INTEREST RATE FUTURES

Transcription

1 INTEREST RATE FUTURES Contact NSE - Corporate Office Nationa Stock Exchange of India Limited Exchange Paza, C-1, Bock G, Bandra Kura Compex, Bandra (E), Mumbai Te No: (022) Fax No: (022) Branch Offices MUMBAI Western Regiona Office: 6th foor, Kohinoor City, Tower 1, Commercia II, Kiro Road, Off. L. B. S. Marg, Kura (W), Mumbai Te. No: (022) Fax No: (022) CHENNAI 8th Foor, Arihant Nitco Park, No 90, Dr Radhakrishnan Saai, Myapore, Chennai Te No : (044) / Fax No : (044) /27. HYDERABAD /A/1, Third Foor, Urmia Heights, Opp Rainbow Hospita, Road No 10, Banjara His, Hyderabad Te No : (040) / Fax No : (040) AHMEDABAD Office No. 304/305, GCP Business Centre, Opposite Memnagar Fire Station, Navrangpura, Ahmedabad Te No : (079) / Fax No : (079) DELHI 4th Foor, Jeevan Vihar Buiding, Pariament Street, New Dehi Te No : (011) / Fax No : (011) KOLKATA 1st Foor, Park View Apartments, 99, Rash Behari Avenue, Kokata Te No : (033) Fax No : (033) NSE Mobie Cash setted Linked to the 6,10,13 year G-Sec Designed speciay for India DISCLAIMER The information contained in this brochure incuding text, graphics or other items are provided on an 'as is', 'as avaiabe' basis. NSEIL does not warrant the accuracy, adequacy or competeness of this information and materia and expressy discaims iabiity for errors or omissions in this information and materia. No warranty of any kind, impied, express or statutory, incuding but not imited to the warranties of non-infringement of third party rights, tite, merchantabiity and fitness for a particuar purpose is given in conjunction with the information and materias. In no event wi NSEIL be iabe for any damages, incuding without imitation direct or indirect, specia, incidenta, or consequentia damages, osses or expenses arising in connection with this brochure or use thereof or inabiity to use by any party, or in connection with any faiure of performance, error, omission, interruption, defect, even if NSEIL or representatives thereof, are advised of the possibiity of such damages, osses or expenses. BOND FUTURES

2 Interest Rate Futures An Interest Rate Futures contract is "an agreement to buy or se the vaue of an underying debt instrument at a specified future date at a price that is fixed today." Exchange Traded Interest Rate Futures are standardized contracts based on a GOI security. The contract is cash setted. A Goba Perspective Interest Rate Futures contracts were first traded in the United States on October 29, And since then, they have become a fundamenta risk management too for financia markets wordwide. They are the most widey traded derivatives instrument in the word. The tota turnover during Jan-Mar 2015 for Interest Rate Futures was around USD 3,21,617 biion, which is more than 9 times higher than equity index futures. Exchange Traded - Notiona Amount Outstanding (USD Bn) - March 2015 Interest Rate, 93% Outstanding Notiona Principa (USD Biion) Currency, 1% Equity Index, 6% Interest Rate Futures in India New Prospects Interest rates are inked to a variety of economic conditions. They can change rapidy, infuencing investments and debt obigations. In a market environment, where ong term debt issuance by the government is increasing and the demand for it is growing, there is a strong need for a cost efficient hedging instrument against interest rate risk Source: RBI Gross Borrowings (GOI & State Government) - ` Crores ` Crores Interest rate risk is caused by fuctuations in interest rates. Such uncertainty accompanied by voatiity increases risk and requires toos to manage risks. The voatiity of interest rates has increased manifod in the ast coupe of years. Source: BIS - Derivative financia instruments traded on organised exchanges Exchange Traded - IRF Turnover (USD Bn) - March ,16,205 2,50, Yr Benchmark Rate 2,00,000 1,50,000 1,00,000 50,000 0 Source: BIS 78,335 14,608 3,374 North America Europe Asia & Pacific Other Markets Source: Reuters Jan-10 Mar-10 Jun-10 Aug-10 Nov-10 Jan-11 Apr-11 Jun-11 Sep-11 Dec-11 Feb-12 May-12 Ju-12 Oct-12 Jan-13 Mar-13 Jun-13 Aug-13 Nov-13 Jan-14 Apr-14 Ju-14 Sep-14 Dec-14 Mar-15 May-15 Aug-15

