1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 35:  Derivatives and commodity markets  Base and precious metals  Energy markets 35cis

2. Derivatives and commodity markets The physical trading of commodities takes place in parallel with the trading of derivatives.  The physical market  Procuring, transporting and consuming real commodities in large quantities on a global basis  The physical market is dominated by international trading houses, governments and the major producers and consumers  Physical commodities have more recently become an investment class in their own right Cargill's business operations include purchasing, processing, and distributing grain and other agricultural commodities, and the manufacture and sale of livestock feed and ingredients for processed foods and pharmaceuticals. It also operates a large financial services arm, which manages financial risks in the commodity markets for the company. Cargill is the largest privately held company in the United States. It is one of the Top 10 largest multi-national corporations in the world. Tankers laden with crude oil at anchor in Torbay, Devon, for months, waiting for the oil price to go up

3. Physical markets Each group of commodities tends to have its own physical market  Base and precious metals  Iron ore, platinum, gold, etc  Energy  Crude oil, naphtha, etc  Power  Electricity  Plastics  PET, etc  Agricultural markets  Grains, frozen concentrated orange juice, pork bellies, etc Pork bellies  Emissions  CO 2 allowances, etc CO 2 emission schemes  Freight and shipping  Baltic index, etc Shipping freight contracts

4. Base and precious metals In common with all commodity prices, metal prices are influenced by supply and demand  Demand for metals  Demand is driven by the underlying users of the metals o Rapidly industrialising economies such as China and India o Overall global economic growth  Demand is also by investors such as hedge funds o Incorporating commodities into investment funds o Anticipating future growth in demand for metals  Flight to safety o Demand for precious metals – especially silver and gold – rises during times of economic crisis. They are seen as the safest store of value  Supply of metals  Supply is determined by the availability of raw materials  The cost of extraction and production Copper mine, Utah, USA

5. Energy markets The energy market includes the market for crude oil (and oil- based products like jet kerosene), natural gas and coal.  Sulphur content o Low sulphur (known as “sweet”) o High sulphur (known as “sour”)  Crude oil is defined by three primary factors  Field of origin, e.g. o Brent (North Sea) o West Texas Intermediate o Dubai  Density o Low density, or “light” o High density, or “heavy”

6. Energy markets Supplies of oil, gas and coal are finite.  Supply of energy  Relatively few countries have reserves of oil, gas, or coal surplus to their own requirements, and are thus able to export  Demand for energy  Driven by manufacturing industry, domestic consumption and transportation o Closely correlated with economic growth, so changes to GDP forecasts can have an impact on energy prices  Political crises — particularly in major oil- producing regions of the world such as the Middle East — can have a major impact on prices Opec logo  Prices can be raised by the restriction of supply by producers o The Organisation of the Petroleum Exporting Countries (Opec) is a cartel which seeks to sustain oil and gas prices at high levels

7. Derivative markets There are two distinct groups of derivatives which are differentiated by the way in which they are traded  Exchange-traded derivatives  Standardised features, e.g. o Futures and options contracts  The exchange provides the market-place for trading to take place o This ensures liquidity  The exchange stands between (i.e. acts as middle-man) between the counterparties o Exchange requires counterparties to post a margin, which has to be topped up if necessary o Exchange guarantees that the trade will be settled  Over-the-counter (OTC) derivatives  Negotiated and traded privately between parties with the use of an exchange o Interest rate swaps, forward rate agreements, and other “exotics” In terms of value of contracts traded daily, the OTC derivative market is bigger than the exchange-traded market. OTC trading takes place predominantly in Europe, centred in the UK

8. Derivative exchanges: NYSE Liffe In 1982, the London International Financial Futures and Options Exchange (Liffe, pronounced “life”) was established  In 2001, Liffe was bought by Euronext, who renamed it Euronext.liffe  Euronext is a network of continental European stock exchanges in Paris, Amsterdam and Brussels  In 2007, Euronext merged with the New York Stock Exchange and became the NYSE Euronext Group  The financial futures exchange was renamed NYSE Liffe  NYSE Liffe is the UK’s main exchange for trading financial derivative products, including futures and options on:  Interest rates and bonds  Equity indices (e.g. FTSE 100)  Individual equities (e.g. BP, HSBC)

9. NYSE Liffe (cont.) NYSE Liffe does not just trade financial derivatives and is not just based in London  NYSE Liffe also trades derivatives on “soft” commodities, e.g.  Sugar  Wheat  Cocoa  NYSE Liffe runs futures and options markets in  Amsterdam  Brussels  Lisbon  Paris  Trading on NYSE Liffe is via an electronic, computer-based system known as Liffe Connect

10. Eurex Eurex is the world’s leading international derivatives exchange, and is based in Frankfurt. Eurex was created by Deutsche Börse and the Swiss Exchange  Its main derivative products are based on German bond futures and options, in particular:  Bund (a type of German bond)  Eurex also trades index products for a wide range of European markets  Trading is via the fully computerised Eurex platform  Members are linked via a dedicated wide- area communications network (WAN)  Members are based all over Europe and in North America

11. IntercontinentalExchange (ICE) ICE operates the global futures and OTC market-place for the trading of energy commodity contracts  ICE contracts include  Crude oil  Refined products  Natural gas  Power  Emissions  The exchange-traded part of the business began life as the London- based International Petroleum Exchange (IPE)  ICE acquired IPE in 2001 and went on to rename it ICE Futures  ICE Futures switched from open-outcry trading to electronic trading in April 2005  Recently, ICE Futures introduced a futures contract in emissions in conjunction with the European Climate Exchange (ECX)  This is now Europe’s leading emissions futures contract

12. London Metal Exchange (LME) The London Metal Exchange is the world’s premier market for non-ferrous metals. It has been operating for 130 years  Although it is based in London, the LME is a global market with an international membership  More than 95% of its business comes from overseas  The LME offers futures and options contracts on a range of metals, including:  Aluminium  Copper  Lead  Nickel  Tin  Zinc  More recently, the LME launched the world’s first futures contract for plastics

13. London Metal Exchange (cont.) Trading on the LME takes place across three trading platforms  Inter-office telephone market  Buyers and sellers contact each other directly to transact deals  Open outcry  Traders sit in the “ring”  Electronically  Using LME Select, the exchange’s own electronic trading platform