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Consider the following statements regarding the London Interbank Offered Rate (LIBOR):
- It acts as a benchmark for long-term interest rates in the international interbank market.
- It is an indicator of the health of the financial system and also the basis for consumer loans in countries around the world.
Which of the statements given above is/are correct?
- a)1 only
- b)2 only
- c)Both 1 and 2
- d)Neither 1 nor 2
Correct answer is option 'B'. Can you explain this answer?
Most Upvoted Answer
Consider the following statements regarding the London Interbank Offer...
The Reserve Bank of India (RBI) recently told banks and other regulated entities to ensure a complete transition away from the London Interbank Offered Rate (LIBOR).
About London Interbank Offered Rate (LIBOR):
- It is a benchmark interest rate at which major global banks lend to one another in the international interbank market for short-term loans.
- It acts as a benchmark for short-term interest rates.
- It is an indicator of the health of the financial system and provides an idea of the trajectory of impending policy rates of central banks.
- LIBOR is also the basis for consumer loans in countries around the world, so it impacts consumers just as much as it does financial institutions.
- How is LIBOR calculated?
- The rate is calculated and will continue to be published each day by the Intercontinental Exchange (ICE).
- It is computed for five currencies with seven different maturities ranging from overnight to a year.
- The five currencies for which LIBOR is computed are the Swiss franc, euro, pound sterling, Japanese yen and US dollar.
- Each day, ICE asks major global banks how much they would charge other banks for short-term loans.
- ICE benchmark administration consists of 11 to 18 banks that contribute for each currency. Only those banks that have a significant role in the London market are considered eligible for membership on the ICE LIBOR panel, and the selection process is held annually.
- The rates received from the banks are arranged in descending order, and the top and bottom quartiles are excluded to remove outliers.
- The arithmetic mean of the remaining data is then computed to get the LIBOR rate.
- The process is repeated for each of the 5 currencies and 7 maturities, thereby producing 35 reference rates.
- The most commonly quoted rate is the three-month U.S. dollar rate, usually referred to as the current LIBOR rate.
Hence only statement 2 is correct.
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Community Answer
Consider the following statements regarding the London Interbank Offer...
**Explanation:**
The correct answer is option **B) 2 only**.
Let's understand each statement one by one:
1. It acts as a benchmark for long-term interest rates in the international interbank market.
The first statement is incorrect. LIBOR is not a benchmark for long-term interest rates; instead, it is a benchmark for short-term interest rates. LIBOR represents the average interest rate at which major banks in London are willing to borrow from each other in the wholesale money market. It is typically quoted for overnight, one-week, one-month, three-month, six-month, and one-year periods.
2. It is an indicator of the health of the financial system and also the basis for consumer loans in countries around the world.
The second statement is correct. LIBOR is indeed an indicator of the health of the financial system. During times of financial stress or uncertainty, LIBOR tends to increase, reflecting the perceived risk in the banking system. Moreover, LIBOR serves as the basis for consumer loans in many countries. It is often used as a reference rate for adjustable-rate mortgages, student loans, credit cards, and other consumer loans. The interest rates charged to consumers are typically based on LIBOR plus a fixed margin.
Therefore, only statement 2 is correct.
The correct answer is option **B) 2 only**.
Let's understand each statement one by one:
1. It acts as a benchmark for long-term interest rates in the international interbank market.
The first statement is incorrect. LIBOR is not a benchmark for long-term interest rates; instead, it is a benchmark for short-term interest rates. LIBOR represents the average interest rate at which major banks in London are willing to borrow from each other in the wholesale money market. It is typically quoted for overnight, one-week, one-month, three-month, six-month, and one-year periods.
2. It is an indicator of the health of the financial system and also the basis for consumer loans in countries around the world.
The second statement is correct. LIBOR is indeed an indicator of the health of the financial system. During times of financial stress or uncertainty, LIBOR tends to increase, reflecting the perceived risk in the banking system. Moreover, LIBOR serves as the basis for consumer loans in many countries. It is often used as a reference rate for adjustable-rate mortgages, student loans, credit cards, and other consumer loans. The interest rates charged to consumers are typically based on LIBOR plus a fixed margin.
Therefore, only statement 2 is correct.
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Consider the following statements regarding the London Interbank Offered Rate (LIBOR): It acts as a benchmark for long-term interest rates in the international interbank market. It is an indicator of the health of the financial system and also the basis for consumer loans in countries around the world.Which of the statements given above is/are correct?a)1 onlyb)2 onlyc)Both 1 and 2d)Neither 1 nor 2Correct answer is option 'B'. Can you explain this answer?
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