Commodity andDerivatives Market

(As per the Revised Syllabus 2016 - 17 of Mumbai University for T.Y.BMS, Semester – V)

Pawan JhabakP.G.D.Ed.M., M.Com. (Finance)

Ex. Vice Principal, Rustomjee Business School,Dahisar (West), Mumbai – 68.

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First Edition : 2016

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ACKNOWLEDGEMENT

I have benefited from scores of books and hundreds of articles. As it is impossible to list allof them, the overall reference book is mentioned:

Prasanna Chandra, IAPM, Tata McGraw–Hill, 2008. The Economist Pocket World in Figures, 2010.

I would like to express my gratitude to: Students for providing the stimulus for writing this book. Deepak Kap, my support staff and staff of Himalaya Publishing House Pvt. Ltd. My grandmother Jhamkudevi, wife Bharati and daughter Param.

Pawan JhabakEx. Vice Principal

Rustomjee Business School

PREFACE

“Genius is the ability to reduce the complicated to the simple.” … Albert EinstienI earnestly hope that the book will make complicated subject Commodity and Derivatives

Market simple to understand and score high marks in exams.I look forward for constructive suggestion from the readers and teachers.I am thankful to one and all who have contributed directly or indirectly to make new edition possible.This book is user-friendly and different. As one goes through the book, one will feel the difference,

and this will help to master Portfolio Management in an enjoyable manner, with lifetime utility.The book covers ‘University’ prescribed syllabus with practical dimension !! Let’s Learn !!

Best wishes!!Million thanks.

AuthorPawan V. Jhabak

scorejhabak@gmail.com

Visiting Faculty Amity Business School. Lala Lajpatrai College.

Ex. Visiting Faculty Vivekanand Education Society. Rajiv Gandhi Institute of Technology. S.K. Somaiya. Narsee Monjee College. Usha Pravin Gandhi. Bhavan’s College (Andheri). Rizvi College. S.K. Somaiya. Akbar Peerbhoy. Bhurani College. Poddar College etc.

Ex. Vice Principal Rustomjee Business School.

SYLLABUS

Commodity and Derivatives MarketBACHELOR OF MANAGEMENT STUDIES PROGRAMME AT SEMESTER V WITH EFFECT

FROM THE ACADEMIC YEAR 2016-2017

[60 Lectures: 3 Credit]

MODULES AT A GLANCE

Sr.No.

Modules No. ofLectures

1 Introduction to Commodities Market and Derivatives Market 152 Futures and Hedging 153 Options and Option Pricing Models 154 Trading, Clearing and Settlement in Derivatives Market and Types of Risk 15

Total 60

OBJECTIVES

Sr.No.

Objectives

1 To understand the concepts related to Commodities and Derivatives market2 To study the various aspects related to options and futures3 To acquaint learners with the trading, clearing and settlement mechanism in derivatives market.

UnitNo.

Name of the Topic No. ofLectures

Unit 1 Introduction to Commodities Market and Derivatives Market (15)

(a) Introduction to Commodities Market Meaning, History and Origin, Types of Commodities Traded,

Structures of Commodities Market in India, Participants inCommodities Market, Trading in Commodities in India (Cash andDerivative Segment), Commodity Exchange in India and Abroad,Reasons for Investing in Commodities.

(b) Introduction to Derivatives Market Meaning, History and Origin, Elements of a Derivative Contract,

Factors Driving Growth of Derivatives Market, Types of Derivatives,Types of Underlying Assets, Participants in Derivatives Market,Advantages and Disadvantages of Trading in Derivatives Market,Current Volumes of Derivative Trade in India, Difference betweenForwards and Futures.

Unit 2 Futures and Hedging (15)(a) Futures

Futures Contract Specification, Terminologies Concept ofConvergence Relationship between Futures Price and Expected SpotPrice, Basis and Basis Risk, Pricing of Futures Contract, Cost of CarryModel.

(b) Hedging Speculation and Arbitrage using Futures, Long Hedge – Short Hedge,

Cash and Carry Arbitrage, Reverse Cash and Carry Arbitrage, PayoffCharts and Diagrams for Futures Contract, Perfect and ImperfectHedge.

