The Quasi-Government Sector
In most parts of the world, the financial system can be divided into two parts viz. the private sector and the government sector. However, in many parts of the world, there is a third sector called the quasi-government sector. This sector has the characteristics of both the government as well as the private sector. The […]
The 4 Basic Types of Derivatives
In the previous articles we discussed about what derivative contracts are and what are the uses of such contracts? However, one important point needs to be noticed. Today, if a new person wants to buy a derivative contract, they will be bewildered at the sheer amount of choice that they will have at their disposal. […]
What is Negative Working Capital ?
Traditional financial analysts would consider a negative working capital i.e. having more current liabilities than current assets, a sign of imminent danger. This view was deep rooted in the belief that a company must always have sufficient cash on hands to meet its short term liabilities failing which the credit will dry up and the […]
Accounting for Stadium Leases
In the previous article, we have already established that there are many sporting franchises across the world that prefer to rent out stadiums instead of building them outright. We also know that a significant number of sports franchises are indeed using the leasing route. Hence, there are a lot of leasing transactions present in the […]
Cash vs. Accrual Basis of Accounting
Cash Basis of Accounting Cash Basis of Accounting uses receipts and payments of cash to record incomes and expenses. Therefore, under the cash basis of accounting, if a corporation makes salary payments of January, 3 months later in April, it will be considered as expenses in the month of April, since that is when the […]
Debt securities are widely issued and traded in the secondary market. Debt securities could have a fixed interest rate or a floating interest rate. When debt is taken for the short term, fixed interest rates are preferred. However, in the medium to long run, the interest rates cannot be directly fixed. This is because, as we move farther into the horizon period, economic uncertainty increases even further. As a result, financial markets all over the world have devised a system of reference-based interest rates. In this article, we will have a closer look at what reference rates are and why they are important.
Reference rates are a type of interest rate. It is actually an intermediate rate which is used to calculate the final rate. Interest rates are defined as the reference rate +/- certain basis points. For instance, if the parties have agreed to pay an interest of reference rate + 500 basis points and the reference rate is 6%, then the applicable interest rate would be 6% + 500 basis points i.e., 6.5%
As already mentioned above, reference rates are used by financial parties when they draw up a medium to long term financial contract. Reference rates serve several important purposes. Some of them have been listed below:
There are some reference rates which are used in several contracts all over the world. These reference rates are as follows:
Most derivative contracts in the world are based on the LIBOR. However, it is not the most reliable interest rate. This is because it is set based upon the bids received by five to six big banks in the London market. Hence, it would be fair to say that LIBOR is open to manipulation.
In fact, there have been cases registered wherein the LIBOR has been manipulated by bankers. The LIBOR is an offered rate. The LIBID is another rate that is published by the same bankers association. This is a bid rate and is only a few basis points different as compared to the LIBOR rate.
The European LIBOR is the Euro-denominated LIBOR rate offered by London bankers. The EURIBOR is a recent invention. Prior to that, each country in the Eurozone had its own interbank rate.
Paris had the PIBOR rate, and Frankfurt had the FIBOR rate. All these rates are now merged into the EURIBOR. The EURIBOR is important since a very large number of derivatives contracts are based on the EURIBOR as well.
There are many reference rates across the world. For instance, Hong Kong has HIBOR, Singapore has SIBOR and Mumbai ha MIBOR. However, these rates are only used locally and do not make much of an impact on the international scene. However, in all cases, the concept remains the same. The reference rates based interest rate system is used in almost all loans across the globe.
Your email address will not be published. Required fields are marked *
