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AEM 202
Block III
Commodity and Future Marketing
Unit 1 :
Commodity Markets
3-20
Unit 2 :
21-38
Unit 3 :
39-54
Unit 4 :
55-69
Published by
National Institute of Agricultural Extension Management (MANAGE),
Rajendranagar, Hyderabad 500 030, Andhra Pradesh, India
First Published: 2008
MANAGE, 2008
All rights reserved . No part of this work may be reproduced in any form, by mimeograph or any
other means without permission in writing from the MANAGE.
Shri K.V. Satyanarayana, IAS
Director General
National Institute of Agricultural Extension Management (MANAGE),
Rajendranagar, Hyderabad 500 030
Andhra Pradesh, India
Program Coordinators
Dr. M.N. Reddy, Director (Agri. Extn. & Commn.) & Principal Coordinator (PGDAEM)
Ph. Off: (040) 24014527, email: mnreddy@manage.gov.in
Dr. N. Balasubramani, Assistant Director (Agri. Extn.)
Ph. Off: (040) 24016702-708 Extn. 275, email: balasubramani@manage.gov.in
Course Coordinator
Dr. Vikram Singh, Director (OB)
National Institute of Agricultural Extension Management (MANAGE),
Rajendranagar, Hyderabad 500 030, Andhra Pradesh, India
Ph. Off: (040) 24016690, email: vikrams@manage.gov.in
Contributors
This material was originally prepared for YASHADA, Pune. The intellectual copy right of this material
belongs to YASHADA, Pune
AEM - 202
Unit 1
Commodity Markets
Structure
1.0
Objectives
1.1
Commodity markets
1.2
Classification of markets
1.3
1.4
1.5
1.6
1.7
1.8
Let us sum up
1.9
Key words
1.0 Objectives
Agriculture occupies a very important place in the economic life of our country. It is the backbone
of our economic system. India is primarily an agricultural country. The fortunes of the economy are, even
now, dependent on the course of agricultural production. Commodity markets have been serving the
livelihood in the Indian economy. There were different kinds of markets based on products, nature of
competition, time etc. This Unit will help you to understand the following concepts viz:
Commodity Markets
Classification of markets,
Market motives,
Characteristics of Commodities
They are essential things that are produced and consumed in large quantities.
Physical goods that have a value attached to them and hence can be called asset classes.
They are often used as inputs in the production of other goods or services.
There is little differentiation between commodity coming from one producer and the same
commodity from another producer.
Generally they do not have brands, if branded they are called as products
Include physical substances, such as food, grains, and metals, which are interchangeable
with another product of the same type, and which investors buy or sell.
3.
They are goods, which have logistics problem - as they are bulky and as their production and
consumption centers are far apart
They have wide variations in quality and hence certain grades are taken as standards
Commodity Markets
4.
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Markets
The term market means not a particular place in which things are bought and sold but the whole
of any region in which buyers and sellers are in such a free intercourse with one another that the prices
of the same goods tend to equality, easily and quickly.
Functioning
Stage
Scale
Time
Place
Products sold
Competition
1.
Regulated
1.
Wholesale
1.
Physical
1.
Perfect
2.
Unregulated
2.
Retail
2.
Electronic
2.
Imperfect
1.
Primary
1.
Spot
1.
Consumer
2.
Secondary
2.
Forwards
2.
Industrial
3.
Futures
Based on Functioning
Regulated Markets: These are markets in which business is done in accordance with the
rules and regulations framed by the statuary market organization representing different sections
involved in markets. The marketing costs in such markets are standardized and marketing
practices are regulated.
Method of sale: in regulated markets, the sale of agricultural produce is undertaken either
by open auction or by the close tender method.
5
ii)
iii) Grading: the produce in the regulated markets is expected to be sold only after grading.
iv) Licensing of market functionaries: all the market functionaries , from the hamals (loaders)
to traders, working in the regulated markets have to obtain license from market committee.
b.
Unregulated Markets: these are the markets in which business is conducted without any set
rules and regulations. Traders frame the rules for the conduct of the business and run the
market. These markets suffer from many ills, ranging from non-uniform charges for marketing
functions to imperfections in the determination of prices.
2.
Based on the marketing, the markets are divided into three categories
a.
Primary Markets
They are markets where most of the raw materials / materials are sold without much processing.
They lie near the origin of commodities. In primary markets, the producers of goods sell their farm
products to the wholesalers and their agents.
b.
Secondary Markets
These markets are mostly far away from the primary centers of production and located at the
consumption centers. This is the market where the wholesalers sell their goods to the retailers for onward
selling to the consumer. The middlemen buy goods from producers and manufacturers and sell to the
retailers.
c.
Terminal Market
This is the market where goods are purchased for final use or consumption. The retailers sell
their goods to consumers. This market is one where the produce is either finally disposed of to the
consumers or processors, or assembled for exports. In these markets, merchants are well organized
and use modern methods of marketing.
The main objectives of setting up Terminal Markets are
i)
To link the farmers to the markets by shortening the supply chain of perishables and enhance
their efficiency and thus increase farmers income,
ii)
Provide professionally managed competitive alternative marketing structures that provide multiple
choices to farmers for sale of their agricultural produce,
6
Commodity Markets
iii)
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iv)
To bring transparency in the market transactions and price fixation for agricultural produce and
through provision of backward linkages to enable the farmers to realise higher price and thus
higher income to the farmers.
3.
a.
Retail Markets
These markets cater to the needs of the general public who are consumers of the products.
Largely small-scale transactions take place at retail level. Retailers are scattered all over mostly
in residential areas. In short retail refers to a market where goods are sold in small quantity
directly to the consumer.
b.
Wholesale Market
This market sells primarily to traders such as caterers and small shopkeepers. Members of the
public however, are not necessarily excluded. Large-scale transactions take place. Whole sale shops are
mostly concentrated in a particular location in a town/city. It is the market where the middlemen buy the
goods in bulk from the producers and manufacturers. Wholesaling is normally characterized by a system
of delivery by the wholesaler to the customer and the extension of credit facilities against bulk purchases.
4.
Based on Time
a.
Futures Market
This is an auction market in which participants buy and sell commodity/future contracts for
delivery on a specified future date. Futures exchanges act as a platform facilitating and regulating trade.
A futures contract is an agreement between two parties to buy or sell a specified and standardized
quantity and quality of an asset at a certain time in the future at a price agreed upon. It is a market in
which the buyers and sellers make agreement for delivery of goods in future. The contract is made on a
certain date but the goods will be delivered in future. Eg: MCX
b.
Forward Market
Forward contract is an agreement between two parties to buy or sell an asset at a future date for
a price agreed upon by both. Contracts are booked in advance, to mitigate risk. Contracts are signed
by the buyers and sellers and they have their own set of norms. Forward trade may not involve the
activity of an Exchange.
7
c.
Spot Market
Commodities are physically bought and sold here so these are called physical markets. In this
market, delivery is taken immediately. Cash settlement is done within a maximum of 11 days. The spot
market is a ready market where the sellers on the spot physically hand over goods to the buyers. There is
an exchange of goods for money at the same time.
5.
Based on Place
a.
Electronic Market
These are markets wherein the buyers and sellers do not meet. They are also called as virtual
markets / online market place eg e-bay. In Futures exchanges also, now trading is taking place
electronically
b.
Physical Markets
A market in which commodities, such as grain, gold, crude oil etc. are bought and sold for cash
and delivered immediately. This is also called cash market or spot market.
6.
a.
Industrial Markets
This involves the sale of goods between businesses. They are not aimed directly at the consumer.
Eg: primary market where the raw materials and inputs are obtained eg: cement.
b.
Consumer Market
Here, the products and services are bought by individuals for their own or family use. This
7.
