The Eurodollar Futures and Options Handbook

Foreword<br/>Part One The Emergence of the Eurodollar Market<br/>Chapter 1 The Emergence of the Eurodollar Market<br/>The Revolution in Finance<br/>The Futures Revolution<br/>Key Money Market Developments<br/>Why Eurodollars?<br/>Eurodollar Futures<br/>The Death of CD Futures and the Birth of Eurodollar Futures<br/>The Market for Interest Rate Derivatives at the Beginning of the 21st Century<br/>Exchange-Traded Money Market Futures and OTC Interest Rate Swaps<br/>Options on Futures, Forward Rates, and Swaps<br/>Markets around the World<br/>Part Two Building Blocks: Eurodollar Futures<br/>Chapter 2 The Eurodollar Time Deposit<br/>Maturities and Settlement<br/>Quotes<br/>LIBOR and LIBID<br/>Interest Calculations<br/>Chapter 3 The Eurodollar Futures Contract<br/>Contract Specifications<br/>Contract Unit<br/>Price Quote<br/>Tick Size<br/>Minimum Fluctuation<br/>Listed Contract Months<br/>Contract Month Symbols<br/>Color-Coded Grid<br/>Expiring versus Lead Contract<br/>Trading Hours and Mutual Offset<br/>Final Settlement Price<br/>Last Trading Day<br/>Value Dates<br/>Additional Trading Facilities<br/>Initial and Maintenance Performance Bonds<br/>Volume and Open Interest<br/>Other 3-Month Money Market Futures Contracts<br/>Chapter 4 Forward and Futures Interest Rates<br/>Deriving a Forward Rate from Two Term Deposit Rates<br/>Locking an Effective Forward Lending Rate Using Eurodollar Futures<br/>Important Differences between Forward and Futures Markets<br/>Determining the Fair Value of a Eurodollar Futures Contract<br/>Richness and Cheapness<br/>Forward Rates Are Break-Even Rates<br/>Yield Curve Trades<br/>Finding the Forward Term Deposit Curve Implied by Today’s Futures Rates<br/>Chapter 5 Hedging with Eurodollar Futures<br/>The Tool Is a Eurodollar Futures Contract<br/>Basic Hedge Algebra<br/>Deriving Present and Forward Values from Eurodollar Futures Rates<br/>Calculating a Forward Value (Terminal Wealth)<br/>Calculating a Zero-Coupon Bond Price (Present Value)<br/>Hedging or Replicating Forward Cash Flows<br/>Forward Valuing the Gain or Loss on the Eurodollar Futures Contract<br/>Present Valuing the Gain or Loss on a Floater<br/>Hedging or Replicating Present Values of Cash Flows<br/>Calculating the Price of a Zero-Coupon Bond<br/>Calculating the Present Value of a Basis Point<br/>Finding the Hedge for a Zero-Coupon Bond<br/>Faster Hedge Ratio Calculations with Calculus<br/>Pricing and Hedging a Coupon-Bearing Bond<br/>Managing Hedge Ratios<br/>As Rates Rise or Fall<br/>As Time Passes<br/>Practical Considerations in Real Hedges<br/>The Stub Period<br/>Date and Term Mismatches<br/>Whole Contracts<br/>Credit Spreads<br/>Variable Credit Spreads<br/>Chapter 6 Pricing and Hedging a Swap with Eurodollar Futures<br/>Fixed/Floating Interest Rate Swaps<br/>Notional Principal Amount<br/>Cash Flows in Arrears<br/>Periodicity<br/>Spot and Forward-Starting Swaps<br/>Day-Count Conventions and Swap Yields<br/>Approaches to Pricing and Hedging Interest Rate Swaps<br/>Cash Flow Approach<br/>Hypothetical Security Approach<br/>Pricing a Swap Using the Cash Flow Method<br/>Hedging a Swap Using the Cash Flow Method<br/>Primary Effects<br/>Secondary Effects<br/>Calculating Hedge Ratios<br/>Hedge Ratios Are Dynamic<br/>Pricing a Swap Using the Hypothetical Securities Method<br/>Hedging a Swap Using the Hypothetical Securities Method<br/>Floating Rate Liability<br/>Fixed Rate Asset<br/>Find the Hedge Ratios<br/>Pricing and Hedging Off-the-Market Swaps<br/>Convexity Differences between Forward and Futures