TO GET STARTED TRADING CME PRODUCTS

® TO GET STARTED TRADING CME INTEREST RATE PRODUCTS

Since the introduction of financial futures at the Chicago Mercantile Exchange in 1972, the importance of futures in transferring financial risk has been proven by the explosive growth in the market. The vast array of CME interest rate prod- ucts allows professionals to manage interest rate risks ranging from one day to ten years.

Interest rates, which loosely can be defined as the price of money, affect the liveli- hoods of individuals and businesses each and every day. The cost of a home mortgage, the finance charge applied to a credit card balance, the amount of inter- est received on a savings account or the coupon on a issue are all examples of the interest rates that influence our personal and commercial activities. Like all goods and services, interest rates are determined by the market forces of supply and demand; however, the federal government also can influence key interest rates via monetary policy, that is, by adjusting them upward or downward to slow down or stimulate the economy. Interest rate levels often are regarded as key indicators of a country’s economic health.

The money market comprises the markets for short-term, heavily traded credit instruments with maturities of less than one year. Money market instruments include Treasury bills, commercial paper, bankers’ acceptances, negotiable certifi- cates of deposit, Federal Funds, and short-term collateralized loans. While the markets for these various instruments are distinct, their respective interest rates reflect general credit conditions with adjustments for differences in risk and liquidity.

As the money markets have become more liquid, money managers borrow and lend in whichever markets offer a price advantage. No longer willing to leave balances as unproductive, non-interest-earning demand deposits, corporations today are making more aggressive use of cash management techniques. Cash market participants primarily use the CME’s interest rate products for pricing and hedging their money market positions. CME INTEREST RATE

The CME lists a variety of contracts The CME’s Eurodollar time on short-term US and foreign interest deposit reflects rates. Here’s a brief description of the the London Interbank Offered Rate markets on which the CME products () for a three-month, $1 mil- are based: lion offshore deposit. A total of 40 quarterly futures contracts, spanning THREE-MONTH EURODOLLARS ten years, plus the two nearest serial Eurodollars are simply US dollars on (non-quarterly) months are listed at deposit in commercial banks outside all times. Eurodollar futures are the of the United States. The Eurodollar cornerstone of the Exchange’s inter- market has burgeoned over the past est rate quadrant and are the most 30 years as the dollar has become a liquid exchange-traded contracts in world currency. Eurodollar deposits the world when measured in terms play a major role in the international of . capital market. The interbank market for immediate (spot) and forward ONE-MONTH LIBOR delivery of offshore dollars is deep and LIBOR is a reference rate for dealing liquid, giving banks the ability to fund in Eurodollar time deposits between dollar loans to foreign importers with- commercial banks in the London out incurring currency exchange risks. Interbank Market. LIBOR often is Eurodollar deposits are direct the benchmark rate for commercial obligations of the commercial banks loans, mortgages, and floating rate accepting the deposits. They are not debt issues. The CME’s LIBOR con- guaranteed by any government. tract is analogous to the Eurodollar Although they represent low-risk contract, but represents one-month investments, Eurodollar deposits are LIBOR on a $3 million deposit. The not risk-free. Exchange currently lists twelve con- secutive monthly LIBOR futures at any given time.

3 THE CME-SIMEX MUTUAL OFFSET SYSTEM (MOS)

In 1984, the Chicago Mercantile Exchange, in partnership with the Singapore International Monetary 13-WEEK TREASURY BILLS contracts traded on the Singapore 91-DAY CETES* Exchange, pioneered an innovative As direct obligations of the US International Monetary Exchange (MEXICAN TREASURY BILLS) approach to futures trading known as government,Treasury bills are consid- (SIMEX). Via the Mutual Offset Certificados de la Tesoreria de the Mutual Offset System (MOS). ered risk-free debt instruments and System with SIMEX, open positions la Federacion, commonly referred Through the MOS, contracts opened provide the foundation for the money may be held either in Chicago or to as Cetes, are government-issued, on one exchange can be liquidated or markets because of their unique Singapore. Like the SIMEX, the CME short-term discount instruments held at the other. The CME-SIMEX safety and liquidity. Because of their currently lists twelve quarterly Euroyen that are denominated and paid in link effectively extends the trading risk-free nature, changes in the yield contracts, covering three years. Mexican pesos. The Cetes market hours of both exchanges beyond on T-bills reflect “pure” interest rate is considered the benchmark for their operating hours, allowing movements. Four quarterly T-bill ONE-MONTH FEDERAL FUNDS short-term interest rates in Mexico. traders to manage their overnight futures contracts are available for Federal Funds are funds in excess of Like US Treasury bills, Cetes are risk. This agreement, the first inter- trading at any given time. reserve requirements held by member issued in a variety of maturities, national futures trading link of its banks of the Federal Reserve System, with 28-day and 91-day maturity kind, is available for both Eurodollar EUROYEN transferable between those banks issues the most common. and Euroyen futures. Analogous to Eurodollars, Euroyen within one business day. Because the For a more detailed description of are Japanese yen deposits outside reserve accounts banks maintain at 28-DAY TIIE MOS, please consult the brochure Japan. Like the dollar, the Japanese the Fed are not interest-bearing, sell- (MEXICAN INTEREST RATE) titled CME/SIMEX Mutual Offset yen is globally traded on a 24-hour-a- ing Fed Funds allows institutions to The Tasa de Interés Interbancario de System:The World’s Most Successful day basis. The CME’s Euroyen futures earn a positive return on balances that Equilibrio, or TIIE,is a benchmark Trading Link. are fully fungible with the Euroyen might otherwise lie idle. The most interbank interest rate that repre- common Fed Funds transaction is an sents the price at which Mexican overnight, unsecured loan between banks are willing to borrow from or two banks. lend to the Bank of Mexico (the coun- The CME lists twelve consecutive try’s central bank). The TIIE is an Fed Funds futures, the same as LIBOR, equilibrium or market-clearing rate. with a new month added on the first business day following of the front-month contract. INTEREST RATE FUTURES INTEREST RATE CONTRACT MONTHS

