Futures Trading on Price Fluctuations in Commodities Market

A Research Report On

“The Effect of Futures Trading on Price Fluctuations in Commodity Markets”
Submitted in partial fulfillment of the requirement for the award of the degree of Master of Business Administration Of Bangalore University By

D’Souza Rohan Francis James
Reg. No: 05XQCM6019 Under the guidance and supervision of

Dr. T. V. N. Rao

M. P. BIRLA INSTITUTE OF MANAGEMENT Associate Bharatiya Vidya Bhavan #43, Race Course Road, BANGALORE-560001 2007
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DECLARATION
I, hereby, declare that this research report entitled “The Effect of Futures Trading on Price Fluctuations in Commodity Markets” submitted in partial fulfillment for the award of Master of Business Administration of Bangalore University is a record of independent work carried out by me under the guidance of Dr. T. V. Narasimha Rao (Faculty member), M. P. Birla Institute of Management Studies, Bangalore. I, also declare that this report is a result of my own effort and has not been submitted earlier for the award of any degree or diploma of Bangalore University or any other University.

Place: Bangalore Date: 17/05/2007

(D’souza Rohan Francis James)
REGD.NO: 05XQCM6019

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ACKNOWLEDGEMENT
The attitude bliss and emphasis that accompanies the successful completion of my task would be incomplete without the expression of appreciation towards those who helped me colour the mosaic of this project with the tiles of their knowledge, expertise, experience and co-operation. I extend my special thanks to my Respected Guide, Dr. T. V. Narasimha Rao who has motivated and inspired me throughout my project work with his timely guidance, help, support and supervision. I am extremely grateful to Dr. N. S. Malavalli for his help and support and for giving me an opportunity to complete my project.

D’souza Rohan Francis James

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CHAPTER
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PARTICULARS
Chapter – 1 Executive Summary 1.1 – Executive Summary 1.2 – Research Extract Chapter – 2 Introduction 2.1 – Introduction 2.2 – The Futures Contract 2.3 – Introduction to Futures Market 2.4 – Agricultural Commodities 2.5 – History 2.6 – About Commodities 2.7 – Commodity Exchanges in India 2.8 – Technical Terminology 2.9 – How an Organized Market works 2.10 – Advantages of Futures Contracts 2.11 – Commodity Futures in India 2.12 – Genesis of the problem 2.13 – Statement of the problem 2.14 – Research Gap 2.15 – Objectives of the Research Chapter – 3 Literature Review 3.1 – Literature Review 3.2 – Benefits from literature review Chapter – 4 Methodology 4.1 – Type of Research 4.2 – Sampling Technique 4.3 – Sample Description 4.4 – Instrumentation Techniques 4.5 – Actual collection of data 4.6 – Tools used for testing hypothesis 4.7 – Other software used

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Presentation & Analysis 5.1 – Hypothesis 5.2 – Test for Stationarity 5.3 – Augmented Dickey Fuller Test 5.4 – Standard Deviation & F -Test 5.5 –F-Test Result Chapter – 6 Conclusion 6.1 - Conclusion 6.2 – Conclusion from the study 6.3 – Implication, 6.4 - Suggestions Bibligraphy Appendices

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S.No.
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Particulars
Fig 1 – Diagrammatic representation of Trading Procedure in Futures Markets Graphical Representation of Price fluctuations before and after in the market Fig – 2 Wheat Fig – 3 Turmeric Fig – 4 Soyabean Fig – 5 Maize Fig – 6 Gur Fig – 7 Castor Augmented Dickey Fuller Test Table – 1: Wheat Table – 2: Turmeric Table – 3: Maize Table – 4: Soya Bean Table – 5: Gur Table – 6: Castor

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1.1 - EXECUTIVE SUMMARY
In ancient times, commodities trading at an officially designated marketplace was a hallmark of civilization. Indeed, the Forum and the Agora defined Rome and Athens as centers of civilization as much as the Pantheon and the Parthenon. While commodities trading was normally conducted on the basis of barter or coin-and-carry, the use of what are known as forward contracts dates at least to ancient Babylonia where they were regulated by Hammurabi’s code. In India commodity futures trading was started by the National Commodities and Derivatives Exchange(NCDEX) and the Multi-Commodity Exchange of India (MCX) with a view to bring stability in the market for commodities and to keep a check on the spiraling prices of commodities. The underlying research work aims at finding out if the exchanges have been successful in maintaining a stable price for the commodities or whether after the introduction of futures markets the prices have fluctuated drastically compared to before the introduction of futures. For the purpose of determining the above the spot prices two years after the introduction of futures were obtained from the (NCDEX) website and two year prices prior to introduction of futures were obtained from the Agricultural marketing websites. The Log Naturals of the data thus collected were calculated and a first difference was calculated based on the Log Naturals. Subsequently the first lag difference was used to conduct the test for stationarity for this purpose Augmented Dickey Fuller Test of stationarity was used. Subsequently standard deviations prior and after the introduction of futures was removed and the values were subjected to a F-test. Based on the results of the above we were able to conclude that after the introduction of futures in the market there has been less fluctuations in the market. Also during the course of the literature review various other information about the futures markets were identified i.e. advantages of futures trading, trading procedures, history of futures trading, technical terminologies and about the commodity exchanges was also learnt during the course of review of the literature. The use of software’s like SPSS, E-Views and Excel Spreadsheets was of immense help in determining the values required for conducting the study. providing the relevant articles that were used as a base for conducting the study. Online database like JSOR was of tremendous help in helping gain an insight into the topic by

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Thus by conducting the Research work it has added immensely to knowledge about the commodities market and also helped clear any doubts about speculation that many claim exists in the futures trading market and which drives the prices of commodities to higher levels. Many claim that a futures market is not necessary for commodities and that the prices determined by the mandis are right and fairly the reward the farmers and are fair to the consumers. But the Research work has been able to prove that the Futures Market for Commodities has helped stabilize the prices of commodities in the market.

1.2 - RESEARCH EXTRACT

The Research is based on an article written by MARK J. POWERS titled Does Futures Trading Reduce Price Fluctuations in the Cash Markets? One of the recurring arguments made against futures markets is that by encouraging or facilitating speculation they give rise to price instability. In case of perishable commodities like onions and potatoes it suggests that a) the seasonal price range is lower with a futures market because of speculative support at harvest time b) sharp adjustments at the end of a marketing season are diminished under futures trading because they have been anticipated c) year-to-year price fluctuations are reduced under futures trading because of the existence of the futures market as a reliable guide to production planning. These conclusions are most valid for seasonally produced storable commodities they probably do not hold for other commodities particularly those that are continuously produced or semi or non storable. The underlying research work aims at identifying if this is true with respect to commodities wheat, maize, castor, gur, turmeric and soyabean.

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2.1 - Introduction
Commodities are not only essential to life, they are absolutely necessary for quality of life. Every person in the world eats. Billions of dollars of agricultural products are traded daily on the world’s commodity exchanges: everything from soybeans, to rice, to corn and wheat, to beef, pork, cocoa, coffee, sugar and orange juice. This is how commodity exchanges began. In the middle of the nineteenth century in the USA, businessmen started to organize market forums to make the buying and selling of agricultural commodities easier. Farmers and grain merchants met in central marketplaces to set quality and quantity standards and establish rules of business. Over 1600 exchanges sprang up, mostly at major railheads, inland water ports and seaports. Around the early twentieth century, communications and transportations became more efficient. This allowed for the building of centralized warehouses in major urban centers such as Chicago. Business became more national and less regional and many of the smaller exchanges disappeared. Today business is global. There remain about two dozen major exchanges, with 80 percent of the world’s business conducted on about a dozen of them. Just about every major commodity vital to life, commerce and trade is represented. Billions of dollars worth of energy products, from heating oil to gasoline to natural gas and electricity are traded every business day. Metals, both industrial (copper, aluminium, zinc, lead, palladium, nickel and tin), precious gold and some of which are both (platinum and silver). Wood products, textiles – how could we live without these? Yet, few of us are aware of how the prices for these vital components of life are set. Plus, today, the world’s futures exchanges trade financial products essential to the economic function of the world as well as physical commodities. From currencies, to interest rate futures, to stock market indices, more money changes hands on the world’s commodity exchanges every day than on all the world’s stock markets combined. Governments allow commodity exchanges to exist so that producers and users of commodities can hedge their price risks. Yet without the speculator, the system would not work. Anyone can be speculator and contrary to popular belief, I do not believe the odds are stacked against the individual.

