Eurex Fundamentals

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Introduction

The purpose of this report is to provide a deeper un-derstanding of the fundamental factors that drive theEuropean equity index and interest rate futures mar-kets. Market participants who fully understand thesefundamentals should be more successful in their trad-ing and hedging activities.

This report covers Eurexs equity index and interestrate futures markets, which are just part of Eurexsoverall product complex. The chart on the right illus-trates the sharp growth in the combined open interestof the Eurex equity and interest rate derivatives mar-kets. Eurex had 63 million outstanding equity andinterest rate contracts as of March 2010.

The most popular Eurex equity index futures contractis the EURO STOXX 50 Index Futures, which hasopen interest of about 2 million contracts in futuresand about 40 million contracts in options. The mostpopular Eurex fixed income products are the Euro-Bund, Euro-Bobl and Euro-Schatz Futures products,which together have open interest of more than 3 mil-lion contracts in futures and more than 2 million con-tracts in options.

The Eurozone

When trading the Eurex equity index and interest ratemarkets, it is important to understand the economic,political, and geographic backdrop of these markets.The euro area, which is commonly referred to as theeurozone, is the group of sixteen countries thathave agreed to use the euro as their national currency(see the list on the next page). The eurozone is a sub-set of the European Union (EU), which is the politi-cal group of 27 European countries that have agreedto a range of common political governance measures.The EU took a big step forward toward streamliningand strengthening the governance process by endingeight years of wrangling and finally implementingthe Treaty of Lisbon as of December 1, 2009.

Of the 27 countries in the European Union, eleven donot use the euro. Of those eleven, eight are obligated

The Fundamentals that Drive the EurexEuropean Equity Index and Interest Rate Futures Markets

April 2010. Author: Richard Asplund, Managing Director, Optima Investment Research, Inc., a leading independentinstitutional research firm providing research to the global futures industry since 1982 (www.oir.com).Copyright, 2010, Optima Investment Research, Inc. See disclaimer on page 14.

to enter the eurozone under the 1992 MaastrichtTreaty, which set out the terms for European Mone-tary Union (EMU). UK and Denmark have explicitopt-out provisions that allow them to remain out of the eurozone indefinitely. Sweden claims an opt-outfrom the eurozone based in part on a public referen-dum vote in 2003 in which voters rejected the euro.

The euro group is the informal name given to thegroup of finance ministers from the eurozone coun-tries that periodically meet to discuss fiscal, currency,and regulatory issues. The euro group represents theinterests of the eurozone countries that fall under thepurview of the finance ministers portfolio. Thepresident of the euro group is currently Jean-ClaudeJuncker.

Eurozone Enlargement Estonia is expected to beapproved in the first half of 2010 for admission intothe eurozone, effective at the beginning of 2011.Other candidates are eager to join the eurozone forprotection followingthe global financialcrisis in 2008-09.However, the globalfinancial crisis and

recession that beganin 2008 causedbudget deficits to bal-loon and made itmore difficult forcountries to join theeurozone. For exam-

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Eurex Equity & Interest Rate Open Interest

Table of Contents

1. The Eurozone2. The Euro4. Fiscal Challenges

5. European Central Bank 6. ECB Monetary Policy7. Economic Data Impact10. Equity Index Futures11. EURIBOR Futures12. Euro-Bund Futures13. Euro-BTP Futures14. Information Sources


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Eurex Equity Index and Interest Rate Futures Market Fundamentals

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ple, Denmarks government favors joining the euro-zone but the Danish economy does not currently meetall the economic criteria and, in any case, the govern-ment must first hold a public referendum to securepublic approval for joining the eurozone. The globalfinancial crisis and European recession significantlyslowed the process of EU and eurozone enlargement.

Eurozone economy The eurozone economic blocis a major player in the global economy, as seen inthe table on the next page. The eurozones popula-tion of 328 million is larger than the U.S. populationof 305 million and is more than 2 times as large asJapans population of 128 million. Despite the euro-zones larger population, however, its GDP of 9.3trillion euros is about three-quarters of the size of theU.S. GDP of 12.3 trillion euros. Still, that makes theeurozone the second largest economy in the worldbehind the U.S. The eurozones per capita GDP of

28,200 is well below the U.S. figure of 40,200 andis slightly below Japans per capital GDP of 28,800.

