Futures Interest Rate

A Interest Rate Futures agreement is between two parties that allows them to purchase or sell a debt instrument at an unspecified future date at a fixed price.

This is a derivative product that allows financial institutions to hedge interest rate risk. In this instance, the underpinning is a 10-year government bond.

Trading is allowed on two types of bonds with coupon 8.83% or 7.16% at the moment.

A trader in an IRF contract will take a position when he believes the price of the 10 year underlying bond will rise. This means that he expects the interest rate to fall or soften. He would also be less optimistic about rates rising or hardening.

As with all other assets, the forces of supply and demand determine the price of a bond. The price of a bond is also affected by a variety of factors. It can fluctuate depending on economic conditions, general market conditions including the state money supply, the prevailing interest rate, future interest rate expectations, and the credit quality of the issuers.

Evolution:

After the RBI relaxed some rules, such as allowing cash settlement based trades, three exchanges - the NSE (BSE) and the MCXX-SX - launched IRF trading in January 2014.

The product had been introduced twice-three times before it fell flat. Experts believe that allowing financial institutions the ability to bridge the cash-futures gap could be a big boost for IRF market. Strong benchmarks for term-money can be created by a term money market. These benchmarks can be transparently linked to all banks' base rates, which ensures convergence between financial institutions as well as end-user benchmarks.

The terms of the bond, i.e. The coupon rate is set in advance, while the price is determined by market forces.
Trading in interest rate futures has been allowed in India's National Stock Exchange and Bombay Stock Exchange.
Interest rate futures are used primarily to offset or hedge interest rate risks.
A futures contract would allow one to pay more for borrowing if he/she believes that interest rates will rise.
As market interest rates rise or fall, the value of the contract will fluctuate.