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Introduction
Treasury Bills are money market instruments to finance the short term requirements of the Government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price. Types of Treasury Bills: There are different types of Treasury bills based on the maturity period and utility of
the issuance like, ad-hoc Treasury bills, 3 months, 6 months and 12months Treasury bills etc. In India, at present, the Treasury Bills are issued for the follo in! tenor"s #1-days, 1$2-days and 36%-days Treasury bills
A contract on the future delivery of interest-bearing securities primarily Treasury bills !on the "hicago #ercantile $%change& or Treasury bonds !on the "hicago Board of Trade& although contracts on certificates of deposit Ginnie #ae certificates and Treasury notes are also available. As with other futures contracts interest rate futures permit a buyer and a seller to lock in the price of an asset !in this case a specified package of securities& for future delivery. The contracts are large in amount !'( million for bills and '()) ))) for bonds& and lend themselves to sophisticated analysis. An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a notional amount of money at a given interest rate. The interest rate derivatives market is the largest derivatives market in the world. The Bank for International *ettlements estimates that the notional amount outstanding in +une ,))- .(/ were 0*'123 trillion for 4T" interest rate contracts and 0*'21, trillion for 4T" interest rate swaps. According to the International *waps and 5erivatives Association 6)7 of the world8s top 9)) companies as of April ,))2 used interest rate derivatives to control their cash flows. This compares with 397 for foreign e%change options ,97 for commodity options and ()7 for options. It consists of swaps forwards and futures An interest rate swap is a derivative in which one party e%changes a stream of interest payments for another party8s stream of cash flows. Interest rate swaps can be used by hedgers to manage their fi%ed or floating assets and liabilities. 0nlike corporate bonds interest rate swaps do not involve risk on the principal amount.(/. They can also be used by speculators to replicate unfunded bond e%posures to profit from changes in interest rates. Interest rate swaps are very popular and highly liquid instruments
Interest :ate ;utures !I:;& is e%pected to provide the following benefits to market participantsE (& I:; will e%pand the scope of the financial markets in India and will further deepen the derivatives markets. ,&$%change Traded I:; are most transparent in terms of price discovery margining risk management and settlement. 2& I:; will enable "orporates to hedge interest rate risk. Interest payments form one of the maAor parts of the e%penditure for companies. Folatility in interest rates could be better managed with the help of Interest :ate ;utures. 1& I:; will provide banks and financial institutions with an avenue for efficient Asset-Biability #anagement. 9&;und managers and Insurance companies can better manage asset allocation and investments using I:;. G& I:; will also help individuals in efficient management of the household balance sheet.
Trading Techniques
;or exa ple !: 4n (?(?,))2 the notional ()-year bond !from H"I"& was :s.19.12. Iou believe the long rate will go up so you short three futures contracts !(, ))) bonds& J :s.1-. 4n 2(?(?,))2 the notional ()-year bond is at :s.2-. Iou have a profit of :s.()?bond or :s.(,) ))) overall. "xa ple #: The futures contract e%pires in 2) days. 2) days from now the seller is obligated to deliver a -)-day tbill. *oE (. Buy a H" bond with (,) days to e%piry ,. *hort the -) day futures with 2) days to
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"xa ple % (.Get * by selling (,) day bond ,. Invest it into a 2)-day tbill gives *!( L r2)M2G9&2)M2G9 on futures e%piration. 2. Buy -)-day futures J ;. 1. 4n e%piration date INm left with *!( L r2)M2G9&2)?2G9- ; in hand. :everse cash and carry.
Interest 'ate Futures Market &articipants !( )anks and &ri ary *ealers
Interest :ate ;utures enable Banks and >rimary 5ealers to mitigate risk improve process efficiency and increase their bottomline. ;ollowing are some of the scenarios when I:; can benefit Banks and >rimary 5eal (& #anage SIield "urve :iskS when banks are e%posed to assets and liabilities across different tenors. ,& #itigate SBasis :iskS when yield on assets and costs on liabilities are based on different benchmarks. 2& 1& @edge against Q:epricing :iskS related to volatility of cash flows due to revaluation of assets and liabilities ove a period of time. >rotect against devaluation of *B: and non-*B: securities inventory !held under Available ;or *ale and @eld ;or Trade categories& due to sudden spike in bond yield rates !and consequent decrease in bond prices&. $%posure to embedded options in structured product can lead to S4ption :iskS due to varying S4ptionalityS. ;or e%ample S>uttabilityS of mortgage !home& loans by borrowers due to home-loan refinancing in lower interest rate regime.
