What is LIBOR Curve?

Example of LIBOR Curve

Let us have a look at an example of a one-year LIBOR Curve for the year 2019.

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The curve is based on the following data.

The curve here represents the movement in the LIBOR interest rateLIBOR Interest RateLIBOR Rate (London Interbank Offer) is an estimated rate calculated by averaging out the current interest rate charged by prominent central banks in London as a benchmark rate for financial markets domestically and internationally, where it varies on a day-to-day basis inclined to specific market conditions.read more every month. The rates for twelve months are depicted in the graph. The LIBOR rate for all twelve months can be determined by looking at the graph.

Uses of LIBOR Curve

  • LIBOR curve is the benchmark rate on a global level used by leading banks, financial institutionsFinancial InstitutionsFinancial institutions refer to those organizations which provide business services and products related to financial or monetary transactions to their clients. Some of these are banks, NBFCs, investment companies, brokerage firms, insurance companies and trust corporations. read more, and credit rating agenciesCredit Rating AgenciesCredit rating agencies (CRAs) evaluate and rate the creditworthiness of debt securities and their issuers, including companies and countries.read more for determining the interest rate for short-term borrowings. Financial institutions are using the rate for determining the interest rate for various debt products such as corporate loans, bonds, credit cards, security-based loans, etc. Also, the LIBOR rate is not limited to debt-based products since the same is also used for other products, such as derivativesDerivativesDerivatives in finance are financial instruments that derive their value from the value of the underlying asset. The underlying asset can be bonds, stocks, currency, commodities, etc. The four types of derivatives are - Option contracts, Future derivatives contracts, Swaps, Forward derivative contracts.
  • read more.It is important to note that the LIBOR rate represents the lowest rate of lending, and the interest rate is represented above this rate. For example, when it is quoted that the rate of interest is “LIBOR + X basis points,” then it means the financial institution is charging x% of the premium above the LIBOR rate to its borrower. Whenever the LIBOR base rate changes, the lending rate will also fluctuate. This is why the LIBOR rate is a floating interest rate.Further, the LIBOR rate is also helpful in interest rate futures contracts for setting up the settlement price, which helps the party to the contract protect itself from the interest rate fluctuations. Also, other beneficiaries have an idea of expected interest rates based on the LIBOR rate.

Importance of LIBOR Curve

The LIBOR curve is an important tool for banks and financial institutions based on the globally determined benchmark rate. The same is useful for determining the interest rates for lending and other financial products such as interest rate swapsInterest Rate SwapsAn interest rate swap is a deal between two parties on interest payments. The most common interest rate swap arrangement is when Party A agrees to make payments to Party B on a fixed interest rate, and Party B pays Party A on a floating interest rate.read more and LIBOR futures. A majority of global financial products are based on LIBOR. The regulatory authorities also use the rate to suggest the maximum spread at which loans can be given to borrowers abroad.

LIBOR Curve vs. Swap Curve

  • The LIBOR curve represents the maturities of the LIBOR rate over a graph, and its maturities are for intervals of less than a year. The rate is based on the five major currencies. Namely, US Dollar, British Pound, Euro, Japanese Yen, and Swiss Franc, and the rate is represented for a total of seven maturities: spot, one week, one month, two months, three months, six months, and twelve months. LIBOR rates are being calculated, and the result is published every day by an organization named ICE (Intercontinental Exchange).On the other hand, the Swap curve represents the swap ratesSwap Curve Represents The Swap RatesSwap rate refers to the fixed exchange rate of a swap contract as ascertained by the parties or the market. The rate is inclusive or exclusive of the spread and determined on the benchmark rates such as LIBOR or MIBOR.read more at different levels of maturities. The swap curve indicates the expected rates of return for various maturity periods. The swap curve is used mainly in the financial marketsFinancial MarketsThe term “financial market” refers to the marketplace where activities such as the creation and trading of various financial assets such as bonds, stocks, commodities, currencies, and derivatives take place. It provides a platform for sellers and buyers to interact and trade at a price determined by market forces.read more and by investors. It represents the interest rates expected by the participants of the market. The rate is based on market expectations and the risks the participants incur.

Conclusion

The LIBOR curve graphically represents the LIBOR rate for various maturities. The rate is being used globally by the leading banks and other financial products and continues to be used to date.

This has been a guide to what is LIBOR Curve. Here we discuss an example of a one-year LIBOR curve with importance, uses, and differences. You may learn more about Financing from the following articles –

  • LIBOR Full FormGuaranteed BondsNegative Yield BondMedium-Term Notes