NISM Series XVI – Commodity Derivatives Interview Questions

Commodity derivatives are contracts that derive their value from a commodity future, commodity option, or related instrument. Trading in commodity derivatives is evolving rapidly both in India and globally. The NISM Series XVI – Commodity Derivatives certification sets a common minimum knowledge benchmark for approval as an associated person of a recognized stock exchange functioning as an approved user or sales personnel in the commodity derivatives segment. To pass the interview, it is essential to have proficiency in the systems and controls that meet internationally accepted standards for the integrity of this segment of trading activities.

This article contains an exhaustive list of interview questions for the NISM Series-XIV: Common Derivatives interview, in order to help prepare you and to give you confidence as you face the interview panel. So let’s begin!

Advanced Interview Questions

What is a commodity derivative and how is it different from other derivatives?

underlying commodity. It gives the holder the right to buy or sell the underlying commodity at a pre-agreed price and date in the future. Some examples of common commodity derivatives include futures contracts, options, and swaps.

Commodity derivatives are different from other derivatives, such as financial derivatives, in that they are based on physical commodities such as oil, gold, or grain. Financial derivatives, on the other hand, are based on financial assets such as stocks, bonds, and currencies.

Another difference between commodity and financial derivatives is that the underlying assets of commodity derivatives have intrinsic value. This means that the underlying assets have value in and of themselves, regardless of the financial markets. For example, gold has value as a precious metal, and oil has value as a source of energy. Financial derivatives, on the other hand, derive their value from the underlying assets, which themselves may not have intrinsic value.

Finally, the risk profile of commodity derivatives is different from financial derivatives. Commodity derivatives are subject to supply and demand risks, as well as geopolitical and weather-related risks. Financial derivatives, on the other hand, are subject to interest rate, credit, and market risks.

Overall, commodity derivatives offer a way for investors to hedge against price changes in specific commodities, while also providing opportunities for speculation. They are different from other derivatives due to their underlying assets, intrinsic value, and risk profile.

What are the common types of commodity derivatives traded in the market?

The common types of commodity derivatives traded in the market are:

1. Futures Contracts: These are agreements between two parties to buy or sell a commodity at a predetermined price on a future date.
2. Options Contracts: These are contracts that give the holder the right but not the obligation to buy or sell a commodity at a specified price within a specified time period.
3. Swaps: These are contracts between two parties to exchange cash flows in the future, based on the change in price of a commodity.
4. Exchange-Traded Funds (ETFs): These are investment vehicles that track the price of a commodity or a basket of commodities.
5. Forward Contracts: These are private agreements between two parties to buy or sell a commodity at a future date at a pre-agreed price.
6. Physical Delivery Contracts: These are contracts in which the delivery of the actual commodity takes place at the expiration of the contract.
7. Cash-Settled Contracts: These are contracts where the profit or loss is settled in cash, rather than physical delivery of the commodity.

What is the role of a commodity derivative exchange in the market?

A commodity derivative exchange plays a crucial role in the market by providing a platform for trading in commodity derivatives. Commodity derivatives are financial instruments that are based on underlying commodities such as oil, gold, silver, wheat, and others.

The primary role of a commodity derivative exchange is to facilitate the trading of commodity derivatives by providing a transparent and organized market. The exchange sets rules and regulations for trading, and acts as a mediator between buyers and sellers. This helps to reduce the risk of fraud and manipulation in the market.

Another important role of a commodity derivative exchange is to provide price discovery. This is the process of determining the fair market value of a commodity by observing the prices at which trades occur in the exchange. This price discovery helps to ensure that the prices of commodity derivatives reflect the true value of the underlying commodity.

Moreover, commodity derivative exchanges also provide liquidity to the market by facilitating the buying and selling of contracts. This allows market participants to easily enter and exit positions, reducing the risk of illiquidity.

In conclusion, the role of a commodity derivative exchange is to provide a transparent, organized, and regulated market for the trading of commodity derivatives. This helps to ensure fair pricing, reduce the risk of fraud and manipulation, and provide liquidity to the market.

How are commodity derivatives priced and what are the key factors affecting their price?

