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1. What are commodity exchanges?
Commodity exchanges are institutions, which provide a platform for trading in 'commodity futures' just as how stock markets provide space for trading in equities and their derivatives. They thus play a critical role in robust price discovery where several buyers and sellers interact and determine the most efficient price for the product.
2. What are the different types of commodities that are traded in these markets?
World-over one will find that a market exits for almost all the commodities known to us. These commodities can be broadly classified into the following:
Precious Metals: Gold, Silver
Other Metals: Copper
Energy: Crude Oil
3. What are the characteristics of the Exchange Traded markets?
The exchange-traded markets are essentially only derivative markets and are similar to equity derivatives in their working. I.e. everything is standardized and a person can purchase a contract by paying only a percentage of the contract value. A person can also go short on these exchanges. Also, even though there is a provision for delivery most of the contracts are squared-off before expiry and are settled in cash. As a result, one can see an active participation by people who are not associated with the commodity.
4. What are standardized contracts?
Futures contracts are standardized. In other words, the parties to the contracts do not decide the terms of futures contracts; but they merely accept terms of contracts standardized by the Exchange.
5. What is a futures contract?
Future Contract is a type of forward contract. 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. Futures contracts are used generally for protecting against adverse price fluctuation (hedging). As the terms of the contracts are standardized, these are generally not used for merchandizing propose.
6. Is delivery mandatory in futures contract trading?
The provision for delivery is made in the Byelaws of the Associations so as to ensure that the futures prices in commodities are in conformity with the underlying. Delivery is generally at the option of the sellers. However, provisions vary from Exchange to Exchange. Byelaws of some Associations give both the buyer and seller the right to demand/give delivery. In case of DGCX there is no delivery option.
7. How are futures prices determined?
Futures prices evolve from the interaction of bids and offers emanating from all over the country - which converge in the trading floor or the trading engine. The bid and offer prices are based on the expectations of prices on the maturity date.
8. How professionals predict prices in futures?
Two methods generally used for predicting futures prices are fundamental analysis and technical analysis. The fundamental analysis is concerned with basic supply and demand information, such as, weather patterns, carryover supplies, relevant policies of the Government and agricultural reports. Technical analysis includes analysis of movement of prices in the past. Many participants use fundamental analysis to determine the direction of the market, and technical analysis to time their entry and exist.
9. How is it possible to sell, when one doesn't own commodity?
One doesn't need to have the physical commodity or own a contract for the commodity to enter into a sale contract in futures market. It is simply agreeing to sell the physical commodity at a later date or selling short. It is possible to repurchase the contract before the maturity, thereby dispensing with delivery of goods.
10.What are long positions?
In simple terms, long position is a net bought position.
11. What are short positions?
Short position is net sold position.
12. What is bull spread (futures)?
In most commodities and financial derivatives market, the term refers to buying contracts maturing in nearby month, and selling the deferred month contracts, to profit from the wide spread which is larger than the cost of carry.
13. What is bear spread (futures)?
In most of commodities and financial derivatives market, the term refers to selling the nearby contract month, and buying the distant contract, to profit from saving in the cost of carry.
Contango means a situation, where futures contract prices are higher than the spot price and the futures contracts maturing earlier.
15. What is ‘Backwardation'?
When the prices of spot or contracts maturing earlier are higher than a particular futures contract, it is said to be trading at Backwardation.
It is normally calculated as cash price minus the futures price. A positive number indicates a futures discount (Backwardation) and a negative number, a futures premium (Contango). Unless otherwise specified, the price of the nearby futures contract month is generally used to calculate the basis.
17. What is cash settlement?
It is a process for performing a futures contract by payment of money difference rather than by delivering the physical commodity or instrument representing such physical commodity (like, warehouse receipt)
It refers to the liquidation of a futures contract by entering into opposite (purchase or sale, as the case may be) of an identical contract.
19. What is settlement price?
The settlement price is the price at which all the outstanding trades are settled, i.e. profits or losses, if any, are paid. The method of fixing Settlement price is prescribed in the Byelaws of the exchanges; normally it is a weighted average of prices of transactions both in spot and futures market during specified period.
