LIBOR, acronym for London Interbank Offered Rate, can be understood as a benchmark interest rate at which major global banks lend to each other in the international interbank market. Basically, it’s the interest rate at which a bank offers to lend funds to another bank. The rate is calculated and published each business day by the Intercontinental Exchange or ICE.
1. How is LIBOR calculated?
The Intercontinental Exchange (ICE) uses a trimmed average method to calculate LIBOR. Banks submit the rates at which they believe they could borrow, then ICE eliminates the highest and lowest figures and takes the mean of the remaining numbers.
2. What makes LIBOR important?
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LIBOR plays a crucial role in the global financial market. It serves as the basis for commercial loans, personal loans, mortgages and student loans. Moreover, it’s used in derivative pricing and can indicate the overall health of the financial system.
3. Is LIBOR going to be phased out?
Yes, it’s anticipated that USD LIBOR is going to be phased out after the end of 2023, replaced by other benchmarks such as the Secured Overnight Financing Rate (SOFR) in the United States.
4. What are some potential consequences of the LIBOR phase-out?
The phase-out might lead to financial market disruption, as contracts referencing LIBOR need to be altered. Transition to new benchmarks could also raise legality issues and impose additional communication requirements with loan customers.
5. What is the difference between LIBOR and SOFR?
LIBOR is a forward-looking term rate, while SOFR is a backward-looking overnight rate. LIBOR indicates credit risk, but SOFR is a nearly risk-free rate as it is secured by the U.S. Treasury securities.