Rates<br/>Comparing Three Yield Curves: Forward, Zero Coupon, and Par Coupon<br/>The Difference between Money Market Rates and Bond Yields<br/>Part Three Eurodollar Futures Applications<br/>Convexity Bias (Chapters 7 through 10)<br/>Term TED Spreads (Chapters 11 and 12)<br/>Hedging and Trading with Eurodollar Stacks, Packs, and Bundles (Chapter 13)<br/>Hedging Extension Risk in Callable Agency Notes (Chapter 14)<br/>Opportunities in the S&amp;P Calendar Roll (Chapter 15)<br/>Trading the Turn (Chapters 16 and 17)<br/>Chapter 7 The Convexity Bias in Eurodollar Futures<br/>Galen Burghardt and William Hoskins Research note originally released September 16, 1994<br/>Synopsis<br/>Introduction<br/>Interest Rate Swaps and Eurodollar Futures<br/>A Forward Swap<br/>The Value of a Basis Point<br/>Eurodollar Futures<br/>Reconciling the Difference in Cash Flow Dates<br/>Hedging the Forward Swap with Eurodollar Futures<br/>The Other Source of Interest Rate Risk in the Forward Swap<br/>Interaction between the Two Sources of Risk<br/>Trading the Hedge<br/>How Much Is the Convexity Bias Worth?<br/>How Correlated Are the Rates?<br/>Estimating the Value of the Convexity Bias<br/>Calculating the Value of the Bias<br/>Reconciling the Difference between a Swap and a Eurodollar Futures Contract<br/>How One Would Pay for the Advantage<br/>Translating the Advantage into Basis Points<br/>A Workable Rule of Thumb<br/>Applying the Rule of Thumb<br/>The Importance of Time to Contract Expiration<br/>The Cumulative Effect of All This Drift<br/>How Sensitive Are the Estimates to the Assumptions?<br/>Practical Considerations in Applying the Rule<br/>The Importance of the Bias for Pricing Term Swaps<br/>Biases in Forward Swap Rates<br/>The Market’s Experience with the Convexity Bias<br/>Now What?<br/>Running a Receive Fixed, Pay Floating Swap Book<br/>Marking a Swap Book to Market<br/>Volatility Arbitrage<br/>Evaluating Term TED Spreads<br/>APPENDIX A Deriving the Rule of Thumb<br/>APPENDIX B Calculating Eurodollar Strip Rates and Implied Swap Rates<br/>Chapter 8 Convexity Bias Report Card<br/>Galen Burghardt, William Hoskins, and Niels Johnson Research note originally released April 15, 1997<br/>What Is the Convexity Bias?<br/>How Have We Done?<br/>Convexity Bias Greeks<br/>Convexity Bias Delta<br/>Convexity Bias Vega<br/>Convexity Bias Theta<br/>Chapter 9 New Convexity Bias Series<br/>Galen Burghardt and Lianyan Liu Research note originally released February 1, 2002<br/>Chapter 10 Convexity Bias: An Update<br/>Chapter 11 Measuring and Trading Term TED Spreads<br/>Galen Burghardt, William Hoskins, and Susan Kirshner Research note originally released July 26, 1995<br/>Synopsis<br/>TED Spreads<br/>Simple TED Spreads<br/>Term TED Spreads<br/>Two Kinds of Term TED Spreads<br/>Unweighted Eurodollar Strip Yields versus Treasury Yields<br/>Weighted Eurodollar Strip Yields versus Treasury Yields<br/>Implied Eurodollar Yield versus Treasury Yield<br/>Fixed Basis Point Spread to Eurodollar Futures Rates<br/>How Do These Rates Compare?<br/>How Directional Is the Spread?<br/>Trading the Spreads<br/>Hedge Ratios<br/>What to Do with the Stub<br/>Overnight Financing<br/>Term Financing<br/>Carry and Convergence<br/>Convexity<br/>Forward Term TED Spreads<br/>Term TED Spreads and Swap Spreads<br/>APPENDIX Complete Operating Instructions for Calculating Term TED Spreads and Hedge Ratios<br/>Chapter 12 TED Spreads: An Update<br/>Chapter 13 Hedging and Trading with Eurodollar Stacks, Packs, and Bundles<br/>Galen Burghardt, George Panos, and Fred Sturm Research note originally released December 15, 1999<br/>Synopsis<br/>Three Objectives<br/>How Good Are Stack, Pack, and Bundle Hedges?