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Commodity - General FAQ
 
  What is "Commodity"?
  What is "Commodity Exchange"?
  What are Commodity Futures?
  What are the main differences between the physical and futures markets?
  How are Commodity futures different from Financial Futures?
  How does a Commodity Futures Exchange help in Price Discovery & Price Risk Management?
  Which are the national level multi-commodity exchanges?
 
What is "Commodity"?

Commodity includes all kinds of goods. FCRA defines "goods" as "every kind of movable property other than actionable claims, money and securities". Futures' trading is organized in such goods or commodities as are permitted by the Central Government. At present, all goods and products of agricultural (including plantation), mineral and fossil origin are allowed for futures trading under the auspices of the commodity exchanges recognized under the FCRA. The national commodity exchanges have been recognized by the Central Government for organizing trading in all permissible commodities which include precious (gold & silver) and nonferrous metals; cereals and pulses; ginned and unginned cotton; oilseeds, oils and oilcakes; raw jute and jute goods; sugar and gur; potatoes and onions; coffee and tea; rubber and spices, etc.

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What are "Commodity Exchange"?

A commodity exchange is an association, or a company or any other body corporate organizing futures trading in commodities.

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What is "Commodity Futures"?

A commodity exchange is an association, or a company or any other body corporate or sell a specified quantity and quality of commodity at a certain time in future at a certain price agreed at the time of entering into the contract on the commodity futures exchange.

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What are the main differences between the physical and futures markets?

The physical markets for commodities deal in either cash or spot contract for ready delivery and payment within 11 days, or forward (not futures) contracts for delivery of goods and/or payment of price after 11 days. These contracts are essentially party to party contracts, and are fulfilled by the seller giving delivery of goods of a specified variety of a commodity as agreed to between the parties. These contracts are mostly settled by issuing or giving deliveries. Very rarely do situations arise when unforeseen and uncontrolled circumstances prevent the buyers and sellers from receiving or taking deliveries. The contracts may then be settled mutually. Unlike the physical markets, futures markets trade in futures contracts which are (physical market), purchases and sales. Futures contacts are mostly offset before their maturity and, therefore, scarcely end in deliveries. Delivery of the commodity takes place during a future delivery period of the contract only if the option of delivery is exercised. Speculators also use these futures contracts to benefit from changes in prices and are hardly interested in either taking or receiving deliveries of goods.

How are Commodity futures different from Financial Futures?

Commodity futures differ from financial futures in the following ways: ·Financial derivatives are mostly cash settled whereas in case of Commodity futures physical delivery may also be given/ taken. ·Even in case of physical settlement, financial assets are not bulky and do not need special facility for storage. Due to the bulky nature of the underlying assets, physical settlement in commodity derivatives creates the need for warehousing. ·The concept of “varying quality of asset” does not really exist as far as financial underlying is concerned. However, in case of commodities, the quality of underlying asset can vary largely.

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How does a Commodity Futures Exchange help in Price Discovery & Price Risk Management?

Unlike the physical market, a futures market facilitates offsetting the trades without exchanging physical goods until the expiry of a contract. As a result, futures market attracts hedgers for risk management and encourages considerable external competition from those who possess market information and price judgment to trade as traders in these commodities. While hedgers have long-term perspective of the market, the traders or arbitragers, prefer an immediate view of the market. However, all these users participate in buying and selling of commodities based on various domestic and global parameters such as price, demand and supply, climatic and market related information. These factors, together, result in efficient price discovery, allowing large number of buyers and sellers to trade on the exchange.

Price Risk Management: Hedging is the practice of off-setting the price risk inherent in any cash market position by taking an equal but opposite position in the futures market. This technique is very useful in case of any long-term requirements for which the prices have to be firmed to quote a sale price but to avoid buying the physical commodity immediately to prevent blocking of funds and incurring large holding costs.

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Which are the national level multi-commodity exchanges?

There are some 21 commodity exchanges in India. However most of them are regional, off-line (non-screen-based) and commodity specific; hence these are almost inoperative. The national level multi-commodity exchanges to trade in all permitted commodities are:

Multi Commodity Exchange of India Ltd, Mumbai (MCX)at www.mcxindia.com. The exchange is promoted mainly by professionals and supported by Financial Technology (FT). UBI, BOI, SBI and corporation bank have taken equity stake in the exchange. The exchange has started operations from November 2003.

National Commodity and Derivative Exchange, Mumbai (NCDEX) at www.ncdex.com. The exchange has been promoted by ICICI, NSE, LIC and NABARD. Later on IFFCO, CRISIL and PNB has taken equity stake in the exchange. It started trading in December 2003.

National Multi Commodity Exchange of India Ltd, (NMCE) at www.nmce.com

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