London Interbank Offered Rate Case Study

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Question No. 2
Answer:
The London Interbank Offered Rate (LIBOR) is the rate used as reference which is used by large banks. Rate at which they can borrow short-term funds in between themselves on in the interbank market and providing loans at rates linked to LIBOR. In 2007 observers noted that LIBOR failed to response to the market prices and rates. Investigations by different international regulators disclosed manipulation by banks to influence interest rate fixation.
It is worthwhile to look at theoretical components of LIBOR to understand its behaviour during the crisis in 2007-08.
LIBOR is thought to be as
Combination of term and risk spreads:
LIBOR = risk free rate over the term
+ Term premium
+ Bank term credit risk
+ Term …show more content…

LIBOR greater volatility became more apparent because of other funding rates after 1st half of 2008. Gap of LIBOR to other funding increased drastically during the high times of crisis, LIBOR rates at that times fell well below what was expected compared to other related investment rates.
Increasing spread highlights the intensity of the crisis. Liquidity &concerns regarding risk brings interbank lending and borrowing more expensive due to demand of higher returns on investments.
Banks’ inability of utilising funds in interbank markets increased the understanding of risk regarding decline in creditworthiness, positive and continuous adverse feedback resulted in higher credit risk component of LIBOR, resulting in wider spreads.
Reasons considered for higher interbank rates stem from supply and demand aspects. Supply side, banks’ were reluctant to tie up funds for longer terms due to financial uncertainty (liquidity …show more content…

Questions were raised from market observers. Banks were unable to act normal as per regular market functioning manipulation does not necessarily entail the creation of these markers, nor do these markers necessarily imply the existence of manipulation. Report that rationalizing banks’ LIBOR submissions proved difficult in light of data from other currencies and measures of funding cost. The positive spread between Eurodollar bid rates and LIBOR from August 2007 to mid-2011 generally ranged from 10-40 bps and is reflective of anomalous market conditions, as offer rates should generally exceed bid rates.
a. What amount ought to Mauna Loa acquire in yen?

Mauna Loa gets money accumulations of one hundred million yen for each month. This is the wellspring of reimbursement of any income in addition to premium, and proselytes the acquired yen to US dollar on the double. An example estimation would be:

Sample Values Units

One month's money flow 100,000,000 Yen
Months per year 12
One year's money flow 1,200,000,000

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