Circular No. CIR/DNPD/8/2011,
Dated 30122011
To
Recognized Stock Exchanges
and their Clearing Corporations/Clearing Houses.
Dear Sir/Madam,
Sub: Exchange Traded Interest Rate Fut ures on 2year and 5year Notional Coupon Bearing Government of India Security
1. It has now been decided to permit the introduction of cash settled futures on 2year and 5year notional coupon bearing Government of India (GoI) security on currency derivatives segment of Stock Exchanges. Eligible Stock Exchanges may do so after obtaining prior approval from SEBI.
2. The details in terms of product design and risk management framework for cash settled futures on 2year and 5year notional coupon bearing GoI security is given in Annexure1 and Annexure2 respectively.
3. This circular is issued in exercise of the powers conferred under section 11(1) of the Securities and Exchange Board of India Act, 1992, read with Section 10 of the Securities Contracts (Regulation) Act, 1956 to protect the interests of investors in securities and to promote the development of, and to regulate the securities market.
4. The circular shall come into force from the date of the circular.
ANNEXURE1
Product Design and Risk Management Framework for Cash settled Futures on 2 Year Notional Coupon Bearing Government of India Security
1. Underlying
Notional coupon bearing 2year GoI security with a notional coupon of 7% paid semiannually and face value of Rs. 100.
2. Trading hours
The trading hours would be from 9 a.m. to 5.00 p.m.
3. Size of the contract
Rs. 2 lakh.
4. Quotation
The quotation would be similar to the quoted price of the GoI security.
5. Tenor of the contract
The maximum maturity of the contract would be 12 months.
6. Contract months
To begin with, three serial monthly contracts can be introduced.
7. Settlement mechanism
The futures on notional GoI security would be settled in cash in Indian Rupees. The settlement price of the notional bond would be determined on the basis of the yields of a basket of eligible bond(s) selected by the exchange with the yields of the bonds in the basket to be determined through a polling process carried out by Fixed Income, Money Market and Derivatives Association (FIMMDA) as detailed in Annexure1a.
Exchanges shall disclose upfront to the market participants the composition of the basket of securities for each of the contracts. Eligible bonds would comprise of GoI securities maturing at least 1.5 years but not more than 2.5 years from the expiry day.
8. Contract Value
The contract value would be : = Quoted price * 2000
9. Daily Contract Settlement Value
The Daily Contract Settlement Value would be: = 2000 * P_{w}
(Here Pw is weighted average futures quote of last half an hour).
In the absence of last half an hour trading, theoretical futures price would be considered for computation of Daily Contract Settlement Value. Exchanges would be required to disclose the model/methodology used for arriving at the theoretical price.
10. Expiry/Last trading day
The expiry/last trading day for the contract would be the last Thursday of the expiry month. If any expiry day is a trading holiday, then the expiry/last trading day would be the previous trading day.
11. Final Contract Settlement Value
The Final Contract Settlement Value would be = 2000 * P_{f}
where P_{f} is the settlement price of the notional bond.
12. Initial Margin
The Initial Margin requirement shall be based on a worst case loss of a portfolio of an individual client across various scenarios of price changes. The various scenarios of price changes would be so computed so as to cover a 99% VaR over a one day horizon. In order to achieve this, the price scan range may initially be fixed at 3.5 standard deviation. The initial margin so computed would be subject to a minimum of 0.35 % of the notional value of the contract on the first day of trading in Futures on 2 Year Notional Coupon Bearing Government of India (GoI) Security and 0.3 % of the notional value of the contract thereafter. The initial margin shall be deducted from the liquid net worth of the clearing member on an online, real time basis.
13. Extreme Loss margin
Extreme loss margin of 0.1 % of the notional value of the contract for all gross open positions shall be deducted from the liquid assets of the clearing member on an on line, real time basis.
14. Calendar spread margin
2 Year Notional Coupon Bearing Government of India (GoI) Security futures position at one maturity hedged by an offsetting 2 Year Notional Coupon Bearing Government of India (GoI) Security futures position at a different maturity would be treated as a calendar spread. The calendar spread margin shall be at a value of Rs. 300 for spread of one month and Rs. 450 for spread of two months. The benefit for a calendar spread would continue till expiry of the near month contract.
