Rates Derivatives

The market at a glance

Interest-rate derivatives are the largest financial market in existence: over $500 trillion of notional outstanding — several times world GDP. The number sounds absurd until you realise what it does: every bank hedging its loan book, every corporate fixing its borrowing costs, every pension fund matching liabilities and every mortgage system on earth routes its rate risk through these contracts. Notional measures traffic, not risk — but the traffic is the global economy's.

Since the 2008 reforms, this market runs through central clearing (LCH clears the majority of global swaps) with daily margining, and since the LIBOR transition it prices off overnight risk-free rates (SOFR, €STR, SONIA). It is the most institutionally mature derivatives market — and the one where central banks' intentions are priced second by second.

The curve is the product

Everything here trades pieces of one object: the forward curve of interest rates. An OIS reads central-bank expectations; a FRA isolates one future period; an interest rate swap bundles a strip of them; STIR futures list the same forwards on-exchange; bond futures package long-maturity risk with a delivery puzzle. On top sits the options layer — swaptions and caps/floors — pricing how uncertain those forwards are. Inflation swaps split nominal rates into real rates plus breakeven inflation.

Interactive: swap mark-to-market & DV01

You pay fixed on a swap struck at K. Rates move to S — what's your position worth, and how sensitive is it?

Notional $M Contract fixed rate K % Current par rate S % Remaining years Discount rate %

Annuity factor

—

DV01

—

Payer MTM

—

Receiver MTM

—

Annual payments, flat continuous discounting — the textbook skeleton of \(V = (S-K) \times A \times N\). Real desks bootstrap full curves; the intuition is identical.

Reading central banks through this market

When headlines say "markets price a 70% chance of a cut", the source is meeting-dated OIS and STIR futures. The mechanics are simple division: if the next-meeting OIS sits 17.5bp below the current rate and a cut is 25bp, the implied probability is 70%. The OIS page walks through it — after which you'll never read a Fed-watching article the same way.

Concepts to master

• DV01 thinking — positions are dollar-per-basis-point numbers, aggregated across the curve in maturity buckets.
• Forwards, not spots — every curve trade is a claim that some forward rate is wrong. Decompose before you trade.
• Convexity is everywhere — futures vs. swaps, cash-settled vs. physical swaptions, long bonds vs. short: second-order terms are first-order money at institutional size.
• Vol as an asset — the swaption grid prices rate uncertainty; its level (watch 1y10y normal vol) is macro's fear gauge.