How do Eurodollar futures work mechanically, and how does a corporate treasurer use them to lock in a borrowing rate?

Eurodollar futures were among the most liquid interest rate derivatives ever created, and understanding their mechanics is foundational for FRM candidates. Even though LIBOR has transitioned to SOFR, the CME's 3-Month SOFR futures use the same quoting convention.

Quoting Convention

The futures price is quoted as 100 minus the annualized rate. If the quoted price is 95.25, that implies a rate of 4.75%. Each contract covers a notional of $1,000,000 for a 90-day period.

Tick Value

One basis point move = $1,000,000 x 0.0001 x (90/360) = $25 per contract per basis point.

Hedging Example

Pemberton Industries expects to borrow $50 million in 6 months at 3-month SOFR + 80 bps. The treasurer fears rates will rise and wants to lock in today's implied rate.

Current 3-Month SOFR futures (6-month expiry): quoted at 95.50, implying 4.50%.

Step 1 — Position sizing: $50,000,000 / $1,000,000 = 50 contracts.

Step 2 — Sell futures at 95.50 (the treasurer is a borrower, so she sells to hedge against rising rates).

Step 3 — At expiry, suppose 3-month SOFR has risen to 5.10%. The futures settle at 94.90.

Gain on hedge: (95.50 - 94.90) x 100 bps x $25 x 50 = 60 x $25 x 50 = $75,000.

Step 4 — Net borrowing cost: Pemberton borrows at 5.10% + 0.80% = 5.90% annualized on $50M for 90 days = $737,500. Subtracting the $75,000 futures gain gives an effective interest cost of $662,500, equivalent to roughly 5.30% all-in — close to the original 4.50% + 0.80% = 5.30% target.

Key Exam Points:

• Borrowers sell Eurodollar/SOFR futures; lenders buy them
• Cash settlement eliminates delivery risk
• Convexity bias means futures rates slightly overstate forward rates for long-dated contracts — this matters for swap pricing

For more practice with interest rate derivatives, explore our FRM Part I question bank.