15. Formula for determining standard deviation
The exponential moving average method would be used to obtain the volatility estimate every day. The estimate of volatility (σ_{t}) for the time period t is estimated using the volatility estimate (σ_{t1}) for the previous time period and the return (r_{t1}) observed in the futures market during the previous time period. The formula would be as under:
(σ_{t})^{2} = λ(σ_{t1})^{2} + (1 – λ ) (r_{t1})^{2}
where
λ is a parameter which determines how rapidly volatility estimates change. The value of is fixed at 0.94.
i. σ_{t} (sigma) means the standard deviation of daily logarithmic returns of futures price of 2 Year Notional Coupon Bearing Government of India (GoI) Security at time t.
ii. The “return” is defined as the logarithmic return: r_{t} = ln(P_{t}/P_{t1}) where P_{t} is the futures price of 2 Year Notional Coupon Bearing Government of India (GoI) Security at time t. The plus/minus 3.5 sigma limits for a 99% VaR based on logarithmic returns would have to be converted into percentage price change by reversing the logarithmic transformation. The percentage margin on short positions would be equal to 100(exp(3.5σ)1) and the percentage margin on long positions would be equal to 100(1exp(3.5σ)). This implies slightly larger margins on short positions than on long positions. The derivatives exchange/clearing corporation may apply the higher margin on both the buy and sell side.
iii. The volatility estimation and margin fixation methodology should be clearly made known to all market participants so that they can compute the margin for any given closing level of the interest rate futures price. Further, the trading software itself should provide this information on a real time basis on the trading workstation screen.
iv. During the first timeperiod on the first day of trading in 2 Year Notional Coupon Bearing Government of India (GoI) Security futures, the sigma would be equal to 0.10 %.
16 Position Limits
i. Client level: The gross open positions of the client across all contracts should not exceed 6% of the total open interest or Rs. 300 crores whichever is higher. The Exchange will disseminate alerts whenever the gross open position of the client exceeds 3% of the total open interest at the end of the previous day’s trade.
ii. Trading Member level: The gross open positions of the trading member across all contracts should not exceed 15% of the total open interest or Rs. 1000 crores whichever is higher.
iii. Clearing Member level: No separate position limit is prescribed at the level of clearing member. However, the clearing member shall ensure that his own trading position and the positions of each trading member clearing through him is within the limits specified above.
iv. FIIs: In case of Foreign Institutional Investors registered with Securities and Exchange Board of India the total gross long (bought) position in cash and Interest Rate Futures markets taken together should not exceed their individual permissible limit for investment in government securities and the total gross short (sold) position, for the purpose of hedging only, should not exceed their long position in the government securities and in Interest Rate Futures, at any point in time.
ANNEXURE1a
Settlement Mechanism
a. Polling shall be carried out by the Fixed Income, Money Market and Derivatives Association, i.e., FIMMDA;
b. The yields (Bid and Ask) of the GoI securities shall be polled from Primary Dealers (PDs) registered with the Reserve Bank of India;
c. Each poll shall involve ten PDs who would be selected at random from the universe of PDs;
d. Polling would be conducted at three instances, i.e., 11.00 am, 11.30 am and 12.00 pm daily;
e. At each instance of polling, for each bond, out of the ten buy yields, two highest and two lowest yields would be treated as outliers and would be ignored. Similarly outliers from ten sell yields would be identified and ignored.
f. After rejecting the outliers in above step, there will be [6 * 2 * 3 * Number of Bonds in Basket] number of remaining yields.
g. Average settlement yield (Ys) is the simple average of the remaining yields. Ys will be rounded off to 4 decimal digits.
h. Ys determined in above step would be used to calculate present value of notional underlying bond on the basis of formula given below. This will be the final settlement price of the contract.
Final settlement price =
where,
Ys: Settlement yield
C: The notional coupon of underlying bond = 7%
WORKED OUT EXAMPLE OF SETTLEMENT PRICE CALCULATION DESCRIBED ABOVE HAS BEEN GIVEN IN ANNEXURE1B.
