Conceptual · Article 8.4.1

Interest Rate Futures.

Hedging Duration Without Selling a Single Bond.

Published as on 22 July 2026

An Interest Rate Future is a standardised, exchange-traded contract to buy or sell a notional government debt instrument — a G-Sec or the 91-day treasury bill — at a price fixed today for a future date. Because bond prices fall when yields rise, an IRF lets a bank or bond fund neutralise that exposure without touching its physical portfolio. In India these contracts trade cash-settled on NSE and BSE at a ₹2 lakh notional, in two families: NBF II bond futures across 6, 10 and 13-year maturity buckets, and 91-day T-bill futures for short-rate risk. SEBI oversees the derivative; the RBI governs the underlying G-Sec market it settles against. They are leveraged, institution-oriented tools — powerful for hedgers, and, in India, persistently thin on liquidity.

₹2 Lakh

Contract Notional

Cash-Settled

No Physical Delivery

6 / 10 / 13-yr

NBF II Buckets

Slab · 43(5)(d)

Business Income

Executive Summary · Page 2

Executive Summary · 6 Findings

An Interest Rate Future exists to answer one problem: how does a large holder of government bonds protect itself when rates are about to move — without dumping the bonds? Sell the bonds and you crystallise tax, move the market, and disturb a carefully built book. The IRF offers a cleaner path: a leveraged, exchange-traded overlay that gains exactly when the portfolio loses, and costs a margin rather than the full value of the underlying.

Covers what an IRF is and the rate–price–duration engine beneath it, the two contract families on NSE (NBF II bond futures and 91-day T-bill futures), full specifications, the cash-settlement mechanism against the underlying market, duration-based hedge ratios and four institutional use-cases, margins and mark-to-market, the persistent liquidity constraint in India, non-speculative business-income taxation under Section 43(5)(d), and six questions Indian investors ask.

Key Findings

A contract on a bond's price, not the bond itself.

An IRF is a standardised agreement to buy or sell a notional government instrument at a fixed price on a future date. You post a margin, not the full value. Because bond prices move inversely to yields, the contract lets a holder take or offset interest-rate exposure without ever transacting in the physical security.

Two families on NSE, both at ₹2 lakh notional.

NBF II bond futures reference a notional GOI bond in 6, 10 and 13-year maturity buckets — the 10-year being the benchmark. The 91-day T-bill future covers short-rate risk, quoted as ₹100 − 0.25 × yield. Both carry a ₹2,00,000 contract value, expire on the last Thursday of the month, and are fully cash-settled.

Duration is the whole mechanism.

A bond's price sensitivity is its modified duration: price change ≈ −duration × change in yield. A portfolio with duration 7 loses ~7% if yields rise 1%. The hedge ratio — portfolio value × duration, divided by contract notional × the underlying's duration — sets how many futures to sell to neutralise that risk.

Cash-settled against the real bond market.

No bond is delivered. NBF II settles at the weighted-average NDS-OM price of the underlying GOI bond over the last two hours on expiry (minimum five trades, FIMMDA price as fallback). The 91-day future settles at ₹100 − 0.25 × the discount yield from that day's primary T-bill auction. Positions are marked to market daily.

An institutional tool — thin for everyone else.

Banks, primary dealers, bond funds and insurers use IRFs to manage duration; FPIs use them within position caps. But Indian IRF liquidity has stayed historically thin across relaunches, so open interest is shallow and spreads can widen. These are leveraged instruments where losses can exceed the margin posted — not a casual retail trade.

Non-speculative business income — nil STT.

Gains and losses fall under Section 43(5)(d): non-speculative business income, taxed at slab. Losses set off against any business income except salary, and carry forward 8 years. Neither STT nor CTT applies, giving IRFs the lowest all-in cost of any Indian exchange-traded derivative — though a Section 44AB audit may apply by turnover.

At A Glance

Metric	Value	Detail
Instrument	IRF	Exchange-traded derivative
Underlying	Notional G-Sec / T-bill	NBF II & 91-day
Notional	₹2,00,000	Per contract
Settlement	Cash	No delivery
Expiry	Last Thursday	Monthly / quarterly
Regulators	SEBI + RBI	Derivative + underlying
Tax	Slab (business)	Section 43(5)(d)
Best Use	Duration hedging	Not retail speculation

Exhibit 01: What a 1% Yield Rise Costs by Duration

Portfolio Duration	Loss on ₹1,000 cr	Exposure
Duration 4	−₹40 cr	Short/medium
Duration 7	−₹70 cr	10-yr benchmark
Duration 10	−₹100 cr	Long
Duration 13	−₹130 cr	Very long

Illustrative. Mark-to-market loss ≈ duration × yield change × portfolio value, for a 1 percentage-point (100 bps) rise in yields. This is the exposure an IRF short position is designed to offset — the higher the duration, the larger the hedge required.

