Eurodollar Futures Arbitrage Edge

This question contrasts a Eurodollar futures contract with a Eurodollar forward contract that have the same quoted rate and maturity but differ in how and when cash flows are realized. The candidate is asked which position is economically more attractive and whether the equality of quoted rates signals a mispricing. The scenario highlights how daily marking to market in futures versus single settlement at maturity in forwards changes the effective payoff, and whether that can be turned into a systematic arbitrage. Fixed income derivative desks and interest rate quant roles commonly encounter this style of reasoning when thinking about pricing on money market futures and swaps.

Conceptually, the problem leans on the distinction between forwards and futures, convexity bias, and the interaction between rate paths and intermediate cash flows. A strong answer will reference the correlation of interest rates with the underlying, explain why identical quoted rates do not guarantee equal economic value, and discuss under what assumptions any advantage appears. The interviewer is watching for clean arbitrage logic, careful treatment of funding and reinvestment, and an understanding of when an apparent edge is merely a risk premium rather than a true mispricing.

What it tests

Whenever two derivative contracts have identical payoffs at maturity but differ in the timing of their intermediate cash flows, their present values can diverge due to the impact of reinvestment risk and the convexity effect. Specifically, futures contracts, which are marked to market daily, expose the holder to the risk that gains are realized and reinvested when rates are low, and losses require financing when rates are high. This asymmetry means that, in environments where interest rates are correlated with the underlying, the expected value of the futures contract can differ from that of the forward, even if their quoted rates are the same. The difference, called convexity bias, arises because the value of early cash flows depends on the path of interest rates, not just their average. Understanding this requires seeing that the timing and uncertainty of cash flows alters their present value, even for contracts that look similar at first glance.