Using Fed Funds Futures Contracts

The fed funds rate is the interest rate that banks pay when they borrow Federal Reserve deposits, usually overnight, from other banks. Financial market participants watch it closely, because the level of the funds rate can be immediately and purposefully affected by Federal Reserve open market operations.

The Federal Open Market Committee, the main policymaking arm of the Federal Reserve, communicates an objective for the fed funds rate in a directive to the Trading Desk at the Federal Reserve Bank of New York. Actions taken to change an intended level of the fed funds rate are motivated by a desire to accomplish ultimate policy objectives, especially price stability. Permanent changes in the fed funds rate level are thus the consequence of deliberate policy decisions.

The fed funds contract, also known as 30-day fed funds futures, calls for delivery of interest paid on a principal amount of $5 million in overnight fed funds. In practice, the total interest is not really paid but is cash-settled daily. This means payments are made whenever the futures contract settlement price changes. ...