Reading 63: LOS g ～ Q1- 3

1.Unlike U.S. T-bills and their futures contracts, no riskless arbitrage relation exists between LIBOR and the Eurodollar futures contract:

A)   but Eurodollar futures contracts are still a useful, widely used hedging vehicle for exposure to LIBOR.

B)   therefore investors must utilize synthetic instruments to hedge their exposure to LIBOR.

C)   so investors have no choice but to maintain an unhedged position against LIBOR.

D)   resulting in most investors hedging their LIBOR exposure with 90-day T-bill contracts.

The correct answer was A)

Although an imperfect hedge, Eurodollar futures are still widely used to hedge exposure to LIBOR.

2.Which of the following statements regarding Eurodollar futures is most accurate?

A)   Eurodollars futures are based on 60-day LIBOR, which is an add-on yield.

B)   In the U.S., Eurodollar futures contracts are denominated in euros.

C)   Every basis point (0.01%) move in annualized 60-day LIBOR represents a $25 gain or loss on the contract.

D)   Eurodollar futures are priced as a discount yield and LIBOR is subtracted from 100 to get the quote.

The correct answer was D)

Eurodollar futures are priced as a discount yield and are quoted as 100 minus 90-day LIBOR.

3.The primary reason that Eurodollar futures contracts do not allow a pure arbitrage opportunity relative to LIBOR is that:

A)   the Eurodollar future is denominated in U.S. dollars and LIBOR is based upon Eurodollar time deposits.

B)   the value of the deposit does not change $25 for every basis point change in expected 90-day LIBOR.

C)   Eurodollar futures are somewhat illiquid relative to other financial futures contracts.

D)   Eurodollar futures do not have a delivery option that increases price efficiency.

The correct answer was B)

Eurodollar futures are priced at a discount yield. LIBOR is an add-on yield, which is the rate that is earned on the face amount of a deposit. The result is that the deposit value is not perfectly hedged by the Eurodollar contract.