How do interest rate futures work? (2024)

How do interest rate futures work?

Interest rate futures are a financial derivative that allows exposure to changes in interest rates. Interest rate futures prices move inversely to interest rates. Investors can speculate on the direction of interest rates with interest rate futures or use the contracts to hedge against rate changes.

What happens to futures when interest rates rise?

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).

How are interest rate futures calculated?

IMM Index = Futures Price = 100.00 – Interest Rate. so that if the yield is 6 percent, the futures price is IMM Index – 100.00 – 6.0 = 93.00. so when the yield is 6.09 percent, the futures price is IMM Index = 100.00 – 6.09 -- 92.91. The price of the futures contract is 92.91 points or 9,291 basis points.

How do banks use interest rate futures?

Interest rate futures enable banks to manage the risk of fluctuating interest rates — so they can loan money to businesses in your community and to people like you.

When should you buy or sell interest rate futures?

If interest rates rise, futures prices will fall, so sell futures contracts now (at the relatively high price) and buy later (at the lower price). The gain on futures can be used to offset the lower interest earned.

What are the pros and cons of interest rate futures?

The most prevalent benefits include simple pricing, high liquidity, and risk hedging. The primary disadvantages are having no influence over future events, price swings, and the possibility of asset price declines as the expiration date approaches.

What are the disadvantages of interest rate futures?

The major disadvantages include no control over future events, price fluctuations, and the potential reduction in asset prices as the expiration date approaches.

What is the difference between interest rate futures and forward rates?

The simplest kinds of interest rate derivatives are futures and forward rate agreements (FRAs). These two types of contracts are essentially identical; one major difference is that a futures contract is an exchange-traded contract and has fixed terms for the notional amount, length of contract, expiry date etc.

What is the most actively traded interest rate futures contract?

Traded on the Chicago Board of Trade (CBOT), this futures contract is used to speculate on the direction of interest rates. Eurodollar – The first futures contract to feature cash settlement, the Eurodollar is the most actively traded futures contract making it a highly liquid market.

What causes futures to go up?

New information about changes in supply and demand causes the prices of futures contracts to fluctuate, sometimes moving them up and down many times in a trading day. For example, news of drought or blight that may reduce the corn harvest, cutting future supplies, causes corn futures contracts to rise in price.

What is an interest rate derivative for dummies?

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 or to speculate on rate moves.

What is the relationship between futures price and interest rate?

(i) If futures prices are positively correlated with interest rates then futures prices will exceed forward prices. (ii) If futures prices are negatively correlated with interest rates, then futures prices will be lower than forward prices.

What are the benefits of interest rate futures?

Is it better to sell when interest rates are high?

Rising mortgage interest rates often mean a smaller pool of buyers who can afford the price you want. Selling a home isn't free, so if you can't maximize your price, you might want to wait. If you recently refinanced your mortgage, it may not make financial sense to sell just yet.

Is it a good time to buy when interest rates are high?

The Bottom Line

No one likes it when interest rates go up, but it's not the end of the world. This is still a great time to buy a house—you'll just pay more than you would've a couple years ago. It's also a good time to sell a house. And if you already have a fixed-rate mortgage locked in, you're in good shape too.

Why futures are better than stocks?

One of the most substantial benefits of trading futures vs. stocks is the tax advantages. All stock trading profits where the stock is held for less than 1 year are taxed at 100% short-term gains, whereas all futures trading profits are taxed using a 60/40 rule.

Why is investing in futures risky?

One of the chief risks associated with futures trading comes from the inherent feature of leverage. Lack of respect for leverage and the risks associated with it is often the most common cause for losses in futures trading.

Why futures are better than cash?

Short-term traders will generally prefer cash vs futures due to the lower spreads, while long-term traders may opt for futures CFDs instead, as they are less sensitive to the spread, but prefer not to pay daily swap charges.

What is the prediction for interest rates in 2024?

Mortgage rate predictions 2024

The MBA's forecast suggests that 30-year mortgage rates will fall into the 6.1% to 6.9% range in 2024, and NAR's forecast is very similar, predicting that rates will remain in the 6.1% to 6.8% range.

Where are interest rates going in the next 5 years?

Projected Interest Rates in the Next Five Years

ING's interest rate predictions indicate 2024 rates starting at 4%, with subsequent cuts to 3.75% in the second quarter. Then, 3.5% in the third, and 3.25% in the final quarter of 2024. In 2025, ING predicts a further decline to 3%.

How are futures risky?

You may end up buying the wrong contract or you may end up buying the wrong expiry. You may place a market order and the actual execution may take place much worse than your intended price. All these are routine risks. Then there are market-level fat-finger risks.

Are futures cheaper than forwards?

If futures prices are positively correlated with interest rates, then futures prices will exceed forward prices. If futures prices are negatively correlated with interest rates, then futures prices will be lower than forward prices.

Why are futures contracts more successful than interest rate forward contracts?

Forward contracts have higher counterparty risk, while futures contracts use exchange clearinghouses to mitigate this risk. Liquidity is generally higher in futures markets due to their exchange-traded nature, whereas forward markets may lack liquidity for certain contracts.

Do futures or forwards have more credit risk?

Initial margin

Futures contracts require a margin payment in advance by both parties. That ensures that both buyer and seller are make a financial commitment towards the contract, which brings down the risk of default. A Forward contract requires no such initial margin, and credit risk remains high as a result.

What is the most liquid futures market?

Crude oil leads the pack as the most liquid commodity futures market followed by corn and natural gas. Agricultural futures tend to generate the highest volume during periods of low stress in the energy pits, while gold futures have gone through boom and bust cycles that greatly impact open interest.