Indian Commodity Market - Groundnut

INDIAN COMMODITY MARKET-GROUNDNUT
1. AN INTRODUCTION
The vast geographical extent of India and her huge population is aptl y complemented by the size of her market. The broadest classification of the Indian Market can be made in terms of the commodity market and the bond market. The commodity market in India comprises of all palpable markets that we come across in our dail y lives. Such markets are social institutions that facilitate exchange of goods for money. The cost of goods is estimated in terms of domestic currency . India Commodity Market can be subdivided into the following two categories: Wholesale Market Retail Market
1.1
MEANING OF MARKET
A market is conventionall y defined as a place where buyers and sellers meet to exchange goods or services for a cons ideration. This consideration is usuall y money. In an Information Technology enabled environment, buyers and sellers from different locations can transact business in an electronic marketplace. Hence the physical marketplace is not necessary for the exchan ge of goods or services for a consideration. Electronic trading and settlement of transactions has created a revolution in global financial and commodit y markets.
1.2
DEFINITON OF COMMODITY
Any product that can be used for commerce or an article of
commerce which is traded on an authorized commodit y exchange is known as Commodity. The article should be movable of value, something which is bought or sold and which is produced or used as the subject or barter or sale.
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1.3
MEANING OF COMMODITY
A commodit y is a product that has commercial value, which
can be produced, bought, sold, and consumed. Commodities are basicall y the products of the primary sector of an economy. The primary sector of an econom y is concerned with agriculture and extraction of raw materials such as metals, energy etc., which serve as basic inputs for the secondary sector of the econom y.
1.4
COMMODITY EXCHANGE
A commodity exchange is an association or a company or any other body corporate organizing futures trading in commodities for which license has been granted by regulating authorit y.
1.5
EVOLUTION OF COMMODITY MARKET
Commodities future trading was evolved from need of assur ed continuous suppl y of seasonal agricultural crops. The concept of organized trading in commodities evolved in Chicago, in 1848. But one can trace its roots in Japan. In 19th century Chicago in United States had merged as a major commercial hub. So that wheat producers from Mid -west attracted here to sell their produce to dealers & distributors. Due to lack of organized storage facilities, absence of uniform weighing & grading mechanisms producers often confined to the mercy of dealers discretion. T hese situations lead to need of establishing a common meeting place for farmers and dealers to transact in spot grain to deliver wheat and receive cash in return. Graduall y sellers & buyers started making commitments to exchange the produce for cash in future and thus contract for futures trading evolved; Whereby the producer would agree to sell his produce to the buyer at a future delivery date at an agreed upon price.
Trading of wheat in futures became very profitable which encouraged the entry of other commodities in futures market. This created a platform for establishment of a body to regulate and supervise these contracts. That is why Chicago Board of Trade (CBOT) was established in 1848. In 1870 and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Agricultural commodities were mostly traded but as long as there are buyers and sellers, any commodit y can be traded. In 1872, a group of Manhattan dairy merchants got together to bring chaotic condition in New York market to a system in terms of storage, pricing, and transfer of agricultural products. The largest commodit y exchange in USA is Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodit y Exchange and New York Coffee, sugar and cocoa Exchange. Worldwide there are major futures trading exchanges in over twent y countries including Canada, England, India, France, Singapore, Japan, Australia and New Zealand.
1.6
COMMODITY EXCHANGES OF THE WORLD

Some of the exchanges of the world are: 1 2 3 4 5 6 7 8 9 10 New York Mercantile Exchange (NYMEX) . London Metal Exchange (LME) . Chicago Board of Trade (CBOT) . New York Board of Trade (NYBOT) . Kansas Board of Trade. Dalian Commodit y Exchange, China . Singapore Commodity Exchange (SICOM). Chicago Mercantile Exchange (CME), US . Tokyo Commodit y Exchange (TOCOM) . Dubai Gold & Commodit y Exchange (DGCX) .
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2. COMMODITY MARKET IN INDIA
2.1
HISTORY OF COMMODITY MARKET IN INDIA .
The history of organized commodity derivatives in India goes back to the nineteenth century when Cotton Trade Association started futures trading in 1875, about a decade after they started in Chicago. Over the time derivatives market developed in several commodities in India. Following Cotton, derivatives trading started in oilseed in Bombay (1900), raw jute and jute goods in Calcutta (1912), Wheat in Hapur (1913) and Bullion in Bombay (1920). However many feared that derivatives fuelled unnecessary speculation and were detrimental to the healthy functioning of the market for the underl ying commodities, resulting in to banning of commodit y options trading and cash settlement of commodities futures after independence in 1952. The parliament passed the Forward Contracts (Regulation) Act, 1952, which regulated contracts in Commodities all over the India. The act prohibited options trading in Goods along with cash settlement of forward trades, rendering a crushing blow to the commodit y derivatives market. Under the act onl y those associations/exchanges, which are granted reorganization from the Government, are allowed to organize forward trading in regulated commodities. The act envisages three tire regulations: i. Exchange which organizes forward trading in commodities can regulate trading on day-to-day basis; Forward Markets Commission provides regulatory oversight under the powers delegated to it by the central Government. The Central Government - Department of Consumer Affairs, Ministry of Consumer Affairs , Food and Public Distribution are the ultimate regulatory authorit y.
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After Liberalization and Globalization in 1990, the Government set up a committee (1993) to examine the role of futures trading. The Committee (headed by Prof. K.N. Kabra) recommended allowing futures trading in 17 commodit y groups. It also recommended strengthening Forward Markets Commission, and certain amendments to Forward Contracts (Regulation) Act 1952, particularl y allowing option trading in goods and registration of brokers with Forward Markets Commission. The Government accepted most of these recommendations and futures trading was permitted in all recommended commodities. It is timel y decision since internationall y the c ommodit y cycle is on upswing and the next decade being touched as the decade of Commodities. Commodit y exchange in India plays an important role where the prices of any commodit y are not fixed, in an organized way.
2.2
PRESENT COMMODITY MARKET IN INDIA

