Gupta Committee on Derivatives had recommended in December the introduction of stock index futures in the first place to be followed by other products once the market matures. The preparation of regulatory framework for the operations of the index futures contracts took some more time and finally futures on benchmark indices were introduced in June followed by options on indices in June followed by options on individual stocks in July and finally followed by futures on individual stocks in November The underlying asset can be equity, forex, commodity or any other asset.
Emergence of Financial Derivative Products Derivative products initially emerged as hedging devices against fluctuations in commodity prices, and commodity-linked derivatives remained the sole form of such products for almost three hundred years. Financial derivatives came into spotlight in the post period due to growing instability in the financial markets.
However, since their emergence, these products have become very popular and by s, they accounted for about two-thirds of total transactions in derivative products. In recent years, the market for financial derivatives has grown tremendously in terms of variety of instruments available, their complexity and also turnover.
In the class of equity derivatives the world over, futures and options on stock indices have gained more popularity than on individual stocks, especially among institutional investors, who are major users of index-linked derivatives. Even small investors find these useful due to high correlation of the popular indexes with various portfolios and ease of use.
The lower costs associated with index derivatives vis—a—vis derivative products based on individual securities is another reason for their growing use. They use futures or options markets to reduce or eliminate this risk. Futures and options contracts can give them an extra leverage; that is, they can increase both the potential gains and potential losses in a speculative venture. Index Copernicus Value: 3. FUTURES A futures contract is an agreement between two parties to buy or sell an asset in a certain time at a certain price, they are standardized and traded on exchange.
Calls give the buyer the right but not the obligation to buy a given quantity of the underlying asset, at a given price on or before a given future date. Puts give the buyer the right, but not the obligation to sell a given quantity of the underlying asset at a given price on or before a given date. Longer-dated options are called warrants and are generally traded over-the counter.
These are options having a maturity of up to three years. The underlying asset is usually a moving average of a basket of assets. Equity index options are a form of basket options.
SWAPS Swaps are private agreements between two parties to exchange cash floes in the future according to a prearranged formula. They can be regarded as portfolios of forward contracts. Thus a swaption is an option on a forward swap. Gupta develop the appropriate regulatory framework for derivative trading in India.
The committee submitted its report in March On May 11, SEBI accepted the recommendations of the committee and approved the phased introduction of derivatives trading in India beginning with stock index Futures. The provision in the SCR Act governs the trading in the securities. The exchange shall regulate the sales practices of its members and will obtain approval of SEBI before start of Trading in any derivative contract. The members of the derivatives segment need to fulfill the eligibility conditions as lay down by the L.
A futures contract might also opt to settle against an index based on trade in a related spot market. Expiry is the time when the final prices of the future are determined. For many equity index and interest rate futures contracts, this happens on the Last Thursday of certain trading month. In other words, the rational forward price represents the expected future value of the underlying discounted at the risk free rate.
Thus, for. Any deviation from this equality allows for arbitrage as follows. In the case where the forward price is higher: 1. The arbitrageur sells the futures contract and buys the underlying today on the spot market with borrowed money. On the delivery date, the arbitrageur hands over the underlying, and receives the agreed forward price.
He then repays the lender the borrowed amount plus interest. The difference between the two amounts is the arbitrage profit. In the case where the forward price is lower: 1. The arbitrageur buys the futures contract and sells the underlying today on the spot market ; he invests the proceeds. On the delivery date, he cashes in the matured investment, which has appreciated at the risk free rate.
He then receives the underlying and pays the agreed forward price using the matured investment. Operational Traded directly between Traded on the exchanges.
Mechanism two parties not traded on the exchanges. Contract Differ from trade to trade. Contracts are standardized Specifications contracts. Counter-party Exists. However, assumed by the risk clearing corp. Liquidation Low, as contracts are High, as contracts are standardized Profile tailor made contracts exchange traded contracts.
Price discovery Not efficient, as markets Efficient, as markets are centralized are scattered. Examples Currency market in India. Underlying asset refers to any asset that is traded. The owner makes a profit provided he sells at a higher current price and buys at a lower future price. The owner makes a profit provided he buys at a lower current price and sells at a higher future price. Hence, no option will be exercised if the future price does not increase.
