INTEREST RATES
Understanding Eurodollar Futures
FEBRUARY 14,2013
John W.Labus zewski
Michael Kamradt
David Gibbs
Managing Director
Executive Dire ctor Directo r
Research&Product Development 312-466-7469 Interest Rate Products 312-466-
7473
Product Marketing 312-207-2591
CME Eurodollar futures have achieved remarkable success since their debut inDecember 1981.Much of this growth may directly be attributed to the fact thatEurodo llar futures represent fundamental building b lo cks o f the interest rate marketp lace.Indeed, they may be deployed in any number of ways to achieve diverse objectives.
This article is intended to provide an understanding regarding how and whyEurodollar futures may be used to achieve these diverse ends.We commence with somebackground on the fundamental nature of Eurodollar futures including a discussion ofpricing and arbitrage relationships.We move on to an explanation of how Eurodollarfutures may be used to take advantage of expectations regarding the changing shape ofthe yield curve or dynamic credit considerations.
Finally,we discuss the symbiotic relationshipbetween Eurodo llar futures and over-the-counter
(OTC interest rate swap s (IRS. In particular,Eurodo llar futures are o ften used toprice and to hedge interest rate swaps with good effect.
Pricing and Quotation
Eurodo llar futures are b ased on a$1 million face-value,3-month maturityEurodollar Time Deposit.They are settled in cash on the 2nd London bank business dayprior to the 3rd Wednesday of the contract month by reference to the British Banker’s
Association(BBA Interest Settlement Rate forthree-month Eurodollar Interbank Time Depo sits.
These contracts mature during the months o f March,June,Septemb er,or December,extending outward 10 years into the future.However, the exchange also offers“serial”contract months in the four nearby months that do not fall into the March quarterly cycle.See Table 1 below for contract specifications.
Where once trading was largely conducted on the floor of the exchange usingtraditional open outcry methods during re gular daylight hours–today, trading activity islargely conducted on the CME Globex®electronic trading platform on nearly an aroundthe clockbasis.
These contracts are quoted in terms of the“IMM index.”1 The IMM index is equalto 100 less the yield on the security.
=100.000−
E.g., if the yield equals 0.750%, the IMM index is quoted as 99.250.
=100.000−0.750%=99.250
Ifthe value of the futures contract should fluctuateby one basis point(0.01%, this equates to a$25.00 movement in the contract value.This maybe confirmed by calculated the basis point value
(BPV of a$1 million face value,90-day money market instrument into the followingformula.=#0.01%=$1,000,000#0.01%=$25.00
The minimum allowable price fluctuation,or“tick”size, is generally established at one-half ofone basis point,or 0.005%.Based on a$1 million face-value 90-day instrument, this equates to$12.50.However, in the nearbyexpiring contract month, the minimum price fluctuation is set at one-quarter basis point,or 0.0025%,equating to$6.25 per contract.
1
The IMM,or International Monetary Market,wasestablished as a division of the CME many years ago.
The distinction is seldom made today because CMEoperates as a unified entity,but re ferenc es to IMMpersist today.
500,000
1,000,000
1,500,0002,000,0002,500,0003,000,000
3,500,000
4,000,0002000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Eurodo llar Average Daily Vo lume
Futures Options
As seen in Table 2 below,March 2014 Eurodollar futures advanced by 1.5 b asispoints on January 30,2013 to settle the day at a price of 99.49.Noting that each basispoint is worth$25 per contract based on a$1 million 90-day instrument, this implies anincrease in value of$37.50 for the day.
Shape ofYield Curve
Pricing patterns in the Eurodollar futures market are very much a reflection ormirror of conditions prevailing in the money markets and moving outward on the yieldcurve.But before we explain how Eurodollar futures pricing patterns are kept in lockstepwith the yield curve, let us consider that the shape of the yield curve may be interpretedas an indicator of the direction in which the market as a whole believes interest rates mayfluctuate.
