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In the context of financial trading, interest rates trading refers to the trading of an interest rate derivative (IRD). While there are many derivative instruments available for trading in the financial markets today, the IRD market actually comprises of the largest segment of the overall derivative market. It has been estimated by the Bank for International Settlements that the outstanding IRD contracts value for 2012/13 amounted to US$494 trillion. Interest rate swaps for the same financial year accounted for an additional US$342 trillion. The International Swaps and Derivatives Association also mentioned that since 2003, more than 50% of the top 500 companies in the world use IRD to manage their cash flows.show more
IRDs were first introduced in 1975 by the Chicago Board of Trade (CBOT) when CBOT launched its GNMA contract. Hence, it is hardly surprising to find CBOT’s IRDs as being the most actively traded futures around the world. The fact that CBOT’s IRDs are based on debt instruments issued by the U.S Government has earned CBOT’s IRDs a reputation as being a safe investment. The list of products covered consists of U.S. Treasury Bills, municipal bonds, mortgage-backed securities, Eurocurrency deposits federal funds, bankers’ acceptances, certificates of deposit and commercial papers.
As mentioned earlier, most IRDs are based on underlying assets that are essentially a debt instrument. The IRD contracts, or more precisely interest rates’ futures are tied to a certain percentage value of the underlying debt instrument. As the value of the debt instrument is linked to the prevailing interest rate, the value of the futures contract will also be affected by any changes in the interest rate. For example, a two basis point change in the prevailing interest rate will also produce a corresponding price change in the futures contract.
As government issued debt instruments are deemed as safe investments, they are highly liquid as well making it easy for investors to enter and exit a market position fairly quickly. In fact, interest rate related financial securities such as Treasury bonds has often being used to hedge against a drop in value of investment portfolios as well as to lock in their future purchase price.
Interest Rates Charts
Depending on your trading objectives, IRDs can be traded for the short term duration or for the long term duration. For example, the Chicago Mercantile Exchange (CME) uses IRDs to manage interest rate risks up to as long as a decade forward. On the other hand, short-term interest rates related instruments are also heavily traded on the CME.
Hence the timeframe of the interest rates charts that you will use hinge heavily on the type of debt instrument that you are tracking. For example, if you are trading the performance of U.S treasury bills which have a maturity rate of less than a year, the time frame used will be based on days, weeks and months. On the contrary if you are tracking the performance of U.S treasury notes which have an expiry date that can range from one year to 10 years, the time frame for your chart will be more on a longer term.