commodity derivative

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A

SUMMER TRAINING REPORT

ON

"Future of Commodity Derivatives Trading inIndia"

Conducted at

Fortune Equity Brokers (India) Limited

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Contents

Chapter No. Description Page No.

1. Introduction 1-29

2. Company Profile 30-44

3. Research Methodology 45

4. Data Analysis and Discussions 46-55

5. Conclusions and Suggestions 56-59

Bibliography 60

Questionnaire 61-62

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CHAPTER-1INTRODUCTION

The term "derivative" indicates that it has no independent

value, i.e. its value is entirely "derived" from the value of the

cash asset. A derivative contract or product, or simply

"derivative", is to be sharply distinguished from the underlying

cash asset, i.e. the asset bought/sold in the cash market on

normal delivery terms. A general definition of "derivative" may

be suggested here as follows: "Derivative" means forward,

future or option contract of pre-determined fixed duration,

linked for the purpose of contract fulfillment to the value of

specified real or financial asset or to index of securities.

Derivatives are meant essentially to facilitate temporarily

(usually for a few months) hedging of price risk of inventory

holding or a financial/commercial transaction over a certain

period. In practice, every derivative "contract" has a fixed

expiration date, mostly in the range of 3 to 12 months from the

date of commencement of the contract. In the markets idiom,

they are "risk management tools". The use of forward/futures

contracts as hedging techniques is a well-established practice

in commercial and industrial operations. Their application to

financial transactions is relatively new, having emerged only

about 25 years ago.

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Derivative is a product whose value is derived from the value

of one or more basic variables called bases (underlying asset

index, or reference rate) in a contractual manner. The

underlying asset can be equity, forex, commodity or any other

asset. For example, wheat farmers may wish to sell their

harvest at a future date of eliminates the risk of a change in

prices by that date. Such a transaction is an example of

derivative. The price of this derivative is driven by the spot

price of wheat which is the underlying.

The securities Contracts (Regulation) Act, 1956 defines

derivative to include:-

Derivatives are securities under the SC(R) Act and hence

the trading of derivatives is governed by the regulatory

framework under the SC(R) Act.

Various types of Derivatives

The most commonly sued derivatives contracts are

forwards futures, options and swaps which we will discuss in

detail later. Here we take a brief look at various derivatives

contracts.

Forwards: A forwards contract is a customized contract

between two entities, where settlement takes place on a

specific date in the future at todays pre agreed price.

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Futures: 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. Futures contracts are special types of forward

contracts in the sense that the former is standardized

exhcngetraded contracts.

Options: Options are of two types- 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.

Warrants: Options generally have lives of 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.

Leaps: The LEAPS means Long-Term Equity Anticipation

Securities. These are options having a maturity of three years.

Baskets: Basket options are options on portfolios of

underlying assets. The underlying asset is usually a moving

average of a basket of assets. Equity index options are a form

of basket options.

Swaps: Swaps are private agreements between two parties to

exchange cash flows in the future according to a pre-arranged

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formula. They can be regarded as portfolios of forward

contracts. The two commonly used swaps are:

Interest Rate Swaps:These entail swapping only the

interest related cash flows between the parties in the same

currency.

Currency Swaps: These entail swapping both principal and

interest between the parties. With he cash flows in one

direction being in a different currency than those in the

opposite direction.

Swaptions: Swaptions are options to buy or sell as swap that

will become operative at the expiry of the options. Thus a

swaption is an option on a forward swap. Rather than have

calls an d puts, the swaption market has receiver swaptions

and payer swaptions. A receiver swaption is an option to

receive fixed and pay floating. A prayer swaption is an option

to pay fixed and receive floating.

Evolution of Derivatives

Derivatives have probably been around for as long as

people have been trading with one another. Forward

contracting dates back at lest to the 12 th century, and m ay

well have been around before then. Merchants entered into

contracts with one another for future delivery of specified

amount of commodities at specified price. A primary

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motivation for pre-arranging a buyer or seller for a stock of

commodities in early forward contracts was to lessen the

possibility that large swings would inhibit marketing the

commodity after a harvest.

The following factors have contributed to the growth of

financial derivatives:

1. Increased volatility in asset prices in financial markets.

2. Increased integration of national financial markets with the

international markets.

3. Market improvement in communication facilities and sharp

decline in their costs.

4. Development of more sophisticated risk management tools,

providing economic agents a wider choice of risk

management strategies, and

5. Innovations in the derivatives markets, which optimally

combine the risks and returns over a larger number of

financial assets leading to higher returns, reduced risk as

well as transactions costs as compared to individual

financial assets.

History of Commodity Derivatives

Policies, Rules and Regulations for the securities market

and development of the commodities market are of different

nature. The volume of trading in commodities will be much

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higher than in securities. Commonly markets in India are more

than 100 years old while stock derivatives are only 4 years old.

With the removal of the ban on forward trading in all

commodities, the Indian commodities futures market has been

totally liberalized. Participants in the securities and other

financial markets can now think of exploring the opportunities

offered by the emerging commodities market. Even though

there are differences between commodity and financial

derivatives markets, yet they also have some close

resemblances in so far as trading practices and mechanisms

are concerned.

If the developments in the commodity derivatives market

are compared with the securities market one would wonder at

the differing pace of progress between the two. However,

before attempting such a comparison it is important to keep in

mind some of the basic difference between the two markets.

The history of Commodity Derivatives is very old. The following

table shows the milestones in Commodity Derivatives since

1848.

Year Developments1848 Setting up of Chicago Board of Trade-first Futures

exchange in the US

1875 First organized futures Exchange in India, namely,

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Bombay Cotton Traders Association1920 Federal regulation of future trading in the USA1952 Enactment of the Forward Contract Regulations Act based

on Shroff Committee recommendations

1955 Commencement of futures trading in Cotton at East India

Cotton Association Mumbai.1956 Commencement of futures trading in castor seed at

Mumbai. Commencement of futures trading in Turmeric at

Sangli.1958 Commencement of futures trading in the jute at Calcutta1966 Suspension of futures trading in cotton and most of the

commodities-Dantawala Committee Report1974 Setting up of the Commodity Futures Trading

Commission- the futures market regulator of the USA1979 Khusro Committee Report1994 Kabra Committee Report1997 Permission for international futures contract in black

pepper2000 Permission for hedging in offshore exchange for actual

uses of non-oil commodities

2001 Approval for futures trading in edible oil block and coffee.

Permission for international futures contract in castor oil2005 Permission for hedging in petro-products in offshore

exchanges. Permission for futures trading in sugar and

tea2007 Permission for three National Level Multi Commodity

Exchanges

Recent Developments

The globalization of the Indian Commodity Sector and the

trade liberalization under the WTO regime offer really a new

opportunity and challenge to the Indian commodity exchanges

to make a success of futures trading in the country for efficient

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price discovery and effective risk management to the diverse

market functionaries in different commodities.

