Reference Rate


DEFINITION of 'Reference Rate'

An interest rate benchmark upon which a floating-rate security or interest rate swap is based. The reference rate will be a moving index such as LIBOR, the prime rate or the rate on benchmark U.S. Treasuries.

Depending on the security or financial contract being written, the reference rate can be more esoteric, in the form of an inflation benchmark (such as the Consumer Price Index) or a measure of economic health (such as unemployment rates or corporate default rates).

BREAKING DOWN 'Reference Rate'

Reference rates are at the core of an adjustable rate mortgage (ARM), where the borrower's interest rate will be the reference rate (usually LIBOR) plus a fixed amount, known as the spread. From the point of view of a lender, the reference rate is a guaranteed rate of borrowing, so at minimum the lender always earns the spread as profit.

If the reference rate makes a sudden move upward, borrowers who must pay floating interest rates will see their payments rise dramatically.

When used in an interest rate swap, the floating reference rate is exchanged by one party to the transaction for a fixed interest rate or set of payments.

  1. Personal Finance

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  2. LIBOR

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  3. Floating-Rate Note - FRN

    A note with a variable interest rate. The interest rate is usually ...
  4. Interest Rate Swap

    An agreement between two parties (known as counterparties) where ...
  5. Reset Margin

    The difference between the interest rate of a security and the ...
  6. Floater

    A bond or other type of debt whose coupon rate changes with market ...
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