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2.2 - The Futures Contract
The basic unit of exchange in the futures markets is the futures contract. Each contract is for a set quantity of some commodity or financial asset, and can only be traded in multiples of that amount. A futures contract is a legally binding agreement providing for the delivery of various commodities or financial entities at a specific date in the future. When you buy or sell a futures contract, you are not actually signing a written piece of paper drawn up by a lawyer you are entering into a contractual obligation which can be met in one of two ways. The first is by making or taking delivery of the actual commodity. This is the exception, not the rule however, as less than 2 per cent of all futures contracts are met by actual delivery. The other way to meet your obligation the method you most likely will use is by offset: Very simply, offset is making the opposite, or offsetting sale or purchase of the same number of contracts bought or sold sometime prior to the expiration date of the contract. This can be easily done because futures contracts are standardized. Every contract on a particular exchange for a specific commodity is identical. The specifications are different for each commodity, but the contract in each market is the same. In other words, every soybean contract traded on the Chicago board of Trade is for 5000 bushels. Every gold contract traded on the New York Mercantile is for 100 troy ounces. Each contract listed on an exchange calls for a specific grade and quality. For example the silver contract is for 5000 troy ounces of 99.99 per cent pure. Therefore the buyers and sellers know exactly what they are trading. Every contract is completely interchangeable. The only negotiable feature of a futures contract is price. The size of the contract determines its value. To determine how much you will make or lose on a particular price movement of a specific commodity, you will need to know the following The contract size How the price is quoted The minimum price fluctuations The value of the minimum price fluctuations

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2.3 - Introduction to Futures Markets
When the possibility of “speculative bubbles” is excluded and the price follows a unique path, the question remains as to whether the quality of price forecasts by rational agents improves with the introduction of a futures market. Futures trading have been viewed to serve for a better distribution of commodities over time, leading to a reduction in their amplitude and frequency of price fluctuations. Since futures traders, in their capacity as speculators, usually take a ‘long position’ when the spot price is expected to be higher than the delivery contract price and a “short position’ when price expectations are lower, futures activities are considered to improve the intertemporal allocation of commodities and therefore stabilize prices. of futures trading have revealed mixed results. Futures markets have been described as continuous auction markets and as clearing houses for the latest information about supply and demand. They are the Today, meeting places of buyers and sellers of an extensive list of commodities. This hypothetical view might appear consistent with economists, institutions but empirical studies on price stabilizing effects

commodities that are sold include agricultural products (grains trading), metals (such as gold and silver), Energies trading (crude and petroleum), financial instruments, foreign currencies, stock indexes and more. Today’s futures market has also become a major financial market. Participants in futures trading include mortgage bankers, farmers and bond dealers as well as grain merchants, food processors, savings and loan associations and individual spectators. Indian markets have recently thrown open a new avenue for retail investors and traders to participate: commodity derivatives. For those who want to diversify their portfolio beyond shares, bonds and real estate, commodities is the best option. With the setting up of three multi-commodity exchanges in the country, retail investors can now trade in commodities futures without having physical stocks. Commodities actually offer immense potential to become a separate asset class for market savvy investors, arbitrageurs and speculators. Retail investors who claim to understand the equity markets may find commodities an unfavourable market. In fact the

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size of the commodities markets in India is also quite significant. Of the country’s GDP of Rs 13,20,730 commodities related industries constitute about 58 percent. Currently the various commodities across the country clock an annual turnover of Rs.1,40,000 crore. With the introduction of futures trading the size of the commodities market will grow many folds here on. Like any other market the one for commodity futures plays a valuable role in information pooling and risk sharing. The market mediates between buyers and sellers of commodities and facilitates decisions related to storage and consumption of commodities. In the process they make the underlying market more liquid. The commodities market has three broad categories of market participants apart from brokers and the exchange administration – hedgers, speculators and arbitrageurs. Brokers will intermediate, facilitating hedgers and speculators. Hedgers are essentially players with an underlying risk in a commodity – they may be either producers or consumers who want to transfer the price-risk onto the market. Producer-hedgers are those who want to mitigate the risk of prices declining by the time they actually produce their commodity for sale in the market, consumer hedgers would want to do the opposite. The total turnover of the commodity futures market in India increased by a whopping 71% to Rs.36.77 lakh crore in FY 2007. Such a thriving growth reflects the increasing popularity of commodity futures as an asset class them to the investment portfolio. Though major commodities like copper and crude oil slumped very sharply at the fag end of the year, the commodities complex was once again the limelight in the first three months of 2007. Precious metals, crude oil and base metals rode high on renewed investor interest. On the other hand global equity markets faced a sell-off in March 2007, with rising risk aversion triggered by a sharp spike in the Japanese yen, pulling all the global indices down quite substantially (Investors would borrow in low interest-bearing yen to invest in risky but high return emerging markets). Though most of the major equity markets have recovered from the recent slump and hit fresh highs afterwards, the Indian markets lagged behind on continuous monetary Commodities are not correlated with other asset classes an attribute frequently cited as an attraction for adding

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tightening by the Reserve Bank of India(RBI). Concerned over soaring wholesale prices overheating the economy, RBI hiked the cash reserve ratio (CRR), the cash that banks have to deposit with the central bank, for the third time in four months and also raised the short-term repo rate (at which the central bank lends to banks) twice in as many months on 31 March 2007. In such a scenario, the thriving commodity futures market which was launched three-and-a half years ago, provides an excellent opportunity for retail investors to allocate part of their funds.

Reasons for the rise in Commodity Price:
Interest in commodities as an assets started in 2002, when global interest rates were comparatively low levels and the rally in the merging markets still nascent. Over the next four years, heavy demand from major economies across the globe, particularly China, spiked prices of metals and energy. Surging credit growth widening trade surplus and double digit economic expansion lent support to the explosive Chinese demand for minerals. This contributed to the sharp increase in world consumption of metals and minerals in recent years, outstripping supply. As a result commodity prices have shown unusual strength in recent years and the robustness has been spread broadly across all the sectors: bullion, base metals prices have skyrocketed. So have livestock and grains, of late. Even precious metals have reached prices not seen since inflation was raging in the late 1970’s. What’s behind the price explosion? First, there has been lack of investment in the production of energy, industrial metal and other commodities in the 1990s. Oil companies were loath to repeat the cycle of enthusiastic expansion of capacity leading to overproduction, which pulled down prices. Industrial metals producers harboured similar sentiments. Second, political turmoil and military action in the Middle East, Nigeria, Russia, Venezuela and other major petroleum producers added a substantial risk premium to oil prices. Third the global economic growth led by American consumers also powered robust demand for commodities. The housing boom in the US and many other countries hyped demand for lumber, copper, gypsum, plastics and many other similar commodities. Fourth and foremost the excess liquidity sloshing around the world, the

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demand for high returns, the speculative atmosphere and rising risk appetite drove investors beyond conventional asset classes like stocks and bonds and into riskier areas, including commodities. Yield hungry investors legitimised commodities as a serious asset class in the global markets in the last few years. Hedge funds, pension funds and other institutional investors have poured money into commodities directly and through investment pools. Thus, with supply limitations and strong demand from commodity users and investors, inventories of many commodities are quite low relative to production an demand. This is true of copper and zinc, and generally for agricultural products specially corn and wheat, which scaled up decades highs in the last year.

2.4 - Agricultural Commodities
The prices of essential food articles like wheat, pulses and edible oils hardened sharply in the spot market in FY 2007. This rise was reflected in the futures market as well, with a generous increase in the volume of business, indicating increased participation by market players. Apart from the notable exception of sugar, whose spot prices drifted lower during the year on supply glut, all pulses, grains, spices, edible oils and oilseeds as well as other soft commodities went up at a sharp pace. As a result futures also rose on very good buying support. Bulk of the gains in the essential commodities segment stemmed from the poor growth of agriculture in FY 2007. The spices complex beat the commodity street. Spices majors jeera and pepper rocked the markets with astounding gains of 118% and 84.47% respectively, in FY 2007, Chana gained 26.41% and refined soy oil 22%. While the supply crunch pushed up food grains higher spices were boosted by a combination of stagnant output and excellent overseas demand. Exports of spices crossed Rs.3000 crore in April-February 2006-07 for the first time and surpassed the target both in volume and value set for the current fiscal. Total exports of spices have been estimated at 3.11 lakh tones valued at Rs 3020 as against 2-92 lakh tones worth Rs.2100.40 crore in April-February 2005-06. Thus exports have shown an increase of 6% in quantity and 44% in value . If this trend persists the spices complex is bound to be the out performer amongst the agri commodities in FY 2008 as well.

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The spurt in the prices of major food articles prompted farmers to plant more pulses and grains this year leading to an increase in the estimated production of certain commodities. According to the third advance estimates, the country’s production of wheat, maize, pulses, cotton as well as sugarcane is placed at a moderately higher level compared with last year. Wheat output is estimated at 73.7 million tones – up 6.27% over the last year, while output of pulses is estimated to have grown 5.30% to 14.1 million tones. However oilseeds production has dipped quite alarmingly. The country imports 50% of its edible oil requirement. In such a scenario, a staggering drop of 17% in estimated oilseeds production points towards a sustained rise in prices of edible oils in the coming months. The best measure to evaluate the consolidated performance of prices of agri commodities on the futures market is the Ncdex Futexagri. The index shot up quite strongly in first half of FY 2007 and topped a high of 1,726.01 in the last week of November 2006. The barometer eased afterwards as the kharif (April-September) output arrived in the domestic markets, easing the spot prices of major agri commodities, before peaking up early 20007 as a poor edible oilseeds crop pushed up the index. Strong gains in the entire spices complex also played a part in the recent rally which saw the index close at 1,625.01 on 31 March 2007 – recording a significant jump of 20% over the last year. Though the agriculture sector grew by 6% in FY 2007, recording a stable output of foodgrains and keeping prices relatively comfortable, the plight of agriculture worsened in FY 2008 with incessant rains in various states like Maharashtra, Andhra Pradesh and Gujarat affecting the kharif output to major extent. Futures started soaring well advance of the actual produce from kharif season arriving in the market. The whole price index started shooting up from the first week of December and rose well above 6.50% in January 2007, prompting the government to announce a surprise ban on futures trading in tur and urad. The markets were pinned down further as the government announced a ban on the introduction of new futures contracts in wheat and rice. This ban has confused genuine hedgers as they are not clear whether a commodity on which they need to hedge will last till its expiry period. Therefore, traders are not coming forward to hedge their risk entirely. Outlook: The outlook for major commodities in the domestic and global markets remains bullish. The recent spurt in the metals and energy prices is an indication that the 15