1. Demutualization of the Exchanges

Earlier the Commodity Exchanges were not demutualized.

Now the ownership of the exchange is being gradually

divested from its management. Unlike the prevailing system

where the exchanges are owned and managed by their

trading members, in the new demutualised, form, the

exchanges and their trading systems are managed

invariably by non-trading professionals. Even on the Boards

of Directors of these commodity exchanges, the non-share

holding professionals and experts drawn from different

academic and market segments are either nominated or co-

opted in a sizeable strength and May at times, constitute a

majority.

2. Trading Systems and Procedures

The open outcry system is slowly giving way the screen

based on line and even impersonal internet trading system.

In the screen based electronic trading system, market

operators are connected through their computer terminals

with the central computer trading system of the exchange,

which matches automatically the bids and offers.

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3. Clearing House Systems and Procedures

The in-house clearing system of the commodity exchanges

has now been replaced by either an independent clearing

house within the exchange or a separate clearing

corporation. The automated clearing system conducts

clearing operations on a daily basis on the principle of

marked to market. Thus, all the market participants settle

their liabilities every day and do not accumulate these over

even a single day.

4. Market Intelligence and Surveillance

The old exchanges merely disseminated price information,

and that too with a time lag but modern exchanges collect,

updates and disseminate all market information influencing

supply and demand of commodities traded on the exchange

on a real time basis. Now a well equipped market

intelligence cell is established in every exchange with

qualified professional staff.

5. Certified Warehousing System

The warehousing facility is a must for a commodity

exchange. The modern commodity exchanges have either

their own warehouses or they designate suitable

warehouses for the purpose of issuing or receiving deliveries

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against the futures contracts traded in them. These

warehouses are constructed according to the prescribed

standards and adopt scientific storage and handling

systems to ensure that the goods stored in them do not

deteriorate in either quantity or quality, and also losses do

not result from storage, stacking or handling of goods while

loading and unloading. The designated or certified

warehouses have their own grading facilities, and even

quality testing laboratories, to certify the goods periodically

for their grade and quality. All the information relating to

the goods stored in such warehouses is computerized, and

these warehouses are linked to the commodity exchange

through computer network to facilitate the delivery of goods

and quantity of goods delivered according to their

ownership.

Now the practice of certified warehouses with the

prescribed storage standards and handling norms indirectly

brings pressure on the trade and industry to upgrade the

quality of their goods to the level acceptable to the

commodity exchanges as per its contract specifications for

the different commodities. It also promotes the

standardization of the commodity trade in the physical

markets for cash or forward deliveries, since the quality

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certificates issued by the exchange designated warehouses

facilitate the physical trade by mere description (instead of

by physical inspection or samples, which is necessarily

cumbersome and time consuming), and also serves as a

norm for such trade.

The issue of certified warehouses receipts by the

authorized warehouse owners in fulfillment of the delivery

orders tendered by the sellers also reduces the survey

disputes relating to quality and weighment, which are

common in the traditional commodity exchanges.

PROBLEM FORMULATION

The Modern Multi Commodity Exchanges are now well

supported by adequately equipped research and training

units/centers. Research is needed not only to assess the

working and utility of the futures market organized by the

exchanges, but also to ascertain from time to time the

lacunae and weaknesses in the contract terms and

specifications, trading and clearing procedures, regulatory

provisions, infrastructure facilities and other support

services. The research also helps promote greater

understanding of the functions and uses of the futures

market among its present potential users, as also among

the policy makers, Government regulatory authorities and

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other relevant Government departments concerned as well

as the academicians, the consumer bodies and the public at

large.

DERIVATIVES TRADING IN INDIA

The first step towards introduction of derivatives trading in

India was the promulgation of the Securities Laws

(Amendment) Ordinance, 1995, which withdrew the prohibition

on options in securities. The market for derivatives, however,

did not take off, as there was no regulatory framework to

govern trading of derivatives. SEBI set up a 24 member

committee under the Chairmanship of Dr. L.C. Gupta on 18 th

November 96 to develop appropriate regulatory framework for

derivatives trading in India. The committee submitted its

report on 17th March 98 prescribing necessary pre-conditions

for introduction of derivatives trading in India. The committee

recommended that derivatives should be declared as

securities so that regulatory framework applicable to trading

of securities could also govern trading of securities SEBI also

set up a group in June 1998 under the Chairmanship of Prof.

J.R. Varma, to recommend measures for risk containment in

derivatives market in India. the report, which ws submitted in

October 1998, worked out the operational details of margining

system, methodology for charging initial margins, broker net

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worth, deposit requirement and real time monitoring

requirements.

The SCRA was amended in December 1999 to include

derivatives within the ambit of securities and the regulatory

framework was developed for governing derivatives trading.

Derivatives trading derivatives trading commenced in India in

June 2007 after SEBI granted the final approval to this effect in

May 2009. SEBI permitted the derivative segments of two

stock exchanges. NSE and BSE, and their clearing

house/corporation to commence trading and settlement in

approved derivatives contracts. To begin with, SEBI approved

trading in index futures contracts based on S&P CNX Nifty and

BSE 30 (Sensex) index. This was followed by approval; for

trading in options based on these two indexes and options on

individual securities. The trading in index options commenced

in June 2007. Futures contracts on individual stocks were

launched in November 2007. Trading and Settlement in

derivative contracts is done in accordance with the rules, bye-

laws, and regulations of the respective exchanges and their

clearing house/corporation duly approved by SEBI and notified

in the official gazette.

Thus, the following five types of Derivatives are now being

traded in the Indian Stock Market.

