Agribusiness Library

1. Agribusiness Library Lesson 060059 Commodity Exchanges and Trade Centers part 1

2. Objectives 1. Explain the history of commodity exchanges.

3. Terms • cash transactions • clearinghouse • forward contracts • miniature contracts • time contracts • to-arrive contracts • trade centers

4. What is the history of commodity exchanges? Futures trading began in the 17th century in Japan with the use of rice futures. Maintaining a year-round supply of seasonal products and agriculture crops was difficult, so futures trading became a well-known tool to solve these problems. In Japan, rice was stored in warehouses and would be available for future use.

5. What is the history of commodity exchanges? Warehouse holders would sell receipts against the stored rice. The rice tickets became a kind of general commercial currency. Rules were developed and were eventually similar to the current rules of American futures trading.

6. What is the history of commodity exchanges? A. Trade centers are locations where resources can be bought or traded. Historically, the first cities were located because they were able to provide people with necessary elements (e.g., water, land, and protection) for survival.

7. What is the history of commodity exchanges? A. Trade Centers….necessary elements (cont’d) 1. Water is the first necessary element. If there is water available in the form of a flowing source or an underground source, people can access it easily. This allows people to have a constant source of water for transportation, cooking, and various other uses. Water is necessary for survival, so it is important to have a dependable source.

8. What is the history of commodity exchanges? A. Trade Centers….necessary elements (cont’d) 2. Accessible farmland was important in the early development of cities. To survive, a city must be able to feed its people. If farmers have nearby farmland, they will be able to produce food for cattle and people and distribute it easily.

9. What is the history of commodity exchanges? A. Trade Centers….necessary elements (cont’d) 3. Protection is another consideration. People need protection from the elements of nature, so they need to settle in an area that is naturally protected or that has the resources to build protective areas. Many cities were formed in hillsides and heavily wooded areas for this reason.

10. What is the history of commodity exchanges? B. As more cities were formed, the location of other trade centers became a consideration. New cities or trade centers were built in areas between established trade routes. As a result, the existing trading was available. 1. Early markets were based on cash transactions. Cash transactions are sales made when the product is delivered and paid for immediately. They were often referred to as “spot transactions” because the buyer was able to visually inspect the product before taking immediate possession.

11. What is the history of commodity exchanges? 2. As trading centers became more established, many changes started to occur. Time contracts (agreements between buyers and sellers to trade before the product could be delivered) were used. a. The price was usually negotiated in advance of delivery when using time contracts. Many of these sales transactions created problems because when the product was finally delivered, there were disputes about quality, quantity, price, and credit.

12. What is the history of commodity exchanges? 2. As trading centers became more established (cont’d) b. To solve these problems, rules were established and became codified bylaws in Europe in the 1300s. Current exchange settings continue to conduct business with strict codes to create fairness between buyers and sellers.

13. What is the history of commodity exchanges? 3. As more trading took place, more problems arose. a. Many of the trading centers did not have adequate storage and transportation for growing deliveries. b. During different seasons, certain products developed shortages because of growing seasons, resulting in increased prices. Without adequate storage space, it was hard to avoid. This situation encouraged the increased use of futures contracts. The two common types were to-arrive and forward.

14. What is the history of commodity exchanges? The two common types were to-arrive and forward. • To-arrive contracts state that delivery will be in a few days with the title passing from the seller to the buyer. • Forward contracts state that delivery will be in a few days, but the title is not passed until delivery occurs.

15. What is the history of commodity exchanges? 4. Storage of products became a big business. Many people built large storage facilities to store products and distribute them over a period of time. Because roads were being built, transportation was less of a problem, and distribution over a longer period of time helped to lower the price difference throughout the year.

16. What is the history of commodity exchanges? C. In 1848, the Chicago Board of Trade (CBT) was founded by 82 businessmen. They established rules to make traders accountable to the terms of the contracts being traded. The newly founded CBT also allowed a consistent place for people to trade. The New York Coffee, Cotton, and Produce Exchanges were started in the 1870s and 1880s.

17. What is the history of commodity exchanges? 1. In 1871, the CBT was destroyed in the Great Chicago Fire. It is believed that modern day contracts were traded as early as 1859, but the records were destroyed in the fire. 2. The CBT started a concept that is still used today. To buy a contract, a portion of the value was paid to insure that buyers would not back out of their contracts. With this new concept in place, defaulting on contracts meant losing the deposit money and the possibility of being sued in court.

