Government plans to launch interest rate futures

October 21, 2013

In order to deepen its financial market, the Govt is all set to launch trading of government bond futures. These interest rate futures would help banks and financial institutions and allow Indian policy makers with an estimate to evaluate market predictions for their future rate decisions. The structure of the product has yet not been decided by RBI.

What are Interest Rate Futures?

An Interest Rate Future is a financial contract which derives its value from the performance of an underlying instrument, actually a debt obligation that pays interest. These are financial derivatives (futures contract) between a buyer and a seller, where they both to lock in the price of the interest-bearing asset for a future date. Example: Treasury-bill futures, etc.

Interest Rate Futures moves in value as interest rates changes.

What is the basic objective of using Interest Rate Futures?

To hedge against the risk of interest rates moving in unfavourable direction, thus causing a cost the company.

What is the basic mechanism of Interest Rate Futures?

When the interest rates go up:
The buyer (of the interest rate futures contract) pays the seller an amount equal to the profit expected when investing at a higher rate against the rate mentioned in the futures contract.
When the interest rates go down:
The seller pays off the buyer for the poorer interest rate when the futures contract expires.