How to Trade Interest Rates?

Date Modified: 21/04/2024

Interest rates have the potential to alter a nation’s economic trajectory by influencing its monetary policy, currency value, and various aspects such as trade.

Given their significant impact, many traders and investors may be interested in gaining exposure to interest rates and learning how to trade them.

Here’s what you need to know about interest rate trading:

How to trade interest rates.

Defining Interest Rates

Interest rates can be defined as either the amount of money one earns on their savings or the amount one must pay to their lender on a loan.

To get a better idea of what interest rates are and how they function, read our article on “What are interest rates? Types and meaning.”

Interest Rates & Central Banks: How Are Interest Rates Set?

Generally speaking, each country or nation has a financial body responsible for its monetary policies, called a “Central Bank.”

Central Banks are financial institutions responsible for the regulation, implementation, and distribution of money or credit within a certain country as they decide on monetary policy.

One of the main aspects Central Banks are responsible for is the setting of interest rates. For example, when inflation is too high, Central Banks usually tend to raise interest rates to counteract the high prices.

Some of the biggest Central Banks in the world are the Federal Reserve (FOMC), the European Central Bank (ECB), the Bank of Japan (BoJ), and the Bank of England (BoE), which are the Central Banks of the US, the Eurozone, Japan, and England, respectively.

Interest rate and the economic cycle.

Forex Interest Rate Trading

Interest rates have a huge impact on the Forex market and may be of great interest to Forex traders.

When interest rates are set, currency values shift in response, thereby affecting the overall Forex market and causing movements in exchange rates.

Therefore, Forex traders may want to keep a close watch on Central Bank monetary policy meetings to observe the decisions that materialize and their subsequent effects on the FX markets.

Additionally, interest rates and currency values typically move in tandem, with higher interest rates potentially bolstering the value of the national currency. This, in turn, can attract increased foreign investments in that country.

Ways of Trading Interest Rates

There are numerous ways available to trade interest rates, with the main options being interest rate derivatives or trading interest rate-tied assets such as bonds or commodities.

Bonds and commodities, like precious metals, are all susceptible to interest rates. For example, precious metals like gold tend to rise in value when rates are lower.

However, if you're interested in directly gaining exposure to interest rates, you may want to consider Interest Rate derivatives.

Interest Rate Derivatives

Interest rate derivatives are contracts that derive their worth from the underlying interest rate benchmark. They can also derive their value from the underlying interest-rate-bearing asset.

Examples of interest rate derivatives are interest rate Futures, interest rate Options, or Forward Rate Agreements (FRAs).

Interest Rate Futures

Interest rate Futures are derivative contracts that require two parties (the buyer and the seller, or the futures provider and the buyer) to exchange the underlying interest rate at a predetermined time and price in the future.

Interest rate Futures can be used to hedge against rate changes. Traders may also choose to trade Futures if they want to speculate on interest rate prices in the future.

Interest rate Futures’ underlying assets can include, for example, Treasury Bonds, Treasury bills, or Eurodollars:

  • Treasury Bonds are US federal government long-term debt securities that provide semiannual interest payments.
  • Treasury Bills are US Treasury Department short-term debt. Their value is derived from interest rates and interest rate predictions.
  • Eurodollars are deposits denominated in US dollars and held in foreign banks or overseas branches of US banks. The interest rates of Eurodollars serve as benchmarks for corporate funding.

Interest Rate Options

Interest rate Options are derivative contracts that provide the traders the option (not the obligation) to buy or sell the underlying interest rate-bearing asset at a predetermined time and price.

There are two types of interest rates Options- a Call Option and a Put Option. The former allows traders to potentially benefit from rising interest rates, while the latter allows them to benefit from falling interest rates.

Forward Rate Agreements

A Forward Rate Agreement, otherwise known as “FRA” is an OTC derivative. FRAs predetermine the rate of interest that must be paid at a set date in the future.

Typically, these agreements involve a borrower (the party obligated to pay the fixed interest rate) and a lender (the party obligated to pay the floating interest rate).

How to Trade Interest Rate Futures

In case you decide Futures trading is the right option for trading interest rates for you, then you may trade them with Plus500’s Futures trading platform. Plus500 allows you to initiate hassle-free trading of micro interest rate futures with a minimum deposit of $100.

To trade interest rate futures on Plus500, follow these steps:

  • First, you need to open a trading account.
  • Log into your trading account from the device of your choice.
  • Search for interest rates in the search bar or select the “interest rate” option in the options bar.
  • Open a buy or sell Futures position based on your speculation.
  • Start trading.

Alternatively, you can choose to practice Futures trading, risk-free and in real-market conditions with Plus500’s free and unlimited demo account. Check out our Support center for more information.

To learn more about Futures trading, check out our free Futures Trading Academy.

Conclusion

In conclusion, interest rate trading can be a compelling avenue for traders due to its significant impact on economies and markets and they can be traded with Plus500’s interest rates Futures contracts.

FAQs About Interest Rates

How are interest rate Futures used for hedging?

Traders can use interest rate Futures for hedging by allowing market participants to offset the risk of interest rate fluctuations.

How are interest rate Futures different from other Futures contracts?

Interest rate Futures, unlike other Futures, may gain value based on shifts in interest rates.

How do you price interest rates in Futures?

Interest rates in Futures are priced on interest rate benchmarks.