Today, commodit y exchanges are purel y speculative in nature. Before discovering the price, they reach to the producers, endorsers, and even the retail investors, at a grassroots level. It brings a price transparency and risk management in the vital market. By Exchange rules and by law, no one can bid under a higher bid, and no one can offer to sell higher than someone else s lower offer. 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 2002, the commodities future market in India has experienced an unexpected boom in terms of modern exchanges, number of commodities allowed for derivatives trading as well as the value of futures trading in commodities, which crossed $ 1 trillion mark in 2006. In India there are 25 recognized future exchanges, of which there are four national level multi -commodit y exchanges. After a gap of almost three decades, Government of India has allowed forward transactions in commodities through Online Commodit y Exchanges, a modification of traditional business known as Adhat
and Vayda Vyapar to facilitate better risk coverage and delivery of commodities. The four exchanges are: i. National Commodity (NCDEX) Mumbai. & Der ivatives Exchange Limited
ii. iii.
Multi Commodit y Exchange o f India Limited (MCX) Mumbai. National Multi - Commodit y Exchange of (NMCEIL) Ahmedabad. India Limited
iv.
Indian Commodit y E xchange Limited (ICEX), Gurgaon.
3. COMMODITY EXCHANGES IN INDIA
3.1
NATIONAL LEVEL COMMODITY EXCHANGES IN INDIA.
1. NATIONAL MULTI-COMMODITY EXCHANGE OF INDIA LTD. (NMCE)
NMCE is the first demutualised electronic commodit y exchange of India granted the National exchange on Govt. of India and operational since 26th Nov, 2002. Promoters of NMCE are, Central warehousing corporation (CWC), National Agricultural Cooperative Marketing Federation of India (NAFED), Gujarat Agro -Industries Corporation Li mited (GAIC L), Gujarat state agricultural Mar keting Board (GSAMB), National Institute of Agricultural Marketing (NIAM) and Neptune Overseas Ltd. (NOL). Main equit y holders are Punjab National Bank (PNB). The Head Office of NMCE is located in Ahmedabad. There are various commodit y trades on NMCE Platform including Agro and non-agro commodities.
2. NATIONAL COMMODITY & DERIVATIVES EXCHANGE
LTD. (NCDEX).
NCDEX is a public limited co. incorporated on April 2003 under the Companies Act 1956; it obtained its certificate for commencement of Business on May 9, 2003. It commenced its operational on Dec 15, 2003. Promoters shareholders are: Life Insurance Corporation of India (LIC), National Bank for Agriculture and Rural Development (NABARD) and National Stock Exchange of India (NSE) oth er shareholder of NCDEX are: Canara Bank, CRIS IL limited, Goldman
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Sachs, Intercontinental Exchange (ICE), Indian farmers Fertilizer Corporation Ltd (IFFCO) and Punjab National Bank (PNB). NCDEX is located in Mumbai and currentl y facilitates trad ing in 57 commodities mainl y in Agro product.
3. MULTI-COMMDITY EXCHANGE OF INDIA LTD. (MCX).

Headquartered in Mumbai, MCX is a demutualised nation wide electronic commodit y future exchange. Set up by Financial Technologies (India) Ltd. permanent recognition from government of India for facilitating online trading, clearing and settlement operations for future market across the country. The exchange started operation in Nov, 2003. MCX equit y partners include, NYSE Euro next, State Bank of India and its associated, NABARD NSE, SBI Life Insurance Co. Ltd., Bank of India, Bank of Baroda, Union Bank of India, Corporation Bank, Canara Bank, HDFC Bank, etc. MCX is well known for bullion and metal trading platform.
4. INDIAN COMMODITY EXCHANGE LTD. (ICEX).

ICEX is latest commodit y exchange of India Started Function from 27 Nov, 09. It is jointl y promote by India bulls Financial Services Ltd. and MMTC Ltd. and has Indian Potash Ltd. KR IBHCO and IFC among others, as its partners having its head office located at Gurgaon (Haryana).
3.2
UNIQUE FEATURES OF NATIONAL LEVEL COMMDITY EXCHANGES.

