The London Interbank Offered Rate (or LIBOR, pronounced /ˈlaɪbɔr/) is a daily reference rate A reference rate is a rate that determines pay-offs in a financial contract and that is outside the control of the parties to the contract. It is often some form of LIBOR rate, but it can take many forms, such as a consumer price index, a house price index or an unemployment rate. Parties to the contract choose a reference rate that neither party based on the interest rates An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. For example, a small company borrows capital from a bank to buy new assets for their business, and in return the lender receives interest at a predetermined interest rate for deferring the use of funds and instead lending it to at which banks Banking is generally a highly regulated industry, and government restrictions on financial activities by banks have varied over time and location. The current set of global bank capital standards are called Basel II. In some countries such as Germany, banks have historically owned major stakes in industrial corporations while in other countries borrow unsecured An unsecured loan is a loan that is not backed by collateral. Also known as a signature loan or personal loan funds from other banks in the London wholesale money market The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers' acceptances, certificates of deposit, federal funds, and short-lived mortgage- and asset- (or interbank market The interbank market is the top-level foreign exchange market where banks exchange different currencies. The banks can either deal with one another directly, or through electronic brokering platforms. The Electronic Brokering Services and Reuters Dealing 3000 Matching are the two competitors in the electronic brokering platform business and).
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Introduction
During 1984 it became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments, notably interest rate swaps A swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. Interest rate swaps can be used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. Interest, foreign currency options In finance, a foreign exchange option is a derivative financial instrument where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date; see Foreign exchange derivative and forward rate agreements. Whilst recognizing that such instruments brought more business and greater depth to the London Interbank market, bankers worried that future growth could be inhibited unless a measure of uniformity was introduced. In October 1984 the British Bankers' Association—working with other parties, such as the Bank of England The Bank of England is (despite its name) the central bank of the whole of the United Kingdom and is the model on which most modern, large central banks have been based. It was established in 1694 to act as the English Government's banker, and to this day it still acts as the banker for HM Government. The Bank was privately owned and operated from—established various working parties, which eventually culminated in the production of the BBAIRS terms—the BBA standard for interest-swap rates. Part of this standard included the fixing of BBA interest-settlement rates, the predecessor of BBA LIBOR. From 2 September 1985 the BBAIRS terms became standard market practice.
BBA LIBOR fixings did not commence officially before 1 January 1986, although before that some rates were fixed for a trial period commencing in December 1984.
It should be noted that member banks are international in scope, with more than sixty nations represented among its 223 members and 37 associated professional firms (as of 2008).
Scope
LIBOR rates are widely used as a reference rate for financial instruments such as
- forward rate agreements
- short-term-interest-rate futures contracts In finance, a futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today . The contracts are traded on a futures exchange. Futures contracts are not "direct" securities like stocks, bonds, rights or warrants. They
- interest rate swaps A swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. Interest rate swaps can be used by hedgers to manage their fixed or floating assets and liabilities. They can also be used by speculators to replicate unfunded bond exposures to profit from changes in interest rates. Interest
- inflation swaps An inflation swap is the linear form of an inflation derivative, an over-the-counter and exchange-traded derivatives that is used to transfer inflation risk from one counterparty to another
- floating rate notes Floating rate notes are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon
- syndicated loans A syndicated loan is one that is provided by a group of lenders and is structured, arranged, and administered by one or several commercial or investment banks known as arrangers
- variable rate mortgages A variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate varies to reflect market conditions[1]
- currencies In economics, the term currency can refer to a particular currency, for example Pound Sterling, or to the coins and banknotes of a particular currency, which comprise the physical aspects of a nation's money supply. The other part of a nation's money supply consists of money deposited in banks , ownership of which can be transferred by means of, especially the US dollar The United States dollar is the official currency of the United States. The U.S. dollar is normally abbreviated as the dollar sign, $, or as USD or US$ to distinguish it from other dollar-denominated currencies and from others that use the $ symbol. It is divided into 100 cents (see also Eurodollar Eurodollars are deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. The term was originally coined for U.S. dollars in European).
They thus provide the basis for some of the world's most liquid and active interest-rate markets.
For the Euro The euro is the official currency of the eurozone: 16 of the 27 Member States of the European Union (EU). It is also the currency used by the EU institutions. The eurozone consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. Estonia is, however, the usual reference rates are the Euribor The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which banks offer to lend unsecured funds to other banks in the euro wholesale money market (or interbank market) rates compiled by the European Banking Federation The European Banking Federation is an organization of the European banking sector, representing interest of over 5000 European banks in 31 countries with combined assets of over 30,000 billion Euro and around 2.4 million employees. It was established in 1960. EBF acts as a forum where members' initiatives are proposed and debated as well as a, from a larger bank panel. A Euro LIBOR does exist, but mainly for continuity purposes in swap contracts dating back to pre-EMU The economic and monetary union of the European Union is the currency union of the European Union members who have adopted the euro as their sole legal tender. Full economic and monetary union has been in effect since 1 January 2002 for twelve countries, with further members joining since. For the European Union, economic and monetary union (EMU) times. LIBOR is just an estimate and not interred in the legally binding contracts of an LLC.
