Interest rate future
Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures.
Interest rate futures are used to hedge against the risk that interest rates will move in an adverse direction, causing a cost to the company.
For example, borrowers face the risk of interest rates rising. Futures use the inverse relationship between interest rates and bond prices to hedge against the risk of rising interest rates. A borrower will enter to sell a future today. Then if interest rates rise in the future, the value of the future will fall (as it is linked to the underlying asset, bond prices), and hence a profit can be made when closing out of the future (i.e. buying the future).
Treasury futures are contracts sold on the Globex market for March, June, September and December contracts. As pressure to raise interest rates rises, futures contracts will reflect that speculation as a decline in price. Price and yield will always be in an inversely correlated relationship.
It is important to note that interest rate futures are not directly correlated with the market interest rates. When one enters into an interest rate futures contract (like a bond future), the trader has ability to eventually take delivery of the underlying asset. In the case of notes and bonds this means the trader could potentially take delivery of a bunch of bonds if the contract is not cash settled. The bonds which the seller can deliver vary depending on the futures contract. The seller can choose to deliver a variety of bonds to the buyer that fit the definitions laid out in the contract. The futures contract price takes this into account, therefore prices have less to do with current market interest rates, and more to do with what existing bonds in the market are cheapest to deliver to the buyer.
A short-term interest rate (STIR) future is a futures contract that derives its value from the interest rate at maturation. Common short-term interest rate futures are Eurodollar, Euribor, Euroyen, Short Sterling and Euroswiss, which are calculated on LIBOR at settlement, with the exception of Euribor which is based on Euribor. This value is calculated as 100 minus the interest rate.
A great deal of the trading on these contracts is exchange traded multi-leg strategies, essentially bets upon the future shape of the yield curve and/or basis. Both Liffe and CME allow direct exchange trading in calendar spreads (the order book for spreads is separate from that of the underlying futures), which are quoted in terms of implied prices (price differences between futures of different expiries). Exchange-traded futures spreads greatly reduce execution risk and slippage, allowing traders to place guaranteed limit orders for entire spreads, otherwise impossible when entering into spreads via two separate futures orders.
- The Fundamentals of Trading U.S. Treasury Bond and Note Futures by CME Group
- Answers.com description of interest rate futures contracts
- Euronext description of short sterling contracts[dead link]
- Quandl: Rates Futures - free, historical data
- Interest Rate Futures Contract Specifications and Tick Values at ExcelTradingModels.com
- "The future regulation of derivatives markets: is the EU on the right track? (Introduction)". Parliament. 23 March 2010. Retrieved 18 June 2013.
- Willette, Jeff (1 October 2013). "Bond Futures: What Do The Quote Prices Really Mean?". www.RadBrains.com. Retrieved 2013-10-08.