The unique features of national level commodit y exchanges are: i. They are demutualized, meaning thereby that they are run professionall y and there is separation of management from ownership. The independent management does not have any trading interest in the commodities dealt with on the exchange. They provide online platforms or screen based trading as distinct from the open outcry systems (ring trading) seen on conventional exchanges. This ensures transparency in operations as everyone has access to the same information. They allow trading in a number of commodities and are hence multi-commodit y exchanges. They are national level exchanges which facilitate trading from anywhere in the country. This is corollary of being an online exchange.
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3.3
MAJOR REGIONAL COMMODITY EXCHANGES IN INDIA a. BATINDA COMMODITY & OIL EXCHANGE LTD. b. THE BOMBAY COMMODITY EXCHANGE c. THE RAJKOT SEEDS OIL AND BULLION MERCHAT d. THE KANPUR COMMODITY EXCHANGE e. THE MEERUT AGRO COMMODITY EXCHANGE THE SPICES AND OILSEEDS EXCHANGE (SANGI) f. AHEMDABAD COMMODITY EXCHANGE g. VIJAY BEOPAR CHAMBER LTD. (MUZAFFARNAGAR) h. INDIA PEPPERS AND SPICE TRADE ASSOCIATION (KOCHI )
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i. RAJDHANI OILS AND SEEDS EXCHANGE ( DELHI ) j. THE CHAMBER OF COMMERCE (HAPUR) k. THE EAST INDIA COTTON ASSOCIATION (MUMBAI) l. THE CENTRAL COMMERCIAL EXCHANGE ( GWALIOR) m. THE EAST INDIA JUTE & HESSIAN EXCHANGE OF INDIA (KOLKATA) n. FIRST COMMODITY EXCHANGE OF INDIA ( KOCHI ) o. BIKANER COMMODITY EXCHANGE LTD. ( BIKANER ) p. THE COFEE FUTURE EXCHANGE LTD. ( BANGALORE ) q. E SUGAR INDIA LTD. (MUMBAI)
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4. COMMODITY FUTURES MARKET.
4.1
MEANING OF COMMODITY MARKET

A market where commodities are traded is referred to as a commodit y market. These commodities include bullion (gold, silver), non -ferrous (base) metals such as copper, zinc, nickel, lead, aluminum, tin, energy (crude oil, natural gas, etc.), agricultural commodities such as soya oil, palm oil, coffee, pepper, cashew, etc. Existence of a vibrant, active, and liquid commodit y market normall y considered as a healthy sign of development of country s econom y. Growth of a transparent commodit y market a sign of development of an econom y. It is therefore important have active commodity markets functioning in a country. is a is to
4.2 COMMODITY FUTURES

A Commodit y futures is an agreement between two parties to buy or sell a specified and standardized quantit y of a commodit y at a certain time in future at a price agreed upon at the time of entering into the contract on the commodity futures exchange. The need for a futures market ari ses mainl y due to the hedging function that it can perform. Commodity markets, like any other financial instrument, involve risk associated with frequent price volatilit y. The loss due to price volatilit y can be attributed to the following reasons:
1. CONSUMER PREFERENCES. In the short -term, their influence on price volatilit y is small since it is a slow process permitting manufacturers, dealers and wholesalers to adjust their inventory in advance.
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2. CHANGES IN SUPPLY They are abrupt and unpredictable bringing about wild fluctuations in prices. This can especially noticed in agricultural commodities where the weather plays a major role in affecting the fortunes of people involved in this industry. The futures market has evolved to neutralize such risks through a mechanism; namel y hedging.
4.3 OBJECTIVES OF COMMODITY FUTURES MARKET

1. Hedging with the objective of transferring risk related to the possession of physical assets through any adverse moments in price. 2. Liquidit y an d Price discovery to ensure base minimum volume in trading of a commodit y through market information and demand suppl y factors that facilitates a regular and authentic price discovery mechanism. 3. Maintaining buffer stock and better allocation of resources as it augments reduction in inventory requirement and thus the exposure to risks related with price fluctuation declines. Resources can thus be diversified for investments. 4. Price stabilization along with balancing demand and suppl y position. Futures tradi ng leads to predictabilit y in assessing the domestic prices, which maintains stabilit y, thus safeguarding against any short term adverse price movements. Liquidit y in Contracts of the commodities traded also ensures in maintaining the equilibrium between d emand and suppl y. 5. Flexibilit y, certainty and transparency in purchasing commodities facilitate bank financing. Predictabilit y in prices of commodit y would lead to stabilit y, which in turn would eliminate the risks associated with running the business of trading commodities. This would make funding easier and less stringent for banks to commodit y market players.
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4.4
BENEFITS OF COMMODITY FUTURES MARKETS

The primary objectives of any futures exchange are authentic price discovery and an efficient price risk management. The beneficiaries include those who trade in the commodities being offered in 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 and services are able to function smoothl y. The benefits of commodit y futures are as follows:
1. PRICE DISCOVERY
Based on inputs regarding specific market information, the demand and supply equilibrium, weather for ecasts, 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. The execution of trade between buyers and sellers leads to assessment of fair value of a particular commodity that is immediately disseminated on the trading terminal.
2. PRICE RISK MANAGEMENT

Hedging is the most common method of price risk management. It is strategy of offering price risk that is inherent in spot market by taking an equal but opposite position in the futures market. Futures markets are used as a mode by hedgers to protect their business from adverse price change. This could dent the profitability of their busine ss. Hedging benefits who are involved in trading of commodities like farmers, processors, merchandisers, manufacturers, exporters, importers etc.
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3. IMPORT- EXPORT COMPETITIVENESS

