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. LIBOR 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.LIBOR is determined every morning at 11:00am London time. A department of the British Bankers Association 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, 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 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, and by extension LIBOR, 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 the Euro has brought with it the creation of the Euribor. Conceptually similar to the LIBOR, the Euribor benchmark is defined and maintained by the European Banking Federation. Source: Wisegeek
The London Interbank Offered Rate (or LIBOR, pronounced /ˈlaɪbɔr/) is a daily reference rate based on the interest rates at which banks borrow unsecured funds from banks in the London wholesale money market (or interbank market). It is roughly comparable to the U.S. Federal funds rate.
Introduction
During 1984 it became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments, notably interest rate swaps, foreign currency options and forward rate agreements. Whilst recognizing that such instruments brought more business and greater depth to the London Interbank market, it was felt that future growth could be inhibited unless a measure of uniformity was introduced. In October 1984 the British Bankers' Association working with other parties such as the Bank of England established various working parties, which eventually culminated in the production of the BBAIRS terms – the BBA standard for interest swap rates. Part of this standard included the fixing of BBA interest settlement rates, the predecessor of BBA LIBOR. From 2 September 1985 the BBAIRS terms became standard market practice.
BBA LIBOR fixings did not commence officially before 1 January 1986, although before that some rates have been fixed for a trial period commencing in December 1984.
It should be noted that member banks are international in scope, with more than sixty nations represented among its 223 members and 37 associated professional firms (as of 2008).
Scope
LIBOR rates are widely used as a reference rate for financial instruments such as:
forward rate agreements
short-term interest rate futures contracts
interest rate swaps
inflation swaps
floating rate notes
syndicated loans
variable rate mortgages[1]
currencies, especially the US dollar (see also Eurodollar).
They thus provide the basis for some of the world's most liquid and active interest rate markets.
For the Euro, however, the usual reference rates are the Euribor rates compiled by the European Banking Federation, from a larger bank panel. A Euro LIBOR does exist, but mainly for continuity purposes in swap contracts dating back to pre-EMU times.
Technical features
LIBOR is published by 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 by designated contributor banks, for maturities ranging from overnight 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 interquartile 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.
LIBOR is often used as a rate of reference for Pound Sterling and other currencies, including US dollar, Euro, Japanese Yen, Swiss Franc, Canadian dollar, Australian Dollar, Swedish Krona, Danish Krone and New Zealand dollar.[2]
In the 1990s, Yen LIBOR rates were influenced by credit problems affecting some of the contributor banks.
For a precise definition of BBA LIBOR, see: The BBA LIBOR fixing & definition.
Six-month LIBOR is used as an index for some US mortgages. In the UK, the three-month LIBOR is used for some mortgages—especially for those with adverse credit history.
Definition of LIBOR
LIBOR is defined as:
“The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00 London time.”
This definition is amplified as follows:-
• The rate at which each bank submits must be formed from that bank’s perception of its cost of funds in the interbank market.
• Contributions must represent rates formed in London and not elsewhere.
• Contributions must be for the currency concerned, not the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets.
• The rates must be submitted by members of staff at a bank with primary responsibility for management of a bank’s cash, rather than a bank’s derivative book.
• The definition of “funds” is: unsecured interbank cash or cash raised through primary issuance of interbank Certificates of Deposit.
LIBOR-based derivatives
Eurodollar contracts
The Chicago Mercantile Exchange's Eurodollar contracts are based on three-month US dollar LIBOR rates. They are the world's most heavily traded short term interest rate futures contracts and extend up to ten years. Shorter maturities trade on the Singapore Exchange in Asian time.
Interest rate swaps
Interest rate swaps based on short LIBOR rates currently trade on the interbank market for maturities up to 50 years. A "five year LIBOR" rate refers to the 5 year swap rate vs 3 or 6 month LIBOR.
"LIBOR + x basis points", when talking about a bond, means that the bond's cash flows have to be discounted on the swaps' zero-coupon yield curve shifted by x basis points in order to equal the bond's actual market price. The day count convention for LIBOR rates in interest rate swaps is Actual/360.
Reliability
On Thursday, 29 May 2008 the Wall Street Journal released a controversial study suggesting that banks may have understated borrowing costs they reported for LIBOR during the 2008 credit crunch.[3] Such underreporting could have created an impression that banks could borrow from other banks more cheaply than they could in reality. It could also have made the banking system appear healthier than it was during the 2008 credit crunch.
For example, the study found that rates at which one major bank "said it could borrow dollars for three months were about 0.87 percentage point lower than the rate calculated using default-insurance data."
