eurodollar futures hedge question

Discussion in 'Financial Futures' started by saminny, Aug 24, 2012.

  1. saminny


    I have a question on hedging eurodollar futures. If I understand correctly, the contract price for far out contract month is roughly based on the 3 month forward price on that month as seen today. So, for example, suppose today is June 25, 2007, the Sep 2008 contract trading today will roughly be based on 3-month Sep 2008 forward price as seen today. Now, if I go long this contract, I lock in the Sep 2008 forward rate prevailing today. Is this correct?

    Now I am looking at the hedging example on this page (
    Suppose today is June 25, 2007, so the contracts of Exhibit 1 are available. A trader is to make a cash payment of $3 million on December 15, 2008, and she wants to hedge the interest rate risk. The article says she goes long three each of the Sep 2007, Dec 2007, Mar 2008, Jun 2008 and Sep 2008 contracts to hedge the risk.

    My question is why can't the trader just go long Sep 2008 contract today to hedge against the interest rate risk. The article also says by doing this, he effectively narrows his duration from 12 months to 3 months. But if he goes long Sep 2008 contract long today, hasn't he locked in the forward rate prevailing today and hedged away all of his risk, so effectively 0 duration?

    Any explanations appreciated.
  2. I responded to you on the other forum.
  3. Nym


    He could and he could not, it is a way to play with the yield curve.

    I suggest you a nice book: Trading STIR Future
    The first chapters explain you the way STIR works, you can start with that and then look around in internet.

    The general message is, no free lunch out there :)
  4. Holdings a futures position <> 0 Duration.
    The futures position is mark-to-market. As Libor goes up or down, there is a cashflow stream.
    What it does do is to link future short-term interest rates, future discount factors, and long-term interest rates.
    If you want no sensitivity to interest rates, consider a forward.
  5. The loan in question (the $3mil cash payment) is like a bond. That's the reason why you need to do a strip, rather than a single contract. This has nothing to do with playing the yield curve, cash flow streams, or long-term interest rates. And the Eurodollar future is a forward already.
  6. Yes, I know what you meant. As I said, a Eurodollar contract is an IMM-dated, exchange-traded FRA (with a fixed notional and slightly different margining arrangements). There's absolutely no reason to bring FRAs into this, in the context of the example provided. It's not going to achieve anything that the Eurodollar contracts don't give you already.
  7. saminny



    I thought more about it and it makes more sense now. I am trying to lock in the present value of the bond that is based on current interest rate curve. Each Eurodollar future in this bundle/strip of futures allow me to hedge the interest rate risk for a 3 month period. When I chain them all together, I am hedged for the period from Sep 2007 to Dec 2008. However, because Eurodollar only offers limited quarterly expirations, I am still exposed to interest rate movements from July to Sep 2007, and if I understand correctly, this is where the residual 3 month duration comes from. I could use the monthly serial contracts to further decrease the duration from 3 month to 1 month. Am I on the right track?

    I understand due to convexity bias and margining effect, there is difference between the actual forward price and eurodollars futures price. But I am only using this example to get a conceptual understanding before I delve into these practical issues.
  8. Yes, you are definitely on the right track.

    Think of everything you do in rate space as a loan. In the example given the trader has an 18 month loan starting today (spot loan or a bond). The idea of the Eurodollar hedge is to offset this spot loan with a "chain" of back-to-back forward loans. That forward vs spot idea is what the example is attempting to illustrate (although they should make it more clear).