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1. Stock Index Futures

2. Stock Index Options

3. Futures on Individual Stocks

4. Options on Individual Stocks

5. Interest Rate Derivatives

FEATURES OF INDIAN COMMODITIES MARKET

The Indian commodities market stands out quite tall amongst

the global markets for a variety of factors. And the reasons for

the same are not difficult to understand

(i) Supply Worlds leading producer of 17 Agricultural

Commodities

(ii) Demand Worlds largest consumer of Edible Oils, Gold

Yellow Metal Mania.

(iii) GDP Driver Predominantly an AGRARIAN Economy.

(iv) Captive Market Agro products are produced and

consumed locally.

(v) Width and Spread Over 30 Major Markets and 7500

Mandies exists in the market.

(vi) Waiting for Explode Value of Production around Rs.

3,00,000 crore and expected futures market potential

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around Rs. 30,00,000 crore (This is assuming a

conservative multiplier of 10 times which is case of US is

20 times and also assuming that all commodities have

futures market over a period of time as the markets

nature)

Commodity V/s. Financial futures

The basic difference between commodity and financial futures

is the nature of the underlying instrument. In a commodity

futures the underlying is a commodity which may be wheat,

cotton, pepper, turmeric, corns, oats, soyabeans, orange juice,

crude oil, natural gas, gold, silver, park bevies etc. is a

financial instrument, the underlying can be treasuries Banks

stocks, Stock index foreign exchange etc. As an evident a

financial future is fairly standard and there are no Quality

issues while a commodity instruments.

COMPARISON

Sr.

No.

Particulars Stock Market Commodity

Market

1. RegulatoryAuthority

Securities &Exchange Board ofIndia (SEBI) MittalCourt B Wing 224Nariman PointMumbai400 021

Forward MarketCommission(FMC) Everest-3rdFloor 100 MarineDriveMumbai400 002

2. Ministry Ministry of Finance,Govt. of India,

Economic AffairsDeptt. Stock

Ministry ofConsumer Affairs

Food and PublicDistribution,

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Exchange DivisionNew Delhi.

Deptt. ofConsumer Affairs,New Delhi.

3. Act forRecognition/Registration

SCR Act, 1956 &Rules 1957 andSEBI Act, 1992

Forward Contract(Regulation) Act1952 and Rules1954

4. No. ofRecognizedExchanges

23 25

5. Trading Stock Bonds-Indices-InterestCurrency-units ofM.F.I. Derivatives

Commodities andPrecious Metals

6. DerivativeInstruments

Futures-Options-Interest Rates

Futures

7. Purpose ofTrading

Speculation-Arbitrage andHedging of Risk

Transfer ofHedging Risk andPrice Discovery

8. Mode ofTrading

Electronic-Computerized &Fully Automated

Computerizedand Physical also

9. Place ofTrading

Recognized StockExchanges

RecognizedCommodity

Exchanges/Mandi10.

Existence/Availability ofDematFacility

Yes of D.P. ServiceBoth of NSDL andCDSL

Being worked outThrough WareHousing Receipts

11.

Status ofExchange

National Level &Regional

National LevelMulti Commodityand Regional also

12.

Intermediaries

Stock Brokers, SubBrokersDepositories,Mutual Funds,

Transfer Agents,Credit RatingAgencies, FIIS,Investors andOthers

Member Brokers,CommodityMutual Funds,Clearing Houses,CollateralManagers,CommodityBrokers, Freight &Forward AgentsMandi OperatorsWarehouse

Keepers andothers

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CHANGING COMMODITIES SCENE

By its sheer size and turnover, the Indian commodities market

offers unparalleled growth opportunities and advantages to a

large cross section of the participants including Producers,

Traders, Corporate, Regional Trading Centers, Importers,

Exporters, Cooperatives, Industry Associations, amongst

others-clearly, the lifeline of the national economy.

The underlying economic purpose of a Commodity Exchange

as a market place is to enable commodity produces to sell

their produce in advance to protect against possible price falls

in the future and allow consumers-traders, processors and

exporters to buy in advance to protect against possible price

increases. In the way they are also able to hedge their price

risk, i.e. to lock in a price which they will receive and pay

respectively, and hence secure financing from their bank, or

just have peace of mind. This price-setting function is

performed by providing a meeting-place for producers and the

ultimate purchasers of the commodities.

1. Very deep level of intermediation

2. Hedging & Speculative trading provides equal liquidity

3.The Underlying are universally traded commodities

4. Unlike Equities, Commodities are Trade Driven

5. SPOT market trading drives Futures trading and vice-versa.

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It is for these reasons the commodity exchanges actively

encourage the participation of market specialist or Liquidity

Providers, Hedgers and Arbitrageurs, who provide market,

depth and liquidity in the system. This in turn introduces the

element of Price Discovery, which increases the likelihood

that buying and selling can be made at all levels and at all

points of time, thereby ensuing continuous entry and exit route

for any participant.

In the Commodities markets too the situation is changing.

Some commodity exchanges are specializing in specific areas

with varying degrees of success. The task force has stressed

the need to have at least a third of each exchange board

manned by independent directors. Licenses have been given

for Multiple Commodities Exchanges and Single Commodity

Exchanges and for conducting trading on-line. Even a single

commodity exchange can trade in multiple commodities after

obtaining permission from the Forward Markets Commission

(FMC).

Commodity exchanges are promoted by institutions and

associations. With convergence, there will be an opportunity to

speed up the development of the commodity markets.

Because of the economics of scale in operations there will be

scope for further improvement.

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COMMODITY EXCHANGES

NATIONAL LEVEL COMMODITY EXCHANGES

The modern Futures Exchanges exist for the purpose of

bringing buyers and sellers together and providing facility

where futures trading can take place. In some of the

Commodity Exchanges, the trading facility is computerized

with fully automated programmed for electronic trading from

remote i.e. through computer screens. It provides the facility of

hedging the risks as well as transfer of risks.

The commodity markets scenario in the country is

expected to go through a sea-change. Futures trading is now

allowed across major commodities in three Multi commodity

Exchanges:-

1. Multi Commodity Exchange of India Limited (MCX)

It is located at Mumbai. It wants live on 19th November 2006

with three futures and in Bullion on 11 th November, 2006.

Globally the value of commodities traded is three times the

value of equity traded. This point to an opportunity for

commodity exchanges worth $600 bullion.

Just four commodities category could make this happen.

