Implementing an interagency agreement for regulating a new generation of investments, federal commodity regulators approved trading yesterday in Eurodollar futures contracts on the Chicago Mercantile Exchange.
The new contract is meant to enable investors to protect themselves from changes in interest rates and potentially to make a profit from the rise and fall of rates paid on dollars deposited in European banks.
The Eurodollar contract is the newest of a burgeoning group of interest-rate futures that have been created by the Commodity Futures Trading Commission.
Because many of the new investments were invented after federal investment laws were written, the CFTC has been at odds with the Securities and Exchange Commission over who should regulate the markets.
On Monday, the two agencies announced a partial agreement on regulatory turf that cleared the way for the CFTC to approve several even more unusual investment vehicles.
Early next year, the CFTC is expected to create a futures contract based on one of the well-known stock market indexes, such as the Dow Jones Industrial Average, the Value Line Index or the Standard & Poor's 500-stock index.
Stock index futures will make it possible to speculate on the overall performance of the stock market in the same way that interest rate futures make it possible to speculate on the state of the money market as reflected in interest rates.
Futures contracts were originally a way of investing in the grain markets. In return for a small down payment, futures contracts give the investor the right to buy a specified amount of some commodity at a specified date and a predetermined price.
If you think wheat prices are going up, you can buy a contract for a carload of wheat to be delivered in March and sell the carload -- or the contract -- at a profit if the price does indeed go up. If you suspect prices are falling, you can sell a contract to deliver wheat you don't own, figuring you can pick up the wheat later at a lower price, and then deliver it.
Now the same futures-contract concept has been extended to such "commodities" as government-insured mortgages, Treasury bills, bonds and notes and certificates of deposit in banks. Eventually futures-contract trading will include things like railroad freight rates and ocean ship charters, CFTC Chairman Philip McBride Johnson predicted Monday.
Under the CFTC-SEC turf truce announced Monday, the CFTC is authorized to approve futures contracts for just about anything except the price of the stocks or bonds of a single company or a small group of companies.
The Eurodollar futures market set up yesterday by the CFTC is the farthest removed yet from the traditional futures markets.
What the contract calls "Eurodollars" don't exist except as a concept--they are dollars deposited in European banks. Since Eurodollars are only a concept, the contract makes no provision for delivering them. It is the first domestic commodity contract specifically to rule out delivery.
To play the Eurodollar futures market, an investor will buy or sell a contract based on the interest paid on $1 million deposited for three months in a London bank. The rate for 90-day deposits is widely quoted as the London Interbank Offered Rate or LIBOR, a continental equivalent of the U.S. prime rate.
The price of Eurodollar futures will be quoted as 100 minus the London interest rate; thus, when the London rate is 14 1/4 percent, Eurodollar futures will sell for 85 3/4. If the rate falls to 14 percent, Eurodollar futures will rise to 86.
Each time the interest rate changes by one one-hundredth of a percent, the actual value of the contract changes by $25. If the interest rate moves up or down a full one percent, the interest due on $1 million for three months will change by $2,500, and so will the value of the Eurodollar futures contract.
The Chicago Mercantile Exchange expects to start Eurodollar futures trading today. Next Tuesday, the CFTC is scheduled to act on applications for additional Eurodollar trading at the Chicago Board of Trade and the Chicago Mercantile Exchange. More than a dozen additional "new generation" financial futures-contract applications are pending.