ANNEXURE1b
Worked out Example of Settlement price calculation:
Yield Figures Obtained by Polling of Dealers  
11:00 AM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9600  5.9500  (6.0100)  (6.0000)  (6.0250)  (6.0425) 
Dealer 2  5.9625  5.9500  6.0025  5.9925  6.0450  6.0300 
Dealer 3  5.9650  (5.9550)  6.0050  5.9950  6.0450  6.0350 
Dealer 4  (5.9600)  (5.9550)  (6.0025)  5.9975  (6.0425)  6.0375 
Dealer 5  5.9625  5.9500  (6.0025)  5.9900  (6.0550)  (6.0275) 
Dealer 6  (5.9725)  5.9525  (6.0175)  5.9975  (6.0575)  6.0375 
Dealer 7  (5.9700)  5.9500  6.0100  (5.9900)  6.0475  (6.0275) 
Dealer 8  (5.9600)  5.9500  6.0100  (6.0000)  6.0500  (6.0400) 
Dealer 9  5.9625  (5.9475)  6.0050  5.9950  6.0450  6.0350 
Dealer 10  5.9700  (5.9500)  6.0100  (5.9900)  6.0450  6.0350 
11:30 AM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9700  5.9600  6.0150  6.0050  (6.0600)  (6.0500) 
Dealer 2  (5.9750)  5.9600  6.0150  6.0000  6.0550  6.0375 
Dealer 3  5.9750  (5.9650)  6.0175  (6.0075)  6.0575  (6.0475) 
Dealer 4  5.9700  (5.9650)  6.0125  (6.0075)  6.0525  6.0475 
Dealer 5  (5.9700)  (5.9500)  (6.0100)  (5.9900)  (6.0450)  (6.0250) 
Dealer 6  5.9725  5.9600  6.0125  6.0000  6.0550  6.0400 
Dealer 7  (5.9775)  5.9575  (6.0200)  6.0000  (6.0600)  6.0400 
Dealer 8  5.9750  5.9550  (6.0200)  6.0000  6.0550  (6.0350) 
Dealer 9  5.9750  (5.9550)  6.0150  6.0050  6.0600  6.0400 
Dealer 10  (5.9700)  5.9600  (6.0050)  (5.9950)  (6.0500)  6.0400 
12:00 PM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9750  (5.9650)  6.0200  (6.0100)  (6.0650)  (6.0550) 
Dealer 2  5.9750  5.9600  6.0175  6.0025  6.0575  6.0450 
Dealer 3  5.9750  (5.9650)  6.0175  (6.0075)  6.0575  (6.0475) 
Dealer 4  (5.9700)  (5.9500)  6.0150  (5.9950)  6.0600  6.0400 
Dealer 5  (5.9800)  5.9600  (6.0225)  6.0025  (6.0625)  6.0425 
Dealer 6  5.9750  (5.9550)  6.0200  6.0000  6.0600  (6.0400) 
Dealer 7  (5.9800)  5.9600  6.0200  (6.0000)  6.0600  (6.0400) 
Dealer 8  5.9800  5.9600  (6.0250)  6.0050  6.0625  6.0425 
Dealer 9  5.9750  5.9650  (6.0150)  6.0050  (6.0550)  6.0450 
Dealer 10  (5.9750)  5.9650  (6.0150)  6.0050  (6.0575)  6.0475 

Futures Settlement Price =
= Rs. 101.8476
ANNEXURE2
Product Design and Risk Management Framework for Cash settled Futures on 5 Year Notional Coupon Bearing Government of India Security
1 Underlying
Notional coupon bearing 5year GoI security with a notional coupon of 7% paid semiannually and face value of Rs. 100.
2 Trading hours
The trading hours would be from 9 a.m. to 5.00 p.m.
3 Size of the contract
Rs. 2 lakh.
4 Quotation
The quotation would be similar to the quoted price of the GoI security.
5 Tenor of the contract
The maximum maturity of the contract would be 12 months.
6 Contract months
To begin with, three serial monthly contracts can be introduced.
7 Settlement mechanism
The futures on notional GoI security would be settled in cash in Indian Rupees. The settlement price of the notional bond would be determined on the basis of the yields of a basket of eligible bond(s) selected by the exchange with the yields of the bonds in the basket to be determined through a polling process carried out by Fixed Income, Money Market and Derivatives Association (FIMMDA) as detailed in Annexure2a.
Exchanges shall disclose upfront to the market participants the composition of the basket of securities for each of the contracts. Eligible bonds would comprise of GoI securities maturing at least 4.5 years but not more than 5.5 years from the expiry day.
8 Contract Value
The contract value would be: = Quoted price * 2000
9 Daily Contract Settlement Value
The Daily Contract Settlement Value would be: = 2000 * P_{w}
(Here P_{w} is weighted average futures quote of last half an hour).
In the absence of last half an hour trading, theoretical futures price would be considered for computation of Daily Contract Settlement Value. Exchanges would be required to disclose the model/methodology used for arriving at the theoretical price.
10 Expiry/Last trading day
The expiry/last trading day for the contract would be the last Thursday of the expiry month. If any expiry day is a trading holiday, then the expiry/last trading day would be the previous trading day.
