Download - The Efficiency of Commodity Futures
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By
AJAI&
SAHLE
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SAHLE
DEFINITION OF TERMS
Efficiency is an important attribute because all
inputs are scarce. Time, money and raw materials
are limited, so it makes sense to try to conserve
them while maintaining an acceptable level of
output or a general production level.
Being efficient simply means reducing the
amount of wasted inputs
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In Commodity Futures Efficiency refers to price discovery
and risk management functions
Commodity is a product having commercial value and which
can be produced, bought, sold and consumed. It basicallyrefers to the products of primary sector economy
Futures are exchange traded contracts to sell or buy
standardized financial instruments or physical commodities
for delivery on a specified future date at an agreed price Used generally for protecting against risk of adverse price
fluctuation and not used for merchandising purpose
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Agriculture: Dimensions ofRisk
Production Risk Weather
Disease
Pest
Financial Risk Access to credit Rate of interest
Debt Obligation
Market Risk Price Realization
Cost of sales
Access to market
Availability of buyers
Technological Risk Selection of inputs
Use of Farm machinery
Human Risk
Crop Management
Labor availability
Debt Obligation
Input Risk
Quality of inputs
Availability at right time
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Impact of Futures Market on Price
Time
PRI
CE
Time
PRI
CE
Absence of FuturesMarket
Presence of FuturesMarket
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Myths about Futures Market
Do you think Commodity Futures lead to price rise /
inflation?
Does it lead to hoarding of stock?
Does it lead to exorbitant speculation?
Does it lead to price aberration or rigging?
Since delivery based volume is low, does it really
provide an alternative marketing platform?
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Agriculture
as economic sector
The major contributor in total GDP
Growth is desirable for overall economic growth of the nation
Development of the agriculture mainly in production and
productivity.
Marketing and thereby realizing fair price continues to be
challenging task for primary producers
Rationalization of the economic resources distribution for
optimum return
Need to strengthen the marketing system and market linked
farming enterprise.
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Characteristics of existing
agriculture market
Agriculture Market is scattered and unorganized Market is biased in favor of traders
Primary producers have little to do with the pricing
They mostly end up as price takers in the market
Very little or no Holding powers to the farmers
No mechanism to deal with the glut situation
Credit need of primary producers are high and access to credit
is tough
No control on input costs and no guarantee of right pricerealization.
All above factors indicate the need for efficient, transparent,
service oriented market.
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Regulation of Agriculture Marketing :
Our understanding
Agriculture markets can be segregated into two parts:
Primary market (Between farmer and trader)
Secondary market( Between traders inter alia or between
local trader and upcountry buyers)
APMC Act regulates both segments in terms of licensing ( e.g.
no person can act as trader, broker, etc. unless he holds a
license)
But the differential approach in regulation is:
W.r.t. secondary market, it does not regulate terms of trade
W.r.t. primary market, it regulates the terms of trade
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Significance of the marketMarket has to be
Efficient
Transparent
Neutral : both for Sellers and Buyers
With backward and forward linkages
Providing performance guarantee to counter parties
Available to all, not proprietary of a particular corporate house
Accessible to large number of buyers and sellers providing
liquidity
Market is pivotal to economic development, Market attracts
investors, entrepreneurs, traders and all other class on its own
without any grant, subsidy or tax holiday and All round
development activities start happening, once it takes off
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Scenario of Agriculture Marketing
Agriculture marketing is state subject
Regulated by APMC acts in each states
Varying degree of rules and regulation
Farmers or producers with little produce hence no or little
bargaining power
Multiplicity of legislation
Storage
Movement
Trade
Infrastructure bottlenecks
Agriculture finance by financial institution is seen more as
regulatory compliance than the business avenues.
