7

Derivatives and Price Risk Management:
A Study of Agricultural Commodity Futures in India
A Seed Money Project Report

Prepared by
K.G. Sahadevan, Ph.D

Associate Professor
Indian Institute of Management
Prabandh Nagar, Off Sitapur Road
Lucknow 226 013
E-mail: devan@iiml.ac.in
Submitted to
INDIAN INSTITUTE OF MANAGEMENT LUCKNOW

MAY 2002
CONTENTS
Chapter 1:
Acknowledgement
Executive Summary
List of Tables and Figures
2
3
4
Derivatives and Price Risk Management: A Study of

Agricultural Commodity Futures in India An Introduction
1.1. Commodity Derivatives and their Uses

1.2. Commodity Derivatives in India
1.3. Objectives of the Study
1.4. Data and Methodology
1.5. The Chapter Scheme
Chapter 2:
Mechanics of Futures Trading
11
2.1. What is a Commodity Futures Exchange?

2.2. What is Commodity Futures Contract?
2.3. Who are the Participants in Futures Market?
2.4. Commodity Orders
2.5. Role of Clearing House
2.6. Margins
2.7. How does Futures Contract Facilitate Hedging against Price Risk?
Chapter 3:
Commodity Futures Exchanges The profile and

Regulatory Environment
22
3.1. The Profile of Futures Exchanges

3.2. Regulation of Commodity Futures
Chapter 4:
Price Discovery, Return, Volatility and Market

Conditions: An Econometric Analysis
27
4.1. Is Futures Market Efficient?

4.1.1. Empirical Results
4.2. The Relationship between Price Volatility, Trading Volume,
and Market Depth
4.2.1. Emprical Results
4.3. Correlation Analysis
4.4. The Test of Equality of Variances
Chapter 5:
Constraints and Policy Options
38
Conclusions
41
Bibliography
Appendi
42
43
I.
II.
III.
IV.
Commodities notified u/s 15 of FCRA 1952

Commodities prohibited for forward contracts u/s 17 of FCRA 1952
Commodities prohibited for NTSD contracts u/s 18(3) of FCRA 1952
Commodities in which section 15 & 18(3) of FCRA 1952 are applied
Agricultural Commodity Futures in India
K.G. Sahadevan, IIM Lucknow

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EXECUTIVE SUMMARY
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. The Chicago Mercantile Exchange; Chicago Board of Trade; NewYork
Mercantile Exchange etc in the United States, International Petroleum Exchange,
London; London Metal Exchange, London Futures and Options Exchange, etc in the
United Kingdom; Sidney Futures Exchange in Australia, Kuala Lumpur Commodity
Exchange in Malaysia are some of the leading commodity exchanges in the world
engaged in trading of multiple derivatives in commodities. 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 present study is an investigation into the derivative markets in agricultura
commodities in India. The study has surveyed the recognized exchanges and their
organizational, trading and the regulatory set up for futures trading in commodities. In
the light of spot visit to a sample of seven exchanges, the study identifies the problems
and prospects of the futures market in agricultural commodities in India. A statistica
analysis has also been carried out to evaluate the efficiency of a sample set of markets in
price discovery and to understand the interrelationship between prices, volume of
transaction, open positions and volatility of the markets. The results of the study revea
that many of the commodity futures ex changes fail to provide an efficient hedge against
the risk emerging from volatile prices of many farm products in which they carry ou
futures trading. The results obtained from a statistical analysis of the data on price
discovery in a sample of six com modities traded in four exchanges showed that the
futures market in those commodities are not efficient in the sense that the futures prices
are not an unbiased predictor of the future ready rates.
A quantitative analysis of the relationship between pric e return, volume, market depth
and volatility on a sample of twelve markets in six commodity items shows that the
market volume and depth are not significantly influenced by the return and volatility o
futures as well as ready markets. The results indicate that the futures and ready markets
are not integrated. The price volatility in the ready markets does not have any impacts
on the market conditions in futures markets. The exchange specific problems like lo
volume and market depth, lack of participation of trading members and irregular trading
activities along with state intervention in many commodity markets are major ills
retarding the growth of futures market. In the presence of these ills no quantitative
analysis of market conditions and interrelations would provide meaningful results.
A revie of the nature of institutional and policy level constraints facing this segmen
calls for more focused and pragmatic approach from government, the regu lator and the
exchanges for making the agricultural fut ures markets a vibrant segment for risk
management which can play an important role especially in an agriculture dominated
economy of India.
LIST OF TABLES AND FIGURES
Page No.
Figure-1.1:
Figure-2.1:
Table-2.1:
Table-2.2:
Table 3.1:
Table 4.1:
Table-4.2:
Table-4.3:
Table-4.4:
Table-4.5:
Typology of risk management instruments

Order and execution flows in electronic futures trade
Membership requirements for Trading Members
Important Specifications of Futures Contract
Profile of Commodity Futures Exchanges
Testing the Unbiasedness Hypothesis
Relationship between Volume, Return and Volatility
Market Depth and Return Volatilities
Bartletts Homogeneity of Variance Test
Correlation Matrix
6
14
19
20-21
26
32-33
34
35
36
37
CHAPTER 1
DERIVATIVES AND PRICE RISK MANAGEMENT:
A STUDY OF AGRICULTURAL COMMODITY FUTURES IN INDIA AN INTRODUCTION
1.1. Commodity Derivatives and their Uses

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 direc
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 actors 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. (see UNCTAD, 1998 for a comprehensive survey of
instruments) 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 tailormade contracts to suit to the requirement of buyers and sellers and are available over-thecounter. In general, these instruments are classified (as shown in figure-1.1) 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 o
rganize
exchanges. A detailed discussion on the futures contracts is presented in the next chapter.
Both forwards and futures contracts have specific utility to commodity producers,
merchandisers and consumers. Apart from being a vehicle for risk trans fer among
hedgers and from hedgers to speculators, futures markets also play a major role in price
discovery
Figure-1.1: Typology of risk management instruments
Risk Management
Marketing
OTC
Forwards
Finance
Organized
exchanges
Futures
Options
OTC
Swaps
CL&Bs
The price risk refers to the probability of adverse movements in price s 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. Thes e contracts
enable them to lock-in the prices of the products well in advance. Moreover, futures
prices give necessary indications to producers and consumer s 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.
An option contract is the right (but not the obligation) to purchase or sell a certain
standard amount of a commodity at a pre -determined price (the strike price) on or before
a specified date. It is an option-delivery forward contract. The buyer has option to
exercise the option either to buy or to sell the underlying commodity for which he pays
premium to the seller. The option which gives the right to buy is the call option and the
one which gives the right to sell is the put option. The call option p rotects the holder
from the risk of any upward price movements while offering the profit potential from
downward price movements o the underlying commodities. Similarly, the holder of a
put option protects himself from risk of downward movement of prices of the underling
commodities while he benefits from the potential gain of an increase in prices.

The
premium which the buyer of put or call option pays up-front is the only cost he incurs for
protecting himself from unfavourable future price variations.
Commodity swap is a long -term price risk management instrumen available over the
counter to meet specific hedging needs without requiring physical delivery o
commodities. It is a financial transaction by which parties exchange cash flows emerging
from the variation of the prices o underlying commodities in the future according to
prearranged formula. The exchange of cash flows at specified intervals on the basis of
fixed and variable prices for a notional quantity of commodity is affected through an
intermediary who functions as an arranger of the contract. For example, in a fixed-tovariable price swap between the producer and consumer of a particular commodity where
one party pays to the other an amount calculated using the variable price and receives an
amount calculated using the fixed price, while the other party pays an amount based on
the fixed price and receives an amount based on the variable price for a notional quantity
of commodity. The swaps are used for locking -in future prices for a ong period.
Commodity-linked loans are a combination of a bank loan with a commodity swap. It is
an agreement to link the repayment amount of principal and/or interest to the price of a
specific commodity or to an index of commodity prices. These loans are useful to market
participants who want to ensure a positive correlation between debt service requirements
and commodity prices.
Commodity bonds are bonds in which the yield to maturity is linked mainly to the price
of the underlying commodity. Instea d of a fixed interest rate and a fixed amount paid a
maturity, the pay -off of a commodity bonds principal and dividends are expressed in
terms of the commodity price. The primary motivation for a commodity producer to issue
a commodity-linked bond is to raise investment capital while insuring through the use o
a single instrument that the return from investment is not affected by changes in the price
of commodity. Therefore, the ultimate objective in using this instrument is to acquire
protection from dverse movements in interest rates and spot commodity prices.
1.2. Commodity Derivatives in India
especially in any agriculture dominated economy. Derivatives like fo rwards, futures,
options, swaps etc are extensively used in many developed and developing countries in
the world. The Chicago Mercantile Exchange; Chicago Board of Trade; NewYork
Mercantile Exchange; International Petroleum Exchange, London; London Metal
Exchange; London Futures and Options Exchange; Marche a Terme International de
France; Sidney Futures Exchange; Singapore International Monetary Exchange; The
Singapore Commodity Exchange; Kuala Lumpur Commodity Exchange ; Bolsa de
Mercadorias & Futuros (in Brazil), the Buenos Aires Grain Exchange; Shanghai Metals
Exchange; China Commod ty Futures Exchange; Beijing Commodity Exchange, etc are
some of the leading commodity exchanges in the world engaged in trading of derivatives
in commodities. However, they have been utilized in a very limited scale in India
Although India has a long history of trade in commodity derivatives, this segment
remained underdeveloped due to government intervention in many commodity markets to
control prices . 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. Free trade in many commodity items is restricted under the
Essential Commodities Ac , 195 , 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 t rading started in cotton in 1875. Subsequently, many
exchanges came up in different parts of the country for futures trade in various
commodities. The Gujrati 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. In 1921, futures in cotton were organized in
Mumbai under the auspices of East India Cotton Association. Many exchanges came up
in the agricultural centres in north India before world war broke out and engaged in
wheat futures until it was prohibited. The exchanges in Hapur, Muzaffarnagar, Meerut,
Bhatinda, etc were established during this period. The futures trade in spices was firs
organized by IPSTA in Cochin in 1957. Futures in gold and silver began in Mumabi in
1920 and continued until it was prohibited by the government by mid-1950s. Later,
futures trade was altogether banned by t he 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 an expert committee
on forward markets under the chairmanship of Prof. K.N. Kabra was appointed by the
government of India 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 hedg ing 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.
more detailed accoun of these
exchanges has been presented in chapter 3. The proposed study is primarily based on the
visit of seven leading exchanges viz., IPST Cochin, which deal in domestic and
international contracts in pepper; BCE Ltd., a mult -commodity international exchange
where futures in castor oil, castor seed, sunflower oi , RBD Palmolein etc are traded; The
East Indi Cotton Association (EICA) Ltd., Bombay, which is a specialized exchange
dealing in forwards and futures in cotton; South India Cotton Association (SICA ,
Coimbatore which deals in forward contracts in cotton; Coffee Futures Exchange India
Ltd., (COFEI) Bangalore wh ich undertakes coffee futures trading; Kanpur Commodity
Exchange (KCE) which deals with futures contracts in mustard oil and gur; and The
Chamber of Commerce, Hapur which undertakes futures trading in gur and potatoes.
1.3. Objectives of the Study
The proposed study has the following objectives:
To study the contract specifications, mechanics of futures trading and price discovery
in the select commodities and exchanges.
To study how successful these exchanges are in India in price discovery and in
providing hedge against price risk in the underlying commodities.
To carry out an econometric analysis of price volatility and market conditions, and
spot (ready) and futures prices behavior.
To identify the bottlenecks in commodity trading and possible policy solutions for
improving the futures markets in India.
1.4. Data and Methodology
The availability of data has been a major constraint of the study. Futures trading on
commodities except on pepper was introduced only in 1997 -98. While daily futures and
comparable ready price data were available for pepper, the relevant data on other
commodities are available for the last 2 -3 years that too only monthly data for many of
them. Due to the difficulty in getting uniform frequency data series he study has utilized
weekly as well as monthly data on various parameters of futures trading in some selected
commodities. The study as mentioned above is based on a visit to seven exchanges.
However, the coverage of the study is not limited to these seven samples. For statistical
analysis commodities other than the ones traded in these exchanges are also chosen
wherever the data are available. The necessary data are collected from official records of
the exchanges which are visited, and the data relating to othe r exchanges are collected
from various reports and publications of Forward Markets Commission. The information
relating to the organization of exchanges, terms and conditions of futures contracts,

