Assignment Code: MFP-3/TMA/JAN/2023

Course Code: MFP-3

Assignment Name: Commodity Markets

Year: 2023

Verification Status: Verified by Professor

1. Try to analyse, using practical examples, how different market participants use commodity derivatives to mitigate risk.

Ans) Commodity derivatives are used by a variety of market participants to mitigate risk in different ways. Here are some practical examples:

1. Farmers: Farmers use commodity derivatives to mitigate price risk associated with their crops. For example, a wheat farmer may sell a futures contract for wheat at a fixed price to lock in a price for their crop, even before it is harvested. By doing so, the farmer is protected against a potential price drop in the wheat market. Conversely, if the price of wheat rises, the farmer will not be able to take advantage of the higher prices.

2. Commodity Producers: Commodity producers can use futures contracts to hedge against price fluctuations. For example, an oil company may sell futures contracts for crude oil at a fixed price to lock in a price for their future production. By doing so, the company is protected against a price drop in the oil market. Conversely, if the price of oil rises, the company will not be able to take advantage of the higher prices.

3. Commodity Traders: Commodity traders use derivatives to make profits from price movements. For example, a trader may buy futures contracts for gold if they expect the price of gold to increase or sell futures contracts if they expect the price of gold to decrease. By doing so, the trader can make a profit if their prediction is correct. However, if the price of gold moves against their prediction, the trader could suffer losses.

4. Consumers and Manufacturers: Commodity consumers and manufacturers use derivatives to hedge against price volatility. For example, a chocolate manufacturer may buy cocoa futures contracts at a fixed price to lock in the cost of their raw materials. By doing so, the manufacturer is protected against potential price increases in the cocoa market. Conversely, if the price of cocoa decreases, the manufacturer will not be able to take advantage of the lower prices.

In summary, commodity derivatives are used by a range of market participants to mitigate different types of risk associated with price movements in commodity markets. These participants can use derivatives to lock in prices, protect against price drops, make profits from price movements, and hedge against price volatility.

2. Discuss the features and functionalities of the user interface for trading in commodity futures on the electronic online trading system of MCX.

Ans) The user interface for trading in commodity futures on the electronic online trading system of MCX (Multi Commodity Exchange) is designed to provide a seamless trading experience to traders.

Here are some of the key features and functionalities of the user interface:

1. User-friendly Interface: The user interface is designed to be user-friendly and easy to navigate. Traders can easily access various features and functionalities through a single dashboard.

2. Real-time Market Data: Traders can access real-time market data for different commodities such as gold, silver, crude oil, etc. This data includes live prices, historical charts, and other relevant information that traders need to make informed trading decisions.

3. Order Management: The user interface allows traders to place different types of orders such as market orders, limit orders, stop-loss orders, etc. Traders can also modify or cancel their orders as needed.

4. Trading Tools: The user interface provides various trading tools such as technical analysis tools, trading signals, and other features that can help traders analyse the market and make better trading decisions.

5. Alerts and Notifications: The system sends alerts and notifications to traders to keep them informed about market events, price movements, and other relevant information.

6. Security and Authentication: The user interface provides secure login and authentication features to ensure the safety of traders' information and trading activities.

7. Support and Assistance: Traders can access support and assistance through various channels such as chat, email, or phone. The platform also provides online resources such as tutorials, guides, and FAQs to help traders get started.

Overall, the user interface for trading in commodity futures on the electronic online trading system of MCX is designed to be user-friendly, intuitive, and secure. It provides traders with real-time market data, trading tools, order management features, and other functionalities that can help them make informed trading decisions and manage their risk effectively.

3. Discuss the trends in Gold trade during the past 5 years. Also analyse the major policy changes that have taken place in this.

Ans) Gold trade has been impacted by various global and domestic factors over the past five years. Here are some of the key trends in gold trade during this period:

1. Price Volatility: The price of gold has been volatile over the past five years, with fluctuations caused by various factors such as changes in interest rates, geopolitical tensions, and economic uncertainty.

2. Increase in Demand: Despite the price volatility, demand for gold has increased in recent years due to its perceived safe-haven status. This has been driven by factors such as geopolitical tensions, economic uncertainty, and the Covid-19 pandemic.

3. Shift Towards Digital Gold: There has been a growing trend towards digital gold, with investors increasingly opting for gold-backed exchange-traded funds (ETFs) and other digital gold products. This has made it easier for investors to buy and sell gold without having to physically hold the metal.

4. Increase in Gold Smuggling: There has been a rise in gold smuggling in recent years, particularly in India, due to high import duties and restrictions on gold imports.

In terms of policy changes, there have been several significant developments in gold trade over the past five years:

1. Demonetization: In November 2016, the Indian government demonetized high-value currency notes, which had a significant impact on the gold trade. The move led to a surge in gold prices in the short term, as people rushed to buy gold with their old currency notes.

