The most famous barometer for short-term
interest rates in the world, the London Inter Bank Offered Rate, or LIBOR, is the interest rate that the most credit-worthy banks around the world charge each other for loans ranging from twenty-four hours to five years. This global inter-bank market provides a means for financial institutions with excess capital to earn higher rates of return by its loaning
liquid assets to those in need of the funds.
LIBOR is released each day at 11 a.m. London time. It then fluctuates throughout the day based upon the market’s expectations for economic activity and the future direction of interest rates.
LIBOR and Eurodollars
LIBOR loans are expressed in
Eurodollars; United States currency held by foreign entities, such as a British or German bank or insurance company. Eurodollars are most often the result of American companies using U.S. dollars to pay internationally-domiciled corporations for goods, service, and merchandise purchased. When Uncle Sam is running a trade deficit – that is, purchasing more goods from abroad than it sells – the natural result is an increase in Eurodollars; the result is more foreigners purchasing American companies and assets.
Why LIBOR is Important
LIBOR is important because it is often used as the base for variable-rate government and corporate loans and
derivative-based products such as credit swaps. A small, impoverished nation, for example, may have to pay a spread of a percentage point or two above and beyond the established LIBOR rate; thus, an increase or decrease in LIBOR will result in a corresponding rise or fall in its cost of borrowing.