In response to the study released by the WSJ, the British Bankers' Association announced that LIBOR continues to be reliable even in times of financial crisis. According to the British Bankers' Association, other proxies for financial health such as the default credit insurance market, are not necessarily more sound than LIBOR at times of financial crisis, though more widely used in Latin America, especially the Ecuadorian and Bolivian markets.
Additionally, other authorities have contradicted the Wall Street Journal article. In their March 2008 Quarterly Review The Bank for International Settlements have stated that "available data do not support the hypothesis that contributor banks manipulated their quotes to profit from positions based on fixings". Further, In October 2008 the International Monetary Fund published their regular Global Financial Stability Review which also found that "Although the integrity of the U.S. dollar LIBOR fixing process has been questioned by some market participants and the financial press, it appears that U.S. dollar LIBOR remains an accurate measure of a typical creditworthy bank’s marginal cost of unsecured U.S. dollar term funding"
Euribor
TIBOR
Leverage (finance)
Margin (finance)
Prime rate
British Bankers' Association Source: Wikipedia
What is LIBOR?
Libor stands for the London Interbank Offered Rate and is the rate of interest at which banks borrow funds from each other, in marketable size, in the London interbank market.
What is BBA LIBOR?
BBA LIBOR is the most widely used "benchmark" or reference rate for short term interest rates. It is compiled by the BBA in conjunction with Reuters and released to the market shortly after 11.00
am London time each day.
Where is the BBA LIBOR standard used?
BBA LIBOR is the primary benchmark for short term interest rates globally. It is used as the basis for settlement of interest rate contracts on many of the world’s major futures and options exchanges (including LIFFE, Deutsche Term Börse, Euronext, SIMEX and TIFFE) as well as most Over the Counter (OTC) and lending transactions.
How is BBA LIBOR produced? And published?
The British Bankers' Association (BBA), advised by senior market practitioners, maintains a reference panel of at least 8 contributor banks. For a full current list of which banks are contributing to each panel please see link at the bottom of the page.
The aim is to produce a reference panel of banks which reflects the balance of the market – by country and by type of institution. Individual banks are selected within this guiding principle on the basis of reputation, scale of market activity and perceived expertise in the currency concerned.
The BBA surveys the panel’s market activity and publishes their market quotes on–screen. The top quartile and bottom quartile market quotes are disregarded and the middle two quartiles are averaged: the resulting "spot fixing" is the BBA LIBOR rate.
The quotes from all panel banks are published on–screen to ensure transparency. For a full description of the process please see the link at the bottom of the page.
BBA LIBOR fixings are provided in ten currencies:
BBA Libor fixing currencies table Currency Name ISO 4217 currency code (* see note)
Pound Sterling GBP
US Dollar USD
Japanese Yen JPY
Swiss Franc CHF
Canadian Dollar CAD
Australian Dollar AUD
Euro (** see note) EUR
Danish Kroner DKK
Swedish Krona SEK
New Zealand Dollar NZD
Note:
(*) This is an international standard describing three letter codes to define the names of currencies established by the International Organization for Standardization (ISO).
(**) BBA EUR LIBOR is the successor BBA LIBOR fixing for the eurozone legacy currencies, which ceased to be fixed at the beginning of 1999.
Where can I find BBA LIBOR data?
BBA LIBOR is compiled each London Business day by Reuters and distributed live via a number of data vendors including Reuters, Thomson Financial, Bloomberg, Quick, Infotec, Class Editori, IDC, Proquote and Telekurs.
Many websites operated by financial services and media outlets are licensed to display BBA LIBOR data at the end of the day (that is, after 5pm London Time). Additionally, the financial press, including the Wall Street Journal and Financial Times publish BBA LIBOR data from the previous day.
All BBA LIBOR is posted on our website, with a rolling 7 day delay, please see link at the bottom of the page.
Why is the BBA LIBOR standard important?
BBA LIBOR is important because:
it is long established
it offers the largest range of international rates
it is a truly international reference rate
it has a wide commercial use
it enjoys wide international dissemination
its mechanism is transparent
it provides a robust settlement rate
the banks represented on the panels are the most active in the cash markets and have the highest credit ratings
BBA LIBOR’s London base is significant: well over 20% of all international bank lending and more than 30% of all foreign exchange transactions take place through the offices of banks in London and represents a unique snapshot of competitive funding costs.
London has representation from close to 500 banks, and many other major financial institutions actively trade in the euromarkets which are based primarily in London. In addition, no reserve requirements are applied in London.
Can you provide a forecast on what BBA LIBOR rates will be in the future?
BBA LIBOR is extremely market sensitive and affected by a number of factors such as liquidity in the London cash markets, constitution of the contributor panels and local interest rate policy.
The BBA therefore is not able to provide any forecasts for the future.
