Meaning and definition of LIBOR
Short for London Inter-Bank Offer Rate, LIBOR is defined as the interest rate charged by one bank from another for loans (generally in Eurodollars). This rate is pertinent to the short term international interbank market, in addition to being applicable to very large loans which are borrowed for any place from one day to five years. This market enables banks having liquidity requirements to borrow instantly from other banks having surpluses, thus enabling banks to avoid holding extremely high amounts of their asset base as liquid assets.
The LIBOR is, moreover, fixed once a day officially by a small group of large banks in London. However, the rate fluctuates throughout the day. As explained by Investopedia, LIBOR can be stated as the world’s most broadly used benchmark for short term interest rates. Besides, it is important as it is the rate at which the most preferred borrowers of the world are capable of borrowing money. It is, moreover, also the rate which is taken as a basis for less preferred borrowers.
Illustrating the definition of LIBOR
As mentioned above, LIBOR is an interest rate at which funds are borrowed by banks, in marketable size, from other banks in the London interbank market. The definition of LIBOR is further amplified as follows:
· The rate at which every individual bank submits needs to be formed from that bank’s discernment of its funds’ cost in the interbank market.
· The contributions must indicate rates formed in London and not anywhere else.
· The contributions must be aimed at the concerned currency, and not the cost of generating one currency by borrowing another and accessing the required currency through the foreign exchange markets.
· The rates must be offered by staff members at a bank with prime responsibility of cash management of a bank, instead of a bank’s derivative book.
· The definition of “funds” can be given as cash raised through primary issuance or unsecured interbank Certificates of Deposit.
Scope of LIBOR
The LIBOR is used widely as a reference rate for financial instruments like forward rate agreements, short term interest rate futures contract, interest rate swaps, inflation swaps, currencies, variable rate mortgages, and floating rate notes.