11 Final Contract Settlement Value
The Final Contract Settlement Value would be = 2000 * P_{f}
where P_{f} is the settlement price of the notional bond.
12 Initial Margin
The Initial Margin requirement shall be based on a worst case loss of a portfolio of an individual client across various scenarios of price changes. The various scenarios of price changes would be so computed so as to cover a 99% VaR over a one day horizon. In order to achieve this, the price scan range may initially be fixed at 3.5 standard deviation. The initial margin so computed would be subject to a minimum of 0.7 % of the notional value of the contract on the first day of trading in Futures on 5 Year Notional Coupon Bearing GoI Security and 0.6 % of the notional value of the contract thereafter. The initial margin shall be deducted from the liquid net worth of the clearing member on an online, real time basis.
13 Extreme Loss margin
Extreme loss margin of 0.15 % of the notional value of the contract for all gross open positions shall be deducted from the liquid assets of the clearing member on an on line, real time basis.
14 Calendar spread margin
5 Year Notional Coupon GoI Security futures position at one maturity hedged by an offsetting 5 Year Notional Coupon Bearing GoI Security futures position at a different maturity would be treated as a calendar spread. The calendar spread margin shall be at a value of Rs. 400 for spread of one month and Rs. 600 for spread of two months. The benefit for a calendar spread would continue till expiry of the near month contract.
15 Formula for determining standard deviation
The exponential moving average method would be used to obtain the volatility estimate every day. The estimate of volatility (σ_{t}) for the time period t is estimated using the volatility estimate (σ_{t1}) for the previous time period and the return (r_{t1}) observed in the futures market during the previous time period. The formula would be as under:
(σ_{t})^{2} = λ (σ_{t1})^{2} + (1 – λ ) (r_{t1})^{2}
where
λ is a parameter which determines how rapidly volatility estimates change. The value of λ is fixed at 0.94.
i. σ_{t} (sigma) means the standard deviation of daily logarithmic returns of futures price of 5 Year Notional Coupon Bearing Government of India (GoI) Security at time t.
ii. The “return” is defined as the logarithmic return: r_{t} = ln(P_{t}/P_{t1}) where P_{t} is the futures price of 5 Year Notional Coupon Bearing GoI Security at time t. The plus/minus 3.5 sigma limits for a 99% VaR based on logarithmic returns would have to be converted into percentage price change by reversing the logarithmic transformation. The percentage margin on short positions would be equal to 100(exp(3.5σ)1) and the percentage margin on long positions would be equal to 100(1exp(3.5σ)). This implies slightly larger margins on short positions than on long positions. The derivatives exchange/clearing corporation may apply the higher margin on both the buy and sell side.
iii. The volatility estimation and margin fixation methodology should be clearly made known to all market participants so that they can compute the margin for any given closing level of the interest rate futures price. Further, the trading software itself should provide this information on a real time basis on the trading workstation screen.
iv. During the first timeperiod on the first day of trading in 5 Year Notional Coupon Bearing GoI Security futures, the sigma would be equal to 0.2 %.
16 Position Limits
i. Client level: The gross open positions of the client across all contracts should not exceed 6% of the total open interest or Rs. 300 crores whichever is higher. The Exchange will disseminate alerts whenever the gross open position of the client exceeds 3% of the total open interest at the end of the previous day’s trade.
ii. Trading Member level: The gross open positions of the trading member across all contracts should not exceed 15% of the total open interest or Rs. 1000 crores whichever is higher.
iii. Clearing Member level: No separate position limit is prescribed at the level of clearing member. However, the clearing member shall ensure that his own trading position and the positions of each trading member clearing through him is within the limits specified above.
iv. FIIs: In case of Foreign Institutional Investors registered with Securities and Exchange Board of India the total gross long (bought) position in cash and Interest Rate Futures markets taken together should not exceed their individual permissible limit for investment in government securities and the total gross short (sold) position, for the purpose of hedging only, should not exceed their long position in the government securities and in Interest Rate Futures, at any point in time.