The Opening · Page 3

The Opening

An Interest Rate Future is a bet, made precise. It is a contract to buy or sell a notional government bond at a price agreed now, for settlement later — and its value tracks the one variable that dominates fixed income: the direction of interest rates. When yields rise, bond prices fall, and a holder of bonds bleeds. The IRF is the instrument that lets that holder pre-place an equal and opposite position, so the two cancel. You do not need to own the underlying bond to trade it, and you do not need to sell your bonds to hedge them.

"A future does not remove interest-rate risk from the world — it moves it. The hedger sells the risk they cannot bear; the speculator buys the risk they choose to take. The contract simply lets the two meet at a price, on an exchange, without a single government bond changing hands."
Risk, Transferred Not Erased

The engine. Two relationships do all the work. First, the inverse link: rates up, prices down. Second, duration — the measure of how much a bond's price moves for a given shift in yield. A portfolio with a modified duration of 7 falls roughly 7% when yields climb one percentage point. For a bank holding ₹1,000 crore of bonds, that is a ₹70 crore mark-to-market hit. Duration turns a vague fear of "rising rates" into a number you can hedge exactly.

The Indian frame. IRFs sit in an unusual regulatory space: SEBI supervises them as exchange-traded derivatives, while the RBI governs the government securities market whose prices they settle against. That dual oversight, and a narrow institutional user base, has kept the market credible but chronically illiquid — a structural fact any user must plan around.

The Honest Boundary: An IRF is NOT a way to earn a coupon — it pays nothing and expires on a date. It is NOT a substitute for owning bonds — it is an overlay on exposure you already have or want. It is NOT a safe retail trade — leverage means losses can exceed your margin, and Indian liquidity is thin. It IS a precise, low-cost tool for a bank or bond manager to add or subtract interest-rate risk without disturbing the physical book.

Structure

Part I

What an IRF Is, the Rate–Price–Duration Engine & Where It Fits

Part II

The Two Contract Families, Specifications & Settlement

Part III

Hedging in Practice, Who Uses IRFs & the Liquidity Reality

Part IV

The Verdict: Tax, Cost & a Hedger's Instrument

Use If

✓ You hold a large bond/G-Sec book

✓ You must hedge duration risk

✓ You want to avoid selling physical bonds

✓ You can manage margin & MTM daily

Do NOT Use If

✕ You want steady income

✕ You cannot absorb leveraged losses

✕ You need to exit a thin market fast

✕ You are a small retail speculator

Part I

What an Interest Rate Future Is, the Engine Beneath It, and Where It Fits

The inverse of rates and prices; duration as the measure of sensitivity; the hedge ratio that turns fear of rising rates into a precise number of contracts — and why IRFs belong in the interest-rate-risk layer of an institutional book, not a retail portfolio.

Part I · Page 4

Rates, Prices & Duration

The Inverse Relationship

A bond pays a fixed stream of cash. When market yields rise, newly issued bonds pay more, so existing lower-coupon bonds become worth less — their price falls. When yields fall, the reverse. This is the single relationship every interest-rate hedge is built on: rates up, prices down; rates down, prices up.

Modified Duration — The Sensitivity

Duration measures how far a bond's price moves for a given yield shift: price change (%) ≈ −duration × change in yield (%). A duration of 7 means a 1% yield rise costs about 7% of value. Longer-dated bonds have higher duration — which is why the 13-year bucket swings far more than the 6-year.

The Hedge Ratio

Turning Risk Into a Number of Contracts

Number of contracts = (Portfolio Value × Portfolio Duration) ÷ (Contract Notional × Underlying's Duration). Selling that many futures reduces the portfolio's effective duration toward zero, so the futures gains offset the bonds' losses when yields rise. The same formula run in reverse lets a manager add duration.

