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LIBOR: LIBOR stands for the London Interbank Offered Rate published by the British Banker’s Association. LIBOR indicates the average rate that a participating institution can obtain unsecured funding for a given period of time in a given currency in the London money market. The rates are calculated based on the trimmed, arithmetic mean of the middle two quartiles of rate submissions from a panel of the largest, most active banks in each currency. In the case of the U.S. LIBOR, the panel consists of fifteen banks. These rates are a benchmark for a wide range of financial instruments including futures, swaps, variable rate mortgages, and even currencies. The LIBOR represents the rate at which banks lend to one another. Due to some…show more content…
And if the large world banks are reluctant to lend to one another, how reluctant will they be in placing new commercial loans? Fortunately, the Fed did what was necessary to eventually bring us back to some normalcy. We can see that in the TED spread which is currently about 15BPs. Use the TED spread as an indication of easing or tightening credit markets. It was useful to investors during the crisis of 2008. Overnight interest rate To make loans in the interbank market for 30 days, a bank could make a one-month loan at the prevailing one-month Libor rate. Alternatively, the bank could make an overnight loan at, say, the federal funds rate and keep rolling it over for the next 30 days; the expected cumulative interest rate for this alternative is given by the 30-day Overnight Index Swap (OIS) rate. (This is the rate underlying the derivative contract between two parties swapping overnight federal funds with one-month federal funds.) The difference between the two lending strategies is that the bank using the one-month Libor is committed to lending the funds for one month and therefore has little control over them during the period. In the alternative strategy, the bank has full control in deciding whether to roll the overnight loan over each day. This rollover option safeguards the lender against unforeseen developments in the next 30 days, including an unexpected deterioration in the creditworthiness of the borrowing bank and other unexpected changes
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