The Importance of Commodity Derivatives

The Importance of Commodity DerivativesEquity Commodity coronationA COMPARATIVE STUDY BETWEEN EQUITY COMMODITY INVESTMENT OPTION swindleIndia, a commodity based economy where ii-third of the cardinal billion population depends on agricultural commodities, surprisingly has an under developed commodity flip-flop. Unlike the natural commercialise, incomings markets trades in commodity argon largely used as risk management (hedging) mechanism on either physical commodity itself or pay positions in commodity contrast. For instance, a jeweller slew hedge his inventory against perceived swindle-term downturn in specious prices by going short in the future markets.The study aims to know how of the commodities market and how the commodities traded on the ex change over. The idea is to interpret the importance of commodity derivatives and learn ab away the market from Indian stain of view. In fact it was unitary of the most vibrant markets till early 70s. Its development and g rowth was shunted due to numerous restrictions earlier. Now, with most of these restrictions being removed, there is horrifying potential for growth of this market in the country.ACKNOWLEDGEMENTSYNOPSIS FOR THESISDESIRED AREAInvestments Commodity grocery store in IndiaTITLE OF THE THESIS comparative Study betwixt Equity Commodity Investment excerptionsPROBLEM DEFINITION / HYPOTHESIS / search OBJECTIVETo have a comparative study between two major Investments options Equity Commodity on the basis of their takes.To study simple properties of commodity futures as an as primed(p) class and analyze the hedging propertiesTo understand the possible amendss by investing in Commodity Futures when the Commodity Spot Prices be falling and comparing them with those in Stocks and Bonds.INTRODUCTION / LITERATURE TO THE AREA OF RESEARCHIn the Capital Markets of the world, preferably in India, Stock is considered as the first option of investment. But, as we all know that there atomic n umber 18 umpteen former(a) options available with the nation to invest / park their hard earned in some of these options argon Derivative Market, Mutual Funds, NSC, KVPS, Insurance, FD, Savings A/cs obviously less considered is the Commodity Market. In the above mentioned options there ar some options that do non have the risk factor in it consequently they give less return, while others having risk gives to a greater extent return to the investor.One does not know that the Investments in Commodities will also yield almost the alike(p) returns as compared with the Stock, having the same amount of risk involved.SCOPEThis research would throw light on the mentioned objectives make people aware of Commodity Futures as an Investment option which is at its growing stage.RESEARCH METHODOLOGYPrimary info CollectionGuidance from the External Guide.Guidance from the Internal Guide.Help from Faculties.Commodities Dealers.Commodities Players (Investors).Secondary Data CollectionWeb sitesJournalsMagazines (Financial)News papersResearch Papers on the same topicReports of ExpertsInvestment is a term with different closely-related meanings in business, finance and economics, related to pitch or deferring consumption. An asset is usually purchased, or in a similar way a deposit is make in a bank, in hopes of acquire a future return or interest from the same. Literally, investment means the action of putting something somewhere elseIn finance, investment pot be referred to as subverting securities or other monetary assets in the money markets or capital markets, or in fairly politic real assets, such as gold, real estate etc. Valuation is the method for finding the true prize of an asset.Different financial investments include parcel of lands, tie downs and other equity investments. These financial assets are then expected to provide income/ positive future cash streams, and may increase or decrease in its value giving the investor capital gains or losses. Trading in contingent claims or derivative securities do not necessarily have future positive cash f abjects, and so are not considered assets, or securities or investments. Nevertheless, since their cash flows are closely related to or it is derived from cash flow of specific securities, they are often treated as investments.Banks, common notes, pension funds, insurance companies, collective investment schemes, and investment clubs tidy sum be used to make investments indirectly. An intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary, though their legal and adjective details differ.LITERATURE REVIEWThe capital market (securities markets) is the market for securities, where the companies and the government can raise funds for long term. Stock market and the bond market form part of capital market. Financial regulators, such as the RBI and SEBI, prevent a watch on the capital markets in their respective countries to ensure that investors are protected against any fraud. The capital markets consist of the primary market, where the company floats late securities to investors, and the secondary market, where existing securities are traded.STRUCTURE OF CAPITAL MARKETPrimary MarketSecondary MarketDerivative