Long-term BBA LIBOR
BBA LIBOR is a short–term interest rate deposit rate and is only calculated up to a maturity of 12 months. We have never calculated BBA LIBOR rates beyond this nor do we have any intention of doing so as the liquidity in the London interbank cash market dries up after a one year maturity.
Some people use interest rates swap rates as approximation for longer periods but please be aware that the methodology is likely to be quite different for BBA LIBOR.
What do the abbreviations s/n, o/n and 1 w, 1 month mean?
These abbreviations stand for the maturities for which BBA LIBOR is fixed. There are 15 different maturities for each currency and day of fixing. The shortest maturity is overnight (O/N) for Euro, US Dollar, Pound Sterling, and Canadian Dollar and spot/next (s/n) for all other currencies. 1 w stands for 1 week and 1m stands for 1 month. The longest maturity for which BBA LIBOR is fixed is 12 months.
An "overnight" rate that you see quoted today will value today and mature tomorrow.
A "spot / next" rate that you see quoted today will value in 2 days (i.e. the day after tomorrow) and mature the day after that.
BBA LIBOR Historic rates
The BBA have posted all rates we hold on our website. Please see a link to the historic BBA LIBOR at the bottom of the page. BBA LIBOR fixings did not commence officially before 1 January 1986, although before that some rates have been fixed for a trial period commencing in December 1984.
Due to the specific methodology of calculating BBA LIBOR it is not possible to reconstruct rates before the official fixings commenced.
There are a few websites that purport to be showing BBA LIBOR rates before the mid-80s but these are in no way affiliated with the BBA, who is the sole supplier of BBA LIBOR, and so we would not vouch for their accuracy.
Is there was any specific reason for why BBA LIBOR started in 1984. What was the historical impetus?
During 1984 it became apparent that an increasing number of banks were trading actively in a variety of relatively new market instruments, notably Interest Rate Swaps, Foreign Currency Options and Forward Rate Agreements.
Whilst recognizing that such instruments brought more business and greater depth to the London Interbank market, it was felt that future growth could be inhibited unless a measure of uniformity was introduced.
In October 1984 the BBA working with other parties such as the Bank of England established various working parties, which eventually culminated in the production of the BBAIRS terms – the BBA standard for Interest Swap rates.
Part of this standard included the fixing of BBA Interest Settlement rates, the predecessor of BBA LIBOR. From 2 September 1985 the BBAIRS terms became standard market practice.
Factors that influence BBA LIBOR rates
BBA LIBOR rates are dependent on a number of factors, including local interest rates, banks expectations of future rate movements, the profile of contributor banks (contributor panels are changed annually), liquidity in the London markets in the currency concerned etc.
Does BBA EUR LIBOR follow Target or London business days?
BBA Euro LIBOR follows the Target calendar – as set by the European Central Bank. So on days in which Target is open but London is closed, only the EUR BBA LIBOR rate will be fixed. If Target is closed but London is trading we will fix EUR BBA LIBOR with the exception of the s/n maturity.
BBA LIBOR calculation basis
BBA LIBOR is not a compounded rate but is calculated on the basis of actual days in funding period/360. Therefore the formula is as follows: interest due = principal x (libor rate/100) x (actual no of days in interest period/360). Please note that for GBP) the calculation basis is 365 days.
It is also important to work out the exact/actual number of days in the funding period which is not always 90 days for a 3 month deposit but could e.g. be 89 or 91 days.
If you have a funding period of, for example, 45 days you could extrapolate between the 1 and the 2 month rate to arrive at the correct BBA LIBOR rate.
Relationship between different currencies
BBA LIBOR is set entirely independently for each currency by a different panel of banks and the rates are not interrelated via a currency conversion or any other means. In fact BBA LIBOR gives an idea at which interest rates banks can borrow funds in the currency concerned in the London cash market.
For instance, borrowings in USD are sometimes referred to as Eurodollar interest rates. The factor that has most impact on each of the rates is the domestic interest, which for USD rates will be the Fed fund rates.
How can I obtain BBA LIBOR rates on the day of calculation?
In order to receive this data you must get a licence from the BBA, for which there may be a charge. Please contact BBA LIBOR Manager John Ewan for more details.
What Is Libor ?
Libor is short for the London InterBank Offered Rate, the interest rate offered for U.S. dollar deposits by a group of large London banks. There are actually several Libors corresponding to different deposit maturities. Rates are quoted for 1-month, 3-month, 6-month and 12-month deposits.
What Is a Libor Mortgage?
A Libor mortgage is an adjustable rate mortgage (ARM) on which the interest rate is tied to a specified Libor. After an initial period during which the rate is fixed, it is adjusted to equal the most recent value of the Libor plus a margin, subject to any adjustment cap.