Industry (manufacturing and construction) accountsfor more of the eurozone GDP (26.4%) than the U.S.(21.8%) but less than Japan (28.5%). This makes theeurozone economy more sensitive to the global busi-ness cycle since the manufacturing and constructionindustries are much more closely tied to the businesscycle than are services. In addition, exports are muchmore important to Europe than to the U.S. Specifi-cally, exports in the eurozone account for 22.6% of GDP, almost double the U.S. figure of 12.6%. Thismakes the eurozone economy more sensitive than theU.S, not only to foreign demand for exports, but alsoto exchange rate fluctuations.

European households earn substantially less dispos-able income than U.S. households (18,500 euros vs30,300 euros, respectively), but they are much bettersavers. Eurozone households save 14.2% of theirdisposable income versus only 5.3% for U.S. house-holds. European households hold fewer financialassets than do U.S. households ( 278% vs 386% of disposable income, respectively), but they also enjoya lower debt level (94% vs 128% of disposable in-come, respectively).

The Euro

The euro is the common currency used by the sixteeneurozone countries. Several other states that are not

members of the eurozone or European Union also usethe euro. Monaco, San Marino, and the Vatican alluse the euro under a formal agreement with the EU.Andorra, Kosovo and Montenegro have also offi-cially adopted the euro as their national currency,although that usage has not been officially sanctionedby an agreement with the EU.

The euro came into existence on January 1, 1999, andbank notes were introduced on January 1, 2002. Inits short 11-year history, the euro has become theworlds second largest reserve currency and the sec-ond most traded currency after the dollar.

The euro as a common currency offered several ad-vantages to the eurozone countries: reduced transac-tion costs through the elimination of currency con-version costs, elimination of exchange rate risks, se-curity of purchasing power, and product price trans-parency for consumers within the eurozone.

The Eurozone vs European Union

Source: European Central Bank

Eurozone countries (16 countries): Germany, France,Italy, Spain, Netherlands, Belgium, Austria, Greece,Ireland, Finland, Portugal, Slovakia, Luxembourg, Slo-venia, Cyprus, Malta.

European Union countries not in Eurozone (11 coun-tries): Denmark, Sweden, UK, Poland, Czech Republic,Bulgaria, Hungary, Romania, Estonia, Latvia, Lithuania.


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Dollar Reserves %

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common currency. However, the eurozone countriesare still separate nation-states that have separate na-tional government budgets and fiscal policies.

The eurozone countries recognized this problemwhen they formed the currency union and theyagreed to the Stability and Growth Pact, which speci-fies that national budget deficits cannot exceed 3% of GDP. Unfortunately, however, there is no seriousenforcement mechanism for this deficit ceiling.

The lack of an effective budget deficit enforcementmechanism did not present any major problems forthe eurozone in the first ten years of its existence.However, the global financial crisis and recessionthat began in late 2008 caused government budgetdeficits to soar and that laid bare the euros Achillesheel of the lack of fiscal unity.

Four countries have emerged to seriously threaten thefiscal discipline of the eurozone: Greece, Portugal,Spain, and Ireland. The graphs on the next page il-lustrate the eurozone government budget deficits andoutstanding debt levels as a percent of GDP. Greecehas been the main culprit and its serious budget situa-tion caused the euro to decline in early 2010. TheEuropean Commission, which is the EUs executivebody, forecasted in November 2009 that the Greek government budget deficit in 2010 would be huge at12.2% of Greek GDP, or about 9 percentage pointsabove the eurozones 3% ceiling.

The Greek debt problems caused a crisis for the euro-zone because it sparked talk that Greece might de-fault on its debt and might even have to exit from theEurozone and go back to using the Greek drachma.The Greek government could then use currency de-valuation as a means to offset the fiscal austerityneeded to curb the budget deficit. After weeks of wrangling, EU political leaders finally reached anagreement to form a credit facility in conjunctionwith the International Monetary Fund (IMF) to pro-vide financing to Greece if financing in the privatemarket becomes impossible. EU officials hope thatthe promise of a rescue facility will bring downGreek bond yield spreads and allow Greece to fi-nance its debt in the private market. Nevertheless,the talk about a Greek bond default has fostereddoubts about the long-term efficacy of the euro. Inaddition, the Greek problems are likely to cause theECB to maintain its emergency monetary policy for

Global Central Bank Currency Reserves Percent held in U.S. Dollars vs Euros

no-nonsense approach to monetary policy and itsanti-inflation resolve. This anti-inflation resolve iscritical for fostering market confidence in the euro asa store of value.