Commodity derivatives are priced based on the underlying commodity’s supply and demand dynamics and other factors that affect its price. The main factors affecting the price of a commodity derivative are:

1. Supply and demand: The price of a commodity is determined by the balance between its supply and demand. An increase in demand or a decrease in supply can drive up the price, and vice versa.
2. Weather conditions: Weather conditions can significantly impact the supply of certain commodities, such as crops, and hence their price.
3. Economic conditions: The overall economic conditions of a country or region can impact the demand for certain commodities and affect their price.
4. Political factors: Political instability, government policies, and trade agreements can also have a significant impact on the price of commodities.
5. Currency fluctuations: The exchange rate of the currency in which a commodity is traded can also affect its price.
6. Speculation: The activities of speculators and market sentiment can also impact the price of commodities and their derivatives.

In general, commodity derivatives prices reflect the expectations of market participants regarding the future price of the underlying commodity. The price of a commodity derivative is usually based on the prevailing market price of the underlying commodity, adjusted for the cost of carry and other factors that affect its price over time.

What is hedging and how is it done using commodity derivatives?

Hedging is a risk management strategy that involves taking offsetting positions in order to reduce the risk of an investment. In finance, hedging is used to reduce the risk of losing money in a particular market. Commodity derivatives, which are financial instruments that are based on the price of a commodity, can be used to hedge against the price risk associated with owning or trading commodities.

Commodity derivatives include futures contracts, options contracts, and exchange-traded funds (ETFs). Futures contracts are agreements between two parties to buy or sell a commodity at a specific price and date in the future. Options contracts are similar to futures contracts, but they give the buyer the right but not the obligation to buy or sell the commodity at a specific price and date. ETFs are investment products that track the price of a particular commodity, and they can be bought and sold on stock exchanges.

To hedge using commodity derivatives, an investor first identifies the risk they want to hedge against. For example, if they own a large quantity of physical gold, they might be concerned about the price of gold falling. To hedge against this risk, they can buy a gold futures contract. If the price of gold falls, the loss they experience on their physical gold will be offset by a gain on their futures contract.

Similarly, an investor who is concerned about the price of crude oil rising might buy a crude oil futures contract. If the price of crude oil rises, the gain on their futures contract will offset the loss they would have experienced if they had held physical crude oil.

In conclusion, hedging using commodity derivatives is a way for investors to manage the risk associated with holding or trading commodities. By taking offsetting positions in futures contracts, options contracts, or ETFs, investors can reduce the impact of market price movements on their investments.

What is margin in commodity derivatives and how does it work?

Margin in commodity derivatives is a good faith deposit made by a trader to ensure performance of the contract obligations. It is a collateral that the trader provides to the exchange or broker to trade in commodity derivatives. The purpose of margin is to mitigate the risk of default by the trader, and it is calculated based on the value of the underlying commodity and the volatility of the market.

The margin requirement is usually a percentage of the contract value and is determined by the exchange or broker. The trader has to deposit initial margin at the time of entering into the contract, and additional margin may be required during the life of the contract to maintain the initial margin requirement.

When the value of the underlying commodity moves in favor of the trader, the value of the margin collateral also increases. Conversely, if the value of the commodity moves against the trader, the value of the margin collateral decreases, and the trader may be required to deposit additional margin to meet the minimum margin requirement.

If the trader is unable to meet the margin requirement, the exchange or broker has the right to liquidate the trader’s position to cover the loss. Hence, margin acts as a mechanism to manage the risk associated with trading in commodity derivatives.

What is the impact of government policies and regulations on the commodity derivatives market?

The commodity derivatives market plays a crucial role in providing price discovery, liquidity, and risk management to various commodity producers and consumers. Government policies and regulations have a significant impact on the functioning and growth of the commodity derivatives market.

Regulations play a vital role in ensuring transparency, fairness, and stability in the commodity derivatives market. For example, regulations like the Commodity Exchange Act (CEA) in the United States and the European Market Infrastructure Regulation (EMIR) in Europe regulate the commodity derivatives market and provide guidelines for the activities of market participants. These regulations help to prevent market manipulation, insider trading, and other fraudulent activities that can negatively impact market participants and the wider economy.

Moreover, government policies and regulations also impact the types of commodity derivatives that can be traded in the market. For instance, in some countries, there may be restrictions on the trade of certain types of commodities, such as agricultural products or energy derivatives. Such restrictions can limit the growth and development of the commodity derivatives market, as it restricts market participants from taking advantage of opportunities to trade in these commodities.

