Forward rate agreement and Eurodollar !

CFA Level I
#1

Hi everyone,

can sombody please explain to m why FRA long position gains when interest rate increases but in Eurodollar loss when interest rate increases.

Thanks.

#2

For Eurodollar future, it’s because they are priced differently.

So if you have a Eurodollar priced at 97.50, the total add-on is 2.50 annualized (100-97.5).

Since the Eurodollar is based on a 90 day add-on yield, 1 M bond, the total price is [.025\*(90/360)\*1,000,000]+1,000,000= 1,006,250.

Lets say the interest rate goes UP, the price woud be 98.50, indicating a add-on of 1.50 (100-98.5), for a price of [.015*(90/260)*1,000,000]+1,000,000=$ 1,003,750. So you lost $2,500 when the interest rate went up.

FRA:

Think of it as the right to borrow at below market interest rates or to lend at above market interest rates. If the interest rate goes up, your right (the long) to borrow at below market interest rates has a positive value. For the other guy (the short), he has to lend money at below market interest rates and lost money.

#3

I got it. Thank you and good luck on your exam.