Eurodollar Futures and TED spreadTrading

Training WorkshopFrançois Choquet

Advanced Application SpecialistJuly 2011

Motivations and Applications

• Speculation on views on interest rates.• Hedge against fluctuations in Interest Rates.

1. Convert fixed rate loans into floating rate loans. 2. Convert Floating rate loans into fixed rate loans.3. Hedging using a stack of Eurodollar Contracts4. Hedging using a strip of Eurodollar Contracts

Motivations and Applications

• Speculation on views on interest rates.• Hedge against fluctuations in Interest Rates.

1. Convert fixed rate loans into floating rate loans. 2. Convert Floating rate loans into fixed rate loans.3. Hedging using a stack of Eurodollar Contracts4. Hedging using a strip of Eurodollar Contracts

Speculating with IR Futures

• Trading by holding an outright positions i.e. long or short or trading a spread

• The long trader bets that interest rate will fall so the price of the futures will rise

• The short trader bets that interest rate will rise so the price of the futures will fall.

• The spread trader bets that interest rate curve will steepen or flatten.

Outright Position• (1) The trader believes that short term rates will rise and execute the

following trade:

• To profit from rising rates, the trader must be short IR futures. Accordingly the trader sells one SEP11 contracts at 99.30. Five days later IR have risen and the futures contract trades at 99.12.

• The trader gains 18 basis points. As each basis point is worth $25, the total profit is $450.

Date Futures Market

5/16/2011 Sell one SEP 11 ED Futures at 99.685

8/14/2011 Buy one SEP 11 ED Futures at 99.505

Profit=18 basis points

Total Gain=18 x 25 x 1 =450

Spreads• Intracommodity spread: Speculation on the changing shape of the IR

curve. E.g. spread between a nearby and more distant futures contract.• Intercommodity spread: Shifting risk from two different instruments:

Libor-OIS spread.• Today, a trader considers the following Libor rates and futures yields:

• The yield curve is upward sloping with a spread between 12 month and 3 month showing 9 basis points.

• The futures yields are consistent with the forward rates implied from the Eurodollar curve.

Time to mty Libor Spot Rates

Futures Contract Ticker Futures Yield

Futures Price

3m 0.264 SEP 11 - 4.4 months EDU1 comdty 0.32 99.68

6m 0.27485 DEC 11 - 7.4 months EDZ1 comdty 0.415 99.585

9m 0.30915 MAR 12 - 10.4 months EDH2 comdty 0.575 99.425

1y 0.35741

Spread Curve Trade • (2) The trader speculates that the curve will flatten within the next 6

months and decides to execute the following trade:

• By buying the more distant MAR12 contract and selling the DEC11 contract today , the trader bets that the yield differential of 16 bps of will narrow.

• On July 30th, the yield spread diff. between MAR12 and DEC11 is 11 bps.• No matter whether rates rise or falls, this spread strategy will produce a

profit.

Date Futures

Buy the MAR12 ED contract at 99.425

Sell the DEC11 ED contract at 99.585Buy the DEC11 ED contract at 99.635Sell the MAR12 ED contract at 99.525

11-May-11

30-Jul-11

Profit=5 basis points

Total Gain=$125

FRA/OIS Spread

• Speculating on changing risk structure of interest rates. • E.g. risk of widespread default triggers widening of

spread between OIS and Libor reflecting the changing perception of the risk involved in holding Eurodollar deposits in the face of potentially very large loan losses.

• Assume the spread between the 3 month IMM OIS and FRA is 17bps.

• The banks’ riskiness is perceived to increase, we might expect the spread to widen. (This would be the case whether interest rates are rising or falling).

• (3) To take advantage of this view, the trader could sell the SEP IMM FRA buy the SEP IMM OIS contract.

• On August 15 the spread between the two contracts has widened by 16 basis points, in line with the trader’s expectations which produces a profit of $400.

