CHAPTER 9

COMMODITY MARKET

LEARNING OUTCOMES
After going through the chapter student shall be able to understand:
 Introduction of Commodity Markets
 Role of Commodity Markets
 Commodity Market in India

 Application of derivative in commodities

 Global Commodities Exchanges

©The Institute of Chartered Accountants of India

 9.2 FINANCIAL SERVICES AND CAPITAL MARKETS

CHAPTER OVERVIEW

Introduction

Influence of Commodity Market on

Prices

Role of Commodity Market

Negative Impact of Speculation

Commodity Market

Problems

Commodity Market in India Regulatory Scenario

Application of Derivative in
Way Forward
Commodities

Important Terms used in Commodity

Market

Global Commodity Exchanges

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.3

1. INTRODUCTION
Like financial markets which deal with money and shares, the commodity markets deal with trading
of ‘commodities’ like metals, raw material commodities like cotton, pulses etc. In fact, the commodity
market is the foremost form of market which was structured more of a barter of commodity
exchanges – usually dissimilar products – which later got one leg as money as time progressed. The
contemporary commodity market is as sophisticated as its stock market counterpart, with the only
distinction being commodities, instead of stocks, traded.
The commodity market is essential to understand how the prices get influenced by many factors
ranging from monsoon predictions to political decisions. The commodity market acts as the
barometer of how the markets perceive these factors, which in turn will impact the demand-supply
dynamics, thereby influencing the futures prices. This leads to a market driven price discovery
mechanism.
For example, a farmer will be very much interested to ‘lock in’ prices for his harvest of pulses next
crop season due in 3 months. Hence, he would ‘sell’ an estimated quantity, say 100 kilograms (kg.)
of his future produce at the future rate of ` 80 per kg, thereby assuring himself of a fixed price. A
wholesaler in pulses would similarly like to have a committed purchase price and would enter the
‘buy’ leg (futures long) at ` 80 per kg. Assume after 3 months, the contract closes out at 81 per kg.
That means the farmer has lost ` 1 per kg whereas the wholesaler has gained by Re 1 per kg. in
the futures contract. Of course, the contracts are settled in cash – rarely there is actual physical
delivery of the commodities involved.

2. ROLE OF COMMODITY MARKETS

Since ancient times people used to trade in primary commodities like cotton, spices, and livestock.
The traders used to engage in futures with the time frame normally that of the harvest duration. Later
with the advent of the Industrial Revolution, people started trading in base metals. In the 2000s, the
matured economies of US and UK also started to have exchange traded commodities (ETCs) and
exchange traded funds (ETFs).

©The Institute of Chartered Accountants of India

 9.4 FINANCIAL SERVICES AND CAPITAL MARKETS

The major role of the early commodity markets was to:

a) Act as a platform for enabling farm produce growers and the end buyers to interact.
b) Enabling intermediaries to engage in representing both the demand and the supply side of
the commodity chain.

c) Price discovery.
Even today the above characteristics hold good in commodity exchanges. The added feature is of
course, a regulated market that is transparent, and real time.

2.1 Influence of commodity markets on prices

Commodity markets influence prices at two levels:
a) Enabling as a platform for both demand and supply factors to determine the prices for a
particular commodity or grade of a particular commodity.
b) Acting as an indicator for produce growers to take informed decision on which product to grow
to reap better prices.
Essentially both the above objectives culminate in price discovery.
However, it’s very important that the information that is getting used to determine the price is real
time and transmitted across markets. In structured markets, the market prices are close to the ‘fair
value’ prices.

2.2 Negative Impact of Speculation

The bane of the commodity market is speculation driven trades and short selling done to gain short-
term profits. Precious metals like gold and diamond attract speculative investors given the hedge
value of these assets. In some cases, there are also instances of black money and money laundering
that mires the true features of an efficient commodity market. A report released by World Bank in
2012 has laid the blame that ‘food prices globally soared by 10 percent’ squarely on the want on
speculative trades executed in parts of the globe.
Speculation cannot be ended in any market; however, it can be regulated, and offenders treated
with high penalties. The European Securities and Markets Authority (ESMA), based in Paris and
formed in 2011, is an "EU-wide financial markets watchdog", which aims at orderly pricing and
settlement conditions. The individual exchanges also have brought their own checking mechanisms
like position limits, trade cutoffs, etc. to discourage pure arbitrage traders.

