Tag: Hedging

FAQs_Commodity

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♦ What is a commodity?

 A commodity is a product having commercial value that can be produced, bought, sold, and consumed.

♦ What is a Derivative contract & what is Commodity future?

 A derivative contract is an enforceable agreement whose value is derived from the value of an underlying asset; the underlying asset can be a commodity, precious metal, currency, bond, stock, or, indices of commodities, stocks etc. Four most common examples of derivative instruments are forwards, futures, options and swaps/spreads.Commodity future is a contract to buy or sell specific commodity, of a specific quality, at a specific price, for a specific future date on the exchange.

♦ What is a forward contract?

 A forward contract is a legally enforceable agreement for delivery of goods or the underlying asset on a specific date in future at a price agreed on the date of contract. Under Forward Contracts (Regulation) Act, 1952, all the contracts for delivery of goods, which are settled by payment of money difference or where delivery and payment is made after a period of 11 days, are forward contracts.

♦ What is a futures contract?

 Futures Contract is a type of forward contract. Futures are exchange traded contracts to sell or buy standardized financial instruments or physical commodities for delivery on a specified future date at an agreed price. Futures contracts are used generally for protecting against rich of adverse price fluctuation i.e. hedging.

♦ How are futures prices determined?

 Futures prices evolve from the interaction of bids and offers emanating from all over the country which converge in the trading floor or the trading engine. The bid and offer prices are based on the expectations of prices on the maturity date.

♦ What is long position?

 In simple terms, long position is a net bought position and its opposite term is Short position.

♦ What is the difference between spot market and futures market?

 In a spot market, commodities are physically bought or sold usually on a negotiable basis resulting in delivery. While in the futures markets, commodities can be bought or sold irrespective of the physical possession of the underlying commodity. The futures market trades in standardized contractual agreements of the underlying asset with specific quality, quantity, and mode of delivery whose settlement is guaranteed by regulated commodity exchanges.

♦ What is a Commodity Exchange?

 As in capital markets, a commodity exchange is an association or a company or any other body corporate that is organizing futures trading in commodities and is registered with FMC (Forward Market Commission). Two major national level commodities exchanges are Multi Commodities Exchange of India (MCX), National Commodities and Derivatives Exchange of India (NCDEX).

♦ Who regulates the commodity exchanges in India?

 Commodity Market in India is regulated by Forward Market Commission (FMC) under the guidance of the Ministry of Consumer Affairs, Food, & Public Distribution.

♦ What are the benefits of futures trading in commodities?

 The biggest advantage of trading in commodity futures is price risk management and price discovery. Farmers can protect themselves against undesirable price movements and decide upon cropping pattern. The merchandisers avoid price risk. Processors keep control on raw material cost and decreasing inventory values. International traders also can lock in their prices.

♦ What is hedging?

 Hedging means taking a position in the futures or options market that is opposite to a position in the physical market. It reduces or limits risks associated with unpredictable changes in price. The objective behind this mechanism is to offset a loss in one market with a gain in another.

♦ What is arbitrage in commodity markets?

 Arbitrage is making purchases and sales simultaneously in two different markets to profit from the price differences prevailing in those markets. The factors driving arbitrage are the real or perceived differences in the equilibrium price as determined by supply and demand at various locations.

♦ Unlike equities where rate is per share basis, does the commodities market have different rate units for different commodities?

 Commodities have predefined lot sizes (set by the respective exchanges as per existing regulation) where current price of a particular commodity, for selected expiry, is shown in contract information available & rate units differ for different commodities. The standard unit based on which the price of the contract is quoted for trading is called quotation or base value. E.g. for gold contract, the quotation or base value is 10 grams while it is 1 kg in case of silver on MCX.

♦ What is a lot Size? Do the trading & delivery lot sizes differ from each other?

 It is the quantity of a commodity specified in the contract as tradable units. The lot size is different for each commodity. The details About lot sizes / delivery lot can be obtained from the respective exchanges’ website. Each contract has a lot size and a delivery size, which are not the same; in the case of gold, the lot size on the NCDEX is 100 gm while the delivery size is 1000 gm. If a person wants to enter into a delivery settlement for gold, he will have to enter into a minimum of 10 contracts or multiples thereof. Market participants are required to negotiate only the quantity and price of the contract, as all other parameters are predetermined by the exchange.

♦ What is the meaning of Basis?

 Basis is the difference between the spot price of an asset and the futures price of the same asset underlying. The spot price is the ready price prevailing in the physical commodity market while the futures price is the price of any specific contract that is prevailing in the exchanges where it is traded.

♦ What is meant by basis risk?

 Generally, the spot price of a commodity and future price of the same underlying commodity do not change by the same amount during the life of the futures contract. This uncertainty in the variation of basis is known as basis risk.

