By Justin Kuepper. International Investing Expert
Justin Kuepper is a financial journalist and private investor with over 15 years of experience in the domestic and international markets. Read more
The London Interbank Offered Rate, or LIBOR rate. is the most popular barometer for short-term interest rates around the world. Calculated by averaging interest rates charged by London banks for periods ranging from overnight to five years, the LIBOR is a benchmark used for financial instruments ranging from currencies to interest rate swaps and forward rate agreements.
Origins of the LIBOR Rate
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In 1984, the British Bankers' Association (BBA) agreed to establish some standards for these instruments, which were based on a common interest rate charged across the industry - eventually known as the LIBOR.
The LIBOR rate was officially established in 1986 with more than 60 nations representing 223 members and 37 associated professional firms, as of 2008. The rate itself is now calculated and published by Thomson Reuters on behalf of the BBA after 11:00am (London Time) each day.
The LIBOR rate is now used in a number of financial products, including:
- Forward Rate Agreements
- Interest Rate Swaps
- Inflation Swaps
- Floating Rate Notes
- Syndicated Loans
- Variable Rate Mortgages
The Importance of Interest Rates
The LIBOR and interest rates are very important for investors. Higher interest
rates negatively affect stocks and bonds by reducing available capital and creating more attractive alternative investment yields. Conversely, lower interest rates signal greater capital availability and higher bond prices, thereby boosting the stock and bond markets .
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On a macroeconomic level, interest rates can affect a number of different markets. For instance, LIBOR rates are commonly used in calculating mortgages interest rates (e.g. LIBOR plus X%), which means that the metric can have a dramatic impact on the housing market. Since this is a key driver of the U.S. economy, it's very important for investors to watch.
LIBOR Rate Vs. Central Bank Rates
The divergence took place because commercial banks became more hesitant to lend to each other and placed a greater risk premium on any lending. For instance, in late 2008, the U.S. Federal Reserve dropped their rate to 1.5%, but the LIBOR rate rose to a high of 4.8%, amid concerns that banks would be inheriting each other's bad subprime loans.
Key Points to Remember
- The London Interbank Offered Rate, or LIBOR rate, is the most popular barometer for short-term interest rates around the world.
- LIBOR is calculated by averaging interest rates charged by London banks for periods ranging from overnight to five years.
- LIBOR rates are considered more important than central bank interest rates, while interest rates can dramatically impact investors.