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SEBI to allow interest rate futures-based ETFs early '09

The Securities & Exchange Board of India (SEBI) plans to allow exchange traded funds (ETFs) based on interest rate futures (IRF) in early 2009, according to TC Nair, whole-time member, SEBI.

This instrument would help banks, financial institutions and FIIs hedge themselves against sharp adverse moves in interest rates. Mr Nair was speaking at an Assocham event. “SEBI would shortly permit FIIs to trade in currency futures once the market gets stabilised,” Mr Nair added. He also said applications for registration of 22- 25 foreign institutional investors (FIIs) was pending with the regulator and would be cleared shortly.

Interest rate futures are typical futures contracts where the holder agrees to take delivery of a given amount of the related debt security at a later date (usually no more than three years). Futures may be in treasury bills and notes, certificates of deposit, commercial paper, or any other interest-bearing certificates.

Interest rate futures are stated as a percentage of the par value of the applicable debt security. The value of interest rate futures contracts is directly tied to interest rates. For example, as interest rates decrease, the value of the contract increases. As the price or quote of the contract goes up, the purchaser of the contract gains, while the seller loses.

A change of one basis point in interest rates causes a price change. Those who trade in interest rate futures do not usually take possession of the financial instrument. In essence, the contract is used either to hedge or to speculate on future interest rates and security prices. For example, a pension fund manager might use interest rate futures to hedge the bond portfolio position.

Speculators find financial futures attractive because of their potentially large return on a small investment due to the low deposit requirement.

An Assocham study on hedge funds points out that assets of hedge funds currently estimated worldwide is in the region of $2-2.5 trillion. Their assets have grown at over 8% annually even with the sub prime crises. It is expected that by 2012, the assets would be over $ 4 trillion. With a leverage of a minimum of five times, the asset play under management currently crosses $10 trillion, the study says.

“If the general level of leverage is taken at 10 times, hedge funds would be controlling portfolios of over $ 20 trillion and possibly $40 trillion in 2012,” the ASSOCHAM study said. According to Assocham, hedge funds are already in India in the form of private equity and joint ventures.

Source: Economic Times

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