**LIBOR and Derivatives – how close are they?**

**By Jasvin Josen**

*This article appeared in The Edge on Dec 3, 2012*

We are quite familiar with the recent LIBOR (London
Interbank Offered Rate) scandal in the financial markets. The obvious effect of
the manipulation of the LIBOR is to mortgage loans and corporate loans. However,
there was a bigger concern that LIBOR was integrated into approximately USD350
trillion worth of derivative contracts globally.

LIBOR affects derivatives in more that one way.
Firstly, interest rate derivatives use LIBOR to determine their payoffs at
certain dates. Secondly, all derivative positions are priced using LIBOR, where
LIBOR is used as the discounting rate.

**Interest rate Derivatives**

Interest rate derivatives have payoffs depending on
interest rate levels. For example if an investor buys the CME Eurodollar
Future, his profit from this derivative will depend on what level the 3-month USD
LIBOR is.

Other common interest rate derivatives are interest
rate forwards (also known as forward rate agreements or FRAs), interest rate
swaps, interest rate options and structured rate products. In this 2-part
article series, I demonstrate how LIBOR can affect interest rate swaps,
interest rate options and structured rate products.