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A DISSERTATION ON TITLE

ROLE OF RMC FOR CONTROLLING RISKS IN FUTURE COMMODITY MARKET


SUBMITTED IN PARTIAL FULFILLMENT OF THE AWARD OF PGDM CURRICULUM BYRAGHAV GOEL PGDM (2008-2010)

UNDER GUIDANCE OF DR. RAGHVENDRA DWIVEDI

INSTITUTE OF TECHNOLOGY & SCIENCE

MOHAN NAGAR, GHAZIABAD. (2008 10)

Certificate

Certified that Raghav Goel has carried out the Dissertation work presented in this thesis entitled ROLE OF RMC FOR CONTROLLING RISKS IN FUTURE COMMODITY MARKET for the award of PGDM from Institute of Technology and Science under my supervision. The Dissertation embodies result of original work and studies carried out by student himself and the contents of the thesis do not form the basis for the award of any other degree to the candidate or to anybody else.

(Dr.Raghvendra Dwivedi) Faculty ITS-Ghaziabad

Date:

ACKNOWLEDGEMENT
For any research project to be undertaken there has to be certain amount of inputs provided through inspiration, motivation and creativity by people and friends. While the number of people who have influenced, supported and guided me in the effort are too numerous. But after completing it, I have realized that it has filled us with beneficial experiences, enormous knowledge & many pleasant memories.

I would also like to thank Dr. Raghwendra Dwivedi (academic mentor) for being a continuous source of inspiration without whose support and guidance this project would not have got its desirable shape. Finally, I would like to express my gratitude to my mentor who has helped me with the much needed support during the dissertation period.

ABSTRACT
This dissertation research was carried out as a part of PGDM curriculum where in I tried to understand the Risk Management policy, procedures & practices (considering regulatory requirements & market competition) adopted and implemented by

commodity broking business houses to take care & control the business risk of the company & its constituents. It enlights various risk management techniques followed by different organizations. The commodity market has witnessed a rampant growth during the last couple of years, and managing risk is essential because of higher risk in commodity market in comparison to equity markets. It will also help the investors to understand various risk factors to which they are exposed.

Need for RMS:Risk is an integral part of any business & it need not necessarily lead to an adverse result. In commodity broking market, not only commodities are traded; in the process, RISK and RETURN are also traded and there is a trade off between the risk and the return.

Risk taking is essential to an active commodity market and legitimate risk taking should not be unnecessarily or unduly avoided, therefore, a good commodity broking outfit necessarily requires a robust & efficient risk management system as an integral part of its effective business model with an objective to meet the competition & the expectation of clients yet it should be able to control the business risks effectively including statutory, Exchange & FMC compliances.

CHAPTERISATION SCHEME
1) Objectives and Scope of the study. 2) Evolution of commodity market. 3) Introduction to commodity market. 4) Introduction to risk management. 5) Risk controlling policies. 6) Modus operandi of RMC 7) Role of risk management cell. 8) Conclusion 9) Bibliography

CHAPTER-1 Objectives and Scope of the study

OBJECTIVE
To know & to understand the Risk Management policy, procedures & practices (considering regulatory requirements & market competition) adopted and implemented by commodity broking business houses to take care & control the business risk of the company & its constituents.

SCOPE

The scope of the study is very wide as it enlights various risk management techniques followed by different organizations. The commodity market has witnessed a rampant growth during the last couple of years, and managing risk is essential because of higher risk in commodity market in comparison to equity markets. It will also help the investors to understand various risk factors to which they are exposed. Moreover it will certainly helpful to the students as it would make them acquaint with risk control policies before going ahead.

RESEARCH DESIGN
DATA
SECONDARY DATA- It means the data which is primarily available i.e. refer to the data which have already been collected and analyzed by someone else, which is collected by various sources. In my report mainly the secondary data has been used, and it has been collected primarily from websites, and to some extent from articles published in newspapers, magazines, journals.

AREA OF STUDY
The area of study is not specified.

RESEARCH PROBLEM
The research problem is that how risk management cell encompasses capital

adequacy of clients, adequate margin requirements, limits on exposure and turnover, online position monitoring and automatic disablement

TYPE OF RESEARCH
The type of research used- descriptive research.

SOFTWARE USED

Ms Word

CHAPTER 2 Evolution of commodity market

EVOLUTION OF COMMODITY MARKET IN INDIA

When did Commodity Futures market begin in India, and how did it grow over the decades?
Organized futures market evolved in India by the setting up of Bombay Cotton Trade Association Ltd in 1875.

