Libor’s Replacement Is a Little Too Real

This post originally appeared in Money Stuff.

Libor, the London Interbank Offered Rate, is the regular interest rate. It comes in different tenors — one-month Libor, three months, etc. — and it’s updated every day, and if you need an interest rate, it’s often the one you will turn to. So when companies take out floating-rate loans, the floating rate is normally Libor: Every three months or whatever, the loan’s interest rate will reset to whatever the current Libor is, plus a fixed spread. (The interest will be Libor + X, where X is a number that will be small for a safe loan and large for a risky one.) If you want an interest-rate swap (a bet on what interest rates will be over the next five or 30 or whatever years), then the interest rate that you will typically bet on will be Libor (you’ll pay a fixed rate and get back floating payments of Libor). More broadly, for quite a long time, the ordinary interest rate that you’d use to, for instance, discount cash flows in derivatives pricing would be Libor. It was just the regular interest rate.