The exporters can hedge their price risk and improve their competitiveness by making use of futures market. A majorit y of traders which are involved in physical trade internationall y intend to buy forwards. The purchases made from the physical market might expose them to the risk of price risk resulting to losses. The existence of futures market would allow the exporters to hedge their proposed purchase by temporaril y substituting for actual purchase till the time is ripe to buy in physical market. In the a bsence of futures market it will be meticulous, time consuming and costl y physical transactions.
4. PREDICTABLE PRICING
The demand for certain commodities is highl y price elastic. The manufacturers have to ensure that the prices should be stable in order to protect their market share with the free entry of imports. Futures contracts will enable predictabilit y in domestic prices. The manufacturers can, as a result, smooth out the influence of changes in their input prices very easil y. With no fut ures market, the manufacturer can be caught between severe short -term price movements of oils and necessit y to maintain price stabilit y, which could onl y be possible through sufficient financial reserves that could otherwise be utilized for making other pr ofitable 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 against unfavorable price fluctuations. This would reduce the risk premiums 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 the farmers determines the extent to which traders/ processors increase price to them.
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Since one of the objectives of futures exchange is to make available these prices as far as possible, it is very likel y 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 activit y to fund. Even a small movement in prices can eat up a huge proportion of capital owned by traders, at times making it virtuall y impossible to payback the loan. There is a high degree of reluctance among banks to fund commodit y traders, especiall y those who do not manage price risks. If in case they do, the interest rate is likel y to be high and terms and conditions very stringent. This possesses a huge obstacle in the smooth functioning and competition of commodities market. Hedging, which is possible through futures markets, would cut down the discount rate in commodit y lending.
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 qualit y of the commodit y to grade that is acceptable by the exchange. It ensures unifor m standardization of commodity trade, including the terms of qualit y standard: the qualit y certificates that are issued by the exchange -certified warehouses have the potential to become the norm for physical trade.
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8. COMMODITIES AS AN ASSET CLASS DIVERSIFICATION OF PORTFOLIO RISK:
FOR
Commodities have historicall y an inverse correlation of dail y returns as compared to equities. The skewness of dail y returns favors commodities, thereby indicating that in a given time period commo dities have a greater probabilit y 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 commoditi es as well as equities. Thus, an Investor can effectivel y minimize the portfolio risk arising due to price fluctuations in other asset classes by including commodities in the portfolio.
9. COMMODITY DERIVATIVES EXTREMELY TRANSPARENT
MARKETS
ARE
Commodit y derivatives markets are extremel y transparent in the sense that the manipulation of prices of a commodit y is extremel y difficult due to globalization of economies, thereby providing for prices benchmarked across different countries and continent s. For example, gold, silver, crude oil, natural gas, etc. are international commodities, whose prices in India are indicative of the global situation.
10.USEFUL TO THE PRODUCER

Commodit y trade is useful to the producer because he can get an idea of the price likel y to prevail on a future date and therefore can decide between various competing commodities, the best that suits him.
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11.USEFUL FOR THE CONSUMER

Commodit y trade is useful for the consumer because he gets an idea of the price at which the commodit y 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.
4.5
INSTRUMENTS AVAILABLE FOR TRADING

In recent years, derivatives have become increasingl y popular due to their applications for hedging, speculation and arbitrage. While futures and options are now activel y traded on many exchanges, forward contracts are popular on the OTC market. While at the moment only commodit y futures trade on the NCDEX, eventuall y, as the market grows, we also have commodit y options being traded. The following are the instruments available for trading:
1. FORWARDS CONTRACT
A forward contract is an agreement to buy or sell an asset on a specified date for a specified price. One of the parties to the contract assumes a long position and agrees to buy the underl ying asset on a certain specified future date for a certain specified price. The other part y assumes a short position and agrees to sell the asset on the same date for the same price. Other contract details like delivery date, price and quantit y are negotiated bilaterall y by the parties to the contract. The forward contracts are normall y traded outside the exchanges. The salient features of forward contracts are: i. They are bilateral contrac ts and hence exposed to counter part y risk. Each contract is custom designed, and hence is unique in terms of contract size, expiration date and the asset t ype and qualit y.
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The contract price is generall y not available in public domain. On the expiration date, the contract has to be settled by delivery of the asset. If the part y wishes to reverse the contract, it has to compulsoril y go to the same counterpart y, which often results in high prices being charged.
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However forward contracts in certain markets have become much standardized, as in the case of for eign exchange, thereby reducing transaction costs and increasing transactions volume. This process of standardization reaches its limit in the organized futures market.
2. FUTURES CONTRACT
Futures markets were designed to solve the problems that exist in forward markets. A futures contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. But unlike forward contracts, the futures contracts are standardized and exchange traded. To facilitate liquidit y in the futures contracts, the exchange species certain standard features of the contract. It is a standardized contract with standard underl ying instrument, a standard quantit y and qualit y of the underl ying instrument that can be deliv ered, (or which can be used for reference purposes in settlement) and a standard timing of such settlement. A futures contract may be offset prior to maturit y by entering into an equal and opposite transaction. More than 99% of futures transaction s are offset this way.
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The standardized items in a futures contract are: Quantit y of the underl ying Qualit y of the underlying The date and the month of delivery The units of price quotation and minimum price change Location of settlement
3. OPTIONS CONTRACT
Options are fundamentall y different from forward and futures contracts. An option gives the holder of the option the right to do something. The holder does not have to exercise this right. In contrast, in a forward or futures contra ct, the two parties have committed themselves to doing something. Whereas it costs nothing (except margin requirements) to enter into a futures contract, the purchase of an option requires an up -front payment. There are two basic t ypes of options, call options and put options. 1. CALL OPTION A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.
2. PUT OPTION A put option gives the holder the right but not the obligation to sell an asset by a certain date for a certain price.
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4.6
PARTICIPANTS OF COMMODITY MARKET