In 1893, following widespread discontent amongst leading cotton mill owners and merchants over the functioning of the Bombay Cotton Trade Association, a separate association by the name Bombay Cotton Exchange Ltd was constituted. Futures trading in oilseeds were organized in India for the first time with the setting up of Gujarati Vyapari Mandali in 1900, which carried on futures trading in groundnut, castor seed and cotton. Before the Second World War broke out in 1939 several futures markets in oilseeds were functioning in Gujarat and Punjab.

Futures trading in Raw Jute and Jute Goods began in Calcutta with the establishment of the Calcutta Hessian Exchange Ltd., in 1919. Later East Indian Jute Association Ltd. was set up in 1927 for organizing futures trading in Raw Jute. These two associations amalgamated in 1945 to form the present East India Jute & Hessian Ltd., to conduct organized trading in both Raw Jute and Jute goods. In case of wheat, futures markets were in existence at several centres at Punjab and U.P. The most notable amongst them was the Chamber of Commerce at Hapur, which was established in 1913. Other markets were located at Amritsar, Moga, Ludhiana, Jalandhar, Fazilka, Dhuri, Barnala and Bhatinda in Punjab and Muzaffarnagar, Chandausi, Meerut, Saharanpur, Hathras, Ghaziabad, Sikandrabad and Bareilly in U.P.

Futures market in Bullion began at Mumbai in 1920 and later similar markets came up

at Rajkot , Jaipur, Jamnagar , Kanpur, Delhi and Calcutta. In due course several other exchanges were also created in the country to trade in such diverse commodities as pepper, turmeric, potato, sugar and gur(jaggory).

After independence, the Constitution of India brought the subject of "Stock Exchanges and futures markets" in the Union list. As a result, the responsibility for regulation of commodity futures markets devolved on Govt. of India. A Bill on forward contracts was referred to an expert committee headed by Prof. A.D.Shroff and Select Committees of two successive Parliaments and finally in December 1952 Forward Contracts (Regulation) Act, 1952, was enacted.

The Act provided for 3-tier regulatory system:-

(a) An association recognized by the Government of India on the recommendation of Forward Markets Commission, (b) The Forward Markets Commission (it was set up in September 1953) and (c) The Central Government.

Forward Contracts (Regulation) Rules were notified by the Central Government in July 1954

The Act divides the commodities into 3 categories with reference to extent of regulation, viz:

(a) The commodities in which futures trading can be organized under the auspices of recognized association. (b) The Commodities in which futures trading is prohibited. (c) Those commodities, which have neither been regulated for being traded under the recognized association nor prohibited, are referred as Free Commodities and the

association organized in such free commodities is required to obtain the Certificate of Registration from the Forward Markets Commission.

In the seventies, most of the registered associations became inactive, as futures as well as forward trading in the commodities for which they were registered came to be either suspended or prohibited altogether.

The Khusro Committee (June 1980) had recommended reintroduction of futures trading in most of the major commodities, including cotton, kapas, raw jute and jute goods and suggested that steps may be taken for introducing futures trading in commodities, like potatoes, onions, etc. at appropriate time. The government, accordingly initiated futures trading in Potato during the latter half of 1980 in quite a few markets in Punjab and Uttar Pradesh.

After the introduction of economic reforms since June 1991 and the consequent gradual trade and industry liberalization in both the domestic and external sectors, the Govt. of India appointed in June 1993 one more committee on Forward Markets under Chairmanship of Prof. K.N. Kabra.

The Committee submitted its report in September 1994. The majority report of the Committee recommended that futures trading be introduced in:

1) Basmati Rice 2) Cotton and Kapas 3) Raw Jute and Jute Goods 4) Groundnut, rapeseed/mustard seed, cottonseed, sesame seed, sunflower seed, safflower seed, copra and soybean, and oils and oilcakes of all of them. 5) Rice bran oil 6) Castor oil and its oilcake

7) Linseed 8) Silver 9) Onions.

The committee also recommended that some of the existing commodity exchanges particularly the ones in pepper and castor seed may be upgraded to the level of international futures markets.

The liberalized policy being followed by the Government of India and the gradual withdrawal of the procurement and distribution channel necessitated setting in place a market mechanism to perform the economic functions of price discovery and risk management.

The National Agriculture Policy announced in July 2000 and the announcements of Finance Minister in the Budget Speech for 2002-2003 were indicative of the Governments resolve to put in place a mechanism of futures trade/market. As a follow up the Government issued notifications on 1.4.2003 permitting futures trading in the commodities, with the issue of these notifications futures trading is not prohibited in any commodity. Options trading in commodity are, however,presently,prohibited.