In conclusion, government policies and regulations play a crucial role in shaping the commodity derivatives market. They provide a framework for ensuring market stability, transparency, and fairness, and also impact the types of derivatives that can be traded in the market. It is essential for market participants to keep abreast of the latest regulations and policies to ensure they comply with the relevant rules and regulations, and avoid any negative consequences.

What are the risks associated with trading in commodity derivatives?

There are several risks associated with trading in commodity derivatives, including:

1. Market Risk: The risk of price fluctuation due to changes in supply and demand for the underlying commodity.
2. Credit Risk: The risk that the counterparty may default on the contract, leading to financial loss.
3. Liquidity Risk: The risk of not being able to sell the contract at the desired price or within a reasonable time frame.
4. Volatility Risk: The risk of price movements in the underlying commodity causing losses in the derivatives position.
5. Operational Risk: The risk of loss due to failure in systems, processes, or human error.
6. Regulatory Risk: The risk of changes in government policies and regulations affecting the commodity derivatives market.
7. Price Discovery Risk: The risk of not getting an accurate reflection of the market price for the underlying commodity.

It’s important for traders to understand these risks and implement proper risk management strategies to minimize potential losses in their commodity derivatives trading activities.

What is the difference between futures and options in commodity derivatives?

Futures and options are both types of financial derivatives that are used to trade commodities. However, they differ in terms of the type of contract they represent and the level of risk they entail.

Futures contracts are agreements between two parties to buy or sell a commodity at a set price at a specific time in the future. The buyer of a futures contract is committed to buying the commodity at the agreed-upon price, regardless of the market price at the time of delivery. The seller of the futures contract is committed to selling the commodity at the agreed-upon price.

Options, on the other hand, are contracts that give the buyer the right but not the obligation to buy or sell a commodity at a set price within a specific time period. The buyer of an option pays a premium for this right and has the ability to either exercise the option and buy or sell the commodity at the agreed-upon price or choose not to exercise the option and let the contract expire.

In terms of risk, futures contracts are considered to be a higher-risk investment than options. This is because the buyer of a futures contract is obligated to purchase the commodity at the agreed-upon price, regardless of market conditions. On the other hand, the buyer of an option has the ability to choose whether or not to exercise the option, which means they have more control over their investment.

In conclusion, while both futures and options are used to trade commodities, they are different in terms of the type of contract they represent and the level of risk they entail. Futures contracts are agreements to buy or sell a commodity at a set price in the future, while options give the buyer the right but not the obligation to buy or sell a commodity at a set price. Futures contracts are considered to be a higher-risk investment, while options are considered to be a lower-risk investment.

How can one get started in commodity derivatives trading and what skills are necessary for success?

Getting started in commodity derivatives trading requires a combination of knowledge and practical experience. Here are some steps to take to get started:

1. Gain knowledge: Understand the fundamentals of commodity derivatives trading, including the various types of contracts, pricing, risk management and trading strategies.
2. Get certified: Consider obtaining a certification, such as NISM Series XVI – Commodity Derivatives, which will provide a deeper understanding of the industry and its regulations.
3. Open a trading account: Open a trading account with a commodity broker to gain hands-on experience in the market.
4. Study market data: Analyze market trends, price movements and trading volumes of different commodities to gain insights into the market.
5. Start with small investments: Start with small investments and gradually increase the investment size as your knowledge and experience grow.
6. Learn risk management: Develop a risk management plan to manage potential losses.
7. Stay informed: Stay updated with market news and developments, and be prepared to adapt to changing market conditions.

Skills required for success in commodity derivatives trading include:

1. Analytical skills: Ability to analyze market data and make informed trading decisions.
2. Risk management skills: Ability to assess and manage risk.
3. Financial knowledge: Understanding of financial markets and principles.
4. Adaptability: Ability to adapt to changing market conditions and make quick decisions.
5. Discipline: Ability to stick to a trading plan and make decisions based on logic rather than emotions.
6. Patience: Ability to wait for the right opportunities and not be swayed by short-term market movements.

Basic Interview Questions

1.   What is NCDEX rain in the case of the commodity market?

NCDEX RAIN is a rainfall index of NCDEX that tells us what percentage of cumulative normal expected rainfall it has actually rained, taking into consideration average actual rainfall at both Colaba and Santa Cruz weather stations in Mumbai. The index is useful to understand how much monsoon activity has taken place so far.

