Quick Smarts - LIBOR Rate

What is it?

The acronym LIBOR stands for London Interbank Offered Rate. It is a money market index with an international flavor. In recent years, homebuyers have been encountering ARMs (Adjustable Rate Mortgages) with interest rates linked to, for example, the 6-month LIBOR rate.

How is it calculated?

The method of calculating the LIBOR rate is explained by Stephen Fletcher of Drexel Burnham Lambert in The Library of Investment Banking, volume VI: International Finance and Investing, chapter 4: "Eurodollar Floating-Rate Notes", page 63 (Dow Jones Irwin, 1988).

"Each FRN (floating-rate note) has a specific method for calculating the LIBOR rate to used on its coupon dates. At issue, an agent bank is appointed to calculate the coupon rate for each period. The method is usually as follows: On the second business day prior to the beginning of each coupon period, the agent bank collects the offered quotations prevailing at 11:00 A.M. on that day for interbank deposits with the London branches of leading banks from a series of reference banks (listed in the prospectus). The arithmatic mean of these rates, rounded up to the nearest sixteenth, is then taken as LIBOR. Using this rate, the coupon payment is then calculated on an ACT/360 day basis rounded, upwards or downwards, to the nearest cent on each note."

What is it good for?

"The interest rate on an international credit facility ... may be fixed ... or float against a benchmark ... related to the intermediary's cost of funding, such as LIBOR." --p. 245, vol. 2, Palgrave's Dictionary of Money and Finance (Macmillan Press, 1992)

"The rate at which banks in London place Eurocurrencies and/or Eurodollars with each other. Since the London Interebank Offered Rate (LIBOR) is a prime bankers' rate, it is often used in international banking as a basic rate, e.g., 'LIBOR plus 1/8 or 1%', in referring to an interest rate negotiated." --p. 713 Encyclopedia of Banking & Finance, Tenth Edition. (Probus Publishing, 1994)

Where is it listed?

A LIBOR rate may be quoted as a 1-month LIBOR, a 3-month LIBOR, a 6-month LIBOR, or a 1-year LIBOR rate. The LIBOR rate is usually released daily or averaged for the week, month, quarter, or year.

Compiled sources include:

1990 Citicorp Interest Rate Spread Analysis. Probus Publishing, 1990.
International Financial Statistics. Monthly. International Monetary Fund.
Los Angeles Times (Sunday) Business Section.

How to learn more about it.

Buchheit, Lee C. "How to negotiate the LIBOR definition,"
. International Financial Law Review, June 1993, p.35-36.
Ertefai, Roger I. "Check out the formula: LIBOR may not save you money,"
. Corporate Cashflow, September 1988, p.50-51.
Smith, Anne Kates "Time to grab an ARM; lenders are pushing complex new loans,"
. U.S. News & World Report, August 8, 1994, p.74+.
Wilson, Michael L. "LIBOR-indexed ARMS can be appealing to foreign investors,"
. Savings Institutions, January 1990, p.20-21.