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8/8/2019 Price Transmission

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Commodity future and price transmission

This is a new bi-monthly column we have introduced. Get all your queries on commodity trading

answered by experts at National Multi-Commodity Exchange of India, Ahmedabad. Email your

queries to : [email protected]

What is commodity futures trading? How does it work?Who are the main

players in a commodity trading market?Commodity Futures trading is a well known price risk

management tool. A futures contract is a contract to buy or sell a standard amount of a standardized

or pre-determined grade(s) of a certain commodity, at a pre-determined location(s), on a pre-

determined future date at a pre-agreed price. Futures contracts are standardized contracts where

the quantity, quality, date of maturity and place of delivery are all standardized and the parties to thecontract only decide on the price and the number of units to be traded.There are two broad

categories of operators/players in the futures markets, namely,hedgers and speculators.

Hedgers are those who have an underlying interest in the specific delivery or ready delivery

contracts and are using futures market to insure themselves against adverse price fluctuations. The

examples could bestockist, exporters and producers.They require some people who are prepared to

accept the counter party position. Speculators are those who may not have an interest in the ready

contracts, etc. but see an opportunity of price movement favorable to them.They are prepared to

assume the risk which the hedgers are trying to cover in the futures market. They provide depth and

liquidity to the market.

What is the relevancy of commodity futures trading now?

Commodity futures trading in India is not a new concept. India has a very rich tradition in commodity

futures.Until late 60’s the country had vibran futures market in castor seed,mustard, linseed, sesame

seed,coconut oil, groundnut seed, turmeric,cotton, raw jute, jute goods, wheat,rice, sugar, gold and

silver etc. In1939, the Indian government banned futures trading in several commodities because of

2nd World War. After independence, the government enacted Forward Contract(Regulation) Act,

1952, set up Forward Market Commission in 1953 and started futures trading in several

commodities. Because of the apprehensions of Indian Government that speculators were

manipulating the market to the detriment, the futures trading was again banned in the 60s except for

a few commodities.This did not make futures trading go away; rather it simply drove it underground.

After four decades of hibernation commodity futures markets in India is rapidly emerging.The era of

suspicion on the benefits of futures market has come to an end. Now in the wave of liberalization

Indian agriculture has to equip with appropriate market instruments(market based risk management

tools) and institutions gradually.

. Indian Commodity Market is basically fragmented and isolated.

. Spot trading in un-graded commodities takes place mostly in regional mand is and un organized

markets . Government procurement activity(mostly restricted to cereals and oilseeds as of date)

. MSP distorting market in favour of food grains

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. Futures trading largely regionalized and based on pit trading.Therefore Indian government felt an

overwhelming need to develop nationwide commodity futures market.

Is Speculation desirable in commodity futures trading?

Yes, speculation is desirable. Practice of speculation facilitates hedging.Without speculation there

can be no effective hedging, because volume of demand for long (buy) and short (sell)hedging will

not be equal except by occasional coincidence. Because of these speculators, a hedger gets

counter party in transferring risk.Speculative activity increases the liquidity of the market and thereby

enabling hedgers to transact large volumes of business.

Therefore, in contrary to popular belief, speculation is healthy for the markets. The important thing is

that speculation is distinct from manipulation, which is always undesirable. Manipulation may be

defined as attempts to artificially create conditions of scarcity or plentitude when such conditions do

not actually exist. In the absence of well-developed and integrated spot market as well as futures

market for commodities, there is a possibility that a few unscrupulous participants artificially rig up

the prices or depressit by creating artificial supply or artificial demand. It is these participants who

bring bad name to this economically useful activity.Actions of speculators tend to wards market

equilibrium whereas that of manipulators tends to distort market equilibrium of demand and supply.How big is commodity futures trading in India today?How does commodity trading in India compare

with more developed countries?

Being an agro based country the opportunity to flourish commodity futures trading in India is very

high.It is strongly apprehended by the market experts that the turnover of Indian commodity futures

market will overtake the capital market turn over in the near future. There is enormous potential in

this sector not only in terms of trading but also in terms of opportunities for developing value added

services in terms of quality warehousing, gradation and certification services, modern marketing

practices, frontier technology based clearing and settlement, dissemination of price &trade

information and so on.

In comparison with the commodity futures market of more developed countries, Indian commodityfutures market, which has set up modern institutions (Demutualised nation wide multi-commodity

exchanges) and adopted the best practices of electronic trading and clearing, is in

anascent/developing stage. Once the market attains more depth and volume, more awareness

among common mass generates, it will turn to an efficient market from all respect.




Differences Between Developed and

Developing Countries

Birth RatesDeveloping countries have high birth rates because

• Many parents will have a lot of children in theexpectation that some will die because of the high infantmortality rate

• Large families can help in looking after the farm• The children will be able to look after their parents if

they become old or sick; there may not be a old age

pension scheme• There may be a shortage of family planning facilities and

advice

This scattergraph shows that a country with a high infant mortality

(many children dieing young) will tend to have a higher birth rate.

