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 Eurodollar currency?
The phrase eurodollar refers to deposits in US dollars held by foreign banks or American bank branches abroad. Eurodollars are not subject to Federal Reserve Board regulation, including reserve requirements, because they are stored outside the United States. Dollar-denominated deposits that were not subject to US banking laws were virtually exclusively held in Europe at first (hence, the name eurodollar). They’re now extensively held in branches in the Bahamas and the Cayman Islands, as well.
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 dollar is the most commonly traded currency, but the market also deals in key European currencies such as the pound sterling, Swiss franc, deutsche mark, Netherlands guilder, and 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 low costs because they have a competitive advantage.
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.
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.
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.
The Eurodollar market is regulated by who?
Eurodollar deposits are unrelated to foreign exchange rates, despite their name. Eurodollars are unsecured US dollar deposits kept in banks or bank branches outside the US. Although dollar deposits are now transacted in all major global financial centers, they are still referred to as Eurodollars. The Eurodollar market began in Europe after World War II. In the Eurodollar market, money market funds, businesses, foreign central banks, and other government accounts are all active lenders.
Despite the fact that Eurodollar deposits are held by institutions outside the United States by definition, there is a vibrant market for Eurodollar deposits within the United States, particularly in New York City. By accepting Eurodollar deposits through offshore branches and then transferring the funds onshore, U.S. depository institutions and U.S. branches of foreign banks (FBOs), which we will collectively refer to as U.S.-based banks, indirectly borrow in Eurodollars. Banks established in the United States accept Eurodollar deposits mostly through their Caribbean operations (usually located in the Bahamas and the Cayman Islands). While these deals are booked abroad, the transactions are usually arranged by traders in the United States, and the revenues are frequently used to fund operations in the United States.
Domestically, U.S.-based banks can accept Eurodollar deposits through international banking facilities (IBFs). Due to regulatory restrictions on IBFs, Caribbean Eurodollar activity is estimated to be substantially larger than IBF Eurodollar activity. For example, IBFs can only accept Eurodollar deposits from foreign institutions, and foreign corporate depositors are subject to extra limitations. Branches of US banks in the Caribbean, on the other hand, can accept deposits from US institutions and have no limits on foreign corporate depositors.
Eurodollars and fed funds are controlled in the same way as the United States. Fed funds are excluded from reserve requirements under Regulation D. Although the Fed has the authority to impose reserve requirements on net Eurodollar deposits held by US-based banks, it has done so since 1990, effectively treating Eurodollars as fed funds. As a result, U.S. banks consider fed funds and Eurodollars to be close alternatives for funding. Fed funds, on the other hand, can only be lent by depository institutions, government-sponsored enterprises, and a few other qualifying entities, whereas Eurodollar deposits can be invested by a wider range of institutions.
Rates and Volumes in the U.S.-Brokered Eurodollar Data
As a significant overnight funding market for U.S.-based banks, the Fed monitors and analyzes the Eurodollar market. The Fed has long gathered fed funds data from U.S.-based brokers, and in 2010, it began collecting Eurodollar data from the same brokers. The overnight brokered Eurodollar market is three to four times greater than the overnight brokered fed funds market, according to these figures. In the last year, the average daily volume of Eurodollars borrowed overnight through brokers was over $140 billion, and the quantity is pretty consistent from day to day, with the exception of quarter ends.
The majority of borrowing in the brokered Eurodollar market happens near the volume-weighted median rate, as seen in the chart below, with more than 80% of daily volumes falling within one basis point. In contrast to the fed funds market, where certain institutions borrow at considerably higher than average rates, above the interest rate provided by the Fed on excess reserves, there isn’t normally much borrowing at either end of the distribution. This disparity is most likely due to the fact that smaller institutions often do not have access to the Eurodollar market and instead borrow from other banks in the fed funds market.
Because Eurodollars and fed funds are close substitutes as funding sources, their rates, as calculated from brokered transactions data, usually follow each other closely (see chart below). The volume-weighted median Eurodollar rate has been around one basis point higher than the volume-weighted median fed funds rate in recent weeks. Different borrowers and lenders engaged in the two markets produce minor variances in the median rates; at times, like as during the financial crisis, these disparities can be more noticeable.
Eurodollar Data in the FR 2420
The FR 2420 Report on Selected Money Market Rates, which includes statistics on transaction-level borrowing in fed funds, Eurodollars, and certificates of deposit, was launched by the Fed in April 2014. These statistics are gathered directly from banks that borrow in Eurodollars and, as a result, include both broker-assisted transactions as well as those arranged directly between two parties. Currently, the FR 2420 only covers a small portion of US-based Eurodollar depositsthat is, only offshore borrowing by US depository institutions, not by US-based FBOs or IBFs.
The Fed recently suggested revisions to the FR 2420 that would expand its Eurodollar market coverage. Ninety-four US depository institutions and seventy-eight FBO branches are expected to make up the suggested panel of banks. Furthermore, FBOs with U.S. branches would be obliged to record Eurodollar borrowing by offshore branches they directly manage and control. All reporting institutions would be required to include their IBFs’ Eurodollar borrowings. By capturing a bigger share of Eurodollar activity, the proposed adjustments to the FR 2420 data, which are scheduled to be adopted later this year, will provide additional insight into the U.S.-based Eurodollar market.
The new overnight bank funding rate will be calculated using the amended FR 2420 data. Because it will be calculated on both fed funds and U.S.-based Eurodollar transactions, this new rate will have a bigger transaction base than the fed funds effective rate. As a result, it will supplement the fed funds rate by providing a comprehensive gauge of overnight funding costs for US-based institutions.
The writers’ opinions are their own and do not necessarily reflect those of the Federal Reserve Bank of New York or the entire Federal Reserve System. The authors are responsible for any errors or omissions.
What is the origin of Eurodollars?
Eastern European countries seeking to hold dollar deposits outside of the United States put them in European banks in the early 1960s, giving rise to the moniker. Later, numerous non-European countries joined the market. A bank receives a balance with a United States bank when it accepts a Eurodollar deposit.
What role may eurocurrencies play in increasing foreign bond demand?
The main advantage of eurocurrency markets is their increased competitiveness. They can simultaneously offer borrowers reduced interest rates while charging lenders higher interest rates. This is primarily due to the fact that eurocurrency markets are less controlled.
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.