3 NBF II (NSE Bond Futures) on Government of India Securities. Product Specifications Attributes 6 Year 10 Year 13 Year Underying GOI Securities with 4-8 years GOI Securities with 8-11 GOI Securities with of residua maturity years of residua maturity years of residua maturity Symbo The symbo sha denote coupon, type of bond and maturity year. Exampe 7.72% Centra Government Security maturing on May 25, 2025 sha be denoted as 772GS2025 Instrument Type FUTIRC Unit of Trading 1 Lot - (1 ot is equa to 2000 bonds with notiona bonds of FV Rs.0.2 Miion or 2 Lakhs) Quotation Price based (derived from underying Cean Price) Contract Vaue 1 Contract sha be equa to Quoted price * 2000 Tick Size Rs Quantity Freeze 1251 ots Trading Hours Monday to Friday: 9:00 a.m. to 5:00 p.m. (The trading hours aigned with underying market in case of market extension) Trading Cyce Three seria monthy contracts & three quarter end contracts (Mar, Jun, Sep & Dec) Expiry Day Last Thursday of the month. In case the ast Thursday is a trading hoiday, the previous trading day sha be the expiry / ast trading day. Base Price Theoretica price on the 1st day of the contract. On a other days, Daiy Settement Price of the contract Price operating range +/- 3% of the base price. (Whenever a trade in any contract is executed at the highest/owest price of the band, Exchange may expand the price band for that contract by 0.5% in that direction after 30 minutes after taking into account market trend. Price band may be reaxed ony 2 times duringthe day) Exchange Leve Overa open interest in IRF contracts on each underying sha not exceed 25% of the Overa Position outstanding of underying bond. Limit Initia Margin SPAN Based Margin (Min 1.5% ) Extreme oss margin 0.5% of the vaue of the gross open positions Daiy Settement Daiy MTM settement on T+1 in cash based on daiy settement price Daiy Settement Voume Weighted Average Futures Price of ast haf an hour or Theoretica Price Price Fina Settement Fina settement on T+1 day in cash based on fina settement price Fina Settement Weighted average price of the underying bond based on the prices during the ast two Price hours of the trading on NDS-OM. If ess than 5 trades are executed in the underying bond during the ast two hours of trading, then FIMMDA price sha be used for fina settement Spread Trading Faciity for spread trading. Margin Rs for a one month spread, Rs.1800 for two months and Rs for three months spread and Rs for greater than 3 month spread. Position Limits Foowing position imits sha be appicabe for IRF contracts: a) Cient/ Category III FPI/ Scheme of Mutua Fund Leve The gross open positions across a contracts within the respective maturity bucket sha not exceed 3% of the tota open interest in the respective maturity bucket or INR 200 crore, whichever is higher. b) Trading Member/ Category I & II FPI/ Mutua Fund/ Insurance Companies /Housing Finance Companies/ Pension Funds Leve The gross open positions across a contracts within the respective maturity bucket sha not exceed 10% of the tota open interest in the respective maturity bucket or INR 600 crore, whichever is higher. c) Additiona restriction for FPIs: The tota gross short (sod) position of each FPI in IRF sha not exceed its ong position in the government securities and in Interest Rate Futures, at any point in time. The tota gross ong (bought) position in cash and IRF markets taken together a FPIs sha not exceed the aggregate permissibe imit for investment in government securities for FPIs. FPIs sha ensure compiance with the above imits. Eigibiity for Trading The Members registered by SEBI for trading in Currency Derivatives Segment sha be eigibe to trade in NSE Bond Futures. Cearing and Settement The cearing and settement sha be done by Nationa Securities Cearing Corporation Limited (NSCCL). The positions in the futures contracts for each member sha be marked to market to the daiy settement price of the futures contracts at the end of each trade day. Daiy mark-to-market settement in Interest rate futures contracts is cash setted. On the expiry date of the futures contracts, NSCCL marks a positions to the fina settement price and the resuting profit / oss is setted in cash.

