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Trying to understand the Eurdollar market a little better. I understand it's the market for dollar denominated deposits outside the US (not just in Europe). They are unregulated and not subject to reserve requirements, unlike traditional deposits.

The players that engage in the Eurodollar futures are wide reaching institutions but they are predominately banks.

Lets say we have two banks: Bank A: JP Morgan, a bank with over a trillion dollar of deposits and has plenty of excess reserves surplus to reserves requirments and the loans they have made to households/companies.

Bank B: Goldman Sachs: Investment Bank with a small deposit base and highly dependent on the open market for funding the banks operations.

If JP Morgan were to engage in a 3M ED contract with Goldman their essentially lending Goldman their surplus deposit at a higher yield to treasuries (3M Libor) and Goldman is borrowing those funds to run their operations. However, is there any money that is actually exchanged when entering the ED contract or is it purely notional of 1M per contract. If its notional what is the purpose of the ED contract other than for hedging. It sounds silly but at the end of the day these futures market were made for producers to not only hedge their risk but to sell their produce to users. Shouldn't their be money exchanged in the idea that one party needs money and the other has it? Are the sellers of ED contracts hedgers or borrowers & users of the funds.

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The Eurodollar futures I know are traded on the CME, that is on a (regulated) organized market. –  edouard Dec 25 '12 at 19:59

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I guess you'll have found the answer to this question sometime in the last couple of years, Gabriel, but anyway: It is purely notional. This market is not made for producers to sell their product, it is simply for hedging. The money market is where actual short-term capital is lent between banks.

In EuroDollar futures there is no exchange of principal. In fact, bank A does not deal with Bank B: instead if Bank A buys and Bank B sells, then actually Bank A buys from the exchange and Banks B sells to the exchange. Each bank pays or receives their mark-to-market value of the trade to the exchange each night.

There is a separate OTC derivative product called FRAs that are similar to Eurodollar futures in terms of risk and value. They are traded between banks, but nowadays even those contract will be cleared (to a central clearing house such as LCH) so that the banks aren't facing each other.

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