1.
2.
3.
4.
Based on Competition
Based on competition the markets are classified into perfect and imperfect markets
a.
Perfect Markets: A perfect market is one in which the following condition will hold good
Commodity Markets
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All the buyers and sellers in the market have perfect knowledge
Prices at any one time are uniform over a geographical area plus or minus the cost
of supplies.
b.
Imperfect Markets: The markets in which the conditions of perfect completion are lacking are
characterized as imperfect markets. The following are the situations based on the imperfections:
i.
ii.
Buyers
Sellers
Stockists
1.
Buyer
2.
Seller
3.
Stockist
A trader who buys goods at lower levels and stores it for some time and sells when prices
improve.
4.
Brokers
They facilitate trade and take some part of the price margin
Investment motive
Speculative motive
Arbitrage motive
1.
Investment motive
A trader who is neither a producer nor a consumer of a produce, but operates in the markets for
profit motive is an investor. He works in the market by buying goods and selling it at a later period or in
a different market and gains from the price differences. Investment may be subdivided into 1) speculative
and 2) arbitrage motive
2.
Speculative motive
A speculator buys, holds and sells commodities in the market to profit from the fluctuations in the
market. Risk involved is more when a person operates with a speculative motive.
3.
Arbitrage motive
Arbitrage is the practice of taking advantage of a price differential between two or more markets,
time periods etc Eg. a person buying in the spot market and selling in the futures market or vice-versa
10
Commodity Markets
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Backward linkage
a.
Contract Farming
b.
Corporate Farming
a.
Contract Farming
Contract farming has been prevalent in various parts of the country for commercial crops like
sugarcane, cotton, tea, coffee, etc. The concept has, however, gained importance in recent times in
the wake of economic liberalization. The main feature of contract farming is that farmers grow
selected crops under a buy back agreement with an agency engaged in trading or processing.
There are many success stories on contract farming such as potato, tomato, groundnut and
chilli in Punjab, Safflower in Madhya Pradesh, oil palm in Andhra Pradesh, seed production contracts
for hybrids seed companies in Karnataka, cotton in Tamil Nadu and Maharashtra etc. which helped
the growers in realization of better returns for their produce.
In our country contract farming has considerable potential where small and marginal farmers
can no longer be competitive without access to modern technologies and support. The contractual
agreement with the farmer provides access to production services and credit as well as knowledge of
new technology. Pricing arrangements can significantly reduce the risk and uncertainty of the market
place.
Small-scale farmers are frequently reluctant to adopt new technologies because of the possible
risks and costs involved. In contract farming, private agribusiness firms normally offer improved
methods and technologies because they have a direct economic interest in improving farmers
production to meet their needs. In many instances, the larger companies provide their own extension
support to contracting farmers to ensure that production is according to the specification. The farmer
learns many skills through contract farming like record keeping, improved methods of applying
chemicals, fertilizers and knowledge of the importance of quality and of the demands of export
markets.
In view of the above, contract-farming arrangements need to be encouraged widely. This
would require arrangement for registration of sponsoring companies and recording of contract
farming agreements, in order to check unreliable and spurious companies. A dispute resolution
mechanism needs to be set up near to farmers which can quickly settle issues, if any, arising between
11
the farmers and the company under a quasi-judicial manner. The farmers while raising the contracted
crops, run the risk of incurring debt and consequent displacement from land in the event of crop failure.
Farmers need to be indemnified from such displacement by law.
Eg: PepsiCo has emerged as one of the biggest providers of high quality seeds (especially tomatoes,
chillies and potatoes) for which farmers have to pay up front. The company recently imported 15,000
citrus plants from California, which are being distributed in Punjab. The idea is to try and develop Punjab
as a major citrus exporter.
b.
Corporate Farming
Corporate farming refers to direct ownership or leasing in of farmland by business organizations
in order to produce for their captive processing requirements or for the open market.
Eg:, Jamnagar Farms Pvt. Ltd.- a subsidiary of Reliance Industries (Mukesh Ambani group)
with 7500 acres of farm land which has mango occupying 450 acres that makes it the largest
mango orchard in Asia. The farm was originally set up as an environmental protection measure
near its refinery. Now, it is being seen as a profitable venture in itself.
2.
Forward linkage
Forward linkage means the dealings with retail chains and processors. The most essential things
Farmers ability to build their associations, which are very much required.
Encourage the retail companies to evolve sourcing models and meanwhile proactively prepare
farmer group to establish linkage with retailers.
12
Commodity Markets
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Improved market access for farmers both in the national and overseas markets
India
a.
APMC
b.
c.
2.
International
a)
WTO
b)
Ensuring complete transparency in pricing system and transactions taking place in market area
Ensuring payment for agricultural produce sold by farmers on the same day
Promoting agricultural processing including activities for value addition in agricultural produce
Publicizing data on arrivals and rates of agricultural produce brought into the market area for
sale.
13
Setup and promote public private partnership in the management of agricultural markets
Provision made for direct sale of farm produce to contract farming sponsor from farmers
field without the necessity of routing it through notified markets
Provision made for imposition of single point levy of market fee on the sale of notified
agricultural commodities in any market area and discretion provided to the State Government
to fix graded levy of market fee on different types of sales
Licensing of market functionaries is dispensed with and a time bound procedure for registration
is laid down. Registration for market functionaries provided to operate in one or more than
one market areas
Provision made for the purchase of agricultural produce through private yards or directly
from agriculturists in one or more than one market area
Provision made for the establishment of consumers/ farmers market to facilitate direct sale
of agricultural produce to consumers
Provision made for resolving of disputes, if any, arising between private market/ consumer
market and Market Committee
Market Committee permitted to use its funds among others to create facilities like grading,
standardization and quality certification; to create infrastructure on its own or through public
private partnership for post harvest handling of agricultural produce and development of
modern marketing system
14
Commodity Markets
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been made specifically responsible for setting up of a separate marketing extension cell in the Board to
provide market-led extension services to farmers
(i)
(ii) Funds of the State Agricultural Marketing Board permitted to be utilized for promoting either
on its own or through public private partnership, for the following
a)
b)
c)
2.a
as a permanent intergovernmental body, UNCTAD is the principal organ of the United Nations General
Assembly dealing with trade, investment and development issues.
To maximizing the trade and development prospects of developing countries and economies in
transition,
Assisting them in their beneficial integration into the globalizing and liberalizing world economy
and the international trading system, and
2.b
The main functions of WTO can be described in very simple terms. These are
Safal Market
This was the initiative by NDDB, which came into existence in April 2003 with setting up of a full-
fledged trading platform for Fruits and Vegetables at Bangalore. It has been formed to establish an
alternative market set-up that operates parallel to mandis to stimulate production, raise quality standards,
reduce losses etc
16
Commodity Markets
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Dominated by small farmers, who were unable to effectively bargain in the Mandis and get
remunerative prices
APMC Act emphasises on regulation and restrictions on marketing activity which create a
situation which is disadvantageous to growers
2.
E-Choupal
E-Choupal is an initiative of ITC Limited (a large diversified group in India) to link directly with
rural farmers for the procurement of agricultural/aquaculture produce like soya, coffee, and prawns.
E-Choupal was conceived to tackle the challenges posed by the unique features of Indian agriculture,
characterized by fragmented farms, weak infrastructure and the involvement of numerous
intermediaries. Traditionally, these commodities are being procured in mandis (major agricultural
marketing centres in rural areas of India), where the middleman used to make most of the profit.
These middlemen used unscientific means to judge the quality of the product, the price difference in
the payout for good quality and inferior quality was less and hence there was no incentive for the
farmers to produce good quality yield. With e-choupal, role of the middleman was restricted.
