1. finance
2. investing
3. futures trading

have been more successful in equity and currency than in interest rate markets, as the
following table shows.
Average daily turnover (Rs Cr) on NSE
Equity
2006-07
2007-08
2008-09
2009-10
2010-11
29,000
52,000
44,000
70,000
116,000
640
7,000
13,600
Currency
Interest rate
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Negligible
Source: NSE Fact Book 2011, National Stock Exchange
Sample Questions
1. Which of the following is the role of derivatives?
a. Financing
b. Cash or liquidity management
c. Risk management
d. All of the above
(Answer: please see Section 4.1)
2. Which of the following derivatives have the largest market size globally as at 2009?
a. Equity derivatives
b. Interest rate derivatives
c. Currency derivatives
d. Commodity derivatives
(Answer: please see Section 4.2)
3. Which of the following derivatives have the largest market size in India?
a. Equity derivatives
b. Interest rate derivatives
c. Currency derivatives
d. Commodity derivatives
(Answer: please see Section 4.5)
4. Bond futures usually are settled as follows
a. Cash settlement
b. Physical settlement
c. Both (a) and (b)
d. None of the above
(Answer: please see Section 4.2)
5. Which of the following correctly describes “hedging”?
a. Risk reduction
b. Risk minimization
c. Risk insurance
d. Risk elimination
(Answer: please see Section 4.1)
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Chapter 5: Contract Specification for Interest Rate Derivatives
Topics
5.1 Underlying
5.2 Contract Amount
5.3 Contract Months, Expiry Date and Last Trading Day
5.4 Price quotation and tick size
5.5 Daily Settlement Price
5.6 Final Settlement Price
5.7 Delivery
The “interest rate derivatives” traded on Exchanges in India are not truly interest rate
derivatives but bond derivatives (see Section 4.2). The underlying for interest rate
derivatives is the interest rate on money, typically, the interbank money; and the
underlying for bond derivatives is a specific debt security issued by a specific borrowers.
Globally, interest rate derivatives dominate bond derivatives because the interest rate
market is one large market while the market for debt securities is fragmented into
specific instruments, which are not fungible with each other. However, the name
“interest rate derivatives” has become stuck in India to what actually are bond
derivatives.
All interest rate derivatives are traded in the Currency Derivatives segment of Exchange.
As of February 2013, the state of trading in interest rate derivatives on Indian Exchanges
is as follows.
x National Stock Exchange (NSE): offers trading in interest rate derivatives
x Bombay Stock Exchange (BSE): transferred its currency derivatives and interest
rate derivatives to United Stock Exchange (USE)
x United Stock Exchange (USE): only currency derivatives are traded
x MCX-SX: only currency and equity derivatives are traded
Thus, NSE is the only Exchange which currently trades interest rate derivatives. Even on
this Exchange, only two of the four permissible contracts are currently traded.
5.1 Underlying
Under the current regulations of SEBI, four interest rate derivatives are allowed to be
traded on the Exchanges. The underlying assets for the four contracts are:
1. 91-day Treasury Bill issued by Government of India (GOI)
2. 2Y 7% GOI Security with semi-annual coupon payment
3. 5Y 7% GOI Security with semi-annual coupon payment
4. 10Y 7% GOI Security with semi-annual coupon payment
The 91-day Treasury Bill is a discount or zero-coupon instrument (see Section 1.3) issued
weekly by GOI on every Wednesday for settlement on the following Friday. It is issued
for a minimum and in multiples of Rs 25,000.
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GOI also issues many “dated securities” with different maturity dates and different
coupons. They are issued for a minimum and in multiples of Rs 10,000. However, none
of the existing dated GOI securities correspond to the coupon and maturity
Unlike the Treasury Bill (which really exists and deliverable), the other three
Government Securities above are notional or imaginary securities. Though there are
many government securities outstanding, none of them match the coupon and maturity
of the last three underlyings. Accordingly, for the purpose delivery, any of the eligible
securities (explained in Section 5.7) are allowed to be substituted for the notional
underlying after adjusting the delivery quantity through a “Conversion Factor”
(explained in Section 5.6). To sum up, the underlying for 91- Treasury Bill is actual
security and can be delivered, but that for other three futures (which are GOI securities)
are notional and can be delivered as substitute securities for equivalent amount.
Though SEBI regulations permit three different bond futures with maturity of 2Y, 5Y and
10Y, NSE currently trades only the 10Y GOI security (in addition to the 91-day Treasury
Bill).
5.2 Contract Amount (or Market Lot)
Contract Amount (or Market Lot) is the minimum and multiple of trade size. It is Rs
200,000 of face value. Because the face value will always be an integral multiple of Rs 2
lakhs, we cannot buy or sell for amounts like Rs 3 lakh, Rs 5 lakh, etc. In contrast, the
market lot in the cash market of wholesale debt market is Rs 5 Cr (which is equal to 250
futures contracts).
