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 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. Investing

    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 of the mortgage, which then becomes a floating interest rate ...
  4. Investing

    Reassessing Your Approach To Bond Investing

    Rethinking your fixed-income portfolio may not resonate in quite the same way as dropping 10 pounds or finally giving up that smoking habit.
  5. Credit & Loans

    What is the difference between APR and APY?

    Learn about the difference between the calculations for APR and APY. APY takes into account the number of times that the interest rate is applied on an amount.
  6. Economics

    How does a bull market affect the economy?

    Find out why it can be difficult to prove any real causal link between rising stock market prices and a healthy, growing national economy.
  7. Bonds & Fixed Income

    How do treasury bill prices affect other investments?

    Find out how the price and yield of Treasury bills can impact the level of risk investors are willing to accept in their securities.
  8. Fundamental Analysis

    What are some examples of economies of scale?

    Take a look at different examples of economies of scale, including how marginal costs can be reduced through external and internal factors.
  9. Economics

    What impact does quantitative easing have on consumers in the U.S.?

    Dig deeper into the Federal Reserve's quantitative easing policies and what potential impacts they may have on American consumers.
  10. Fundamental Analysis

    How can quantitative easing be effective in the economy?

    Take a deeper look at the impacts of the Federal Reserve's large scale asset purchase plan, better known as quantitative easing, or QE.

You May Also Like

Hot Definitions
  1. Treasury Bond - T-Bond

    A marketable, fixed-interest U.S. government debt security with a maturity of more than 10 years. Treasury bonds make interest ...
  2. Weight Of Ice, Snow Or Sleet Insurance

    Financial protection against damage caused to property by winter weather specifically, damage caused if a roof caves in because ...
  3. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  4. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  5. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  6. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
Trading Center