Libor & Swap Rate

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AMC

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Maybe it is stupid to ask such a question after L3 exam. But what are the relations between Libor Rate & Swap Rate ?
 
If my memory serves me well, swap rate is the fixed rate in fixed to floating swap. The spread is difference in LIBOR + spread paid on floating rate loan and LIBOR rate received on swap which can be added to fixed rate to know the spread over fixed rate. This is more popular in Europe as compared to spread over Treasuries in US.
Any other thoughts?
 
I buy a ford bond priced at treasury plus 300 bps, enter into a pay fixed recieve float swap. the fixed part is Treasury plus 100 bps.
Here is what it would look like
Treasury + 300 bps - Treasury - 100 bps + Libor = Libor + 100
I would enter into this series of transactions if i expect Libor to increase.
 
Um… this is the difference:
1) Libor is the rate at which banks in London can borrow from each other. It’s determined by a bunch of old white guys in a council.
2) The swap rate is the fixed rate that makes the value of a swap zero at initiation - so it’s like a weighted value of various interval rates along the yield curve. Swap rates are determined by markets.
Obviously, these two things are highly correlated. Both are used as general measures of credit risk and borrowing costs.
 
Libor & Swap Rate are very basic in financial industry while I don’t have a clear concept about what is the linkage between them.
Any other clarification / explanation ? Please !
 
I’m not a Swap trader, but the below is what my experience tells me…
> 1) Libor is the rate at which banks in London can
> borrow from each other. It’s determined by a bunch
> of old white guys in a council.
LIBOR
In simple terms at the end of each day, all the big international banks (from their London entity) report their currency lending rates to bbalibor. The upper and lower 25% are thrown away, and what’s left is averaged. The rate is determined by 11am the next day, and is valid for 24 hrs.
LIBID
What banks (on the other side) bid for funds.
For the details look here:
http://www.bbalibor.com/bba/jsp/polopoly.jsp?d=1625
LIBOR and LIBID will be quoted for a range of time horizons.
You can use LIBOR for the SWAP rate, but you can also use EURIBOR for the SWAP rate. Day count basis can be that of the rate you are using or something else (including another rate). I’m pretty sure you can use whatever you like as your swap rate (Treasury rates/Gilts etc) but since LIBOR/EURIBOR rates have a built-in allowance for interbank credit risk, why would you want to?
EURIBOR vs EURO LIBOR
Libor is maintained by the British Bankers’ Association.
Eurobor is maintained by the European Banking Federation.
There are small differences in how the rate is determined (upper 15%/lower 15% are trashed I believe)
http://www.euribor.org/html/content/euribor_tech.html
LIBOR is used as a standard globally because all the big banks have an entity in London, and they’re all borrowing/lending in all currencies. It just happens to be an old standard dating back to the release of the first ‘Back to the Future’ film…
Who’s for a new-build Delorean!?
 
Primer: London Interbank Offered Rate (LIBOR) is the interest rate at which one London bank offers funds to another London bank of acceptable credit quality. The rate is “fixed” by the British Bankers’ Association by taking the average of the rates supplied by member banks.
I assume by the context of your question you’re asking how this is related to a swap rate.
LIBOR, as you might imagine, isn’t tied to a swap rate per se, but the fixed rate on most interest rate swaps is a function of the LIBOR curve at the time that the swap is initiated.
Not all, but most swaps are tied to 3 Month Libor. The rate on the fixed rate side of an interest rate swap is the rate that, at initiation, makes the discounted value of cash flows on the fixed and floating side of the swap equal to one another.
I hope that helped. If you still aren’t clear on something and can pinpoint what exactly that is we may be able to answer your question more directly.
 
Bankin’ Wrote:
——————————————————-
> Not all, but most swaps are tied to 3 Month Libor.
Do not get it. For example, a 2 years SWAP with semiannual payments shall be tied to 6/12/18/24 months LIBORs, right ?
> The rate on the fixed rate side of an interest
> rate swap is the rate that, at initiation, makes
> the discounted value of cash flows on the fixed
> and floating side of the swap equal to one
> another.
The cash flows (or floating rates) of floating side in a swap are determined by LIBORs (or LIBOR Curve), right ? And a borrower’s floating borrowing rates is LIBORs +Credit Spread, right ?
My another queation is :
What is the relationship between the Swap Spread and Credit Spread ?
 