20.Why do we need speculators in futures market?
Participants in physical markets use futures market for price discovery and price risk management. In fact, in the absence of futures market, they would be compelled to speculate on prices. Futures market helps them to avoid speculation by entering into hedge contracts. It is however extremely unlikely for every hedger to find a hedger counter party with matching requirements. The hedgers intend to shift price risk, which they can only if there are participants willing to accept the risk. Speculators are such participants who are willing to take risk of hedgers in the expectation of making profit. Speculators provide liquidity to the market; therefore, it is difficult to imagine a futures market functioning without speculators
21. What are the benefits from Commodity Forward/Futures Trading?
Forward/Futures trading performs two important functions, namely, price discovery and price risk management with reference to the given commodity. It is useful to all segments of the economy. It enables the ‘Consumer' in getting an idea of the price at which the commodity would be available at a future point of time. He can do proper costing and also cover his purchases by making forward contracts. It is very useful to the ‘exporter' as it provides an advance indication of the price likely to prevail and thereby helps him in quoting a realistic price and secure export contract in a competitive market It ensures balance in supply and demand position throughout the year and leads to integrated price structure throughout the country. It also helps in removing risk of price uncertainty, encourages competition and acts as a price barometer to farmers and other functionaries in the economy.
Hedging is a mechanism by which the participants in the physical/cash markets can cover their price risk. Theoretically, the relationship between the futures and cash prices is determined by cost of carry. The two prices therefore move in tandem. This enables the participants in the physical/cash markets to cover their price risk by taking opposite position in the futures market.
Hedger is a user of the market, who enters into futures contract to manage the risk of adverse price fluctuation in respect of his existing or future asset.
Arbitrage refers to the simultaneous purchase and sale in two markets so that the selling price is higher than the buying price by more than the transaction cost, so that the arbitrageur makes risk-less profit.
Day traders are speculators who take positions in futures or options contracts and liquidate them prior to the close of the same trading day.
A floor trader is an Exchange member or employee, who executes trade by being personally present in the trading ring or pit floor trader has no place in electronic trading systems.
A trader, who trades or takes position without having exposure in the physical market, with the sole
A market maker is a trader, who simultaneously quotes both bid and offer price for a same commodity throughout the trading session.
Credit risk on account of default by counter party: This is very low or almost zeros because the Exchange takes on the responsibility for the performance of contracts.
30.What is liquidity risk?
Liquidity risks is the risk that unwinding of transactions may be difficult, if the market is illiquid
Legal risk is that legal objections might be raised; regulatory framework might disallow some activities.
32. What is Mark-to-Market margin?
Mark-to-market margins (MTM or M2M or valan) are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that day) or the previous day's clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.
33. Why is Mark-to-Market margin collected daily in commodity market?
Collecting mark-to-market margin on a daily basis reduces the possibility of accumulation of loss, particularly when futures price moves only in one direction. Hence the risk of default is reduced. Also, the participants are required to pay less upfront margin – which is normally collected to cover the maximum, say, 99. 9%, of the potential risk during the period of mark-to-market, for a given limit on open position. Alternatively, for the given upfront margin the limit on open position would have to be reduced, which has the effect of restraining the trade and liquidity.
It is a measurement of the variability rate (but not the direction) of the change in price over a given time period. It is often expressed as a percentage and computed as the annualized standard deviation of percentage change in daily price.
35. What is a Client Account?
Client Account is an account maintained for any individual or entity being serviced by an agent (broker, members), for a commission. A customer's business must be segregated from the broker's/member's/principal's own business and clients' money should be kept in segregated accounts.
36. What is a client agreement?
It is a legal document entered into between the broker and the client setting out the conditions of their relationship and meeting the requirements of the relevant self-regulatory organization and the Regulator.
37. What is the role of Clearing House?
Clearing House performs post trading functions like confirming trades, working out gains or losses made by the participants during the course of the clearing period – usually a day-collecting the losses from the members and paying out to other who have made gains.