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INTRODUCTION
TED Spread is defined as the interest rate differential in the Treasury bill futures and the eurodollar futures contracts. These futures contracts provide a mechanism for locking into short-term rates in advance of their later settlement dates. For example, eurodollar futures contracts, which are traded on the Chicago Mercantile Exchange, provide expectations regarding future short-term rates linked to the threemonth London Interbank Offered Rate (LIBOR) deposits. When eurodollar futures rise in price, rates are expected to fall. For example a price of 96 for the nearby eurodollar futures contracts implies an expectation of 4 percent rate of interest. (i.e.,100-96=4.) When the eurodollar futures price rises to 97, rates are expected to fall to 3 percent (i.e., 100-97=3). Eurodollar futures prices and rates provide a tool for formulating expectations regarding changes in interest rates. For example, if the LIBOR is 5.5 percent, and the nearby eurodollar futures price is 94.25 producing an expected short-term rate of 5.75 percent ( i.e.,100-94.25=5.75), investors may assume a 25 basispoint (0.25 percent) rise in short-term rates. (Bary 1996.) Similarly, Treasury bill futures contracts provide expectations regarding short-term rates on Treasury bills issued by the U.S. government.
Bary (1995) reports that arbitrage between the U.S. Treasury bill futures and eurodollar futures contracts, which involves buying U.S. Treasury bill futures and selling eurodollar futures of similar maturity, is popular. The spread between the U.S. Treasury bill futures and eurodollar futures contracts may widen as a result of any negative news which could deteriorate investors' confidence. The widening of the TED Spread would lead to a rise in the eurodollar rate (fall in eurodollar futures price) due to their lower quality as compared with the perceived security in the U.S. Treasury bills. Thereby, TED Spread widens as investors' confidence fall, and vice versa, TED Spread narrows in times of high confidence in the performance of stock prices.
Another confidence index, as reported in Barron's, concerns differential in yields between the high-grade and intermediate-grade bonds. Barron's reports the ratio of the high-grade bond yield to the intermediate grade yield, referred to as the Confidence Index. A narrowing of this yield spread, resulting in a rising value for the Confidence Index, indicates rising confidence in performance of the economy...