• The futures prices already embed the expectation of higher rates and spread between Eurodollar and OIS. Thus, by engaging into this strategy, the trader speculates AGAINST the rest of the market.

• It is not enough to expect yield spreads to widen, but the trader must expect them to widen MORE than the market EXPECTS.

Date Futures

Today Sell $1mm SEP IMM 3MO FRA at a rate of 0.32%Buy $1mm SEP IMM OIS at a rate of 0.16%

August 15th

Sell $1mm SEP IMM OIS at a rate of 0.17% Buy one SEP IMM 3MO FRA at a rate of 0.40%

Profit = 7 basis pointsTotal Gain = 7 x 25 = $175

Motivations and Applications

• Speculation on views on interest rates.• Hedge against fluctuations in Interest Rates.

1. Convert fixed rate loans into floating rate loans. 2. Convert Floating rate loans into fixed rate loans.3. Hedging using a stack of Eurodollar Contracts4. Hedging using a strip of Eurodollar Contracts

Creating a Synthetic Fixed Rate Loan

• A construction firm plan a project that will take six months to complete. It is worth $100 million. The bank provides funds for 6 months at a single rate, that is 200 bps above the 90- day Libor.

• The rate for the second quarter is 200 bps above the 90 day Libor rate that prevails at that date.

• The company must pay interest at the end of 3 month and interest plus principal at the end of the 6 month period.

Schedule Cash Market Futures Market

June 20th, 2011 Borrow $100 m at 2.316% for three months from the bank who commit to extend the loan for 3 additional months at 200 bps above 3 month Libor.

Sell 100 Sept. Eurodollar Futures Contracts at 99.66 which corresponds to a 0.34% yield.

September 20th, 2011 The company pays interest of $591,886.67. The 3 Mo Libor is now at 0.84% so the company borrows for another 3 months at 2.84%.

Offset 100 Sept. contracts at 99.06 reflecting a 0.84% yield. The trade produces a profit of $125,000. (50*25*100)

December 20th, 2011 Pay interest of $717,888.89 and repay principal of $100m. Total interest expense $1,309,755.56

Futures Profit: $125,000.

Net Interest Expense after Hedging: $1,184,755.56

Synthetic Floating Rate Loan

• The bank decides to let the company borrowing at a fixed rate.

• The bank’s cost of funds is 90 day Libor and expect to pay 0.316% this quarter and 0.34% next quarter, so an average of 0.328% over 6 months.

• Therefore the bank decides to make a fixed rate 6 month loan to the construction company at 2.328%.

• The bank’s expected profit is the 200 basis points between the lending rate and the bank’s Libor based cost of funds.

• If Libor rises by 50 bps to .% for the second quarter, the bank will have to pay an additional $125,000 in interest. To avoid that the bank will transact as follows:

Schedule Cash Market Futures Market

June 20th, 2011 Borrow principal of $100m at 0.316% and lend it for 6 months at 2.316% to the construction company.

Sell 100 September Eurodollar contracts at 99.66 (.34% yield)

September 20th, 2011 Pay Interest of $80,755.56 Libor is now at .84% so the bank borrows $100m @ .84%.

Offset the 100 Sept. contracts at 99.16 reflecting the .84% yield. It produces a profit of $125,000.00

March 20th, 2011 Pay interest of $212,333.33 and repay principal of $100m. Total Expense=$293,088.89 Profit=$125,000

Net interest expense after hedging: $168,088.89

Multi-Period Funding• In the previous example, the interest risk focuses on a single date. Often

the period of the loans comes at a number of different dates at which the rate might be reset.

• The company makes a more realistic assessment of the completion date of the project: 1 year.

• The bank insists on making a floating rate loan for 3 months at a rate of 200 basis points above the 90 day Libor rate prevailing at the time. – 3 month Libor: 0.316%– SEP Eurodollar: 0.34%– DEC Eurodollar: 0.416%– MAR Eurodollar: 0.595%

• The cost of funds is then 2.316%, 2.34%, 2.416% and 2.595% or @100m @ an average rate of 2.41675%.

