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Eurodollars are deposits of U.S. dollars at foreign banks or foreign branches of U.S. banks. The account is denominated in American dollars for the depositor. The Eurodollars lie outside of the jurisdiction of the Federal Reserve. This term was originally used for U.S. dollar deposits in European banks, but it is now universally used for the dollar deposits irrespective of the location of the bank. (Euro- prefix is now deemed for general usage to indicate any currency outside its official nation).
Banks dealing in Eurodollar markets operate on slimmer margins since it is relatively regulation-free. Hence, the Eurodollar market avoids regulatory costs. Although deposited in foreign banks or locations, Eurodollars ironically never leave U.S. regardless of the owner’s nationality. U.S.A.’s constant balance of payments deficit ensures a steady flow of dollars being converted into Eurodollars. Eurodollar futures are a very active instrument in capital markets, where the contracts are derivatives on interest paid on the Eurodollar deposits.
Eurodollars can be used by banks to make loans and interbank placements. Eurodollar loans have fixed maturities and bear interest but cannot be used to create U.S. dollars i.e. their loaning only transfers the ownership of deposits at American banks. The loans and interbank placements use LIBOR (London interbank offered rate) as the basis for interest rates. This rate may include a spread over LIBOR.
Eurodollars are used as a source of funds by large companies (U.S. domestic, foreign or MNCs), central banks, Bank for International Settlements and HNIs (High Net-worth Individuals). These funds are generally in the form of fixed deposits.