18. What is the history of commodity exchanges? 3. In 1926, the CBT established a clearinghouse for futures trades. The clearinghouse is a third party between traders that insures performance from all involved parties. Since the clearinghouse was established, no contracts have caused any trader to lose money because of the default of another contracting party.

19. What is the history of commodity exchanges? 4. Early on, the CBT dealt with the trading of grains (e.g., oats, wheat, and corn). After World War II, many other contracts were added. Iced broilers, gold, and silver were traded along with the grains. In 1975, the first mortgage interest rate contracts were traded. 5. Currently, the CBT has contracts for gold, silver, U.S. Treasury bonds, U.S. Treasury notes, wheat, corn, oats, rough rice, and others. Anyone who can put a deposit down for part of the contract price is able to buy and sell at the CBT.

20. What is the history of commodity exchanges? D. The Chicago Mercantile Exchange (CME) began as the Chicago Butter and Egg Board in 1898. In 1919, the name was changed to the Chicago Mercantile Exchange. 1. The first butter and egg contracts were traded there in 1919. Live cattle and hogs were added in 1964 and 1966, respectively. Many other contracts have been traded, including onions, potatoes, and scrap iron.

21. What is the history of commodity exchanges? 2. In 1972, the CME formed the International Monetary Market to trade foreign currencies a. As the exchange rates fluctuate in an uncertain world economy, international investors use the trading of foreign currencies for protection and profit. b. Some currencies the CME trades are the Japanese yen, Brazilian real, French franc, and the Mexican peso.

22. What is the history of commodity exchanges? E. Midamerica Commodity Exchange (MCE): After the Civil War ended in 1868, the MCE was started. It specialized in miniature contracts — contracts like other exchanges trade only smaller. For instance, instead of trading a corn contract for 5,000 bushels at another exchange, someone could trade for 1,000 bushels. The MCE merged with the CBT in 1986.

23. What is the history of commodity exchanges? F. Minneapolis Grain Exchange (MPLS): The MPLS was organized in 1881 to trade spring wheat futures and options. It is also a large cash wheat market. It currently trades barley, white wheat, spring wheat, white shrimp, and black tiger shrimp.

24. What is the history of commodity exchanges? G. Kansas City Board of Trade (KCBT): The KCBT was formed in 1856. It started the first stock index futures and also trades western natural gas. H. New York Mercantile Exchange (NYME): The NYME was founded in 1872. It has been the major force in developing energy-based futures and options. It trades platinum, silver, crude oil, unleaded gasoline, propane, electricity, and others.

25. What is the history of commodity exchanges? I. New York Cotton, Citrus, Finex, and NYFE Exchange (NYCE): The NYCE was formed in 1870. The citrus trading was added in 1966 to trade frozen orange juice concentrate. In 1985, financial futures and options were added.

26. What is the history of commodity exchanges? J. The New York Coffee, Sugar, and Cocoa Exchange (CSCE): The CSCE was started in 1882. Sugar was added in 1914, and it merged with the New York Cocoa Exchange in 1979. Current trading includes sugar, coffee, cocoa, milk, cheese, butter, and others.

27. Review • What were the main resources at the first trade centers? • What is a time contract and why was it needed? • What is a clearinghouse? Who established the first clearinghouse for futures trades? • What was the major force in developing energy-based futures and options?

28. Agribusiness Library Lesson 060059 Commodity Exchanges and Trade Centers part 2

29. Objectives 2. Identify and describe the major commodity exchanges in the United States and around the world. 3. Distinguish between speculators and hedgers, and define related terms. 4. Describe and demonstrate hand signals used on commodity trading floors.

30. Terms • day traders • electronic traders • floor brokers • floor traders • hedgers • open outcry • positions traders • scalpers • speculators

31. What are some of the major commodity exchanges? The largest exchange in the world was formed in 2007 when The Chicago Mercantile Exchange (CME) and The Chicago Board of Trade (CBOT) merged. This formed the CME Group Inc., which is now the world’s most diverse exchange. The global offices are in Chicago, New York, Houston, Washington D.C., London, Hong Kong, Singapore, Sydney, and Tokyo.

32. What are some of the major commodity exchanges? A. The CME trades futures on just about anything. Products from all major asset classes are available for futures trading: foreign currencies, stock index products, interest rate and Treasury products, commodities, energy, metals, and weather and housing indexes. CME Globex is an electronic trading platform that offers trading continuously.

33. What are some of the major commodity exchanges? B. The New York Mercantile Exchange (NYMEX) became part of the CME Group Inc. during 2008 and was to be fully integrated in 2009. The NYMEX was the world’s largest physical commodity future exchange. The New York Mercantile Exchange and Commodity Exchange (COMEX) were separate and had merged.

