100830724 project-on-commodity-market-vishnu-mantri

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2. CONTENTChapter TopicPageNoNo.Literature review1 Introduction to Commodity Market042 History of Evolution of Commodity 08Markets3 India and the Commodity Market104 International Commodity Exchanges 155 How Commodity Market Works? 176 How to Invest in a Commodity19Market7 CurrentScenarioinIndian 23Commodity Market8 Commodities 289 Analysis38ANNAXTURE 47Summary 55Bibliography562 3. ACKNOWLEDGEMENT It is great pleasure for me to acknowledge the kind of help andguidance received to me during my project work. I was fortunate enough toget support from a large number of people to whom I shall always remaingrateful. I would like to express my sincere gratitude to Mr.ASHOTOSH DAGAfor giving me this opportunity to undergo this lucrative project and also fortheir great guidance and advice on this project, without which I will not beable to complete this project. I am very thankful to our Director Sir ______________ for givingme valuable suggestion and encouragement to bring out good project. I am very thankful to my mentor Prof. ____________ for himinspiration and for initiating diligent efforts and expert guidance in course ofmy study and completion of the project and I am very thankful to myproject guide for giving me timely and concrete guidance for making thisproject successful. I would thank to God for their blessing and my Parents also fortheir valuable suggestion and support in my project report. I would also like to thank our friends and those who have helped usduring this project directly or indirectly.VISHNU MANTRI 3 4. LITERATURE REVIEWT he emerg ence of t he market f or derivat iv e product s,mostnot abl yf or wa rd s, f u t u r e s a n d o p t i o n s , c a n b e t r a c e d b a c kto the willingness of risk-averseeconomic agentsto guard themselves against uncertainties arising o u t o f f luct uat io ns in asset prices.B y t heir ver y nat ure,t he f inanci al market s are m a r k e d b y a v e r y h i g h d e gr e e o f v o l a t i l i t y . T h r o u g h t h e u s e o f d e r i v a t i v e products, it is possible to partially or fully transfer price risksby locking-in assetprices. Asinstruments ofrisk management, these generally do not influencethefluctuations in the underlying asset prices. However, bylocking-in asset prices,derivat iv e product s minimize t heimpact of f luct uat ions in asset prices on t he profitabilityand cash flow situationofrisk-averseinvestors.Derivative products initially emerged, as hedgingdevices against fluctuations incommodity prices andcommodity-linked derivatives remained the sole formof such products for almost three hundred years. Thefinancial derivativescameint o spot light in post -1970 perio d due t o gro win g inst abil it y in t he f inancia lmarkets. However, since their emergence, these productshave become verypopular and by 1990s, they accounted forabout two-thirds of total transactions inderivat iv e product s.I n recent ye ars, t he market f or f inancial derivat iveshasgro wn t remend ousl y bot h in t erms of variet y of inst rument s avail abl e, t heir comple xit yandalsot urnover. I n t he class of equit y derivat ives, f ut uresand options on stock indices have gained more popularitythanonindividualstocks,especia lly among inst it ut ion al invest ors, wh o are major users of index- linke d derivatives.Evensmallinvest ors f ind t hese usef ul due t o high correlat io n oft he pop ular indices with various portfolios and ease 4 5. of use.The lower costs associatedwithindex derivat ives vis- vis derivat iv e product sbased on indivi dua l securit ies is another reason for theirgrowing use.As in the present scenario, Derivative Trading is fastgaining momentum. Chapter 1 Introduction to Commodity MarketWhat is Commodity? Any product that can be used for commerce or an articleof commerce which is traded on an authorized commodity exchange isknown as commodity. The article should be movable of value,something which is bought or sold and which is produced or used asthe subject or barter or sale. In short commodity includes all kinds ofgoods. Indian Forward Contracts (Regulation) Act (FCRA), 1952defines goods as every kind of movable property other thanactionable claims, money and securities.In current situation, all goods and products of agricultural(including plantation), mineral and fossil origin are allowed forcommodity trading recognized under the FCRA. The nationalcommodity exchanges, recognized by the Central Government, permitscommodities which include precious (gold and silver) and non-ferrousmetals, cereals and pulses, ginned and un-ginned cotton, oilseeds, oilsand oilcakes, raw jute and jute goods, sugar and gur, potatoes andonions, coffee and tea, rubber and spices. Etc.What is a commodity exchange?A commodity exchange is an