Economic Functions: 1. 2. In a free market economy, Futures trading performs two important economic functions, viz.

, price discovery and price risk management. Such trading in commodities is useful to all sectors of the economy. The forward prices give advance signals of an imbalance between demand and supply. This helps the government and the private sector to make plans and arrangements in a shortage situation for timely imports, instead of having to rush in for such imports in a crisis-like situation when the prices are already high. This ensures availability of adequate supplies and averts spurt in prices. Similarly, in a situation of a bumper crop, the early price signals emitted by futures market help the importers to defer or stagger their imports and exporters to plan exports, which avoid glut situations and ensures remunerative prices to the producers. At the same time, it enables the importers to hedge their position against commitments made for import and exporters to hedge their export commitments. As a result, the export competitiveness of the country improves. Benefits to the farmers and other stakeholders: 1. 3. Farmers and growers also benefit through the price signals emitted by the futures markets even though they may not directly participate in the futures market. The futures markets, through advance price discovery lead to a shift in sale-purchase patterns during harvest and lean seasons and thereby facilitate reduction in the amplitude of seasonal price variation and help the farmer realize somewhat better price at the time of harvest. These price signals help the farmer in planning his cultivation in advance as well as to determine the kind of crop which he should prefer to raise. These signals also help him in fine tuning his marketing strategy after the harvest. Empowered with the price information the farmer is able to avoid excess sale immediately after the harvest and is also able to bargain for better prices from trade in the mandi. By providing the manufacturers and the bulk consumers a mechanism for covering price-risks, the futures market induces them to pay higher price to the producers, as the need to pass on the price-risk to farmers is obviated. The manufacturers are able to hedge their requirement of the raw materials and as also their finished products. This results in greater competition in the market and ensures viability of the manufacturing units.

How Future Markets Work ...A Detailed Example

How does this whole Future Commodities Market thing work? Let's take the above short example and expand on it. A Corn farmer wants to protect himself from possible future declining prices and a potential loss at harvest time. . What does he do? Well, the farmer has 'x' cost into planting, growing and harvesting his Corn crop. He wants to get his cost back plus hopefully a profit on it. But his crop won't be ready to harvest and sell for 6 months. All sorts of factors like weather temperature, rain, drought, higher or lower yields from competing international producers could impact his Corn crop and the final price he'll be able to get for it...IF he sold it 6 months later. So, he agrees to sell his Corn in the future markets to a Commercial Producer TODAY, for a set specified price per bushel...for delivery 6 months later. The farmer wants to ensure he doesn't lose money should the overall market for his crop produce a glut, depressing commodity prices at harvest time. Now, if there's a short supply (and high demand) of his Corn at harvest time, his crop would be worth even more money in the future market ...IF he sold it at harvest time. So in this case, the farmer would lose what would have been a higher profit for his crop, had he waited to sell his crop at harvest...but he still came out to the good, locking in a good price to cover his costs and a profit by trading in the future markets 6 months ahead of harvest time. But, what if there was an unexpected supply glut of his commodity at harvest? We'll, he's still to the good, protecting himself by locking in a pre-determined profit for his Corn when he agreed to sell his crop 6 months earlier at planting time.

The same scenario works for the Commercial Commodity Producer ...from the other side of the coin This Corn Chex cereal producer wants to lock in the lowest price he can for his raw Corn commodity...just in case the farmer has a crop shortage/resulting in high demand and rising prices at harvest. Should that happen in the future, he has to pay a lot more for the Corn, ...IF he were to wait and buy at harvest time.

Waiting, in this case, could cause his profits to be negatively impacted no matter how many boxes of Corn Chex cereal he sells. He might even take a loss if potentially higher commodity Corn costs drive his total cost to make the cereal beyond what he can sell the cereal for. The cereal maker wants to avoid this negative potential, so he agrees to buy the corn he needs in the commodities market, and locks in a price months earlier at planting time, for delivery in 6 months. If the farmers' crop harvest results in a future supply glut and declining commodity prices, the cereal maker could have bought the commodity at an even lower price...by waiting until harvest time,...and made more profit on sales of his Corn Chex. But, he wasn't willing to take the upfront risk of a supply shortage occurring months later at harvest, potentially costing him money and lower profits later on....so he locked in a reasonable price at planting 6 months earlier by trading in the commodity future market. 'Hedging' his bet, this ensures the cereal maker still makes a profit on each box of cereal, by locking in a good price months before the corn commodity harvest.

Bottom line? - both Commercial parties got what they wanted out of the trade. They're both more concerned with minimizing their future risk than maximizing their profits. The farmer protected himself from possible future declining prices and a potential loss in that event...locking in an acceptable price and delivering his crop to the cereal maker6 months later. And the cereal maker protected himself from possible future risingcommodity prices and potential lower profits...or even potential loss...by agreeing to buy the farmers crop at an acceptable price 6 months earlier, taking delivery at harvest time. As speculators, we hope to profit from rising or falling prices in the commodity market during the 6 months we're trading our corn futures contract, depending on the direction we feel the market will move.