Three fundamental theories are referenced to explain the shape ofthe yield curve–(1 the expectations hypothesis; (2 the liquidity hypothesis;and, (3 the segmentationhypothesis.
Let’s start with the assumption that the yield curve is flat. I.e., short-term andlonger-term interest rates are equivalent and investors are expressing no particularpreference for securities on the basis of maturity.The expectations hypothesis modifiesthis assumption with the supposition that rational investors may be expected to alter thecomposition of their fixed-income portfolios to reflect their beliefs with respect to thefuture direction o f interest rates.
Thus, investors move from long-term into short-term securities in anticipation ofrising rates and falling fixed-income security prices,noting that the value of long-terminstruments reacts more sharply to shifting rates than short-term instruments or by
moving from short-term into long-term securities in anticipation of falling rates and risingfixed-income prices.
Yields expected to rise Yield curve is steep
Yields expected to fall Yield curve is flat or inverted
In the process of shortening the maturity of one’s portfolio, investors bid up theprice of short-term securities and drive down the price of long-term securities.As a result,short-term yields decline and long-term yields rise- the yield curve steepens. In theprocess of extending maturities, the opposite occurs and the yield curve flattens or inverts.
2
The liquidity hypothesis modifies our initial assumption that investors may generallybe indifferent between short-and long-term investments in a stable rate environment.Rather,we must assume that investors generally prefer short-over long-term securities tothe extent that short-term securities roll over frequently,offering a measure of liquidityby virtue of the fact that one’s principal is redeemed at a relatively short-term maturityd ate.
As such, long-term securities must pay a liquidity premium to attract investment,and long-term yields typically exceed short-term yields,a natural upward bias to theshape of the curve.
Finally, the segmentation hypothesis suggests that investors may be less than fullycapable of modifying the composition oftheir portfolios quickly and efficiently in order
to take advantage of anticipated yield fluctuations. In particular, investors sometimes faceinternally or externally imposed constraints: the investment policies of a pension
2 Although these observations are generally true, they may not be absolutely true.
E.g., the Fed had been pushing short-term rates higher in early 2005 while longer-termrates remained relatively stable.As such, the yield curve was in the process of flatteningwhile many analysts still expected the Fed to continue tightening.
0%
1%
2%
3%
4%
5%
6%
3
-
Mth
6
-
Mth
1-
Yr
2-
Yr
3-
Yr
5
Yr
全球领先的IDC服务商华纳云“美国服务器”正式发售啦~~~~此次上线的美国服务器包含美国云服务器、美国服务器、美国高防服务器以及美国高防云服务器。针对此次美国服务器新品上线,华纳云也推出了史无前例的超低活动力度。美国云服务器低至3折,1核1G5M低至24元/月,20G DDos防御的美国服务器低至688元/月,年付再送2个月,两年送4个月,三年送6个月,且永久续费同价,更多款高性价比配置供您选择。...
捷锐数据官网商家介绍捷锐数据怎么样?捷锐数据好不好?捷锐数据是成立于2018年一家国人IDC商家,早期其主营虚拟主机CDN,现在主要有香港云服、国内物理机、腾讯轻量云代理、阿里轻量云代理,自营香港为CN2+BGP线路,采用KVM虚拟化而且单IP提供10G流量清洗并且免费配备天机盾可达到屏蔽UDP以及无视CC效果。这次捷锐数据给大家带来的活动是香港云促销,总共放量40台点击进入捷锐数据官网优惠活动内...
DiyVM是一家低调国人VPS主机商,成立于2009年,提供的产品包括VPS主机和独立服务器租用等,数据中心包括香港沙田、美国洛杉矶、日本大阪等,VPS主机基于XEN架构,均为国内直连线路,主机支持异地备份与自定义镜像,可提供内网IP。最近,商家对香港机房VPS提供5折优惠码,最低2GB内存起优惠后仅需50元/月。下面就以香港机房为例,分享几款VPS主机配置信息。CPU:2cores内存:2GB硬...