Euro Dollar Market

Euro-Dollars are time deposits denomination in US $ at banks outside the US, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the US. The term was originally coined for US $ in European Banks, but it expanded over the years to its present definition. Now, a US $ in Tokyo or Beijing would be likewise deemed a euro$ deposit. There is no connection with the euro currency or the euro zone. More generally, the "euro" prefix can be used to indicate any currency held in a country where it is not the official currency: for example, euro-yen or even euroeuro. Market Size: The Euro$ market is by a wide margin the largest source of global finance. In 1997, nearly 90% of all international loans were made this way. Future Contracts: The Euro$ future Contracts refers to the financial Future contract based upon the deposits, traded at the Chicago Mercantile Exchange. Euro $ futures are ways for companies and banks to lock in an interest rate today, for money; it intends to borrow or lend in the future. Each CME Euro $ future contract has a notional value or Face Value of $ 1,000,000 though the leverage used in future allows one contract to be traded with a margin of about 1000 $ The Minimum Ticket Size in Euro $ is .0025 = $6.25 per contract in the nearest month and one half of one basis point (0.005=$ 12.5) in all other future contract CME Euro$ Future Prices are determined by the markets forecast of the 3 month USD- LIBOR interest rate expected to prevail on the settlement date. The settlement price of a contract is defined to be 100.00 minus the official British Bankers Association fixing of 3-month LIBOR on the contract settlement date. For example, if 3-month LIBOR sets at 5.00% on the contract settlement date, the contract settles at a price of 95.00.

How the Eurodollar futures contract works For example, if on a particular day an investor buys a single three month contract at 95.00 (implied settlement LIBOR of 5.00%): If at the close of business on that day, the contract price has risen to 95.01 (implying a LIBOR decrease to 4.99%), US$25 will be paid into the investor's margin account; or If at the close of business on that day, the contract price has fallen to 94.99 (implying a LIBOR increase to 5.01%), US$25 will be deducted from the investor's margin account. On the settlement date, the settlement price is determined by the actual LIBOR fixing for that day rather than a market-determined contract price. Eurodollar futures contract as synthetic loan A single Eurodollar future is similar to a forward rate agreement to borrow or lend US$1,000,000 for three months starting on the contract settlement date. Buying the contract is equivalent to lending money and selling the contract short is equivalent to borrowing money. Consider an investor who agreed to lend US$1,000,000 on a particular date for three months at 5.00% per annum (calculated on a 30/360 basis). Interest received in 3 months' time would be US$1,000,000 5.00% 90 / 360 = US$12,500. If the following day, the investor is able to lend money from the same start date at 5.01%, s/he would be able to earn US$1,000,000 5.01% 90 / 360 = US$12,525 of interest. Since the investor only is earning US$12,500 of interest, s/he has lost US$25 as a result of interest rate moves. On the other hand, if the following day, the investor is able to lend money from the same start date only at 4.99%, s/he would be able to earn only US$1,000,000 4.99% 90 / 360 = US$12,475 of interest. Since the investor is in fact earning US$12,500 of interest, s/he has gained US$25 as a result of interest rate moves.

This demonstrates the similarity. However, the contract is also different from a loan in several important respects: In an actual loan, the US$25 per basis point is earned or lost at the end of the three-month loan, not up front. That means that the profit or loss per 0.01% change in interest rate as of the start date of the loan (i.e., its present value) is less than US$25. Moreover, the present value change per 0.01% change in interest rate is higher in low interest rate environments and lower in high interest rate environments. This is to say that an actual loan has convexity. A Eurodollar future pays US$25 per 0.01% change in interest rate no matter what the interest rate environment, which means it does not have convexity. This is one reason that Eurodollar futures are not a perfect proxy for expected interest rates. This difference can be adjusted for by reference to the implied volatility of options on Eurodollar futures. In an actual loan, the lender takes credit risk to a borrower. In Eurodollar futures, the principal of the loan is never disbursed, so the credit risk is only on the margin account balance. Moreover, even that risk is the risk of the clearinghouse, which is considerably lower than even unsecured single-A credit risk. LIBOR (London Interbank Offered Rate) The LIBOR is a daily reference rate based on the interest rate at which banks borrow unsecured funds from other banks in the London wholesale money market.

Scope The LIBOR is widely used as a reference rate for financial instruments such as o o o o o o o o forward rate agreements short-term-interest-rate futures contracts interest rate swaps inflation swaps floating rate notes syndicated loans variable rate mortgages Currencies, especially the US dollar (see also Eurodollar).

They thus provide the basis for some of the world's most liquid and active interest-rate markets. For the euro, however, the usual reference rates are the Eurbor rates compiled by the European Banking Federation, from a larger bank panel. A euro LIBOR does exist, but mainly for continuity purposes in swap contracts dating back to preEMU times. LIBOR is an estimate and not interred in the legally binding contracts of an LLC. It is, however, specifically mentioned as a reference rate in the market standard International Swaps and Derivatives Association documentation, which are used by parties wishing to transact in over-the-counter interest rate derivatives. LIBOR is used by the Swiss National Bank as their reference rate for monetary policy LIBOR is calculated and published by Thomson Reuters on behalf of the British Bankers' Association (BBA) after 11:00 AM (and generally around 11:45 AM) each day (London time). It is a trimmed average of interbank deposit rates offered by designated contributor banks, for maturities ranging from overnight to one year. LIBOR is calculated for 10 currencies. There are eight, twelve, sixteen or twenty contributor banks on each currency panel, and the reported interest is the mean of the 50% middle values (the interquartile mean). The rates are a benchmark

rather than a tradable rate; the actual rate at which banks will lend to one another continues to vary throughout the day. LIBOR is often used as a rate of reference for pound sterling and other currencies, including US dollar, euro, Japanese yen, Swiss franc, Canadian dollar, Australian dollar, Swedish krona, Danish krone and New Zealand dollar. In the 1990s, the yen LIBOR was influenced by credit problems affecting some of the contributor banks. Six-month USD LIBOR is used as an index for some US mortgages. In the UK, the three-month GBP LIBOR is used for some mortgagesespecially for those with adverse credit history LIBOR-based derivatives o Eurodollar contracts The Chicago Mercantile Exchange's Eurodollar contracts are based on threemonth US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to ten years. Shorter maturities trade on the Singapore Exchange in Asian time. o Interest rate swaps Interest rate swaps based on short LIBOR rates currently trade on the interbank market for maturities up to 50 years. In the swap market a "five year LIBOR" rate refers to the 5 year swap rate where the floating leg of the swap references 3 or 6 month LIBOR (this can be expressed more precisely as for example "5 year rate vs 6 month LIBOR").