An interest rate future (IRF) is a financial derivative with an interest-bearing instrument as the underlying asset.
Interest rate futures means standardized interest rate derivative contracts traded on a recognized stock exchange to buy or sell notional security or any other interest-bearing instrument or an index of such instruments or interest rates at a specified future date, at a price determined at the time of contract.
Interest rate futures are a relatively new financial statement. It is one of the most successful financial futures instruments in the world.
Interest rate futures trade in several maturities, currencies, and different markets such as mortgages, federal issuance, and short-term commercial paper.
Interest rate futures tend to be highly liquid and are valued by the changing price of the security.
Future trading on interest-bearing securities started only in 1975, but the growth in this market has been tremendous.
Examples of Interest rate futures are Treasury-bill futures, Treasure-bond futures, and Euro-Dollar futures.
Features of Interest Rate Futures
Salient features of exchange-traded interest rate futures are as follows:
1. Increased market reach enables higher liquidity.
2. Exchange platform ensures protection against counterparty default risk due to novation by Clearing House of the Exchange.
3. Greater transparency due to automated anonymous order matching system and settlement.
4. Delivery of underlying assets is possible on the exchange platform.
5. Futures contract available on Notional 7% coupon 10-year Government of India Security as the underlying asset.
6. Large number of informed participants can trade using online electronic trading systems, leading to efficient price discovery.
7. Allows hedgers to efficiently transfer risk to speculators and arbitragers.
8. Exchange-traded IRF ensures robust systems for risk management and surveillance, thereby capable of eliminating any kind of market manipulation.
9. Uniform standards and well-established procedures in the IRF market allow symmetry of treatment to various participants.
10. IRF expands the set of hedging tools available to financial as well as non-financial entities to manage interest rate risk.
11. Simple derivative instrument and easy to understand due to its linear pay-offs.
12. IRF are standardized products that allow for gauging the utility and effectiveness of different positions and strategies.
13. Online real-time dissemination of prices.
14. Exchange-traded IRF provides a credit guarantee by the Clearing Corporation and hence eliminates counterparty risk, thereby increasing the capital efficiency of the market participants.