• In a stack hedge, all of the futures contracts are concentrated or stacked in a single futures expiration date.

Scenario 1: Parallel Shift

• Shortly after the company enters the hedge, Libor rates jump by 50 basis points. The borrowing rate for the next 3 quarters are then: – September 11 – December 11 : 0.84%– December 11– March 12: 0.916%– March 12 – June 12: 1.095%

• Hedge $100 m with 300 September Eurodollar Futures contracts.

Cash Market Futures Market

Jun 20th, 2011 Borrow $100 m at 2.316% for 3 months and commit to roll over the loan for 3 quarters at 200 basis points over the prevailing Libor rate.

Sell 300 Dec Eurodollar futures contracts @ 99.66 which corresponds to a yield of 0.34%.

Sep 20th, 2011 Co pays interest of $591,866.67. Libor is now 0.84% so the co borrows $100m @ 2.84%.

Offset 300 Dec Eurodollar contracts @ 99.16 which reflects the yield of 0.84%. The trade produces a profit of 50*25*300=$375,000.

Dec 20th, 2011 Co pays interest of $717,888.89. and borrows $100 m for 3 months @ 2.916%.

Mar 20th, 2012 Co pays interest of $737,100.00 and borrows $100m for 3 months @ 3.095%.

June 20th, 2012 Co pays interest of $790,044.44 and repays principal of $100m.

Total interest expense: @$2,837,800.00 Futures profit : $375,000

Total interest expense net of hedging: $2,462,800.00Initial cost without 50 basis point increase: $2,457,029.17 (2.41675%*100m*366/360)

Eurodollar Stack Hedge

Scenario 2: Steepening Curve• Shortly after the company enters the hedge, Libor rates jump unevenly across the

Libor curve. The borrowing rate for the next 3 quarters are then: – September 11 – December 11 : 0.43% (+9bps)– December 11– March 12: 0.93% (+51bps)– March 12 – June 12: 1.5% (+55 bps)

• Hedge $100 m with 300 September Eurodollar Futures contracts. • With this changes the company will suffer an increase in borrowing costs as

follows:

• This change in rates produces an increase in costs of $348,171.00 from the initially expected level of $2,457,029.17 to $2,841,200.00

• Here the DEC contract produces only a gain of which is equal to: 0.09/0.005*12.5=$67,500. It isn’t sufficient to cover the increase in cost.

New rate Days in period

Cost for the period

June – September: 2.32% 92 591,866.67September-December: 2.43% 91 614,250.00December-March 2.93% 91 740,638.89March-June 3.50% 92 894,444.44

2,841,200.00$

Interest Rate Curve Scenarios

today (June 20th 2011) Sep 11-Dec 11 Dec 11-Mar 12 Mar 12-June 120.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

1.40%

1.60%

expected cost of funding todayCost of funding (+50 bps parallel shift)Cost of funding (steepening)

A Strip Hedge• Unlike a stack hedge which concentrates the position on a single

expiration date, a strip hedge uses an EQUAL number of contracts for each futures expiration over the hedging horizon.

• For a $100 mln financing requirements at risk for three quarters, the co sells 100 ED contracts each of the SEP, DEC and MAR futures instead of the 300 contracts on SEP futures.

• With the hedge in place, each quarter of the coming year is hedged against shifts in IR for that quarter.

• (see next table) Timing of the futures hedge to that of the market risk exposure: The performance of the strip hedge results from the alignment of the futures market hedges with the actual risk exposure of the firm.

• Performance depends on the horizon and the liquidity of the most distant contracts.

Eurodollar Strip Hedge Cash Market Futures Market

Jun 20th, 2011 Borrow $100 m at 2.316% for 3 months and commit to roll over the loan for 3 quarters at 200 basis points over the prevailing Libor rate.

