Interest Rates

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Eurodollar Futures Contract

At the same time, eurodollar refers to the financial futures contract based upon these deposits. Traded at the Chicago Mercantile Exchange (CME) in Chicago, each CME Eurodollar futures contract has a notional or 'face value' of $1,000,000, though the leverage used in futures allows one to trade a contract for just hundreds of dollars. Trade in Eurodollar futures is extensive, thus offering uniquely deep liquidity. A purchase or sale is, in effect, a bet on U.S. short-term interest rates. Prices are quite responsive to Fed policy, inflation, and other economic indicators.

CME Eurodollar futures prices are determined by the market’s forecast of the 3-month London Inter Bank Offered Rate (LIBOR). The futures prices are derived by subtracting that implied interest rate (yield) from 100.00. For instance, an anticipated interest rate of 5.00 percent will translate to a futures price of 95.00 (100.00 – 5.00 = 95.00). Given this price construction, if interest rates rise, the price of the futures contract falls, and vice versa. This retains the expected relationship between the price of an interest rate based contract and the yield of the same contract

If you believe that interest rates will fall, you would then buy a CME Eurodollar futures contract (and vice versa; if you believe rates will rise, you would sell a CME Eurodollar futures contract).

Prices of CME Eurodollar futures trade in increments of one-quarter and one-half of one basis point, depending upon when the contract expires, and this is often referred to as the “tick” value. Gains or losses are calculated simply by determining the number of ticks moved, multiplied by the value of the tick.

A full tick or basis point in CME Eurodollar futures, for example, is worth $25.00. The $25.00 basis point value is based on the $1,000,000 notional value of this contract, as calculated below:

$1,000,000 notional value x .0001 (one basis point) x 90/360 (three month) deposit period = $25.00

For the nearest expiring or “spot” month in CME Eurodollar futures (serial or quarterly), the minimum price fluctuation is 1⁄4 of a basis point or a “1⁄4 tick,” which is $6.25. For all other CME Eurodollar contracts, the minimum price fluctuation is 1⁄2 of one basis point, or a “1⁄2 tick,” which is $12.50.

The CME Eurodollar futures contract is used to hedge interest rate swaps. There is an arbitrage relationship between the interest rate swap market, the Forward Rate Agreement market and the Eurodollar contract. CME Eurodollar futures can be traded by implementing a spread strategy among multiple contracts to take advantage of movements in the forward curve for future pricing of interest rates.

The front month contracts are among the most liquid futures contracts in the world. The contract suite has quarterly expirations out to 10 years. Each year has a reference color, with the first year from today being referred to as 'front' months.

source: Wikipedia: Eurodollar