ITC Limited has now established computers and Internet access in key rural areas where the
farmers can directly negotiate the sale of their produce with ITC Limited. The PCs and Internet access
at these centers enable the farmers to obtain information on mandi prices, good farming practices
and place orders for agricultural inputs like seeds and fertilizers. This helps farmers in improving the
quality of produce, and also helps in realizing a better price. Each ITC Limited kiosk having an
access to Internet is run by a sanchalaka trained farmer. The computer housed in a farmers house
is linked to the Internet via phone lines or by a VSAT connection and serves an average of 600
farmers in 10 surrounding villages within about a 5 km radius. The sanchalak bears some operating
cost but in return gets commissions for the e-transactions done through his eChoupal. The warehouse
hub is managed by middle-men called samyojaks. The samyojak acts as a local commission agent
for ITC Limited.
The system saves procurement costs for ITC Limited. The E-Choupal model is quite different
from the other models, as the farmers do not pay for the information and knowledge they get from
E-Choupals.
17
replaced with discounts. Metros Cash & Carrys business model brings together small, medium and
large-sized producers, farmers, agricultural cooperatives and manufacturers, with the dispersed
community of hotels, restaurants, caterers, traders, retailers and small to medium business enterprises,
under one roof. They buy directly from producers and manufacturers and sell to business customers
at wholesale centers. This way, they shorten the supply chain and thereby eliminate the high costs
associated with a fragmented supply chain. They also cut costs and wastage by building modern
trade infrastructure and implementing modern IT-based systems, which improve efficiency. By
aggregating the demand of small and medium businesses, they are able to buy in bulk quantities at
lower costs, a part of which is passed on to the customers.
Commodity Markets
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processing units are termed as forward linkages. Under the changing scenario, commodity markets are
facing many challenges such as increased infrastructure requirement, market access to farmer, improving
the bargaining power of farmers, introduction of de-intermediation process. To pace up the challenges,
market functionaries have been introducing innovations in marketing such as E-Choupal, Cash and
Carry markets and Safal market.
2.
3.
4.
What are the major primary markets for different agricultural commodities
5.
6.
7.
8.
9.
20
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Unit 2
Introduction to Commodity Exchanges
Structure
2.0
Objectives
2.4
2.5
2.6
Exchange transactions
2.7
Let us sum up
2.8
Key words
2.9
Further readings
2.0 Objectives
On completing this unit you will be able to
21
Futures
utures: A futures contract is an agreement between two parties to buy or sell the underlying
asset at a future date at a future price. Futures contracts differ from forward contracts in the
sense that they are standardized and exchange traded.
b.
Options
Options: There are two types of options - calls and puts. 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.
c.
Warrants
arrants: 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.
d.
Swaps
Swaps: Swaps are private agreements between two parties to exchange cash flows in the
future according to a prearranged formula. They can be regarded as portfolios of forward
contracts.
a.
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Forward contracts
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 underlying
asset on a certain specified future date for a certain specified price. The other party 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 quantity are negotiated bilaterally by the parties to the contract. The forward
contracts are normally traded outside the exchanges.
The salient features of forward contracts are
They are bilateral contracts and hence exposed to counter party risk.
Each contract is custom designed, and hence is unique in terms of contract size, expiration
date and the asset type and quality
On the expiration date, the contract has to be settled by delivery of the asset
If the party wishes to reverse the contract, it has to compulsorily go to the same counter party,
which often results in high prices being charged.
b.
Futures contract
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 liquidity in the futures contracts, the exchange specifies certain standard
features of the contract. It is a standardized contract with standard underlying instrument, a standard
quantity and quality of the underlying instrument that can be delivered, (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 maturity by entering into an equal and opposite transaction. Majority of the futures transactions are
offset this way.
The standardized items in a futures contract are:
Location of settlement
23
Forwards
OTC in nature
No margin payment
Futures Terminology
Spot price
price: The price at which an asset trades in the spot market.
Futures price:
price The price at which the futures contract trades in the futures market.
Contract cycle:
cycle The period over which a contract trades. The commodity futures contracts on the
exchanges have one-month, two-months and three-months expiry cycles.
Expiry date:
date It is the date specified in the futures contract. This is the last day on which the contract
will be traded, at the end of which it will cease to exist.
Delivery unit:
unit The amount of asset that has to be delivered under one contract. For instance, the
delivery unit for futures on Long Staple Cotton on the NCDEX is 55 bales. The delivery unit for the
Gold futures in MCX contract is 1 kg.
Basis
Basis: Basis can be defined as the futures price minus the spot price. There will be a different basis for
each delivery month for each contract. In a normal market, basis is positive. This reflects that futures
prices normally exceed spot prices.
Cost of carry:
carry The relationship between futures prices and spot prices can be summarized in terms of
what is known as the cost of carry. This measures the storage cost plus the interest that is paid to
finance the asset less the income earned on the asset.
Initial margin:
margin The amount that must be deposited in the margin account at the time a futures
contract is first entered into is known as initial margin.
Marking
-to
-market (MTM): In the futures market, at the end of each trading day, the margin account
Marking-to
-to-market
is adjusted to reflect the investors gain or loss depending upon the futures closing price. This is
called marking to market.
Maintenance margin: This is somewhat lower than the initial margin. This is set to ensure that the
24
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balance in the margin account never becomes negative. If the balance in the margin account falls
below the maintenance margin, the investor receives a margin call and is expected to top up the
margin account to the initial margin level before trading commences on the next day.
Short position: The sale of a security or commodities futures not owned by the seller at the time of the
trade. Short sales are usually made in anticipation of a decline in the price.
Long PPosition:
osition: Owning a commodity with an anticipation of increase in prices.
c.
Options trading
An option gives the holder of the option the right to do something but the holder does not have
the obligation to exercise this right. In contrast, in a forward or futures contract, the two parties have
committed themselves to the act of buying and selling. Whereas it costs nothing (except margin
requirements) to enter into a futures contract, the purchase of an option requires an up front payment.
To inculcate best international practices like de-modularization, technology platforms, low cost
solutions and information dissemination without noise etc. into the trade
2.
Exchange membership
Membership of exchanges is open to any person, association of persons, partnerships, cooperative
societies, companies etc. that fulfills the eligibility criteria set by the exchange. All the members of the
exchange have to register themselves with the competent authority before commencing their operations.
25
The members of Exchanges fall into two categories, Trading cum Clearing Members (TCM) and Professional
Clearing Members (PCM).
a.
b.
Professional Clearing Member (PCM) - Any Financial Institution or Bank, which is registered
as PCM is conferred the right only to clear and settle trades through the clearing-house of the
exchange. They may clear and settle trades of such members of the exchange who choose to
do so through that PCM.
3.
arbitragers.
a.
Hedgers
Hedgers: a person who makes investment in order to reduce the risk of adverse price
movements in a commodity, by taking an offsetting position in a related commodity, such as
long and short position is called as hedger. Hedgers could be government institutions, private
corporations like financial institutions, trading companies and even other participants in the
value chain, for instance farmers, extractors, ginners, processors etc., who are influenced by
the commodity prices.
b.
Speculators
Speculators: Speculators are participants who wish to bet on future movements in the price
of an asset. Futures and options contracts can give them leverage; that is, by putting in small
amounts of money upfront, they can take large positions on the market. As a result of this
leveraged speculative position, they increase the potential for large gains as well as large
losses.
c.
26
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27
Forward Market Commission (FMC) is a regulatory authority for all Commodity Derivatives
Exchanges in India, which is overseen by the Ministry of Consumer Affairs and Public Distribution,
Government of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation)
Act, 1952.