Global central banks have been confident enoughabout the euro that the percentage of global reservesheld in euros climbed to a record high of 27.7% inQ3-2009 from the high-teens seen in the euros earlydays. The U.S. dollar is still the worlds dominantreserve currency since 61.6% of world reserves areheld in dollars. However, global central banks aretrying to slowly diversify their risks by moving someof their reserves away from dollars and the euro is themain beneficiary of that diversification effort. Afterthe euro, the British pound and the yen are usedmuch less as reserve currencies with only 4.3% and3.2% shares of global reserves, respectively. Thatmeans there is no serious challenger at present to theeuro as the worlds second favorite reserve currency.

The fact that an increasing amount of reserves arebeing held in euros is good news for the Europeangovernment bond market since those reserves areusually parked in euro-denominated European gov-ernment bonds. This tends to keep European bondyields down and that is a favorable factor for theEuropean economy.

Eurozone Fiscal Challenges

The euro is different from the usual type of currencybecause it is not the currency of a single nation-state,but is rather the currency of a group of nation-states.The eurozone countries have agreed to a commonmonetary policy, which was necessary to create a


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of executing policydetermined by theGoverning Counciland handles the day-to-day operations of the ECB. The Gen-eral Council issuesreports on conver-gence and contrib-utes to the ECBscollection of statistical data and reporting activities.

The ECB Governing Council consists of the sixmembers of the Executive Board, plus the governorsof the national banks of the sixteen eurozone coun-tries. The ECB Governing Council usually meetstwice a month. At the first meeting of the month,which is usually held on the first Thursday of themonth, the Governing Council makes its monthlymonetary policy decision. This decision is typicallyannounced to the public at around 1:45 PM CentralEuropean Time (CET), which equates to 7:45 AMU.S. Eastern time and 8:45 PM Tokyo time, depend-ing on fluctuations in daylight savings time. Shortlyafter the conclusion of the meeting, the ECB Presi-dent holds a press conference to explain the ECBsdecision and general policy stance. ECB Councilmembers generally follow the unwritten rule to re-frain from commenting about monetary policy in theweek before an ECB policy meeting. The markets donot pay any attention to the second Governing Coun-cil meeting of the month, which focuses mainly oninternal business issues.

2010 Government Budget Deficit as % of GDP 2010 Government Debt as % of GDP

ECB Eurotower inFrankfurt, Germany

ECB Governing Council meeting

-5.0%-8.2%

-5.3%-10.1%

-6.1%-5.8%

-5.5%-12.2%

-14.7%-4.5%

-8.0%-5.5%

-4.2%-7.0%

-5.7%-4.4%

-20%-15%-10%-5%0%

GermanyFrance

ItalySpain

NetherlandsBelgium AustriaGreeceIrelandFinland

PorfugalSlovakia

LuxembourgSlovenia

CyprusMalta

77%83%

117%66%66%

101%74%

125%83%

47%85%

39%16%

43%59%

71%

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GermanyFrance

ItalySpain

NetherlandsBelgium AustriaGreeceIrelandFinland

PorfugalSlovakia

LuxembourgSlovenia

CyprusMalta

Source: European CommissionNovember 2009 Forecasts

longer than it might otherwise prefer, which is a bear-ish factor for the euro in itself since an excessivelyeasy monetary policy is bearish for a currency.

European Central Bank

The European Central Bank (ECB) is responsible foradministering monetary policy in the eurozone. OtherECB duties include holding foreign reserves, con-

ducting foreign exchange opera-tions, and promoting the smoothoperation of bank payment sys-tems. The ECB coordinates andcontrols the eurosystem, whichincludes the national centralbanks (NCBs) of the respectiveeurozone nations such as theBundesbank and Bank of France.

The ECB by treaty is guaranteedindependence from other institu-

tions in the EU and from the member states. TheECBs primary mandate is to maintain price stabil-ity. This is a narrower and more hawkish mandatethat the U.S. Federal Reserve, which is charged notonly with price stability but also with maximizingemployment.

The decision-making bodies of the ECB are the Gov-erning Council, the Executive Board, and the GeneralCouncil. The Governing Council is the main bodythat formulates monetary policy and decides on keyECB interest rates. The Executive Board is in charge


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Table note: Members as of March 2010. Please see ECB web-site at www.ecb.int for any changes.

