Interest-Rate Derivative.
What is an 'Interest-Rate Derivative'
An interest-rate derivative is a financial instrument with a value that increases and decreases based on movements in interest rates; among the most common are interest rate swaps, caps and floors. Interest-rate derivatives are often used as hedges by institutional investors, banks, companies and individuals to protect themselves against changes in market interest rates, but they can also be used to increase or refine the holder's risk profile.
BREAKING DOWN 'Interest-Rate Derivative'
Interest Rate Swap.
A plain vanilla interest rate swap is the most basic and common type of interest-rate derivative. There are two parties to a swap: party one receives a stream of interest payments based on a floating interest rate and pays a stream of interest payments based on a fixed rate. Party two receives a stream of fixed interest rate payments and pays a stream of floating rate payments. Both payment streams are based on the same notional principal, and the interest payments are netted. Through this exchange of cash flows, the two parties aim to reduce uncertainty and the threat of loss from changes in market interest rates.
A swap can also be used to increase an individual or institution's risk profile, if they choose to receive the fixed rate and pay floating. This strategy is most common with companies with a credit rating that allows them to issue bonds at a low fixed rate but prefer to swap to a floating rate to take advantage of market movements.
Caps and Floors.
A company with a floating rate loan that does not want to swap to a fixed rate but does want some protection can buy an interest rate cap. The cap is set at the top rate that the borrower wishes to pay; if the market moves above that level, the owner of the cap receives periodic payments based on the difference between the cap and the market rate. The premium, which is the cost of the cap, is based on how high the protection level is above the then-current market, the interest rate futures curve and the maturity of the cap; longer periods cost more as there is a higher chance that it will be in the money.
A company receiving a stream of floating rate payments can buy a floor to protect against declining rates. Like a cap, the price depends on the protection level and maturity.
Selling, rather than buying the cap or floor, increases rate risk.
Other Instruments.
Less common interest-rate derivatives include eurostrips, which are a strip of futures on the eurocurrency deposit market; swaptions, which give the holder the right but not the obligation to enter into a swap if a given rate level is reached; and interest rate call options, which give the holder the right to receive a stream of payments based on a floating rate and then to make payments based on a fixed rate.
Interest Rates Products.
CME Group’s Interest Rate products span the entire U. S. dollar-denominated yield curve including futures and options on the most widely followed U. S. Interest Rate benchmarks: Eurodollars, U. S. Treasury Securities, 30-Day Fed Funds, and Interest Rate Swaps.
We provide customers around the world with safe, efficient means for managing interest rate risk.
All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds.
All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds.
All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds.
All market data contained within the CME Group website should be considered as a reference only and should not be used as validation against, nor as a complement to, real-time market data feeds.
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CME Group is the world's leading and most diverse derivatives marketplace. The company is comprised of four Designated Contract Markets (DCMs). Further information on each exchange's rules and product listings can be found by clicking on the links to CME, CBOT, NYMEX and COMEX.
Interest Rate Derivatives: Fixed Income Futures.
Thu, 26/05/2005 - 07:13.
Interest Rate Derivatives - Fixed Income Futures: The latest in series of product guides from Eurex.
Eurex's fixed income derivatives are the benchmark for the European yield curve and often serve as a standard reference when comparing, evaluating, and hedging interest rates in Europe.
In addition to hedging pure duration risk of euro-denominated portfolios, the Euro-Bund, Euro-Bobl and Euro-Schatz Futures allow investors to enter positions based on interest rate movements. Investors are able to use these products to take relative value positions between different maturity ranges or market segments as well as to arbitrage between the cash and futures markets.
For these purposes, Eurex provides the fixed income market with the most liquid marketplace for interest rate derivatives in the world.
Contract Specifications - Fixed Income Futures.
Euro-Bund Futures are based on a notional long-term debt instrument with a term of 8.5 to 10.5 years, Euro-Bobl Futures are based on a notional medium-term debt with a term of 4.5 to 5.5 years, and Euro-Schatz Futures are based on a notional short-term debt instrument with a term of 1.75 to 2.25 years. All of the aforementioned futures bear a notional coupon rate of six percent and are based on debt instruments issued by the Federal Republic of Germany. Euro-Bund as well as Euro-Bobl Futures have contract values of EUR 100,000 and minimum price changes of 0.01 percent - equivalent to a value of EUR 10. Euro-Schatz Futures have a contract value of EUR 100,000 and a minimum price change of 0.005 percent - equivalent to a value of EUR 5.
There are contracts available for the three succes-sive quarterly months within the March, June, September and December cycle. The Delivery Date is the tenth calendar day of the respective quarterly month, if this day is an exchange trading day; other-wise the following trading day. The Last Trading Day lies two exchange trading days prior to the Delivery Day of the relevant delivery month. Trading hours of the fixed income futures are from 08:00 to 19:00 CET. On the Last Trading Day, trading in the maturing delivery month ceases at 12:30 CET.
Traded Contracts & Open Interest.
Eurex's Euro-Bund (FGBL), Euro-Bobl (FGBM) and Euro-Schatz (FGBS) Futures are the world's most heavily traded fixed income futures. The most actively traded product amongst them, the Euro-Bund Future, had a daily average volume of approximately one million contracts during 2004. Open interest for the Euro-Bund Future at the end of 2004 was approximately 1,200,000 - an increase of four percent compared to 2003. Trading volume in the Euro-Schatz Future has increased by five percent during 2004, rising to 123 million contracts. Likewise, open interest rose by 20 percent in comparison to 2003.
The total volume of the Euro-Bund, Euro-Bobl and Euro-Schatz Futures contracts has risen sharply in recent years. In 2004, approximately 240 million Euro-Bund Futures, 159 million Euro-Bobl Futures and 123 million Euro-Schatz Futures contracts were traded at Eurex. Combined open interest stood at 2,645,253 at the end of December 2004.
Eurx offers significant liquidity of these futures in terms of average trade size, bid/offer size and market depth. The average number of contracts per trade as well as the tradable sizes (bid/offer) for Euro-Bobl and Euro-Schatz Futures are larger in comparison to Euro-Bund Futures, which feature a higher sensitivity to interest rate changes.
Euro-Bund Futures, however, are the dominant contracts as they generate the largest number of trades and the highest turnover. In comparison with Global Fixed Income Products During 2004, the Euro-Bund Futures contract accounted for more than 51 percent of trading in the global long-term segment with 240 million contracts traded. During the same period, 196 million 10 Year U. S. Treasury Note Futures, 14 million Long Gilt Futures and 8 million Japanese Government Bonds were traded.
For more detailed information on the Euro-Bund, Euro-Bobl and Euro-Schatz Futures, including contract specifications and margin rates, please refer to the Eurex website at eurexchange.
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