Where IRFs Fit

Layer	Instrument	Role
Underlying	G-Secs / T-bills	Held exposure
Rate overlay	Interest Rate Futures	Hedge / adjust duration
OTC	Interest-rate swaps	Customised hedge
Cash	Repo / call money	Short funding
Retail	Debt mutual funds	Indirect access

IRFs are the exchange-traded overlay in the interest-rate-risk toolkit: cheaper and more transparent than an OTC swap, more precise than selling bonds. They sit on top of a physical book, adjusting its rate sensitivity up or down without disturbing the holdings themselves.

Appropriate uses: a bank neutralising mark-to-market risk on its bond portfolio before a tightening cycle; a debt fund cutting duration ahead of an expected rate rise; a primary dealer covering auction inventory; a treasury locking a future borrowing cost. Inappropriate: a retail trader using leverage to punt on rate direction in a thin market — a fast route to losses larger than the margin posted.

Part II

The Two Contract Families, Their Specifications, and How They Settle

NBF II bond futures across three maturity buckets and the 91-day T-bill future on its IMM quotation; ₹2 lakh notional, last-Thursday expiry, 9-to-5 trading aligned to the bond market; and cash settlement that imports the real underlying price on expiry day.

Part II · Page 6

NBF II — Bond Futures

Contract	Maturity Bucket	Duration
6-year	4–8 years	Medium
10-year	8–11 years	Benchmark
13-year	11–15 years	Long

Each NBF II contract references a notional GOI bond of ₹100 face value with a semi-annual coupon. The specific bond used for final pricing is chosen by the exchange with FIMMDA and announced before expiry. As the contracts are fully cash-settled, the international "cheapest-to-deliver" idea operates here only as a pricing and hedging reference, not an actual delivery.

91-Day T-Bill Future

The IMM Price Convention

Futures Price = ₹100 − 0.25 × Yf, where Yf is the annualised discount yield of the 91-day GOI T-bill. The 0.25 reflects the roughly quarter-year tenor. At a 6.80% yield the price is ₹98.30; if yields fall to 6.40% it rises to ₹98.40 — a ₹0.10 gain per unit, or about ₹200 per basis point on a ₹2 lakh contract.

Contract Specifications

Parameter	NBF II	91-Day T-Bill
Notional	₹2,00,000	₹2,00,000
Settlement	Cash	Cash
Expiry	Last Thu	Last Thu
Hours	9am–5pm	9am–5pm
Initial margin	1.5–2.8%	~0.10%
STT / CTT	Nil	Nil

Cycle: 3 serial monthly + 3 quarterly (Mar/Jun/Sep/Dec). The 9am–5pm window runs two and a half hours past the equity F&O close, keeping IRF prices tethered to the NDS-OM bond market through the full day.

Settlement Mechanism

Daily vs Final

Daily (DSP): VWAP of the last 30 minutes of futures trading; positions marked to market, cash exchanged on T+1. Final (NBF II): the weighted-average NDS-OM price of the underlying bond over the last 2 hours on expiry, minimum 5 trades, else the FIMMDA published price — anchoring the future to the real bond market.

91-Day Final Settlement

Final price = ₹100 − 0.25 × Yf, where Yf is the weighted-average discount yield from that day's primary 91-day T-bill auction. The future settles at literally what the government paid to borrow for 91 days on the expiry date.

Part III

Hedging in Practice, Who Uses Interest Rate Futures, and the Liquidity Reality

A worked bank hedge, the primary dealer, the duration-adjusting fund and the treasury locking a borrowing cost; margins and daily mark-to-market as the price of leverage; and the persistent thinness of the Indian IRF market that every user must factor in.

Part III · Page 8

A Worked Bank Hedge

₹500 Cr, Duration 7.5, Rates Feared Higher

A bank treasury holds ₹500 crore of 10-year GOI bonds and expects yields to rise. It sells NBF II 10-year futures. With the underlying bond's duration near 7.0: N = (₹500 cr × 7.5) ÷ (₹2 lakh × 7.0) ≈ 26,786 short contracts. If yields rise 0.50%, the portfolio loses ~₹18.75 crore and the short futures gain roughly the same — net impact near zero. No bonds are sold, no tax event triggered, no book disturbed.

Three More Uses

Primary Dealer · Fund · Treasury

Primary dealer: hedges inventory risk on underwritten auction bonds by selling futures until the bonds are placed. Debt fund: cuts effective duration from 7 to 5 through a futures overlay, sidestepping capital gains and market impact. Corporate treasury: planning an NCD issue in three months, sells futures to lock today's yield against a rise in borrowing cost.

