Fed Funds Futures

This is a good day to talk about the Fed funds rate and Fed funds rate futures. Traders can buy and sell futures based on the Fed funds rate and expectations for changes in that rate. If you think the Fed will raise rates in the future you would sell these futures and if you think the Fed will lower rates, you would buy these futures contracts. These are a great way for institutional traders to hedge interest rate risk and speculate on changes in the future.

Here is an introduction to the Eurodollar futures contract using current quotes to illustrate: Assume we take a long position in a December 2008 Eurodollar futures contract. The quote is 97.005. That means we are “locking in” an annualized LIBOR rate of 2.995% (1100 — 97.005). The quote of 97.005 corresponds to a contract price of 2513 (the contract is on a par of million). If the LIBOR rate declines to, say, 2.0% in December, the quote goes up to 98 (100 — 2) and contract price goes up to 5000. As a long position, we gained (by design) per 1 basis point decline in the LIBOR.
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