Notes on London Inter-Bank Offered Rate (LIBOR)

By | May 28, 2017

The London Inter-Bank Offered Rate (LIBOR) is considered as a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market or also known as interbank market. LIBOR is generally higher than the London Interbank Bid Rate (LIBID), the rate at which banks are prepared to accept deposits. LIBOR rates are mainly used as a reference rate for various financial instruments.

The LIBOR rate is responsible for measuring the cost to the bank for fundraising from the existing market in order to re-land. This forms the basis of the entire floating rate lending in the Euro market. LIBOR, the London Interbank Offered Rate, is the most dynamic interest rate market in the world. It is calculated by rates that banks participating in the London money market offer each other for short-term deposits. LIBOR is used in determining the price of many other financial derivatives, including interest rate futures, swaps, and Euro-dollars. 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.

LIBOR is estimated at 11:00 am at London time on daily basis. The department of the British Bankers Association calculates it. They average the inter-bank interest rates offered by its membership. The periods of calculating the LIBOR is a short as overnight and as long as one year. The rates offered by banks vary constantly throughout the day. However, LIBOR is fixed constantly throughout the day. However, LIBOR is fixed for the 24-hour period. Generally, the difference between the instantaneous rate and LIBOR is very small, especially for short durations.

The most important financial derivatives related to LIBOR are Euro-dollar futures. The interest rate paid on Euro-dollars is largely determined by LIBOR, and Eurodollar futures provide a way of betting on or hedging against future interest rate changes.