A Dissertation on Rmc

7/31/2019 A Dissertation on Rmc

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A DISSERTATION ON

TITLE

ROLE OF RMC FOR CONTROLLING RISKS IN FUTURE

COMMODITY MARKET

SUBMITTED IN PARTIAL FULFILLMENT OF THE

AWARD OF PGDM CURRICULUM

BY-

RAGHAV GOEL

PGDM (2008-2010)

UNDER GUIDANCE OF

DR. RAGHVENDRA DWIVEDI

INSTITUTE OF TECHNOLOGY & SCIENCE

MOHAN NAGAR, GHAZIABAD.

(200810)


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Certificate

Certified that Raghav Goel has carried out the Dissertation work

presented in this thesis entitled ROLE OF RMC FOR CONTROLLING

RISKS IN FUTURE COMMODITY MARKET for the award of PGDM

from Institute of Technology and Science under my supervision. The

Dissertation embodies result of original work and studies carried out by

student himself and the contents of the thesis do not form the basis for the

award of any other degree to the candidate or to anybody else.

(Dr.Raghvendra Dwivedi)

FacultyITS-Ghaziabad

Date:


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ACKNOWLEDGEMENT

For any research project to be undertaken there has to be certain amount of inputs provided

through inspiration, motivation and creativity by people and friends. While the number of peoplewho have influenced, supported and guided me in the effort are too numerous. But after

completing it, I have realized that it has filled us with beneficial experiences, enormous

knowledge & many pleasant memories.

I would also like to thankDr. Raghwendra Dwivedi (academic mentor) for being a continuous

source of inspiration without whose support and guidance this project would not have got its

desirable shape. Finally, I would like to express my gratitude to my mentor who has helped me

with the much needed support during the dissertation period.


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ABSTRACT

This dissertation research was carried out as a part of PGDM curriculum where in I tried

to understand the Risk Management policy, procedures & practices (consideringregulatory requirements & market competition) adopted and implemented by

commodity broking business houses to take care & control the business risk of the

company & its constituents.

It enlights various risk management techniques followed by different

organizations. The commodity market has witnessed a rampant growth during the last

couple of years, and managing risk is essential because of higher risk in commodity

market in comparison to equity markets. It will also help the investors to understand

various risk factors to which they are exposed.

Need for RMS:-

Risk is an integral part of any business & it need not necessarily lead to an adverse result.

In commodity broking market, not only commodities are traded; in the process, RISK and

RETURN are also traded and there is a trade off between the risk and the return.

Risk taking is essential to an active commodity market and legitimate risk taking should

not be unnecessarily or unduly avoided, therefore, a good commodity broking outfit

necessarily requires a robust & efficient risk management system as an integral part of its

effective business model with an objective to meet the competition & the expectation of

clients yet it should be able to control the business risks effectively including statutory,

Exchange & FMC compliances.


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CHAPTERISATION SCHEME

1)Objectives and Scope of the study.

2)Evolution of commodity market.

3)Introduction to commodity market.

4)Introduction to risk management.

5)Risk controlling policies.

6)Modus operandi of RMC

7)Role of risk management cell.

8) Conclusion

9) Bibliography


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CHAPTER-1

Objectives and Scope of the study


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OBJECTIVE

To know & to understand the Risk Management policy, procedures & practices

(considering regulatory requirements & market competition) adopted and implemented

by commodity broking business houses to take care & control the business risk of the

company & its constituents.


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SCOPE

The scope of the study is very wide as it enlights various risk management techniques

followed by different organizations. The commodity market has witnessed a rampant

growth during the last couple of years, and managing risk is essential because of higher

risk in commodity market in comparison to equity markets.

It will also help the investors to understand various risk factors to which they

are exposed. Moreover it will certainly helpful to the students as it would make them

acquaint with risk control policies before going ahead.


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RESEARCH DESIGN

DATA

SECONDARY DATA- It means the data which is primarily available i.e. refer to the data

which have already been collected and analyzed by someone else, which is collected by

various sources.

In my report mainly the secondary data has been used, and

it has been collected primarily from websites, and to some extent from articles

published in newspapers, magazines, journals.

AREA OF STUDY

The area of study is not specified.

RESEARCH PROBLEM

The research problem is that how risk management cell encompasses capital

adequacy of clients, adequate margin requirements, limits on exposure and turnover,

online position monitoring and automatic disablement


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TYPE OF RESEARCH

The type of research used- descriptive research.

SOFTWARE USED

Ms Word


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CHAPTER 2

Evolution of commodity market


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EVOLUTION OF COMMODITY MARKET IN INDIA

When did Commodity Futures market begin in India, and how did itgrow over the decades?

