Evaluate the role of commodity exchanges for hedging and speculation with the help of appropriate examples.

Commodity Exchanges provide platforms to suit the varied requirements of customers. A commodity exchange acts as a portal or a common place where traders can buy and sell commodities. Such exchanges enable seamless trading, eliminate the need for middle men and allow the market to fix a price that is driven purely by demand and supply of the product. They help in price discovery as players get to set future prices which are also made available to all participants. Hence, a farmer in the southern part of India would be able to know the best price prevailing in the country which would enable him to take informed decisions. Secondly, these exchanges enable actual users (farmers, agro processors, industry where the predominant cost is commodity input/output cost) to hedge their price risk given the uncertainty of the future - especially in agriculture where there is uncertainty regarding the monsoon and hence prices. This holds good also for non agro products like metals or energy products as well where global forces could exert considerable influence. Purchasers are also assured of a fixed price which is determined in advance, thereby avoiding surprises to them. It must be borne in mind that commodity prices in India have always been woven firmly into the international fabric. Today, price fluctuations in all major commodities in the country mirror both national and international factors and not merely national factors. Thirdly, Commodity Exchanges provide liquidity and buoyancy to the system by involving the group of Investors and Speculators. Hedging in the futures market in general is a two-step process, depending upon the hedger's cash market situation. First step: If the hedger is going to buy a commodity in the cash market at a later time, his first step is to buy futures contracts. Or if he is going to sell cash commodity at a later time, his first step in the hedging process is to sell futures contracts. Second step: when the cash market transaction takes place, the futures position is no longer needed for price protection and should therefore be offset (closed out). Depending on the initial position taken long (long hedge) or short (short hedge), hedger would offset his position by selling or buying back the futures contract. Both the opening and closing positions must be for the same commodity, number of contracts, and delivery month. Example :- In June if a farmer expects an output of 100 tonnes of soyabean in October. Soyabean prices in October are expected to rule relatively lower as it is harvesting season for soya bean. In order to hedge against the price fall, the farmer/producer sells 100 contracts of one tonne each at 1347 on June 22. On a fall of price to 1216 per tonne in October he makes a profit of 131 per tonne.