(i)Agricultural Commodities have the potential to trade

10 times the underlying physicals of $30 bullion.

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(ii) Bullion has the potential to trade 20 times underlying

Physicals of $8 bullion.

(iii) Edible Oils have the potential to trade 10 times

underlying physicals of $5.4 bullion.

(iv) Metals have the potentials of trading 10 times the

underlying physicals of $2 bullion.

2. National Commodity & Derivatives Exchange (NCDEX)

This Exchange is also located at Mumbai and it offers

facilities in about 40 cities throughout the country. The

Exchange has already started Trading in many commodities

including Gold-Silver-Soyabean-Refined Soyabean Oil-

Rapeseed Mustard Seed Oil-RBD Palmolein-Crude Palm Oil

and Raw Cotton and Wheat very recently. It affects its

bullion futures trading could jump to Rs. 10 billion a day

within one year.

The Exchange is also intending to start Futures trading in

other Agricultural Products, Metals, including Precious

Metals, Precious Stones, Diamonds, Petroleum and Energy

Product and all other commodities and Securities in Spot

Market and in Futures Market. It has accredited warehouses

at many places as delivery centers.

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3. National Multi Commodities Exchange of India

(NMCE) Ahmadabad

It is located at Ahmadabad. This exchange is already

working since October 2005 and started trading in Bullion in

early October 2004. They have 49 commodities, out of these

35 are varieties of oil, oil seeds and oil cakes out of

remaining 6 are Non Ferros Metals two are Spices and

Pulses and Gur-Sugar-Rubber-Pepper-Vanaspati etc.

This Exchange has an arrangement with CWC Central

Warehousing Corporation to assess the quality of goods

deposited and the Warehouse Receipt will be dematerialized

in due course.

4. National Board of Trade (NBOT) Indore

It is located at Indore and is functional. It is one of the

vibrant commodity exchanges with a Daily Turnover of

around 350 cores to 400 cores. It may have Multi

Commodity Exchange status in due course of time, the one

which other three have now.

Legal Framework

After Independence, the Constitution of India adopted by

Parliament on 26th January, 1950 placed the subject of "Stock

Exchanges and Futures Market" in the Union list and therefore

the responsibility for regulation of forward contracts devolved

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on Government of India. The Parliament passed Forward

Contracts (Regulation) Act, 1952 which presently regulated

forward contracts in commodities all over India. The features of

the Act are as follows:

The Act applies to goods, which are defined as any

movable property other than security, currency,

actionable claims.

The very preamble of the Act announces the intention of

the legislature to prohibit options in goods. By a specific

provision, section 19, such agreements are prohibited.

(The proposal to regulate options in goods is under

consideration of Government).

The Act classifies contracts/agreements into two broad

categories, viz., ready delivery contract and forward

contract. Ready delivery contract are those where

delivery of goods and full payment of price therefore is

made within a period of eleven days. (The proposal to

extend the period to thirty days is under consideration of

Government). It is further clarified that notwithstanding

the period of performance contract, if the contract is

performed by payment of money difference it would not

be a ready delivery contract.

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The Act defines forward contract as the contract for

delivery of goods which is not a ready delivery contract

Forward contracts are implicitly classified into two broad

categories, viz., specific delivery contract and non-

specific delivery contract or standardized contract.

Though, de-facto, the focus of the regulation are

standardized contracts i.e., futures contracts, these are

not defined in the present Act (it is proposed to introduce

definition of "futures contract" in the Act).

Specific delivery contracts (where the terms of the

contracts are specific to each contract - customized

contracts) in which, the buyer does not transfer the

contract by merely transferring document of title to the

goods and exchanging money difference between the

sale and purchase price, termed as Non-transferable

Specific Delivery Contract are normally outside the

purview of the Act, but there is an enabling provision

empowering the Government to regulate or prohibit such

contracts.

The Act provides for either regulation of the other

forward contract in specified commodities or prohibition

of specified commodities. Such contracts in the

commodities which do not figure in regulated or

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prohibited categories are outside the purview of the Act,

except when they are organized by some Exchange.

The Act envisages three-tier regulation. The Exchange

which organizes forward trading in regulated

commodities can prepare its own rules (articles of

association) and byelaws and regulate trading on a day-

to-day basis. The Forward Markets Commission approves

those rules and Byelaws and provides regulatory

oversight. It also acquires concurrent powers of

regulation either while approving the rules and byelaws

or by making such rules and byelaws under the delegated

powers. The Central Government - Department of

Consumer Affairs, Ministry of Consumer Affairs, Food and

Public Distribution - is the ultimate regulatory authority.

Only those associations, which are granted recognition by

the Government, are allowed to organize forward trading

in regulated commodities. Presently the recognition is

commodity-specific. Government has original powers to

suspend trading, call for information, require the

Exchanges to submit periodical returns, nominate

directors on the Boards of the Exchanges, and supersede

Board of Directors of the Exchange etc. Most of these

powers are delegated to the FMC; otherwise the role of

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FMC is recommendatory in nature. (The Government has

full control over the FMC, which is the subordinate office

of the Department of Consumer Affairs, depending upon

the budget allocation for its existence. The FMC also is

subject to the rules and regulations relating to all matters

including appointment of staff and officers, incurring

office expenses and conducting tours etc. as are

applicable to any Government Department.)

Only police authorities have powers to enforce illegal

trading in prohibited commodities and options in goods.

FMC can merely forward information and render technical

assistance to police. The penalties provided under the Act

are nominal and does not have deterrent effect. Since

judicial magistrate first class has jurisdiction to try

offences under this Act, the fine cannot exceed Rs.10,

000. The minimum fine prescribed for the second offence

is Rs. 1,000 only. There is no provision to relate the

penalty to the amount involved in the offence. (The

Government is considering amending the Act to raise the

fine to Rs.5000)

Policy Liberalization

Forward trading was banned in 1960s except for Pepper,

Turmeric, Castor seed and Linseed. A future trading in

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Castorseed and Linseed was suspended in 1977. Apparently on

the basis of the recommendations made by Khusro Committee

forward trading in Potato and Gur was allowed in early 1980s

and in Castor seed in 1985. After the process of liberalization

of the economy started in 1990, the Government set up a

Committee under the Chairmanship of Prof. K. N. Kabra in 1993

to examine the role of futures trading in the context of

liberalization and globalization. The Kabra Committee

recommended allowing futures trading in 17 commodity

groups. It also recommended strengthening of Forward

Markets Commission and amendments to Forward Contracts

(Regulation) Act, 1952. The major amendments include

allowing options in goods, increase in outer limit for delivery

and payment from 11 days to 30 days for the contract to

remain ready delivery contract and registration of brokers with

Forward Markets Commission. The Government accepted most

of these recommendations and a future trading has been

permitted in all recommended commodities except Bullion and

Basmati Rice. Additional staff was provided to the FMC and the

post of Chairman was upgraded to the legal of Additional

Secretary to the Government of India.

