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The Spread: Libor and Fed Funds Rate

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Information about The Spread: Libor and Fed Funds Rate
Finance

Published on December 17, 2008

Author: saldb

Source: slideshare.net

Description

A presentation from early fall about changes in the Libor and the Fed Funds Rate. We discuss the relationship between the two rates. * Leave a comment if you download, please! *
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Armando, Arseny, Cory, Joe, Neekunj SPREAD

Question Source: Historical data

BACKGROUND Libor FED History Why Libor Matters

Libor

FED

History

Why Libor Matters

London Interbank Offered Rate Average rate at which banks loan to one another Libor FED History Why Libor Matters

Average rate at which banks loan to one another

Libor Calculation 16 Banks 10 Currencies Libor FED History Why Libor Matters

Federal Funds Rate The interest rate at which a member institution lends immediately available funds to another depository institution overnight. “ 2%” FED (FOMC) Target Rate Open Market Operations Funds Rate Libor FED History Why Libor Matters

FED & Central Banks Control Inflation Control Inflation Promote economic growth Federal Reserve Other Central Banks Libor FED History Why Libor Matters

Control Inflation

Control Inflation

Promote economic growth

Commercial Banks Federal Reserve (Central Banks) Market Conditions PREMIUM Libor FED History Why Libor Matters

The Credit Crunch Market Conditions Libor FED History Why Libor Matters Washington Mutual Barclays Capital Citigroup Lehman Brothers Merrill Lynch UBS

Crisis Cycle ? Libor FED History Why Libor Matters

Not US - Exclusive Libor FED History Why Libor Matters LEGEND: CURRENT Sept 2007 Dec 2007

Why the Libor Matters Borrowing Short-term interest rates Forward rate agreements Syndicated loans Variable rate mortgages Financial Instruments Derivatives - futures, forwards, options, and swaps. Floating rate notes Currencies Source: WSJ, Apr 2008 Libor FED History Why Libor Matters

Borrowing

Short-term interest rates

Forward rate agreements

Syndicated loans

Variable rate mortgages

Financial Instruments

Derivatives - futures, forwards, options, and swaps.

Floating rate notes

Currencies

IMPACT OF SPREAD Borrowing Costs Mortgage Rates Bank Profits Counter Fed

Borrowing Costs

Mortgage Rates

Bank Profits

Counter Fed

Borrowing Costs Borrowers v. Lenders Businesses v. Consumers Borrowing Costs Mortgage Rates Bank Profits Counter Fed

Borrowers v. Lenders

Businesses v. Consumers

Mortgage Rates FED: 47 % Decrease Mortgage Rates: 10% Increase Borrowing Costs Mortgage Rates Bank Profits Counter Fed

Bank Profits % banks keep Borrowing Costs Mortgage Rates Bank Profits Counter Fed

Countering Fed FED was designed to protect / stabilize the economy Government is not affective at setting lending rates Borrowing Costs Mortgage Rates Bank Profits Counter Fed

FED was designed to protect / stabilize the economy

Government is not affective at setting lending rates

REASONS FOR SPREAD Seven Reasons

Seven Reasons

1. Banks Hoarding Cash Banks holding onto cash/cash equivalents Massive de-leveraging Flight to quality assets like Treasuries as opposed to inter-bank loans

Banks holding onto cash/cash equivalents

Massive de-leveraging

Flight to quality assets like Treasuries as opposed to inter-bank loans

2. Fear of Counterparty Risks Ability of other banks to pay back loans has been called into question Sub prime/credit crunch, capital structure unknown Lehman affirmed balance sheet $27/share Bear affirmed balance sheet $60-80/share

Ability of other banks to pay back loans has been called into question

Sub prime/credit crunch, capital structure unknown

Lehman affirmed balance sheet $27/share

Bear affirmed balance sheet $60-80/share

3. Role of Bank Write Downs Many banks/I-banks highly leveraged and have risky positions Insufficient capital / collateral to finance loans

Many banks/I-banks highly leveraged and have risky positions

Insufficient capital / collateral to finance loans

4. Symptomatic of Financial Crisis Where there is fear of uncertainty, premiums must be paid. Risk premium rising, credit crunch still continues “ Worst of the Credit Crisis may be over.” - Henry Paulson, May 7, 2008

Where there is fear of uncertainty, premiums must be paid.

Risk premium rising, credit crunch still continues

5. Liquidity Issue Trillions of US dollar positions tied to LIBOR, not enough $ to go around Fed as of Sunday expanded credit facilities to allow use of risky collateral Banks less likely to borrow from Fed, Fed is lender of last resort Banks don’t want perception that they are in trouble

Trillions of US dollar positions tied to LIBOR, not enough $ to go around

Fed as of Sunday expanded credit facilities to allow use of risky collateral

Banks less likely to borrow from Fed, Fed is lender of last resort

Banks don’t want perception that they are in trouble

6. Predatory Lending Banks are interested in limiting exposure to a concentrated amount of banks Bear’s trades not cleared by Goldman then other trading partners Survival of the Fittest (biggest) Goldman Bear Stearns

Banks are interested in limiting exposure to a concentrated amount of banks

Bear’s trades not cleared by Goldman then other trading partners

Survival of the Fittest (biggest)

7. Clean balance sheets Banks are interested in keeping strong cash positions on balance sheets Banks want to show the market they have adequate cash and liquidity in case of a market fall out Bear Stearns Liquidity issue not a capital issue

Banks are interested in keeping strong cash positions on balance sheets

Banks want to show the market they have adequate cash and liquidity in case of a market fall out

Bear Stearns Liquidity issue not a capital issue

SOLUTIONS Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Inject Liquidity

Creation of NYBor

Expand US Libor

Tighter Scrutiny of Banks

Time?

1. Inject Liquidity Who would really be paying the price? Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Who would really be paying the price?

To the Rescue! Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Moral Hazard Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

2. Creation of a NYBOR Would only track borrowing costs of US banks only. Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Would only track borrowing costs of US banks only.

3. Expand US LIBOR Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Expand the LIBOR Expand the panels of banks which report their borrowing costs to LIBOR More complete, reflective average Increase the accuracy of the benchmark by better capturing the US market. Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Expand the panels of banks which report their borrowing costs to LIBOR

More complete, reflective average

Increase the accuracy of the benchmark by better capturing the US market.

4. Tighter Scrutiny on Banks “… tighter governance of the rate-setting process. This means broadening the Foreign Exchange and Money Markets committee that oversees Libor and creating a new group that would scrutinize the data submitted by banks.” Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

5. Time? We can use the history to examine the present and predict the future. Easy and comforting to call it “cyclical” and say we’re between crests. Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

We can use the history to examine the present and predict the future.

Easy and comforting to call it “cyclical” and say we’re between crests.

What happens when the present has never been seen before? We are in unknown territory, and no one knows how deep this will go… Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

What happens when the present has never been seen before?

We are in unknown territory, and no one knows how deep this will go…

This could be you. Inject Liquidity Creation of NYBor Expand US Libor Tighter Scrutiny of Banks Time?

Thank you

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