Who Uses Them

User	Purpose
Primary dealers	Auction / inventory hedge
Banks	AFS/HFT book, SLR bonds
Debt funds	Tactical duration
Insurers	Asset-liability matching
FPIs	Capped positions

The Liquidity Reality

Across repeated relaunches, Indian IRF volumes have stayed modest. The user base is narrow, and many hedgers still prefer the physical G-Sec market or OTC swaps. Thin open interest means wider spreads and harder exits — check depth in your specific contract before assuming a fair entry or exit. FPI gross open positions are capped at the higher of 10% of open interest or ₹600 crore.

The cost of leverage: an initial margin of roughly 1.5–2.8% controls the full ₹2 lakh notional, so a small yield move is amplified against the margin. Positions are marked to market daily and losses collected on T+1 — a hedge that moves against you demands cash promptly. Leverage cuts both ways: on an unhedged directional position, losses can exceed the amount first posted.

Part IV

The Verdict

A hedger's precision instrument. Not a speculator's shortcut.

Part IV: The Verdict · Page 10

30-Second Summary

An Interest Rate Future is an exchange-traded, cash-settled contract on a notional government instrument, used to hedge or express a view on rates without trading the physical bond. India offers two families on NSE and BSE at ₹2 lakh notional: NBF II bond futures (6, 10 and 13-year buckets) and the 91-day T-bill future. Duration sets the hedge — sell futures to cut a portfolio's rate sensitivity — and cash settlement imports the real underlying price on expiry. SEBI oversees the derivative; the RBI governs the underlying market.

On cost, IRFs are the cheapest Indian exchange-traded derivative: neither STT nor CTT applies. On tax, gains and losses are non-speculative business income under Section 43(5)(d), taxed at slab, set off against any business income except salary, and carried forward 8 years, with a possible Section 44AB audit. The catch is structural: leverage magnifies losses, and Indian IRF liquidity remains thin — so these are tools for institutions and informed hedgers, accessed by most retail investors only indirectly through debt funds.

"The future answers one question — can I hold this bond risk without the bond's price moving against me? Yes, by transferring the risk to someone willing to take it. It is one of the sharpest hedging tools a treasury has, and one of the fastest ways for a leveraged speculator to lose money in a thin market. The instrument is the same; only the intent differs."
The Final Orientation

The Bottom Line: Use IRFs to hedge duration on a real bond book — size the position with the duration hedge ratio, sell futures to neutralise rate risk, and keep the physical portfolio intact. Budget for daily mark-to-market and posted margin; verify liquidity in the exact contract before trading. Treat the nil-STT, nil-CTT cost edge as a genuine advantage for large hedgers, but never mistake low cost for low risk: this is leveraged, and losses on a directional bet can exceed your margin. Book the tax as business income and check whether a 44AB audit applies. Confirm current contract specifications on the official NSE website before acting.

ADWIZR · July 2026

Decision Rules

Use Correctly As

✓ A duration hedge on a bond book

✓ Auction / inventory cover for a PD

✓ Tactical duration for a debt fund

✓ A locked future borrowing cost

Misuse Destroys Value

✕ A leveraged retail rate punt

✕ A source of regular income

✕ A position you can't exit in size

✕ Capital you cannot risk losing

Three Misconceptions

What People Get Wrong

(1) "A future is just a cheaper bond." No — it pays no coupon, expires, and is leveraged. (2) "The hedge is free." Margin and daily MTM are real cash flows, and an imperfect hedge leaves basis risk. (3) "I can always trade out." Indian IRF liquidity is thin; large exits can move the price against you.

vs the Underlying

Contract vs Asset

The G-Sec is the asset you own — full capital, a coupon, no expiry. The IRF is a contract about its price — a margin, no coupon, a fixed expiry, cash-settled. Own bonds to hold exposure; trade futures to hedge or adjust it. Different tools for different jobs.

₹2 L

Notional

Per contract

Cash

Settlement

No delivery

Slab

Business tax

43(5)(d), 8-yr c/f

Investor FAQ

Questions Indian Investors Ask

Six questions, answered directly.

Investor FAQ · Page 12

Frequently Asked Questions

Q1 Can retail investors trade interest rate futures in India?

