With the introduction of interest rate futures (IRFs), banks, primary dealers and financial institutions will be benefitted immensely , said market players .
?The market was waiting for this instrument since long. Banks will now be in a position to hedge their risk well using IRFs. We think the participation will be immense as this product will help in managing the asset/liability of the balancesheet of banks in a suitable manner,? noted Golak C Nath, vice-president & economic advisor with Clearing Corporation of India (CCIL).
Market players say banks, primary dealers and financial institutions will use this product in a major way.
?A lot of companies today are not so happy with the way the pricing is done on the interest rate swaps and will look at exchange traded IRFs,? said a dealer.
RVS Sridhar, senior vice president of treasury at Axis Bank noted that losses on the SLR portfolio for banks could now be offset through the IRF market.
?Banks can now hedge their positions in an effective way to avoid losses, if interest rate go up, using the IRF product,? he noted.
However, he is also of the opinion that it would take a while for Indian banks to trade in this product.
In RBI?s report in August 2008, it had said that depending on the market response and appetite, the exchanges concerned may consider introducing contracts based on 2-year, 5-year and 30-year GoI securities or those of any other maturities or coupons.
?For the success of IRF, it would be necessary to improve the liquidity and efficiency of the repo market,? said a trader.
Interest rate futures are based on an underlying security which is a debt obligation and moves in value as interest rates change.
When interest rates move higher, the buyer of the futures contract will pay the seller an amount equal to that of the benefit received by investing at a higher rate versus that of the rate specified in the futures contract. Conversely, when interest rates move lower, the seller of the futures contract will compensate the buyer for the lower interest rate at the time of expiry.
Interest rate risk affects not only the financial sector, but also the corporate and household sectors. Banks, insurance companies, primary dealers and provident funds bear a major portion of the interest rate risk on account of their exposure to government securities.
Today, with a large stock of household financial savings on the assets side and an increasing quantum of housing loans on the liabilities side, interest rate risk is becoming increasingly important for the household sector as well.
Interest rate products are the primary instruments available to hedge inflation risk, which is typically the single most important macro-economic risk faced by the household sector. In this context, therefore, it is important that the financial system provides the household sector greater access to interest rate risk management tools through exchange-traded interest rate derivatives.