Organized futures market evolved in India by the setting up of Bombay Cotton Trade

Association Ltd in 1875.

In 1893, following widespread discontent amongst leading cotton mill owners and

merchants over the functioning of the Bombay Cotton Trade Association, a separateassociation by the name Bombay Cotton Exchange Ltd was constituted. Futures

trading in oilseeds were organized in India for the first time with the setting up of

Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut,

castor seed and cotton. Before the Second World War broke out in 1939 several

futures markets in oilseeds were functioning in Gujarat and Punjab.

Futures trading in Raw Jute and Jute Goods began in Calcutta with the establishment

of the Calcutta Hessian Exchange Ltd., in 1919. Later East Indian Jute AssociationLtd. was set up in 1927 for organizing futures trading in Raw Jute. These two

associations amalgamated in 1945 to form the present East India Jute & Hessian Ltd.,

to conduct organized trading in both Raw Jute and Jute goods. In case of wheat,

futures markets were in existence at several centres at Punjab and U.P. The most

notable amongst them was the Chamber of Commerce at Hapur, which was

established in 1913. Other markets were located at Amritsar, Moga, Ludhiana,

Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar,

Chandausi, Meerut, Saharanpur, Hathras, Ghaziabad, Sikandrabad and Bareilly in

U.P.

Futures market in Bullion began at Mumbai in 1920 and later similar markets came up


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at Rajkot , Jaipur, Jamnagar , Kanpur, Delhi and Calcutta. In due course several other

exchanges were also created in the country to trade in such diverse commodities as

pepper, turmeric, potato, sugar and gur(jaggory).

After independence, the Constitution of India brought the subject of "Stock

Exchanges and futures markets" in the Union list. As a result, the responsibility for

regulation of commodity futures markets devolved on Govt. of India. A Bill on

forward contracts was referred to an expert committee headed by Prof. A.D.Shroff

and Select Committees of two successive Parliaments and finally in December 1952

Forward Contracts (Regulation) Act, 1952, was enacted.

The Act provided for 3-tier regulatory system:-

(a) An association recognized by the Government of India on the recommendation of

Forward Markets Commission,

(b) The Forward Markets Commission (it was set up in September 1953) and

(c) The Central Government.

Forward Contracts (Regulation) Rules were notified by the Central Government in

July 1954

The Act divides the commodities into 3 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 prohibited.

(c) Those commodities, which have neither been regulated for being traded under the

recognized association nor prohibited, are referred as Free Commodities and the


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association organized in such free commodities is required to obtain the Certificate of

Registration from the Forward Markets Commission.

In the seventies, most of the registered associations became inactive, as futures aswell as forward trading in the commodities for which they were registered came to be

either suspended or prohibited altogether.

The Khusro Committee (June 1980) had recommended reintroduction of futures

trading in most of the major commodities, including cotton, kapas, raw jute and jute

goods and suggested that steps may be taken for introducing futures trading in

commodities, like potatoes, onions, etc. at appropriate time. The government,accordingly initiated futures trading in Potato during the latter half of 1980 in quite a

few markets in Punjab and Uttar Pradesh.

After the introduction of economic reforms since June 1991 and the consequent

gradual trade and industry liberalization in both the domestic and external sectors, the

Govt. of India appointed in June 1993 one more committee on Forward Markets under

Chairmanship of Prof. K.N. Kabra.

The Committee submitted its report in September 1994. The majority report of the

Committee recommended that futures trading be introduced in:

1) Basmati Rice

2) Cotton and Kapas

3) Raw Jute and Jute Goods

4) Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed,

safflower seed, copra and soybean, and oils and oilcakes of all of them.

5) Rice bran oil

6) Castor oil and its oilcake


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7) Linseed

8) Silver

9) Onions.

The committee also recommended that some of the existing commodity exchanges

particularly the ones in pepper and castor seed may be upgraded to the level of

international futures markets.

The liberalized policy being followed by the Government of India and the gradual

withdrawal of the procurement and distribution channel necessitated setting in place a

market mechanism to perform the economic functions of price discovery and riskmanagement.

The National Agriculture Policy announced in July 2000 and the announcements of

Finance Minister in the Budget Speech for 2002-2003 were indicative of the

Governments resolve to put in place a mechanism of futures trade/market. As a follow

up the Government issued notifications on 1.4.2003 permitting futures trading in the

commodities, with the issue of these notifications futures trading is not prohibited in

any commodity. Options trading in commodity are, however,presently,prohibited.


