What does interest rate futures mean?
What Is an Interest Rate Future? The contract is an agreement between the buyer and seller for the future delivery of any interest-bearing asset. The interest rate futures contract allows the buyer and seller to lock in the price of the interest-bearing asset for a future date.
What is interest rate futures with example?
An interest rate futures contract is a futures contract, based on an underlying financial instrument that pays interest. It is used to hedge against adverse changes in interest rates. The pricing for futures contracts starts at a baseline figure of 100, and declines based on the implied interest rate in a contract.
How do you value interest rates in the future?
Long term futures have a maturity period of more than one year. Pricing for these futures is derived by a simple formula: 100 – the implied interest rate. So a futures price of 96 means that the implied interest rate for the security is 4 percent.
What is an interest rate future how can they be used to reduce interest rate risk by a borrower?
Interest rate futures are used to hedge against the risk that interest rates will move in an adverse direction, causing a cost to the company. For example, borrowers face the risk of interest rates rising.
How is interest risk managed?
Interest rate risk can be managed through the mix of loans and deposits, although this can result in either too much risk on the balance sheet, or place the bank at a competitive disadvantage if it is reluctant to offer long-term fixed-rate financing.
What is interest rate risk for banks?
Interest rate risk in the banking book (IRRBB) refers to the current or prospective risk to the bank’s capital and earnings arising from adverse movements in interest rates that affect the bank’s banking book positions.
What are the types of interest rate risk?
#1 – Duration Risk – It refers to the risk arising from the probability of unwilling pre-payment or extension of the investment beyond the pre-determined time period. #2 – Basis Risk – It refers to the risk of not experiencing the exact opposite behavior to interest rate changes in the securities with inverse features.