Put and calls are almost always written on equities, although occasionally preference shares, bonds and warrants become the subject of options. In case of swap, only the payment flows are exchanged and not the principle amount.
The two commonly used swaps are:. The fixed rate payer takes a short position in the forward contract whereas the floating rate payer takes a long position in the forward contract. The parties to the swap contract of currency generally hail from two different countries. This arrangement allows the counter parties to borrow easily and cheaply in their home currencies. Under a currency swap, cash flows to be exchanged are determined at the spot rate at a time when swap is done.
Such cash flows are supposed to remain unaffected by subsequent changes in the exchange rates. It also allows the investors to exchange one type of asset for another type of asset with a preferred income stream. Baskets options are option on portfolio of underlying asset. Equity Index Options are most popular form of baskets. Normally option contracts are for a period of 1 to 12 months.
However, exchange may introduce option contracts with a maturity period of years. These long-term option contracts are popularly known as Leaps or Long term Equity Anticipation Securities. Options generally have lives of up to one year, the majority of options traded on options exchanges having a maximum maturity of nine months. Longer-dated options are called warrants and are generally traded over-the-counter. Swaptions are options to buy or sell a swap that will become operative at the expiry of the options.
Thus a swaption is an option on a forward swap. Rather than have calls and puts, the swaptions market has receiver swaptions and payer swaptions. A receiver swaption is an option to receive fixed and pay floating. A payer swaption is an option to pay fixed and receive floating. The history of derivatives is quite colourful and surprisingly a lot longer than most people think. Forward delivery contracts, stating what is to be delivered for a fixed price at a specified place on a specified date, existed in ancient Greece and Rome.
Roman emperors entered forward contracts to provide the masses with their supply of Egyptian grain. These contracts were also undertaken between farmers and merchants to eliminate risk arising out of uncertain future prices of grains.
Thus, forward contracts have existed for centuries for hedging price risk. Futures trading grew out of the need for hedging the price risk involved in many commercial operations. The first financial futures to emerge were the currency in in the US. Currency futures were followed soon by interest rate futures. Stock index futures and options emerged in The first stock index futures contracts were traded on Kansas City Board of Trade on February 24, The first of the several networks, which offered a.
Options are as old as futures. Their history also dates back to ancient Greece and Rome. Options are very popular with speculators in the tulip craze of seventeenth century Holland.
Tulips, the brightly coloured flowers, were a symbol of affluence; owing to a high demand, tulip bulb prices shot up. Dutch growers and dealers traded in tulip bulb options. There was so much speculation that people even mortgaged their homes and businesses. These speculators were wiped out when the tulip craze collapsed in as there was no mechanism to guarantee the performance of the option terms.
The first call and put options were invented by an American financier, Russell Sage, in These options were traded over the counter. Agricultural commodities options were traded in the nineteenth century in England and the US. Options on shares were available in the US on the over the counter OTC market only until without much knowledge of valuation.
This model helped in assessing the fair price of an option which led to an increased interest in trading of options. The market for futures and options grew at a rapid pace in the eighties and nineties. The collapse of the Bretton Woods regime of fixed parties and the introduction of floating rates for currencies in the international financial markets.
The CBOT now offers 48 futures and option contracts with the annual volume at more than million in The CBOE is the largest exchange for trading stock options. The Philadelphia Stock Exchange is the premier exchange for trading foreign options. The US indices and the Nikkei trade almost round the clock. The N is also traded on the Chicago Mercantile Exchange. Derivatives are an integral part of liberalisation process to manage risk. NSE gauging the market requirements initiated the process of setting up derivative markets in India.
In July , derivatives trading commenced in India. Table 2. Gupta Committee to draft a policy framework for index futures.
Gupta Committee submitted report. Today, derivatives have become part and parcel of the day-to-day life for ordinary people in major part of. Until the advent of NSE, the Indian capital market had no access to the latest trading methods and was using traditional out-dated methods of trading.
Financial derivatives came into the spotlight along with the rise in uncertainty of post, when US announced an end to the Bretton Woods System of fixed exchange rates leading to introduction of currency derivatives followed by other innovations including stock index futures.