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CHAPTER-3

Introduction to commodity market


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INTRODUCTION TO COMMODITY MARKET IN

INDIA

The commodity market is a market, where commodities are bought and sold. The

commodity market differs from a regular market by a specific organizational form of

trading according to established rules. The main function of the commodity exchange

is assurance of regular communication between buyers and sellers, when transactions

are carried out with available batches of goods. The exchange, while developing,

started establishing trade customs, commodity standards, standard contracts,

performing price quotations, resolving dispute, etc. Commodity Markets and

Commodity Futures are a mechanism for hedging. The leverage in trading commodity

markets is impressive. A community must somehow believe that the commodity

instrument is real, enforceable, and well worth paying for. The law of demand and it's

application to fundamental analysis of commodities rests upon an understanding of

consumer behavior. In the commodity futures exchanges the peak value of trading

have touched Rs 15,000 crores on some days with the average around of Rs 6,000

crores. Open interests in certain commodities such as gold, silver, rubber, pepper,

soya are also substantial. The modern commodity markets have their roots in the

trading of agricultural products For centuries, sugar has been a highly valued and

widely traded commodity. The main advantages of a call option are protection against

higher prices, limited liability with no margin deposits, and the potential to benefit

from lower cash prices. The National Commodity Derivatives Exchange (NCDEX)

has emerged as the largest commodity futures exchange. The policy vision of the

Indian commodity futures markets is converting India into a global hub at least in the

major commodities in the economy. Freedom in the commodity futures market was

won after long, pitched battles. Cash prices are the prices for which the commodity is

sold at the various market locations. The futures price represents the current market


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opinion of what the commodity will be worth at some time in the future. The

Government of India recognized three nation-wide multi commodity exchanges to

promote a healthy, competitive futures market. It was rightly presumed that there is

room for multiple players to grow in size and stature in the huge commodity economyof India.

Many people have become very rich in the commodity markets. It is one of a few

investment areas where an individual with limited capital can make extraordinary

profits in a relatively short period of time. For example, Richard Dennis borrowed

$1,600 and turned it into a $200 million fortune in about ten years. Nevertheless,

because most people lose money, commodity trading has a bad reputation as being too

risky for the average individual. The truth is that commodity trading is only as risky

as you want to make it. Those who treat trading as a get-rich-quick scheme are likely

to lose because they have to take big risks. If you act prudently, treat your trading like

a business instead of a giant gambling casino and are willing to settle for reasonable

return, the risks are acceptable. The probability of success is excellent. The process of

trading commodities is also known as futures trading. Unlike other kinds of

investments, such as stocks and bonds, when you trade futures, you do not actuallybuy anything or own anything, you are speculating on the future direction of the price

in the commodity you are trading. This is like a bet on future price direction. The

terms buy and sell merely indicate the direction you expect future prices will

take. If, for instance you were speculating in wheat, you would buy a futures contract

if you thought the price would be going up in the future. You would sell a futures

contract if you thought the price would go down. For every trade, there is always a

buyer and a seller. Neither person has to won any wheat to participate. He must onlydeposit sufficient capital with a brokerage firm to insure that he will be able to pay the

losses if his trades lose money in addition to speculators, both the commoditys

commercial producers and commercial consumers also participate. The principal

economic purpose of the futures markets is for these commercial participants to


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eliminates their risk from changing prices on one side of a transaction may be a

producer like a farmer. He has the field full of wheat growing on his farm. It wont be

ready for harvest for another three months. If he is worried about the price going

down during that time, he can sell futures contracts equivalent to the size of his cropand deliver his wheat to fulfill his obligation under the contract. Regardless of how

the price of wheat changes in the three months until his crop will be ready for

delivery, he is guaranteed to be paid the current price.On the other side of the

transaction might be a producer such as a cereal manufacturer who needs to buy lots

of wheat. The manufacture, such as HLL, may be concerned that in the next three

months the price of wheat will go up, and it will have to pay more than the current

price. To protect against this, HLL can buy futures contracts at the current price. Inthree months HLL can fulfill its obligation under the contracts by taking delivery of

the wheat. This guarantees that regardless of how the price moves in the next three

months.. HLL will pay no more than the current price for its wheat. In addition to

agricultural commodities, there are futures for financial instruments and intangibles

such as currencies, bonds and stock market indexes. Each futures market has

producers and consumers who need to hedge their risk from future price changes. The

speculators, who do not actually deal in the physical commodities, as where to

provide liquidity. This maintains an orderly market where price changes from one

trade to the next are small. Rather than taking delivery or making delivery, the

speculator merely offsets his position at some time before the date set for future

delivery. If price has moved in the right direction, he will profit. If not, he will lose.

