Financial Derivatives: Unit-5 Commodity Derivatives market (Theory Only)
1) What is a commodity?
A commodity is a group of assets/goods that are important in everyday life, such as food, energy
or metals. A commodity is alternate and exchangeable by nature. It can be categorized as every
kind of movable good that can be bought and sold, except for actionable claims and money.
2) What are commodity futures?
Ans: Definition of Commodity futures: Commodity futures contracts are derivative instruments
which can be used for hedging the price risk involved in commodity trading and its value is
derived from underlying assets are physical commodities such as sugar, wheat, rubber, gold etc
are referred to as commodity futures.
3) Differentiate between commodity and financial futures. (or) Write a brief note on
economic functions of commodity derivatives markets
Commodity Futures Financial futures
Physical Settlement Cash Settlement
Requires Storage cost No Storage Cost
Warehouse facility needed No warehouse facilities
Variation of Quality exist No variation of quality
Physically held Dematerialized
Delivery notification to buyer No delivery notification
4) Discuss Commodity trading advantages and disadvantages.
Advantages:
Commodity futures are highly leveraged investments, which means with a
relatively small amount of money you can take a bigger bet.
Future markets generally are very liquid, which means entry and exit are easy.
Commodity futures can potentially give huge profits, if traded carefully and
smartly
Disadvantages
Commodity futures trading are that markets are volatile, which means risk is higher.
Direct investment in the commodity markets is of high-risk, especially for new
investors.
.Gains and losses are magnified by leverage, which means you win big or lose big.
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Financial Derivatives: Unit-5 Commodity Derivatives market (Theory Only)
5) Write any functions of commodity derivatives / Benefits of commodity futures
market
Price Discovery: Based on inputs regarding specific market information, buyers and
sellers conduct trading at futures exchanges. This results into continuous price discovery
mechanism.
Hedging: It is strategy of managing price risk that is inherent in spot market by taking an
equal but opposite position in the futures market to protect their business from adverse
price change.
Import- Export competitiveness: The exporters can hedge their price risk and improve
their competitiveness by making use of futures market. A majority of traders which are
involved in physical trade internationally intend to buy forwards. The existence of futures
market allows the exporters to hedge their proposed purchase by temporarily substituting
for actual purchase till the time is ripe to buy in physical market.
Portfolio Diversification: Commodity offers at another investment options which is
largely negatively correlated with equity and currency and thus could offer great portfolio
diversification.
6) Discuss the commodities traded in the commodity exchanges. What are the various
exchanges for trading commodity futures in India?
The following are the commodities traded in the commodity exchanges:
1. Metals – Silver, Gold, Platinum, and Copper
2. Energy – Crude oil, Natural gas, Gasoline, and Heating oil
3. Agriculture – Corn, Beans, Rice, Wheat, etc.,
4. Livestock and Meat – Eggs, Pork, Cattle, etc.,
Various exchanges for trading commodity futures in India
Multi Commodity Exchange (MCX),
National Commodity and Derivatives Exchange (NCDEX),
Indian Commodity Exchange (ICEX),
National Multi Commodity Exchange (NMCE),
ACE Derivative Exchange (ACE) and Universal Commodity Exchange (UCX).
In 2018 both National Stock Exchange (NSE) and Bombay Stock Exchange (BSE)
launched trading in commodities
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Financial Derivatives: Unit-5 Commodity Derivatives market (Theory Only)
7) Write a note on any two commodity exchanges in India.
Below is a list of commodity exchanges in India and the products traded on these exchanges:
1. MCX : Multi Commodity Exchange
This is the largest commodities exchange in India and it operates in over 40 countries. It
is also the world’s largest exchange in silver and gold.
Established in November 2003
Headquartered in Mumbai
Promoters include the National Spot Exchange, IEX, Singapore Mercantile exchange,
Global board of trade, IBS Forex, National Bulk Handling Corporation, Ticker Plant Ltd.
Traded Commodities:Bullion, metals, fibre, energy, spices, plantations, pulses,
petrochemicals, cereals among others
2. ICEX : Indian Commodity Exchange
It is a screen-based online derivatives exchange for commodities.
Establishedin November 2009
Headquartered in Gurgaon
Promoters include Reliance Exchange Next Ltd – an anchor investor, MMCTC Ltd,
Indiabulls Financial Services Ltd, Indian Potash Ltd, and KRIBHCO among others.
Traded Commodities:
Gold, silver, diamond, copper, lead, crude oil, natural gas, mustard, soya bean, jute, iron
ore.