structure of clearinghouse and delivery mechanism, and other details about trading are
collected from the bye-laws of the respective exchanges. To the possible extent,
amendments to these bye-laws have been incorporated in the study
The study has utilized ordinary least square (OLS) method for estimating regre ssion
equations. The problem of serial correlation has been diagnosed and the iterative
Cochrane-Orcutt procedure has been used for making necessary adjustments in
coefficient estimates. The study has used Wald chi-square procedure for restriction on
coefficients to test market efficiency and unbiasedness of futures prices. For empirical
testing of relationship between futures and ready price return, their volatility, trade
volume, market depth, regression as well as correlation methods have been resorte d.
Bartletts homogeneity of variance test has been used for testing the integration between
ready and futures markets.
1.5. The Chapter Scheme
The remainder of the report has been organized as follows. The chapter 1 has already
dealt with various derivative instruments available in commodity markets world -over and
their utility for hedging risk against price changes, and the current status and the
evolution of futures markets in commodities in India.
The functioning of futures
exchanges with trading details, contract specifications, and organizational structure of
and membership requirements in various exchanges in India as well as in clearinghouses
has been described in chapter 2. Chapter 3 provides a brief profile of commodity futures
exchanges and their regulatory framework in India. An econometric analysis or testing
market efficiency in terms of better price discovery mechanism, for testing the
interrelationship between return, volatility and market conditions, and correlation
between various parameters of some selected markets are carried out in chapter 4. In the
light of visit to some of the exchanges problems confronting the futures segment have
been identified for taking necessary policy initiatives. Chapter 5 summarises these
constraint and policy solutions for transforming the commodity futures segment a
vibrant, mass participatory and transparent one. The summary of the study, bibliography
and appendices are presented at the end of the report.
10
CHAPTER 2
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 contrac 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 non-members.
2.1. What is a Commodity Futures Exchange?
Exchange is an association of members which provides all organizati onal 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 fro
among the members of the Association who have trading and business interest in the
exchange. The Board is assisted by the chief executive officer and his team in day-to-day
administration. 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. The membership requirement for trading members in so me selected exchanges
are presented in table-2.1.
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 me mbers 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 o
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, pay-out
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.
11
2.2. 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 are settled by physical delivery futures are
standardized contracts whose 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)
(b)
(c)
(d)
(e)
(f)
Trading in futures is necessarily organized under the auspices of a recognized

association so that such trading is confined to or conducted through members o
the association in accordance with the procedure laid down in the Rules an d
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 t ese 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 centres.
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 are presented in table-2.2. 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 affects the margins required and the commission charged. Similarly, the margin to
be 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 in chapter 5.
12
2.3. 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 a gainst 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.
2.4. 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
13
trading beginning from placing the buy/sell order to the confirmation of the transaction
have been shown in figure -2.1 below.
Figure-2.1: Order and execution flows in electronic futures trade
Buyer
Seller
Order input
Order input
Computer
Computer
Verification of order
Verification of order
Check credit risk

Legitimate orders
are transferred
Check credit risk

Legitimate orders
are transferred
Orders are matched
Execution
Transfer of positions
Confirmation
Confirmation
Electronic
trading
Clearing House
Clearing Member
Position and
margin settlements
Clearing Member
2.5. 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 matur es. 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)
14
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 o
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 peppe
exchange have 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; Kanpu
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 networth 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
are required to have networth 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 e xchanges where
clearing house is a part of the exchange the payment requirements are lower. For
example, Kanpur Commodity Exchange prescribed only Rs. 25,000, Rs. 1000 and Rs.
500 respectively towards security deposit, registration fee and annual fee for a clearingcum-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
15
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 bot
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 o
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 contribu tion 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 institu ional members. The Cochin pepper exchange has
fixed a net exposure limit of 60 units (equivalent to 1500 quintals) for domestic contract
and 90 units (equivalent to 2250 quintals) for international contract . Moreover, enough
financial strength is ensured in case the clearinghouse faces default by setting up of
settlement guarantee fund. 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 in table-2.2. I
is 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 trading-cum-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!
2.6. Margins
Margins (also called clearing margins) are goo -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. This amount in turn is collected from the clients by the member who executes
trade for them. 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 clien s 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.
Maintenance margin which usually ranges from 60 to 80 per cent of initial margin is als
required by the exchange. Variation margin is to compensate the risk borne by the
16
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, marking-to-market ensures that the holder gets the payment equivalent to
the difference between the initial contract value and its change over the life time of the
contract on the basis of its daily price movements. If the member is not able to pay the
variation margin, he is bound to square off his position or else the clearing house 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 (see table 3.1 in chapter 3) 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.
2.7. 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 compe te 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 wha
prices are available, and the opportunity for producer, proce ssor, 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 is the counter party to each
buyer and seller ensuring zero default risk, market participants need not worry about thei
counterparts creditworthiness.
17
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 agains
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 o perations 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
tonnes (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. 2.10 lakh 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 m arket 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 imperfec ions will lead to the basis risk
emerging from the mismatch between the gain/loss from the futures market not
compensated by loss/gain in the ready market. This issue has been discussed further in
chapter 4 in the light of some empirical evidence.
18
Table-2.1: Membership requirements for Trading Members

Exchange
Deposit/Equity (Rs.)
Registration fee (Rs.)
East
India
Cotton
Association, Mumbai
Coffee
Futures
Exchange, Bangalor *
The Kanpur Commodity
Exchange, Kanpur
The
Bombay
Commodity Exchange,
Mumbai.
The
Chamber
of
Commerce, Hapur.
25,000
2,000
Annual
(Rs.)
1,500
1 lakh
10,000
Nil
10,000
1,000
100
50,000
1 lakh
2,000
5000
Rs. 5000
Rs. 600
subscription
* Coffee exchange is a public limited company with authorized equity capital of Rs. 2 crore.
19
Table-2.2: Important Specifications of Futures Contracts

Commodity/
Exchange
Contract
Unit an
Lot size
(LS)
Maximum Price Fluctuation

on any trading day
A
Price Results in
Change of
profit/loss per
contract unit
Initial Margin (IM)/ IM Liability

Variation
Margin for one lot
(VM)
Cotton;
East India
Cotton
Association,
Mumbai
55 bales
(93.5
quintals)
Rs. 150 per

100 kg
Rs. 14025.00
IM: Rs. 10,000 pe

unit over and above
the free limit of 300
units.
VM: 2.5 to 7.5 % of
BMP depending on
2
variation in the BMP
Coffee;
Coffee
Futures
Exchange,
Bangalore
1000/600
kgs for
raw/proc
essed
coffee
LS:
1000/600
Kgs
Rs.3/1.50
per Kg for
Plantation
A/R.C. AB
Rs.125/Rs.
60 per bag
of 50kg for
Arabica/
Rob.Chy
Rs. 1800.00
for Plantation
A and Rs. 900
for RB AB
IM: Rs. 6 per Kilo fo

