Definition: The market for commodities means the location for the exchange between investors of products produced or grown. It brings all participants together to determine the price at which the goods can be traded throughout the market.
The price of a product is determined by the use of sellers for a particular price in an auction mechanism, whereas buyers offer a price and then pay at a mutually acceptable price. One thing that should be noted here is that salesmen and buyers interact through brokers.
The risk factor is comparatively higher in a commodity market than the share market because the market is extremely volatile and investors from various countries participate in the commodity exchange.
What is Commodity?
Commodities refer to the different raw materials used for the production of products used on a daily basis by consumers. They are fundamental elements of the utility of a common man. It comprises items moving in nature with the exception of actionable claims, money, and financial instruments.
Any valuable tangible item with uniform quality and produced in bulk by several manufacturers is a commodity. Commodity therefore means:
A physical substance that is delivered throughout the market.
No distinguishing product.
Demand exists.
Manufactured and sold by various producers.
Price is a result of supply and demand.
In India, derivative contracts are used for commodities trade. Do you now have to ask what the derivative contract is? A derivative contract is a contract among investors, which depends on the financial asset or commodity that underlies the contract.
The four most frequently used derivative contracts are forward, future, options and swaps. However, the trade-in of goods is largely carried out via future contracts.
Difference Between Forward Contracts and Future Contracts:
Future Contracts are a standard forward contract in which, at a predefined time and at the current locked price, two parties mutually decide to sell or buy the underlying asset. These are seen as a less hazardous alternative to currency fluctuations.
Why is it considered a separate hedging tool if future contracts are forward contracts? Well, these contracts look the same, but they are different. The following points explain these differences:
The forward contract is a more customised contract in which the terms and conditions between the buyers and sellers are negotiated, while the future contract is a standardised contract, with standardised rates, quantities and delivery conditions.
Future contracts do not have secondary markets, while future contracts are being negotiated on an organised trade.
Normally no collateral is required in the case of a forward agreement, while a margin is necessary in the case of a futures contract.
The final settlement of futures contracts takes place at maturity whereas future agreements are “marked for the market” every day, meaning that the profits and losses from these contracts are settled every day.
Future agreements often end with deliveries, while the future is mainly settled by differences.
The above comparison shows therefore quite clearly that forward contracts as well as future contracts are different and are used for different purposes.