The introduction of interest rate futures on National Stock Exchange (NSE) on August 31 has not only deepened India?s derivatives market but also has opened another avenue for investors. Though the options for individuals is very limited at present, experts feel there are a number of benefits awaiting individual investors. This new segment holds out great opportunities for individual investors in bonds, home loan and automobile buyers to hedge against rate risk. Experts feel this segment will see a growing number of day traders in future, propping up the volumes significantly.
On the last trading day, September 4, contracts worth Rs 9,444.85 were traded. There were 5,061 outstanding contracts, or open interest. The underlying asset of interest rate futures is the notional 10-year government of India securities with a notional coupon of 7%.
In fact, interest rate futures was introduced in early 2001 on NSE but it failed to take off due to a number of reasons. First, banks were not allowed to trade at that time, and then there were issues relating to settlement. This time the joint committee of the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI) has chalked out all modalities in detail, and the market participants are upbeat on this segment.
Data pertaining to the last one week?s trade show that banks are the major participants in interest rate futures market. On the other hand, many broking houses, though registered with the exchanges, are adopting a wait-and-watch policy before plunging into this nascent market.
Individual investors have a variety of reasons to hedge their risk of interest rate fluctuation by taking a position in this market, but the most worrying factor currently is the shortage of expertise. Most top-rung broking houses have either no fixed-income operations or have scarce resources. This apart, experts feel individual investors can effectively invest in this segment, not only to hedge their rate risk but also to make handsome returns.
The most important beneficiaries are investors, especially high net worth individuals, who hold government securities. ?The RBI, interestingly, have been keen on increasing retail participation in government securities but for some reason individuals and HNIs were shying away from them. Now that they can effectively protect bond prices in the interest rate futures market, the individual investment in bonds must increase,? said a bond dealer. This will in turn strengthen the interest rate futures market itself, and prop up volumes. Sandip Sabharwal, CEO, portfolio management, Prabhudas Lilladher, agrees, ?There is indeed a scope for interest rate futures in terms of individual investment. This can be effectively used at a time when the interest rates are likely to go up.? Experts, however, feel rates are unlikely to go up in the immediate future. For long-term borrowers like home loan buyers, the picture is bright. Interest rate futures is also the best tool to protect debt holdings against looming inflation.
Many experts feel that if the settlement cycle is fine-tuned, more retail participation will follow. The settlement period is very long at present, and many feel this has to be brought down to two days or so.
?India has a very robust clearing and settlement system, acquired over many years. All this add up to the back-end of the market. The launch of interest rate futures is the first step towards strengthening the front-end of the market. This is a qualitative improvement. We will also see a significant shift of business from the over-the-counter market to the exchange-traded platform,? said Jayesh Mehta, country treasurer and head of fixed income and currency, at DSP Merril Lynch. Currently, even the exchange-traded futures market is dominated by banks.
There are some 21 banks estimated to be active in the interest rate futures segment. The growth of the futures segment will also see an increasing number of other intermediaries such as broking firms becoming more active.
This will increase the opportunities for arbitrage between the spot market, in this case the bond market, and the interest rate futures market. Traders as well as hedgers will be able to explore arbitrage opportunities in a scenario where interest rates fluctuate. As far as real hedging is concerned, borrowers of huge home loans and auto loans will be the biggest beneficiaries. But there needs to be a variety of products in the interest rate futures segment for them to capitalise on such opportunities. In any case, for those hedgers and investors who want to take a view on the interest rate scenario can participate in interest rate futures.
Traders and brokers alike feel that interest rate futures is set for big growth this time unlike in the first attempt which failed due to various reasons. And this time, experts feel, individual investors also can reap the benefits from trading in interest rate derivatives.