Chapter 4
Interest Rate Futures
Chapter 3 introduced bonds as the foundation product for the fixed income market. The bonds we considered are traded to be bought and sold immediately, in what is known as a spot transaction. However, this does not need to be the case. An agreement can be made to buy or sell a bond, or any other financial instrument, at a certain point in the future, known as a forward trade. For any tradable asset, the ability to trade the asset on a forward basis is one of the simplest modifications that can be made. This chapter considers the futures markets, which standardize the concept of forward products in order to enable more investors to participate and increase trading volume.
Trading a forward instrument entails buying or selling the underlying asset at a fixed date in the future at an initially agreed-on price. The buyer of a forward contract is obligated to receive the asset on the initially chosen forward date at the agreed-on price. Conversely, the seller is obligated to deliver the asset to the buyer. Since the price of the asset being delivered is fixed, the buyer of a forward contract benefits if the price of the asset rises while the seller benefits if the price declines. To make this concept concrete, consider the example of a farmer who plants corn in the spring and plans to sell it in the fall. The farmer could choose to avoid any transactions in the market at the moment and sell the corn at the prevailing price in the fall, but that would ...
