LIBOR Curve

What Is the LIBOR Curve?

The LIBOR curve is the graphical representation of the interest rate term structure of different maturities of the London Interbank Offered Rate, normally known as LIBOR. LIBOR is a short-term floating rate at which large banks with high credit ratings loan to one another. The LIBOR curve portrays the yield curve for short-term LIBOR rates of short of what one year. The progress from LIBOR to different benchmarks, for example, the secured overnight financing rate (SOFR), started in 2020.

Understanding the LIBOR Curve

LIBOR is one of the world's most widely involved benchmark for short-term interest rates. It fills in as a primary indicator for the average interest rate, at which contributing banks might get short-term loans in the London interbank market. The LIBOR curve plots rates against their comparing maturities. The LIBOR curve ordinarily plots its yield curve across seven unique maturities — overnight (spot next (S/N)), multi week, one month, two months, 90 days, six months, and 12 months.

A yield curve is a line that plots yields (interest rates) of bonds having equivalent credit quality yet varying maturity dates. The incline of the yield curve gives a thought of future interest rate changes and economic activity. There are three principal types of yield curve shapes: normal (up inclining curve), inverted (descending slanting curve), and flat.

1. Up slanting: long-term yields are higher than short-term yields. This is viewed as the "normal" slant of the yield curve and signals that the economy is in an expansionary mode.
2. Descending inclining: short-term yields are higher than long-term yields. Named as an "inverted" yield curve and means that the economy is in, or going to enter, a latent period.
3. Flat: very little variation among short-and long-term yields. Signals that the market is uncertain about the future bearing of the economy.

Albeit not hypothetically risk-free, LIBOR is viewed as a decent proxy against which to measure the risk/return tradeoff for other short-term floating rate instruments. The LIBOR curve can be predictive of longer-term interest rates and is particularly important in the pricing of interest rate swaps.

Analysis of the LIBOR Curve

Maltreatment of the LIBOR framework for personal gain was uncovered in the wake of the financial crisis that started in 2008. Enormous disengagements in global banking empowered people working at supporter banks to control LIBOR rates. In 2013, the Financial Conduct Authority (FCA) of the U.K. assumed control over the regulation of LIBOR. As of December 2020, plans were in place to phase out the LIBOR framework by 2023 and replace it with different benchmarks, for example, the Sterling Overnight Index Average (SONIA).

Highlights

• The LIBOR curve is taken a gander at to perceive how lending rates in an assortment of debt markets are expected to act in the close to mid-term.
• The LIBOR curve portrays the yield curve for different short-term LIBOR maturities in graphical form.
• These LIBOR rates range from overnight as long as several months in maturity.
• The progress from LIBOR to different benchmarks, for example, the secured overnight financing rate (SOFR), started in 2020.