CHAPTER-3 Introduction to commodity market

INTRODUCTION TO COMMODITY MARKET IN INDIA

The commodity market is a market, where commodities are bought and sold. The commodity market differs from a regular market by a specific organizational form of trading according to established rules. The main function of the commodity exchange is assurance of regular communication between buyers and sellers, when transactions are carried out with available batches of goods. The exchange, while developing, started establishing trade customs, commodity standards, standard contracts, performing price quotations, resolving dispute, etc. Commodity Markets and Commodity Futures are a mechanism for hedging. The leverage in trading commodity markets is impressive. A community must somehow believe that the commodity instrument is real, enforceable, and well worth paying for. The law of demand and it's application to fundamental analysis of commodities rests upon an understanding of consumer behavior. In the commodity futures exchanges the peak value of trading have touched Rs 15,000 crores on some days with the average around of Rs 6,000 crores. Open interests in certain commodities such as gold, silver, rubber, pepper, soya are also substantial. The modern commodity markets have their roots in the trading of agricultural products For centuries, sugar has been a highly valued and widely traded commodity. The main advantages of a call option are protection against higher prices, limited liability with no margin deposits, and the potential to benefit from lower cash prices. The National Commodity Derivatives Exchange (NCDEX) has emerged as the largest commodity futures exchange. The policy vision of the Indian commodity futures markets is converting India into a global hub at least in the major commodities in the economy. Freedom in the commodity futures market was won after long, pitched battles. Cash prices are the prices for which the commodity is sold at the various market locations. The futures price represents the current market

opinion of what the commodity will be worth at some time in the future. The Government of India recognized three nation-wide multi commodity exchanges to promote a healthy, competitive futures market. It was rightly presumed that there is room for multiple players to grow in size and stature in the huge commodity economy of India. Many people have become very rich in the commodity markets. It is one of a few investment areas where an individual with limited capital can make extraordinary profits in a relatively short period of time. For example, Richard Dennis borrowed $1,600 and turned it into a $200 million fortune in about ten years. Nevertheless, because most people lose money, commodity trading has a bad reputation as being too risky for the average individual. The truth is that commodity trading is only as risky as you want to make it. Those who treat trading as a get-rich-quick scheme are likely to lose because they have to take big risks. If you act prudently, treat your trading like a business instead of a giant gambling casino and are willing to settle for reasonable return, the risks are acceptable. The probability of success is excellent. The process of trading commodities is also known as futures trading. Unlike other kinds of investments, such as stocks and bonds, when you trade futures, you do not actually buy anything or own anything, you are speculating on the future direction of the price in the commodity you are trading. This is like a bet on future price direction. The terms buy and sell merely indicate the direction you expect future prices will take. If, for instance you were speculating in wheat, you would buy a futures contract if you thought the price would be going up in the future. You would sell a futures contract if you thought the price would go down. For every trade, there is always a buyer and a seller. Neither person has to won any wheat to participate. He must only deposit sufficient capital with a brokerage firm to insure that he will be able to pay the losses if his trades lose money in addition to speculators, both the commoditys commercial producers and commercial consumers also participate. The principal economic purpose of the futures markets is for these commercial participants to

eliminates their risk from changing prices on one side of a transaction may be a producer like a farmer. He has the field full of wheat growing on his farm. It wont be ready for harvest for another three months. If he is worried about the price going down during that time, he can sell futures contracts equivalent to the size of his crop and deliver his wheat to fulfill his obligation under the contract. Regardless of how the price of wheat changes in the three months until his crop will be ready for delivery, he is guaranteed to be paid the current price.On the other side of the transaction might be a producer such as a cereal manufacturer who needs to buy lots of wheat. The manufacture, such as HLL, may be concerned that in the next three months the price of wheat will go up, and it will have to pay more than the current price. To protect against this, HLL can buy futures contracts at the current price. In three months HLL can fulfill its obligation under the contracts by taking delivery of the wheat. This guarantees that regardless of how the price moves in the next three months.. HLL will pay no more than the current price for its wheat. In addition to agricultural commodities, there are futures for financial instruments and intangibles such as currencies, bonds and stock market indexes. Each futures market has producers and consumers who need to hedge their risk from future price changes. The speculators, who do not actually deal in the physical commodities, as where to provide liquidity. This maintains an orderly market where price changes from one trade to the next are small. Rather than taking delivery or making delivery, the speculator merely offsets his position at some time before the date set for future delivery. If price has moved in the right direction, he will profit. If not, he will lose.

