Interest Rate Future

What Is an Interest Rate Future?

An interest rate future is a futures contract with an underlying instrument that pays interest. The contract is an agreement between the buyer and seller for the future delivery of any interest-bearing asset.

The interest rate futures contract permits the buyer and seller to lock in the price of the interest-bearing asset for a future date.

Understanding Interest Rate Futures

An interest rate future can be founded on underlying instruments, for example, Treasury bills on account of Treasury bill futures traded on the CME or Treasury bonds on account of Treasury bond futures traded on the CBOT, which is a division of the CME.

Different products, for example, CDs, Treasury notes, and Ginnie Mae securities are likewise accessible to trade as underlying assets of an interest rate future. The most famous interest rate futures are the 30-year, 10-year, five-year, and two-year Treasuries, as well as the eurodollar.

Interest Rate Futures Example

Treasury-based interest rate futures and eurodollar- based interest rate futures trade in an unexpected way. The face value of most Treasuries is $100,000. In this way, the contract size for a Treasury-based interest rate future is normally $100,000. Each contract trades in handles of $1,000, yet these handles are split into thirty-seconds (32nds), or augmentations of $31.25 ($1,000/32). On the off chance that a quote on a contract is listed as 101'25 (or frequently listed as 101-25), this would mean the total price of the contract is the face value, plus one handle, plus 25/32s of another handle, or:
$\begin 101^\prime25 \text &=\ $100,000 + $1,000 + \left($1,000 \times\frac{25}{32}\right)\ &=\ $101,781.25 \end$
Eurodollar-based contracts have a contract size of $1 million, a handle size of $2,500, and trade in augmentations of $25. These contracts, not at all like Treasury-based contracts, additionally can trade at half-tick and quarter-tick values. This means that the base price movement of a $1 million contract is just $6.25, which equals $25 x 25%.

The price of an interest rate future moves contrarily to the change in interest rates. On the off chance that interest rates go down, the price of the interest rate future goes up and vice versa. For example, a trader guesses that interest rates might fall throughout the next month, and bond prices will rise. The trader purchases a 30-year Treasury bond futures contract at a cost of 102'28. After one month, the trader's prediction has worked out. Interest rates are lower, and the interest rate future is presently priced at 104'05. The trader sells, and the profit is:
$\begin &\text = 102^\prime28 = $102,875\ &\text = 104^\prime05 = $104,156.25\ &\text = $1,281.25\text1.25$

Special Considerations

Interest rate futures are utilized for speculation purposes, yet additionally for hedging bond portfolios or interest rates. While examiners can utilize interest rate futures to wager on the bearing of rate changes, hedgers can likewise utilize them to quiet the effect of an unfavorable move in bond prices and rates.

For example, a borrower that has a loan with a variable rate will be harmed assuming interest rates rise. Accordingly, the borrower could sell (short) an interest rate future that will fall assuming rates rise and gains from the short futures contract can assist with offsetting the increased cost of the loan.

Features

• An interest rate future is a financial derivative that permits exposure to changes in interest rates.
• Interest rate futures price moves conversely to interest rates.
• Investors can hypothesize on the course of interest rates with interest rate futures, or, more than likely utilize the contracts to hedge against changes in rates.
• Most interest rate futures that trade on American exchanges use U.S. Treasury securities as the underlying asset.