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commodity bull run has resumed its course and further gains can be expected for commodity heavy weights like gold, crude oil, zinc and copper. The International Monetary Fund’s latest World Economic Outlook states that the world economy still looks well set for continued robust growth in 2007 and 2008, notwithstanding the recent bout of financial volatility; the intense sell-off endured by the major asset classes in March 2007 on risk aversion triggered by a sudden appreciation in the Japanese yen. While the US economy has slowed more than was expected earlier, spillovers have been limited, growth around the world looks well sustained and inflation risks have moderated. Thus, with a global economic growth projected to be at elevated levels, steady gains can be expected in the metals and energy complex. The global picture is slightly different for soft commodities. The United Nations Food and Ágriculture Organisation (FAO) has forecast a record cereal crop for 2007 – World cereal production in 2007 is estimated to increase 4.3% to a record 2,082 million tones, according to the April issue of FAO’s Crop Prospects and Food Situation Report. The bulk of the increase is expected in maize, with a bumper crop already in South America, and a sharp increase in plantings expected in the US. A significant rise in wheat output is also forseen, with recovery in some major exporting countries after weather problems last year. FAO forecasts wheat output to increase 4.8% to about 626 million tones. Global rice production in 2007 could also rise marginally to 423 million tones in milled terms – about three million tones more than in 2006. Thus in terms of prices the grains are likely to remain under constraints on account of seemingly adequate supplies. The outlook for domestic agri commodities would largely depend on the vagaries of monsoon. The monsoon is likely to be normal this year. Recently, the World Meteorological Organization (WMO) projected that there is a substantial possibility of the emergence of La Nina, a weather effect, which invariably has a positive influence on the monsoon. This should augur well for the kharif crop in the country. However, the short term fluctuations in the prices of major commodities like chana, jeeera, pepper, guarseed, menthe oil and red chilli are likely to generate substantial opportunities for market participants. Moreover since the basic trading units in the commodities market are futures players can protect themselves quite safely against the unanticipated deviations in either direction. Despite the recent confrontations stemming from the ban on futures trading of certain key commodities, Indian commodities exchanges are tipped for good time in the coming months. Spurred by growing investor interest in stock exchanges, the government has very recently decided to allow foreign investment in commodity exchanges as well. The Government has pegged the foreign

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investment limit for commodity exchanges at 49% on the line of equity bourses. While foreign direct investment, FDI will be capped at 26%, the limit for foreign institutional investors (FII’s) is fixed at 23%. The next big step for the commodities market would be setting up online spot exchanges. Both the Multi Commodity Exchange (MCX) and the National Commodities and Derivatives Exchange (NCDEX) are set to launch national online spot exchanges, giving an instantaneous spot price discovery across the nation. This is likely to reduce the disparity in the spot prices, which are currently determined solely by the interplay of the local demand supply factors in thousands of local markets or mandis. These developments are likely to provide the much needed fillip to the commodities market in terms of exposure as well as increased participation. Right now, it is good time for retail investors to participate in this highly geared market and enhance as well hedge the value to their investment portfolio.

2.5 - History
Although the first recorded instance of futures trading occurred with rice in 17th Century Japan, there is some evidence that there may also have been rice futures traded in China as long as 6,000 years ago. Futures trading are a natural outgrowth of the problems of maintaining a yearround supply of seasonal products like agricultural crops. In Japan, merchants stored rice in warehouses for future use. In order to raise cash, warehouse holders sold receipts against the stored rice. These were known as "rice tickets." Eventually, such rice tickets became accepted as a kind of general commercial currency. Rules came into being to standardize the trading in rice tickets. These rules were similar to the current rules of American futures trading. In the United States, futures trading started in the grain markets in the middle of the 19th Century. The Chicago Board of Trade was established in 1848. In the 1870s and 1880s the New York Coffee, Cotton and Produce Exchanges were born. Today there are ten commodity exchanges in the United States. The largest are the Chicago Board of Trade, The Chicago Mercantile Exchange, the New York Mercantile Exchange, the New York Commodity Exchange and the New York Coffee, Sugar and Cocoa Exchange. Worldwide there are major futures trading exchanges in over twenty countries including

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Canada, England, France, Singapore, Japan, Australia and New Zealand. The products traded range from agricultural staples like Corn and Wheat to Red Beans and Rubber traded in Japan. The biggest increase in futures trading activity occurred in the 1970s when futures on financial instruments started trading in Chicago. Foreign currencies such as the Swiss Franc and the Japanese Yen were first. Also popular were interest rate instruments such as United States Treasury Bonds and T-Bills. In the 1980s futures began trading on stock market indexes such as the S&P 500. The various exchanges are constantly looking for new products on which to trade futures. Very few of the new markets they try survive and grow into viable trading vehicles. Some examples of less than successful markets attempted in recent years are Tiger Shrimp and Cheddar Cheese. Futures trading are regulated by an agency of the Department of Agriculture called the Commodity Futures Trading Commission. It regulates the futures exchanges, brokerage firms, money managers and commodity advisors. The futures contract, as we know it today, evolved as farmers (sellers) and dealers (buyers) began to commit to future exchanges of grain for cash. For instance, the farmer would agree with the dealer on a price to deliver to him 5,000 bushels of wheat at the end of June. The bargain suited both parties. The farmer knew how much he would be paid for his wheat, and the dealer knew his costs in advance. The two parties may have exchanged a written contract to this effect and even a small amount of money representing a "guarantee." Such contracts became common and were even used as collateral for bank loans. They also began to change hands before the delivery date. If the dealer decided he didn't want the wheat, he would sell the contract to someone who did. Or, the farmer who didn't want to deliver his wheat might pass his obligation on to another farmer the price would go up and down depending on what was happening in the wheat market. If bad weather had come, the people who had contracted to sell wheat would hold more valuable contracts because the supply would be lower; if the harvest were bigger than expected, the seller's contract would become less valuable. It wasn't long before people who had no

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intention of ever buying or selling wheat began trading the contracts. They were speculators, hoping to buy low and sell high or sell high and buy low. The ancient system of oral agreement between farmer and buyer which is the prototype of Future Trading gradually became contracts. Later the buyer began to make some advance payment for the surety of the contracts. When contracts became a normal practice, they were assigned the value of the commodities themselves. Also these contracts began to be sold and bought just as the commodities. Humans ever since they began farming searched for ways to face the vagaries of weather. With the arrival of market systems, their challenge increased. They now needed to ensure just price for their product. Indian farming faced with droughts, floods and natural calamities has always been a bet on the nature. When the farmer wins the bet and comes to the market the supply is more than the actual demand. That pushes the price down shattering the farmer. Futures trading should be seen as an idea originated from framers search to face the challenges of unpredictable weather and fluctuating market prices. It must have originated from the execution of a prior to harvest agreement made between the farmer (who promises to sell the harvest at a definite price) and one who needs the grain (who agrees to buy it at that price) In India it started in an organized manner in 1875 at Mumbai for cotton by Bombay Cotton Trade Association. It then began to spread. Certain mill owners unhappy with the working of their association began a new association in 1893, called the Bombay Cotton Exchange Limited. It conducted Futures Trading for cotton. In 1890 a Gujarati merchant Mandali started the Futures Trade of oil seeds. They also did futures trading for cotton and peanuts. Although futures trading worked in Punjab and Uttar Pradesh earlier too the Chambers of Commerce, Hampur which came into being in 1931 was the first one to get noticed. Soon after wheat futures market started in various places in Punjab like Amritsar, Moga, Ludhiana, Jalandhar, Fasilka, Dhuri, Baamala and Bhatinda and in Uttar Pradesh at Muzzafarnagar, Chandahusi, Meerut, Charanput, Hatras, Ghaziabad, bareili etc. In due time futures market started for pepper, turmeric, potato, sugar and jaggery. When the Indian constitution was framed share market and futures market were put in the union list. So the regulation of futures markets is with the central government. According to the Futures Contracts Regulation Act, a three-leveled regulatory system came into existence, Central Food and Public Distribution Ministry, Futures Market Commission (FMC) and the associations that are recommended by the

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FMC for conducting futures market. When futures trade was temporarily breezed in the 1970s many associations were de-activated. In 1980 Khusro Committee suggested to restart Futures trade for cotton, jute etc. It also sanctioned Futures Trade in potato and onion. In 1994, the Prof. K. N. Kabra Committee which was appointed in view of the marker liberalization, recommended Futures Trading of Basmati rice, cotton, jute, oilseeds, groundnut oil, onion, silver etc. There was also a suggestion to raise Futures Market for Pepper to the international levels. With the liberalization government intervention began to decrease in setting price limits of commodities. The government also narrowed its role of buying and distributing commodities. Gradually by 2003 the Central Government gave consent to start Futures Trading for most of the major commodities. Along with major agricultural commodities like rubber, pepper and cardamom, there are 127 commodities that can be traded in the Futures markets now.

2.6 - About commodities
Almost everything you see around is made of what market considers commodity. A commodity could be an article a product or material that is bought and sold. It could be an article a product or material that is bought and sold. It could be any kind of movable property, except actionable claims, money and securities. Commodity trade forms the backbone of world economy. The Indian commodity market is estimated to be around Rs.11 million and forms almost 50 percent of the Indian GDP. It deals with agricultural commodities such as rice, wheat, groundnut, tea, coffee, jute, rubber, spices and cotton. Besides precious metals such as gold and silver the commodity market also deals with base metals like iron and Aluminium and energy commodities such as crude oil and coal.

2.7 - Commodity Exchanges in India
There are three national commodity futures market exchanges in India. The Futures Market Commission(FMC) which is under the Central Government supervises and regulated the working of all these commodities market. National Multi Commodity Exchange of India Limited (NMCE) Ahmedabad. Promoted by Central Warehousing Corporation, National Agricultural Cooperative Marketing Federation of India Limited, Gujarat Agro Industries Corporation Limited,

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Gujarat State Agricultural Marketing Board, National Institute of Agricultural Marketing, Neptune Overseas Limited and Punjab National Bank. Multi Commodity Exchange of India Limited (MCX), Mumbai. Promoted by Financial Technologies (India) Ltd, State Bank of India, Union Bank of India, Bank of India, Corporation Bank and Canara Bank. National Commodity and Derivatives Exchange Limited (NCDEX), Mumbai, Promoted by ICICI Bank Limited, Life Insurance Corporation of India, National Bank for Agriculture and Rural Development and National Stock Exchange of India Limited, Punjab National Bank, CRISIL Limited, Indian Farmers Fertiliser Cooperative Limited and Canara Bank.

