A Synopsis

On

DERIVATIVES AND PRICE RISK MANAGEMENT: A STUDY OF AGRICULTURAL COMMODITY FUTURES IN INDIA

Submitted in Partial Fulfillment Of the Requirements For the Degree of Master of Business Administration

Submitted by; Aayushi Sharma

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School of Business
GALGOTIAS UNIVERSITY
Feb. 2013

INDEX S. NO. 1. 2. 3. 4. 5. PARTICULARS Introduction Literature Review Research Problems and Objectives Research Methodology References PAGE NO. 3 4 6 7 9

INTRODUCTION
Commodity derivatives have a crucial role to play in the price risk management processes especially in any agriculture dominated economy. Derivatives like forwards, futures, options, swaps etc are extensively used in many developed and developing countries in the world. The present study is an investigation into the derivative markets in agricultural commodities in India. The study has surveyed the recognized exchanges and their organizational, trading and the regulatory set up for futures trading in commodities. A statistical analysis has also been carried out to evaluate the efficiency of a sample set of markets in price discovery and to understand the interrelationship between prices, volume of transaction, open positions and volatility of the markets. The results of the study reveal that many of the commodity futures exchanges fail to provide an efficient hedge against the risk emerging from volatile prices of many farm products in which they carry out futures trading. The results obtained from a statistical analysis of the data on price discovery in a sample of six commodities traded in four exchanges showed that the futures market in those commodities are not efficient in the sense that the futures prices are not an unbiased predictor of the future ready rates. A quantitative analysis of the relationship between price return, volume, market depth and volatility on a sample of twelve markets in six commodity items shows that the market volume and depth are not significantly influenced by the return and volatility of futures as well as ready markets. The results indicate that the futures and ready markets are not integrated. The price volatility in the ready markets does not have any impacts on the market conditions in futures markets. The exchange specific problems like low volume and market depth, lack of participation of trading members and irregular trading activities along with state intervention in many commodity markets are major ills retarding the growth of futures market. In the presence of these ills no quantitative analysis of market conditions and interrelations would provide meaningful results. A review of the nature of institutional and policy level constraints facing this segment calls for more focused and pragmatic approach from government, the regulator and the exchanges for making the agricultural futures markets a vibrant segment for risk management which can play an important role especially in an agriculture dominated economy of India.

LITERATURE REVIEW
Reserve Bank of India Occasional Papers, Vol. 28, No. 2, Monsoon 2007

: S.M. Lokare states Commodity derivatives trading in India notwithstanding its long and
tumultuous history, with globalization and recent measures of liberalisation, has witnessed a massive resurgence turning it one of the most rapidly growing areas in the financial sector today. This paper endeavors to test the efficiency and performance of commodity derivatives in steering the price risk management. The critical analytics of performance divulges that these markets although are yet to achieve minimum critical liquidity, almost all the commodities throw an evidence of co-integration in both spot and future prices, presaging that these markets are marching in the right direction of achieving improved operational efficiency, albeit, at a slower pace. In the case of some commodities, however, the volatility in the future price has been substantially lower than the spot price indicating an inefficient utilization of information. Several commodities also appear to attract wide speculative trading. Hedging proves to be an effective proposition in respect of some commodities, while others entail moderate or considerably higher risk. As the markets develop, it remains to be seen whether the information content of future prices could be factored in the course of future monetary policy setting. Kaleel, Nisha, Yashmeen And Haider In Their Research Paper Named

Impact Of Commodity Derivative Trading On Commodity Prices states

Many research studies relating to the impact of commodity futures prices on spot prices were carried out by Indian researchers. Among those are the studies conducted by Lokare (2007), Sahi and Raizada (2006) and Nath and Lingareddy (2008). They have witnessed different results in different commodities market. Besides comovement of futures trading and spot prices, there also exists co-movement among different commodity futures prices. Although the motive behind finding the co-movement in commodity prices was different in different cases, the existence of correlation in these commodity prices cannot be denied. This paper also presented various models that can be used to test these relationships. The research conducted in this regard is very limited in India, taking into consideration, the commodities traded in Indian commodity exchanges. Hence, there is lot of scope for future research in this area, where, the correlation between futures prices of various commodities that are traded in India can be identified and tested. Finding such relationships are important to interpret the dynamics of commodity futures market in a macroeconomic context and to develop better policy measures to optimize and stabilize the markets.