Technical features
LIBOR is calculated by Thomson Reuters Thomson Reuters is an information company created by the Thomson Corporation's purchase of Reuters on 17 April 2008. Thomson Reuters shares are listed on the Toronto Stock Exchange and the New York Stock Exchange (NYSE: TRI). Thomson Reuters is headquartered in Midtown Manhattan, New York City, USA. The Woodbridge Company, a holding company for and published by the British Bankers' Association (BBA) after 11:00 am (and generally around 11:45 am) each day (London time). It is a trimmed average of inter-bank deposit rates offered by designated contributor banks, for maturities ranging from overnight to one year. LIBOR is calculated for 10 currencies. There are either eight, twelve or sixteen contributor banks on each currency panel and the reported interest is the mean of the middle values (the interquartile mean). The rates are a benchmark rather than a tradable rate, the actual rate at which banks will lend to one another continues to vary throughout the day.
GBP LIBOR is often used as a rate of reference for Pound Sterling The pound sterling , commonly called the pound, is the official currency of the United Kingdom, its Crown dependencies (the Isle of Man and the Channel Islands) and the British Overseas Territories of South Georgia and the South Sandwich Islands, British Antarctic Territory and Tristan da Cunha. It is subdivided into 100 pence (singular: penny) and other currencies, including US dollar The United States dollar is the official currency of the United States. The U.S. dollar is normally abbreviated as the dollar sign, $, or as USD or US$ to distinguish it from other dollar-denominated currencies and from others that use the $ symbol. It is divided into 100 cents, Euro The euro is the official currency of the eurozone: 16 of the 27 Member States of the European Union (EU). It is also the currency used by the EU institutions. The eurozone consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. Estonia is, Japanese Yen The Japanese yen (sign: ¥; code: JPY) is the official currency of Japan. It is the third most-traded currency in the foreign exchange market after United States dollar and the euro.[verification needed] It is also widely used as a reserve currency after the U.S. dollar, the euro and the pound sterling. As is common when counting in East Asia,, Swiss Franc The franc is the currency and legal tender of Switzerland and Liechtenstein; it is also legal tender in the Italian exclave Campione d'Italia. Although not formally legal tender in the German exclave Büsingen (the sole legal currency is the euro), it is widely used on a day-to-day basis. The Swiss National Bank issues banknotes and the federal, Canadian dollar The Canadian dollar is the currency of Canada. It is normally abbreviated with the Dollar/Peso sign $, or C$ to distinguish it from other dollar-denominated currencies. It is divided into 100 cents. As of 2007, the Canadian dollar was the 7th most traded currency in the world, behind the US dollar, the euro, the yen, the pound sterling, the Swiss, Australian Dollar The Australian dollar is the currency of the Commonwealth of Australia, including Christmas Island, Cocos (Keeling) Islands, and Norfolk Island, as well as the independent Pacific Island states of Kiribati, Nauru and Tuvalu. Within Australia it is almost always abbreviated with the dollar sign ($), with A$ or AU$ sometimes used informally to, Swedish Krona The krona has been the currency of Sweden since 1873. It is locally abbreviated kr. The plural form is kronor and one krona is subdivided into 100 öre (singular and plural). The currency is sometimes informally referred to as the "Swedish crown" in English (since krona literally means crown in Swedish). The Swedish krona also circulates, Danish Krone The krone is the currency of the Kingdom of Denmark. The krone is pegged to the euro via the European Union's exchange rate mechanism. The plural of krone is kroner. The krone is divided into 100 øre, the singular form being the same as the plural. The ISO 4217 code is DKK; the domestic abbreviation is "kr.". Occasionally, the variants and New Zealand dollar The New Zealand dollar is the currency of New Zealand. It also circulates in the Cook Islands (see also Cook Islands dollar), Niue, Tokelau, and the Pitcairn Islands. It is divided into 100 cents.[2]
In the 1990s, Yen LIBOR rates were influenced by credit problems affecting some of the contributor banks.
For a precise definition of BBA LIBOR, see: The BBA LIBOR fixing & definition.
Six-month USD LIBOR is used as an index for some US mortgages. In the UK, the three-month GBP LIBOR is used for some mortgages A variable rate mortgage or floating rate mortgage is a mortgage loan where the interest rate varies to reflect market conditions—especially for those with adverse credit history.