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Commodity Derivatives:
India
Regulator: FMC
Exchanges
Member: Brokers
Client: Retail & Others
FCRA
Rules & Bye Laws
Derivatives:
1. Futures
2. Option
Commodities:
1. Agri
2. Metals
3. Energy
Trading of Commodity Contract
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Market
Pricing throughnegotiation orauction
Flexible system
One to one trade
Physical Goods
Visual inspection
Pricing throughcontinuous auction
Rigid system
Many to Many trade
CommodityContract
Standardization
SPOT Futures
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Exchange a market place
Commodity contract: Product
Members: Buyers and Sellers
Warehouse: Storage of the commodity
Quality Certification: Grading and quality
maintenance
Margining: For smooth Settlement
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Market Participants
HedgersRisk Offload
Investors
Rate of Interest
ArbitrageursInefficiency
Speculators
Direction and Movement
Stated and Unstated Purpose: Making Profits
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Settlement of the
contract
Daily Settlement
Mark to Market
Closing Price of the day
Final Settlement
Reference Price
Delivery Option
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Pricing of the commodity
A. Underlying Commodity
B. Underlying Spot Market
C. Underlying QualityD. Underlying Contract
E. Contract Condition
F. Settlement System
G. Cost of packaging
H. Cost of assaying
I. Cost of warehousing
J. Margin
Loose Price+
Arahat(to make fit)+
Market Fees+
Hamali+
Taxation+
Packaging+Transportation
+Assaying (investigating)
+Warehousing
Futures Spot
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Valuations of the
contract
Quantitative: In Reference to Underlying prices and
cost of carry
Qualitative: In Reference to change in the
fundamentals
Cropping Season
Weather Local and upcountry trade dynamics
Policy changes
Each commodity has its own fundamentals
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Usefulness of Futures market
Access to banks: Ease in financing as the reference
price and market is available.
Helpful for Financial Institution: To finance and
recover
Hedging tool:To lock in price in advance.
Better vigilance of trade: Leads to transparency
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Price transparency
Price Risk Hedging
Price dissemination
Price discovery
- Unified National level platform providing equal opportunity
to buyers and sellers to express themselves
Achievements of Commodity Futures
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Barriers to Farmers in Futures Market
Entry Knowledge
Intraday volatility
Costly
Low Quantity
Different Quality
Logistics
APMC Regulation
States Regulation
Exit
Knowledge
Market timings
Costly Access to market
Infrastructure
Market Rules
Settlement System
Farming & Marketing vs. Trading
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Issues in Spot & Futures
Issues Spot Futures Remarks
Price Reference Real Price Trap
Operations Unstructured Structured Default/Costly
Surety Relations Regulations New entrant
Taxation Loopholes Full proof Price Distortion
Information Choked Free Price Distortion
Execution of
trade
Physical/
Trust
Electronic/
Transparent
Price Distortion
Bridging The Desirable Gap: Electronic Spot Market
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Challenges in organizing futures
market in Agri commodities
Issues of basis quality
Issues of basis market
Issues of basis price
Varying rate of the same quality on the same market with little or
no sanctity (Purity)
Poor infrastructure
No practices of gradation and quality survey and certification
Poor understanding of the relevance of futures market among,
traders and other market participants
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Benefit to farmers
Farmers can know the benchmark authentic price
Farmers can plan their crop in advance
Farmers can avail better credit access
Banks can finance to farmers with availability of hedging
instrument
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Ultimately for better efficiency
Pan India Electronic Spot Market
Providing localized contract with national
reach
Price reference vs. price realization
An alternative marketing infrastructure to
support the primary producers
Freedom from the grip of local traders
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CONCLUSION1. Reduces Price Volatility and Risk
This brings thingsin balance as the
market constantly
adjusts to thecurrent market
situation and
helps avoid boomand bust cycles.
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2. Price Determination
Supply and demand are never in perfect harmony and so
there has to be a mechanism to determine the price of a
commodity
Commodity futures markets provide the perfect system
and place for buyers and sellers to use all of the available
information in the market to determine the market price
at that moment
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3. Balances Production and Consumption
Helps to keep a balance between consumption and
production as price adjustments are constantly being
made in the market based on supply and demand.
These individual decisions on production and
consumption levels based on daily pricing through
commodity futures exchanges around the world helps
to keep levels in balance.
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THANK YOU!!
WISH YOU VERY HAPPY NEW
YEAR