libor - sanchita

8/7/2019 LIBOR - SANCHITA

http://slidepdf.com/reader/full/libor-sanchita 1/19

INTERNATIONAL FINANCIAL MANAGEMENT

PRESENTATION TOPIC :LIBOR ( LONDON INTERLIBOR ( LONDON INTER ± ±BANK OFFERED RATE)BANK OFFERED RATE)

TUTORIAL GROUP B



WHAT IS LIBOR ?

� The London Inter-bank OfferedRate (or LIBOR) is a daily r efer ence rate based on the inter est rates atwhich banks borrow unsecur ed f unds f rom

other banks in the London wholesale money mar ket (or inter-bank lending mar ket).

� This can be seen f rom the point of view of the banks making the 'offers', in terms of

the inter est rate the banks will lend toeach other: that is 'offer' money in the f orm of a loan f or various time periods(maturities) and in differ ent curr encies.



� Ther e ar e ten curr encies f or which LIBORis computed:

� Australian Dollar (AUD)

� Canadian Dollar (CAD)

� Swiss Franc (CHF)

� Danish Krone (DKK)

� Euro (EUR)

� British Pound (GBP)

� Japanese Yen (JPY)

� New Zealand Dollar (NZD)

� Swedish Krona (SEK)

� U.S. Dollar (USD)



The LIBOR is among the most common of

benchmark interest rate indexes used to make

adjustments to adjustable rate mortgages.,

business loans, and financial instruments tradedon global financial markets.

This rate is applicable to the short-term

international inter bank market, and applies to

very large loans borrowed for anywhere from one

day to five years.

This market allows banks with liquidity

requirements to borrow quickly from other banks

with surpluses, enabling banks to avoid holding

excessively large amounts of their asset base asliquid assets.

The LIBOR is officially fixed once a day by a small

group of large London banks, but the ratechanges throughout the day.



HISTORY OF LIBOR� In 1984 it became appar ent that an incr easing number of banks wer e

trading actively in a variety of r elatively new mar ket instruments,notably inter est rate swaps, f or eign curr ency options and f orward rate agr eements.

� While r ecognizing that such instruments brought mor e business and gr eater depth to the London Inter bank mar ket, bankers worried that f utur e growth could be inhibited unless a measur e of unif ormity was introduced.

� In October 1984 the British Bankers' Association (BBA) ²wor king with other parties, such as the Bank of England --

established various wor king parties, which eventually culminatedin the production of the BBA standard f or inter est rate swaps,

or "BBAIRS" terms.

� Part of this standard included the f ixing of BBAinter est-settlement rates, the pr edecessor of BBA LIBOR.



� From 2 September 1985, the BBAIRS terms became

standard mar ket practice.

� Member banks ar e inter national in scope,

with mor e than sixty nations r epr esentedamong its 223 members and 37 associated

professional f irms (as of 2008).



WHO CALCULATES LIBOR?

AND HOW IS IT CALCULATED?

� LIBOR is calculated and published by Thomson Reuters onbehalf of 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 bydesignated contributor banks, for maturities ranging fromovernight 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 inter-quartile 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.



SCOPE OF LIBOR

The LIBOR is widely used as a r efer ence rate f or f inancial instruments such as

� f orward rate agr eements

� short-term-inter est-rate f utur es contracts

� inter est rate swaps

� inf lation swaps

� f loating rate notes

� syndicated loans

� variable rate mortgages

� curr encies, especially the US dollar .

They thus provide the basis f or some of the world'smost liquid and active inter est-rate mar kets.



TYPES OF LIBOR

When talking about the curr ent LIBOR rates several rate types exist, which ar e used as indexes f or the Adjustable Rate Mortgage. Some of these LIBOR rate types include the f ollowing:

� One Month LIBOR Rate ± Inter est on the loan wouldnot change f or a one-month period. To determine the amount of inter est the borrower would pay,a calculation would be completed when the originalloan inter est rate and amount of mar gin would be added,based on the LIBOR Index. The value of this Index isdetermined on a monthly basis, which in tur n cr eatesf luctuations f or the inter est payment on a monthly basis.

