commodity market

1. 25-2010

2.  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

3. RISK IN COMMODITY MARKET
Refers to the uncertainties of future market values and of the size of the
future income, caused by the fluctuation in the prices of commodities
Commodity future contracts are standardised in terms of quality of the
underlying commodity
LIQUIDITY: given that the features of futures contracts are standardised
by the exchange allowing them to trade on the exchange, the contracts are
liquid and there is always a ready market for them.
Absence of counter party risk:
PRICE DISCOVERY: the electronic trading platform provided by the
commodity exchange combined with liquidity and risk free trading
encourages wider participation, ensuring larger volumes and minimised
price manipulation.

4.  Market risk- Risk of loss suffered by buyers or sellers on
account of adverse event of prices
 Credit risk-It is very low or almost zero because the
exchange takes on the responsibility for the performance
 Operational risk arising out of some operational difficulties
 Legal risk is risk coming from legal objections that might
be raised since the exchange regulatory framework might
disallow some activities

5. COMMODITY CLEARING HOUSE
 Clearing house can be defined as entity which is
different from the exchange,
 The clearing house is responsible for keeping records

6. Clearing house
 Clearing house acts as a seller to all buyers and a buyer to all
sellers.

 Each day of trading all exchange members must report their buys
and sell to the clearing house.
 The clearing house then ensures that financial settlement from
all buyers and sellers is made to the clearing house.
 The clearing house guarantees all contracts by requiring that the
participants maintain cash deposits called margins or margins
money.
 As soon as a contract is processed by the clearing house the
buyer and seller of the contract will have a contract with the
clearing house instead of counter party with their original trade

7. Margining method
 Margin money- Margin money is like a security deposit or insurance against
possible future loss of value.
 The aim of margin money like good faith money is to minimise the risk
 To safeguard the integrity of the market and its own interest, the exchange imposes
the margin money
 New contracts on the first day are assigned on base rate
 Settlement price based on average of the last trades of the trading day
 Due date rate calculated based on average of the last few days closing prices

8.  Initial margin
initial margin is the amount to be deposited by the market
participants in their margin account with the clearing
house before they can place buy or sell order of a futures
contract.
 VARIATION OR MARK TO MARKET MARGIN:
 Margin is worked out on the difference between the
closing rate and rate of the contract
 It helps to protect the interest of the exchange

9.  Additional (volatility) margin:
 Volatility margin is extra margin imposed by exchange on
the buyer and the seller in the event of sudden increase in
volatility of prices of the underlying in the market.
 Tender period margin:
 Extra margin imposed on the contracts during concluding
phase
 Maintenance margin
It is the minimum amount of margin that is required to be
held in the margin account relative to the futures position
held

10. OTHER RISK CONTAINMENT MEASURES USED BY EXCHANGES
 Guarantee for Settlements
 The exchange only ensures proper correlation between
prices in the spot and futures markets and guarantees the
performance of the contracts by analysing the risks on
continuous basis.
 The Settlement Guarantee Fund (SGF), also called the
Trade Guarantee Fund (TGF)
 Objective of the funds are
 To guarantee settlement of bonafide transactions
 To inculcate confidence in the minds of market
participants
 To protect the interest of investors

11. Price limit and circuit breakers
 procedures to control overreactions in times of serious
market volatility these mechanisms are known as circuit
breakers and price limits.
 Price limit affect the way trading in the future market
 And circuit breaker deals with whether trading will be
halted temporarily, or stopped together entirely

12.  Settlement process
Physical delivery Cash settlement
Based on the
underlying spot price

13. TYPES OF SETTLEMENT

14. WAREHOUSING AND WAREHOUSE RECEIPTS
 Warehousing provides critical logistic support to the
commodity sector
 If the trade is expected to be settled by way of delivery
of the commodity the clearing house of the
commodity exchange
 warehouse receipts from the seller instead of actual
commodities and pass such warehouse receipts over to
the buyer.

15. Warehouse receipts (WRs) are title documents
issued by warehouse to depositors against the
commodities deposited in the warehouse
 The Warehousing (Development and Regulation)
Act 2007
 Negotiable warehouse receipts (NWRS)
 this help the farmers to avoid the distress sale of their
produce by ensuring them access to finance against
their produced stored

16. Dematerialisation of warehouse receipts
 Act prescribes the form and the manner of registration of
warehouse and issue of NWRs in electronic form
 Disadvantages of physical warehouse receipts:
 1. Need for splitting the warehouse receipts in case the
depositor has an obligation to transfer only a part of the
commodity
 2.Need to move the warehouse receipt from one place to
another with risk of theft, mutilation etc.
 3. Risk of forgery

17. DELIVERY PROCESS
FUTURE
SPOT TRADE TRADE

18. DELIVERY TYPES
 BOTH OPTION-
 delivery of the commodity will take place only if both
buyer and seller give their intention to give/take
delivery before the expiry of the contract.
 SELLERS OPTION
 delivery is based on seller’s intention.
 The buyer has to take delivery on compulsory basis
that has been allocated to him by the Exchange.

19.  COMPULSORY DELIVERY
All the open positions on the date of expiry of
the contract shall result in delivery.
 The commodities will be compulsorily
delivered either by giving delivery or taking
delivery