Eurodollar, LIBOR,TIIE, Fed Funds and T-bill contracts are listed for all calendar months. Cetes and Euroyen contracts are on a March quarterly INTEREST RATE number of ticks moved, multiplied properly constructed futures hedge cycle–March, June, September and FUTURES BASICS by the value of the tick. For the first can also generate losses that will off- December. A contract month identi- All CME interest rate futures con- four quarterly and two serial set the effects of a beneficial interest fies the month and year in which the tracts are traded using a price index, Eurodollar and T-bill contracts,as rate move. In addition, because futures or options contract ceases to which is derived by subtracting the well as all LIBOR contracts, the mini- futures are quoted in terms of price exist. It is also known as the “deliv- futures’ interest rate from 100.00. For mum tick is .005, or $12.50. Thus a rather than interest rate, futures ery month.” This procedure ensures instance, an interest rate of 5.00 per- price move of from 95.005 to 95.01 exhibit an inverse relationship that the futures price converges with cent translates to an index price of for example, would mean a $12.50 between rates and price. A borrower the cash market price. However, the 95.00 (100.00 – 5.00 = 95.00). Given gain for the long position and a would sell futures to protect against vast majority of market participants this price index construction, if inter- $12.50 loss for the short position. an interest rate rise, i.e., to profit from close out their positions before expi- est rates rise, the price of the contract For the Euroyen contract and the a decrease in the futures price, and a ration by establishing new positions falls and vice versa. Therefore, to Mexican interest rates, the treat- lender would buy futures to hedge in the next month or rolling their profit from declining interest rates, ment is analogous, but the gains and against an interest rate decline or positions forward. In fact, only a very you would buy the futures contract losses are realized in Japanese yen capitalize on an increase in the futures small percentage of futures transac- (go long); to profit from a rise in inter- and Mexican pesos, respectively. price. Consider these examples: tions reach delivery. est rates, you would sell the contract That is, each 0.01 price move gives a (go short). In either case, if your view ¥2,500 or MP 50 result. Hedging a Forward Borrowing Rate turns out to be correct, you will be In late September a corporate trea-

CONTRACT MONTH SYMBOLS able to liquidate or offset your original HEDGING WITH surer projects that cash flows will position and realize a gain. If you are require a $1 million bank loan on January F July N INTEREST RATE FUTURES wrong, however,your trade will result Interest rate futures can be used to December 16. The contractual loan February G August Q in a loss. hedge against an existing or future rate will be 1% over the three-month March H September U The design of most CME interest interest rate risk. This is accom- Eurodollar (LIBOR) rate on that April J October V rate futures contracts features a min- plished by maintaining a futures date. LIBOR is currently at 5.56%. May K November X imum price move, or “tick” of 0.01. position that will generate profits to The December Eurodollar futures, June M December Z Gains or losses, therefore, are calcu- cover (or offset) the losses associated which can be used to lock in the for- lated simply by determining the with an adverse move in interest ward borrowing rate, are trading at rates. It is important to note that a