Sell 100 for each of Sept, Dec and Mar @ 99.66, 99.584, 99.405 respectively.

Sep 20th, 2011 Co pays interest of $591,866.67. Libor is now 0.43% so the co borrows $100m @ 2.43%.

Offset 100 Sep contracts @ 99.57. Profit=$22,500.00

Dec 20th, 2011 Co pays interest of $614,250.00 and borrows $100 m for 3 months @ 2.93%.

Offset 100 Dec contracts @ 99.07. Profit=$128,500.00

Mar 20th, 2012 Co pays interest of $740,638.89 and borrows $100m for 3 months @ 3.5%.

Offset 100 Mar contracts @ 98.5. Profit=$226,250.00

June 20th, 2012 Co pays interest of $894,444.44 and repays principal of $100m. Total interest expense: $2,841,200.00

Total Profit = $377,250.00

Total interest expense net of hedging: $2,463,950.00

TED SPREADArbitraging and Hedging Treasuries against Eurodollars.

Speculating with IR Futures

• Trading by holding an outright positions i.e. long or short or trading a spread

• The long trader bets that interest rate will fall so the price of the futures will rise

• The short trader bets that interest rate will rise so the price of the futures will fall.

• The spread trader bets that:– Interest rate curve will steepen or flatten.– The correlation between the ED futures rates and yield

on Treasuries will change over time (TED).

G7 Macro Situation TodayEvents with Significant Impact

• Strong recovery of the global economy in 2010 to 1st quarter 2011 but outlook for growth tilted on the downside amid weaker consumer sentiment.

• Price risk is rising but expectations remain anchored to central banks’ objective of keeping inflation close to 2%.

• Expectations for higher policy rates from ECB & BOE. • Severe stress in the bond markets reflecting the on-going

sovereign crisis in the Euro-zone. Downgrades of Greece and Portugal.

• Large exposure of G7 banks to Greece, Ireland, Portugal and Spain.

• Geopolitical tensions and North African and the middle east.

