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What is Exchange?
Exchange is the physical location with established rules and regulation that provides an efficient online trading platform to buyers and sellers to hedge their risk exposure in future. They facilitate price discovery and price risk management for the entire value chain participants in the commodity ecosystem. Currently, commodity exchanges are traded for Precious metals, Base metals, Energy products and Agro products.

What are commodities?
Human being is totally dependent on commodities, from Ancient time. It is a part of our daily routine starting with a cup of milk, energy we consumed, nutrious food we eat, precious metal that we use as luxurious need and so on. Each and every raw product is commodity but only those commodities are traded in derivative exchange that have:

  • Standard Size
  • Many buyers and Suppliers
  • Existence of demand and supply for the product
  • Has not gone through complicated process
  • Must have large volume.

What are derivatives?
Derivatives are the financial instrument which derives its value from the performance of other underlying assets such as commodities, equities, currencies and stocks. It is the margin trading used mainly to mitigate the price risk from now to future date.

 

Types of derivative contract:

  • Future

Futures are the standardized contracts among buyers and sellers of commodities that specify the amount of a commodity, grade/quality and delivery location. Commodity trading with future contract takes place at future exchange.   
   
Consider the example of a farmer hedging by entering into a futures contract to sell October corn at $3 a bushel.  The standard contract size is 5,000 bushels and so the notional value of the contract can be thought of as $15,000.  The margin requirement for the position is say $750 in initial margin to open the position, and then $500 for maintenance margin.  The first day the price rises by $0.02 so that the value of the short position loses $100 (the two cents times the 5000 bushels specified in the contract).  The clearing house debits $100 from the farmer’s margin account which now totals $650.  The new amount in the account does not fall below the maintenance level, and so no further action is required.  If the loss were to reduce the level in the account to below the maintenance level, then the farmer would be required to add resources to the account (cash or Treasury securities) until it reached the higher initial margin level.  If the price moves in favor of the farmer, then the clearing house credits the farmer’s margin account and the farmer is allowed to withdraw excess funds from the margin account.  This process of adjusting the margin account to the daily changes in futures prices is known as marking the position to the market value, or “mark to market” for short.

 

  • Forward

Forward are the mutual agreements between two parties to buy or sell the underlying assets at predetermined price in future specified date. These contracts are not traded in exchange.
Consider the case of the farmer entering into a forward contract to sell corn upon harvest.  The farmer needs to plant corn in the spring, when the spot price is $3 per bushel, in order to harvest in October when the spot price is unknown.   In order to avoid the risk of a price decrease, the farmer could enter into a forward contract to sell 50,000 bushels of corn to the local grain dealer or grain elevator between October 5th and 15th, at a price of $3.15 bushel (the quality, such as No. 1 yellow corn, would also be specified).  The farmer would thus be long corn in the field and short corn in the forward market; the grain dealer would be long corn in the forward market.  The farmer would thereby hedge his price risk by shifting his long corn price exposure to the grain dealer through the forward contract.  The grain dealer could either hold the long price exposure as a speculator or hedge the risk away by entering another forward contract – this time as a seller – with either a speculator or another hedger such as a food processor that wants to hedge its price exposure to possible future price increases.

 

  • Option

An option is a contract that gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date. An option, just like a stock or bond, is a security. It is also a binding contract with strictly defined terms and properties.
In the case of a call option on a stock, which is the type granted as employee stock options, the holder has the right to buy the underlying stock at a specified price – known as the strike or exercise price – at a specified time in the future.  If the spot market price of the stock were to exceed the strike price during the time period in which the option could be exercised, then the holder would be able to exercise the option and buy at the lower strike price.  The value of exercising the option would be the difference between the higher market price and the lower strike price.  If the market price were to remain below the strike price during the period when the call option was exercisable, then the option would not be worth exercising and it would expire worthless.

*Option: is the choice remaining with the trader whether to buy or sell depending upon types of the     option.
*Call option: right to buy the option
*Put option: right to sell the option

 

  • Swaps

 The basic idea in a swap contract is that the counterparties agree to swap two different types of payments.  Each payment is calculated by applying some interest rate, index, exchange rate, or the price of some underlying commodity or asset to a notional principal.  The principal is considered notional because the swap generally does not require the transfer or exchange of principal (except for foreign exchange and some foreign currency swaps).  Payments are scheduled at regular intervals throughout the tenor or lifetime of the swap.  When the payments are to be made in the same currency, then only the net amount of the payments are made.



What is the structure of derivative market in Nepal?


Who is safe guarding the current framework of the derivative market?
A derivative trading will takes place under the provisions of the Securities and Exchange Board of Nepal. SEBON would also frame suggestive bye-law for Derivative Exchanges/Segments and their Clearing Corporation/House which lays down the provisions for trading and settlement of derivative contracts as soon as possible.