7 94.24, implying a forward Eurodollar extending the duration of the loan. or vice versa. When using futures month funds at 5.75%, but has to roll rate of 5.76% (100.00 – 94.24). By sell- Liability managers can achieve the contracts as part of a swaps transac- over this funding in three successive ing one December Eurodollar futures same effects by doing the opposite, tion, it is important to note that quarters. If he does not lock in a fund- contract, the corporate treasurer i.e., selling futures to lengthen their futures cover single interest periods ing rate and interest rates rise, the ensures a borrowing rate of 6.76% for liabilities and buying futures to only, whereas swaps are multi-period loan could prove to be unprofitable. the three-month period beginning shorten them. instruments. To hedge between The three quarterly re-funding December 16. This rate reflects the The use of futures may be an futures and swaps then, it is neces- dates fall shortly before the next bank’s 1% spread above the rate attractive alternative when physical sary to transact a strip, i.e., a three Eurodollar futures contract implied by the futures contract. restructuring is not possible; for coordinated purchase or sale of a expirations in March, June, and example, term deposits cannot be series of futures contracts with September. At the time the loan is Modifying Maturities bought back prior to their maturity successive expiration dates. For a made, the price of each contract is With either assets or liabilities, dates. It also may be less expensive detailed description of using 94.12, 93.95, and 93.80, corresponding hedging can serve as an alternative to to use futures because transaction Eurodollars to construct interest to yields of 5.88%, 6.05%, and 6.20%, restructuring the portfolio in the cash costs may be lower than those in rate swaps, see the CME strategy respectively. Coupled with the initial markets. Asset managers can cash markets, or liquidity conditions paper titled “Comparing Eurodollar funding rate of 5.75%, the bank could lengthen the effective maturity of in the cash market would result in Strips to Interest Rate Swaps.” lock in a cost of funds for the year short-term investment assets by buy- substantial market penalties. equal to 6.11%.* ing futures contracts, or shorten the Locking in a Funding Rate The banker knows that the effective maturity by selling futures. Swapping Fixed and Floating Rates Consider the case of a bank that money needed to fund the loan can Assume a lender places $1 million in Many swaps dealers incorporate funds itself with three-month be locked in for a year at approxi- a three-month time deposit at 5% in CME interest rate futures into their Eurodollar Time Deposits at LIBOR. mately 6.11% in the futures market. September. After some time, the portfolios to hedge and/or arbitrage Let’s assume this bank has a customer This rate can be used as a basis for lender believes that rates will decline their money market swaps. One of who wants a one-year,fixed-rate loan quoting the fixed rate to the cus- in the coming months and wants to the most common uses of Eurodollar of $10 million, with interest to be paid tomer. Generally speaking, the rate extend the duration of the loan out to futures is to convert a floating inter- quarterly. At the time of the loan quoted will cover hedging expenses six months. At this time, the lender est rate exposure to a fixed rate, disbursement the banker raises three- and allow a profit . can purchase a December Eurodollar * futures contract, thereby synthetically 91 91 91 91 364 ≈ []((1 + .0575 x3 60 ) x (1 + .0588 x 360) x (1 + .0605 x ) 360x (1 + .0620 x ) - 1 360) x 6.11% 360

8 9 contracts would be liquidated in The unhedged interest expense however, the actual funding over the June; and September contracts over the four quarters would have term of the loan was, on average, one would be liquidated in September. been 6.89%, substantially higher, in and one-third basis points lower than In this scenario, the banker is able fact, than the hedged expense. It the futures liquidation rates. Put to re-fund at 7.00%, 7.15%, and 7.35% should be recognized that effective another way, these basis adjustments for the respective quarters. The futures hedges materially lock in an positively affected the performance. corresponding futures are liquidated interest rate, precluding both advan- The minimal difference between at 92.98 (7.02%), 92.80 (7.20%), and tage and loss from rate movement. the target rate and the effective 92.66 (7.33%). The overall results Had interest rates moved lower over funding rate can be attributed to the are shown below. the life of the hedge, the bank would fact that the re-funding dates were have incurred an opportunity cost quite close but not identical to the

QUARTERLY EURODEPOSIT COSTS roughly equal to the difference futures expiration dates. If the

Qtr 1: $10 million x .0575 x 91/360 = $145,347 between the effective (hedged) rate respective dates were further apart, Qtr 2: $10 million x .0700 x 91/360 = $176,944 and the lower rate which could have the funding rates and the futures Qtr 3: $10 million x .0715 x 91/360 = $180,736 been realized by forgoing the use rates would not necessarily converge

