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Libor versus Prime Rate

See Also:
LIBOR
Prime Lending Rate
Interest Expense
Interest Rate Swaps
Federal Funds Rate

Libor versus Prime Rate

The London Interbank Offered Rate (Libor) and the US Prime Rate are both benchmark interest rates. Both rates are used as reference rates for various lending and borrowing transactions. (For current and historical rates, see the links below.) To see comparisons of Libor versus prime rate, keep reading.

Libor History – Prime Rate History

Libor originated in London, England, and was established between 1984 and 1985. The US Prime Rate, also called the WSJ Prime Rate, originated in the United States. Historical prime rate data go back as far as 1929. When we study the age of Libor versus prime rate, prime rate is much older than Libor.

Setting Libor and Prime Rate

Libor is an average derived from the rates at which major banks lend to each other in London’s money markets. Whereas, US Prime Rate is typically set at three percentage points above the federal funds rate. Setting Libor is more complicated than setting US Prime Rate.

Fixed Rate, Floating Rate

Libor is a floating rate as it fluctuates continually. US Prime Rate is a fixed rate, which means it typically remains unchanged for extended periods of time. Prime Rate versus Libor: Prime rate is a fixed rate, whereas Libor is a floating rate.

Primary Users of Libor and Prime Rate

Libor is used by banks – it is the interest rate at which banks lend to each other in certain London money markets. (Borrowers, lenders, and investors may use Libor as a reference rate.) Comparatively, US Prime Rate is used by consumers – it is the rate at which banks lend to their best customers. (Borrowers, lenders, and investors may use prime rate as a reference rate.) Libor is used primarily by banks (in theory). Prime is used primarily by consumers.

Libor Benchmark – Benchmark Prime Lending Rate

Libor is a benchmark interest rate used as a reference in lending and borrowing transactions around the globe. (Keep in mind, Libor bank rates are also used as reference rates in various financial derivatives.) Comparatively, US Prime Rate is a benchmark interest rate used as a reference in lending and borrowing transactions in the United States and elsewhere. When we look at Libor versus Prime Rate, we find both rates are benchmark interest rates with wide global usage.

Publication of Libor and Prime Rate

Libor bank rates are published daily at 11:30am GMT by the British Bankers’ Association (bba.org.uk). The US Prime Interest Rate, also called the Wall Street Journal Prime Rate, is published in the Wall Street Journal. Prime Rate versus Libor: Prime interest rate is published by the WSJ whereas Libor is published by the BBA.

Variations of Libor and Prime Rate

Libor is published for 10 currencies and 15 maturities. It also ranges from overnight to one year. In comparison, prime lending rates may vary slightly among individual commercial banks. Libor vs Prime Rate: there are many more official versions of Libor than there are official versions of US Prime Rate.

Wall Street Journal Prime Rate (WSJ Prime Rate)

To see historic US Prime Rates, from 1947 to the present, go to: wsjprimerate.us

If you want to learn prime rate historical data from 1929 to present, then go to: research.stlouisfed.org

To read about current and recent US Prime Rates, as well as other rates, go to: bloomberg.com

Libor Historical Rates and Current Rates

For Libor rates, go to: bba.org.uk, bankrate.com and bloomberg.com.

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Libor versus prime rate

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Fixed Interest Rate vs Floating Interest Rate

See Also:
Effective Rate of Interest Calculation
What is Compound Interest
When is Interest Rate Not as Important in Selecting a Loan?
Nominal Interest Rate
Interest Rate Swaps

Fixed Interest Rate vs Floating Interest Rate

A loan can have a fixed interest rate or a floating interest rate. If the loan has a fixed interest rate, the interest rate remains constant for the duration of the loan. If the loan has a floating interest rate, also called a variable interest rate, then the interest rate fluctuates over the duration of the loan. Floating rates typically fluctuate with the overall market, with an underlying index, or with the prime rate.

Fixed interest rates and floating interest rates can apply to any type of debt or loan agreement. This includes monetary loans, credit card bills, mortgages, auto loans, and corporate bonds. Fixed rates and floating rates can also apply to financial derivative instruments.

Advantages and Disadvantages

Fixed Rate Loan

The primary advantage of a fixed interest rate loan is the elimination of uncertainty. Once the loan agreement is finalized, the value of the future interest payments is known.

A fixed interest rate can also be advantageous to the borrower (disadvantageous to the lender) if the market rates rise above the fixed rate, giving the borrower implicit gains (and the lender implicit losses). A fixed rate can be advantageous to the lender (disadvantageous to the borrower) if the market rates fall below the fixed rate, giving the lender implicit gains (and the borrower implicit losses).

