CHAPTER 2
The Eurodollar Time Deposit

A Eurodollar time deposit is nothing more than a dollar deposit with a bank or bank branch outside of the United States or with an international banking facility (IBF) located in the United States. The world’s center for Eurodollar trading is London, but there are active Eurodollar markets in other parts of the world as well.

In this chapter, we cover various aspects of the Eurodollar time deposit market, including:

• Maturities and settlement

• Quotes

• LIBOR and LIBID

• Interest rate calculations

MATURITIES AND SETTLEMENT

Exhibit 2.1 shows the bid and ask rates for Eurodollar time deposits with maturities ranging from overnight to 10 years. The rates begin with two 1-day term deposits: overnight (O/N) and tomorrow next (T/N). Each represents a 1-day term, but the overnight rate settles today and the tomorrow next rate settles tomorrow. A spot/next rate, not shown here but available for trading, represents a 1-day rate that settles 2 days from now.

EXHIBIT 2.1
Eurodollar Deposit Rates Monday, June 17, 2002

The next basic maturities are 1, 2, and 3 weeks. Beyond this, the standard maturities range from 1 month to 12 months in single-month increments. Maturities then fall every year out to 10 years. Any other maturity can be negotiated. The settlement period is 2 London business days for all deposit maturities, with the exception of overnight and tomorrow next deposits.

QUOTES

Eurodollar deposits are add-on as opposed to discount instruments. Consequently, a $1 million Eurodollar transaction requires the initial transfer of $1 million, while a $1 million Treasury bill transaction requires an initial transfer of something less than $1 million.

Interest rates for Eurodollar deposits are money market yields quoted in percentage points and fractions of percentage points. The Eurodollar deposit market uses the ACT/360 day count convention to calculate interest.

LIBOR AND LIBID

In practice, the rate at which a London bank is willing to lend dollars is known as LIBOR, which is an acronym for London Interbank Offered Rate. The rate at which a London bank is willing to borrow is referred to by the less well known LIBID, or London Interbank Bid Rate. For example, as shown in Exhibit 2.1, 1-month Eurodollars were offered at 1.81 percent (LIBOR) and bid at 1.78 percent (LIBID) as of June 17, 2002. That is, the quoting bank was willing to lend dollars for 1 month to a prime credit at 1.81 percent and to accept anyone’s deposit at 1.78 percent for a spread of 3 basis points.

INTEREST CALCULATIONS

For deposits with maturities less than or equal to 1 year, interest is paid at maturity. For deposits with maturities past 1 year, interest is paid on each anniversary and at maturity. For example, interest on a Eurodollar deposit with 1 year or less to maturity would be calculated as shown in Equation 2.1.

EQUATION 2.1
Interest on a Eurodollar Term Deposit

where

Deposit is the dollar amount

    Rate is the quoted rate

    Days is the actual number of days in the deposit term

Days/360 represents the fraction of a year based on the ACT/360 day count convention. The U.S. dollar, Euro (€), Japanese yen, and Swiss franc money markets all use the ACT/360 day count convention. The British pound and Canadian dollar money markets use the ACT/365 convention. For these currencies, the fraction of a year in Equation 2.1 would be Days/365.

Interest on a time deposit with more than 1 year to maturity would be calculated in stages. On each anniversary, the interest paid out on the deposit would be calculated as shown in Equation 2.1, with “Days” equal to the actual number of days between anniversary dates. The final interest calculation for any remaining partial year is done just as it would be for a deposit with less than 1 year to maturity, using the actual number of days remaining in the deposit’s life.

EXAMPLE 2.1

EXAMPLE 2.2