The president of the ECB is currently Jean-ClaudeTrichet. Mr. Trichets term ends on October 31,2011. Current ECB Council Member and Bundes-bank President Axel Weber, who has a reputation asan anti-inflation hawk, is presently thought to havethe best chance of succeeding Mr. Trichet when histerm expires. Current Council Member Vtor ManuelRibeiro Constncio from Portugal, who is generallyconsidered a pro-growth dove on monetary policy,has been nominated by the eurozone finance minis-ters to take over for ECB Vice President Lucas Pap-demos when his term expires on May 31, 2010. EUleaders are expected to ratify the appointment of Mr.Constncio as the ECB Vice President when theymeet in April 2010.

ECB Monetary Policy

In pursuing its overall monetary policy goals, theECB has a set of policy instruments that include con-ducting open market operations to adjust reserves,offering standing facilities for banks, and requiringbanks to hold minimum reserves to back their loans.The ECB conducts its main refinancing operations toadjust the level of reserves in the banking system andto keep the overnight interest rate near its target, withthe ultimate purpose of controlling the money supplyand maintaining price stability in the economy.

The ECB typically conducts its main refinancing op-erations at the refinancing rate, which is the ECBskey policy rate. This policy rate provides a similarfunction as does the Federal Reserves federal fundstarget rate and the Bank of Japans target for the un-secured overnight call rate. The ECBs 2-week refi-nancing rate is currently at 1.00%, where it has beensince May 2009.

The ECB through its open market operations seeks totarget the overnight market interest rate, which iscalled the Eonia rate (an acronym for the euroovernight index average). The Eonia rate is the rateat which banks lend funds to each other on an unse-cured basis in the interbank market and is comparableto the federal funds rate in the U.S. The Eonia rate iscurrently near 0.30%.

There are two other important ECB rates to watch:the deposit rate and the marginal lending rate. TheECBs deposit rate is the interest rate the ECB paysbanks for depositing excess reserves with the ECB inits deposit facility . The deposit rate, which is cur-rently at 0.25%, usually acts as a floor for the over-night market interest rate since banks can deposittheir excess reserves in this facility and thus do nothave to lend those reserves to other banks at a ratelower than the deposit rate.

The marginal lending rate is the rate that banks pay tothe ECB to borrow reserves from the ECBs mar-ginal lending facility . The marginal lending facilityis similar to the Federal Reserves discount windowin the U.S. The marginal lending rate is a penaltyrate that is set above the main refinancing rate. TheECBs marginal lending rate, which is currently at1.75%, typically acts as a ceiling on overnight rates.

ECB Governing Council Members (22)Executive Board Members (6)

Jean-Claude Trichet ECB President

Lucas D. Papademos ECB Vice-President

Lorenzo Bini Smaghi Exec. Board Member

Jos Manuel Gonzlez-Pramo Exec. Board Member

Jrgen Stark Exec. Board Member

Gertrude Tumpel-Gugerell Exec. Board Member

National Central Bank Governors (16)

Guy Quaden Belgium

Axel A. Weber Germany

Patrick Honohan Ireland

Georgios Provopoulos Greece

Miguel Fernndez Ordez Spain

Christian Noyer France

Mario Draghi Italy

Athanasios Orphanides Cyprus

Yves Mersch Luxembourg

Michael C. Bonello Malta

Nout Wellink Netherlands

Ewald Nowotny Austria

Vtor Manuel Ribeiro Constncio Portugal

Marko Kranjec Slovenia

Jozef Makuch Slovakia

Erkki Liikanen Finland


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for more than three-quarters of eurozone GDP. Mar-ket participants therefore pay the most attention tothe national economic data from these top four coun-tries as well as the overall Eurozone data. Marketparticipants do not pay as much attention to the na-tional economic data from the smaller eurozone na-tions.

The table below illustrates the reaction of the Euro-pean stock and bond futures markets to key economicreports for the 14 -month period from January 2009through mid-March 2010. The fourteen indicatorsshown in this table are the indicators that have themost impact on the Euro-Bund market, according to acomprehensive report from the Royal Bank of Scot-land entitled: What Moves the European Bond Mar-ket? (March 2007). The table shows the average of how much the Eurex EURO STOXX 50 Futures andEuro-Bund Futures moved in the 10 minutes follow-ing the release of the economic report in question.

