An interest rate future means the futures contract with an interest-paying underlying product. A contract is an agreement between a buyer and a seller for the delivery of an interest-bearing asset in the future.
The buyer and seller of an interest rate futures contract can lock in the price of an interest-bearing asset for a future date.
The underlying securities for these futures contracts are government bonds or T-Bills. On the NSE, standardized contracts based on 6-year, 10-year, and 13-year Government of India Security (NBF II) and 91-day Government of India Treasury Bills are traded (91DTB). All futures contracts sold on the interest rate futures NSE are settled in cash.
As the interest rates and bond prices are inversely related, when interest rates rise, bond prices fall, and vice versa when interest rates fall.
Let's assume an investor has a long position in a bond and anticipates selling it at a higher price. Rising interest rates, on the other hand, will lower the bond's value. Hence rising interest rates constitute a danger for this investor. Bond prices will fall because bonds are an underlying asset in the contract. Such investors can sell these futures and repurchase them at a lower price to compensate for the decline in the value of the bonds they own.
Let's look at an example. Let's imagine you have a home loan of Rs 50 lakh, and you expect interest rates to rise in a particular length of time, say six months or a year, as a result of RBI policy. When interest rates rise, your EMI rises with them. You could sell an interest rate futures contract to mitigate the risk of rising EMIs as interest rates climb. If interest rates rise, the value of these futures contracts will decrease, and you will be able to repurchase them.
The higher EMI outlay is partially compensated by the difference in futures prices, and you are protected against the danger of rising interest rates.
We'll look at some crucial elements now that we've looked at what interest rate futures are.
Let's have a look at the advantages: