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London Interbank Offer Rate and Overnight Indexed Swap Essay


In case LIBOR becomes kaput or ineffective to work, it is possible to replace it with the Overnight Indexed Swap (OIS). The latter is also a viable reference rate. It is a standard value of the discount. According to Gensler, LIBOR has myriads of structural flaws, especially during the process of submitting the rates. Most of the submissions made by banks are sometimes not realistic (Madigan, 2013). This is a clear indication that OIS can be used if LIBOR fails at any given time.

In most instances, LIBOR relies on voluntary submissions at the expense of the actual transactions. Benchmarks rooted in real deals can be adopted instead of relying on submissions based on free will from major players in the financial markets. LIBOR has also made it easier for major market players to manipulate the market. There are claims that the ideals of LIBOR have been grossly rigged at the expense of the economy (Madigan, 2013).

On the other hand, the OIS rate has been embraced by the derivative markets, especially in cases where trading takes place with cash as the main security. When OIS is used, the currency of security usually determines the precise rate. However, most of the adjustable rates for the US housing market and the futures markets are still being controlled by LIBOR (Madigan, 2013). Therefore, in the event, LIBOR fails to work, there is an alternative reference rate that can still be used. It should also be noted that the Overnight Indexed Swap (OIS) has various appealing features compared to LIBOR. For instance, it can eliminate any chances of manipulating the financial market.

According to Norris (2013), LIBOR has not been a favourable preference rate, especially for the large banks in the market. They are torn between abiding by the regulatory measures that have been set up and defying the same rules for the sake of their own survival. Already, LIBOR is no longer a secure and trusted mode of determining the actual prevailing rates in the market. Perhaps, the general collateral repo rates can be used instead of the fictitious LIBOR.

The main advantage of a repo is that whoever sells debt instruments, shares or securities is the actual owner contrary to LBOR whereby fake submissions are made with the aim of reaping huge profits from the market (HM Revenue & Customs, n.d). In addition, the first phase of the transaction is usually used to compute the purchase price. This computation is carried out by factoring in the initial interest rate obtained. In other words, a repo rate is applied when calculating the most appropriate buying price.

At this point, it is vital to mention that the fluctuations experienced in the market price do not affect the repo rate at all. Therefore, there are no chances of market manipulation by major financial players. Moreover, a given duration of the repo is supposed to be stable in terms of the lending and purchasing rate. In any case, the prevailing market risks do not affect the interim holder (HM Revenue & Customs, n.d). However, if the securities are sold, the holder may experience the risks.

Nonetheless, repo rates can conveniently replace LIBOR since it is a convenient reference or benchmark rate that safeguards the interests of both borrowers and lenders. If LIBOR is declared kaput, then the repo rates can fit the system quite well.

References

HM Revenue & Customs (n.d). CFM17170 – Repos: commercial background: general collateral repos. Web.

Norris, F. (2013). Finding a Rate That’s Fairer Than Libor. Web.

Madigan, P. (2013). Gensler: OIS rate could be replacement for LIBOR. Web.

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IvyPanda. (2021, January 12). London Interbank Offer Rate and Overnight Indexed Swap. Retrieved from https://ivypanda.com/essays/london-interbank-offer-rate-and-overnight-indexed-swap/

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"London Interbank Offer Rate and Overnight Indexed Swap." IvyPanda, 12 Jan. 2021, ivypanda.com/essays/london-interbank-offer-rate-and-overnight-indexed-swap/.

1. IvyPanda. "London Interbank Offer Rate and Overnight Indexed Swap." January 12, 2021. https://ivypanda.com/essays/london-interbank-offer-rate-and-overnight-indexed-swap/.


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IvyPanda. "London Interbank Offer Rate and Overnight Indexed Swap." January 12, 2021. https://ivypanda.com/essays/london-interbank-offer-rate-and-overnight-indexed-swap/.

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IvyPanda. 2021. "London Interbank Offer Rate and Overnight Indexed Swap." January 12, 2021. https://ivypanda.com/essays/london-interbank-offer-rate-and-overnight-indexed-swap/.

References

IvyPanda. (2021) 'London Interbank Offer Rate and Overnight Indexed Swap'. 12 January.

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