34. What are some of the major commodity exchanges? C. Trading takes place at several locations around the world. The world of trading is rapidly changing with new electronic movements. However, there are a few minor exchanges compared to the CME Group Inc. 1. The Winnipeg Commodity Exchange is in Canada. In 1999, it was the 41st largest futures and options exchange in the world.

35. What are some of the major commodity exchanges? C. Trading takes place at several locations (cont’d) 2. Initiatives in Mexico to develop an exchange have been introduced. However, no organized commodity futures exchange has yet been created.

36. What are some of the major commodity exchanges? C. Trading takes place at several locations (cont’d) 3. The Tokyo Commodity Exchange Inc. (TOCOM) is the largest exchange in Japan. This exchange group has undergone major consolidation throughout the past 10 years.

37. What are some of the major commodity exchanges? C. Trading takes place at several locations (cont’d) 4. The London Commodity Exchange (LCE) merged with London International Financial Futures Exchange (LIFFE) in 1996. Currently, both are a part of the NYSE Euronext Group. a. The NYSE Euronext was created in 2007 with a merger between the NYSE Group (parent of the New York Stock Exchange) and Euronext. b. The NYSE Euronext provides exchanges in five countries. It offers trading, clearing/settlement in cash equities, equity interest, commodities, and currency/bonds.

38. What are some of the major commodity exchanges? D. The Commodity Futures Trading Commission (CFTC) was formed in 1974 to regulate all trading. It insures that business is legal and professionally carried out with all the exchanges. 1. The Commodity Futures Trading Commission is regulated by the Department of Agriculture. 2. It regulates the futures exchanges, brokerage firms, money managers, and commodity advisors.

39. What is the difference between speculators and hedgers? What are some of the related terms? The participants within futures and options trading are important to understand. The following is a brief description of the wide variety of participants:

40. What is the difference between speculators and hedgers? What are some of the related terms? A. Hedgers can be agriculture producers or processors, mining companies, banks, and others who use futures or options as an alternative for buying or selling the actual commodity. Hedgers buy or sell contracts to offset risk associated with the changing prices within the cash market. These participants, a hog producer, a grain farmer, or a food processing company will manage price risk while having the ultimate goal as long-term price certainty.

41. What is the difference between speculators and hedgers? What are some of the related terms? B. Speculators can be investors, hedge-fund managers, banks, and others who accept price risk. They try to make money by buying and selling futures and options. Speculators try to predict what the markets will do (go up or down), the movement of the market, and the price direction. Speculators also provide the market liquidity.

42. What is the difference between speculators and hedgers? What are some of the related terms? B. The speculator group has grown and changed due to the introduction of electronic trading, which allows for more of a diverse population of traders instead of the traditional high net-worth individuals. The different types of speculators are the following: 1. Position traders are individuals who hold on to a position for several days or weeks and tend to have an opinion about the general price trends.

43. What is the difference between speculators and hedgers? What are some of the related terms? B. The different types of speculators (cont’d) 2. Day traders are individuals who close out positions by the end of the trading day. This allows for no overnight margin calls. 3. Scalpers are the traders who hold on to positions for a short time. This time period can be within a few minutes or even seconds, which has become a trend due to the increase of electronic traders.

44. What is the difference between speculators and hedgers? What are some of the related terms? C. Floor traders are speculators who are buying and selling contracts on the floor. D. Floor brokers are people who serve as agents for customers. E. Electronic traders are individuals who rely on the information provided electronically to buy or sell futures and options.

45. What common hand signals are used on the commodity trading floor? A few common hand signals are used in trading by floor traders. These signals allow traders to communicate during open outcry (trading is done publicly, so each trader has a fair chance to buy and sell).

46. What common hand signals are used on the commodity trading floor? A. To buy contracts, the hand should be in a position with the palms shown inward and the number of fingers shown indicating how many contracts are desired for purchase. For example, three fingers should be shown with the palm of the hand in to buy three contracts.

47. What common hand signals are used on the commodity trading floor? B. To sell contracts, the hand should be in a position with the palms shown outward and the number of fingers shown indicating how many contracts are desired for purchase. For instance, four fingers should be shown with the palm of the hand out to sell four contracts.

48. What common hand signals are used on the commodity trading floor? C. If the price needs to be shown, the floor trader will exhibit his or her fingers in a sideways motion.

49. Review • What is the largest exchange in the world? When was it created? • When and why was the Commodity Futures Trading Commission developed? • How has electronic trading changed the speculator group? • Demonstrate the hand signals learned in this lesson.