|
Commodities are any interchangeable item. For example, goods such as livestock, grains, metals, crude oil, natural gas cotton, and lumber. Furthermore, financial based products such as bonds, treasury notes, and stock market indices and currencies are also considered to be commodities within the financial world.
Commodity transactions typically take place in two, non-identical, but closely related markets: the cash market and the commodity futures market. Prices are established within the marketplace by the financial objectives of buyers and sellers. Buyers are hunting for the lowest possible price, while sellers are seeking to get the highest possible price. Depending on the circumstances within the marketplace, buyers may have more incentive’s behind their bids driving up prices. However, if buyers are scarce and sellers are more eager to execute a trade, prices are driven lower.
Cash Market
The cash market can be either a spot or forward market. In a spot market there is immediate physical delivery of a specified commodity. A forward contract specifies a commodity to be delivered at a predetermined date in the future. A forward contract is similar to that of a futures contract, but there are some important differences. A futures contract is standardized as to the commodity, acceptable grade, quantity, and delivery date. Forward contract specifications are negotiated between the buyer and the seller as to the grade, quantity, and delivery date.
Commodity Futures Market
The first modern day commodity futures market, the Chicago Board of Trade, was established in Chicago during the 1860’s. It was originally founded as a cash market, and began trading futures contracts after inception. Since the beginning of the CBOT, other exchanges have been established throughout the United Stands and world.
A commodity futures contract is simply a special type of forward contract. They are standardized binding contracts designed to reduce the risk and increase flexibility of forward contracts. The central theme of commodity futures markets is standardization. Commodity futures contracts are standardized with regard to commodity, quantity, quality (grade) and point of delivery. The delivery dates are standardized within each delivery month: i.e. , there is a range of days during which all contracts must be performed on. Commodity futures markets provide:
Forward Pricing
Efficiency
Liquidity
Easy Access
Storability is Not Required
By standardizing contract terms, futures markets make it easier to transfer the risk of loss caused by price fluctuations from those who do not wish to bear this risk (hedgers) to those who are willing to accept the risk (speculators). Risk transfer is facilitated because each contract for a particular commodity in a particular delivery month is identical (interchangeable of fungible) in all of its terms with every other contract for that commodity and that delivery month: thus, anyone entering into a futures contract either knows exactly what he is getting, or can easily find out. No negotiation of terms is required, a market participant need only make a bid or offer on the contract.
|