4 Advantages of NBF-II Cash setted futures contract Contract based on a singe GOI security Easier and cheaper access to rates trading Centraized cearing supported by guaranteed settement Usefu to a types of investors Low transaction cost Uses of NBF-II Directiona Trading As there is an inverse reationship between interest rate movement and underying bond prices, the futures price aso moves in tandem with the underying bond prices. If one has a strong view that interest rates wi rise in the near future and wants to benefit from rise in interest rates; one can do so by taking short position in IRF contracts on NSE and benefit from the faing futures prices. A trader expects ong term interest rates to rise. He decides to se NBF II contracts as he sha benefit from faing future prices. Usage by Different Category of Market Participants Participant Reguation Possibe Strategies Expectation Interest Rate Interest Rate Position Short Futures Long Futures Banks Hedging and Trading Hedging, Arbitrage, View Based Trading, Changing duration of portfoio, Caendar Spread, Lock In of Yied Primary Deaers Hedging and Trading Hedging, Arbitrage, View Based Trading, Changing duration of portfoio, Caendar Spread, Lock In of Yied FPI s Hedging. Restricted Hedging, View Based Trading, Caendar Spread, trading Lock In of Yied, changing duration of portfoio Mutua Funds Hedging, Exposure Hedging, View based trading Insurance Hedging Future Long Hedge Companies Cashfows Corporates Hedging and Trading Hedging, View Based Trading, ock in of yied etc. NBFC s Hedging Hedging, Changing duration of portfoio Individuas Hedging and Trading Hedging, View Based Trading, Lock In of Yied etc. Trading Members Hedging and Trading Hedging, View Based Trading, Caendar Spread, etc. View Based Trading-Short Position Exampe: An investor expects yieds to rise or that bond price wi fa. He wi se NBF II on the expectation of decine in prices. Underying Bond 8.40% GOI 2024 Futures Contract 25th June 2015 Trade Date 4th June 2015 Future Price (INR) Yied 8.01% Position Se Futures No. of Lot 10 Tota Vaue (INR) 20,49,000 (2000*10*102.45) Margin (2.5% approx.) (INR) 51,225 Trade Date 12th June 2015 Future Price (INR) Yied 8.10% Position Square off positions (Buy Futures) Tota Vaue (INR) 20,38,000 (2000*10*101.90) Profit/Loss (INR) 11,000

