Can someone explain to me in simple terms how Eurodollar futures work. Particularly, I want to understand why shorting eurodollar futures could be used as a strategy to reduce interest rate risk when someone has shorted a floating rate bond (Schweser qbank question id #88538)
You are short a floating rate bond. This means you want rates to go down. Therefore, you fear rates going up. You want to find a way to take advantage of higher future rates. If you short a eurodollar future that means you will be able to sell the future at a later time, when the rate will be higher, thus taking advantage of higher future rates and hedging your short floating rate bond position.
Thanks! So I can think of it like sort of a future equivalent of an FRA… which can be used to lock in interest rates? Also… part of what confuses me is the pricing of Eurodollar futures… with the (1-int rate%) or discount way of pricing, interest rate going down means price goes up, right?
it’s just a type of interest future. think the buyer wants to borrow money at the contracted LIBOR rate and everything else is solved.