2. GST Implementation: In July 2017, the Indian government implemented the Goods and Services Tax (GST), which had an impact on the gold trade. The GST rate for gold was set at 3%, which initially led to a decline in demand. However, demand later recovered as consumers adjusted to the new tax regime.

3. Gold Monetization Scheme: In November 2015, the Indian government launched the Gold Monetization Scheme, which aimed to mobilize gold held by households and institutions in the country. The scheme allows individuals to deposit their gold and earn interest on it, while the government can use the gold to meet its domestic needs.

4. Changes in Import Duties: The Indian government has made several changes to import duties on gold over the past five years, in an effort to control the trade deficit. Import duties were increased to 12.5% in July 2019, but were subsequently reduced to 7.5% in October 2020.

Overall, the gold trade has been impacted by various global and domestic factors over the past five years, with significant policy changes aimed at controlling the trade deficit and promoting domestic gold mobilization.

4. What is ‘Emission Trading’? Explain the use of Futures on Carbon Credits for mitigating risk of increasing costs in pollution control. Also discuss the present status of ‘Emission Trading’ in India.

Ans) Emission trading is a market-based mechanism used to reduce pollution by allowing companies to buy and sell emission credits. Companies that emit less than their allocated limit of pollution can sell their excess credits to those that exceed their limits, thus creating an incentive for companies to reduce their emissions.

Futures on carbon credits are financial instruments that allow companies to hedge against the risk of increasing costs in pollution control. These futures contracts allow companies to buy or sell a certain amount of carbon credits at a future date and a pre-determined price, which can help them to manage their exposure to price fluctuations in the carbon credit market.

In India, the concept of emission trading is relatively new, and the government has taken several steps to promote the use of carbon credits. In 2010, the National Action Plan on Climate Change was launched, which included a National Mission on Enhanced Energy Efficiency, aimed at reducing energy consumption and promoting the use of renewable energy sources. The government has also introduced various policies and incentives to encourage the use of clean energy, such as the National Solar Mission and the National Wind Energy Mission.

In 2016, the Ministry of Environment, Forest and Climate Change released the draft of the Carbon Pricing Policy, which aimed to create a market for carbon credits in India. The policy proposed a market-based mechanism for controlling emissions, which would allow companies to trade carbon credits and incentivize them to reduce their emissions.

However, the implementation of emission trading in India has been slow, and there is currently no active carbon trading exchange in the country. The government is currently working on developing a framework for carbon trading, and several pilot projects have been launched in different parts of the country to test the feasibility of emission trading.

In conclusion, emission trading is a market-based mechanism that can help to reduce pollution by incentivizing companies to reduce their emissions. Futures on carbon credits can be used to manage the risk of increasing costs in pollution control. While the concept of emission trading is still in its early stages in India, the government is taking steps to promote the use of carbon credits and create a market for emission trading.

5. Describe the application of long and short Hedge in managing risk using commodity futures with the help of suitable examples.

Ans) Hedging is a risk management strategy used by traders and investors to protect themselves against price movements in the underlying asset. There are two types of hedges, namely long hedge and short hedge, which are used depending on the type of exposure that needs to be hedged.

A long hedge is used when a trader or investor has a long position in the underlying asset and wants to protect themselves against a potential price decline. In this case, the trader can take a short position in the futures market to offset the potential loss in the underlying asset. For example, a farmer who has planted wheat but is concerned about a fall in wheat prices can take a short position in wheat futures to protect themselves against a decline in wheat prices.

A short hedge, on the other hand, is used when a trader or investor has a short position in the underlying asset and wants to protect themselves against a potential price increase. In this case, the trader can take a long position in the futures market to offset the potential loss in the underlying asset. For example, a jeweller who has sold gold jewellery but is concerned about a rise in gold prices can take a long position in gold futures to protect themselves against an increase in gold prices.

Let's take another example to understand the application of long and short hedge in managing risk using commodity futures. Suppose an airline company is concerned about rising fuel prices and wants to hedge against the risk of higher fuel costs. The company can take a long position in crude oil futures to protect themselves against a potential increase in fuel prices. If the price of crude oil rises, the company will be able to offset the increased cost of fuel by making a profit on the long position in crude oil futures.

On the other hand, a refinery company may want to hedge against the risk of falling crude oil prices. In this case, the company can take a short position in crude oil futures to protect themselves against a potential decline in crude oil prices. If the price of crude oil falls, the company will be able to offset the loss in the value of their crude oil inventory by making a profit on the short position in crude oil futures.

In conclusion, long and short hedges are used in managing risk using commodity futures depending on the type of exposure that needs to be hedged. A long hedge is used to protect against a potential price decline in the underlying asset, while a short hedge is used to protect against a potential price increase. By taking positions in the futures market, traders and investors can hedge against price movements in the underlying asset and protect themselves against potential losses.