Dec-98

Jul-99

Feb-00

Sep-00

Apr-01

Nov-01

Jun-02Jan

-03

Aug-03

Mar-04

Oct-04

May-05

Dec-05

Jul-06

Feb-07

Sep-07

Apr-08

Nov-08

Jun-09Jan

-10

Aug-10

Mar-11

-12-10

-8-6-4-202468

Real Output Growth YoY changes %

U.S. Eurozone U.K. Japan

Mar-04

Aug-04Jan

-05

Jun-05

Nov-05

Apr-06

Sep-06

Feb-07

Jul-07

Dec-07

May-08

Oct-08

Mar-09

Aug-09Jan

-10

Jun-10

Nov-10

Apr-11

0

10

20

30

40

50

60

70

Global Purchasing Manager Index

PMI Composite

Mar-04

Jul-0

4

Nov-04

Mar-05

Jul-0

5

Nov-05

Mar-06

Jul-0

6

Nov-06

Mar-07

Jul-0

7

Nov-07

Mar-08

Jul-0

8

Nov-08

Mar-09

Jul-0

9

Nov-09

Mar-10

Jul-1

0

Nov-10

Mar-11

-40-30-20-10

010203040

Industrial Production YoY %

U.S. Eurozone U.K. Japan

Dec-96

Jul-9

7

Feb-98

Sep-98

Apr-99

Nov-99

Jun-00

Jan-01

Aug-01

Mar-02

Oct-02

May-03

Dec-03

Jul-0

4

Feb-05

Sep-05

Apr-06

Nov-06

Jun-07

Jan-08

Aug-08

Mar-09

Oct-09

May-10

Dec-10

-60

-40

-20

0

20

40

60

Exports YoY %

U.S. Eurozone U.K. Japan

Dec-98

Jul-99

Feb-00

Sep-00

Apr-01

Nov-01

Jun-02Jan

-03

Aug-03

Mar-04

Oct-04

May-05

Dec-05

Jul-06

Feb-07

Sep-07

Apr-08

Nov-08

Jun-09Jan

-10

Aug-10

Mar-11

-3-2-101234567

Inflation Rates YoY changes %

U.S. Eurozone U.K. Japan

2003 2004 2005 2006 2007 2008 2009 20100

20

40

60

80

100

120

140

160

Ireland; 94.2

Italy; 118.1

Greece; 144

Spain; 63.4

Portugal; 83.2

Public Debt / GDP %

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010-35

-30

-25

-20

-15

-10

-5

0

5

10

Ireland; -32.4

Italy; -4.6

Greece; -10.5

Spain; -9.2Portugal; -9.1

Budget Deficit (-) %

Jan-09

Feb-09

Mar-09

May-09

Jun-09

Aug-09

Sep-09

Nov-09

Dec-09

Feb-10

Mar-10

May-10

Jun-10Jul-1

0

Sep-10

Oct-10

Dec-10Jan

-11

Mar-11

Apr-11

050

100150200250300350400450

Global Commodity IndicesAgriculture Metal Energy

Tensions in the Government Bond Markets

0

200

400

600

800

1000

1200

1400

Ireland; 709.7

Italy; 121.7

Greece; 1209.4

Spain; 193.1

Portugal; 547.6

Government Bond Spreads in 2010 and 2011

Spre

ads i

n bp

s

Deterioration in perceived debt sustainability of “PIGS”

0

200

400

600

800

1000

1200

1400

1600

spain cds usd sr 5y; 232.248

greece cds usd sr 5y; 1248.397

portug cds usd sr 5y; 606.5

Five Year CDS spreads

Banks Exposure to “PIGS”End of Q3 2010; in billion of US dollars – Source BIS

Greece Ireland Portugal Spain

Germany; 179.2

Germany; 570.7

Germany; 137.1

Germany; 685.6

France; 247.3

France; 200.8 France; 128.5

France; 632.5

17.7

64.1

20.5

112.397.3

193

63.8

523.7

UK; 55.8

UK; 609.3

UK; 92.8

UK; 421.2

5.9

66

8

82.893.2

287.5

98.7

U.S.; 426.7

26.1

151.7

15.7

111.5

Germany France Italy Other Euro AreaUK Japan U.S. R.O.W

Total exposure $2.512 trillion

Counterparty Risk

0

5

10

15

20

25

30

35

40

45

50

OIS USD; 15.95

OIS EUR; 26OIS GBP; 27.94

3 Month Libor OIS Spreads

Spre

ads i

n bp

s

AXE

• Less accommodative monetary policy resulting in an increase in interbank rates.

• Growing concerns about PIGS’ sustainability of public finances and fiscal outlook. Talks amongst EU leaders about debt restructuring for Greece.

• Large exposure of banks to “PIGS”.• Flight to safety resulting in a decrease in AAA

rated government bond yields. – > BUY TREASURY, SELL EURODOLLARS/EURO FUTURES

TED Spread

Speculative trades on TED are executed in anticipation of a change in the spread between Treasury and Eurodollar deposits based on the assumption that the correlation between returns of the two instruments will change overtime.

• Long position in TSY and a short position in a strip of euro-dollar contracts with similar maturity.

• Position is established when the spread is narrow. The spread between the two yields is constantly changing as it is affected by the turmoil or uncertainty in the international markets and banks’ overall liquidity position.

• A manager takes a position on the on-the-run 2 year TSY when the spread is at 16 basis points.

• The manager anticipates that the spread will widen to 26 basis points allowing him to exit the trade at a profit…(see next slide)

Trade Example

Position Established on 5/12/2011 (T+1)Bought 100mm of 0 5/8 13@100.142 (YTM 0.552%)Sold 2 year Eurodollar bundle i.e. first 8 quarterly CME Eurodollar contracts.