For a market to succeed, it must have all three kinds of participants hedgers, speculators and arbitrageurs. The confluence of these participants ensures liquidit y and efficient price discovery on the market. Commodit y market gives opportunit y for all three kinds of participants.
1. HEDGERS
A Hedger can be Farmers, manufacturers, importers and exporter. A hedger buys or sells in the futures market to secure the future price of a commodit y intended to be sold at a later date in the cash market. This helps protect against price risks. The holders of the long position in futures contracts (buyers of the commodit y), are trying to secure as l ow a price as possible. The short holders of the contract ( sellers of the commodit y) will want to secure as high a price as possible. The commodit y contract, however, provides a definite price certaint y for both parties, which reduces the risks associated with price volatilit y. By means of futures contracts, Hedging can also be used as a means to lock in an acceptable price margin between the cost of the raw material and the retail cost of the final product sold. Someone going long in a securities fut ure contract now can hedge against rising equit y prices in three months. If at the time of the contract's expiration the equity price has risen, the investor's contract can be closed out at the higher price. The opposite could happen as well: a hedger coul d go short in a contract today to hedge against declining stock prices in the future .
2. SPECULATORS.
Other commodit y market participants, however, do not aim to minimize risk but rather to benefit from the inherentl y risky nature of the commodit y market. These are the speculators,
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and they aim to profit from the very price change that hedgers are protecting themselves against. A hedger would want to minimize their risk no matter what they're investing in, while speculators want to increase their ri sk and therefore maximize their profits. In the commodit y market, a speculator buying a contract low in order to sell high in the future would most likel y be buying that contract from a hedger selling a contract low in anticipation of declining prices in t he future. Unlike the hedger, the speculator does not actuall y seek to own the commodit y in question. Rather, he or she will enter the market seeking profits by off setting rising and declining prices through the buying and selling of contracts.
3. ARBITRAGEURS.
A central idea in modern economics is the law of one price. This states that in a competitive market, if two assets are equivalent from the point of view of risk and return, they should sell at the same price. If the pric e of the same asset is different in two markets, there will be operators who will buy in the market where the asset sells cheap and sell in the market where it is costl y. This activit y termed as arbitrage, involves the simultaneous purchase and sale of the same or essentiall y similar securit y in two different markets for advantageousl y different prices. The buying cheap and selling expensive continues till prices in the two markets reach equilibrium. Hence, arbitrage helps to equalize prices and restore mar ket efficiency. Since the cash and futures price tend to move in the same direction as they both react to the same suppl y/demand factors, the difference between the underl ying price and futures price is called as basis. Basis is more stable and pr edictable than the movement of the prices of the underl ying or the Futures price. Thus, arbitrageur would predict the basis and accordingl y take positions in the cash and future markets.
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5. TRADING, CLEARING AND SETTLEMENT
5.1
TRADING
The trading system on the Commodities exchange provides a full y automated screen -based trading for futures on commodities on a nationwide basis as well as an online monitoring and surveillance mechanism. It supports an order driven market and provides complete trans parency of trading operations. After hours trading has also been proposed for implementation at a later stage. The NCDEX system supports an order driven market, where orders match automaticall y. Order matching is essentiall y on the basis of commod it y, its price, time and quantit y. All quantit y fields are in units and price in rupees. The exchange specifies the unit of trading and the delivery unit for futures contracts on various commodities. The exchange notifies the regular lot size a nd tick size for each of the contracts traded from time to time. When any order enters the trading system, it is an active order. It tries to find a match on the other side of the book. If it finds a match, a trade is generated. If it does not find a m atch, the order becomes passive and gets queued in the respective outstanding order book in the system; Time stamping is done for each trade and provides the possibilit y for a complete audit trail if required.
5.2
CLEARING
Clearing of trades that take place on an exchange happens through the exchange clearing house. A clearing house is a system by which exchanges guarantee the faithful compliance of all trade commitments undertaken on the trading floor or electronicall y over the electronic tradi ng systems. The main task of the clearing house is to keep track of all the transactions that take place during a day so that the net position of each of its members can be calculated. It guarantees the
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performance of the parties to each transaction. Typic all y it is responsible for the following: Effecting timel y settlement. Trade registration and follow up. Control of the evolution of open interest. Financial clearing of the payment flow. Physical settlement (by delivery) or financial settlement (b y price difference) of contracts. Administration of financial guarantees demanded by the participants.
CLEARING MECHANISM
The clearing house has a number of members, who are mostl y financial institutions responsible for the clearing and settlement of commodities traded on the exchange. The margin accounts for the clearing house members are adjusted for gains and losses at the end of each day (in the same way as the individual traders keep margin accounts with the broker ). Onl y clearing members including professional clearing members (PCMs) are entitled to clear and settle contracts through the clearing house. The clearing mechanism essentiall y involves working out open positions and obligations of clearing members. This position is considered for exposure and dail y margin purposes. The open positions of PCMs are arrived at by aggregating the open positions of all the TCMs clearing through him, in contracts in which they have traded. A TCM's open position is arrived at by the summation of his clients' open positions, in the contracts in which they have traded. Client positions are netted at the level of individual client and grossed across all clients, at the member level without any set offs between clients. Proprietary po sitions are netted at member level without any set -offs between client and proprietary positions.
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5.3
SETTLEMENT
Futures contracts have two t ypes of settlements, the MTM settlement which happens on a continuous basis at the end of each day, and the final settlement which happens on the last trading day of the futures contract.
Daily settlement price:

Dail y settlement price is the consensus closing price as arrived after closing session of the relevant futures contract for the trading day. However, in the absence of trading for a contract during closing session, dail y settlement price is computed as per the methods prescribed by the exchange from time to time.
Final settlement price:

Final settlement price is the closing price of th e underl ying commodity on the last trading day of the futures contract. All open positions in a futures contract cease to exist after its expiration day.
SETTLEMENT MECHANISM
Settlement of commodit y futures contracts is a little different from settlement of financial futures which are mostl y cash settled. The possibilit y of physical settlement makes the process a little more complicated.
A. DAILY MARK TO MARKET SETTLEMENT

Dail y mark to market settlement is done till the date of the contract expiry. This is done to take care of dail y price fluctuations for all trades. All the open positions of the members are marked to market at the end of the day and the profit/ loss is determined as below:
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On the day of entering into the contract, it is the difference between the entry value and dail y settlement price for that day.
On any intervening days, when the member holds an open position, it is the difference between the dail y settlement price for that day and the previous day's settlement price. On the expiry date if the member has an open position, it is the difference between the final settlement price and the previous day's settlement price.
B. FINAL SETTLEMENT
On the date of expiry, the final settlement price is the spot price on the expiry day. The spot prices are collected from members across the country through polling. The polled bid/ ask prices are bootstrapped and the mid of the two bootstrapped prices is taken as the final settlement price. The responsibilit y of settlemen t is on a trading cum clearing member for all trades done on his own account and his client's trades. A professional clearing member is responsible for settling all the participants trades which he has confirmed to the exchange.
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5.4
REGULATORY MARKET
FRAMEWORK
INDIAN
COMMODITY
The need for regulation arises on account of the fact that the benefits of futures markets accrue in competitive conditions. Proper regulation is needed to create competitive conditions. In the absence of regulatio n, unscrupulous participants could use these leveraged contracts for manipulating prices. This could have undesirable influence on the spot prices, thereby affecting interests of societ y at large. Regulation is also needed to ensure that the marke t has appropriate risk management system. In the absence of such a system, a major default could create a chain reaction. The resultant financial crisis in a futures market could create systematic risk. Regulation is also needed to ensure fairness and transparenc y in trading, clearing, settlement and management of the exchange so as to protect and promote the interest of various stakeholders, particularl y non -member users of the market. After independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibilit y for regulation of commodit y futures markets devolved on Govt. of India. A Bill on forward contracts was referred to an expert committee headed by Prof. A.D.Shroff and Select Committees of two successive Parliaments and finall y in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted. The Act provided for 3 -tier regulatory system;
a. An association recognized by the Government of India on the recommendation of Forward Markets Commission b. The Forward Markets Commission (it was set up in September 1953) c. The Central Government.
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Forward Contracts (Regulation) Rules were notified by the Central Government in July, 1954.The Act div ides the commodities into 3 categories with reference to extent of regulation, viz.: (a) The commodities in which futures trading can be organized under the auspices recognized association. The Commodities prohibited. in which futures trading is
(b)
(c)
Those commodities which have neither been regulated for being traded under the recognized association nor prohibited are referred as Free Commodities and the association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission.
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6.
TRADING IN AGRI-COMMODITY: GROUNDNUT
6.1
INTRODUCTION
Groundnut is an important crop both for oil and food. It is grown in over 100 countries in the world and plays an important role in the econom y of several countries. About two thirds of the crop produced in the world is crushed to extract oil and one -third is used to make other edible products. India accounts for 40 per cent of the world area and 30 per cent of world output of groundnut. On the other hand groundnut and groundnut oil is the most illiquid commodit y in the commodit y exchanges in India. T herefore the focus of the study is to understand the trade volume of groundnut as a commodit y in commodit y exchanges all over the world and gain knowledge about various factors governing suppl y, demand and price of these commodities in Indian market.
6.2
OVERVIEW
Groundnut is considered to be the one of the most important oilseed crops in the world. It is grown in over 100 countries of the world and plays a crucial role in the world econom y. The seeds are a good source of edible oil and proteins p resent in the groundnut oil cake. The percentage of oil and protein are extracted from the seed are approximatel y 55% and 28% respectivel y. The oil cake meal left after the extraction of the oil is used as an animal fodder and fertilizer. The peanut oil is primaril y needed as a cooking agent but it also has some industrial uses like in paint, varnish, lubricating oil, soap, furniture polish etc. the peanut seeds are also consumed directl y in roasted form, as butter, in brittle and candies etc. Groundnut production has reached the mark of around 34 million tons. China followed by India is the largest producer of this oilseed crop in the world. The groundnut oil production hovers around 8 million tons annuall y. These two countries are also responsibl e for the highest consumption of groundnut.
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The list depicting the major groundnut consuming countries is given below: China India Nigeria United States European Union
Except European Union, all the countries lie in the list of major groundnut producing countries as well. European Union countries are the largest consumer of groundnuts where the crop is not produced. The major demand i.e. around 75% comes from the food sector and the rest from other sectors. As European Union is the largest consumer of the oilseed where it is not produced, it has to rel y on imports and that makes the countries in the union the largest importers of groundnut. The trade done in the world in the context of groundnuts is estimated to about 1 lakh tons per year. The leading groundnut exporting countries are: Argentina China Senegal Vietnam Nigeria South Africa India Gambia United States
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The countries mentioned above contribute to about 90% of the world exports. Argentina makes the largest groundnut exporter to the world. The major countries that satisfy their domestic consumption demand by importing groundnuts are: Belgium United States France Germany United Kingdom Ireland Sweden Ital y Indonesia Netherlands Canada Malaysia Philippines Singapore Japan
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6.3
GROUNDNUT PRODUCING COUNTRIES

