Trading and Capital-Markets Activities Manual
Profiles: Eurodollar Certificates of Deposit
A Eurodollar certificate of deposit (Eurodollar CD) is a negotiable dollar-denominated time deposit issued by a U.S. bank located outside the United States or by a foreign bank located abroad. Dollars deposited in international banking facilities (IBFs) in the United States are also considered Eurodollars.
CHARACTERISTICS AND FEATURES
Eurodollar CDs are not FDIC-insured. Eurodollar deposits are generally free from domestic (U.S.) regulation and reserve requirements, and are not subject to other fees imposed by the FDIC. Most Eurodollar CDs are issued in denominations over $1 million. Although their maturities must be at least seven days, and most CDs are issued for three to six months, there is no upward limit on the term. Issuing banks cannot purchase their own CDs.
The primary reason for issuing in the Eurodollar market (besides the basic reason to issue a CD-to provide a source of funds) is the lower cost of funds available as a result of the elimination of regulatory costs and reserve requirements. Buyers, on the other hand, can take advantage of the slightly higher yields while maintaining reasonable liquidity. Eurodollar CD issuers subsequently take the funds received from the issuance and redeposit them with other foreign banks; invest them; retain them to improve reserves or overall liquidity; or lend them to companies, individuals, or governments outside the United States.
DESCRIPTION OF MARKETPLACE
The Eurodollar CD market is centered in London. Activity also takes place in offshore branches, including those in Nassau and the Cayman Islands. Issuers include the overseas branches of money-center U.S. banks, large British banks, and branches of major Canadian and Japanese banks. Only the largest banks with strong international reputations usually sell Eurodollar CDs. Since the advent of the medium-term note market, the Eurodollar CD market has been on a decline and is now a relatively illiquid market.
Eurodollar CDs are sold by the issuing bank at face value either directly to investors or depositors or through CD dealers and brokers. Settlement is on a two-day basis and occurs at the New York correspondents of the issuers' and investors' banks.
Eurodollar CDs are priced off the London Inter-bank Offered Rate (LIBOR). Their yields are generally slightly higher than yields for domestic CDs to compensate the investor for the slightly higher risk.
Eurodollar CDs are quoted and sold on an interest-bearing basis on an actual 360-day basis. The bid/offer quotes are in 16ths (for example, 12 7/16). The quotes directly translate to rates on the given Eurodollar CD. Thus, bid/offer rates of 12 7/16 and 12 3/16 would roughly translate to a bid interest rate of 12.4375 percent and an offer rate of 12.1875 percent, respectively, giving the dealer a spread of .25 percent.
Eurodollar futures may be used to hedge Eurodollar time deposits. Eurodollar futures are one of the most actively traded futures contracts in the world.
The risks associated with purchasing Eurodollar CDs include credit risk, sovereign risk, and liquidity risk. To reduce credit risk, a detailed analysis should be performed on all Eurodollar CD issuers in which the investor has invested. Although the instruments themselves are not rated, most issuers are rated by either Thompson Bankwatch (for domestic banks) or IBCA, Ltd. (for foreign banks).
The secondary market for Eurodollar CDs is less developed than the domestic CD market. The current perception of the issuer's name, as well as the size and maturity of the issue, may affect marketability.
The Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, ''Accounting for Certain Investments in Debt and Equity Securities,'' as amended by SFAS 125, ''Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,'' determines the accounting treatment for investments in Eurodollar CDs. SFAS 125 has been replaced by SFAS 140, which has the same title. Accounting treatment for derivatives used as investments or for hedging purposes is determined by SFAS 133, ''Accounting for Derivatives and Hedging Activities.'' (See section 2120.1, ''Accounting,'' for further discussion.)
RISK-BASED CAPITAL WEIGHTING
In general, a 20 percent risk weighting is appropriate for depository institutions based in OECD countries. For specific risk weights for qualified trading accounts, see section 2110.1, ''Capital Adequacy.''
LEGAL LIMITATIONS FOR BANK INVESTMENT
Owning Eurodollar CDs is authorized under the ''incidental powers'' provisions of 12 USC 24 (seventh). Banks may legally hold these instruments without limit.
Cook, Timothy Q., and Robert LaRoche,
eds. Instruments of the Money Market. 7th ed. Richmond, Va.: Federal Reserve
Bank of Richmond, 1993.
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