MarketCommodity Market foreign MarketIPO Public Issue)Right IssuePrivate PlacementSale purchase of existing share debenture Mutual fund alternativeFutureCallOptionPut OptionGoldSilverMaterialEtc.NYSE CompositeNASDAQ CompositeDow Jones I.A.S4P 500NIKKEI 225NSEBSE relations inMCX dealing inSTRUCTURE OF SECURITY MARKETPrimary MarketSecondary MarketDerivative MarketCommodity Market world(prenominal) MarketIPO Public Issue)Right IssuePrivate PlacementSale purchase of existing share debenture Mutual fundOptionFutureCallOptionPut OptionGoldSilverMaterialEtc.NYSE CompositeNASDAQ CompositeDow Jones I.A.S4P 500NIKKEI 225NSEBSEtransaction inMCX dealing inA) Primary Market It is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funds through the issue of a new stock or bond which is called initial public offering (IPO). This is typically done through a syndication of securities dealers which in return earn a commission that is built into the price of the security offering.B) Secondary Market The secondary market is the market for trading of securities that have already been issued in the market. Aftermarket is known as the market that exists in a new security just after the new issue. Investors and speculators can intimately trade on the exchange once a newly issued stock is listed on a stock exchange, as market makers make bids and offers in the new stock.C) Derivative Market Derivative MarketFuture MarketOption MarketFuture ContractSay One calendar month Two month Three monthCall OptionPut OptionPremium will change at the time of buyingNo RiskPremium will change at the time of sellsNo RiskFuture Contracts The future issues are the future contracts or bids for some specific period like one month, two months and leash months, accepted from investor in capital market which is put.Option Market - The option market is the place where trading is for call and put or buy and sell and only the premium is charged for all call and put trading.D) Commodity MarketCommodity trading might sound like a strange term, but simply put, commodities are items like, wheat, corn, gold and silver, and Cattle and Pork Bellies, and Crude Oil and it has emerged as an important player in the way that people invest in and speculate.INVESTMENT ALTERNATIVESINVESTMENTFinancial AssetsReal EstateMarketable Financial Assets.Non- vendible Financial AssetsTreasury BillsC.D.C.P.RepoGovt. Fixed Insurance bondGovt. Securities unsecured bondSharesMutual FundEquityPrefNSSBank DepositPost OfficeKVPNSCCompany DepositEPF/PPFLICGoldSilverPrevious objectsPainting /Art filth / BuildingMachin ery/Equipment etcMARKETABLE FINANCIAL ASSETSEquity or Preference sharesGovt/PSU/Pvt/other bondsMutual FundsShares (Equity and Preference Share) If you have equity shares of a company, you have an self-control stake in that company. This essentially means that you have a residual interest in income and wealth of the company. Equity shares are classified into the quest commodious categories Blue chip sharesGrowth sharesIncome sharesCyclical sharesSpeculative sharesBonds Bonds or debentures represent long-term debt instruments where issuer of a bond promises to pay a stipulated stream of cash flow. Bonds may be classified into the following categories Government securities.Savings bondsGovernment agency securities.PSU bondsDebentures of private sector companiesPreference sharesMoney Market Instruments- Money market instruments are debt instruments which have a maturity of less than one social class at the time of issue. The important money market instruments areTreasury billsCommer cial paperCertificates of depositMutual FundsA Mutual Fund is a trust that collects the savings of a number of investors, and invest in capital market instruments such as shares, debentures and other securities who share a common financial goal. Unit holders share the income earned through these investments and the capital wait in resemblance to the number of units owned by them. Mutual Fund offers an opportunity to invest in a diversified, professionally managed b aimet of securities at a relatively low cost and thus is the most suitable investment for the common man.NON-MARKETABLE FINANCIAL ASSETSA adept portion of financial assets is represented by non-marketable financial assets. These can be classified into the following broad categories.Bank depositsPost office depositsCompany depositsProvident fund deposits/EPFLICNSCNSSKVPLife Insurance Life insurance can also be considered as an investment as insurance premiums represent the sacrifice, and the assured sum represents the b enefit. The important types of insurance policies in India are Endowment confidence policyMoney back policyWhole life policyTerm assurance policyREAL ESTATES AND OTHERSReal Estate Residential post is the most important asset in the portfolio for the bulk of the investors. More affluent investors are likely to be interested in the following types of real estate, in addition to a residential house Agricultural landSemi urban landCommercial propertyPrecious Object Precious objects are items that are highly valuable in monetary terms. Some important precious objects are Gold and silverPrecious stonesArt objectsFinancial Derivatives