Page 139 - DMGT513_DERIVATIVES_AND_RISK_MANAGEMENT

Derivatives & Risk Management

Notes 10.1 T-Bill and T-Bond Futures

Interest-rate futures are contracts of the future delivery of interest-bearing securities (debt).
Interest-rate futures allow speculators and hedgers to buy and sell these contracts through the
locking prices of these securities for future delivery.
Interest-rate futures include the following securities:
1. Treasury bonds

2. Treasury notes
3. Treasury bills
4. 10-year agency notes

5. 10-year Muni note Index
6. 30-day federal funds
7. Eurodollar deposits
8. Selected foreign government bonds
Changes in interest rates affect bond prices. Speculators buy or sell interest-rate futures based on
their future projections about which direction will the future interest-rates take in an attempt to
get greater returns.
Investors with large bond portfolios can reduce their loss risk due to the changes in the rates of
interest by hedging their positions using interest-rate futures. Let´s pretend that a speculator is
expecting interest rates to decline in the near future. The speculator would take a long position
by buying a futures contract for delivery of Treasury bonds. If rates of interest fall, the price of
Treasury bonds would go up, and the value of Treasury bonds futures contract would also be
increased. The speculator then can benefit from the sales of Treasury bond futures contract at a
higher price.
But, if rates of interest raise, the speculator will lose money, because Treasury bond prices
would fall resulting in a decline in the price of bond futures contract.

The opposite occurs when the speculator is able to anticipate a raise in interest rates. The speculator
would sell in short Treasury bond futures contract, and if the rates of interest increase the value
of Treasury bond futures contract will fall. Then the speculator would buy the return of the
contract at a normal price, closing out his position with a profit for him.

The bond portfolios managers and individuals with large bond portfolios can hedge against
raises in interest rates by selling short Treasury bonds and other bond Index futures that resemble
the markup of the kind of bonds that are in the portfolio. The difference between speculators and
hedgers is that the hedgers are really the owners of the financial securities and negotiate with
them.

Notes In June 2003 IRF was launched with the following three types of contracts for
maturities up to 1 year on the NSE.
1. Futures on 10-year notional GoI security with 6% coupon rate
2. Futures on 10-year notional zero-coupon GoI security
3. Futures on 91-day Treasury bill.

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