Bond forward
Also written Bond forwards · Forward contract in government securities
An OTC rupee interest rate derivative in which a buyer agrees to buy a specific Government Security from a seller on a future date at a price fixed today — governed by RBI's Directions of 21 February 2025.
In plain language
A bond forward is a plain forward contract whose underlying is a government bond.
Two parties agree today on the specific Government Security, the quantity, the price and a future date. On that date the seller delivers the bond and the buyer pays the agreed price — or, if the contract is cash-settled, only the price difference changes hands.
The RBI definition quoted in the workbook: "a rupee interest rate derivative contract in which one counterparty (buyer) agrees to buy a specific Government Security from another counterparty (seller) on a specified future date and at a price determined at the time of the contract." Hence, as the workbook adds, the underlying for a bond forward can be Government Securities only.
It does for a bond what a forward rate agreement does for an interest rate: it locks in today a price for a transaction that will happen later.
How it works
The framework. RBI notification dated 21 February 2025 issued the Reserve Bank of India (Forward Contracts in Government Securities) Directions, 2025, which apply to bond forwards undertaken in the OTC market in India.
Who may participate.
| Participant | Eligibility |
|---|---|
| Residents | Eligible, to the extent permitted |
| Non-residents | If eligible to invest in G-Secs under the FEM (Debt Instruments) Regulations, 2019 |
| Market-makers | Certain entities like banks and PDs |
| Users | Any entity eligible to be a non-retail user under the Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019 |
How it settles.
| Settlement | Route |
|---|---|
| Physically-settled | Through CCIL or another clearing agency or arrangement approved by RBI |
| Cash-settled | Bilaterally, or through a clearing arrangement approved by RBI |
The workbook's grid of interest rate derivatives places the bond forward in the forward row under interest rate instruments, beside the FRA under interest rates: the seller agrees to provide certain debt securities on a mutually agreed date at a specified price and quantity, settled either by delivery or through cash settlement that takes account of price differentials.
As a forward it differs from interest rate futures in the same way all forwards do: it is negotiated bilaterally rather than traded on an exchange with margins, mark-to-market and a clearing corporation's settlement guarantee.
A worked example
Illustrative participants and prices, ignoring accrued interest.
An insurance company eligible as a non-retail user expects premium inflows in three months and wants to lock in today's price on a government bond it plans to buy then. It enters a bond forward with a bank acting as market-maker:
| Term | |
|---|---|
| Underlying | A specific 10-year Government Security |
| Face value | Rs 25 crore (25,00,000 bonds of Rs 100) |
| Forward price | Rs 101.20 |
| Settlement date | Three months from today |
On the settlement date the bond trades at Rs 102.05.
If physically settled through CCIL:
Insurer pays = 25,00,000 × 101.20 = Rs 25,30,00,000
Insurer gets = Rs 25 crore face of the bond, worth 25,00,000 × 102.05 = Rs 25,51,25,000
If cash settled, only the difference moves:
Bank pays insurer = (102.05 − 101.20) × 25,00,000 = Rs 21,25,000
The insurer then buys the bond in the market at Rs 102.05, and the Rs 21.25 lakh brings its effective cost back to Rs 101.20. Had the bond fallen to Rs 100.50 instead, the insurer would have paid Rs 17,50,000 — the price of certainty is giving up a better market price.
Why NISM asks about it
Chapter 2 (Interest Rate Derivatives) sets out the RBI bond forward Directions in section 2.2.1 on forwards, right after the FRA examples, and places bond forwards in the forward row of its table of derivatives on interest rates versus interest rate instruments. Expect questions on what the underlying may be (Government Securities only), who may act as market-maker and user, and how physically-settled and cash-settled bond forwards clear.
Common exam traps
- The underlying can only be a Government Security. Not corporate bonds, not a rate.
- Bond forwards are OTC. The exchange traded analogue is a bond future.
- Physically-settled bond forwards go through CCIL or another RBI-approved clearing arrangement; cash-settled ones may be bilateral.
- Users must be eligible non-retail users under the 2019 Rupee IRD Directions; banks and PDs can be market-makers.
- Non-residents qualify only if eligible to invest in G-Secs under the FEM (Debt Instruments) Regulations, 2019.
- An FRA locks a rate; a bond forward locks a bond price. They share a row in the workbook's table, not a definition.
Check yourself
1.Under the RBI (Forward Contracts in Government Securities) Directions, 2025, how must a PHYSICALLY-settled bond forward transaction be settled?
- a)Through the Clearing Corporation of India Ltd. (CCIL) or any other clearing agency or arrangement approved by the Reserve Bank
- b)Bilaterally between the two counterparties, at their discretion
- c)Through the Electronic Book Provider platform of a recognised stock exchange
- d)Through the Public Debt Office of the Reserve Bank of India
Show the answer
Answer: (a) Through the Clearing Corporation of India Ltd. (CCIL) or any other clearing agency or arrangement approved by the Reserve Bank
The Directions, issued by Notification No. FMRD.DIRD.17/14.03.042/2024-25 dated February 21, 2025, draw a deliberate asymmetry:
- A cash-settled bond forward may be settled bilaterally OR through any clearing arrangement approved by the Reserve Bank
- A physically-settled bond forward shall be settled through the Clearing Corporation of India Ltd. (CCIL) or any other clearing agency or clearing arrangement approved by the Reserve Bank
So bilateral settlement is available only for the cash-settled variety. Also worth locking in: the underlying for a bond forward can be Government Securities only; banks and PDs may act as market-makers; and a user must be eligible to be classified as a non-retail user under the Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019.
Where this is taught
- Series IV · Chapter 2: Interest Rate Derivativesintroduced here
- Series V-D · Chapter 19: Interest Rate Derivativesintroduced here
Related terms
- Forward Rate AgreementAn OTC contract that locks in an interest rate today for a borrowing or lending period starting later; only the rate difference on a notional principal is settled, in cash.
- Forward contractA bilateral, over-the-counter agreement between two parties to buy or sell an asset on a fixed future date at a price agreed today — customised to suit them, and binding on both.
- Government SecurityA tradeable debt instrument issued by the Central Government or a State Government — treated as free of default risk, and the benchmark against which other rupee interest rates are priced.
- Interest Rate FuturesA standardised exchange-traded contract to buy or sell a notional government security, or an interest rate itself, at a price agreed today for settlement on a future date.
- OTC derivativeA non-standard derivative contract settled directly between counterparties on mutually agreed terms, relying on trust between them rather than on an exchange and clearing house.