Reference Rate

AAA

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).

INVESTOPEDIA EXPLAINS '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.

RELATED TERMS
  1. LIBOR

    LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate ...
  2. Floating-Rate Note - FRN

    A note with a variable interest rate. The interest rate is usually ...
  3. Reset Margin

    The difference between the interest rate of a security and the ...
  4. Personal Finance

    All financial decisions and activities of an individual, this ...
  5. Interest Rate Swap

    An agreement between two parties (known as counterparties) where ...
  6. Floater

    A bond or other type of debt whose coupon rate changes with market ...
RELATED FAQS
  1. What is the difference between a 2/28 and a 3/27 ARM?

    An adjustable rate mortgage (ARM) is a type of mortgage that has a fixed interest rate for a certain time period at the beginning ... Read Full Answer >>
  2. Which is more important to a nation's economy, the balance of trade or the balance ...

    There is no question the composition of a country's balance of payments is more important than its balance of trade. This ... Read Full Answer >>
  3. What does a futures contract cost?

    The value of a futures contract is derived from the cash value of the underlying asset. While a futures contract may have ... Read Full Answer >>
  4. What are the differences between the Federal Funds Rate and LIBOR?

    In macroeconomics, the interest rate plays a crucial role in delivering an equilibrium on the assets market by equating the ... Read Full Answer >>
  5. What are the ethical arguments against government subsidies to companies like Tesla?

    The ethical argument behind government subsidies is that they should be put into place to help industries that will, in turn, ... Read Full Answer >>
  6. How can tariffs cause inefficiencies in domestic industries?

    Any government regulation naturally creates inefficiencies in a pure supply and demand marketplace. When it comes to the ... Read Full Answer >>
Related Articles
  1. Options & Futures

    An Introduction To Swaps

    Learn how these derivatives work and how companies can benefit from them.
  2. Home & Auto

    Option ARMs: American Dream Or Mortgage Nightmare?

    Option adjustable rate mortgages could make or break your home-buying experience.
  3. Economics

    What Happens to the Economy If China Deleverages

    Attempts to deleverage and institute reforms that will foster more sustainable growth could exacerbate an already slowing Chinese economy.
  4. Stock Analysis

    Southwest & Cheap Oil: The Perfect Combination?

    Discover how falling oil prices (and well-timed futures contracts) benefit Southwest Airlines.
  5. Economics

    As Fed Prepares To Move, Gold Is Losing Its Luster

    Last week’s Semi-Annual Monetary Policy Report to Congress returned investors’ focus back to the fundamentals, and a general upbeat of the economy.
  6. Economics

    Do Transport Stocks Signal a U.S. Selloff?

    The Dow Jones Transportation Average index has underperformed the broader DJ Industrials Average, leading some market watchers to speculate a selloff.
  7. Professionals

    Will Consumer Spending Save 2015?

    Consumer spending is considered an important number (and it is), but a savvy investor will always look at "why" rather than just "what." You should too.
  8. Economics

    Why U.S. Consumers Aren’t Spending

    Despite continued improvement in the labor market and lower gasoline prices, consumers' activity remains soft: retail sales growth is close to its lowest.
  9. Economics

    Examples Of Negative Interest Rates

    Negative interest rates seem like an abstract notion. But, they have practical consequences for an economy and are present all around us.
  10. Personal Finance

    Are Markets Ready For An Interest Rate Hike?

    Despite financial market fears over the uncertainty of Greece’s debt crisis and the recent drop in China’s stock-market, Federal Reserve Chairwoman Janet Yellen has reaffirmed the Fed’s plans ...

You May Also Like

Hot Definitions
  1. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  2. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
  3. Killer Bees

    An individual or firm that helps a company fend off a takeover attempt. A killer bee uses defensive strategies to keep an ...
  4. Sin Tax

    A state-sponsored tax that is added to products or services that are seen as vices, such as alcohol, tobacco and gambling. ...
  5. Grandfathered Activities

    Nonbank activities, some of which would normally not be permissible for bank holding companies and foreign banks in the United ...
  6. Touchline

    The highest price that a buyer of a particular security is willing to pay and the lowest price at which a seller is willing ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!