Tuesday, January 11, 2011

euro dollar deposit, spot, forward, FRA, IRS

Eurodollar (without "futures") is a monolithic (non-derivative) CD with a term always from _today_ for 1 day (overnight), or 7 days, 14 days ... 3 months, .. up to 12 months.
* Eurodollar deposit rate is a always spot rate, not a forward rate.
* Libor 11am announced rate is always a spot rate, not a forward rate.

In contrast,
- an ED futures price is always a forward rate, not a spot rate.
- the rate in an ED "contract" is always a forward rate

An Eurodollar futures contract is a loan with a 3 month term always starting on an IMM date (never today).

In the interest rate business, "Spot rate" has broader, more generic meanings but here we focus on USD short-term spot rate. The libor eurodollar deposit rate is exactly that. Zeros (STRIPS) are also relevant. Example below is a Zero with semi-annual compounding.

Suppose spot rate == 250 bps/6months for a 2 year term (ie 4 x 6 months), it means on the present market, people are willing to close deals like "Take my $1M today. Repay in 2 years (1.025*1.025*1.025*1.025)*$1m=$1,103,800"

When studying IRS or FRA, always always bear in mind eurodollar is nothing but a simple time deposit but depositor is a lending bank and interest payer is a corporate borrower.

FRA is an contract or agreement referencing "tomorrow's [2] published libor rate" for eurodollar deposit rates.

[2] In reality, "tomorrow" is more likely months away.

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