Just what is a LIBOR rate, anyway?

I keep hearing about the LIBOR rate and it seems to be important. Can you explain what it is and how it plays a part in the whole Europe crisis that is going on right now? I know it is probably a long and involved answer, but if you could explain it in the simplest terms you can, I'd appreciate it. Most explanations these days are gobbledegook to me. Thank Marc

Dear Marc,

You are right that for me to try and explain the importance and use of LIBOR would be a very long and involved answer. I will try and explain it in easy to understand terms. I apologize that I cannot cover all aspects and scenarios.

LIBOR is the acronym that stands for London Interbank Offered Rate. It is the rate that banks lend money to each other.

It is set daily around 11:00 a.m. London time each day.

It is a daily reference or benchmark rate for short-term rates that is used to set yields of the various European bonds and fixed income instruments against. The yield amount that a bond is traded at determines the price. That yield is a yield above the LIBOR known as the spread.

The larger the spread, the higher the risk of the issuer. The LIBOR is used as a reference rate by various countries including Canada.

In Canada, the bank rate is used as the benchmark rate in a similar fashion as the LIBOR.

In the U.S., they use the Fed funds rate.

Similar to the way Greenwich Mean time is used as the starting reference point for times around the world, the LIBOR is used as the major reference point for interest rates around the world. The pricing and yields of various countries, companies and issuers are pegged off of the LIBOR.

So, in short: the LIBOR is an important rate that is used worldwide to determine the risk of an asset that is tied to the debt markets. This is true for not only European-based investments, but those around the world.

Nancy Woods, CIM, FCSI, is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc. To ask her a question, send an e-mail to asknancy@rbc.com or visit her web site at nancywoods.com

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