How to trade safely in derivative market?
The price of the commodity can fluctuate based on the need of the consumers and the amount of the product has been available. So, lots and lots of information and in depth knowledge regarding this market are required in order to trade in commodity derivative.

  • Always consult your broker and do homework by visiting related websites, reading books and newspaper, seek advice from experts before trading.
  • Trading with the trend (pattern) that is currently working in the market by simply observing and logging   is a core strategy for futures traders.
  • Proper money management technique can go a long way to helping you in future trading.
  • Having control over fear, anxiety and greed.

Since commodity future is all about volatility market so try to invest your money in that commodity those are more fluctuating. Commodity is something that’s in demand and has a global need.


EXCHANGE HISTORY
The first organized commodity exchanges in the United States date back to the 19th century. The Chicago Board of Trade (CBOT), founded in 1848, is the oldest U.S. futures exchange. When it was first established, the CBOT was a centralized cash market, formed in response to the need for a central marketplace that would bring together large numbers of buyers and sellers, thus providing liquidity, as well as providing a place with rules for ethical trading practices and reliable standards of weights and measures. Soon after the founding of the exchange, grain brokers began trading in "cash forward contracts," in order to assure buyers a source of supply and sellers the opportunity to sell 12 months a year. As the use of the cash forward contracts escalated, the futures contract, as it is known today, evolved. Futures contracts differed from cash forward contracts in that they specified the price at the time the contract was made, as well as the quantity, quality, and delivery time.


Popular Exchanges of the world


Exchange

Abbreviation

Product type

Africa

Ethiopia Commodity Exchange

ECX

Agricultural

America

Brazilian Mercantile & Future Exchange

BMF

Agricultural, Biofuels, Precious Metals

Chicago Board of Trade

CBOT

Agricultural, Biofuels,

Chicago Mercantile Exchange

CME

Agricultural, Biofuels,

Chicago Climate Exchange

CCX

Emissions

Hedge Street Exchange

 

Energy, Industrial Metals

Intercontinental Exchange

ICE

Agricultural, Biofuels, Emissions, Energy

Kankas City Board of Trade

KCBT

Agricultural

Memphis  Cotton Exchange

 

Agricultural

Mercado a Termino de Buenos Aires

MATba

Agricultural

Minneapolis Grain Exchange

MGEX

Agricultural

New  York Mercantile Exchange

NYMEX

Energy, Precious Metals,  Industrial Metals

U.S. Future Exchange

USFE

Energy

Asia

Bursa Malaysia

BMEX

Biofuels,

Central Japan Commodity Exchange

 

Energy, Industrial Metals, Rubber

Commodity Exchange of Nepal

COMEN

 

Dalian Commodity Exchange

DCE

Agricultural, plastics

Dubai Mercantile Exchange

DME

Energy

Hong Kong Mercantile Exchange

HKMEX

Gold

Iranian oil bourse

IOB

Oil, Gas, Petrochemicals

Kansai Commodity Exchange

KANEX

Agricultural

Mercantile Exchange Nepal Ltd

MEX

Agriculture,Bullion,Base metal and biofuels

Multi Commodity Exchange

MCX

Agriculture,Bullion,Base metal and biofuels

National Multi commodity Exchange of India Ltd

NMCE

Agriculture,Bullion,Base metal

National Commodity Exchange Ltd

NCEL

Agriculture,Bullion,Base metal

Bhatinda Om & Oil Exchange Ltd

BOOE

Agricultural

National Commodity and Derivative Exchange of India Ltd

NCDEX

All

Nepal Derivative Exchange Ltd

NDEX

Agriculture,Bullion,Base metal and biofuels

Shanghais future Exchange

 

Industrial metals, fuel oil, Rubber

Singapore Commodity Exchange

SICOM

Rubber, Agricultural

Tokyo Commodity Exchange

TOCOM

Agriculture,Bullion,Base metal and biofuels

Tokyo Grain Exchange

TGE

Agricultural

Europe

European Climate Exchange

ECX

Emission

Energy Exchange Austria

EXAA

Electricity, Emission allowances

London Metal Exchange

LME

Industrial Metals, Plastics

Risk Management Exchange

RMX

Agriculture

European Energy Exchange

EEX

Energy, Emissions

Austria

Australian Commodity Exchange

ASX

Agricultural, Electricity, Thermal Coal, Natural Gas



Related Websites:

www.marketwatch.com

www.barchart.com
www.investopedia.com
www.bloomberg.com
www.onlygold.com
www.ndex.com.np
www.comexnepal.com
www.mexnepal.com
www.mcxindia.com
www.cbot.com
www.kitco.com
www.iqn.com
www.ncel.com.pk
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