Variable Rate Loan

The primary advantage of a floating interest rate is that it moves with the market rates. Of course, this can also be a disadvantage, depending on which way the market rates move and which side of the transaction the party is on.

A rise in market rates can increase the cost of the loan for the borrower and increase the interest income for the lender. Conversely, a fall in market rates can decrease the cost of the loan for the borrower and decrease the interest income for the lender.

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Federal Funds Rate Definition

See Also:
Interest Rate Swaps
LIBOR
Interest Rate Definition
Interest Rate Risk
Prime Lending Rate
Libor versus Prime Rate
Interest Rate in Selecting Loan

Federal Funds Rate Definition

The federal funds rate definition, or fed funds rate, is the target interest rate for overnight lending and borrowing transactions between banks. The Federals Open-Market Committee (FOMC) sets the US fed funds rate. FOMC is a committee within the central bank of the United States. (For current and historic fed funds rates see the links below).

The fed funds rate is a macroeconomic indicator, closely watched by economists. It is also a central bank monetary policy tool used to influence the nation’s money supply. Use the rate as a reference rate for the US Prime Rate.

Commercial banks and other depository institutions maintain required reserves of capital at district Federal Reserve banks. Furthermore, the fed funds rate technically refers to the rate at which these institutions lend their Federal Reserve account balances to other institutions for short-term or overnight loans.

Federal Reserve Interest Rate Changes

The FOMC meets eight times per year – approximately every six weeks. At these meetings the committee discusses, among other things, the possibility of changing the fed funds rate. Additionally, the actual market rates may differ from the fed funds target rate. However, the target rate is set with the expectation that market rates will conform to the target rate.

The FOMC can lower the fed funds rate. This is typically done to stimulate the economy. The idea is that lower interest rates will encourage lending and borrowing and stimulate economic activity. Increased lending and borrowing also increases the nation’s money supply. Thus, an increased money supply can spur inflation.

The FOMC can increase the fed funds rate. They do this to reduce inflation or slow transactions growth. The idea is that higher interest rates will discourage lending and borrowing transactions. Less lending and borrowing can dampen economic growth. Therefore, this will reduce the money supply and reduce inflation.

Federal Open Market Committee

The Federal Open-Market Committee is a committee within the US Federal Reserve System, the US central bank. This committee is responsible for, among other things, setting the federal funds target rate.

Federal Funds Rate – Prime Rate

Use the fed funds rate as a reference for setting the US Prime Rate. The US Prime Rate is typically set at 300 basis points (or three percentage points) above the fed funds rate. For instance, if the fed funds rate is 2%, then the Prime Rate would be 5%.

Current Fed Funds Rate

To see the current and recent fed funds target interest rates, to go: www.bankrate.com.

Historic Fed Funds Rate

To see historic fed funds target interest rates, to go: www.newyorkfed.org.

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federal funds rate definition

federal funds rate definition

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Basis Points

See Also:
Accounts Payable
Margin vs Markup
Collateralized Debt Obligations
Are You Collecting Business Data?
Benchmarking

A basis point is one hundredth of a percentage point. A single basis point would look like this: 0.01%. Fifty basis points is a half a percentage point: 0.50%. 100 basis points equal one percentage point: 1.00%.

When To Use Basis Points

In finance, changes in the values of financial instruments or interest rates may be denoted in basis point. They are used to describe quantities less than one percent. When the Federal Reserve lowers its fed funds rate by a half a percent, the media may report that the fed funds rate was lowered by 50 basis points.

Similarly, the interest rate on a loan or debt instrument that is based on a reference rate, such as LIBOR or the Prime Rate, may have a spread quoted using the term basis point. The rate may be described as Prime Rate plus 50 basis point. If Prime Rate is 5%, then the rate on that loan or debt instrument would be 5.5%.

basis points

 

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Libor vs Prime Rate

Interesting article in the April 23rd Wall Street Journal on page C1 highlighting the divergence of Libor from U.S. Prime Rate. Let’s dive into what the difference between Libor vs Prime Rate is.

What’s the Difference Between Libor vs Prime Rate?

Libor has been increasing while the Prime Rate has been dropping.

You need to check your loan agreement to see what is the index for setting your loan rate. Now is also a good time to see if there is a floor on your interest rate. I have had clients in the past who woke up to find that the prime rate had fallen significantly but their interest rate had a floor on it. You can often negotiate that floor away.

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Libor vs Prime Rate

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