Trade Forex - Forex Market

The Eurorate

If we know that the difference between the spot and forward rates reflects the difference between the interest rate yield of the U.S. dollar and the foreign currency, the question becomes, "which interest rate?" Obviously, choosing an arbitrary rate of interest for one currency to compare with an arbitrary rate of interest for another would create an unreliable and inconsistent forward market. A universal standard is required. The Forex market has chosen the Eurorate, a reasonable choice because this is the rate that the interbrain applies to loans of foreign currency deposits.

Interest Rates

Specifically, Eurorates are the interest rates one bank charges another to borrow foreign currency for the short term (overnight to one year). If the U.S. dollar is the foreign currency, the Eurodollar rate applies. If the foreign currency is the Japanese yen, the borrower is charged the Euroyen rate, if it is the Deutsche mark, the Euromark rate applies, and so forth. The terminology should be clarified. The Eurodollar is not an interest rate. It is the term used for a forex trading currency deposit, in which the currency happens to be U.S. dollars. The rate charged for Eurodollars is the LIBOR, or the London Interbank Offered Rate. Eurodollars are lent at the LIB OR because the Eurorate market originated in London with U.S. dollar deposits.

Futures Rates and Forward Exchange Rate

You may notice little difference between the interbank currency forward exchange market, in which foreign currency deposits are bought and sold on time, and the interbank Eurorate market, in which foreign currency deposits are lent and borrowed on time. There is, in fact, virtually no difference between these two markets. The variance between spot and forward is actually the difference between the LIB OR and the corresponding Eurorate. In fact, some dealer to dealer quotes for forward pricing involve simply quoting LIB OR plus or minus the points. The rest is extrapolated. We can summarize the interrelations between forward exchange rates and futures rates by stating.