2.   What is Isin in Commodity Market?

ISIN is an internationally accepted means of identifying both physical and non-physical entities in a commodity market. In other words, each commodity along with its specific details is uniquely represented by ISIN. ISIN is a 10-digit international code that can identify a commodity regardless of the time and place of trade.

3.       How would you explain the Offer Price?

The offer price in the commodity market is nothing but the lowest price at which a dealer is willing to sell a commodity. It is also known as the asking price, or offer rate in the futures market, and the buy price in physical markets.

4.    What is meant by Closing Price in Commodity Market?

The daily closing price is the price at the end of the day’s trading on a commodity market. It is also known as settlement price since this is the price at which traders settle their positions and cash in or out.

5.    Can you describe FreightEX in Commodity Market?

FreightEX is the NCDEX benchmark for freight rates in India. The index represents a simple average of the freight rates per tonne across high-density routes for a distance of 1000 kilometers. The calculation is made once a week on every Wednesday. The average rates are obtained using the formula: (Rs ly / 2 x20)/100

6.   What is the simplest definition of GDP?

GDP in the commodity market simply implies the Agricultural Gross Domestic Product. It includes agriculture, forestry, and fisheries activity measured at the earliest stage of production.

7.   What Is MCX In Commodity Market?

Multi Commodity Exchange of India (MCX) is a demutualized online commodity exchange of India promoted by Financial Technologies (I) Ltd, SBI, Fidelity International, NSE, NABARD, HDFC Bank, the SBI Life Insurance Co., the Union Bank of India, Canara Bank, Bank of India, Bank of Baroda and the Corporation Bank. MCX markets Gold, Silver, Crude Oil, and Natural Gas contracts through its web-based trading platform

8.   Are there any custody charges for holding Demat units for commodity?

Certainly no. There is no such custody charge for holding the Demat units.

9.   How would you describe CIF in Commodity Market?

CIF in the commodity market essentially implies the cost, insurance & freight which is basically the transaction cost of doing commodity trading. CIF mainly includes three parts:

• Cost – A price including freight and other related charges
• Insurance – An insurance fee to cover possible losses during the transportation
• Freight – The actual cost of sending the shipment to the destination

10.  What is an Assayer?

The assayer is an authorized entity (person/institution) that certifies and grades the commodities that are delivered in exchange accredited warehouses. Assayer’s authorization is provided by the exchanges through which commodities are delivered, on behalf of the user (owner) of those warehouses who agrees to use the services of these licensed market professionals.

11.   Why should one invest in commodities?

Commodity futures trading is an ideal method of risk management to hedge price volatility, cost reduction, and increased revenue potentials. Trading in commodity futures also provides a low-cost hedging solution to the users in terms of low transaction costs, high liquidity, and quick entry and exit from the positions. A transparent and fair price discovery ensures that the prices are based on demand-supply fundamentals of the commodity concerned.

12.   What do you understand by the term Bullion?

Bullion is the generic term for gold or silver in the commodity market.

13.   What do you know about the National Commodity and Derivative Exchange of India?

NCDEX is India’s first and only demutualized online commodity exchange. NCDEX has been promoted by the National Stock Exchange, ICICI Bank, LIC, PNB, CRISIL, IFCI, NABARD IFFCO, and Canara Bank. The Exchange has successfully conducted its operations on Internet since March 1997 and was formally launched on June 9th, 1999.

14.   Can you explain what is F.A.O In Commodity Market?

Food and Agriculture Organization or F.A.O is an agency of the United Nations concerned with international food policy issues.  The organization’s goals emphasize higher production, food security, improved distribution, and greater rural development.

15.   What is the meaning of Nafed in the Commodity Market?

National Agricultural Cooperative Marketing Federation of India Ltd (NAFED), a Government Owned Company, was established in October 1958, as an apex body of a massive country-wide network of Agricultural Produce Marketing Committees (APMC’s). Since its inception, NAFED has been functioning as a Marketing Agency and procurer of Agricultural Produce and then trader for various agricultural products.

16.   How would you define a Futures Contract?

The India Commodity Derivatives Exchange (NCDEX) Futures contract is a standardized contract between two parties to buy or sell a commodity for a specific price at a specific time in the future. When one buys a futures contract, the obligation is to take delivery of the underlying asset (of which the futures contract tracks) on the contract date.