Today, derivatives have become part and parcel of the day-to-day life for ordinary people in major parts of the world. While this is true for many countries, there are still apprehensions about the introduction of derivatives. There are many myths about derivatives but the realities that are different especially for Exchange traded derivatives, which are well regulated with all the safety mechanisms in place.
What are these myths behind derivatives? Derivatives are a low-cost, effective method for users to hedge and manage their exposures to interest rates, commodity prices or exchange rates. The need for derivatives as hedging tool was felt first in the commodities market. Agricultural futures and options helped farmers and processors hedge against commodity price risk. After the fallout of Bretton wood agreement, the financial markets in the world started undergoing radical changes.
This period is marked by remarkable innovations in the financial markets such as introduction of floating rates for the currencies, increased trading in variety of derivatives instruments, on-line trading in the capital markets, etc. As the complexity of instruments increased many folds, the accompanying risk factors grew in gigantic proportions. This situation led to development derivatives as effective risk management tools for the market participants.
Looking at the equity market, derivatives allow corporations and institutional investors to effectively manage their portfolios of assets and liabilities through instruments like stock index futures and options. An equity fund, for example, can reduce its exposure to the stock market quickly and at a relatively low cost without selling off part of its equity assets by using stock index futures or index options.
By providing investors and issuers with a wider array of tools for managing risks and raising capital, derivatives improve the allocation of credit and the sharing of risk in the global economy, lowering the cost of capital formation and stimulating economic growth. Now that world markets for trade and finance have become more integrated, derivatives have strengthened these important linkages between global markets, increasing market liquidity and.
Here, we look into the pre- requisites, which are needed for the introduction of derivatives, and how Indian market fares: TABLE 3. High Liquidity in the The daily average traded volume in Indian capital underlying market today is around crores. These are clear indicators of high liquidity in the underlying. A Good legal guardian In the Institution of SEBI Securities and Exchange Board of India today the Indian capital market enjoys a strong, independent, and innovative legal guardian who is helping the market to evolve to a healthier place for trade practices.
It increases the no of options investors for investment. The figure 3. If market goes up, as circuit filters long position benefit else limit to curtail losses.
Exchange-traded vs. OTC derivatives markets The OTC derivatives markets have witnessed rather sharp growth over the last few years, which has accompanied the modernization of commercial and investment banking and globalisation of financial activities. The recent developments in information technology have contributed to a great extent to these developments.
While both exchange-traded and OTC derivative contracts offer many benefits, the former have rigid structures compared to the latter. It has been widely discussed that the highly leveraged institutions and their OTC derivative positions were the main cause of turbulence in financial markets in These episodes of turbulence revealed the risks posed to market stability originating in features of OTC derivative instruments and markets.
The OTC derivatives markets have the following features compared to exchange- traded derivatives: 1. The management of counter-party credit risk is decentralized and located within individual institutions, 2.
There are no formal centralized limits on individual positions, leverage, or margining, 3. There are no formal rules for risk and burden-sharing, 4.
There are no formal rules or mechanisms for ensuring market stability and integrity, and for safeguarding the collective interests of market participants, and 5.
Some of the features of OTC derivatives markets embody risks to financial market stability. Instability arises when shocks, such as counter-party credit events and sharp movements in asset prices that underlie derivative contracts, occur which significantly alter the perceptions of current and potential future credit exposures. When asset prices change rapidly, the size and configuration of counter-party exposures can become unsustainably large and provoke a rapid unwinding of positions.
There has been some progress in addressing these risks and perceptions. However, the progress has been limited in implementing reforms in risk management, including counter-party, liquidity and operational risks, and OTC derivatives markets continue to pose a threat to international financial stability.
The problem is more acute as heavy reliance on OTC derivatives creates the possibility of systemic financial events, which fall outside the more formal clearing house structures. Moreover, those who provide OTC derivative products, hedge their risks through the use of exchange traded derivatives.
In view of the inherent risks associated with OTC derivatives, and their dependence on exchange traded derivatives, Indian law considers them illegal. Factors contributing to the explosive growth of derivatives are price volatility, globalisation of the markets, technological developments and advances in the financial theories.
The objects having value maybe commodities, local currency or foreign currencies. The concept of price is clear to almost everybody when we discuss commodities. There is a price to be paid for the purchase of food grain, oil, petrol, metal, etc.