If the loan is made and the risk Qtr 4: $10 million x .0735 x 91/360 = $185,792 of futures. as closely as those used in the above is hedged in the futures market, the $688,819 (6.89%) Recall that the banker had example. banker would sell 10 contracts for expected to lock up funding at 6.11%. This example of a one-year loan LESS THE FUTURES PROFITS each expiration, reflecting the fund- In fact, funds were acquired at 6.03%, funded with three-month deposits Mar: 10 contracts x (9412-9298) x $25 = $28,500 ing need of $10 million per quarter. or approximately eight basis points illustrates a negative interest rate Jun: 10 contracts x (9395-9280) x $25 = $28,750 Then, on the refinancing dates, the lower. This discrepancy occurred “gap”– that is, where shorter-term Sep: 10 contracts x (9380-9266) x $25 = $28,500 banker would take in three-month because of less-than-perfect conver- liabilities are funding a longer term Futures gain ($85,750) (0.86%) Eurodeposits and simultaneously gence between the cash re-funding asset, and rising interest rates will Total interest expense $603,069 liquidate the appropriate hedging rates and the futures liquidation have an adverse impact. The same Effective rate 6.03% contracts by buying them back. rates. If the bank had funded at basic hedging approach can be fol- With the March refunding, the March exactly the same rate as the futures lowed to remedy an overall balance contracts would be liquidated; June liquidation rate, the target would sheet maturity mismatch. have been achieved. In this case,

10 11 INTEREST RATE STRIP COLOR CODES

Bundles Packs COLOR YEAR CONTRACTS Bundles are the simultaneous sale or Packs are another simultaneous pur- White One 1-4 purchase of one each of a consecu- chase or sale of an equally weighted, tive series of Eurodollar or Euroyen consecutive series of Eurodollar Red Two 5-8 contracts. The first contract in any futures; however, the number of con- bundle is generally the first quarterly tracts in a pack is fixed at four. Packs Green Three 9-12 contract in the strip. Currently one-, are quoted in minimum quarter-tick Blue Four 13-16 two-, three-, five-, seven-, and ten- increments and, like Eurodollar year Eurodollar bundles are available futures, are designated by a color Gold Five 17-20 for trading. For example, a two-year code that corresponds to their posi- bundle consists of the first eight tion on the yield curve (see sidebar). Purple Six 21-24 Eurodollar contracts. A five-year For example, the red pack consists Orange Seven 25-28 “forward” bundle, which is com- of the four contracts that constitute posed of the twenty Eurodollar year two on the curve, the green Pink Eight 29-32 EURODOLLAR AND EUROYEN contracts from years six through ten, pack those in year three, etc. As a BUNDLES AND PACKS is also listed. Similarly, one-, two-, result, there are generally nine Silver Nine 33-36 To expedite the execution of strip and three-year bundles are available Eurodollar packs (covering years two Copper Ten 37-40 trades the CME offers bundles and for Euroyen futures. through ten) and two Euroyen packs packs for Eurodollar and Euroyen Bundles are quoted on the basis of (spanning years two and three) avail- futures. Bundles and packs are simply the net average price change of the able for trading at a given time. “pre-packaged” series of contracts contracts in the bundle relative to that facilitate the rapid execution of the previous day’s settlement price,

strip positions in a single transaction in increments of one-quarter (1/4) of rather than constructing the same a basis point. positions with individual contracts.

12 ON INTEREST RATE FUTURES

FINAL SETTLEMENT CONTRACT FINAL SETTLEMENT/DELIVERY Options on interest rate futures pro- position by purchasing a call PROCEDURES 13-week The final settlement price will be vide the opportunity to limit losses or put, a performance bond (margin) Treasury bills equal to 100 minus the weighted aver- The CME’s interest rate futures are age discount rate of the 91-day T-bill while maintaining the possibility of is not required because the price auction in the week of the third much like Forward Rate Agreements Wednesday of the contract month. profiting from a favorable move in paid on the option, also referred to (FRAs) in that delivery of the face value Three-month All open positions are debited or rates. Options are analogous to an as the option premium, is the maxi- Eurodollar credited based on the final settlement of the contract never occurs. All CME time deposits price as determined by the British insurance policy – the option buyer mum loss that can be incurred by a interest rate futures are cash-settled Bankers Association Interest pays a price or premium in return long option position. Settlement Rate for three-month dol- upon expiration. Long and short posi- lar deposits at 11:00 a.m. London time for the right to buy (call) or sell The CME lists options on on the contract’s last trading day. The tions are simply marked to a final (put) a futures contract, within a Eurodollars, LIBOR, 13-week cash market offered rate for three- settlement price. The following table month Eurodollar time deposits (or stated period of time, at a predeter- T-bills and Euroyen (Euroyen options LIBOR) is deducted from 100.00 to shows the final settlement procedures determine the final settlement price. mined price known as the strike are not eligible for mutual offset). for the CME’s interest rate contracts. One-month Settled in a manner analogous to that (or ) price. If the price of Quarterly and serial (non-quarterly) LIBOR for the Eurodollars, however, the cash market offered rate for one-month the underlying futures contract options are available for Eurodollar, Eurodollar time deposits is deducted never reaches a level that makes it LIBOR, Euroyen, and 13-week T-bills. from an index of 100.00. Three-month The final settlement price is based on profitable for the option buyer to Mid-curve options, which are short- Euroyen time the interest rate for three-month yen exercise his/her right, the option dated, American-style options deposits deposits offered to prime banks in Tokyo. This is the same final settle- expires worthless. on long-dated Eurodollar futures, ment price used by the Singapore International Monetary Exchange All CME interest rate options are also are listed. These options have (SIMEX). American-style, meaning that the as their underlying instrument One-month The final settlement price is deter- Federal mined by subtracting from 100 the options may be exercised on or Eurodollar futures contracts one and Funds Rate arithmetic mean of the Fed Funds before expiration. When taking an two years out. Because the options effective overnight rates calculated by the Federal Reserve during the are short-dated, they offer a low-pre- period covered by the contract. mium, high-time-decay alternative in this segment of the yield curve.