Commodity Exchanges:Wooed by Foreign investors:
In the 1960’s the government banned forward trading in most of the commodities. Only after the country embraced free-market reforms in the early 1990s was the need for a structured commodity futures trading appreaciated. In 1991, the Kabra Committee advised resumption of futures markets in 17 commodities initially. The entire commodity spectrum opened up for futures trading by April 2003. In the last quarter of 2003, the Multi Commodity Exchange (MCX), National Multi Commodity Exchange (NMCE) and National Commodity and Derivatives Exchange (NCDEX) started functioning in full swing, making good the difference between the buying/selling of the futures and the prevailing price of the futures at the expiry of the contract. Futures trading is conducted on margin. This makes the market highly leveraged for the retail customer. He can trade by locking only a fraction of the actual contract value of a particular commodity. Futures market attracts hedgers, who minimise their risk, and encourages competition from other traders who possess market information and price judgment. While hedgers have a long term perspective of the market, traders or arbitragers hold an instantaneous view of the market. The primary objectives of a futures market are price discovery and risk management. This is very much possible because a large number of different market players participate in buying and selling activities in the market based on diverse domestic and global information such as price, demand and supply, climatic conditions and other market related information.

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All these factors put together result in efficient price discovery. This also facilitates effective risk management by physical market participants by taking an appropriate position in the respective commodity futures. With the constantly rising volumes and increasing retail participation a number of overseas entities picked up stakes in the domestic commodity bourses. Fidelity International, a leading foreign institutional investor, bought about 9% (equivalent to about $49 million) equity in MCX in 2006. New York based investment banker Goldman Sachs also acquired a 7% holding divested by ICICI Bank in NCDEX for around $23.1 million (106 crore)

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2.8 - MEANING OF TECHNICAL TERMS USED IN FUTURES TRADING Arbitrage: The simultaneous purchase and sale of similar commodities in different
exchanges or in different contracts of the same commodity in one exchange to take advantage of a price discrepancy.

Carry Forward Position: The situation in which a client does not square off his
open positions on that day and carries it to the next day is known as the Carry Forward Position. Cash Commodity: The actual physical commodity as distinguished from the futures contract based on the physical commodity.

Cash Settlement: A method of settling future contracts whereby the seller pays the
buyer the cash value of the commodity traded according to a procedure specified in the contract.

Clearing: The procedure through which the clearing house or association becomes the
buyer to each seller of a futures contract and the seller to each buyer and assumes responsibility for protecting buyers and sellers from financial loss by assuring performance on each contract.

Clearing House: An agency or separate corporation of a futures exchange that is
responsible for settling trading accounts, collecting and maintaining margin monies, regulating delivery and reporting trade data.

Convergence: The tendency for prices of physical commodities and futures to
approach one another usually during the delivery month.

Day Trader: A speculator who will normally initiate and offset a position within a
single trading session.

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Default: The failure to perform on a futures contract as required by exchange rules,
such as a failure to meet a margin call or to make or take delivery.

Delivery: The tender and receipt of an actual commodity or warehouse receipt or other
negotiable instrument covering such commodity in settlement of a futures contract.

Delivery Period: The interval between the time when the warehouse receipt is given
to the exchange by the seller and the time incurred by the buyer in getting this warehouse receipt is known as delivery period.

Derivative: A financial instrument traded on or off the exchange the price of which is
directly dependent upon the value of one or more underlying securities, equity indices, debt instruments, or any agreed upon pricing index or arrangement.

Hedging: The practice of offsetting the price risk inherent in any cash market position
by taking the opposite position in the futures market. Hedgers use the market to protect their businesses from adverse price changes.

Long: One who has bought futures contracts or owns a cash commodity. Mark-to-Market: To debit or credit on a daily basis a margin account based on the
close of that day's trading session.

Open Interest: The sum of all long or short futures contracts in one delivery month or
one market that have been entered into and not yet liquidated by an offsetting transaction or fulfilled by delivery.

Position: A commitment, either long or short, in the market. Price Discovery: The process of determining the price level of a commodity based on
supply and demand factors.

Price Limit: The maximum advance or decline from the previous day's settlement
price permitted for a futures contract in one trading session.

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Settlement Price: The daily price at which the clearing house settles all accounts
between clearing members for each contract month. Settlement prices are used to determine both margin calls and invoice prices for deliveries. The term also refers to a price established by the clearing organization to calculate account values and determine margins for those positions still held and not yet liquidated.

Short: One who has sold futures contracts or the cash commodity. Speculator: One who tries to profit from buying and selling future contracts by
anticipating future price movements.

Spot: Usually refers to a cash market price for a physical commodity that is available
for immediate delivery.

Squaring: The practice by which the goods sold in the market are bought back before
the term ends to meet the cycle or the practice that the bought goods are sold before the term ends to settle the deal is called squaring. Here price or commodity is not exchanged, but only profit or loss.

Tick: The smallest allowable increment of price movement for a contract. Also referred
to as Minimum Price Fluctuation.

Trade Account: To trade in the Futures market the client has to register himself and
open an account with the broking organization known as trading account.

Trading Lot: Each commodity should be sold and bought in the Futures market at a
specific quantity. These quantities are called trading lots fixed by the exchanges. For rubber and pepper it is 1 ton, while it is 1 quintal for cardamom.

Volatility: A measurement of the change in price over a given time period. Warehouse Receipt: When the commodity sold in the Futures market is taken to the
warehouse, the client receives a legal document from the warehouse known as warehouse receipt. This document has a trade value.

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2.9 - How an Organized Market Works
An organized futures market is an institution that is the result of long experience and adaptation to needs. No single person can claim credit as its investor. Its development, still continuing, is the work of many hands. Starting from spot trades between a buyer and a seller, there gradually arose an increasingly refined and abstract financial instrument in response to changing circumstances. The advantage of deferred delivery may have been discovered by sheer accident. In this process improvements were made, defects removed, and safeguards developed. At some point in the last third of the nineteenth century came the growing recognition that an important new commercial discovery, the organized futures market, was in operation. Even those who are most familiar with the actual daily operation of these markets may be unaware of their important distinguishing features and may thus be puzzled by the growing number of things traded on organized futures markets. I believe that one reason for this growth is that the invention has attained a level of performance that makes it a useful tool for a wide range of commodities. A well-run, organized futures market now has features making it a reliable instrument suitable for trading a wide range of goods. Let us now consider the main features of an organized exchange. It is first necessary to have a contract such that the principals can give instruction to their agents who trade on their behalf in terms of price and quantity alone. Buying or selling an actual physical commodity requires more information than this. The commodity must be In these inspected, its quality ascertained, its location determined, and so on.

circumstances a principal instructing his agent who will, say, buy on his behalf must tell him more than how much he wants and the most he is willing to pay. He must also tell his agent what attributes to seek and how to compare one with another. The agent needs guidance to convert these into bids according to the needs of his principal. Plainly, this process requires judgement, honesty, and familiarity with the principal’s needs. Judgement of another kind is necessary to act on behalf of a principal for the purpose of trading a standardized commodity such as a futures contract. Now the focus is on the price and on the forces affecting it. The principal can instruct his agent in terms of prices and quantities, and the agent can carry out these orders for futures contracts. Familiarity with the properties of the commodity and the preferences of the principal is not necessary.

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Hence by trading futures contracts the principal can reap the advantages of specialization because he can supervise his agents at a lower cost. An organized futures market confines trades to those who are its members. This limitation has definite advantages. Each member has a proprietary interest in the survival of the exchange and in the value of his membership. He wants the other members to be reliable. Members who trust each other can trade more quickly at a lower cost. Members may also trade as agents of nonmembers. They are liable to the exchange for faithfully carrying out the terms of these trades. Exchange members will therefore accept accounts only from those in whom they have confidence. All of these considerations enable the exchange to operate on a larger scale, which increases liquidity. The clearing house of the exchange also has a vital part in this process. A member who buys futures contracts obtains liabilities of the clearing house that are offset by the sales of futures contracts which constitute the assets of the clearing house. In terms of the quantities of futures contracts bought and sold, the assets and liabilities of the clearing house are always equal. The clearing house is to its members as a bank is to its depositors and debtors. The backing of the clearing house behind the futures contracts traded on the exchange enhances the fungibility of the contract. It enables the transition from trading in forward contracts, where the identity of the parties involved is necessary information to judge the safety and reliability of the contract, to trading in futures contracts whose validity depends on the faith and credit of the organized exchange itself and not on the individual parties to a transaction. Consequently a futures contract acquires the same advantages over a forward contact as trade conducted with the aid of money has over barter. Because a futures contact has some of the attributes of money, it becomes suitable as a temporary abode of purchasing power. It is this aspect of a futures contract that is relevant to hedging. An inventory holder can sell futures in a liquid market so that he can choose the best time for making final sales of his inventory with little effect on the current futures price. One who has made commitments to sell the commodity can buy futures contracts as a temporary substitute for the purchases of the actual commodities and also have little effect on the price. Money is the most liquid of all assets for two reasons. First, the transaction cost of buying money by selling goods or buying goods by selling money is a minimum. Second, the real price of money is the amount of goods and services that can be

