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What is LIBOR?

Damir Wallener
Damir Wallener

LIBOR, the London Interbank Offered Rate, is the most active interest rate market in the world. It is determined by rates that banks participating in the London money market offer each other for short-term deposits. The number is used in determining the price of many other financial derivatives, including interest rate futures, swaps and Eurodollars. Due to London's importance as a global financial center, LIBOR applies not only to the Pound Sterling, but also to major currencies such as the US Dollar, Swiss Franc, Japanese Yen and Canadian Dollar.

The rate is determined every morning at 11:00am London time by a department of the British Bankers Association, which averages the inter-bank interest rates being offered by its membership. LIBOR is calculated for periods as short as overnight and as long as one year. While the rates banks offer each other vary continuously throughout the day, this specific rate is fixed for the 24 hour period. Generally, the difference between the instantaneous rate and LIBOR is very small, especially for short durations.

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The most important financial derivatives related to this rate are Eurodollar futures. Traded at the Chicago Mercantile Exchange (CME), Eurodollars are US dollars deposited at banks outside the United States, primarily in Europe. By holding the deposits outside the country, US depositors are not subject to Federal Reserve margin requirements, allowing higher leverage of the funds. The interest rate paid on Eurodollars is largely determined by LIBOR, and Eurodollar futures provide a way of betting on or hedging against future interest rate changes.

Interest rate swaps are another significant financial derivative dependent on LIBOR. In an interest rate swap, two parties exchange sets of interest payments on a given amount of capital. Generally, one party will have a fixed interest payment, while the other will have a variable rate. The variable rate payment stream is often defined in terms of LIBOR. Interest rate swaps are extremely important in providing a liquid secondary market for residential mortgages, which in turn allows lower interest rates on US mortgages.

While LIBOR does have implications for transactions conducted in Euros, the advent of this currency has brought with it the creation of the Euribor. Conceptually similar, the Euribor benchmark is defined and maintained by the European Banking Federation.

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Discussion Comments

anon178449

Can someone please tell me firstly that what is 'Interbank Rate'. Second in countries like india how does LIBOR affect it? Also, does it affect or matter to stock markets' bank rates small businesses doing cross border business. Does the interest rate matter due to LIBOR in being financed in a project if the financier is of another country? Please help clarify my questions. Thank you in advance.

anon163773

I want to know if there is anything about the african libor rate, as most of currencies in african countries are not strong compared to western world currencies.

anon133436

I have an ARM tied to the one year Libor. I'm trying to understand how interest rates might be trending as I head into my next rate adjustment in 2011. What financial indexes track with the movement of the Libor one year rate?

anon66505

can you describe the characteristics about LIBOR. TQ

anon60445

Add on reply 9 (referred to anon 14158, question 2)

It makes sense not to have many rates but I wonder that TIBOR (Tokyo Interbank Offered Rate) also has its own rates which are "Japanese Yen" and " Euroyen".

From this point,

1) I am not sure which one financial market participants will choose to use between "JPY LIBOR" or "TIBOR" ?

2) Are those two rates different?

anon60443

Not sure there is US LIBOR announced by FED. If yes, why does Eurodollars traded in CME have to use USD LIBOR from BBA?

anon40833

What is libor? How it is used in the Euro credit market?

anon36524

good explanation.earlier i didn't know much about and was comnfused on some matters. now it is clear.

anon36267

Reply to anon14158

1) the UK is one of the largest economies in the world; or at least, larger Australia as you mentioned in Q2. LIBOR is used because of convention; things are already settled. Also, London is the biggest FOREX market in the world with 1/3 daily turnovers of the world. Why? It's because of geographical reason; the ease for international parties to trade. When the NY market is closes, London and Tokyo market is still open. When Tokyo market is closed, NY and London are still open.

2)It is not a good idea to have different rate when there are international transactions. If for domestic interbank lending, that's fine. However, most banks are reluctant to borrow domestically because of domestic legal regulations.

3)I think you need to find out more about the interbank market. LIBOR is used because major banks in the world trade there so it reflects a certain degree of liquid assets of banks.

Also for those want to know why LIBOR fluctuates, LIBOR is an average rate in the interbank market. It is only a benchmark. Most banks with better credibility borrow at a rate several basis points (bps) below LIBOR.

Another feature of LIBOR is that, LIBOR is closely related to the Fed effective rate. There are some exceptions such as during the credit crunch. Yet, in undergraduate course, students are told LIBOR movement is almost the same as the counterpart of the Fed effective rate.

anon24532

I often wondered when Rick Santelli mentioned LIBOR what it actually was. Now I know.

anon23778

may be its LIBOR rate fixed for the duration of six months....just a guess

anon14158

Thanks for such a well detailed description of LIBOR. i have some questions about LIBOR:

1) U.K is not the largest economy or dominating one, than why Globally LIBOR is used as a benchmark rate in many european, asia pacific and Also in USA (may be not in Russia)?

2) why not USA, France, Germany, Australia, Canada, have their own Inter Bank rate as a standard bench mark or they do they have?, By what names? Are they comparable to LIBOR or should these be?

3) I have been told that inter-Bank rate (money market arte) is primarily determined by demand and supply of money (transaction motives) among participating Banks/ Authorized Dealers in a particular location? So how can the LIBOR be the bench mark rate for USA inter Bank market? How can it said to reflecting the Global money demand and supply?

Muhammad Sabir The Bank of Punjab Pakistan LAHORE

deacon

Is there such a thing as European LIBOR, and if so, what are its characteristics?

deepali

What factors impact the rise and fall of LIBOR?

anon4739

What factors impact the rise and fall of LIBOR?

anon3812

Can you please explain what is 6 month LIBOR rate? is it a average value of LIBOR fixed daily?

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