Instability of commodity prices has always been a major concern of the producers as well as the consumers in an agriculture -dominated country like India. Farmers’ direct exposure to price fluctuations, for instance, makes it too risky for many farmers to invest in otherwise profitable activities. There are various ways to cope with this problem.
Apart from increasing the stability of the market, various factors in the farm sector can better manage their activities in an environment of unstable prices through derivative markets. These markets serve a risk -shifting function, and can be used to lock -in prices instead of relying on uncertain price developments.
There are a number of commodity-linked financial risk management instruments, which are used to hedge prices through formal commodity exchanges, over -the-counter (OTC) market and through intermediation by financial and specialized institutions who extend risk management services. (see UNCTAD, 1998 for a comprehensive survey of instruments) These instruments are forward, futures and option contracts, swaps and commodity linked -bonds. While formal exchanges facilitate trade in standardized contracts like futures and options, other instruments like forwards and swaps are tailor made contracts to suit to the requirement of buyers and sellers and are available over-the counter.
In general, these instruments are classified (as shown in figure-1.1) based on the purpose for which they are primarily used for price hedging, as part of a wider marketing strategy, or for price hedging in combination with other financial deals. While forward contracts and OTC options are trade related instruments, futures, exchange traded options and swaps between banks and customers are primarily price hedging instruments. In the case of swaps between intermediaries and producers, and commodity linked loans and bonds (CL&BS) price hedging are combined with financial deals.... [continues]
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