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exchanged for one dollar. The effect on the general price level of a small change in the quantity of money offered in exchange for a quantity of goods and services is negligibly small. This is to say that the elasticity of demand for money facing an individual seller of money who is a buyer of goods and services is infinitely elastic. Similarly, the elasticity of supply of money facing an individual seller of goods and services is infinitely elastic. Therefore, owing to the low transaction cost and the highly elastic excess demand for money facing an individual, money is the most liquid of all assets. An organized futures market is a device for making a futures contract a highly liquid instrument of trade. It accommodates a given volume of trade at the least transaction cost. It can furnish the services of its members so that the excess demand for futures contracts facing an individual traders is highly elastic, provided it can maintain a highly liquid market. The analogy between money and futures contracts is even closer than the preceding argument implies. Just as the total liability of a bank is limited by the size of its reserves, so too the total liabilities of the clearing house of an organized exchange is limited by the total amount of the commodity that may be delivered to settle futures commitments that are still outstanding during the month the futures contracts mature. This total stock of the deliverable commodity stands to the total liability of the clearing house as the reserves of the bank stand to its deposits which are its liabilities. However in contrast to a bank there need not be fixed relation between the deliverable stock of the commodity and the size of the outstanding commitments of futures contracts. It is always possible to extinguish a futures commitment by an offsetting transaction before the maturity date. This occurs at the then prevailing price of the futures contract and not at the price of the original futures transaction. The very absence of a close tie between the size of the outstanding futures commitments and the stock of deliverable supplies of the commodity enhances the liquidity of the futures contract. It allows the size of the outstanding commitment to adjust flexibly to the needs of the transactors and to depend on the mutually agreeable terms they can arrange among themselves. There is a risk of a price squeeze only during the delivery month of the contract. Such a squeeze resembles a run on a bank. A run on a bank occurs when nearly all of the depositors withdraw their deposits almost at once. The effect on the bank is almost the same as would be the effect on the clearinghouse if all buyers of future contracts stood for delivery. The analogy is imperfect because the clearinghouse itself has assets in the form of commitments from those who owe it the commodity in the delivery month because they had previously sold

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futures contracts. A bank cannot call all of its loans to settle the demands of its depositors who wish to withdraw their funds. The clearinghouse, however always have assets that match exactly in timing its liabilities. Nevertheless, an unexpectedly large demand for delivery by the buyers of futures contracts accompanies an unexpectedly large increase in the spot price for deliverable supplies during the delivery month. So there is said to be a price squeeze.

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Fig-1: Diagrammatic Representation of Trading Procedure in the Futures Market

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2.10- Advantages of Futures contracts Farmers:
Efficient Price Discovery/Forecast made by the exchange will enable farmers decide cropping pattern and investment on inputs. Price Stability resulting from equilibrium in supply and demand for a commodity would be possible through exchanges. Get an extensive market opened for them. Get opportunity to trade, knowing the national and international trends and standards. Can sell the commodity to the customer without any agents. Can decide the market even before harvest. Get an opportunity to gain profit by spending only a small percentage of the actual commodity price. There is an opportunity to keep the commodity in the warehouse and use the warehouse receipt to deal with financial needs, as it is an endurable document. Can avoid deliberate decrease in price in the name of quality. Farmers can trade by asking the help of the experts in trading organizations even if they are computer illiterate.

Traders:
Can trade by spending only the margin amount. Can sell the commodities that he buys from the ready market and can rescue himself from the loss happening from price fall. For those who have kept their commodity in the Central Warehouse, loans are available on the basis of the stock. The benefit is that you can keep the commodity somewhere without blocking the working capital in the stock.

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Consumer, Industrialist & Exporters:
Can be sure that the commodity is available when they require it. Can calculate the price since it is predetermined and can arrange everything according to that. Can buy goods without agents. Can buy them even while sitting in their office. Can be assured the quality of the good. Commodities can be purchased with only margin amount instead of giving the whole price.

2.11- COMMODITY FUTURES IN INDIA
Government of India, in 2002-03, has demonstrated its commitment to revive the Indian agriculture sector and commodity futures markets. Prime Minister’s Independence Day address to the nation on August 15, 2002, which enlisted nation-building initiatives, included setting-up of national commodity exchange among the important initiatives. The year 2002-03, certainly was an eventful year in terms of regulatory changes and market developments that could set the agenda for development for the years to come.

Policy Initiatives:
Firstly, Government of India, in early 2003, has given mandate to four entities to set-up nation-wide multicommodity exchanges. Secondly, expansion of permitted list of commodities under the Forward Contracts (Regulation) Act, 1952 (FC(R)A). This effectively translated into futures trading in any commodities that can be identified. Thirdly, 11 days restriction to complete a spot market transaction (ready delivery contract) is being abolished. Fourthly, non-transferable specific delivery (NTSD) contracts is removed from the purview of the FC(R). The above four policy decisions have the potential to proliferate futures contracts usage in India to manage price risk. National level exchanges would make availability of futures contracts across the nation in the most cost-effective manner through technology and at the same time would improve the risk management systems to improve and maintain financial integrity of futures markets in the country. Expansion of list of

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commodities would make available risk management mechanism for all commodities where such a demand exists but never made possible in the past. Abolition of the 11 days restriction on spot market transactions and removal of NTSD contracts from the purview of FC(R)A would effectively mean unhindered forward contracting among the constituents of commodity trade value chain. Forward contracting is an important activity for any economy to meet raw material requirements, to facilitate storage as a profitable economic activity and also to manage supply and demand risk; forward contracts give rise to price risk, so to the need of price risk management. Futures markets and forward contracts compliment each other for effective price discovery and pricing of forward contracts. Price risk in forward contracts can be managed through futures contracts.

Performance of commodity exchanges:
Year 2002-03 witnessed a surge in volumes in the commodity futures markets in India. The 20 plus commodity exchanges clocked a volume of about Rs.100,000 crore in volumes against the volume of 34,500 crore in 2001-02 remarkable performance for an industry that is being revived. This performance is more remarkable because the commodity exchanges as of now are more regional and are for few commodities namely soybean complex, castor seed, few other edible oilseed complex, pepper, jute and gur. Interestingly commodities in which future contracts are successful are commodities those are not protected through government policies; and trade constituents of these commodities are not complaining too. This should act as an eye-opener to the policy makers to leave pricing and price risk management to the market forces rather than to administered mechanisms alone. With the value of India’s commodity economy being around Rs.300,000 crore a year potential for much greater volumes are evident with the expansion of list of commodities and nationwide availability. Opening up of the world trade barriers would mean more price risk to be managed. All these factors augur well for the future of futures.

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National commodity exchanges and regional commodity exchanges:
Demutualization has gathered pace around the world and Indian commodity exchanges are also looking into it. Existing single and regional commodity exchanges have realised the possible threat that the national level exchange may pose on their future. Given the experience of the regional stock exchanges in India, commodity exchanges are becoming proactive to counter such a threat. Commodity exchanges may not face the threat of extinction because of the following reasons. (1) Commodity exchanges are trading in futures contracts on those commodities, which have regional relevance. It is not going to be easy as a share of a company to get listed in a different exchange. (2) Delivery of commodity is a physical activity; delivery of shares is an electronic activity (3) Commodity exchange members are stakeholders in those commodities wherein stock exchange members were never the owners of the stock to control where the stock should get traded. (4) Importance of commodity exchanges wherein success of a stock exchange is more on transparency and low transaction cost. Above reasons are possibilities; national level exchanges could woo the existing commodity exchanges and their members to the national stream. Such exchanges and members are of relevance to the Indian economy as a whole and for the success of commodity futures in particular important aspect the regulator and exchanges should address is the regulator cost. Unless the regulator cost is kept low, thriving parallel markets will never join the mainstream exchanges.

Impact of WTO regime:

India being a signatory to WTO may open up the India’s

agricultural and other commodity markets more to the global competition.

uniqueness as a major consumption market is an invitation to the world to explore the Indian market. Indian producers and traders too would have the opportunity to explore the global markets. Price risk management and quality consciousness are two important factors to succeed in the global competition. Futures and other derivatives contracts have significant role in price risk management. Indian companies are allowed to participate in the international commodity exchanges to hedge their price risk resultant from export and import activities of such companies. Due to the compliance issues and international exchanges rules, 90 percent of

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the commodity traders and producers are not in a position to participate in the international exchanges International exchanges have trading unit size, which are prohibitive for many of the Indian traders and producers to participate in the international exchanges. Addressing the risk management requirements of the majority is of concern and the way to address is through on-shore exchanges. In a more liberalised environment, Indian exchanges have significant role to play as vital economic institutions to facilitate risk management and price discovery; price discovery would have greater link to global demand and supply which could assist the producers to decide on what crops they should produce.

Way ahead:
Commodities exchanges in India are expected to contribute significantly in strengthening Indian economy to face the challenges of globalisation. Indian markets are poised to witness further developments in the areas of electronic warehouse receipts (equivalent of dematerialised shares), which would facilitate seamless nationwide spot market for commodities. Amendments to Essential Commodities Act and Options implementation of Value-Added-tax would enable movement of across states and more unified tax regime, which would facilitate easier trading in commodities. risk management markets in the country. contracts in commodities are being considered and this would again boost the commodity We may see increased interest from the international players in the Indian commodity markets once national exchanges become operational. Commodity derivatives as an industry is poised to take-off which may provide the numerous investors in this country with another opportunity to invest and diversify their portfolio. Finally, we may see greater convergence of markets equity, commodities, forex and debt – which could enhance the business opportunities for those have specialised in the above markets. Such integration would create specialised treasuries and fund houses that would offer a gamut of services to provide comprehensive risk management solutions to India’s corporate and trade community. In short, we are poised to witness the resurgence of India’s commodity trading which has more than 100 years of great history.