<br/>Curve-Augmented TED Spreads?<br/>Hedging and Trading with Eurodollar Stacks, Packs, and Bundles<br/>Basics: Dates, Names, Packs, Bundles, and Quotes<br/>Contract Colors<br/>Packs and Bundles<br/>Quote Practices 1: Ticks<br/>Quote Practices 2: Use Price Level for Individual Contracts<br/>Quote Practices 3: Use Price Changes for Packs and Bundles<br/>Unpacking Packs, Unbundling Bundles<br/>Hedging with Stacks, Packs, and Bundles<br/>What Happens to the Correlations?<br/>Best Pack Proxies for Key Treasury Maturities<br/>Horizon Matters<br/>The Dangers of Decorrelation<br/>Scaling Your Hedges to Reduce Hedge Error<br/>Trading Curve TEDs<br/>Calculating the Hybrid Spread<br/>Looking for Opportunities<br/>Chapter 14 Hedging Extension and Compression Risk in Callable Agency Notes<br/>Galen Burghardt and William Hoskins Research note originally released March 24, 1995<br/>Synopsis<br/>Introduction<br/>What Is the Exposure in a Callable Agency Issue?<br/>Extension and Compression Risk<br/>A Packaged Deal<br/>What Is the Package Worth?<br/>What Is the Risk Exposure?<br/>Structuring a Hedge<br/>The Option Is Tougher<br/>Focus on Delta Hedging<br/>Synthetic Forward Notes<br/>Different Deltas<br/>Example of Hedging a 10-Year, 8.5 Percent Coupon Note, Callable in 5 Years<br/>Step 1: Find the Price of the Forward Note<br/>Step 2: Find the Embedded Option’s Delta<br/>Step 3: Calculate Spot Market Hedge Ratios<br/>Step 4: Calculate Futures Hedge Ratios<br/>Step 5: Adjust the Hedge as Interest Rates Change<br/>The Costs and Risks of Delta Hedging<br/>Risks in the Hedge<br/>The Yield Spread between Agencies and Treasurys<br/>What If There Is Little or No Call Protection?<br/>Sometimes Strips of Eurodollar Futures Provide Better Hedges<br/>Netting Positions<br/>Adjusting the Hedges<br/>Chapter 15 Opportunities in the S&amp;P 500 Calendar Roll<br/>Galen Burghardt and George Panos Research note originally released June 7, 1999<br/>Synopsis<br/>Save 15 Basis Points per Year on the Roll<br/>Eliminate Interest Rate Risk in the Roll<br/>Earn Superior Money Market Returns<br/>The Value of the Calendar Spread<br/>Fair Value of the Spread<br/>Implied Financing Rate<br/>How the Calendar Spread Has Behaved<br/>What Is Your Exposure to Interest Rates?<br/>Handling Rate Exposure in the Roll<br/>Hedging against Interest Rate Risk<br/>Cash Management and Portfolio Replication<br/>Chapter 16 Trading the Turn: 1993<br/>Galen Burghardt, Mike Bagatti, and Kevin Ferry Research note originally released October 25, 1993<br/>Synopsis<br/>What Is “the Turn”?<br/>Two-Day Turns<br/>Three-Day Turns<br/>Four-Day Turns<br/>Rate Behavior around the Turn<br/>Effects on Eurodollar and LIBOR Futures Prices<br/>Rule of Thumb for a 4-Day Turn<br/>Rule of Thu
mb for a 3-Day Turn<br/>Rule of Thumb for a 2-Day Turn<br/>Implied Turn Rates<br/>Implications for Futures Spreads<br/>December LED Spread<br/>December/January LIBOR Spread<br/>December/March Eurodollar Spread<br/>December TED Spread<br/>Effect of the Turn on LIBOR and Eurodollar Volatilities<br/>Theoretical Turn Volatility Premiums<br/>So What?