The functions of the FForward
orward Markets Commission are as follows:
(a) To advise the Central Government in respect of the recognition or the withdrawal of recognition
from any association or in respect of any other matter arising out of the administration of the
Forward Contracts (Regulation) Act 1952.
(b) To keep forward markets under observation and to take such action in relation to them, as it
may consider necessary, in exercise of the powers assigned to it by or under the Act.
(c) To collect whenever the Commission thinks it necessary, to publish information regarding the
trading conditions in respect of goods to which any of the provisions of the act is made
applicable, including information regarding supply, demand and prices, and to submit to the
Central Government, periodical reports on the working of forward markets relating to such
goods;
(d) To make recommendations generally with a view to improving the organization and working
of forward markets;
(e) To undertake the inspection of the accounts and other documents of any recognized association
or registered association or any member of such association whenever it considerers it
necessary.
accorded approval for setting up of national level multi commodity exchanges. Accordingly three
national level exchanges are there which deal in a wide variety of commodities and which allow
nation-wide trading. They are
a.
b.
c.
28
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Today commodity exchanges are offering spectacular growth opportunities and advantages to a
large cross section of the participants including Producers / Processors, Traders, Corporate, Regional
Trading Centers, Importers, Exporters, Cooperatives and Associations.
a.
independent Board of Directors and professionals. It is a professionally managed by ICICI Bank, LIC,
NABARD and (NSE). NCDEX is a public limited company incorporated on April 23, 2003 under the
Companies Act, 1956.
Unit of price
Unit of trading
quotation
Yield/Re.
Movement
Precious metals
Gold
10gm
100gm
10.00
Kilo gold
10gm
1000gm
100.00
1kg
5KG
5.00
Soya oil
10KG
1000kg
100.00
Cotton-l
1T
11 bales
18.70
Mustard
20KG
1000kg
50.00
Mustard oil
10KG
1000kg
100.00
10KG
1000kg
100.00
Pepper
1T
1000kg
10.00
Chana
1T
10000kg
100.00
Guar seeds
1T
10000kg
100.00
Rubber
1T
1000kg
10.00
Silver
Agricultural products
29
b.
2003. It has permanent recognition from Government of India for facilitating online trading, clearing
and settlement operations for commodity futures markets across the country. Key shareholders of
MCX include Financial Technologies (I) Ltd., State Bank of India & associates, Fidelity International,
National Stock Exchange of India Ltd. (NSE) and National Bank for Agriculture and Rural Development
(NABARD).
Unit of price
quotation
Unit of trading
Yield/Re.
Movement
Gold-m
10gm
100gm
10.00
Gold
10gm
1000gm
100.00
Silver-m
1kg
5kg
5.00
Silver
1kg
30kg
30.00
1t
10 t
10.00
Soya oil
10kg
1000kg
100.00
10kg
1000kg
100.00
Rbd palmolein
10kg
1000kg
100.00
Castor seed
100kg
1t
10.00
Castor oil
10kg
1t
100.00
10kg
1t
100.00
Gaur seed
100kg
5t
50.00
Black pepper
100kg
1t
10.00
Rubber
100kg
25 t
250.00
Kapas
20kg
4t
200.00
Steel long
1t
25 t
25.00
Steel flat
1t
25 t
25.00
Copper
1kg
1t
1000.00
Nickel
1kg
250kg
250.00
Tin
1kg
500kg
500.00
Precious metals
Agricultural products
Soya
Industrial metals
30
c.
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Electronic Multi-Commodity Exchange in India. On 25th July, 2001, it was granted approval by the
Government to organize trading in the edible oil complex. It has operationalized from November
26, 2002. It is being supported by Central Warehousing Corporation Ltd., Gujarat State Agricultural
Marketing Board and Neptune Overseas Limited. It got its recognition in October 2002.
Apart from these national exchanges there are other regional commodities exchanges in
India, which are listed below. Most of these commodity exchanges are offline and commodity specific.
Registered commodity exchanges in India
The Rajkot Seeds oil & Bullion Merchants Association, Ltd. Castorseed
31
2.
a.
interests, metals and US treasuries, soya complex, wheat and corn prices across the world are
referenced here. It has both electronic as well as open cry system of trading. It trades both in futures
as well as options.
b.
New Y
ork Board of TTrade
rade (NYBO
T)
York
(NYBOT)
New York Board of Trade (NYBOT) is the worlds largest commodities exchange for Coffee,
Sugar, Cotton and Frozen Concentrated Orange Juice. The exchange was founded as the New York
Cotton Exchange in 1870. NYBOT also facilitates trades in foreign currencies and derivative indices
for equities.
c.
trades in interest rates, equities, foreign exchange and agricultural commodities. It has both open cry
as well as electronic trading systems. Agricultural commodities traded on the exchange include dairy
products (butter, milk cheese) and live stock futures.
d.
lead, nickel, tin and zinc. Consumers as well as producers of metals use the official prices of LME for
their long-term contracts pricing. There are over 400 LME approved warehouse in some 32 locations
covering USA, Europe, the middle & the Far East. (At the moment there is none in India)., The
exchange has both open outcries as well as electronic system for trade.
e.
New Y
ork Mercantile Exchange (NYMEX)
York
New York Mercantile Exchange in its current form was created in 1994 by the merger of the
former New York Mercantile Exchange and the Commodity Exchange of New York (COMEX). Together
they represent one of worlds largest exchanges for precious metals and energy.
f.
commodity exchange in the world for futures and options. Crude oil, gasoline, kerosene, gas oil,
gold, silver, aluminum, platinum and rubber are the commodities that are actively traded.
32
e.
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Dubai government as well as MCX and FTIL. Dubai has an advantage of its location of serving all
time zones.
f.
Mercantile Exchange (NYMEX) and the Oman Investment Fund (OIF). It is a premier international
energy futures and commodities exchange in the Middle East.
Trading
The trading system on the electronic exchanges provide a fully automated screen based trading
for futures on commodities on a nationwide basis as well as an online monitoring and surveillance
mechanism, which is called as terminal. It supports an order driven market and provides complete
transparency of trading operations. The system supports an order driven market, where orders match
automatically. Order matching is essentially on the basis of commodity, its price, time and quantity. All
quantity fields are in specified 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
and 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 match, the order becomes passive and gets queued in the
respective outstanding order book in the system. Electronic recording is done for each trade and this
provides the possibility for a complete audit trail if required.
a.
investing/trading in commodities market. The prerequisite for trading in commodities markets are
BROKER
BROKER
BROKER
Client opens trading account, by signing Client Agreement with the Broker
CLIENT
CLIENT
CLIENT
CLIENT
CLIENT
CLIENT
34
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NCDEX/MCX
PAY-IN
PAY-OUT
BROKER
CLIENT
Daily exchanges calculate the difference of the entry value and closing price of the particular
date. If the difference is positive the exchanges credit that particular amount into the client account.
In case the difference is negative, the exchanges deduct that particular amount from the credit
account. If the account does not have balance then pay in request is sent to the clients.
2.
Clearing
National Securities Clearing Corporation Limited (NSCCL) undertakes clearing of trades executed
on the exchanges. The settlement guarantee fund is maintained and managed by exchanges. Only
clearing members including Professional Clearing Members (PCMs) are entitled to clear and settle contracts
through the clearinghouse. At exchanges, after the trading hours on the expiry date, based on the
available information, the matching for deliveries takes place firstly, on the basis of locations and then
randomly, keeping in view the factors such as available capacity of the vault/ warehouse, commodities
already deposited and dematerialized and offered for delivery etc. Matching done by this process is
binding on the clearing members. After completion of the matching process, clearing members are
informed of the deliverable/ receivable positions and the unmatched positions. Unmatched positions
have to be settled in cash. The cash settlement is only for the incremental gain/ loss as determined on the
basis of final settlement price.