14 15 OPTIONS ON EURODOLLAR FUTURES

The CME currently offers three different PRICES OF INTEREST types of options on Eurodollar futures: RATE OPTIONS quarterly, serial and Mid-curve. CME interest rate option prices are quoted in terms of index points rather A Glossary of Options Terms OPTION TYPE QUARTERLY SERIAL MID-CURVE than a dollar value. Because the Call: Gives the holder the right to buy a futures UNDERLYING CONTRACT Corresponding Next quarterly Quarterly Eurodollar contract at the futures contract futures contract futures that expires one or futures price, options price and strike Gives the buyer the right to sell a futures two years after the option price are quoted in the same terms, Put: contract at the strike price CONTRACT MONTHS Mar, Jun, Sep, Dec Jan, Feb, Apr, All twelve calendar months the price relationships are clearly May, Jul, Aug, for one-year mid-curves Strike: The price at which the underlying futures contract will be bought (in the case of Oct, Nov and Mar, Jun, Sep, Dec for observable. The price of an option is calls) or sold (in the case of puts) two-year mid-curves shaped by the following factors:

NUMBER LISTED 6 2 8: 2 serial, 4 red quarterly, Intrinsic Value: The amount the futures price is 1. Option strike price versus the higher than a call’s strike; or the amount the 2 green quarterly current underlying futures price: As a futures price is below a put’s strike. LAST TRADING DAY 11:00 a.m. London time on 2:00 p.m. Chicago Time on 2:00 p.m. Chicago Time on the second London bank the Friday preceding the 3rd the Friday preceding the 3rd rule of thumb, the closer an out-of- Time Value: The part of the option price that is not intrinsic value business day preceding the Wednesday of the contract Wednesday of the contract the-money option is to being at-the- third Wednesday of the month month An option is said to be “at-the- money, the higher the option price. At-the-money: contract month money” when the underlying futures price is For in-the-money options, the more equivalent to the option strike price. SETTLEMENT/EXERCISE Cash-settled Position in front quarterly Quarterly options: Position futures contract in the corresponding futures an option is in-the-money, the In-the-money: An option is said to be “in-the- contract expiring either money” when the underlying futures price is greater its value and thus, price. greater than a ’s strike price or less one or two years after the than a ’s strike price. option expires; 2. Time to expiration: Premiums Serial options: Position in on options with a greater time to Out-of-the-money: An option is said to be the next quarterly futures “out-of-the-money” when the underlying expiration tend to be higher than futures price is less than a call option’s strike contract expiring one year price or greater than a put option’s strike price. after the option expires those that are close to expiring. This Delta: A measurement of the rate of change of occurs because a longer time period OPTIONS ON 5-YEAR EURODOLLAR BUNDLES an option premium with respect to a price provides more opportunity for the change in the underlying futures contract. Delta UNDERLYING CONTRACT One 5-year Eurodollar bundle is always expressed as a number between –1 and +1. CONTRACT MONTHS All 12 calendar months option to expire “in-the-money.”

NUMBER LISTED Two quarterly and two serial months 3. Market : Generally, the LAST TRADING DAY Friday 2:00 p.m. Chicago Time preceding the third Wednesday of the contract month greater the volatility of the underly- SETTLEMENT/EXERCISE Position in the 5-year bundle (First 20 quarterly Eurodollar contracts) ing futures price, the more valuable the option.

