Part 3 - LIBOR

Question 1

LIBOR

Answer 1

LIBOR is the London Interbank Offered Rate: ‘The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by asking for and then accepting
inter-bank offers in reasonable market size, just prior to 11.00 London time

Question 2

LIBOR Issues (2)

Answer 2

Each bank what they think overnight rates should be: based on loans they made and market data loans they observed
Now for the one month in the the overnight transactions more than 50% of the submissions were based on loans that they themselves had made.
Longer term submissions 2 to 12 months, less was based on market data
Diminish - estimates not based on their data

Interbank lending - very little was uncollatarised after financial crises -overnight debt was not collatarised

Question 3

Interest rate risk: 10-year zero-coupon vs 10-year 10% coupon

Answer 3

This increased sensitivity is due to the zero-coupon bond’s longer duration, meaning all its cash flows (the principal repayment) are received at the end of the bond’s term. Any change in interest rates has a more pronounced effect on the present value of the zero-coupon bond’s single cash flow, as opposed to the 10% coupon bond, which distributes its cash flows throughout its life. Therefore, the zero-coupon bond’s price will be more volatile in response to interest rate changes compared to the coupon bond