An interest rate derivative is a derivative where the underlying asset is the right to pay or receive a notional amount of money at a given interest rate. These structures are popular for investors with customized cash flow needs or specific views on the interest rate movements (such as volatility movements or simple directional movements) and are therefore usually traded Over The Counter (OTC).
The interest rate derivatives market is the largest derivatives market in the world. The Bank for International Settlements estimates that the notional amounts outstanding in June 2009 were US$437 trillion for OTC interest rate contracts, and US$342 trillion for OTC interest rate swaps. According to the International Swaps and Derivatives Association, 80% of the world's top 500 companies as of April 2003 used interest rate derivatives to control their cash flows. This compares with 75% for foreign exchange options, 25% for commodity options and 10% for stock options.
Modeling of interest rate derivatives is usually done on a time-dependent multi-dimensional Lattice ("tree") built for the underlying risk drivers, usually domestic or foreign short rates and foreign exchange market rates, and incorporating delivery- and day count conventions. Specialized models are also often used. The trading in Interest Rate Futures was launched on the National Stock Exchange of India (NSE) on 31st August 2009 and will be launched shortly on MCX Stock Exchange (MCX-SX). PASSION GROUP has membership of both these exchanges to offer interest rate derivatives product to its customers through Exchange Traded Interest Rate Futures (ETIRF) which are standardized interest rate contracts traded on the exchange.
The benefits of Interest rate derivatives are as under:
• FIIs and NRIs are permitted to trade in ETIRF
• Provides flexibility of multiple securities deliveries for one contract
• Provides flexibility of timing for securities deliveries
• Provides flexibility between square-up and delivery settlement of position.