17 To determine how much an inter- futures position, which determines a The effective floor or ceiling hedger could guarantee a minimum est rate option premium is in dollar forward investment return for an rate provided by the option is deter- return of 5.75 percent for a cost of 12 terms, simply take the stated price, asset, the purchase of a call option mined by its strike price and the basis points. In other words, the real- for example 1.32 points, and multiply can be substituted. The call gives the premium paid. The “strike yield” ized minimum return would be 5.63 by $2,500. In this case, the premium right to buy the futures contract at a (simply 100 minus the option strike percent as a worst case (5.75 – .12). equals $3,300. stated price, providing a floor for a price) is adjusted to reflect the cost If the rate falls below 5.75 percent, return on the asset while preserving of the option. For example, suppose futures prices would rise and the call

HEDGING WITH OPTIONS the opportunity for a potential profit. the following prices were observed: option would increase in value. The ON INTEREST RATE FUTURES On the other hand, instead of lower investment rate on the asset Price/ Whenever Eurodollar, LIBOR, or taking a short futures position to Contract Premium Delta would be supplemented by the profit

T-bill futures can be used to lock in a predetermine a liability rate, buying Dec Eurodollar futures 94.24 1.00 on the call to ensure a minimum net

rate, options on futures can be sub- a put option can provide protection. Dec 94.25-strike call .12 .49 return of 5.63 percent. On the other

stituted to guarantee a rate floor or The put gives the right to sell the Dec 94.50-strike call .025 .22 hand, if the rate rises above 5.75 per-

ceiling. As an alternative to a long futures at a stated price, providing a Dec 94.25-strike put .13 .51 cent, the option would be worthless

ceiling for the liability rate, while Dec 94.00-strike put .05 .23 at expiration, and the investor would preserving the opportunity for a simply lose the cost of the option and lower cost of funds. Under these conditions, the user receive the higher market rate on of the futures contract could expect the asset. to lock in a target LIBOR of 5.76 per- Using the 94.50-strike call, the cent (100.00 – 94.24) – an asset investment hedger would establish a return if long or a liability cost if minimum return of 5.475 percent short. Subject to basis risk, this yield (100.00 – 94.50 – .025). Why would would be locked in regardless of someone use the 94.50-strike call whether market rates rise or fall rather than the 94.25-strike call, when over the hedge period. the latter offers a higher minimum Using the 94.25-strike call to return? The question involves an hedge a floating rate investment, a important tradeoff consideration.

19 GLOBEX® THE TRADING GLOBEX is a network-based electronic trading system developed by the CME and Reuters to provide after-hours access to exchange-traded products. All of the CME’s interest rate products, While it is true that the 94.25- THE WORLD OF INTEREST floor via telephone or data transmis- with the exception of Euroyen, are strike call provides a more attractive RATE TRADING NEVER SLEEPS sion lines. Upon receipt, the order is available for GLOBEX trading. CME worst-case scenario, it does so for a At any time of the day or night time-stamped and delivered to the members, their parents and affiliates, larger upfront cost. The purchaser someone, somewhere, is trading trading area, or pit, by an order clerk and CTA’s are eligible to have GLOBEX of the 94.25-strike call pays $300 for interest rates. You can too. CME or runner. (If you’re trading on terminals. Members and their parent/ this protection ($25 x 12 basis interest rate products are available GLOBEX, your order would be affiliates can trade for their own points), while the cost of the 94.50- for trading virtually 24 hours a day. entered into a GLOBEX terminal. If account or for their customers. strike call is only $62.50 ($25 x 2.5 Pit trading on the CME trading floor your order is matched, it is confirmed A primary benefit of trading via basis points). begins at 7:20 a.m.(Chicago time), to your broker and then to you. To GLOBEX is the opportunity for pre- To hedge floating rate liabilities, and runs until 2:00 p.m. Monday ensure fairness, the GLOBEX system execution discussions. Potential coun- put options present a similar set of through Friday. Once these open processes all orders based on price terparties may discuss their intent to choices. A short futures contract can outcry trading hours end, trading and time priority. Your broker can give place or fill an order prior to entering establish a forward rate of 5.76 per- resumes at 2:45 p.m. on GLOBEX® . you further GLOBEX information.) it through a GLOBEX terminal. If the cent; the 94.00-strike put can provide GLOBEX is the CME’s automated The trading pits are each divided trade has not been filled within a rea- a ceiling rate of 5.95 percent (100.00 order-entry and matching system, into a number of sections designated sonable period of time (15 seconds for – 94.00 – .05) for the premium of available worldwide. The GLOBEX for trading in particular contract a futures order and 30 seconds for an $125 ($25 x 5 basis points); and the trading session ends at 7:05 a.m. the months. No trading may occur options order), the party with which 94.25-strike put can provide a 5.62 following business day. ( You can even outside a contract’s assigned pit, nor the pre-execution discussion took percent (100.00 – 94.25 – .13) ceiling trade interest rates on Sundays on is trading permitted at any time other place can enter the opposite side. rate for the price of $325 ($25 x 13 GLOBEX, beginning at 5:30 p.m.) than during those hours which have CME interest rate products are basis points). been designated by the Exchange. traded on GLOBEX from 2:45 p.m. to HOW AN ORDER IS EXECUTED 7:05 a.m. Chicago time. On Eurodollar Once you’ve made your trading deci- FLOOR BROKER and LIBOR expiration days, traders can sion, you would then contact your RESPONSIBILITIES access the products exclusively through futures broker. After you give your An individual floor broker is respon- GLOBEX because the final settlement broker the buy or sell order, it is sible for executing your order in the occurs at 11:00 a.m. London time transmitted directly to the CME trading pit. (Your brokerage firm can (5:00 a.m. Chicago time), before the execute it on the GLOBEX system.) CME trading floor opens.