Prices are generally determined by market forces. These factors are constantly interacting in the market causing changes in the price over a short period of time. For example, gold may trade at different prices in Mumbai and Delhi but a derivatives contract on gold would have one value and so traders in Mumbai and Delhi can validate the prices of spot markets in their respective location to see if it is cheap or expensive and trade accordingly.
Second, the prices of the futures contracts serve as prices that can be used to get a sense of the market expectation of future prices. For example, say there is a company that produces sugar and expects that the production of sugar will take two months from today.
As sugar prices fluctuate daily, the company does not know if after two months the price of sugar will be higher or lower than it is today.
How does it predict where the price of sugar will be in future? It can do this by monitoring prices of derivatives contract on sugar say a Sugar Forward contract. If the forward price of sugar is trading higher than the spot price that means that the market is expecting the sugar spot price to go up in future. If there were no derivatives price, it would have to wait for two months before knowing the market price of sugar on that day. Based on derivatives price the management of the sugar company can make strategic and tactical decisions of how much sugar to produce and when.
A c ommon misconception is that open interest is the same thing as volume of options and futures trades. This is not correct since there could be huge volumes but if the volumes are just because of participants squaring off their positions then the open interest would not be large.
On the other hand, if the volumes are large because of fresh positions being created then the open interest would also be large. The Contract column tells us about the strike price of the call or put and the date of their settlement. For example, the first entry in the Active Calls section It is interesting to note from the newspaper extract given above is that it is possible to have a number of options at different strike prices but all of them have the same expiry date. Positive trend: It gives information about the top gainers in the futures market.
Negative trend: It gives information about the top losers in the futures market. Active Calls: Calls with high trading volumes on that particular day. Active Puts: Puts with high trading volumes on that particular day. The settlement process is somewhat elaborate for derivatives instruments which are exchange traded.
They have been very briefly outlined here. The settlement process for exchange traded derivatives is standardized and a certain set of procedures exist which take care of the counterparty risk posed by these instruments. There are two clearing entities in the settlement process: Clearing Members and Clearing Banks. Clearing members A Clearing member CM is the member of the clearing corporation i.
There are three types of clearing members with different set of functions: 1 Self-clearing Members: Members who clear and settle trades executed by them only on their own accounts or on account of their clients.
Financial settlement can take place only through Clearing Banks. The clearing members keep a margin amount in these bank accounts. Settlement of Futures When two parties trade a futures contract, both have to deposit margin money which is called the initial margin.
Futures contracts have two types of settlement: i the mark-to- market MTM settlement which happens on a continuous basis at the end of each day, and ii the final settlement which happens on the last trading day of the futures contract i.
Mark to market settlement To cover for the risk of default by the counterparty for the clearing corporation, the futures contracts are marked-to-market on a daily basis by the exchange. Mark to market settlement is the process of adjusting the margin balance in a futures account each day for the change in the value of the contract from the previous day, based on the daily settlement price of the futures contracts Please refer to the Tables given below. This process helps the clearing corporation in managing the counterparty risk of the future contracts by requiring the party incurring a loss due to adverse price movements to part with the loss amount on a daily basis.
Simply put, the party in the loss position pays the clearing corporation the margin money to cover for the shortfall in cash. In extraordinary times, the Exchange can require a mark to market more frequently than daily. To ensure a fair mark-to-market process, the clearing corporation computes and declares the official price for determining daily gains and losses.
The closing price for any contract of any given day is the weighted average trading price of the contract in the last half hour of trading. Final settlement loss is debited and final settlement profit is credited to the relevant clearing bank accounts on the day following the expiry date of the contract. Suppose the above contract closes on day 6 that is, it expires at a price of Rs.
Settlement of Options In an options trade, the buyer of the option pays the option price or the option premium. The options seller has to deposit an initial margin with the clearing member as he is exposed to unlimited losses.
There are basically two types of settlement in stock option contracts: daily premium settlement and final exercise settlement.