Swap spread is yield on a given bond vs Libor.
* Libor includes interbank credit spread but not the additional bps credit spread which say Ford would pay above Libor on a Swap.
* Bond yield incorporates a specific credit spread (ford in this example). Plus maturity premium, liquidity premium, blah blah.
>Do not get it. For example, a 2 years SWAP with semiannual payments shall be tied to 6/12/18/24 months LIBORs, right ?
The fixed side at inception will be based on these rates, yes. The floating side’s rate will reset at the end of each period, so the latest six month Libor rate would be used in your example. The payment based on this rate occurs at the end of the following period (So in 6 months time).
Everything is based on Libor/Euribor, and then a credit spread is added.
 
allépourpêcher Wrote:
——————————————————-
> Swap spread is yield on a given bond vs Libor.
As far as I know, Swap Spread is the spread [paid by fixed-rate payer (dealer)] over the rate on the on-the-run Treasury of same maturity when investors use a swap to convert fixed-rate payments to floating-rate payments.
Referring to 2010 CFAI text V4 P.77~78, the 5-year Swap Spread is 83 bps. But which Treasury is referred here ? US Treasury or UK Treasury ? or even Germany Treasury ?
On the other hand, is it that different corporates will have different Swap Rates (suppose the dealer is the same one) due to different credit ratings (i.e., different credit spreads are added to LIBORs to arrive at the Swap Rates) ?
 
Swap spread is paid on libor to swap from fixed to floating, depending on maturity. Libor + 5 year swap spread = 5 year fixed rate. It can get confusing because Libor also has multiple rates eg. for payments made in 1,2,3,6,9,12 months from now. To simplify the calculation you can just refer to the “swap rate”. Which is the appropriate combined Libor + Swap Rate for your specified term to maturity.
 
You’re right there pal, my mistake. Don’t know what I was thinking - the Swap Spread is versus Treasuries, not corporate bonds.
The word ‘Treasury’ suggests US Treasury. UK would be Gilts, Germany is Bunds. But the principle’s the same (and the rates similar)…. so If I were you and quoting the Swap Spread I’d do it vs UST.
> is it that different corporates
> will have different Swap Rates (suppose the dealer
> is the same one) due to different credit ratings
> (i.e., different credit spreads are added to
> LIBORs to arrive at the Swap Rates) ?
Yes definitiely, yes this is right.
AMC Wrote:
——————————————————-
> allépourpêcher Wrote:
> ————————————————–
> —–
> > Swap spread is yield on a given bond vs Libor.
>
> As far as I know, Swap Spread is the spread over
> the rate on the on-the-run Treasury of same
> maturity when investors use a swap to convert
> fixed-rate payments to floating-rate payments.
>
> Referring to 2010 CFAI text V4 P.77~78, the 5-year
> Swap Spread is 83 bps. But which Treasury is
> referred here ? US Treasury or UK Treasury ? or
> even Germany Treasury ?
>
> On the other hand, is it that different corporates
> will have different Swap Rates (suppose the dealer
> is the same one) due to different credit ratings
> (i.e., different credit spreads are added to
> LIBORs to arrive at the Swap Rates) ?
 
The 1 year swap rate is generally the fixed leg payment on a one year swap with the counter party paying 3m LIBOR settled every quarter.
A 12m LIBOR is the rate on a loan with the entire repayment at the end of a year. This is in contrast to the above situation where the swap is settled every quarter.
The associated credit risk is more because the payment is made at the end of an year, hence the 12m LIBOR is generally higher than the 1 year swap rate.
There is a liquidity argument as well that adds a premia on the 12m LIBOR and not to the 1 year swap rate.
That being said, the 12-month LIBOR will almost always be higher than the 1-year swap rate.
 
I remember that in CFA L2 curriculum. the Swap (fixed) rate for “semi-annual” payment is calculated as follows :
C = (1- Zn) / (Z1+… +Zn) and Swap (fixed) rate = C x (360/180)
Zn : Discount Factor and Zn = 1 / (1+Rn) 1+Rn : n-period discount factors at LIBOR
Thus, the Swap (fixed) rate is derived from LIBOR. But why the Swap Spread is the spread over the rate on the on-the-run US Treasury ?
On the other hand, it seems that credit spread is not added to the LIBOR to arrive at the Swap (fixed) rate. Then, different corporates will have almost same Swap Rates even they have different credit ratings ?
I am confused ! Anyone can clarfy / explain ?
 
A 1,000 notional swap entails a lot less credit risk than lending someone 1,000. So you would never add a regular credit spread to the charge for one leg of a swap (though it’s common practice to add it to both the fixed and floating legs).
Also, swaps are assumed to be between highly rated counterparties; IIRC roughly AA-rated.
You might have the wrong definition of swap spread; it’s the difference between swap rate and treasury rate. Thus a low-rated issuer’s coupon = treasury + swap spread + credit spread.
(Note however that credit spreads can be wrt treasury or swap rate. In North America they’re typically to treasury rate, so include the “swap spread” in them.)
 
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