It is perhaps surprising that eight of the fourteen eco-nomic reports with the most impact on the Europeanequity index market are U.S. reports and not Euro-pean reports. This finding is consistent with other

academic studies on the issue. Three reasons havebeen offered to explain this phenomenon: (1) theU.S. economy is the worlds largest economy andtherefore has the largest impact on the global andEuropean business cycles, (2) eurozone economicdata tends to be released later than the U.S. data, and(3) there is some correlation between monetary pol-icy responses from the ECB and the Federal Reserve,meaning that U.S. economic data that influences achange in Federal Reserve policy can also influenceECB policy.

The national governments and Eurostat have takensteps to ensure that economic data is safeguarded andis not leaked before the official release time. An aca-demic study published by the ECB entitled WhichNews Moves the Euro Area Bond Market, foundthat over the course of the study period (1999-2005)there was no compelling evidence of macroeco-nomic statistics being released early or of allegedleakages, with one notable exception, the Germanunemployment figures. In more recent years, alle-gations of leaks of economic data have largely disap-peared, even for the German unemployment data.

European Market Impact (10 minutes) from Top Market-Moving Economic Reports

Economic IndicatorEURO STOXX 50 Futures Euro-Bund Futures

10-Minute Change 10-Minute Change

Points Percent Std Devs Points Percent Std DevsU.S. Payroll Employment 21.00 0.83% 0.50 0.25 0.21% 0.53German GDP 17.00 0.65% 0.40 0.12 0.10% 0.26U.S. GDP 11.00 0.42% 0.26 0.08 0.07% 0.17U.S. Retail Sales 11.00 0.44% 0.26 0.11 0.09% 0.22U.S. ISM Manufacturing Index 9.00 0.34% 0.21 0.08 0.06% 0.17U.S. ISM Non-Manufacturing Index 8.00 0.32% 0.19 0.06 0.05% 0.13U.S. Consumer Confidence (Univ. of Michigan) 8.00 0.31% 0.19 0.06 0.05% 0.13U.S. Philadelphia Fed Manufacturing Index 6.00 0.25% 0.14 0.09 0.07% 0.18German IFO Business Climate Index 5.00 0.21% 0.12 0.07 0.06% 0.15German State CPI 5.00 0.19% 0.12 0.10 0.08% 0.21

Euro-Zone M3 5.00 0.21% 0.12 0.03 0.03% 0.07U.S. CPI 4.00 0.16% 0.09 0.08 0.07% 0.17Euro-Zone Manufacturing PMI 4.00 0.14% 0.09 0.04 0.03% 0.08German ZEW Economic Sentiment 3.00 0.13% 0.07 0.08 0.07% 0.17Average across all reports: 9.00 0.32% 0.21 0.09 0.07% 0.18

Table Notes: 1. Covers economic releases from January 2008 through mid-March 2010.2. "Std Devs" column shows the point-change response in terms of the number of standard deviations. One daily standarddeviation over the period averaged 42.27 points for the EURO STOXX 50 and 0.47 points for Euro-Bunds (i.e., standarddeviation of the daily returns over the period times the average nearest-futures price over the period)


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European Market Impact (10 minutes) from Top Market-Moving Economic Reports (in % terms)

European Market Impact (10 minutes) from Top Market-Moving Economic Reports (in std deviations)

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U.S. Payroll Employment

German GDP

U.S. GDP

U.S. Retail Sales

U.S. ISM Manufacturing Index

U.S. ISM Non-Manufacturing Index

U.S. Consumer Confidence (Univ. of Michigan)

U.S. Philadelphia Fed Manufacturing Index

German IFO Business Climate Index

German State CPIEurozone M3

U.S. CPI

Eurozone Manufacturing PMI

German ZEW Economic Sentiment

Upper Bar: EURO STOXX 50 Response

Lower Bar: Euro-Bund Response

0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70

U.S. Payroll Employment

German GDP

U.S. GDP

U.S. Retail Sales

U.S. ISM Manufacturing Index

U.S. ISM Non-Manufacturing Index

U.S. Consumer Confidence (Univ. of Michigan)

U.S. Philadelphia Fed Manufacturing Index

German IFO Business Climate Index

German State CPI

Eurozone M3

U.S. CPI

Eurozone Manufacturing PMI

German ZEW Economic Sentiment

Upper Bar: EURO STOXX 50 Response

Lower Bar: Euro-Bund Response

Illustrates re sponse of the move in terms

of daily standard deviations (one standard

deviation is 42.27 for EURO STOXX 50

and 0.47 for Euro-Bunds over study

period).