 Mukherjee, Dr. Kedar Nath (2011): Impact of Futures Trading on Indian

Agricultural Commodity Market. Besides the well-established fact towards the

requirement of market based instrument, there is always been a doubt, as expressed by different bodies, on the usefulness and suitability of futures contract in developing the underlying agricultural commodity market, especially in agricultural based economy like India. Therefore, an attempt has been made to re-validate the impact of futures trading on agricultural commodity market in India. The daily price information in spot and futures markets, for a period of 7 years (2004 2010), for 9 major agricultural commodities, taken from different categories of Agri-products, are incorporated into various econometric models to test the concerned objective. Like most of the other studies undertaken on world and Indian commodity market, the present study have also exhibited that even though the inflationary pressure on commodity, especially agricultural commodity, prices have gone up sharply after the introduction of commodity futures contracts, the destabilizing effect of the futures contract is casual in nature and tends to vary over a long period of time. The empirical findings significantly shows that comparative advantage of futures market in disseminating information, leading to a significant price discovery and risk management, that can again help to successfully develop the underlying commodity market in India. Therefore instead of curbing the commodity futures market, it can always be suggested to strengthen the market structure to achieve the broader target.

RESEARCH PROBLEM AND OBJECTIVES

The proposed study has the following objectives: To study the contract specifications, mechanics of futures trading and price discovery in the select commodities and exchanges. To study how successful these exchanges are in India in price discovery and in providing hedge against price risk in the underlying commodities. To carry out an econometric analysis of price volatility and market conditions, and spot (ready) and futures prices behavior. To identify the bottlenecks in commodity trading and possible policy solutions for improving the futures markets in India.

RESEARCH METHODOLOGY Research Design

The report has been organized as follows. The chapter 1 deals with various derivative instruments available in commodity markets world-over and their utility for hedging risk against price changes, and the current status and the evolution of futures markets in commodities in India. The functioning of futures exchanges with trading details, contract specifications, and organizational structure of and membership requirements in various exchanges in India as well as in clearinghouses has been described in chapter 2. Chapter 3 provides a brief profile of commodity futures exchanges and their regulatory framework in India. An econometric analysis or testing market efficiency in terms of better price discovery mechanism, for testing the interrelationship between return, volatility and market conditions, and correlation between various parameters of some selected markets are carried out in chapter 4. Chapter 5 summarizes these constraint and policy solutions for transforming the commodity futures segment a vibrant, mass participatory and transparent one. The summary of the study, bibliography and appendices are presented at the end of the report.

Data Analysis Tools

The availability of data has been a major constraint of the study. Futures trading on commodities except on pepper was introduced only in 1997 -98. While daily futures and comparable ready price data were available for pepper, the relevant data on other commodities are available for the last 2-3 years that too only monthly data for many of them. Due to the difficulty in getting uniform frequency data series he study has utilized weekly as well as monthly data on various parameters of futures trading in some selected commodities. The study as mentioned above is based on a visit to seven exchanges. However, the coverage of the study is not limited to these seven samples. For statistical analysis commodities other than the ones traded in these exchanges are also chosen wherever the data are available. The necessary data are collected from official records of the exchanges which are visited, and the data relating to other exchanges are collected from various reports and publications of Forward Markets Commission. The information relating to the organization of exchanges, terms and conditions of futures contracts, structure of clearinghouse and delivery mechanism, and other details about trading are collected from the bye-laws of the respective exchanges. To the possible extent, amendments to these bye-laws have been incorporated in the study The study has utilized ordinary least square (OLS) method for estimating regression equations. The problem of serial correlation has been diagnosed and the iterative Cochrane-Orcutt procedure has been used for making necessary adjustments in coefficient estimates. The study has used Wald chi-square procedure for restriction on coefficients to test market efficiency and unbiasedness of futures prices. For empirical testing of relationship between futures and ready price return, their volatility, trade volume, market depth, regression as well as correlation methods have been resorted. Bartletts homogeneity of variance test has been used for testing the integration between ready and futures markets.

REFERENCES
http://dilbert.iiml.ac.in/~devan/comex-smp.pdf
rbidocs.rbi.org.in/rdocs/publications/pdfs/82992.pdf

http://www.aims-international.org/aims10/AIMS10Proceedings/PDF/P763done.pdf http://mpra.ub.uni-muenchen.de/29290/