3. NCDEX : National Commodity and Derivatives Exchange
It specialises mainly in agricultural commodities trading.
Establishedin December 2003
Headquartered in Mumbai
Promoters include NSE, ICICI Bank, LIC, NABARD, Canara Bank, Intercontinental
Exchange, and Crisil among others.
Traded Commodities:
Cereals, pulses, fibres, oils & oil seeds, spices, gold, silver, steel, copper, crude oil, and
brent crude oil among others.
4. NMCE : National Multi Commodity Exchange
Establishedin 2002
Headquartered in Ahmedabad
Promoters include National Institute of Agricultural Marketing, Punjab National Bank,
Gujarat State Agricultural Marketing Board, Gujarat Agricultural Industries Corporation
Limited.
Traded Commodities:
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Financial Derivatives: Unit-5 Commodity Derivatives market (Theory Only)
Castor seeds, rapeseed, mustard, soya bean, sesame, copra, black pepper, gram, gold,
aluminum, rubber, copper, lead, zinc, jute, and coffee among others
8) Explain in brief the National Commodity Exchange along with their salient features.
The National Commodity & Derivatives Exchange (NCDEX) is a commodities exchange dealing
primarily in agricultural commodities in India. The National Commodity & Derivatives
Exchange was established in 2003, and its headquarters are in Mumbai. Many of India's leading
financial institutions have a stake in the NCDEX. As of September 2019, significant
shareholders included Life Insurance Corporation of India (LIC), the National Stock Exchange
of India Limited (NSE), and the National Bank for Agricultural and Rural Development
(NABARD)
The key features are:
The National Commodity & Derivatives Exchange (NCDEX) is a commodities exchange
dealing primarily in agricultural commodities in India.
The National Commodity & Derivatives Exchange is located in Mumbai but has offices
across the country to facilitate trade.
Exchanges like NCDEX have also played a key role in improving Indian agricultural
practices.
Barley, wheat, and soybeans are some of the leading agricultural commodities traded on
the NCDEX
9) What are commodity derivatives? Explain the process of settlement of any
commodity in any national commodity exchange.
Clearing of trade take place on through the exchange clearing house.
The Exchange has an in house clearing department which monitors and performs all
activities relating to delivery, fund settlement, margining and managing the settlement
guarantee funds.
After the trading hour matching of delivery take place based on the location
The clearing house collects margin from the members, effect of pay-in and pay-out and
monitor delivery and settlement process
Clearing members informed to look into the contract for cash/physical settlement and
inform further to the concern
Future contract has two settlement based on:
MTM settlement: based on the daily closing prices
Final settlement: based on the final closing prices
Settlement methods:
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Financial Derivatives: Unit-5 Commodity Derivatives market (Theory Only)
Physical Settlement: on the last day of closing the delivery of the physical asset takes
place on based on delivery place, date, time, quality, with following receipt producing.
Cash settlement: contract held till the last day of trading can be cash settled when a
contract is settled in cash, its mark to market at the end of the last day trading day & all
position are declared closed.
Closing out open position: most of the contract is settled by closing out at open position,
in closing out, the opposite transaction is effected to close out the original future position
Ex: a buy contract is closed out by a SELL& sell contract is closed out by BUY (or)
Squared off
10) What is forward market commission? What are its functions?
Forward Market Commission (FMC)
Commodity futures market is regulated under the provision of the forward contract (Regulation)
Act 1952. Is the regulatory body overseeing the functioning of the commodity futures market,
it functions under the ministry of consumer affairs, food and public distribution ,government of
India
The major functions of the Forward market Commission are as follows:
To advise the central government in respect of the recognition /the withdrawal of
recognition from any association.
To keep forward market under observational and take action under any necessary
consideration
To collect & publish the information where its necessary, regarding the supply demand
and prices
To make recommendation generally with a view to improve the market
To undertake the inspection of the accounts and other documents of any recognized
association /registered association
In 2015, the regulatory body of the commodities trading – Forward Market Commission (FMC)
merged with the Securities and Exchange Board of India (SEBI). Commodity trading in these
exchanges requires standard agreements as per the instructions so that trades can be executed
without visual inspection.
11) What is convenience yield?
Solution: A convenience yield is the benefit or premium associated with holding an
underlying product or physical good, rather than the associated derivative security or
contract.
12) What is clearing house
Solution: The clearing house collects margin from the members, effect of pay-in and pay-
out and monitor delivery and settlement process.
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