Groundnut is one of the vastly produced oilseed crop in the world as it is cultivated in more than 100 countries in the world and that is why it is referred to as a universal crop. The areas in the tropical belt of the earth enjoy the major s hare in this groundnut crop production as this t ype of weather conditions suit well to it. It is estimated that around 65% of the crop produced in the world is crushed to extract groundnut oil and the rest is used in making other edible products. The world production of groundnut seeds hovers around 34 million tons per year in the current scenario. The groundnut oil is produced to an extent of around 8 million tons. The major producers of groundnut in 2005 along with their production figures are 1. CHINA (14408500 TONS) 2. INDIA (5900000 TONS) 3. NIGER IA (2937000 TONS) 4. United States of America (2112700 tons) 5. Indonesia (1469000 tons) 6. Sudan (1200000 tons) 11. Chad (450000 tons) 12. Ghana (389649 tons) 13. Congo (368110 tons) 14. Guinea (300000 tons)
15. Brazil (291966 tons) 16. Burkina tons) Faso (245307
7. Senegal (820569 tons) 8. Myanmar (715000 tons) 9. Argentina (593000 tons) 10. Vietnam (453000 tons)
17. Cameroon (225000 tons) 18. Egypt (190000 tons) 19. Mali (163900 tons) 20. Malawi (161162 tons)
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In context of the production of groundnut oil, China again tops the chart with a production of around 2.5 million tons India following with the production of around 2 million tons. The other regions where groundnut oil is produced includes sub -Saharan African countries and central and southern America. The maximum area that is used for the production of this oilseed is bagged by India with around 8 million hectares that accounts up to 30% share in the total area of around 26.5 million hectares. The country that gets maximum yield from the groundnut crop is USA which has a yield of approximately 3540 Kg/ hectare. The world production has been in the up - trend since last d ecade and still, it is rising steadil y.
6.4
PRODUCTION OF GROUNDNUT IN INDIA

India has been producing groundnut since it has been introduced in Asia in the 16th century. The weather in the Indian subcontinent suited well to the crop and India transformed into an important contributor to the world production. The country ranks 2nd in the world groundnut production scenario with an annual groundnut seed production of 5.9 million tons and annual groundnut oil production of 1.5 million tons in 2007 . Also, Indi a has the maximum area covered under groundnut cultivation. The major states in India that are indulged in the production of this crop along with their production figures are: Gujarat (2.5 million tons) Tamil Nadu (1 million tons) Andhra Prad esh (1 million tons) Karnataka (0.5 million tons) Maharashtra (0.5 million tons) Madhya Pradesh Orissa Rajasthan
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The Indian production and area covered is largel y concentrated in the above-mentioned states. Today, groundnut has a share of approximatel y 25% in the total Indian oilseed production. But this share is constantl y reducing since India got independent, as it was around 70% in 1950s. A quick summary of area under cu ltivation, production and yield of groundnut crop is provided in the tables below:
YEAR WISE AREA UNDER CULTIVATION OF GROUNDNUT IN INDIA
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PRODUCTION OF GROUNDNUT IN INDIA

10 9 8 7 6 5 4 3 2 1 0 PRODUCTION (IN TONS)
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6.5
INDIAN GROUNDNUT MARKET

India has been a land where oilseeds have much importance than any other crop. Groundnut constitutes one of the major oil seed in India. As already mentioned, it accounts to about 25% share in the total oilseeds production in India. The country produces ar ound 6 million tons of groundnuts annuall y; Gujarat being the leader in the production of the crop producing over 40% of the crop produced India. The groundnut oil production in India hovers around 1.5 million tons per year. The production of groundnut seed in the country has shown fluctuations quite often largel y due to the monsoon behavior. India places 2nd in the world groundnut consumption list. The country actuall y consumes all most all of its groundnut yield produced that is around 30% of the world s total consumption. The main demand of groundnut and derivatives generate from the western and southern parts of the country. This consumption pattern of the country contracts the Indian groundnut export size and does not allow it to gain dominance over the world market even though a high production level. Earlier it was an important exporter of groundnut and its by-products in 1970s. But with time it lost all its importance due to its high prices and increasing competitiveness. The Indian exports of groundnut oil to the world showed a fluctuating trend in the last decade. In 2003 -04 India exported around 1 lakh tons of groundnut oil due to a crop failure in Argentina and Senegal. The imports in the country are second to none as the production level is quite sufficient for the domestic demand level in the country.
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MARKET INFLUENCING FACTORS

Weather regions. conditions in major groundnut producing
Monsoon status in the country. Price fluctuations of the other competitive edible oils. International price movements. High consumption in festive seasons and celebrations.
MAJOR TRADING CENTERS OF GROUNDNUT

