How does a decrease in the interest rate lead to gain for the long position in Eurodollar futures contract?
So lets say, I’m long a eurodollar contract at the strike rate of 5%. If the interest rate falls to 2%, that means earlier I was willing to borrow at my strike rate of 5% and now I would be able to borrow at a reduced interest rate of 2% and hence I have gained? This is more like the concept of FRA?
Does that mean that the long party is actually trying to hedge against the risk of interest rates going up?
It’s the same as any other bond futures contract:
- Interest rates go down, bond value goes up
- Bond value goes up, long gains
Ok… So this is when it is the case of futures/forwards. However, if you have a long position in a floating rate bond, then you would lose if the interest rates go down right. Cause you would then be receiving the lower coupon payments
Yes as rates fall a long position in a floater loses. Regarding the ED future think of it like this. At 5% the price was 95 ie, (100-(5%*100)). At 2%, the price becomes 98. It’s a gain to the long who entered at 95. ED futures are linearly priced: 100 - (IMM rate)