Corporate Bond Index Futures

Until 2023 a fund manager holding corporate bonds could only hedge with government bond futures. That works for the part of the risk that comes from the general level of interest rates, and not at all for the part that comes from credit spreads widening. When corporate yields move and G-sec yields do not, the hedge sits still while the portfolio falls.

Corporate Bond Index Futures close that gap. The underlying is not a single bond but an index of corporate debt securities rated AA+ and above, and the contract settles in cash against the index's closing value.

An index rather than a bond is a deliberate choice: individual corporate bonds in India trade too thinly to support a futures contract, while a diversified basket, reviewed regularly, does not.

SEBI's circular of 10 January 2023 sets the product design, and the numbers in it are the examinable part.

The index must satisfy all of the following:

• composed of corporate debt securities, with adequate liquidity and issuer-level diversification
• at least 8 issuers
• no single issuer above 15% weight
• no more than 25% in a particular group of issuers, and no more than 25% in a particular sector — in both cases excluding securities issued by PSUs, Public Financial Institutions and Public Sector Banks
• constituents reviewed at least half-yearly, and aggregated at issuer level for exposure limits
• a track record of at least one year
• duration buckets decided by the stock exchanges

The contract:

Contract value = Index level × Contract multiplier      (≥ Rs 2,00,000 at introduction)

Profit on a short position = (Entry index − Exit index) × Multiplier × Lots

A debt fund holds Rs 10 crore of AA+ corporate bonds and expects credit spreads to widen ahead of a busy issuance calendar. The exchange lists a corporate bond index future with a multiplier of 200 units per lot; the index is at 1,012.40.

Contract value = 1,012.40 × 200 = Rs 2,02,480 — comfortably above the Rs 2 lakh floor SEBI requires at introduction.

Lots needed to cover the portfolio:

Rs 10,00,00,000 ÷ Rs 2,02,480 = 493.9  →  494 lots sold

The index falls to 995.60 by expiry, a drop of 16.80 points, or 1.66%.

Futures gain = (1,012.40 − 995.60) × 200 × 494 = Rs 16,59,840

The portfolio, falling by roughly the same 1.66%, loses about Rs 16,60,000. The hedge covers all but a couple of hundred rupees of it — the residue being the rounding from 493.9 lots up to 494.

The price band on the same day. With a base price of 1,012.40, the initial 5% band runs from 961.78 to 1,063.02. If the contract trades at the top of that band, the exchange may widen it by 0.5% after 30 minutes, twice at most — a maximum of 6% for the day, or 1,073.14 on the upside.

Chapter 3 carries the product design under "Interest Rate Futures based on Corporate Bond Index", and Chapter 6's price limit table (section 6.5) carries the 5% band. The numbers are the question: how many issuers minimum, what single-issuer cap, what group and sector caps and who is excluded from them, what minimum track record, what minimum contract value, when does it expire and against what is it finally settled.

It also appears in the position-limit material in Chapter 7, and as the standard illustration of why a G-sec hedge on a corporate portfolio leaves residual risk.

• AA+ and above, not AAA only. The rating floor admits AA+ paper.
• The 25% group and sector caps exclude PSUs, PFIs and PSBs. A question that puts a public sector issuer over the cap is testing that exclusion.
• Rs 2 lakh is a floor at introduction, not a fixed lot value. Exchanges review contract value or lot size half-yearly.
• The price band starts at 5%, against 3% for GOI bond futures and 1% for 91-day T-bill futures. Two 0.5% expansions take it to 6%, not to 7%.
• Final settlement is the index closing price on expiry — not a two-hour weighted average from NDS-OM, which is the rule for single-bond futures.
• Tenure runs up to 3 years, and the cycle can include weekly and half-yearly contracts, which no other IRF contract offers.
• Hedging a corporate portfolio with GOI bond futures leaves credit-spread basis risk; CBIF reduces it but cannot remove it, because an index is still not your portfolio.