3.
Settlement
Futures contracts have two types 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. On the Exchanges, daily MTM settlement and final MTM settlement in
respect of admitted deals in futures contracts are cash settled by debiting/ crediting the clearing
accounts of CM (Clearing Member) with the respective clearing bank. All positions of a CM, either
brought forward created during the day or closed out during the day, are marked to market at the
daily settlement price or the final settlement price at the close of trading hours on a day. On the date
of expiry, the final settlement price is the spot price on the expiry day. The responsibility of settlement
35
is on a trading cum clearing member for all trades done on his own account and his clients trades. A
professional clearing member is responsible for settling all the participants trades, which he has confirmed
to the exchange. On the expiry date of a futures contract, members submit delivery information through
delivery request window on the trader workstations provided by the exchanges for all open positions for
a commodity for all constituents individually. Exchanges on receipt of such information match the
information and arrive at a delivery position for a member for a commodity.
The seller intending to make delivery takes the commodities to the designated warehouse. These
commodities have to be assayed by the exchange specified assayer. The commodities have to meet the
contract specifications with allowed variances. If the commodities meet the specifications, the warehouse
accepts them. Warehouse then ensures that the receipts get updated in the depository system giving a
credit in the depositors electronic account. The seller then gives the invoice to his clearing member, who
would courier the same to the buyers clearing member. On an appointed date, the buyer goes to the
warehouse and takes physical possession of the commodities.
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Trading hours: The exchange announces the normal trading hours/ open period in advance from time
to time. In case necessary, the exchange can extend or reduce the trading hours by notifying the members.
Unit of price quotation: Unit of price quotation is the price shown on the trading screen.
Unit of trading: Unit of trading or lot size or contract size is all unanimous. Lot size is the minimum size
of the derivatives, futures or options contract.
Yield / Rupee = Lot Size (Unit of Trading)/ Unit of price quotation.
2.
3.
Define TCM
4.
5.
6.
7.
8.
9.
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Unit 3
Futures Exchange and Risk Management
Structure
3.0
Objectives
Types of hedging
3.0 Objectives
This unit has been designed to help you to understand
Production Risks
As the demand for agricultural products is inelastic, supply shocks caused due to production
variations are magnified in price variations. Agricultural production risks may be due to those arising
out of weather related factors, pests or diseases, farm and management practices, genetics, machinery
efficiency, quality of inputs and also due to risks from variable prices.
b.
strengthening the rural economy. However, complicated operational mechanism of farm credit services,
high transaction costs, uncomfortable repayment schedules, higher interest rates, lower access to
credit, heavy reliance on money lenders, insolvency problems etc have increased the associated
price risks of the commodities.
40
c.
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Institutional Risks
If Government policy framework may come unwarranted that would create a profound impact
on the prices. The government intervention sometimes instead of protecting may result in distortion
of trade, as it does not let the natural market forces of supply and demand in identifying the prices.
Eg. Reform measures like restriction on storage and movement of produces, direct price support
measures, subsidies etc.
d.
factors arise due to nascent nature of such markets. Lack of participation, non-availability or low
dissemination of market information, infrastructure bottlenecks, market structure etc tend to increase
the price risks.
1)
Retained holding the risk, that is taking no protection for the downside risk
2)
Avoided Risks can be avoided fully by going for a totally new venture
3)
Reduced risks can be reduced or mitigated by different possible ways in order to get some
assured income.
b.
Self-insurance
Here the farmers use the previous periods accumulated savings to protect
against uncertainties that they cannot control.
c.
themselves
Crop storage It is a means of avoiding seasonally low prices when there is expectation of
price fall in the season and adequate price rise later. However financial resources and storage
space are required which may limit the scope of this kind of risk management.
d.
e.
Taking credit The farmers may lean on to credit given by government banks, co-operative
societies, commercial banks, etc as well as money lenders. If collateral is insisted on advancing
of the loan then this measure may not be feasible for poor farmers.
41
f.
Contract farming Contract farming is normally associated with vertical integration, where
an agribusiness firm coordinates all aspects of a producer from production to obtaining the
end produce. Here a stable market or price is guaranteed.
g.
Crop Insurance Insuring a crop against the risks basically gives protection against the
losses and also sometimes offers opportunity for gains.
h.
Hedging in futures
With the advent of futures, the use of futures and other derivative products to manage risk
has turned out to be one of the most important and practical innovations in evolving market economies.
Of all the measures intended to reduce risk in futures, hedging is a concept that gains utmost
importance and is used as a financial offset to cash market risks, prevalently. Here the risk averse
producers can buy protection from the risk taking speculators looking for profit.
Hedging is defined as, the establishing of a position in the futures market that is equal and
opposite the position, or intended position, in the cash market with an objective of transferring cash
price risk. Simply put, it involves establishing a position in the futures market that is equal and
opposite of a position in the physical or spot market, i.e. buying in futures markets the quantity sold
in spot markets and vice versa, thus offsetting any loss attained in one market by a gain in the other
market. It helps the participants who are associated with the produce (in this case the producers or
the farmers) to reduce the risks of unanticipated loss by locking in the futures price of a commodity
to their advantage in advance.
42
Strategy
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Advantages
Limitations
Self-insurance
Crop Storage
Increased returns
Diversification
Taking credit
Contract
farming
Crop
Insurance
Hedging
3.5 Hedging
What is hedging?
Taking a position in the futures market that is opposite to a position in the physical market
The objective behind this mechanism is to offset a loss in one market with a gain in another
A temporary substitution of futures market transaction for a planned cash market transaction
Goals of Hedging
1.
2.
Hedgers
Hedgers could be government institutions, private corporations like financial institutions, trading
companies and even other participants in the value chain, for instance farmers, extractors, ginners,
processors etc., who are influenced by the commodity prices.
43
b.
c.
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45
Short Hedge
A Short hedge is a hedge that requires a short position in futures contracts. It is appropriate
when the hedger already owns the asset, or is likely to own the asset and expects to sell it at some
time in the future. For example, a short hedge could be used by a cotton farmer who expects the
cotton crop to be ready for sale in the next two months. Short hedgers are merchants and processors
who acquire inventories of the commodity in the spot market and who simultaneously sell an equivalent
amount of less in the futures market. The hedgers in this case are said to be long in their spot
transactions and short in the futures transactions.
a.
b.
the hedger incurs a larger loss on short futures position and a smaller profit on the corresponding
cash position. But when the spot price increases more than that of the futures price due to narrowing
of basis, the hedger incurs a smaller loss on the futures position and a larger profit on the corresponding
cash position.
c.
Examples
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increase in the price of oil over the next three months and lose Rs.10000 for each one rupee decrease in
the price of oil during this period. Suppose the spot price for soy oil on January 15 is Rs.450 per 10 Kgs
and the April soy oil futures price on the NCDEX is Rs.465 per 10 Kgs. Eg: gives the soy oil futures
contract specification. The producer can hedge his exposure by selling 10,000 Kgs worth of April futures
contracts(10 units). If the oil producer closes his position on April 15, the effect of the strategy would be
to lock in a price close to Rs.465 per 10 Kgs.
Eg: gives the payoff for a short hedge. Let us look at how this works.
On April 15, the spot price can either be above Rs.465 or below Rs.465.
Case 1
1: The spot price is Rs.455 per 10 Kgs. The company realises Rs.4,55,000 under its sales
contract. Because April is the delivery month for the futures contract, the futures price on April 15 should
be very close to the spot price of Rs.455 on that date. The company closes its short futures position at
Rs.455, making a gain of Rs.465 - Rs.455 = Rs.10 per 10 Kgs, or Rs.10,000 on its short futures
position. The total amount realized from both the futures position and the sales contract is therefore
about Rs.465 per 10 Kgs, Rs.4,65,000 in total.