Unit 3 Options and Option Pricing Models (15)(a) Options:

Options Contract Specifications, Terminologies, Call Option, PutOption, Difference between Futures and Options, Trading of Options,Valuation of Options Contract, Factors Affecting Option Premium,Payoff Charts and Diagrams for Option Contract, Basic Understandingof Option Strategies.

(b) Options Pricing Models: Binomial Option Pricing Model, Black–Scholes Option Pricing Model.

Unit 4 Trading, Clearing and Settlement in Derivatives Market andTypes of Risk

(15)

(a) Trading, Clearing and Settlement in Derivatives Market: Meaning and Concept, SEBI Guidelines, Trading Mechanism – Types

of Orders, Clearing Mechanism – NSCCL – its Objectives andFunctions, Settlement Mechanism – Types of Settlement.

(b) Types of Risk: Value at Risk, Methods of Calculating VaR, Risk Management

Measures, Types of Margins, SPAN Margin.

QUESTION PAPER PATTERN(2.5 Hours) [Total Marks: 75]

N.B. All questions are compulsory.

Q.1 Attempt any two (15)(a) Theory – Commodities Market Chapter 7.5 Marks(b) Theory – Derivatives Market Chapter 7.5 Marks(c) Theory – Derivatives Marekt Chapter 7.5 Marks

Q. 2 Attempt any two (15)(a) Theory – Futures Chapter 7.5 Marks(b) Theory – Hedging Chapter 7.5 Marks(c) Sum – Futures/Hedging 7.5 Marks

Q. 3 Attempt any two (15)(a) Theory – Options Chapter 7.5 Marks(b) Theory – Options Pricing Models Chapter 7.5 Marks(c) Sum Black-Scholes 7.5 Marks

Q.4 Attempt any two (15)(a) Theory – Tradings, Clearing and Settlement 7.5 Marks(b) Theory – Types of Risk Chapter 7.5 Marks(c) Sum VAR/SPAN 7.5 Marks

Q.5 Case Study/Numericals (15)

CONTENTSUnit 1

Introduction to Commodities Market and Derivative Market

1 (a) Introduction to Commodities Market 1 – 12

1 (b) Introduction to Derivatives Market 13 – 21

Unit 2Futures and Hedging

2 (a) Futures 22 – 34

2 (b) Hedging 35 – 41

Unit 3Options and Option Pricing Models

3 (a) Options 42 – 79

3 (b) Options Pricing Models 80 – 86

Unit 4Trading, Clearing and Settlement in Derivatives Market and

Types of Risk

4 (a) Trading, Clearing and Settlement in Derivatives Market 87 – 97

4 (b) Types of Risk 98 – 105

1

Structure: Meaning/Introduction to Commodity Market History and Origin Types of Commodities Traded Types of Commodity Futures Markets Structure of Commodities Market in India Participants in Commodity Market Trading in Commodities in Cash Segment / Cash Commodities Trading in Commodities in India in Derivative Segment Commodity Exchanges in India and Abroad Reasons for investing in commodities Review Questions

Meaning/Introduction to Commodity Market

Unknown to us, the commodities that have always been a part of our day-to-day existence arealso one of the finest investment avenues available. The wheat in our bread, the cotton in our clothes,our gold jewels, the fuel that runs our cars, etc; are all traded across the world in major exchanges.Over the ages, commodities have been the basis for trade and industry. They have spurred commerce,

encouraged exploration and altered the histories of nations. Today, they play a very important role inthe world economy with billions of dollars of these commodities traded each day on exchanges acrossthe world.

Commodities today have become an attractive investment vehicle. In the current investmentscenario, it is increasingly getting difficult for individuals and institutions to create a well-balancedinvestment portfolio. With uncertainty in interest ratio, it is tough for the investor to beat the ever-rising inflation. Averse to being over exposed to equity markets, the investors are left with limitedchoices... Well no more!

