Eurodollar Futures Are Notional Rate Hedges, Not Bank Loans
Summary
The answer distinguishes Eurodollar futures from the short-term deposit market. A futures contract references a notional amount and interest rate exposure, but entering the contract does not transfer the principal from one bank to another. Instead, buyers and sellers trade through the exchange and settle mark-to-market gains and losses daily.
The explanation corrects the idea that a bank selling a futures contract is borrowing funds from the buyer. Actual short-term capital lending occurs in the money market. It also compares futures with forward rate agreements, which provide similar interest-rate exposure through an over-the-counter contract; the answer notes that these may be centrally cleared. The discussion is conceptual and does not explain contract pricing, delivery conventions, or detailed hedging mechanics.
Key ideas
- Eurodollar futures create interest-rate exposure without exchanging the contract’s notional principal.
- Futures counterparties trade through the exchange and settle mark-to-market amounts daily.
- Banks seeking or supplying short-term capital use the money market rather than the futures contract.
- Forward rate agreements offer related exposure as over-the-counter derivatives and may be centrally cleared.
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# Eurdollar Futures # Eurdollar Futures Trying to understand the Eurdollar market a little better. I understand it's the market for dollar denominated deposits outside the US (not just in Europe). They are unregulated and not subject to reserve requirements, unlike traditional deposits. The players that engage in the Eurodollar futures are wide reaching institutions but they are predominately banks. Lets say we have two banks: Bank A: JP Morgan, a bank with over a trillion dollar of deposits and has plenty of excess reserves surplus to reserves requirments and the loans they have made to households/companies. Bank B: Goldman Sachs: Investment Bank with a small deposit base and highly dependent on the open market for funding the banks operations. If JP Morgan were to engage in a 3M ED contract with Goldman their essentially lending Goldman their surplus deposit at a higher yield to treasuries (3M Libor) and Goldman is borrowing those funds to run their operations. However, is there any money that is actually exchanged when entering the ED contract or is it purely notional of 1M per contract. If its notional what is the purpose of the ED contract other than for hedging. It sounds silly but at the end of the day these futures market were made for producers to not only hedge their risk but to sell their produce to users. Shouldn't their be money exchanged in the idea that one party needs money and the other has it? Are the sellers of ED contracts hedgers or borrowers & users of the funds. ## Answer by Rostock (score 3) https://quant.stackexchange.com/a/15495 I guess you'll have found the answer to this question sometime in the last couple of years, Gabriel, but anyway: It is purely notional. This market is not made for producers to sell their product, it is simply for hedging. The money market is where actual short-term capital is lent between banks. In EuroDollar futures there is no exchange of principal. In fact, bank A does not deal with Bank B: instead if Bank A buys and Bank B sells, then actually Bank A buys from the exchange and Banks B sells to the exchange. Each bank pays or receives their mark-to-market value of the trade to the exchange each night. There is a separate OTC derivative product called FRAs that are similar to Eurodollar futures in terms of risk and value. They are traded between banks, but nowadays even those contract will be cleared (to a central clearing house such as LCH) so that the banks aren't facing each other.
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