CFA Practice Question

CFA Practice Question

A decrease in the Eurodollar-T-bill spread indicates that:
A. there is a heavy demand for T-bills due to the economic strength of the U.S.
B. investors are ready to take on higher credit risks and there is reduced demand for t-bills relative to Eurodollar futures.
C. investors are bearish on a global basis.
Explanation: Eurodollar rate is the rate of interest paid on inter-banking U.S. Dollar loans and deposits outside the U.S. Since the U.S. Treasury has the best credit in the world, the yield on U.S. Treasury bills is lower than the Eurodollar rate. The "spread" or the difference between the two rates is a measure of the additional credit risk involved in inter-bank loans compared to loans to the U.S. Treasury. If the demand for Eurodollar lending increases relative to the purchase of t-bills, the spread will narrow. Thus, the behavior of the spread reflects the risk attitude of investors in the lending markets.

User Contributed Comments 4

User Comment
stefdunk erm, if the spread decreases, doesn't it mean people want more T-bills and less eurodollars bonds, causing the price of eurodollars to drop, meaning that people want the safety of t-bills (ergo, bearish)
memphisbanker no, since yield on T-Bills is lower than the Eurodollar rate, decreased demand for T-Bills means T-Bill rate will increase while new demand for eurodollar returns will drive down their yield and therefore spread will narrow.
ontrack excellent explanation by analyst notes.
Procbaby1 For anything other than Eurodollars this would signify a "flight to quality" (ergo, bearish).
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