Spread bettors can make a lot of money out of betting on interest rates, and there are different ways to do this. Some spread betting providers actually allow you to place a spread bet on the official interest rate, and one of the financial instruments for this is called the short sterling future, which is often bet at three months out, that is betting on what the interest rate will be in three months’ time.
When you ask your broker for a spread bet quote on the interest rate, you could be confused by the numbers you receive. Interest rates are quoted on the basis of 100 minus the rate, for instance if the rate is 4% then the quote will be 96. You will receive two quotes for the spread bets, and can decide whether to go long or short, bearing in mind that this system reverses the bet. If you believe the interest rate will increase, then the quote from your spread betting broker will reduce – for an interest rate of 5%, the quote would be 95.
But another way of betting on interest rates is to look at the impact of them on foreign exchange and the price of currency. In foreign exchange, there are many factors that can affect the relative values of money, but an obvious and fairly reliable one is the interest rate that you can obtain if you invest your money in a particular country, or currency. If banks are offering a higher interest rate in the USA than in the UK, this will encourage investors to hold more dollars, as the ROI will be better.
For effective trading, you need to look at changing markets and values, and this means that you need to follow the news closely and anticipate any changes in a country’s economy that will cause interest rates to be adjusted. As is typical with the markets, even if you watch the news you may find that the change has been anticipated and already priced into the currency by the time the announcement is made. You’ll need to use observation and judgment to determine if there is an effective trading opportunity.
Finally, it’s also possible to spread bet directly on long-term interest rates by trading on government bonds. As these are sold as fixed rate of return investments, the value of them varies in accordance with the current market interest rates on offer.
For instance, if interest rates are falling, a fixed rate bond becomes more attractive, and therefore the value of it increases above the face value. The market tends towards equalizing the return from safe investments in different financial instruments, so you must pay more for a bond that earns more. If you think that interest rates on the free market are going to increase, then government bonds, despite the security of government backing, will fall in value. Money will be diverted towards the higher interest bearing accounts.
An example would be great again I think:
We believe that interest rates in the US will fall and therefore the US T Bonds will rise as result. So we decide to go LONG on the US T Bond March Contract.
Now I don’t want to freak you out here, but T Bonds are quoted in fractions – no I don’t like it either. So we get a quote of 98-20; which works out as 98 & 20/32nds We get a quote of 98-17/98-23 so we go LONG at 98-23 @ $10 per point.
The interest rates fall, T Bonds rise in value and we sell at the quote of 101-11/101-17 closing the trade at the sell to close point of 101-11. Working our profit out is simple:
- Opening Price: 101-11
- Closing Price: 98-23
- Profit 84 32nds = 84 x $10 = $840
As you can see, there are several ways in which you can spread bet on interest rates. All you need to do is follow the news and get ahead of the announcements to exploit them for your profit.