Suppose that the 9-month LIBOR interest rate is 8 % per...

Suppose that the 9-month LIBOR interest rate is $8 \%$ per annum and the 6 -month LIBOR interest rate is $7.5 \%$ per annum (both with actual/365 and continuous compounding). Estimate the 3-month Eurodollar futures price quote for a contract maturing in 6 months.

Key Concepts

LIBOR Interest Rate

LIBOR (London Interbank Offered Rate) is a benchmark rate at which major global banks lend to one another on an unsecured basis. It serves as a reference rate for many financial products, including loans, mortgages, and derivatives such as Eurodollar futures. Understanding LIBOR is crucial since its quoted rates reflect market expectations of future interest rates based on prevailing market conditions.

Continuous Compounding

Continuous compounding is a method of calculating interest where the rate of growth is exponential and interest is added an infinite number of times in a given period. In financial calculations, continuous compounding accurately represents the accumulation of interest and simplifies the mathematical treatment of interest rate problems, especially when comparing to discrete compounding methods.

Eurodollar Futures

Eurodollar futures are derivative contracts that represent the market’s forecast of the future 3-month LIBOR rate on U.S. dollars deposited outside the United States. They are used by investors and financial institutions for hedging and speculating on changes in short-term interest rates. The price of a Eurodollar futures contract is typically quoted as 100 minus the implied interest rate, making it straightforward to interpret the market's interest rate expectations.

Day Count Conventions

Day count conventions, such as the actual/365 method mentioned here, define how interest accrues over time by specifying how the days in a period are counted. Such conventions are critical in accurately computing interest rates and future values in financial contracts. The actual/365 convention assumes that the number of days in a year is 365, which affects the calculation of accrued interest and yields when using continuous compounding.

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