Derivatives: Markets, Valuation, and Risk Management

CHAPTER 17

Interest Rate Products: Futures and Options

Interest rate derivative contracts seem less in the spotlight than are derivatives on stocks and stock indexes. One reason is that the markets for bonds are less active than the market for stocks. Do not be misled, however. The bond markets in the United States are, in fact, larger than stock markets. Of the $34.34 trillion in market value of stocks and bonds outstanding in the United States at the end of 2003, about 56% was bonds. It should not be surprising, therefore, that interest rate risk management is a primary concern for corporations, agencies, municipalities, and governments. Indeed, more than two-thirds of all OTC derivatives traded worldwide are written on interest rate instruments.

The first interest rate derivative contract on an exchange appeared 30 years ago, when the CBT introduced futures contracts on GNMA pass-through certificates. Futures contracts on U.S. Treasury bonds, notes, and bills quickly followed. Options on interest rate instruments were launched in late 1982. Even though many of these markets have become incredibly active by exchange standards, the greatest success story is the OTC interest rate swap market. The first interest rate swap was consummated in 1981. Today, about 20 years later, interest rate swaps account for more than half the notional amount of all derivatives outstanding worldwide. The interest rate products discussion is divided into two chapters. This chapter focuses on futures ...