Plantation A, and
Rs.3.00 per kilo fo
Robesta Cherry AB.
4000 Kgs
(40
quintals)
Rs. 30 per
quintal over
the clearing
rate on the
last day of
the previous
week.
Rs. 1200.00
Rs. 800.00
IM: Rs. 500 per unit

up to 100 units and
Rs. 600 per unit for
above 100 units.
VM: 2 to 4 % of the
BMP depending on
3
Rs. 1300.00
IM: 1.5 % per unit for

net open position
ranging between 6250 and 2.5% for
251-500.
VM: 2% of the BMP
if
closing
price
rises/falls by more
than 10 % of BMP
and 4% if it is more
than 15%.
Gur;
The
Chamber of
Commerce,
Hapur
LS: 55
bales.
LS: 400
Kgs (40
quintals)
Potato;
The
Chamber of
Commerce,
Hapur
4000 Kgs
(40
quintals)
LS: 400
Kgs (40
quintals)
Rs. 20 per
quintal over
the clearing
rate on the
last day of
the previous
week.
Mustard
Seed;
The Kanpur
Commodit
Exchange,
Kanpur
2 Metric
Tonnes
Rs. 65 per
100 Kg
Rs. 2500/
Rs.1200
for
Arabica/
Robes. Cherry
Clearing
Contracts
(duration
in months)
Rs. 10,000
Daily at
settlement
price
Dec.(7),
Feb.(7),
Apr.(6),
June
(5),
Sep. (6)
Rs. 3,600
for
Plantation A
(Rs. 1800
for Robesta
Chery AB)
Daily at
settlement
price
Jan., Mar.,
May, July,
Sep., and
Nov.
(18
months)
Daily at
settlement
price
Mar. (4),
May (3),
July (3),
Dec. (6)
Rs. 500
Daily at
settlement
price
Mar.(6),
July (5),
Oct. (4)
1.5 % of the
value of
contract.
Dail
clearing
May (6),
July (4),
Oct. (4),
Jan. (9)
IM: Rs. 500 per unit Rs. 500

upto 100 units
Rs.600 for each unit
above 100 units.
VM: 2 to 4 % of the
BMP depending on
3
LS: 2
Metric
Tonnes
20
Commodity/
Exchange
Contract
Unit an
Lot size
(LS)
The Bombay
Commodit
Exchange,
Mumbai.
1 Metric
Tonne
Pepper
Exchange,
Cochin8
2.5
Metric
Tonnes
Maximum Price Fluctuation

on any trading day
A
Price Results in
Change of
profit/loss per
contract unit
Clearing
Contracts
(duration
in months)
4% of the
4
OCP of the
previous day
Depends
on
the
closing
price.
IM: No margin if
5
Gross Exposure
<
Rs. 10 lakh, 1.5 % for
Rs. 10 50 lakh, Rs.
0.6 lakh +3% of the
GE in excess of Rs.
50 lakh.
Delivery
period
margin:
10% if the GE < Rs.
50lakh, Rs. 5lakh +
20% if the GE > Rs.
50lakh
Varies
depending
on the value
of contract.
Daily at
official
closing
price
Feb., Apr.,
June, Aug,
Oct., and
6
Dec.
(6months)
US$ 125 per

tonne
for
international
contracts
and Rs. 600
per quintal
for domestic
contracts.
US$
312.50
and
Rs.
15000.00 for
international
and domestic
contracts
respectively.
IM: US$ 125 and 375

per tonne respectively
for net open position
up to 150 and from
151 to 225 tonnes.
Rs. 1200, 1600, 2000
and Rs. 2800 per
quintal for net open
position up to 100,
150, 200 and above
200
tonnes
respectively
US$ 312.50
for
international
contract and
Rs. 30,000
for domestic
contract.
Dail
clearing
and
settlement
For all 12
months in
an year
(6months)
LS: 1
Metric
Tonne
LS: 2.5
M.T and
15 M.T
as deliverable
quantit
Initial Margin (IM)/ IM Liability

Variation
Margin for one lot
(VM)
SM: 10, 20 and 30 %

respectively of th
7
BMP if it increases
>20%, >30% and
>40%
IM and SM represent initial margin and special margin respectively.
Price limit and margins vary from time to time.
1. Delivery month of the contract.
2. Bench Mark Price is the average of the opening, highest, lowest and the closing prices of the first three
trading days of commencement month of any contract.
3. Bench Mark Price is arrived at by taking the average of the opening, highest, lowest and closing prices
of the commencement day of trading of any contract.
4. The official closing price (OCP) is the weighted average price of the trades executed during the last 30
minutes of the trading session.
5. Gross Exposure (GE) means the sum total of net outstanding position.
6. Delivery month relating to international castor oil contracts and all other specifications are common fo
all commodities traded in Bombay Commodity Exchange.
7. The Bench Mark Price (BMP) is determined by taking the weighted average of the transacted price of
all the contracts traded on the first five days of the contract.
21
CHAPTER 3
COMMODITY FUTURES EXCHANGES
THE PROFILE AND REGULATORY ENVIRONMENT
3.1. The Profile of Futures Exchanges

Presently, 15 exchanges are in operation in India carrying out futures trading activities in
as many as 30 commodity ite ms (details are given in table-3.1). Moreover, per ission
has been given to another two exchanges viz., The First Commodities Exchange of India
Ltd, Kochi (for copra/coconut, its oil and oilcake), and Keshav Commodity Exchange
Ltd., Delhi (for potato), where futures trading is expected to start soon. The government
has also permitted four exchanges viz., East India Cotton Association, Mumbai; The
Central Gujarat Cotton Dealers Association, Vadodara; The South India Cotton
Association, Coimbatore; and The Ahmedabad Cotton Merchants Association,
Ahmedabad, for conducting NTSD contracts (explained below) in cotton. Lately, as part
of further liberalization of trade in agriculture and dismantling o Essential Commodities
Act (ECA), 1955 futures trade in sugar has been permitted and three new exchanges viz.,
e-Commodities Limited, Mumbai; NCS Infotech Ltd., Hyderabad; and e
-Sugar
India.Com, Mumbai, have been given approval for conducting sugar futures.
A brief profile of the exchanges which are currently in operation has been presented in
table-3.1. Many of these exchanges have become weaker in spite of considerable
membership strength and potential for large volume of trade. Some of the observations
drawn on the basis of visit to six of these exchanges have been presented in the later part
of this paper. The number of members who are actively involved in trading in all these
exchanges is abysmally low. Any attempt to revive the exchanges and rejuvenate the
futures market in India needs an investigation into why members shy away from trading.
It is interesting to note that even in case of commodities in which very active domestic
and international ready market exists with volatile prices, futures trade in those
commodities are no attraction to the merchandisers. The pepper exchange located in
Cochin which is known for futures trade in spices for over five decades has not attracted
many traders. It is the only exchange in the world engaged in trading of futures in
pepper. Kerala being the producer of lions share (around 95 per cent) of pepper in India
and Cochin being the port city where majority of pepper exporters are operating the
existing futures exchange is expected to have a larger role to play. However, in spite of
having more than 150 members in the exchange, only around 10 members cubicles in
the trading ring found to have the presence of their representatives during the trading
hour. A further inquiry in to the issue reveals that these members have been trading for
generations and no new member is coming forward to the business. The members f the
exchange still choose to retain the status of the exchange as a single-commodity
exchange!
22
The Bombay Commodity Exchange arguably the richest exchange in India in terms of it
infrastructure is also facing the problem of empty trading ring. Though he exchange has
membership strength close to 600, only less than 5 members are actively trading. It is
clear from the data given in table-3.1 that the volume in castor seed futures declined from
2.53 lakh tonnes during 1996-97 to just 10,000 tonnes during 2000-01.
The cotton exchange in Mumbai which is one of the oldest exchanges in the country has a
different story to tell. Cotton has a long tradition of futures trading in India. Cotton
futures started in 1857 and continued until it was suspended in 1966. Cotton has large
potential for futures trading due to its uncontrolled and uncertain supply and variability of
prices. While prices within a crop season fluctuate between 7.5 to 26.2 per cent in the
last decade, its output varied as much as 14 per ce nt from one year to the next. It has a
very strong domestic and international market. India is the third largest producer and the
second largest consumer of cotton in the world. Moreover, cotton is placed under OGL
list with zero import duty, and quota system for its exports is likely to be dismantled by
2005. Nevertheless, the present status of cotton exchange and the Indian cotton futures
contract is no different from other exchanges. Although the exchange has membership
strength over 400, not more t han 10 members actively trade in the exchange. It is often
argued by the exchange authorities that the governments indirect control on supply of
cotton and on prices by its procurement makes the futures market unattractive.
Futures market in many other commodities indeed shows that there is scope for the
rejuvenation of this sector in the country. The buoyant trading activities in the newly
started National Board of Trade at Indore, the old exchanges like the Chamber of
Commerce, Hapur; Viajai Beopar Ch amber, Muzaffarnagar; Ahmedabad Commodity
Exchange; Bhatinda oil exchange; The East India Jute Exchange, Calcutta, etc., are the
indications of prospects of futures trade in agricultural commodities.
3.2. Regulation of Commodity Futures
Merchandising and stockholding of many commodities in India have always been
regulated through various legislations like the Essential Commodities Act, 1955 (ECA,
1955) and Forward Contracts (Regulation) Act, 1952, (FCRA, 1952) and Prevention of
Blackmarketing and Maintenance of Supplies of Commodities Act, 1980. The ECA,
1955 gives powers to control production, supply, distribution, etc. of essential
commodities for maintaining or increasing supplies and for securing their equitable
distribution and availability at fair prices. Using the powers under the ECA, 1955 various
Ministries/Departments of the Central Government have issued control orders for
regulating production/distribution/quality aspects/movement etc. pertaining to the
commodities which are essential and admi nistered by them. The FCRA, 1952 provided
for 3-tier regulatory system for commodity futures trading in India: (a) an association
recognized by the Government of India on the recommendation of Forward Market
Commission, (b) the Forward Markets Commission and (c) the Central Government
Stock exchanges and futures markets being a part of the Union list their regulation is the
responsibility of the central government. All types of forward contracts in India are
23
governed by the provisions of the FCRA, 1952. The Act divides commodities into three
categories with reference to extent of regulation, viz., (a) the commodities in which
futures trading can be organized under the auspices of recognized association, (b) the
commodities in which futures trading is proh ibited and (c) the free commodities which
are neither regulated nor prohibited. While options in goods are prohibited by the FCRA,
1952, the ready delivery contracts remain outside its purview. The ready delivery contract
as defined by the Act is the one which provides for the delivery of goods and payment of
a price therefor, either immediately or within a period not exceeding eleven days after the
date of the contract. All ready delivery contracts where the delivery of goods and/or
payment for goods is not completed within eleven days from the date of the contract are
forward contracts. The Act classified forward contracts into two: (a) specific delivery
contracts and (b) other than specific delivery contracts or futures contracts. Specific
delivery contract means a forward contract which provides for the actual delivery of
specific qualities or types of goods during a specified time period at a price fixed thereby
or to be fixed in the manner thereby agreed and in which the names of both the buyer and
the seller are mentioned.
The specific delivery contracts are of two types: transferable and non-transferable. The
distinction between the transferable specific delivery (TSD) contracts and non transferable specific delivery (NTSD) contracts is based on the transferability of the
rights or obligations under the contract. Forward trading in TSD and NTSD contracts are
regulated by the government. As per the section 15 of the FCRA, 1952 every forward
contract in notified goods (currently 36 commodity items) which is entered into excep
those between members of a recognized association or through or with any such membe
is treated as illegal or void (see appendix I for the list). As per the section 17(1) of the
Act, 82 items are prohibited for forward cont ract (see appendix II for the list). The
section 18(1) of the Act exempts the NTSD contracts from the regulatory provisions.
However, over the years the regulatory provisions of the Act were applied to the NTSD
contracts and 79 commodity items are curren tly prohibited for NTSD contracts under
section 17 of the Act (see appendix III for the list). Moreover, another 15 commodity
items are brought under the regulatory provisions of the section 15 of the Act out of
which trading in the NTSD contract has been suspended in 12 items (see appendix IV for
the list). At present, the NTSD contracts in cotton, raw jute and jute goods are permitted
only between, through or with the members of the associations specifically recognized
for the purpose.
Subsequent to the report of the Committee on Forward Markets (known as the Kabra
Committee) submitted in 1994 the government has so far permitted futures trading in
nearly 35 commodities under the auspices of 23 commodity exchanges located in
different parts of the country. The commodities in which futures trading is permitted are:
pepper, turmeric, gur, castorseed, Hessian, jute sacking, cotton, potato, castor oil
soyabean and its oil and cake, coffee, mustardseed and its oil and oilcake, ground nut and
its oil, sunflower oil, copra/coconut and its oil and oilcake, cottonseed and its oil and
oilcake, kapas, RBD palmolein, rice bran and its oil and oilcake, sesame seed and its oil
and oilcake, safflower seed and its oil and oilcake, and sugar. This list may get enlarged
24
with the repeal of ECA, 1955 and with further liberalization of farm sector as envisaged
in the National Agricultural Policy, 2000 and the Union Budget, 2002-03.
The exchanges are required to get prior approval of the FMC for opening of each contract
in commodities which are notified under the relevant sections in FCRA 1952.
Regulation is essential especially in a private ownership and market oriented system t
ensure the necessary checks and balances in the system. However, stringent and
continuous regulation for long period of time would do no good to the system. The initial
stringent regulation should ensure that a foolproof and growth oriented control system in
terms of set up of the exchange and its sound management, a clearinghouse which can
promote trade and its financial integrity, sound and facilitating contract terms and
conditions, etc. is in place. The exchanges are already assumed to be self-regulatory
agencies. Their role must get strengthened further along with FMC minimizing its role as
a facilitator making the existing regulation an appropriate regulation.
25
Table 3.1: Profile of Commodity Futures Exchanges