<br/>The Risks in the Trade<br/>Chapter 17 The Turn: An Update<br/>Hedging the Stub<br/>Part Four Building Blocks: Eurodollar Options<br/>Chapter 18 The Eurodollar Option Contract<br/>Option Expirations and Underlying Futures<br/>Standard Quarterly Options<br/>Serial Options<br/>Mid-curve Options<br/>Five-Year Bundle Options<br/>Option Contract Specifications<br/>Contract Unit<br/>Price Quote<br/>Tick Size<br/>Minimum Fluctuation<br/>Strike Price Increments<br/>Listed Contract Months<br/>Contract Type and Month Symbols<br/>Sample Option Quotes<br/>Trading Hours<br/>Last Trading Day<br/>Exercise of Option<br/>Assignment<br/>Chapter 19 Price, Volatility, and Risk Parameter Conventions<br/>Pricing Options on Futures<br/>Option Price (Market)<br/>Volatility<br/>Relative Rate Volatility<br/>Rate (Basis Point) Volatility<br/>Period Volatility<br/>Implied Volatility<br/>Risk Parameters<br/>Delta<br/>Gamma<br/>Vega<br/>Theta<br/>Rho<br/>Intrinsic and Time Value<br/>Chapter 20 Caps, Floors, and Eurodollar Options<br/>Chapter 21 Structure and Patterns of Eurodollar Rate Volatility<br/>Historical, Implied, Realized, and Break-Even Volatilities<br/>Term Structure of Eurodollar Rate Volatility<br/>Volatility Calendar Spread Trade<br/>Yield Curve Trade<br/>Maturity Structure of Volatility (Volatility Cones)<br/>Volatility Skews<br/>Implied Rate Distributions<br/>Chapter 22 Practical Considerations<br/>Early Exercise<br/>Cash Settlement and Exercise<br/>Part Five Eurodollar Option Applications<br/>Trading with Serial and Mid-curve Eurodollar Options (Chapters 23 and 24)<br/>What Happens to Eurodollar Volatility when Rates Fall? (Chapters 25 and 26)<br/>Hedging Convexity Bias (Chapter 27)<br/>Chapter 23 Trading with Serial and Mid-curve Eurodollar Options<br/>Galen Burghardt and Scott Lyden Research note originally released June 22, 1998<br/>Synopsis<br/>Eurodollar Strategy Triangle<br/>FOMC and Other Volatility Trades<br/>Spreads against OTC Treasury Options<br/>LIFFE Joins the Crowd<br/>The Full Constellation of Eurodollar Options<br/>Standard Quarterly Options<br/>Serial Options<br/>Mid-curve Options<br/>Serial 1-Year Mid-curve Options<br/>The Beauty of This Design<br/>The Eurodollar Strategy Triangle<br/>June/Short June (A Yield Curve Spread)<br/>Short June/Red June (A Time Decay Spread)<br/>March/Red June (A Volatility Curve Spread)<br/>Different Volatility Horizons<br/>Mid-curve Options versus OTC Treasury Options<br/>Eurodollar/Treasury Volatility Spread Trading<br/>How Do You Compare the Volatilities?<br/>How Do You Construct the Trades?<br/>Some Things to Keep in Mind<br/>LIFFE’s Options<br/>Chapter 24 Serial and Mid-curve Options: An Update<br/>Chapter 25 What Happens to Eurodollar Volatility When Rates Fall?<br/>Galen Burghardt, George Panos, and Eric Zhang Research note originally released October 18, 2001<br/>Background<br/>Was Volatility Rich or Cheap?<br/>Volatility and Rate Levels<br/>Why Relative Rate Volatility?<br/>What Is the Evidence?<br/>Is it the Fed?<br/>Practical Consequences<br/>Chapter 26 Eurodollar Volatility: An Update<br/>Chapter 27 Hedging Convexity Bias<br/>Galen Burghardt and George Panos Research note originally released August 2, 2001<br/>Synopsis<br/>The Challenges<br/>Overcoming the Challenges<br/>Hedging a 4-Year Swap/Eurodollar Position<br/>Gamma<br/>Vega<br/>Eurodollar Options<br/>Gamma Mismatch?<br/>The Choice?<br/>Robustness?<br/>Glossary<br/>Index<br/>About the Author<br/>Footnotes<br/>Chapter 1<br/>Footnote 1<br/>Chapter 3<br/>Footnote 1<br/>Footnote 2<br/>Chapter 4<br/>Footnote 1<br/>Footnote 2<br/>Footnote 3<br/>Footnote 4<br/>Footnote 5<br/>Chapter 6<br/>Footnote 1<br/>Chapter 8<br/>Footnote 1<br/>Footnote 2<br/>Chapter 11<br/>Footnote 1<br/>Footnote 2<br/>Chapter 13<br/>Footnote 1<br/>Chapter 14<br/>Footnote 1<br/>Chapter 17<br/>Footnote 1<br/>Chapter 18<br/>Footnote 1<br/>Chapter 21<br/>Footnote 1<br/>Footnote 2<br/>Chapter 23<br/>Footnote 1<br/>Footnote 2<br/>Glossary<br/>Footnote 1