Hvammen uses short-term borrowings in dollars, from both European and U.S. banks, to meet the liquidity needs of his oil investments, and he has Champion hedge these short positions with Eurodollar futures. Silvers suggests that Champion should consider using T-bill futures to hedge the loans from U.S. banks, and use Eurodollar futures only for the Eurodollar loans. Champion says he will look into that, as well as forward rate agreements, as alternative hedging tools for Hvammen.
With respect to using Eurodollar futures, instead of T-bill futures, to hedge short-term loans from U.S. banks, Champion is:
justified because the Eurodollar futures market is very liquid, and LIBOR is more correlated with short-term loan rates than is the T-bill rate.
Eurodollar futures are futures on dollar LIBOR, and LIBOR is the prevailing rate on very large bank loans called Eurocurrency loans. The rates on T-bills can be driven by influences (e.g., a flight to quality) that are different than those that drive dollar LIBOR rates. As a result, Eurodollar futures are more highly correlated with (dollar) bank loan rates should provide a better hedge for the client’s bank loan exposure. Moreover, the Eurodollar futures market is large and very liquid.
from schweser… is there an easy way to keep this straight? a pnemonic i can learn?