Economic Importance of Commodity Futures Market

Introduction

Be it currencies, agricultural commodities, live stocks, metals, interest rates or fuels, all of them are effected by the price movements. A risk is always associated with such price movements and can mean a lot in the final analysis over the difference between gain or loss in a company's business which is open to such price risks. The commodity futures industry has played a major role in helping such businesses manage that price risk. For over a century ,the futures industry has played a major role in helping businesses manage those price risks. Futures Industry is a world leader in providing efficient markets and unparallel operational procedures for hedging and managing the volatility of the price movements associated with the markets.

Futures Industry is in short provides the most cost effective and efficient risk management tool.

Futures markets Vital Roles in the service of the Economy

PRICE DISCOVERY

Futures industry do not set prices. They are free markets and just provide platform for trading where the forces that influence prices are brought together in open auction. As this markets assimilates new information through out the day, it translates this information into a single benchmark price-that is agreed upon by both the buyer and the seller. For this reason many knowledgeable business men view the futures as the leading indicator.

PRICE RISK MANAGEMENT

This another economic function provided by the futures industry. The most common method of which is hedging.

Hedging, in its simplest form is the practice of offsetting the price risk inherent in the cash market position by taking an equal and opposite position in the futures market to protect from adverse price changes that could negatively impact the profitability of the business

Hedging can benefit any-one –farmer, grain elevator/operator, merchandiser, producer, exporter, importer, processors etc

Important factors that makes the Futures Markets successful

AUCTION SYSTEM

The foundation of the futures industry is the open out cry auction system. This is the most crucial of all the other factors as it provides the real life example of the basic economic law of supply and demand. Although now the electronic platform is used to carry out this auction system

LIQUIDITY

Futures market work due to liquidity. It provides buyers and sellers with smooth, orderly price movements and enables market participant to enter and exit the markets quickly and efficiently. Liquidity is achieved through the constant participation of buyers and sellers; some of them are speculators, who act as risk takers. Because of this activity, the risk takers narrow the bid /ask spread and provide consistent trading activity so hedgers can execute their trades quickly and efficiently. Finding offsetting hedging trades without the risk takers (Speculators) would be time consuming and if not impossible. A large number of ready buyers and sellers are needed and essential for continuous operation of the futures market and hence the need for speculators. Thus with liquidity enough, the futures market provides an efficient risk management mechanism for those businessmen concerned with the cash market price fluctuation.

A FAIR RELATIONSHIP BETWEEN CASH/ FUTURES MARKET

Futures contract are so designed that they represent the underlying cash market prices through out the life of the contract .Because without a tight correlation between the cash market prices, futures contract could not serve their intended purpose as risk management tools. Futures prices are kept in line with the cash market prices in two ways.

Through the possibility of delivery of the underlying contract and
Through the participation of spreaders and arbitrageurs

LEVERAGING

This is the proven method for ensuring the financial integrity of the futures market. This system of the futures markets combines the use of margins and daily cash settlement feature that has proven itself capable of ensuring the financial integrity of the futures industry system and protecting the interest of all concerned.

Integrity of the futures market

COMMODITY EXCHANGES BYE-LAWS AND BUSINESS RULES

The business rules and bylaws o the exchange covers all floor operations/ electronic platforms for wide ranging, self-regulatory procedures designed to support competitive, liquid markets and to protect the interest of all market participants.

REGULATIONS

The Rules and regulations of the exchanges in India are subject to approval by Forward Markets Commission (FMC) (A division of Government of India, Ministry of Consumer Affairs and Public distribution), which is empowered with the regulation of futures trading and enforcement of these rules and regulations by the exchanges are subject to close FMC scrutiny

CLEARING HOUSES

An independent entity that handles the Exchange’s clearing functions is know as the clearing Corporation, and it ensures the integrity of the market place. In this capacity the clearing corporation acts as the guarantor for all trades cleared by it, reconciles all clearing member firm accounts each day to ensure that all gains have been credited and all losses has been collected and adjusts clearing member Margin for the changing market conditions.