Eurodollar: Eurodollar refers to a U.S. dollar denominated deposit in a bank outside the U.S. and thus outside the jurisdiction of the Federal Reserve System.
Eurodollar Future: A Eurodollar Future is a future contract for a notional Eurodollar deposit amount, whose value at expiration is based upon the term relevant LIBOR rate on the expiration date.
A Eurodollar future is comparable to a forward rate agreement.
Unlike other futures and forwards, Eurodollar futures face a pricing challenge because pure risk-free arbitrage is not possible.
- An arbitrageur cannot simultaneously take a position in the asset and the Eurodollar future because the net value at expiration is not certain.
- Both the value of the Eurodollar deposit and the Eurodollar future are dependent upon the relevant LIBOR rate and these cannot be offset.
- As an underlying asset, a Eurodollar pays incremental interest on top of a deposit; compare that to a Treasury bill, which is a discount instrument.
- Despite these pricing challenges, Eurodollar futures can still be an effective instrument for hedging exposure to floating interest rates.