the efficiency of commodity futures

7/30/2019 The Efficiency of Commodity Futures

1/29

By

AJAI&

SAHLE


2/29

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


3/29

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


4/29

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


5/29

Impact of Futures Market on Price

Time

PRI

CE

Time

PRI

CE

Absence of FuturesMarket

Presence of FuturesMarket


6/29

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?


7/29

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.


8/29

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.


9/29

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


10/29

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


11/29

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.


12/29

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


13/29

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


14/29

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


15/29

Market Participants

HedgersRisk Offload

Investors

Rate of Interest

ArbitrageursInefficiency

Speculators

Direction and Movement

Stated and Unstated Purpose: Making Profits


16/29

Settlement of the

contract

Daily Settlement

Mark to Market

Closing Price of the day

Final Settlement

Reference Price

Delivery Option


17/29

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


18/29

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


19/29

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


20/29

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


21/29

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


22/29

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


23/29

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


24/29

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


25/29

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


26/29

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.


27/29

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


28/29

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.


29/29

THANK YOU!!

WISH YOU VERY HAPPY NEW

YEAR

the efficiency of commodity futures

Documents