Eurodollar – US dollar which is deposited outside USA. The most of the eurodollar are held in London branches of the biggest worldwide known banks. These dollars are the base for USD loans accommodated  by the European commercial banks and per se show 3 month interbank offered interest rate or so called 3M LIBOR.

Floating interest rates. Eurodollar.

Eurodollar futures are traded on Commodity Mercantile Exchange (CME). The price fluctuates from 87% to 100%, which shows the short-term interest rate fluctuations from 0% to 13%. Actually eurodollar shows premium received for loan of $100000. The value of 99.7325 for futures with expiration in July means: today (13.06.2011) market predicts that deposit holder at the expiration date will receive 0.2675%.

Eurodollar futures is one of the most liquid markets in the World. What is important to mention it is liquid not only for nearest expiration dates but also for dates. For example, there is daily volume of 6758 contracts (in the morning) for futures with expiration in december 2012. In comparison, S&P 500 index futures has only one market with volume different from 0, which is Sep 2011 and is equal to 391 contracts. 

Eurodollar futures contract is often used for interest rate hedging purposes. Of course interest rates are basically hedged by OTC swaps and forwards, but this is the most popular exchange-traded instrument.

Floating interest rates. London Interbank Offered Rate.

LIBOR (London Interbank Offered Rate) – the interest rate which banks want to receive (offer) for lending money to each other for the period from 1 day (overnight) to 1 year. The most common usage of the interest rates happens for eurodollars. Therefore saying Eurodollar talking about interest rates, people mean 3M USD LIBOR.

As previously mentioned, LIBOR rate is calculated for several periods from 1 day to 12 months. The most popular LIBOR is for US dollars. However, there are various LIBOR rates for: Euros, Swiss franks, Canadian dollars, sterling pounds, Тew Zealand dollars, Australian dollar, Swedish and Danish krones, as well as Japanese yen.

The fixing of the LIBOR

The fixing of the interest rate (which is published) is made by the authorized British Bank Association’s (BBA) agent – Reuters. Reuters is calling to 16 Prime Banks, which where previously chosen and considered as the British money market makers, and obtains information about their rates. The lowest four and the highest four rates are excluded and arithmetic mean is calculated basing on the eight left.

There is another rate LIBID, which is the interest rate which banks want to pay for lending money from another bank. But this rate (as all ID rates) are rarely taken into account. You will not find a historical data on it from BBA.

Author: Glebs Kabanovs

Translated and edited: Nikita Kabanovs