Exchange
Active Member
1999
India Pepper and Spice 55
Trade
Association,
Cochin.
The
Bombay
Commodity Exchang
Ltd., Mumbai.
Kanpur Commodity
Exchange, Kanpur.
The East India Cotton
Association, Mumbai.
The
Chamber
of
Commerce, Hapu
Coffee Futures E xch

ange Ltd., Bangalore.
Ahmedabad Commodity Exchange Ltd.
The Rajkot Seeds Oil
& Bullion Merchant
Association Ltd
National Board of
Trade Ltd., Indor
Commodity
Traded
2000
42
2001
31
Pepper
Pepper (intl.)
Castor seed
Castor oil
Volume in lakh tonnes

(Value in Rs. Crore)
RBD Palmol
1999-00
1.24
(2862)
0.40
(106)
0.9
(15)
0.04
(14)
-
Mustard seed,
oil and cake
Cotton
36
21
Potato
26
34
26
Gur
Coffee
38
36
55
Castor seed
12
Castor seed
48
51
15
17
36
Vijai Beopar Chamber

Ltd., Muzaffarnagar
Bhatinda Om Oil &
Oilseeds Exchang
Ltd Bhatinda
The Meerut Agro Commodities Exchang
Co. Ltd., Meerut
The Rajdhani Oils and
Oilseeds Exchang
Ltd., Delhi.
The East India Jute &
Hessian Exchang
Ltd., Calcutta.
40
35
35
Soy seed, oil &

cake
Mustard seed &
Mustard oil
Gur
16
16
15
Gur
10
11
11
17
21
57
1
The Spices & Oilseeds

Exchange Ltd., Sangli
1996-97
0.86
(765)
-
1997-98
1.56
(2834)
-
2.53
(279)
-
0.25
(30)
-
1998-99
1.73
(3411)
.007
(15)
0.11
(17)
-
0.79
(29)
29.28
(1655)
-
1.76
(56)
30.10
(2760)
-
0.02
(9)
0.09
(5)
23.85
(2162)
-
54.84
(5981)
19.85
(2167)
68.76
(8006)
21.36
(2495)
44.91
(6854)
16.77
(2562)
30.68
(5220)
16.35
(2811)
40.71
(2281)
29.81
(1936)
44.06
(3429)
23.60
(1896)
61.34
(9518)
20.41
(1813)
47.48
(4510)
21.88
(2263)
32.56
(7874)
0.13
(31)
31.28
(2877)
21.24
(2060)
Gur
2.45
(144)
3.25
(248)
3.58
(304)
4.1
(389)
3.7
(311)
24
Gur
8.51
(548)
28.60
(2231)
4.51
(383)
8.24
(787)
7.78
(668)
40
71
Sackin
Hessia
Turmeric
41.38
(15604)
0.83
(149)
25.21
(5022)
2.43
(569)
0.01
(6)
5.58
(1234)
0.003
(0.81)
0.0002
(0.03)
7.88
(1703)
0.0008
(0.22)
0.002
(0.21)
0.35
(143)
0.22
(5)
23.79
(2236)
-
26.60
(7342)
0.81
(152)
1.093
(261)
-
2000-01
1.29
(2580)
0.02
(5.6)
0.10
(14)
0.01
(5)
0.04
(9)
0.108
(14)
0.21
(139)
0.52
(14)
28.80
(2555)
0.50
(289)
24.73
(3469)
18.94
(2761)
Source: Forward Markets Commission, Mumbai.
26
CHAPTER 4
PRICE DISCOVERY, RETURN, VOLATILITY AND MARKET CONDITIONS:
AN ECONOMETRIC ANALYSIS
4.1. Is Futures Market Efficient?