Definition of LIBOR
LIBOR is defined as:
"The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time."
This definition is amplified as follows:-
- The rate at which each bank submits must be formed from that bank’s perception of its cost of funds in the interbank market.
- Contributions must represent rates formed in London and not elsewhere.
- Contributions must be for the currency concerned, not the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets.
- The rates must be submitted by members of staff at a bank with primary responsibility for management of a bank’s cash, rather than a bank’s derivative book.
- The definition of “funds” is: unsecured interbank cash or cash raised through primary issuance of interbank Certificates of Deposit.
LIBOR-based derivatives
Eurodollar contracts
The Chicago Mercantile Exchange The Chicago Mercantile Exchange (often called "the Chicago Merc," or "the Merc") is an American financial and commodity derivative exchange based in Chicago. The CME was founded in 1898 as the Chicago Butter and Egg Board. Originally, the exchange was a non-profit organization. The exchange demutualized in November 2000, went's Eurodollar Eurodollars are deposits denominated in U.S. dollars at banks outside the United States, and thus are not under the jurisdiction of the Federal Reserve. Consequently, such deposits are subject to much less regulation than similar deposits within the U.S., allowing for higher margins. The term was originally coined for U.S. dollars in European contracts are based on three-month US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to ten years. Shorter maturities trade on the Singapore Exchange SGX was inaugurated on 1 December 1999, following the merger of two established and well-respected financial institutions - the Stock Exchange of Singapore and the Singapore International Monetary Exchange (SIMEX) in Asian time.
Interest rate swaps
Interest rate swaps An interest rate swap is a derivative in which one party exchanges a stream of interest payments for another party's stream of cash flows. Interest rate swaps can be used by hedgers to manage their fixed or floating assets and liabilities. Unlike corporate bonds, interest rate swaps do not involve risk on the principal amount. They can also be based on short LIBOR rates currently trade on the interbank market The interbank market is the top-level foreign exchange market where banks exchange different currencies. The banks can either deal with one another directly, or through electronic brokering platforms. The Electronic Brokering Services and Reuters Dealing 3000 Matching are the two competitors in the electronic brokering platform business and for maturities up to 50 years. A "five year LIBOR" rate refers to the 5 year swap rate vs 3 or 6 month LIBOR. "LIBOR + x basis points A basis point is a unit related to the change in an interest rate, and it is equal to 1/100th of a percentage point. Put another way: 1 bp = 0.01%", when talking about a bond, means that the bond's cash flows have to be discounted on the swaps' zero-coupon yield curve In finance, the yield curve is the relation between the interest rate and the time to maturity of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S. Treasury securities for various maturities are closely watched by many traders, and are commonly plotted on a graph such as the one on the shifted by x basis points in order to equal the bond's actual market price. The day count convention In finance, a day count convention determines how interest accrues over time for a variety of investments, including bonds, notes, loans, mortgages, medium-term notes, swaps, and forward rate agreements . This determines the amount transferred on interest payment dates, and also the calculation of accrued interest for dates between payments. The for LIBOR rates in interest rate swaps is Actual/360.
Reliability
On Thursday, 29 May 2008 the Wall Street Journal The Wall Street Journal is an American English-language international daily newspaper published by Dow Jones & Company, a division of News Corporation, in New York City, with Asian and European editions released a controversial study suggesting that banks may have understated borrowing costs they reported for LIBOR during the 2008 credit crunch.[3] Such underreporting could have created an impression that banks could borrow from other banks more cheaply than they could in reality. It could also have made the banking system appear healthier than it was during the 2008 credit crunch.
For example, the study found that rates at which one major bank "said it could borrow dollars for three months were about 0.87 percentage point lower than the rate calculated using default-insurance data."
In response to the study released by the WSJ, the British Bankers' Association announced that LIBOR continues to be reliable even in times of financial crisis. According to the British Bankers' Association, other proxies for financial health, such as the default-credit-insurance market, are not necessarily more sound than LIBOR at times of financial crisis, though they are more widely used in Latin America, especially the Ecuadorian and Bolivian markets.
