Derivative markets rank among recent years' big innovations in national and international financial markets. Derivatives were designed as a buffer against price and interest rate fluctuations, with specific products developed as a hedge against public debt portfolio risk. The first such market in Spain, OM Ibérica, came into being in 1989 and made way for MEFF Renta Fija, started up in 1992 as the official market for public debt futures and options. This Barcelona based market channels the trading, clearing and settling of all Treasury security futures and options contracts. MEFF is electronically run, with members feeding buy and sale orders through a central processing unit, which stores, matches and executes them.
Market Members can be of various types:
- 1. Clearing members: authorised to trade and settle on their own behalf, as well as on behalf of their clients and other members.
- 2. Clearing and custodian members: authorised as above, but also acting as depositories or custodians of the margin posted to cover of market transactions.
- 3. Non clearing members: intermediaries trading on their own behalf or on their clients' behalf, but who need to settle via a clearing member.
In addition, for each contract traded there are a set number of Market Makers whose task is to give depth and liquidity to the markets.
One particular characteristic of MEFF Renta Fija is that the margin -updated daily- that agents must post is calculated by the Clearing House with regard to their net position, i.e. offsetting futures and options operations, and is correspondingly lower.
Government Debt Futures
A futures contract is a forward contract agreeing the sale/purchase of an asset at a prearranged price on a stipulated future date. One essential characteristic of futures contracts is that they are traded on organised markets and that practically all contract features are standardised, except for the price of the operation which is obviously open to negotiation. Markets have a Clearing House which matches transactions -ensuring a counterparty-, tracks the daily evolution of trading in a process known as mark to market, and requires contracting parties to post margin (initial and daily adjustments).
At present, Future contracts on spanish Goverment Debt are only available for 10-year bonds. In this contract, the underlying asset is a notional bond theoretically issued at face value on the contract expiry date, and with an annual coupon of 4%. The securities deliverable on expiry are the Obligaciones del Estado appearing on the list drawn up by MEFF Renta Fija. Generally speaking, each expiry requires the delivery of all the 10-year Obligaciones del Estado issued at the auction held the month of the first due date, as well as all those Obligaciones del Estado originally issued for a ten-year term which, on the delivery date of the corresponding maturity, have a residual lifetime equal to or greater than seven years, six months. In issues including an early redemption clause, the date of this option will be taken as the redemption date. Also deliverable will be Obligaciones del Estado issued for terms longer than 10 years, provided certain conditions are met (to do with their residual life, outstanding amount and trading). Futures on 30-year bonds: the underlying asset is a notional bond theoretically issued at face value on contract expiry date, and with an annual coupon of 6.50%. The securities deliverable on contract expiry are Obligaciones del Estado having a residual lifetime equal to or greater than fifteen years on the corresponding date.
Futures on a basket of European 10-year sovereign bonds (DEBS): the underlying asset is a synthetic bond based on the issues of the four biggest sovereign debt issuers in the euro zone. The basket comprises 30% German debt, 30% French debt, 20% Italian and 20% Spanish. The references selected are the most liquid, and the maturities the nearest existing to 10 years within each country's interest rate curve.
Government Debt Options
An options contract is one in which the buyer of the option acquires the right (not the obligation) to buy (call option) or sell (put option) an asset at a future date at a previously stipulated price (strike price). In return for this right the buyer pays a premium (option price), limiting his exposure to the corresponding amount. The seller of the option undertakes to buy or sell the underlying asset if the counterparty exercises his option, and accordingly assumes a greater risk.
At presetn, option contracts on Spanish Debt are only available on the 10-year future. In this contract, the underlying is the 10-year futures contract. Expiry is monthly (January, Frebruary, April, May, July, August, October and November) and the option is American.