A financial derivative is an instrument whose value is derived, from the value of an underlying asset be it a real asset, such as gold wheat or oil, or a financial asset, such as a stock, stock index, bond or foreign currency.Forwards ContractsA forward contract, as it occurs in both forward and futures markets, invariably involves a contract initiated at one timePerformance in accordance with the terms of the contract occurs at one timePerformance in accordance with the terms of the contract occurs at a subsequent time.Further, the type of forward contracting to be considered here always involves an exchange of one asset for another and the price at which the exchange occurs is set at the time of the preliminary contracting. Actual payment and delivery of the good occur afterwards.Futures ContractsA futures contract is highly standardized forward contract with closely specified contract terms and it calls for the exchange of some good at a future date for cash, with the payment for the good to occur at that future date like all forward contracts. The buyer of a futures contract undertakes to receive delivery of the good and pay for it while the seller of a futures promises to deliver the good and take delivery of payment. The price of the good is determined at the initial time of contracting.OptionOption contracts grant the right b ut not the compulsion to buy in the case of a call or sell, in the case of a put a specified quantity of an asset at a predetermined price on or earlier a specified future date option contract would expire if it is not in the best interest of the option owner to exercise.SwapsSwaps normally trade in the OTC market but there is monitoring of this market segment. Swaps are agreement between two parties to exchange cash flows in the future according to a approved formula and In case of popular interest rate swap, one party agrees to pay a series of set cash flows in exchange for a sequence of variable cost.When compared to global derivatives markets Indian derivative markets are still in the emerging stage. Indian derivatives markets share in the world derivatives markets value and volumes are very small. But with the starting of trading in different financial and commodities segment, Indian markets are growing very fast. Indian markets are operating with high efficiency and on parity with international standards.The major exchanges and the derivative products traded in India1. Bombay Stock veer (BSE)2. National Stock Exchange OF India Ltd (NSE)3. National Commodity Derivatives Exchange Limited (NCDEX)4. Multi Commodity Exchange of India Ltd (MCX)5. National Multi Commodity Exchange of India Ltd (NMCE)INVESTMENT ATTRIBUTESFor evaluating an investment values, the following attributes are relevant.Rate of returnRiskSafetyProfitabilityPurchasing power riskMaturityMarketability revenue enhancement shelterConvenienceRate of come aboutThe rate of return on an investment for a period (which is usually a period of one year) is defined as followsRate of return = one-year income + (Ending price Beginning price)Beginning priceTo illustrate, consider the following information about a certain(p) equity share.Price at the beginning of the year Rs. 80.00Dividend paid in the year Rs. 4.00Price at the end of the year Rs. 87.00The rate of return of this share is calculated a s follows4.00 + (87.0-80.00)= 13.75 percent80.00YieldIn general, yield isthe yearly rate of returnfor any investment and is expressed as a percentage,With stocks, yield can refer to the rate of income generated froma stock in the form of regular dividends and is often represented in percentage form, calculated as the annual dividend payments divided by the stocks current share price.Investors can use yield to measure the performance of their investments andcompare it to the yield on other investments or securities. Generally, high risk securities offer higher expected yields as compensation for the additional risk incurred through ownership of the security. Investors looking to make income or cash flow streams from equity investments commonly look for stocksthat shell out high dividend yields, in other words, stocks that give a relatively large amount of annual cash dividends for a relatively low share price.yearly income (interest or dividends) divided by the current price of the security. This measure looks at the current price ofa bond instead of its face value and represents the return an investor would expect ifhe/ shepurchased the bond and held it for a year. This measure is not an accurate reflection of the actual return thatan investorwill receive in all casesbecause bond and stockprices are continuously changing due to market factors.Capital Appreciation Its the rise in the market price of an asset. Capital appreciation is one of two major ways for investors to profit from an investment in a company. The other is through dividend income.RiskThe risk of investment may be classified in following waysType of RiskInternal Rate of Return RiskMarket riskInflation Risk carelessness RiskBusiness RiskFinancial RiskManagement Risk runniness RiskThe rate of return from investments like equity shares, real estate, and gold can vary rather