Futures trade assumes significance in a volatile ready market and price risk management
because of the price discovery. The price discovery is the process of determining the
price of a commodity, based on supply and demand factors. The expectations theory
hypothesises that the current futures price is a consensus forecast of th e value of the
ready (spot) price in the future. For example, todays 180 day pepper futures rate is a
market forecast of the ready rate that will exist in 180 days. The futures market for a
commodity is said to be efficient when the n-period futures rate (Ft,n) is equal to the
future ready rate (St+n). The efficient market ensures that the average difference between
todays futures rate (with n day maturity) and the subsequent ready rate n days later was
zero. The difference, if any, represents both th e futures rates forecasting error and the
opportunity for gain (or loss) from open positions in the market. The efficiency of the
futures market is usually examined by testing the unbiasedness of futures rate as a
predictor of the future ready rate.
The hypothesis that the premium or discount in the futures market is an unbiased linea
predictor of the price change in the corresponding ready market may be tested using the
regression equation:
DS i t +1 = + FP i t + u i t +1 ,
(1)
t=1,,T,
i=1,,N (commodities)
in which
DS i t +1 ( S i t +1 S i t ) and FP i t ( F i t S i t ),
where St and St+1 are the logarithm of the ready rate at time t and t+1 respectively, Ft is
the logarithm of the futures rate established at time t for period t+1, and ut+1 is an error
term. In this form, the unbiasedness hypothesis implies that and . Such a
restriction is consistent with a model of a competitive market with no transaction costs,
risk-neutral speculators and market expectations which are rational. For that model, we
should have
Et DS i t +1 = FP i t ,
(2)
Where Et is the mathematical expectation operator conditional upon some information
set. The test relation (1) and the joint null hypothesis of rational expectations and no risk
premium implicit in (2) can be related by decomposing the actual change in the spot rate
into two orthogonal components:
27
DS i t +1 = Et DS i t +1 + ( DS i t +1 Et DS i t + 1 )
(3)
Substituting (2) into (3) yields (1) under the null hypothesis. Testing the unbiasedness
hypothesis involves estimating regression equation (1) and dete rmining whether the
coefficient estimates of and are significantly different from zero and one respectively.
Alternatively, futures rate is an unbiased predictor of the future ready rate, if the average
forecast error ( et+1 in (1)) is not significantl y different from zero. The optimal forecas
would be one that minimizes the average of the squared forecast errors i.e., minimum
mean square errors (MSE) over the sample period. The forecast error (et+1) represents the
speculative profit for traders who buy futures contracts a Ft and sell in the ready marke
at St+1. The forecast error is unlikely to be consistently large and positive because large
profits would attract speculators buying futures resulting increase in Ft and decrease in
et+1, thus removing profits.
4.1.1. Empirical Results
The test results based on the estimates of the equation (1) have been presented in table-2.
The study has utilized the OLS method to estimate the equation for daily futures prices o
six commodities viz., pepper, cotton, castor seed and castor oil, mustard seed and gur
traded in pepper exchange in Cochin, cotton exchange in Mumbai, Bombay Commodit
Exchange and Kanpur Commodity Exchange respectively. The coefficient estimates of
the equation are corrected for ser al correlation by using iterative Cochrane -Orcutt
procedure and the autoregressive parameter ( ) estimates are reported. For each
commodity item daily prices of multiple contracts have been used for estimation. The
price data used for the analysis have been sourced from the respective exchanges directly.
To test the unbiasedness and whether futures prices are the optimal forecaster of the
future ready prices, the restriction 0 and =1 has been tested by estimating equation
(1) by OLS and by using Wald chi-square test of the joint hypothesis that =0 and =1.
The joint null hypothesis that =0 and =1 is rejected in all sample cases baring two
(Mustard seed, July 2000 and Gur, March 1998 contracts) out of 25 sample futures
contracts. The significant Wald chi-square test statistics indicate that futures markets are
not efficient in predicting the future ready prices. This result is rather expected given the
fact that many exchanges have thin trade volumes and infrequent trading. In spite of a
developed ready market in most of these commodities, futures markets do not attract
traders.
The results also testify the fact that the futures contracts are not perfect hedge against the
variations in ready prices. A perfect hedge guarantees that the profit or lo ss on the
futures contracts fully offsets the loss or profit on the physical transactions in the ready
market. Any disparity between the futures price for a specific maturity contract and the
ready prices in physical market on the day of the maturity of futures contract exposes the
participants to basis risk. The users of futures markets face this risk because the specific
physical commodity they wish to hedge does not have the same price development as tha
of the standardized futures contract. There may be many imperfections in the market for
28
the commodities under study which would make ready prices deviate from the
corresponding futures prices. The export oriented commodity like pepper the prices in
ready market are to certain extent driven by the unexpected changes in exchange rate
which are not factored into the futures prices and by the demand situation in international
market. Secondly, in cases where government intervenes to manipulate the market by
affecting supply (e.g., cotton) the relation between futures prices and ready market prices
may get distorted. Thirdly, in most cases futures exchanges are not located in the area
where very developed ready market exists. Though gur futures are traded in Kanpur and
Hapur exchanges, this particular co mmodity has ready market spreading across the
country. Finally, most of the agricultural products are produced in unorganized sector
involving thousands of smallholdings and there are many intermediaries between farmer
and wholesaler/exporter. This makes the supply and price development in ready marke
unpredictable.
4.2. The Relationship between Price Volatility, Trading Volume, and Market Depth
The present study examines the interactions betwee return volatility, trading volume and
market depth using the price, volume and open position data from twelve futures markets
in six commodities. The commodity items and name of exchanges are lis ed in table-4.1.
Theories predict a positive contemporaneous correlation between trading volume and
price volatility. Evidence from empirical studies such as those by Jones, Kaul, and
Lipson (1994); Bessembinder and Senguin (1993); and Gallant, Rossi, and Tauchen
(1992) proved that return volatility and volume are positively related. It is expected that
higher the market depth lower would be the price volatility.
The present study
investigates the relationship of volume and market depth with return and volatility and
specifies their relationship in the following estimatable form:
FV = + FR + SD + e
it
1 it
2 it
it
FM
it
(4)
= + FD + SD + w
1 it
2 it
it
(5)
th
where FVit is the futures trading volume for the i commodity at time t, FR, FM, and
FD represent return, depth and volatility of futures, and SD measures volatility of the
ready market prices. The return is calculated from the closing price (Pcit) data as
log(Pci,t/Pci,t-1). The open interest (position) is taken as a proxy for market depth
because it reflects the current willingness of futures traders to risk their capital in the
futures position, which indicates the level of market depth. As traders take positions in
response to a perceived deviation of price from intrinsic value, volatility of futures and
ready price returns are defined as the deviations from their respective mean values. The
coefficients 1 and 2 in equation (4) expected to have positive values while 1 and 2 in
equation (5) have negative and positive values respectively. The market becomes deepe
and busy when return volatility is lower and vice versa. If the volatility of the ready
market is high, on the contrary, futures market b ecomes more active and deeper. The
study has used month-end total open position, total volume and month -end closing prices
29
of the contract closes to expiration. The study covers a period of 38 months from Januar
1999 to August 2001.
4.2.1. Emprical Results
The equations (4) and (5) have been estimated for all sample futures markets using the
OLS method and making necessary adjustments for autocorrelation in their residuals.
The tables 4.2 and 4.3 report the estimates of equations (4) and (5) respe ctively. The test
of relationship between volume, futures price return and ready price volatility does not
provide any uniform evidence across the markets. The futures price return found to have
statistically significant and expected positive relationship with the volume of futures
trade only in gur exchange, Bhatinda and pepper exchange, Cochin. Similarly, spot price
volatility has significant role in explaining volume of trade in gur in Meerut exchange,
castorseed in the Bombay Commodity Exchange and pepper in Cochin pepper exchange.
The price volatility in the ready market is expected to influence the volume in futures
market if both the markets are better integrated. Bombay and Cochin being the major
exports centres price variations in ready market have an immediate impact in the futures
market as it gives forward cover against ready price risk. The statistically significan 2
coefficient signifies that the futures markets are more utilized for hedging price risk than
for making speculative transactions. The overall results in table-4.2 indicate that price
return volatility in futures and ready markets do not determine the v olume of trade in
futures markets.
Similarly, the estimates of equation (5) reported in table -4.3 show that the net open
positions in futures markets are not determined by ready and futures price return
volatilities in any of the markets except for gur in Bhatinda exchange and Castorseed in
Bombay Commodity Exchange.
4.3. Correlation Analysis
Studies have shown that return volatility is positively related to the level of volume o
trade, and inversely to the market depth. In a deep market the pressu re on prices woul
be lower making the price return volatility lower. The correlation of futures and ready
price returns with volume and open positions and between the two return series are
presented in table-4.5. In most cases the correlation coefficients are very low except the
one between futures and ready returns. The gur market shows very insignificant
correlation between the futures and ready returns. This is expected when country-wide
demand and supply conditions drive futures prices while the local ready markets are
primarily influenced by the supply and demand factors in a particular region . The hig
correlations in other markets are the indications of better integration between the ready
and futures markets. In an ideal situation, the developm ents in the ready market have
immediate impact on the market conditions in futures market and vice versa. The futures
markets in export commodities like castorseed, cotton and pepper have been driven by
ready market condition in those commodities and also the exchanges deal in these
commodities are situated in developed commercial centres where domestic and
international trades take place.
30
The coefficient of correlation between volume of transactions and futures price return
shows very low values in mo t of the markets. This is expected in a market where trad
volume is low with less frequent quotations available for futures transactions. Similarly,
the coefficient of correlation between net open positions (market depth) and price return
shows low values with negative sign in most markets . If the return is high, the holders
square off their transactions and they hold on to the contract when return is low.
4.4. The Test of Equality of Variances
The price and return behaviour in futures and ready ma rkets may differ. However, both
the markets would be better integrated if the market is matured. Higher price volatility in
the ready marke would make the futures market more active as it provides hedge agains
the risk and provide better opportunity f r speculators for booking profit. The uniform
and interdependent behaviour of the two markets has been verified by testing the equality
of variances of futures and ready market price changes using Bartletts statistic.
According to the tes here is evidence to reject the null hypothesis of equal variances if
2
distribution with ( -1) degrees of

freedom.
The results of Bartletts homogeneity of variance test are reported in table-4.4. The test
statistic is significant only in case of gur in Bhatinda exchange and potato in Hapur
exchange signifying that these two markets are better aligned with their respective ready
markets. An essential condition for a vibrant futures marke in any commodity is the
presence of an active ready market in t e particular commodity in the region where the
exchange is located. This proximity and interdependence make risk management more
efficient and accessible to various participants. A highly volatile ready market boosts
trading activity in utures and a resultant increase in the volume of activity which would
eventually reduce futures price volatility.
To conclude, a quantitative analysis of the relationship between price return, volume,
market depth and volatility on a sample of twelve mark ets in six commodity items
showed that the market volume and depth are not significantly influenced by the return
and volatility of futures as well as ready markets. The results indicated that the futures
and ready markets are not integrated. The price v olatility in the ready markets did not
have any impacts on the market conditions in futures markets. The exchange specific
problems like low volume and market depth, lack of participation of trading members and
irregular trading activities along with state intervention in many commodity markets are
major ills retarding the growth of futures market. In the presence of these ills no
quantitative analysis of market conditions and interrelations would provide meaningful
results.
31
Table 4.1: Testing the Unbiasedness Hypothesis
Commodity
Contract
(NOBS)
Wald
D-W
Adj.
R2
1
2
3
Pepper
June 1999
(117)
0.04
(2.72)*
-0.05
(-0.46)
110.19
(0.00)
1.99
0.93
1.23
(13.75)
-0.27
(-2.98)
Jan. 2000
(75)
-1.00
(-9.4)*
0.43
(2.56)*
172.23
(0.00)
1.91
0.98
1.51
(13.01)
-0.68
(-3.48)
Dec. 1999
(51)
-0.07
(-1.15)
0.33
(1.88)**
16.7
(0.00)
1.85
0.96
1.45
(11.71)
-0.47
(-3.77)
Nov. 2000
(143)
-0.59
(10.92*
0.06
(0.51)
189.93
(0.00)
1.47
0.99
1.02
(68.97)
Dec. 2000
(142)
-0.23
(-1.22)
0.02
(0.17)
76.93
(0.00)
1.51
0.99
1.29
(16.21)
-0.30
(-3.76)
June 2000
(126)
-0.01
(-0.70)
-0.05
(-0.52)
137.05
(0.00)
2.00
0.94
1.33
(16.10)
-0.38
(-4.59)
Feb. 2000
(80)
-0.17
(-16.37)*
0.34
(2.63)*
498.21
(0.00)
1.95
0.96
1.38
(12.11)
-0.47
(-2.52)
April
2000
(119)
Sep. 2000
(114)
0.08
(2.88)*
0.94
(29.29)*
11.89
(0.003)
1.72
0.97
1.47
(18.36)
-0.49
(-6.14)
0.01
(1.05)
0.55
(10.34)*
75.56
(0.00)
1.72
0.97
1.23
(13.70)
-0.27
(-3.04)
Sep. 1999
(73)
0.01
(2.47)*
0.69
(10.03)*
22.86
(0.00)
1.92
0.96
1.12
(9.83)
-0.23
(-1.97)
Castor Seed
Sep. 2000
(78)
-0.12
(-2.73)
0.13
(1.61)
118.26
(0.00)
1.40
0.96
1.14
(10.28)
-0.17
(-1.48)
June 2000
(60)
-0.04
(-0.96)
0.64
(6.33)*
14.27
(0.00)
1.68
0.88
0.99
(45.12)
Dec. 2000
(87)
-0.04
(-1.14)
0.12
(1.76)***
169.37
(0.00)
1.41
0.99
1.39
(14.35)
-0.42
(-4.26)
Feb. 2001
(64)
-0.02
(-0.64)
0.69
(5.98)*
7.64
(0.02)
1.98
0.97
1.16
(9.47)
-0.19
(-1.54)
Apr. 2001
(34)
-0.02
(-1.14)
0.10
(0.92)
73.04
(0.00)
1.96
0.91
1.29
(8.04)
-0.35
(-2.17)
Cotto
32
0.17
(1.42)
0.10
(1.84)
Contract
(NOBS)
Wald
1
2
Apr. 2001
(70)
-0.03
(-1.94)**
0.61
(9.73)*
45.11
(0.00)
2.20
0.95
1.30
(11.54)
-0.33
(-2.92)
Apr 2000
(68)
0.13
(8.78)*
0.76
(13.25)*
86.06
(0.00)
1.71
0.99
1.03
(35.73)
Oct.2000
(52)
-0.06
(-1.64)***
0.35
(3.15)*
37.46
(0.00)
1.45
0.98
1.38
(10.89)
-0.40
(-3.15)
Oct. 2000
(63)
-0.11
(-9.19)*
0.62
(7.68)*
471.44
(0.00)
1.48
0.92
0.73
(5.30)
0.36
(1.86)
-0.09
(-1.59)
July 2000
(43)
-0.01
(-0.14)
0.80
(7.69)*
3.76
(0.15)
1.89
0.96
1.31
(9.22)
-0.35
(-2.48)
Dec. 1998
(136)
-0.03
(-3.32)*
0.93
(46.86)*
13.39
(0.00)
1.93
0.99
1.06
(12.62)
-0.15
(-1.80)
Mar. 1999
(76)
0.03
(5.54)*
0.92
(26.06)*
31.86
(0.00)
1.83
0.98
0.86
(15.06)
Dec. 1997
(132)
0.45
(16.26)*
0.92
(38.77)*
349.98
(0.00)
2.37
0.99
1.02
(54.39)
Mar. 1998
(73)
-0.03
(-1.97)**
0.98
(38.87)*
4.31
(0.12)
1.72
0.99
0.94
(23.17)
July 1997
(63)
0.19
(39.18)*
0.99
(37.03)*
1784.4
(0.00)
1.73
0.99
1.41
(13.22)
-0.52
(-4.88)
Item
Castor Oil
Mustard
Seed
Gur
D-W
Adj.
R2
3
The contract indicates the month and year in which the particular contract matures.
The values in parenthesis are t-statistics and one, two and three asterisks indicate level of confidence at
one, five and ten percent respectively.
Wald is the Wald Chi-square test statistic with the corresponding p-values in parenthesis.
D-W is the Durbin-Watson statistic. NOBS stands for number of data points under each contract.
The notations 1, 2, and 3 are first, second and third order autoregression parameter estimates
respectively with their t-statistic in parenthesis.
33
Table-4.2: Relationship between Volume, Return and Volatility
1
2
D-W
Adj.
R2
1
2
0.003
(0.018)
-0.115
(-0.453)
2.05
0.24
0.53
(3.51)
Gur; Vijay Beopar Chamber, 5.82