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2.12 -Genesis of the problem
In recent times we have seen fluctuations in the prices of various essential commodities. A lot of the speculation has been attributed to the futures markets of these commodities i.e. by encouraging or facilitating speculation they give rise to price instability. Most of the research done in this regard has been on perishable commodities like onion and potatoes which suggest that the seasonal price range is lower with a futures market because of speculative support at harvest time. Secondly sharp adjustments at the end of a marketing season are diminished under futures trading because they have been anticipated and lastly year-to-year price fluctuations are reduced under futures trading because of the existence of the futures market as a reliable guide to production planning. By this research we aim to study by examining commodity prices after and before introduction of futures markets whether volatility exists.

2.13 – Statement of the Problem
1) What would happen to the systematic and random parts if a viable futures market were introduced into the pricing system? 2) There have been few studies of the impact of futures trading on the variance of the systematic component associated with fundamental economic conditions. 3) Is the commodity future an effective tool to hedge against price fluctuations or else it leads to the price fluctuations of the underlying commodity? To examine whether the introduction of futures markets has caused volatility in the prices of the commodities in the futures market and whether the introduction has caused benefit or loss to the farmers by helping get an optimum price for their commodities.

2.14 – Research Gap (Need and importance of the study)
The study done until recently on whether commodity futures markets affects the prices of the commodities by encouraging speculation have always considered selected commodities like onion and potatoes. As such to assume that they hold good for other commodities would be wrong particularly those commodities that are continuously produced and semi-or non storable. A more general approach to the study of the impact of futures trading on cash prices is needed. The statistical evidence assembled in support of the three conclusions namely:

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1) The seasonal price range is lower with a futures market because of speculative support at harvest time. 2) Sharp adjustments at the end of a marketing season are diminished under futures trading because they have been better anticipated. 3) Year-to-Year price fluctuations are reduced under futures trading because of the existence of the futures market as a reliable guide to production planning. The above conclusions have always dealt with the total seasonal variation in cash prices. The research concerns itself with an analysis of the impact of futures trading on the fluctuations of the separate elements of price series. It focuses mainly on the effect futures trading has on the random element.

2.15 – Objectives of the Research
The main focus of this study would be to study the effect of variance of the error or random component which represents noise and disturbance in the price system when a futures market is injected with commodities like wheat, rice, maize, gharm, tur, urad, palm oil, sunflower oil and ground oil. To analyse if futures trading has an impact on the price of the commodities.

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3.1 – Literature Review Research Article – 1: Does Futures Trading Reduce Price Fluctuation in the Cash Markets?
Mark J. Powers (The American Economic Review, Vol.60, No.3. (Jun.,1970)

Methodology followed by the author:
MARK J. POWERS in his article has collected weekly cash prices for pork bellies and live beef for eight years, four years preceding the start of futures trading and four afterwards. The four-year periods considered for port bellies were 1958 through 1961, and 1962 through 1965. For beef, the four-year periods were 1961 through 1964 and 1965 through 1968. The cash prices used for choice live steers represented the average weekly prices paid for choice steers at Chicago. The data were analyzed on the basis of four-year and two year periods. For the purposes of conducting the study it was hypothesized that (The Variance error or Random component which represents noise and disturbance in the price system) would be lower during time periods with futures trading than during time periods without futures trading. To analyze the data and test the hypothesis it was desirable to use a technique which would isolate and estimate the random element in a variable which is changing over time. The technique actually selected was the Variate Difference Method, developed by Gerhard Tintner. The Variate difference method fits our purpose best, mainly because it is a statistical method that does not require specification of a rigid model and it isolates and estimates the random element without affecting the systematic component. The Variate difference method starts from the assumption that an economic time-series consists of two additive parts. The first is the mathematical expectation or systematic component of the time-series. The second is the random or unpredictable component. The assumption is that these two parts are connected by addition but are not correlated. It is further assumed that the random element is not auto correlated and has a mean of zero; that the random element is normally distributed; and that the systematic component is a ‘smooth'function of time.

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The steps involved in the analysis are essentially three. First, the random element is isolated in the time-series. This is accomplished by finite differencing. Successive finite differencing of a series will eliminate or at least reduce to any desired degree the systematic component without changing the random element at all. The random component cannot be reduced by finite differencing because it is not ordered in time. Second the variance of the random element is calculation. Then the variance of the series was calculated. In order to determine whether or not there is a statistically significant difference in the random variance for price series in different time periods, a standard error-difference formula for testing the difference between two variances was used.

Conclusion: In each of the two-year periods considered in live beef, the random
fluctuations were significantly lower than in each of the two-year periods without futures trading. Likewise for port bellies the analysis indicates that for similar years in the price cycle the random fluctuations were significantly lower when there was futures trading than when there was not. During the time periods considered in this study the only major changes in information flows for these commodities were those resulting from futures trading. Therefore part of the reduction in the variance in the random element can be attributed to the inception of futures trading in these commodities and the relationship between the reductions in random price fluctuations and futures trading is explained in part by the improvements in the information flows fostered by futures trading.

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Research Article - 2 Price Volatility of Storable Commodities under Rational Expectations in Spot and Futures Markets. - Masahiro Kwai - (International No.2(Jun.1983)
When the possibility of “speculative bubbles” is excluded and the price follows a unique path, the question remains as to whether the quality of price forecasts by rational agents improves with the introduction of a futures market. Futures’ trading has been viewed to serve for a better distribution of commodities over time, leading to a reduction in the amplitude and frequency of price fluctuations. Since futures traders, in their capacity as speculators, usually take a “long position”when the spot price is expected to be higher than the delivery contract price and a “short position”when price expectations are lower, futures activities are considered to improve the intertemporal allocation of commodities and therefore stabilize prices. This hypothetical view might appear consistent with economist’s institutions, but empirical studies on price stabilizing effects of futures trading have revealed mixed results. Only a few works have attempted to resolve the issued from theoretical perspectives and they have emphasized a pricestabilizing tendency of the futures market. Price determination process of storable commodities by explicitly taking into account the important fact that the introduction of a futures market alters the decision-making procedure of individual optimizing agents in a way described in the text. Then the effect on spot volatility would be evaluated. First, the microeconomic decision-making problems of risk-averse, price-taking agents (producers, inventory holding dealers, and pure speculators) are presented in order to derive individual linear supply and demand functions in terms of a set of known prices, as well as the subjective expectations and variances of the random price. Second, market supply and demand functions for the commodity and futures contracts are obtained by aggregating individual functions over all agents. Third the equilibrium price distributions are solved under rational expectations and the rational price variances are compared in the presence and in the absence of futures trading.

Economic

Review,

Vol.

24,

Methodology used:
Variance Analysis

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Conclusion:
The research work began by analyzing the optimizing behaviour of agents, who produce and trade storable commodities in the absence or presence of opportunities for futures contracting, and derived a set of individual supply and demand functions under price uncertainty and risk aversion. This optimizing approach enables us to understand how activities of production and inventory holding should be modified as a consequence of introducing futures markets. After aggregating individual functions over all agents and obtaining market supply and demand schedules, equilibrium commodity price distributions are solved in a stochastic rational expectations framework. The usual “nonspeculative bubble” condition is imposed on the rational expectations equilibrium path of prices. A futures market plays the role of transferring price risk from hedgers to speculators. The futures market provides another important facility for distributing commodity demand and supply from one period to the next and, hence, may have a potential to reduce price fluctuations over time. The conditional variances of the T-period ahead spot prices are computed and compared for the absence and presence of a futures market. The nonlinear relationships among the structural parameters, which are required by the rationality of expectations formation, make a general comparison virtually impossible, particularly in the light of the possibilities of non-existence and nonuniqueness of the solution as discussed by Mc Cafferty and Driskill. However, with additional restrictions concerning the nature of inventory holding or the agent’s attitudes towards risk and with the aid of numerical examples, it is found that the identification of the source of random disturbances is crucial in this comparison. If the consumption demand disturbance is the primary random element in the commodity market then the introduction of a futures market tends to stabilize spot prices; whereas if the inventory demand disturbance is preponderant, a futures market tends to be price destabilizing (except for the case of infinitely large marginal cost of inventory carrying). The role of production disturbances is generally ambiguous. The existence of a futures market may extend the scope of successful price stabilization through government intervention. It has been shown that, if the consumer demand or output supply disturbance predominates the market, the futures intervention rule of fixing futures prices while maintaining constant (or even zero) reserves can stabilize at least short-term price volatility. In this case the role of futures trading as an intertemporal resource allocator can be effectively exploited by the intervening authority. However, the authority has to be quite cautious in

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implementing this intervention scheme, because it can be detrimental in the face of large unanticipated shocks in inventory holding.

3.2 - Benefits derived from the literature review:
The above citied articles and other articles reviewed during the process of

gathering information on the topic have helped in understanding the reasons why fluctuations exist in certain markets whether it is due to pure speculative causes or whether any other hidden elements are influencing the price of the commodities in the market. Also the various methods of analysing the data using different statistical tools was learnt and how these statistical tools help in interpreting the data. Another thing leant from the literature review is that one of the major advantages of organizing futures exchanges is that the authority can influence the movement of spot prices through futures intervention without causing fluctuations in commodity reserves held by the intervention authority and hence without actually storing any commodity reserves. An infinitely elastic spot-market intervention could, of course, fix the spot price at an arbitrary level, but would induce changes in official commodity reserves. Also that market information has a particularly important place among the factors that determine what is offered for sale and what is demanded, and hence among the factors that determine prices. As markets become more decentralized, information concerning current and future demand and supply conditions must be carefully collected and interpreted. Commodity future exchanges have been termed clearing centers for information. Information relative to supplies, movements, withdrawals from storage, purchases, current production, cash and futures prices and volume of futures trading, is collected, collated and distributed by the exchange its members and the institutions such as brokerage houses which serve the exchange. This information is used not only by current and potential traders in futures, but it is also carefully evaluated by cash market operators. As such the literature review helped in understanding the market forces that determine that demand and supply conditions in the market and how futures markets have helped in this and to what extent they have influenced the prices of the commodities.

