Interest rate futures are the forward contract based on a benchmark, interest rate traded on the stock exchange, It’s a contract whose underlying security is a debt obligation. It is an agreement to buy or sell a standard quantity of a specific interest bearing instrument, at a predetermined future date at a price agreed upon between parties. They allow participant to take a view on the movement interest rate in the foreseeable future and accordingly enter into contract.
For instance, you can sell a future contract on T-BILLS to lock in borrowing rate, or buy a future contract to lock in a lending rate.
In futures, participant enter into contract and pay margin on a daily basis over the period of the contract and settle the difference due to changes in interest rates by paying margins to the stock exchange.
Interest rate future can be used for three purposes-hedging, arbitraging and spreading.

Suppose on June 23, 2009 you decided to borrow Rs10 million on July 31, 2009 for a period of 3 months and pay off the loan at the end of the period. The SBI agrees to provide this fund at 50 basis point above the MIBOR rate on the borrowing date. You are concerned that if MIBOR changes during the period during the borrowing period your borrowing cost will also change. So in order to protect from the rising interest rate, the borrower would go for Shorting 50 July future right now (each contract Size is Rs200000).

Arbitraging refers to making gains on temporary price differential, either between the cash and future market or same future contract but with a different delivery date. Arbitrage mainly aims to take advantage of a temporary mispricing in the market.

Spreading is a speculative method, which allows a trader to make gains from a potential change in the relative values of two different contracts.

Introduction of exchange traded interest rate derivatives in India is expected to be a path breaking development in the evolution of the Indian Financial market. It is likely to open up a range of possibilities for efficient pricing, hedging and managing of the interest rate risk and thus providing the market participant a good risk containment measures. The interest rate future can prove useful to the bond portfolio managers, bank, Financial Institutions, individuals by allowing them absorb volatility and risk. They also provide a low cost and efficient means of dealing with market risk either for speculative or risk control purposes.

Who can trade in them?
Companies, Banks, Foreign Institutional Investors (FIIs), non-resident Indians (NRIs) and retail investors can trade in the Interest rate future.

What are the contract size and quotation?
On NSE, the minimum contract size will be Rs 2 lakh. The quotation would be similar to the quoted price of GoI securities with 30/360-day count convention.

What is the maximum tenor of the contract?
The maximum tenor of the contract is 12 months and it will have to be rolled over in three months. So, the contract cycle would be four fixed quarterly contracts for the year-ending March, June, September and December.

How will daily settlement of contracts be done?
For daily settlement, the weighted average price of the futures contract for the last 30 minutes would be considered. In the absence of this trading, the theoretical price, as determined by the exchange, would be considered as daily settlement price.

What will be the mechanism for daily settlement?
The daily settlement would be done on a daily mark-to-market mechanism basis and contracts would be physically settled in the delivery month —the contract expiry month.



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