Interest Rate Futures: The Concept worth Exploring Once Again
The news about interest rates futures trading or bond futures trading is gathering headlines in the national dailies once again. The concept that’s been projected as ‘Rajan’s Baby’ at present, has witnessed two failed attempts in the domestic markets, in the year 2003 and 2009 already – the reason being faulty designs.
Launched the last time, the bond futures clocked trading volumes of Rs 276 crore on August 31, 2009 in their first day of trade – a dream debut of sorts – but lost the air pretty soon.
What is Interest Rate Future Trading?
An interest rate future is basically a financial derivate, that is based on an underlying security. This underlying security in actuality is a debt obligation whose value changes along with a change in rate of interest. The interest rate future allows the buyer and seller to lock in the price of the interest-bearing asset for a pre-decided future date.
When interest rate moves up, the buyer will pay the seller (selling the futures contract) an amount that is equal to the profit expected when investing at a higher rate in opposition to the rate mentioned in the futures contract. However, when the interest rates scale down, the seller will compensate the buyer by paying off for the lower interest rate, when the futures contract expires.
More about Them
These futures can help banks and financial institutions in assessing borrowing costs and hedging risks associated with rate changes to their bond portfolios. Also, policymakers will be able to make much more informed decision and analyze mood of the market while making future interest rate decisions.
Reserve Bank of India (RBI) is still to finalize the structure of these bond futures which are all certain to be released in the market after two months. Unlike previous two times, RBI doesn’t want to take any chances with the design of the product.
RBI is considering two important points before launching the products:
- Benchmarking bond futures contracts against different types of debt maturities and not limiting to the benchmark 10-year bond as the basis of contract pricing.
- The RBI is considering making settlements cash-based as against the conventional practice of physical delivery.
Who can trade these futures?
You can trade in interest rate futures market if are a company, bank, foreign institutional investor, non-resident Indian or retail investor.
Interest Rate Futures can be Good for Domestic Bond Market
Indian debt market is still immature despite large number of government securities actively traded here. Introduction of robust debt future instrument will surely lead to an increase in G-securities market, leading to deepening of the present domestic debt market.
Daily settlement and final settlement
Normally, as per the practice adopted across the world, the weighted average price of the futures contract for the final thirty minutes is considered as the daily settlement price. However, in absence of trade, the exchange fixes the theoretical price as the daily settlement rate. More often than not, the daily settlement is performed on a daily marked-to-market procedural basis, and the final settlement is done through physical delivery of securities.
Let’s keep fingers crossed, this time the product is accepted warmly by the market!