Fortnightly report on the project

Role of Commodity Derivatives in Efficient Price Discovery

Submitted by:
Varun B.S. 4NY10MBA49 II MBA, Banking and Finance JKSHIM, Nitte

Submitted to:
Dr. Sudhir M Assistant Professor JKSHIM, Nitte

The fortnightly report is prepared according to the information collected from the company as well as through some of the observations made in the trading practices of various products. This information was collected from November 21st, 2011 to December 3rd, 2011. They are as under: The Kotak Mahindra group is a financial organization established in 1985 in India. It was previously known as the Kotak Mahindra Finance Limited, a non-banking financial company. In February 2003, Kotak Mahindra Finance Ltd, the group's flagship company was given the license to carry on banking business by the Reserve Bank of India (RBI). Kotak Mahindra Finance Ltd. is the first company in the Indian banking history to convert to a bank. Today it has more than 20, commodity deerivatives000 employees and Rs. 10,000 crore in revenue. Kotak Commodity Services Limited (KCSL) is promoted by the Kotak family that has decades of experience in commodity trading. KCSL is a trading-cum-clearing member of the leading national commodity exchanges - MCX, NCDEX & ACE. It is also a member of NCDEX Spot Exchange. KCSL is also associated with All India Cottonseed Crushers Association, Cotton Association of India and The Solvent Extractors Association of India. Kotak Commodity offers one of the best online commodity trading solutions to individual clients through its Individual Trading desk. The Individual Trading desk enables a client to trade in any commodity futures, listed on the national commodity exchanges, with a slew of value-added services attached to it at no extra cost.

Commodities as we know it: 1. The corn in your morning cereal which you have for breakfast, 2. The gold on your watch and jewellery, 3. The cotton that makes your clothes, 4. The steel which makes your motor bike or car and the crude oil which runs it and takes you to work, 5. The Rice or Rotis you eat for lunch, 6. All the above can be termed as Commodities.

 Commodity derivative markets are always futures contracts and which are regulated by Forward Market Commission (FMC). There are mainly 2 types of commodity exchanges: 1. National Exchanges: It includes Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX), Ahmadabad Commodity Exchange (ACE), National Multi Commodity Exchange (NMCE) and Indian Commodity Exchange (ICE). Out of these 5 national level commodity exchanges, Kotak Commodity Services Limited is a member of MCX and NCDEX in 2003. 2. 20 and odd regional exchanges. MCX is the dominant player in the world having 90% trade and it is a private company which trades energy, bullion and metals the most. NCDEX records 90% trade in agricultural commodities and is a public company. Ahmadabad Commodity Exchange was launched in the year 2010 by Kotak Commodity Services limited. Earlier the company was trading only in cotton. Every commodity to enter into a futures contract should have certain features. Some of the important features are as under: 1. Every commodity has to be standardised and in basic, unprocessed state. 2. It should have adequate shelf life 3. It should have sufficient price volatility There are mainly 4 major types of commodities which are entered into futures contract. They are Bullion (Gold and silver), Metals (copper, tin, zinc, aluminium etc), Energy (Natural gas, crude oil etc) and Agricultural commodities (sugar, cotton, chana etc). There are more than 60 commodities which are traded in various exchanges. The market timings for metals, bullion and energy is from 10 am to 11.55 pm, and for agricultural commodities is 10 am to 5 pm. There are 5 major market timings are taken as base to know the fluctuations in the prices of these commodities in international markets. They are Tokyo Commodity Exchange (TOCOM), Multi Commodity Exchange of India ltd (MCX), London Multi-Commodity Exchange (LME), New York Multi-Commodity Exchange (NYMEX) and Chicago Multi Commodity Exchange (COMEX). Commodities are traded in global market and operate as per Law of Unprice, where price of a commodity should be same all across the world.

 A commodity market is of 2 types. Spot market, where the price for the commodities is paid on spot and delivery is received. Futures market where a commoditys actual delivery may be made or may not be made as per the contract agreed upon and the price includes spot price + cost of carry. Futures contract is always a derivatives contract. Though forward and futures market sounds same, there are certain differences involved in it. Some difference can be classified under lot size, maturity date, margin and mark to market (MTM). Most of the people believed that commodity futures market will lead to rise in the price of commodities in the near future. To resolve this misconception of the people, Parliamentary Standing Committee of the Ministry of Consumer Affairs Food and Public Distribution, appointed an Expert Committee under the Chairmanship of Prof. Abhijit Sen, Member of Planning Commission, to examine whether and to what extent futures trading has contributed to price rise in agricultural commodities. The objectives of the committee were: To study the extent of impact, if any, of futures trading on wholesale and retail prices of agricultural commodities

2. Depending on this impact, to suggest ways to minimize such an impact 3. Make such other recommendations as the Committee may consider appropriate regarding increased association of farmers in the futures market/trading so that farmers are able to get the benefit of price discovery through Commodity Exchanges. The committee came up with the reasons as well as necessary steps to minimise the potential risks of derivatives trading. There are mainly 3 types of participants. They are: 1. Hedgers- Persons who try to minimize market risk by transferring risk and locking in margins against physical positions. 2. Speculators- Persons who take on extra risk in anticipation of a higher reward in the process. 3. Arbitragers - Operators present in more than one market trying to benefit from the imbalances of the markets. The main products offered by Kotak Commodities are: 1. Hedging on international commodity exchange 2. Commodities on local exchanges 3. Alternative investment products

 There are certain doubts to the investors about the delivery procedure in this commodity trading. It is depending on the agreements; contract can be settled either in cash or in delivery transaction. In case of delivery transaction, warehouse receipts are necessary as a proof. The option to settle in cash or through delivery can be changed as many times as one wants till last day of expiry of contract. Any person to have a position in the commodity futures market, one should have a bank account and separate commodities Demat account from NSDL to trade in NCDEX. Information on commodities will be available in newspapers daily about spot prices and in websites also. The margin amount is calculated by Value at Risk (VaR) system. It will vary from 5% to 10% of the contract amount. For some commodities circuit filters will also be attached so as to avoid maximum fluctuation of the prices. The maximum circuit filters to be put is 6% above and below the market price.