Islamic Capital Markets: Theory and Practice

Chapter 10

Interest-Rate Futures Markets and Applications to Sukuks

Futures contracts are extremely useful for speculating on the direction of rates and for hedging against interest rate risk. This usefulness stems from the great liquidity of many interest rate futures contracts relative to that of the individual assets and from the very small amount of capital needed to establish a futures position relative to a spot position of equivalent size.

Investing in sukuks faces a yield rate risk. Sukuk issuers face the risk of an increase in yield rates; in contrast, sukuk investors face the risk of a drop in yield rates. Interest rate futures are efficient and inexpensive instruments for sukuk portfolio management. Sukuk managers can use interest rate futures to lock yield rates, alter the yield rate sensitivity—that is, duration—of a portfolio, and cross-hedge a sukuk portfolio. Managers who have strong expectations about the direction of the future course of yield rates may adjust the duration of their portfolio so as to capitalize on their expectations. If yield rates are expected to rise, sukuk managers may shorten portfolio duration through selling futures contracts; in contrast, if yield rates are expected to fall, sukuk managers may increase portfolio duration through buying futures contracts. A sukuk manager may use interest rate futures contracts in portfolio immunization over a planning horizon and in bank immunization, which consists of equalizing the durations of assets ...