This has been driving me nuts all day. On page 41 of CFA volume 6 (Bottom of page). It states that when an end user goes long and the dealer goes short: the long position will benefit when the rate increases, the short will benefit when the rate decreases. My understanding is this happens b/c the long: locked in at a lower rate. The short locked in at a higher rate (assuming the rates go favorable ways for either party). Now on page 66 at the bottom of the page: a trader has a futures contract in a t-bill. If the rate increase the long looses, but the short gains… Why? I understand the math for page 66. But why does this happen? why the difference between Forward rate agreements on the Libor and the difference on the T-Bills? Is it b/c T-bills subract 1 from the rate rather than add? Thanks for clarifying this.
Yep. Eurodollar deposits are quoted as add-on interest. T-bills are quoted on a discount basis. Therefore, when rates increase, the quote on the T-bill falls, creating a losing positon for the long. When rates increase, the quote on the Eurodollar will rise, creating a gain for the long.