widely. The risk of investment refers to the variability of its rate of return How much do individual outcomes deviate form t he expected value? A simple measure of dispersion is the range of values, which is simply the difference between the highest and the lowest values. Other measures commonly used in finance are as followsVariance This is the mean of the squares of deviations of individual returns around their average valuesStandard deviationThis is the square root of varianceBeta This reflects how volatile the return from an investment is, in response to market swings.Risk = Actual Return Expected ReturnsConditionIf, Actual Return = Expected Return = Risk set-apart InvestmentIf, Actual Return or first gear Variance (Low Risk) noble Variance (High Risk)ExpectedReturnMarketabilityAn investment is highly marketable or liquid if (a) it can be transacted quickly (b) the transaction cost is low and (c) the price change between two successive transactions is negligible. The liquidity of a market may be judged in terms of its depth, breadth, and resilience. Depth refers to the existence of buy as well as sell orders around the current market price. width implies the presence of such orders in substantial volume. Resilience means that new orders emerge in response to price changes. Generally, equity shares of large, well established companies fuck high marketability and equity shares of small companies in their formative years have low marketability. High marketability is a desirable characteristic and low marketability is an undesirable one.How does one evaluate the marketability of an investment like a thrifty fund deposit which is non-marketable by its very nature? In such a case, the relevant questions of ask is can coitus interruptuss be made or loans be taken against the deposit? Such as investment may be regarded as highly marketable if any of the following conditions are satisfiedA substantial portion of the accumulated balance can be withdrawn without significant penaltyA loan (representing a significant portion of the accumulated balance) can be raised at a rate of inte rest that is only slightly higher than the rate of interest earned on the investment itself.Tax ShelterSome investments provide tax benefits others do not. Tax benefits are of the following three kinds.Initial Tax Benefit An initial tax benefit refers to the tax relief enjoyed at the time of making the investment. For example, when you make a deposit in a Public Provident Fund Account, you get a tax benefit under Section 80 C of the Income Tax Act.Continuing Tax Benefit A continuing tax benefits represent the tax shield associated with the periodic returns form the investment. For example, dividend income and income from certain other sources are tax exempts, upto a certain limit, in the hands of the recipient.Terminal Tax Benefits A terminal tax benefit refers to relief from taxation when an investment is realized or liquidated. For example, a withdrawal from a Public Provident Fund Account is not subject to tax.ConvenienceConvenience broadly refers to the ease with which the inve stment can be made and looked after. Put differently, the questions that we ask to judge convenience areCan the investment be made right away?Can the investment be looked after easily?The degree of convenience associated with investments varies widely. At one end of the spectrum is the deposit in a savings bank account that can be made readily and that does not require any maintenance effort. At the other end of the spectrum is the purchase of a property that may involved a lot of procedural and legal hassles at the time of acquisitions and a great deal of maintenance effort subsequently.A COMPARATIVE STATEMENT OF VARIOUS INVESTMENTS ALTERNATIVESA summary military rank of these investment avenues in terms of key investment attributes is given in Exhibit below. It must be emphasized that within each investment household individual assets display some variations.Exhibit Summary Evaluation of Various Investment AvenuesReturnCurrent yieldCapital appreciationRiskMarketability / Liquid ityTax shelterConvenienceEquity SharesLowHighHighFairly highHighHighNon convertible DebenturesHigh paltryLowAverageNilHighEquity SchemesLowHighHighHighHighVery highDebt SchemesModerateLowLowHighNo tax on dividendsVery highBank depositsModerateNilNegligibleHighNilVery highPublic provident fundNilModerateNilAverageSection 80 C benefitVery highResidentialModerateModerateNegligibleLowHighFairGold and SilverNilModerateAverageAverageNilAverageINVESTMENT VERSUS SPECULATIONWhile it is onerous to draw the line of distinction between investment and speculation, it is possible to broadly distinguish the characteristics of an investor from those of a speculator as follows.InvestorSpeculatorPlanning horizonAn investor has a relatively longer homework horizon. His holding period is usually at least one year.A speculator has a very short planning horizon. His holding may be a few days to a few months.Risk dispositionAn investor is normally not willing to assume more than moderate risk. Rarely d oes he knowingly assume high risk.A speculator is ordinarily willing to assume high risk.Return expectation