What is IMM

News from the Federal Reserve is one of the most closely watched headlines. It has a large impact on foreign exchange and interest rates, so investors across the world wait to see what the Fed does next. Investors use interest rate derivatives to express their views on issues such as the Federal Reserve through the International Monetary Market (IMM).

How Does the International Monetary Market Work?

The IMM makes up one of four groups of the Chicago Mercantile Exchange (CME). The CME provides investors with access to futures, options, and other derivatives, automatically matching buyers and sellers for a variety of products, ranging from equity derivatives to agricultural derivatives. Derivatives are financial contracts that are dependent on an underlying asset. For example, in a wheat futures contract two parties agree to buy or sell a certain number of wheat contracts at a set price and date. 

The IMM creates and matches buyers and sellers of these contracts for forex and interest rates, among other things. The IMM houses derivative contracts for underlying assets such as G10 currencies, secured overnight financing rate (SOFR), global bonds and the consumer price index (CPI). It allows investors to access these products, both for speculation and hedging activities. 

IMM Index Conversion

The IMM Index accurately and efficiently prices interest rate futures. It creates a standard for the pricing of derivatives that reduces confusion and enhances comparison because some are quoted in yield while others are quoted in price. When derivatives for eurodollars first began trading, the exchanges could not handle them in yield terms, so they had to change their pricing to the index standard. While SOFR has replaced eurodollars, the pricing convention is still beneficial. 

The index is calculated by subtracting the interest rate in basis points from the par value, which is usually 100:

IMM Index = 100 - R

Realized three-month compounded SOFR rate (R) = 5%

IMM Index = 100 - 5

IMM Index = 95

With this system, the inverse relationship between yield and price still holds true: when yields rise, the price goes down and vice versa. This standard pricing system applies to all interest-rate derivatives traded on the IMM.

IMM Date

As with all derivatives, the contract has to have an end date. This factor separates derivative investing from simply investing in the underlying asset. IMM dates are used to define key expiration dates for SOFR contracts. The date system makes it so that contracts stop trading on the Tuesday before the expiration date. The expiration date is the third Wednesday three months after the contract’s month. For example, the September 2023 three-month SOFR contract expires on the third Wednesday of December and stops trading on the Tuesday before that.

• Wednesday, Sept. 20, 2023: First day of September 3-month SOFR contract trades
• Tuesday, Dec. 19, 2023: Last trading day for the contract
• Wednesday, Dec.20, 2023: Expiration for the contract

This standard practice also allows for comparison and less confusion within the interest rate derivative market. In fact, the dates have started being used by over-the-counter (OTC) interest rate derivatives. OTC derivatives are fully customizable and only between two parties. Despite the ability to customize, OTC investors still use IMM dates for standardization and simplicity. 

History of the International Monetary Market 

The IMM has a long and rich history, dating back to the 1970s. In 1971, President Nixon suspended the U.S. dollar’s ability to be converted into gold. The idea of this was to prevent a potential run on gold as inflation soared. The move caused many investors in the forex market to look for new places to house and hedge risk. To fill this need, the IMM was born. Originally, the IMM only allowed for the trading of futures on major currencies, such as the U.S. dollar, British pound, Swiss franc and Canadian dollar, among others. However, as the forex market grew, demand rose for emerging market currencies, such as the Russian ruble, Mexican peso and Brazilian real. 

In 1981, the IMM introduced Three-Month-Eurodollar futures, allowing companies and banks to secure a specific interest rate for money they intend to borrow or lend in the future and introducing a new form of hedging and speculation into the market. In 1986, the CME group merged with the IMM. CME then merged with the Chicago Board of Trade in 2007 to form the CME Group. 

Drawbacks of the IMM

As with any security, trading derivatives on the IMM comes with significant risks that are important to be aware of. Some risks specific to derivatives on the IMM are:

• Global economic conditions
• Lack of liquidity
• Changes in legislation
• Global geopolitical conditions

Another drawback of the IMM is that it has a steep membership fee. The application to apply costs $2,000 and is offered on a bid/offer basis. The current offer price for an IMM membership is well over $100,000. This high barrier to entry makes it such that only the largest institutions can access the exchange. However, memberships can be leased on a 3-6 month range for a little under $1,000. 

How the IMM Affects Investors

The IMM provides a place for investors to buy and sell derivatives through electronic processes that verify and match orders. The process involves multiple steps of verification from the broker and the exchange to ensure that the investor has enough capital to execute the trade and that the order will not impact the market too much. For example, the exchange can reject a limit order that is too far away from the current price as it could have an impact on the price of the derivative. The IMM also sets daily price limits so that derivatives cannot move up or down too much in one day. These controls and verifications are done instantaneously, and investors will likely not notice. 

The IMM Provides Liquidity for Macro Derivatives

If you want to trade securities, you will likely have to go through an exchange that matches buyers and sellers. This system benefits all parties: investors can get orders matched for better prices and at quicker speeds, and the exchange can make a profit. The IMM is the exchange that provides these services for interest rate, foreign exchange and other derivatives that are considered to be macro products. 

Frequently Asked Questions