LIBOR vs. Treasury Index: Understanding Interest Rate Benchmarks

Money

The London Interbank Offered Rate (LIBOR) and the Treasury Index are important interest rate benchmarks, or standards. The LIBOR and the Treasury Index are published each day and are used as a basis for calculating interest on bonds and very large loans.

Main Authorities

The LIBOR is determined by the British Bankers Association. The Treasury Index is determined by the U.S. Treasury.

LIBOR Calculation

The LIBOR is calculated as an average. It represents the average short-term (between one day and one year) interest rate charged by banks that borrow from each other in the London Interbank Market.

Treasury Index Calculation

The Treasury Index may reflect one of two things. It may reflect what people believe interest rates will be in the future, as expressed in the Treasury Yield Curve. Alternatively, it can reflect the interest yield on Treasury bills (T-bills) determined through an auction system.

Implications for Borrowers

The LIBOR is used by banks in the U.S. as well as in the U.K., Europe, and Canada as a basis for large short-term loans by borrowers with excellent credit. The Treasury Index is frequently used by U.S. banks to help calculate the interest on mortgages and other loans with a period of more than one year.

Implications for Investors

The LIBOR is frequently the basis of investments including interest swap agreements (two parties agree to pay each other's interest based on an imaginary amount of money, or principal), bonds with a variable interest yield, and forward contracts (investors use these to hedge risk based on what they believe interest rates will be at a specific time in the future). For investors interested in purchasing Treasury bonds, the Treasury Index, in and of itself, comprises the yields of T-bills with five-, 10-, and 30-year maturity periods. The Treasury index can also be an important indicator for investors in mortgage-backed securities, because it is often the basis for mortgages with adjustable interest rates.