Anyone understands that formula that is used to get the 3-month libor? I am beyond confused! Thanks.
This is confusing for me too. I have been meaning to figure this out myself but to no avail. First of all, where are the Eurodollar futures prices coming from: June - 96.09 and Sept. - 96.13. What is the difference between this price and the prices given in the next page in the table?
Sparty419, From my reading of the Problem, it appears that the (96.09, 96.13) pair and the numbers given on Table 9 (p. 188) are very different things. The 96.09 and 96.13 are Eurodollar futures prices. These are (forward) interest rates. It would appear that these Eurodollar futures prices are simply given to us for the sake of the example. On the other hand, Table 9 (p. 188) shows us gold futures prices. The Eurodollar futures prices and gold futures prices are then used to illustrate Equation 12 (p. 182). Let us take the Eurodollar futures prices first. In particular, let us look at how the 96.09 is used. The June futures price of 96.09 means that you earn 3.81 percent on an annual basis. That is, you earn 0.0381 (i.e, 1.00 - 0.9613), or 3.81%. Using a 360-day year, we earn this much on a daily basis: 0.0381/(40x9). Note that the [June, July, August] time frame consists of 30 (June) + 31 (July) + 31 (August) = 92 days (although it seems odd that the example uses 91 days). Thus we must multiply 92 x [0.0381/(40x9] = 0.978% (approximately). Adding a one gives us 1.00978. A similar line of thinking, I think, holds for the other Eurodollar futures price of 96.13 which results in three month return of 0.00988. Compounding the returns gives 1.00988 x 1.00978. Subtracting 1 gives us 0.019763 which is the six month rate. We square this because we want the annual rate. Indeed, the “r” in Equation 12 (p. 182) is assumed to be an annual rate. As to the gold futures prices 269 and 265.7, they come straight from Table 9 (p. 188). The reason we use the exponent of 1/0.5 in the denominator of the odd looking calculating at the end of Example 2 is that we are dealing with six months, i.e., half a year. What do you think?