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What is London Inter Bank Offered Rate (LIBOR)

BY: Vivek SHARMA | Category: Finance | Submitted: 2011-04-05 02:18:00
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Article Summary: "The article describes the method used to calculate LIBOR..."

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London Inter Bank Offered Rate (LIBOR) is the most important short term interest rate parameter used for lending and borrowing across the world. LIBOR is determined by the British Bankers' Association on a daily basis for 10 currencies with 15 maturities quoted for each. The LIBOR rates are determined for period ranging from overnight to 12 Months. Given the combination, 150 different rates are created for each business day.

LIBOR is the rate at which banks lend money to one another. This rate is determined using a method of polling. Banks participating in LIBOR rate determination are asked to answer the following question,' At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?" (Within quotes information from BBA website) It is important to note here that,'reasonable market size' is loosely defined and there is no specification for it.

LIBOR is calculated for the following currencies:
• Swiss Franc (CHF)
• Canadian Dollar (CAD)
• Australian Dollar (AUD)
• Euro (EUR)
• Danish Kroner (DKK)
• Swedish Krona (SEK)
• New Zealand Dollar (NZD)
• Pound Sterling (GBP)
• United States Dollar (USD)
• Japanese Yen (JPY)

A range of 8 to 20 banks contributor for determination of LIBOR rates. The selection of these banks is done on the basis of their 'reputation, scale of activity in the London market, and perceived expertise in the currency concerned, and giving due consideration to credit standing'. As per BBA,' Each panel for the 10 currencies, ranging from 8 to 20 contributors, is chosen by the independent Foreign Exchange and Money Markets Committee (FX&MM Committee) to give the best representation of activity within the London money market for a particular currency. Therefore, with all due to consideration to current economic situations, BBA LIBOR submissions from panel members will be on average the lowest interbank unsecured loan offers within the money market that are on offer'. (Within quotes information from BBA website)

BBA receives the quotes from the contributor banks and ranks the quotes from highest to lowest. For example if 12 banks have contributed the data, it would rank the rates from highest rate to the lowest rate. After the ranking has been done, the BBA drops the highest and lowest 25% of the contributors. This means out of 12, top 3 and bottom 3 are excluded from the list of the contributors. For remaining 6 it takes average. The result is the official BBA London Interbank Offered Rate (LIBOR) for the specific currency and maturity.

Source: BBA official website has been used for some of the information and it has been explicity mentioned in the article

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