Financial Futures and Interest-rates

Financial futures have been a growing segment of the futures market. Financial futures contracts are obligations to buy or sell positions in financial securities.

Financial futures are negotiated in Treasury bonds, Treasury notes, Treasury bills, S&P 500 Index, mini S&P 500 Index, Dow Jones Industrial Average, British pound, Euro currency and Japanese yen.

Financial futures contracts include negotiating an interest-rate futures, index futures and currency trading futures.

Interest-rate futures
Interest-rate futures are contracts of the future delivery of interest-bearing securities (debt). Interest-rate futures allow speculators and hedgers to buuy and sell these contracts through the locking prices of these securities for future delivery.

Interest-rate futures include the following securities:

  • Treasury bonds
  • Treasury notes
  • Treasury bills
  • 10-year agency notes
  • 10-year Muni note Index
  • 30-day federal funds
  • Eurodollar deposits
  • Selected foreign government bonds

Changes in interest rates affect bond prices. Speculators buy or sell interest-rate futures based on their future projections about which direction will the future interest-rates take in an attempt to get greater returns.

Investors with large bond portfolios can reduce their loss risk due to the changes in the rates of interest by hedging their positions using interest-rate futures. Let?s pretend that a speculator is expecting interest rates to decline in the near future. The speculator would take a long position by buying a futures contract for delivery of Treasury bonds. If rates of interest fall, the price of Treasury bonds would go up, and the value of Treasury bonds futures contract would also be increased. The speculator then can benefit from the sales of Treasury bond futures contract at a higher price.

But, if rates of interest raise, the speculator will lose money., because Treasury bond prices would fall resulting in a decline in the price of bond futures contract.

The opposite occurs when the speculator is able to anticipate a raise in interest rates. The speculator would sell in short Treasury bond futures contract, and if the rates of interest increase the value of Treasury bond futures contract will fall. Then the speculator would buy the return of the contract at a normal price, closing out his position with a profit for him.

The bond portfolios managers and individuals with large bond portfolios can hedge against raises in interest rates by selling short Treasury bonds and other bond Index futures that resemble the markup of the kind of bonds that are in the portfolio. The difference between speculators and hedgers is that the hedgers are really the owners of the financial securities and negotiate with them.