ANNEXURE – 2a
Settlement Mechanism
a. Polling shall be carried out by the Fixed Income, Money Market and Derivatives Association, i.e., FIMMDA;
b. The yields (Bid and Ask) of the GoI securities shall be polled from Primary Dealers (PDs) registered with the Reserve Bank of India;
c. Each poll shall involve ten PDs who would be selected at random from the universe of PDs;
d. Polling would be conducted at three instances, i.e., 11.00 am, 11.30 am and 12.00 pm daily;
e. At each instance of polling, for each bond, out of the ten buy yields, two highest and two lowest yields would be treated as outliers and would be ignored. Similarly outliers from ten sell yields would be identified and ignored.
f. After rejecting the outliers in above step, there will be [6 * 2 * 3 * Number of Bonds in Basket] number of remaining yields.
g. Average settlement yield (Ys) is the simple average of the remaining yields. Ys will be rounded off to 4 decimal digits.
h. Ys determined in above step would be used to calculate present value of notional underlying bond on the basis of formula given below. This will be the final settlement price of the contract.
Final settlement price =
where,
Ys: Settlement yield
C: The notional coupon of underlying bond = 7%
WORKED OUT EXAMPLE OF SETTLEMENT PRICE CALCULATION DESCRIBED ABOVE HAS BEEN GIVEN IN ANNEXURE2B.
ANNEXURE2b
Worked out Example of Settlement price calculation:
Yield Figures Obtained by Polling of Dealers  
11:00 AM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9600  5.9500  (6.0100)  (6.0000)  (6.0250)  (6.0425) 
Dealer 2  5.9625  5.9500  6.0025  5.9925  6.0450  6.0300 
Dealer 3  5.9650  (5.9550)  6.0050  5.9950  6.0450  6.0350 
Dealer 4  (5.9600)  (5.9550)  (6.0025)  5.9975  (6.0425)  6.0375 
Dealer 5  5.9625  5.9500  (6.0025)  5.9900  (6.0550)  (6.0275) 
Dealer 6  (5.9725)  5.9525  (6.0175)  5.9975  (6.0575)  6.0375 
Dealer 7  (5.9700)  5.9500  6.0100  (5.9900)  6.0475  (6.0275) 
Dealer 8  (5.9600)  5.9500  6.0100  (6.0000)  6.0500  (6.0400) 
Dealer 9  5.9625  (5.9475)  6.0050  5.9950  6.0450  6.0350 
Dealer 10  5.9700  (5.9500)  6.0100  (5.9900)  6.0450  6.0350 
11:30 AM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9700  5.9600  6.0150  6.0050  (6.0600)  (6.0500) 
Dealer 2  (5.9750)  5.9600  6.0150  6.0000  6.0550  6.0375 
Dealer 3  5.9750  (5.9650)  6.0175  (6.0075)  6.0575  (6.0475) 
Dealer 4  5.9700  (5.9650)  6.0125  (6.0075)  6.0525  6.0475 
Dealer 5  (5.9700)  (5.9500)  (6.0100)  (5.9900)  (6.0450)  (6.0250) 
Dealer 6  5.9725  5.9600  6.0125  6.0000  6.0550  6.0400 
Dealer 7  (5.9775)  5.9575  (6.0200)  6.0000  (6.0600)  6.0400 
Dealer 8  5.9750  5.9550  (6.0200)  6.0000  6.0550  (6.0350) 
Dealer 9  5.9750  (5.9550)  6.0150  6.0050  6.0600  6.0400 
Dealer 10  (5.9700)  5.9600  (6.0050)  (5.9950)  (6.0500)  6.0400 
12:00 PM  Bond 1  Bond 2  Bond 3  
Dealer  Buy Yields  Sell Yields  Buy Yields  Sell Yields  Buy Yields  Sell Yields 
Dealer 1  5.9750  (5.9650)  6.0200  (6.0100)  (6.0650)  (6.0550) 
Dealer 2  5.9750  5.9600  6.0175  6.0025  6.0575  6.0450 
Dealer 3  5.9750  (5.9650)  6.0175  (6.0075)  6.0575  (6.0475) 
Dealer 4  (5.9700)  (5.9500)  6.0150  (5.9950)  6.0600  6.0400 
Dealer 5  (5.9800)  5.9600  (6.0225)  6.0025  (6.0625)  6.0425 
Dealer 6  5.9750  (5.9550)  6.0200  6.0000  6.0600  (6.0400) 
Dealer 7  (5.9800)  5.9600  6.0200  (6.0000)  6.0600  (6.0400) 
Dealer 8  5.9800  5.9600  (6.0250)  6.0050  6.0625  6.0425 
Dealer 9  5.9750  5.9650  (6.0150)  6.0050  (6.0550)  6.0450 
Dealer 10  (5.9750)  5.9650  (6.0150)  6.0050  (6.0575)  6.0475 

Futures Settlement Price =
= Rs. 104.2397