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EURO STOXX 50 IndexTop 10 Members

Eurex Equity Index Futures

Eurex offers a wide range of equity products, includ-ing equity options, single stock futures, equity indexfutures and options, dividend derivatives, volatilityindex derivatives, and Exchange-Traded Fund deriva-tives. This report will highlight the actively-tradedEURO STOXX 50 Index Futures contract, whichcurrently has open interest of nearly 2 million con-tracts and average daily volume of more than 1 mil-lion contracts.

The EURO STOXX 50 Index is a market-capweighted index of 50 blue-chip European companies.Even though the index has only 50 companies, it in-cludes just over 50% of the free-float market capitali-zation in the larger EURO STOXX 600 index,meaning it provides an effective representation of theoverall European stock market. The index is heavilyweighted toward companies based in France and Ger-many, which together account for 62% of the indexsmarket capitalization.

The two charts on the right show that the EUROSTOXX 50 Index has performed relatively wellagainst both the S&P 500 and Japans Nikkei 225Index over the past decade. Over the past ten years,the EURO STOXX 50 Index has shown a correla-tion of 0.82 with the S&P 500 and 0.59 with the Nik-kei 225, based on weekly returns.

Like all the worlds stock markets, the EUROSTOXX 50 Index plunged during the global finan-cial crisis, but has so far rebounded by 71% from the

post-crisis low. The index has rallied on the eco-nomic recovery in Europe and the sharp improve-ment in corporate earnings. The analyst consensus isthat European earnings will grow by about 40% in2010. The forward price/earnings ratio for the indexis currently at a relatively low 11.5, which leavesroom on the upside for stock appreciation in comingyears.

Company Weight Coun-try Sector

Total SA 5.8% FR Energy

Banco Santander 5.0% SP Financials

Telefonica SA 4.5% SP TelecomSanofi-Aventis 3.9% FR Health Care

Siemens AG 3.9% GE Industrials

BNP Paribas 3.5% FR Financials

E.ON AG 3.3% GE Utilities

Nokia OYJ 2.6% FI Info Tech

ENI SpA 2.6% IT Energy

Bayer AG 2.6% GE Health Care

EURO STOXX 50 Index vs Forward P/E Ratio

EURO STOXX 50 Index vs U.S. S&P 500 Index

EURO STOXX 50 Index vs Japan Nikkei 225

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Forward P/E Ratio (right scale)

P/E RatioIndex Price


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Eurex EURIBOR Futures

Eurex offers futures and options on the 3-monthEURIBOR rate, which is the acronym for the Euro-pean Interbank Offered Rate. The EURIBOR rate isthe rate that banks charge to lend money to eachother on an unsecured basis in the interbank market,and is the benchmark used for many other loans andderivatives.

The main factor driving the 3-month EURIBOR rateis the ECBs monetary policy and the ECBs targetsfor the refinancing rate and Eonia overnight rate (seecharts on the right). Over the past decade, the 3-month EURIBOR rate has traded at a median of 15basis points above the ECBs refinancing rate. Asthe ECB changes its monetary policy and moves itsrefinancing rate, the EURIBOR rate generally tendsto follow suit with the fairly predictable spread of about 15 basis points above the refinancing rate.However, when the market is expecting the ECB toraise its refinancing rate, the EURIBOR rate tends totrade at a higher spread to the refinancing rate, asseen during the 2007-08 period. The EURIBOR rateis currently trading about 40 basis points below therefinancing rate because the ECB has flooded thefinancial system with liquidity, thus pushing downinterbank rates.

The Eurex EURIBOR Futures contracts provide valu-able information about where the market expects the3-month EURIBOR rate to be in the future. Thechart to the right plots the yield (i.e., 100.00 minusfutures price) of the EURIBOR contracts stretchedout into the future along the horizontal axis, startingwith the current June 2010 futures contract and end-ing with the March 2013 contract. This chart illus-trates that the market currently expects the 3-monthrate to rise from its present level near 0.58% to2.00% by the end of 2011 and to 2.70% by March2012. The market is expecting the 3-month EURI-BOR rate to rise as the ECB slowly raises interestrates in response to the expected improvement in theEuropean economy and increased inflation risks.

