Question

Assume that you observe the following prices in the T-Bill and Eurodollar futures markets:

	T-Bill	Eurodollar
September	95.24	94.6

a. If you expected the TED spread to narrow over the next month then an appropriate strategy would be to do what long or short and why?

b. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the T-Bill futures position.

c. Assume that a month later the price of the September T-Bill future is 96.25 and the price of the Eurodollar future is 95.9. Calculate the profit on the Eurodollar futures position.

(Please explain steps taken)

Answer 1

a) When spread is expected to narrow then short the spread i.e. Short T-bill future and Long Eurodollar future. Spread narrowing means interest rates might fall and value of eurodollar future should increase more than t-bill future thereby reducing the spread

b) at t=0, t bill future = 95.24 , Eurodollar Future = 94.6, TED spread = 95.24 - 94.6 = 0.64 = 64 basis point

t=1 month, t bill future = 96.25 , Eurodollar Future = 95.9, TED spread = 96.25 - 95.9 = 0.35 = 35 basis point

Profit on Long Eurodollar future = 95.9 - 94.6 = 1.3 = 130 Basis points

c) Profit on Short T-Bill future = 95.24 - 96.25 = -1.01 = -101 Basis points