What do we need overnight rate futures?
A participant who has concluded a contract at a certain rate and has held the position open until the settlement day will receive the variation margin that equals to the difference between the income from the daily investment of funds at the RUONIA rate for the period before futures settlement and the income from investing these funds at a rate equal to the contract conclusion price. The amount of funds invested for this period and equivalent to 1 futures contract is indicated in the Trading System FYI.
Example 1:
The futures price is 6%, 10 days left before contract settlement. The amount of funds for investment (calculated in roubles according to the formula of futures price) for 1 contract is 998 358 roubles. The market participant sells the contract at this price and holds an open position until settlement. At the same time the participant invests 998,360 roubles for 1 day at the RUONIA rate and then the funds received under RUONIA reinvests on a daily basis during 10 days (until the day of futures settlement). Financial result: regardless of how RUONIA rates fluctuated during these 10 day the participant aggregates the investment result and variation margin. Finally he will receive an income equal to the income from daily reinvestment of funds at the rate of 6% during 10 days.
The opposite situation – the participant has raised up the funds through a sequence of one-day loans over a certain period of time. The total fee for the market participant will be equal to the average (for this time period) interest rate on the one-day loan market. In case of substantial rate increase on the market, our investor’s expenses will significantly grow. In order to fix the average rate for this set of loans, the investor can buy futures at a certain price. In this case the potential interest rate change will be completely offset by the variation margin that the investor will receive (pay) under the futures contract.
Example 2:
An investor needs a 500 million roubles loan for 3 weeks. Moreover, the exact period is unknown and it is possible that the funds will be used faster than the period. One of the best ways of lending in this case is a set of overnight loans. At the same time, the most effective way to eliminate the risk of an interest rate increase is to futures contracts buy. If the investor’s loan rate is usually 1.2 times higher than the RUONIA rate, buying 500 * 1.2 futures for the average RUONIA rate at 6% the investor fixes the cost of the loan at 7.2 %% (i.e. 6*1.2). In this case compensation for the overnight rate increase will be a positive variation margin for the futures contract.