Unit 1Introduction to Commodities Market and Derivative Market

Chapter 1Introduction to Commodities

Market

Commodity and Derivatives Market2

In order to understand the growth of Commodities Market we need to know the history involvedCommodity Futures Trading.

In the next chapter we will learn about the history of commodity market, it's evolution andvarious commodity future exchanges.

History and Origin

Brief History of Commodity Trading and Commodity ExchangesTrading in commodities futures has a long history. Though the modern trade in commodity

futures could trace its origins back to the 17th century in Osaka, Japan, there is evidence to suggestthat a form of futures trading in commodities existed in China 6000 years earlier. Organized trading onan exchange started in 1848 with the establishment of the Chicago Board of Trade (CBOT).The first milestone in the 125 years rich history of organized trading in commodities in India was theconstitution of the Bombay Cotton Trade Association in the year 1875. India had a vibrant futuresmarket in commodities till it was discontinued in the mid 1960's, due to war, natural calamities and theconsequent shortages.

Types of Commodities Traded

1. Agriculture commoditiesBroadly speaking commodities can be divided in two categories: Soft and Hard

Soft commodities are typically grown. Corn, wheat, soybean, Soybean oil, sugar are all examples of“soft” commodities. Many soft commodities are subject to spoilage, which can create huge volatilityin the short term. Weather plays a huge role in the softs market, which makes predicting supplyespecially difficult.

On the other Hard commodities are typically mined from the ground or taken from other naturalresources: gold, oil, aluminum. In many cases, initial products are refined into further commodities, asoil is refined into gasoline. Because “hard” commodities are easier to handle than “softs,” and becausethey are more integrated into the industrial process, most investors focus on these products.

Agriculture provides the principal means of livelihood for over 58.4% of India's population. Itcontributes approximately one-fifth of total gross domestic product (GDP). Agriculture accounts forabout 10 per cent of the total export earnings and provides raw material to a large number of industries.Being the third largest land mass in world it is number top producer of many agriculture commodities.And yet Indian agriculture has one of the lowest yields in most commodities, nearly 55.7% of areasown is dependent on rainfall. Clearly while there are challenges there are huge potentials as well.

2. Non-Agriculture commoditiesWhile Non-agricultural commodities can include everything that is not agriculture, the derivative

segment has evolved in Industrial Metals, Energy and Precious Metals.

India has huge deposits of natural resources in form of minerals like copper, iron ore, bauxite,and gold. Even on demand front India is one the major consumer of industrial metals and largestconsumer of Gold. India is one of the few high growth economies. With growing focus oninfrastructure the demand for these metals will continue to rise. India’s energy consumption has been

Introduction to Commodities Market 3

increasing at one of the fastest rates in the world due to population growth and economicdevelopment.

Commodities traded in Commodity ExchangesLarge numbers of commodity are traded on commodity exchanges in around the world. The

commodities are classified on the basis of their use and consumption. Further classification is based onthe characteristics of the commodity.

Some of the commodities traded on various futures exchanges are as follows:

Foodstuff Industrial Metals Precious Metal Energy Coffee Copper Gold Crude Oil Sugar Lead Platinum Natural Gas Cocoa Zinc Palladium Maize Tin Silver Rough rice Aluminium Soybean Nickel Wheat Recycled Sunflower Oil Barley Orange Juice

In order to understand the different types of commodity futures market, namely normal futuresmarket and inverted futures market you need to know all the commodities which exist for trading andwhich commodity portfolio suits you the best.

A commodities exchange is an exchange where various commodities and derivatives products aretraded. Most commodity markets across the world trade in agricultural products and other rawmaterials (like wheat, barley, sugar, maize, cotton, cocoa,coffee, milk products, porkbellies, oil, metals, etc.) and contracts based on them. These contracts can include spotprices, forwards,futures and options on futures. Other sophisticated products may include interest rates,environmental instruments, swaps, or oceanfreight contracts.

Commodities exchanges usually trade futures contracts on commodities, such as trading contractsto receive something, say corn, in a certain month. A farmer raising corn can sell a future contract onhis corn, which will not be harvested for several months, and guarantee the price he will be paid whenhe delivers; a breakfast cereal producer buys the contract now and guarantees the price will not go upwhen it is delivered. This protects the farmer from price drops and the buyer from price rises.

