Commodities Exchange and Commodity Market
A commodities exchange is an exchange where various commodities and derivatives products are traded. An entity, usually an incorporated non-profit association, it determines and enforces rules and procedures for the trading of commodities and related investments, such as commodity futures. The term can also refer to the physical centre where the actual trading takes place. Investors can range from commodity producers to investment speculators, who buy and sell the futures contracts in attempt to make a profit and provide liquidity to the system.
In the 19th century, modern commodity markets began with the trading of agricultural products, such as corn, cattle, wheat and pigs. Today, most commodity markets across the world still trade in agricultural products and other raw materials, and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. For example, a farmer raising corn can sell a future contract on his corn, which will not be harvested for several months, and guarantee the price he will be paid when he delivers; a breakfast cereal producer buys the contract now and guarantees the price will not go up when it is delivered. This protects the farmer from price drops and the buyer from price rises.
The term commodity market refers to the markets that trade in primary rather than manufactured products. Soft commodities are agricultural products such as wheat, coffee, cocoa and sugar. Hard commodities are mined, such as gold, rubber and oil. Futures contracts, such as described above, are the oldest way of investing in commodities. Farmers have used a simple form of derivative trading in the commodity market for centuries for price risk management.
A financial derivative is a financial instrument which is either exchange-traded or over-the-counter (OTC). OTC contracts are privately negotiated bilateral contracts entered into between the contracting parties directly. Derivatives such as futures contracts, swaps, exchange-traded commodities, and forward contracts have become the primary trading instruments in commodity markets. Futures are traded on regulated commodities exchanges.