Exchange Traded Interest Rate Futures — NISM V-D

The heaviest Module 3 chapter (10 marks). Exchange-traded interest-rate futures are the workhorse hedging tool — standardised forward contracts on government securities, guaranteed by the clearing corporation. This chapter covers contract mechanics, the lot size and tick conventions, how a tick move translates into rupees, and the settlement methods (cash for bill futures, physical or cash for bond futures).

Foundation

An interest-rate future is a standardised, exchange-traded agreement to buy or sell a fixed amount of a debt instrument on a future date at an agreed price, with the clearing corporation guaranteeing settlement. As with equity futures, the buyer takes a long position and the seller a short — and because bond prices move inversely to yields, a party expecting rates to RISE (bond prices to FALL) SHORTS the future to hedge or profit. The Indian contract convention: 1 lot = notional bonds of ₹2 lakh face value (i.e., 2,000 bonds), so contract value = 2,000 × the trade price (quoted per ₹100 face). 91-day Treasury-bill futures are CASH settled. Open interest is the total number of derivative contracts outstanding — a gauge of how much money is committed to the market.

Deep Dive

Tick mechanics matter for sizing a hedge. With a lot of 2,000 and a tick (minimum price move) of ₹0.0025 per ₹100 face, the change in contract value per tick for one lot = 2,000 × 0.0025 = ₹5. So a hedger who needs to offset a given rupee sensitivity can compute how many lots to trade. Payoff is linear and mirror-imaged: a long gains ₹1 per ₹1 rise in the futures price (per unit); a short gains when the price falls. Concretely, if you are SHORT at ₹100 and the price ends at ₹101, you lose ₹1 (per unit) because the short profits only when the price falls. Settlement differs by product: money-market (91-day bill) futures are cash-settled against the benchmark yield; bond futures may be physically settled (deliver an eligible security) or cash-settled depending on the contract.

Worked example

Worked example — contract value, tick value and a short's P&L (NISM workbook data) (A) Contract value You buy 10 lots of a single/notional bond future at a price of ₹99 (quoted per ₹100 face). Lot size = 2,000. Contract value = 2,000 × price × lots = 2,000 × 99 × 10 = ₹19,80,000. (At par, ₹100, it would be ₹20,00,000 — the discount price gives ₹19,80,000.) (B) Tick value Tick = ₹0.0025 per ₹100 face. Change in value per tick, one lot = 2,000 × 0.0025 = ₹5. (C) Short P&L You go SHORT one contract at ₹100 and the underlying ends at ₹101 on expiry. A short profits only when the price FALLS. Here the price rose ₹1, so the short makes a LOSS of ₹1 per unit. These three — contract value, tick value, and payoff direction — are the exam's favourite Chapter 20 mechanics.

Real-world scenario

Real-world scenario — sizing a duration hedge A debt-oriented SIF holds a ₹100 crore bond book and the manager expects the RBI to raise rates. Selling ₹100 crore of bonds would be slow and costly, so she hedges with interest-rate futures instead. She SHORTS bond futures: if rates rise and her bonds lose value, the short futures gain and offset the loss. To size it she uses the contract value (2,000 × price per lot) and the book's duration to work out how many lots neutralise the rate exposure. The hedge is fast, liquid and centrally cleared — but it tracks a notional bond, so a residual basis remains. A distributor explaining this fund should be able to say: "it shorts government-bond futures to protect against rising rates," and note that the protection is close but not perfect.

Advanced

Interest-rate futures overcome the limitations of the OTC FRA/forward: standardisation makes them liquid and fungible; central clearing removes counterparty risk; daily mark-to-market prevents unfunded loss build-up. The trade-off is loss of customisation — the future is on a notional/standard bond, not your exact exposure, which reintroduces basis risk (Chapter 22). For sizing, the practitioner uses the contract value (2,000 × price) and the per-tick value (₹5/lot) together with the portfolio's duration to decide the number of lots. The exam commonly tests: the direction a hedger takes (short to hedge a long bond book against rising rates), the contract-value arithmetic, the meaning of open interest, and the settlement method for bill futures (cash).

Regulatory references

SEBI / RBI framework for exchange-traded interest-rate futures
Exchange contract specifications — lot 2,000 (₹2 lakh FV), tick ₹0.0025
91-day T-bill futures — cash settlement

Common mistakes & pitfalls

Going long to hedge a bond book against rising rates — you must go SHORT (bond prices fall when rates rise).
Computing contract value at par when the price is not 100 — use 2,000 × the actual trade price.
Thinking a short profits when the price rises — a short gains only when the price FALLS.
Assuming all interest-rate futures are physically settled — 91-day bill futures are cash-settled.

Frequently asked

To hedge a bond portfolio against rising interest rates, do I go long or short futures?

Short. Rising rates push bond prices down, so a short bond-futures position gains when your bonds lose — offsetting the loss. Going long would double the exposure.

How is the contract value of an interest-rate future computed?

Contract value = lot size × price. In India the lot is 2,000 (₹2 lakh face value), so value = 2,000 × the trade price quoted per ₹100 face. At a price of 99, one lot is worth ₹1,98,000.

What is open interest?

The total number of derivative contracts outstanding (not yet closed or settled) — a measure of how much money is committed to that contract.

Practice questions

Click each question to reveal the answer and explanation.

Q 1

What is the settlement method for 91-day bill futures?

(a)Cash
(b)Physical
(c)Can be cash or physical
(d)None of the above

Correct: (a) Cash

91-day Treasury-bill futures are cash-settled against the benchmark bill yield — there is no delivery of a physical bill.

Q 2

The total number of derivative contracts outstanding is called ____________.

(a)Long position
(b)Short position
(c)Open interest
(d)None of the above

Correct: (c) Open interest

Open interest is the count of outstanding (un-closed) contracts — a gauge of committed money. Long/short describe the direction of an individual position, not the market-wide total.

Q 3

A person goes short a futures contract at ₹100 and on expiry the underlying price is ₹101. The result is ____________.

(a)Profit of ₹1
(b)Loss of ₹1
(c)No profit, no loss
(d)None of the above

Correct: (b) Loss of ₹1

A short profits only when the price FALLS. Here the price rose from ₹100 to ₹101, so the short makes a loss of ₹1 per unit.

Q 4

A participant buys 10 lots of a bond future at ₹99 (lot size 2,000, price per ₹100 face). The contract value is ____________.

(a)₹20,00,000
(b)₹19,99,000
(c)₹19,80,000
(d)None of the above

Correct: (c) ₹19,80,000

Contract value = lot × price × lots = 2,000 × 99 × 10 = ₹19,80,000. At par (₹100) it would be ₹20,00,000; the below-par price of ₹99 gives ₹19,80,000.

Educational purposes only. The numbers, returns, and examples used in this lesson are illustrative. Past performance does not guarantee future results. Mutual fund and securities investments are subject to market risks. This lesson is not investment advice; for advice tailored to your circumstances, consult a SEBI-registered Investment Adviser. Read our full disclaimer.