Speculators and investors also buy and sell the futures contracts in attempt to make a profit andprovide liquidity to the system. However, due to the financial leverage provided to traders by theexchange, commodity futures traders face a substantial risk.

Commodity and Derivatives Market4

Types of Commodity Futures Markets

The futures market for a commodity can be normal or inverted.

1. Normal Futures MarketA normal futures market is one where the price of the nearby contract is less than the price of the

distant futures contract. This is illustrated by the figure below, which shows the prices of gold futuresin a normal market. The more distant the contract month, the higher is the contract price, in a normalmarket. The price difference between the futures contracts of different months is due to the cost ofcarry. The cost of carry is the cost incurred in carrying a commodity to some future date. It includesinterest, insurance and storage costs. This is logically what should happen for all contracts since costof insurance, interest and storage will be a finite positive number.

2. Inverted Futures MarketIn an inverted futures market, the price of the near contract is greater then the price of the distant

contract. As shown in the figure below, the more distant the contract, the lower is the price.An inverted futures market is seen when there are short term supply disruptions, resulting in shortages.

30400

30200

30000

29800

29600

29400

2920029000

28800

28600Jun-12 Aug-12 Oct-12 Dec-12

Normal Market

Introduction to Commodities Market 5

Once we understand the types of commodity market participants it is essential to understandthe concept of commodity basis along with the definition and how to calculate basis from spot andfutures price to make better trading decisions for optimizing your returns.

Structure of Commodities Market in India

Ogranisational Structure Of Indian Commodity Market

Ministry of ConsumerAffairs

Forward Market Commission

Commodity Exchanges Commodity Derivatives

Futures Market

Precious Metals

Agriculture

Base Metals

Energy

23 OtherExchanges

Other Regional ExchangesRegional CommodityExchanges

16 RegionalExchanges

National Commodity Exchanges

MCX

MCDEX

MCE

ICE

ADCE

UCE

Recent Developments in IndiaThe advent of economic liberalization helped the cause of laying emphasis on the importance

of commodity trading. By the beginning of 2002, there were about 20 commodity exchanges in India,trading in 42 commodities, with a few commodities being traded internationally.

Commodities futures contracts and the exchanges they trade in are governed by the ForwardContracts (Regulation) Act, 1952. The regulator is the Forward Markets Commission (FMC), adivision of the Ministry of Consumer Affairs, Food and Public Distribution.

In 2002, the Government of India allowed the re-introduction of commodity futures in India.Together with this, three screen based,nation-wide multi-commodity exchanges were also permitted tobe set up with the approval of the Forward Markets Commission. These are:

1. National Commodity and Derivative ExchangeThis exchange was originally promoted by ICICI Bank, National Stock Exchange (NSE),

National Bank for Agriculture and Rural Development (NABARD) and Life Insurance Corporation ofIndia (LIC). Subsequently other institutional shareholders have been added on. NCDEX is popular fortrading in agricultural commodities.

Commodity and Derivatives Market6

2. Multi Commodity ExchangeThis exchange was originally promoted by Financial Technologies Limited, a software company

in the capital markets space. Subsequently other institutional shareholders have been added on. MCXis popular for trading in metals and energy contracts.

3. National Multi Commodity Exchange of IndiaThis exchange was originally promoted by Kailash Gupta, an Ahmedabad-based trader, and

Central Warehousing Corporation (CWC). Subsequently other institutional shareholders have beenadded on. NMCE is popular for trading in spices and plantation crops, especially from Kerala, asouthern state of India.

In terms of market share, MCX is today the largest commodity futures exchange in India, with amarket share of close to 70%. NCDEX follows with a market share of around 25%, leaving thebalance 5% for NMCE.

In order to start investing in Commodities Futures, you should have comprehensive knowledgeabout all the above Commodity Futures, which will help you further in learning about the basics ofcommodity futures contract and it's various features.

