What is meant by interest rate derivatives?
Table of Contents
An interest rate derivative is a financial contract whose value is based on some underlying interest rate or interest-bearing asset. These may include interest rate futures, options, swaps, swaptions, and FRA’s.
Is interest rate swap a derivative?
An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another, over a set period of time. Swaps are derivative contracts and trade over-the-counter.
What is an interest rate futures contract?
An interest rate future is a futures contract with an underlying instrument that pays interest. The contract is an agreement between the buyer and seller for the future delivery of any interest-bearing asset.
How many types of interest rate derivatives are there?
Interest rate derivatives are often called IRDs and are subclassified into essentially two types: linear and non-linear.
What is the difference between a swap and a derivative?
Derivatives are a contract between two or more parties with a value based on an underlying asset. Swaps are a type of derivative with a value based on cash flow, as opposed to a specific asset.
What is interest rate futures with example?
An interest rate future is a financial derivative (a futures contract) with an interest-bearing instrument as the underlying asset. It is a particular type of interest rate derivative. Examples include Treasury-bill futures, Treasury-bond futures and Eurodollar futures.
How do you hedge interest rate futures?
The approach used with futures to hedge interest rates depends on two parallel transactions:
- Borrow/deposit at the market rates.
- Buy and sell futures in such a way that any gain that the profit or loss on the futures deals compensates for the loss or gain on the interest payments.
How are derivatives priced?
Derivatives are priced by creating a risk-free combination of the underlying and a derivative, leading to a unique derivative price that eliminates any possibility of arbitrage.