♦ What is initial margin?

 It is the minimum percentage of the contract value required to be deposited by the members/clients to the exchange before initiating any new buy or sell position. This must be maintained throughout the time their position is open and is returnable at delivery, exercise, expiry or closing out.

♦ What do you mean by delivery period margin?

 It is the extra margin imposed by the exchange on the contracts when it enters the concluding phase i.e. it starts with tender period and goes up to delivery/settlement of trade. This amount is applicable on both the outstanding buy and sell positions.

♦ What is Mark-to-market (MTM)?

 Mark-to-market margins (MTM or M2M) are payable based on closing prices at the end of each trading day. These margins will be paid by the buyer if the price declines and by the seller if the price rises. This margin is worked out on difference between the closing/clearing rate and the rate of the contract (if it is entered into on that day) or the previous day’s clearing rate. The Exchange collects these margins from buyers if the prices decline and pays to the sellers and vice versa.

♦ What is due date rate?

 It is the rate at which the contract is settled on the expiry date. Usually it is the average of the spot prices of the last few trading days (as specified by the exchange) before the contract maturity.

♦ What is Cash Settlement?

 It is a process of settling a futures contract by payment of money difference rather than by delivering the physical commodity or instrument representing such physical commodity (like, warehouse receipt). In India, most of the future trades are cash settled.

♦ What is meant by calendar spread?

 A calendar spread means taking opposite positions in futures contract of the same commodity with different expiry dates. It is also known as an intra-commodity spread.

♦ Are there any circuit breakers in commodities like in equity markets?

 Yes, like equity markets, commodity market has circuit breakers. Exchanges have circuit filters in place. The filters vary from commodity to commodity but the maximum individual commodity circuit filter is 6 per cent. The price of any commodity that fluctuates either way beyond its set price limit will fall in circuit breaker category.

♦ What kinds of risks do participants face in derivatives markets?

 A.Credit risk:Credit risk on account of default by counter party: This is very low or almost zeros because the Exchange takes on the responsibility for the performance of contracts

B.Market risk:Market risk is the risk of loss on account of adverse movement of price.

C.Liquidity risk:Liquidity risks is the risk that unwinding of transactions may be difficult, if the market is illiquid

D.Legal risk:Legal risk is that legal objections might be raised; regulatory framework might disallow some activities.

E.Operational:Operational risk is the risk arising out of some operational difficulties, like, failure of electricity, due to which it becomes difficult to operate in the market.

♦ Can I take delivery of the commodity? If yes, how can I do the same?

 A settlement takes place either through squaring off your position or by cash settlement or physical delivery. Squaring off is taking a opposite position to the initial stance, which means in the case of an original buy contract an investor would have to take a sell contract.
An investor who intends to give or take delivery would have to inform his broker of the same prior to the start of delivery period. In case of delivery, a warehouse receipt is provided. Delivery is at the option of the seller; a buyer can take delivery only in case of a willing seller. All unmatched/rejected/excess positions are cash settled; all open positions for which no delivery information is submitted are also cash settled. Under cash settlement, the difference between the contract price and settlement price is to be paid or received.  In online commodity trading, client can not go for delivery & all positions are cash settled.

♦ What are the costs involved in trading of commodities?

 While trading in commodities, with any registered broker, client has to pay certain charges (apart from margin requirements for trading) which are as follows:

  1. Brokerage
  2. Service  Tax
  3. Exchange Transaction Charges
  4. Educational Cess

 

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FAQs_Currency

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♦  What is Currency Derivatives?

 Currency Derivatives are Future and Options contracts which you can buy or sell specific quantity of a particular currency pair at a future date. It is similar to the Stock Futures and Options but the underlying happens to be currency pair (i.e. USDINR, EURINR, JPYINR OR GBPINR) instead of Stocks. A future contract of USDINR of expiry 27th Jan, 2015 will be represented by symbol ‘FUTCUR-USDINR-27JAN2015’. A call option contract of USDINR of expiry 27th Jan, 2015 for Strike Price ‘63’ will be represented by symbol ‘OPTCUR-USDINR-27JAN2015-63-CE’.

♦ What are the benefits of trading in Currency Derivatives?

 Currency Derivatives are very efficient risk management instruments and you can derive the below benefits:

  1. Hedging: You can protect your foreign exchange exposure in business and hedge potential losses by taking appropriate positions in the same. For e.g. If you are an importer, and have USD payments to make at a future date, you can hedge your foreign exchange exposure by buying USD INR and fixing your pay out rate today. You would hedge if you were of the view that USD INR was going to depreciate. Similarly it would give hedging opportunities to Exporters to hedge their future receivables, Borrowers to hedge foreign currency (FCY) loans for interest and principal payments, Resident Indians, who can hedge their offshore investments.
  2. Speculation: You can speculate on the short term movement of the markets by using Currency Futures. For e.g. If you expect oil prices to rise and impact India’s import bill, you would buy USD INR in expectation that the INR would depreciate. Alternatively if you believed that strong exports from the IT sector, combined with strong FII flows will translate to INR appreciation you would sell USD INR.