association or a company or anyother body corporate organizing futures trading in commodities forwhich license has been granted by regulating authority.What is Commodity Futures?A Commodity futures is an agreement between two parties tobuy or sell a specified and standardized quantity of a commodity at acertain time in future at a price agreed upon at the time of enteringinto the contract on the commodity futures exchange.The need for a futures market arises mainly due to thehedging function that it can perform. Commodity markets, like any 5 6. other financial instrument, involve risk associated with frequent pricevolatility. The loss due to price volatility can be attributed to thefollowing reasons:Consumer Preferences: - In the short-term, their influence on pricevolatility is small since it is a slow process permitting manufacturers,dealers and wholesalers to adjust their inventory in advance.Changes in supply: - They are abrupt and unpredictable bringingabout wild fluctuations in prices. This can especially noticed inagricultural commodities where the weather plays a major role inaffecting the fortunes of people involved in this industry. The futuresmarket has evolved to neutralize such risks through a mechanism;namely hedging.The objectives of Commodity futures: - Hedging with the objective of transferring risk related to the possession of physical assets through any adverse moments in price. Liquidity and Price discovery to ensure base minimum volume in trading of a commodity through market information and demand supply factors that facilitates a regular and authentic price discovery mechanism. Maintaining buffer stock and better allocation of resources as it augments reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments. Price stabilization along with balancing demand and supply position. Futures trading leads to predictability in assessing the domestic prices, which maintains stability, thus safeguarding against any short term adverse price movements. Liquidity in Contracts of the commodities traded also ensures in maintaining the equilibrium between demand and supply. Flexibility, certainty and transparency in purchasing commodities facilitate bank financing. Predictability in prices of commodity would lead to stability, which in turn would eliminate the risks associated with running the business of trading commodities. This would make funding easier and less stringent for banks to commodity market players.Benefits of Commodity Futures Markets:- The primary objectives of any futures exchange are authenticprice discovery and an efficient price risk management. The6 7. beneficiaries include those who trade in the commodities being offeredin the exchange as well as those who have nothing to do with futurestrading. It is because of price discovery and risk management throughthe existence of futures exchanges that a lot of businesses andservices are able to function smoothly.1. Price Discovery:-Based on inputs regarding specific market information, the demand and supply equilibrium, weather forecasts, expert views and comments, inflation rates, Government policies, market dynamics, hopes and fears, buyers and sellers conduct trading at futures exchanges. This transforms in to continuous price discovery mechanism. The execution of trade between buyers and sellers leads to assessment of fair value of a particular commodity that is immediately disseminated on the trading terminal.2. Price Risk Management: - Hedging is the most common method of price risk management. It is strategy of offering price risk that is inherent in spot market by taking an equal but opposite position in the futures market. Futures markets are used as a mode by hedgers to protect their business from adverse price change. This could dent the profitability of their business. Hedging benefits who are involved in trading of commodities likefarmers,processors,merchandisers, manufacturers, exporters, importers etc.3. 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 purchases made from the physical market might expose them to the risk of price risk resulting to losses. The existence of futures market would allow the exporters to hedge their proposed purchase by temporarily substituting for actual purchase till the time is ripe to buy in physical market. In the absence of futures market it will be meticulous, time consuming and costly physical transactions.4. Predictable Pricing: - The demand for certain commodities is highly price elastic. The manufacturers have to ensure that the prices should be stable in order to protect their market share with the free entry of imports. Futures contracts will enable predictability in domestic prices. The manufacturers can, as a result, smooth out the influence of changes in their input prices7 8. very easily. With no futures market, the manufacturer can becaught between severe short-te