5 Hedging A types of investors are exposed to interest rate risk. Interest rate exposure can be hedged by taking an opposite position in NBF-II to offset a oss (gain) in underying exposure with potentia gain (oss) in the NBF-II. Hedging Asset Investor hods debt oriented mutua fund. Expects yied wi rise and NAV of MF wi decrease. However, he does not want to redeem the MF units. : Investor wi hedge with short position in IRF On Trade Date (29th Apri, 2015): Investment Hoding Future price of 8.40% GS 2024 (May contract) Rs On Expiry Date (28th May, 2015): NAV of MF Rs Assume Debt Oriented MF 10,000 Rs Se NBF-II 1 ot of 2,000 bonds Fina Settement Price of 8.40% GS 2024 (May contract) Rs Loss on underying MF 10,000*( ) = (Rs. 1500) Profit In NBF-II 2,000*( ) = Rs Net Profit / (Loss) (Rs. 100) Note: Amount of hedge wi depend upon duration of IRF and duration of MF units. Caendar Spread A Caendar Spread, aso known as an Inter-deivery Spread, is the simutaneous purchase of one deivery month of a given futures contract and the sae of another deivery month of the same underying on the same exchange. First Leg - 10th Apri 2015 Second Leg - 22nd Apri 2015 Security 8.40% GS % GS 2024 Se Spread i.e. Buy near month Square off the position and Se mid month Buy Apri Se Apri 3.20 Se May Buy May Profit/ Loss (INR) 0.10 (0.05) Tota Profit/ Loss (INR) 0.05 per bond. Rs. 100 per ot Long Hedge (Locking of Returns) Sometimes, participants fee current yied is attractive and decides to ock it. However, it does not have sufficient funds to invest immediatey. In such a case, participants can ock yied by going ong on NBF-II & when funds are avaiabe for investment he can buy the bond & square off the future contract. Locking the yied - Long Hedge On 7th May 2015 an investor expects cash infow worth X amount on 28th May He finds current yied attractive for investment. : Buy IRF contracts and ock the current yied. When actua money is received, he squares off the IRF position and invest in underying bond. Trade Date Underying NBF-II 8.40% GS % GS 2024 (May Contract) 7th May 2015 Price Rs Rs Traded Yied 7.99% 7.99% Buy future at Rs and ock yied 28th May 2015 Price Rs Rs Traded Yied 7.85% 7.85% Square off the position and buy underying Current Market Price Rs / Yied 7.85% Effective price and Yied ( ) = due to hedging Yied 7.99%

6 Bond Basics Coupon Interest rate is the amount charged, expressed as a percentage of principa, by a ender to a borrower for the use of assets. They are typicay noted on an annua basis, known as the annua percentage rate (APR). E.g May 2025 security bears an interest rate of 7.72% annuay which is aso referred to as coupon. Does the rate of return remain same throughout the tenure of the bond? No, to measure the rate of return on your investment et us first understand the concept of yied. Yied Yied is the income (return) on an investment. This refers to the income received from a security and is usuay expressed as a percentage (annua return) based on the investment's cost, its current market vaue or its face vaue. Yied and price of a bond have an inverse reationship. As yied increases the price of the bond decreases and vice-versa. Cean Price Cean price is the price of a coupon bond not incuding any accrued interest. When bond prices are quoted in the underying market (NDS-OM) they are quoted using the cean price. Accrued interest Accrued interest is the interest amount accrued from ast coupon payment date / issue date up to the day prior to the settement date. It is cacuated using 30/360 day count convention which assumes each month has 30 days. Dirty Price or Cash Price The dirty price is the price of a bond incuding any interest that has accrued since issue of the most recent coupon payment. Dirty price = Cean price + Accrued interest Modified duration Modified duration is a measure of the sensitivity of the price (the vaue of principa) of a fixed-income investment to a change in interest rates. Rising interest rates mean faing bond prices, whie decining interest rates mean rising bond prices. The greater the duration number, the greater the interest-rate risk or reward for the bond. Theoretica Futures Price = Cash price + Financing cost - Income on cash position Where, I Cash price of the underying = Cean price + Accrued interest I Financing cost = Financing cost for the period on Cash price I Income on cash position = Accrued interest expected to be received on expiry + Coupon payment + Interest on coupon payment I The component of coupon payment and interest on coupon payment are appicabe in case of any coupon payments faing during the hoding period Growth of NBFII Introduction of Interest Rate Futures is an exceent exampe of coaborative efforts on the part of market participants, exchanges and reguators. It is a great addition to the existing portfoio of financia products in the Indian Financia Markets. Since its aunch in January 2014, the Interest Rate Futures average daiy voume has grown from Rs. 981 crores in January 2014 to Rs crores in August Average Daiy Turnover - INR Crores 3,500 3,000 2,500 2,000 1,500 1, Source: NSE Average Daiy Voume (Rs. Crores) (hs.) Open Interest (rhs.) 4,50,000 4,00,000 3,50,000 3,00,000 2,50,000 2,00,000 1,50,000 1,00,000 50,000 - No. of contracts