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4.1 - Type of research: The Research work undertaken in the report is both a
qualitative and quantitative one. Qualitative data was analyzed to find for any reasons that may exist in which cause any variations in the commodity futures markets. Quantitative data like the prices of the commodities for the two years preceding the date of introduction of futures to after introduction of futures was collected and analyzed.

4.2 - Sampling technique: The sample size includes the following commodities and
the prices two years prior to introduction and after the introduction of futures was the considered. The commodities are as follows: Maize Wheat Castor Gur Turmeric Soyabean

4.3 - Sample description:
Synoptic view of the commodities selected as sample:

MAIZE

Maize is a cereal grain that was domesticated in Mesoamerica and then spread throughout the American continents. It spread to the rest of the world after European contact with the Americas in the late 15th century and early 16th century. Corn is a shortened form of Indian corn i.e. the Indian grain. Maize is widely cultivated throughout the world and a greater weight of maize is produced each year than any other grain. While the United States produces almost half of the world’s harvest other top producing

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countries are as widespread as China, Brazil, France, Indonesia and South Africa. Worldwide production was over 600 million metric tons in 2003 – just slightly more than rice or wheat. In 2004, close to 33 million hectares of maize were planted worldwide with a production value of more than $23 billion. Human consumption of corn and cornmeal constitutes a staple food in many regions of the world

Wheat:

WHEAT SCENARIO IN INDIA: Wheat is one of the most important staple food grains of human race. India produces about 70 million tones of wheat per year or about 12 per cent of world production. It is now the second largest producer of wheat in the world. Being the second largest in population, it is also the second largest in wheat consumption after China, with a huge and growing wheat demand. Relevance of Wheat Futures Trading: For a commodity to be suitable for smooth futures trading, generally a favorable supply-demand balance is considered necessary, though this condition is no longer very relevant in globalized commodity markets. There are no quantitative restrictions on imports of food grains under the EXIM policy of India. Nevertheless, India is no longer dependent on imports of food grains with nearly 2% of surplus of Wheat over the last decade. With the withdrawal of Government in the Wheat market, volatility and vibration in wheat market would be conducive for Futures trading in the country. Traders and manufactures could do away with storing excessive stock of Wheat resulting in increased

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carrying cost. For instance, the economic cost of carrying buffer stocks of Wheat for FCI is projected to rise to Rs 921/per quintal in 2003-04 from the present cost of 879.16/per quintal due to increase in MSP, open ended procurement and hike in the rates of state taxes and levies. In light of this, futures trading in Wheat would provide a mechanism to lock in prices today of future production or future sale. This would enable reduction of buffer stocks with traders and stockiest who would use futures to maintain optimal levels of Wheat stocks. The locking in of Futures price and buying/selling forward on estimated production would help in removing intra seasonal and inters seasonal abnormal price variance. Such a futures market would not only provide management of price risks through hedging but also assist in efficient discovery of prices, which could serve as reference for trade in physical commodities in both domestic and international markets.

Soybean: Soybean is a species of legume native to Eastern Asia. It is an annual plant
that may vary in growth, habit and height. Beans are classified as pulses whereas soybeans are classified as oilseeds. Soybeans occur in various sizes, and in several hull or seed coat colors, including black, brown, blue, yellow and mottled. Soybeans are an important global crop, grown for oil and protein. The bulk of the crop is solvent extracted for vegetable oil and then defatted soy meal is used for animal feed. A very small proportion of the crop is consumed directly as food by humans. Soybean products, however appear in a large variety of processed foods. Soybean is a fast expanding oilseed crop in India. During recent years, it has shown a tremendous growth in production in the country. Out of the estimated production of 15.06 million tonnes of all the oil seeds in the country, the soybean shared about 30 percent (4.56 million tonnes) during the year 2002-03. The soybean has a vibrant international trade due to its multiple beneficial

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qualities. Soybean is being promoted as an important oilseed under the Technology Mission on Oilseeds and Pulses in India. For its nutritional profile the soy food market has the potential to grow at about 200 percent per annum.

Turmeric: Turmeric is a member of the ginger family. It’s also called tumeric or
kunyit insome Asian countries. Its dried roots are ground into a deep yellow spice commonly used in curries and other South Asian cuisine. curcumin and it has an earthy bitter peppery flavour. Sangli a town in the southern part of the Indian state of Maharashtra, it is the largest and most important trading centre for turmeric in Asia or perhaps in the entire world. Tumeric powder is used extensively in Indian cuisine. Turmeric has found application in canned beverages, baked products, dairy products, ice cream, yogurt, yellow cakes, biscuits, popcorn-color, sweets, cake icings, cereals, sauces, gelatings, etc. It is significant ingredient in most commercial curry prowders. Turnmeric is used to protect food products from sunlight. Over-coloring such as in pickles, relishes and mustard, is sometimes used to compensate for fading. In the Ayurvedic medicine, turmeric is thought to have many medicinal properties and many in India use it as a readily available antiseptic for cuts and burns. It is taken in some Asian countries as a dietary supplement which allegedly helps with stomach problems and other ailments. Turmeric is currently used in the formulation of some sunscreens. Turmeric paste is used by some Indian women to keep them free of superfluous hair. Its active ingredient is

Castor Oil: It is a vegetable oil obtained from the castor bean. Castor oil and its
derivatives have applications in the manufacturing of soaps, lubricants, hydraulic and brake fluids, paints, dyes coatings, inks, cold resistant plastics, waxes and polishes, nylon, pharmaceuticals and perfumes. In internal combustion engines, castor oil is renowned for

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its ability to lubricate under extreme condtions and temperatures such as in air-cooled engines. In the food industry, Castor oil (food grade) is used in food additives, flavourings, candy (I,e. chocolate) as a mold inhibitor and in packaging. Castor oil is also used in the food stuff industries. Castor oil has 1000 patented industrial applications and is used in the following industries: automobile, aviation, cosmetics, electrical, electronics, manufacturing, pharmaceutical, plastics and telecommunications. Castor oil’s value was recognized by the United States Congress in the Agricultural Materials Act of 1984 and classified as a strategic material.

Gur: Jaggery is the traditional unrefined sugar used in India. Though “jaggery’ is used
for the products of both sugarcane and the date palm tree, technically the word refers solely to sugarcane sugar. The sugar made from the sap of the date palm is both more prized and less available outside of the districts where it is made. Hence outside of these areas, sugarcane jaggery is sometimes called “gur” to increase its market value. Jaggery is considered by some to be a particularly wholesome sugar and, unlike refined sugar, it retains more mineral salts. Moreover the process does not involve chemical agents. Ayurvedic medicine considers jaggery to be beneficial in treating throat and lung infections. Jaggery is used as an ingredient in both sweet and savory dishes across India and Sri Lanka. Jaggery is also considered auspicious in many parts of India, and is eaten raw before commencement of good work or any important new venture. Muzaffarnagar district in Uttar Pradesh has the largest jaggery market in India.

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4.4 - Instrumentation techniques: Time series
A time series is a sequence of data points, measured typically at successive times, spaced at (often uniform) time intervals. Time series analysis comprises methods that attempt to understand such time series, often either to understand the underlying theory of the data points (where did they come from? what generated them?), or to make forecasts (predictions). Time series prediction is the use of a model to predict future events based on known past events: to predict future data points before they are measured. The standard example is the opening price of a share of stock based on its past performance.

UNIT ROOT TEST:
A unit root test tests whether a unit root is present in an autoregressive model. The most famous test is the Dickey-Fuller test. Another test is the Phillips-Perron test.

Theory of Stationarity
Following are different ways of thinking about whether a time series variable Xt is stationary or has a unit root: In the AR (1) model, if F=1, then X has a unit root. If |F| <1 then X is stationary. If X has a unit root, then its autocorrelations will be near one and will not drop much as a lag length increases. If X has a unit root, then it will have a long memory. Stationary time series do not have long memory. If X has a unit root then the series will exhibit trend behavior. If X has a unit root, then DX will be stationary. For this reason, series with unit root are often referred to as difference stationary series. The stationarity condition of the data series used in the study has been tested using Augmented Dickey Fuller Test.

Augmented Dickey-Fuller Test (Unit root testing)
In Statistics and econometrics, an Augmented Dickey-Fuller test (ADF) is a test for a unit root in a time series sample. It is an augmented version of the Dickey-Fuller test to accommodate some forms of serial correlation. Testing Procedure

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The testing procedure for the ADF test is the same as for the Dickey-Fuller test but it is applied to the model.

where μ is a constant, β the coefficient on a time trend and p the lag order of the autoregressive process. Imposing the constraints μ = 0 and β = 0 corresponds to modeling a random walk and using the constraint β = 0 corresponds to modeling a random walk with a drift. By including lags of the order p the ADF formulation allows for higher-order autoregressive processes. This means that the lag length p has to be determined when applying the test. One possible approach is to test down from high orders and examine the t-values on coefficients. The unit root test is then carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. Once a value for the test statistic computed it can be compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present.

