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Libor
The interest rate that most international banks charge each other for loans in Eurodollars overnight in the London market. Libor is a global rate benchmark for floating-rate consumer and corporate loans, It is also a basis for numerous exchange-traded and over-the-counter financial instruments.
London Interbank Offered Rate (or LIBOR, pronounced LIE-bore) is 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 interbank market). LIBOR will be slightly higher than the London Interbank Bid Rate (LIBID), the rate at which banks are prepared to accept deposits.
Markets effected:
Libor, the British Bankers’ Association interest rate that determines borrowing costs on about $360 trillion of financial agreements ranging from home mortgages to corporate bonds. Compare that to: Global losses and writedowns have swelled to $1.29 trillion, helping to sink the global economy into its first recession since World War II. But, with more to come... "The International Monetary Fund is expected to raise its estimate of bad assets held by financial institutions worldwide to $4 trillion, the London-based Times newspaper reported April 7, without citing anyone. The IMF’s forecast for bad assets originating in the U.S. will increase to $3.1 trillion from a January estimate of $2.2 trillion, according to the newspaper."
Libor Rates:
01/2009. source: http://www.tradingeconomics.com/World-Economy/LIBOR-Rates.aspx
Sonia & Eonia:
overnight interest rates, known as the Sonia for sterling and Eonia for the eurozone. These are the base off which interbank rates take their cue
Why they are important: "Some economists and analysts think that the ECB is pursuing a twin-pronged strategy that differentiates between a base rate that is important among the broader population and a financial interest rate that is the real driver of the cost of credit." Source: ft.com
see Euro
source: http://www.ft.com/cms/s/0/5b9ef378-f489-11dd-8e76-0000779fd2ac.html#
Measuring banking trust
"Ted Spread" :between the 3-month Libor rate and three month treasuries...TED is an acronym formed from T-Bill and ED, the ticker symbol for the Eurodollar futures contract. The size of the spread is usually denominated in basis points (bps). For example, if the T-bill rate is 5.10% and ED trades at 5.50%, the TED spread is 40 bps. The TED spread fluctuates over time, but historically has often remained within the range of 10 and 50 bps (0.1% and 0.5%), until 2007. A rising TED spread often presages a downturn in the U.S. stock market, as it indicates that liquidity is being withdrawn. read more from wikipedia
see Chart from Bloomberg:
Chart the Performance of .TEDSP:IND
The gap between the Fed’s target rate for overnight loans between banks and Libor widened to 3.32 percentage points on Oct. 10 from 0.82 percentage point just before Lehman failed and an average of 0.22 percentage point in the five years before credit markets froze. The cost banks said they’d pay to borrow from each other soared even as central banks lowered benchmark interest rates and provided unlimited dollar funding.
US efforts to fix the banking system: stimulus
Now, strategists say, credit is starting to move again. The U.S. government and the Fed spent, lent or committed $12.8 trillion, the equivalent of 90 percent of last year’s gross domestic product, to stem the longest recession since the 1930s. Obama met with more than a dozen chief executive officers from banks including JPMorgan Chase & Co., Morgan Stanley and Goldman Sachs Group Inc. on March 27, imploring them to get credit flowing through the markets again. Source: bloomberg Libor Falling Fastest Since January on Credit Revival By Gavin Finch and Anna Rascouet 4.14.09
see more in our globotrends section on USA macro data and fiscal stimulus and crisis recovery 2009
Relationship between 3-month LIBOR and Fed Funds Rate
You can use the gap (difference) between the 3-month Libor rate and the Fed Funds Rate to measure the amount of trust (or distrust) that banks have in lending money to each other. The greater the gap, the less trust, as can be illustrated in the following graph. It shows a widening gap as the credit crisis reached a worrying level in Septemeber 2008:
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 10 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.
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