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LIBOR Curve

Updated on April 29, 2024
Article byNiti Gupta
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What is a LIBOR Curve?

The LIBOR curve represents the values of the LIBOR rate graphically at various maturity intervals, such as one-month rate, two-month rate, etc., and various banks and other financial institutions use it to determine the interest rate for debt-based and other financial products. A graphical representation makes it easier to analyze and make decisions.

What is a LIBOR Curve

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The LIBOR curve data is a fundamental financial benchmark that plays a pivotal role in global financial markets, particularly in the realm of interest rates. It represents the interest rates at which major banks can borrow funds from one another in the London interbank market. The LIBOR curve provides a graphical representation of the relationship between these interest rates and the time to maturity.

Key Takeaways

  • The LIBOR curve visually represents the LIBOR rate at different maturity intervals, like one-month or two-month rates. Many banks and financial institutions use it to calculate interest rates for their debt-based and other financial products.
  • Banks and rating agencies use LIBOR as a benchmark rate to determine interest rates for short-term borrowing. This rate is used for different types of debt and derivatives.
  • LIBOR rate is used in interest rate futures contracts to establish settlement prices and provides helpful information on projected interest rates.

LIBOR Curve Explained

The LIBOR curve graphically represents the LIBOR rate for various maturities. The rate is being used globally by the leading banks and other financial products and continues to be used to date.

It serves as a reference point for setting interest rates on a wide range of financial products, including loans, mortgages, and derivatives. The curve reflects the cost of borrowing money, impacting everything from consumer loans to corporate debt.

Changes in the shape and steepness of the curve can signal economic health or instability. A steep curve, where long-term rates are significantly higher than short-term rates, may indicate market expectations of economic growth. A flat or inverted curve, on the other hand, can signal potential economic downturns.

Financial institutions use this metric as a basis for pricing financial products. It helps in valuing fixed-income securities, structuring interest rate swaps, and hedging against interest rate risk.

The LIBOR curve graph reflects market expectations regarding future interest rates, providing insights into investor sentiment. Central banks often consider these expectations when setting their monetary policies.

It’s important to note that this curve underwent significant changes due to the discontinuation of LIBOR in favor of alternative reference rates such as SOFR (Secured Overnight Financing Rate). As a result, financial markets have transitioned to these new benchmarks. Nonetheless, the concept of the LIBOR curve remains vital in understanding interest rate dynamics and its historical significance in the financial world.

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Examples

Now that we understand the basics of LIBOR curve data, let us apply the theoretical knowledge to practical application through the examples below.

Example #1

Let us have a look at an example of a one-year LIBOR Curve for the year 2019.

Example of LIBOR Curve 2

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Source: LIBOR Curve (wallstreetmojo.com)

The curve is based on the following data.

Month Rate
Dec1.96%
Nov1.93%
Oct 2.04%
Sep1.95%
Aug2.24%
Jul2.20%
Jun2.41%
May2.71%
Apr2.73%
Mar2.88%
Feb2.96%
Jan3.00%

The curve here represents the movement in the LIBOR interest rateLIBOR Interest RateLIBOR Rate (London Interbank Offer) is an estimated rate calculated by averaging out the current interest rate charged by prominent central banks in London as a benchmark rate for financial markets domestically and internationally, where it varies on a day-to-day basis inclined to specific market conditions.read more every month. The rates for twelve months are depicted in the graph. The LIBOR rate for all twelve months can be determined by looking at the graph.

Example #2

The central bank of the Philippines, The Bangko Sentral ng Pilipinas or BSP, announced in June 2023 that they are moving away from LIBOR to a 28-day bill rate.  

They chose the 28-day securities bill as it is a heavily-populated tenor. They also mentioned that since macro financial decisions are made based on this metric, it is for everyone’s benefit that the benchmark is more credible and efficient, citing that the LIBOR curve had its flaws that cannot be overlooked.

Uses

Let us understand the uses of LIBOR curve graph through the discussion below.

Importance

The LIBOR curve data is an important tool for banks and financial institutions based on the globally determined benchmark rate. The same is useful for determining the interest rates for lending and other financial products such as interest rate swapsInterest Rate SwapsAn interest rate swap is a deal between two parties on interest payments. The most common interest rate swap arrangement is when Party A agrees to make payments to Party B on a fixed interest rate, and Party B pays Party A on a floating interest rate.read more and LIBOR futures. A majority of global financial products are based on LIBOR. The regulatory authorities also use the rate to suggest the maximum spread at which loans can be given to borrowers abroad.

LIBOR Curve vs. Swap Curve

Let us understand the differences between LIBOR curve data and swap curve through the comparison below.

Frequently Asked Questions (FAQs)

How is LIBOR curve construction?

Typically, the curve is split into three sections. LIBOR rates establish the short end, the middle is formed by Eurodollar futures or forward rate agreements (FRA), and mid-swap rates determine the far end.

What is the three-month LIBOR curve?

The 3-month USD LIBOR forward curve indicates what the market expects for future USD LIBOR rates. It is determined by analyzing trade data from Eurodollar Futures and LIBOR swap rates. The angle also considers the future expectations of the Federal Open Market Committee (FOMC) policy.

What will replace the LIBOR curve?

In the United States, SOFR is the main alternative to LIBOR. This benchmark is determined by the interest rates that American financial institutions charge each other for overnight loans. These loans are typically in the form of Treasury bond repurchase agreements or repos agreements.

What does the shape of the LIBOR curve indicate?

The shape of the LIBOR curve can indicate market expectations about future interest rates and economic conditions. A standard or upward-sloping curve suggests that markets expect interest rates to rise over time. An inverted or downward-sloping curve might offer expectations of lower interest rates in the future.

Recommended Articles

This has been a guide to what is a LIBOR Curve. Here we explain its examples, uses, importance, and compare it with the swap curve in detail. You may learn more about Financing from the following articles –