Case 2
2: The spot price is Rs.475 per 10 Kgs. The company realises Rs.4,75,000 under its sales
contract. Because April is the delivery month for the futures contract, the futures price on April 15 should
be very close to the spot price of Rs.475 on that date. The company closes its short futures position at
Rs.475, making a loss of Rs.475 - Rs.465 = Rs.10 per 10 Kgs, or Rs.10,000 on its short futures
position. The total amount realized from both the futures position and the sales contract is therefore
about Rs.465 per 10 Kgs, Rs.4,65,000 in total.
2.
Long Hedge
Hedges that involve taking a long position in a futures contract are known as long hedges.
Long hedge strategy is used by dealers, consumers, fabricators, traders and processors etc, who
47
b.
hedger incurs smaller profit on the long futures position and larger loss on the corresponding cash
position. But when the futures price increased more than that of the cash price due to widening of the
basis, the hedger incurs larger profit on the long futures position and smaller loss on the corresponding
cash position.
c.
Examples
A long hedge is appropriate when a company knows it will have to purchase a certain asset
in the future and wants to lock in a price now. Suppose that it is now January 15. Arm involved in
industrial fabrication knows that it will require 300 kgs of silver on April 15 to meet a certain contract.
The spot price of silver is Rs.1680
Eg: Payoff for buyer of a long hedge
This shows the payoff for an industrial fabricator who takes a long hedge. Irrespective of what
the spot price of silver is three months later, by going in for a long hedge he locks on to a price of
Rs.1730 per kg. Profit Loss 1730 Price of silver Long position in silver futures Short position in silver
Eg; Silver futures contract specification
Unit of trading 5 Kgs
Delivery unit 30 Kgs
Quotation/ base value Rs. per kg of Silver
Tick size 5 paisa per kg and the April silver futures price is Rs.1730. The fabricator can hedge his
position by taking a long position in sixty units of futures on the NCDEX. If the fabricator closes his
position on April 15, the effect of the strategy would be to lock in a price close to Rs.1730 per kg.
Eg; gives the payoff for the buyer of a long hedge. Let us look at how this works. On April 15,
the spot price can either be above Rs.1730 or belowRs.1730.
Case 1: The spot price is Rs.1780 per kg. The fabricator pays Rs.5,34,000 to buy the silver
from the spot market. Because April is the delivery month for the futures contract, the futures price on
April 15 should be very close to the spot price of Rs.1780 on that date. The company closes its long
hedging.
Futures position at Rs.1780, making a gain of Rs.1780 - Rs.1730 = Rs.50 per kg, or Rs.15,000
on its long futures position. The effective cost of silver purchased works out to be about Rs.1730 per
MT, or Rs.5,19,000 in total.
48
AEM - 202
Case 2
2:: The spot price is Rs.1690 per MT. The fabricator pays Rs.5,07,000 to buy the silver
from the spot market. Because April is the delivery month for the futures contract, the futures price on
April 15 should be very close to the spot price of Rs.1690 on that date. The company closes its long
futures position at Rs.1690, making a loss of Rs.1730 - Rs.1690 = Rs.40 per kg, or Rs.12,000 on
its long futures position. The effective cost of silver purchased works out to be about Rs.1730 per MT,
or Rs.5,19,000 in total.
Note that the purpose of hedging is not to make profits, but to lock on to a price to be paid in the
future upfront. In the industrial fabricator example, since prices of silver rose in three months, on hind
sight it would seem that the company would have been better off buying the silver in January and holding
it. But this would involve incurring interest cost and warehousing costs. Besides, if the prices of silver fell
in April, the company would have not only incurred interest and storage costs, but would also have
ended up buying silver at a much higher price.
In the examples above we assume that the futures position is closed out in the delivery month.
The hedge has the same basic effect if delivery is allowed to happen. However, making or taking
delivery can be a costly process. In most cases, delivery is not made even when the hedger keeps the
futures contract until the delivery month. Hedgers with long positions usually avoid any possibility of
having to take delivery by closing out their positions before the delivery period.
3.
Cross Hedging
Hedging as a price risk management tool is applicable for spot commodities that also have
active futures contracts. But for commodities that do not have futures market, cross hedging comes
to help. Cross hedging is the process of hedging a cash commodity in the futures market of a
different, but related, commodity. In this case, jowar or bajra are traded only in the cash or spot
markets, so they are hedged for risk exposure against that of a related but different commodity like
maize, which is actively traded in the futures market. Therefore, a cross-hedge utilizes information in
one market, in this case the NCDEX/ MCX maize futures market to predict the price of jowar in spot
markets.
Cross hedging will generally work well for reducing price risk if
The price of the commodity being cross hedged and the price of the futures commodity are
closely related and follow one another in a predictable manner, meaning hedged price risk
is less than unhedged price risk (it refers to the general price level variability)
Large enough quantities are being traded to meet cross hedged futures contract size
specifications.
49
Here maize is used for cross hedging jowar because these prices follow each other closely as
they can be substituted in poultry feed rations. To explain in a detailed way we can say that the prices
of jowar/bajra and maize tend to move in similar patterns because people tend to purchase the
under priced commodity or sell the overpriced commodity. For instance, poultry owners will substitute
jowar / bajra for maize and vice-versa depending upon the price of maize relative to the jowar/bajra
price. That is if the maize prices in spot market go high then feed manufacturing industry will shift to
jowar and consequently prices of jowar will also go high. Thus the prices of Maize and jowar should
be positively correlated for hedging the price risk against the exposure. In this study we can see that
during the period from July to December the correlation coefficient between the jowar and maize
prices is 0.79. This substitution causes the two prices to converge toward each other, creating a
relatively stable price relationship.
Now if they are cross-hedged the producer of jowar can establish a price for their produce.
This may be done anytime before the planting of the crop, before the actual grain is sold into the
local cash market, after planting, or even after harvest (during storage).
a.
profit. Moreover hedging addresses only the price risk and not the production or other risks. The
hedging decision must still take into account production costs and market outlook.
Hedging could be imperfect at times due to differences in the actual selling price and the
closure of the contract. In short term, hedging may lead to a disadvantageous position, so, a longterm view has to be taken for evaluating the merits of hedging.
For many producers, deciding when and how to hedge is one of the most difficult aspects.
Since cross hedging appears to be complex from the farmers point of view, to hedge successfully,
producers must understand futures markets, cash markets, and the basic relationships. They must
trade in the futures market and will have to involve more people such as a commodity broker and a
lender in their market decision-making.
Margin money is required to maintain a position in the futures market. Also since this process
involves extra marketing cost, including brokerage commissions and interest on margin money it
demands adequate cash flow with the farmers.
Moreover the commodity exchanges in India are relatively new. So, the contracts, especially
far month contract may not exist or may not be active.
50
AEM - 202
Let us consider an example. A company knows that it will require 11,000 bales of cotton in
three months. Suppose the standard deviation of the change in the price per Quintal of cotton over
a three month period is calculated as 0.032. The company chooses to hedge by buying futures
contracts on cotton. The standard deviation of the change in the cotton futures price over a three
month period is 0.040 and the coefficient of correlation between the change in price of cotton and
the change in the cotton futures price is 0.8. The unit of trading is 11 bales and the delivery unit for
cotton on the NCDEX is 55 bales. What is the optimal hedge ratio? How many cotton futures
contracts should it buy?
51
If the hedge ratio were one, that is if the cotton spot and futures were perfectly correlated, as
shown in Equation 3, the hedger would have to buy 1000 units (one unit of trading = 11 bales of
cotton) to obtain a hedge for the 11,000 bales of cotton it requires in three months.
