NISM Series V-D · Unit 11 of 12 · about 11% of the paper
Interest rate futures and options: NISM Series V-D notes and practice questions
How exchange-traded interest rate futures and options are built, priced and settled.
What to know in Unit 11
- Notional bond and T-bill futures.
- PV01 and hedge ratio.
- Interest rate options.
Key terms, examples and exam traps
Interest rate futures
An interest rate future is an exchange-traded contract on an underlying interest rate instrument, such as a government security or T-bill.
Example. A fund buys a G-Sec future on the exchange.
Exam trap. This statement is false: Interest rate futures trade only over the counter.
Notional underlying
Interest rate futures on bonds use a notional security, so settlement is in cash and no actual bond is delivered.
Example. A contract settles in cash against a notional bond.
Exam trap. This statement is false: The seller must deliver a bond at expiry.
Price and yield
The futures price moves inversely to yield, so a rise in yields lowers the futures price.
Example. A long position loses if yields rise.
Exam trap. This statement is false: A long position gains when yields rise.
Long and short IRF
A long position gains when yields fall and a short position gains when yields rise.
Example. A bond fund sells futures to hedge against a rate rise.
Exam trap. This statement is false: A short position gains when yields fall.
PV01
PV01 is the change in the value of a position for a one basis point change in yield.
Example. A position loses ₹5,000 for each 1 bp rise in yield.
Exam trap. This statement is false: PV01 is measured for a 1% change in price.
Basis point
One basis point is one hundredth of a percentage point, so 100 basis points equal 1%.
Example. A rise from 7.00% to 7.25% is 25 basis points.
Exam trap. This statement is false: One basis point equals one percent.
Hedge ratio
The hedge ratio gives the number of futures contracts needed to offset the portfolio's interest rate sensitivity, using the PV01 of the portfolio and the future.
Example. A fund divides its portfolio PV01 by the future's PV01.
Exam trap. This statement is false: The hedge ratio is the portfolio's credit rating.
T-bill futures
A T-bill future is based on a short-term treasury bill and can be used to hedge short-term rates.
Example. A short-term fund hedges using T-bill futures.
Exam trap. This statement is false: T-bill futures are based on long-term bonds.
Mark-to-market in IRF
Interest rate futures are marked to market daily like other futures, with gains and losses settled through margin.
Example. A day's yield rise is settled in the margin account.
Exam trap. This statement is false: Interest rate futures are settled only at expiry.
Interest rate options
An interest rate option gives the buyer the right, not the obligation, to buy or sell the underlying interest rate instrument at a strike.
Example. A buyer pays premium to protect against a yield rise.
Exam trap. This statement is false: An interest rate option obliges the buyer to transact.
Basis risk in IRF
Hedging with futures leaves basis risk because the portfolio and the contract do not move together perfectly.
Example. A hedge does not offset all loss because bonds differ.
Exam trap. This statement is false: A futures hedge removes every kind of risk.
Who uses IRDs
Banks, mutual funds, insurers and corporates use interest rate derivatives to manage rate risk.
Example. A debt fund manager uses futures to manage duration.
Exam trap. This statement is false: Interest rate derivatives are only for speculators.
6 practice questions
Read each question and choose your answer before opening the free mock, which shows the correct answer and the reason.
Q1. Which statement best describes “T-bill futures”?
- Accredited investors are exempt from the ₹10 lakh minimum investment.
- An interest rate future is an exchange-traded contract on an underlying interest rate instrument, such as a government security or T-bill.
- The strike is the fixed price at which the option holder can buy or sell the underlying.
- A T-bill future is based on a short-term treasury bill and can be used to hedge short-term rates.
Q2. Which term is described here? An interest rate option gives the buyer the right, not the obligation, to buy or sell the underlying interest rate instrument at a strike.
- Interest rate options
- Exit load
- New fund offer
- Mutual fund
Q3. Which statement best describes “Long and short IRF”?
- A long position gains when yields fall and a short position gains when yields rise.
- Beta measures a fund's sensitivity to the market, where 1.2 means a move 20% larger than the market.
- A forward is a customised OTC agreement to buy or sell an asset at a fixed price on a future date.
- The profit on a long futures trade is the exit price minus entry price multiplied by lot size and lots.
Q4. Which term is described here? The futures price moves inversely to yield, so a rise in yields lowers the futures price.
- PV01
- SEBI as regulator
- Price and yield
- Derivative
Q5. Which statement best describes “Interest rate futures”?
- Accredited investors are exempt from the ₹10 lakh minimum investment.
- Futures positions are marked to market daily, with gains and losses settled each day through the margin account.
- An interest rate future is an exchange-traded contract on an underlying interest rate instrument, such as a government security or T-bill.
- Cumulative gross exposure across cash and derivatives must not exceed 100% of net assets.
Q6. Which term is described here? The hedge ratio gives the number of futures contracts needed to offset the portfolio's interest rate sensitivity, using the PV01 of the portfolio and the future.
- Accredited investors
- Hedge ratio
- Specialized Investment Fund
- Cut-off time
Frequently asked questions
How much of NISM Series V-D comes from Unit 11?
Unit 11 (Interest rate futures and options) usually carries about 11% of the questions. The whole exam has 150 questions and the pass mark is 60%.
What should I study in NISM Series V-D Unit 11?
Notional bond and T-bill futures. PV01 and hedge ratio. Interest rate options.
Are these NISM Series V-D practice questions free?
Yes. Take the full free mocks to see the correct answer and the reason for every question.
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