1
CONTENTS
CHAPTER 1: INTEREST RATES AND TIME VALUE OF MONEY.................................................4
1.1 I
NTRODUCTION
.........................................................................................................................41.2 F
ACTORS AFFECTING THELEVEL OF
I
NTEREST
R
ATE
......................................................................41.3 I
MPACT OF INTEREST RATES
.......................................................................................................51.4 C
LASSIFICATION OF
I
NTEREST
R
ATES
..........................................................................................61.5 P
RESENT
V
ALUE
,
F
UTURE
V
ALUE AND
D
ISCOUNT
F
ACTOR
.............................................................7
CHAPTER 2: MONEY AND FIXED INCOME MARKETS.............................................................11
2.1 M
ONEY
M
ARKETS
....................................................................................................................11
2.2 F
IXED
I
NCOME
M
ARKETS
.........................................................................................................14
2.2.1
Fixed Income Securities ...........................................................................................15
2.2.2
Participants in Fixed Income Markets......................................................................15
CHAPTER 3: GOVERNMENT BONDS...........................................................................................16
3.1 I
NTRODUCTION TO
B
ONDS
.......................................................................................................163.2 C
HARACTERISTICS OF
B
ONDS
...................................................................................................183.3 C
ONCEPT OF YIELD
..................................................................................................................183.4 R
ELATIONSHIP BETWEEN
B
OND
P
RICE AND
I
NTEREST
R
ATE
.........................................................20
3.4.1
Duration.....................................................................................................................20
3.4.2
PVBP...........................................................................................................................22
3.5 O
THER
B
OND
T
ERMINOLOGY
....................................................................................................22
3.5.1
Accrued Interest........................................................................................................22
3.5.2
Clean Price/Dirty Price..............................................................................................24
3.5.3
Cost of Carry.............................................................................................................24
3.6 R
EPO AND
C
OST OF
F
UNDING
...................................................................................................25
3.6.1
Repo Rate ..................................................................................................................26
3.6.2
Advantages of using repo.........................................................................................26
CHAPTER 4: INTEREST RATE DERIVATIVES............................................................................27
4.1 OTC
D
ERIVATIVES
..................................................................................................................27
4.1.1
Forwards ....................................................................................................................28
4.1.2
Interest rate swap.....................................................................................................28
4.2 E
XCHANGE
T
RADES
C
ONTRACTS
...............................................................................................29
4.2.1
Futures .......................................................................................................................30
4.2.2
Options.......................................................................................................................30
4.3
Key Terminology for Futures Market ............................................................................30
2
CHAPTER 5: INTEREST RATE FUTURES IN INDIA..................................................................32
5.1 I
NTEREST
R
ATE
F
UTURES
(IRF)...............................................................................................325.2 R
ATIONALE OF
IRF
S
...............................................................................................................335.3 IRF:
C
ONTRACT
S
PECIFICATIONS
.............................................................................................34
5.3.1
Product Features .......................................................................................................34
5.3.2 Trading Aspects..........................................................................................................35
5.3.3 Settlement Aspects ....................................................................................................35
5.4 S
ETTLEMENT AND
R
ISK
M
ANAGEMENT
.......................................................................................36
5.4.1
Margin Requirement.................................................................................................37
5.4.2
Position Limits ...........................................................................................................37
5.4.3
Settlement Methods..................................................................................................38
CHAPTER 6: AN EXPLANATION OF KEY CONCEPTS IN IRF.................................................40
6.1 W
HY A
N
OTIONAL
B
OND IS BEING USED AS
U
NDERLYING
............................................................406.2 C
ONVERSION
F
ACTOR
..............................................................................................................406.3 I
NVOICE
P
RICE
.......................................................................................................................416.4 C
HEAPEST TO DELIVER BOND
....................................................................................................416.5 B
OND
B
ASIS
..........................................................................................................................43
CHAPTER 7: APPLICATIONS AND TRADING OF INTEREST RATE FUTURES....................44
7.1 P
ARTICIPANTS IN THE
I
NTEREST
R
ATE
F
UTURES MARKET
.............................................................447.2 H
EDGING
A
PPLICATIONS OF
IR
D
ERIVATIVES
.............................................................................447.3 S
PECULATION STRATEGIES
.......................................................................................................45
7.3.1 Long Only Strategy ...................................................................................................45 7.3.2 View Based Trading..................................................................................................45
7.4 A
RBITRAGE STRATEGY
............................................................................................................46
1
REFERENCES............................................................................................................................50
2
APPENDIX I: IMPORTANT FORMULAE..............................................................................51
3
APPENDIX II: USEFUL EXCEL FUNCTIONS......................................................................53
4
APPENDIX III: GLOSSARY OF TERMINOLOGY................................................................54
MODEL TEST....................................................................................................................................57
3
Distribution of weights in theInterest Rate Derivatives: A Beginner’s Module CurriculumChapterNo.Title Weights (%)
1 Interest Rates and Time Value of Money 172 Money and Fixed Income Markets 103 Government Bonds 224 Interest Rate Derivatives 85 Interest Rate Futures in India 86 An Explanation of key concepts in IRF 187 Applications and Trading of Interest Rate Futures 17Note: Candidates are advised to refer to NSE’s website: www.nseindia.com, click on ‘NCFM’ link and then go to ‘Announcements’ link, regarding revisions/updations in NCFM modules orlaunch of new modules, if any.Copyright © 2009 by National Stock Exchange of India Ltd. (NSE)Exchange Plaza, Bandra Kurla Complex,Bandra (East), Mumbai 400 051 INDIAAll content included in this book, such as text, graphics, logos, images, data compilation etc.are the property of NSE. This book or any part thereof should not be copied, reproduced,duplicated, sold, resold or exploited for any commercial purposes. Furthermore, the book in itsentirety or any part cannot be stored in a retrieval system or transmitted in any form or by anymeans, electronic, mechanical, photocopying, recording or otherwise.
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