The major trading centers of groundnut and derivatives in India are: Rajkot (Gujarat) Mumbai (Maharashtra) Ahmedabad (Gujarat) Indore (Madhya Pradesh) Gondal (Gujarat) Delhi Junagarh (Gujarat)
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CONCLUSION
Prices of all commodities are heading northwards due to rapid increase in demand for commodities. Developing countries like China are voraciously consuming the commodities. That s why globall y commodit y market is bigger than the stock market. 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. The Commodities Derivatives market has seen ups and downs, but seems to have finall y arrived now. The market has made enormous progress in terms of Technology, transparency and trading activit y. Interestingl y, this has happened onl y after the Government protection was removed from a number of Commodities, and market force was allowed to play their role. This should act as a major lesson for policy makers in developing countries, that pricing and price risk management should be left to the market forces rather than trying to achieve these through administered price mechanisms. The management of price risk is going to assume even greater importance in future with the promotion of free trade and removal of trade barriers in the world. As majority of Indian investors are not aware of organized commodity market; their perception about is of risky to very risky investment. Many of them have wrong impression about commodi t y market in their minds. It makes them specious towards commodit y market. Concerned authorities have to take initiative to make commodit y trading process easy and simple. Along with Government efforts NGO s should come forward to educate the people about commodit y markets and to encourage them to invest in to it. There is no doubt that in near future commodit y market will become Hot spot for Indian farmers rather than spot market. And producers, traders as well as consumers will be benefited from it. But for this to happen one has to take initiative to standardize and popularize the Commodity Market.
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BIBLIOGRAPHY
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ANNEXURE1: COMMONLY USED TERMS IN COMMODITY MARKET
Accruals: Commodities on hand ready for shipment, storage and manufacture Arbitragers: Arbitragers are interested in making purchase and sale in different markets at the same time to profit from price discrepancy between the two markets. At the Market: An order t o buy or sell at the best price possible at the time an order reaches the trading pit. Basis: Basis is the difference between the cash price of an asset and futures price of the underl ying asset. Basis can be negative or positive depending on the prices prevailing in the cash and futures. Basis grade: Specific grade or grades named in the exchanges future contract. The other grades deliverable are subject to price of underl ying futures Baskets: Basket options are options on portfolios of underl ying assets. The underl ying asset is usuall y a weighted average of a basket of assets. Equit y index options are a form of basket options. Bear: A person who expects prices to go lower. Bid: A bid subject to immediate acceptance made on the floor of exchange to buy a definite number of futures contracts at a specific price. Breaking: A quick decline in price. Bulging: A quick increase in price. Bull: A person who expects prices to go higher.
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Buy on Close: To buy at the end of trading session at the price within the closing range. Buy on opening: To buy at the beginning of trading session at a price within the opening range. Call: An option that gives the buyer the right to a long position in the underl yi ng futures at a specific price, the call writer (seller) may be assigned a short position in the underl ying futures if the buyer exercises the call. Cash commodity: The actual physical product on which a futures contract is based. This product can include agricultural commodities, financial instruments and the cash equivalent of index futures. Close: The period at the end of trading session officiall y designated by exchange during which all transactions are considered made at the close. Closing price: The price (or price range) recorded during the period designated by the exchange as the official close. Commission house: A concern that buys and sells actual commodities or futures contract for the accounts of customers. Consumption Commodity: Consumption commodities are held mainl y for consumption purpose. E.g. Oil, steel Cover: The cancellation of the short position in any futures contract buys the purchase of an equal quantit y of the same futures contract. Cross hedge: When a cash commodit y is hedge d by using futures contract of other commodit y. Day orders: Orders at a limited price which are understood to be good for the day unless expressl y designated as an open order or good till canceled order.
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Delivery: The tender and receipt of actual c ommodit y, or in case of agriculture commodities, warehouse receipts covering such commodit y, in settlement of futures contract. Some contracts settle in cash (cash delivery). In which case open positions are marked to market on last day of contract based o n cash market close. Delivery month: Specified month within which delivery may be made under the terms of futures contract. Delivery notice : A notice for a clearing member s intention to deliver a stated quantit y of commodit y in settlement of a short futures position. Derivatives: These are financial contracts, which derive their value from an underl ying asset. (Underl ying assets can be equit y, commodit y, foreign exchange, int erest rates, real estate or any other asset.) Four t ypes of derivatives are trades forward, futures, options and swaps. Derivatives can be traded either in an exchange or over the counter. Differentials: The premium paid for grades batter than the basis grade and the discounts allowed for the grades. These differentials are fixed by the contract terms on most exchanges. Exchange: Central market place for buyers and sellers. Standardized contracts ensure that the prices mean the same to everyone in the mar ket. The prices in an exchange are determined in the form of a continuous auction by members who are acting on behalf of their clients, companies or themselves. Forward contract: It is an agreement between two parties to buy or sell an asset at a future d ate for price agreed upon while signing agreement. Forward contract is not traded on an exchange. This is oldest form of derivative contract. It is traded in OTC Market. Not on an exchange. Forward contract is generall y settled by
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physical delivery. In thi s case delivery is carried out at delivery center specified in the customized bilateral agreement. Futures Contract: It is an agreement between two parties to buy or sell specified and standardized quantit y and qualit y of an asset at certain time in the future at price agreed upon at the time of entering in to contract on the futures exchange. It is entered on centralized trading platform of exchange. It is standardized in terms of quantit y as specified by exchange. Contract price of futures contract is transparent as it is available on centralized trading screen of the exchange. Here valuation of Mark -toMark position is calculated as per the official closing price on dail y basis and MTM margin requirement exists. Futures contract is more liquid as it is traded on the exchange. Futures contract is generally cash settled but option of physical settlement is available. Delivery tendered in case of futures contract should be of standard quantit y and qualit y as specified by the exchange. Futures commissio n merchant: A broker who is permitted to accept the orders to buy and sale futures contracts for the consumers. Futures Funds: Usuall y limited partnerships for investors who prefer to participate in the futures market by buying shares in a fund managed by professional traders or commodit y trading advisors. Futures Market: It facilitates buying and selling of standardized contractual agreements (for future delivery) of underl yin g asset as the specific commodit y and not the physical commodit y itself.
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