1. What is a Derivative contract?
A derivative contract is an enforceable agreement whose value is derived from the value of an underlying asset; the underlying asset can be a commodity, precious metal, currency, bond, stock, or, indices of commodities, stocks etc. Four most common examples of derivative instruments are forwards, futures, and options.
2. What is a forward contract?
A forward contract is a legally enforceable agreement for delivery of goods or the underlying asset on a specific date in future at a price agreed on the date of contract. Under Forward Contracts (Regulation) Act, 1952, all the contracts for delivery of goods, which are settled by payment of money difference or where delivery and payment is made after period of 11 days, are forward contracts.
3. What are standardized contracts?
Futures contracts are standardized. In other words, the parties to the contracts do not decide the terms of futures contracts; but they merely accept terms of contracts standardized by the Exchange.
4. What are customized contracts?
Forward contracts (other than futures) are customized. In other words, the terms of forward contracts are individually agreed between two counter-parties.
5. What are Commodity Futures?
Commodity Futures are contracts to buy/sell specific quantity of a particular commodity at a future date. It is similar to the Index futures and Stock futures but the underlying happens to be commodities instead of Stocks and indices.
Commodity futures’ trading is a mechanism for price discovery and price risk management for the entire commodity chain participants of the economy. Owing to the seasonality in production and perishable nature, presence of commodity price cycles in various agricultural commodities are the general trend in India, since prices are at their lowest at the time of harvest and attain peak during lean season. Hence during harvest the supply exceeds the immediate short term demand by the consumers, processors and other stakeholders associated with the commodity markets and during lean season the demand exceeds the supply which adversely affect the farmers as they realize lower prices of their produce in the harvest season and consumers as they have to pay higher prices in the lean season to meet their requirements. Forward/ futures markets provide a market mechanism to balance this imbalance in the supply – demand pattern of agricultural commodities. Futures markets therefore are beneficial to both the consumers and farmers.
Evolution of Commodity Futures Markets in India
The Commodity Futures market in India is more than a century old and the first organized futures market was established in 1875, under the name of Bombay Cotton Trade Association to trade in cotton derivative contracts. Commodity Derivative markets were set up in oilseeds in 1900 at Bombay. Forward trading in raw jute and jute goods started at Calcutta in 1912. Forward Markets in Wheat had been functioning at Hapur since 1913, and in bullion at Bombay, since 1920. This was followed by institutions for futures trading in other crops also. A large number of commodity exchanges trading futures contracts in several farm commodities were prohibited during the World War periods to overcome the delicate supply situation under the Defence of India Act. In 1960s, commodity futures trading in most of the commodities was banned and futures trading continued in two minor commodities, viz, pepper and turmeric.
After the recommendations of the Khusro Committee (1980), introduction of economic reforms (1991) and the recommendations of the Kabra Committee (1994) emphasized the need for introducing futures trade once again in India. In April 1999, futures trading was permitted in various edible oilseed complexes. The National Agriculture Policy announced in July 2000 and the announcements of Honourable Finance Minister in the Budget Speech for 2002-2003 indicated the Government’s resolve to put in place a mechanism of futures trade/market. Futures trading in sugar were permitted in May 2001 and the Government issued notifications on 1.4.2003 permitting futures trading in all the commodities.
Commodities Suitable for Forward Contracts
All the commodities are not suitable for futures trading and for conducting futures trading. For being suitable for futures trading the market for commodity should be competitive, i.e., there should be large demand for and supply of the commodity - no individual or group of persons acting in concert should be in a position to influence the demand or supply, and consequently the price substantially. There should be fluctuations in price. The market for the commodity should be free from substantial government control. The commodity should have long shelf-life and be capable of standardization and gradation.
The administered price is announced for different agricultural crops by the Government of India on the recommendations of Commission for Agricultural Costs and Prices (CACP).
Aspects while recommending the price
- The need for incentives to farmers for the adoption of improved technology and maximization of production.
- The need for ensuring a rational utilization of land and other production resources.
- The likely effect of the price policy on the rest of the economy.
The Commission has been recommending two sets of administered prices viz., minimum support prices and procurement prices.
The major Commodity Exchanges in India
- Multi- National Commodity and Derivatives Exchange of India, Mumbai (NCDEX).
- The Multi Commodity Exchange of India Limited (MCX),
- National Multi Commodity Exchange, Ahmedabad (NMCE).
- Indian Commodity Exchange (ICEX)
- National Spot Exchange Limited (NSEL)
- ACE Derivatives & Commodity Exchange Ltd.
- CME Group - Agricultural Commodities Products
Major commodity exchanges in around the world
- New York Mercantile Exchange (NYMEX)
- Chicago Board of Trade (CBOT)
- London Metals Exchange (LME)
- Chicago Board Option Exchange (CBOE)
- Tokyo Commodity Exchange (TCE)
- Malaysian Derivatives Exchange (MDEX)
- Commodities Exchange (COMEX)