The recommendations to set up Regional office at

Lucknow, Delhi and Kochi were kept in abeyance for the time

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being. In Para 44 of the National Agricultural Policy announced

by the Government in the year 1999 it was stated that the

Government will enlarge the coverage of futures market to

minimize the wide fluctuations in commodity prices, as also for

hedging their risk. It was mentioned that an endeavor would be

to cover all important agricultural products under futures

trading in the course of time. An expert Committee on

Agricultural Marketing headed by Shri Shankerlal Guru

recommended linkage of spot and forward markets,

introduction of electronic warehouse receipt system, inclusion

of more and more commodities under futures trading and

promotion of national system of warehouse receipt. The sub-

group on forward and futures markets formed under the

chairmanship of Dr. Kalyan Raipuria, Economic Adviser, and

Department of Consumer Affairs to examine the feasibility of

implementing the recommendations made by the Expert

Committee chaired by Shankerlal Guru recommended that the

commodity specific approach to the grant of recognition should

be given up. The Exchanges, which meet the criteria to be

stipulated by the Government, should be able to trade

contracts in any permitted commodity.

In the Budget speech made on 28th February 2007, the

Finance Minister announced expansion of futures and forward

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trading to cover all agricultural commodities. The economic

survey for the year 2006-2007 indicated the intention of the

Government to allow futures trading in Bullion. The policy

statements announced by the Government indicate its resolve

to introduce reforms in commodity sector. A number of

initiatives were also taken to decontrol the spot markets in

commodities. The number of commodities listed as essential

commodities has been pruned down to 17.

RATIONALE OF THE TOPIC

A commodity is anything a market can place a value on

derivatives are financial instruments that derives their

value from the underlying physical commodity market. With

a constant new stream of financial coming to the market

each often more exotic and complicated than the last, the

financial services industry which includes commodity

derivatives exchange brokerage houses and banks

providing price risk reduction services is one of the fastest

growing industries.

Although commodity derivatives command a humble

share of 6% in derivatives markets across the world, yet these

record high volumes in the markets the world over compared

to equity derivatives. In this era risks to investments are on the

rise. Integration of spot and forward market is another critical

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factor for growth of commodity futures in India. Spot market is

controlled to a large extent by state governments. There are

restrictions on holding of stocks, turnover and movement of

goods and there re variations in the duties levied by the

different state government.

Introduction of institutional reforms is also cited as a

major factor affecting the growth and development of

commodity derivatives market. Setting up a modern and

demutualised national wide multi commodity exchange is

considered necessary to create competitive pressure on

existing exchanges to adopt reforms. Now a days government

would soon move towards having a single regular for equity

and commodity markets has an expected created a flitter.

Among commodity exchange especially the regional one. In

this study I will cover how it will be beneficial to the different

parties of commodity market.

In the present state of economy there is an imperative

need for the corporative client to protect their operating profile

by shifting some of uncontrollable risks to those who are bale

to bear and manage them. Thus the management becomes a

must for survival. Since there is a high volubility in the present

market. In this context derivatives occupy an important place

as a risk reducing machinery.

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This will protect the investors from the unforeseen risks

and helps them to get their due operating profits. This study

attempts to give an overview of the development in the

commodity derivatives markets and tries to explain the scopes

for this.

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CHAPTER-2COMPANY PROFILE

Fortune Financial Services (India) Limited was

incorporated in the year 1991 by Mr. J. T. Poonja, Chairman

and Mr. Nimish C Shah, Vice Chairman and Managing Director.

Fortune Group which comprises the holding company Fortune

Financial Services (India) Limited and its wholly-owned

subsidiaries, is engaged in providing a range of Financial

Services right from Equities and Derivatives trading, Equity

Research, Commodities Trading, Portfolio Management

Services, Distribution of Mutual Funds, IPO & Insurance

products and also Investment banking services.

The main activities of the company are conducted

through Fortune Financial Services which is also the holding

company & its wholly owned subsidiaries. A brief snapshot of

all the companies is outlined as under.

M/s. Fortune Financial Services (India) Ltd.

M/s. Fortune Financial Services (India) Ltd. is listed on the

Bombay Stock Exchange Ltd and is SEBI registered Category I

Merchant Banker. It has recently got approval from SEBI to

launch its Portfolio Management Services (PMS). FFSIL has four

business verticals viz. Fortune Equity Brokers (India) Limited,

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Fortune Commodities & Derivatives (India) Ltd., Fortune Credit

Capital Ltd. and Fortune Financial India Insurance Brokers

Limited.

M/s. Fortune Equity Brokers (India) Ltd.

M/s. Fortune Equity Brokers (India) Ltd. is 100%

subsidiary company of M/s. Fortune Financial Services (India)

Ltd. It offers broking services in the Cash and Future & Option

Segments of the National Stock Exchange of India Ltd and the

Bombay Stock Exchange Limited. It is also a Depository

Participant of Center Depository Services (India) Ltd.

M/s. Fortune Commodities & Derivatives (India) Ltd.

M/s. Fortune Commodities & Derivatives (India) Ltd. is

subsidiary company of M/s. Fortune Financial Services (India)

Ltd. and engaged in the business of commodities broking. It is

having memberships with the MCX and NCDEX, two leading

Indian Commodities Exchanges.

M/s. Fortune Credit Capital Ltd.

Fortune Credit Capital Ltd. is 100% subsidiary company

of M/s. Fortune Financial Services Ltd. It is formed for the

purpose of financing, lending to the clients. The Company has

received license from RBI for NBFC operations.

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M/s. Fortune Financial India Insurance Brokers Limited.

