Reference rate
Encyclopedia
A reference rate is a rate that determines pay-offs in a financial contract and that is outside the control of the parties to the contract. It is often some form of LIBOR rate, but it can take many forms, such as a consumer price index
, a house price index or an unemployment rate. Parties to the contract choose a reference rate that neither party has power to manipulate.
s, loan
s, swaps
, short term interest rate futures contract
s, etc. The rates are calculated by an independent organisation, such as the British Bankers Association (BBA) as the average of the rates quoted by a large panel of banks, to ensure independence.
Another example is that of swap reference rates for constant maturity swap
s. The rate that is used is calculated daily by an independent organisation, the International Swaps and Derivatives Association
, from quotes from a large panel of banks.
In the credit derivative
market a similar concept to reference rates is used. Pay offs are not determined by a rate, but by possible events. In this case, the reference event has to be a very precisely defined credit event
, to make sure there can be no disagreement on whether the event has occurred or not.
Typically the benchmark LIBOR is the three-month rate.
Consumer price index
A consumer price index measures changes in the price level of consumer goods and services purchased by households. The CPI, in the United States is defined by the Bureau of Labor Statistics as "a measure of the average change over time in the prices paid by urban consumers for a market basket of...
, a house price index or an unemployment rate. Parties to the contract choose a reference rate that neither party has power to manipulate.
Examples of use
The most common use of reference rates is that of short term interest rates such as LIBOR in floating rate noteFloating rate note
Floating rate notes are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter...
s, loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
s, swaps
Swap (finance)
In finance, a swap is a derivative in which counterparties exchange certain benefits of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved...
, short term interest rate futures contract
Futures contract
In finance, a futures contract is a standardized contract between two parties to exchange a specified asset of standardized quantity and quality for a price agreed today with delivery occurring at a specified future date, the delivery date. The contracts are traded on a futures exchange...
s, etc. The rates are calculated by an independent organisation, such as the British Bankers Association (BBA) as the average of the rates quoted by a large panel of banks, to ensure independence.
Another example is that of swap reference rates for constant maturity swap
Constant maturity swap
A constant maturity swap, also known as a CMS, is a swap that allows the purchaser to fix the duration of received flows on a swap.The floating leg of an interest rate swap typically resets against a published index...
s. The rate that is used is calculated daily by an independent organisation, the International Swaps and Derivatives Association
International Swaps and Derivatives Association
The International Swaps and Derivatives Association is a trade organization of participants in the market for over-the-counter derivatives....
, from quotes from a large panel of banks.
In the credit derivative
Credit derivative
In finance, a credit derivative is a securitized derivative whose value is derived from the credit risk on an underlying bond, loan or any other financial asset. In this way, the credit risk is on an entity other than the counterparties to the transaction itself...
market a similar concept to reference rates is used. Pay offs are not determined by a rate, but by possible events. In this case, the reference event has to be a very precisely defined credit event
Credit event
A credit event is the financial term used to describe either:* A general default event related to a legal entity's previously agreed financial obligation. In this case, a legal entity fails to meet its obligation on any significant financial transaction...
, to make sure there can be no disagreement on whether the event has occurred or not.
Typically the benchmark LIBOR is the three-month rate.
Reference rates for short term interest rates
Examples of reference rates for short term interest rates are:- EuriborEuriborThe Euro Interbank Offered Rate is a daily reference rate based on the averaged interest rates at which Eurozone banks offer to lend unsecured funds to other banks in the euro wholesale money market .-Scope:...
- Euro Interbank Offered Rate - LIBOR - London Interbank Offered Rate
- SIBORSIBORSIBOR stands for Singapore Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Singapore wholesale money market . It is similar to the widely used LIBOR , and Euribor...
- Singapore Interbank Offered Rate - TIBORTIBORTIBOR stands for the Tokyo Interbank Offered Rate and is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the Japan wholesale money market...
- Tokyo Interbank Offered Rate - WIBOR - Warsaw Interbank Offered Rate
- MIBORMIBORMIBOR may refer to:*MIBOR *MIBOR *MIBOR...
- Mumbai Interbank Offered Rate - KIBOR - Karachi Interbank Offered Rate