I've never quite figured out this dynamic.. But every time i look at a GE future.. it looks drifting up.. does this represent the value associated with moving from a longer dated interest rate contract to a shorter term interest rate contract... . I know that It's a future on a spot price of interbank lending.. But doesn't the price imply something in between? I understood before you could derive a curve from it.. therefore i would think something to the degree of my first statement..
CD....the ED prices the interest into the future contract. Over time that interest is synthetically getting paid through the future. Remember, ED are simply debt instruments that are discounted to the present value. Over time that discount converges to par. Another way to look at it, you should be able to replicate the cash flows of an ED contract by depositing money in a bank over the same duration and collecting interest at fixed libor.
Right.... This is what I was thinking..... So holding a long future is working your way along the curve......converging on par... The yield curve is derived from these futures is why I thought that made sense., you ever trade these Mav?
I was looking at spread trades on this before.. But it seems just as viable to trade expirations outright with stops
That is just not correct. The Eurodollar isn't issued/originated at a discount like other short term bills. It settles to libor at a specific time. http://www.cmegroup.com/confluence/display/EPICSANDBOX/Eurodollar The drift that you see I imagine has more to do with our current interest rate structure.
Right, I should have been more clear. It's not a discount as in t-bills or savings bonds but the interest rate is embedded in the contract, i.e a 3% forward rate is equivalent to 97.00 in the futures.
Well, the Eurodollar contract essentially replicates a zero coupon synthetic loan instrument. The convexity is different from other short term bills because the interest payout is different. And we won't even bother with the lawsuit and scandal re: banks making up the LIBOR rates they report for competitive advantage. And this upward forward curve shape is indeed a reflection of present monetary policy and market expectations, and is not a consistent feature of the Eurodollar.
There is an interest rate component embedded in the contract that gives the contract some convexity in that if you are short ED and they go down, because you get the p&l from the day to day marks, the excess p&l can be re-invested at the higher rate and vice versa losses can be paid at lower rates.
If you look at the open interest in forward curve, you'll get a better sense of how the market uses various duration expiries. Since most loans are quoted in Libor plus basis points, the forward hedging component is huge. http://www.cmegroup.com/trading/interest-rates/stir/eurodollar_quotes_settlements_futures.html