Eurodollar

Eurodollar

Key takeaways
* Eurodollars are U.S. dollar–denominated deposits held at banks outside the United States (including foreign banks and overseas branches of U.S. banks).
* Because they sit outside U.S. jurisdiction, eurodollars are not subject to Federal Reserve reserve requirements or FDIC insurance.
* The eurodollar market is a large, global source of short-term, unsecured funding and can offer higher interest rates in exchange for higher risk.
* Typical transactions are large and short-term, often overnight; longer maturities are usually issued as CDs with limited secondary markets.

What is a eurodollar?
A eurodollar is any deposit denominated in U.S. dollars that is held in a bank outside the United States. The name comes from the market’s historical concentration in Europe, but eurodollars can be located anywhere offshore (for example, in Caribbean financial centers). Because these deposits are outside U.S. banking regulation, they operate under the rules of the host jurisdiction rather than under Federal Reserve rules.

Why the eurodollar market matters
The eurodollar market is one of the world’s primary international capital markets. It supplies short-term, unsecured dollar funding to corporations, banks, and other financial institutions. Because eurodollar deposits are not subject to U.S. reserve requirements or FDIC insurance, they often pay higher interest rates than comparable domestic deposits—compensation for increased regulatory and counterparty risk. Corporations also use eurodollar funding or instruments to hedge dollar exposures.

Market structure and liquidity
* Transaction size: Participants are typically institutional; deposits commonly start at $100,000 and often exceed $5 million. Single overnight deposits of $500 million or more are not unusual.
* Volume: Average daily overnight eurodollar activity is large (on the order of hundreds of billions of dollars).
* Tenors: Most activity is overnight (settling the next business day). With weekends and holidays, an “overnight” position can extend to several days. Longer maturities (generally over six months) are often represented by certificates of deposit (CDs), which have a limited secondary market.
* Settlement: Interbank payments for eurodollar transactions typically move over international payment systems such as Fedwire and CHIPS when U.S. dollar funds are transferred between banks.

Example
A U.S. company with excess dollar cash may deposit those funds in an overseas bank account denominated in dollars. If offshore dollar deposits offer higher interest rates than comparable domestic accounts, the company can earn a better return. Many such deposits are taken by U.S. banks through their offshore branches (for example, in the Caribbean) and by large European banks.

History
The eurodollar market emerged after World War II as large amounts of U.S. dollars circulated overseas, partly via U.S. aid and trade flows. A parallel, less-regulated market developed for holding and lending those dollar balances outside U.S. banking supervision.

Who borrows in the eurodollar market?
Major borrowers include branches and agencies of foreign banks operating in the United States and large financial institutions that need dollar funding. These participants commonly borrow in both the eurodollar and domestic fed funds markets.

How individuals can access eurodollars
Direct access to eurodollar deposits is usually limited to large institutions and high-balance accounts. Individual investors can gain exposure indirectly through financial products such as mutual funds or ETFs that invest in eurodollar futures or other dollar-denominated offshore instruments. Opening a dollar account at an overseas bank is another route, but minimums and regulatory differences may make this impractical for most retail investors.

Risks
* Regulatory and insurance gaps: Eurodollar deposits are not covered by Federal Reserve reserve rules or FDIC insurance, increasing counterparty and systemic risk.
* Jurisdictional risk: Deposits are subject to the laws and political environment of the host country.
* Liquidity risk: The market depends on a steady supply of offshore dollar deposits; a sudden withdrawal of deposits can create funding stress for banks.
* Credit risk: As unsecured deposits, eurodollars expose depositors to the creditworthiness of the accepting institution.

Bottom line
Eurodollars are simply U.S. dollar deposits held outside the United States. They play a central role in global dollar funding markets and can offer higher yields than domestic deposits, but they carry additional regulatory, credit, and liquidity risks. The name has no connection to the euro currency.