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.5

3. COMMODITY MARKET IN INDIA

3.1 Indian Commodity Markets
MCX (Multi Commodity Exchange of India Limited) and the NCDEX (National Commodity &
Derivatives Exchange Limited) are the primary commodity trading platforms in India. MCX is a
commodity futures exchange started in 2003 and is listed on the BSE. NCDEX is another exchange
that is promoted jointly by LIC, NABARD, etc. and has a robust online trading system.
The National Multiple Commodity Exchange (NMCE) started its operations on November 26, 2002,
as the country’s first, online, demutualized, multi-commodity exchange with nationwide reach. It not
only revived futures trade electronically in the commodities in India after a gap of 41 years, but also
integrated the centuries old commodity market with the latest technology. It is backed by compulsory
delivery-based settlement to ensure transparent and fair-trade practices. NMCE offers an electronic
platform for future trading in plantation, spices, food grains, non-ferrous metals, oil seeds and their
derivatives.
NCDEX started its first agricultural index — ‘Dhanya’ — in 2012, which was later named ‘N-Krishi’
but this index was not tradable.
The National Commodity and Derivatives Exchange (NCDEX) in May 2020 launched the
country’s first agricultural futures trading index — ‘Agridex’ — with four contracts expiring in June,
July, September, and December. This agriculture index is based on the revised guidelines issued
by the Securities and Exchange Board of India, which allowed futures trading in commodity indices.
Agridex, launched on 25 May 2020 comprises 10 liquid commodities traded on NCDEX. The spot
and future of these 10 commodities — soybean, chana, coriander, cottonseed oilcake, guar gum,
guar seed, mustard seed, refined soy oil, castor seed and jeera — will define the value of this index.
The index represents various agricultural commodities of both kharif and rabi seasons, with price
references throughout the year. Agridex will also facilitate the participants in hedging their
commodity risk based on price anticipation of the products.

In the present times, due to disruption in domestic business and exports, the volumes of individual
commodities listed under Agridex have remained low. However, for Agridex the only factor that is
important for the index is the overall market sentiment for the agricultural sector as it’s not just
dependent on a single agricultural commodity.
For example, if soybean mandi across the country remains closed but other commodity mandis are
open, the trading activities for soybean may remain low in futures as a commodity, but trading in the
Agridex, which is an overall index, will not be affected as other commodities trade will move it.

©The Institute of Chartered Accountants of India

 9.6 FINANCIAL SERVICES AND CAPITAL MARKETS

The Agridex futures exchange will also help market participants to take advantage of generating
returns with less risk and excessive research because they do not have to research individual
commodities. For trading on Agridex, one needs to only know specific news or reports about
agricultural commodities to get a sense of the price direction.
This is like the equity market wherein participants trade at the NIFTY index as Agridex also has a
base value of 1,000. Agridex also provides an opportunity for those already trading in equity markets
as well as with farm produce organisations, farmers, retail traders and others. (Source: The Print)

The below is a screen shot of the same –

3.2 Problems with the Indian Commodity Markets

The Indian markets have been plagued by the ‘speculator’ and ‘fly-by-night’ operators. The Chairman
of the now defunct NSEL (National Spot Exchange Limited) had to be arrested for having entered
futures markets without adequate documentation – many commodities that were traded didn’t have
any underlying to them. SEBI has passed tough strictures on fresh forward contracts in the
commodity markets in Feb 2016, and it has derecognized OTCEI (Over-the-counter exchange of
India).

Another big problem is that the commodity markets have not been able to see the ‘exponential’
growth that is required for platforms to sustain it. The basic problem is ‘inclusion’ – farmers that form
the backbone of agri-based commodities are not able to connect to the market, even though both
MCX and NCDEX have created several awareness programs towards the same.

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.7

Political ramifications have also added to the woes – price sensitive commodities like sugar have
been on and off the futures platform.

3.3 Way Forward

The commodity markets in India have a long way to go to become globally competent. There is a
persisting need to close the chain between farmers to markets, which is even more challenging given
that the hold of intermediaries is too strong in Indian scenario. An impetus from the government is
also required to both educate and popularize the adoption of commodity markets in India.

