How do Eurodollar futures differ from Treasury futures when hedging interest rate exposure?

Question

AcadiFi · Accepted Answer

Great question — this trips up a lot of FRM candidates. The two instruments serve different hedging purposes despite both being interest rate derivatives.

**Eurodollar Futures**
These are based on the 3-month SOFR (formerly LIBOR) rate and are quoted as 100 minus the annualized rate. Each basis point move equals $25 per contract. They hedge **short-term funding costs** — think a bank that needs to roll its 90-day commercial paper.

**Treasury Bond Futures**
These deliver an actual Treasury bond (or note) and are quoted in price terms (e.g., 118-16 means 118 and 16/32nds). They hedge **longer-duration bond portfolios** — think a pension fund managing its 10-year duration.

**Key Differences:**

| Feature | Eurodollar Futures | Treasury Futures |
|---|---|---|
| Underlying | 3-month SOFR rate | T-Bond or T-Note |
| Settlement | Cash-settled | Physical delivery (CTD bond) |
| Duration exposure | ~0.25 years | 4–20 years depending on contract |
| Quote convention | 100 − rate | Price in 32nds |
| Convexity | Minimal | Significant |

**Convexity Bias**
Eurodollar futures are **linearly priced** — each basis point is always $25. But the actual present value of a rate change is nonlinear. This creates a systematic bias: Eurodollar futures rates are slightly higher than equivalent forward rates. The bias grows with maturity. For contracts beyond 2 years, traders apply a **convexity adjustment** (typically 0.5 × sigma^2 × T1 × T2) to convert futures rates to forward rates.

```mermaid
flowchart TD
    A[Interest Rate Risk] --> B{Exposure Type?}
    B -->|Short-term funding| C[Eurodollar / SOFR Futures]
    B -->|Bond portfolio duration| D[Treasury Futures]
    C --> E[Cash-settled at expiry]
    C --> F[Linear payoff per bp]
    D --> G[CTD bond delivery]
    D --> H[Nonlinear price/yield]
    F --> I[Apply convexity adjustment for maturities > 2yr]
```

**When to Choose Which:**
- Hedging a floating-rate loan resetting in 90 days? Eurodollar futures.
- Hedging a portfolio of 10-year Treasuries? Treasury bond futures with the cheapest-to-deliver analysis.

For more practice on interest rate derivatives, explore our FRM question bank.

How do Eurodollar futures differ from Treasury futures when hedging interest rate exposure?

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Practice Questions

Feature	Eurodollar Futures	Treasury Futures
Underlying	3-month SOFR rate	T-Bond or T-Note
Settlement	Cash-settled	Physical delivery (CTD bond)
Duration exposure	~0.25 years	4–20 years depending on contract
Quote convention	100 − rate	Price in 32nds
Convexity	Minimal	Significant