Futures price of Eurodollar futures

Question

From Wikipedia:

The Eurodollar futures contract refers to the financial futures contract based upon these deposits, traded at the Chicago Mercantile Exchange (CME). ... CME Eurodollar futures prices are determined by the market’s forecast of the 3-month USD LIBOR interest rate expected to prevail on the settlement date.

Compared to commodity futures whose futures prices are determined by the price of underlying commodity in the future, I was wondering why Eurodollar futures prices are not determined by the interest rate of the underlying Eurodollar time deposit in the future, but instead by the LIBOR rate in the future?

Or is the price of Eurodollar time deposit determined by the LIBOR rate in some way?

Thanks and regards!

Answer 1

The Euro Dollars are USD held outside US. The LIBOR is the largest market where banks borrow from each other. The borrowoing [interest] rates are published by currency. Hence for USD, there would be a US LIBOR rate.

The Euro Dollars time deposits would more or less reflect the US LIBOR rates. There can be a small difference between Bank to Bank.

The Euro Dollar futures are determined on the US LIBOR rate in future as this is a readily available figure and there are quite a few instruments that use this rate. Thus in a way you are tracking it to Euro Dollar Time Deposits.

Answer 2

Dheer has a good answer.

But your question can be taken another way: if not the LIBOR, then whose EuroDollar time deposit should the futures be based on? Every bank will have a different rate.

The buyer and seller of a forward contract, for instance, would have to agree on a common underlying rate.

On one hand, the CME decided on LIBOR as a matter of convention - they could have created/defined a different basket of EuroDollar banks to calculate on instead.

However, to maximize liquidity, they have chosen a standard underlying that is well accepted by the market. For hedgers who use the futures contract, this is important - they need an underlying that is well correlated to their specific needs.

Answer 3

I would add that LIBOR isn't actually an interest rate, it's an index that is computed on quotes of interest rates. Indexes that are fairly and consistently calculated can be used as the reference for futures settlement prices. Note also that LIBOR is used as reference in many contracts, not just futures.