Options being European style, they cannot be exercised before expiry. Daily premium settlement Buyer of an option is obligated to pay the premium towards the options purchased by him. Similarly, the seller of an option is entitled to receive the premium for the options sold by him. The same person may sell some contracts and buy some contracts as well. The premium payable and the premium receivable are netted to compute the net premium payable or receivable for each client for each options contract at the time of settlement.
Exercise settlement Normally most option buyers and sellers close out their option positions by an offsetting closing transaction but a better understanding of the exercise settlement process can help in making better judgment in this regard.
Stock and index options can be exercised only at the end of the contract. An investor who has a long position in an in-the-money option on the expiry date will receive the exercise settlement value which is the difference between the settlement price and the strike price. Similarly, an investor who has a short position in an in-the-money option will have to pay the exercise settlement value. Accounting and Taxation of Derivatives The Institute of Chartered Accountants of India ICAI has issued guidance notes on accounting of index future contracts from the view point of parties who enter into such future contracts as buyers or sellers.
For other parties involved in the trading process, like brokers, trading members, clearing members and clearing corporations a trade in equity index futures is similar to a trade in, say shares, and accounting remains similar as in the case of buying or selling of shares. Taxation of Derivative Instruments Prior to the year , the Income Tax Act did not have any specific provision regarding taxability of derivatives.
The only tax provisions which had indirect bearing on derivatives transactions were sections 73 1 and 43 5. All profits and losses were taxed under the speculative income category. Therefore, loss on derivatives transactions could be set off only against other speculative income and the same could not be set off against any other income.
This resulted in high tax liability. They are treated under the business income head of the Income tax Act. Any losses on these activities can be set off against any business income in the year and the losses can be carried forward and set off against any other business income for the next eight years. MCX, having a permanent recognition from the Government of India, is an independent and demutualised multi commodity Exchange.
MCX, a state-of-the-art nationwide, digital Exchange, facilitates online trading, clearing and settlement operations for a commodities futures trading. It is a public limited company registered under the Companies Act, with the Registrar of Companies, Maharashtra in Mumbai on April 23, It has an independent Board of Directors and professionals not having any vested interest in commodity markets. It has been launched to provide a world-class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency.
It is located in Mumbai and offers facilities to its members in more than centres throughout India. The reach will gradually be expanded to more centres.
While various integral aspects of commodity economy, viz. Even today, NMCE is the only Exchange in India to have such investment and technical support from the commodity relevant institutions. It has robust delivery mechanism making it the most suitable for the participants in the physical commodity markets.
It has also established fair and transparent rule-based procedures and demonstrated total commitment towards eliminating any conflicts of interest. NMCE follows best international risk management practices.
The contracts are marked to market on daily basis. The system of upfront margining based on Value at Risk is followed to ensure financial security of the market. Global Business School A Study of Derivatives Market in India 46 In the event of high volatility in the prices, special intra-day clearing and settlement is held. NMCE was the first to initiate process of dematerialization and electronic transfer of warehoused commodity stocks. These deliveries are executed through a sound and reliable Warehouse Receipt System, leading to guaranteed clearing and settlement.
Global Business School A Study of Derivatives Market in India 47 Literature Review Dr Premalata examines the impact of introducing index futures and options contracts on the volatility of the underlining stock index in India. The results suggest that futures and options trading have not led to a change in the volatility of the underlying stock index. Susan Thomas and Ajay Shah examine the characteristics, growth in liquidity and turnover of Futures and Options. Snehal Bandwadekar and Saurabh Ghosh identify that derivative products like futures and options on Indian Stock Market have become important instruments of price discovery, portfolio diversification and risk hedging in recent times.
Ashutosh Vashishtha examines that derivative turnover has grown from crores in to Rs crores, within a short span of eight years derivative trading in India has surpassed cash segment in terms of volume and turnovers. P Gupta study suggest that the overall volatility of the stock market has declined after the introduction of the index futures for both Nifty and Sensex indices, However there is no conclusive evidence. Sandeep Srivastava uses the call and put option open interest and volume based predictors as given by Bhuyan and Yan The results show that these predictors have significant explanatory power with open interest being more significant as compared to trading volume.
