NSE to launch IRFs today

The National Stock Exchange (NSE) is all set to launch interest rate futures (IRFs) tomorrow. The launch would elevate the country’s financial markets into the big league, making it possible for investors, traders, banks and business class to hedge their interest rate risks.

Initially, the segment would be available only on NSE, as the other two exchanges, the Bombay Stock Exchange (BSE) and MCX SX would take time to launch the trading in this segment. While BSE has been granted permission for IRFs by the Securities and Exchange Board of India (Sebi) and has announced that the segment would be launched in a couple of months, MCX SX is awaiting permission from the regulator.

IRFs are known to be a complex products for retail and small investors but it generates nearly 20 per cent volume in the derivative financial market around the world. Large banks, mutual funds and institutions use it to hedge their investment and loan risks.

The concept of IRFs is like any other derivative product, except for the underlying — which is 10-year notional coupon bearing government security. This underlying security is assumed to pay interest (called a coupon) at a rate compounded at 7 per cent on a half-yearly basis.

How can you make use of this instrument?
If one has invested Rs 3 lakh in an infrastructure bond and the central banks lowers the repo and reverse repo rates, the floating benchmark in this case will lead to an interest rate decline, which would also mean a decline in your assets. However, in such a scenario one can hedge this risk with the use of IRFs, by taking long position in the segment.

When the interest rate declines, the yield rates of the bonds would also decline resulting in corresponding price of a bond to increase. So, when the bond future prices go up your long position can help you hedge your risk. Bond prices decrease with an increase in interest rates.

The contracts to be settled on delivery basis would be through any one of the 19 different government securities for a contract. The daily settlement would be done on a daily mark-to-market mechanism basis.

The size of the contract would be Rs 2 lakh and there would be four contracts ending in March, June, September and December. The last trading day would be the seventh business day prior to the last one of the delivery month.