They can, technically — IRFs are listed on NSE and BSE and open to any exchange client — but they are built for institutions. The ₹2 lakh notional, the leverage from thin margins, and historically shallow liquidity mean small orders can face wide spreads and difficult exits. Most retail participants are better served by debt mutual funds whose managers use IRFs internally. If you do trade them, you are taking a leveraged position on interest rates, and losses can exceed the margin you posted.

Q2 How is an interest rate future different from a bond or a T-bill?

A bond or T-bill is the underlying asset you own; an interest rate future is a contract about its price. Buying a G-Sec commits your full capital and pays you a coupon; an IRF commits only a margin, pays nothing, expires on a fixed date, and is cash-settled against the underlying's price. You use bonds to hold exposure and IRFs to hedge or adjust that exposure — reducing duration, for example — without buying or selling the physical securities.

Q3 How are interest rate futures taxed in India?

Gains and losses on exchange-traded IRFs are non-speculative business income under Section 43(5)(d) of the Income Tax Act — the same treatment as currency futures on a recognised exchange. They are taxed at your slab rate. Losses can be set off against any business income except salary in the same year and carried forward for 8 years against future business income. No STT is levied, so there is no STT deduction, and a Section 44AB tax audit may apply depending on turnover. Individuals and HUFs report on ITR-3.

Q4 What does it mean that IRFs are cash-settled?

No government bond changes hands at expiry. Instead the exchange computes a final settlement price from the underlying market and pays or collects the difference in cash. For NBF II bond futures, that price is the weighted-average price of the underlying GOI bond on the NDS-OM platform over the last two hours of trading (with a minimum of five trades, or the FIMMDA price as a fallback). For 91-day T-bill futures it is ₹100 minus 0.25 times the discount yield from that day's primary T-bill auction. Positions are also marked to market daily, with gains and losses exchanged on T+1.

Q5 Why is interest rate futures liquidity so thin in India?

Despite repeated relaunches, IRF volumes in India have stayed modest. The user base is narrow — mainly banks, primary dealers and a few bond funds — and many large hedgers manage duration through the physical G-Sec market or over-the-counter swaps instead. Thin open interest means wider bid-ask spreads and harder exits, which in turn discourages new participants. It is a structural feature to plan around: check depth in your specific contract before assuming you can enter or exit at a fair price.

Q6 How many futures contracts do I need to hedge a bond portfolio?

Use the duration-based hedge ratio: Number of contracts = (Portfolio Value × Portfolio Modified Duration) ÷ (Contract Notional × Modified Duration of the underlying bond). A ₹500 crore portfolio with a modified duration of 7.5, hedged with NBF II contracts (₹2 lakh notional) whose underlying bond has a duration near 7.0, needs roughly 26,800 short contracts. Selling futures reduces the portfolio's effective duration, so the futures gains offset the bonds' mark-to-market losses when yields rise.

Key Terms & Definitions

Interest Rate Future (IRF)

A standardised, exchange-traded contract to buy or sell a notional government debt instrument at a price fixed today for a future date. Used to hedge or take a view on interest rates without trading the underlying bond; in India, cash-settled on NSE and BSE at a ₹2 lakh notional.

Modified Duration

The measure of a bond's price sensitivity to yield changes: price change (%) ≈ −duration × change in yield (%). A duration of 7 implies roughly a 7% price fall for a 1 percentage-point rise in yields. The core input to any interest-rate hedge.

NBF II

NSE Bond Futures II — cash-settled futures on a notional GOI bond of ₹100 face value, offered in 6, 10 and 13-year maturity buckets. The specific settlement bond is chosen with FIMMDA and announced before expiry.

Hedge Ratio

The number of futures to trade to offset a portfolio's rate risk: (Portfolio Value × Portfolio Duration) ÷ (Contract Notional × Underlying's Duration). Selling that many futures drives the portfolio's effective duration toward zero.

Mark-to-Market (MTM)

Daily revaluation of open positions at the settlement price, with resulting gains or losses exchanged in cash on T+1. Because IRFs are leveraged, an adverse move demands cash promptly — a hedge that loses money on paper still costs money each day.

Section 43(5)(d)

The Income Tax Act provision treating exchange-traded derivative transactions on a recognised stock exchange — including IRFs — as non-speculative business income. Taxed at slab, with set-off against business income (except salary) and an 8-year loss carry-forward.