COMMODITY FORWARDS AND FUTURES

Commodity forwards and futures are two tools of commodity derivatives. Commodity derivatives are nothing but contract based buying or sales of commodity which will be executed at a time in future.

Commodity forward is an agreement between two parties to buy and sell some commodity at a particular price at a particular time in future.  Commodity futures have all the property of commodity forwards how ever the commodity futures can be sold and bought in commodity exchange.

Need for commodity futures and forwards,

• The main advantage of forward and futures is that we can earn money out of speculation.
• Hedging is possible only with the help of forwards and futures, which reduces many risks involved in commodity market.
• Management of liquidity, fund, and credit are possible only with the help of commodity derivatives.
• It increases the efficiency of financial transactions.

The important features of derivatives are,

• The date of execution of the contract.
• The cost and quantity of the commodity.
• Location for the delivery of the commodity.

The commodity derivative are again classified into three types based on the payment mode they are,

• Spot transaction is the one in which payment are made by the buyer during the execution of the contract to the seller.
• Prepaid transaction is the one in which payment are made by the buyer before the execution of the contract to the seller.
• Traditional forward payment is the one in which payment are made by the buyer post the execution of the contract to the seller.

Commodity exchanges are the place where commodity derivatives are traded. Some of the largest commodity exchanges in the world are New York commodity exchange, Tokyo commodity exchange, Dalian commodity exchange market. In India we have multi commodity exchange. Commodity derivatives are sold in these markets just like derivatives of stocks. Commodity futures and forwards are used by the managers to hedge any loss that might occur due to the fluctuation of the commodity price in the market. The only loss that the buyers might incur in the commodity futures is the loss of the premium when the contract is not executed. .