Definition of LIBOR
LIBOR, or the London Inter Bank Offered Rate, is a globally recognized benchmark interest rate. It represents the average rate at which major banks are willing to lend to one another for short-term loans. This rate is determined daily and serves as a reference point for a wide range of financial products, including mortgages, corporate loans, derivatives, and other financial instruments. LIBOR is published in multiple currencies and for various maturities, typically ranging from overnight to one year.
Examples of LIBOR in Use
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Variable Rate Mortgages: A homeowner with a mortgage tied to the 6-month USD LIBOR will see their interest payments adjust every six months based on the prevailing 6-month LIBOR rate plus a fixed margin.
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Corporate Loans: A corporation may take out a loan with an interest rate of 3-month EURIBOR plus 2%. The EURIBOR (Euro Interbank Offered Rate) is a similar interbank rate to LIBOR, used in Europe.
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Interest Rate Swaps: In a typical swap contract, two parties might exchange payments where one makes fixed payments while receiving floating payments tied to 3-month GBP LIBOR.
Frequently Asked Questions
1. What is the significance of LIBOR in financial markets?
LIBOR is crucial because it serves as a global benchmark for interest rates on various financial products, impacting trillions of dollars in loans and derivatives.
2. How is LIBOR calculated?
LIBOR is calculated based on submissions from a panel of major banks, reporting the rates they would charge each other for unsecured loans in different currencies and maturities.
3. Why is LIBOR being replaced?
LIBOR is being phased out because of past manipulation scandals and a decline in the volume of actual transactions underlying the rate. New benchmark rates like SOFR (Secured Overnight Financing Rate) are being introduced to provide a more robust and transaction-based reference.
4. What are the alternatives to LIBOR?
Alternatives to LIBOR include SOFR (U.S.), SONIA (U.K.), ESTR (Europe), TONA (Japan), and SARON (Switzerland). These alternative rates are based on actual transaction data.
5. When will LIBOR be officially discontinued?
LIBOR is set to be phased out by the end of 2021 for most currencies, with some USD LIBOR rates continuing until mid-2023.
Related Terms
- SOFR (Secured Overnight Financing Rate): The U.S. replacement for LIBOR, based on overnight transactions in the Treasury repurchase market.
- EURIBOR (Euro Interbank Offered Rate): A similar to LIBOR, it is the rate at which eurozone banks lend to one another.
- Interest Rate Swap: Financial derivatives where two parties exchange interest rate payments, typically switching between fixed and floating rates.
- Fixed Rate: An interest rate that remains constant over the life of the loan or financial instrument.
- Floating Rate: An interest rate that adjusts periodically based on an underlying benchmark, like LIBOR.
Online References
Suggested Books for Further Studies
- “Interest Rate Swaps and Other Derivatives” by Howard Corb
- “Fixed Income Securities: Tools for Today’s Markets” by Bruce Tuckman
- “The Basics of Finance: An Introduction to Financial Markets, Business Finance, and Portfolio Management” by Pamela Peterson Drake and Frank J. Fabozzi
Accounting Basics: “LIBOR (London Inter Bank Offered Rate)” Fundamentals Quiz
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