Investments, tenth edition

  Other Interest Rate Contracts 

 

Swaps are multiperiod forward contracts that trade over the counter. There are also 

exchange-listed contracts that trade on interest rates. The biggest of these in terms of 

trading activity is the Eurodollar contract, the listing for which we show in  Figure 23.7 . 

The profit on this contract is proportional to the difference between the LIBOR rate at 

contract maturity and the contract rate entered into at contract inception. There are analogous 

rates on interbank loans in other currencies. For example, one close cousin of LIBOR is 

EURIBOR, which is the rate at which euro-denominated interbank loans within the euro 

zone are offered by one prime bank to another.  

 The listing conventions for the Eurodollar contract are a bit peculiar. Consider, for 

example, the first contract listed, which matures in February 2013. The settlement price 

is presented as  F  

0

   5  99.7075, or approximately 99.71. However, this value is not really 

a price. In effect, participants in the contract negotiate over the contract interest rate, and 

the so-called futures price is actually set equal to 100  2  contract rate. Because the futures 

price is 99.71, the contract rate is 100  2  99.71, or .29%. Similarly, the final futures price 

on contract maturity date will be marked to  F  

 T 

      5   100   2   LIBOR 

 T 

 . Thus, profits to the 

buyer of the contract will be proportional to   

F

T

 2 F

0

 5 (100 2 LIBOR

T

) 2 (100 2 Contract rate) 5 Contract rate 2 LIBOR

T

 

Thus, the contract design allows participants to 

trade directly on the LIBOR rate. The contract 

multiplier is $1 million, but the LIBOR rate on 

which the contract is written is a 3-month (quar-

terly) rate; for each basis point that the (annu-

alized) LIBOR increases, the quarterly interest 

rate increases by only ¼ of a basis point, and the 

profit to the buyer decreases by   

.0001 3 ¼ 3 $1,000,000 5 $25  

 Examine the payoff on the contract, and you 

will see that, in effect, the Eurodollar contract 

allows traders to “swap” a fixed interest rate 

(the contract rate) for a floating rate (LIBOR). 

Company A

Swap Dealer

Company B

LIBOR

6.95%

7.05%

7% Coupon

LIBOR

LIBOR

 Figure 23.6 

Interest rate swap. Company B pays a fixed rate of 7.05% to the swap dealer 

in return for LIBOR. Company A receives 6.95% from the dealer in return for LIBOR. The 

swap dealer realizes a cash flow each period equal to .10% of notional principal.  

Open

High

Settle

Chg

Open

interest

Contract

hi   lo   Low