3.4 Regulatory scenario in India

In India, the Forward Markets Commission (FMC) was the chief regulator of commodity futures
markets in India before it got merged with SEBI. The government, considering it wise to bring the
commodity market under a common regulator, repealed the Forward Contracts Regulation Act
(FCRA) 1952 and the regulation of commodity derivatives market shifted to Securities and Exchange
Board of India (SEBI) under Securities Contracts Regulation Act (SCRA) 1956 with effect from 28th
September 2015.

4. APPLICATION OF DERIVATIVE IN COMMODITIES

4.1 Difference between Commodity Markets and Financial Markets
It should be noted that following are some of the differences between commodity and financial
derivatives:
(i) Storage Cost: Commodities, especially agricultural commodities, are perishable in nature
and they require storage. Due to this reason, the buyer must bear the cost of storage and
transportation charges. In case if location of goods is not in the same state, then, the buyer
also has to borne taxes, octroi etc. However, storage cost is not there in financial derivatives.
(ii) Complexity: Compared to Financial Market, there are low volumes of transactions and
transparency in commodity market, and, thus, often relationship between future and spot get
distorted. Further, delivery in the financial market is comparatively less cumbersome.
(iii) Higher Cost: While in the financial market, only costs in the form of interest cost and
exchange rate loss are involved, while in the commodity market a lot of costs are involved
such as transportation, delivery, storage etc.

©The Institute of Chartered Accountants of India

 9.8 FINANCIAL SERVICES AND CAPITAL MARKETS

(iv) Physical Delivery: Since the quality of goods commodities even in two different batches
cannot be same, the delivery of commodities becomes a challenging task. Stating otherwise,
this is the most distinguishing feature of commodity derivatives.
4.2 Pre-requisites for Futures trading on a Commodity Exchange
For a future to be traded on a Commodity Exchange, following are the prerequisites:
(i) Durability - Commodity should be storable and durable.
(ii) Homogeneity - The commodity should be homogeneous in nature.
(iii) Free from Control - The trading in commodities should be free from any type of price or
regulatory control.
(iv) Frequent Trading - The demand and supply should be large, leading to a daily fluctuation in
prices. Practically, it has been seen that even if the same commodities possess the above
characteristics, they are still required to be traded successfully.
4.3 Trading and Settlement Process
Broadly, commodity trading involves following three mechanisms:
(i) Order Matching Mechanism - Firstly, a trader places his/her order with any registered broker
who in turn enter the same into online terminal. In case order matches with opposite order
(one party buys and other party sells) the trade is said to be complete.
(ii) Trade Clearing Mechanism - The clearing of the matched order takes place through a
Registered Clearing House. The function of these clearing houses is as follows: -
(a) Follow up with parties
(b) Timely Settlement
(c) Delivery versus payment (DVP) of commodity traded.
(d) In case of non-delivery, settlement through fund transfer.
(iii) Processing of Delivery - The main issues to be considered in the delivery processes are as
follows:
(a) Availability of warehouse

(b) Location of order

(c) Quantity of Commodity deposited and dematerialized.
Further, delivery process involves following steps:

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.9

(i) Buyer request Depository Participant (DP) to deliver the commodity.

(ii) DP forward this request to the Registrar and then to Transfer Agent.
(iii) Transfer Agent after verifying authenticity of request passes the details of delivery to
the warehouse.
(iv) After thorough identification checking, a warehouse arranges the delivery of the
concerned goods to the designated buyer.

4.4 SEBI’s Approval for Option in Commodities

SEBI has now allowed option trading in the Commodity Future market. On expiry date, if option ends
in “Out the Money” (OTM) position it will be squared off at loss (premium) and the holder of “In the
Money” (ITM) position will have a choice either to square it off at profit or get converted into a Future
Contract. Once it is converted into a future contract it will be subject to margin requirement as other
future contracts.

4.5 Important Terms to be understood in the context of the Commodity

Market
(a) Short position in a contract: The party who agrees to deliver (sell) the contracted
commodity.
(b) Long position in a contract: The party who agrees to receive (purchase) the contracted
commodity.
(c) Futures Contract: The formal agreement where one party agrees to take a short position
and another party assumes the long position on contracted commodity. The contract will
specify the quantity and quality of the commodity, the specific price per unit, and the date and
method of delivery.
(d) Settlement: The close out day of the futures contract. The positions get wounded, and the
resulting profit / loss of either party gets settled in cash.
(e) Margin: This is perhaps the most important term in commodity futures – the parties entering
a contract must furnish a margin equal to a % (usually 5 to 15 percent) of the contract value.
Traders are required to keep margin monies usually based on the traded volumes.
(f) Open: This is the opening price of the trade
(g) High: The highest price in the trading session / day
(h) Low: The lowest price in the trading session / day
(i) Open Interest (Volume): The number of open positions of contracts