21 HOW A TRADE IS MADE

Floor brokers are licensed by an TRACKING YOUR TRADES agency of the federal government to “What’s the current price?” is the Buyer Seller execute trades for the public. first and most important question you need to answer when you’re ORDER TYPES trading. Price information is avail- Member Member and returnstofirm Broker endorsesorder There’s lots of variety in the instruc- able from: Firm Firm tions you can give to the floor • Brokers broker to help you get exactly the • Information services, such as type of order execution you want. Reuters,Telerate, Bloomberg, etc.

Broker endorses order and returns to firm You may wish to rely on your broker Order Order • Major daily and weekly newspapers for expert advice as to which instruc- Pit • Computer information services, Bid/Ask tions you should use in a particular Floor Floor such as the CME’s Home Page on the Broker Trade Broker market situation. (Please note that Executed World Wide Web: some of these orders are not avail- http://www. cme. com able on GLOBEX.) • Private advisory services Pit Reporter • Financial programs on television Quotation Ticker Market (MKT) An order to be executed imme- and radio Boards Network diately at the current market price. • The CME MercLine, at 312-930-8282

Trade submissionClearing Trade submission Limit An order that can be executed only at a House specified price or better.

Day An order that automatically expires if it is not executed on the day it is entered.

Open An order that remains in force until canceled or until the contract expires. Also called a “good-’til-canceled” order.

Spread An order to simultaneously buy and sell at least two different contracts at a quoted dif- ferential; sometimes three or more “legs” are involved.

Stop An order that becomes a market order only when the market trades at a specified price; also called a “stop-loss” order.

23 TO GET STARTED

HOW TO READ In the daily newspaper listings, SELECT A BROKER SIGN ACCOUNT PAPERS INTEREST RATE PRICES the tables reflect the previous day’s Futures and options on futures con- Once you’ve found a broker who Finding futures and options prices is prices. Open interest figures are tracts are bought and sold through meets your needs, you would then fairly easy. But how do you decipher published on a two-day lag. Here are brokerage firms, just like stocks. open a trading account. Opening an what you see or hear? Although the some of the terms you’ll need to You may want to talk to several account can involve several steps. amount of information published by know to read the tables. futures brokers before making your After you’ve met the financial a source often differs, all the informa- selection; you shouldn’t enter the requirements set by your particular tion will look something like Tables Open The average price at which the first bids and offers market until you feel comfortable broker, you must sign a risk disclosure were made or the first transactions were completed. 1 and 2. with your choice. Your broker statement. You cannot open an High Top bid or top price at which a contract was traded during the trading period. represents YOU —he or she will account until you’ve read and signed Low Lowest offer or the lowest price at which a contract enter your order as you instruct and this document, indicating that you Futures 1 was traded during the trading period. EURODOLLAR (CME) -$1 million; pts of 100% report the execution price back to understand the risks involved in The official daily closing price, typi- Yield Open Settlement price Open High Low Settle Change Settle Chg Interest cally set at the midpoint of the closing range. you promptly. In addition, you may futures and options trading. Other Mr97 94.52 94.58 94.52 94.55 +.04 5.45 -.04 381,130 Net change The amount of increase or decrease from wish your broker to give you advice documents that you may need to the previous trading period’s settlement price. June 94.44 94.48 94.43 94.47 +.05 5.53 -.05 300,057 and help on various aspects of the sign are a performance bond agreement Yield settlement The interest rate implied by the Sept 94.35 94.40 94.30 94.39 +.06 5.61 -.06 187,615 settlement price market and to simply “be there” (a statement that binds you to pay Dec 94.23 94.27 94.22 94.25 +.06 5.75 -.06 179,957 Yield change One day’s change in the futures’ interest when you have questions. for any losses incurred in the course Est vol 492,446; vol Fri 376,752; open int 2,386,860, +3,387. rate–equal and opposite to change the in settlement price All brokers in the U.S. must pass of trading) and a futures account Volume The number of contracts traded (one side of each trade only) for each delivery month during the trad- qualifying examinations and receive agreement outlining how the account ing period. a license before they are permitted is to be handled by the broker. Open interest The accumulated total of all currently Options outstanding contracts (one side only). Refers to unliqui- to handle customer orders. You can 2 dated purchases and sales. EURODOLLAR (CME) -$1 million; pts of 100% check on the registration status of DEPOSIT PERFORMANCE BOND Strike Calls-Settle Puts-Settle Strike price The price at which the buyer of a call Dec Jan Feb Dec Jan Feb Price (put) option may choose to exercise the right to purchase your broker, or “associated person,” Before you open an account to trade 9400 0.56 0.55 .... 0.00 0.00 0.01 (sell) the underlying futures contract. Also known as 9425 0.26 0.32 0.33 0.00 0.01 0.02 exercise price. by calling the National Futures CME interest rate futures or options, 9450 0.03 0.10 0.13 0.02 0.05 0.08 Association at 312-781-1410. you must deposit cash or certain 9475 0.00 0.02 0.04 0.24 0.22 .... Put The right, but not the obligation, to sell a futures 9500 0.00 0.00 .... 0.49 ...... contract at the option’s strike price on or before the expi- securities with your broker. The 9525 0.00 ...... 0.74 ...... ration date.