In the next chapter we will learn about the basics of commodity futures contract and it's variousfeatures

Participants in Commodity Market

Hedgers, Speculators and ArbitrageursAn efficient market for commodity futures requires a large number of market participants with

diverse risk profiles. Ownership of the underlying commodity is not required for trading in commodityfutures. The market participants simply need to deposit sufficient money with brokerage firms to coverthe margin requirements. Market participants can be broadly divided into hedgers, speculators andarbitrageurs.Hedgers

They are generally the commercial producers and consumers of the traded commodities. Theyparticipate in the market to manage their spot market price risk. Commodity prices are volatile andtheir participation in the futures market allows them to hedge or protect themselves against the risk oflosses from fluctuating prices. For e.g. a copper smelter will hedge by selling copper futures, since it isexposed to the risk of falling copper prices.

SpeculatorsThey are traders who speculate on the direction of the futures prices with the intention of making

money. Thus, for the speculators, trading in commodity futures is an investment option. MostSpeculators do not prefer to make or accept deliveries of the actual commodities; rather they liquidatetheir positions before the expiry date of the contract.

ArbitrageursThey are traders who buy and sell to make money on price differentials across different markets.

Arbitrage involves simultaneous sale and purchase of the same commodities in different markets.Arbitrage keeps the prices in different markets in line with each other. Usually such transactions arerisk free.

Introduction to Commodities Market 7

The market functions because of the differing risk profiles of the market participants. Thefluctuation in commodity prices represents both, a risk and a potential for profit. The hedgers transferthis risk by foregoing the associated profit potential. The speculators assume this risk in the hope ofrealizing profits by predicting price movements. The arbitrageurs make the process of price discoverymore efficient

Once we understand what are the risks and returns involved for respective Commodity MarketParticipants, we can start investing indifferent commodity avenues.

In the next chapter we will learn about why commodity futures are good investmentavenues along with it's advantages and different commodities traded in commodities market.

Trading in Commodities in Cash Segment / Cash Commodities

Cash commodities or “actuals” refer to the physical goods—e.g., wheat, corn, soybeans, crude oil,gold, silver—that someone is buying/selling/trading as distinguished from derivatives.

Trading in Commodities in India in Derivative Segment

How to Trade in Commodity Futures in IndiaWith the setting up of nation-wide multi-commodity exchanges, a new avenue has been thrown

open for Indian investors. These exchanges have electronic trading and settlement systems making iteasy to trade in commodity futures. Trading on these exchanges does not require the investor topossess physical stocks. In fact less than 1% of the total traded volume involves the transfer ofphysical commodities.

Trading in commodity futures comprises of three simple steps. Step One: Choosing a Broker Step Two: Depositing the Margin Step Three: Access to Information and a Trading Plan Process Flow In Commodity Futures Trading

All the above steps are common when investing in any of the Commodity Exchanges like MCXand NCDEX . In the next chapter we will learn how to choose a commodity broker that will offer youthe best trading experience.

Step One: Choosing a BrokerThe broker you choose should be a member of the exchanges you wish to trade in. Other than this,

one should keep the following factors in mind while choosing a broker: Competitive edge provided by the broker. Broker's knowledge of commodity markets. Credibility of the broker. Experience of the broker. Net-worth of the broker. Quality of broker's trading platforms.

Commodity and Derivatives Market8

The relationship between the broker and the client is long-term. Thus there must be a strongrapport, and mutual trust between the client and the broker. Further, the client must communicateclearly to the broker his needs and objectives for trading in commodities, whether they are for thepurpose of hedging, investment, etc. Further, your objectives for entering the market provide you witha valuable parameter to judge whether a broker fits your needs.

In order to keep your investment decisions and objectives in check, it is important to choose theright certified Commodities Broker, it is important to learn about the process of depositing margin forcommodity trading and why it is necessary to deposit margin with the broker.

Step Two: Depositing the MarginTo begin trading, the investor needs to deposit a margin with his broker. Margin requirements are

of two types, the initial margin and the maintenance margin. These margin requirements vary acrosscommodities and exchanges but typically, the initial margin ranges from 5-10% of the contract value.

