A new derivative product makes hedging easier against interest rate fluctuations
A new derivative product makes it easier to hedge against interest rate fluctuations.
What's new: The National Stock Exchange, or NSE, the country's largest bourse, recently introduced trading in interest rate futures, or IRF, on 91-day treasury bills. T-bills are money market instruments issued by the government to meet its shortterm requirements of funds. IRF on 91-day T-bills will be traded in the currency segment of the exchange and will be settled in cash. Besides, it will not attract securities transaction tax, or STT. Given the volatile interest rate scenario, the NSE expects the product to get a positive response from banks, mutual funds, companies and foreign institutional investors, as it will provide them with a credible institutional hedging mechanism against short-term risks arising from interest rate fluctuations.
What will change: In August 2009, the NSE had launched IRF contracts on 10-year government bonds, but the product failed to generate much interest beyond the initial period. Since those contracts could only be settled through physical delivery of the securities, their trading was marked by thin volumes and low participation, and there was a lack of hedging interest in them. The cash settlement of the new product will make it more liquid. "While the introduction of such a product will help develop the market, its success depends on how fast market players adopt it," says Dwijendra Srivastava, Head of Fixed Income, Sundaram Mutual.
Benefits: Apart from the lower cost of trading in the absence of STT, a major advantage is that the new product allows players to trade in excess of the supply of the underlying T-bills. Says Srivastava: "In this, one can take huge bets on the interest rate movement even if the total trading exceeds the underlying supply of securities." Also, since the paper duration is just 91 days, the impact of rising yields will not be huge compared to longer-duration bonds such as 364-day, and five- and 10-year bonds, he adds.
Global experience: At NYSE Liffe, US, the futures exchange of NYSE Euronext, IRFs are available on short-term treasury bills and bond instruments such as treasury notes with two-, five- and 10-year maturity and treasury bonds with 25-year maturity. Large financial institutions show a greater tendency to use these hedging devices to minimise their risks. "The product offered by NSE is a plain-vanilla derivative. RBI has inhibitions about allowing trading in such products because of the high risk associated with them," says Srivastava.
What will change: In August 2009, the NSE had launched IRF contracts on 10-year government bonds, but the product failed to generate much interest beyond the initial period. Since those contracts could only be settled through physical delivery of the securities, their trading was marked by thin volumes and low participation, and there was a lack of hedging interest in them. The cash settlement of the new product will make it more liquid. "While the introduction of such a product will help develop the market, its success depends on how fast market players adopt it," says Dwijendra Srivastava, Head of Fixed Income, Sundaram Mutual.
Benefits: Apart from the lower cost of trading in the absence of STT, a major advantage is that the new product allows players to trade in excess of the supply of the underlying T-bills. Says Srivastava: "In this, one can take huge bets on the interest rate movement even if the total trading exceeds the underlying supply of securities." Also, since the paper duration is just 91 days, the impact of rising yields will not be huge compared to longer-duration bonds such as 364-day, and five- and 10-year bonds, he adds.
Global experience: At NYSE Liffe, US, the futures exchange of NYSE Euronext, IRFs are available on short-term treasury bills and bond instruments such as treasury notes with two-, five- and 10-year maturity and treasury bonds with 25-year maturity. Large financial institutions show a greater tendency to use these hedging devices to minimise their risks. "The product offered by NSE is a plain-vanilla derivative. RBI has inhibitions about allowing trading in such products because of the high risk associated with them," says Srivastava.
