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: This August 31, 2009, India successfully saw the launch of interest rate futures (IRFs) by the National Stock Exchange. Starting off with a big bang, the current level of attention is not high, but going ahead, there are a lot many advantages that stand out for investors.
At the moment, the NSE has already begun trading, the Securities and Exchange Board of India (Sebi) has already given permission to the Bombay Stock Exchange (BSE) to start trading in IRFs as well. BSE should in fact be all set to begin trading in a few more weeks, and, hot on their heels are the Multi-Commodity Exchange of India (MCX) and the United Stock Exchange (USE), both waiting for their chance to get in on the action.
This move comes one year after India saw currency futures enter into the financial markets in August 2008. Internationally, interest rate derivatives’ trading has a turnover which is way higher than that, even of equity index futures. In fact, the global turnover of interest rate derivatives in 2004 was estimated to be $60 trillion! Speaking on the launch of IRFs, NSE managing director Ravi Narain said, "The launch of interest rate derivatives means a lot to the NSE, its constituency of brokers and all economic entities who face interest rate risk."
The framework
Interest rate futures are inherently no different from other derivative products. You take a position on the underlying asset based on which way do you feel the price will move. However, in IRFs the underlying security is not stocks but a bond, a 10-year government bond to be more precise, and hence it is essentially the interest rate that you are speculating on. The underlying security is a 10-year government security, bearing a notional 7% interest rate coupon payable half yearly. An interest rate future contract is an agreement to buy or sell a debt instrument at a specified date at a fixed price. The minimum contract size for an IRF on the NSE is Rs 2 lakh.
This instrument is very useful for anyone, who wants to benefit from interest rate movements and is also a very good hedging mechanism for investors who have invested heavily in government securities, or for retail investors who have taken loans. Retail investors exposed to interest rate risks, corporate houses, mutual funds, primary dealers, foreign institutional investors, brokers, pension funds, insurance companies, banks and NRIs will...
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