Commodity

Any goods that are unbranded and are commonly traded in the market come under

commodities.


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Commodity Market:

Commodity markets are quite like equity markets. The commodity market also has two

constituents i.e. spot market and derivative market. In case of a spot market, the

commodities are bought and sold for immediate delivery. In case of commodities are

bought and sold for immediate delivery. In case of a commodities derivative market,

various financial instruments having commodities as underlying are traded on the

exchanges. It has been seen that traditionally in India people have hedged their risks with

Gold and Silver.

Commodity markets are markets where raw or primary products are exchanged. These

raw commodities are traded on regulated commodities exchanges, in which they are

bought and sold in standardized Contracts.

Market Structure


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Reasons why commodity markets have a bright future

Agriculture26%of GDP

Agricultural commodities thrivin

Huge domestic consumption

Worlds largest importer of gold, edible oils

Ministry of consumer affairs, food &public distribution

Online Exchanges Outery Exchanges

NBOTIndore

NMCEAhmadabad

NCDEXMumbai

MCXMumbai


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Third largest producer of cotton

Leading coffee/tea/sugar producer

Commodity trading:

Commodity trading in India is regulated the forward markets commotions (FMC)

headquartered at Mumbai; it is a regulatory authority which is overseen by th3e ministry

of consumer affairs and PUBLIC Distribution, govt. of India. It is a statutory body set up

in 1953 under the Forward Contracts (Regulation) Act, 1952. after equity, trading

commodity is going to be the next big thing for investors. In India people have a love for

Gold and silver, trading is also going to pick up in Gold and Silver. Globally, the

commodity trade market is about three times the size of equities trade market. In India,

presently, the commodities market is still in a nascent stage and is gradually picking up

taking a cue from global markets.

Commodities future

Commodity future is a derivative instrument for the future delivery of a commodity on a

fixed date at a particular price. The underlying in this case is a particular commodity.

In an investor purchases an oil future, he is entering into a contract to the contract expiry

date. The fixed quantity is called the contract size. These futures can be bought and sold

on the commodity exchanges. The commodities include agricultural commodities like

wheat, rice, tea, jute, spices Soya, groundnut, coffee, rubber, cotton, etc, precious metals-

gold and silver, base metals iron ore, lead, aluminum, nickel, zinc, etc, and energy


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commodities crude oil and coal. The number of retail invertors participating in the

market in increasing gradually after the introduction of commodities futures. The

expected growth rate of commodity market is 40 percent annually over the next five

years.

Benefits of trade in commodities

Driven by demand and supply

True reflector of economic activity

Impervious to intangibles like management quality

Not impacted by performance or results

Physical settlement of futures

Global market

Benefits of commodities futures:

To producer

A producer of a commodity can sell the futures of the commodity, thereby ensuring

that he can sell a particular quantity of his commodity at a particular price at a

particular date.


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To investors

An investor has alternative investment instruments where he can take a position as to

future price and the spot price at a particular date in future and buys and sells options.

He is not interested in taking deliveries of the commodities.

To commodity trader

A commodity trader can use these to ensure that he is protected against any adverse

changes in the price. He can enter into a futures contract for purchase of a certain

quantity of the underlying at a particular price on a particular date, or he can enter

into a futures contract for sale of a particular quantity on a particular date at a

particular price and be assured of the margins because both his purchase price as well

as the sale price are fixed. Traders do a good arbitrage in Gold and Silver. Whenever

they find Gold moving up, they short silver and similarly whenever they find silvermoving up and gold likely to move down, they hedge.

To exporters

Future trading is very useful to the exporters as it provides an advance indication of

the price likely to prevail and thereby help the exporter in quoting a realistic price

and thereby secure export contract in a competitive market. Having entered into an

export contract, it enables him to hedge his risk by operating in futures market.

PRODUCTS


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Bullion: - Gold, Silver

Oil and Oil Seeds: - Soya, castor seed, mustard

Spices: - Pepper, jeera, chilly, turmeric

Metals: - copper, tin, nickel, steel, zinc

Fiber: - Long staple cotton, medium staple cotton

Pulses: - chana, yellow peas, masur

Cereals: - Rice, wheat, maize

Energy: - Crude Oil, Brent crude oil

Plantations: - Rubber, cashew

Others: - Plastics, menthe oil, coffee, sugar, guar

Characteristics of commodity


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A commodity has value, which represents a quantity of human labor. The fact that is

has value implies straightway that people try to economize its use. A commodity also

has a use value, an exchange value and a price.

