Interest rate futures: an innovation in financial techniques for the management of risk

Introduction

In recent years there has been a marked advance in the prominence and status of financial futures markets in the hierarchy of international money and capital markets. This development reflects the growing recognition by increasing numbers of economic agents, particularly financial institutions, of the rational basis for their own participation in financial futures markets. At the same time, in many quarters, questions continue to be raised about the rationale and justification of the proliferation of financial futures contracts and about whether, in fact, such markets mainly serve to provide opportunities for speculation. Those who take this view generally see recent innovations in financial techniques as having adversely affected economy-wide productivity growth. James Tobin has expressed such sentiments by admitting to ". . . an uneasy Physiocratic suspicion, perhaps unbecoming in an academic, that we are throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity."

Be that as it may, there can be no denying that interest rate movements have become much more volatile in recent years, and in consequence the interest rate risks associated with borrowing and lending activity are perceived to have greatly increased. It is not surprising, therefore, that economic agents, in the natural course of their affairs, should seek to protect themselves from unwanted interest rate exposures, nor for that matter that other participants should find speculative interest. In this respect the markets that have sprung up to provide for these preferences and tendencies are not inherently different from other types of forward or futures markets.

The purpose of this paper is to describe and analyse this new development and to pose some of the questions it raises for the conduct of monetary policy, the supervision of financial institutions and the overall performance of financial markets.