What is LIBOR Flat
LIBOR flat is an interest rate benchmark that is based on LIBOR.
BREAKING DOWN LIBOR Flat
LIBOR flat is often used in interbank lending and interest rate swap contracts. It refers to the LIBOR rate with no additional spread added. LIBOR flat represents one of the best global interest rates available for short-term lending in the current market. As a universal lending rate, LIBOR is also used by banks as a base rate for which a risk generated spread level is added for non-interbank lending.
LIBOR stands for London Interbank Offered Rate. LIBOR is an important interest rate followed in the financial services industry. It is generally a gauge of short-term rates. Global banks primarily use LIBOR in their interbank lending as a central interest rate reference. The one-year LIBOR can also be used as a proxy for savings account rates which pay annual interest. LIBOR offers seven different maturities: overnight, one week, and 1, 2, 3, 6 and 12 months. Thus, its yield curve formation will vary from a longer curve of yields such as the Treasury yield curve which spans from short term to 20+ years.
Like U.S. Treasury yields, the LIBOR rate changes daily based on the current market environment. Global banks will also often use LIBOR with an additional spread as their base rate for commercial and consumer lending.
LIBOR and Swaps
LIBOR and LIBOR flat are also commonly used in the interest rate swap market which is heavily utilized by banking institutions. Interest rate swaps are constructed with a fixed and floating rate component. Counterparties in an interest rate swap will take either a fixed or floating rate position based on their balance sheet exposure and outlook for interest rate levels.
LIBOR flat consists of a designated LIBOR rate with no additional spread. In a simple interest rate swap example LIBOR flat can serve as the base interest rate. The fixed rate payer may contract to pay interest at the LIBOR rate quoted at the time the transaction commences. This would allow the fixed rate counterparty to pay a fixed LIBOR rate throughout the contract. The floating rate counterparty may agree to pay LIBOR flat throughout the life of the contract. This would mean the floating rate counterparty pays the market’s LIBOR rate of interest at each required interval payment with no additional spread. In this scenario the floating rate counterparty would benefit when LIBOR decreased while the fixed rate counterparty would benefit when LIBOR increased.