For example, on April 26, 2004, one lender was offering a 6-month Libor ARM at 3%, zero points, and a margin of 1.625%. The new rate 6 months later will be 1.625% plus the 6-month Libor at that time. If that is (say) 2.625%, the new rate will be 1.625% + 2.625% = 4.25%. If the adjustment cap that limits the size of rate changes is 1%, however, the new rate will be only 3% + 1% = 4%.
Special Features of Libor Mortgages
Low Margins for A-Quality Borrowers: Libor ARMs were developed to meet the needs of foreign investors looking to minimize their interest rate risk on dollar-denominated investments. A foreign bank that buys the 6-month Libor ARM containing a 1.625% margin can borrow the funds it needs in the inter-bank market for 6 months at the 6-month Libor. The bank pays the depositor Libor, and it earns Libor + 1.625% on the ARM. The margin is locked in, except to the extent that changes in Libor are not fully matched by changes in the ARM rate because of rate caps.
Because of the reduced risk, investors in Libor ARMs are willing to accept a smaller margin than is common on other ARMs. On April 26, 2004, for example, the Libor margin available to A-quality borrowers was as low as 1.50%, compared to 2.25 – 2.75% on ARMs indexed to other series.
But not everyone can benefit from the low margin. On the same day that the lender cited above was offering a 6-month Libor ARM at 3% with a 1.625% margin, a sub-prime lender was offering a 6-month Libor ARM to borrowers with D-credit at 10% with a 7% margin!
Attractive Buydowns: On 30-year fixed-rate mortgages, borrowers can usually "buy down" the rate by ¼% by paying about 1.5 points. I have seen 30-year Libor ARMs that allow the borrower to buy down the rate and margin by ¼% for only 3/8 of a point. This is an incredible bargain, but the Libors that offer it may have an unusually high maximum rate.
No Negative Amortization: Libor ARMs don’t offer the payment flexibility, nor the associated risks, of negative amortization ARMs.
High Index Volatility: Libor is about as volatile as rates on short-term US Government securities, and more volatile than the COFI, CODI and MTA indexes.
Common Features of Libor Mortgages
The remaining features of Libor ARMs are very similar to those of other ARMs.
Initial rate period. This is the period during which the initial rate holds. Initial rate periods on Libor ARMs range from 6 months to 10 years.
Subsequent adjustment period. This is period between rate adjustments after the first adjustment. For example, an ARM on which the initial rate holds for 3 years and is then adjusted every year is a "3/1". Most Libor ARMs adjust every 6 or 12 months.
Rate Adjustment Caps: Rate adjustment caps that limit the size of a rate change are generally 1% on 6-month Libors, and 2% on 1-year and 3-year Libors. On 7 and 10-year Libors, the cap is usually 5% on the first adjustment and 2% on subsequent (annual) adjustments. On some 5-year Libors, however, the adjustment cap is the same as that on 1-year and 3-year Libors, while on others it is the same as on 7-year and 10-year Libors.
Maximum Interest Rate: This is the highest interest rate allowed on the ARM over its life. The maximum rate on some Libor ARMs is set at 5% or 6% above the initial rate. On others it is set at an absolute level – 11%, for example, regardless of the initial rate.
Why Select a Libor Mortgage?
You select a Libor loan not because it uses Libor but because it has a combination of other features that in combination add up to an attractive ARM for you. An ARM is attractive if, during the period you expect to have the mortgage, the interest savings early in that period (relative to a FRM or an ARM with a longer initial rate period) outweigh the risk of interest rate and payment increases later on.
The best way to make such a judgment is by using interest rate scenario analysis. An interest rate scenario is an assumption about what will happen to rates in the future. Usually, we focus on rising rate scenarios, because those are the ones we worry about.
For any given scenario, we can calculate exactly how high the rate and payment will go, and when it will get there. Using the same scenario, we can compare different ARMs, as well as ARMs against an FRM. We can also calculate the cost of an ARM or FRM over any period specified by the borrower.
Because their margins can be small, borrowers who take Libor ARMs may find it attractive to reduce the risk of future rate increases by adopting the FRM payment strategy. This involves making the payment they would have had to make had they chosen an FRM, for as long as the FRM payment remains above the Libor ARM payment.
To see a sample of rates/payments and costs on an ARM and an FRM under different scenarios, including results for an FRM payment strategy, click on Sample Rates/
Payments and Costs .
Information Needed to Assess a Libor Mortgage
You get it in two steps. In step 1, you have your loan officer or mortgage broker provide the essential data on the features of each loan you are considering. To make it as easy as possible for them, print out and give them Worksheet of ARM Features. In Step 2, you transfer the data on ARM features into the ARM Tables calculator which will generate your tables. Have your data in hand before clicking on ARM Tables calculator above or selecting the ARM Tables calculator on the Tutorials Menu.