Eurodollar futures are interest-rate-based financial futures contracts that are particular to the Eurodollar, which is basically a US dollar held in commercial banks outside of the US. Eurodollar futures have evolved into one of the world’s most popular and inventive contracts, with unrivaled flexibility and adaptability, since their inception in the early 1980s.
What exactly is the distinction between a dollar and a Eurodollar?
Eurodollars are not to be confused with the euro, the European Union’s official currency. A eurodollar is not the same thing as a euro. Any United States dollar (“US dollar”) stored outside the US financial system is referred to as a eurodollar.
What is the structure of the Eurodollar market?
The Euro-dollar market is a loan and borrowing market for the world’s most important convertible currencies, based primarily in Europe. The currency generally dealt in is the dollar, but the market also deals in such significant European currencies as the pound sterling, the Swiss franc, the deutsche mark, the Netherlands guilder, and the French franc. Commercial banks are the professional participants, however merchant banks, private banks, and some investment banking businesses are also included.
Official monetary institutions, other government organizations, banks, industrial and commercial enterprises, and private individuals possess funds that flow into the market from 40 or 50 countries on all continents. A huge number of countries, including Japan and the United States, receive funds for investment. Commercial banks in London, Paris, and other European cities are the primary intermediaries or dealers in the Euro-dollar market, and they “make” the market by accepting Euro-dollars as time deposits (a few banks have also been willing to issue negotiable certificates of deposit since June 1966) or by making loans or investments in Euro-dollars. These transactions are common in the market because they are conducted in big amounts, often $1 million or more, and at competitive interest rates.
The Euro-dollar market attracts funds by offering higher rates of interest, greater maturity flexibility, and a broader range of investment attributes than other short-term capital markets; the market also attracts borrowers by lending funds at relatively low rates of interest. As a result, it provides a financial service by acting as a middleman between fund owners and potential borrowers. Because the banks and other firms that use it are well-known, the transactions are for large sums, and the dealings are highly competitive, the market functions at a low cost. Depositors and borrowers benefit from the reduced costs since they have a competitive edge.
However, this explanation neglects to include one feature of the market that distinguishes it from others: the fact that transactions in each currency take place outside of the country from which it originated. The Eurodollar market refers to the dollar market outside of the United States, not to the origin or character of the dollars being traded. As a result, the Euro-dollar market in, say, London, is dominated by rights to dollar deposits, i.e., dollars placed in US banks. Similarly, the Euro-sterling market refers to the sterling market outside of the United Kingdom.
The Euro-dollar market (to use this common term to refer to all external markets in all major convertible currencies) is inextricably linked to the vast network of arbitrage transactionsthat is, transactions designed to profit from differences in exchange rates and interest rates among trading centers. Banks can borrow dollars, swap them for dollars, and then lend dollars; or they can borrow dollars, switch them for deutsche mark, and then lend deutsche mark. Eurodollar transactions primarily concern the transfer of funds from an initial owner to a final borrower, but they also have an impact on the level of interest rates in various nations for funds lent for as little as one day or as long as 18 months. They also have an impact on the major convertible currencies’ exchange rates, as well as the relationship between the rates provided for current money (spot rates) and the rates offered for the same currency on specific future dates (forward rates). All of these other components of the worldwide financial market are affected by Eurodollar operations, but they are not determined by them. The market’s components are all interconnected, and they’re all arbitraged in all directions.
What is an example of Eurodollar?
U.S. dollars deposited in foreign banks are referred to as Eurodollars. Assume that someone deposits $5,000 in a Brazilian bank account. Eurodollars are the currency in question. It’s also known as eurocurrency because it’s money issued by one government and deposited in a separate country’s account. If someone deposited 5,000 Mexican pesos at the same Brazilian bank, the money would be treated as eurocurrency, but not as eurodollars. As “dollar” is the nickname for US cash, eurodollars only refer to US dollars that have been deposited in another country.
What distinguishes Eurodollar futures from Fras?
The margining of Eurodollar futures versus a FRA product. In comparison to a FRA, the cash flows paid out over the life of a futures contract. The clearinghouse marks futures to market every day, whereas cash flows in a FRA are paid off differently.
When you buy a Eurodollar futures contract, are you locking in a price?
The Eurodollar futures contract, which is traded on the Chicago Mercantile Exchange, is a financial futures contract based on these deposits (CME). EuroDollar futures contracts, in particular, are derivatives on the interest rate paid on those deposits. A Eurodollar futures contract is a cash-settled futures product whose price swings in tandem with the LIBOR interest rate. Eurodollar futures allow businesses and banks to lock in an interest rate on money they want to borrow or lend in the future. The notional or “face value” of each CME Eurodollar futures contract is $1,000,000, while futures leverage allows one contract to be traded with a margin of around $1,000.
The market’s prediction of the 3-month USD LIBOR interest rate expected to prevail on the settlement date determines the price of CME Eurodollar futures. An interest rate of 100.00 – 95.00, or 5%, is implied by a price of 95.00. A contract’s settlement price is defined as 100.00 less the official British Bankers’ Association 3-month LIBOR fixing on the day the contract is settled.
What is the significance of the Eurodollar?
One of the world’s most important international capital markets is the eurodollar market. They need a continual stream of depositors who are willing to put their money in foreign banks. If the supply of deposits falls, these eurodollar banks may face liquidity issues.
How do Eurodollar futures contracts work?
Eurodollar futures, on the other hand, are settled in cash. If there is a profit, buyers and sellers of Eurodollar futures contracts who retain their contracts until final settlement will be awarded the cash difference between what they bought for the contract and what they sold it for.
Who are the Eurodollar market’s participants?
Large corporations, particularly international firms, commercial banks, and central banks are the primary lenders in the Euro-dollar market. Commercial banks are the most common intermediaries, whereas end borrowers of all economic and institutional stripes borrow in the market.
What is the Eurodollar exchange rate?
LIBOR rate is another name for it. This rate is the same as the Eurodollar base rate, but it has been changed to account for the maximum reserve requirements that lenders must meet on their Eurodollar deposits.
Is the Eurodollar LIBOR equivalent?
The interest rate offered on U.S. dollar-denominated deposits held in banks outside the United States is reflected in the price of eurodollar futures. The price represents the market estimate of the 3-month US dollar LIBOR (London Interbank Offered Rate) interest rate expected on the contract’s settlement date. LIBOR stands for London Interbank Offered Rate, which is a benchmark for short-term interest rates at which banks can borrow funds. Eurodollar futures are a LIBOR-based derivative that represent the London Interbank Offered Rate (LIBOR) for a three-month $1 million offshore deposit.