4.5 - Actual collection of data: The data includes the following:
1) Two years prior to introduction of futures trading 2) Two years after the introduction of futures trading

4.6 - Tools used for testing of hypothesis: The following statistical tools were
used to analyze the data: 1) Log Natural 2) Augmented Dickey Fuller Test (for stationarity) 3) Standard Deviation 4) F-Test

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4.7 - Other software used for data analysis:
The following software’s were used for data analysis: 1) SPSS 2) E-VIEWS 3) EXCEL SPREADSHEET

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Graphical Representation of Price fluctuations before and after in the market: Wheat: (Fig-2)

1000

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800

Value BEFORE

700

600 1 27 53 79 105 131 157 183 209 235 261 287 313 339 365 391 417 443 469 495

Case Number
1300

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V alue A FTE R

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700 1 27 53 79 105 131 157 183 209 235 261 287 313 339 365 391 417 443 469 495

Case Number

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Turmeric :( Fig-3)
4000

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Value BEFORE

2000

1000 1 28 55 82 109 136 163 190 217 244 271 298 325 352 379 406 433 460 487 514

Case Number
3400 3200 3000 2800 2600 2400

Value AFTER

2200 2000 1800 1 28 55 82 109 136 163 190 217 244 271 298 325 352 379 406 433 460 487 514

Case Number

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Soyabean :( Fig-4)
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1500

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1300

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V lu B F R a e EO E

1100

1000 900 1 30 59 88 117 146 175 204 233 262 291 320 349 378 407 436 465 494 523 552

Case Number
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V lu A T R a e FE

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1000 1 30 59 88 117 146 175 204 233 262 291 320 349 378 407 436 465 494 523 552

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Maize :( Fig-5)
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V alue B FO E E R

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400 1 30 59 88 117 146 175 204 233 262 291 320 349 378 407 436 465 494 523 552

Case Number
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V alue A FTE R

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400 1 30 59 88 117 146 175 204 233 262 291 320 349 378 407 436 465 494 523 552

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Gur :( Fig-6)

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V alue B FO E E R

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400 1 31 61 91 121 151 181 211 241 271 301 331 361 391 421 451 481 511 541 571

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V lu A T R a e F E

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400 1 31 61 91 121 151 181 211 241 271 301 331 361 391 421 451 481 511 541 571

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Castor :( Fig-7)

2200

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V lu B F R a e EOE

1400

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1000 1 31 61 91 121 151 181 211 241 271 301 331 361 391 421 451 481 511 541 571

Case Number
420 400 380 360 340 320

V lu A T R a e FE

300 280 260 1 31 61 91 121 151 181 211 241 271 301 331 361 391 421 451 481 511 541 571

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Presentation and analysis of data and interpretation 5.1 - Hypothesis:
Null Hypothesis (Ho) The volatility before and after the introduction of futures is the same Alternative hypothesis (H1) The volatility after the introduction of futures is less

5.2 –Test for Stationarity:
The price collected for the periods prior to and after introduction of futures had to be subjected to a stationarity test for this purpose Log natural or the price and a first lag difference was taken. The data thus obtained was tested for stationarity to see if the data was stationary with the help of E-views software the Augmented Dickey Fuller test for stationarity was conducted to test if the data is stationary or not. Following are the results and conclusions that were obtained from the test:

5.3 - Augmented Dickey fuller test (Unit root testing) to test data for stationarity: Table: 1
Wheat Before Introduction of Futures: Unit root test at 1 lag & 1st Difference
ADF Test Statistic -37.73725 1% Critical Value* 5% Critical Value -3.4437

-2.8667

10% Critical Value

-2.5695

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Wheat After Introduction of Futures: Unit root test at 1 lag & 1st Difference
ADF Test Statistic -23.18122 1% Critical Value* 5% Critical Value 10% Critical Value *MacKinnon critical values for rejection of hypothesis of a unit root. -3.4468 -2.8681 -2.5702

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

Table- 2:
Turmeric Before Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -25.02025 1% Critical Value* 5% Critical Value 10% Critical Value -3.4533 -2.8710 -2.5718

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Turmeric After Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -25.52701 1% Critical Value* 5% Critical Value 10% Critical Value -3.4452 -2.8674 -2.5699

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

Table 3: Maize Before Introduction of Futures: Unit root test at 1 lag and 1st
Difference

ADF Test Statistic

-27.80740

1% Critical Value* 5% Critical Value 10% Critical Value

-3.4507 -2.8699 -2.5712

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Maize After Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -29.48832 1% Critical Value* 5% Critical Value 10% Critical Value -3.4448 -2.8672 -2.5698

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

Table 4:
Soyabean Before Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -28.17292 1% Critical Value* 5% Critical Value 10% Critical Value -3.4489 -2.8691 -2.5708

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Soyabean After Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -24.34491 1% Critical Value* 5% Critical Value 10% Critical Value *MacKinnon critical values for rejection of hypothesis of a unit root. -3.4442 -2.8669 -2.5696

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

Table 5: Gur Before Introduction of Futures: Unit root test at 1 lag and 1st
Difference

ADF Test Statistic

-31.40239

1% Critical Value* 5% Critical Value 10% Critical Value

-3.4446 -2.8671 -2.5697

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Gur After Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -29.75963 1% Critical Value* 5% Critical Value 10% Critical Value -3.4439 -2.8668 -2.5696

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

Table 6:
Castor Before Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -31.46235 1% Critical Value* 5% Critical Value 10% Critical Value -3.4462 -2.8678 -2.5701

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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Castor After Introduction of Futures: Unit root test at 1 lag and 1st Difference
ADF Test Statistic -27.45583 1% Critical Value* 5% Critical Value 10% Critical Value -3.4455 -2.8675 -2.5700

*MacKinnon critical values for rejection of hypothesis of a unit root.

Unit root test is carried out under the null hypothesis γ = 0 against the alternative hypothesis of γ < 0. The value for the test statistic computed is compared to the relevant critical value for the Dickey-Fuller Test. If the test statistic is less than the critical value then the null hypothesis of γ = 0 is rejected and no unit root is present. However, in our analysis the value of the test statistic is greater than the critical value for the Dickey Fuller Test. Hence null hypothesis of γ = 0 is accepted and unit root is present.

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5.4 - Standard deviations and F test:
The daily prices of the commodities collected for a two year period prior and after the introduction of futures. Log naturals of the prices of the commodities was removed subsequent to which a 1st difference of the log natural values was removed. Standard Deviation month wise was removed of the 1st difference. Subsequent to which a Standard Deviation of the monthly Standard Deviations was removed. Based on which an F-Test was conducted to see if the values are significant or not.

Standard Deviation of Monthly Standard Deviation are: Commodity Castor Turmeric Wheat Soya Bean Gur Maize Standard Deviation Before 0.007859891 0.066302 0.012954 0.023054 0.015833 0.020249508 After 0.003100916 0.003379 0.00535 0.005906 0.008234 0.005296832

F- Test = (Standard Deviation 1)2 (Standard Deviation 2)2 5.5 - Results: F-TEST Commodity Castor Turmeric Wheat Soya Bean Gur Maize F- Test 6.424702507 384.9394 5.863431 15.2345 3.697444 14.6149225

If the value of the F-Test is greater that 1 then the Alternative hypothesis is accepted and the null hypothesis is rejected. If the value is greater than 1 it is significant and thus we can say that the volatility after the introduction of futures is less.

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6.1 - Conclusion: Castor: The F-Test value of Castor is 6.424702507 which is greater than 1 as such we
can say that after the introduction of futures the volatility in the futures market for Castor has decreased and thus the alternative hypothesis is accepted in the case of Castor.

Turmeric: The F-Test value of Turmeric is 384.9394 which is a very high value and
thus is significant as it is greater than 1 we can thus conclude that the volatility in the futures market of Turmeric after the introduction of futures has decreased. Here alternative hypothesis is accepted and null hypothesis is rejected.

Wheat: The F-Test value of Wheat is 5.863431 which is greater than 1 thus we can say
that after the introduction of futures the volatility in the market has decreased. Thus alternative hypothesis is accepted and null hypothesis is rejected in the case of Wheat.

Soya bean – The F-Test value of Soyabean is 15.2345 which is a significant value as it
is greater than 1. Thus we can conclude by saying that the volatility in the Soya bean market has decreased after the introduction of futures. Alternative hypothesis is accepted and null hypothesis is rejected.

Gur – The F-Test value of Gur is 3.697444 which is a significant value as it is greater
than 1. Thus we can say the volatility in the futures market has reduced after the introduction of futures. Alternative hypothesis is accepted and null hypothesis is rejected.

6.2– Conclusions from the study:
Thus from the study we can conclude that the introduction of futures has reduced the volatility in the futures market and thus the introduction of futures has helped cause speculation in the market and keep the prices of the commodities under check.

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6.3 – Implications:
The study of the prices before and after the introduction of futures has thus revealed that the prices have remained stable after the introduction of futures trading and have thus helped stabalize the prices of the commodities. We can thus conclude that Futures Markets has brought a lot of stability in the market as a result of which the price fluctuations have been bought under check and that the government has been successful in controlling the prices of essential commodities. Also the National Commodities and Derivatives Exchange (NCDEX) and the Multi-Commodity Exchange of India (MCX) have been instrumental in providing a common trading platform for traders. By providing the relevant information about the market they have helped the market participants keep abreast of the latest developments they have also prevented black marketing and hording of essential commodities in the market. Thus we can conclude by saying that the Futures Markets has come as boon to farmers and to the consumers as well.

6.4 – Suggestions:
In the research study done only a limited number of commodities have been studied. To have a perfect picture about the implications of the futures markets a study on the metals that are traded on the exchange and whether there have been significant price fluctuations in the metals market needs to be studied. With the government suspending the trading in some of the commodities and metals a study on why trading in these metals and commodities was suspended and whether the futures market was a possible cause for this can be studied. This should offer ample opportunities for such research in the years immediately ahead.

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Bibliography
Research Articles: Futures Trading in Perishable Agricultural Commodities –Sidney Hoos (Washington, D.C) Price Volatility of Storable Commodities under Rational Expectations in Spot and Futures Markets – Masahiro Kawai (International Economic Review) Why There Are Organized Futures Markets – - Lester G. Telser (Journal of Law and Economics) Does Futures Trading Reduce Price Fluctuations in the Cash Markets? - Mark J. Powers (The American Economic Review) Books: Capital Market Commodity Option and Futures Online Database: www.jstor.com Websites: www.ncdex.com www.mcxindia.com www.agmarket.com Search Engines: www.google.com

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