1. What is it?
DI futures, or futures from interbank loans and deposits, are the main asset traded in BMF&Bovespa, as the benchmark rate stands as one of the main economic fundaments, and influences the moves in other assets and derivatives, even cash buyer or future contracts.
As we know, interbank loans and deposits correspond to a rate applied in loans and capital raises exchanged between banks and other financial institutions, in order to balance their cash daily to meet Central Bank’s requirements for reserves and savings.
To improve the risk management tools, BM&F startd trading the DI futures in June 1991, which quickly became one of the most innovative derivatives in Brazil.
The object of a DI future is the interest tax rate until the expiry date, based on cumulative daily DI rates, calculated between the date of the operation (in the future market) and the last trading date. These contracts show market perspectives for the interest tax rates in a period. As interest rates are an abstract object, there is no physical delivery, but such instrument allows the investor to execute different strategies together with other assets, as well as hedging operations. Remember that for a contract expiring in April, you’ll be operating with the interest rates of the previous month, March in this case.
DI futures are crucial for managing fixed income portfolios. Their main function is to hedge them against interest floats. Thus, we can rely on two different hedging strategies:
Post fixed rates versus pre fixed rates: if an investor or company has debts with post fixed interest rates and the scenario points to a hike in those rates, it is recommendable to sell a DI future contract. This way, if interest rates increase, confirming the trend, debts would not be affected anymore, once the investor converted post fixed rates to pre fixed ones. However, DI future expiry date must be the same than the debt.
Pre fixed rates versus post fixed rates: if an investor or a company has debts with pre fixed interest rates, he could buy a DI future, earning from a drop in interest rates.
Also, DI futures can be used to market lifting and speculating.
2. Characteristics
Terminology
DI futures terminology follows a pattern:
1. DI futures code is DI, for instance “DI1”.
2. The letter corresponds to the expiry month, as follows:
Month | Letter |
January | F |
April | J |
July | N |
October | V |
*International Standards
3. Expiry year.
Example: For a DI future expiring by January 2014, we would have the following code:
DI1 F 14
Unit price (PU)
Deals with DI futures follow the annual interest tax rates, based on 252 work days, with up to three decimal places. After a trading day, deals are converted to a unit price (PU), that indicates the reverse position held by an investor:
– A purchase of a DI1 future (dealt in interest rates) will be transformed into a sold position in DI1 contract (in PUs).
– In case of a sale of a DI1 future (dealt in interest rates), it will be transformed into a bought position in DI1 contract (in PUs).
So, the volume of PUs in a contract is then multiplied by the value for a PU unit. Each DI future represents the amount of BRL100,000.00 minus DI average rates, counting from the trading date until the expiry date. This is an operation based in expectations about interest rates. And as a PU unit is worth BRL1.00, such contract will be always valued at 100,000 PUs by the expiration date.
Thus, we can use the formula to calculate the unit price:
PU = ___100.000___
(1 + i/100) n/252
Given:
i = interest rates for the operation
n = number of days between the operation and the expiry date of the contract.
Remind that the PU value changes inversely to the interest tax rates, so the higher the interest rates become, the lower the PU will be and vice-versa.
Day trade
It is possible to close a day trade (buying and selling futures with same expiry date in a same day) of DI futures. However, a day trade is forbidden if happening in the day that the contract expires.
Daily settlement
The daily settlement is nothing more than a mechanism used by BMF&Bovespa to balance the investor accounts. As futures change in a daily basis, generating credits or debts, investors are daily updated on their positions, earning or losing as prices change – in other words, they either get their profits or pay for their losses daily. The mechanism is a protection against any noncompliance among investors.
For DI contracts, the daily change is subject to the following criteria:
1. Converted positions:
When buying and selling operations are hired originally over interest rates, they will be then converted to PU values.
2. Daily adjustment:
Once operations are PU indexed, they will be updated based on daily prices, according to the stock exchange rules. The daily adjustment will occur until the expiry date.
If daily adjustments are positive, and will be credited to PU buyers and deducted from PU sellers. If the adjustment is negative, the opposite happens.
By the expiration date, adjustments price will be 100,000.
Guaranty margin
It is a value deposited in cash or notes which will covering any noncompliance of an investor in daily adjustments. Usually to operate options, the investor is forced to deposit a guarantee to mitigate risks. The margin is defined by the stock exchange, according to the analysis of the futures market.
The assets accept as guarantee include cash, gold, government or private bonds, letters of pledge and quotes at funds.
Operational costs
There are basically two costs associated to this kind of investment:
Brokerage – it can change depending on the broker. However, most of them use the basic operational fees, stipulated by Bovespa. In this case, costs reach 3% for regular operations and 1.5% for the day trade, based on the theoretical redeem value.
Stock exchange fees – that includes emoluments and registering fees by BM&F. The settlement rate, for example, cost around R$ 0.01166 per contract. The emoluments fees varies with the volume of contracts traded in the last twenty-one sessions, usually being 1% of basic commission rate. Trading involving DI futures contracts with maturity less than 63 days are exempt from the payment of the registration fee. The retention fee costs around R$ 0.0081600 per contract. This amount may be reduced depending on the volume of business involving this contract. Also, ISS tax applies to the service.