Golaka C Nath studies the behaviour of volatility in cash market after the introduction of derivatives. Rajendra P. Chitale examines issues and impediments in the use of different types of derivatives available for use by these institutional investors in India. Sumon Bhaumik and Suchismita Bose examines the impact of expiration of derivatives contracts on the underlying cash market on trading volumes, returns and volatility of returns. This study also covers the recent developments in the derivative market taking into account the trading in past years.
Through this study I came to know the trading done in derivatives and their use in the stock markets. For better understanding various strategies with different situations and actions have been given. It includes the data collected in the recent years and also the market in the derivatives in the recent years. This study extends to the trading of derivatives done in the National Stock Markets. Being a wide topic I had a limited time. Limited resources were available to collect the information about commodity trading The primary data has been collected through a structured questionnaire to a sample of investors, which may not reflect the opinion of the entire population.
H1: Income and investment in different type of derivative instruments are related. H0: Age and purpose of Investing in Derivative market are not related.
H1: Age and purpose of Investing in Derivative market are related. H0: Income per annum and monthly income available for investment are related H1: Income per annum and monthly income available for investment are related H0: Maturity period of investment and results of investment are no related.
H1: Maturity period of investment and results of investment are related. The Questionnaire was distributed through online platform by E-mail. I made use of Internet and miscellaneous sources such as brochures, pamphlets under external sources. The research questionnaire was pre-tested through pilot survey. In its draft form it went under a pre test with Channel Partner of two different companies. The second pre-test was conducted after discussion with the experts in the field. Table 1: What is your Gender?
Age of the respondents Table 2: What is your Age? Occupation of the respondents Table 3: Which of the following best describes your current Occupation? Percentage of monthly income available for investment in Derivatives Table 6: What percentage of your monthly household income would you invest in Derivatives? Kind of risk perceive while investing in Derivatives Table 7: What kind of risk do you perceive while investing?
Participation in different type of Derivative instrument Table 9: In which of the following would you like to participate? Interest of investment in terms of time frame Table Which contract maturity period would interest you for trading in? Result of Investment Table What was the result of your Investment? What is your approximate Income per Annum? Cross Tab Count In which of the following would you like to participate?
The chi-squared statistic has 12 degree of freedom. The p value. Hence there is significant relationship between income and investment in different type of derivative instruments. Others never had a say. Today, commodity exchanges are purely speculative in nature.
Before discovering the price, they reach to the producers, end-users, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. A big difference between a typical auction, where a single auctioneer announces the bids and the Exchange is that people are not only competing to buy but also to sell.
That keeps the market as efficient as possible, and keeps the traders on their toes to make sure no one gets the purchase or sale before they do. Since till commodity datives market was virtually non- existent, except some negligible activities on OTC basis. In India there are 25 recognized future exchanges, of which there are three national level multi- commodity exchanges.
After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodity Exchanges, a modification of traditional business known as Adhat and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. There are other regional commodity exchanges situated in different parts of India. Legal framework for regulating commodity futures in India:- The commodity futures traded in commodity exchanges are regulated by the Government under the Forward Contracts Regulations Act, and the Rules framed there under.
Commission consists of minimum two and maximum four members appointed by Central Govt. Out of these members there is one nominated chairman. There are more than 15 regional commodity exchanges in India.
It is committed to provide a world class commodity exchange platform for market participants to trade in a wide spectrum of commodity derivatives driven by best global practices, professionalism and transparency. NCDEX currently facilitates trading of 57 commodities. MCX facilitates online trading, clearing and settlement operations for commodity futures market across the country. MCX deals with about commodities. It got reorganization in Oct Exchanges have to apply for trading each commodity.
There are two kinds of trades in commodities. The first is the spot trade, in which one pays cash and carries away the goods. The second is futures trade. The underpinning for futures is the warehouse receipt. A person deposits certain amount of say, good X in a ware house and gets a warehouse receipt. Which allows him to ask for physical delivery of the good from the warehouse.
But someone trading in commodity futures need not necessarily posses such a receipt to strike a deal. A person can buy or sale a commodity future on an exchange based on his expectation of where the price will go. Squiring off is done by taking an opposite contract so that the net outstanding is nil.
