An interest rate futures contract is a standardized agreement between two parties that arrange for the delivery of a certain amount of an interest-bearing asset (such as a bond or other debt instruments) for a certain price at a certain date.
These type of derivatives allow financial entities to devise a great variety of risk hedging strategies. For example, a bank might protect its fixed income portfolio from capital losses due to rising interest rates, as well as lock in rates for either future investments or debt issuances. Given the high leverage associated with futures, they also represent a valuable tool for speculators looking to profit from volatility on interest rates.
Trading on interest rate futures as we know it today is a relatively recent practice, although there has been reports of derivatives trading on government bonds as far as the 19th century.1 The first standardized contracts on US dollar-denominated debt instruments (such as US treasury notes) appeared during the 1970’s in the Chicago-based derivatives exchanges (Chicago Mercantile Exchange and Chicago Board of Trade).
Trading volume in such assets would be relatively low until the 1980’s, when interest rates acquired higher volatility as a result of the Federal Reserve’s monetary policy. Eurodollar futures, which are presently the most traded interest rate futures contract, were not introduced until 1981. Ever since, these derivatives would progressively spread into the main European and Asian financial hubs.2
According to information gathered by the Futures Industry Association (FIA), trading in interest rate futures and options accounted for almost 14% of total volume (measured in contracts), with almost 2,271 million units traded. The following chart shows the evolution of trading volume for different asset classes throughout the past decade, displaying a sensible drop in the rate of participation of interest rate derivatives.
However, such comparison does not paint a full picture as to the relevance of interest rate futures, given the size of these contracts. For example, Chicago Mercantile Exchange Eurodollar futures contract have a size of USD 1,000,000, whereas futures on US Treasury notes with a maturity of more than 2 years trade on a USD 100,000 basis. In contrast, products such as Chicago Board of Trade grain futures have a size of 5,000 bushels per contract, falling short of USD 50,000 in the best of scenarios. The next chart shows the ranking of the most traded interest rate futures worldwide.
Locally, trading on interest rate futures has been limited to the most liquid USD-denominated government bonds, which serve as underlying for ROFEX futures contracts. These bonds’ terms tend to be quite diverse, and they mostly have long maturities (upwards of 7 years). Lebac futures contracts represent a welcome alternative since they provide the opportunity to trade on short-dated peso-denominated debt.
1 See Weber, E.J. (2008) “A Short History of Derivative Security Markets”. Discussion paper 08.10. The University of Western Australia. Available at: http://www.rdi.uwa.edu.au/__data/assets/pdf_file/0003/94260/08_10_Weber.pdf
2 See Frankel, A.B. (1984) “Interest rate futures: an innovation in financial techniques for the management of risk”. BIS Economic Papers N° 12. Bank of International Settlements. Available at: http://www.bis.org/publ/econ12.pdf.