A eurodollar is money issued by the United States that is deposited in a bank outside of the United States. These banks can be located anywhere in the world, including in foreign branches of U.S.-based financial institutions. The eurodollar market is used to finance international transactions, and eurodollar futures are popular in derivative trading.
- Eurodollars vs. Eurocurrency
- History of Eurodollars
- How Do Eurodollars Work?
- What Is the Eurodollar Market?
Eurodollars refer to U.S. dollars that are deposited in foreign banks. Say, for example, that someone deposits $5,000 into an account in Brazil. That money is considered eurodollars. It’s also eurocurrency because it is money issued by one government and deposited into an account located in a different country. Were someone to deposit 5,000 Mexican pesos in that same Brazilian bank, that money also would be considered eurocurrency but not eurodollars. “Dollar” is the nickname of U.S. currency, and as such, eurodollars refer only to dollars from the U.S. that have been deposited in another country.
It’s easy to confuse eurodollars with similar terms like euros and eurocurrency because of the similarities in their names. The euro is the currency used by the European Union. Euros can never be called eurodollars but they are a form of eurocurrency if someone deposits them in a bank outside the EU.
The eurodollar market emerged in the wake of World War II as European countries sought money to recover from the war’s devastation. The United States helped aid this recovery through the Marshall Plan, and as part of the plan sent money overseas. With so many U.S. dollars circulating across the continent in less regulated financial markets, a new opportunity appeared in the banking system. Banks could use the U.S. dollar as a financing resource.
This eventually sparked a need for an interest rate pricing system, and the result was the London Interbank Offered Rate, or Libor, which developed in the 1970s. Under this system, daily Libor interest rate quotes reflect estimates provided by a collective of banks. In 2014, the Alternative Rates Reference Committee was created as an alternative to Libor.
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Eurodollars technically work like any other deposit made in the local currency. What makes eurodollars different is where they are deposited. Deposits in banks outside the United States are not subject to the U.S. Federal Reserve Bank’s guidelines and do not need to meet the requirements for Federal Deposit Insurance Corp. insurance. As a result, these accounts can yield higher returns than American-based accounts.
The reduced restrictions made eurodollar accounts attractive to investors, and the accounts eventually spread to other parts of the world. Today, many American and European banks have branches offshore where they conduct business with eurodollars.
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The term eurodollar also refers to eurodollar securities that are popular with banks, trading firms and other financial entities that buy and sell exchange-traded securities to lock in current interest rates for money they want to use in the future. Most eurodollar futures trades take place on the Chicago Mercantile Exchange. The Chicago Mercantile Exchange is part of CME Group, the world’s largest futures exchange.
Eurodollar futures on the CME are tied to a time deposit with a three month maturity period. The value of eurodollar futures can fluctuate in response to changes in interest rates and international political events. Trade wars and tariffs that disrupt the movement of imports and exports around the world affect business. Eurodollar futures respond to these effects because so many international companies use eurodollars for financing.
Eurodollars serve an important role in the world’s economy, especially in the international capital market. In the event you’re interested in learning more about eurodollars and their pluses and minuses, sit down with a financial planner or other qualified financial expert and go over everything in rigorous detail. In the process, you’ll also learn more about the world’s financial system and how it affects your money and your future.
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This article has been updated with additional reporting since its original publication.