Interest-rate-sensitive securities are securities whose payoff depends on the levels and/or evolution of interest rates. The interest rate derivatives market is enormous. The global notional principal of over-the-counter derivative contracts was an estimated U.S.$72 trillion as of the end of June 1998, of which 67% were interest rate instruments and 31% were forex instruments [51]. The use of such derivatives in portfolio risk management has made possible economical and efficient alteration of interest rate sensitivities [325]. Throughout this book, interest rate derivative securities exclude fixed-income securities with embedded options.

Interest Rate Futures and Forwards

An interest rate futures contract is a futures contract whose underlying asset depends solely on the level of interest rates. Figure 21.1 gives an idea of the diversity of interest rate futures.

Treasury Bill Futures

The first financial futures contract was based on a fixed-income instrument, the Government National Mortgage Association (GNMA or “Ginnie Mac”) mortgage-backed certificates whose trading began in 1972 at the CBT. The IMM of the CME followed 3 months later with futures contracts based on the 13-week T-bill [95].

The T-bill futures contract traded on the IMM is based on the 13-week (3-month) T-bill with a face value of $1 million. The seller of a T-bill futures contract agrees to deliver to the buyer at the delivery date a T-bill with 13 weeks remaining to maturity and a face value of $1 million. The T-bill delivered can be newly issued or seasoned. The futures price is the price at which theT-bill will be sold by the short and purchased by the buyer.