Finance

How The Interest Rate In Eurocurrency Markets Is Determined

Interest rate In Eurocurrency Market. Interest in Eurocurrency market is generally a floating rate of interest. Periodically, the interest rate will change with reference to a benchmark rate like LIBOR. For instance, the interest on a Eurobond for five years may be fixed at 150 basis points over Libor. (One basis point is 1/100 of 1%).

The Libor at the time of issue plus 1.5% will be applicable for six months. At the end of this period, Libor then prevailing will be reckoned and the interest for the next six months will be based on the Libor then prevailing.This will be repeated every six months.

LIBOR is the London Interbank Offered Rate and represents the rate at which banks in London will lend a currency to other banks for a specific maturity. Since London is a major Eurocurrency market, Libor is used as the basis for most Eurocurrency transactions. Libor varies for different maturities. Thus we have 1 month Libor, 3 months Libor, 6 months Libor etc.

Rates quoted by different banks may vary slightly, the bigger banks offering lower rates. In respect of a particular contract based on Libor, say a Eurobond issue, the rate is fixed by nominating reference banks. The reference banks may be from among those syndicating the issue. Or, to maintain neutrality, they may be banks outside the syndicate. The rates quoted by these banks at a stipulated time, often 11 AM London time, two business days before start of the due date, is taken as the basis. The average of such rates is rounded off to the nearest 1/8 per cent.

LIBID is the ‘London Interbank Bid’ rate. It is the rate at which banks accept eurocurrency deposits. Bid rates are lower than offered rates usually by 1/8 to 1/4 per cent. LIMEAN is the average of Libor and Libid.

Prime Rate. This is the rate of interest charged by first class banks in USA on advances to their first class borrowers. For example, it may relate to an advance made to a multinational corporation with a very high credit rating. This rate is usually a couple of percentage points higher than the discount and Federal funds rate. While it follows the same trends, it is determined rate calculated from money market rates, specially from the 90-day Certificate of Deposit rate.

Every bank in the USA announces independently its prime rate, but this tends to influence the rate of other banks also. Similarly, the prime rate has influence over the Eurodollar rate and is also influenced by it. A change in the prime rate is followed by a change in the Eurocurrency rate and vice versa.

SIBOR. This represents the Singapore Interbank Offered Rate. Similar to Libor, it is the rate at which principal banks in Singapore offer to lend Asian dollars and other currencies to other banks. Sibor forms the basis for interest rate on Asian dollar and syndicated loans.

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