©The Institute of Chartered Accountants of India

 9.10 FINANCIAL SERVICES AND CAPITAL MARKETS

(j) Expiry Date: The closure date of the contract

(k) LTP: Last traded price

(l) Unit traded: The unit of measurement (For e.g. Cotton will be measured in ‘bales’)

4.6 The Role of Derivatives

(i) Forward Contract: This is the simplest of all contracts, which states that there would be an
exchange of an agreed quantity of a given commodity at a particular price (the forward price).

(ii) Futures Contract: These are standardized forward contracts that are done through an
exchange, for a particular quantity of commodity at a particular future date and location, the
price is left undetermined.
(iii) ETCs: Exchange traded commodities are the commodities that are traded on a stock
exchange, just like a stock. They track the performance of an underlying commodity index
including total return indices based on a single commodity.

4.7 How Hedging works in Commodity Markets

One type of hedger is a farmer. Farmers plant crops, like soybeans in this case, and assume the
risk that by the time the crop is harvested, its price will have dropped. By selling soybean futures,
which might lock in a price for their crops early in the growing season, farmers can protect
themselves against that risk.
Five thousand bushels of soybeans make up a soybean futures contract on the Chicago Board of
Trade exchange operated by the CME Group. Growing 500,000 bushels of soybeans annually would
require a farmer to sell 100 soybean futures contracts.
Assume for the moment that a bushel of soybeans costs $13. He suspects the downfall of soybean
prices in the future. It could make sense for the farmer to sell (short) the futures contracts at $13 to
lock in the price if he is certain to make a profit at $10. By doing this, the farmer could save i.e.
hedge himself from the loss even if the price drops below $13 at the time of expiry of the futures
contract.

It is always possible that by harvest time, soybean prices will have increased significantly. If the
farmer sold the $13-a-bushel futures contracts, they would lose out on the potential increase in
soybean prices to $16 a bushel. Anyhow, the farmer has not incurred any losses by hedging the
soybean price at $13. And this is the basic purpose of hedging i.e. to protect from losses.

5. GLOBAL COMMODITIES EXCHANGES

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.11

5.1 London Metal Exchange (LME)

The iconic London Metal Exchange, popularly referred to as ‘LME,’ is one of the world’s largest
futures exchange market established in 1877, when Great Britain was at the peak of its glory. With
half the world under the British Empire, London had become the epicenter of commodity trades of
all kinds. Shortly after, the industrial revolution further spurred the growth of markets for metals like
copper, tin, and aluminum. The ‘three-month contract’ which is now considered as the standard
period for a future, was borne out of the time frame that took copper to be shipped from Chile to UK.
The opening of Suez Canal in 1869 similarly reduced the time for shipment of tin to arrive from
Malaya to 3 months, which gave rise to the ‘3-month contract’ now in vogue.
LME was acquired in 2012 by Hong Kong Exchanges & Clearing Limited and a new custom clearing
house was designed and introduced to bring technology into the global metal trade platform.
Today, LME sets the standards for operating in the commodity metals market within the framework
of corporate governance – LME has an operational committee for each of the metal traded, like an
‘aluminum’ committee for aluminum, a ‘molybdenum’ committee for molybdenum, and so on. LME
also has an elaborate ‘Ring Disciplinary’ committee and an appeal mechanism for both traders and
members in place.
The LME price discovery mechanism works in all the three ways –
(a) Open out-cry – the trading floor on the LME that is also called as the ‘Ring’, where the prices
are determined on the traditional out-cry (verbal) method,
(b) LME Select – the electronic trading platform, and,
(c) Inter-office telephone market system.
Thus, the LME is active for trading 24 hours a day. There is a common misconception that precious
metals like gold are traded on the LME, but they aren’t. The LME specializes in ferrous and
nonferrous metals, whereas gold and silver are traded on the OTC managed by the London Bullion
Market.

5.2 Eurex Exchange

Eurex is the largest European futures and options market, established in Germany. One of the
foremost exchanges to usher in electronic trading, its trading platform T7 is the best in the world.
Eurex is constantly pushing itself to explore new areas and product classes, for example, they have
introduced a factor index-based futures that allow investors to trade six individual risk factors in
futures format. The six factors are - size, value, carry, momentum, low risk and quality, and is a
dynamic attempt to allocate to alternative sources of beta to deliver equity-like returns with low
correlation.