Commodity
Any goods that are unbranded and are commonly traded in the market come under commodities.

Commodity Market:
Commodity markets are quite like equity markets. The commodity market also has two constituents i.e. spot market and derivative market. In case of a spot market, the commodities are bought and sold for immediate delivery. In case of commodities are bought and sold for immediate delivery. In case of a commodities derivative market, various financial instruments having commodities as underlying are traded on the exchanges. It has been seen that traditionally in India people have hedged their risks with Gold and Silver. Commodity markets are markets where raw or primary products are exchanged. These raw commodities are traded on regulated commodities exchanges, in which they are bought and sold in standardized Contracts.

Market Structure

Ministry of consumer affairs, food & public distribution

Forward Market Commission

Online Exchanges

Outery Exchanges

MCX Mumbai

NCDEX Mumbai

NMCE Ahmadabad

NBOT Indore

Reasons why commodity markets have a bright future


Agriculture 26%of GDP Agricultural commodities thrivin Huge domestic consumption Worlds largest importer of gold, edible oils

Third largest producer of cotton Leading coffee/tea/sugar producer

Commodity trading:
Commodity trading in India is regulated the forward markets commotions (FMC)

headquartered at Mumbai; it is a regulatory authority which is overseen by th3e ministry of consumer affairs and PUBLIC Distribution, govt. of India. It is a statutory body set up in 1953 under the Forward Contracts (Regulation) Act, 1952. after equity, trading commodity is going to be the next big thing for investors. In India people have a love for Gold and silver, trading is also going to pick up in Gold and Silver. Globally, the commodity trade market is about three times the size of equities trade market. In India, presently, the commodities market is still in a nascent stage and is gradually picking up taking a cue from global markets.

Commodities future
Commodity future is a derivative instrument for the future delivery of a commodity on a fixed date at a particular price. The underlying in this case is a particular commodity. In an investor purchases an oil future, he is entering into a contract to the contract expiry date. The fixed quantity is called the contract size. These futures can be bought and sold on the commodity exchanges. The commodities include agricultural commodities like wheat, rice, tea, jute, spices Soya, groundnut, coffee, rubber, cotton, etc, precious metalsgold and silver, base metals iron ore, lead, aluminum, nickel, zinc, etc, and energy

commodities crude oil and coal. The number of retail invertors participating in the market in increasing gradually after the introduction of commodities futures. The expected growth rate of commodity market is 40 percent annually over the next five years.

Benefits of trade in commodities


Driven by demand and supply True reflector of economic activity Impervious to intangibles like management quality Not impacted by performance or results Physical settlement of futures Global market

Benefits of commodities futures:


To producer
A producer of a commodity can sell the futures of the commodity, thereby ensuring that he can sell a particular quantity of his commodity at a particular price at a particular date.

To investors
An investor has alternative investment instruments where he can take a position as to future price and the spot price at a particular date in future and buys and sells options. He is not interested in taking deliveries of the commodities.

To commodity trader
A commodity trader can use these to ensure that he is protected against any adverse changes in the price. He can enter into a futures contract for purchase of a certain quantity of the underlying at a particular price on a particular date, or he can enter into a futures contract for sale of a particular quantity on a particular date at a particular price and be assured of the margins because both his purchase price as well as the sale price are fixed. Traders do a good arbitrage in Gold and Silver. Whenever they find Gold moving up, they short silver and similarly whenever they find silver moving up and gold likely to move down, they hedge.

To exporters
Future trading is very useful to the exporters as it provides an advance indication of the price likely to prevail and thereby help the exporter in quoting a realistic price and thereby secure export contract in a competitive market. Having entered into an export contract, it enables him to hedge his risk by operating in futures market.

PRODUCTS

Bullion: - Gold, Silver

Oil and Oil Seeds: - Soya, castor seed, mustard

Spices: - Pepper, jeera, chilly, turmeric

Metals: - copper, tin, nickel, steel, zinc

Fiber: - Long staple cotton, medium staple cotton

Pulses: - chana, yellow peas, masur

Cereals: - Rice, wheat, maize

Energy: - Crude Oil, Brent crude oil

Plantations: - Rubber, cashew

Others: - Plastics, menthe oil, coffee, sugar, guar

Characteristics of commodity

A commodity has value, which represents a quantity of human labor. The fact that is has value implies straightway that people try to economize its use. A commodity also has a use value, an exchange value and a price. It has an exchange value, meaning that a commodity can be traded for other commodities, and thus give its owner the benefit of others labor (the labor done to produce the purchased commodity). Price is then the monetary expression of exchange-value (but exchange value could also be expressed as a direct trading ratio between two commodities without using money). It has a use value because, by its intrinsic characteristics, it can satisfy some human need or want, physical or ideal. By nature this is a social use value, i.e. the object is useful not just to the producer but has a use for others generally.