Muzaffarnagar
(50.16)*
0.42
(1.09)
-0.09
(-0.24)
1.74
0.22
0.52
(3.37)
Gur; Bhatinda Om and Oil

Exchange.
5.20
(118.9)*
0.691
(2.48)*
-0.762
(-1.54)
1.84
0.23
0.20
(1.15)
Gur; The Meerut

Agro 3.49
Commodities Exchange.
(80.07)*
-0.176
(-0.68)
-0.562
(-2.1)**
1.92
0.17
0.43
(2.53)
-0.30
(-1.75)
Castorseed;
The
Bombay -0.42
Commodity Exchange.
(-2.94)*
3.15
(1.28)
-4.25
(-1.8)***
1.81
0.23
0.38
(2.26)
Castorseed; Ahmedabad
Commodity Exchange.
0.175
(0.13)
0.32
(0.22)
2.10
0.11
0.36
(2.18)
Castorseed; The Rajkot Seeds 4.96

Oil and Bullion Merchants (60.89)*
Association.
-0.767
(-0.67)
0.401
(0.33)
2.00
0.12
0.39
(2.39)
Potato; The Chamber

Commerce, Hapur
1.20
(1.06)
-0.74
(-1.18)
2.11
0.60
1.09
(6.45)
-0.44
(-2.57)
Cotton;The
East
India 1.66
CottonAssociation, Mumbai
(2.34)**
-0.068
(-0.05)
1.35
(0.82)
1.96
0.75
0.90
(11.27)
Pepper; India Pepper & Spice 2.40

Trade Association, Cochin.
(38.02)*
3.05
(1.8)***
-2.78
(-1.7)***
2.07
0.04
Coffee Plan ationn A; Coffee -0.12

Futures Exchange, Bangalore.
(-0.23)
0.32
(0.27)
2.15
0.54
0.86
(9.46)
Coffee Rob. Cherry AB; Coffee -0.58

(-1.89)
-1.55
(-1.12)
2.05
0.41
0.67
(5.03)
Commodity & Name of the

Commodity Exchange
Gur;
The
Chamber
Commerce, Hapur
of 5.37
(85.44)*
5.46
(46.78)*
of -0.28
(-0.35)
The values in parenthesis indicate t-statistics and o ne, two and three asterisks indicate level of confiden ce at one,
five and ten percent respectively. D-W is the Durbin-Watson statistic.
The notations 1, and 2 are first and second order autoregression parameter estimates respectively with thei tstatistic in parenthesis.
34
Table-4.3: Market Depth and Return Volatilities
Commodity &
Name of the Exchange
1
2
D-W
Adj.
R2
1
Gur; The Chamber of Commerce

Hapur
-0.295
(-5.19)*
0.526
(1.01)
0.059
(0.094)
1.89
0.04
-0.313
(-1.84)
Gur; Vijay Beopar Chamber,

Muzaffarnagar
0.001
(0.009)
-0.184
(-0.26)
-0.766
(-1.08)
2.19
0.05
-1.66
(-1.8)***
4.54
(3.02)*
1.95
0.24
-1.89
(-9.52)*
0.95
(0.74)
-1.12
(-0.83)
1.43
0.07
0.14
(1.79)
Castorseed;
The
Commodity Exchange.
Bombay -3.27
(-22.6)*
6.02
(1.21)
-9.72
(-2.06)*
1.91
0.12
-0.19
(-1.04)
Castorseed; Ah
Commodity Exchange.
medabad 2.01
(14.2)*
0.48
(0.35)
-1.39
(-0.93)
2.02
0.15
0.45
(2.80)
Castorseed; The Rajkot Seeds Oil 0.566

-3.16
*
and
Bullion
Merchants (10.64) (-1.45)
Association.
2.03
(0.88)
1.86
0.06
-0.18
(-1.02)
Potato;
The
Chamber
Commerce, Hapur
0.474
(0.67)
2.09
0.08
0.35
(2.00)
-0.328
(-0.123)
2.04
0.60
0.83
(8.21)
Gur; Bhatinda
Exchange.
Om
and
Gur;
The
Meerut
Commodities Exchange.
Oil -1.01
(-9.04)*
Agro
of -1.54
(-4.32)*
Cotton; The East India Cotton

Association, Mumbai
-0.559
(-0.43)
-0.005
-0.002
(-0.007) (0.001)
Pepper; India Pepper and Spice -0.17

Trade Association, Cochin.
(-1.36)
-0.609
(-0.706)
0.628
(0.790)
2.14
0.50
0.746
(6.13)
Coffee Plan ation A; Coffee -0.69

(-3.12)*
0.27
(0.36)
1.77
0.63
0.79
(7.21)
Coffee Rob. Cherry AB; Coffee -1.11

(-5.56)*
0.514
(0.679)
1.59
0.51
0.72
(5.81)
The values in parenthesis indicate t-statistics and one, two and three asterisks indicate level of confiden ce
at one, five and ten percent respectively. D-W is the Durbin-Watson statistic .
The notaion 1 is the first order autoregression parameter estimate with its t-statistic in parenthesis.
35
Table-4.4: Bartletts Homogeneity of Variance Test
Commodity & Name of the Exchange
Variance of
Futures Ready
Return Return
Bartletts
Statistic
Gur; The Chamber of Commerce, Hapur
0.019
0.013
1.391
Gur; Vijay Beopar Chamber,

Muzaffarnagar
0.018
0.017
0.014
Gur; Bhatinda Om and Oil Exchange.
0.016
0.006
7.37
Gur; The Meerut Agro Commodities Exchange.
0.018
0.016
0.103
Castorseed; The Bombay C mmodity Exchange.
0.005
0.006
0.059
Castorseed; Ahmedabad Commodity Exchange.
0.006
0.005
0.041
Castorseed; The Rajkot Seeds Oil and Bullion 0.006

Merchants Association.
0.005
0.108
Potato; The Chamber of Commerce, Hapur
0.035
0.121
9.45
Cotton; The East India Cotton Association, Mumbai
0.004
0.003
1.952
Pepper; India Pepper and Spice Trade Association, 0.013

Cochin.
0.014
0.048
36
Table-4.5: Correlation Matrix
Correlation Coefficient
FV
FM
SR
Commodity & Name of the Exchange
Gur; The Chamber of Commerce, Hapur
FR
SR
-0.21
-0.13
0.11
-0.02
0.07
-
Gur; Vijay Beopar Chamber, Muzaffarnagar
FR
SR
0.14
0.04
-0.08
-0.21
0.16
-
Gur; Bhatinda Om and Oil Exchange.
FR
SR
0.44
-0.21
-0.25
0.45
0.10
-
Gur; The Meerut Agro Commodities Exchange.
FR
SR
-0.04
-0.26
0.15
-0.18
0.009
-
Castorseed; The Bombay Commodity Exchange.
FR
SR
-0.21
-0.37
-0.27
-0.38
0.88
-
Castorseed; Ahmedabad Commodity Exchange.
FR
SR
0.25
0.21
-0.05
-0.13
0.79
-
Seeds Oil and Bullion FR

SR
0.10
0.04
-0.25
-0.14
0.89
-
Castorseed; The Rajko

Merchants Association.
Potato; The Chamber of Commerce, Hapur
FR
SR
-0.03
0.05
-0.09
0.15
0.33
-
Cotton; The East India Cotton Association, Mumbai
FR
SR
0.12
0.08
0.12
0.07
0.66
-
Pepper; India Pepper and Spice Trade Association,

Cochin.
FR
SR
0.10
0.02
-0.20
-0.18
0.97
-
Coffee Plantation A; Coffee Futures Exchange,

