UDAYBHANSINHJI REGIONAL INSTITUTE OF CO-OPERATIVE MANAGEMENT

AGRI BUSINESS MANAGEMENT

Assignment on
COMMODITY ECO-SYSTEM

Submitted To: Mr.JONSHEN (MANAGER OF KARVI FINANCE)

SUBBIMTTED By: Anamika (1002) Manoj (1009) Rinkal (1010)

Commodity Markets Ecosystem

After studying the importance of commodity markets and trading in commodity futures, it is essential to understand the different components of the commodity markets ecosystem. The commodity markets ecosystem includes the following components:

1. Buyers/Sellers or Consumers/Producers: Farmers, manufacturers, wholesalers, distributors, farmers co-operatives, APMC mandis, traders, state civil supplies corporations, importers, exporters, merchandisers, oil refining companies, oil producing companies, etc. 2. Logistics Companies: Storage and transport companies/operators, quality testing and certifying companies, valuers, etc. 3. Markets and Exchanges: Spot markets (mandis, bazaars, etc.) and commodity exchanges (national level and regional level) 4. Support agencies: Depositories/de-materializing agencies, central and state warehousing corporations, and private sector warehousing companies 5. Lending Agencies: Banks, financial institutions The users are the producers and consumers of different commodities. They have exposure to the physical commodities markets, exposing themselves to price risk. In turn, they depend on logistics companies for transportation of commodities, warehouses for storage, and quality testing and certification agencies for assessment and evaluation of commodity quality standards. Commodity derivatives exchanges provide a platform for hedging against price risk for these users.

Benefits

of

Trading

in

Commodity

Derivatives

Trading in futures provides two important functions of price discovery and price risk management. It is useful to all the segments of the economy, particularly to all the constituents of the commodity market ecosystem. It is important to know how resorting to commodity trading benefits the constituents.

Benefits to Investors, Producers, Consumers, Manufacturers:

Price risk management: All participants in the commodity markets ecosystem across the value chain of different commodities are exposed to price risk. These participants buy and sell commodities and the time lag between subsequent transactions result in exposure to price risk. Commodity derivatives markets enable these participants to avoid price risk by utilizing hedging techniques.

Price discovery: This is the mechanism by which a fair value price is determined by the large number of participants in the commodities derivatives markets. This is the result of automation and electronic trading systems established on the commodities derivatives exchanges.

High financial leverage: This is possible in commodity markets. For example, trading in gold calls for only 4% initial margin. Thus, if one gold futures contract (each gold futures contract lot size is 1 kg) is valued at Rs 900,000, the investor is expected to deposit an initial margin of only Rs 36,000 to be able to trade. If the price of gold goes up by even 2%, the investor would make a profit of Rs 18,000 on a deposit of Rs 36,000 before the expiry of the contract. This is the benefit of leveraged trading transactions. With futures contracts, the investor trades in the expectation of the price at a later date. This is possible with a margin deposit, which is usually between 5% and 10% of the value of the commodity. Correspondingly, the margins required for equity futures contracts are higher, due to higher volatility in equity markets as compared to commodities futures contracts. The reason for higher volatility in equity markets (especially in India) as compared to commodities derivatives transactions is due to the fact that delivery is possible in commodity derivatives transactions.

Commodities as an asset class for diversification of portfolio risk: Commodities have historically an inverse correlation of daily returns as compared to equities. The skewness of daily returns favours commodities, thereby indicating that in a given time period commodities have a greater probability of providing positive returns as compared to equities. Another aspect to be noted is that the Sharpe ratio of a portfolio consisting of different asset classes is higher in the case of a portfolio consisting of commodities as well as equities. Even with a marginal distribution of funds in a portfolio to include commodities, the Sharpe ratio is greatly enhanced, thereby indicating a decrease in risk.

Commodity derivatives markets are extremely transparent in the sense that the manipulation of prices of a commodity is extremely difficult due to globalization of economies, thereby providing for prices benchmarked across different countries and continents. For example, gold, silver, crude oil, etc. are international commodities, whose prices in India are indicative of the global situation.

An option for high networth investors: With the rapid spread of derivatives trading in commodities, the commodities route too has become an option for high networth investors.

Useful to the producer: Commodity trade is useful to the producer because he can get an idea of the price likely to prevail on a future date and therefore can decide between various competing commodities, the best that suits him. Farmers, for instance, can get assured prices, thereby enabling them to decide on the crop that they want to grow. Since there is transparency in prices, the farmer can decide when and where to sell, so as to maximize his profits.

Useful for the consumer: Commodity trade is useful for the consumer because he gets an idea of the price at which the commodity would be available at a future point of time. He can do proper costing/financial planning and also cover his purchases by making forward contracts. Predictable pricing and transparency is an added advantage.

Corporate entities can benefit by hedging their risks if they are using some of the commodities as their raw materials. They can hedge the risk even if the commodity traded does not meet their requirements of exact quality/technical specifications.

Useful to exporters: Futures 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.