For commodity futures to work, the seller should be able to deposit the commodity at warehouse nearest to him and collect the warehouse receipt. The buyer should be able to take physical delivery at a location of his choice on presenting the warehouse receipt. But at present in India very few warehouses provide delivery for specific commodities. Figure 1. Today Commodity trading system is fully computerized. Traders need not visit a commodity market to speculate. With online commodity trading they could sit in the confines of their home or office and call the shots.
The commodity trading system consists of certain prescribed steps or stages as follows: I. Settlement: - This stage has following system followed as follows- - Marking to market - Receipts and payments - Reporting - Delivery upon expiration or maturity. Current Scenario in Indian Commodity Market Need of Commodity Derivatives for India:- India is among top 5 producers of most of the Commodities, in addition to being a major consumer of bullion and energy products.
All this indicates that India can be promoted as a major centre for trading of commodity derivatives. Table 1. Trends in volume contribution on the three National Exchanges:- Pattern on Multi Commodity Exchange MCX :- MCX is currently largest commodity exchange in the country in terms of trade volumes, further it has even become the third largest in bullion and second largest in silver future trading in the world. Coming to trade pattern, though there are about commodities traded on MCX, only 3 or 4 commodities contribute for more than 80 percent of total trade volume.
As per recent data the largely traded commodities are Gold, Silver, Energy and base Metals. Whose market sizes are considerably small making then vulnerable to manipulations. Moreover, as per the survey, during CY , MCX was the world's largest exchange in silver and gold futures, second largest in copper and natural gas futures, and the third largest in crude oil futures.
These alliances enable the Exchange in improving trade practices, increasing awareness, and facilitating overall improvement of commodity futures market. Trade on NMCE had considerable proportion of commodities with big market size as jute rubber etc. But, in subsequent period, the pattern has changed and slowly moved towards commodities with small market size or narrow commodities. Analysis of volume contributions on three major national commodity exchanges reveled the following pattern, Major volume contributors: - Majority of trade has been concentrated in few commodities that are Non Agricultural Commodities bullion, metals and energy Agricultural commodities with small market size or narrow commodities like guar, Urad, Menthol etc.
As of March , futures trading in urad, tur and rice remain suspended. The five major commodity exchanges contributed These are MCX, Mumbai The paper also summarizes the recent developments and trends in fundaments on both the demand and supply side.
They have urged that due to increase in the number of investors in commodity market who do not base their trading purely on the basis of demand and supply has lead to misleading price signals in the market.
Another finding in this paper was that investors want to diversify their portfolio which is playing an important role for them to invest in commodity market rather than understanding the fundamentals for investment.
Ke Tang and Wei Xiong, March ,The primary objective of this paper was to find out the effect growing investment in commodity futures markets has had on commodity price co-movements. In order to find out the relationship between the two the authors conducted a regression test between the oil and selected commodities from various sectors and the major finding was that with the increase in investment by investors observed since the early s futures prices of non-energy commodities have become increasingly correlated with oil.
John Baffes and Tassos Haniotis ,July ,The main objective of this paper was to analyze three potentially key factors behind recent commodity price increases: excess liquidity and speculation, increasing food demand by emerging economies and the use of some food commodities for biofuel production.
The major findings in this paper was speculation played a key role during the price rise whereas the use of some food commodities for biofuel production played a small role and the increase in food demand by emerging economies played no noticeable role. Lutz Kilian and Dan Murphy, 16 March , The main objective of this study was to develop a structural vector autoregressive VAR model of the global oil market. The major findings of this study was that the increase in oil prices observed from to was caused by fluctuations in the flow demand for oil driven by the global business cycle.
The model also suggests that speculative trading played an important role during oil price shocks observed in , and The findings of this study was that both bubble behavior and index investments have had a substantial impact on commodity futures prices. Jeffrey Currie, Allison Nathan, David Greely and Damien Courvalin, 30 March ,The major findings of this study was that commodity price movements can be explained by increasing marginal costs in the long term and fluctuations in inventories in the short term.
The authors also find speculative investors contributed to increased price levels and price volatility in recent years noting as speculators buy, prices generally tend to rise, and vice versa. Also the author points out that there is close relationship between price volatility, inventories and storage capacity, as inventories help in closing the gap between physical supply and demand.
