Interim Report

PROJECT TITLE -Commodity market

Submitted By: Vishal Sharma
UNDER THE GUIDANCE OF: Prof. Kiran Karande

What is Commodity Market?

A 'commodity market' is a market that trades in primary rather than
manufactured products. Soft commodities are agricultural products such
as wheat, coffee, cocoa and sugar. Hard commodities are mined, such
as gold, rubber and oil. Investors access about 50 major commodity
markets worldwide with purely financial transactions increasingly
outnumbering physical trades in which goods are delivered. Futures
contracts are the oldest way of investing in commodities. Futures are
secured by physical assets. Commodity markets can include physical
trading and derivatives trading using spot prices, forwards, futures,
and options on futures. Farmers have used a simple form of derivative
trading in the commodity market for centuries for price risk
management.
A financial derivative is a financial instrument whose value is derived
from a commodity termed an underlier. Derivatives are eitherexchangetraded or over-the-counter (OTC). An increasing number of derivatives
are traded via clearing houses some with Central Counterparty Clearing,
which provide clearing and settlement services on a futures exchange,
as well as off-exchange in the OTC market.

What is Commodity?
In economics, a commodity is a marketable item produced to
satisfy wants or needs. Economic commodities
comprise goods and services.[2]
The exact definition of the term commodity is specifically used to
describe a class of goods for which there is demand, but which is
supplied without qualitative differentiation across a market.
There is another important class of energy commodities which includes
electricity, gas, coal and oil. Electricity has the particular characteristic
that it is usually uneconomical to store; hence, electricity must be
consumed as soon as it is produced.
Commoditization occurs as a goods or services market loses
differentiation across its supply base, often by the diffusion of
the intellectual capital necessary to acquire or produce it efficiently. As
such, goods that formerly carried

premium margins for market participants have become commodities,

such as generic pharmaceuticals and DRAM chips. TheNew York
Times also discusses multivitamin supplements as an example of
commoditization; a 50 mg tablet of calcium is of equal value to a
consumer no matter what company produces and markets it, and as
such, multivitamins are now sold in bulk and are available at any
supermarket with little brand differentiation.[6] Following this
trend,nanomaterials are emerging from carrying premium profit margins
for market participants to a status of commodification.

The objectives of Commodity futures: Hedging with the objective of transferring risk related to thepossession 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 andauthentic price
discovery mechanism.
Maintaining buffer stock and better allocation of resources as it
augments reduction in inventory requirement and thus theexposure to risks related with pric
e fluctuation declines. Resources can thus be diversified for investments.
Price stabilization along with balancing demand and supplyposition. Futures trading
leads to predictability in assessing
thedomestic prices, which maintains stability, thus safeguardingagainst any short term
adverse price movements. Liquidity i n Contracts of the commodities traded also ensures in
maintainingthe equilibrium between demand and supply.
Flexibility, certainty and transparency in purchasing commodities
facilitate bank financing. Predictability i n p r i c e s o f commoditywould lead to
stability, which in turn would eliminate the
risksassociated with running t h e b u s i n e s s o f t r a d i n g c o m m o d i t i e s . 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. Thebeneficiaries include
those who trade in the commodities being offered the exchange as well as those who
have nothing to do with futures trading. It is because of price discovery and risk
management through
the existence of futures exchanges that a lot of businesses andservices are able to
function smoothly.
Price Discovery:-

Based on inputs regarding specific marketinformation, 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. Theexecution of trade between b
uyers and sellers leads toassessment of fair value of a particular commodity th
at isimmediately disseminated on the trading terminal.

2.P r i c e R i s k M a n a g e m e n t : Hedging is the most commonmethod of price risk management. It is strategy of offering
pricerisk that is inherent in spot market by taking an equal butopposite position in the futur
es market. Futures markets areused as a mode by hedgers to protect their business fromadv
erse price change. This could dent the profitability of
theirbusiness. Hedging benefits who are involved in trading of commodities like farmers, p
rocessors, 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
inphysical trade internationally intend to buy forwards. Thepurchases made from the
physical market might expose them to the risk of price risk resulting to losses. The
existence of futuresmarket would allow the exporters to hedge their proposedpurchase 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
sharewith the free entry of imports. Futures contracts will enablepredictability in domestic
prices. The manufacturers can, as a result, smooth out the influence of changes in their
input prices very easily. With no futures market, the manufacturer can be caught between
severe short-term price movements of oils and necessity to maintain price stability, which
could only be possiblethrough sufficient financial reserves that could otherwise beutilized
for making other profitable investments.
5.Benefits for farmers/Agriculturalists:
Price instability has a direct bearing on farmers in the absence of futures market. There
would be no need to have large reserves to cover
againstunfavorable price fluctuations. This would reduce the riskpremiums associated with
the marketing or processing margins enabling more returns on produce. Storing more and
being more active in the markets. The price information accessible to
thefarmers determines the extent to which traders/processorsincrease price to them. Since
one of the objectives of future change is to make available these prices as far as possible, it
is very likely to benefit the farmers. Also, due to the time lag between planning and
production, the market-determined price information disseminated by futures exchanges
would be crucial for their production decisions.

6.Credit accessibility: The absence of proper risk management tools would attract the marketing and processing
of commodities to high-risk exposure making it risky business activity to fund .Even a
small movement in prices can eat up a huge proportion of capital owned by traders, at times
making it virtually impossible to payback the loan. There is a high degree of reluctance
among banks to fund commodity traders, especially those who do not manage price risks. If
in case they do, the interest rate is likely to be high and terms and conditions very stringent.
This huge obstacle in the smooth functioning and competition of commodities market.
Hedging, which is possible through
futuresmarkets, would cut down the discount rate in commoditylending.
7.Improved product quality:
- The existence of warehouses for facilitating delivery with grading facilities along with
other related benefits provides a very strong reason to upgrade and enhance the quality of
the commodity to grade that is acceptable by
theexchange. It ensures uniform standardization of commoditytrade, including the terms of
quality standard: the qualitycertificates that are issued by the exchange-certified
warehouses have the potential to become the norm for physical trade.