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The Indian fixed income markets have charted impressive growth in the last few years. The current markets are vastly different from the 'administered interest rate regime' used until the early-nineties. Until 1999 market participants had to reduce duration or switch to cash if they wanted to hedge interest rate exposures or had a view that interest rates were set to rise because short-selling was not allowed. Now an investor can use interest rate derivatives to hedge against a rise in interest rates or even to profit from such moves.
Market Size
The Indian interest rate derivatives market is now over three years old and growing fast. The Reserve Bank of India announced the introduction of over-the-counter rupee derivatives in the form of forward rate agreements and interest rate swaps in July 1999. These have helped manage and control interest rate risks and also deepen the money markets. Only banks, primary dealers and financial institutions are allowed to trade FRAs and swaps to hedge interest rate risk for their own balance sheet management and for market-making purposes. Corporates are allowed to use these products to hedge their interest rate risk. Swaps having explicit or implicit option features such as caps, floors and collars are not permitted. RBI started by allowing market participants to use debt market rates as benchmarks, but this was later extended to include implied foreign currency rates.
The size of the market has also grown exponentially. In terms of the number of contracts and outstanding notional principal, interest rate...