M/s. Fortune Financial India Insurance Brokers Limited is 100%

subsidiary company of Fortune Financial India Insurance

Brokers Limited and formed for the purpose of providing

insurance broking and related products and services.

MANAGEMENT TEAM

Mr. J. T. Poonja,

Co-Founder & Executive Chairman

Mr. J. T. Poonja is first generation entrepreneur and has over

43 years of experience in Financial Service Sector ranging from

Banking, Merchant Banking and Institutional Broking Activities.

He presently oversees the group operations, expansion and

extensively involved in strategic planning of Fortune's future

growth plan.

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Mr. Nimish C Shah

Co-Founder, Vice-Chairman & Managing Director

Nimish C Shah is first generation entrepreneur and has over 23

years of experience in Indian Capital Market. His core acumen

lies in Investment Banking, Institutional & HNI Broking. He

presently oversees assignments relating to structuring custom

financial solutions for clients, assisting companies in raising

capital (private equity / venture capital, debt and equity),

mergers and acquisitions, strategic partnerships, valuations,

other merchant banking activity. He is also actively involved in

pitching ideas and concepts to prospective clients. He looks

after the core business development and contributes to

evolving new growth strategies.

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Mrs. Sangeeta Poonja

Director

Mrs. Sangeeta J Poonja is an M.A. in Economics and has

good acumen in finance field. She is actively involved in

various socio-cultural activities and is one of the

promoting directors of the Company

Mr. Ramesh Venkat

Director

Mr. Ramesh Venkat is a fellow member of the Institute of

Chartered Accountants of India and The Institute of Company

Secretaries of India, Associate Member of Institute of Cost and

Works Accountants of India. He has more than 23 years of

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work experience in the fields of Banking, Corporate Finance

and Treasury Management. Mr. Venkat is currently President of

Finance at Anil Dhirubhai Ambani Enterprises (ADAE Group)

Mr. C. R. Mehta

Director

Mr. C.R. Mehta is a Fellow Member of Institute of Chartered

Accountant of India and Institute of Company Secretaries of

India. In 1964, Mr. Mehta joined the Govt. of India in the

Department of Company Affairs and held several positions in

the Inspection and Investigation side. Later Mr. Mehta was

appointed as the Registrar of Companies of Delhi as well as

Registrar of Companies, Maharashtra, Mumbai. He also

occupied the position of Regional Director in the Department of

Company Affairs for Northern Region at Kanpur as well as for

Western Region at Mumbai. He was also in deputation to

Shipping Development Fund Committee as Dy. Executive

Director for about six years. He also acted as Govt. Nominee

Director on the governing Board of Ahmadabad Stock

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Exchange for about two years. He was elected and appointed

as the Member of Company Law Board and worked in the

Western Region Bench at Mumbai and also in the principal

Branch of the Company Law Board at Delhi. After serving the

Govt. for more than 37 years, retired from the Government

service in the year 2001.

Mr. Sohan. C. Mehta

Director

Mr. Sohan C. Mehta is an Engineer and has rich industry and

professional experience in the fields of manufacturing, trading

of chemical and other related fields.

Mr. Manoj Patel

Director

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Mr. Manoj Patel is a Science Graduate in Civil Engineering from

U K. At present he is the Chairman of C Tiles Limited a wholly

owned subsidiary of G A K Patel & Co. Ltd., the Company is

engaged in manufacturing colored cement and tiles. Earlier he

has handled the business of building and civil contracts,

investment funds, bottling plant and other distribution

activities.

Mr. H. R. Prasad

Director

Mr. H R Prasad is a graduate in Electrical Engineering from the

University of Madras, Mr Prasad went to the United States

under the Fulbright programmed and studied at the

Massachusetts Institute of Technology and Harvard Business

School and graduated with a Master of Science degree in

Management from the MIT Sloan School of Management. He

also holds a diploma in Social service from madras.

A former Managing Director and CEO of Schrader Duncan

Ltd, Joint Managing Director of Gabriel India Ltd, Mr. Prasad is

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the Corporate Group Advisor to the Anand Group of

Companies. He is a Director of Victor Gaskets India Ltd, Haldex

India Limited, Uni Abex Alloy Products Ltd, Uni Deritend Ltd,

Quorum Consulting PVT ltd.

He also served as a Director of Perfect Circle India Ltd,

Tata Unisys Ltd, Camphor & Allied Products Ltd, Pinsel

Computer Products Ltd, N B Footwear Ltd, Terpene Industries

Ltd, Profeel Sentinel Limited, SkyTel India Private Ltd, and

Anand Technology Resource Park Private Ltd. He was a

Member of the All India Board of Technician Education,

Government of India, and of the Governing Council of Central

Manufacturing Technology Institute, Government of India.

He is Chairman of the Audit Committee and the Investors/

Shareholders Grievances Committee of Victor Gaskets India

Ltd; is Chairman of the Audit Committee and the Remuneration

Committee of Uni Deritend Ltd; is Member of the Audit

Committees of Uni Abex Alloy Products Ltd and Haldex India

Limited.

Mr. Prasad is a former President of Indo-American Chamber of

Commerce, Indo-American Society, American Alumni

Association and Bombay Management Association.

Mr. Prasad was a Founding Member of the Advisory Committee

of the School of Management, Indian Institute of Technology,

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and Mumbai. He taught MBA students a course in International

Management at the Graduate School of Business

Administration, University of Connecticut, USA.

Mr. Prasad was a Member of the General Committee and the

Executive Committee of the Willington Sports Club, Bombay

from 1989 for three years during which period he served as

Chairman of the Swimming Pool Subcommittee. He was a

Member of the Clubs Managing Committee from 2001 for six

years during which period he also served as Chairman of the

Human Resource Development Subcommittee, the Special

Projects Subcommittee, and as a Member of the Finance &

Taxation Subcommittee. Mr. Prasad was Chairman of the Club

for two years from October 2005 until September 2007.

Mr. Shailesh Haribhakti

Alternate Director to Mr. Manoj Patel

Mr. Shailesh V. Haribhakti is a Fellow Chartered Accountant.

His professional interests spread across several industries,

governance issues, risk management and standard setting.

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Mr. Haribhakti is a Director on the board of many highly

acclaimed & reputed public and private companies holding the

position of Chairman or Member of Audit committee of the

Board of Directors in some of these companies.

