when i take a long position in a FRA, i am looking to borrow funds at the specified rate in the FRA.
when i take a long position in an interest rate futures, what am i doing?
“Futures use the inverse relationship between interest rates and bond prices to hedge against the risk of rising interest rates. A borrower will enter to sell a future today. Then if interest rates rise in the future, the value of the future will fall (as it is linked to the underlying asset, bond prices), and hence a profit can be made when closing out of the future (i.e. buying the future).”
the underlying on an “interest rate future” is just a bond, so you’re really just buying a bond future. if interest rates fall, bond prices rise (so the future rises). if interest rates rise, bond prices fall (so the future falls).
The borrower needs funds now. He is paying floating rate , so he will be exposed to interest rates . A rise in rates would cause him to pay more interst in the future periods than in the current period. To protect or hedge against this exposure , he has to take a short position in a security that will pay off when rates rise.
Shorting interest rate futures ( e.g. treasury bond futures ) would give him the short exposure he requires. If rates rise , his payment goes up , but the short futures contract pays off and covers the increased interest payments ( because the futures contract drops in market value, when rates increase , and he is short the contract )
I think bizzle is correct on how an interest rate future works.
However, i don’t think that answers your question because i was confused by exactly the same thing as you.
I believe that an interest rate future does not in any way = FRA. A forward rate agreement is an agreement to pay a future rate. Interest rate futures are inversly related to bond value.
I think market convension came about in this way because otherwise, the market would be buying a future to hedge a bond instead of shorting a future which is the modus operandi to hedge other things. Possibly, it keeps things simpler and cleaner (but that’s just my amateur opinion).