www.msfpl.com 7) www.indiainfoline.com
8) www.investopedia.com 9) www.fmc.gov.in

Books Refered:
Ncfms- capital markets Ncfms-commodity derivatives

Reports/News papers: The economic times Business line

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