What Are Eurodollars
Eurodollars are cash deposits measured in U.S. Dollars, placed in foreign banks outside the United States. Previously, the term was for U.S. dollars held in European banks but it has expanded over the years to mean any U.S. dollars held in any bank outside the United States. For example, U.S. dollars held in a Mexican bank would be a Eurodollar deposit. There is no relation to the euro currency or euro zone.
Introducing Eurodollar Futures Contracts
Eurodollar futures contracts represent a fixed amount of these deposits. Each Eurodollar futures contract has a face value of $1,000,000 but because of the leverage used in futures trading, it could be traded for a margin of $1,000. This is 1/10th of 1% of the contract value. The enormous leverage provides futures trader with a very large opportunity to make lots of money when used with proper risk management.
Retail Traders Can Profit From Interest Rates Movements
Although trading in futures is an extremely risky undertaking and most individual speculators end up losing money, retail traders who put in the necessary time and effort to study the historical interest rates charts can still succeed. In order to make money with Eurodollar futures trading, one is able to make a good guess on the future direction of interest rates. This involves an ongoing study and research on the economic factors that cause interest rates to move. As more time is invest in the study, the new Eurodollar trader will find it easier to understand the price movements.
Eurodollar Futures Contract Specification
Eurodollar contracts fluctuate up or down in value. The least fluctuation is 1/4 of one basis point in the next expiring contract month or 1/2 of one basis point in the next contract months. These equal to $6.25 per contract and $12.50 respectively.
Although the price of the Eurodollar futures contract depends on the three-month US dollar London Interbank Offered Rate forecast at the contract expiration date, L.I.B.O.R forecast can increase or decrease with no or little correlation. For example, if the price of Eurodollar contract goes up from 95.00 to 95.01 this implies a L.I.B.O.R decrease of.01% or one basis point. In this case $25.00 would be deposited into the owners margin account at the end of the day. If the opposite occurred, $25.00 would be removed from the account at the end of the day. On the contract expiration date the real L.I.B.O.R rate would be used and not a forecast rate.
Instrument For Borrowing Or Lending
A Eurodollar future is essentially a forward rate agreement to borrow or lend $1,000,000 for three-month periods. Buying a contract is the same as lending money and selling a contract (going short) is the same as borrowing money.
How To Use Eurodollar Futures To Your Advantage
Many business owners with very good financial knowledge make use of Eurodollar futures to lock in interest rates on money they expect to borrow or lend. In this way they limit future interest rate fluctuation risk and make sure their certain profits from business operations.
Interest rates speculators transact in Eurodollar futures contracts, based on the direction they expect the L.I.B.O.R rate to move. If expectations are correct, the speculator will make a profit, and if wrong there will be a loss. There are techniques that could be used to limit losses and thus limit risk.