17.   What is the meaning of Msp in Commodity Market?

MSP is minimum support prices set by the Government of India to protect the farmers. It is fixed at the beginning of each financial year for all staple crops for that year. Moreover, it is applicable to the notified quantity of crops only. This can be as much as 50% of the production projected to be harvested in a particular year in the case of winter and rain-fed rabi crops.

18.   What is an OCEIL in the Commodity Market?

The Online Commodity Exchange India Ltd. (OCEIL) is a national multi-commodity exchange in Ahmedabad, India. It was started by the National Board of Trade in 2013 and it is controlled by Financial Technologies (India) Ltd. BSE Limited has made a 15% investment in the pre-IPO equity shares of Financial Technologies (India) Limited, which owns and operates the OCEIL platform.

19.   What do you know about the Beneficiary Account?

A beneficiary account is a collection of assets, which can be in the form of stocks, bonds, mutual funds, etc. It is an account, in the name of an individual (single or jointly) and hence can be operated by them only. This also means that you as an individual investor can use your own Demat account. Each NSE-listed company has its own Demat account number allotted to it and that number can be used to trade in shares of the company.

20.   What is an FCI in a Commodity Market?

The Food Corporation of India (FCI) is an Indian Public Sector Undertaking, which provides food grain-based subsidies to the Government of India. Widely known as the “Food Cupboard” of the Government of India, FCI was set up in 1954 to minimize the vulnerability of the Indian farmer to the vagaries of nature and market forces.

21.   Can you detect whether the given stock is expensive or not, by just knowing its price?

No, the value of a stock depends on the potential earnings it holds. A stock with a lower potential than its price will not be considered a good stock. Thus, one must never judge the stock price by just looking at its price but must look at the earnings of the company and the P/E ratio

22.   What is a call option?

A call option is a right of the shareholders, where you can buy the stock at a specified date and price. This option is non-obligatory. The call option is the right of the buyer or seller/writer to buy or sell at a fixed date in the future.

23.   When purchasing any stock, what are the charges that are payable?

Charges payable when purchasing a stock are Commission, Cost of the Stock, Stamp duty, and Stock Brokers.

24.   Can you explain what is Option trading?

Options trading is a form of derivative. It gives the buyer of exchange a right to buy or sell an asset at a pre-determined price on or before the expiry of the contract. There are two types of options based on the time horizon, i.e., the time left for expiry are long-term options and short-term options.

25.   What is meant by the term Global Commodities?

Global Commodities is an online resource that explores the commodities that have been conveyed, exchanged, and demolished around the globe for a number of years. These commodities encouraged transform societies, habits of consumption, global trading operations, and social practices.

26.   How does the OTC market work?

An over-the-counter (OTC) market is a decentralized business in which market members trade stocks, currencies, commodities or other devices straight between 2 parties and without a central exchange or broker. This is very distinct from an auction market system. In an OTC market, people seeking to purchase stocks can call their brokers who will buy them directly from the stockholders of the company.

27.   Why according to you is the forward rate generally higher than the spot rate?

The forward rate for the currency pair is recorded at a higher level because there are differences in the interest rates among the 2 countries included. Forward currency rates are often distinctive from the spot exchange rate for the currencies.

28.   Can you elaborate what is the spot market in India?

The spot market is essentially a financial marketplace where all the financial instruments such as currencies, commodities, and securities are traded for immediate fulfillment. Such instruments are typically delivered on the same day.

29.   How is the clearing and settlement method operating?

Clearing and settlement occur when members have ‘settled’ their protection obligations. The clearing corporation is in charge of confirming members have adequate funds to deliver before honoring their protection receipt. The clearing corporation settles by paying off protection receipts, and by transferring cash to the member’s bank account.

30.   How would you define a long hedge?

The long hedges are applied by the companies and processors to eliminate price dryness from the purchase of needed inputs. Without this hedging technique, the price of the commodity in the open market may fluctuate beyond the organization’s ability to pay for the commodity or raw material.

Expert Corner

Forget about your fears regarding the NISM Series XVI -Commodity Derivatives exam. With our exclusive practice exam, you will be able to pass the actual test easily on the first attempt. We provide the best option for a successful outcome through excellent NISM Series XVI – Commodity Derivatives free practice tests. So certify your skills and become job ready!