According to the labor theory of value, product-values in an open market are regulated by the average socially necessary labor time required to produce them, and price relativities are ultimately governed by the law of value.

Commodity trading as an investment vehicle


As an investment vehicle over other investment alternatives such as savings accounts, stocks, bonds, options, real estate and collectibles. Of its in a short period of time. The reason that futures trading can be so profitable is leverage. White profits can be large in commodity trading, it is not easy to make consistently correct decisions about what and when to buy and sell. Commodity speculation offers an important advantage over such illiquid vehicles as real estate and collectibles. The balance in your account is always available. If you maintain sufficient margin, you can even spend your current profit on a trade without closing out the position. With stocks, bonds and real estate, you cant spend your gains until you actually sell the investment. As you will see, commodity trading is

not particularly complicated. Unlike the stock market where there are over ten thousand potential stocks and mutual funds, there are only about forty viable futures markets to trade. Those markets cover the gamut of market sectors, however, so you can diversify throughout all important segments of the world economy. In futures trading, it is as easy to sell (also referred to as going short) as it is to buy (also referred to as going long). By choosing correctly, you can make money whether prices go up or down. Therefore, trading a diversified portfolio of futures markets offers the opportunity to profit from any potential economic scenario. Regardless of whether we have inflation or deflation, boom or depression, hurricanes, droughts, famines or freezes, there is always the potential for profit trading commodities. There are even tax advantages to making your money from futures trading. Regardless of the actual holding period, commodity profits are automatically taxed as sixty percent long-term capital gains and forty percent short-term capi9tal gains. The current maximum capital gains rate is thirty-three percent, somewhat less than the maximum rate for ordinary income. To the extent that capital gains tax rates are reduced in the future, commodity traders will benefit. If a distinction is re-established so that taxes on long-term gains are lower than on short-term gains, commodity traders will benefit.

CHAPTER-4 Introduction to risk management

RISK MANAGEMENT

What are the risk factors?

Commodity trading is done in the form of futures and that throws up a huge potential for profit and loss as it involves predictions of the future and hence uncertainty and risk. Risk factors in commodity trading are similar to futures trading in equity markets.

Risk Management System


Need for RMS:Risk is an integral part of any business & it need not necessarily lead to an adverse result. In commodity broking market, not only commodities are traded; in the process, RISK and RETURN are also traded; and, there is a trade off between the risk and the return.

Risk taking is essential to an active commodity market and legitimate risk taking should not be unnecessarily or unduly avoided, therefore, a good commodity broking outfit necessarily requires a robust & efficient risk management system as an integral part of its effective business model with an objective to meet the competition & the expectation of clients yet it should be able to control the business risks effectively including statutory, Exchange & FMC compliances. Considering these objectives in mind RCL has framed its risk management policy which is reviewed & revised from time to time & is reproduced as under :-

Risk Management System-Process


Identification of area of risk Analysis of factors/reasons causing risk Planning for control of risks associated with the business Strategic decision making for risk management tools and its implementation Measuring results Continuous Improvement

ROLE OF RMC
Monitoring of Clients Position and Margin Preparation and circulation of Margin Report on daily basis and following it up with Branches. Keeping Track of the Daily MTM losses and coordinating with branches to top up the margin shortfall. Liquidating Positions of Clients in case of non-arrangement of funds. Trade facilitation - setting parameters onto Trading Platform.

Risk Management System


Identification of area of risk Analysis of factors/reasons causing risk Planning for control of risks associated with the business Strategic decision making for risk management tools and its implementation Measuring results Continuous Improvement

ROLE OF RISK MANAGEMENT CELL Monitoring of Clients Position and Margin Preparation and circulation of Margin Report on daily basis and following it up with Branches. Keeping Track of the Daily MTM losses and coordinating with branches to top up the margin shortfall. Liquidating Positions of Clients in case of non-arrangement of funds. Trade facilitation - setting parameters onto Trading Platform. Support in relation to Trading / Back office / Exchange related compliance.