What Is the LIBOR Curve?
Let me explain the LIBOR curve directly to you—it's the graphical representation of the interest rate term structure for various maturities of the London Interbank Offered Rate, or LIBOR. You should know that LIBOR is a short-term floating rate where large banks with high credit ratings lend to each other. The curve specifically shows the yield for short-term LIBOR rates under one year. Keep in mind that the shift from LIBOR to benchmarks like the secured overnight financing rate (SOFR) started in 2020.
Key Takeaways
The LIBOR curve illustrates the yield curve for different short-term LIBOR maturities in a graph. Remember, the move away from LIBOR to options like SOFR began in 2020. These rates cover from overnight to several months. You look at the LIBOR curve to gauge how lending rates in various debt markets might act in the near to mid-term.
Understanding the LIBOR Curve
LIBOR stands as one of the most widely used benchmarks for short-term interest rates worldwide. It indicates the average rate at which contributing banks can get short-term loans in the London interbank market. The curve plots these rates against their maturities, typically across seven: overnight (spot next), one week, one month, two months, three months, six months, and 12 months.
A yield curve is simply a line plotting yields of bonds with equal credit quality but different maturity dates. Its slope hints at future interest rate shifts and economic trends. You'll find three main shapes: normal (upward-sloping), inverted (downward-sloping), and flat.
An upward-sloping curve means long-term yields exceed short-term ones, signaling economic expansion. A downward-sloping, or inverted, curve shows short-term yields higher than long-term, pointing to an upcoming recession. A flat curve indicates minimal difference between short- and long-term yields, reflecting market uncertainty about the economy's direction.
While not entirely risk-free in theory, LIBOR acts as a solid proxy for assessing risk-return in other short-term floating rate instruments. The curve can predict longer-term rates and plays a key role in pricing interest rate swaps.
Criticism of the LIBOR Curve
Abuse of LIBOR for personal gain came to light after the 2008 financial crisis. Disruptions in global banking allowed individuals at contributor banks to manipulate rates. In 2013, the UK's Financial Conduct Authority (FCA) assumed regulation of LIBOR. By December 2020, plans were set to end the LIBOR system by 2023, replacing it with benchmarks like the Sterling Overnight Index Average (SONIA).
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