How do you read an interest rate for the future?
An interest rate future is a futures contract based on an asset paying interest. The contract is an agreement between the buyer and seller to give any asset that earns interest in the future.
The buyer and seller of an interest-rate futures contract can agree on a future date to lock in the price of an object that earns interest.
How to Understand Interest Rate Futures
Treasury bills are used as underlying instruments for Treasury bill futures traded on the CME, and Treasury bonds are used as underlying instruments for Treasury bond futures traded on the CBOT, which is a branch of the CME.12
You can also trade other things, like CDs, Treasury notes, and Ginnie Mae securities, as the base assets of an interest rate future. Bonds with terms of 30, 10, 5, 2, and 10 years and the eurodollar are the most traded interest rate futures.2
Example of Interest Rate Futures
Interest rate futures are based on the U.S. dollar, and interest rate futures are based on the euro. Most Treasury bonds are worth $100,000 when they are first issued. To put it another way, a Treasury-based interest rate futures contract is generally worth $100,000. There are 1,000 handles in a contract, but each handle is broken up into 32nds, which are $31.25 chunks ($1,000/32). If a contract quote says 101’25, or more often, 101-25, it means that the total price of the contract is the face value plus one handle and 25/32s of another handle.
101.25 Price = $100,000 plus $1,000 plus ($1,000 times 2532) = $101,781.25101.25 Price = $100,000 plus $1,000 plus ($1,000 times 3225) = $101,781.25
Eurodollar-based contracts can be worth up to $1 million, have a handle size of $2,500, and trade in $25 amounts. Unlike Treasury-based contracts, these contracts can trade at half-tick and quarter-tick prices. This means that a $1 million deal only needs the Price to change by $6.25, which is $25 times 25%.
When interest rates change, the price of an interest rate goes down in the future. The price of an interest rate future goes up when interest rates go down and down when interest rates go up. Investors might think that interest rates will decrease over the next month and bond prices will increase. 102’28 is the seller’s price for a 30-year Treasury bond futures contract. It had been a month, and the trader’s guess was correct. The future interest rate is now set at 104’05 because interest rates have decreased. When the seller sells, they make:
Price to buy: 102′28, which is $102,875; Price to sell: 104′05, which is $104,156.25; Profit: $1,281.25, or 1.25%Buy Price = 102’28, which is $102,875The sale price is 104.05. That’s 104,156.25 dollars.Earnings: $1,281.25, or 1.25%
Unique Things to Think About
People speculate on interest rate futures, which are also used to protect bond investments or interest rates. Speculators can bet on the way rates change with interest rate futures. Hedgers can also use them to lessen the impact of an alarming bond price and rate change.
One person who will lose money if interest rates go up is someone who has a loan with a changeable rate. So, the borrower could sell (short) an interest rate future that will go down if rates go up. The gains from the short futures contract can help cover the higher loan cost.
Conclusion
- An interest rate future is a type of derivative financial instrument that lets you bet on changes in interest rates.
- The Price of interest rate futures goes down when interest rates go up.
- You can bet on the direction of interest rates with interest rate futures or use the contracts to protect yourself against rate changes.
- U.S. Treasury assets back up most interest-rate futures that trade on American exchanges.
