Definition
The term London Interbank Offered Rate refers to a short-term interest rate charged by the largest banks in the world, if they borrowed from each other. In practice, the London Interbank Offered Rate (LIBOR) serves as a benchmark, or index, reference for a variety of debt instruments.
Calculation
The British Bankers' Association (BBA) conducts a daily survey among the eighteen largest banks in the world, asking each bank the rate at which they could borrow money via inter-bank offers. That day's LIBOR is then calculated by removing the lowest four and highest four responses from the average.
Thomson Reuters publishes the daily LIBOR, and this is considered the definitive source of this information.
Explanation
The London Interbank Offered Rate, or LIBOR, is the most widely-used benchmark for short-term interest rates in the world. While its primary purpose is to determine the rate of interest charged between the largest banks in the London interbank marketplace for short term loans, it's also used as a reference point for a wide variety of debt instruments.
The LIBOR is published in ten of the world's leading currencies, including the U.S. Dollar (USD), Euro (EUR), British Pound (GBP), Japanese Yen (JPY), and the Swiss Franc (CHF). It's also published in maturities that range from one day through twelve months. The most commonly used LIBOR interest rate benchmark is the three-month USD.
In addition to interbank loans, LIBOR is also used as an index when setting interest rates charged on floating rate loans such as adjustable rate mortgages, interest-only mortgages, credit card debt, as well as credit default swaps.
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