The European EURIBOR rate is comparable to theU.S. dollar 3-month Libor rate and Japans 3-monthTibor rate. The chart at the top of the page showshow the EURIBOR rate and the 3-month dollar Liborrate in the past decade have traded in roughly thesame cycle with a correlation of 0.61. However, the

Japanese 3-month Tibor rate has traded far below theEURIBOR rate in the past decade. The EURIBORrate was above 5% in mid-2008 but then plunged tothe current level near 0.58% due to the financial cri-sis, which sparked an economic recession in Europeand an extraordinarily easy ECB monetary policy.

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3-Mo EURIBOR

ECB Refinancing Rate

3-Month EURIBOR Rate vs ECB Refinancing Rate

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Expected 3-month EURIBOR Rate in the Future

3-Month EURIBOR Futures Strip Curve

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3-Mo US Dollar Libor

3-Mo EURIBOR

EURIBOR Correlations: 0.61 US, 0.45 Japan

3-mo Japan Tibor

3-Month EURIBOR Rate vs U.S. and Japan Rates


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10-year T-note Yield

German Bund Yield

Bund Correlations: 0.81 U.S., 0.35 Japan

Japan 10-yr JGB Yield

Eurex German Fixed Income Futures

Eurex offers a full complement of German govern-ment fixed-income products including 30-year Euro-Buxl Futures, 10-year Euro-Bund Futures, 5-yearEuro-Bobl Futures, and 2-year Euro-Schatz Futures,as well as options on those futures products. TheEuro in the names of those products refers to thefact that German government bonds are now denomi-nated in euros rather than in deutschemarks, as theywere prior to European Monetary Union in 1999. Inthe fixed-income complex, the Eurex also offers 10-year Euro-BTP Italian Government Bond Futures andSwiss Confederation Bond Futures.

European government bond prices are driven by avariety of factors including inflation expectations,ECB monetary policy, and the supply of bonds soldby the government, among others. Short-term bondyields such as the 2-year yield are tied more closelyto the ECBs policy target rates. Longer-term 10-year yields, on the other hand, are driven more byinflation expectations. The spread between the 10-year and the 2-year German government bond yieldis shown in the chart at the bottom of the page. Thisspread, which is one way of defining the steepness of the yield curve, can be traded with Eurex futuresproducts. The German 10-2 yield curve spread iscurrently very high at 210 basis points because theECB has pegged short-term rates at a very low levelin order to deal with the financial crisis.

The middle chart to the right shows how German 10-year yields have tracked the U.S. 10-year T-notefairly closely in the past several years due to the simi-larity of the European and U.S. business cycles andof ECB and Federal Reserve monetary policy. Thechart also shows how the Japanese 10-year JGB yieldhas been far below German yields in the past decadesince the Japanese economy continues to experiencesub-par economic growth and the threat of deflation.The German 10-year government bund yield hasshown a correlation based on monthly returns of 0.81with U.S. T-note yields since 1999 and a correlationof 0.35 with Japanese 10-year JGB yields.

The chart at the top of the page shows how German10-year Euro-Bund prices rallied sharply in late 2008in response to the global financial crisis, whichemerged in force with the bankruptcy of LehmanBrothers in September 2008. Since then, Euro-Bund

prices have remained generally strong due to theweak eurozone economy, low inflation pressures, andthe ECBs extremely easy monetary policy. Euro-zone GDP was negative for five consecutive quartersfrom Q2-2008 through Q2-2009 and so far the euro-zone economic recovery has been tepid.

Eurex German 10-yr Euro-Bund Futures Prices

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Steeper Yield CurveFlatter Yield Curve

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German 10-yr Bund Yield vs U.S. and Japan Yields

German 10-year Minus 2-year Govt Yield Spread


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Italian 10-yr Yield

German Bund Yield

German - Italian 10-yr Yield Correlation: 0.93

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Eurex Euro-BTP Italian Bond Futures

The Eurex Euro-BTP Italian Government Bond Fu-tures contract calls for the delivery of the sovereignbonds of Italy with a remaining maturity of 8.5 to 11years and an original term of no more than 16 years.Euro-BTP Futures have a contract value of 100,000euros and a coupon of 6%.