Number of contracts =11000/11
(2)
Np-1 = 1000
(3)
However, in this case as shown in Equation 5, the hedge ratio works out to be 0.64. The
company will hence require to take a long position in 640 units of cotton futures to get an effective
hedge (7)
Optimal hedge ratio = 0.8 X 0.0325/0.040 (4)
h=0.64
(5)
(6)
Np-1 = 640
(7)
52
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www.nse-india.com
www.ncdex.com
2.
3.
What is hedging
4.
5.
6.
7.
8.
9.
54
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Unit 4
Warehouse Receipts and Collateral Management
Structure
4.0
Objectives
4.1
4.2
Functions of warehouses
4.3
Classification of warehouses
4.4
Warehouse receipt
4.5
4.6
4.7
4.8
4.9
Let us sum up
4.0 Objectives
In this unit you will learn about the following related concepts
Functions of Warehouses
Classification of Warehouses
Store the Material properly: Provide the right and adequate storage and preserve the material
properly. Ensure that the materials do not suffer from damage, pilferage or deterioration.
Mixing/R
epacking of material
Mixing/Repacking
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Arranging transport
Arranging FFinance:
inance: The material stored in the warehouses are recognized as safe collaterals
by various banks and about 75% of the value of the produce may be financed. We would
discuss in detail about this function in later sections.
Price Stabilization and Market Intelligence: Warehouses provide an opportunity to the farmers
and the traders to store the produce when the prices are too low. They also sometimes
become information suppliers on the price trends through the data on offloading. Thus they
help the prices to stabilize through controlling excessive supplies in the market.
a.
General W
arehouses: These are ordinary warehouses used for storage of most food grains,
Warehouses:
fertilizers, etc.
b.
Special Commodity W
arehouses: These are warehouses, which are specially constructed for
Warehouses:
the storage of specific commodities like cotton, tobacco, wool and petroleum products.
c.
Refrigerated W
arehouses/Cold Storages: These are warehouses in which low temperature is
Warehouses/Cold
maintained as per requirements and are meant for such perishable commodities as vegetables,
fruits, fish, eggs and meat.
2.
a.
Private warehouses: These are owned by individuals, large business houses or wholesalers
for the storage of their own stocks. They also store the products of others for a rent.
b.
Public warehouses: These are the warehouses, which are owned by the government and are
meant for the storage of goods. In India, Central Warehousing Corporation (CWC) and
State Warehousing Corporations (SWC) are the government organizations, which have the
mandate of building and operating warehouses all across the country. The CWC was
established as a statutory body in New Delhi on 2nd March 1957. CWC provides safe and
reliable storage facilities for about 120 agricultural and industrial commodities.
Separate warehousing corporations have been also set up in different States of the Indian
Union. The areas of operation of the State Warehousing Corporations are centers of district
importance. The total share capital of the State Warehousing Corporations is contributed
equally by the concerned State Govt. and the Central Warehousing Corporation.
57
Apart from CWC and SWCs, the Food Corporation of India has also created storage facilities.
The Food Corporation of India is the single largest agency which as a capacity of 25.2
million tons.
c.
Type of Warehouse
CWC
10.27
SWC
25
FCI
25.2
10
20
The extent of warehouse facilities available are very less in India as argued by experts in
commodity trading and there is a need to create further investment in the sector. The 11 th plan says
that a further capacity of 35 million tons should be created in the Warehousing sector.
b)
c)
Date of Issue
d)
Warehouse receipts are issued by all approved warehouses after quality certification of the
stored goods.
The warehouse receipt can perform various functions. It converts agricultural produce or
58
AEM - 202
other inventory to a tradable warrant, which can be sold or used to raise a loan and even used for
delivery against a derivative instrument like futures contract.
Different banks have different guidelines for providing loans against the stored produce.
The amount of loan advanced depends on the market price, minimum support price and the
guidelines issued by the bank. The interest charged also depends on the norms of the bank for that
type of commodity. The other charges may involve collateral management charges and other fixed
charges as stipulated by the banks. By and large there are two systems prevalent:
1.
Hypothecation/Pledge of stocks
This system is prevalent mostly for the small private warehouses where the entire warehouse is
occupied with material belonging to a single entity. The material deposited in the warehouse is pledged
/Hypothecated as security. Once the loan is repaid after negotiations with the buyer, the borrower is free
to express his control over the stocks. This scheme is also popular as Produce Marketing Loan
a.
Storage receipts
It is a term closely associated with pledge financing, which is most common for Private gowdons/
private licensed warehouses. These receipts are issued by collateral managers of an agency known to
the bank who will have control over the commodity by lock-key method. In this way, the bank finances
the depositor only if the collateral manager approves the stock through the storage receipt.
2.
by the warehouse. The warehouse receipt duly endorsed in favor of the Bank is to be deposited at the
bank and the material is released once the bank receives the payment from the buyer.
It is felt by various industry analysts that warehouse receipt-based funding has tremendous growth
potential in India. With the priority sector lending norms making it mandatory for banks to advance 18%
of loans to agriculture, warehouse-based receipt financing is being considered as the next big opportunity
in catering for the agricultural sector. The Planning Commission has also recently reinforced its commitment
to double the farm sectors growth from a low 2% per annum to 4% a year during the 11th Five Year
Plan. The government is now keen to break the logjam of low production and productivity of the farming
sector by beefing up infrastructure and irrigation sectors simultaneously. Therefore, in the near future
agricultural commodities will flow more steadily from farms. The management of these commodities will
prove to be both a challenge and an opportunity for banks and warehousing companies.
59
2.
3.
4.
5.
6.
Insurance
60
7.
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exchanges. Collateral management ensures efficient and risk-free physical delivery systems. In the
recent past we have seen increased integration of collateral management and commodity exchanges.
Companies like National Bulk Handling Corporation (NBHC) and National Collateral Management
Services Limited (NCMSL) have developed as specialized agencies, which provide complete solutions
related to Collateral Management.
it operates must meet certain conditions. The legal system must support pledge instruments, such as
Warehouse Receipts, as secure collateral. The pertinent legislation must meet several conditions:
61
2.
fungible equivalent on liquidation or default of the warehouse; and the prospective recipient of a
Warehouse Receipt should be able to determine, before acceptance, if there is a competing claim
on the collateral underlying the receipt.
4.
quantity and the quality of stored commodities, based on a national grading system. This should be
accompanied with an inspection mechanism of warehouses and stored commodities and the availability
of property and casualty insurance.
5.
the existence of a performance guarantee for warehouses, assuring that the quantities of goods
stored match those specified by the Warehouse Receipt and that their quality is the same as, or better
than, that stated on the receipt. Without this guarantee, farmers and traders will be reluctant to store
their crops, and banks will be hesitant to accept Warehouse Receipts as secure collateral for financing
agricultural inventories.
Context
Producers and traders stock various commodities such as food grain, pulses, sugar, metals and
oil in warehouses. The warehouse issues a receipt certifying that it is holding the specific commodity. The
receipt may be used as collateral to borrow money. The receipt can be transferred to a buyer of the
goods, who can take delivery from the warehouse. However, in India, trading in warehouse receipts
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(WRs) is limited as these are not considered negotiable instruments, i.e., they cannot be transferred from
one owner to another by endorsement and delivery.
A number of expert committees have deliberated on the possible methods and legislation required
to enable trading in these receipts, and related issues. The Warehousing (Development and Regulation)
Bill, 2005 seeks to make WRs negotiable, and establishes a structure to enable trading in these instruments.
For example, the proposed law would enable a farmer to store his produce in a warehouse, and sell it at
a later time by transferring the WR to a buyer or trader. The trader can subsequently sell the goods by
another transfer of the receipt, without physically moving the goods.
