The derivative instrument Interest rate future IRF is back in India after a period of 6 years .IRF was launched in the year 2003 for the first time in India, it did not took off as there was lack of liquidity and various complexities including the delivery of the product.
Last Saturday I attended the seminar at NSE, again introduction of IRFs in the Indian market. Came across various things and still could not able to digest few things because of the complexities.
The best part of IRFs is that they are deliverable at the end of maturity and the catch is IRFs will be functioning on the basis of underlying 7% Notional Government bond having a maturity of 10years.
The committee has recommended 11 Government of India Bonds having maturity not more than 10 years any of these could be delivered by the seller at the end of maturity depends upon the seller option.
At a time four contracts would be available to trade with the expiry of March, June, September and December so far only two are available they are of September and December.
The concept of Cheapest to Deliver CTD has been introduced (keeping in mind the lack of liquidity in the Indian bond market). Out of 11 bond chosen by the exchange the bond having less CTD will be delivered by the seller in the normal circumstances. Quoting the example:
An Upward sloping yield curve and having a long maturity will be delivered by the seller (keeping in mind the reinvestment risk so it would be CTD contact)
It’s a great move in reforming the India’s Bond market having lot of potentials to outperform in the world market. In India generally the IRF are traded by the Banks, Primary dealers, financial institutions and Mutual fund. Earlier IRF where only used for the balance sheet management and Mutual funds were allowed only to hedge their risk. Thankfully they will be allowed to trade now.
The market for the derivatives on Bond world wide is much bigger comparing to the size of equities market world over. The CBOT allow to trade spreads between the two different bonds. (Say a 10 year note and 30 year bond), means we can long on one and short on the other. The product attracts lot of volume and volatility.
In India calendar spread can be traded current month and the far month. The response in the last 10 days reported by the business newspaper is not that great. Hopefully the volume will pick up but the delivery part complexities will be there so IRFs could prove out to be great Trading, Arbitrage and hedging product.
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different terms to maturity (but no other differences) is called Term Structure of Interest Rates.
A positive yield curve, which is most natural, is when the slope of the curve is positive, i.e. the yield at the longer end is higher than at the shorter end of the time axis. This result as people demand higher compensation for parting their money for a longer time into the future. A neutral yield curve is that which has a zero slope, i.e. is flat across time. View full article »
