Fixed Income Securities, 4th Edition

CHAPTER 12Short‐Term Rates and Their Derivatives

Short‐term funds trade in money markets in significant volumes and at a variety of interest rates. Interest rates vary across currencies, of course, but even within a single currency there are typically several rates that reflect differences in collateral, market participants, and term. This chapter introduces some of the most important short‐term interest rates across currencies and describes the global transition away from LIBOR. The chapter then describes a number of interest rate derivatives contracts – one‐month SOFR futures, fed funds futures, three‐month SOFR futures, Euribor FRAs, and Euribor futures – and explains their use in hedging exposures to short‐term interest rates. A detour shows how combining fed funds futures prices with Federal Reserve Board meeting dates is used to imply expectations of the Federal Reserve's target rate and to construct benchmark interest rate curves for general use. The chapter concludes with a brief discussion on the difference between futures and forward rates. Notes on pricing rate forwards and futures on rates with term structure models can be found in the appendix to Chapter 12.

12.1 SHORT‐TERM RATES AND THE TRANSITION FROM LIBOR

Since a first trade in 1969,¹ LIBOR (London Interbank Offered Rate) grew to become the dominant set of reference rates for short‐term interbank borrowing. Across a wide variety of loans and derivatives, huge volumes of cash flows were set based on LIBOR. ...