Additionally, other authorities have contradicted the Wall Street Journal article. In their March 2008 Quarterly Review The Bank for International Settlements The Bank for International Settlements is an international organization of central banks which "fosters international monetary and financial cooperation and serves as a bank for central banks." It is not accountable to any national government. The BIS carries out its work through subcommittees, the secretariats it hosts, and through its have stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings". Further, In October 2008 the International Monetary Fund The International Monetary Fund is the international organization that oversees the global financial system by following the macroeconomic policies of its member countries, in particular those with an impact on exchange rate and the balance of payments published their regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar LIBOR-fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding"
Market participants of course understand that there exist substantial incentives for banks to under-report LIBOR values, as many floating-rate debt instruments are based on the LIBOR value plus some additional number of basis-points. Faking up a low LIBOR number by false reporting will lower funding costs for market participants whose interest costs are pegged to LIBOR values. And as LIBOR is not an actual bid or offer—this means that it is not possible to legally require the person or agency posting the number to actually make a loan at that price—then it is almost certain to be different from the actual price that would prevail for any entity attempting to obtain funds in a marketplace. This virtually ensures that the LIBOR rate will understate any true market-negotiated interest rate. The LIBOR numbers are not worthless, nor are they explicitly fraudulent. But as they are simply posted values created by an association of coöperating bankers, and not the result of any true open-outcry fair-market process, they are almost certain to understate the true cost of borrowing money, regardless of counterparty creditworthiness. The LIBOR value is a rate at which a loan *may* happen, not a rate at which a loan *shall* happen. This subtle difference rendered the LIBOR rate an almost worthless indicator during the recent credit crisis, as it reflected what might occur, rather than what was actually occuring.
See also
- Euribor The Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which banks offer to lend unsecured funds to other banks in the euro wholesale money market (or interbank market)
- TIBOR TIBOR stands for the Tokyo Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Japan wholesale money market . TIBOR is published daily by the Japanese Bankers Association (JBA)
- Prime rate Prime rate or prime lending rate is a term applied in many countries to a reference interest rate used by banks. The term originally indicated the rate of interest at which banks lent to favored customers, i.e., those with high credibility, though this is no longer always the case. Some variable interest rates may be expressed as a percentage
- Ted spread
- Libor-OIS spread
- LIBID
References
- ^ What Is a Libor Mortgage?
- ^ www.bba.org.uk
- ^ "Study Casts Doubt on Key Rate - WSJ.com". http://online.wsj.com/article/SB121200703762027135.html?mod=MKTW.
Further reading
- Carrick Mollenkamp and Mark Whitehouse, "Study Casts Doubt on Key Rate: WSJ Analysis Suggests Banks May Have Reported Flawed Interest Data for Libor", The Wall Street Journal The Wall Street Journal is an American English-language international daily newspaper published by Dow Jones & Company, a division of News Corporation, in New York City, with Asian and European editions, Thursday, May 29th, 2008, p. 1.
- Donald MacKenzie, "What's in a Number?", London Review of Books The LRB was founded in 1979 during the year-long lock-out at The Times. Its founding editors were Karl Miller, then professor of English at University College London, Mary-Kay Wilmers, formerly an editor at The Times Literary Supplement, and Susannah Clapp, a former editor at Jonathan Cape. For its first six months it appeared as an insert in the, September 25th, 2008, p. 11-12.
External links
- LIBORATED.COM, News, rates, education, opinion, calculator, graphs
- BBALIBOR.COM, including historical worldwide rates, on the British Bankers' Association website
Categories: Interbank offered rates | Economics terminology | Terms and concepts of the 2000s United States housing bubble
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Fri, 25 Jun 2010 14:42:30 GMT+00:00
BusinessWeek ... three-month London interbank offered rate , widened this week by 24 basis points, or 0.24 percentage point, to 478 basis points, according to S&P LCD. ...
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Casino Hotels and Gaming Industry Projects With Interest Rate as Low as LIBOR 1 London Interbank Offered Rate Fast Loan Approval From OPEC Bankers Usually Between 17 25 days Celebrate Your Loan Is Approved
Nemo
hu, 01 Apr 2010 18:29:12 GM
The . London Interbank Offered Rate. , or Libor, has been driven sharply higher as banks have adopted the fetal position, reluctant to lend to each other because of need for their own cash. But those rates may not tell the entire story. ...
Q. Hi guys, can you please help me with this clarification. Recently I applied to a loan. They just informed me that they changed to the 3-month London Interbank Offered Rate ( LIBOR ) index instead of the Prime Rate index. I'm very unsure of what the difference between these two are. Does this mean a good thing or a bad thing? What are the finace charges for each. Any sort of info will be of great help, thanks alot!
Asked by Sara - Mon Nov 10 04:22:43 2008 - - 1 Answers - 0 Comments
A. There are other terms of the loan you need to know about besides the index. But first, in terms of the index you are better off with the Prime Rate. The LIBOR is much more volatile, and that means you could be stuck with a high interest rate for several periods - rates are typically changed every six months. You also need to know the margin - how much is added to the index to determine your actual interest rate. This is commonly expressed as an interest rate, and you want to have the lowest possible margin. For example, if the prime rate were 4.00% and your margin were 6.00%, your interest would be 10.00%. You also need to know the caps. These are the maximum percentage increases that can be applied to your interest rate in any time… [cont.]
Answered by doreen k - Mon Nov 10 10:22:04 2008