In addition, he is a committee member of Futures & Options

segment of National Stock Exchange of India and a member of

SEBI Committee on disclosures and Accounting Standards. He

serves as a member of managing committees of ASSOCHAM

and IMC, Corporate Governance committee of ASSOCHAM and

CII and is Chairman of the Global Warming Committee of IMC.

He was a member of the ICAIs Group on Implementation of

Convergence with IFRS. He was Member on the Standards

Advisory Council of the International Accounting Standards

Board.

Mr. Haribhakti has in the past served as Chairman of the Indian

affiliate of the Certified Financial Planner Board of Standards

FPSB (India).

He has been awarded The Best Non Executive Independent

Director Award 2007 by the Asian Centre for Corporate

Governance & IMC.

His present associations also include: Membership of Rotary

Club of Mumbai.

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Mr. Sanjay Kothari

Director

Mr. Sanjay Kothari is a Fellow member of The Institute of

Chartered Accountants of India & the Institute of Company

Secretaries of India & Associate member of The Institute of

Cost & Works Accountants of India. He also holds a Diploma in

Business Finance from The Institute of Chartered Financial

Analysts of India.

At present he is a Practicing Chartered Accountant specializing

in corporate communications, loan syndications, equity

placements, and financial restructuring exercises.

Between the period from 1987 to July 2000 and he has served

in various capacities heading the finance & accounts Dept. of

public companies and also served as Head of the Family

Wealth Management Office of the promoter of Gujarat Ambuja.

During the period August 2006 to December 2008.

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Mr. Kothari is also a Guest Faculty at Welingkar Institute and

Sydneham College for PGDBM course on project appraisals and

financial markets.

Mr. Kothari has served on the panel of the Stock Exchange,

Mumbai for arbitration between members and non-members.

Mr. Kothari was on the committee of Indian Merchants

Chamber on capital markets and on Finance, Banking &

Insurance.

Retention

In order to get the best out of its employees and retain them in

a high attrition rate industry, Fortune has established a

number of attractive schemes and incentive programs for its

employees. All employees are full time salaried employees.

These salaries, which are among the top tier of industry

earnings, are complemented by performance-based incentives.

Impeccable attendance ratesand employee longevityare also

recognized and bonuses paid accordingly. Fortune believes

that recognition programs are vital to maintaining the highest

levels of motivation.

Career Development

For promising employees, Fortune has a career development

program in place. Employees ready to take on higher

responsibilities are identified and relevant training is imparted

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upon them. Employees are also encouraged to upgrade their

skills from external sources if these skills are relevant to their

current profiles.

Training

Fortune adopts a scheduled training process and a modular

approach for imparting theoretical and practical knowledge in

its trainees.

Training Schedule

Employees, on being hired, go through an intensive induction-

training module, which covers technical enhancement and

orientation in cross cultural sensitization. The induction

training is followed by process specific training, which is tailor-

made to the client's requirement

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Training Tools

Fortune's trainers make use of a wide variety of training tools

and applications to make the learning process both fun and

interesting. Tools and methodologies used include Discussions,

Lecture Debates, Assignments, Shadowing Process, Movie

Clips, and Reading exercises

Fortune customers have the advantage of trading in all the

market segments together in the same window, as we

understand the need of transactions to be executed with high

speed and reduced time. At the same time, they have the

advantage of having all kind of Insurance & Investment

Advisory Services for Life Insurance, General Insurance, Mutual

Funds, and IPO's also.

Fortune is a customer focused financial services organization

providing a range of investment solutions to our customers.

We work with clients to meet their overall investment

objectives and achieve their financial goals. Our clients have

the opportunity to get personalized services depending on

their investment profiles. Our personalized approach enables

clients to achieve their Total Investment Objectives.

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CHAPTER-3RESEARCH METHODOLOGY

Research methodology involves:

To know why a research study has been undertaken

How the research problem has been denied and in what

why?

What data have been collected and from which source?

This study is Descriptive and Analytical in nature.

Descriptive study means we have to describe the thing, which

already exists.

Analytical study means in which we have to analyses the

trends or the results we have with us. In this study I will find

out the effect of commodity derivatives in risk management

and how it is beneficial to use commodity derivatives as risk

management tool.

Research Tool

Simple analytical and statistical tools shall be used in this

study.

OBJECTIVES OF PROPOSED PROJECT:

Defining the Derivatives and its types?

What are commodity derivatives?

Evolution of commodity derivatives market in India?

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Regulations and policy issues for the commodity derivatives

in India.

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CHAPTER-6DATA ANALYSIS AND INTERPRETATION

1. Are you aware with Commodity Derivatives?

Yes No100 0

0

20

40

60

80

100

120

Yes No

Yes

No

Inference:

During the survey out of the 100 respondents all the

respondents echoed that they are well aware with the

commodity derivatives and they were indulge in commodity

trading in somewhat manner.

2. Which commodity exchange do you prefer?

NationalCommodity & National MultiCommodities NationalBoard of MultiCommodity

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DerivativesExchange(NCDEX)

Exchange ofIndia (NMCE)Ahmadabad

Trade (NBOT)Indore

Exchange ofIndia Limited(MCX)

75 4 6 15

75

15

64

0

10

20

30

40

50

60

70

80

NCDEX NMCE NBOT MCX

NCDEX

NMCENBOT

MCX

Inference:

During the survey out of the 100 respondents 75

respondents were trading with NCDEX, followed by 15

respondents going with MCS. Only 6 and 4 respondents were

involved with NBOT and NMCE respectively.

3. Futures trading is allowed only across major

commodities in three Multi commodity Exchanges,

do you want to start in all exchanges?

Yes No Cant say

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12 22 66

12

66

22

0

10

20

30

40

50

60

70

Yes No Cant say

Yes

No

Cant say

Inference:


respondents could express their opinion, followed by 22

respondents going with negative remarks and 12 respondents

going with positive remarks.

4. Do you think that trading in commodity impacts

inflation?

Yes No Cant say22 72 6

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22 6

72

010

20

30

40

50

60

70

80

Yes No Cant say

Yes

No

Cant say

Inference:


respondents don't thing that commodity trading is root cause

of inflation, however 22 respondents blame it. Six respondents

could not express their opinion.

5. Do you think that trading on essential commodities

should be banned?


