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An interest rate in a particular situation defines the amount of money a borrower promises to pay the lender.
It depends on the credit risk
The credit risk is the risk that there will be a default by the borrower of funds, so that the principal and the interest will not be paid to the lender as promised.
The higher the credit risk, the higher the interest rate that is promised by the borrower.
Are the interest rates an investor earns on Treasury Bills and Treasury Bonds.
T-Bills, T-Bonds: the instruments used by a government to borrow in its own currency.
It is usually assumed that there is no chance that a government will default on a obligation denominates in it’s own currency.
This is why Treasury rates are considered totally risk-free rates.
Is the rate of interest at which the bank is prepared to make deposit with other banks.
A deposit with a bank can be regarded as a loan to that bank. A bank must therefore satisfy certain creditworthiness criteria in order to be able to accept a LIBOR quote from another bank and receive deposits from that bank at LIBOR. Usually it must have to have a AA credit rating.
LIBOR rates are not totally free of credit risk. It exist a small chance that a AA rated financial institution will default on a LIBOR loan. But is very close to risk-free.
Derivatives traders regard LIBOR as a better indication of the “true” risk-free rate.
LIBID – London Interbank Bid Rate: is quoted by the largest banks.
is the rate at which the bank will accept deposits from other banks.
LIBOR > LIBID but the spread between them usually is very small.
Repo = Repurchase Agreement: a contract where an investment dealer who owns securities agrees to sell them to another company now and buy them back later at a slightly higher price.
Repo Rate = The price at which the securities are repurchased – The price at which the securities are sold.
If the borrower does not honor the agreement the lending company (buyer of the securities) will keep the securities.
The Overnight Repo – the agreement is renegotiated each day.
The Term Repo – we speak in this case about long –term arrangements.
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