The face value and market value are linked by the market price. In both cash and futures
markets, the prices are quoted for Rs 100 face value so that the relation between face
value and market value is:
Market Value = Face Value × (Market Price / 100)
Thus, if the price is 106.10, the face value of 200,000 will have a market value of:
200,000 × (106.10/100) = 212,200.
5.3 Contract Months, Expiry Dates and Last Trading Day
Contract Month (also known as Expiry Month) is the month in which the contract
expires or settles. On any trading day, there will be multiple contracts expiring in
different months. Current SEBI regulations allow the following number of contract
months.
91D Treasury
futures
Bill Three nearest “serial months” and three nearest
“quarterly” months, for a total of six contract months
7% 10Y GSec futures
Four nearest “quarterly” months
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The “quarterly” months are March, June, September and December; and “serial” month
is a month other than the four quarterly months. As against the above regulations, NSE
lists only the following contract months:
91D Treasury
futures
Bill Three nearest “serial
“quarterly” month
7% 10Y GSec futures
months”
and
one
nearest
Two nearest “quarterly” months
Expiry date is the date on which the contract is settled; and the last trading day (LTD) is
the date on which trading in the contract ceases and it will be (naturally) before the
expiry date. The following are the expiry date and LTD for the two futures contracts.
91D Treasury
futures
Bill Expiry date: last business day of Contract Month
LTD: last Wednesday (or previous business day, if it is
holiday) of Contract Month. Trading halts at 1pm on
LTD
7% 10Y GSec futures
Expiry date: last business day of Contract Month
LTD: Two business days prior to Expiry Date
5.4 Price Quotation and Tick Size
Price quotation refers to the style of quoting the contract price; and tick size is the
minimum change in price. The tick size for both contracts is Rs 0.0025. The price
quotation for T-bill is 100 minus the discount rate (which is different from investment
yield, see Section 2.5) and that for GOI security is price per 100 face value. For example,
if the discount yield is 5%, then the price of T-bill futures will be: 100 – 5 = 95.0000.
Given that the face value of one contract is equal to Rs 200,000 and given that tick size
is 0.0025, the minimum change per contract will be:
200,000 u 0.0025 / 100 = 5.
5.5 Daily Settlement Price (DSP)
Daily settlement price (DSP) is the price at which margining and mark-to-market (see
Unit 6) is implemented. Because of daily mark-to-market, the carry price of the contract
changes every day. The following is the procedure for determining the DSP.
For 91-day T-bill futures
DSP is determined in one of the following ways in that order of preference:
(a) If there are at least five trades in the last 30 minutes of trading:
DSP = 100 – 0.25 u Y
where Y is the weighted average yield price of trades, the weights being the
number of contracts in the trade.
(b) If there are at least five trades in the last 60 minutes of trading:
DSP = 100 – 0.25 u Y
(c) If there are at least five trades in the last 120 minutes of trading:
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DSP = 100 – 0.25 u Y
(d) Theoretical price will be determined by the Clearing Corp in accordance with the
disclosed procedure from the rates published by Fixed Income and Money
Market Derivatives Association (FIMMDA).
For 10Y GSec futures
DSP is determined in one of the following ways in that order of preference.
(a) If there are at least five trades for a minimum total amount of Rs 10 Cr in the last
30 minutes of trading:
DSP = volume-weighted average price of such trades
(b) If there are at least five trades for a minimum total amount of Rs 10 Cr in the last
60 minutes of trading:
DSP = volume-weighted average price of such trades
(c) If there are at least five trades for a minimum total amount of Rs 10 Cr in the last
120 minutes of trading:
DSP = volume-weighted average price of such trades
(d) Theoretical price will be determined by the Clearing Corp in accordance with the
disclosed procedure.
5.6 Final Settlement Price (FSP)
Final settlement price (DSP) is the price at which the contract is settled on the expiry
date. For 91D T-bill, FSP is the weighted average discount yield (Y) in the auction of 91day T-bill conducted by Reserve Bank of India (RBI) on the expiry date. The FSP is
(100 – 0.25 u Y)
Note that 91 days is considered exactly one-fourth of the year (i.e. 0.25) in the formula
above. For example, if the weighted average discount yield (Y) in the RBI auction is 5%,
then the FSP will be
(100 – 0.25 u 5%) = 99.9875
The value of one contract, given its face value of 200,000 and given that the price is for
100 face value, will be
(200,000 / 100) u 99.9875 = 199,975
For 10Y GSec futures, FSP is the last DSP at which the contract is held.
5.7 Delivery
The settlement method for the 91-day T-bill futures is compulsory cash settlement and
that for 10Y GSec futures is physical settlement.
The T-bill futures are settled in cash for the difference between the contract price and
the final settlement price. The 10Y GSec futures are settled by physical delivery of the
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