    3.  Arbitrage: You can make profits by taking advantage of the exchange rates of the currency in different                         markets and different exchanges.

    4.   Leverage: You can trade in the currency derivatives by just paying a % value called the margin amount                         instead of the full traded value.

    ♦  What categories of Currency Derivatives contracts are offered for trading through Beeline                       Broking Ltd.

 Future and Option contracts in Currency derivatives have been introduced in India. Trading in Currency derivatives through Beeline Broking Ltd. is presently offered in both Future and Option contracts in NSE and BSE.

     ♦ What are Currency Futures Contracts?

 Currency Futures contracts are legally binding agreement to buy or sell a financial instrument sometime in future at an agreed price. Currency Future contracts are standardized in terms of lots and delivery time. The only variable is the price, which is discovered by the market. Currency Futures contracts have different expiry validity and will expire after the completion of the specified tenure.

     ♦ Who is eligible to trade in Currency Derivatives?

 All Resident Indians as defined in section 2(v) of the Foreign Exchange Management Act, 1999 (FEMA, Act 42 of 1999) are eligible to trade in the Currency Derivatives segment. For participation by regulated entities, concurrence  from  respective  regulators should be obtained. Currently, trading facility in Currency Derivatives at I-Sec will be offered to all Resident Individuals / HUFs / eligible Corporates fulfilling the FEMA criteria.

      ♦ What is the date of expiry?

 All Currency contracts expire two working days prior to the last business day of the expiry month at 12 noon.

      ♦ What are the trade timings of Currency trading?

 Currency Derivatives the trade timings in  exchanges are as follows: Trading Session- Monday to Friday- 9:00 AM to 5:00 PM.

      ♦  Can Currency futures help small traders?

 Yes. The minimum size of the USD INR futures contract is USD 1,000. Similarly EUR INR future contract is EURO 1000, GBP INR future contract is GBP 1000 and JPY INR future contract is YEN 1,00,000. These are well within the reach of most small traders. All transactions on the Exchange are anonymous and are executed on a price time priority ensuring that the best price is available to all categories of market participants irrespective of their size. As the profits or losses in the futures market are also paid / collected on a daily basis, the scope of accumulation of losses for participants gets limited.

      ♦  How is Currency Price determined?

 Currency prices are affected by a variety of economic and political conditions, but probably the most important are interest rates, international trade, inflation, and political stability. Sometimes governments actually participate in the foreign exchange market to influence the value of their currencies. They do this either by flooding the market with their domestic currency in an attempt to lower the price or, conversely, buying in order to raise the price. This is known as central bank intervention. Any of these factors, as well as large market orders, can cause high volatility in currency prices. However, the size and volume of the FOREX market make it impossible for any one entity to drive the market for any length of time.

      ♦  How are the margin charged in currency Future and Option Contracts?

 Generally, Currency futures and options contracts require a margin percentage of the contract value, i.e. defined by exchange. The exchange also requires the daily profits and losses to be paid in/out on open positions (Mark to Market or MTM) so that the buyers and sellers do not carry a risk for not more than one day.

      ♦  Can I use same margin to trade in both Equity and Currency segment?

 Yes, same margin can be used to trade in both Equity and Currency segment.

       ♦  Will I have single login id to access both equity and Currency trading account?

 Yes, you can trade in Equity, F&O, Commodity and Currency segment by logging in to our single integrated trading platform – or can login to our trading website with same login id and password.

       ♦  I am an existing equity customer; do I need to open a separate trading account for currency?

 No, you don’t need to open a separate trading account for currency trading. You have to place a request to enable currency trading permissions along with submission of required documents. You can visit the nearest branch; can contact your relationship manager or call at Client Helpline Number: …..

        ♦  What are the risk involved in currency trading

 Risks in currency futures pertain to movements in the currency exchange rate. There is no rule of thumb to determine whether a currency rate will rise or fall or remain unchanged. A judgment on this will depend on the knowledge and understanding of the variables that affect currency rates.

        ♦  If I am an individual with no exposure to foreign exchange risks, does a currency futures                         exchange mean anything to me?

 Yes, it does, if you want to invest purely as an investor. You can benefit from exchange rate fluctuations just as you can benefit by investing in equities in the stock market. However, as in the stock markets, you also stand to lose money if the price movements are not in keeping with what you had anticipated. Participating in a currency futures exchange is risky, just as the stock market is. You should therefore be knowledgeable about the currency market if you want to participate as an investor.

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