In the beginning, it can be difficult to grasp interest rate futures for the simple fact that it is traded in the present for future delivery. These futures are traded in contract form for future delivery of interest bearing securities; which is considered to be a debt instrument. Many speculators and those who hedge use this instrument to buy and sell these contracts for delivery in the near future.

These futures consist of the following securities:

Eurodollar deposits
• 10 year agency notes
• 10 year Muni note Index
• 30 day federal funds

Selected foreign government bonds:
• Treasury bills
• Treasury bonds
• Treasury notes

Interest rates fluctuate and these changes in fluctuation can have a direct affect on bond prices.

In an attempt to get returns speculators and or traders will buy and sell the contracts on interest rate futures based on how they project the direction rates will go in the future. Clients that have an exorbitant amount of bonds in their portfolio may want to try to protect themselves against losses. Changes in interest rates can directly hinder ones portfolio. This would be considered a hedging tool. There is significant risk of loss in all futures and options trading.

An example of someone who feels interest rates may decline in the future

A trader or investor that feels rates may decline might consider buying a long position in treasury bonds. If interest rates plunge the treasuries would be likely to rise and the contact would have increased in value. The owner of treasuries can sell the contract for a profit in this case. If the trader or investor guesses wrong and interest rates rise a substantial loss can occur because treasury bond prices would likely fall decreasing the bond futures contract.

An example of someone who feels interest rates may increase in the near future

This would be the opposite of the example above but is very important to discuss. A trader or investor who feels interest rates will rise would sell short treasury bond contract. Hopefully in this case rates increased and treasury bond futures fell. By buying the contract back closing out the position the client would have realized a profit. (A short position has to be covered in order to see a return).

By selling short treasury bonds and bond indexes futures one may try to reduce the risk of losing money in their portfolio. Those who are retired and have bond portfolios made up of municipal bonds many times think they are safe from market fluctuations. These people tend to live off the interest of their bonds, many times not realizing that interest rates directly affect their portfolios. There is a substantial risk of loss in futures and options trading.

Educating yourself on the ins and outs of the futures markets may help one make proper decisions in the bond market. Click here to register for a free report from an institutional bond trader about interest rates and futures! Tips from an Institutional Bond Trader