The LIBOR Trading Guide for Beginners
LIBOR, the London Interbank Offered Rate, is a benchmark interest rate used for many financial transactions. It indicates bank borrowing costs and is vital to global financial markets.
Understanding LIBOR is crucial for traders starting out since it affects loan, mortgage, and derivative prices. This page explains LIBOR, how it’s calculated, and its importance in trading.
LIBOR, what?
Libor is an average interest rate based on London’s major banks’ submissions. It indicates the interbank lending rate between these banks. Submissions are made daily in several currencies and time frames: overnight, 1-week, 1-month, 3-months, 6-months, and 1-year.
From a panel of banks’ responses, LIBOR measures banking sector liquidity and confidence. Banks, financial institutions, and investors use it to price financial securities.
Calculating LIBOR
Calculating LIBOR comprises these steps:
The panel banks submit borrowing rates in various currencies and timeframes.
Average the remaining rates after removing the top and lowest submissions.
The average becomes the LIBOR rate.
The British Bankers’ Association (BBA) oversaw the computation procedure until ICE LIBOR took over. The change sought to improve rate-setting dependability and openness.
Significance in Trading
Adjustable-rate mortgages, corporate loans, and interest rate swaps are priced using LIBOR. LIBOR is used by traders to calculate loan interest rates and derivative contract values.
LIBOR affects borrowing costs, which affect consumer spending, company investments, and economic development. LIBOR changes indicate credit risk and liquidity, therefore traders watch them.
Complex derivatives like interest rate futures and options are priced using LIBOR. Traders use derivatives to manage or speculate on interest rate changes. Understanding LIBOR is essential for hedging or leveraging financial securities.