But unlike the Commodity Producer and Consumer who want to minimize risk, speculators want to MAXIMIZE profits. Thus, we take on greater risk trading the future market to hopefully capture maximum trading profits - but with no guarantee of success. In any case, we exit our futures contract in the commodities market before the end of the delivery date 6 months later, as we don't want to take physical delivery of 5000 bushels of corn! Hopefully this detailed example gives you a better understanding of the important role of futures market trading in the lives of various players who engage in trading both the physical raw commodity and speculators trading contracts in the commodity market.

orking of commodity market There are two kinds of trades in commodities. The first is the spot trade, in which one pays cash and carries away the goods. The second is futures trade. The underpinning for futures is the warehouse receipt. A person deposits certain amount of say, good X in a ware house and gets a warehouse receipt. Which allows him to ask for physical delivery of the good from the warehouse. But some one trading in commodity futures need not necessarily posses such a receipt to strike a deal. A person can buy or sale a commodity future on an exchange based on his expectation of where the price will go. Futures have something called an expiry date, by when the buyer or seller either closes (square off) his account or give/take delivery of the commodity. The broker maintains an account of all dealing parties in which the daily profit or loss due to changes in the futures price is recorded. Squiring off is done by taking an opposite contract so that the net outstanding is nil. For commodity futures to work, the seller should be able to deposit the commodity at warehouse nearest to him and collect the warehouse receipt. The buyer should be able to take physical delivery at a location of his choice on presenting the warehouse receipt. But at present in India very few warehouses provide delivery for specific commodities. The commodity trading system consists of certain prescribed steps or stages as follows: I. Trading: - At this stage the following is the system implementedOrder receiving Execution Matching Reporting Surveillance Price limits Position limits II. Clearing: - This stage has following system in placeMatching Registration Clearing Clearing limits Notation Margining Price limits Position limits Clearing house. III. Settlement: - This stage has following system followed as followsMarking to market Receipts and payments Reporting Delivery upon expiration or maturity.

A speculator is a trader who enters the market to profit from short term price changes. In doing so, he/she assumes risk that other individuals are trying to dispose of. A scalper is an individual that enters the futures market to profit from very short term price movements. A scalper is generally trying to guess the short term psychology of the market. Day traders attempt to profit from trades that occur during a single trading day. A position trader is a speculator that holds a position overnight. Sometimes they may hold them for weeks or months. A hedger is an individual who enters the futures market in order to reduce a preexisting risk.

Do hedgers need speculators? Hedgers, as a group, need speculators to take positions and bear risk only for the mismatch in contracts demanded by long and short hedgers. If long and short hedgers had exactly offsetting needs, hedgers would not need speculators.

bENEFITS TO INDUSTRY FROM FUTURES TRADING

Hedging the price risk associated with futures contractualcommitments.

Spaced out purchases possible rather than large cash purchases and itsstorage.

Efficient price discovery prevents seasonal price volatility.

Greater flexibility, certainty and transparency in procuring commoditieswould aid bank lending.

Facilitate informed lending.

Hedged positions of producers and processors would reduce the risk of default faced by banks. * Lending for agricultural sector would go upwith greater transparency in pricing and storage.

Commodity Exchanges to act as distribution network to retail agri-finance from Banks to rural households.

Provide trading limit finance to Traders in commodities Exchang

http://www.scribd.com/doc/15961806/Commodity-Market-Report COMMODITY A commodity may be defined as an article, a product or material that isbought and sold. It can be classified as every kind of movable property,except Actionable Claims, Money & Securities. Commodities actually offerimmense potential to become a separate asset class for marketsavvyinvestors, arbitrageurs and speculators. Retail investors, who claim tounderstand the equity markets, may find commodities an unfathomablemarket. But commodities are easy to understand as far as fundamentals of demand and supply are concerned. Retail investors should understand therisks and advantages of trading in commodities futures before taking aleap. Historically, pricing in commodities futures has been less volatilecompared with equity and bonds, thus providing an efficient portfoliodiversification option.In fact, the size of the commodities markets in India is also quitesignificant. Of the country's GDP of Rs 13, 20,730 crore (Rs 13,207.3billion), commodities related (and dependent) industries constitute about58 per cent.

7 Currently, the various commodities across the country clock an annualturnover of Rs 1, 40,000 crore (Rs 1,400 billion). With the introduction of futures trading, the size of the commodities market grows many folds hereon. COMMODITY MARKET Commodity market is an important constituent of the financial markets of any country. It is the market where a wide range of products, viz.,precious metals, base metals, crude oil, energy and soft commodities likepalm oil, coffee etc. are traded. It is important to develop a vibrant, activeand liquid commodity market. This would help investors hedge theircommodity risk, take speculative positions in commodities and exploitarbitrage opportunities in the market.