Est vol 148,132 Fri 70,693 calls 66,151 puts Call The right, but not the obligation, to buy a futures Op int Fri 1,078,385 calls 1,232,462 puts contract at the option’s strike price on or before the expi- ration date.

24 25 CME establishes minimum initial and FINANCIAL SAFEGUARDS CONCLUSION maintenance performance bond levels OF THE CME The Chicago Mercantile Exchange is for all products traded at the The Chicago Mercantile Exchange recognized as the world’s leading Exchange; your broker’s require- uses sophisticated risk management marketplace for short-term interest ments may be higher. (Buyers of and financial surveillance techniques rate futures and options. These con- options pay the full price of the If your account falls below the to protect Exchange members and tracts serve as benchmarks for option and are not subject to perfor- maintenance level (a set minimum customers from default on futures pricing a wide range of financial mance bond requirements.) performance bond per outstanding and options contracts. The Exchange products. CME interest rate prod- futures trade), your broker will con- Clearing House acts as the third party ucts offer a myriad of expirations and MARKING TO THE MARKET tact you for additional funds to to every trade (the seller to every combinations covering interest rate At the end of each trading day and replenish it to the initial level. Of buyer and the buyer to every seller), exposure from one day to ten years all following days that your position course, if your position generates a thus ensuring the integrity of all out on the yield curve. Trading inter- remains open, the contract value is gain, you may be able to withdraw trades. The CME is financially est rate futures and options at the “marked-to-the-market”; your any excess funds from your account. backed by its clearing members as CME gives market participants the account is credited or debited based well as a special Trust Fund. This most efficient, global risk manage- on that day’s trading session. This COMMISSIONS combination provides unparalleled ment tools available today. system gives futures trading rock- Commission costs vary according to safeguards for the protection and solid credit standing because losses the services provided by a brokerage benefit of all CME market users. In are not allowed to accumulate. firm. For futures and options con- the entire history of the Chicago tracts, the commission is normally a Mercantile Exchange, there never “roundturn” fee charged to cover the has been a default or failure result- trades you make to open and close ing in a loss of customer funds. each position. This is payable when you exit the position.

26 27 .

Chicago Chicago Mercantile Exchange Inc. 30 South Wacker Drive Chicago, Illinois 60606-7499 1 312 930-1000 FAX: 1 312 466-4410 E-mail: [email protected] London Chicago Mercantile Exchange Inc. Pinnacle House 23-26 St. Dunstan’s Hill London EC3R 8HN England 44 20 7623 2550 FAX: 44 20 7623 2565 Tokyo Chicago Mercantile Exchange Inc. Level 16, Shiroyama JT Mori Building 4-3-1 Toranomon, Minato-ku Tokyo 105-6016 Japan 813 5403-4828 FAX: 813 5403-4646 Internet www.cme.com

The information within this publication has been compiled by the Chicago Mercantile Exchange for general information purposes only. Although every attempt has been made to ensure the accuracy of the information, the Chicago Mercantile Exchange assumes no responsibility for any errors or omissions. Additionally, all examples in this publication are hypothetical fact situations, used for explanation purposes only, and should not be considered investment advice or the results of actual market experience. All matters pertaining to rules and specifications herein are made subject to and are superseded by official Chicago Mercantile Exchange rules. Current Chicago Mercantile Exchange rules should be consulted in all cases concerning contract specifications.

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