I understand the idea that Eurodollars are US Dollars that exist in foreign banks. What I don’t understand is how or why they are traded on the CME Futures market.
Could somebody explain what or how you gain from purchasing a Eurodollar futures contract?
What is their core market? Meaning, who is actually buying and taking delivery of Eurodollars and what are they using it for?
Best Answer - Chosen by Asker
this is a big chicago product, popular in chicago among speculators and market makers. but people in the real world can use it to hedge a forward rate. so i want to expand my factory and the bank offers me a 5 year loan in 3 months at a floating rate. well, i can hedge this by selling a similar eurodollar contract at the cme, to protect against an interest rate increase. also, the bank could buy the eurodollar contract and hedge its exposure, too. basically, eurodollars are a proxy for LIBOR, or the rate at which banks in london borrow and lend to each other. so there is a credit risk component involved.I should note, too, that it’s priced as 100- interest rate, so that if the interest rate is 1.20%, the eurodollars contract will be 98.80. so as rates rise, the price decreases, and in theory, the price can’t go above 100, but it has before, implying negative interest rates.
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