The Italian government bond yield typically trades ata premium above the German yield because Italianbonds are perceived by the market to have higher risk than German bonds. The chart in the middle on theright provides an overlay of German and Italian 10-year bond yields. German government bond yieldsare typically the lowest in the eurozone because of the size of the German economy and the Germangovernments reputation for fiscal rectitude relativeto most of the other countries in the eurozone.

The chart at the bottom of the page shows how thespread of the Italian 10-year bond yield has soaredabove the German yield in the past two years due tothe financial crisis and Italys poor budget situation.This German-Italian spread can be traded with theEurex Euro-Bund and Euro-BTP Futures contracts.

The European Commission is forecasting that Italysbudget deficit in 2010 will be 5.3% of GDP, which islarger than Germanys deficit of 5.0%. Moreover,Italy already carries much more cumulative debt thanGermany, which increases the risk of default. TheEuropean Commission is forecasting that Italys cu-mulative government debt through the end of 2010will be a very hefty 117% of GDP, the second high-est in the eurozone behind Greece at 125%. By con-trast, Germanys government debt through 2010 willbe significantly lower at 77%. The risk on Italianbonds is also higher than on German bonds becausethe Italian economy has been weaker than Germanyseconomy with negative quarter-on-quarter ItalianGDP growth in seven of the last nine quarters versusfour out of nine for Germany.

The higher risk attributed to Italian bonds can also beseen in the 5-year credit default swap (CDS) price of 115 basis points for Italy, which is more than threetimes higher than the German CDS price of 32 basispoints. The credit default swap price indicates thecost of insuring sovereign bonds against default. Interms of credit ratings, Germany has the best rating

Euro-BTP Italian Government Bond Futures Prices

German vs Italian 10-year Government Bond Yields

Italian Minus German 10-Year Govt Bond Yield

possible for its long-term debt of a triple-A ratingfrom all of the rating agencies. Italy, on the otherhand, has a long-term debt rating of Aa2 fromMoodys (two notches below Aaa), A+ from Stan-dard & Poors (four notches below AAA), andAA- from Fitch (three notches below AAA).


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Sources of InformationEurex Product Information

Product Guidehttp://www.eurexchange.com/download/documents/publications/Eurex_Produkte_2010_en.pdf

Sources of European economic news and data

Bloomberghttp://www.bloomberg.com/news/regions/europe.html

Reutershttp://www.reuters.com/finance/markets/europe

Financial Timeshttp://www.ft.com/world/europe

Wall Street Journal Europehttp://online.wsj.com/public/page/news-european-union.html

Forbes Europe http://www.forbes.com/home_europe/

CNBC Europehttp://www.cnbc.com/id/15838668/

Sources of European economic and financial data

Eurostathttp://ec.europa.eu/eurostat

European Central Bankhttp://www.ecb.int/stats/keyind/html/sdds.en.html

Principal European Economic IndicatorsA Statistical Guide, Eurostat 2009 edition. http:// epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-81-08-398/EN/KS-81-08-398-EN.PDF

Papers on the European market impact from economic indicators

Andersson, Magnus, and Lars Jul Overby, Which News Moves the Euro Area Bond Market? European Central Bank,Working Paper Series, No. 631, May 2006 (also published in German Economic Review 10(1): 1-31).See http://www.ecb.int/pub/pdf/scpwps/ecbwp631.pdf.

Cailloux, Jacques, What Moves the European bond market?, The Royal Bank of Scotland, March 2007.

Goldberg, Linda, and Deborah Leonard, What Moves Sovereign Bond Markets? The Effects of Economic News onU.S. and German Yields, New York Federal Reserve, Vol 9, No. 9, September 2003. http://www.newyorkfed.org/ research/current_issues/ci9-9.pdf

European Institutions

European Unionhttp://europa.eu/index_en.htm

European Commissionhttp://ec.europa.eu/index_en.htm

European Central Bankhttp://www.ecb.int/home/html/index.en.html

Copyright, 2010, Optima Investment Research, 847-242-9197. All rights reserved. Eurex , EURO STOXX 50 , Euribor and Eonia are worldwide registered trademarks their respective owners. Optima takes full responsibility for the contents of this reportEurex hasno responsiblity for any information contained in this report. The information contained herein is taken from sources believed to bereliable but is not guaranteed as to its accuracy or completeness. No responsibility is assumed for the use of this material and no expressor implied warranties nor guarantees are made. Nothing contained herein should be construed as an offer to buy or sell, or as asolicitation to buy or sell, any securities or derivative instruments.

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