Scott Irwin and Dwight Sanders, ,The paper aims to test whether the major growth in index funds has increased price volatility in both agricultural and energy markets and, in particular, whether they helped cause a commodity price bubble in The findings of this study was that there were no strong evidence that index funds caused a price bubble in commodity futures markets. The authors also find increasing index fund positions are consistently associated with declining price volatility and this paper gives a reasonable explanation for this negative correlation arguing speculation helps to provide sufficient liquidity for hedging needs.
International Monetary Fund, October ,The basic output of this study was that strong demand from emerging economies, low capacity, low inventories resulting in slow supply responses and the interaction between these factors have been the primary causes of the surge in commodity prices observed in the first half of In addition, demand for biofuel, supply disruptions and trade restrictions have caused food prices to surge even higher.
The authors also note that this price momentum may have been reinforced by increased cross-commodity price linkages. Gary Gorton and K. Commodity futures have offered the same return and risk premium as equities over the study period and are negatively correlated with equity and bond returns due to different behavior over the business cycle and positively correlated with inflation, unexpected inflation and changes in expected inflation. Research Design: Exploratory design has been selected as data has been collected from the secondary sources inorder to understand the functioning of commodity market and data has been collected from primary source inorder to satisfy the research objectives.
Data Collection Method: Most of the data has collected from secondary sources whereas for conduct of research the primary data has been collected through a structured questionnaire wherein a total of respondents took part out of which only have been taken into consideration as the questionnaire pertains to a specific class of respondents, so inorder to reduce the error this has been done.
A total of 63 males and 37 females have been include in the research. Sampling: The study mainly deals with the financial behavior of Individual Investors towards Commodity market in India. The required data was collected through a pretested questionnaire administered on a combination of convenience and judgment sample of individual investors.
Judgment sample selection is due to the time. Respondents were screened and inclusion was purely on the basis of their knowledge about Financial Markets, Commodity market in particular. This was necessary, because the questionnaire presumed awareness of some basic terminology about Commodity market. The purpose of the survey was to understand the behavioral aspects of individual investors, mainly their fund selection behavior, various factors influencing this behavior and also the conceptual awareness level among individual investors.
Sample of the questionnaire is given in Annex. Instruments used: The primary data was collected through a structured questionnaire by one to one interactions with investors and contact was also made through emails.
Analysis and Interpretations: The analysis of the data collected has been performed appropriately and inferences have been drawn. The techniques that are used for analysis of data are Descriptive technique, Crosstabs and Annova which have been performed by the use of SPSS software.
The sample size may not adequately represent the national market. Graph 4. So, it can be said that investors are looking for safe investment options along with safe return which can be used as a motivation factor for investors to lure them in investing in commodity market.
According to the recent reports commodity market are the first to revive for current situation which add as an added incentive for investors to invest in this market as returns are going to be favorable. Gold and Silver are the most favored commodities to be traded in followed by Energy products such as Crude oil, Petroleum. Under the category of diversification it is almost equal so investors think that commodity market plays a role to a certain extent in diversification but not too a great extent.
Lastly, investors are not very favorable towards capital appreciation due to investment in commodity market. H1:There exists significance difference between Investment portion and occupation of investors. Between Groups 4. What is your investment Between Groups. H1:There exists significance difference between Awareness of commodity market and various sources.
How do you come to know Between Groups. H1:There exists significance difference between investment purpose and gender. Error Difference F Sig. Since the economic slowdown all over the world, the first scenes of recovery have been witnessed in commodity market. It was in that when the prices of commodity markets were on a rise after recession which triggered a revival of many economies such as USA, UK , India , China etc. Now the trend for commodity market is shifting to developing countries like India due to high agricultural dependence and production.
Moreover, in coming years China will take over USA in commodity trading all over the world and India will jump to 3rd place this will be because of high and growing population which will lead to increase in demand for agriculture products and if we see the trend the overall yield per hectare is also increasing for the last decade.
India is one of the top producers of large number of commodities and also has a long history of trading in commodities and related derivatives. As majority of Indian investors are not aware of organized commodity market; their perception about it is of risky to very risky investment. So, there is a large or vast amount of untapped market in India in both urban as well as rural sectors and regulatory bodies have to play a major role in tapping these markets and luring investors to invest in commodity market.
It is also believed that Indians have a high risk appetite.
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