The maintenance margin is usually lower than the initial margin. The investor's position ismarked to market daily and any profit or loss is adjusted to his margin account. The investor has theoption to withdraw any extra funds from his margin account if his position generates a gain. Also, ifthe account falls below the maintenance margin, a margin call is generated from the broker and theinvestor needs to replenish his account to the initial level.

Step Three: Access to Information and a Trading PlanAs commodity futures are not long-term investments, their performance needs to be monitored.

The investor should have access to the prevailing prices on the exchanges as well as marketinformation that can help predict price movements. Brokers provide research and analysis to theirclients. Other information sources are financial dailies, specialized magazines on commodities and theinternet. Further, an investor requires a trading plan. Such a trading plan can be developed inconsultation with the broker. In any case, the investor has to remember to ride his profits and cut hislosses by using stop loss orders.

Commodity Exchanges in India and Abroad

Main commodity exchanges worldwide

Africa

Exchange Abbreviation Location Product TypesAfrica Mercantile Exchange AfMX Nairobi, Kenya Agricultural, EnergyEgyptian Commodities Exchange EGYCOMEX Cairo, Egypt Agricultural, EnergyNairobi Coffee Exchange NCE Nairobi, Kenya Coffee

AmericasExchange Abbreviation Location Product Types

Brazilian Mercantile and Futures Exchange BMF São Paulo, Brazil Agricultural, Biofuels,Precious Metals

Chicago Board of Trade (CME Group) CBOT Chicago, UnitedStates

Grains, Ethanol,Treasuries, equity index,Metals

Introduction to Commodities Market 9

Chicago Mercantile Exchange (CME Group) CME Chicago, UnitedStates

Meats,Currencies, Eurodollars,equity index

Chicago Climate Exchange CCX Chicago, UnitedStates

Emissions

AsiaExchange Abbreviation Location Product Types

Manila CommodityExchange

MCX Manila Philippines commodities, futures contracts andoptions contracts on various basemetals, agriculture commodities,energy, and currencies

International CommodityExchange Kazakhstan

Almaty Kazakhstan Industrial and Mineral Products, OilBy-products and Petrochemicals,Agricultural

Agricultural FuturesExchange of Thailand

AFET Bangkok Thailand Agricultural

Central Japan CommodityExchange

Nagoya, Japan Energy, Industrial Metals, Rubber

Chittagong Tea Auction Chittagong, Bangladesh Tea

Dalian Commodity Exchange DCE Dalian, China Agricultural, Plastics, Energy

Dubai Gold and CommoditiesExchange

DGCX Dubai Precious Metals

Hong Kong MercantileExchange

HKMEx Hong Kong Gold, Silver

Indonesia Commodity andDerivatives Exchange

ICDX Indonesia, Jakarta FutureExchange

Agricultural Products, Base Metals,Financial Products

Iran Mercantile Exchange IME Tehran, Iran Industrial and Mineral Products, OilBy-products and Petrochemicals,Agricultural

Jakarta Futures Exchange JFX Jakarta, Indonesia Cocoa, Arabica and Robusta Coffee,Precious Metals, Olein, CPO, Coal,Tea, and Rubber

Kansai CommoditiesExchange

KANEX Osaka, Japan Agricultural

Commodities and MetalExchange Nepal Ltd.

COMEN Nepal Gold, Silver

National Spot ExchangeLimited

[NSEL] Mumbai, India

Pakistan MercantileExchange

PMEX Pakistan Precious Metals, AgriculturalProducts, Crude Oil, Interest RateFuture

Shanghai Futures Exchange Shanghai, China Industrial metals, Gold,Petrochemicals, Rubber, Base metals

Shanghai Gold Exchange Shanghai, China Precious Metals

Singapore CommodityExchange

SICOM Singapore Agricultural, Rubber

Commodity and Derivatives Market10

Singapore MercantileExchange

SMX Singapore Precious Metals, Base Metals,Agricultural, Energy

Uzbek Commodity Exchange UZEX Tashkent, Uzbekistan Metals, crude oil products,chemicals, base oils, LPG andpolyethylene, sugar, agricultural, etc.

