Now, this is as big as it gets !
The Stock Exchanges in India are on their way to launch Interest Futures. This move will take the turnover and volume of the exchanges over the roof.
Interest Rate Futures are contractual agreements to buy or sell underlying interest bearing instruments on a specific future date at a pre-determined price and is traded on the exchange.
To get an estimate of the potential of Interest Rate Futures, in the organized exchanges worldwide, the notional principal amount outstanding in interest rate futures stood at $17,833.70 billion as on March 2009 which is 30 times higher than equity index futures where the amount outstanding was $592.5 billion.
Given the uncertainty in the Interest rate changes, Interest rate Future Contracts will help the Investor hedge against any major fluctuations in the Interest Rates.
This will immensely appeal to corporate, banks, mutual funds along with institutional and pension fund investors who always have the Interest Rate risk on their investments.
Here are the two scenarios bound with the Interest Rate Fluctuation Risk and the role that the Interest rate Futures can play
- An investor, who has invested in long-term floating rate bonds has the risk of lower return if the interest rate comes down, can hedge against that risk by taking a long position in interest rate futures.
- An investor, who has taken a long-tenure loan has the risk of higher cash outgo in case the interest rate increases, can hedge that risk by taking a short position or selling interest rate futures
The major challenges when it comes to launching them will be to create awareness among the Investors about the benefits of Interest rate Futures. Given the complex nature of these Contracts, the average investor might initially be skeptical.
However, the exchanges along with the Domestic Brokerages are doing their part in reaching out to potential Investors through various workshops and seminars.
Even though, I don’t trade in Futures and Options, I strongly believe that the addition of Interest Rate Futures will be a welcome move for the Exchanges as well as the Investors.
[This Finance Friday post is written by Ankit Agarwal, an ERP Consultant by profession, a wannabe entrepreneur and stock market stalker by passion]