Improved product quality: Since the contracts for commodities are standardized, it becomes essential for the producers/sellers to ensure that the quality of the commodity is as specified in the contract. The advent of commodities futures markets has also enabled defining quality standards of different commodities.

Credit accessibility: Buyers and sellers can avail of the bank finances for trading in commodities. Nationalized banks and private sector banks have come forward to offer credit facilities for commodity trading.

 Commodity Ecosystem

Commodity Market Structure

Commodity Markets Overview Indian commodity market set for paradigm shift
Four licenses recently issued by Govt. of India to set-up National Online Multi Commodity Exchanges to ensure a transparent price discovery and risk management mechanism List of commodities for futures trade increased from 11 in 1990 to over 100 in 2003 Reforms with regard to sale, storage and movement of commodities initiated Shift from administered pricing to free market pricing WTO regime Overseas hedging has been allowed in metals Petro-products marketing companies have been allowed to hedge prices

Institutionalization of agriculture About MCX National Level Online Multi Commodity Futures Exchange Key Promoters Financial Technologies (India) Ltd, India, Corporation Bank, State Bank of

Union Bank Bank of India, Canara Bank,

State Bank of Indore Baroda Operations from 300 cities with over 775 members & 3000 TWS

Bank

of

First Indian Exchange to enter into an agreement with an International Exchange (TOCOM) Facilitating Cost effective and economic technology. Real-time price & information dissemination through website and info vendors MCX Business Associates Statutory Auditor Haskins & Sells Internal AuditorAiyer & Company Network services Ltd.(VSAT)S HCL Comnet M/s V.Shankar M/s. Deloitte,

VSNL (Internet)

Tata (Leased line)

Tele

Reliance gateway ( Wireless ) Clearing Banks IndusInd, UBI & UTI Quality Certification Geochem , Dr. Amin Lab., SGS, Agencies Rubber Board Warehouses Kerala, Tamilnadu and UP Bullion Logistics Brinks Arya Salient Futures of MCX On-line monitoring at members and contract level - exposure, price, open interest, quantity, client, etc. On-line margin adjustment - Business in relation to deposit System driven control and actions Electronic fund transfer Daily clearing marked to market Pay-in and pay-out: T+1 working day Exchange approved depositories Group 4 and CWC, Gujarat, BOI, HDFC,

Seller to submit proof of delivery with proper quality certification to MCX

Participants in Commodity Futures Farmers/ Producers Merchandisers/ Traders Importers Exporters Consumers/ Industry Commodity Financers Agriculture Credit providing agencies Corporate having price risk exposure in commodities

Benefits of Futures Trading Price discovery for commodity players A farmer can plan his crop by looking at prices prevailing in the futures market

Hedging against price risk A farmers can sell in futures to ensure remunerative prices A processor/ manufacturing firm can buy in futures to hedge against volatile raw material costs An exporter can commit to a price to his foreign clients A stockist can hedge his carrying risk to ensure smooth prices of the seasonal commodities round the year

Easy availability of finance

Based on hedged positions commodity market players (farmers, processors, manufacturers, exporters) may get easy financing from the banks

How Commodity Futures Help Risk Management

Growers Short hedge on upcoming produce Traders Short Hedge on stored quantity Manufacturers Long Hedge on input cost, Short hedge on finished products Any price risk that is not managed is a cost; any cost is a direct dent on profitability Price Discovery

Futures prices can be used as indicative prices for negotiating the export prices and also upcountry sales

Nation-wide Multi Exchanges vis a vis Regional Exchanges

Better Reach in all parts of the country Wider base for speculators from other markets including securities market Broad basing of the underlying commodity Industry diffused in several parts of the country may also directly participate Few commodities can be projected viable for an international futures Contract, with participation from global player Novation of all open positions in the market by the exchange Best management practices, end of day mark to market, online margining and surveillance, daily pay-in & pay-out are some of the features to woo the players Key Differentiators of MCX Team Best Industry Professionals Technology, Exchange Management and Advisory Board with 8 Decades of Exchange Management Expertise Best Support Agencies Warehouses, Quality, Banks & Others Best Intermediaries across the country & in multiple commodities

Technology State of the art Information Technology Real time price and trade information dissemination Robust risk management system and controls

Techniques (Practices) Best International practices of Exchange governance Competitive membership fee structure and operational cost.

To provide information - international & spot markets and commodity research Whats in it for Industry Free Markets price commodities best & consistently Globalisation & standardisation - global price convergence Futures Market - Most efficient Market Place Price discovery on futures Exchange with consistent Agriculture policy will give right direction to market for pricing commodities MSP does not serve much purpose in free market regime Problems of different sectors in Agriculture need a different policy with a common direction Future of Commodity Market India - Largest Consumer - Producer - Exporter - Importer Large size intermediaries penetrate commodities market Banks to Finance commodities Futures a secured route RBI permits Banks to hedge their bullion risk through Futures Exchange Other commodities to follow Using Exchange Network for various products & Services BPO & Trade Interest will attract International players Hub for value added services & food processing

New class of commodity Traders & Value Investors