Tokyo Commodity Exchange TOCOM Tokyo, Japan Energy, Precious Metals, IndustrialMetals, Agricultural

Tokyo Grain Exchange TGE Tokyo, Japan Agricultural

Zhengzhou CommodityExchange

CZCE Zhengzhou, China Agricultural, PTA

Asia (India)Indian Commodity Exchange Limited ICEX India Energy, Precious Metals, Base Metals,

Agricultural

Multi Commodity Exchange MCX India Precious Metals, Base Metals, Energy,Agricultural

National Commodity and Derivatives Exchange NCDEX India Precious Metals, Base Metals, Energy,Agricultural

National Multi-Commodity Exchange of India Ltd NMCE India Precious Metals, Base Metals,Agricultural

Chamber of Commerce, Hapur COC India Agricultural

Ace Derivatives and Commodity Exchange Ltd. ACE India Agricultural

Bhatinda Om and Oil Exchange Ltd. BOOE India Agricultural

Universal Commodity Exchange UCX India Agricultural, Energy, Precious Metals

EuropeExchange Abbreviation Location Product Types Life Time

APX-ENDEX APX-ENDEX Amsterdam,Netherlands Energy

Trieste CommodityExchange

BMTS Trieste, Italy Agricultural

European ClimateExchange

ECX London, UK Emissions founded in 2005,acquired by ICE in2010 and mergedintoICE Futures Europe

European EnergyExchange

EEX Leipzig, Deutschland Power, NaturalGas, Emissions,Coal

Energy ExchangeAustria

EXAA Vienna, Austria Energy,Emissions

CommoditiesInvestmentExchange

COINVEX London, England Oil and Gas,Mining,RenewableEnergy

Integrated Nano-Science andCommodityExchange

INSCX United Kingdom Nanomaterials

Introduction to Commodities Market 11

OceaniaExchange Abbreviation Location Product Types

Australian SecuritiesExchange

ASX Sydney, Australia Agricultural, Energy, Interest RateFuture

ABX Global ABX Brisbane, Australia Precious Metals

Reasons for Investing in Commodities

Commodity Futures as an Investment AvenueCommodity futures are globally recognized to be a part of every successful and diversified

investment portfolio. The fact that the returns from most of the commodities in the last 53 years from1951 to 2006 have been higher than the global inflation rate, establishes that investments incommodity are an effective hedge against inflation.

Some of the reasons that make investing in commodity futures an attractive preposition aredescribed below:

LeverageCommodity Futures trading is done on margins. The investor only deposits a fraction of the value

of the futures contract with the broker to cover the exchange specified margin requirements. This givesthe investor greater leverage and thus the ability to generate higher returns.

LiquidityUnlike investment vehicles like real estate, investments in commodity futures offer high liquidity.

It is equally easy to both buy and sell futures and an investor can easily liquidate his positionwhenever required. There is also another advantage of being able to use the profits from a tradeelsewhere, without having to close the position.

DiversificationInvestments in commodity markets are an excellent means of portfolio diversification. For

example, gold prices have historically shown a low correlation with most other asset prices (such asequities) and thus offer an excellent means for portfolio diversification.

Inflation HedgeAs the commodity prices determine price levels and consequently inflation, investing in

commodity futures can act as a hedge against inflation.

Physical GoldPhysical Gold is a product by which retail and high net worth investors can take investment

positions in dematerialized physical gold using the futures market. In this product, the investor canhold physical gold, in a safe deposit vault approved by the exchange, which is reflected in theinvestor's demat account. The main features of this are:

Liquidity Assurance of purity

Commodity and Derivatives Market12

Transparency of rates Safety

These features have attracted a large number of clients to the product since its introduction. Manybrokers offer a full package of services associated with the Physical Gold contract, including acting ascommission agent to take care of sales tax / VAT related issues.

Review Questions

1. Concept Testing(a) Commodities Market(b) Types of Commodities Market(c) Participants in Commodities Market

2. Long Questions(a) Explain History and Origin of Commodities Market.(b) Explain Commodity Exchange in India and Abroad.