Position reviewed on 6/13/2011 Sell 100mm of 0 5/8 13 @ 99.951 (YTM 0.651% up 10 bps)Buy 2 year Eurodollar bundle at following prices (implying a 20 basis point increase in rates):

Last Price Rate # Contracts

Front Stub 99.80097 0.19903125 36EDM1 Comdty 99.735 0.265 101EDU1 Comdty 99.69 0.31 101EDZ1 Comdty 99.595 0.405 101EDH2 Comdty 99.455 0.545 101EDM2 Comdty 99.22 0.78 101EDU2 Comdty 98.925 1.075 100EDZ2 Comdty 98.615 1.385 99EDH3 Comdty 98.34 1.66 99

Price Rate P&LFront Stub 99.60097 0.399031 0EDM1 Comdty 99.535 0.465 50500EDU1 Comdty 99.49 0.51 50500EDZ1 Comdty 99.395 0.605 50500EDH2 Comdty 99.255 0.745 50500EDM2 Comdty 99.02 0.98 50500EDU2 Comdty 98.725 1.275 50000EDZ2 Comdty 98.415 1.585 49500EDH3 Comdty 98.14 1.86 49500

$401,500

Bond position 5/12/2011 6/13/2011

Principal : 100,142,000.00 99,953,125Accrued: 22,078.80 76,426.63Total: 100,164,078 100,029,551.63Profit (Loss): ($134,526.37)

Futures Strip Position: Profit: 803*20*25=$401,500

Total Gain: $266,973.63

Margin per Contract ($650)Capital employed (803 contracts x $650 – 0% haircut)=$521,950

Total Return on Capital for 32 days: 51.15%

# Contracts:

Face value x (days in contract/360) x discount factor strip--------------------------------------------------------------------------

Risk of ED Futures x 10,000

The rate used in calculating the discount factor is the ED rate. (the TED spread can be subtracted from it).

Futures TableEurodollar Contract Table

* Libor Rates

Period Ticker Last Price Rate Exp. Month Exp. Date Deposit Period Start

Deposit Period ends

No. days in period

1 Front Stub* 99.8024 0.1976 5/12/2011 5/16/2011 6/15/2011 302 EDM1 Comdty 99.7350 0.2650 May-11 6/15/2011 6/17/2011 9/16/2011 913 EDU1 Comdty 99.6900 0.3100 Jun-11 9/21/2011 9/23/2011 12/23/2011 914 EDZ1 Comdty 99.6000 0.4000 Jul-11 12/21/2011 12/23/2011 3/23/2012 915 EDH2 Comdty 99.4550 0.5450 Aug-11 3/21/2012 3/23/2012 6/22/2012 916 EDM2 Comdty 99.2200 0.7800 Sep-11 6/20/2012 6/22/2012 9/21/2012 917 EDU2 Comdty 98.9300 1.0700 Oct-11 9/19/2012 9/21/2012 12/21/2012 918 EDZ2 Comdty 98.6300 1.3700 Dec-11 12/19/2012 12/21/2012 3/21/2013 909 EDH3 Comdty 98.3600 1.6400 Mar-12 3/20/2013 3/22/2013 6/21/2013 91

10 EDM3 Comdty 98.0950 1.9050 Jun-12 6/19/2013 6/21/2013 9/20/2013 9111 EDU3 Comdty 97.8450 2.1550 Sep-12 9/18/2013 9/20/2013 12/20/2013 91

Libor Tenor Periodicity Expiration RateUS0002W index 2 W 5/30/2011 0.17975US0001M index 1 M 6/16/2011 0.19875US0002M index 2 M 7/18/2011 0.232

How is the TED spread calculated? 3 methods.

1. Implied Yield:The stub Libor and ED rates are used to find the par coupon of a swap whose cash flows correspond to that of the treasury note. The TSY yield is subtracted from this par coupon to produced the spread.

