Eurostrip

What Is an Eurostrip?

An eurostrip, short for "eurodollar futures strip," is a type of interest rate derivative that permits the holder to hedge against changes in interest rates. It comprises of buying a series of three-month futures contracts known as eurodollars. Thusly, if a trader wishes to hedge their risk for one year, they would buy four continuous eurodollar contracts, each going on for a considerable length of time.

Grasping Eurostrips

Eurostrips are a casual name utilized by derivative traders to allude to a series of transactions including eurodollar futures contracts. Eurodollars are basically U.S. dollar-designated deposits held at foreign banks or at U.S. banks' overseas branches.

With no guarantees so frequently the case in modern finance, there exists an active derivative market in view of these eurodollar deposits. Specifically, starting around 1981, the Chicago Mercantile Exchange (CME) has worked with trading in eurodollar deposits utilizing cash-settled eurodollar futures contracts.

These contracts have as their underlying asset eurodollar deposits with principal values of $1 million and maturity periods of 90 days. The value of these futures contracts changes in light of the three-month U.S. dollar London Interbank Offered Rate (LIBOR). Along these lines, traders can utilize eurodollar futures to hedge against or hypothesize on changes to interest rates.

The Intercontinental Exchange, the authority responsible for LIBOR, will stop distributing one-week and two-month USD LIBOR after Dec. 31, 2021. Any remaining LIBOR will be discontinued after June 30, 2023.

Eurostrips are a derivative transaction where the trader purchases a series of back-to-back eurodollar futures contracts. The length of the chain will differ contingent upon the trader's aims. For example, a trader wishing to hedge or guess one year into the future would develop an eurostrip in view of four eurodollar futures (90 days every, 12 months altogether), a trader looking six months ahead would buy two futures contracts, etc.

The outcome of hedging utilizing eurostrips is equivalent to that of utilizing interest rate swaps, yet the two contracts are traded diversely and have an alternate set of cash flows. One decision might be more alluring than one more at a given chance to meet a specific investment objective, or both might be utilized together. Eurostrips are well known as a result of their flexibility to be structured in a wide range of ways to meet an assortment of hedging needs.

In spite of the fact that eurostrips are most normally used to hedge interest rate risks, they can likewise be utilized to guess on LIBOR or on the state of the interest rate term structure.

Real World Example of an Eurostrip

To illustrate, assume you operate a global investment bank situated in Paris, which holds U.S. dollar deposits in its European branches. You are uncertain about the future heading of interest rates and are hence anxious to hedge against the foreign exchange risk associated with these dollar holdings.

To hedge against this risk, you make an eurostrip position by taking a long position in four back to back eurodollar futures contracts. Since each contract goes on for quite some time, this eurostrip position successfully hedges your interest rate exposure for one year.

Features

• Despite the fact that they are basically used to hedge currency risk, eurostrips are additionally utilized by traders who wish to guess on interest rate developments.
• Eurostrips are a well known derivative transaction.
• They comprise of a series, or "strip," of sequential eurodollar futures contracts.