National Stock Exchange of India (NSE) has launched interest rate futures in June 2003. The current interest rate future products are:

1. Notional 10 Year Zero Coupon Bond ................. Symbol:NSE10YZC

2. Notional 10 Year Coupon Bearing Bond (6%)...... Symbol:NSE10Y06

3. Notional 91 day Treasury Bill ........................... Symbol:NSETB91D

Investors can sell and buy the interest future contracts from different locations in the country through registered NSE brokers in the same manner as they buy and sell equities and derivatives today. The financial settlement of all trades is guaranteed by National Securities & Clearing Ltd. (NSCCL)

The pricing of all bonds will be based on the Zero Coupon Yield Curve of NS

The zero coupon yield curve (ZCYC for short) starts from the basic premise of ‘time value of money’ – that a given amount of money due today has a vaoue different from the same amount due at a future point of time. At any point of time therefore different spot rates of interest are associated with different terms of maturity. The term structure of interest rates, or ZCYC is the set of such spot interest rates. The present exercise estimates the ZCYC using the ‘Nelson-Siegel’ (NS) functional form [Nelson & Siegel (1987)] using data on secondary market trades in Government securities. Reported on the Wholesale Debt Market Segment of the National Stock Exchange (NSE-WDM). Further details in this regard are available on the NSE website at the following path www.nseindia.com/content/debt/debt_zcyc.htm

A derivative is a financial instrument, which derives its value from the underlying. In respect of Interest Rate Derivatives, the underlying factor is the interest rate. Interest Rate Derivatives enable various users to deal with the volatility associated with interest rate movement effectively.

A futures contract is a forward contract, which trades on an exchange. Interest Rate Futures, entail notional purchase and sale of a bond at the traded price and a notional delivery of the underlying at the expiry date.

In the cash market issuers issue Bonds, T-Bills, securities etc. And investors trade in those bonds. However, with Futures, there is no issuer entity, and hence there is no fixed issue size. Buyers and Sellers determine the quantity of futures available in the market. A contract (trade) takes when a buy order and sell order matches on the screen. The total number of net open contracts that exist at a point is called open interest.

Futures trade in Interest Rate can be generally used for the following purposes:

1. Taking a view on interest rates
   Trading involves entering into positions in the Futures market for the purpose of making a profit, assuming that market developments are forecast properly

2. Hedging
   People holding portfolio of bonds or investments subject to interest rate risk can reduce losses arising out of interest rate volatility by hedging.

3. Spreading
   Spread trading is trading method for a trader who observes mispricing in the relative value of two different contracts. The same can be in two contracts of same underlying with different expiries or between two contracts on two different underlying.

Interest rate futures can be bought and sold through the trading members of National Stock Exchange

You may contact NSE members before deciding on the member through whom you would commence trading. To open an account with the trading member you will be required to complete the formalities, which includes signing of the member-constituent agreement, constituent registration form and a risk disclosure document. The trading member will allot you a unique client identification number

To begin trading you must deposit requisite amount of cash or collateral with the trading member.

Futures trading involves the payment of initial margins. At the time of starting your trading activities through the NSE, you would be required to pay an initial/ up front margin to your broker. The initial margin serves as a security deposit, which in turn the broker has to pay to the exchange.

Your positions in the interest rate futures market will be revalued or ‘marked to market’ everyday. This is done by the exchange to assess the value of your positions on a daily basis. If the market value of your positions shows a loss, then you would be required to pay the difference. Similarly, incase your position has gained in value, you will be paid the profit amount.

The Daily Mark to Market of all Interest Futures Contracts is on the T+1 basis. Daily Mark to Market settlement price is the closing price of the4 contract. In case the contract is illiquid, the theoretical futures price of contract is used as the settlement price.

All open positions in the interest rate futures are cash settled on the expiry / settlement day through clearing members with whom the trading members are associated.

For a RBI regulated entity, they can get their trade cleared through a professional clearing member or they can become participant clearing members themselves for clearing trades for self.

Upon expiry the futures contract will be cash settled by a cash amount equal to the previous days settlement price of the contract and final settlement price as on the last trading day. There is no physical settlement of the4 Interest rate Derivatives. The final settlement is done on a T+1 basis. The final settlement price of the contract is the underlying close price arrived at by using the NSE ZCYC.

1. Have a view that the Interest Rates will fall
   Current Implied Interest Rate: 5.95%
   Buy one NSE 10YZC Future Contract @ Rs.55.40
   1 Contract = 2000 units
   
   After a few days:
   Implied Interest Rate: 5.00%
   Sell one NSE10YZC @ Rs.60.80
   Gain Rs.10,800 [2000*(60.80 –55.40)]

2. Have a view that Interest rate will rise
   Current Implied Interest Rate : 5.00%
   Sell one NSE10YZC Future Contract @ Rs.60.80
   1 Contract = 2000 units
   
   After a few days:
   Implied Interest rte 5.32%
   Buy one NSE10YZC @ Rs.59.80
   Gain Rs.3600/- [2000*(60.80 –59.00)]

3. Hedging Using Interest Rate Futures
   You have Rs.10,00,000 worth Govt. Bonds maturity period of around 10 Years. You expect Interest rate to go up as a result the prices of the bonds to fall. In such a case you can hedge by selling interest rate futures.

Sell NSE10Y06 futures contracts (nominal value rs.10 Lakhs). The outcome of the strategy is given below: