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INTEREST RATES
Source: TheSTAR 5 August 2002
Highlight on Malaysian Klibor futures traded on Malaysia Derivatives Exchange
A well-used financial futures prevalent in markets today – the short-term interest rate futures contract.
Financial futures, first introduced in 1972 by the Chicago Mercantile Exchange (CME), are now the world’s most actively traded futures contracts. They make up about two-thirds of trades in US futures markets alone!
Locally, FKB3 ( KLIBOR 3 months futures) was launched in May 1996, providing a necessary hedging and trading tool for the Malaysian money market. Market participants, faced with interest rate volatility, could use it to eliminate such risks. One contract is worth RM1mil, with quarterly cycle contract months of March, June, September and December, going up to 5 years forward.
Quoted in index terms (100 minus interest rate), the minimum price fluctuation is 0.01%. This would be equivalent to RM25. The contract is cash-settled and usually expires on the 3rd Wednesday of the delivery month.
The fact that the contract is quoted in index terms implies that there will be an inverse relationship between the futures price and interest rates. Therefore, if one thinks that short-term rates will rise tomorrow, one should sell the futures today (as a rise in interest rates will lead to a drop in the futures price) and vice versa.
A unique aspect of FKB3 is the presence of STRIPS. These are synthetic interest rate swaps (IRS) which involve the simultaneous purchase or sale of 4 or more FKB3 contract months. They help institutional traders seeking certainty to lock-in a fixed rate for the longer term.
Why would an individual investor or even a large financial institution trade these interest rate products which are based on contracts worth RM1mil and RM100,000?
Besides the obvious answer of hedging, one of their attractions is the high leverage. This is possible due to the system of margins.
A trader needs only deposit a small initial outlay, which is dependent on the product’s volatility but is generally about 5% to 10% of the futures contract underlying value.
This is a good-faith deposit and enables the trader to have exposure to a much larger sum, thus the ability to make large profits or losses from small variations in price.
In Malaysia, as well as in other parts of the world, these type of financial futures provide a quick, efficient and cost effective means of securing asset values or obtaining exposure to the cash and debt markets. As trading becomes more sophisticated, the use of such instruments will be frequent and commonplace.
Back to Interest Rates
Source: Bernama, British Banker's Association
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