What is LIBOR?

The London Interbank Offered Rate, or LIBOR, is the European version of the federal funds rate in the United States and represents the interest rate at which London banks charge each other on funds borrowed. This is not to be confused with the BBA LIBOR rate, which is a filtered average of inter-bank loans maturing within 1 year. BBA LIBOR is published once per day by the British Bankers Association at around 11 AM London standard time. The BBA is advised by a group of senior banking experts from at least 8 contributor banks and uses their lending activity to derive the BBA LIBOR rate.

How is it used?

LIBOR represents a benchmark for short term borrowing worldwide and is used to settle interest rate contracts in many of the world's futures and options exchanges. BBA LIBOR is created in ten different currencies and is done so by polling a new set of relevant contributor banks for each currency. BBA currency LIBOR will then provide the borrower with an interest rate to borrow a specific currency in the London cash market. You may hear the term Eurodollars or Euroyen; this defines the interest rate at which you can borrow US dollars or Japanese Yen in the London market.

BBA LIBOR is also referenced in many instruments that have a variable rate structure; such as, adjustable rate mortgages, floating rate notes, interest rate swaps, syndicated loans, and much more.

How do you calculate Interest using LIBOR?

BBA LIBOR is not a compounded rate; rather, it is calculated on the basis of the actual funding term. The formula to calculate interest using LIBOR would be done as follows:

Principal Loan Amt X BBA LIBOR rate X (Loan Term/360)

This formula would apply to the US LIBOR ; however, the GBP LIBOR is based on an ACTUAL/365 scheme and therefore you would have to adjust that formula to divide by 365.

Tim Ord
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