©The Institute of Chartered Accountants of India

 9.12 FINANCIAL SERVICES AND CAPITAL MARKETS

5.3 Chicago Mercantile Exchange (CME) Group

Chicago Mercantile Exchange & Chicago Board of Trade (CME) is the US based largest futures and
options platform for trading. Established in 1898, CME offers the entire bouquet of trades based on
ferrous, non-ferrous metals, precious metals, and even on weather and real-estate. The acquisition
of New York Mercantile Exchange (NYMEX) by the CME group in 2007 catapulted it to the number
one status in US. The platform also allows for agri-based commodity contracts like Class IV milk,
Class III milk, Feeder Cattle etc. CME has developed ‘SPAN’ (‘Standard Portfolio Analysis of Risk’)
which is standardized software to calculate margin requirements for futures, which has been adopted
by many agencies as benchmark software across the globe.

Contract specifications on MCX

Following is the illustration of contract specifications of Crude Oil on MCX for the practical and
conceptual understanding of the students.
FUTURES CONTRACT SPECIFICATIONS OF CRUDE OIL
Symbol CRUDEOIL
Description CRUDEOILMMMYY
Contract Listing Contracts are available as per the Contract Launch
Calendar.
Contract Start Day As per the Contract Launch Calendar
Last Trading Day As per the Contract Launch Calendar
Trading
Trading Period Mondays through Fridays
Trading Session Monday to Friday: 9.00 a.m. to 11.30/ 11.55 p.m.*
* based on US daylight saving time period.
Trading Unit 100 barrels
Quotation/Base Value Rs. Per barrel
Maximum Order Size 10,000 barrels
Tick Size (Minimum Price Re. 1
Movement)
Daily Price Limits The Exchange has implemented a narrower slab of
4%. Whenever the narrower slab is breached, the
relaxation will be allowed up to 6% without any cooling
off period in the trade. In case the daily price limit of
6% is also breached, then after a cooling off period of
15 minutes, the daily price limit will be relaxed upto

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.13

9%.
In case price movement in international markets is
more than the maximum daily price limit (currently
9%), the same may be further relaxed in steps of 3%.
Initial Margin Minimum 10% or based on Standard Portfolio Analysis
of Risk (SPAN) # whichever is higher.
Extreme Loss Margin Minimum 1 %
Additional and/ or SpecialMargin In case of additional volatility, an additional margin
(on both buy & sell side) and/ or special margin (on
either buy or sell side) at such percentage, as
deemed fit, will be imposed in respect of all
outstanding positions.
Maximum Allowable Open For individual clients: 4,80,000 barrels or 5% of the
Position market wide open position, whichever is higher for all
Crude Oil contracts combined.
For a member collectively for all clients: 48,00,000
barrels or 20% of the market wide open position,
whichever is higher for all Crude Oil contracts
combined.
Quality Specification Light Sweet Crude Oil confirming to the following
quality specification:
Sulfur 0.42% by weight or less,
API Gravity: Between 37 degree – 42 degrees
Due Date Rate (DDR) Due date rate shall be the settlement price, in
Indianrupees, of the New York Mercantile Exchange’s
(NYMEX)# Crude Oil (CL) front month contract on the
lasttrading day of the MCX Crude Oil contract. The
last available RBI USDINR reference rate will be used
for the conversion. The price so arrived will be
rounded off to the nearest tick.
For example, on the day of expiry, if NYMEX Crude
Oil (CL) front month contract settlement price is
$40.54 and the last available RBI USDINR reference
rate is 66.1105, then DDR for MCX Crude oil contract
would be Rs. 2680 per barrel (i.e. $40.54 * 66.1105
and rounded off to the nearest tick).
#A market division of Chicago Mercantile Exchange
Inc. (“CME Group”)
Settlement Mechanism The contract would be settled in cash
# Exchanges use SPAN to figure out margins and risk for F&O portfolios. In addition to several other
factors, SPAN analyzes the price and volatility of the underlying investment to calculate the
maximum loss that can occur for a portfolio and to provide the proper margin.

