Chapter 6: Trading Mechanism in Exchange Traded Interest Rate Derivatives **NISM Series IV — Interest Rate Derivatives | ~8% weightage | ~32 questions**

What this chapter is about

Same structure as Series VIII CH6 and Series I CH6. Order types, trading members, price bands, position limits, quantity freeze. IRD-specific: price range for bonds/T-bills, minimum age 21 for trading member, SPAN margining applied client-by-client, and proprietary position netting at trading member level.

Market participants in IRD trading

**Trading Members (TMs):** Members of the Exchange. Can EXECUTE trades only (not settle unless also a clearing member). Can trade for own account + clients.

**Clearing Members:** Members of Clearing Corporation. Can clear and settle trades.

**Trading-cum-Clearing Member:** Member of both Exchange and Clearing Corporation. Can execute AND settle trades including for other TMs.

**Professional Clearing Member (PCM):** Member of Clearing Corporation ONLY. Cannot execute trades. Can ONLY clear and settle trades of other TMs.

**Key rule:** - Trading Member = executes trades only - PCM = settles trades of other TMs only (cannot execute) - TCCM = both executes and settles

**Minimum age for individual trading member:** 21 years (per Securities Contracts (Regulation) Rules, 1957)

Order types — same as other modules

**Limit price order:** Buy at or below / Sell at or above specified price. Executes at favorable price.

**Market order:** No price specified. System determines price. Price-related condition.

**Stop Loss order:** Has a trigger price. Activated when market reaches trigger. - Stop Loss Buy: trigger price is HIGHER than current market offer price - Stop Loss Sell: trigger price is LOWER than current market bid price - Stop Loss order (without limit) = more likely to execute than Stop Loss Limit order

**IOC (Immediate or Cancel):** Execute immediately or cancel. Partial execution allowed.

**Day order = Good Till Day (GTD):** Valid for the day. Auto-cancelled at EOD if unexecuted.

**Good Till Cancelled (GTC):** Valid until cancelled.

**Passive orders:** Unmatched orders sitting in the order book. Active orders = incoming orders seeking to match.

**Order priority:** Best price first. Same price → earlier time priority. Buy = highest price first; Sell = lowest price first.

Position limits

**Definition:** Maximum exposure levels for the entire market, trading member, and each client.

Position limits are set at: - Client level - Trading member level - Exchange/market level

**Netting of positions:** - Client positions: Long and short in SAME underlying CAN be netted (3 short) - Client A and Client B positions: CANNOT be netted across clients (added separately) - Proprietary long and short: netted at trading member level

**Example from exam:** - TM Client A: net long 12 | TM Client B: net short 10 - TM reports: long 12 AND short 10 separately (cannot net across clients) - TM's own proprietary: can net (buy 6, sell 9 = net short 3)

Price bands and operating ranges

**Price range = specified percentage above AND below base price**

For exchange-traded IRDs: - The exchange can further tighten (reduce) the range set by SEBI regulations - Cannot widen (dilute) beyond SEBI's specified range

**Example:** If SEBI says max 1%, exchange can set 0.5% but NOT 2%.

**Overnight MIBOR futures:** Operating range = ±5% of base rate

**Quantity Freeze:** - NOT a limit on trade size - A check to prevent erroneous (accidental) order entry - Orders above Quantity Freeze require TM to separately confirm to Exchange that order is genuine - TM must confirm the order is without errors before it executes

SPAN Margining

**SPAN = Standard Portfolio Analysis of Risk**

SPAN considers the entire portfolio of an investor for computing portfolio-wide margin requirements.

**Applied between:** Trading Members and their CLIENTS (not at CC-clearing member level)

**Margins collected on:** Client-by-client basis. Netting between clients NOT allowed for margin collection.

**Contract-level minimum margin:** - Same for all the days of a contract - Different for T-bills vs G-Sec bonds - Same for all G-Sec bond futures (regardless of 6Y, 10Y, 13Y)

**T-bill futures initial margin:** VaR (99%, 1-day), minimum 0.10% on first day, 0.05% thereafter

**G-Sec bond futures initial margin:** VaR (99%, 1-day), minimum 2.8% on first day, 1.5% thereafter

Risk management — broker level

**90% collateral utilization = risk reduction mode** When broker's collateral utilization hits 90%, all unexecuted orders are automatically cancelled.

**Delivery versus Payment (DvP):** Settlement method that eliminates settlement risk. Both parties simultaneously exchange cash and security — if one fails, other withholds.

**Value at Risk (VaR):** Maximum likely price change over a given horizon at a given confidence level. - VaR (1 Day, 99%) of Rs 17 = In the next 1 day, loss will NOT exceed Rs 17 in 99 out of 100 days.

Trap Alert

**Trap 1: "PCM can execute and settle trades" — FALSE** PCM can ONLY settle trades of other TMs. Cannot execute any trades.

**Trap 2: "Client positions can be netted across clients" — FALSE** Client A long 12 + Client B short 10 must be reported separately as long 12 AND short 10.

**Trap 3: "Quantity Freeze = maximum trade size limit" — FALSE** Quantity Freeze is a check against erroneous entries. Not a hard limit. Orders above it just need explicit confirmation.

**Trap 4: "Exchange can widen SEBI's price range" — FALSE** Exchange can only TIGHTEN, not widen, the regulator's prescribed range.

**Trap 5: "SPAN margin is applied between CC and clearing members" — FALSE** SPAN is applied between TMs and their CLIENTS.

**Trap 6: "T-bill and bond futures have same minimum margin" — FALSE** Different: T-bills = 0.10%/0.05% | Bonds = 2.8%/1.5%

Must-remember rules

• TM = execute only | PCM = settle only | TCCM = both
• PCM cannot execute any trades
• Minimum age for individual TM = 21 years (not 18)
• Client positions: netted individually but not across clients
• Proprietary positions: netted at TM level
• Price range: exchange can tighten but NOT widen SEBI limits
• Quantity Freeze = error check (not a hard limit)
• 90% collateral utilization = all unexecuted orders cancelled
• SPAN applied: TM-client level (not CC-clearing member level)
• VaR (1D, 99%) = maximum loss not exceeded in 99 of 100 days
• DvP = eliminates settlement risk (simultaneous exchange)
• T-bill minimum margin: 0.10% first day, 0.05% thereafter
• Bond minimum margin: 2.8% first day, 1.5% thereafter

Quick revision — 60 second scan

• TM: execute | PCM: settle only | TCCM: both
• Min age 21 for individual TM
• Client positions: net each client separately, add across clients (don't net across)
• Proprietary: net at TM level
• Best price priority → time priority
• Quantity Freeze = error check, not limit
• 90% collateral → cancel all pending orders
• SPAN = TM to clients | VaR = max loss at confidence level
• Exchange can tighten but not widen SEBI's price range