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14

17

69

010

20

30

40

50

60

70

80

Yes No Cant say

Yes

No

Cant say

Inference:


respondents don't recommend ban on trading of essential

commodities, however 14 respondents recommended for ban.

17 respondents could not express their opinion.

6. Have you ever availed services of Fortune

Financial Services (India) Limited?

Yes No63 37

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63

37

010

20

30

40

50

60

70

Yes No

Yes

No

Inference:


respondents have availed the services of FFSIL: however 37

respondents have never availed any service from FFSIL.

7. If yes how was your experience?

Very good Average Bad42 19 2

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42

2

19

05

10

15

20

25

3035

40

45

Very good Average Bad

Very good

Average

Bad

Inference:


respondents have very good experience with company,

however 2 respondents have bad experience, and 19 have

average experience.

8. Do you think government should lift the ban over

trading of some commodities?

Yes No Cant say

42 32 26

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42

2632

05

10

15

20

25

3035

40

45

Yes No Cant say

Yes

No

Cant say

Inference:


respondents don't recommend government to lift ban some

commodities, however 42 respondents recommended for

lifting ban. 17 respondents could not express their opinion.

9. Do you think commodity trading will proliferate

more in future


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71

12

17

010

20

30

40

50

60

70

80

Yes No Cant say

Yes

No

Cant say

Inference:


respondents feel that commodity trading will proliferate in

future, however 17 respondents don't think so. 12 respondents

could not express their opinion.

10. Would you recommend others to go for FFSIL?

Yes No55 8

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55

80

10

20

30

40

50

60

Yes No

Yes

No

Inference:


respondents feel that they would certainly recommend others,

however 8 respondents don't have such an idea.

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CHAPTER-5FINDINGS

Basically speaking, derivatives are used for volatity,

arbitrage, hedging risks spread strategies or cash extraction.

The investors Fund Managers, institutions and Corporate can

use this Financial Instrument with little risk if they have a clear

understanding of the products. They should understand

multiple derivative strategies, simple and complex. The

importance of sound derivatives markets for the economic

development particularly in emerging markets can not be over-

emphasized. However, emerging markets exchanges need

solid foundations, for instance well functioning underlying

markets.

1. History shows that the text book basics are not pre-se

sufficient to make a derivatives market successful.

2. There should be product diversification to fulfill the market

needs.

3. There should be continued education of the users, members

and market makers.

4. The technology factor, speed, continued access and

connectivity are decisive for all exchanges.

While analyzing the role of Commodity Exchanges in emerging

markets, starting point is the recognition that the poorer

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people are the costlier risks, because there is no back up.

Managing these risks-particularly in agricultural commodities-

therefore, is a means of development. Current initiatives of

development agencies are focusing on access strategies i.e.

how to link the producers and exchanges. It is a fact that may

commodities exchanges face similar bottlenecks usually

unstable markets the successful contenders did not copy

Western Exchanges but develop new innovative concepts.

Commodities Futures Trading is a global phenomenon

and offers tremendous potential to market participants for

both profit taking on small price corrections as well as also it

hedgers looking at managing price risk on account of price

fluctuations. In fact, so well established is this market that a

cursory glance at the trading turnover of the equities and the

commodities markets, displays the reality.

The exchange can appoint intermediaries from the

existing commodity exchanges, securities exchanges and

other sections of trade and industry to penetrate all

sections of the economy connected with commodities

production, consumption and trading. The commodity

exchanges are to educate these intermediaries on a

continuous basis to enable them to make use of this

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market effectively. Further commodity exchanges are to

work closely with trade and industry to create a user

friendly and business oriented environment to tap the

potential market and also in association with the existing

securities derivative markets.

During the survey out of the 100 respondents all the

respondents echoed that they are well aware with the

commodity derivatives and they were indulge in commodity

trading in somewhat manner.


respondents were trading with NCDEX, followed by 15

respondents going with MCS. Only 6 and 4 respondents

were involved with NBOT and NMCE respectively.


respondents could express their opinion, followed by 22

respondents going with negative remarks and 12

respondents going with positive remarks.


respondents don't thing that commodity trading is root

cause of inflation, however 22 respondents blame it. Six

respondents could not express their opinion.

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respondents don't recommend ban on trading of essential


ban. 17 respondents could not express their opinion.


respondents have availed the services of FFSIL: however 37

respondents have never availed any service from FFSIL.

During the survey out of the 63 respondents 42 respondents

have very good experience with company, however 2

respondents have bad experience, and 19 have average

experience.


respondents don't recommend government to lift ban some


lifting ban. 17 respondents could not express their opinion.


respondents feel that commodity trading will proliferate in

future, however 17 respondents don't think so. 12

respondents could not express their opinion.

During the survey out of the 63 respondents 5 respondents

feel that they would certainly recommend others, however 8

respondents don't have such an idea.

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BIBLIOGRAPHY

Data have been collected from the Secondary sources:

Books

Magazines

Stock Exchanges

Internet

Reports and Previous Studies

References

Options, future and other derivativesJohn C. Hull

Kothari C.R. Research Methodology Methods and Techniques.

www.wikipedia.com

www.sharekhan.com

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Questionnaire

1. Are you aware with Commodity Derivatives?

i. Yes

ii. No

2. Which commodity exchange do you prefer?

i. National Commodity & Derivatives Exchange (NCDEX)

ii. National Multi Commodities Exchange of India (NMCE)

Ahmadabad

iii. National Board of Trade (NBOT) Indore

iv. Multi Commodity Exchange of India Limited (MCX)

3. Futures trading is allowed only across major

commodities in three Multi commodity Exchanges,

do you want to start all exchanges?

i. Yes

ii. No

4. Do you think that trading in commodity impacts

inflation?

i. Yes

ii. No

iii. Can't say5. Do you think that trading on essential commodities

should be banned?

i. Yes

ii. No

iii. Can't say

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6. Have you ever availed services of Fortune

Financial Services (India) Limited?

i. Yes

ii. No

7. If yes how was your experience?

i. Very good

ii. Average

iii. Bad

8. Do you think government should lift the ban over

trading of some commodities?

i. Yes

ii. No

iii. Can't say

9. Do you think commodity trading will proliferate

more in future

i. Yes

ii. No

iii. Can't say

10. Would you recommend others to go for FFSIL?

i. Yes

commodity derivative

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