Definition
The full form of LIBOR is London Interbank Offered Rate. It is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. LIBOR serves as a globally accepted key reference rate for financial instruments such as forward rate agreements, short term-interest rate futures contracts, and swap contracts.
Key Takeaways
- LIBOR stands for London Interbank Offered Rate. It’s the interest rate at which major global banks lend to each other in the international interbank market for short-term loans.
- It is an essential benchmarking rate in global financial markets and directly impacts the interest rates on various financial products such as bonds, loans, and mortgages worldwide.
- The rate is calculated for seven different maturities (ranging from overnight to 12 months) and five different currencies, including the U.S. dollar (USD), Euro (EUR), British Pound (GBP), Japanese Yen (JPY), and Swiss Franc (CHF).
Importance
The Full Form of LIBOR, which stands for London Interbank Offered Rate, holds significant importance in global finance. It’s used as a reference interest rate in financial markets around the world and serves as a benchmark for short-term interest rates.
Financial institutions utilize it in setting rates on various financial products, including derivatives, loans, and bonds. It is significant because it gives an indication of the cost of borrowing between banks, and broadly reflects the health of the financial system.
Its movements can directly influence the value of trillions of dollars of financial deals between banks and other institutions. Therefore, understanding the LIBOR is crucial for financial market participants.
Explanation
LIBOR, which stands for London Interbank Offered Rate, serves a crucial purpose as one of the primary benchmark interest rates in the global finance industry. It represents the interest rate at which an array of leading banks in London estimate they would be able to borrow funds from each other in different currencies and over varying short-term periods.
Initiated in the 1980s, it became a standardized benchmark that reflects the health of the financial system by indicating the level of confidence banks have in each other’s fiscal stability. The purpose of LIBOR extends beyond its role as an interbank lending rate.
In fact, it underpins a massive range of financial products and contracts around the globe including but not limited to mortgages, student loans, and credit cards. Financial professionals consider LIBOR as the basis of calculations for these products to determine the interest rates they charge to consumers.
It also proves essential in hedging and risk management strategies. Thus, even small fluctuations can potentially influence the costs of borrowing or the investment returns for millions of people and businesses worldwide.
Examples of Full Form of LIBOR
The full form of LIBOR is the London Interbank Offered Rate, a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. Here are three real-world examples:
Mortgages: Many variable or adjustable-rate mortgages use LIBOR as the benchmark for changing interest rates over time. For instance, a homeowner with a LIBOR-based adjustable-rate mortgage might see their interest rate and monthly payments rise or fall in line with LIBOR fluctuations.
Student Loans: Some private student loans also have variable interest rates tied to LIBOR. If a student has a loan with a variable rate, and the LIBOR rate increases, the interest they owe might also increase, affecting their monthly repayments.
Financial Derivatives: LIBOR is extensively used as a reference rate for many financial instruments, including interest rate swaps, futures contracts, and options. For example, a company may hedge its interest rate risk by entering into a swap contract where it agrees to pay a fixed rate interest and receive a floating rate interest based on LIBOR. If LIBOR increases, the company’s payments may also increase.
FAQ: Full Form of LIBOR
1. What is the full form of LIBOR?
LIBOR stands for London Interbank Offered Rate.
2. What does LIBOR mean?
LIBOR is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans. It serves as a global benchmark for short-term interest rates.
3. Why is LIBOR important?
LIBOR is important because it’s a globally accepted benchmark for short term interest rates. It is used as a base rate by banks, securities and other financial institutions worldwide. It affects the pricing of loans and financial products.
4. How is LIBOR determined?
LIBOR is determined daily by the Intercontinental Exchange (ICE), which asks major global banks how much they would charge other banks for short-term loans. The rates are then averaged to arrive at the LIBOR for that day.
5. Is LIBOR being phased out?
Yes, LIBOR is being phased out. The UK’s Financial Conduct Authority (FCA) has announced that the majority of LIBOR rates will no longer be published by the end of 2021. Banks and financial institutions are transitioning to alternative rates, such as SOFR in the US and SONIA in the UK.
Related Entrepreneurship Terms
- Interbank Rate: It is the rate that banks charge each other for short-term loans. LIBOR is the prime example of an interbank rate.
- Interest Rate Swaps: LIBOR is frequently used as the benchmark rate for interest rate swaps where one party swaps their interest payments with another.
- Variable-Rate Mortgages: These are home loans with interest rates that adjust over time. LIBOR is often used as a reference rate for this type of mortgage.
- Foreign Exchange Rates: LIBOR can impact the value of currencies around the world, as the interest rates set by LIBOR affect the rates of return for investors.
- Benchmark Rate: This is a standard against which the performance of a security, index, or investment can be measured. LIBOR is one of the most widely used benchmark rates in the world.
Sources for More Information
- Investopedia: This website offers clear definitions and explanations of various finance and investment terms including LIBOR.
- Reuters: A global news website that provides information on various topics including finance and LIBOR.
- Bloomberg: Bloomberg is a financial, software, data, and media company that provides information about LIBOR among other financial indicators.
- Federal Reserve: The US central bank’s official site may also provide definition and explanation of LIBOR.