Bangalore.
FR
-0.009
-0.06
FR
Coffee Robusta Cherry AB; Coffee Futures
-0.19
-0.04 Exchange, Bangalore.
SR represents ready price return. All other variables are as defined in equations (4) and
(5).
37
CHAPTER 5
CONSTRAINTS AND POLICY OPTIONS
Commodity exchanges in India are in their nascent stage of development. There are
numerous bottlenecks in the growth of this particular segment in India. These
institutional and policy level issues have to be addressed by the government and the FMC
for taking appropriate solutions towards rejuvenation of the paralyzed agricultural futures
markets. Some of the major problems that handicap the commodity exchanges are
discussed below.
a. Constitution of exchanges: All commodity exchanges in India are mutual
organizations. They are promoted by traders who carryout trading as well as manage the
exchanges. The exchange staff including the chief executive officer/secretary is the staff
of promoters. This structure poses a serious threat to the integrity of exchanges. The
structure needs to be altered so as to ensure an arms length relationship between those
who promote and anage the exchange on the one hand and those who have trading
interest in exchanges on the other. Many leading exchanges in the world like Chicago
Mercantile Exchange, International Petroleum Exchange, and New York Mercantile
Exchange etc. are demutualized organizations where arms-length relationship between
management and trading is maintained. The pepper exchange in Cochin is seriously
considering change in its set up from a non -profit making organization to a profit making
equity based organization.
b. Trading parameters: The terms and conditions of contracts play a crucial role in the
growth and development of trading in any exchange. They should be market friendly in
the sense that the terms are affordable to small and large traders alike and shou d be
attracting all prospective beneficiaries of futures trading including growers, processors,
merchandisers, consumers, etc. However, the contract specifications (as given in table
2.2) in many exchanges are prohibitive to many segments. For example, the lot size of
cotton contract in cotton exchange, Bombay, is 55 bales which amounts to 10 tonnes.
Similarly, the costlier commodity like pepper for which the lot size fixed by the peppe
exchange, Cochin is 2.5 tonnes with 15 tonnes as deliverable quantit y. Many such finer
aspects of contracts can be pointed out which apparently seem to go against the wider
interests of prospective beneficiaries of futures trading. One needs to really go into the
micro details of these specifications before making any judgements as to how market
friendly these contracts are.
c. Infrastructur : Lack of efficient and modern infrastructural facilities are a majo
bottleneck in the growth of futures markets in India. Though some of the exchanges
notably Bombay Commodity Exchange and Cotton Exchange, Mumbai own huge office
premises, they lack necessary institutional infrastructure including warehousing facilities
independent clearing house in addition to modern trading ring. The Kanpur Commodity
Exchange for example, lacks basic facilities to disseminate the trading information. The
exchange has only a couple of small office rooms and a poorly maintained trading ring
which seems to have never been utilized.
38
d. The trading system: Most of the exchanges till date have open outcry system. Of the
sample of six exchanges visited, only Coffee Futures Exchange, Bangalore has
introduced electronic trading system. The Forward Markets Commission has been
emphasizing the need for automation and on -line trading system for ensuring better
transparency and fairness in trading practices. It has been observed that less than 10 pe
cent of members are only actively trading in these exchanges. Volume of trade has been
consistently declining. In some exchanges e.g., Kanpur Commodity Ex change the
market is non-existent. An active and vibrant market is necessary for introducing
electronic trading system. Steps have to be initiated for creating market and making the
exchange financially sound for investing in automation and on-line trading. The Coffee
Futures Exchange, Bangalore where automation was introduced which did not encourage
the traders consequent to which volume dropped leaving a large financial burden.
Moreover, majority of trading members in some of the exchanges are not edu cate
enough to handle English and to operate computer. For example, most of the members of
the commodity exchange in Hapur said to have no working knowledge in Engl ish without
which computerised trading is almost impractical.
e. Broking community: Although a large number of members exist in the records of
exchanges, most of them shy away from trading due to the fact that the business is not
very profitable. It is essential to attract large scale broking firms who have diversified
into stock broking and other related businesses. Regulation including setting standards
for brokers, imposing capital adequacy norms, qualification criterion, etc would become
more meaningful when more and more active traders are attracted to the business.
f. Existence of uno fficial market: The grey/black market which existed outside the
exchange premises during the ban on futures trading for over 30 years still continues to
exist even inside the exchanges. It has been widely accepted and admitted by some of the
CEOs/Secretaries of exchanges that at least 25 30 per cent trade in the exchanges go
unreported. The unofficial market operating outside the official exchange is much larger.
These unofficial traders find the margin, stamp duty and income tax requirements least
encouraging to come to the official contract channels.
g. Multiplicity of exchanges: Currently twenty exchanges are operational of which three
are specifically for conducting NTSD contracts and the remaining are in the trade of
nearly 30 commodity items. Recently, five new exchanges have been approved and three
of them are exclusively for futures contract in sugar. Many of these exchanges are set up
as specialized ones for trading in one or a few commodities. The international experience
shows that exchanges are only to provide a platform for trade in many commodities and
different forms of contracts. The Chicago Mercantile Exchange started as an agricultural
exchange, and now largely relies on trade in financial futures; while the New York
Mercantile Exchange, now the worlds largest energy exchange, once traded butter and
potatoes. If an exchange provides a well-organised trading system for certain
commodities, with well-developed procedures, a good intermediary structure, and a
sound clearing house, it can build on these strengths to introduce new products.
39
h. Controlled market: Price variability is an essential pre-condition for futures markets.

Any distortion in the market mechanism where free play of supply and demand forces for
commodities determines prices will dilute the variability of prices and potential risk. It is
imperative that for a vibrant futures market commodity pricing must be left to market
forces, without monopolistic or undue government control. However, in India many of
the c mmodities in which futures trading is allowed have been still protected under ECA,
1955. There are also commodity based specialized government agencies like Cotton
Corporation of India, NAFED, Jute Corporation of India, etc. which seek to control
supplies of some farm products.
i. Regulation and self -regulation: Government has two important role to play: an
oversight role by which the government disciplining those who try to manipulate the
markets for their own benefit, and ensuring the sanctity of contra cts; and secondly, an
enabling role by which the government providing the necessary legal and regulatory
framework for the smooth functioning of the system. The regulatory intervention shoul
be most active at the time of the establishment of the exchange and of contracts. If the
contracts are well formulated, and delivery modalities provide effective line of defence
against attempts at manipulation, government has to only act as a watchdog intervening
only when necessary. The goal of regulatory agency i s not only regulate but also to
inculcate the culture of sel -regulation among the participants. This in turn, over a period
of time, will give way for more self-regulation supported by the advisory role of state
regulation.
j. Wider use of Commodity der ivatives: With the increasing technological
sophistication of trading methods, better transparency and guarantee of trade in futures,
more institutional players like mutual funds, foreign institutional investors should be
allowed to trade in recognized commodity exchanges. The exchanges under the guidance
of the Forward Markets Commission must undertake publicity and mass awareness
programmes for the promotion of this segment. For this purpose it would be beneficial
for them to have a policy level alliance with the counterparts in stock markets.
k. Modification of income tax provisions and rationalization of stamp duty : In the
past, speculative and non-speculative businesses were treated equally for taxation so far
as right to set off or carry forward of loss was concerned. As a result, it was possible t
set off speculative losses against speculative profits. Current tax rule however does not
allow for setting off or carrying forward of speculative losses against regular business
income. It does not treat losses on futures transaction as a normal business expense. The
futures trading industry has been demanding amendments in the tax law for the better
development of futures trading. Similarly, the stamp duty provisions on futures trading
make the transaction cost higher and moreover the rates vary from one state to the other.
While states like Gujarat, Madhya Pradesh, Kerala, etc do not impose stamp duty on
futures trading, some other states like Maharashtra imposes stamp duty on futures trading
of certain commodity items.
40
CONCLUSIONS
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 present study is an investigation into the derivative markets in agricultural
commodities in India. The study has surveyed the recognized exchanges and their
organizational, trading and the regulatory set up for futures trading in commodities. The
study has outlined the status of futures markets in agricultural commodities in the Indian
context In the light of spot visit to seven exchanges the study identifies the problems
and prospects of the futures market in agricultural commodities in India.
A statistical analysis has also been carried out to evaluate the efficiency of a sample set of
markets in price discovery and to understand the interrelationship between prices, volume
of transaction, open positions and volatility of the markets. The results of the study revea
that many of the commodity futures exchanges fail to provide an efficient hedge agains
the risk emerging from volatile prices of many farm products in which they carry out
futures trading. The results obtained from a statistical analysis of the data on price
discovery in a sample of six commodities traded in four exchanges showed that the
futures market in those commodities are not efficient in the sense that the futures price s
are not an unbiased predictor of the future ready rates. The difference between the
futures prices and the future ready prices is an indication of inefficiency arising from the
underdeveloped nature of the market. Many bottlenecks faced by this segmen are
common across exchanges.
A quantitative analysis of the relationship between price return, volume, market depth
and volatility on a sample of twelve markets in six commodity items shows that the
market volume and depth are not significantly influen ced by the return and volatility of
futures as well as ready markets. The results indicate that the futures and ready markets
are not integrated. The price volatility in the ready markets does not have any impacts on
the market conditions in futures mark ets. The exchange specific problems like low
volume and market depth, lack of participation of trading members and irregular trading
activities along with state intervention in many commodity markets are major ills
retarding the growth of futures market. In the presence of these ills no quantitative
analysis of market conditions and interrelations would provide meaningful results.
A review of the nature of institutional and policy level constraints facing this segment
calls for more focused and pragmatic approach from government, the regulator and the
exchanges for making the agricultural futures markets a vibrant segment for risk
management which can play an important role especially in an agriculture dominated
economy of India.
41
BIBLIOGRAPHY
Bessembinder, H., & Seguin, P.J., Price volatility, trading volume, and market depth:
Evidence from futures markets, Journal of Quantitative and Financial Analysis, Vol. 28,
1993, pp.21-39.
Commodity Futures Trading Commission ; Economic purposes of futures tradin g,
Washington, 1997.
Forward Markets Commission, Ministry of Food and Consumer Affairs, Government of
India; Forward Contracts (Regulation) Act, 1952.
Forward Markets Commission, Ministry of Food and Consumer Affairs, Government of
India; Forward trading and Forward Markets Commission, 2000.
Gallant, A.R., Rossi, P.E., & Tauchen, G., Stock prices and volume, Review o
Financial Studies, Vol. 5, 1992, pp.199-242.
Jones, C.M., Kaul, G., & Lipson, M.L., Transactions, volume and volatility, Review o
Financial Studies, Vol. 7, 1994, pp. 631-651.
Ministry of Food and Consumer Affairs, Government of India; Futures trading,
commodity exchanges and Forward Markets Commission, New Delhi, 1999.
Sahadevan, K.G., Risk management in agricultural commodity markets: A study of
some selected commodity futures, Working Paper Series: 2002-07, Indian Institute of
Management Lucknow, April 2002.
Tomek, W G and Peterson, H H; Risk management in agricultural markets: A review,
The Journal of Futures Markets, Vol. 21 (10), 2001, pp.953-985.
United Nations Conference on Trade and Development, Feasibility study on a
worldwide pepper futures contract, (UNCTAD/COM/64), October 1995.
United Nations Conference on Trade and Development, Emerging commodity
exchanges: From potential to success, (UNCTAD/ITCD/COM/4), February 1997.
United Nations Conference on Trade and Development, A survey of commodity risk
management instruments, (UNCTAD/COM/15/Rev.2), April 1998.
Youssef, Frida; Integrated report on commodity exchanges and Forward Markets
Commission, Report of the World Bank Project for the improvement of the commodities
futures markets in India, 2000.

