23 May WHAT IS THE DIFFERENCE BETWEEN LIBOR AND OIS AS BENCHMARKS IN VALUING INTEREST -RATE SWAPS?
Learning Objective: After completion of the case, students should be able to: This case has been designed for use at both the undergraduate and graduate levels and can be used in courses on international finance, investments, fixed-income markets, and derivatives securities. After completing the case, students will have developed their ability to do the following: • Appreciate the historical evolution of the LIBOR market and the recent scandals. • Understand the differences between LIBOR and OIS rates. • Identify why and how LIBOR or OIS would be used in valuing derivatives. • Calculate forward interest rates from the zero yield curve. • Value an interest-rate swap. Price: $4.25 CAD / $4.25 USD Printed Copy $3.75 CAD / $3.75 USD Permissions $3.75 CAD / $3.75 USD Digital Download Issues: LIBOR, overnight indexed swap, interest rate swaps Disciplines: Finance, International Industries: Finance and Insurance Setting: United States, Large, 2016 Intended Audience: Undergraduate/MBA In April 2016, a large U.S. proprietary trading group in New York, with a significant fixed-income portfolio, was debating what discount rate to use to value the group’s interest-rate swap portfolio. The counterparties to these swaps were major banks, and the deals were collateralized. Criticisms about the use of the London interbank offered rate (LIBOR) as a benchmark for valuing these swaps were circulating, and there were reports that LIBOR was being manipulated. There was talk about an alternative, nearly “risk-free” reference rate that could potentially be launched during 2016. Was it time for the trading group to substitute some of its maturing LIBOR-based interestrate swaps with overnight index swaps? ASSIGNMENT QUESTIONS: 1. What is the difference between LIBOR and OIS as benchmarks in valuing interest -rate swaps? Is LIBOR a risk -free rate? 2. Value the interest -rate swap by relying on the data provided on the LIBOR and OIS rates. What differences do you find, and what might account for these differences? 3. Does the valuation of an interest-rate swap in particular, and derivatives in general, depend on who the counterparty is and whether the contract is collateralized?
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