Expiration
Expiry dates can be place in any of the four subsequential months after the operation, and then by the beginning of each quarter. The maturity will be the first business day of the delivery month. For instance, a DI traded in February can have the expiry dates placed in March, April, May or June, and then by July, October, or January next year and so on.
Liquidation
By the expiration date, all positions that remain opened, after a last adjustment, wil be financially executed by the stock exchange, by registering the inverse operation of the position held, by the same number of contracts at the price of 100,000 points.
DI Long
In this particular case, instead of dealing with one-day DI contracts, DI Long usually operates projected interest rates for six months as of the expiry date.
That was firstly created to give Tesouro Nacional an instrument to roll over its fixed income debts.
Trading happens in the same way it does for one-day DI contracts, and rules and conditions are basically the same. The only change happens at the contract’s object, which will be the futures for the one-day DI, with expiration date settled for six months ahead of the DI Longo expiry date.
3. Risks and Profitability
Risks and profitability of investing in DI futures are related to the country’s benchmark interest rates, as well as to its future projections. If the investor buys a DI future and the benchmark rises, he loses money. The same happens if he sells a DI future and the benchmark drops.
DI futures are widely used for hedging assets, or protecting investments against interest tax rates changes, but they can also be used for leveraging and speculating on markets.
4. Taxation
Taxes over DI futures follow the same logic of any other variable income investment. Income tax is equal to 15% of the sum of all daily adjustments (if positive) and is charged just when you close a position. Also, income withholding taxes of 0.005% are due over the full amount of gains. If this value is equal to or less than R$ 1.00, this is exempted withholding tax.
For day trade operations, the income tax reaches 20% of profits, and the withholding tax other 1%.
All costs and fees paid for investing can be deducted from the income tax amount, including those from BMF&Bovespa. In case of losses, a compensation can be applied in any gains in the subsequential months, as long as the operations are the same type and operation mode.
The investor himself is responsible for paying all taxes, except when withholding taxes apply – then taxes must be accounted monthly and paid in every subsequential month.
A apuração é realizada ao longo da vigência do contrato e não mensalmente. The calculation is carried out throughout the duration of the contract and not monthly.
5. Example
Let’s say an investor has depository certificates which sum BRL 1 MM, at pre-fixed interest rates of 8.5% a year, for expiring in three months. He expects benchmark rates to hike in the next few days. Hence, he is building a strategy for being protected against that change.
Considering the information below:
Main Information | |
Risk | Increase on interest rate |
Investment | R$ 1.000.000,00 |
Maturity | 90 work days |
Pre-fixed rate | 8,50% |
Cumulative CDI rate | 8,90% |
Work days in the year | 252 |
First step is calculating the PU for the operation, by using the formula:
PU = ___100.000___
(1 + i/100) n/252
Then:
PU = 100.000 / (1 + 8,5/100) ^ 90/252 = 97.128,46
To find the quantity of contracts to be purchased by the investor, it is just divide the CDB (deposit certificate) for the PU. Then:
R$ 1.000.000,00 / 97.128,46 = 10,2956 (10 contract)
To find investor’s losses with the incrase interest rates, it is a matter of calculating what will be the profits from the pre-fixed rates and the same for DI accumulated rates. Then, deducting the first from the latter.
Pre-fixed rates:
R$ 1.000.000,00 * (1+8,5/100)90/252 = R$ 1.029.564,31
DI accumulated rates:
R$ 1.000.000,00 * (1+8,9/100)90/252 = R$ 1.030.918,29
Difference between DI accumulated rates and Pre-fixes rates:
R$ 1.030.918,29 – R$ 1.029.564,31 = R$ 1.353,98
This way, investor’s losses (if he doesn’t hedge his positions against increasing interest rates) will be BRL1,353.98.
However, as the investor bought 10 DI contracts at a 8.90% interest rate, then we have:
97.128,46 * (1+ 8,90/100)90/252 = R$ 131,51
That means the investor is given BRL131.25 per contract, and as he got 10 contract, such value will be times 10.
R$ 131,51 * 10 = R$ 1.351,10
Hence, the investor protects himself against benchmark rates increases, making profits of BRL1,351.10 in the operation, which compensated most of his losses. The value is not exactly the same as the losses he accounted, once the number of contracts is actually low, but he can actually buy as much contracts as he wants.
*In the example, we considered that the benchmark rates increased in a pre-fixed rate in the moment of purchase of the depository receipts.
6. Advantages
- DI futures top advantage is the possibility of hedging and protecting other investments from interest rates ups and downs, provinding more flexibility to turn post fixed assets into pre fixed ones and vice-versa.
7. Disadvantages
- Daily settlement;
- Guarantee margins;
- Income taxes;
- Expiry dates. Thus, you cannot undefinedly hold positions on that, and everytime you want to keep them, you must postpone their expiry dates to a next exercise;
- High risk investment.