Interest Rate Swaps
Prime Lending Rate
Libor versus Prime Rate
Federal Funds Rate
The LIBOR definition is a benchmark interest rate derived from the rates at which banks are able to borrow funds from one another in the London inter-bank market, is the foundation of all lending rates. Furthermore, this term is a common reference rate for short-term lending transactions around the world. The British Bankers‘ Association publishes this rate daily at approximately 11:30am GMT.
LIBOR, explained below, is one of the most pivotal lending rates for the entire world. LIBOR rates are based on a filtered average of the market rates at which banks are willing to offer deposits to other banks for certain currencies, maturities, and fixing dates. In addition, LIBOR publishes rates for Australian Dollars, Euros, Japanese Yen, Sterling, US Dollars, and other currencies. Maturities can range from overnight to one year. LIBOR commonly quotes the rates for 1 month, 3 months, 6 months, and 1 year. The fixing date is the date on which the rate is relevant. While actual market rates fluctuate throughout the day, LIBOR remains fixed for 24 hours.
LIBOR as a Reference Rate
LIBOR is used as a reference interest rate for loans to borrowers with good credit as well as loans to borrowers with poor credit.
For example, a borrower with good credit might secure a loan at LIBOR, the reference rate, plus a narrow quoted margin, or the percentage point spread above the reference rate. Meanwhile, a borrower with poor credit might secure a loan at LIBOR plus a wider quoted margin. LIBOR swap rates are also used as a reference rate for currencies, mortgages, interest rate swaps and other financial instruments.
LIBOR, calculated daily by the British Bankers’ Association (BBA), is based on a filtered average of inter-bank deposit offer quotes submitted from certain contributor banks.
The BBA selects a panel of at least 8 Contributor Banks for each relevant currency. For example, the Australian Dollar panel consists of 8 banks. The Canadian Dollar panel consists of 12 banks. And the Japanese Yen panel consists of 16 banks. The Contributor Panel selections are based on the banks’ credit standing, reputation, participation in the London inter-bank market, and other relevant factors. The compositions of the Contributor Bank Panels are reviewed annually.
Each day, between 11:00am GMT and 11:10am GMT, each Contributor Bank submits to the BBA the actual rate at which it could borrow funds just before 11:00am GMT on that day in the London inter-bank market for particular currencies, maturities, and fixing dates.
Then the submitted rates are ranked. Then they calculate the mean using only the two middle quartiles of the ranking. For example, if 16 rates are submitted, then calculate the mean using the middle 8 rates. Whereas if 12 rates are submitted, then use the middle 6 rates. And if 8 rates are submitted, then use the middle 4. The calculated mean becomes the London Inter-bank Offered Rate for that particular currency, maturity, and fixing date. The BBA then publishes this rate at approximately 11:30am GMT.
History of LIBOR
LIBOR was established between 1984 and 1985. It provides a standardized rate to facilitate the increasing usage of new financial instruments, such as interest rate swaps, foreign currency options, and forward rate agreements.
LIBOR Historical Rates and Current Rates
For LIBOR rates, see:
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