Developed countries have low birth rates because

•

It is expensive to look after large families• More women prefer to concentrate on their careers• Increasing sexual equality has meant women have more

control over their own fertility• There is a ready availability of contraception and family

planning advice




The

proper name for this is The Demographic Transition Model.

l trade

Table of Contents:ArticleHistorical overviewMercantilismLiberalismResurgence of protectionismThe “new”

mercantilismThe theory of international tradeComparative-advantage analysisSimplified theory of comparative

advantageAmplification of the theorySources of comparative advantageNatural resourcesFactor endowments: the

Heckscher-Ohlin theoryEconomies of large-scale productionTechnologyThe product cycleState interference in

international tradeMethods of interferenceTariffsHow tariffs workMeasuring the effects of tariffsNontariff

barriersProtectionism in the less-developed countriesArguments for and against interferenceRevenueEconomic

developmentProtection of domestic industryThe infant-industry argumentUnemploymentNational defenseAutarkyThe

terms-of-trade argumentBalance-of-payments difficultiesContemporary trade policiesTrade agreementsBilateral trade

agreementsReciprocityThe most-favoured-nation clauseThe “national treatment” clauseMultilateral agreements after

World War IIThe General Agreement on Tariffs and TradeThe World Trade OrganizationThe Organisation for

Economic Co-operation and DevelopmentEconomic integrationForms of integrationIntranational integrationThe

United StatesSwitzerlandIntegration of colonial empiresThe ZollvereinThe Benelux Economic UnionThe European

Coal and Steel CommunityThe constitution of the communityLater developmentsThe European EconomicCommunityFormation of a customs unionDevelopment of a common agricultural policyToward a harmonization of

policiesThe European UnionThe European CommunityEU institutionsNew membersThe European Free Trade

AssociationOperation of the EFTAEFTA’s recordComeconEconomic integration in Latin AmericaThe Central

American Common MarketThe Latin American Free Trade Association and the Latin American Integration

AssociationThe Andean Group and the Andean Community of NationsThe Caribbean Community and Common

MarketThe Association of South East Asia and the Association of Southeast Asian NationsThe North American Free

Trade AgreementRegional arrangements and WTO rulesPatterns of tradeDegrees of national participationTrade

among developed countriesTrade between developed and developing countriesAdditional ReadingGeneral




textsTheories of international tradeInternational trade arrangementsYear in Review LinksRelated

ArticlesSupplemental InformationSpotlightsExternal Web sites

Trade between developed and developing countriesDifficult problems frequently arise out of trade between developed and developing countries. Most less-developedcountrieshave agriculture-based economies, and many are tropical, causing them to rely heavily upon the proceedsfrom export of one or two crops, such as coffee, cacao, or sugar. Markets for such goods are highly competitive (inthe sense in which economists use the term competitive)—that is, prices are extremely sensitive to every change indemand or in supply. Conversely, the prices of manufactured goods, the typical exports of developed countries, arecommonly much more stable. Hence, as the price of its export commodity fluctuates, the tropical country experienceslarge fluctuations in its “terms of trade,” the ratio of export prices to import prices, often with painful effects on thedomestic economy. With respect to almost all important primary commodities, efforts have been made at pricestabilization and output control. These efforts have met with varied success.Trade between developed and less-developed countries has been the subject of great controversy. Critics citeexploitation of foreign labour and of the environment and the abandonment of native labour needs as multinationalcorporations from developed countries transport business to countries with cheaper labour pools and relatively littleeconomic or political clout. Especially after 1999, when trade talks were disrupted by globalization protesters duringthe WTO ministerial conference in Seattle, Washington, the work of the WTO came under increasing scrutiny from itscritics. These critics voiced a number of concerns about the power and scope of the WTO, with the gravest criticisms

clustering around issues such as environmental impact, health and safety, the rights of domestic workers, thedemocratic nature of the WTO, national sovereignty, and the long-term wisdom of endorsing commercialism and freetrade to the neglect of other values.

Romney Robinson

16

Risk and Rewards associated with trading in futures

Since the F & O positions involve a certain time frame, if the trade is not

squared off,

it will be settled at the end of the month. So, open positions with losses in market

tomarket carry a risk. In case of options, the investor faces the risk losing theentirepremium amount, if the market turns against his position.

Since contracts are traded in lots, the profits could be higher. Commissions

are also

less compared to cash segment. It is possible to remain short on index or stocks

whereas it is possible in cash segment.

It will be a good strategy to trade in F & O for active traders. They have

access to all

the price charts, open interest positions, FII activity etc.

It aids in the process of proper price discovery and hedging of price riskwith

reference to the given commodity.

It is useful to producer because he can get an idea of the price likely to

prevail at a

future point of time and therefore can decide between various competing

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commodities.

It helps the consumer get an idea of the price at which the commodity would

be

available at a future point of time. The consumer can do proper costing and also

cover his purchases by making forward contracts. It provides the exporters an advance indication of the price likely to prevail

and

thereby helps them in quoting a realistic price and secure export contract in a

competitive market.

17

Economic Importance of Futures market

Because the futures market is both highly active and central to the globalmarketplace,

it’s a good source for vital market information and sentiment indicators.

Price Discovery-Due to its highly competitive nature, the futures market has

become an important economic tool to determine prices based on today’s and

tomorrow’s estimated amount of supply and demand. Futures market prices

depend on a continuous flow of information from around the world and thusrequire

a high amount of transparency. Factors such as weather, war, debt default,refugee

displacement, land reclamation and deforestation can all have a majoreffect on

supply and demand and, as a result, the present and future price of acommodity.

This kind of information and the way people absorb it constantlychanges the price

of a commodity.

Risk Reduction- Futures markets are also a place for people to reduce risk

when

making purchases. Risks are reduced because the price is pre-set, therefore

lettingparticipants know how much they will need to buy or sell. This helps reduce

theultimate cost to retail buyer because with less risk there is less of a chance

thatmanufacturers will jack up prices to make up for profit losses in the cashmarket.

Helps balance in supply and demand position throughout the year

price transmission

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