Commodity Derivative

Presented By:
Enrolment No. Name.
201504100710021 Bhakta Ankita.
201504100710023 Kher Sejal.
201504100710024 Mulla Rahila
201504100710027 Patel Mitali .
 Commodity derivative

Introduction

Commodity derivative are complex financial instruments which

covers options, future, swap etc.

The value is determined by its underlying assets, in this by its

underlying commodity.
 How it works

Commodity prices may vary significantly & by using commodity

derivative, the consequences of prices changes can be controlled.

It enables in increasing, reducing or completely avoiding risk.

 Commodity forward

It is an agreement between two parties in which both buyer and seller

commit to buy or sell underlying commodity at a predetermine price after
maturity.

Used by customers who stores, buy or sell commodities.

Using commodity forward the risk of undesired price change can be

reduced or avoided.
 Average swap

It is suitable for customers who regularly buy or sell commodities at

average prices.

The risk of undesired price change can be avoided.

 Commodity options

Is a product that may be used by customers who have future exposure to a

commodity.

The risk can be avoided

 Risk

Risk signify the probability that invested capital will fall.

Greater the risk, greater the fluctuations in price.

Lower the risk, the more even price performance to be expected.

 Risk.

OPTION

Price movement can be greater for option than underlying assets.

FUTURE

Risk is same as for underlying assets.

 Commodity in OTC market V/S
Exchange Traded

Derivatives that are traded on exchange are exchange traded

derivatives whereas privately negotiated derivatives are called OTC
derivative contracts.

OTC commodities derivatives trading originally involved 2 parties

without an exchange. Exchange trading offers greater transparency
& regulatory protection. In an OTC trade price is not generally
made public & it also involves higher risk but also leads to earn
higher profits.
Difference between Exchange Trading &
OTC Trading

Exchange Trading OTC Trading

Centralization of Market
Standardization
Counterparty Risk
Visibility
Parties involved
 Difference between Exchange Trading &
OTC Trading

Centralization of Market
Exchange trading transactions are completed through the
centralized source, where as in OTC trading it is decentralized.

Standardization
In exchange trading occurs a standard contract wherein stock
exchange acts as guarantor for all the trades, where as in OTC contracts are
customized and there is no specified guarantor.
 Difference between Exchange Trading &
OTC Trading

Visibility
Exchange trading is an open market where there is a clear
visibility for prices, start date, expiration date &counter parties involves
in a deal, where as in OTC it sis not the case as the exchange trading.

Parties involved
The exchange is the counter party to all the trader.
Additionally there is price standardization & execution. These exchanges
involves less price competition, where as in OTC it has no centralised
trading facility here the lack of regulation can introduced the fraudulent
firms &transaction execution quality may decrease.
Difference between Exchange Trading &
OTC Trading

Counter-party Risk
In exchange trading counter risk is not an issue
because of the presence of regulatory body, where as in OTC
trading there is always the counter party risk.
 Commodity Swap

In commodity swaps, the cash flows

to be exchanged are linked to
commodity prices. Commodities are
physical assets such as metals,
energy and agriculture.

For example: In a commodity swap,

a party may agree to exchange cash
flows linked to prices of oil for a
fixed cash flow.
 Commodity Swap

Commodity swaps are used for hedging against Fluctuations in

commodity prices or Fluctuations in spreads between final product
and raw material prices

(For example: Cracking spread which indicates the spread between

crude prices and refined product prices significantly affect the
margins of oil refineries)
 How do Commodity Swaps work

A gold mining firm wants to fix the price it will receive for the gold it will
mine over the next 3 years.

A gold user wants to fix the price it will have to pay for the gold it needs for
the next 3 years.

NP = 10,000 oz.

Pfixed = $320/oz.

Settlement is semi-annual, based on average price of gold during the past

six months.
 How do Commodity Swaps work

Subsequently:

Avg. gold price Producer pays (-)

Time during past pd. or receives (+)

0.5 $305 +$150,000

1.0 $330 -$100,000
1.5 $368 -$480,000
2.0 $402 -$820,000
2.5 $348 -$280,000
3.0 $300 +$200,000