2.
Features
This Bill establishes minimum standards for WRs to make them negotiable. It establishes a
Warehouse Development and Regulatory Authority (WDRA) to regulate the WR system including
registering warehouses, providing for negotiability of WRs, and listing offences and penalties.
3.
goods, issuing the WR, and delivering the deposited goods on retrieval of the receipt. Every warehouse
has to be registered with WDRA. The Bill outlines the role of the warehousemen, including liabilities,
duties, special powers to handle perishable and hazardous goods, as well as the lien of warehouse
on goods.
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5.
Regulatory Structure
The Bill establishes a Warehousing Development and Regulatory Authority (WDRA) to regulate
and promote the negotiable WR system. WDRA may constitute a Warehousing Advisory Committee,
which would consist of fifteen members who represent relevant interests.
WDRA may register Accreditation agencies, which would grant registration certificates to
warehouses.
6.
The Bill seeks to penalize the warehouseman who knowingly issues a WR without taking actual
physical delivery of goods in his warehouse; who knowingly issues a duplicate WR without following the
proper procedure; who knowingly delivers goods without obtaining proper possession of the receipt; or
who fails to deliver the goods as agreed. It also imposes a fine of up to one lakh rupees, or imprisonment
for a term of up to three years, depending on the nature of the offence.
The Bill also seeks to penalise any depositor who knowingly declares the improper value of goods
to the warehouseman with imprisonment for a term of up to three years or with a fine of up to three times
the value of the goods or both.
7.
a)
High real interest rates are often linked to perceived risks, particularly when it concerns agriculture.
Secure and Negotiable Warehouse Receipts would reduce risk and lead to lower lending rates.
Collateralizing agricultural inventories through negotiable warehouse receipt system will lead to
an increase in the availability of credit, reduce its cost, and mobilize external financial resources
for the sector.
b)
Correctly structured Negotiable Warehouse Receipts provide secure collateral for banks by assuring
holders of the existence and condition of agricultural inventories.
c)
Warehouse Receipts contribute to the creation of cash and forward markets and thus enhance
competition. They can form the basis for trading commodities, since they provide all the
essential information needed to complete a transaction between a seller and a buyer. The
availability of negotiable warehouse receipts will thus both increase the volume of trade and
reduce transaction costs. Since buyers need not see the goods, transactions need not take
place at either the storage or the inspection location. With a functioning Warehouse Receipt
system, commodities are rarely, if ever, sold at the warehouse proper. A transaction can take
place informally or on an organized market or exchange. In either case, the Warehouse
Receipt forms the basis for the creation of a spot, or cash market. If transactions involve the
delivery of goods on a future date, Warehouse Receipts can form the basis for the creation of
a forward market and for the delivery system in a commodity futures exchange.
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d)
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A broader benefit of Warehouse Receipts is that they increase the confidence of participants,
particularly those in the private sector, in market transactions.
e)
A system of Negotiable Warehouse Receipts provides a way to reduce the need of government
agencies in procurement of agricultural commodities. Government intervention in agricultural
markets usually has two main objectives: to support prices, by buying directly from producers,
and to guarantee a measure of food security. In order to support prices, government can
accept Warehouse Receipts when prices drop below a support floor, rather than taking delivery
of physical inventories. Since Warehouse Receipts guarantee the existence of stocks,
governments can achieve their food - security
objectives by merely holding these receipts.
f)
Need for splitting the warehouse receipt in case the depositor has an obligation to transfer only
a part of the commodities
Need to move the warehouse receipt from one place to another with risk of theft/mutilation, etc.
if the transferor and transferee are at two different locations
Risk of forgery
Drawing lessons from the depository system for securities, depositories such as NSDL and CDSL
and national level multi-commodity exchanges have worked out a scheme to extend depository services
for settling trades in commodity futures. Investors trading in commodity futures may avail depository
services for receiving and delivering warehouse receipts.
A demat account for commodities has to be opened with empanelled DPs (Depository Participants).
Warehouses, that have entered into an agreement with depositories and commodity exchanges, can
issue depository eligible warehouse receipts. For example, NSDL has agreements with two multi-commodity
exchanges viz., National Commodity & Derivatives Exchange Limited (NCDEX) and Multi Commodity
Exchange of India Limited (MCX) and few warehouses that hold designated commodities in their custody.
The warehouse receipts in demat form can be used to give delivery and also physical delivery of goods
can be obtained against warehouse receipts credited in the demat account, through prescribed procedures.
In fact the smooth functioning of commodity exchanges is enabled through electronic warehouse
receipts increasing the association between the warehousing and futures trading. This is enabled through
the following:
a)
b)
With a good networking of warehouses, delivery can be taken at any location. This would
encourage hedge participation in the exchanges
c)
Better integration of spot and futures market increasing the efficiency of futures market
d)
Better information on crop fundamentals like stock positions helps to reduce risk of excess
volatility in prices
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conditions around the storage structures as well as knowledge of safekeeping of grains while they are
inside the warehouses through techniques like fumigation and record keeping.
Warehouses are classified according to type of commodities stored as General Warehouses,
Special purpose Warehouses and Cold storages. On the basis of ownership they could be Private or
Public or Bonded Warehouses.
A warehouse receipt is a document stating the ownership of commodity. It specifies the
quantity, quality and grade of produce stored, warehouse location, storage fee and other details.
The warehouse receipt can perform various functions. As it converts agricultural produce or other
inventory to a tradable warrant, which can be sold or used to raise a loan and even used for delivery
against a derivative instrument like futures contract.
The Term Collateral Management refers to a third-party commitment accepted by the collateral
taker to secure an obligation of the collateral provider. Thus, collateral is the security, which provides
protection against the financing done by the financial institution. Collateral management basically
involves management of risk associated with maintaining the value of the collateral and deals with
aspects like Storage and Preservation,, Testing and Certification and other aspects related to price
risk management of commodities serving as collateral.
Negotiable warehouse receipts can be traded, sold, swapped, used as collateral to support
borrowing, or accepted for delivery against a derivative instrument such as a futures contract. The
Warehousing (Development and Regulation) Bill, 2005, which has been passed in the Parliament in
early 2007 has features that would create a regulatory framework for making the warehouse receipts
fully negotiable.
Negotiable warehouse receipts have many advantages such as low risk for the banker and
high credibility apart from efficient usage in delivery against a futures contract.
Recent advancements in dematerialization of Warehouse Receipts i.e. Holding Warehouse
Receipts in Electronic Form has solved problems of splitting the warehouse receipt, high risk of losing
the document and the risk of forgery. This has brought greater integration between warehousing and
futures trading.
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in the warehouse stating details on quantity, quality and grade of produce stored.
Warehouse: Scientifically designed storage structure technically designed to protect the quality and
quantity of the stored produce.
2.
3.
4.
5.
What are the various methods of obtaining loan for produce stored in Warehouses?
6.
7.
What is the difference between a negotiable and non-negotiable Warehouse receipt? How is a
negotiable Warehouse receipt better?
8.
What are the penalties for various offences as per Warehousing (Development and Regulation)
Bill, 2005?
9.
How are warehouse receipts in demat form better than paper receipts?
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Block I :
Entrepreneurship
Unit 1
Unit 2
Cash Management
BlockII :
Agri Business
Unit 1
Unit 2
Rural Marketing
Unit 3
Procurement
Unit 4
Block III :
Unit 1
Commodity Markets
Unit 2
Unit 3
Unit 4
Block IV :
Unit 1
Unit 2
Unit 3
Unit 4
Unit 5
Unit 6
Unit 7
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AEM - 202
AEM 202
Agri-Business and Entrepreneurship Development
(3 Credits)
Block III
Commodity and Future Marketing