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G& Improve the financial performance by increasing theSIield on ;und AdvancesS ratio thereby decreasing the SBreakeven Iield :atioS for the bank resulting in increase in SCet Interest IncomeS. 3& 5ecrease the sensitivity of returns on bank assets and liabilities due to volatility in interest rates. 6& Banks have lower entry and e%it costs by using I:; as compared to Interest :ate *waps !I:*&. -& I:; pricing is directly dependent on the widely accepted Government of India *ecurities leading to efficient price discovery and high liquidity. ()& "learing and settlement through e%change clearing houses ensures safety for banks leading to decrease in risk capital allocation for hedged assets and better S"apital Adequacy :atioS.
13) >rimary dealers can use I:; for interest rate risk mitigation in the process of adhering to :BI guidelines for annual minimum bidding for dated securities minimum success ratio minimum annual turnover limits and commitment to underwrite the shortfall !gap& between the subscribed accepted amount and the notified amount. (1& Banks and >rimary dealers can minimi<e portfolio volatility by using I:;.
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,&Mutual Funds E#utual ;und managers can immensely benefit from I:;. The Cet Asset Falue can be protected by hedging against interest rate volatility. ;ollowing are some of the maAor benefits to these participantsE a&@edging to mitigate interest rate risk for 5ebt #arket #; b&Increasing the absolute performance of a portfolio on a risk adAusted basis over a specific time period !improved +ensen8s measure and lower drawdown as compared to unmanaged portfolios&. c& Investors can diversify their portfolio by taking positions in Interest :ate ;utures resulting in increased *harpe ratio !risk adAusted returns&. d&$asy entry into and e%it out of debt market e%posure. e&Arbitrage between cash and futures markets. f&Bow transaction costs due to higher liquidity g&*pread Trading to leverage on interest rate differentials. h&Beveraged trades using I:; i&Falue-added services for "lients using Interest :ate ;utures. A&#T# *ettlement on TL( day basis through $%change "learing @ouse. k&Innovative #utual ;und !#oney and 5ebt #arket& >roducts using Interest :ate ;utures to mitigate risk. l&4ptimi<e CAF by hedging interest rate risk m&$%change "learing "orporation provides counterparty guarantee to trades thereby minimi<ing risk. n&$fficient price discovery and greater liquidity due to wider participation o&$lectronic trading on e%change platform.
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%( Insurance +o panies
;ollowing are some of the maAor benefits of Interest :ate ;utures for Insurance "ompanies both in Bife Insurance and General Insurance IndustryE a&@edgingE Insurance companies having e%posure to Government *ecurities and "orporate 5ebt can leverage on Interest :ate ;utures for mitigation against volatility of interest rate bearing assets and liabilities. b&5ecrease Boss - $%pense :atio and Increase Investment Iield of assets. c&Increasing :eturn on Investments and 5ecreasing the Insurance "laims-ratio due to foreclosures. d&$fficient management of Asset-Biability mismatch e&@edging against events such as credit crisis leading to increased claims against *ocial Insurance and Bond Insurance policies. f&>rotection against :einsurance risk g&5ecrease underwriting e%penses of insurance policies by effective and efficient management of interest rate risk. h& >rotect payment of Annuities in >ension ;unds as well as manage liquidity requirements in $ndowment Insurance policies. i& Increase the return on investments in Interest bearing securities thereby enhancing actuary numbers for the Insurance "ompany. A&@edge against interest rate risk for protection of the *um Assured. k&Increase reversionary and terminal bonus interest rate risk management. l&Innovative Insurance >roducts using Interest :ate ;utures can be structured.
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The 'oad -head Introduction of Interest :ate ;utures is an e%cellent e%ample of collaborative efforts on the part of market participants e%changes and regulators. It is a great addition to the e%isting portfolio of financial products in the Indian ;inancial #arkets. Cow we need to quickly work on the products proposed in the Technical paper prepared by the *ecurities and $%change Board of India8s !*$BI& risk management group. Availability of the large number of products always creates more and more opportunities for trading which in turn result in the better price discovery and efficiency in the system. The *$BI8s risk management group has recommended that reference rate products linked to the #IB4: and #I;4: be introduced in the market only after all related legal issues have been addressed in order to avoid the legal risk. 4nce the said issues are resolved market would see these products which are well established and e%tremely popular globally. The market participants also appear to be really looking forward to these reference rate products. Another issue is that the market participants should be given the freedom to use these products. ;ocus of regulations should be on the proper disclosures and the transparency in the operations of the market participants instead of putting the restrictions on their usage. *trategic uses of the products are discovered and rediscovered by the market participants on day to day basis and any kind of restrictions on the products8 usage hamper the market developments by containing the creativity and imagination of the market place. Therefore market participants must be given the freedom to e%plore the value creation opportunities with these products within the given framework. Introduction of $%change Traded Interest :ate ;utures by *ecurities and $%change Board of India !*$BI& U :eserve Bank of India !:BI& marks a maAor policy and product innovation that will have significant impact on the deepening of financial markets in India. .5erivatives have become a dirty word after the global financial crisis. *o why then are our regulators allowing a new type of derivativeV
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