2.2.2. Eurodollar Futures
Eurodollars are U.S. dollar deposits held in banks located outside the boundaries of the United States. They differ from dollars deposited inside the United States in one respect only. They are not subject to U.S. banking regulations. Because they have lower reserve requirements and are charged lower tax rates, dollars held in foreign banks or foreign branches of U.S. banks earn higher interest rates and can be lent at lower interest rates.
The Eurodollar market began in Europe after World War II. Today corporations, money market funds, and foreign central banks actively lend in the Eurodollar market. Its popularity has extended the market to other continents and other currencies. Eurodollar futures today are the most actively traded of the short-term interest rate futures. Their success triggered the eventual demise of the T-bill futures contract.
The Eurodollar futures contract is a three-month Eurodollar time deposit, traded in the U.S. on the IMM. Like Treasury bill futures, the contract size is $1 million, and contracts mature in March, June, September, and December. Both have the same tick value for all but the nearest contract, and every change of one basis point in the price of a Eurodollar futures contract is worth $25.
Eurodollar futures differ from T-bill futures in two important respects. First, the underlying security is an interest-bearing instrument. Recall that T-bills are issued at discount and do not earn interest. Their net carrying cost is simply the negative cost of financing a futures contract. With Eurodollar futures, the net carrying cost is the difference between the cost of financing a futures contract and the interest earned on the underlying. As a result, net carrying costs may be either positive or negative. A positive carrying cost means that the interest earned is greater than the financing cost, and the futures price will be lower than the spot price. Second, a Eurodollar futures contract is