It has an exchange value, meaning that a commodity can be traded for other

commodities, and thus give its owner the benefit of others labor (the labor

done to produce the purchased commodity). Price is then the monetary

expression of exchange-value (but exchange value could also be expressed as

a direct trading ratio between two commodities without using money). It has a

use value because, by its intrinsic characteristics, it can satisfy some human

need or want, physical or ideal. By nature this is a social use value, i.e. theobject is useful not just to the producer but has a use for others generally.

According to the labor theory of value, product-values in an open market are

regulated by the average socially necessary labor time required to produce them, and

price relativities are ultimately governed by the law of value.

Commodity trading as an investment vehicle

As an investment vehicle over other investment alternatives such as savings accounts,

stocks, bonds, options, real estate and collectibles. Of its in a short period of time. The

reason that futures trading can be so profitable is leverage. White profits can be large in

commodity trading, it is not easy to make consistently correct decisions about what and

when to buy and sell. Commodity speculation offers an important advantage over such

illiquid vehicles as real estate and collectibles. The balance in your account is always

available. If you maintain sufficient margin, you can even spend your current profit on a

trade without closing out the position. With stocks, bonds and real estate, you cant spend

your gains until you actually sell the investment. As you will see, commodity trading is


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not particularly complicated. Unlike the stock market where there are over ten thousand

potential stocks and mutual funds, there are only about forty viable futures markets to

trade. Those markets cover the gamut of market sectors, however, so you can diversify

throughout all important segments of the world economy. In futures trading, it is as easyto sell (also referred to as going short) as it is to buy (also referred to as going long).

By choosing correctly, you can make money whether prices go up or down. Therefore,

trading a diversified portfolio of futures markets offers the opportunity to profit from any

potential economic scenario. Regardless of whether we have inflation or deflation, boom

or depression, hurricanes, droughts, famines or freezes, there is always the potential for

profit trading commodities. There are even tax advantages to making your money from

futures trading. Regardless of the actual holding period, commodity profits areautomatically taxed as sixty percent long-term capital gains and forty percent short-term

capi9tal gains. The current maximum capital gains rate is thirty-three percent, somewhat

less than the maximum rate for ordinary income. To the extent that capital gains tax rates

are reduced in the future, commodity traders will benefit. If a distinction is re-established

so that taxes on long-term gains are lower than on short-term gains, commodity traders

will benefit.


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CHAPTER-4

Introduction to risk management

RISK MANAGEMENT

What are the risk factors?


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Commodity trading is done in the form of futures and that throws up a huge potential for

profit and loss as it involves predictions of the future and hence uncertainty and risk. Risk

factors in commodity trading are similar to futures trading in equity markets.

Risk Management System

Need for RMS:-

Risk is an integral part of any business & it need not necessarily lead to an adverse result.

In commodity broking market, not only commodities are traded; in the process, RISK and

RETURN are also traded; and, there is a trade off between the risk and the return.

Risk taking is essential to an active commodity market and legitimate risk taking should

not be unnecessarily or unduly avoided, therefore, a good commodity broking outfit

necessarily requires a robust & efficient risk management system as an integral part of its

effective business model with an objective to meet the competition & the expectation of

clients yet it should be able to control the business risks effectively including statutory,

Exchange & FMC compliances. Considering these objectives in mind RCL has framed its

risk management policy which is reviewed & revised from time to time & is reproduced

as under :-

Risk Management System-Process

Identification of area of risk

Analysis of factors/reasons causing risk

Planning for control of risks associated with the business

Strategic decision making for risk management tools and its implementation

Measuring results

Continuous Improvement


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ROLE OF RMC

Monitoring of Clients Position and Margin

Preparation and circulation of Margin Report on daily basis and following it up

with Branches.

Keeping Track of the Daily MTM losses and coordinating with branches to top up

the margin shortfall.

Liquidating Positions of Clients in case of non-arrangement of funds.

Trade facilitation - setting parameters onto Trading Platform.

Risk Management System

Identification of area of risk

Analysis of factors/reasons causing risk

Planning for control of risks associated with the business

Strategic decision making for risk management tools and its implementation

Measuring results

Continuous Improvement

ROLE OF RISK MANAGEMENT CELL

Monitoring of Clients Position and Margin

Preparation and circulation of Margin Report on daily basis and following it up

with Branches.

Keeping Track of the Daily MTM losses and coordinating with branches to top up

the margin shortfall.

Liquidating Positions of Clients in case of non-arrangement of funds.

Trade facilitation - setting parameters onto Trading Platform.

Support in relation to Trading / Back office / Exchange related compliance.


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A Dissertation on Rmc