42
APPENDIX I
Commodities to which Section 15 of FCRA 1952 has been applied thereby rendering
illegal all orward contracts except those entered into between members of a recognized
association or through or with such a member.
Sl.
No
Commodity
Region
Sl.
No
Commodity
Region
1.
3.
5.
7.
9.
11.
Groundnut
Groundnut oilcake
Cottonseed oil
Sesamum (till)
Sesamum oilcake
Copra/Coconut oil
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
2.
4.
6.
8.
10.
12.
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
13
15.
Safflower
Safflower oilcake
Entire Country
Entire Country
14.
16.
17.
Entire Country
18.
19.
21.
23.
25.
27.
Rapeseed/Mustard
seed oil
Rice bran
Rice bran oilcake
Sunflower oil
RBD Palmolein
Indian cotton (ful
& half pressed or
loose
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
20.
22.
24.
26.
28.
Groundnut oil
Cottonseed
Cottonseed oilcake
Sesamum oil
Copra/Coconut
Copra/Coconut
oilcake
Safflower oil
Rapeseed/Mustard
seed
Rapeseed/Mustard
seed oilcake
Rice bran oil
Sunflower seed
Sunflower oilcake
Gur
Raw jute
29.
31.
33.
Kapas
Jute goods
Pepper
30. Staple fibre yarn

32. Turmeric
34. Castorseed
35.
Castor oil
Entire Country
Entire Country
Kerala
and
within the limit
of
Greater
Bombay
Maharashtra
Entire Country
Entire Country
Entire Country
Entire Country
The states of
Mizoram, WB,
Bihar, Assam,
Orissa,Tripura,
Meghalaya, &
Arunachal
Pradesh.
Entire Country
Entire Country
Entire Country
36. Potato
Entire Country
43
Entire Country
Entire Country
Entire Country
APPENDIX II
Commodities in which forward contracts have been prohibited under section 17 of the
FCRA 1952
Sl.
No
Commodity
Region
Sl.
No
Commodity
Region
1.
3.
5.
7.
9.
11.
13
15.
17.
19.
21.
23.
25.
27.
29.
31.
33.
Wheat
Jowar
Maize
Small millets
Urad (Mash)
Moth
Kulthi
Lakh(Khesari)
Guar
Arhar Chuni
Tur dal
Mung dal
Sugar
Taramiraseed
Mowraseed
Linseed
Castor oil
2.
4.
6.
8.
10.
12.
14.
16.
18.
20.
22.
24.
26.
28.
30.
32.
34.
Gram
Bajra
Ragi
Tur (Arhar)
Murg
Masur
Peas
Barley
Rice or Paddy
Mung Chuny
Urad da
Gram dal
Khandasari sugar
Taramiraseed oil
Mowraseed oi
Linseed oil
Vanaspati
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
35.
37.
39.
41.
43.
45.
47.
49.
51.
53.
55.
Neemseed
Karnaja
Salseed
Khakan seed
Kokum seed
Nahor seed
Undi seed
Watermelon seed
Tobacco seed
Niger seed
Taramiraseed
oilcake
Celeryseed
Cotton Yarn
Art silk yarn
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Excep
Maharashra
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
36.
38.
40.
42.
44.
46.
48.
50.
52.
54.
56.
Neemseed oi
Karnaja oil
Sal oil
Khakan oil
Kokum oil
Nahor oil
Undi oil
Watermelon oil
Tobacco seed oil
Niger oil
Linseed oilcake
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
58. Cotton pods

60. Cotton cloth
62. Raw Jute
57.
59.
61.
44
Entire Country
Entire Country
Except
the
states
of
Mizoram, WB,
Bihar, Assam,
Orissa,Tripura,
Meghalaya, &
Arunachal
Pradesh.
63.
65.
Methi
Aniseed
67.
69.
71.
73.
75.
77.
Betelnuts
Except Kerala
Chillies
Except Kerala
Cloves
Except Kerala
Nutmegs
Except Kerala
Silver
Entire Country
Copper, zinc, lead Entire Country
or Tin
Seedlac
Entire Country
Camphor
Entire Country
79.
81.
Entire Country
Entire Country
64. Coriander seed

66. Pepper
Cardamom
Cinnamon
Ginger
Gold
Silver coins
Shellac
Except Kerala
and
Greater
Bombay
Except Kerala
Except Kerala
Except Kerala
Entire Country
Entire Country
Entire Country
80. Chara or berseem

82. Gram Husk
Entire Country
Entire Country
68.
70.
72.
74.
76.
78.
45
APPENDIX III
Commodities in which non -transferable specific delivery contracts are prohibited under
section 18(3) of FCRA 1952.
Sl.
No
Commodity
Region
Sl.
No
Commodity
Region
1.
3.
5.
7.
9.
11.
13
15.
17.
19.
21.
23.
25.
27.
29.
31.
33.
35.
Wheat
Jowar
Maize
Small millets
Urad (Mash)
Moth
Kulthi
Lakh (Khesari
Guar
Arhar Chuni
Tur dal (Arhar dal)
Mung dal
Mustardseed
Taramiraseed
Mustardseed oil
Taramiraseed oil
Linseed oil
Vanspati
and
vegitable oil
Neemseed oi
Karanja
Kusumseed
Salseed
Khakan seed
Kokum seed
Nahor seed
Undi seed
Rice bran
Watermelon seed
Tobacco seed
Sunflower seed
Niger seed
Castor oil
Mustardseed
oilcake
Taramiraseed
oilcake
Linseed oilcake
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
2.
4.
6.
8.
10.
12.
14.
16.
18.
20.
22.
24.
26.
28.
30.
32.
34.
36.
Gram
Bajra
Ragi
Tur (Arhar)
Mung
Masur
Peas
Barley
Rice or paddy
Mung Chuni
Urad dal (Mash dal)
Gram dal
Rapeseed or Toria
Mowraseed
Rapeseed oil
Linseed
Cottonseed oil
Mowraseed oi
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
38.
40.
42.
44.
46.
48.
50.
52.
54.
56.
58.
60.
62.
64.
66.
Neem oil
Karanja oil
Kusum oil
Sal oil
Khakan oil
Kokum oil
Nahor oil
Undi oil
Rice bran oil
Watermelonseed oil
Tobacco seed oil
Sunflower oil
Niger oil
Sesamum oilcake
Rapeseed oilcake
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
68. Cottonseed oilcake
Entire Country
Entire Country
70. Celeryseed
Entire Country
37.
39.
41.
43.
45.
47.
49.
51.
53.
55.
57.
59.
61.
63.
65.
67.
69.
46
71.
73.
75.
77.
79.
Art
Silk
yarn
imported in to Indi
Coriander seed
Gold
Silver coins
Gram husk
Entire Country
72. Methi
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
74. Aniseed
76. Silver
78. Chara or berseem
Entire Country
Entire Country
Entire Country
Entire Country
47
APPENDIX IV
Commodities in which Sections 15 and 18(3) of the FCRA 1952 are applied to non transferable specific delivery contracts
Sl.
No
Commodity
Region
Sl.
No
1.
3.
5.
7.
9.
Groundnut
Khardiseed
Sesamum (till)
Copra
Cottonseed
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
2.
4.
6.
8.
10.
11.
Kapas
13
Jute goods
15.
Castorseed
Within
limits
Punjab,
Haryana,
Rajastan, UP
& the UTs of
Delhi
and
Chandigarh
In the city of 14. Gur
Calcutta
Entire Country
Commodity
Groundnut oil
Khardiseed oil
Sesamum oil
Cocunut oil
Indian cotton (ful
& half pressed or
loose)
the 12. Raw jute
of
48
Region
Entire Country
Entire Country
Entire Country
Entire Country
Entire Country
The states of
Mizoram, WB,
Bihar, Assam,
Orissa,Tripura,
Meghalaya, &
Arunachal
Pradesh.
Entire Country

7

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Derivatives and Price Risk Management:

A Study of Agricultural Commodity Futures in India

A Seed Money Project Report

K.G. Sahadevan, Ph.D

INDIAN INSTITUTE OF MANAGEMENT LUCKNOW

Derivatives and Price Risk Management: A Study of

1.1. Commodity Derivatives and their Uses

Mechanics of Futures Trading

2.1. What is a Commodity Futures Exchange?

Commodity Futures Exchanges The profile and

3.1. The Profile of Futures Exchanges

Price Discovery, Return, Volatility and Market

4.1. Is Futures Market Efficient?

Constraints and Policy Options

Commodities notified u/s 15 of FCRA 1952

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

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Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

LIST OF TABLES AND FIGURES

Typology of risk management instruments

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

1.1. Commodity Derivatives and their Uses

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Figure-1.1: Typology of risk management instruments

K.G. Sahadevan, IIM Lucknow

commodities while he benefits from the potential gain of an increase in prices.

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

relating to the organization of exchanges, terms and conditions of futures contracts,

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

2.2. What is Commodity Futures Contract?

Trading in futures is necessarily organized under the auspices of a recognized

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

2.3. Who are the Participants in Futures Market?

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Check credit risk

Check credit risk

Orders are matched

2.5. Role of Clearing House

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

clearinghouse on account of price volatility of the commodity underlying the contract to

Agricultural Commodity Futures in India

K.G. Sahadevan, IIM Lucknow

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