2. SpreadIt represents the bps that must be subtracted from the stub Libor and Eurodollar futures contract rates to set the PV of the TSY notes cash flows to its full market price (dirty). Act/360 money market basis points.

3. Implied Price. Method used in the next slide. The TSY notes cash flows are discounted at the stub Libor and Eurodollar futures rates. The implied yield resulting from the PV is subtracted from the TSY notes yield (S/A bond equivalent basis points).

1 – Implied Yield TED: Par Coupon on a swap: Not tradable2 – Spread: Subtracting basis points from Futures 3 – Implied Price: PV of cash flows (best).

Calculate the TED spread Step 1 – Match the cash flows of the treasury note with the Eurodollar deposit periods. Step 2 – Find the interpolated Eurodollar discount function.

Df 9/16/2011 = [1+0.00197632*30/360]-1

*[1+0.00265*91/360]-1

=0.99166031

Df 12/23/2011 = [1+0.00197632*30/360]-1

*[1+0.00265*91/360]-1

*[1+0.0031*91/360] -1

*[1+0.004*91/360]-1

=0.998383686We interpolate the discount factors for 10/31/2011,the payment date of the note. Rather than using the actual values, we use the natural log of these values (which flattens or smoothen the curvature of the ED forward curve).

LN(Df9/16/2011)=LN(0.99166031)=-0.00083

LN(Df12/23/2011)=LN(0.998383686)=-0.00162

As 10/31/2011 is 45 days into the Sep – Dec 11 period, the discount factor should reflect 45/91 day change for the period.

Df 10/31/2011=-0.00083+(45/91)*(-0.00162-(-0.00083)=-0.00122

Using e ln(x) =x, where e is the base of the natural logarithm, we have e -

0.00122=0.998779081

The discount factors for the 2nd, 3rd and 4th terms are solved similarly. All the values are show in the cash flow table.

Cash Flows

Date Interest Principal DfPresent Value

10/31/2011 3125 0 0.9987791 3121.194/30/2012 3125 0 0.9967968 3114.9910/31/2012 3125 0 0.9928456 3102.644/30/2013 3125 1000000 0.9861227 989204.3

Total PV= 998,543.1

Dirty Price 99.85431

Clean px 99.83223

Yield 0.711475

TED 16.48806 (0.711475-0.5465946)

On-the-run Treasury 2 year noteCoupon 0.625 percentMaturity 4/30/2013Settlement 5/16/2011Accrued Interest 0.0220788 percentClean Price 100.1523438Full price 100.1744226Yield 0.5465946 percentFace Amount $1,000,000.00

How to create an ED strip• The first step is to construct a forward strip that begins with the soonest-

to-expire, front futures.• It ends with the contract whose deposit contains the maturity of the

contiguous swap.• A cash libor deposit that spans the period from settlement to the front

contract’s expiration is added to the front of the strip: The ‘front stub’. • The resulting structure is a synthetic, long term, Libor quality deposit that

begins at settlement and terminates at the end of the final contract’s deposit period.

• The rates in the chain determine the future value to which a present value would grow if invested during the sequence of deposits that makes up the strip.

• In other words, the chain also determines the PV of a future payment occurring at the final maturity of the strip.

Appendix:

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Appendix: Pricing a Eurodollar Strip

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periodof end the at paid sum aof period,of start the at - value present in ,determines factor discount The .discounted is which over periods deposit any over

period for, factor, discount the is quantity The

period, first the over it gdiscountin by-today is, that-period deposit theof sart the at flow cash theof value present the at arrive We

33

Solving for the PV of a sequence of investments from n to today and Discount Function

.DF*FVPVnDF

idf)df*...df*df*df(DF

n)df*...df*df*df(*FVPV

PV

n

n

i

n31n

n31n

gives It factors. discount period- theof product theof composed function discount

period for factor discount where

:as written is and function discount the called is It strip. the compose that factors discount theof product the is sparenthese the between term most right The

:as the express then can We

2

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