©The Institute of Chartered Accountants of India

 9.14 FINANCIAL SERVICES AND CAPITAL MARKETS

MCX Crude Oil Futures (100 Barrels)

Contract Launch Calendar for Contracts Expiring During the Calendar Year 2024

Contract Month Contract Launch Date Contract Expiry Date

Jan-24 20th July 2023 19th January 2024
Feb-24 22nd August 2023 16th February 2024
Mar-24 20th September 2023 19th March 2024
Apr-24 20th October 2023 19th April 2024
May-24 20th November 2023 20th May 2024
Jun-24 19th December 2023 18th June 2024
Jul-24 22nd January 2024 19th July 2024
Aug-24 19th February 2024 19th August 2024
Sep-24 20th March 2024 19th September 2024
Oct-24 22nd April 2024 21st October 2024
Nov-24 21st May 2024 19th November 2024
Dec-24 19th June 2024 18th December 2024
(Reference Circular No. MCX/TRD/425/2023 dated June 30, 2023)

TEST YOUR KNOWLEDGE

Multiple Choice Questions (MCQs)

1. ………. among the following is not a role of commodity markets.
(a) Act as a platform for enabling farm produce growers and the end buyers to interact.
(b) Enabling intermediaries to engage in representing both the demand and the supply
side of the commodity chain.

(c) Price discovery.

(d) Enabling speculation driven trades and short selling done to gain short-term profits.
2. Agridex, launched on 25 May 2020 comprises 10 liquid commodities on ……….

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.15

(a) National Commodity and Derivatives Exchange

(b) Multi Commodity Exchange of India

(c) Indian Commodity Exchange
(d) ACE Derivatives & Commodity Exchange Limited

3. ……….. is not a problem with the Indian Commodity Markets.

(a) Commodity markets have not been able to see the ‘exponential’ growth that is required
for platforms to sustain it.

(b) Farmers that form the backbone of agriculturally based commodities are not able to
connect to the market.
(c) MCX and NCDEX have created several awareness programs.
(d) Political ramifications have also added to the woes – price sensitive commodities like
sugar have been on and off the futures platform.
4. ………… is a prerequisite for futures trading on a commodity exchange.
(a) Complexity
(b) Higher Cost
(c) Homogeneity
(d) Physical Delivery
5. ………… offers the entire bouquet of trades based on ferrous, non-ferrous metals, precious
metals, and even on weather and real-estate.
(a) London Metal Exchange
(b) Chicago Mercantile Exchange
(c) Eurex Exchange

(d) National Stock Exchange of India Limited

Theoretical Questions
1. Discuss the role of commodity market and influence of commodity markets on prices.
2. Explain the problems with the Indian Commodity Markets and the way forward.
3. Explain how Commodity Derivatives are different from Financial Derivatives.
4. Discuss the trading and settlement process in commodity trading.

©The Institute of Chartered Accountants of India

 9.16 FINANCIAL SERVICES AND CAPITAL MARKETS

5. What is the standardized software to calculate margin requirements for futures developed by
CME and adopted by many agencies as benchmark software across the globe?
Practical Questions
1. A company is long on 10 MT of copper @ ` 474 per kg (spot) and intends to remain so for
the ensuing quarter. The standard deviation of changes of its spot and future prices are 4%
and 6% respectively, having correlation coefficient of 0.75.
What is its hedge ratio? What is the amount of the copper future it should short to achieve a
perfect hedge?

ANSWERS/SOLUTIONS
Answers to Multiple choice Questions:
1. (d) 2. (a) 3. (c) 4. (c) 5. (b)

Answers to Theoretical Questions

1. Please refer paragraph 2
2. Please refer paragraph 3.2 and 3.3
3. Please refer paragraph 4.1

4. Please refer paragraph 4.3

5. Please refer paragraph 5.3

Answers to the Practical Questions

1. The optional hedge ratio to minimize the variance of Hedger’s position is given by:
σS
H= ρ
σF
Where
σS = Standard deviation of ΔS
σF = Standard deviation of ΔF
ρ = coefficient of correlation between ΔS and ΔF
H = Hedge Ratio
ΔS = change in Spot price.

©The Institute of Chartered Accountants of India

 COMMODITY MARKET 9.17

ΔF = change in Future price.

Accordingly
0.04
H = 0.75 x = 0.5
0.06
No. of contract to be short = 10 x 0.5 = 5
Amount = 5000 x ` 474 = ` 23,70,000

©The Institute of Chartered Accountants of India