Question

• How can a SOFR, Federal Funds, or Eurodollar futures contract be used to imply the SOF rate, the Fed Funds rate, or the Eurodollar rate? Describe the underlying vs. the actual futures contract in both of these cases.

Answer 1

Eurodollar futures prices are expressed numerically using 100 minus the implied 3-month U.S. dollar LIBOR interest rate. In this way, a euro dollar futures price of $96.00 reflects an implied settlement interest rate of 4%. if an investor buys one eurodollar futures contract at $96.00 and the price rises to $96.02, this corresponds to a lower implied settlement of LIBOR at 3.98%. The buyer of the futures contract will have made $50.

Fed funds futures enable market participants to take a position in which the payoff is determined by the arithmetic average of the effective federal funds rate for a given contract month, and are a commonly used proxy for federal funds rate expectations. Fed funds futures contracts mature on the final business day of the delivery month, and are cash settled against the average daily effective federal funds rate for that month.

Benchmark rates such as SOFR are essential in the trading of derivatives—particularly interest-rate swaps, which corporations and other parties use to manage interest-rate risk and to speculate on changes in borrowing costs. Interest-rate swaps are agreements in which the parties exchange fixed-rate interest payments for floating-rate interest payments.