[R-SIG-Finance] Yield Curve

Robert Sams robert at sanctumfi.com
Wed Feb 4 19:42:04 CET 2009

Hi Joe, 

It's due to the spread between libor and fed funds, which blew out in
August 2007 and has been very volatile since. This is of course due to
the total breakdown of the banking system and the inter-bank lending
market, which is what libor represents.  In theory, all of these money
market tenors represent expectations of the average overnight rate that
is targeted by the central bank (in USD the Fed Funds Effective) + some
credit/liquidity risk spread. Prior to the banking blow-up this spread
traded in a tight 10-20bp range but has been as high has 360ish in
October last year and is currently about 98bps for the 3m tenor. The
spread has a term-structure: 1m is about 23bp, 6m is about 150 and the
12m is over 170 (12m libor is meaningless btw, as there is no longer ANY
interbank lending done for 12m terms these days). Given the volatility
of these things we speculate on their direction and trade them in the
rate derivatives market. In the jargon it's called the "FRA/OIS basis
swap" (a forward rate agreement (libor) vs a forward-dated overnight
index swap (fed funds).

And now you can see why why that 12m libor is 2.08 whilst the 1y swap is
1.32. The 1y USD swap is a 1y 30/360 fixed rate vs four 3m libor
fixings, so the swap rate really embodies the 3m FRA/OIS spread even
though it's a 1y maturity; the 12M libor is also a 1y maturty but of
course trades at much wider spread over expected fed funds.. on the
basis of the numbers above, an additional 72bp to be precise.

There is btw a general point to be made here about forward rates. Actual
forward rates (like those traded in the FRA market or implied in the FX
forwards, etc) are not equal to the implied forward off the spot curve.
For example, a 3x6 FRA is NOT just some algebra on the 3m and 6m spot
rates because the basis spread implied in the 6m tenor is different from
the 3m tenor, but the 3x6 fra represents the expected 3m basis in
3-month's time, which is not the same thing. This has always been the
case but in the old regime didn't matter because the error involved in
ignoring it was tiny. Now it's big and matters allot. 


-----Original Message-----
From: r-sig-finance-bounces at stat.math.ethz.ch
[mailto:r-sig-finance-bounces at stat.math.ethz.ch] On Behalf Of Micha
Sent: 04 February 2009 18:02
To: Joe W. Byers
Cc: r-sig-finance at stat.math.ethz.ch
Subject: Re: [R-SIG-Finance] Yield Curve


Money costs money: swap is simply exchanging cash flows, while LIBOR
contains the cost of borrowing/lending money. LIBOR has costs for
liquidity, while swap doesn't. And apparently 1Y liquidity is priced at
around 70bps.


2009/2/4 Joe W. Byers <ecjbosu at aol.com>

> This may be outside this discussion group but you finance junkies 
> might like this.
> The term structure Rate curve is really interesting lately.  The one 
> year libor swap and one year money market differ by about 70 basis
> The data is below.  I am searching for a reason for this difference.
> The forward rates derived from this curve take a big dip one year out.
> 1 WEEK  0.351%
> 1 MONTH 0.445%
> 2 MONTH 0.949%
> 3 MONTH 1.234%
> 4 MONTH 1.460%
> 5 MONTH 1.600%
> 6 MONTH 1.776%
> 7 MONTH 1.827%
> 8 MONTH 1.881%
> 9 MONTH 1.935%
> 10 MONTH        1.981%
> 11 MONTH        2.033%
> 12 MONTH        2.084%
> USD IR Swap 1Y  1.316%
> USD IR Swap 2Y  1.600%
> USD IR Swap 3Y  1.955%
> USD IR Swap 4Y  2.244%
> USD IR Swap 5Y  2.457%
> USD IR Swap 6Y  2.615%
> USD IR Swap 7Y  2.757%
> USD IR Swap 8Y  2.866%
> USD IR Swap 9Y  2.951%
> USD IR Swap 10Y 3.031%
> USD IR Swap 12Y 3.162%
> USD IR Swap 15Y 3.299%
> USD IR Swap 20Y 3.340%
> USD IR Swap 25Y 3.329%
> USD IR Swap 30Y 3.328%
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