� Three Month LIBOR Rate ± In this case, the inter estrate f or the loan would r emain the same f or thr ee months. However, if the borrower wer e to extend the length of the loan, the value of that loan would be modif ied.



� Six Month LIBOR Rate ± Next, curr ent LIBORrates f or this would be set and r emain unchanged

f or a f ull six months. Again, if the borrower of the loan wer e to extend the length of the loan, the rate would be adjusted.

� One Year LIBOR RATE ± Finally, the one-year curr ent LIBOR rates would be the rate that London banks in the inter bank mar ket would be allowed toborrow f rom other banks within the one-year period.

For this, the rate established on any particular daywould apply on the day the loan was issued. As f ar

as changes with the inter est rate, they wouldr emain unchanged until the term of the loan ends.



LIBORLIBOR -- USAGEUSAGE� LIBOR is often used as a rate of reference for Pound

Sterling and other currencies, including USdollar , Euro, Japanese Yen, Swiss Franc, Canadiandollar , Australian Dollar , Swedish Krona, DanishKrone and New Zealand dollar .

� Six-month USD LIBOR is used as an index for someUS mortgages.

� In the UK, the three-month GBP LIBOR is used for some mortgages²especially for those with adversecredit history.

� LIBOR is used by the Swiss National Bank astheir reference rate for monetary policy.

� The difference between the LIBOR rate and theinterest rate on treasury bills is a key marker of thefinancial health of banks.



FACTORS AFFECTING LIBOR

� Financial mar kets ar e what set curr ent LIBOR rates.

� In addition to this, the LIBOR rates ar e also affected bythe Federal Funds Rate. This means that LIBOR

rates could change whenever the Federal Funds Rate experiences change.

� Curr ent LIBOR rates can also be affected

by a number of f inancial instruments. As an example, f loating rate loans,

Variable Rate Mortgages, and Adjustable Rate Mortgages all inf luence these rates.



� Curr ency movements - activities r elated tof or eign curr encies, especially the US

dollar and the Euro, also play an importantrole in determining the LIBOR rates on adaily basis.



DERIVATIVES RELATED TO LIBOR

Eurodollar futures� Traded at the Chicago Mer cantile

Exchange (CME), Eurodollars ar e USdollars deposited at banks outside the United States, primarily in Europe.

� By holding the deposits outside the country, US depositors ar e not sub jectto Federal Reserve mar gin r equir ements,allowing higher leverage of the f unds.

� The inter est rate paid on Eurodollars islar gely determined by LIBOR, andEurodollar f utur es provide a way of betting on or hedging against f utur e inter est rate changes.



� Interest rate swaps ar e another

signif icant f inancial derivative dependenton LIBOR.

� In an inter est rate swap, two partiesexchange sets of inter est payments on agiven amount of capital. Generally, one

party will have a f ixed inter est payment,while the other will have a variable rate.

� The variable rate payment str eam is of ten def ined in terms of LIBOR. Inter est rate swaps, and by extension LIBOR, ar e

extr emely important in providing aliquid secondary mar ket f or r esidentialmortgages, which in tur n allows lower inter est rates on US mortgages.



Why is Knowledge of Current LIBORRates Important?

For example, if the current LIBOR rate is 3.5%

and a bank includes a margin of 2%, you will

have to bear a 5. 5% interest rate on



� LIBOR Rates: Historical Charts



RELIABILITY OF LIBOR

� On May 29, 2008, the W all Street Journal r eportedthat certain banks had been r eporting lower rates tothe BBA than what WSJ analysis suggested theyshould have been.

� Given the trillions of dollars tied to the LIBOR, even a

small inaccuracy in either dir ection can cost lenders,borrowers, companies, or even whole economiesbillions of dollars.

� The WSJ study estimated that, if true, the artif iciallylow U.S. dollar LIBOR saved U.S. borrowers about$45 billion over the f irst f our months of 2008.

� The banks, however, denied this claim and stuck bythe rates they'd r eported to the BBA and Reuters.

libor - sanchita

Documents